Air Transport Services Group Inc. (“ATSG”) is a holding company whose principal subsidiaries include three independently operated and U.S certificated airlines and an aircraft leasing company. The three airlines, ABX Air, Inc. (“ABX”), Capital Cargo International Airlines, Inc. (“CCIA”), and Air Transport International, LLC (“ATI”), primarily transport cargo within the United States and include operations in Europe, Central America, South America, and Asia. ATSG’s leasing subsidiary, Cargo Aircraft Management, Inc. (“CAM”), leases aircraft to ATSG’s airlines and to external customers. (When the context requires, we may use the terms “Company” and “ATSG” in this report to refer to the business of ATSG and its subsidiaries on a consolidated basis.)
ABX was incorporated in 1980 and is based in Wilmington, Ohio. ABX provides air cargo transportation through a fleet of Boeing 767 aircraft. ABX complements its air transport capabilities with package handling services. Between 1980 and August 2003, ABX was an affiliate of Airborne, Inc. (“Airborne”), a publicly traded, integrated delivery service provider. On August 15, 2003, ABX was separated from Airborne in conjunction with the acquisition of Airborne by an indirect wholly owned subsidiary of DHL Worldwide Express, B.V. The merger agreement required Airborne to separate its air operations from its ground operations with the air operations being retained by ABX. At that time, ABX became an independent publicly traded company. Airborne was subsequently merged into DHL.
On December 31, 2007, ABX was reorganized, forming a holding company structure incorporated in Delaware. ABX became a wholly owned subsidiary of ATSG and all of the common shares of ABX, which were then publicly traded, were converted into shares of ATSG. The Company’s shares are publicly traded on the NASDAQ Stock Market under the symbol ATSG.
Immediately after ABX became a wholly owned subsidiary of the Company, the Company completed the acquisition of Orlando, Florida based Cargo Holdings International, Inc. (“CHI”), at that time the privately-owned parent company of CAM, CCIA and ATI. The Company acquired all of the outstanding stock, stock options and warrants of CHI for a combination of cash, shares of the Company, and debt repayment. The overall transaction value was approximately $340 million. ATSG financed the deal partially through a $270 million unsubordinated term loan.
CCIA obtained its airline operating certificate in 1996 and currently operates Boeing 727 and 757 aircraft, primarily providing air freight transportation for BAX Global, Inc. (“BAX”). ATI, based in Little Rock, Arkansas, began operations in 1979 and was an affiliate of BAX prior to 2006. ATI operates Boeing 767 aircraft and McDonnell Douglas DC-8 aircraft, also for BAX, and provides airlift to the U.S. military through the Air Mobility Command. The acquisition of CHI also includes the operations of CAM and LGSTX Services, Inc. These CHI companies provide aircraft leasing, fuel management, specialized transportation management and air charter brokerage services.
Description of Business
During 2008, the Company operated three reportable segments, “DHL,” “ACMI Services,” and “CAM.” The Company’s other business operations include aircraft maintenance and modification services, aircraft part sales, equipment leasing and maintenance, mail handling for the U.S. Postal Service (“USPS”), specialized services for aircraft fuel management and freight logistics. These other business operations do not constitute reportable segments. Financial information about our segments and geographical revenues is presented in Note Q to the accompanying consolidated financial statements.
Business with DHL
ABX operates primarily under two commercial agreements with DHL; the aircraft, crew, maintenance and insurance agreement with DHL Network Operations (USA), Inc. (“ACMI agreement”) and the hub services agreement (“Hub Services agreement”) with DHL Express (USA), Inc., both of which became effective August 16, 2003, in conjunction with the acquisition of Airborne (DHL Network Operations (USA), Inc. and DHL Express (USA), Inc. are individually and collectively referred to herein as “DHL”). Since August 2003, DHL has served as ABX’s largest customer, constituting a significant portion of ABX’s revenues in recent years. Revenues from DHL operations accounted for 72% of the Company’s consolidated 2008 revenues. Under these agreements, ABX and DHL generally operate under a cost-plus pricing structure.
ABX provides the airlift for DHL’s express and deferred delivery services using its aircraft. ABX has also managed a U.S. network of hubs for DHL, including DHL’s primary U.S. sorting facility, which is located in the air park in Wilmington, Ohio. ABX staffed the network, providing package sorting and handling at as many as 19 hubs for DHL. Under the Hub Services agreement, ABX provides staff to conduct package sorting, as well as airport, facilities and equipment maintenance services for DHL.
The ACMI agreement and Hub Services agreement each allow DHL to reduce the scope of services that ABX provides. This includes, for example, the reduction in air routes that ABX flies, the removal of aircraft from service and the termination of hub management services. Since 2004, DHL has from time to time reduced the scope of services provided by ABX, and in 2008, DHL announced a restructuring plan to focus exclusively on handling international freight destined to or from the U.S. By January 31, 2009, DHL had ceased to service intra-U.S. shipments (shipments having both an origin and destination within the U.S.). DHL’s announcement of a U.S. restructuring plan and its withdrawal from the intra-U.S. market has had, and will continue to have, an impact on the Company’s operations. Between DHL’s restructuring announcement in May 2008 and February 2009, ABX removed 47 McDonnell Douglas DC-9 aircraft from DHL service, closed all regional sorting hubs, downsized the Wilmington, Ohio sort operations and terminated over 4,800 employees.
At this time, ABX continues to provide airlift and package sorting for DHL’s international delivery services through ABX’s Boeing 767 aircraft and personnel at the Wilmington, Ohio night sort operations. ABX provides these services to DHL under the preexisting ACMI and Hub Services agreements, as amended in November 2008. DHL has indicated that their network will continue to utilize some ABX Boeing 767 aircraft and sorting operations in Wilmington to support its international services at least through September 2009. Management cannot reasonably predict the types or level of ABX services that DHL will utilize on a longer term basis.
The ACMI agreement automatically renews for a period of three years in August 2010, unless at least a one year notice of non-renewal is given. The Hub Services agreement renewed in August 2008 and automatically renews for additional periods of one year each, unless at least 90 days notice of non-renewal is given. Renewal of these agreements is uncertain. DHL continues to plan its long term operational strategy for the U.S. and is evaluating various alternatives, some of which may involve utilizing airlift or services from ABX. (See Item 7 of this report for additional information about the effects of the DHL restructuring plan.)
Business with BAX
CCIA and ATI each have contracts to provide airlift to BAX under ACMI agreements. BAX provides freight transportation and supply chain management services, specializing in the heavy freight market for business-to-business shipping. Revenues from BAX operations accounted for 14% of the Company’s consolidated 2008 revenues. During 2008, CCIA operated twelve Boeing 727s for the BAX network. ATI operated nine McDonnell Douglas DC-8s as part of the BAX network. The BAX central hub is located in Toledo, Ohio. CHI has the exclusive right to supply all main deck freighter airlift in BAX’s U.S. domestic network through December 31, 2011.
The Company, through its three airlines, provides airlift to freight forwarders, other airlines and other customers, typically under ACMI and charter contracts. A typical ACMI contract requires the ATSG airline to supply, at a specific rate per block hour, the aircraft, crew, maintenance and insurance for specified cargo operations, while the customer is responsible for substantially all other aircraft operating expenses, including fuel, landing fees, parking fees and ground and cargo handling expenses. Charter agreements usually require the airline to provide full service, including fuel and other operating expenses, in addition to aircraft, crew, maintenance and insurance for a fixed, all-inclusive price. The Company also provides air cargo transportation under block space agreements. These agreements include multiple customers contracting for space on specific routes. The customers are typically charged based upon the weight carried. Under the Company’s ACMI, charter arrangements and block space agreements, it has exclusive operating control of its aircraft, and its customers must typically obtain any government authorizations and permits required to service the designated routes. The Company reports its business from ACMI, charter and space available contracts, including the services it provides for BAX, in the ACMI Services segment.
Other Products and Services
U.S. Postal Service
During the third quarter of 2006, ABX’s subsidiary, ABX Cargo Services, Inc. (“ACS”), was awarded contracts to manage USPS mail sort centers in Dallas, Texas and Memphis, Tennessee. In 2006, ACS was also awarded a renewal of a USPS sort center in Indianapolis, Indiana that it has operated since 2004. Under each of these contracts, ACS is compensated at a firm price for fixed costs and an additional amount based on the volume of mail handled at each sort center. Each of the contracts has a four-year term with extensions at the discretion of the USPS.
Airport-to-Airport Transportation of Freight on a Space-Available Basis
The ACMI agreement with DHL allows ABX, subject to certain limitations described in the agreement, to sell to other customers any aircraft space that DHL does not use. On the routes ABX operates for DHL, we sell airport-to-airport transportation services to freight forwarders.
Aircraft Maintenance and Modification Services
ABX operates a Federal Aviation Administration (“FAA”) certificated 145 repair station. ABX leverages the repair station facilities (including hangars and a component shop leased from DHL) and its engineering capabilities to perform airframe and component maintenance and repair services for other airlines and maintenance repair organizations. ABX has developed technical expertise related to aircraft modifications as a result of its long history in aviation. ABX owns many Supplemental Type Certificates (“STCs”). An STC is granted by the FAA and represents an ownership right, similar to an intellectual property right, which authorizes the alteration of an airframe, engine or component. ABX markets its capabilities by identifying aviation-related maintenance and modification opportunities and matching them to its capabilities.
ABX’s marketable capabilities include the installation of terrain awareness warning systems (“TAWS”), terminal collision avoidance systems (“TCAS”), reduced vertical separation minima (“RVSM”) and flat panel displays for Boeing 757 and Boeing 767 cockpits. The flat panel display updates aircraft avionics equipment and reduces maintenance costs by combining multiple display units into a single instrumentation panel. ABX has the capabilities to perform heavy maintenance and airframe overhauls on DC-9 and Boeing 767 aircraft and line maintenance on DC-8, DC-9, Boeing 747 and Boeing 767 aircraft. ABX has the capabilities to refurbish approximately 60% of the airframe components for DC-8 and DC-9 aircraft and the wheels and brakes for DC-8, DC-9 and Boeing 767 aircraft types. Additionally, ABX provides digital aircraft manuals for customers in conjunction with the modification of aircraft from passenger to cargo configuration.
Aircraft Parts Sales and Brokerage
ABX’s subsidiary, ABX Material Services, Inc. (“AMS”), which holds a certificate relating to free trade zone rights, is an Aviation Suppliers Association 100 Certified reseller and broker of aircraft parts. AMS carries an inventory of DC-8, DC-9 and Boeing 767 spare parts and also maintains inventory on consignment from original equipment manufacturers, resellers, lessors and other airlines. AMS’s customers include the commercial air cargo industry, passenger airlines, aircraft manufacturers and contract maintenance companies serving the commercial aviation industry, as well as other resellers.
Flight Crew Training
ABX and CCIA are FAA-certificated to offer training to customers and rent usage of its flight simulators for outside training programs. ATSG owns six flight simulators, including one Boeing 767, one DC-8, two Boeing 727 and two DC-9 flight simulators. The Company’s Boeing 767, one of its Boeing 727 and one of its DC-9 flight simulators are level C certified and one of its Boeing 727 flight simulators is level D certified. The level C and D flight simulators allow the Company to qualify flight crewmembers under FAA requirements without performing check flights in an aircraft. The DC-8 and the other DC-9 flight simulators are level B certified, which allows the Company to qualify flight crewmembers by performing a minimum number of flights in an aircraft.
Flight Operations and Control
Airline flight operations, including aircraft dispatching, flight tracking and crew scheduling, are planned and controlled by personnel within each airline. ABX staffs aircraft dispatching and flight tracking 24 hours per day, 7 days per week from the DHL Air Park in Wilmington, Ohio. CCIA flight operations, including flight tracking and crew scheduling, are controlled by on-duty personnel in CCIA’s operations center in Orlando, Florida, and the same functions for ATI are controlled from ATI’s operations center in Little Rock, Arkansas.
Our airlines’ operations are regulated by the FAA for aircraft safety and maintenance. Each airline performs routine inspections and airframe maintenance, including Airworthiness Directive and Service Bulletin compliance on all of their aircraft. The airlines’ maintenance and engineering personnel coordinate routine and non-routine maintenance requirements. Each airline’s maintenance program includes tracking the maintenance status of each aircraft, consulting with manufacturers and suppliers about procedures to correct irregularities and training maintenance personnel on the requirements of its FAA-approved maintenance program. ATI and CCIA contract with maintenance repair organizations (“MROs”) to perform heavy airframe maintenance on airframes and engines. ABX, as a certificated FAA repair station, can perform maintenance on DC-8, DC-9, and Boeing 767 aircraft and their related avionics and accessories. ABX accomplishes heavy maintenance on Boeing 767 airframes in-house as well as through outside MROs. ABX contracts with MROs for the performance of heavy maintenance on its aircraft engines. Each airline owns a supply of spare aircraft engines, auxiliary power units, aircraft parts and consumable items. The number of spare items maintained is based on the fleet size, engine type operated and the reliability history of the item types.
Our airline subsidiaries are required by the Department of Transportation (“DOT”) to carry liability insurance on each of their aircraft. Their aircraft leases, loan agreements and the ACMI agreements also require them to carry such insurance. The Company currently maintains public liability and property damage insurance, and our airline subsidiaries currently maintain aircraft hull and liability insurance and war risk insurance for their respective aircraft fleets in amounts consistent with industry standards.
As of December 31, 2008, ATSG and its subsidiaries had approximately 5,620 employees, including 3,830 full-time employees and 1,790 part-time employees. ATSG employs approximately 855 flight crewmembers, 1,195 aircraft maintenance technicians and flight support personnel, 1,635 sort employees at the Wilmington facility, 1,110 sort employees at the regional hubs and postal centers, 425 employees for airport and hub maintenance, 20 employees for warehousing and logistics and 380 employees for administrative functions.
On December 31, 2007, the Company had approximately 10,150 employees. The decline in the number of employees from 2007 to 2008 is primarily due to the DHL restructuring plan and reduced shipment volumes. The Company is making additional headcount reductions in 2009.