10-K 1 a201210k.htm 10-K 2012 10K

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ________________________________________________________________
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
Commission file number 000-50368
________________________________________________________________
(Exact name of registrant as specified in its charter)
________________________________________________________________
Delaware
 
26-1631624
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
145 Hunter Drive, Wilmington, OH 45177
(Address of principal executive offices)
937-382-5591
(Registrant’s telephone number, including area code)
 ________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $.01 per share
Preferred Stock Purchase Rights
(Title of class)
Name of each exchange on which registered: NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
________________________________________________________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o NO x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o
  
Accelerated filer x
Non-accelerated filer o (Do not check if a smaller reporting company)
  
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). YES o NO  x
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, as of the last business day of the registrant’s most recently completed second fiscal quarter: $275,383,113. As of March 4, 2013, 64,130,056 shares of the registrant’s common stock, par value $0.01, were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders scheduled to be held May 10, 2013 are incorporated by reference into Part III.



FORWARD LOOKING STATEMENTS
Statements contained in this annual report on Form 10-K, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Item 7, that are not historical facts are considered forward-looking statements (as that term is defined in the Private Securities Litigation Reform Act of 1995). Words such as “projects,” “believes,” “anticipates,” “will,” “estimates,” “plans,” “expects,” “intends” and similar words and expressions are intended to identify forward-looking statements. These forward-looking statements are based on expectations, estimates and projections as of the date of this filing, and involve risks and uncertainties that are inherently difficult to predict. Actual results may differ materially from those expressed in the forward-looking statements for any number of reasons, including those described in “Risk Factors” starting on page 10 and in “Results of Operations” starting on page 22.





AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
2012 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
 
 
 
 
 
  
 
Page
PART I
Item 1.
  
Item 1A.
  
Item 1B.
  
Item 2.
  
Item 3.
  
Item 4.
  
 
 
 
PART II
Item 5.
  
Item 6.
  
Item 7.
  
Item 7A.
  
Item 8.
  
Item 9.
  
Item 9A.
  
Item 9B.
  
 
 
 
PART III
Item 10.
  
Item 11.
  
Item 12.
  
Item 13.
  
Item 14.
  
 
 
 
PART IV
Item 15.
  





PART I

ITEM 1. BUSINESS
General Development of Business
Air Transport Services Group, Inc. (“ATSG”), provides airline operations, aircraft leases, aircraft maintenance and other support services primarily to the 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. (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.) Our services are summarized below:
Aircraft leasing: The Company's aircraft leasing subsidiary, Cargo Aircraft Management, Inc. (“CAM”), services global demand for medium range and medium capacity airlift by offering Boeing 767 and 757 aircraft leases. CAM is able to provide competitive lease rates by monitoring the related passenger aircraft sale markets, acquiring passenger aircraft based on projected into-service costs and rate of return targets, then managing the modification of passenger aircraft into freighters. As the result, the converted freighters can be deployed into regional markets more economically than larger capacity aircraft or competing alternatives. CAM leases cargo aircraft internally to ATSG airlines, and to external customers, typically under multi-year agreements.
ACMI Services: The Company's airlines provide Boeing 767 and Boeing 757 freighter aircraft and McDonnell Douglas DC-8 "combi" aircraft (which are capable of carrying passengers and cargo containers on the main flight deck), typically under contracts supplying a combination of aircraft, crews and maintenance services for customers. Our airlines are ABX Air, Inc. (“ABX”), Air Transport International, Inc. (“ATI”), and Capital Cargo International Airlines, Inc. (“CCIA”), each independently certificated by the U.S. Department of Transportation.
Support services: We offer a range of complementary solutions to shippers, freight forwarders and other airlines that provides us with a competitive advantage for growth and diversification. Customers who lease our aircraft typically need related services, such as scheduled aircraft maintenance, line maintenance and crew training which our subsidiaries can provide. Our businesses and subsidiaries providing support services are summarized below.
ABX provides flight crew training, flight simulator rental and aircraft maintenance services;
Airborne Maintenance and Engineering Services, Inc. (“AMES”), an aircraft maintenance, repair and overhaul business;
AMES Material Services, Inc. ("AMS"), reseller and broker of aircraft parts;
LGSTX Services, Inc. (“LGSTX”), provides facility maintenance and ground equipment rentals for aircraft support;
LGSTX Distribution Services, Inc. ("LDS"), operates mail sorting centers for the U.S Postal Service ("USPS");
Global Flight Source ("GFS"), provides aircraft dispatch and flight tracking services.
Customer revenues for 2012 are summarized as follows (in thousands):
 
 
 
ACMI Services
 
Aircraft leasing
 
Support services
 
 
 
 
 
 
 
 
 
External revenue (in thousands)
 
$477,722
 
$74,599
 
$55,117
 
Subsidiaries
 
ABX, ATI, CCIA
 
CAM
 
ABX, AMES, AMS, GFS, LDS, LGSTX
 
 
Airborne Global Solutions, Inc. ("AGS") is a subsidiary that assists our businesses in achieving their sales and marketing plans. AGS provides sales leads to our subsidiaries by identifying customers' business and operational requirements and leveraging the capabilities of our subsidiaries and other third party service providers to develop a customized air cargo solution that meets their customers' needs.

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ATSG is incorporated in Delaware and its headquarters is in Wilmington, Ohio. The Company's common shares are publicly traded on the NASDAQ Stock Market under the symbol ATSG. ATSG was formed on December 31, 2007, from the reorganization of ABX for the purpose of creating a holding company structure. 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 and became an independent publicly traded company, in conjunction with the acquisition of Airborne by an indirect wholly-owned subsidiary of DHL Worldwide Express, B.V. ATSG acquired CAM, ATI and CCIA on December 31, 2007. ATI, based in Little Rock, Arkansas, began operations in 1979 and was an affiliate of BAX Global, Inc. (“BAX/Schenker”) prior to 2006. ATI operates McDonnell Douglas DC-8 and Boeing 767 aircraft and provides airlift to the U.S. Military, DHL and various other customers. CCIA obtained its airline operating certificate in 1996 and operates Boeing 757 aircraft, primarily providing air freight transportation for DHL.
Description of Business
The Company has two reportable segments,“ACMI Services" and "CAM." Due to the similarities among the Company's airline operations, the airline operations are aggregated into a single reportable segment - ACMI Services. The Company’s other business operations, including aircraft maintenance and modification services, aircraft part sales, equipment leasing and maintenance and mail handling for the USPS do not constitute reportable segments due to their size. Financial information about our segments and geographical revenues is presented in Note N to the accompanying consolidated financial statements.
DHL Network Operations (USA), Inc. and its affiliates (individually and collectively, "DHL"), is the Company's largest customer, totaling 53% of the Company's consolidated revenues in 2012, while the U.S. Military comprised 16% of the Company's consolidated revenues in 2012. During 2011, BAX/Schenker totaled 26% of the Company's consolidated revenues. However, on July 22, 2011, BAX/Schenker announced its decision to phase out its dedicated air cargo network in North America, which was supported by the Company through 2011. Instead of a dedicated aircraft network, BAX/Schenker began to utilize DHL and other delivery services for its air transportation delivery requirements. We provided limited airlift directly to BAX/Schenker through the peak delivery season, until late December 2011. Beginning in January 2012, the Company contracted with DHL to supplement DHL's U.S. air network to service BAX/Schenker's freight volumes on DHL's expanded air network.
CAM
CAM’s fleet of 48 serviceable aircraft as of December 31, 2012, consists of Boeing 767, Boeing 757 and McDonnell Douglas DC-8 aircraft. A list of the Company's aircraft is included in Item 2, Properties.
CAM leases aircraft to ATSG airlines and to external customers, including DHL, usually under multi-year contracts with a schedule of fixed monthly payments. Under a typical lease arrangement, the customer maintains the aircraft in serviceable condition at its own cost. At the end of the lease term, the customer is typically required to return the aircraft in approximately the same maintenance condition as it was in at the inception of the lease, as measured by airframe and engine time, until the next scheduled maintenance event. CAM examines the credit worthiness of potential customers, their short and long term growth prospects, their financial condition and backing, the experience of their management and the impact of governmental regulation when determining the lease rate that is offered to the customer. In addition, CAM monitors the customer’s business and financial status throughout the term of the lease.
Through CAM, we have expanded in recent years the Company's combined fleet of Boeing 767 and 757 aircraft and retired less efficient Boeing 727 and McDonnell Douglas DC-8 freighter aircraft. CAM anticipates demand for cargo airlift based on input from customers, the volume of bids requested by the U.S. Military, management's interface with customer planning personnel and aircraft utilization trends. During 2013, we expect to complete the modification and certification of seven more aircraft and place them into service. Information about the Company's open commitments for aircraft expenditures is included in Note G to the accompanying consolidated financial statements.
ACMI Services
Through the Company's three airline subsidiaries, we provide airline operations to DHL, other airlines, freight forwarders and the U.S. Military. A typical operating agreement requires the ATSG airline to supply, at a specific rate per block hour and/or per month, the aircraft, crew, maintenance and insurance ("ACMI") for specified cargo operations,

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while the customer is responsible for substantially all other aircraft operating expenses, including fuel, landing fees, parking fees and ground and cargo handling expenses. However, some charter agreements, including with the U.S. Military, 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.
Demand for air cargo services correlates closely with general economic conditions and the level of commercial activity in a geographic area. Stronger general economic conditions and growth in a region typically increase the need for product transportation. Historically, the cargo industry has experienced higher volumes during the fourth calendar quarter of each year due to increased shipments during the holiday season. Generally, time-critical delivery needs, such as just-in-time inventory management, increase the demand for air cargo delivery, while higher costs of aviation fuel generally reduces the demand for air delivery services. When aviation fuel prices increase, shippers will consider using ground transportation if the delivery time allows.
The Company, through ABX, has had long term contracts with DHL since August 15, 2003. Beginning in August 2003, ABX operated primarily under two commercial agreements with DHL; an aircraft, crew, maintenance and insurance agreement (“DHL ACMI agreement”) and a hub services agreement (“Hub Services agreement”), both of which had become effective in conjunction with DHL's acquisition of Airborne. Under these agreements, ABX and DHL generally operated under a cost-plus pricing structure. ABX provided staff to conduct package sorting, as well as airport, facilities and equipment maintenance services for DHL under the Hub Services agreement. In 2008, DHL began to restructure its U.S. operations. Pursuant to its restructuring plan, DHL discontinued intra-U.S. domestic pickup and delivery services and now provides only international services to and from the U.S. In the third quarter of 2009, ABX ceased all remaining sort operations for DHL and the Hub Services agreement expired. Additionally, in the third quarter of 2009, DHL assumed the management of aircraft fuel services for its U.S. network that were previously provided by ABX.
ABX continued to provide airlift for DHL’s international delivery services in the U.S. through ABX’s Boeing 767 aircraft under the DHL ACMI agreement until March 2010. At that point, the Company and DHL terminated the DHL ACMI agreement and executed new follow-on agreements. Under the agreements, DHL committed to lease 13 Boeing 767 freighter aircraft from CAM, each for a term of seven years. ABX was separately contracted to operate those aircraft for DHL under a five year crew, maintenance and insurance agreement ("CMI agreement"). As of December 31, 2012, DHL was leasing 13 aircraft from CAM, all of which ABX operates for DHL under the CMI agreement.
ATI provides airlift to the Air Mobility Command ("AMC"), through contracts awarded by the U.S. Transportation Command ("USTC"), both of which are organized under the U.S. Military. ATI contracts its unique fleet of McDonnell Douglas DC-8 "combi" aircraft,which are capable of simultaneously carrying passengers and cargo containers on the main flight deck for the AMC. The USTC awards flights to U.S. certificated airlines through annual contracts. During 2012, USTC awarded ATI three international routes for combi aircraft through September of 2014. These routes are not based on or related to the current conflicts in the Middle East. Additionally, ATI often operates temporary "expansion" routes for the U.S Military using its McDonnell Douglas DC-8 combi and Boeing 767 freighter aircraft.
The Company has limited exposure to fluctuations in the price of aviation fuel under contracts with our customers. DHL, like most of our ACMI customers, procures the aircraft fuel and fueling services necessary for their flights. The charter agreements with the U.S. Military are based on a preset pegged fuel price and include a subsequent true-up to the actual fuel prices.
Aircraft Maintenance and Modification Services
We provide aircraft maintenance and modification services to other airlines through our ABX and AMES subsidiaries. ABX and AMES have technical expertise related to aircraft modifications as a result of ABX’s long history in aviation. They own 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.
AMES operates a Federal Aviation Administration (“FAA”) certificated 145 repair station, in Wilmington, Ohio, including hangars, a component shop and engineering capabilities. AMES is AS9100 quality certified for the aerospace industry. AMES markets its capabilities by identifying aviation-related maintenance and modification opportunities and matching them to its capabilities. AMES’ marketable capabilities include the installation of avionics systems and

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flat panel displays for Boeing 757 and Boeing 767 aircraft. The flat panel display modernizes aircraft avionics equipment and reduces maintenance costs by combining multiple display units into a single instrumentation panel. AMES has the capability to perform line maintenance and airframe maintenance on McDonnell Douglas DC-9, MD-80, Boeing 767, 757, 737 and 727 aircraft. AMES also has the capability to refurbish airframe components, including approximately 60% of the components for Boeing 767 aircraft.
DHL contracts with the Company to provide scheduled airframe maintenance for the 13 Boeing 767 aircraft that it leases from CAM. The Company also provides scheduled maintenance for four DHL-owned aircraft operated by ABX under the CMI agreement.
Aircraft Parts Sales and Brokerage
AMS is an Aviation Suppliers Association 100 Certified reseller and broker of aircraft parts. AMS carries an inventory of Boeing 767, DC-9 and DC-8 spare parts and also maintains inventory on consignment from original equipment manufacturers, resellers, lessors and other airlines. AMS' 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.
Equipment and Facility Maintenance
LGSTX provides contract maintenance services for aviation ground support equipment and facility services throughout the U.S. LGSTX has a large inventory of ground support equipment, such as power units, airstarts, deicers and pushback vehicles that it rents to airports, airlines and other customers. LGSTX is also licensed to resell aircraft fuel. LGSTX arranges fueling services for customers and can provide fuel for aircraft charter customers.
U.S. Postal Service
Since September 2004, we have provided mail sorting services under contracts with the USPS. Our subsidiary, LDS, manages USPS mail sort centers in Indianapolis, Dallas and Memphis. Under each of these three contracts, we are compensated at a firm price for fixed costs and an additional amount based on the volume of mail handled at each sort center. The contracts for these three USPS facilities were renewed in 2012 with similar economic terms through September 2014. LDS also provides labor for load transfer services to the USPS at two facilities under short term contracts.
Flight Support
ABX is FAA-certificated to offer flight crew training to customers and rent usage of its flight simulators for outside training programs. ABX has three flight simulators in operation. ABX’s Boeing 767 and DC-9 flight simulators are level C certified. The level C flight simulators allow ABX to qualify flight crewmembers under FAA requirements without performing check flights in an aircraft. The DC-8 simulator is level B certified, which allows ABX to qualify flight crewmembers by performing a minimum number of flights in an aircraft.
The Company's GFS business provides aircraft dispatch and flight monitoring to supplemental air carriers.
Discontinued operations
Discontinued operations are a result of DHL's decision in 2008 to restructure its U.S. operations. Pursuant to its restructuring plan, DHL discontinued intra-U.S. domestic pickup and delivery services and now provides only international services to and from the U.S. In the third quarter of 2009, ABX ceased all remaining sort operations for DHL. Additionally, in the third quarter of 2009, DHL assumed management of aircraft fuel services for its U.S. network previously provided by ABX. The results of discontinued operations for 2012 and 2011 primarily reflect pension expense for the former hub employees and costs related to legal claims involving ABX's use of temporary workers in its hub services operation (See Item 3, Legal Proceedings).

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Competitive Conditions
Our airline subsidiaries compete with other cargo airlines to place aircraft under ACMI arrangements and charter contracts. Other cargo airlines include Amerijet International, Inc., Atlas Air Worldwide Holdings, Inc., Evergreen International Aviation, Inc., National Air Cargo Group, Inc., Southern Air Inc. and World Airways, Inc. The primary competitive factors in the air cargo industry are price, fuel efficiency, geographic coverage, aircraft range, aircraft reliability and capacity. Cargo airlines also compete for cargo volumes with passenger airlines that have substantial belly cargo capacity. The air cargo industry is capital intensive and highly competitive, especially during periods of excess capacity of aircraft compared to cargo volumes.
The scheduled delivery industry is dominated by integrated door-to-door carriers including DHL, TNT Holdings B.V., the USPS, FedEx Corporation and United Parcel Service, Inc. Although the volume of our business is impacted by competition among these integrated carriers, we do not usually compete directly with them.
Competition for aircraft lease placements is generally affected by aircraft type, aircraft availability and lease rates. We target our leases to cargo airlines and delivery companies seeking medium widebody airlift. The Airbus A300-600 and A330 aircraft can provide capabilities similar to the Boeing 767 for medium widebody airlift.
The aircraft maintenance industry is labor intensive and typically competes based on cost, capabilities and reputation for quality. U.S. airlines may contract for aircraft maintenance with maintenance and repair organizations ("MROs") in other countries or geographies with a lower labor wage base, making the industry highly cost competitive.
Airline Operations
Flight Operations and Control
Each of the Company's airline operations are conducted pursuant to authority granted to them by the FAA. Airline flight operations, including aircraft dispatching, flight tracking and crew scheduling, are planned and controlled by personnel within each airline. The Company staffs aircraft dispatching and flight tracking 24 hours per day, 7 days per week.
Aircraft Maintenance
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. The airlines contract with MROs, including AMES, to perform heavy airframe maintenance on airframes and engines. Each airline owns and maintains an inventory 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.
Insurance
Our airline subsidiaries are required by the Department of Transportation (“DOT”) to carry a minimum amount of aircraft liability insurance. Their aircraft leases, loan agreements and 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. CAM’s customers are also required to maintain similar insurance coverage.
Employees
As of December 31, 2012, the Company had approximately 1,900 employees, including 1,655 full-time employees and 245 part-time employees. The Company employed approximately 460 flight crewmembers, 910 aircraft maintenance technicians and flight support personnel, 265 warehousing, sorting and logistics personnel, 75 employees for airport maintenance and logistics, 20 employees for sales and marketing and 170 employees for administrative functions. On December 31, 2011, the Company had approximately 2,010 employees.

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Labor Agreements
The Company’s flight crewmembers are unionized employees. The table below summarizes the representation of the Company’s flight crewmembers at December 31, 2012.
 
Airline
  
Labor Agreement Unit
  
Contract
Amendable
Date
  
Percentage of
the Company’s
Employees
ABX
  
International Brotherhood of Teamsters
  
12/31/2014
  
14.3%
ATI
  
Airline Pilots Association
  
5/28/2014
  
5.9%
CCIA
  
Airline Pilots Association
  
7/31/2013
  
4.1%
Under the Railway Labor Act (“RLA”), as amended, the crewmember labor agreements do not expire, so the existing contract remains in effect throughout any negotiation process. If required, mediation under the RLA is conducted by the National Mediation Board, which has the sole discretion as to how long mediation can last and when it will end. In addition to direct negotiations and mediation, the RLA includes a provision for potential arbitration of unresolved issues and a 30-day “cooling-off” period before either party can resort to self-help, including, but not limited to, a work stoppage.
We began to merge the airline operations of ATI and CCIA during 2012. In September 2012, ATI and CCIA flight crewmembers, as represented by the Air Line Pilots Association International ("ALPA") ratified a collective bargaining agreement which allows for an integrated seniority list. The airlines and ALPA completed the integration of the seniority lists by the end of 2012. We expect to complete the merger of ATI and CCIA's airline operations in the first quarter of 2013.

Training
The flight crewmembers are required to be licensed in accordance with Federal Aviation Regulations (“FARs”), with specific ratings for the aircraft type to be flown, and to be medically certified as physically fit to operate aircraft. Licenses and medical certifications are subject to recurrent requirements as set forth in the FARs, to include recurrent training and minimum amounts of recent flying experience.
The FAA mandates initial and recurrent training for most flight, maintenance and engineering personnel. Mechanics and quality control inspectors must also be licensed and qualified to perform maintenance on Company operated and maintained aircraft. Our airline subsidiaries pay for all of the recurrent training required for their flight crewmembers and provide training for their ground service and maintenance personnel. Their training programs have received all required FAA approvals.
Intellectual Property
The Company owns a small number of U.S. patents that have a nominal commercial value. The Company also owns many STCs issued by the FAA. The Company uses these STCs mainly in support of its own fleets; however, AMES has marketed certain STCs to other airlines.
Information Systems
The Company has invested significant management and financial resources in the development of information systems to facilitate flight and maintenance operations. We utilize systems to maintain records about the maintenance status and history of each major aircraft component, as required by FAA regulations. Using the systems, we track and control inventories and costs associated with each maintenance task, including the personnel performing those tasks. In addition, the Company’s flight operations systems coordinate flight schedules and crew schedules. We have developed and procured systems to track crewmember flight and duty times, and crewmember training status.

Regulation
Our subsidiaries’ airline operations are generally regulated by the DOT, the FAA and the Transportation Security Administration (“TSA”). Those operations must comply with numerous security and environmental laws, ordinances

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and regulations. In addition, they must also comply with various other federal, state, local and foreign laws and regulations.
Environment
Under current federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or clean-up of hazardous or toxic substances on, under, or in such property. Such laws often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. In addition, the presence of contamination from hazardous or toxic substances, or the failure to properly clean up such contaminated property, may adversely affect the ability of the owner of the property to use such property as collateral for a loan or to sell such property. Environmental laws also may impose restrictions on the manner in which a property may be used or transferred or in which a business located thereon may be operated and may impose remediation or compliance costs. Under its former air park sublease with DHL, ABX and DHL are required to defend, indemnify and hold each other harmless from and against certain environmental claims associated with the Air Park in Wilmington, Ohio.
Our subsidiaries’ aircraft currently meet all known requirements for engine emission levels. However, under the Clean Air Act, individual states or the U.S. Environmental Protection Agency may adopt regulations requiring reductions in emissions for one or more localities based on the measured air quality at such localities. Such regulations may seek to limit or restrict emissions by restricting the use of emission-producing ground service equipment or aircraft auxiliary power units. Further, the U.S. Congress has, in the past, considered legislation that would regulate greenhouse gas emissions and some form of federal climate change legislation is possible in the future.
In addition, the European Commission has approved the extension of the European Union Emissions Trading Scheme ("ETS") for greenhouse gas emissions to the airline industry. Beginning in 2012, all Company airline subsidiary flights to and from any airport in any member state of the European Union are covered by the ETS requirements, and each year we are now required to submit emission allowances in an amount equal to the carbon dioxide emissions from such flights. In November 2012, the European Commission proposed to defer airlines' compliance obligations for non-European flights and suspended related non-compliance sanctions until after the 38th ICAO Assembly to be held in late September and early October of 2013. The European Commission has taken this action to give the process at ICAO, which is considering international treaties or other actions focusing on reducing greenhouse gas emissions from aviation, time to come to a conclusion. Under the European Commission proposal, airlines will not face enforcement action if they do not surrender allowances for their emissions related to flights operated to and from non-EU destinations; however, all intra-EU flights on any carrier (based in the EU or not) will still have to comply with the requirements of the ETS.  Legislation is required to implement this proposed change and a co-decision by both the EU Member States and the European Parliament on this change is necessary. A decision is expected before April 2013. Further, at the end of November 2012, the United States government enacted legislation exempting U.S. airlines from the ETS. ABX currently operates intra-EU flights, and both ABX and ATI operated intra-EU flights during 2012. Management believes that ABX's and ATI's intra-EU flights were operated in compliance with ETS requirements.
The federal government generally regulates aircraft engine noise at its source. However, local airport operators may, under certain circumstances, regulate airport operations based on aircraft noise considerations. The Airport Noise and Capacity Act of 1990 provides that, in the case of Stage 3 aircraft (all of our operating aircraft satisfy Stage 3 noise compliance requirements), an airport operator must obtain the carriers’ consent to, or the government’s approval of, the rule prior to its adoption. We believe the operation of our airline subsidiaries’ aircraft either complies with or is exempt from compliance with currently applicable local airport rules. However, some airport authorities have adopted local noise regulations, and, to the extent more stringent aircraft operating regulations are adopted on a widespread basis, our airline subsidiaries may be required to spend substantial funds, make schedule changes or take other actions to comply with such local rules.
The U.S. government, working through the International Civil Aviation Organization, has in the past adopted more stringent aircraft engine emissions regulations with regard to newly certificated engines and aircraft noise regulations applicable to newly certificated aircraft. Although these rules will not apply to any of our airline subsidiaries’ existing aircraft, additional rules could be adopted in the future that would either apply these more stringent noise and emissions standards to aircraft already in operation or require that some portion of the fleet be converted over time to comply with these new standards.

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Department of Transportation
The DOT maintains authority over certain aspects of domestic air transportation, such as requiring a minimum level of insurance and the requirement that a person be “fit” to hold a certificate to engage in air transportation. In addition, the DOT continues to regulate many aspects of international aviation, including the award of international routes. The DOT has issued ABX a Domestic All-Cargo Air Service Certificate for air cargo transportation between all points within the U.S., the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. The DOT has issued ATI certificate authority to engage in scheduled interstate air transportation, which is currently limited to all-cargo operations. ATI's DOT certificate authority also authorizes it to engage in interstate and foreign charter air transportation of persons, property and mail. CCIA holds DOT certificate authority to engage in interstate all-cargo air transportation and DOT certificate authority to engage in foreign charter air transportation of property and mail.  Additionally, the DOT has issued ABX, CCIA and ATI Certificates of Public Convenience and Necessity authorizing each of them to engage in scheduled foreign air transportation of cargo and mail between the U.S. and all current and future U.S. open-skies partner countries, which currently consists of over 100 foreign countries.  ABX also holds exemption authorities issued by DOT to conduct scheduled all-cargo operations between the U.S. and certain foreign countries with which the U.S. does not have an open-skies air transportation agreement. 
By maintaining these certificates, the Company, through its airline subsidiaries, can conduct all-cargo charter operations worldwide. Prior to issuing such certificates, and periodically thereafter, the DOT examines a company’s managerial competence, financial resources and plans, compliance, disposition and citizenship in order to determine whether the carrier is fit, willing and able to engage in the transportation services it has proposed to undertake.
The DOT has the authority to impose civil penalties, or to modify, suspend or revoke our certificates for cause, including failure to comply with federal laws or DOT regulations. A corporation holding the above-referenced certificates must qualify as a citizen of the United States, which, pursuant to federal law, requires that (1) it be organized under the laws of the U.S. or a state, territory or possession thereof, (2) that its president and at least two-thirds of its Board of Directors and other managing officers be U.S. citizens, (3) that less than 25% of its voting interest be owned or controlled by non-U.S. citizens, and (4) that it not otherwise be subject to foreign control. We believe our airline subsidiaries possess all necessary DOT-issued certificates and authorities to conduct our current operations and continue to qualify as a citizen of the United States.
Federal Aviation Administration
The FAA regulates aircraft safety and flight operations generally, including equipment, ground facilities, maintenance, flight dispatch, training, communications, the carriage of hazardous materials and other matters affecting air safety. The FAA issues operating certificates and operations specifications to carriers that possess the technical competence to conduct air carrier operations. In addition, the FAA issues certificates of airworthiness to each aircraft that meets the requirements for aircraft design and maintenance. ABX, CCIA and ATI believe they hold all airworthiness and other FAA certificates and authorities required for the conduct of their business and the operation of their aircraft, although the FAA has the power to suspend, modify or revoke such certificates for cause, or to impose civil penalties for any failure to comply with federal laws and FAA regulations.
The FAA has the authority to issue airworthiness directives and other mandatory orders relating to, among other things, the inspection and maintenance of aircraft and the replacement of aircraft structures, components and parts, based on the age of the aircraft and other factors. For example, the FAA has required ABX to perform inspections of its Boeing 767 aircraft to determine if certain of the aircraft structures and components meet all aircraft certification requirements. If the FAA were to determine that the aircraft structures or components are not adequate, it could order operators to take certain actions, including but not limited to, grounding aircraft, reducing cargo loads, strengthening any structure or component shown to be inadequate, or making other modifications to the aircraft. New mandatory directives could also be issued requiring the Company’s airline subsidiaries to inspect and replace aircraft components based on their age or condition. As a routine matter, the FAA issues airworthiness directives applicable to the aircraft operated by our airline subsidiaries, and our airlines comply, sometimes at considerable cost, as part of their aircraft maintenance program. In addition to the FAA practice of issuing Airworthiness Directives as conditions warrant, the FAA has adopted new policies to address issues involving older, but still economically viable, aircraft on a more systematic basis. FAA regulations mandate that aircraft manufacturers establish limits on aircraft flight cycles before which widespread fatigue damage might occur. The Boeing Company has provided its recommendation to the FAA, which is reviewing those limits. Once these limits are approved by the FAA, carriers must then incorporate them into

8


their maintenance programs over time. After the limits are reached, airlines will be unable to continue to operate the aircraft without the FAA first granting an extension of time to the operator. As the FAA has not yet set the new limits, the Company cannot yet estimate the impact of the new rule on any of its airline subsidiaries.
The FAA has adopted a policy regarding the proper application of airport rates and charges imposed on airlines. The policy provides greater flexibility to airport operators to impose charges that would expressly allow for the imposition of “congestion fees” rather than uniform airport fees. If airports in the U.S. seek to use the flexibility offered by this policy, it could have an impact on the cost of conducting our flight operations.
The FAA requires each of the airline subsidiaries to implement a drug and alcohol testing program with respect to all employees that engage in safety sensitive functions. Each of the airlines comply with these regulations.
Transportation Security Administration
The TSA, an administration within the Department of Homeland Security, is responsible for the screening of passengers, baggage and cargo and the security of aircraft and airports. Our airline subsidiaries comply with all applicable aircraft and cargo security requirements. The TSA has adopted cargo security-related rules that have imposed additional burdens on our airlines and our customers. Among other things, the TSA requires each airline to perform criminal history background checks on all employees. In addition, we may be required to reimburse the TSA for the cost of security services it may provide to the Company’s airline subsidiaries in the future.
Department of Defense
ABX and ATI participate in the Department of Defense ("DOD") Civil Reserve Air Fleet ("CRAF") program. Our participation in the CRAF program allows the DOD to requisition specified aircraft for military use during a national defense emergency. The DOD compensates us for the use of aircraft under the CRAF program. In addition, participation in CRAF entitles our airlines to bid for military cargo charter operations.
International Regulations
When operating in other countries, our airlines are subject to aviation agreements between the U.S. and the respective countries or, in the absence of such an agreement, by principles of reciprocity. International aviation agreements are periodically subject to renegotiation, and changes in U.S. or foreign governments could result in the alteration or termination of the agreements affecting our international operations. Commercial arrangements such as ACMI agreements, between our airlines and our customers in other countries, may require the approval of foreign governmental authorities. Foreign authorities may limit or restrict the use of our aircraft in certain countries. Also, foreign government authorities often require licensing and business registration before beginning operations.
Other Regulations
Various regulatory authorities have jurisdiction over significant aspects of our business, and it is possible that new laws or regulations or changes in existing laws or regulations or the interpretations thereof could have a material adverse effect on our operations. In addition to the above, other laws and regulations to which we are subject, and the agencies responsible for compliance with such laws and regulations, include the following:
 
The labor relations of our airline subsidiaries are generally regulated under the Railway Labor Act, which vests in the National Mediation Board certain regulatory powers with respect to disputes between airlines and labor unions arising under collective bargaining agreements; 
The Federal Communications Commission regulates our airline subsidiaries’ use of radio facilities pursuant to the Federal Communications Act of 1934, as amended; 
U.S. Customs and Border Protection inspects cargo imported from our subsidiaries’ international operations; 
Our airlines must comply with U.S. Citizenship and Immigration Services regulations regarding the citizenship of our employees; 
The Company and its subsidiaries must comply with wage, work conditions and other regulations of the Department of Labor regarding our employees.

9


Security and Safety
Security
The Company’s subsidiaries have instituted various security procedures and protocols to comply with FAA and TSA regulations. The airline subsidiaries’ customers are required to inform them in writing of the nature and composition of any freight which is classified as “Dangerous Goods” by the DOT. In addition, the Company and its subsidiaries conduct background checks on our respective employees, restrict access to aircraft, inspect aircraft for suspicious persons or cargo, and inspect all dangerous goods. Notwithstanding these procedures, our airline subsidiaries could unknowingly transport contraband or undeclared hazardous materials for customers, which could result in fines and penalties and possible damage to the aircraft.
Safety and Inspections
Management is committed to the safe operation of its aircraft. In compliance with FAA regulations, our subsidiaries’ aircraft are subject to various levels of scheduled maintenance or “checks” and periodically go through phased overhauls. In addition, a comprehensive internal audit and evaluation program is in place and active. Our subsidiaries’ aircraft maintenance efforts are monitored closely by the FAA. They also conduct extensive safety checks on a regular basis.
Available Information
Our filings with the Securities and Exchange Commission, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, are available free of charge from our website at www.atsginc.com as soon as reasonably practicable after filing with the SEC. The Securities and Exchange Commission maintains an Internet site that contains reports, proxy and information statements and other information regarding Air Transport Services Group, Inc. at www.sec.gov.

ITEM 1A. RISK FACTORS
The risks described below could adversely affect our financial condition or results of operations. The risks below are not the only risks that the Company faces. Additional risks that are currently unknown to us or that we currently consider immaterial or unlikely could also adversely affect the Company.
The economic conditions in the U.S. and throughout the globe may negatively impact the demand for the Company’s aircraft and services.
Air cargo transportation volumes are strongly correlated to general economic conditions, including the price of aviation fuel. An economic downturn could reduce the demand for delivery services offered by DHL and other delivery businesses, in particular expedited services shipped via aircraft. Accordingly, an economic downturn could reduce the demand for airlift and cargo aircraft leases. Further, during an economic slowdown, customers generally prefer to use ground-based or marine delivery services instead of more expensive air delivery services. Additionally, if the price of aviation fuel rises significantly, the demand for cargo aircraft and air delivery services may decline below expectations. During periods of downward economic trends and uncertainty, freight forwarders and integrated delivery businesses are more likely to defer market expansion plans. As a result, we may experience delays in the deployment of available aircraft with customers under lease, ACMI or charter arrangements.
The Company continues to make significant investments in additional aircraft which may impact the Company’s operating results and financial condition.
During 2013, we plan to make capital investments to complete the modification of Boeing 767 and Boeing 757 freighter aircraft and Boeing 757 combi aircraft. The actual demand for the Boeing 767 and 757 may be less than we anticipate. The actual lease rates for newly modified aircraft may be less than we projected, or new leases may start later than we expect. Further, other airlines and lessors may be willing to offer aircraft to the market under terms more favorable to lessees.
The Company's future operating results and financial condition will depend in part on our subsidiaries’ ability to successfully deploy these aircraft in operations that provide a positive return on investment. Our success will depend, in part, on their ability to secure additional cargo volumes from customers, in both U.S. and international markets. Deploying aircraft in international markets can pose additional risks, regulatory requirements and costs.

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Our costs incurred in providing airline services could be more than the contractual revenues generated.
Each airline develops business plans for ACMI, charter and other operating contracts by projecting operating costs, crew productivity and maintenance expenses. Projections contain key assumptions, including flight hours, aircraft reliability, crewmember productivity and crewmember compensation and benefits. We may overestimate revenues, the level of crewmember productivity, and/or underestimate the actual costs of providing services when preparing for new business opportunities. If actual costs are higher than projected or aircraft reliability is less than expected, future operating results may be negatively impacted.
The Company’s airlines rely on flight crews that are unionized. If collective bargaining agreements increase our costs and we cannot recover such increases, it may be necessary for us to terminate customer contracts or curtail planned growth. If disagreements arise, airline operations could be interrupted and business could be adversely affected until agreements are reached with the crewmembers.
To further streamline the operations impacted by the loss of the BAX/Schenker business, we intend to complete the merger of the airline operations of ATI and CCIA in the first quarter of 2013, with ATI being the surviving corporation. The merger will require the FAA to amend ATI's operations specifications to include all CCIA aircraft to be operated by ATI after the merger. The DOT may also conduct a fitness review of ATI as a result of the merger. The merger of ATI and CCIA's operations could result in restructuring costs, contract termination costs and other charges. The execution of the merger plan could be delayed due to regulatory requirements or business reasons, which could increase expected costs and have an adverse effect on future operating results.
Our airline operating agreements include on-time reliability requirements which can impact the Company's operating results and financial condition.
Our airline operating agreements may contain monthly incentive payments for reaching specific on-time reliability thresholds. Additionally, our airline operating agreements may contain monetary penalties if aircraft reliability falls below certain monthly thresholds. As a result, our operating revenues may vary from period to period depending on the achievement of monthly incentives or the imposition of penalties. Further, an airline could be found in default of an agreement if it does not maintain minimum thresholds over an extended period of time.
If ABX fails to maintain aircraft reliability above a minimum threshold in DHL's U.S. domestic network for two consecutive calendar months or three months in a rolling twelve month period, ABX would be in default of the CMI agreement with DHL. In that event, DHL may elect to terminate the CMI agreement, unless ABX maintains the minimum reliability threshold during a 60-day cure period. If DHL terminates the CMI agreement due to an ABX event of default, ABX would be subject to a monetary penalty payable to DHL. The penalty through the remaining initial term of the CMI agreement would be $10 million.
Under provisions of the CMI and lease agreements with DHL, DHL can terminate the CMI or lease agreements subject to early termination provisions.
DHL may terminate the CMI agreement for convenience at any time during the initial five-year term (through March 30, 2015) on the date that it ceases operating or causing to be operated the aircraft on air routes for which the origin and destination are within the United States, subject to providing six months notice and paying to ABX a termination fee. The termination fee started at $70 million on March 31, 2011, and amortizes to zero during the remaining four year initial term of the CMI agreement. DHL may terminate one or more of the aircraft leases for convenience at any time after the first 24 months of the respective terms thereof, upon providing six months' notice and paying to CAM a lump sum amount equal to six months' rent. DHL may also terminate one or more aircraft leases at any time after the first 54 months of the term of the CMI agreement, in the event that DHL desires to transfer operational control of such aircraft, but is restricted from doing so by the terms of the collective bargaining agreement between ABX and its pilots' union providing that members of the pilots' union have the right to follow the aircraft to another operator, subject to providing six months' notice and paying to CAM a lump sum amount equal to two months rent.

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The U.S. Military may not renew our contracts or may reduce the number of routes that we operate.
Our contracts with the U.S. Military are typically for one year and are not required to be renewed. The U.S. Military may terminate the contracts for convenience or in the event we were to default for failure to satisfy reliability requirements or for other reasons. The number and frequency of routes is sensitive to changes in military priorities and U.S. defense budgets.
Our business could be negatively impacted by adverse audit findings by the U.S. Government.
Our U.S. Military contracts are subject to audit by government agencies, including with respect to performance, costs, internal controls and compliance with applicable laws and regulations. If an audit uncovers improprieties, we may be subject to civil or criminal penalties, including termination of such contracts, forfeiture of profits, fines and suspension from doing business with the U.S. Military.
Proposed rules from the DOT, FAA and TSA could increase the Company's operating costs and reduce customer utilization of airfreight.
In December 2011, the FAA finalized new rules for Flightcrew Member Duty and Rest Requirements (FMDRR) for passenger airlines. If applied to cargo carriers, the new rules would require a pilot to have nine hours for the opportunity to rest before reporting to flight duty and place other restrictions on the number of duty hours in particular time periods. In May 2012, the FAA indicated that it would reconsider its initial decision to exclude cargo pilots from these new requirements. While not currently required for the Company's cargo operations, if such rest requirements and restrictions were imposed on our cargo operations, these rules could have a significant impact on the costs incurred by ATSG airlines. The airlines would attempt to pass such additional costs onto their customers in the form of price increases. Customers, as a result, may seek to reduce their utilization of aircraft in favor of less expensive transportation alternatives. The ATSG airlines are each monitoring the rules and evaluating the effect that the rules could have on their flight resources and costs.
The concentration of aircraft types and engines in the Company's airlines could adversely affect our operating and financial results.
The combined aircraft fleet is concentrated in three aircraft types. If any of these aircraft types encounter technical difficulties that resulted in significant FAA Airworthiness Directives or grounding, our ability to lease the aircraft would be adversely impacted, as would our airlines' operations. The market growth in demand for the Boeing 767 and 757 aircraft types and configurations may be less than we anticipate. Customers may develop preferences for the Airbus A300-600 and A330 aircraft, which provide capabilities similar to the Boeing 767 aircraft.
The cost of aircraft repairs and unexpected delays in the time required to complete aircraft maintenance could negatively affect our operating results.
Our aircraft provide ACMI services throughout the world, sometimes operating in remote regions. Our aircraft may experience maintenance events in locations that do not have the necessary repair capabilities or are difficult to reach. As a result, we may incur additional expenses and lose billable revenues that we would have otherwise earned. Under the CMI agreement with DHL, AMES provides scheduled airframe maintenance for the 13 Boeing 767 aircraft that DHL leases from CAM and we are required to provide a spare aircraft while the scheduled maintenance is completed. If delays occur in the completion of aircraft maintenance, we may incur additional expense to provide airlift capacity and forego revenues.
We rely on third parties to modify aircraft and provide aircraft and engine maintenance.
We rely on certain third party aircraft modification service providers and aircraft and engine maintenance service providers that have expertise or resources that we do not have. Third party service providers may seek to impose price increases that could negatively affect our competitiveness in the airline markets. An unexpected termination or delay involving service providers could have a material adverse effect on our operations and financial results. A delay in an aircraft modification could adversely impact our revenues and our ability to place the aircraft in the market. We must manage third party service providers to meet schedules and turntimes and to control costs in order to remain competitive to our customers.

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The Company's operating results could be negatively impacted by disruptions of its information technology and communication systems.
Our businesses depend heavily on information technology and computerized systems to communicate and operate effectively. The Company's systems and technologies, or those of third party's on which we rely, could fail or become unreliable due to equipment failures, software viruses, cyberattacks, natural disasters, power failures or other causes. Certain disruptions could prevent our airlines from flying as scheduled, possibly for an extended period of time, which could have a negative impact on our operating results and reliability. We continually monitor the risks of disruption, take preventative measures, develop backup plans and maintain redundancy capabilities. However, the measures we use may not prevent the causes of disruptions we could experience or help us recover failed systems quickly.
The costs incurred in expanding our aircraft maintenance facilities could negatively impact our financial results.
We have agreed to a long term lease of a new 100,000 square foot maintenance hangar, in Wilmington, Ohio that is currently under construction and expected to be completed in 2014. The new hangar is being built in anticipation of additional aircraft maintenance contracts, including the ability to house Boeing 747 and 777 aircraft. As construction agent, we are responsible for managing the construction costs of the project. Additionally, we could incur incremental operating costs associated with the new hangar, including costs associated with employing additional aircraft maintenance personnel, before it is completed. Further, we will need to grow the Company's aircraft maintenance revenues utilizing the expanded capabilities by securing additional business. Those anticipated level of revenues may not coincide with our costs of operating the new facility.
The Company could violate debt covenants.
The Senior Credit Agreement contains covenants including, among other requirements, limitations on certain additional indebtedness and guarantees of indebtedness. The Senior Credit Agreement is collateralized by certain of the Company's Boeing 767 and 757 aircraft that are not collateralized under aircraft loans. Under the terms of the Senior Credit Agreement, the Company is required to maintain aircraft collateral coverage equal to 150% of the outstanding balance of the term loan and the maximum capacity of the revolving credit facility. The Senior Credit Agreement stipulates events of default, including unspecified events that may have material adverse effects on the Company. The Senior Credit Agreement and aircraft loans cross default. If an event of default occurs, the Company may be forced to repay, renegotiate or replace the Senior Credit Agreement and loans. In such an event, the Company’s cost of borrowings could increase, and our ability to modify and deploy aircraft could be limited as a result.
The Company's existing sources of liquidity may not be sufficient for our planned fleet expansion.
As of December 31, 2012, the Company's liquidity included $15.4 million of cash balances, $70.9 million available under the revolving credit facility and a $50 million accordion feature through the Senior Credit Agreement subject to lender consent. Our fleet expansion plan for 2013 involves the acquisition of two Boeing 757 aircraft and the modification of Boeing 767 and Boeing 757 aircraft which we expect to finance through the Senior Credit Agreement and cash generated from operations. The existing sources of liquidity may not be sufficient to support our planned fleet expansion. We may need additional sources of credit to complete the fleet expansion. If such additional sources of credit are not available when we need the funds, the fleet expansion could be delayed. Further, such sources of credit would likely result in an increase in our borrowing costs and additional covenant requirements.
Operating results may be affected by fluctuations in interest rates.
Effective March 31, 2011, in conjunction with our decision to refinance the unsubordinated term loan, the Company ceased hedge accounting for certain interest rates swaps which it continues to hold. In addition to these interest rate swaps, the Company's Senior Credit Agreement requires the Company to maintain derivative instruments for fluctuating interest rates for at least 50% of the outstanding balance of the new unsubordinated term loan. Accordingly, in July 2011, the Company entered into new derivative instruments. The Company did not designate the derivative instruments as hedges. Future fluctuations in LIBOR interest rates will result in the recording of gains and losses on interest rate derivatives that the Company holds.
The Company sponsors defined benefit pension plans and post-retirement healthcare plans for certain eligible employees. The Company's related pension expense and funding requirements are sensitive to changes in interest rates used to discount the estimated future benefits payments that have been earned by participants in the plans. The annual pension expense is recalculated at the beginning of each calendar year using market interest rates at that point in time.

13


Future fluctuations in interest rates could result in the recording of additional expense for pension and other post-retirement healthcare plans.
The ability to use net operating loss carryforwards to offset future taxable income for U.S. federal income tax purposes may be further limited.
Limitations imposed on the ability to use net operating losses (“NOLs”) to offset future taxable income could cause U.S. federal income taxes to be paid earlier than otherwise would be paid if such limitations were not in effect and could cause such NOLs to expire unused, in each case reducing or eliminating the benefit of such NOLs. Similar rules and limitations may apply for state income tax purposes.
Changes in the ownership of the Company on the part of significant shareholders could limit our ability to use NOLs to offset future taxable income. In general, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its pre-change NOLs to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of significant stockholders increases by more than 50 percentage points over such stockholders’ lowest percentage ownership during the testing period (generally three years).
Operating results and cash flows will be impacted by the sales value of Boeing 727 and DC-8 aircraft, engines and related parts.
As of December 31, 2012, the Company has approximately $3.4 million of Boeing 727 and DC-8 freighter aircraft, engines and related parts. Although we are marketing the Boeing 727 and DC-8 aircraft, engines and related parts to other airlines and parts dealers, management cannot predict when the assets will be sold. The market value of the assets could decline before we are able to sell them, resulting in additional impairment charges. Further, assets may be sold for an amount that is less than their carrying value at the time of sale, resulting in losses.
We may need to reduce the carrying value of the Company’s assets.
The Company owns a significant amount of aircraft, aircraft parts and related equipment. Additionally, the balance sheet reflects assets for income tax carryforwards and other deferred tax assets. The removal of aircraft from service or continual losses from aircraft operations could require us to evaluate the recoverability of the carrying value of those aircraft, related parts and equipment and record an impairment charge through earnings to reduce the carrying value.
We have recorded significant amounts of goodwill and other intangible assets related to acquisitions. If we are unable to achieve the projected levels of operating results, it may be necessary to record an impairment charge to reduce the carrying value of goodwill and related intangible assets. Similarly, if we were to lose a key customer or one of our airlines were to lose its authority to operate, it could be necessary to record an impairment charge.
If the Company incurs operating losses or our estimates of expected future earnings indicate a decline, it may be necessary to reassess the need for a valuation allowance for some or all of the Company’s net deferred tax assets.
Penalties, fines and sanctions levied by governmental agencies or the costs of complying with government regulations could negatively affect our results of operations.
The operations of the Company’s subsidiaries are subject to complex aviation, transportation, security, environmental, labor, employment and other laws and regulations. These laws and regulations generally require our subsidiaries to maintain and comply with a wide variety of certificates, permits, licenses and other approvals. Their inability to maintain required certificates, permits or licenses, or to comply with applicable laws, ordinances or regulations could result in substantial fines or, in the case of DOT and FAA requirements, possible suspension or revocation of their authority to conduct operations.
The costs of maintaining our aircraft in compliance with government regulations could negatively affect our results of operations.
All aircraft in the Company’s fleet were manufactured prior to 1995. Manufacturer Service Bulletins and FAA Airworthiness Directives issued under its “Aging Aircraft” program cause operators of such aged aircraft to be subject to extensive aircraft examinations and require such aircraft to undergo structural inspections and modifications to address problems of corrosion and structural fatigue at specified times. The FAA may issue Airworthiness Directives that could require significant inspections and major modifications to such aircraft. The FAA may issue Airworthiness Directives that could limit the usability of certain aircraft types. In 2012, the FAA issued an Airworthiness Directive

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that requires the replacement of the aft pressure bulkhead on Boeing 767-200 aircraft based on a certain number of landing cycles. As a result, we expect that most of the Boeing 767-200 aircraft in the Company's fleet will be affected. The cost of compliance is estimated to be $0.5 to $0.7 million per aircraft over the next ten years.
In addition, FAA regulations require that aircraft manufacturers establish limits on aircraft flight cycles to address issues involving older, but still economically viable, aircraft, as described in Item 1 of this report, under "Federal Aviation Administration." These regulations may increase our maintenance costs and eventually limit the use of our aircraft.
Failure to maintain the operating certificates and authorities of our airlines would adversely affect our business.
The airline subsidiaries have the necessary authority to conduct flight operations pursuant to the economic authority issued by the DOT and the safety based authority issued by the FAA. The continued effectiveness of such authority is subject to their compliance with applicable statutes and DOT, FAA and TSA rules and regulations, including any new rules and regulations that may be adopted in the future. The loss of such authority by an airline subsidiary could cause a default of covenants within the Senior Credit Agreement and would materially and adversely affect its airline operations, effectively eliminating the airline's ability to operate air services.
The Company may be affected by global climate change or by legal, regulatory or market responses to such potential climate change.
The Company is subject to the regulations of the U.S. Environmental Protection Agency and state and local governments regarding air quality and other matters. In part, because of the highly industrialized nature of many of the locations where the Company operates, there can be no assurance that we have discovered all environmental contamination or other matters for which the Company may be responsible.
Concern over climate change, including the impact of global warming, has led to significant federal, state and international legislative and regulatory efforts to limit greenhouse gas emissions. The European Commission has mandated the extension of the European Union Emissions Trading Scheme ("ETS") for greenhouse gas emissions to the airline industry. Beginning in 2012, all Company airline subsidiary flights to and from any airport in any member state of the European Union is covered by the ETS requirements, and each year we are required to submit emission allowances in an amount equal to the carbon dioxide emissions from such flights. Exceedance of the airlines' emission allowances would require the airlines to purchase additional emission allowances on the open market. In November 2012, the European Commission proposed to defer airlines' compliance obligations for non-European flights and suspended related non-compliance sanctions until after the 38th ICAO Assembly to be held in late September and early October of 2013. The European Commission has taken this action to give the process at ICAO, which is considering international treaties or other actions focusing on reducing greenhouse gas emissions from aviation, time to come to a conclusion. Under the European Commission proposal, airlines will not face enforcement action if they do not surrender allowances for their emissions related to flights operated to and from non-EU destinations; however, all intra-EU flights on any carrier (based in the EU or not) will still have to comply with the requirements of the ETS.  Legislation is required to implement this proposed change and a co-decision by both the EU Member States and the European Parliament on this change is necessary. A decision is expected before April 2013. Further, at the end of November 2012, the United States government enacted legislation exempting U.S. airlines from the ETS.
The U.S. Congress and certain states have also considered the regulation of greenhouse gas emissions. In addition, the U.S. Environmental Protection Agency could regulate greenhouse gas emissions, especially aircraft engine emissions. The cost to comply with potential new laws and regulations could be substantial for the Company. These costs could include an increase in the cost of the fuel and capital costs associated with updating aircraft. Until the timing, scope and extent of any future regulation becomes known, we cannot predict its effect on the Company’s cost structure or operating results.



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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

ITEM 2. PROPERTIES
The Company leases portions of the air park in Wilmington, Ohio, under a lease agreement with a regional port authority, the term of which expires in May of 2019. The lease includes corporate offices, 210,000 square feet of maintenance hangars and a 100,000 square foot component repair shop at the air park. ABX also has the non-exclusive right to use the airport, which includes one active runway, taxi ways and ramp space.
As of December 31, 2012, the Company and its subsidiaries' in-service aircraft fleet consisted of 48 owned aircraft and six leased aircraft, on an operating basis, for a total of 54 aircraft. The aircraft were all formerly passenger aircraft that have been modified for standard cargo operations, except for four DC-8 combi aircraft. The aircraft are generally described as having mid size to medium wide-body cargo capabilities. The cargo aircraft carry gross payloads ranging from approximately 67,000 to 125,000 pounds. These aircraft are well suited for intra-continental flights and medium range inter-continental flights. Because an airline's flight operations can be hindered by inclement weather, sophisticated landing systems and other equipment are utilized to minimize the effect that weather may have on flight operations. For example, ABX’s Boeing 767-200 and 767-300 aircraft are operated for Category III landings. This allows their crews to land under weather conditions with runway visibility of only 600 feet at airports with Category III Instrument Landing Systems.
The table below shows the combined fleet of aircraft in service condition.
 
 
 
 In-service Aircraft as of December 31, 2012
 
 
 
 
 
 
Aircraft Type
 
Total
 
Owned
 
Operating Lease
 
Year of
Manufacture
 
Gross Payload
(Lbs.)
 
Still Air Range
(Nautical Miles)
 
 
 
 
 
 
 
 
 
 
 
 
 
767-200 SF (1)
 
40
 
36
 
4
 
1982 - 1987
 
67,000 - 99,000
 
1,800 - 4,400
767-300 SF (1)
 
7
 
5
 
2
 
1988 - 1989
 
125,000
 
2,800 - 4,400
DC-8-CF (2)
 
4
 
4
 
-
 
1968 - 1970
 
80,000 - 85,000
 
1,800 - 4,400
757-200 SF (1)
 
3
 
3
 
-
 
1984 - 1991
 
68,000
 
2,700 - 4,000
Total in-service
 
54
 
48
 
6
 
 
 
 
 
 
____________________
(1)
These aircraft are configured for standard cargo containers, including large standard main deck cargo doors.
(2)
These aircraft are configured as “combi” aircraft capable of carrying passenger and cargo containers on the main flight deck.
In addition, as of December 31, 2012, CAM had two Boeing 767-300 aircraft that were undergoing modification to a standard freighter configuration, one Boeing 757-200 aircraft that was undergoing modification to a standard freighter configuration and two Boeing 757-200 aircraft that were completing modification and certification as combi aircraft (capable of carrying passengers and cargo containers on the main flight deck). These aircraft are expected to be completed in 2013 and are not reflected in the table above. CAM also had one Boeing 767-200 passenger aircraft, currently in storage, not reflected in the table above. In January 2013, CAM purchased two more Boeing 757 combi aircraft which we expect to enter service in 2013.
We believe that our existing facilities, aircraft fleet and planned aircraft investments as further described in Note G to the accompanying financial statements, are appropriate for our current operations and growth plans. We may make additional investments in aircraft and facilities if we identify favorable opportunities in the markets that we serve.



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ITEM 3. LEGAL PROCEEDINGS
Civil Action Alleging Violations of Immigration Laws
On December 31, 2008, a former ABX employee filed a complaint against ABX, a total of four current and former executives and managers of ABX, Garcia Labor Company of Ohio, and three former executives of the Garcia Labor companies, in the U.S. District Court for the Southern District of Ohio. The case was filed as a putative class action against the defendants, and asserts violations of the Racketeer Influenced and Corrupt Practices Act (RICO). The complaint, which was later amended to include a second former employee plaintiff, seeks damages in an unspecified amount and alleges that the defendants engaged in a scheme to hire illegal immigrant workers to depress the wages paid to hourly wage employees during the period from December 1999 to January 2005.
On December 2, 2011, the parties agreed to settle this matter at a conference presided over by the Court. The settlement calls for ABX to pay to the plaintiffs a monetary amount, which management believes to be less than it would have cost for ABX to defend the case at trial. Once the plaintiffs have provided notice to the putative class members of the settlement, the Court will hold a hearing to consider any objections and seek final confirmation of the settlement.
Brussels Noise Ordinance
The Brussels Instituut voor Milieubeheer ("BIM"), a governmental authority in the Brussels-Capital Region of Belgium that oversees the enforcement of environmental matters, imposed four separate administrative penalties on ABX in the approximate aggregate amount of €0.4 million ($0.5 million) for numerous alleged violations of an ordinance limiting the noise caused by aircraft overflying the Brussels-Capital Region (which is located near the Brussels Airport) during the period from May 2009 through December 2010. ABX has exhausted its appeals with respect to the first administrative penalty, but is continuing to pursue the appeal of the remaining three.
The ordinance in question is controversial for the reason that it was adopted by the Brussels-Capital Region and is more restrictive than the noise limitations in effect in the Flemish Region, which is where the Brussels Airport is located. The ordinance is the subject of several court cases currently pending in the Belgian courts and numerous airlines have been levied fines thereunder.
Other
In addition to the foregoing matters, we are also currently a party to legal proceedings, including FAA enforcement actions, in various federal and state jurisdictions arising out of the operation of our business. The amount of alleged liability, if any, from these proceedings cannot be determined with certainty; however, we believe that our ultimate liability, if any, arising from the pending legal proceedings, as well as from asserted legal claims and known potential legal claims which are probable of assertion, taking into account established accruals for estimated liabilities, should not be material to our financial condition or results of operations.

ITEM 4. MINE SAFETY DISCLOSURES
Not applicable



17


PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock
Our common stock is publicly traded on the NASDAQ Global Select Market under the symbol ATSG. The following table shows the range of high and low prices per share of our common stock for the periods indicated:
 
2012 Quarter Ended:
Low
 
High
December 31, 2012
$
3.38

 
$
4.56

September 30, 2012
$
3.88

 
$
5.75

June 30, 2012
$
4.67

 
$
5.88

March 31, 2012
$
4.71

 
$
6.88

 
 
 
 
2011 Quarter Ended:
Low
 
High
December 31, 2011
$
3.86

 
$
5.92

September 30, 2011
$
4.30

 
$
7.04

June 30, 2011
$
6.14

 
$
8.50

March 31, 2011
$
7.00

 
$
8.65

On March 4, 2013, there were 1,732 stockholders of record of the Company’s common stock. The closing price of the Company’s common stock was $5.46 on March 4, 2013.

18



Performance Graph
The graph below compares the cumulative total stockholder return on a $100 investment in the Company’s common stock with the cumulative total return of a $100 investment in the NASDAQ Composite Index and the cumulative total return of a $100 investment in the NASDAQ Transportation Index for the period beginning on December 31, 2007 and ending on December 31, 2012.
 
12/31/2007
 
12/31/2008
 
12/31/2009
 
12/31/2010
 
12/31/2011
 
12/31/2012
Air Transport Services Group, Inc.  
100.00

 
4.31

 
63.16

 
189.00

 
112.92

 
95.93

NASDAQ Composite Index
100.00

 
59.03

 
82.25

 
97.32

 
98.63

 
110.78

NASDAQ Transportation Index
100.00

 
72.93

 
72.29

 
91.64

 
79.89

 
95.85

Dividends
The Company is restricted from paying dividends on its common stock in excess of $50.0 million during any calendar year under the provisions of its Senior Credit Agreement. Under the provisions of ABX's promissory note due to DHL, the Company is required to prepay the DHL note in the amount of $0.20 for each dollar of dividend distributed to the stockholders of ATSG. The same prepayment stipulation applies to stock repurchases. No cash dividends have been paid or declared and no stock repurchases have been made or declared.
Securities authorized for issuance under equity compensation plans
For the response to this Item, see Item 12.


19


ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and the notes thereto and the information contained in Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The selected consolidated financial data and the consolidated operations data below are derived from the Company’s audited consolidated financial statements.
  
As of and for the Years Ended December 31
 
2012
 
2011
 
2010
 
2009
 
2008
 
(In thousands, except per share data)
OPERATING RESULTS:
 
 
 
 
 
 
 
 
 
Continuing revenues
$
607,438

 
$
730,133

 
$
667,382

 
$
823,483

 
$
941,686

Operating expenses (1)
528,750

 
667,504

 
585,706

 
751,693

 
963,638

Net interest expense and other non operating charges (4)
12,368

 
21,769

 
18,359

 
26,432

 
34,667

Earnings (loss) from continuing operations before income taxes (1)
66,320

 
40,860

 
63,317

 
45,358

 
(56,619
)
Income tax expense
(24,672
)
 
(16,995
)
 
(23,413
)
 
(17,156
)
 
(6,229
)
Earnings (loss) from continuing operations
41,648

 
23,865

 
39,904

 
28,202

 
(62,848
)
Earnings (loss) from discontinued operations, net of taxes (2)
(774
)
 
(673
)
 
(70
)
 
6,247

 
6,858

Net earnings (loss)
$
40,874

 
$
23,192

 
$
39,834

 
$
34,449

 
$
(55,990
)
EARNINGS (LOSS) PER SHARE FROM CONTINUING OPERATIONS:
 
 
 
 
 
 
 
 
 
Basic
$
0.66

 
$
0.38

 
$
0.64

 
$
0.45

 
$
(1.01
)
Diluted
$
0.65

 
$
0.37

 
$
0.62

 
$
0.44

 
$
(1.01
)
WEIGHTED AVERAGE SHARES:
 
 
 
 
 
 
 
 
 
Basic
63,461

 
63,284

 
62,807

 
62,674

 
62,484

Diluted
64,420

 
64,085

 
64,009

 
63,279

 
62,484

SELECTED CONSOLIDATED

 
 
 
 
 
 
 
 
 
FINANCIAL DATA:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
15,442

 
$
30,503

 
$
46,543

 
$
83,229

 
$
116,114

Deferred income tax asset
19,154

 
31,548

 
12,879

 
31,597

 
74,979

Property and equipment, net (1)
818,924

 
748,913

 
658,756

 
636,089

 
671,552

Goodwill and intangible assets (1)
92,126

 
93,376

 
99,036

 
99,890

 
100,777

Total assets
1,035,611

 
993,719

 
900,654

 
1,002,773

 
1,101,349

Post-retirement liabilities
187,533

 
188,110

 
119,746

 
155,720

 
299,964

Capital lease obligations (3)

 

 
6,103

 
12,918

 
72,282

Long term debt and current maturities, other than leases (3)
364,481

 
346,904

 
296,425

 
364,509

 
440,204

Deferred income tax liability
46,422

 
42,530

 
39,746

 
50,044

 

Stockholders’ equity
299,256

 
270,147

 
302,077

 
245,982

 
80,392

____________________ 
(1)
In the third quarter of 2011, the Company recorded an impairment charge of $22.1 million on aircraft, $2.8 million on goodwill and $2.3 million on acquired intangibles. (See Notes C and E to the accompanying consolidated financial statements.) In the fourth quarter of 2008, the Company recorded an impairment charge of $73.2 million on goodwill and $18.0 million on acquired intangibles.
(2)
In the third quarter of 2009, ABX ceased providing hub services and fuel services for DHL. Accordingly, these business activities are reflected as discontinued operations for all years presented.
(3)
Capital lease obligations reflects the assumption and extinguishment of aircraft lease obligations by DHL during 2009 totaling $45.7 million. Additionally, Long term debt reflects the extinguishment of $46.3 million of the DHL promissory note during 2009.
(4)
During 2011, in conjunction with the execution of the Senior Credit Agreement (see Note F to the accompanying consolidated financial statements) the Company terminated its previous credit agreement, which resulted in the write-off of $2.9 million of unamortized debt issuance costs associated with that credit agreement and recognized $3.9 million of losses for certain interest rate swaps previously designated as cash flow hedges of interest payments stemming from the former term loan.

20


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 and should be read in conjunction with the “Risk Factors” in Item 1A of this report, our historical financial statements, and the related notes contained in this report.

BACKGROUND
The Company provides airline operations, aircraft leases, aircraft maintenance and other support services primarily to the cargo transportation and package delivery industries. Through the Company's subsidiaries, it offers a range of complementary services to delivery companies, freight forwarders, airlines and government customers. The Company's principal subsidiaries include three independently certificated airlines, ABX Air, Inc. (“ABX”), Capital Cargo International Airlines, Inc. (“CCIA”) and Air Transport International, Inc. (“ATI”), and an aircraft leasing company, Cargo Aircraft Management, Inc. (“CAM”).
At December 31, 2012, the Company owned 48 cargo aircraft in serviceable condition and leased six more under operating leases. The owned fleet consisted of thirty-six Boeing 767-200 aircraft, five Boeing 767-300 aircraft, three Boeing 757 and four McDonnell Douglas DC-8 "combi" aircraft. The combi aircraft are capable of simultaneously carrying passengers and cargo containers on the main flight deck. The Company's airline subsidiaries also leased four Boeing 767-200 freighter aircraft and two Boeing 767-300 freighter aircraft from third parties as of December 31, 2012.
In recent years we have modernized the Company's aircraft fleet, retiring less efficient Boeing 727 and DC-8 aircraft and adding Boeing 767-200, Boeing 767-300 and Boeing 757 aircraft to the fleet. During 2013 we plan to continue adding Boeing 767 and Boeing 757 aircraft to the fleet by modifying former passenger aircraft. As of December 31, 2012, the Company owned two Boeing 767-300 aircraft that were being modified from passenger configuration into a standard freighter configuration, one Boeing 757 aircraft undergoing standard freighter modification and two Boeing 757 aircraft being prepared for service as combi aircraft. Additionally, in January 2013, the Company purchased two more Boeing 757 combi aircraft that are in the process of obtaining airworthiness certification for their combi modification. We expect all seven of these aircraft to enter service during 2013.
The Company's largest customer is DHL Network Operations (USA), Inc. and its affiliates ("DHL"), which accounted for 53% of the Company's consolidated revenues in 2012 and 36% of the Company's consolidated revenues in both 2011 and 2010. The Company has had long term contracts with DHL since August 2003. Commencing 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. We also provide two Boeing 757 aircraft to DHL under multi-year contracts. Additionally, during 2012 the Company's airlines provided eight other Boeing 767 aircraft and one Boeing 757 aircraft to DHL under contracts and arrangements having durations of one year or less.
The U.S. Military comprised 16%, 12% and 14% of the Company's consolidated revenues during the years ended December 31, 2012, 2011 and 2010, 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.
A substantial portion of the Company’s revenues and cash flows have historically been derived from providing airlift in North America to BAX Global, Inc., an affiliate of DB Schenker ("BAX/Schenker"). BAX/Schenker is a specialized heavy weight, business to business shipper. In July 2011, BAX/Schenker announced its plans to adopt a new operating model that phased out the dedicated air cargo network in North America supported by the Company. In September 2011, BAX/Schenker ceased air cargo operations at its air hub in Toledo, Ohio and began to conduct air operations from the Cincinnati/Northern Kentucky airport, utilizing DHL's U.S. air hub. Instead of dedicated aircraft, BAX/Schenker now utilizes DHL and other delivery services for its air transportation delivery requirements.
The Company ceased providing services to BAX/Schenker as of the end of 2011. The Company's revenues from

21


the services performed for BAX/Schenker, derived primarily by providing Boeing 727 and DC-8 airlift, were $187.0 million and $194.3 million for the years ended December 31, 2011 and 2010, respectively. The Company's revenues from BAX/Schenker comprised approximately 26% and 29% of the Company's total revenues during the years ended December 31, 2011 and 2010, respectively, (15% and 18% of total revenues, excluding directly reimbursable revenues).
The Company has two reportable segments: ACMI Services, which primarily includes the cargo transportation operations of its three 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.

RESULTS OF OPERATIONS
Summary
The consolidated net earnings from continuing operations were $41.6 million and $23.9 million for 2012 and 2011, respectively. The pre-tax earnings from continuing operations were $66.3 million and $40.9 million for 2012 and 2011, respectively. The increase in earnings from continuing operations in 2012 as compared to 2011 was primarily due to the 2011 recognition of asset impairment charges of $27.1 million, interest rate derivative losses of $4.9 million and the write-off of $2.9 million of unamortized debt issuance related to the refinancing of the Company's debt in 2011. Adjusted pre-tax earnings from continuing operations, a non-GAAP measure (a definition and reconciliation of adjusted pre-tax earnings is shown below), after removing impairment charges, net derivative gains or losses and charges related to debt refinancing was $64.4 million for 2012 compared to $75.8 million for 2011. The adjusted pre-tax earnings in 2012 compared to 2011 was bolstered by increased operations for the Company's Boeing 767 and Boeing 757 aircraft, but were negatively impacted by the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Total customer revenues from continuing operations decreased by $122.7 million to $607.4 million during 2012 compared to 2011. The decline reflects $187.0 million of revenues during 2011 from services for the BAX/Schenker air network which was discontinued. Revenues from reimbursed fuel and other reimbursed operating expenses declined by $85.7 million during 2012 compared to 2011. These declines were also primarily due to the discontinuation of the BAX/Schenker air network. Excluding directly reimbursed revenues, customer revenues decreased by $37.0 million during 2012 compared to 2011. Revenue from the deployment of additional Boeing 767 and Boeing 757 aircraft by ACMI Services during 2012, was more than offset by the revenue decline from the discontinuation of the BAX/Schenker air network.

22


A summary of our revenues and pre-tax earnings from continuing operations is shown below (in thousands):
 
Years Ending December 31
 
2012
 
2011
 
2010
Revenues from Continuing Operations:
 
 
 
 
 
CAM
$
154,565

 
$
140,469

 
$
101,375

ACMI Services
 
 
 
 
 
Airline services
404,053

 
444,778

 
432,082

Reimbursable
74,940

 
160,683

 
143,330

DHL S&R activities

 

 
4,000

Total ACMI Services
478,993

 
605,461

 
579,412

Other Activities
112,343

 
105,284

 
87,660

Total Revenues
745,901

 
851,214

 
768,447

Eliminate internal revenues
(138,463
)
 
(121,081
)
 
(101,065
)
Customer Revenues
$
607,438

 
$
730,133

 
$
667,382

 
 
 
 
 
 
 
 
 
 
 
 
Pre-Tax Earnings from Continuing Operations:
 
 
 
 
 
CAM, inclusive of interest expense and impairment charges
$
68,499

 
$
53,221

 
$
41,586

ACMI Services
 
 
 
 
 
Airline services
(14,503
)
 
6,576

 
17,339

Asset impairment charges

 
(20,383
)
 

DHL S&R activities

 

 
3,549

Total ACMI Services
(14,503
)
 
(13,807
)
 
20,888

Other Activities
11,650

 
11,331

 
8,017

Net unallocated interest expense
(1,205
)
 
(2,118
)
 
(7,174
)
Net gain (loss) on derivative instruments
1,879

 
(4,881
)
 

Write-off of unamortized debt issuance costs

 
(2,886
)
 

Pre-Tax Earnings from Continuing Operations
66,320

 
40,860

 
63,317

Add Asset impairment charges

 
27,144

 

Less Net (gain) loss on derivative instruments
(1,879
)
 
4,881

 

Add Write-off of unamortized debt issuance costs

 
2,886

 

Less DHL Severance and Retention activities

 

 
(3,549
)
Adjusted Pre-Tax Earnings
$
64,441

 
$
75,771

 
$
59,768

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 asset impairment charges, interest rate derivative gains and losses, the write-off of debt issuance costs and earnings from the termination of the severance and retention agreement ("S&R agreement") with DHL in March 2010. Management uses adjusted pre-tax earnings to compare the performance of core operating results between periods. 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.
As of December 31, 2012, CAM had 48 aircraft in serviceable condition, 28 of them leased internally to the Company's airlines. CAM's revenues grew $14.1 million during 2012 compared to 2011, as a result of additional aircraft leases over the last two years. During 2012, CAM completed the modification of one Boeing 767-200 freighter aircraft and three Boeing 767-300 freighter aircraft, and placed those aircraft under leases with internal customers. As of December 31, 2012 and 2011, CAM leased 20 and 21 aircraft to external customers, respectively. Revenues from

23


external customers accounted for $6.8 million of the increased revenue for 2012, due primarily to four additional aircraft leases placed with external customers throughout 2011. During the fourth quarter of 2012, a regional carrier returned a Boeing 767-200 aircraft to CAM before the end of the original lease term. The aircraft is being prepared for redeployment in ACMI services.
CAM's revenues from the Company's airlines totaled $80.0 million during 2012, compared to $72.7 million for 2011. CAM's revenues from internal leases of Boeing 727 and DC-8 freighter aircraft for 2012 declined $15.0 million compared to 2011 due to the retirement of Boeing 727 and DC-8 aircraft previously operated for BAX/Schenker, but the decline was more than offset by the additional Boeing 767 aircraft leases.
CAM's pre-tax earnings, inclusive of an interest expense allocation and a $6.8 million charge for aircraft impairment in 2011, were $68.5 million and $53.2 million during 2012 and 2011, respectively. CAM's pre-tax earnings, excluding the aircraft impairment charges, increased by $8.5 million for 2012 compared to 2011. Improved earnings reflected additional Boeing 767 aircraft placed under leases during 2011 and 2012. CAM's pre-tax earnings for 2012 do not reflect $0.9 million of unpaid rents related to Boeing 767 aircraft under lease with a regional airline. Those amounts will be recognized as we receive payment from the carrier. Management and the lessee are discussing the timing of future payments which could result in the early return of a leased Boeing 767-200 aircraft in 2013.
During 2013, we expect CAM to deploy two more Boeing 767-300 and five 757-200 aircraft that are being prepared for future deployment, as discussed further below under "Fleet Summary 2012." The reputation of the Boeing 767 and Boeing 757 aircraft for reliability and cost effectiveness in medium range markets remains strong. The placement of additional aircraft under long term leases, however, could be affected by economic conditions and market uncertainty.
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 December 31, 2012, ACMI Services included 47 in-service aircraft, including 28 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.
Revenues from ACMI Services were $479.0 million and $605.5 million during 2012 and 2011, respectively. The decrease of $126.5 million is primarily the result of the discontinuation of services for BAX/Schenker's North American air network. Since June 30, 2011, we have retired all of our Boeing 727 and DC-8 freighter aircraft in response to the discontinuation of BAX/Schenker's North American air network in 2011. Airline services revenues, which do not include revenues for the reimbursement of fuel and certain operating expenses, declined 9% during 2012 compared to 2011, reflecting the loss of BAX/Schenker revenues of $85.7 million during 2011. During 2011, ACMI Services revenues also included $100.9 million for the reimbursement of fuel and other operating expenses for the BAX/Schenker air network.
Revenue declines from BAX/Schenker were partially offset by revenues from additional Boeing 767 aircraft added to the ACMI Services fleet since December 31, 2011. Since December 31, 2011, ACMI Services has added two Boeing 767-200 and four Boeing 767-300 aircraft into the operating fleet. Airline service revenues, excluding those from BAX/Schenker, increased $44.9 million during 2012 compared to 2011, driven by these additional Boeing 767 aircraft. Aircraft block hours flown for customers other than BAX/Schenker increased 9% during 2012, compared to 2011.
ACMI Services incurred pre-tax losses of $14.5 million during 2012, compared to pre-tax losses of $13.8 million for 2011. Excluding asset impairment charges of $20.4 million incurred during 2011, ACMI Services achieved pre-tax earnings of $6.6 million in 2011. The operating results during 2012 were negatively impacted by the discontinuation of BAX/Schenker's North American air network, the cost of training flight crew members for the Boeing 767 aircraft, increased pension expenses, higher engine maintenance expenses and delays in placing aircraft into revenue service. While ATI and CCIA reduced the number of crew members and other employees in the ACMI Services segment due to the termination of the BAX/Schenker network, salaries and benefits expenses during 2012 included the costs of training senior, former DC-8 and Boeing 727 crewmembers for the Boeing 767 aircraft the Boeing 757 aircraft.

24


During 2012, four Boeing 767-300 aircraft and two Boeing 767-200 aircraft were added into the ACMI Services in-service fleet. Due to sluggish economic conditions, initial deployment and redeployment of aircraft into incremental revenue generating services were delayed, thereby adversely impacting operating results for 2012. In December 2012, DHL discontinued an ACMI contract for a Boeing 767 on a transatlantic flight. However, in January 2013, we reached agreements to operate three more Boeing 767-200 aircraft and a Boeing 757 aircraft for DHL's U.S. network. These aircraft replace the Boeing 727 aircraft that were retired at the end of 2012.
ATI operates four DC-8 combi aircraft for the U.S. Military. In July 2012, the U.S. Military's Air Mobility Command notified ATI that it was awarded a two-year agreement to continue the combi aircraft flights through September 2014. ATI intends to service the award with its DC-8 combi aircraft and phase-in more modern Boeing 757 combi aircraft starting in the second quarter of 2013.
To further streamline the operations impacted by the loss of the BAX/Schenker business, we began to merge the airline operations of ATI and CCIA during 2012. In September 2012, ATI and CCIA flight crewmembers, as represented by the Air Line Pilots Association International ("ALPA"), ratified a collective bargaining agreement which allows for an integrated seniority list. The airlines and ALPA completed the integration of the seniority lists in 2012, to be effective beginning in March of 2013. We expect to complete the merger of ATI and CCIA's airline operations in the first quarter of 2013. The combined operation will benefit from the standardized fleet, two person flight crew, common pilot type rating and improved reliability of the Boeing 767 and Boeing 757 aircraft compared to the Boeing 727 and DC-8 freighter aircraft formerly operated by the airlines.
Revenue for ACMI Services depends on a number of key factors including regulatory approvals, the cost competitiveness of the airlines, aircraft reliability, market preferences for the type of aircraft that we operate and general economic conditions. Continued stagnant economic conditions and market uncertainty may continue to slow the pace by which we deploy aircraft into incremental revenue operations. We may further reduce staff levels as required to match with customer demand and aircraft utilization levels.
When new deployments of aircraft begin, typically start-up expenses are incurred, including those for proving flights, route authorities, overfly rights, travel and other activities which may impact future operating results. Revenue-generating service may begin sometime later; however, depending on the satisfaction of a number of conditions, including international regulations and laws, contract negotiations, flight crew availability, and arranging resources for aircraft handling.
Other Activities
The Company sells aircraft parts and provides aircraft maintenance and modification services to other airlines. The Company also operates five U.S. Postal Service (“USPS”) sorting facilities and provides ground support equipment, related maintenance, leasing and facility maintenance services, including fuel 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.
External customer revenues from all other activities were $55.1 million and $57.4 million for 2012 and 2011, respectively. Revenues from services provided to the USPS increased $2.1 million during 2012 primarily due to two additional USPS facilities that we started in mid 201l. Increased revenues from the USPS, however, were more than offset by lower aircraft maintenance revenues from external customers, which declined $4.2 million. Maintenance services revenues for external customers declined during 2012 compared to 2011 because the Company's aircraft maintenance and repair business, Airborne Maintenance and Engineering Services, Inc. ("AMES"), has limited hangar facilities and used those facilities for more internal contracts for the Company's own airlines and CAM instead of external customer projects during 2012.
The pre-tax earnings from other activities were $11.7 million and $11.3 million for 2012 and 2011, respectively. The increase of $0.4 million of pre-tax earnings for 2012 compared to 2011 primarily reflects process streamlining initiatives at the sorting facilities.
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. While the current facility houses aircraft as large as the Boeing 767, the new facility will provide AMES the capability of servicing aircraft as large as a Boeing 747 and the Boeing 777. The hangar is anticipated

25


to cost approximately $15.7 million and is expected to take approximately 12 to 14 months to complete. The Company will lease the facility from the CCPA and begin to make related rent payments beginning in 2014. We could incur incremental costs associated with the new hangar, including the costs of aircraft maintenance personnel before the hangar is completed. 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.
Discontinued Operations
Discontinued operations are a result of DHL's decision in 2008 to restructure its U.S. operations. DHL discontinued intra-U.S. domestic pickup and delivery services and now provides only international services to and from the U.S. In the third quarter of 2009, ABX ceased all remaining hub and parcel sorting operations for DHL. Additionally, in the third quarter of 2009, DHL assumed management of aircraft fuel services for its U.S. network previously provided by ABX.
Pre-tax losses related to the former sorting operations were $1.2 million for 2012 compared to $1.1 million for 2011. The results of discontinued operations primarily contain pension expense for former employees that supported sort operations under a hub services agreement with DHL and expenses for certain legal matters associated with those former sorting operations. During 2011, the Company recorded $0.9 million of charges related to a civil action alleging that ABX violated immigration labor laws while managing the sort operations in Wilmington, Ohio. The matter is described further under Item 3, Legal Proceedings, of this report. During 2013, pension expense for discontinued operations is expected to decrease approximately $1.2 million due primarily to the effects of recent investment returns used to actuarially calculate the Company's annual pension expense.
Fleet Summary 2012
The Company’s aircraft fleet is summarized below as of December 31, 2012 ($'s in thousands):
 
ACMI
Services
 
CAM
 
Total
In-service aircraft
 
 
 
 
 
Aircraft owned
 
 
 
 
 
Boeing 767-200
16

 
20

 
36

Boeing 767-300
5

 

 
5

Boeing 757
3

 

 
3

DC-8 combi
4

 

 
4

Total
28

 
20

 
48

Carrying value
 
 
 
 
$
656,388

Operating lease
 
 
 
 
 
Boeing 767-200
4

 

 
4

Boeing 767-300
2

 

 
2

Total
6

 

 
6

Carrying value
 
 
 
 
$
1,134

Aircraft for freighter and combi modification
 
 
 
 
 
Boeing 767-300

 
2

 
2

Boeing 757

 
3

 
3

Total

 
5

 
5

Carrying value
 
 
 
 
$
108,697

As of December 31, 2012, ACMI Services leased 28 of its in-service aircraft internally from CAM. As of December 31, 2012, 13 of CAM's 20 Boeing 767-200 aircraft shown above were leased to DHL and operated by ABX and CAM leased the other seven Boeing 767-200 aircraft to external airlines.

26


Aircraft fleet activity during 2012 is summarized below:
- CAM completed the standard freighter modification of one Boeing 767-200 aircraft and leased the aircraft internally to an airline affiliate.
- A Boeing 767-200 passenger aircraft was placed in temporary storage when its airframe maintenance cycle expired. The aircraft will remain in storage until it enters the freighter modification process or is prepped for service.
- ABX began to lease a Boeing 767-300 aircraft from an external lessor.
- CAM purchased two Boeing 767-300 passenger aircraft for modification into standard freighter aircraft.
- CAM completed the freighter modification of three Boeing 767-300 aircraft and leased the aircraft internally to an airline affiliate.
- CAM received a Boeing 767-200 aircraft, returned from a lessee, and placed the aircraft internally with an airline affiliate.
- CAM purchased a Boeing 757 combi aircraft that is completing the process for obtaining its airworthiness certificate.
- We removed three DC-8 freighter aircraft and four Boeing 727 aircraft from the in-service fleet.
In 2013, CAM purchased two more Boeing 757 combi aircraft that are completing the process for airworthiness certification. We expect to place four Boeing 757 combi aircraft into service for the U.S. Military during the first half of 2013. We also expect to complete the modification of one Boeing 757 freighter and place it into service for DHL during the first half of 2013. Additionally, we expect to complete the modification of two Boeing 767-300 aircraft during the first half of 2013.
As of December 31, 2012, the Company had Boeing 727 and DC-8 airframes and engines with a carrying value of $3.4 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 $4.2 million during 2012 compared to 2011. Reductions in the number of employees, including Boeing 727 and DC-8 crew members, since 2011 were partially offset by costs of additional crew members for the expanded number of Boeing 767 aircraft operated by the Company and by increased pension expense compared to 2011. Pension expense for continuing operations increased $5.7 million during 2012 when compared to 2011 due to the effects of lower discount rates used to actuarially calculate the Company's annual pension expense.
Fuel expense decreased by $96.1 million during 2012 compared to 2011. The decrease occurred in conjunction with BAX/Schenker's discontinuation of its North American air network in the fourth quarter of 2011. During 2011, while under contract with BAX/Schenker, ATI provided aviation fuel for the BAX/Schenker air network and was reimbursed by BAX/Schenker for the costs of fuel. The Company is no longer incurring aviation fuel expenses or recording a related reimbursable revenue for the BAX/Schenker network. Fuel expense during 2012 primarily reflects the costs of fuel to operate U.S. Military charters, position aircraft for service and for maintenance purposes.
Maintenance, materials and repairs expense increased by $10.6 million during 2012 compared to 2011. During 2012, maintenance expense reductions stemming from the discontinuation of Boeing 727 aircraft and DC-8 freighter aircraft since 2011 were offset by higher maintenance expenses to support the larger fleet of Boeing 767 and 757 aircraft. The Company expensed 20 and 14 scheduled airframe heavy maintenance events during 2012 and 2011, respectively, We expect aircraft maintenance expenses to increase in 2013 due to higher costs for aircraft parts and rate increases under certain maintenance agreements.
Depreciation and amortization expense decreased $6.6 million during 2012 compared to 2011. The decline in depreciation expense reflects the removal of the Boeing 727 aircraft and the DC-8 freighter aircraft from service, offset by incremental depreciation expense for four Boeing 767 aircraft added to the in-service fleet since December 2011. The Boeing 727 aircraft and DC-8 freighter aircraft were removed from service in conjunction with BAX/Schenker's

27


discontinuation of its North American air network in 2011.
Travel expense decreased by $5.7 million during 2012 compared to 2011. The decrease is a result of the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Rent expense increased by $0.8 million during 2012 compared to 2011. Rent expense increased primarily due to the lease of an additional Boeing 767-300 aircraft beginning in May 2012. Rent expense was not significantly affected by the discontinuation of the BAX/Schenker North American air network because the Company did not lease the aircraft used in that network.
Landing and ramp expense, which includes the cost of deicing chemicals, decreased by $6.7 million during 2012 compared to 2011. The decrease during 2012 reflects the discontinuation of the BAX/Schenker North American air network in the fourth quarter of 2011.
Insurance expense decreased by $1.6 million during 2012 compared to 2011, primarily due to the reduction in Boeing 727 and DC-8 aircraft during 2012 and the fourth quarter of 2011.
Other operating expenses include professional fees, navigational services, employee training, utilities and the cost of parts sold to customers. Other operating expenses decreased by $2.2 million during 2012 compared to 2011. During 2012, increased expenses for international aircraft operations were offset by lower costs stemming from the discontinuation of the BAX/Schenker North American air network.
Interest expense increased by $0.2 million during 2012 compared to 2011. Interest expense was higher in 2012 compared to 2011 primarily due to an increase in the amount of borrowings under the revolving credit loan offset by lower interest rates. Interest rates on the Company’s variable interest, unsubordinated term loan decreased to 2.47% at December 31, 2012 from 2.58% at December 31, 2011. We expect interest expense to increase during 2013 due to a higher level of debt which is being used to expand the Company's aircraft fleet.
During 2012, the Company recorded pre-tax net gains on derivatives of $1.9 million compared to pre-tax net losses on derivatives of $4.9 million during 2011, reflecting the impact of higher market interest rates since December 31, 2011 on the interest rate swaps held by the Company at December 31, 2012.
In 2011, the Company executed a Senior Credit Agreement replacing its previous credit agreement. During 2011, the Company wrote off $2.9 million of unamortized debt issuance costs associated with the former credit agreement. During 2011, the Company terminated its hedge accounting of interest rate swaps related to the former term loan, which resulted in the recognition of $3.9 million of pre-tax losses which had previously been reflected in other comprehensive income.
The effective tax rate from continuing operations for the year ended December 31, 2012 was 37.2% compared to 41.6% for 2011. The effective tax rate from continuing operations in 2011 was affected by impairment charges that are not deductible for federal income tax purposes. The Company's effective tax rate from continuing operations was approximately 39% for the year ended December 31, 2011 after adjusting for $2.8 million of non-deductible impairment charges. The decline in the effective tax rate from continuing operations for 2012 compared to 2011 was also a result of decreased state income taxes for 2012 as a result of the the discontinuation of services for BAX/Schenker's North American air network during 2011.
We estimate that the Company's effective tax rate for 2013 will be approximately 37.5%. As of December 31, 2012, the Company had operating loss carryforwards for U.S. federal income tax purposes of approximately $93.4 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 through 2014 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.

2011 compared to 2010
Summary
The consolidated net earnings from continuing operations were $23.9 million and $39.9 million for 2011 and 2010, respectively. The pre-tax earnings from continuing operations for 2011 were $40.9 million, inclusive of asset impairment

28


charges and interest rate derivative losses during 2011, compared to pre-tax earnings of $63.3 million in 2010, in which no impairment charges or derivative losses were recorded. The decline in earnings from continuing operations in 2011 as compared to 2010 resulted primarily from the recognition of asset impairment charges of $27.1 million, interest rate derivative losses of $4.9 million and the write-off of $2.9 million of unamortized debt issuance costs related to the refinancing of the Company's debt in 2011. Adjusted pre-tax earnings from continuing operations, a non-GAAP measure (see reconciliation table below), after removing impairment charges, net derivative losses and charges related to debt refinancing was $75.8 million for 2011 compared to $59.8 million for 2010 after removing pre-tax earnings related to DHL's restructuring. The improved earnings, as adjusted, over 2010, was driven primarily by CAM, which placed five additional aircraft under external customer leases since December 31, 2010.
The Company provided limited airlift directly to BAX/Schenker from September 2011 through the peak delivery season, until late December 2011. Beginning in January 2012, DHL contracted with the Company's airlines to supplement DHL's U.S. air network to service BAX/Schenker freight volumes on its expanded air network without use of the Company's DC-8 aircraft and with only limited use of Boeing 727 aircraft. The Company's impairment charges in 2011 stemming from BAX/Schenker's 2011 transition to a new U.S. business model are described below:
- $22.1 million ($13.7 million after income tax benefit) to write-down Boeing 727 and DC-8 freighters, engines and related parts to their appraised fair values. In light of BAX/Schenker's decision to phase-out its dedicated air network in the U.S. and after evaluating business prospects for these aircraft, management has decided to discontinue the service of Boeing 727 and DC-8 freighters sooner than previously expected.
- $2.3 million ($1.4 million after income tax benefit) to write-down customer relationship intangible assets, reflecting the closure of BAX/Schenker's dedicated air network.
- $2.8 million ($2.8 million after income tax benefit) to write-down goodwill acquired when the Company purchased ATI, which operated the DC-8 aircraft for BAX/Schenker. The write-down reflects the lower forecasted cash flows in the near term as ATI re-fleets by replacing the DC-8 aircraft operated for BAX/Schenker with more efficient Boeing 767 and 757 aircraft to be operated for other customers.
During 2011, the Company executed a Senior Credit Agreement with a consortium of banks. The Senior Credit Agreement refinanced the Company's previous term loan and provides liquidity to expand the Company's aircraft fleet through April 2016. The Senior Credit Agreement includes a term loan of $150 million and a $175 million revolving credit facility, of which the Company has drawn $106 million, net of repayments. In conjunction with the execution of the Senior Credit Agreement, the Company terminated its previous credit agreement, which resulted in the write-off of $2.9 million of unamortized debt issuance costs associated with that credit agreement and the recognition of $3.9 million of losses for certain interest rate swaps previously designated as cash flow hedges of interest payments stemming from the former term loan. These charges, which totaled $6.8 million before income tax effects, were recorded in March 2011.
Customer revenues from continuing operations increased by $62.8 million to $730.1 million during 2011 compared to 2010. Excluding directly reimbursed revenues, customer revenues increased by $45.4 million during 2011 compared to 2010. Revenue growth during 2011 compared to 2010 reflects additional external aircraft leases by CAM, up $24.5 million, additional Boeing 767 aircraft operations being performed under the ACMI Services segment, up $12.7 million, and increased aircraft maintenance services, up $9.9 million, which is reflected under other activities. Revenue growth comparisons to 2010 are affected by the termination of the DHL ACMI agreement and S&R agreement with DHL in March 2010. Under the S&R agreement, DHL compensated and reimbursed ABX for its management and costs associated with DHL's network restructuring starting in May 2008 and continuing through March 2010. Revenues from the S&R agreement were $4.0 million in the first quarter of 2010.
CAM
The Company offers aircraft leasing through its CAM subsidiary. Aircraft leases normally cover a term of five to seven years. In a typical leasing agreement, customers pay rent and a maintenance deposit on a monthly basis.
CAM's revenues for 2011 grew to $140.5 million compared to $101.4 million during 2010. Revenues from external customers accounted for $24.5 million of the increased revenue for 2011. Since December 31, 2010, CAM has leased five more Boeing 767-200 aircraft to external customers. CAM's revenues from the Company's airlines totaled $72.7 million during 2011, compared to $58.1 million for 2010.

29


As of December 31, 2011, CAM had 52 aircraft that were under lease, 31 of them internally to ATSG airlines. CAM's pre-tax earnings, inclusive of an interest expense allocation and $6.8 million for aircraft impairment charges, were $53.2 million and $41.6 million, during 2011 and 2010, respectively. CAM's pre-tax earnings, excluding the aircraft impairment charges, increased by $18.4 million for 2011 compared to 2010. Improved earnings reflected five more Boeing 767 freighter aircraft under lease since December 31, 2010. During 2011, CAM completed the freighter modification of two Boeing 767-200 aircraft and leased them to a Brazilian airline under long term leases. Also during 2011, CAM leased two additional Boeing 767-200 aircraft to DHL, fulfilling its commitment from March 2010 to lease 13 aircraft to DHL under long term leases. CAM also leased one additional Boeing 767-200 freighter aircraft to a Miami, Florida, based operator in 2011. During 2011, CAM completed the modification of its first two Boeing 767-300 freighter aircraft and leased the aircraft internally to its affiliate, ATI, which began to operate the aircraft for customers under ACMI agreements.
ACMI Services Segment
As of December 31, 2011, ACMI Services included 49 in-service aircraft, including 31 leased internally from CAM, five leased from external providers and 13 CAM-owned freighter aircraft which were under lease to DHL and operated by ABX under the CMI agreement. During 2011, ABX began to lease and operate two more DHL-owned aircraft, bringing to four the number of DHL-owned aircraft that ABX leases from DHL and operates under the CMI agreement. During 2011, ATI leased two Boeing 767-300 aircraft from CAM and began to operate the aircraft under ACMI agreements. Also in December 2011, CCIA began to operate a Boeing 757 aircraft under an ACMI agreement.
ACMI Services revenues were $605.5 million and $579.4 million during 2011 and 2010, respectively. Revenues from airline services increased 3% during 2011 compared to 2010, driven by higher block hours flown for customers. Aircraft block hours flown for customers increased 2% during the year, however, block hours for customers other than BAX/Schenker increased 11% in 2011 compared to 2010. This increase in block hours reflects the additional Boeing 767 aircraft placed into service during 2011, as described above. Reimbursable revenues increased $17.4 million during 2011, compared to 2010. The comparison of airline services revenues and reimbursable revenues to 2010 reflects the new commercial agreements between ABX and DHL which became effective in April 2010. Airline services revenues for the first quarter of 2010 included compensation based on aircraft depreciation and certain maintenance expenses under the former cost-plus DHL ACMI agreement. Beginning in April 2010, lease revenues for the DHL network aircraft have been reflected in CAM's revenues, while compensation for certain aircraft related maintenance costs have been reflected as reimbursable revenues. Revenues from activities under the S&R agreement declined by $4.0 million during 2011 compared to 2010, due to the termination of the S&R agreement in March 2010.
ACMI Services incurred a pre-tax loss of $13.8 million during 2011 due to asset impairment charges of $20.4 million. The pre-tax earnings for ACMI Services, excluding asset impairment charges, were $6.6 million from airline services for 2011 compared to $17.3 million from airline services during 2010. Operating results during 2011 were negatively impacted by the phase-out of BAX/Schenker's North American air network, unscheduled aircraft downtime, start-up costs for new Boeing 767 passenger operations and reductions in revenues from U.S. Military charters. As a result of unscheduled aircraft maintenance events, revenue flights were missed and higher operating expenses were incurred during the aircraft downtime. Some of the downtime affected DC-8 combi aircraft and Boeing 767 freighters operating in remote regions that were difficult to service. Revenues from the U.S. Military declined $2.6 million during 2011 compared to 2010 due to maintenance related cancellations and contractual rate reductions. The results for 2011 were impacted by start-up costs incurred by ATI in order for it to gain passenger authority and operate passenger routes under an ACMI agreement with a tourist operator beginning in April 2011. This agreement was primarily for the purpose of allowing ATI to build 12 months of passenger operating experience on the Boeing 767 aircraft, which is required in order to transport passengers for the U.S. Military on such aircraft. Additionally, ATI incurred higher crew training costs in 2011 to support the addition of its first two Boeing 767-300 aircraft during the year and transition DC-8 crews to the Boeing 767 aircraft.
Revenues from DHL, BAX/Schenker and other customers included the reimbursement of certain expenses. Excluding these reimbursable revenues, DHL, BAX/Schenker and the U.S. Military accounted for 37%, 19% and 20%, respectively, of ACMI Services revenues during 2011. Excluding reimbursable revenues, DHL, BAX/Schenker and the U.S. Military accounted for 39%, 22% and 21% of ACMI Services revenues for 2010.

30


Fleet Summary 2011
The Company’s aircraft fleet is summarized below as of December 31, 2011 ($'s in thousands):
 
ACMI
Services
 
CAM
 
Total
In-service aircraft
 
 
 
 
 
Aircraft owned
 
 
 
 
 
Boeing 767-200
15

 
21

 
36

Boeing 767-300
2

 

 
2

Boeing 757
3

 

 
3

Boeing 727
4

 

 
4

DC-8
7

 

 
7

Total
31

 
21

 
52

Carrying value
 
 
 
 
$
617,373

Operating lease
 
 
 
 
 
Boeing 767-200
4

 

 
4

Boeing 767-300
1

 

 
1

Total
5

 

 
5

Carrying value
 
 
 
 
$
419

Aircraft for freighter modification
 
 
 
 
 
Boeing 767-200

 
1

 
1

Boeing 767-300

 
3

 
3

Boeing 757

 
2

 
2

 
 
 
 
 
 
Total

 
6

 
6

Carrying value
 
 
 
 
$
101,700

As of December 31, 2011, ACMI Services was leasing 31 of its 36 in-service aircraft internally from CAM. ACMI Services operated 13 of the 21 Boeing 767-200 aircraft that CAM leases to external customers.
Aircraft fleet activity during 2011 is summarized below by fleet type:
CAM completed the freighter modification of five Boeing 767-200 aircraft and ABX returned a Boeing 767-200 aircraft to CAM. CAM leased five more Boeing 767-200 aircraft to external customers under long-term agreements, including two to DHL, bringing to 13 the total number of Boeing 767-200 aircraft leased to DHL.
CAM also leased one Boeing 767-200 aircraft internally to an airline affiliate. ABX began to lease and operate two DHL-owned aircraft, bringing to four the number of DHL-owned aircraft that ABX leases from DHL and operates under the CMI agreement.
CAM completed the freighter modification of its first two Boeing 767-300 aircraft and leased them internally to ATI, which is operating them under ACMI agreements. CAM purchased two more Boeing 767-300 passenger aircraft with the intent of modifying them into standard freighters.
CAM purchased three Boeing 757 passenger aircraft with the intent of modifying two of them into combi configured aircraft and the other into a standard freighter. CAM completed the freighter modification of one Boeing 757 aircraft and it was placed into service during the fourth quarter of 2011.
We reduced the in-service number of Boeing 727 and DC-8 aircraft in response to the phase-out of BAX/Schenker's North American network and diminished demand for these aircraft. The carrying value for all of the Company's Boeing 727 and DC-8 freighter aircraft, engines and aircraft parts totaled $12.5 million as of December 31, 2011. These aircraft were not collateral for the Company's Senior Credit Agreement.

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Other Activities
The Company sells aircraft parts and provides aircraft maintenance and modification services to other airlines. The Company also operates five U.S. Postal Service (“USPS”) sorting facilities. The Company provides ground equipment leasing and facility maintenance, including fuel 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.
External customer revenues from all other activities were $57.4 million and $45.9 million for 2011 and 2010, respectively. The increase in other revenues during 2011 primarily reflects additional aircraft maintenance projects and additional services provided to the USPS beginning in April 2011.
The pre-tax earnings from other activities were $11.3 million and $8.0 million in 2011 and 2010, respectively. The increase of $3.3 million in pre-tax earnings for 2011 compared to 2010 reflects increased aircraft maintenance projects completed during 2011 and additional business with the USPS, offset by higher facility expenses for the other business segments, additional corporate expenses to support the subsidiaries and additional business development expenses to support the Company's growth.
Discontinued Operations
Pre-tax losses from former hub services operations were $1.1 million for 2011 compared to $0.1 million for 2010. During 2011, the results of discontinued operations primarily contain pension for former employees that supported sort operations under a hub services agreement with DHL and expenses for certain legal matters associated with those former sorting operations. During 2011, the Company recorded $0.9 million of charges related to a civil action alleging that ABX violated immigration labor laws while managing the sort operations in Wilmington, Ohio.
During 2010, the results of discontinued operations primarily contained pension expenses for former employees that supported sort operations and medical costs in excess of initially estimated accruals for former employees under severance benefit plans and COBRA.

Expenses from Continuing Operations
Salaries, wages and benefits expense increased by 7% during 2011 compared to 2010. The increase reflects an increase in the number of flight crew members employed during 2011 to support additional aircraft block hours and revenue growth. Additionally, labor expenses for customer aircraft maintenance projects increased during 2011, coinciding with the increase in aircraft maintenance revenues.
Fuel expense increased by $16.2 million during 2011 compared to 2010. The increase reflects the higher cost of aviation fuel which increased 38% during 2011 compared to 2010. The cost of fuel is generally reimbursed to our airlines under the operating agreements with their customers and are reflected as revenues. In conjunction with BAX/Schenker's phase-out of its dedicated North American air network in 2011, the Company no longer incurred fuel expenses or recording a related reimbursable revenue for the BAX/Schenker network.
Depreciation and amortization expense increased $3.5 million during 2011 compared to 2010. Depreciation expense increased during the year primarily due to the deployment of seven owned Boeing 767 aircraft since the beginning of 2011.
Maintenance, materials and repairs expense increased by $7.8 million during 2011 compared to 2010. The increase in maintenance expense was primarily a result of increased flight hours on the Company's Boeing 767-200 aircraft engines. The Company maintains the General Electric CF6 engines for its Boeing 767-200 aircraft through "power by the hour" agreements ("PBH agreements") with a major service provider. The Company incurs a fee under the PBH agreements for each flight hour operated. The Company has also arranged for CAM's external leasing customers to participate under its PBH arrangements. Engine maintenance expense increased due to the increase in hours flown by aircraft operated by the Company and an increase in hours flown by aircraft leased by CAM to external customers. During 2011 and 2010, the Company expensed 14 scheduled airframe heavy maintenance events. We experienced an increase in costs for parts during 2011 due to a declining supply of used Boeing 767 parts.
Landing and ramp expense, which includes the cost of deicing chemicals, decreased by $1.2 million during 2011 compared to 2010. The decrease during 2011 reflects reduced flying for BAX/Schenker and a milder winter in North America compared to 2010.

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Travel expense increased by $5.6 million during 2011 compared to 2010. The increase is a result of additional flying operations, particularly in the European and Asia-Pacific regions.
Rent expense increased by $9.9 million during 2011 compared to 2010. The increase primarily reflects five additional Boeing 767 freighter aircraft that we have added to the Company's fleet since the fourth quarter of 2010 and an increase in the rental rates for the Company's facilities in Wilmington, Ohio, in conjunction with a new lease agreement executed with a regional port authority in May 2010. Four of the five aircraft leased by the Company are owned by DHL and operated by ABX under the CMI agreement.
Insurance expenses increased by $0.1 million during 2011 compared to 2010 due to the addition of Boeing 767 aircraft during the year.
Other operating expenses include professional fees, navigational services, employee training, utilities, and the cost of parts sold to customers. Other operating expenses increased by $0.8 million during 2011 compared to 2010, primarily due to additional aircraft operations during 2011.
Interest expense decreased by $4.5 million during 2011 compared to 2010. The decline in interest expense reflects the reduction in the level of the Company’s debt during the first four months of 2011, lower interest rates and an increase in capitalized interest for the aircraft undergoing freighter modification. Interest rates on the Company’s variable interest, unsubordinated term loan decreased from an average of approximately 2.9% in 2010 to approximately 2.4% in 2011.
During 2011, the Company recorded a pre-tax net loss on derivatives of $4.9 million, reflecting the impact of lower market interest rates at December 31, 2011 on the interest rate swaps held by the Company. During, 2011, in conjunction with the Senior Credit Agreement, the Company terminated its hedge accounting of interest rate swaps related to the former term loan, which resulted in the recognition of $3.9 million of losses that had previously been reflected in other comprehensive income. Additionally, the Senior Credit Agreement requires the Company to maintain interest rate derivative instruments for at least 50% of the outstanding balance of the new subordinated term loan. As a result, the Company entered into a new interest rate swap in July of 2011. The Company did not designate the recent interest rate swap as a hedge for accounting purposes. Accordingly, the effect of lower interest rates since the purchase of the interest rate swap resulted in a net unrealized loss for 2011.
During 2011, the Company wrote off $2.9 million of unamortized debt issuance costs associated with the former credit agreement.
The effective tax rate from continuing operations for the year ended December 31, 2011, was 41.6% compared to 37.0% for 2010. The effective tax rate from continuing operations in 2011 was affected by impairment charges that are not deductible for federal income tax purposes. The Company's effective tax rate from continuing operations was approximately 39% for the year ended December 31, 2011, after adjusting for $2.8 million of non-deductible impairment charges. The effective tax rate increased for 2011 due to proportionately higher level of non-deductible tax expenses in 2011 compared to 2010. The effective tax rate for 2010 was lower due to the recognition of a deferred tax benefit of $0.4 million in the third quarter of 2010. The deferred tax benefit in 2010 related to a previously unrecognized tax position under the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 740-10 Income Taxes. The statute of limitations for this item expired, resulting in the recording of the deferred tax benefit.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Cash Flows
Net cash generated from operating activities totaled $110.6 million, $136.1 million and $112.3 million in 2012, 2011 and 2010, respectively. Cash flows generated from operating activities decreased in 2012 compared to 2011 primarily reflecting payments to vendors associated with the wind-down of the BAX/Schenker operations, the timing of cash collections from customers and additional pension contributions. Cash outlays for pension contributions were $24.7 million, $18.0 million and $36.6 million in 2012, 2011 and 2010, respectively. During 2010, cash flows included the receipt from DHL of amounts in reimbursement for severance payments made to employees and costs incurred arising from the termination of ABX's former contracts with DHL.
Capital spending levels were primarily the result of aircraft modification costs and the acquisition of aircraft for

33


freighter modification. Cash payments for capital expenditures were $155.2 million, $213.1 million and $110.7 million in 2012, 2011 and 2010, respectively. Capital expenditures in 2012 included $134.9 million for the acquisition of two Boeing 767-300 aircraft and one Boeing 757 aircraft and the costs of aircraft modifications, $11.3 million for required heavy maintenance and $9.0 million for other equipment costs. Our capital expenditures in 2011 included $184.3 million for the acquisition and modification of aircraft, $21.9 million for required heavy maintenance and $6.9 million for other equipment costs. Our capital expenditures in 2010 included $74.8 million for the acquisition and modification of aircraft, $29.9 million for required heavy maintenance and $6.0 million for other equipment costs.
Cash proceeds of $5.8 million, $11.1 million and $32.0 million were received in 2012, 2011 and 2010, respectively, for the sale of aircraft engines, airframes and parts. During 2010, we received proceeds from DHL to complete the sale of aircraft put to DHL under provisions of the former DHL ACMI agreement.
Net cash provided by financing activities was $23.8 million and $48.0 million in 2012 and 2011, respectively. Our borrowing activities were necessary to finance the our strategy to acquire and modify aircraft for deployment into the air cargo markets. During 2012, we drew $50.0 million from the revolving credit facility under the Senior Credit Agreement to fund capital spending and we made debt principal payments of $26.2 million. Additionally, $6.2 million of the principal balance of the DHL promissory note was extinguished during 2012, pursuant to the CMI agreement with DHL. During 2010, we made principal payments of $70.2 million and did not need to draw from the revolving credit facility.
Commitments
Through CAM, the Company continues to make investments in Boeing 767 and 757 aircraft. As these aircraft are modified, we will place them into service under dry leasing arrangements to external customers or ACMI operations using our airlines, depending on which alternative provides the best long term return and considering other factors, including geographical placement and customer diversification.
In August 2010, the Company entered into an agreement with M&B Conversions Limited and Israel Aerospace Industries Ltd. ("IAI"), for the conversion by IAI of up to ten Boeing 767-300 series passenger aircraft to a standard freighter configuration during the 10-year term of the agreement. As of December 31, 2012, five such aircraft have completed the modification process, one Boeing 767-300 aircraft was undergoing modification to a standard freighter configuration and one Boeing 767-300 aircraft was awaiting modification. If the Company were to cancel the conversion program as of December 31, 2012, it would owe IAI approximately $2.0 million associated with engineering efforts, and conversion part kits.
Since October 2010, the Company has entered into separate agreements with Precision Conversions, LLC (“Precision”) for the conversion of Boeing 757 passenger aircraft to standard freighter configuration and a combi aircraft variant. The Boeing 757 combi variant developed by Precision incorporates 10 full cargo pallet positions along with seating for up to 52 passengers. As of December 31, 2012, one Boeing 757 had completed, and another was undergoing, the modification process for standard freighter configuration and a third Boeing 757 aircraft was in the combi conversion process. If the Company were to cancel the conversion program as of December 31, 2012, it would owe Precision approximately $5.0 million associated with engineering efforts and conversion part kits.
In December 2012, the Company entered an agreement to purchase three Boeing 757 aircraft modified for combi service and a spare engine. The Company purchased one of the aircraft in 2012 while the other two and the spare engine were purchased in January of 2013.

34


The table below summarizes the Company's contractual obligations and commercial commitments (in thousands) as of December 31, 2012.
 
Payments Due By Period
Contractual Obligations
Total
 
Less Than
1 Year
 
2-3
Years
 
4-5
Years
 
After 5
Years
Long term debt, including interest payments
$
409,296

 
$
33,360

 
$
68,434

 
$
289,892

 
$
17,610

Operating leases
78,323

 
25,208

 
35,060

 
13,791

 
4,264

Hangar lease
18,303

 

 
1,194

 
1,666

 
15,443

Aircraft purchase and modification obligations
55,599

 
55,599

 

 

 

Total contractual cash obligations
$
561,521

 
$
114,167

 
$
104,688

 
$
305,349

 
$
37,317

The long term debt bears interest at 2.47% to 7.36% per annum.
In 2012, the Company entered into agreements with the CCPA to construct and lease an aircraft hangar in Wilmington, Ohio, adjacent to the existing aircraft maintenance facility currently leased by the Company. The Company acts as construction agent for the CCPA and began construction of a 100,000 square foot aircraft hangar in 2013. The hangar is projected to cost approximately $15.7 million and is expected to take approximately 12 to 14 months to complete. The CCPA is financing the construction of the hangar primarily through a State of Ohio bond program and a State of Ohio loan on incremental taxes. The table above does not include the costs to build the hangar because the projected costs will be reimbursed by the State of Ohio during the construction period. The costs incurred to build the hangar will be included in "Property and equipment" and the amounts that are reimbursed through the State of Ohio and the CCPA will be included in "Other liabilities" on the Company's balance sheet. We will begin to make lease payments for the hangar directly to the trustee for the State of Ohio beginning in 2014. The initial term of the hangar lease expires in 2036.
The Company provides defined benefit pension plans to certain employee groups. The table above does not include cash contributions for pension funding due to the absence of scheduled maturities. The timing of pension and post-retirement healthcare payments cannot be reasonably determined, except for $29.9 million expected to be paid in 2013.
We estimate that capital expenditures for 2013 will be $95 million for the acquisition of two Boeing 757 aircraft, related modification costs for Boeing 767-300 and Boeing 757 aircraft and other aircraft related expenditures. Also, capital expenditures for 2013 are expected to include an additional $15 million for the new hangar construction and other projects. Actual capital spending for any future period will be impacted by the progress in the aircraft modification process and hangar construction. We expect to finance the aircraft purchases and modifications from current cash balances, future operating cash flow and the Senior Credit Agreement.
Liquidity
The Company has a Senior Credit Agreement with a consortium of banks that includes an unsuborinated term loan of $144.4 million and a revolving credit facility from which the Company has drawn $143.0 million, net of repayments as of December 31, 2012. On July 20, 2012, the Company executed the first amendment to the Senior Credit Agreement ("Credit Amendment"). The Credit Amendment increased the amount available under the revolving credit facility by $50 million to $225 million, extended the maturity of the term loan and revolving credit facility to July 20, 2017, and provided for an accordion feature whereby the Company may draw up to an additional $50 million, subject to the lenders' consent. If the Company exercises the accordion feature, the same terms and conditions of the Senior Credit Agreement would apply to the accordion feature and additional collateral would need to be posted to maintain the 150% collateral coverage requirement. The additional debt 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 2.47%. The Credit Amendment did not affect the EBITDA based pricing or covenants of the Senior Credit Agreement.
The Senior Credit Agreement is collateralized by certain of the Company's Boeing 767 and 757 aircraft that are not collateralized under aircraft loans. Under the terms of the Senior Credit Agreement, the Company is required to

35


maintain collateral coverage equal to 150% of the outstanding balance of the term loan and the total revolving credit facility. 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.
At December 31, 2012, the Company had $15.4 million of cash balances. The Company had $70.9 million available under the revolving credit facility, net of outstanding letters of credit, which totaled $11.1 million. In January 2013, the Company drew an additional $60.0 million through the revolving credit facility to finance aircraft acquisitions and related modification costs. If needed, the Company also expects to have available the $50 million accordion feature noted above. As specified under the terms of ABX's CMI agreement with DHL, the $14.0 million balance at December 31, 2012 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 December 31, 2012 and 2011, 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. We believe the following significant and critical accounting policies involve the more significant judgments and estimates used in preparing the consolidated financial statements.
Revenue Recognition
Revenues generated from airline service agreements are typically recognized based on hours flown or the amount of aircraft and crew resources provided during a reporting period. Certain agreements include provisions for incentive payments based upon on-time reliability. These incentives are typically measured on a monthly basis and recorded to revenue in the corresponding month earned. Revenues for operating expenses that are reimbursed through customer agreements, including consumption of aircraft fuel, are generally recognized as the costs are incurred. Revenues from

36


charter service agreements are recognized on scheduled and non-scheduled flights when the specific flight has been completed. Revenues from the sale of aircraft parts are recognized when the parts are delivered. Revenues earned and expenses incurred in providing aircraft-related maintenance, repair or technical services are recognized in the period in which the services are completed and delivered to the customer. Revenues derived from transporting freight and sorting parcels are recognized upon delivery of shipments and completion of services. Aircraft lease revenues are recognized as operating lease revenue on a straight-line basis over the term of the applicable lease agreements.
Goodwill and Intangible Assets
In accordance with the Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Topic 350-20 Intangibles—Goodwill and Other, we assess in the fourth quarter of each year whether the Company’s goodwill acquired in acquisitions is impaired. Additional assessments may be performed on an interim basis whenever events or changes in circumstances indicate an impairment may have occurred. Indefinite-lived intangible assets are not amortized but are assessed for impairment annually, or more frequently if impairment indicators occur. Finite-lived intangible assets are amortized over their estimated useful economic lives and are periodically reviewed for impairment.
Application of the goodwill impairment test requires significant judgment, including the determination of the fair value of each reporting unit that has goodwill. The Company has two reporting units, ATI and CAM, that have goodwill. We estimate the fair value of ATI and CAM separately using a market approach and an income approach utilizing discounted cash flows applied to a market-derived rate of return. The market approach utilizes market multiples from comparable publicly traded companies. The market multiples include revenues, EBIT (earnings before interest and taxes), EBITDA (earnings before interest, taxes, depreciation and amortization) and EBITDAR (earnings before interest, taxes, depreciation, amortization and rent). We derive cash flow assumptions from many factors including recent market trends, expected revenues, cost structure, aircraft maintenance schedules and long term strategic plans for the deployment of aircraft. Key assumptions under the discounted cash flow models include projections for the number of aircraft in service, capital expenditures, long term growth rates, operating cash flows and market-derived discount rates.
The first step of the goodwill impairment test requires a comparison of the fair value of the reporting unit to its respective carrying value. If the carrying value of a reporting unit is less than its fair value, no indication of impairment exists and a second step is not performed. If the carrying amount of a reporting unit is higher than its fair value, there is an indication that an impairment may exist and a second step is performed. In the second step, fair values are assigned to all of the assets and liabilities of a reporting unit, including any unrecognized intangible assets, and the implied fair value of goodwill is calculated. If the implied fair value of goodwill is less than the recorded goodwill, an impairment loss is recorded for the difference and charged to operations.
We have used the assistance of an independent business valuation firm in estimating an expected market rate of return, and in the development of a market approach for ATI and CAM using multiples of EBITDAR, EBITDA, EBIT and revenues from comparable publicly traded companies. Based on our analysis, as of December 31, 2012, CAM's fair value exceeded its carrying value by more than 25% and ATI's fair value exceeded its carrying value by 7%.
The Company's key assumptions used for goodwill testing include uncertainties. Those uncertainties include the level of demand for cargo aircraft by shippers, the U.S. Military and freight forwarders and CAM's ability to lease aircraft near expected modification completion dates. We anticipate that CAM will successfully modify two Boeing 767 freighter aircraft over the next year and place them under long term lease agreements. We anticipate that CAM will successfully complete the modification of four Boeing 757 aircraft into combi configuration and one Boeing 757 aircraft to standard freighter configuration and that ATI will deploy them over the next year. We expect that ATI will operate four combi aircraft for the U.S. Military and that ATI will operate four Boeing 757 aircraft and eight Boeing 767 aircraft for DHL and other customers. The demand for customer airlift is projected based on input from customers, the volume of bids requested by the U.S. Military, management's interface with customer planning personnel and aircraft utilization trends. Certain events or changes in circumstances could negatively impact our key assumptions. Customer preferences for cargo aircraft may be impacted by changes in aviation fuel prices. Key customers, including the U.S. Military, may decide that they do not need as many aircraft as projected, or they may find alternative airlift.
The Company's finite lived intangible asset is for customer relationships acquired with ATI. This asset is amortized over the estimated useful economic life and reviewed for impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. The fair value of the asset was derived using projected revenues from existing customers and related attrition rates using the guidance under FASB ASC Topic 360-10 Property, Plant

37


and Equipment, and separately from a discounted cash flow model used for goodwill impairment. The projected net cash flows attributed to existing customers were discounted using an estimated cost of capital, based on market participant assumptions.
Long-lived assets
Aircraft and other long-lived assets are tested for impairment whenever events or changes in circumstances indicate the carrying value of the assets may not be recoverable. Factors which may cause an impairment include termination of aircraft from a customer's network, extended operating cash flow losses from the assets and management's decisions regarding the future use of assets. To conduct impairment testing, the Company groups assets and liabilities at the lowest level for which identifiable cash are largely independent of cash flows of other assets and liabilities. For assets that are to be held and used, impairment is recognized when the estimated undiscounted cash flows associated with an asset group is less than the carrying value. If impairment exists, an adjustment is made to write the assets down to fair value, and a loss is recorded as the difference between the carrying value and fair value. Fair values are determined considering quoted market values, discounted cash flows or internal and external appraisals, as applicable.
Depreciation
Depreciation of property and equipment is provided on a straight-line basis over the lesser of an asset’s useful life or lease term. We periodically evaluate the estimated service lives and residual values used to depreciate our property and equipment. The acceleration of depreciation expense or the recording of significant impairment losses could result from changes in the estimated useful lives of our assets. We may change the estimated useful lives due to a number of reasons, such as the existence of excess capacity in our air networks, or changes in regulations grounding or limiting the use of aircraft.
Self-Insurance
We self-insure certain claims related to workers’ compensation, aircraft, automobile, general liability and employee healthcare. We record a liability for reported claims and an estimate for incurred claims that have not yet been reported. Accruals for these claims are estimated utilizing historical paid claims data and recent claims trends. Changes in claim severity and frequency could result in actual claims being materially different than the costs provided for in our results of operations. We maintain excess claim coverage with common insurance carriers to mitigate our exposure to large claim losses.
Contingencies
We are involved in legal matters that have a degree of uncertainty associated with them. We continually assess the likely outcomes of these matters and the adequacy of amounts, if any, provided for these matters. There can be no assurance that the ultimate outcome of these matters will not differ materially from our assessment of them. There also can be no assurance that we know all matters that may be brought against us at any point in time.
Income Taxes
We account for income taxes under the provisions of FASB ASC Topic 740-10 Income Taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s financial statements or tax returns. Fluctuations in the actual outcome of expected future tax consequences could materially impact the Company’s financial position or its results of operations.
The Company has significant deferred tax assets including net operating loss carryforwards (“NOL CFs”) for federal income tax purposes which begin to expire in 2024. Based upon projections of taxable income, we determined that it was more likely than not that the NOL CF’s will be realized prior to their expiration. Accordingly, we do not have an allowance against these deferred tax assets at this time.
We recognize the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position.

38


Post-retirement Obligations
The Company sponsors qualified defined benefit pension plans for ABX’s flight crewmembers and other eligible employees. The Company also sponsors non-qualified, unfunded excess plans that provide benefits to executive management and crewmembers that are in addition to amounts permitted to be paid through our qualified plans under provisions of the tax laws. Employees are no longer accruing benefits under any of the defined benefit pension plans. The Company also sponsors unfunded post-retirement healthcare plans for ABX’s flight crewmembers and non-flight crewmember employees.
The accounting and valuation for these post-retirement obligations are determined by prescribed accounting and actuarial methods that consider a number of assumptions and estimates. The selection of appropriate assumptions and estimates is significant due to the long time period over which benefits will be accrued and paid. The long term nature of these benefit payouts increases the sensitivity of certain estimates on our post-retirement costs. In actuarially valuing our pension obligations and determining related expense amounts, assumptions we consider most sensitive are discount rates and expected long term investment returns on plan assets. Other assumptions concerning retirement ages and mortality also affect the valuations. Actual results and future changes in these assumptions could result in future costs that are materially different than those recorded in our annual results of operations.
Our actuarial valuation includes an assumed long term rate of return on pension plan assets of 6.75%. Our assumed rate of return is based on a targeted long term investment allocation of 50% equity securities, 45% fixed income securities and 5% real estate. The actual asset allocation at December 31, 2012 was 48% equities, 49% fixed income, 3% real estate and 0% cash. The pension trust includes $44.2 million of investments (6% of the plans' assets) whose fair values have been estimated in the absence of readily determinable fair values. Such investments include private equity, hedge fund investments and real estate funds. Management’s estimates are based on information provided by the fund managers or general partners of those funds.
In evaluating our assumptions regarding expected long term investment returns on plan assets, we consider a number of factors, including our historical plan returns in connection with our asset allocation policies, assistance from investment consultants hired to provide oversight over our actively managed investment portfolio and long term inflation assumptions. The selection of the expected return rate materially affects our pension costs. Our expected long term rate of return remained at 6.75% after analyzing expected returns on investment vehicles and considering our long term asset allocation expectations. If we were to lower our long term rate of return assumption by a hypothetical 100 basis points, expense in 2012 would be increased by approximately $6.8 million. We use a market value of assets as of the measurement date for determining pension expense.
In selecting the interest rate to discount estimated future benefit payments that have been earned to date to their net present value (defined as the projected benefit obligation), we match the plan’s benefit payment streams to high-quality bonds of similar maturities. The selection of the discount rate not only affects the reported funded status information as of December 31 (as shown in Note H to the accompanying consolidated financial statements), but also affects the succeeding year’s pension and post-retirement healthcare costs. The discount rates selected for December 31, 2012, based on the method described above, were 4.25%. If we were to lower our discount rates by a hypothetical 50 basis points, pension expense in 2012 would be increased by approximately $5.5 million.
The assumed future increase in salaries and wages is no longer a significant estimate in determining pension costs because each defined benefit pension plan was frozen during 2009 with respect to additional benefit accruals.
The following table illustrates the sensitivity of the aforementioned assumptions on our pension expense, pension obligation and accumulated other comprehensive income (in thousands):
 
Effect of change
 
 
 
December 31, 2012
Change in assumption
2012
Pension
expense
 
Pension obligation
 
Accumulated
other
comprehensive
income (pre-tax)
100 basis point decrease in rate of return
$
6,813

 
$

 
$

50 basis point decrease in discount rate
5,498

 
(65,745
)
 
65,745

Aggregate effect of all the above changes
12,311

 
(65,745
)
 
65,745


39


Discontinued Operations
In accordance with the guidance of FASB ASC Topic 205-20 Presentation of Financial Statements, a business component whose operations are discontinued is reported as discontinued operations if the cash flows of the component have been eliminated from the ongoing operations of the Company and the Company will no longer have any significant continuing involvement in the business component. The results of discontinued operations are aggregated and presented separately in the consolidated statement of operations. FASB ASC Topic 205-20 requires the reclassification of amounts presented for prior years to reflect their classification as discontinued operations.
Exit Activities
We account for the costs associated with exit activities in accordance with FASB ASC Topic 420-10 Exit or Disposal Cost Obligations. One-time, involuntary employee termination benefits are generally expensed when the Company communicates the benefit arrangement to the employee that it will no longer require the services of the employee beyond a minimum retention period. Liabilities for contract termination costs associated with exit activities are recognized in the period incurred and measured initially at fair value.
New Accounting Pronouncements
In December 2011, the FASB issued Accounting Standards Update No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities,” (“ASU 2011-11”). ASU 2011-11 enhances disclosures regarding financial instruments and derivative instruments. Entities are required to provide both net information and gross information for these assets and liabilities. This new guidance is to be applied retrospectively beginning in 2013. The Company anticipates that the adoption of this standard will expand its consolidated financial statement footnote disclosures.
In July 2012, the FASB issued Accounting Standards Update No. 2012-02, "Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment," ("ASU 2012-02"). ASU 2012-02 is a revised standard which provides entities with the option to first use an assessment of qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. If a conclusion is reached that the indefinite-lived intangible asset fair value is not more likely than not below carrying value, no further impairment testing is necessary. This revised guidance applies to fiscal years beginning after September 15, 2012, and the related interim and annual goodwill impairment tests. The Company does not believe this standard will have a material impact on the condensed consolidated financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk for changes in interest rates and changes in the price of jet fuel. The risk associated with jet fuel, however, is largely mitigated by reimbursement through the agreements with our customers.
On May 9, 2011, the Company executed a syndicated credit agreement ("Senior Credit Agreement"). The Senior Credit Agreement includes a term loan of $150 million. On July 20, 2012, the Company executed the first amendment to the Senior Credit Agreement (“Credit Amendment”). The Credit Amendment increased the amount available under the revolving credit loan by $50 million, extended the maturity of the term loan and revolving credit loan to July 20, 2017, and provided for an accordion feature whereby the Company may draw up to an additional $50.0 million, subject to the lenders' consent. Under the terms of the Senior Credit Agreement, interest rates will be adjusted quarterly based on the Company's earnings before interest, taxes, depreciation and amortization expenses ("EBITDA"), its outstanding debt level and prevailing LIBOR or prime rates (see Note F to the consolidated financial statements). The Company's Senior Credit Agreement requires the Company to maintain derivative instruments for fluctuating interest rates, for at least fifty percent of the outstanding balance of the new unsubordinated term loan. Accordingly, in July 2011, the Company entered into a new interest rate swap instrument. As a result, future fluctuations in LIBOR interest rates will result in the recording of unrealized gains and losses on interest rate derivatives held by the Company. The notional values were $72.2 million as of December 31, 2012. See Note J in the accompanying consolidated financial statements for a discussion of our accounting treatment for these hedging transactions.
As of December 31, 2012, the Company has $77.1 million of fixed interest rate debt and $287.4 million of variable interest rate debt outstanding. Variable interest rate debt exposes us to differences in future cash flows resulting from changes in market interest rates. Variable interest rate risk can be quantified by estimating the change in annual cash

40


flows resulting from a hypothetical 20% increase in interest rates. A hypothetical 20% increase or decrease in interest rates would have resulted in a change in interest expense of approximately $1.3 million for the year ended December 31, 2012.
The debt issued at fixed interest rates is exposed to fluctuations in fair value resulting from changes in market interest rates. Fixed interest rate risk can be quantified by estimating the increase in fair value of our long term debt through a hypothetical 20% increase in interest rates. As of December 31, 2012, a 20% increase in interest rates would have decreased the fair value of our fixed interest rate debt by approximately $1.8 million.
The Company is exposed to concentration of credit risk primarily through cash deposits, cash equivalents, marketable securities and derivatives. As part of our risk management process, we monitor and evaluate the credit standing of the financial institutions with which we do business. The financial institutions with which we do business are generally highly rated. The Company is exposed to counterparty risk, which is the loss we could incur if a counterparty to a derivative contract defaulted.
At December 31, 2012, ABX's defined benefit pension plans had total investment assets of $682.6 million under investment management. See Note H in the accompanying consolidated financial statements for further discussion of these assets.


41


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
 



42



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Air Transport Services Group, Inc.
Wilmington, Ohio
We have audited the accompanying consolidated balance sheets of Air Transport Services Group, Inc. and subsidiaries (the "Company") as of December 31, 2012, and 2011, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Table of Contents at Item 15a(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note B to the consolidated financial statements, the Company's two principal customers account for a substantial portion of the Company's revenue. The Company's financial security is dependent on its ongoing relationship with its principal customers existing as of December 31, 2012.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2012, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 4, 2013 expressed an unqualified opinion on the Company's internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Dayton, Ohio
March 4, 2013



43


AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
 
December 31,
 
December 31,
 
2012
 
2011
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
15,442

 
$
30,503

Accounts receivable, net of allowance of $749 in 2012 and $434 in 2011
47,858

 
42,278

Inventory
9,430

 
8,906

Prepaid supplies and other
8,855

 
9,785

Deferred income taxes
19,154

 
31,548

Aircraft and engines held for sale
3,360

 
9,831

TOTAL CURRENT ASSETS
104,099

 
132,851

Property and equipment, net
818,924

 
748,913

Other assets
20,462

 
18,579

Intangibles
5,146

 
6,396

Goodwill
86,980

 
86,980

TOTAL ASSETS
$
1,035,611

 
$
993,719

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
36,521

 
$
48,360

Accrued salaries, wages and benefits
22,917

 
23,226

Accrued expenses
8,502

 
10,291

Current portion of debt obligations
21,265

 
13,223

Unearned revenue
10,311

 
12,487

TOTAL CURRENT LIABILITIES
99,516

 
107,587

Long term debt obligations
343,216

 
333,681

Post-retirement liabilities
185,097

 
185,562

Other liabilities
62,104

 
54,212

Deferred income taxes
46,422

 
42,530

TOTAL LIABILITIES
736,355

 
723,572

Commitments and contingencies (Note G)

 

STOCKHOLDERS’ EQUITY:
 
 
 
Preferred stock, 20,000,000 shares authorized, including 75,000 Series A Junior Participating Preferred Stock

 

Common stock, par value $0.01 per share; 75,000,000 shares authorized; 64,130,056 and 64,015,789 shares issued and outstanding in 2012 and 2011, respectively
641

 
640

Additional paid-in capital
523,087

 
520,613

Accumulated deficit
(107,185
)
 
(148,059
)
Accumulated other comprehensive loss
(117,287
)
 
(103,047
)
TOTAL STOCKHOLDERS’ EQUITY
299,256

 
270,147

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,035,611

 
$
993,719

 
 
 
 
See notes to consolidated financial statements.

44


AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
Year Ended December 31
 
2012
 
2011
 
2010
REVENUES
$
607,438

 
$
730,133

 
$
667,382

OPERATING EXPENSES
 
 
 
 
 
Salaries, wages and benefits
184,644

 
188,884

 
176,988

Fuel
53,928

 
150,003

 
133,776

Maintenance, materials and repairs
97,540

 
86,929

 
79,143

Depreciation and amortization
84,477

 
91,063

 
87,594

Travel
22,683

 
28,335

 
22,709

Rent
25,970

 
25,201

 
15,339

Landing and ramp
15,973

 
22,630

 
23,782

Insurance
7,716

 
9,309

 
9,171

Impairment of goodwill

 
2,797

 

Impairment of acquired intangibles

 
2,282

 

Impairment of aircraft

 
22,065

 

Other operating expenses
35,819

 
38,006

 
37,204

 
528,750

 
667,504

 
585,706

OPERATING INCOME
78,688

 
62,629

 
81,676

OTHER INCOME (EXPENSE)
 
 
 
 
 
Interest income
136

 
179

 
316

Interest expense
(14,383
)
 
(14,181
)
 
(18,675
)
Net gain (loss) on derivative instruments
1,879

 
(4,881
)
 

Write-off of unamortized debt issuance costs

 
(2,886
)
 

 
(12,368
)
 
(21,769
)
 
(18,359
)
 
 
 
 
 
 
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
66,320

 
40,860

 
63,317

INCOME TAX EXPENSE
(24,672
)
 
(16,995
)
 
(23,413
)
EARNINGS FROM CONTINUING OPERATIONS
41,648

 
23,865

 
39,904

EARNINGS (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAXES
(774
)
 
(673
)
 
(70
)
NET EARNINGS
$
40,874

 
$
23,192

 
$
39,834

 
 
 
 
 
 
BASIC EARNINGS PER SHARE
 
 
 
 
 
Continuing operations
$
0.66

 
$
0.38

 
$
0.64

Discontinued operations
(0.02
)
 
(0.01
)
 
(0.01
)
TOTAL BASIC EARNINGS PER SHARE
$
0.64

 
$
0.37

 
$
0.63

 
 
 
 
 
 
DILUTED EARNINGS PER SHARE
 
 
 
 
 
Continuing operations
$
0.65

 
$
0.37

 
$
0.62

Discontinued operations
(0.02
)
 
(0.01
)
 

TOTAL DILUTED EARNINGS PER SHARE
$
0.63

 
$
0.36

 
$
0.62

 
 
 
 
 
 
WEIGHTED AVERAGE SHARES
 
 
 
 
 
Basic
63,461

 
63,284

 
62,807

Diluted
64,420

 
64,085

 
64,009


See notes to consolidated financial statements.

45



AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
 
Years Ended December 31
 
2012
 
2011
 
2010
NET EARNINGS
$
40,874

 
$
23,192

 
$
39,834

OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
 
 
Defined Benefit Pension
 
 
 
 
 
Actuarial gain (loss) for retiree liabilities
(27,518
)
 
(91,715
)
 
(19,685
)
Reclassifications to net income
10,681

 
2,700

 
2,068

Income tax benefit
5,861

 
32,714

 
6,395

Defined Benefit Post-Retirement
 
 
 
 
 
Actuarial gain (loss) for retiree liabilities
168

 
192

 
22,659

Reclassifications to net income
(5,119
)
 
(5,341
)
 
(3,847
)
Income tax (expense) or benefit
1,724

 
1,892

 
(6,827
)
Gains and Losses on Derivatives
 
 
 
 
 
Unrealized gain (loss) for derivative instruments

 
631

 
(848
)
Reclassifications to net income
(57
)
 
3,709

 
(106
)
Income tax (expense) or benefit
20

 
(1,595
)
 
346

 
 
 
 
 
 
TOTAL COMPREHENSIVE INCOME (LOSS)
$
26,634

 
$
(33,621
)
 
$
39,989


See notes to consolidated financial statements.


46


AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
Years Ended December 31
 
2012
 
2011
 
2010
OPERATING ACTIVITIES:
 
 
 
 
 
Net earnings from continuing operations
$
41,648

 
$
23,865

 
$
39,904

Net loss from discontinued operations
(774
)
 
(673
)
 
(70
)
Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
 
 
Impairment of aircraft

 
22,065

 

Impairment of goodwill and acquired intangibles

 
5,079

 

Depreciation and amortization
84,477

 
91,063

 
87,594

Pension and post-retirement
5,562

 
(2,641
)
 
(1,990
)
Deferred income taxes
23,749

 
17,126

 
20,820

Amortization of stock-based compensation
3,231

 
2,877

 
1,720

Amortization of DHL promissory note
(6,200
)
 
(6,200
)
 
(4,650
)
Net (gain) loss on derivative instruments
(1,879
)
 
4,881

 

Write-off of unamortized debt issuance costs

 
2,886

 

Changes in assets and liabilities:
 
 
 
 
 
Accounts receivable
(4,328
)
 
1,980

 
41,529

Inventory and prepaid supplies
(1,759
)
 
(13
)
 
(6,253
)
Accounts payable
(5,688
)
 
(1,715
)
 
2,729

Unearned revenue
654

 
9,337

 
6,789

Accrued expenses, salaries, wages, benefits and other liabilities
4,898

 
(8,209
)
 
(44,648
)
Pension and post-retirement liabilities
(27,926
)
 
(23,159
)
 
(32,789
)
Other
(5,032
)
 
(2,443
)
 
1,578

NET CASH PROVIDED BY OPERATING ACTIVITIES
110,633

 
136,106

 
112,263

INVESTING ACTIVITIES:
 
 
 
 
 
Capital expenditures
(155,243
)
 
(213,083
)
 
(110,681
)
Proceeds from property and equipment
5,772

 
11,147

 
31,981

Proceeds from the redemption of interest-bearing investments

 
1,750

 

NET CASH (USED IN) INVESTING ACTIVITIES
(149,471
)
 
(200,186
)
 
(78,700
)
FINANCING ACTIVITIES:
 
 
 
 
 
Principal payments on long term obligations
(26,223
)
 
(214,424
)
 
(70,249
)
Proceeds from borrowings
50,000

 
265,000

 

Financing fees

 
(2,536
)
 

NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
23,777

 
48,040

 
(70,249
)
 
 
 
 
 
 
NET DECREASE IN CASH AND CASH EQUIVALENTS
(15,061
)
 
(16,040
)
 
(36,686
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
30,503

 
46,543

 
83,229

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
15,442

 
$
30,503

 
$
46,543

 
 
 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
Interest paid, net of amount capitalized
$
13,195

 
$
12,985

 
$
16,656

Federal alternative minimum and state income taxes paid
$
377

 
$
2,448

 
$
523

SUPPLEMENTAL NON-CASH INFORMATION:
 
 
 
 
 
Debt extinguished
$
6,200

 
$
6,200

 
$
4,650

Accrued capital expenditures
$
4,770

 
$
10,921

 
$
1,404

See notes to consolidated financial statements.

47



AIR TRANSPORT SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands, except share data)
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
 
Number
 
Amount
 
BALANCE AT JANUARY 1, 2010
63,416,564

 
$
634

 
$
502,822

 
$
(211,085
)
 
$
(46,389
)
 
$
245,982

Stock-based compensation plans
 
 
 
 
 
 
 
 
 
 
 
Grant of restricted stock
367,200

 
4

 
(4
)
 
 
 
 
 

Withholdings of common shares, net of issuances
(95,736
)
 
(1
)
 
(958
)
 
 
 
 
 
(959
)
Forfeited restricted stock
(35,800
)
 

 

 
 
 
 
 

Tax benefit from common stock compensation
 
 
 
 
498

 
 
 
 
 
498

Amortization of stock awards and restricted stock
 
 
 
 
1,720

 
 
 
 
 
1,720

Debt extinguishment, net of tax
 
 
 
 
14,847

 
 
 
 
 
14,847

Total comprehensive income
 
 
 
 
 
 
39,834

 
155

 
39,989

BALANCE AT DECEMBER 31, 2010
63,652,228

 
$
637

 
$
518,925

 
$
(171,251
)
 
$
(46,234
)
 
$
302,077

Stock-based compensation plans
 
 
 
 
 
 
 
 
 
 
 
Grant of restricted stock
313,300

 
3

 
(3
)
 
 
 
 
 

Issuance of common shares, net of withholdings
161,161

 
1

 
(1,187
)
 
 
 
 
 
(1,186
)
Forfeited restricted stock
(110,900
)
 
(1
)
 
1

 
 
 
 
 

Amortization of stock awards and restricted stock
 
 
 
 
2,877

 
 
 
 
 
2,877

Total comprehensive income (loss)
 
 
 
 
 
 
23,192

 
(56,813
)
 
(33,621
)
BALANCE AT DECEMBER 31, 2011
64,015,789

 
$
640

 
$
520,613

 
$
(148,059
)
 
$
(103,047
)
 
$
270,147

Stock-based compensation plans
 
 
 
 
 
 
 
 
 
 
 
Grant of restricted stock
254,200

 
3

 
(3
)
 
 
 
 
 

Withholdings of common shares, net of issuances
(83,933
)
 
(1
)
 
(755
)
 
 
 
 
 
(756
)
Forfeited restricted stock
(56,000
)
 
(1
)
 
1

 
 
 
 
 

Amortization of stock awards and restricted stock
 
 
 
 
3,231

 
 
 
 
 
3,231

Total comprehensive income (loss)
 
 
 
 
 
 
40,874

 
(14,240
)
 
26,634

BALANCE AT DECEMBER 31, 2012
64,130,056

 
$
641

 
$
523,087

 
$
(107,185
)
 
$
(117,287
)
 
$
299,256


See notes to consolidated financial statements.



48


AIR TRANSPORT SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A—SUMMARY OF FINANCIAL STATEMENT PREPARATION AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations
Air Transport Services Group, Inc. is a holding company whose principal subsidiaries include an aircraft leasing company and independently certificated airlines. The Company provides airline operations, aircraft leases, aircraft maintenance and other support services primarily to the cargo transportation and package delivery industries. Through the Company's subsidiaries, it offers a range of complementary services to delivery companies, freight forwarders, airlines and government customers.
The airlines, ABX Air, Inc. (“ABX”), Capital Cargo International Airlines, Inc. (“CCIA”) and Air Transport International, Inc. (“ATI”), each have the authority, through their separate U.S. Department of Transportation ("DOT") and Federal Aviation Administration ("FAA") certificates, to transport cargo worldwide. The Company's leasing subsidiary, Cargo Aircraft Management, Inc. (“CAM”), leases aircraft to each of the Company's airlines as well as to non-affiliated airlines and other lessees.
The Company provides aircraft and airline operations to its customers, typically under contracts providing for a combination of aircraft, crews, maintenance and insurance ("ACMI") services. The Company serves a base of concentrated customers who have a diverse line of international cargo traffic. DHL Network Operations (USA), Inc. and its affiliates, “DHL,” is the Company's largest customer. ATI provides passenger transportation, primarily to the U.S. Military, using "combi" aircraft, which are certified to carry passengers as well as cargo on the main deck.
In addition to its airline operations and aircraft leasing services, the Company sells aircraft parts, provides aircraft and equipment maintenance services, and operates mail sorting facilities for the U.S. Postal Service (“USPS”).
Basis of Presentation
The accompanying consolidated financial statements include the accounts of Air Transport Services Group, Inc. and its wholly-owned subsidiaries. Inter-company balances and transactions have been eliminated. The financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP").
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts reported in the consolidated financial statements. Estimates and assumptions are used to record allowances for uncollectible amounts, self-insurance reserves, spare parts inventory, depreciation and impairments of property, equipment, goodwill and intangibles, post-retirement obligations, income taxes, contingencies and litigation. Changes in estimates and assumptions may have a material impact on the consolidated financial statements.

Cash and Cash Equivalents
The Company classifies short-term, highly liquid investments with maturities of three months or less at the time of purchase as cash and cash equivalents. These investments, consisting of money market funds, are recorded at cost, which approximates fair value. Substantially all deposits of the Company’s cash are held in accounts that exceed federally insured limits. The Company deposits cash in common financial institutions which management believes are financially sound.
Accounts Receivable and Allowance for Uncollectible Accounts
The Company's accounts receivable is primarily due from its significant customers (see Note B), other airlines, the USPS and freight forwarders. The Company performs a quarterly evaluation of the accounts receivable and the allowance for uncollectible accounts by reviewing specific customers' recent payment history, growth prospects,

49


financial condition and other factors that may impact a customer's ability to pay. The Company establishes an allowance for uncollectible accounts for probable losses due to a customer's potential inability or unwillingness to make contractual payments. Account balances are written off against the allowance when the Company ceases collection efforts.
Inventory
The Company’s inventory is comprised primarily of expendable aircraft parts and supplies used for aircraft maintenance. Inventory is generally charged to expense when issued for use on a Com