Atlas Air Worldwide Holding's (AAWW) CEO William Flynn on Q4 2015 Results - Earnings Call Transcript

| About: Atlas Air (AAWW)

Atlas Air Worldwide Holdings, Inc. (NASDAQ:AAWW)

Q4 2015 Earnings Call

February 18, 2016 11:00 AM ET

Executives

Edward McGarvey - Vice President and Treasurer

William Flynn - President and Chief Executive Officer

Spencer Schwartz - Executive Vice President and Chief Financial Officer

Analysts

Kevin Sterling - BB&T Capital Markets

Jack Atkins - Stephens

Scott Group - Wolfe Research

Helane Becker - Cowen & Company

Robert Magic - CJS Securities

David Campbell - Thompson Davis

Geoffrey Dancey - Cutler Capital Management

Steve O’Hara - Sidoti

Operator

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter Earnings Call for Atlas Air Worldwide. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. [Operator Instructions]

I would now like to turn the call over to Atlas Air. Please go ahead.

Edward McGarvey

Thank you, Michelle, and good morning everyone. I'm Ed McGarvey, Vice President and Treasurer for Atlas Air Worldwide. Welcome to our fourth quarter 2015 results conference call.

Today's call will be hosted by Bill Flynn, our President and Chief Executive Officer. Joining Bill is Spencer Schwartz, our Executive Vice President and Chief Financial Officer.

As a reminder, today's call is complemented by a slide presentation that can be viewed at atlas air.com. You may find the slides by clicking on the link to Presentations in the Investor Information section of the site.

As indicated on slide two, we'd like to remind you that our discussion about the company's performance today include some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events and expectations and they involve risks and uncertainties.

Our actual results or actions may differ materially from those projected in any forward-looking statements. For information about risk factors related to our business, please refer to our 2014 Form 10-K, as amended or supplemented by our subsequently filed SEC reports. Any references to non-GAAP measures are meant to provide meaningful insights and are reconciled with GAAP in today's press release and in the appendix that is attached to today's slides. You can also find these on our website at atlasair.com.

During our question-and-answer period today, we'd like to ask participants to limit themselves to one principal question and one follow-up question, so that we may accommodate as many participants as possible. After we've gone through the queue, we'll be happy to answer any additional questions as time permits.

At this point, I'd like to turn the call over to Bill Flynn.

William Flynn

Thank you, Ed, and good morning everyone. And thank you for joining us today. Starting with slide three, we had a great year in 2015. We outperformed the airfreight market and we grew earnings substantially. We also positioned Atlas for earnings growth in 2016, even before the incremental accretion from our recently announced acquisition of Southern Air Holdings which we expect to close in the next few months.

We delivered adjusted earnings of $5.1 per share in 2015, up significantly from $3.72 in 2014. We continue to see good demand from our customers for our aircraft and services. Many of our customers are outperforming the market as well. In addition to the acquisition of Southern Air, we expect our total EPS in 2016 to increase by a low to mid-single digit percentage over our 2015 adjusted EPS.

Slide four highlights the attractiveness of the Southern Air acquisition. It is strategically compelling, highly complementary, immediately accretive and a foundation for growth. Subject to customary closing conditions in regulatory approvals, we intend to acquire Southern Air in all-cash debt-free transaction valued at approximately $110 million. Southern Air is a premier provider of intercontinental and domestic CMI services. It immediately expands our platform into 777 and 737 aircraft operations, something that might take up to 18 months or more to do organically.

The combination with Southern Air is anticipated to add approximately $100 million in annualized revenues, with adjusted EBITDA and adjusted net income margins in line within ours. The transaction also provides opportunities for developing additional business with existing in new customers of both companies. The result will be a more diversified and profitable company, offering customers access to the widest range of modern efficient aircraft.

Slide five focuses on our framework for 2016. It begins with our fleet initiatives and debt refinancings in 2015. During the course of the year, we added a 10th 747-8 freighter, increased our CMI operations by 4767s, we activated a 747-400 BCF into our growing charter business and expanded our dry leasing portfolio to include two 767 aircraft that we will also operate on a CMI basis.

In addition, we refinanced higher cost debt on a number of our aircraft enabling us to reduce our cost of debt, increase our cash flows, enhance our adjusted EPS and add flexibility to our fleet. We will see a full year of benefits from each of these actions in 2016. Together they provide a foundation for earnings growth in 2016 even before accretion from Southern Air and compare with a year that included approximately $0.55 to $0.60 in adjusted EPS driven by incremental demand that we captured related to congestion at ports on the U.S. West Coast.

Given the inherencies anomaly of airfreight demand, we expect the majority of our earnings in 2016 to be generated in the second half. Unlike results in 2015, which benefited from port congestion in the first half we anticipate that results in 2016 will be more reflective of historical patterns with approximately 75% of our adjusted EPS in the second half of the year.

In addition, we expect earnings per share in the first quarter which is usually our lowest volume generating and highest maintenance expense quarter of the year to be approximately 25% of first quarter 2015 adjusted EPS of $1.3.

To revive some context regarding our first quarter outlook, we estimate that about $0.50 of our first quarter 2015 adjusted EPS was driven by the incremental demand related to the West Coast port congestion. In addition, we earned approximately $0.20 from revenue recognized on the return of aircraft.

For the full year, we anticipate that block hour volumes including the Southern Air transaction will increase more than 20% compared with 2015, with about 75% of the total in ACMI and the balance in charter. Including Southern Air, we anticipate that aircraft maintenance expense will total about $205 million this year. In addition, depreciation expense should be approximately $145 million, while core capital expenditures which are mainly for spare parts for our fleet should total approximately $50 million to $60 million for the year.

At this point, I’d like to ask Spencer to provide you with some additional information on our fourth quarter. After Spencer, I’ll provide some additional perspective on Atlas and then we’ll be happy to take your questions. Spencer.

Spencer Schwartz

Thank you, Bill and hello everyone. Slide six highlights our fourth quarter results. Our adjusted net income totaled $39.4 million or $1.59 per share. Earnings in the fourth quarter were driven by our diverse business mix, including a sharp increase in charter segment contribution, and underlying strength in dry leasing. On a reported basis, results during the period reflected a net loss of $37.6 million or $1.53 per share, primarily due to charges associated with the previously disclosed litigation settlement.

During the quarter, we generated a free cash flow of $96 million or $3.88 per share, in line with the fourth quarter of last year. That brought free cash flow in 2015 to $327 million or $13.06 per share, a substantial increase from $248 million or $9.86 per share in 2014.

Reported results in the fourth quarter, also included an effective income tax rate benefit of approximately 46%. On an adjusted basis, the effective income tax rate was approximately 20% for the quarter. That reflects the continued reinvestment of the net earnings of certain of our foreign subsidiaries outside of the U.S. as well as changes in state taxes. Based on our current tax framework, we do not expect to pay any significant federal income tax until 2020 or later.

Looking at slide seven; ACMI revenues during the quarter benefited from an increase in the number of aircraft compared with the fourth quarter of 2014. This impact was partially offset by a lower blended average rate per block hour, which reflected the mix effect, related to increases in 767 CMI flying.

Average CMI aircraft equivalents increased 34% to 16 aircraft during the quarter, while 747 cargo equivalents rose 8% to 23.2 aircrafts. Since or CMI arrangements don’t include component for aircraft ownership, the average block hour rate for these planes is less than the average rate for our other aircraft in this segment. We expect to continue to grow our CMI fleet and enhance our business mix.

The change in charter segment revenues in the fourth quarter was primarily driven by the impact of lower fuel prices. This impact was partially offset by an improvement in yields, excluding fuel. In dry leasing, revenues were comparable with the fourth quarter of 2014. Looking ahead, dry leasing revenue should benefit from the two 767s that we’ve added to our portfolio.

Moving to slide eight; segment contribution totaled $95 million in the fourth quarter up from $90 million in the fourth quarter of 2014. Similar to the third quarter of 2015, ACMI results were affected by an increase in crew training costs for the additional pilots we’ve hired in connection with our fleet growth initiatives. These were partially offset by a reduction in aircraft ownership costs, following the refinancing in 2015 of higher cost debt related to several of our 747-8 and 747-400 aircraft.

Charter's strong contribution was driven by an improvement in cargo yields excluding fuel, and increase in passenger flying, a reduction in heavy maintenance expense and a reduction in aircraft ownership costs. As with dry leasing revenues, dry leasing contribution during the quarter was similar to the contribution of the fourth quarter of 2014.

Slide nine highlights our refinancings of higher cost debt during the second half of 2015. We used approximately $113 million from our issuance of $224 million of convertible senior notes at 2.25% to retire higher rate, enhanced equipment trust certificates related to five of our 747-400 freighters. Those WTCs had a weighted average cash coupon of 8.1%.

During the fourth quarter, we entered into new term loans that reduced the rates on two of our original 747-8 by 284 basis points 6.37% to 3.53%. In addition to reducing our cost of debt, the refinancings have reduced aircraft ownership costs, enhance earnings and cash flows and increased our fleet flexibility.

Turning to slide 10 and our balance sheet. We ended 2015 with cash including cash equivalents, restricted cash and short-term investments totaling $444 million that compared with $331 million at the end of 2014. Our cash position at December 31 reflected net cash of $373 million provided by operating activities during 2015. Net cash of $80 million used for financing activities which included $569 million of outflows for debt payments. And net cash of $165 million used for investing activities.

Net cash used for investing activities in 2015, primarily related to the purchase of aircraft and engines, including our 10th -8, as well as rotable spare parts. These were partly offset by proceeds from investments and from the disposition of aircraft.

As slide 11 shows, we reduced leverage while growing our fleet. At the end of the fourth quarter, our net leverage ratio, which includes capitalized rents was 4.9 times trailing 12 month EBITDA, including the benefit of our remaining investment in our outstanding WTCs. That's down from six times at the beginning of 2014 and 5.4 times at end of 2014, primarily driven by the pay down of outstanding debt and an increase in earnings.

With that, I would like to turn it back to Bill.

William Flynn

Thank you, Spencer. As I noted at the start and as reflected on slide 12, we had a great year in 2016. We outperformed the airfreight market, and we grew earnings substantially. We are also positioned to grow earnings in 2016 and that will be enhanced by the accretion from our acquisition of Southern Air.

I would like to put our achievements in our framework in a larger context. What we have learned over the years is that there are ways to respond to profit from opportunities in any environment, to outperform the airfreight market and produce attractive earnings. The key ingredients and basic, above all we focused on our superior customers, we have a modern and efficient fleet and a solid financial structure. And we’re prepared to address the unexpected that comes at us, find a way to respond affectively and bring the results to the bottom line. That’s it we’re about at Atlas.

With that Michelle, may we have the first question please?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Kevin Sterling from BB&T Capital Markets. Your line is open.

Kevin Sterling

Thank you, operator. Good morning, gentlemen and congrats on another nice quarter and positive outlook for 2016.

Spencer Schwartz

Hi Kevin, thank you.

William Flynn

Hi Kevin, thank you.

Kevin Sterling

So Bill, you guys recently acquired Southern Air. It seems to be a great acquisition for you to have a 767 fleet. What’s the premise behind this acquisition, besides diversifying your fleet, is it maybe to capitalize on ecommerce growth?

William Flynn

So there is a couple of things there, Kevin. So the air fleet consists of 777s and they’re also operating 7373 freighters. And so if you think about that, that puts us in a position to offer our customers or continue to offer our customers a 747 fleet, now offer the 777 fleet and there are – there are applications or routes and other considerations in the market where one or the other aircraft might would be the customer’s choice. We’re growing that 767 operation. And now with 737s we can also participate in shorter haul smaller volume regional flying. So, from my perspective it puts us in a position to offer our customers both the heavy freight operators as well as a ray of the integrators, the aircraft and the services that meet their network requirements the best.

So, the premise really is about growth, getting into that platform on an immediately accretive basis within install customer base and a solid operating platform but the buy versus build the organic build decision that we talk about in press releases and then I talked about today.

A couple other comments I’ll make. I think there is a very good cultural fit between our two organizations. Both of us are very much focused on the customer. The principle customer [indiscernible] and there is DHL we know that customer very well, they’re very demanding customer, appropriately so. And Southern, like Atlas has a very solid track record of meeting those very high performance standards on a continuingly for Southern. So in that context we think that cultural fit, how we view the world, how we view our customers is very much aligned and I think that all goes well for the integration that we’re going to accomplish once we acquire Southern.

Kevin Sterling

Great, Bill, thanks for the color. That sound like a good fit and obviously diversifying your fleet and capitalize on some customer opportunities. So let me take you back on that if you don’t mind. You talked about maybe supplementing some of the integrated network with some shorter haul flying and obviously with all this growth in ecommerce which is showing no signs is slowing down, maybe some networks to get strained during the peak season. Have you been contacted by any large ecommerce companies, maybe outside of the integrator network looking for capacity, not just during peak season but maybe beyond peak season, maybe a more permanent solution in the future?

William Flynn

Yeah. Well, I didn’t address ecommerce on your first question, I’ll take a moment to address it. Now we think ecommerce is clearly, in my view it’s a game changer in underlying airfreight demand, whatever the channel it may come through and whoever the customers’ maybe. Not all the datas in yet but our sense is that there was good growth in airfreight or growth in airfreight in the fourth quarter and it was contraction in international container shipping in the fourth quarter. I don’t know what the exact numbers are but I think that’s relatively right. And I think that one of the explanations there in my mind is the role of ecommerce, and because ecommerce is airfreight oriented.

So clearly we’re watching airfreight, sorry ecommerce and if impact an airfreight and integrator traffic as a key part of growth and growth going forward.

Kevin Sterling

Okay, great. Thanks for your time this morning.

William Flynn

Thanks, Kevin.

Operator

Your next question comes from Jack Atkins from Stephens. Your line is open.

Jack Atkins

Good morning, guys, thanks for time.

William Flynn

Thanks, Jack.

Jack Atkins

So just kind of a couple of questions here on the guidance. Spencer or Bill, could you provide organic expectations for block hour growth, maintenance expense and depreciation if you wanted to strip out Southern Air for 2016?

Spencer Schwartz

Sure Jack, I can do that. So let’s – for maintenance, Southern should add approximately $20 million approximately, so if you look at the slide that we showed if you backed out 20 – you’d see that Atlas’s maintenance, organic maintenance is lower, expected to be lower in 2016 than it was in 2015. As far as depreciation and capital expenditures they’re fairly small for Southern, they’re primarily a CMI operator or they are a CMI operator and so they have some rotable parts and they have a small amount of depreciation, so neither of those impacted our forecast for those amounts dramatically. Sorry, did I miss another piece of your question?

Jack Atkins

Block hours.

Spencer Schwartz

Block hours, I’m sorry. So, block hours for 2016 Southern should add approximately 25,000 to 35,000 block hours to our number.

Jack Atkins

Okay, that’s really helpful Spencer, thank you. And then I guess sort of thinking about the second half guidance for a moment, it looks like just with what you issued in the press release. Roughly $0.25 is what you implied, $0.25, $0.26 for the first quarter, kind of a $1.5 for the second quarter and then about $3.85 or so in the second half of the year which was up roughly a $1 year-over-year from what you are in 2015. Could you maybe take us through the puts and takes in terms of what’s driving that significant increase in earnings? Obviously you differed some maintenance expense or pull forward some maintenance expense from 2016 or 2015, you have Southern – what are some of the other factors driving that in your model from a fundamental perspective?

Spencer Schwartz

Sure, sure. Jack, it’s a great question. So looking at 2016 versus 2015 I’d say a few things. First is heavy maintenance as you pointed out, and as I mentioned a moment ago we expect heavy maintenance to be lower in 2016 for Atlas excluding Southern, so we expect that to be lower we’ll enjoy that benefit. We added a -8 as you know, our tenth -8 late in 2015, so we’ll enjoy a full year of that flying, and so there is a pretty significant incremental benefit there. Of course we get hurt because we don’t benefit from the West Coast port congestion in 2016 but the -8 flying the lower maintenance certainly contribute to that. Obviously Southern’s earnings contribute to that. We also have lower return conditions from our dry leasing business.

Jack Atkins

Okay, okay. Guys thanks again for the time.

Spencer Schwartz

Thank you.

Operator

The next question comes from Scott Group from Wolfe Research. Your line is open.

Scott Group

Hey thanks. Good morning guys.

Spencer Schwartz

Hi Scott.

William Flynn

Good morning, Scott.

Scott Group

So just to follow-up on that question, I want to say more about the first half of the year a little bit. So, the guidance of the color $0.25 to $0.26 in the first quarter and implied of more than a dollar in the second quarter. So we typically don’t see that big of a ramp from first quarter to second quarter. Is there – and even if you include Southern Air starting in the second quarter, so is there something unusual that’s hurting in the first quarter or something different coming from a seasonality perspective in the second quarter to help kind of bridge that 1Q to 2Q ramp?

Spencer Schwartz

Sure, Scott. I know it’s your role to take a look at several previous years and quarters and try to come up with how things have looked in the past and like we obviously understand that. I think from our perspective we do our best to take a look at what we think the first quarter is going to look like, what we think the full year is going to look like, regardless of what the past looked like. I can say with regard to the first quarter of this year just to talk about that in a little bit more detail, if you look at the first quarter of last year, if you’re sort of doing that you back out the West Coast port congestion benefit which was about $0.50 in the first quarter, there is a little bit in early second quarter as well, but so you back out the first quarter.

We had an incremental about $0.20 related to aircraft that were returned. There is a heavy maintenance, heavy maintenance is a little higher in the first quarter of 2016 than it was in the first quarter of 2015, and there is a few cents of other items. So you’ve kind of put all that together, those are the big variance drivers when we look at it. If you go back to the first quarter of 2014 that reflected – so the first quarter of 2015 as I just talked about, we had the return of aircraft, we had the West Coast port changes and heavy maintenance and so forth. If you go back to the first quarter of 2014 that reflected a substantial number of unflown ACMI block hours, if you recall that was a pretty unusual quarter for us. We received payments in connection where the customers return of aircraft in that first quarter of 2014.

So, it’s hard to say what normal is, but 2014 and 2015 certainly had their issues and we think our estimate for 2016 is our best estimate at this stage and so that’s my way of trying to reconcile versus the past – first quarter of the past couple of years if that helps.

Scott Group

Okay, that is helpful. And then just second question, in terms of just normal annual contract, ACMI contracts up for renewal, is this a fairly normal year or is this lighter or heavier and can you comment if you’ve already kind of resigned all those contracts coming up for the year?

William Flynn

Yeah. Scott, this is Bill. It’s really a normal year for us and that’s pretty much as much we want to comment, because contracts renewed throughout the course of the year. And so our expectation around renewal of those contracts and other places we have around the market are all reflected in the framework we provided.

Scott Group

Okay, perfect. Thank you guys.

Spencer Schwartz

Thank you.

Operator

Your next question comes from Helane Becker from Cowen & Company. Your line is open.

Helane Becker

Hi, thanks very much operator. Hi guys, thank you very much for the time. So, now with Southern, what percentage of your revenue will be to [indiscernible] and with DHL support of the acquisition?

Spencer Schwartz

Sure. Helane, it’s Spencer, hi. With – our 2015 revenue related to DHL was about 24%. When you add Southern into it for 2016 should be about 27%. So still while we realize it’s a large number, still clearly a minority. And obviously we wouldn’t be pursuing this transaction if our largest customer and their so customer was not supportive of the transaction. So yes, we’re moving forward and DHL is happy with it, we’re happy with it. As Bill said, it makes great sense to the acquisition.

Helane Becker

Great, got you. And then for my follow-up question, is there a size that you get to where you’re too big or where it’s hard to source aircraft or how do you think about like long-term growth prospects either through acquisition or organic growth?

Spencer Schwartz

Well I think…

William Flynn

Helane, we have a pretty solid track record we could stand here today and look back and see how the company has done. So, not so long ago maybe sometimes it seems that long ago, I think we were at a low of 24 operating aircraft, right and today plus Southern will be in the 60s in terms of operating aircraft. Now what was important there was to diversify, I don’t know that we would have grown from 24 to 66 aircraft that they were all 747. And so the diversification from the four 7s to add the six 7s, now we have 777s and three 7s to add passenger and that add as well as CMI operations, because not all the aircraft arrives and we haven’t had to acquire all that aircraft. I think speak to the business model diversification that we’ve continue to pursue.

We believe airfreight is right at the center of the global economy, we believe it is the underlying demand I should say, it’s right at the center of the global economy. It is growing. Earlier questions today I think underscore how ecommerce will continue to catalyze growth. And then we’ve also built out a complementary earnings stream enlightened because our dry leasing business more of an annuity like earnings stream, our focus there is freight eccentric where we think we are competitive and may have an advantage in terms of our knowledge and insight of the underlying market overall.

So I don’t know that there is a capt of growth but it has to be smart growth, not growth for growth sake, we will do this, we’ll continue to grow in a balanced view, understanding what the opportunities are, what the returns should be for our investors, the kinds of investments we should make. All in while maintaining a healthy balance sheet and as Spencer – and I always talk about maintaining our dial and leverage so that we don’t put the company in a risk position and continue to maintain that healthy cash balance and generate the kind of free cash flows that we have I think a good track record of producing over these past several years.

A long answer but it was – I think it was a question that invited a longer answer.

Helane Becker

All right, it was very well sort out answer, and I appreciate your time. Thank you.

William Flynn

Thank you.

Spencer Schwartz

Thanks, Helane.

Operator

Your next question comes from Bob Labick from CJS Securities. Your line is open.

Robert Magic

Good morning. This is actually Robert Magic in for Bob.

William Flynn

Hey Robert.

Spencer Schwartz

Hi Robert.

Robert Magic

What is the expected timing of placing the -8 into a long-term ACMI contract and what are the rates relative to existing contracts?

William Flynn

So we’ll place the 747-8 – you’re talking about the tenth aircraft, and we expect to place that into ACMI. What I can tell you right now are operating in our commercial chart of business and we are earning very attractive returns, returns on that aircraft that are commencered with our returns on ACMI so that’s commencered are slightly better. So that’s attractive for us. So we expect to place it, we’ll place it into customer operations in ACMI at some point and it will be consistent with the other ACMI rates that we enjoy on our current nine 747-8s that are placed.

Robert Magic

Thanks. And direct contribution margin, not just dollars but both has come down again in ACMI. We know that revenue per block hour significantly affected by mix, particularly with more CMI. So why is margin continuing to decline and what should it look like going forward?

Spencer Schwartz

Sure Robert. As I mentioned earlier, it’s primarily driven by increases in crude cost. We are, as we’ve talked about we’ve been growing our fleet and so as we grow our fleet, in advance our growing our fleet we need to grow our crew and train our crew. And so there is a cost of doing that. And so our ACMI earnings were brought down by the increase in crude cost. Our fourth quarter ACMI did show – our contribution did show sequential increase as we noted during the last earnings call, even with incremental maintenance expense and even with incremental crude training. If you exclude the impact of the crude training, ACMI contribution and margins would have increased year-over-year for the fourth quarter. So it’s really being driven by that.

William Flynn

Right.

Spencer Schwartz

And then if you would have ask where that is headed the crude training we think should level off probably around the middle of this year, subject to any other growth initiatives and that leveling off is included in our framework that we provided for 2016.

William Flynn

Right, and the point you’re making Spencer is that we have to hire a crew in advance of aircraft coming on board, right because they need to be there on the roaster before we can fly and we’ve had a number of aircraft additions.

Spencer Schwartz

Absolutely.

Robert Magic

Appreciate the color. Thank you.

William Flynn

Thank you.

Spencer Schwartz

Thanks, Robert.

Operator

[Operator Instructions] Your next question comes from David Campbell from Thompson Davis. Your line is open.

David Campbell

Yes, hi good morning everybody. Just a question on Southern Air, when are you assuming the acquisition takes place?

William Flynn

Yeah. David, we think the closing will happen really within the next couple of months. Subject to normal regulatory approval but given the size of transaction relative to Atlas and some other considerations it’s really the DOT process we don’t have a required Hart-Scott-Rodino filing here. So it’s on the less complex and more complex side of those approvals, so we think in the next couple of months.

David Campbell

So, but you’ve estimated revenue block hours and revenues and so forth, I just wondered when…?

William Flynn

April – that assumes April 1.

David Campbell

Assumes April 1, all right. Okay, and did you give us the block hours for Southern Air, I can’t remember.

Spencer Schwartz

Yes, I said for 2016 approximately 25,000 to 30,000 block hours.

David Campbell

That’s right.

Spencer Schwartz

So, again that’s three quarters and so if you want to annualize that the fair approximation for the full year.

David Campbell

Right. And what happens to Southern Air in the first quarter, which you of course won’t have newer numbers but is that a breakeven quarter for them normally or is it worse than that?

William Flynn

Southern is a CMI operator and it’s not probably appropriate for us to talk about their Q1, but the nature of the operation which is CMI serving DHL and express operations tends to be flatter than perhaps our business because of our other ACMI customers are participation in charter, sometimes a variability of military. So they’re flatter through the year than we are.

David Campbell

Right, right. And Bill, what do you – do you have any insights into the first quarter tonnage market in the international markets, I know that March of course is the key month, but February got – and February is distorted by the early Chinese New Year, do you have any way of looking through all of that and seeing whether the first quarter will be consistent with your assumed I guess both little roughly 2% growth to the year?

William Flynn

I think – so you raised all the right points. Lunar New Year in February kind of distorts the quarter a bit so you really need to look at the full quarter or at least on the year-over-year basis, Jan, sorry February and March together because of where Lunar New Year is. So January essentially met our expectations overall and February we’re just now – really this week is kind of when everyone in China is back to work after at least a week or so of holidays associated with Lunar New Year. Our outlook for – sitting here and we know about the balance of this month and in March we think we’re pretty much on target to obviously hit the numbers that we talk about this morning for the quarter and feel good about the trajectory for the balance of the year. Probably we’ll have a much – we’re going to be more precise about some of the different markets after we get past the Lunar New Year and talk to you about first quarter results.

Spencer Schwartz

David, I’ll just add just – it’s Spencer, just a little bit more color. The 2% to 3% that you talked about clearly I think is right around the range and that everyone is seeing. China continues to grow the express providers, the express business continues to grow, certainly fueled by ecommerce. Our customers are benefiting which means that Atlas is benefiting. Clearly we’re seeing growth in automotive and fashion which is in the fashion piece somewhat consistent with the growth in the ecommerce. So, those are some of the biggest areas we’re seeing grow.

David Campbell

And the problem with ecommerce is it’s pretty light weight, lightweight shipments, so it doesn’t have as much impact on tonnage. Is that a good idea?

William Flynn

That’s right, it burns less fuel then too.

David Campbell

Right, right, right.

William Flynn

Its £7 per cubic but – versus maybe £10 per cubic but in terms heavy freight so all the volume gets consumed and paid for our ACMI customers and in our charter market as well, but it’s a lighter on a fuel burn as a result of the different density.

David Campbell

Right. And last question is, do you see any changes at DHL good or bad assuming from their continuing profit problems, there has been rumors too Deutsche post night consider taking that out of their operations. What’s you’re feeling about that right now?

William Flynn

Well, I would look where you and everyone else on the call were looking, that would be at the reports that the parent company puts out, and they report on the segment basis and I think DHL express who is our customer, has reported very strong results year-over-year-over-year for some time now and I think they – I think they’ll continue to grow. But they’ll talk about their prospects when they release results and upcoming I guess.

David Campbell

Right, right. Okay, thank you.

William Flynn

Thank you, David.

Operator

Your next question comes from Geoffrey Dancey from Cutler Capital Management. Your line is open.

Geoffrey Dancey

Good morning.

William Flynn

Good morning.

Spencer Schwartz

Good morning, Geoffrey.

Geoffrey Dancey

Couple of questions. First I was hoping you could refresh my memory on what your long-term leverage targets are.

Spencer Schwartz

Sure Geoffrey. So, we don’t really provide any sort of long-term target, instead what we do is we take a look at each investment that we make, every investment that we make. We take a look at what the expected MPV and IRR will be. We take a look at EPS accretion, the quality of the investment, the contribution towards our overall strategic goals. We don’t focus on any particular leverage but if you look at slide 11 which we provided today you can see our overall net leverage coming down, while our fleet size has been growing. And from a capital allocation standpoint, since I think the two are really, really tied together. From a capital allocation standpoint we’ve been committed to creating, enhancing and returning value to our shareholders but we’ve really focus on having a balanced approach. So we maintain a strong balance sheet and we talked about how we refinance some higher cost debt with lower cost debt. We maintained a really strong cash position. We invest in the business, we acquired our tenth -8, we acquired two 767 so we continue to invest in our business and we returned capital shareholders.

We repurchased 1.7% of our outstanding stock last year which brought our total over 10% over the last three years. So it’s been a really balanced approach, we’ve been bringing down our debt, increasing our fleet and we’ve had a really balanced capital allocation approach throughout.

Geoffrey Dancey

Okay. So I – and you’ve guiding here are expecting to hit on $40 million at that per quarter, so we should see these ratios continue to decline. So I guess the question is, how far – how much further do you want to take down that leverage ratio what you think was appropriate and versus I guess buying back more stock. So my next question is, on the cash, the $444 million available on the balance sheet, how much of that do you think is excess that would be available for say acquisitions or repurchasing of stock as oppose to being needed for the business or for debt repurchase, debt pay downs?

Spencer Schwartz

Sure, Geoffrey. We have internal numbers about where we think are sort of minimum cash balances, it’s not something that we share externally. And really as I mentioned before with regard to capital allocation, we really focused on those three key areas, we want to have a strong balance sheet, we want to continue to invest in the business and return capital. And so we have been very focused on that as you know or as we’ve just talked about. We’re buying Southern which should close in the next couple of months, that’s about a $110 million so that’s a great use, it gets us entry into two new platforms, two new operating platforms 777s, five 737s to start and really allow us to continue to grow those platforms. So, that’s what we’re all about.

Geoffrey Dancey

Great. And then my last question. In regards to that Southern acquisition, I know you’re not assuming any debt or taking any debt on, it sounds like is that something that you considered and is it something that you would consider going forward? And then if you could just comment on the current environment for financing.

Spencer Schwartz

Sure. So with regard to Southern, absolutely, we looked at all available options to acquire Southern, taking on debt and then what type of debt, whether it’s issue equity, whether to use cash or whether some combination of all those. We looked at all of those things, we felt we had an appropriate level of cash that we could acquire Southern with available cash and we thought that made the best sense for our investors. It makes it immediately accretive and it comes to us with no additional debt, no impact on our net leverage ratio. So it certainly did consider all the options and we think this was the right approach.

As far as second part of your question was to really talk about the kind of financing markets or that sort of thing. I think we have – we’ve been quite fortunate, the lending market really understands the strength of our underlying credit and we’ve been quite fortunate. We’ve been able to refinance higher yielding debt with lower yielding debt. As we talked about earlier we refinanced some -8s, we refinanced some 747-400s, really lowers our aircraft ownership costs and allows us to have more a flexible fleet. So the financing market remains strong and remains open to us.

Geoffrey Dancey

And rates have spreads, can you just comment on how that’s evolved with at this location high yield market?

Spencer Schwartz

Yeah, the spreads have come down. You saw that we refinanced higher costing debt with lower costing debt and so therefore we’ve been able to take advantage of the current environment. It is a really good time to finance aircraft right now and we’ve been taking advantage of that to both finance aircraft and also refinance prior transactions that had a higher rate. As we talked about in the fourth quarter alone, we refinanced too of our regional -8s they were at the rate of 6.37% we refinanced those at a rate of 3.53%. So we really been able to take advantage of lower cost financing.

Geoffrey Dancey

All right, that’s great. Thank you for taking all my questions.

Spencer Schwartz

Thank you.

William Flynn

Thank you.

Operator

Your next question comes from Steve O’Hara from Sidoti. Your line is open.

Steve O’Hara

Hi, good morning.

Spencer Schwartz

Good morning, Steve.

William Flynn

Hey Steve.

Steve O’Hara

I was wondering just on two quick ones, I mean it looks like the 4Q refi should be pretty beneficial for 2016. And could you just talk maybe, I don’t know if you’ve mentioned this already but what’s the impact year-over-year, what’s the expectation for the impact of the refi on 2016 versus 2015? And then second is just on the acquisition of Southern, what type of integration cost do you expect and then synergies and I don’t know if there is union differences and how long that takes as well. Thank you.

Spencer Schwartz

Sure Steve, I’ll take the first part of it, which is we have the convertible note and we use the proceeds from the convertible note as you know the pay down some higher costing 747, WTC debt, and then we refinanced the two -8s. And so I think if you look at it together, taking a look at our net interest expense, net of interest income in 2015 it was about $84 million, in 2016 we think it’ll be about $6 million lower and so you can see the impact there. We also added a tenth -8 and so therefore that then increased our debt, but taken all together, we expect about $6 million or less interest expense in 2016 versus 2015.

Steve O’Hara

Okay.

William Flynn

Yeah, so this is Bill, Steve, on the second part of your – second question. So the primary deal rational on the acquisition of Southern is to acquire their platforms, they come to us immediately accretive. They have excellent customer platform in DHL, someone who we know very well. And it creates that growth platform in 777s and 737s that we can go out and offer to current new customer – current and new customers and sort of perhaps more markets as a result, and that’s what we really learned by ramping up the 767, that catalyze growth for the company that we wouldn’t have necessarily achieved if we simply continue to offer their market a single platform.

There are some synergy and there will be some cost to achieve that synergy but this is not a synergy driven transaction, synergies are relatively small, we haven’t disclosed those. In terms of the complexity of the integration, all integrations have some degree of complexity. We think this is some of the less complex as suppose to a more complex type of integration and we want to get on that shortly after we close. In terms of labor, both of our pilot groups are represented by The Teamsters, the same Local 1224. So in terms of airlines coming together we don’t have different representation groups, it’s the same, it’s the IBT and its Local 1224 so that’s I think a good thing in terms of that context.

Our goal is to merge Southern in to Atlas, we will amalgamate Southern into Atlas and at the end of that process there will be one collective bargain agreement and all pilots will be Atlas pilots.

Steve O’Hara

Okay. And then maybe just on – I think you gave your CapEx outlook for let’s say, I guess it was more of a maintenance CapEx rather than aircraft and engines or something. And I’m just wondering I mean, so if pretax income is almost a $170 million in 2015, you don’t pay cash taxes. Depreciation is $145 million in 2016, taking out $50 million or $60 million in CapEx, I mean it would be seem like you have a pretty good runway for free cash flow this year, and I’m just wondering maybe why that isn’t more the story or I mean is there something that, maybe a fleet transition that you’re contemplating or you need to get done or something like that? Thank you.

Spencer Schwartz

Sure, Steve. No, our free cash flow has been incredibly strong. I think it’s something that the market seems to be underestimating. But as we said, we delivered $13.6 per share of free cash flow in 2015 and the increase from the prior year which was $9.86 was primarily due to operating cash flows. And so we expect in 2016 results to be somewhat similar to 2015, again outstanding free cash flow. So yes, we agree with you, very strong free cash flows.

Steve O’Hara

Okay. And I mean, but in terms of aircraft CapEx there is nothing planned right now, so I mean there is a possibility that CapEx – I mean even at a $100 million it’s, I think close to $10 a share it seems.

Spencer Schwartz

There is no – we have no commitment at the moment. There are no sort of big commitments related to that, no.

Steve O’Hara

Okay. And I’m sorry, last one, do you have a buyback in place now and maybe what’s the size of it?

Spencer Schwartz

As far as buybacks we generally talk about those after they happen and we’ve shared that, we purchased over $10 million – sorry 10% of the company back and I think the other thing I would say there Steve is that we have $25 million remaining under our board approval or share repurchases.

Steve O’Hara

Okay, thank you very much.

Spencer Schwartz

Thank you.

Operator

And your final question for today will come from Jack Atkins from Stephens. Your line is open.

Jack Atkins

Hey guys, thanks for taking my follow-up question. On the charter side of your business, could you speak to the military piece of that and how that performed in the fourth quarter and what’s your outlook for that business moving into 2016?

William Flynn

Thank you, Jack. So our outlook into – coming into 2016 is for fairly stable, 2016 over 2015 a similar mix of cargo versus passenger hours. Spencer, do you have the hours there for 2015?

Spencer Schwartz

Sure. For 2015 AMC hours were approximately 22,000 hours.

Jack Atkins

Okay.

William Flynn

Right, so something in that order of magnitude is what we know now in terms of the kind of forecast we’re getting from AMC.

Jack Atkins

Okay.

Spencer Schwartz

We expect 2016 to be similar to or perhaps slightly better than 2015.

Jack Atkins

Okay, that’s helpful. And then last question, you’ve had a lot of question on the souvenir but, could you speak to the – is there any seasonality within the Southern Air earnings stream? And then when you think about the lease structure in terms of the aircraft of Southern Air leases in and then leases back out the DHL, are those lease terms matched up in terms of length, are there any sort of overlap or staggering there, could you maybe just give us some color?

William Flynn

So I mentioned earlier, I think earlier question about Southern. It is a currently 100% CMI operation, so the customer provides the aircraft. And because it’s essentially CMI there is not as much seasonal or quarter-to-quarter variance at Southern compared to ours because of the different – because they’re essentially in one segment with one predominant customer, we’re in many segments. And so we’ve got more quarter-to-quarter volatility because of – well, not volatility. We have a more seasonal results given the nature of the markets, the different segments that we’re in and timing of heavy maintenance.

Spencer Schwartz

And Jack, it’s Spencer, I’ll just add that the Southern earnings, their block hours and their associated earnings generally due ramp up as the year goes on and they’re certainly higher in the fourth quarter, but as Bill said, that variability is much [indiscernible].

Jack Atkins

Okay, okay. That’s great, thanks again for the time.

William Flynn

Thanks, Jack.

Spencer Schwartz

Thank you.

William Flynn

Okay.

Operator

Well, I have no further questions at this time.

William Flynn

Okay, well thank you Michelle, and to everyone on the call. Thanks again for taking the time to be with us today. That’s both Spencer and I certainly appreciate your interest in the company, and we look forward to speaking with you again soon. Thank you very much.

Operator

Thank you everyone. This concludes today’s conference call. You may now disconnect.

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