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AIR TRANSPORT SERVICES GROUP, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following Management's Discussion and Analysis has been prepared with reference to the historical financial condition and results of operations of Air Transport Services Group, Inc. and its subsidiaries. Air Transport Services Group, Inc. and its subsidiaries may hereinafter individually and collectively be referred to as "the Company", "we", "our" or "us" from time to time. The following discussion and analysis describes the principal factors affecting the results of operations, financial condition, cash flows, liquidity and capital resources. It should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the related notes prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") contained in this report and our Annual Report on Form 10-K for the year ended December 31, 2013. BACKGROUND The Company provides airline operations, aircraft leases, aircraft maintenance and other support services primarily to the air cargo transportation and package delivery industries. Through the Company's subsidiaries, we offer a range of complementary services to delivery companies, freight forwarders, airlines and government customers. The Company's principal subsidiaries include two independently certificated airlines, ABX Air, Inc. ("ABX") and Air Transport International, Inc. ("ATI"), and an aircraft leasing company, Cargo Aircraft Management, Inc. ("CAM"). At June 30, 2014, the Company owned 51 cargo aircraft in service condition and leased six more under operating leases. The combined fleets consisted of forty Boeing 767-200 aircraft, nine Boeing 767-300 aircraft, four Boeing 757-200 aircraft and four Boeing 757 "combi" aircraft. The Boeing 757 combi aircraft are capable of simultaneously carrying passengers and cargo containers on the main flight deck. The Company's largest customer is DHL Network Operations (USA), Inc. and its affiliates ("DHL"), which accounted for 57% of the Company's consolidated revenues for the first six months of 2014 compared with 54% of the Company's consolidated revenues in the corresponding period in 2013. The Company has had long term contracts with DHL since August 2003. On March 31, 2010, the Company and DHL executed commercial agreements under which DHL leases 13 Boeing 767 freighter aircraft from CAM and contracted with ABX to operate those aircraft under a separate crew, maintenance and insurance ("CMI") agreement. The CMI agreement pricing is based on pre-defined fees, scaled for the number of aircraft operated and the number of flight crews provided to DHL for its U.S. network. The initial term of the CMI agreement is five years and the terms of the aircraft leases are seven years, with early termination provisions. In addition to the 13 CAM-owned Boeing 767 aircraft, ABX also operates four DHL-owned Boeing 767 aircraft under the CMI agreement. ATI provides four Boeing 757 aircraft to DHL's U.S. network. Additionally, ABX provides six other Boeing 767 aircraft primarily to DHL's U.S network under contracts and arrangements having durations of one year or less. During 2013, ATI provided three Boeing 767 aircraft to DHL's Middle East operations, however, these agreements were terminated during the first quarter of 2014. The U.S. Military comprised 16% and 17% of the Company's consolidated revenues during the six month periods ended June 30, 2014 and 2013, respectively. The Company's airlines contract their services to the Air Mobility Command ("AMC"), through the U.S. Transportation Command ("USTC"), both of which are organized under the U.S. Military. During 2013, ATI retired its four DC-8 combi aircraft and replaced them with three Boeing 757 combi aircraft operating for the U.S. Military. Our fourth and final Boeing 757 combi aircraft entered service in the first quarter of 2014 after completing the necessary regulatory certification. The Company has two reportable segments: ACMI Services, which primarily includes the cargo transportation operations of its airlines, and the CAM segment. The Company's other business operations, which primarily provide support services to the transportation industry, include aircraft maintenance, aircraft parts sales, ground equipment leasing and mail handling services. These operations do not constitute reportable segments due to their size. 23 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Summary Customer revenues from continuing operations increased by $10.7 million to $149.6 million and by $11.0 million to $293.2 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Customer revenues, excluding revenues from directly reimbursed expenses, increased by $4.8 million and $2.1 million during the three and six month periods ended June 30, 2014, respectively, compared with 2013. Increased revenues were led by our aircraft maintenance service operations which completed more heavy maintenance checks for customers' aircraft during 2014 compared to 2013. Revenues for ACMI Services were negatively impacted by the discontinuation of flying services to DHL's Middle East operation during the first quarter of 2014. The consolidated net earnings from continuing operations were $9.3 million and $15.8 million for the three and six month periods ended June 30, 2014, respectively, compared to $6.9 million and $15.4 million for the corresponding periods of 2013. The pre-tax earnings from continuing operations were $14.7 million and $25.0 million for the three and six month periods ended June 30, 2014, respectively, compared to $11.1 million and $24.7 million for the corresponding periods of 2013. Improved earnings were driven by aircraft maintenance services and ACMI Services which reflects reduced employee expenses, deployment of the more fuel efficient Boeing 757 combi aircraft for the U.S. Military, and fewer heavy maintenance checks compared to 2013. Total operating expenses increased primarily due to the cost of parts sold and CAM's depreciation expense, which increased as a result of adding five aircraft to the fleet since June 30, 2013. A summary of our revenues and pre-tax earnings from continuing operations is shown below (in thousands): Three Months Ending Six Months Ending June 30, June 30, 2014 2013 2014 2013 Revenues from Continuing Operations: CAM $ 40,590 $ 39,362 $ 81,225 $ 78,331 ACMI Services Airline services 88,657 89,920 176,164 183,077 Reimbursable 22,647 16,684 43,736 34,843 Total ACMI Services 111,304 106,604 219,900 217,920 Other Activities 36,493 26,951 63,301 53,205 Total Revenues 188,387 172,917 364,426 349,456 Eliminate internal revenues (38,769 ) (34,013 ) (71,215 ) (67,273 ) Customer Revenues $ 149,618 $ 138,904 $ 293,211 $ 282,183 Pre-Tax Earnings (Loss) from Continuing Operations: CAM, inclusive of interest expense $ 10,667 $ 17,214 $ 25,107 $ 34,087 ACMI Services 309 (9,093 ) (6,737 ) (14,497 ) Other Activities 4,108 2,607 7,125 4,788 Net unallocated interest expense (424 ) (95 ) (803 ) (443 ) Net gain on derivative instruments 31 452 330 742 Pre-Tax Earnings from Continuing Operations 14,691 11,085 25,022 24,677 Less Net gain on derivative instruments (31 ) (452 ) (330 ) (742 ) Adjusted Pre-Tax Earnings $ 14,660 $ 10,633 $ 24,692 $ 23,935 Reimbursable revenues include certain operating costs that are reimbursed to the airlines by their customers. Such costs include fuel expense, landing fees and certain aircraft maintenance expenses. The types of costs that are reimbursed varies by customer operating agreement. Adjusted pre-tax earnings, a non-GAAP measure, is pre-tax earnings excluding interest rate derivative gains. Management uses adjusted pre-tax earnings to compare the performance of core operating results between periods. 24 -------------------------------------------------------------------------------- Adjusted pre-tax earnings should not be considered in isolation or as a substitute for analysis of the Company's results as reported under GAAP. CAM Through the CAM subsidiary, we offer aircraft leasing to external customers and also lease aircraft internally to the Company's airlines. Aircraft leases normally cover a term of five to seven years. In a typical leasing agreement, customers pay rent and maintenance deposits on a monthly basis. CAM's revenues grew $1.2 million and $2.9 million during the three and six month periods ended June 30, 2014 compared to the corresponding periods of 2013, as a result of additional aircraft leases. CAM's revenues from the Company's airlines totaled $22.8 million and $45.0 million during the three and six month periods ended June 30, 2014, compared to $21.5 million and $42.2 million for the corresponding periods of 2013. Since June 30, 2013, CAM has placed two Boeing 767-300 freighter aircraft and three Boeing 757 combi aircraft under leases with internal airlines. Revenue growth from external customers was flat for the three and six month periods ended June 30, 2014 compared to 2013. During the second quarter of 2014, CAM received redelivery of a Boeing 767 aircraft from an internal airline and, beginning in June 2014, began an additional long term lease of the aircraft to an external customer. During the first quarter of 2014, CAM's fourth and final Boeing 757 combi aircraft completed its airworthiness certification and began operations for ATI in service to the U.S Military. Also during the first quarter of 2014, CAM completed the modification of a Boeing 767-300, which was not under lease as of June 30, 2014. CAM's pre-tax earnings, inclusive of an interest expense allocation, were $10.7 million and $25.1 million for the three and six month periods ending June 30, 2014, respectively, compared to $17.2 million and $34.1 million for the corresponding periods of 2013. Reduced earnings reflect increased depreciation expense of $5.5 million for the quarter and $9.4 million in the first six months for the five newly modified Boeing 767 and Boeing 757 aircraft that were added to the fleet since June 30, 2013, as described above. As of June 30, 2014, CAM had 51 freighter aircraft consisting of 26 leased internally to the Company's airlines, 21 leased to external customers, three that were being prepped for additional customer leases expected to begin later in 2014 and another aircraft that is available for lease. In May 2014, CAM executed agreements to lease two Boeing 767-200 aircraft, currently leased to ATSG airlines, to a Canadian airline for a term of up to three years. Additionally, in May 2014, CAM executed agreements to lease two Boeing 767-300 aircraft to a Florida based airline under six year terms. Both airlines are existing customers of CAM. The first of these four aircraft leases began in June of 2014 and the second began in July 2014 with the remaining two scheduled to start by the end of September 2014. One customer may elect to return a Boeing 767-200 currently leased from CAM when the Boeing 767-300 aircraft are deployed. Additionally, CAM is working with a European carrier to add one Boeing 767 aircraft lease later this year. In July 2014, CAM entered into agreement to purchase two Boeing 767-300 freighters. These aircraft are currently operated by ABX, under operating leases ending in 2015 and 2017, respectively. We expect CAM to complete the purchase in the third quarter of 2014. As part of the transaction, CAM also received an option to purchase another Boeing 767-300 freighter in 2015 and may lease the aircraft until then. ACMI Services Segment The ACMI Services segment provides airline operations to its customers, typically under contracts providing for a combination of aircraft, crews, maintenance and insurance ("ACMI"). Our customers are usually responsible for supplying the necessary aviation fuel and cargo handling services and reimbursing our airline for other operating expenses, such as landing fees, ramp expenses and certain aircraft maintenance expenses. Aircraft charter agreements, including those for the U.S. Military, usually require the airline to provide full service, including fuel and other operating expenses for a fixed, all-inclusive price. As of June 30, 2014, ACMI Services included 45 in-service aircraft, including 26 leased internally from CAM, six leased from external providers and 13 CAM-owned freighter aircraft which are under lease to DHL and operated by ABX under the CMI agreement. During the second quarter of 2014, the Company's airlines returned four Boeing 767 aircraft that were underutilized to CAM and CAM prepared the aircraft for external customer leases. 25 -------------------------------------------------------------------------------- Revenues from ACMI Services were $111.3 million and $219.9 million for the three and six month periods ending June 30, 2014, respectively, compared to $106.6 million and $217.9 million for the corresponding periods of 2013. ACMI Services generated pre-tax earnings of $0.3 million and pre-tax losses of $6.7 million for the three and six month periods ending June 30, 2014, respectively, compared to pre-tax losses of $9.1 million and $14.5 million for the corresponding periods of 2013. Airline services revenues from external customers, which do not include revenues for the reimbursement of fuel and certain operating expenses, declined $1.3 million and $6.9 million for the three and six month periods ending June 30, 2014, respectively, compared to the corresponding periods of 2013. Block hours declined 6% and 4% for the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. The decline in revenues and block hours were primarily due to the discontinuation of services for DHL's Middle East operations in February 2014. Excluding our services for DHL's Middle East operations, block hours increased 4% for the three and six month periods ending June 30, 2014, compared to the corresponding periods of 2013, driven by additional hours for DHL's U.S. and South American network. Block hours flown for the U.S. Military for the three and six month periods ending June 30, 2014 were up 10% and 2%, respectively, compared to the corresponding periods of 2013. Fewer trips were operated for the military during the second quarter of 2013 as ATI transitioned its fleet to the Boeing 757 combi aircraft from the legacy DC-8 combi aircraft. Operating expense, excluding reimbursable expenses, for ACMI Services declined $10.7 million and $14.7 million during the three and six month periods ending June 30, 2014, respectively, compared to the corresponding periods of 2013. Lower expense for employee wages and benefits, travel, aircraft landing fees, C-checks and fuel were partially offset by higher expenses for aircraft depreciation and maintenance. Employee wages and benefits expense declined due to a 13% reduction in the number of airline personnel since June 30, 2013 and lower pension expense. Lower fuel expense reflects the replacement of DC-8 combi aircraft with Boeing 757 combi aircraft for service with the U.S. Military since May of 2013. Operating expenses for landings and travel declined primarily due to the discontinuation of service for DHL in the Middle East. Lower aircraft maintenance expenses for 2014 reflect three and two fewer airframe heavy checks compared to the three and six month periods ending June 30, 2013, respectively. DHL recently terminated the services of two of the Company's Boeing 767 aircraft (one in May and one in July of 2014) which ABX operated under short term contracts in lower volume U.S. markets and replaced them with smaller Boeing 737 aircraft operated by another airline. We understand that DHL may replace one more Boeing 767 aircraft operated by ABX in a lower volume cargo market with a smaller Boeing 737 aircraft in the fourth quarter of 2014. Additionally, the ACMI Services segment currently has two aircraft that are underutilized at this time. We expect to continue the recent operational improvements in ACMI Services and we expect this segment to generate a pre-tax profit for the second half of 2014. Maintaining profitability in the ACMI Services segment will depend on new revenue opportunities for airline services, the corresponding costs of flight operations and number of aircraft we operate, as well as other factors. Our airlines may return lower utilized aircraft to CAM for lease to external customers after considering a number of factors including the duration of the customer commitment, the underlying credit quality of the customer and market pricing for each opportunity. Management and DHL have begun to discuss modifications to the operating agreement for DHL's U.S domestic network and the extension of services for DHL beyond March 30, 2015 when the CMI agreement becomes renewable. The CMI agreement could be renewed in a similar form or a new arrangement may be reached. We have no assurances that ABX will retain the same level of operations that it currently provides to DHL or that we will be able to achieve the current level of financial results. Other Activities The Company sells aircraft parts and provides aircraft maintenance and modification services primarily through its aircraft maintenance and repair business, Airborne Maintenance and Engineering Services, Inc. ("AMES"). The Company also provides services to the U.S. Postal Service ("USPS"), which mainly consists of sorting services at five USPS facilities. The Company also leases and maintains ground support equipment and provides facility maintenance services. Other activities also include the management of workers' compensation claims under an agreement with DHL, and gains from the reduction in employee post-retirement obligations. 26 -------------------------------------------------------------------------------- External customer revenues from all other activities were $20.5 million and $37.1 million for the three and six month periods ending June 30, 2014, respectively, compared to $14.5 million and $28.1 million for the corresponding periods of 2013. Our revenue from AMES aircraft maintenance, USPS sort operations and facility maintenance each increased compared to the corresponding periods of 2013. The pre-tax earnings from other activities were $4.1 million and $7.1 million for the three and six month periods ending June 30, 2014, respectively, compared to $2.6 million and $4.8 million for the corresponding periods of 2013. Pre-tax earnings from other activities increased due to stronger revenues, particularly driven by AMES, offset by additional expenses for higher headcount levels, cost of parts sold and higher employee benefit costs for these businesses in 2014 compared to 2013. AMES's revenues and earnings often vary among quarters due the maintenance schedule of customers and the maintenance tasks completed during a period. In 2013, the Company, as construction agent for the Clinton County Port Authority ("CCPA") in Wilmington, Ohio, began construction of a 100,000 square foot aircraft hangar facility adjacent to the existing aircraft maintenance facility currently utilized by AMES. Construction was primarily completed by the end of June 2014. While the current facility houses aircraft as large as the Boeing 767, the new facility provides AMES the capability of servicing aircraft as large as a Boeing 747-400 and the Boeing 777. The Company leases the facility from the CCPA and began to make related rent payments in 2014. We could incur incremental costs associated with the new hangar, including the costs of aircraft maintenance personnel, before the hangar is fully operational. Further, we will need to grow aircraft maintenance revenues utilizing the expanded hangar capabilities by expanding business with current customers and contracting with new customers. Our future operating results could be adversely impacted if anticipated revenues do not coincide with our costs of operating the new facility. The Company has been providing mail sorting services to the USPS since September 2004. The contracts for three of the facilities we service were last renewed in 2012 and currently expire at the end of September, 2014. We understand that the USPS may be considering other alternatives for the mail volumes currently serviced at these locations. The contracts for some or all of these facilities may not be renewed. Discontinued Operations Pre-tax gains related to the former sorting operations were $0.7 million for the first six months of 2014 compared to pre-tax losses of less than $0.1 million for the corresponding period of 2013. The results of discontinued operations primarily reflect the effects of defined benefit pension plans for former employees that supported sort operations under a hub services agreement with DHL. 27 -------------------------------------------------------------------------------- Fleet Summary 2014 The Company's cargo aircraft fleet is summarized below as of June 30, 2014 ($'s in thousands): ACMI Services CAM Total In-service aircraft Aircraft owned Boeing 767-200 13 21 34 Boeing 767-300 5 - 5 Boeing 757-200 4 - 4 Boeing 757-200 Combi 4 - 4 Total 26 21 47 Carrying value $ 665,772 Operating lease Boeing 767-200 4 - 4 Boeing 767-300 2 - 2 Total 6 - 6 Carrying value $ 782 Other aircraft Boeing 767 available or staging for lease - 4 4 As of June 30, 2014, ACMI Services leased 26 of its in-service aircraft internally from CAM. As of June 30, 2014, 13 of CAM's 21 Boeing 767-200 aircraft shown above were leased to DHL and operated by ABX. CAM leased the other eight Boeing 767-200 aircraft to external airlines. Aircraft fleet activity during 2014, through June 30 is summarized below: - CAM completed the modification of one Boeing 767-300 freighter aircraft and it is available for lease. - CAM completed the modification of one Boeing 757 combi aircraft and leased the aircraft internally to ATI, which deployed the aircraft for the U.S. Military. - CAM began to lease its only Boeing 767-200 passenger aircraft to an external airline. - ABX returned two Boeing 767-200 freighter aircraft and ATI returned one Boeing 767-200 freighter aircraft and one Boeing 767-300 freighter aircraft to CAM. CAM leased one aircraft to an external customer and was preparing the other three for external customer leases. As of June 30, 2014, the Company had Boeing 727 and DC-8 airframes and engines with a carrying value of $1.0 million that were available for sale. This carrying value is based on fair market values less the estimated costs to sell the airframes, engines and parts. Expenses from Continuing Operations Salaries, wages and benefits expense decreased $1.1 million and $1.3 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. While the number of airline employees declined 13% from June 30, 2013, the total level of headcount was unchanged. We have added staff for our USPS sort operations, facility maintenance operations and AMES, driven by additional revenues in these businesses since June of 2013. Maintenance, materials and repairs expense decreased by $1.8 million and increased by $0.9 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Maintenance expense decreased primarily due to three and two fewer airframe heavy checks performed during the three and six month periods ended June 30, 2014 compared to the corresponding periods of of 2013. Aircraft maintenance 28 -------------------------------------------------------------------------------- expenses can vary among periods due to the number of scheduled airframe maintenance checks and the scope of the checks that are performed. Depreciation and amortization expense increased $5.4 million and $9.4 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. The increase in depreciation expense reflects the removal of the DC-8 combi aircraft from service, offset by incremental depreciation expense for two Boeing 767 aircraft and three Boeing 757 combi aircraft added to the in-service fleet since June 2013. Fuel expense increased by $1.6 million and decreased by $0.5 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Fuel expense reflects the costs of fuel to operate U.S. Military charters, reimbursable fuel billed to DHL and fuel used to position aircraft for service and for maintenance purposes. The decrease during 2014 compared to 2013 reflects our use of the more fuel efficient Boeing 757 combi aircraft instead of DC-8 combi aircraft and an increased level of reimbursable fuel for customers. The average cost per gallon of fuel decreased about 1.5% and 2.2% for the three and six month periods ending June 30, 2014, respectively, compared to the corresponding periods of 2013. Rent expense increased by $0.1 million and $0.7 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Rent expense increased primarily for building rents and aircraft simulator facilities for pilot training. Travel expense decreased by $0.4 million and $0.5 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. The decrease reflects the lower level of employee headcount in the airlines and less international travel needed to support fewer international flight operations during 2014. Landing and ramp expense increased by $0.6 million and decreased by $0.7 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Landing and ramp fees can vary based on the flight schedules and the airports that are used in a period. Insurance expense increased by $0.2 million and decreased by $0.1 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. While aircraft fleet insurance has declined as the DC-8 aircraft were retired, the cost of employee insurance has risen compared to 2013. Other operating expenses increased by $2.2 million and $1.8 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Other operating expenses include professional fees, navigational services, employee training, utilities and the cost of parts sold to customers. Other operating expenses increased compared to the corresponding periods of the previous year primarily due to additional parts sold to aircraft maintenance customers. Interest expense decreased by $0.1 million and increased by $0.6 million during the three and six month periods ended June 30, 2014, respectively, compared to the corresponding periods of 2013. Interest expense decreased during the second quarter of 2014 compared to the second quarter of 2013 due to interest rates decreasing in the second quarter of 2014. Interest rates were 2.15% and 2.58% at June 30, 2014 and 2013, respectively. The higher interest expense for the six month period ended June 30, 2014 was primarily due to lower capitalized interest during the first six months of 2014 compared to 2013 and higher interest rates under the Senior Credit Agreement during the first three months of 2014. Capitalized interest was higher in 2013 while aircraft were undergoing the freighter modification process. The Company recorded pre-tax net gains on derivatives of less than $0.1 million and $0.3 million during the three and six month periods ended June 30, 2014, respectively, compared to $0.5 million and $0.7 million during the corresponding periods of 2013, reflecting the impact of fluctuating market interest rates. The provision for income taxes for interim periods is based on management's best estimate of the effective income tax rate expected to be applicable for the current year, plus any adjustments arising from changes in the estimated amount of taxable income related to prior periods. Income taxes recorded through June 30, 2014 have been estimated utilizing a 36.7% rate based upon year-to-date income and projected results for the full year. The final effective tax rate applied to 2014 will depend on the actual amount of pre-tax book income generated by the Company for the full year. The effective tax rate from continuing operations for the three and six month periods ended June 30, 2013 was 37.6% and 37.5%, respectively, based on projections of taxable income and tax deductions at that time. 29 -------------------------------------------------------------------------------- As of December 31, 2013, the Company had operating loss carryforwards for U.S. federal income tax purposes of approximately $97.5 million, which will begin to expire in 2024 if not utilized before then. We expect to utilize the loss carryforwards to offset federal income tax liabilities in the future. As a result, we do not expect to pay federal income taxes until 2016 or later. The Company may, however, be required to pay alternative minimum taxes and certain state and local income taxes before then. The Company's taxable income earned from international flights are primarily sourced to the United States under international aviation agreements and treaties. If we begin to operate in countries without such agreements, the Company could incur additional foreign income taxes. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Cash Flows Net cash generated from operating activities totaled $55.4 million and $48.0 million for the first six months of 2014 and 2013, respectively. Cash flows generated from operating activities increased in the first six months of 2014 compared to 2013 primarily due to lower contributions to pension plans and better operating profitability, offset by lower payments received from DHL and increased costs of inventory and billable work in process. Cash outlays for pension contributions were $1.0 million in 2014 compared to $9.7 million for the corresponding period of 2013. Investing cash flows for the first half of 2014, included $15.0 million to acquire a 25% interest in West Atlantic AB of Sweden. Cash payments for capital expenditures were $23.5 million and included $6.7 million for required heavy maintenance, $5.3 million for construction of a new aircraft hangar, $6.6 million for next generation navigation and communication modifications and $4.9 million for other equipment, including purchases of aircraft engines and rotables. Capital spending for the first six months of 2013 was $72.8 million and included $61.5 million for the acquisition and modification of aircraft, $6.6 million for required heavy maintenance, $1.5 million for construction of the new aircraft hangar and $3.2 million for other equipment costs. Net cash used by financing activities was $26.3 million for the first six months of 2014 compared to $29.0 million of cash provided by financing activities in the corresponding period of 2013. During the first six months of 2014, we drew $15.0 million from the revolving credit facility to fund the investment in West Atlantic AB and capital spending, and we made debt principal payments of $44.3 million. During the first six months of 2013, we drew $60.0 million from the revolving credit facility to fund capital expenditures as described above and we made debt principal payments of $32.6 million. Additionally, $3.1 million of the principal balance of the DHL promissory note was extinguished during the first six months of 2014 and 2013, respectively, pursuant to the CMI agreement with DHL. Commitments In July 2014, CAM entered into agreement to purchase two Boeing 767-300 freighters which are currently operated by ABX, under operating leases ending in 2015 and 2017, respectively. We expect CAM to complete the purchase in the third quarter of 2014. As part of the transaction, CAM also acquired an option to purchase another Boeing 767-300 freighter aircraft in 2015 and may lease it until then. We estimate that capital expenditures for 2014 will be $95 million for airframe and engine maintenance, hangar construction and other expenditures. Actual capital spending for any future period will be impacted by aircraft maintenance and modification processes and hangar construction. We expect to finance the capital expenditures from current cash balances, future operating cash flow and the Senior Credit Agreement. Liquidity The Company's Senior Credit Agreement is through a consortium of banks and includes an unsubordinated term loan of $123.8 million and a revolving credit facility from which the Company has drawn $173.0 million, net of repayments as of June 30, 2014. On May 6, 2014, the Company executed the third amendment to the Senior Credit Agreement (the "Third Credit Amendment"). The Third Credit Amendment extends the maturity of the term loan and revolving credit facility to May 6, 2019, provides for annual, one year extension options, provides for an accordion feature whereby the Company can draw up to an additional $50 million subject to the lenders' consent, reduces the EBITDA based pricing, eases requirements for stock dividends and stock buybacks and reduces the collateral requirements. The Senior Credit Agreement is collateralized by the Company's fleet of Boeing 767 and 757 aircraft that are not collateralized under aircraft loans. Under the amended terms of the Senior Credit Agreement, the Company is required to maintain collateral coverage equal to 150% of the outstanding balances of the term loan and the maximum 30 -------------------------------------------------------------------------------- capacity of the revolving credit facility or 175% of the outstanding balance of the term loan and the total funded revolving credit facility, whichever is less. The minimum collateral coverage which must be maintained is 50% of the outstanding balance of the term loan plus the revolving credit facility commitment of $275 million. The Third Credit Amendment does not change the repayment terms of the Senior Credit Agreement. Beginning May 6, 2015, and each year thereafter through May 6, 2019, the Company may request a one year extension of the final maturity date, subject to the lenders' consent. Under the Senior Credit Agreement, the Company is subject to covenants and warranties that are usual and customary, including among other things, limitations on certain additional indebtedness, guarantees of indebtedness, as well as a total debt to EBITDA ratio and a fixed charge coverage ratio. The Senior Credit Agreement stipulates events of default including unspecified events that may have a material adverse effect on the Company. If an event of default occurs, the Company may be forced to repay, renegotiate or replace the Senior Credit Agreement. Additional debt or lower EBITDA may result in higher interest rates. Under the Senior Credit Agreement, interest rates are adjusted quarterly based on the prevailing LIBOR or prime rates and a ratio of the Company's outstanding debt level to earnings before interest, taxes, depreciation and amortization expenses ("EBITDA"). At the Company's current debt-to-EBITDA ratio, the unsubordinated term loan and the revolving credit facility both bear a variable interest rate of 2.15%. At June 30, 2014, the Company had $23.8 million of cash balances. The Company had $91.8 million available under the revolving credit facility, net of outstanding letters of credit, which totaled $10.2 million. As specified under the terms of ABX's CMI agreement with DHL, the $4.7 million balance at June 30, 2014 of the unsecured note payable to DHL will be extinguished ratably without payment through March 31, 2015. We believe that the Company's current cash balances and forecasted cash flows provided from its operating agreements, combined with its Senior Credit Agreement, will be sufficient to fund operations, scheduled debt payments, required pension funding and planned capital expenditures for at least the next 12 months. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of June 30, 2014, we were not involved in any material unconsolidated SPE transactions. Certain of our operating leases and agreements contain indemnification obligations to the lessor or one or more other parties that are considered usual and customary (e.g. use, tax and environmental indemnifications), the terms of which range in duration and are often limited. Such indemnification obligations may continue after the expiration of the respective lease or agreement. No amounts have been recognized in our financial statements for the underlying fair value of guarantees and indemnifications. CRITICAL ACCOUNTING POLICIES AND ESTIMATES "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as certain disclosures included elsewhere in this report, are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to select appropriate accounting policies and make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingencies. In certain cases, there are alternative policies or estimation techniques which could be selected. On an ongoing basis, we evaluate our selection of policies and the estimation techniques we use, including those related to revenue recognition, post-retirement liabilities, bad debts, self-insurance reserves, valuation of spare parts inventory, useful lives, salvage values and impairment of property and equipment, income taxes, contingencies and litigation. We base our estimates on historical experience, current conditions and on various other assumptions that are believed to be reasonable under the circumstances. Those factors form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources, as well as for identifying and assessing our accounting treatment with respect to commitments and contingencies. Actual results may differ from these estimates under different assumptions or conditions. 31 -------------------------------------------------------------------------------- There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Estimates included in our Annual Report on Form 10-K for the year ended December 31, 2013 except as described below. In January 2014, the Company acquired a 25 percent equity interest in West Atlantic AB of Gothenburg, Sweden ("West"). The Company exercises significant influence but does not exercise control over West. Accordingly, the investment in West is accounted for using the equity method of accounting and is initially recognized at cost. The Company's share of West's income or loss is recognized in the consolidated statement of earnings and cumulative post-acquisition changes in the investment are adjusted against the carrying amount of the investment. The Company's carrying value of West is reflected in "Other Assets" in the Company's consolidated balance sheets. For information regarding recently issued accounting pronouncements and the expected impact on our annual statements, see Note A "SUMMARY OF FINANCIAL STATEMENT PREPARATION AND SIGNIFICANT ACCOUNTING POLICIES" in the accompanying notes to Condensed Consolidated Financial Statements included in Part II, Item 1 of this Form 10-Q. |