Atlas Air Worldwide Holdings (AAWW) Q4 2018 Earnings Conference Call Transcript

AAWW earnings call for the period ending December 31, 2018.

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Atlas Air Worldwide Holdings (NASDAQ:AAWW)
Q4 2018 Earnings Conference Call
Feb. 19, 2019 11:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning. My name is Heidi, and I will be your conference operator today. At this time, I would like to welcome everyone to the fourth-quarter 2018 earnings call for Atlas Air Worldwide. [Operator instructions] Atlas Air, you may begin your conference.

Ed McGarvey -- Treasurer

Thank you, Heidi, and good morning, everyone. I'm Ed McGarvey, treasurer for Atlas Air Worldwide. Welcome to our fourth-quarter 2018 results conference call. Today's call will be hosted by Bill Flynn, our chief executive officer; and Spencer Schwartz, our chief financial officer.

Today's call is complemented by a slide presentation that can be viewed at atlasairworldwide.com under Presentations in the Investor Information section. As indicated on Slide 2, we'd like to remind you that our discussion about the company's performance today includes some forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events and expectations and they involve risks and uncertainties. Our actual results or actions may differ materially from those projected in any forward-looking statements.

For information about risk factors related to our business, please refer to our 2017 Form 10-K as amended or supplemented by our subsequently filed SEC reports. Any references to non-GAAP measures are meant to provide meaningful insights and are reconciled with GAAP in today's press release and in the appendix that is attached to today's slides. During our question-and-answer period today, we'd like to ask participants to limit themselves to one principal question and one follow-up question so that we can accommodate as many participants as possible. After we've gone through the queue, we'll be happy to answer any additional questions as time permits.

At this point, I'd like to draw your attention to Slide 3 and turn the call over to Bill Flynn.

Bill Flynn -- Chief Executive Officer

Thank you, Ed, and good morning, everyone. We're very pleased to have you join us. 2018 was another great year for Atlas. We drove substantial growth in the scale, diversity and profitability of our business.

As noted in our press release, we generated record volumes, revenue and earnings both in the fourth quarter and for the full year. And we expect to generate record volume, revenue and earnings in 2019. We're excited about our future and the future of airfreight. Our strategic initiatives have expanded our capabilities and enabled us to serve a greater range of customers.

They also provide solid platform for future growth initiatives. Our focus is is on express and e-commerce and fast-growing markets in Asia and elsewhere, such as, South America, where we have the strongest year in the company's history. As airfreight continues to grow further globalization will require time-definite air networks to facilitate the flow of goods. We're well-positioned to capitalize on the scale and scope of our domestic and worldwide operations, drive higher volumes, revenue, adjusted EBITDA and adjusted net income and further reduce our net leverage ratio.

We expect to benefit from a full year of flying by the aircraft we added in 2018 for customers, such as, Asiana, DHL Express, Inditex and SF Express. We will see our first full year of flying 20 767-300s for Amazon. We look forward to continuing to -- we look forward to operating three incremental 747-400 freighters for Nippon Cargo Airlines, which will increase our near-term fleet to 115 aircraft. And we anticipate that the flying we do for the military will be higher than in 2018.

These opportunities build on the growth in our business mix, customer base, fleet and operational capabilities. In addition to delivering record results in 2018, we added 16 aircraft to our operating fleet in response to customer demand and grew to more than 100 planes. We ended the year at a 112 aircraft across five fleet types. These aircraft are well suited to are growing domestic and regional flying, as well as our international operations.

We also ramped up for Amazon as scheduled, which included successfully managing multiple station openings throughout the United States. We enhanced our balance sheet by lowering our net leverage ratio, and thanks to our strong and experienced team who executed extremely well during the peak season. Moving to Slide 4, our fourth-quarter adjusted earnings reflected a 17% increase in block hours and 22% increase in revenue. They also included a 21% increase in adjusted EBITDA and 31% increase in adjusted net income.

We began flying for SF Express, China's leading express operator, during the quarter, and we ramped up to 20 aircraft for Amazon. Slide 5 highlights our framework for 2019. It reflects our outlook for another year of volume and earnings growth. For the full year, we expect volume to rise to around 340,000 block hours, revenue to grow to approximately $3 billion.

Adjusted EBITDA to increase to about $600 million and adjusted net income to grow by a mid- to upper-single-digit percentage. Similar to historical patterns, we anticipate that over three quarters of our adjusted net income in 2019 will occur in the second half of the year. Maintenance expense in 2019 is expected to total approximately $420 million. The increase from 2018 mainly reflects an increase in daily line maintenance driven by the growth of our fleet and the anticipated growth in over block hours this year.

Similar to 2018, we expect line maintenance to comprise about two-thirds of our total maintenance expense in 2019. Our outlook also anticipates depreciation and amortization of about $260 million and core capital expenditures, which exclude aircraft and engine purchases, between $135 million to $145 million, mainly for parts and components for our fleet. Looking to the first quarter, we expect volumes to total about 75,000 block hours, revenue of approximately $680 million, adjusted EBITDA of approximately $110 million and adjusted net income similar to the $23.8 million we reported in the first-quarter 2018. Our first quarter outlook also reflects anticipated revenue in our Titan dry-leasing business from maintenance payments related to the schedule return of a 777 cargo aircraft, which we expect to receive late in the first quarter.

This will be partially offset by a higher level of heavy maintenance expense compared with the first quarter of last year. This is a good point, I'll ask, Spencer, to provide some additional detail about our fourth quarter 2018 results. And after Spencer's remarks, I'll add a few additional comments and then we'll be happy to take your questions. Spencer?

Spencer Schwartz -- Chief Financial Officer

Thank you, Bill, and hello everyone. Our record fourth-quarter results are highlighted on Slide 6. On an adjusted basis, income from continuing operations, net of taxes total $87 million, which was an increase of 31% over the fourth quarter of 2017. As Bill noted, our results reflected record block hours, revenue, adjusted EBITDA and adjusted net income.

Our segments also generated substantially higher total direct contribution. On a reported basis, income from continuing operations, net of taxes totaled $211 million, which included an unrealized gain of $134.8 million on outstanding warrants. Our adjusted earnings in the fourth quarter included an effective income tax rate of 20.5%. For the full year, we had an effective tax rate of 15.2%.

With respect to 2019, we expect our full year adjusted income tax rate to be approximately 20%. Looking at Slide 7. Higher ACMI segment revenues in the fourth quarter were primarily driven by an increase in volumes, which reflected increased flying for Amazon and the start-up of new or incremental flying for several customers, including Asiana Cargo, DHL and SF Express. In Charter, higher segment revenues reflected an increase in total volumes and increases in average cargo and passenger rates.

Overlapping the end of peak season, we also operated 32 flights during the college football bowl season for 15 universities. In our dry leasing segment, higher revenues were primarily driven by an increase in the number of 767-300 aircraft throughout 2018, as well as the placement of one 777 freighter in February and a second one in July. Moving to Slide 8. Segment contribution totaled $185.1 million in the fourth quarter, a 14% increase over the previous year.

ACMI earnings, primarily, reflected increases in 747-400 rates and volumes. These were partially offset by two key items. First, higher heavy maintenance costs, including an increase in the proportion of heavy maintenance costs attributed to the segment due to our volume-based allocation methodology and the higher levels of ACMI flying during the December peak flying period. And second, higher crew costs, including enhanced wages and work rules resulting from our interim agreement with our Southern Air pilots.

The improvement in Charter contribution during the period was primarily due to increases in military and commercial cargo yields, excluding fuel. And higher military cargo demand, partially offset by an increase in heavy maintenance. Both ACMI and Charter contribution during the quarter reflected the redeployment of two 747-400 VIP passenger craft from ACMI to Charter, following our acquisition of these aircraft from a former CMI customer. We have used these 747s to grow our VIP Charter business and our earnings.

In dry leasing, higher segment contribution during the quarter primarily reflected the placement of additional aircraft. Turning to Slide 9, you can see the multi-year growth for Atlas. And as we said, that growth is continuing in 2019. Our performance and our outlook reflect the strategic initiatives that we have put in place over many years.

The robust compound annual growth rates we have generated reflect the addition of 45 aircraft to our fleet since the beginning of 2016. They also reflect our move into 777 and 737 operations through Southern Air, expansions with existing customers, such as DHL Express and the U.S. Military, and key new customer agreements, such as with Amazon, Asiana Cargo, Cathay Pacific, Nippon Cargo and SF Express. As a result, we are driving record volumes, record revenue and record earnings.

We are capitalizing on our strong market position and are focused on express, e-commerce and fast-growing global markets. Our financial and operating performances also reflect the leadership and strength of our ACMI and Charter businesses, the growth in annuity-like contribution of our Dry Leasing operations, ongoing efficiency and productivity initiatives and a well-disciplined balance sheet approach. We have built a solid platform for future growth initiatives. Turning to Slide 10, we ended the fourth quarter of 2018 with cash, including cash equivalents, restricted cash and short-term investments, totaling $248.4 million.

Our cash position at December 31st reflected cash used for investing activities, partially offset by cash provided by operating and financing activities. Net cash used for investing activities during 2018, primarily related to payments for the acquisition of 777 and 767 aircraft. 767 conversions to freighter configuration, spare engines and upgrade kits and core capital expenditures. Net cash provided by financing activities during the period, primarily reflected proceeds from our attractive financings of 777 and 767 aircraft, partially offset by payments on debt obligations.

We are focused on maintaining a strong balance sheet. As the slide shows, we have grown our fleet to take advantage of great opportunities. In doing so, we have applied a disciplined approach to financing. As a result, our debt has a low weighted average interest rate of 3.3%, all of which is at a fixed rate -- almost all of which is at a fixed rate.

In addition, the vast majority is secured by our aircraft assets, which have a value in excess of the related debt. As you can also see, our net leverage ratio, which remained fairly consistent while we increased our fleet significantly, began to move lower in the second half of 2018. We ended the year at 4.2 times, down from 4.8 times, and we expect our net leverage ratio to continue to improve gradually during 2019 as we benefit from flying the aircraft we added to the fleet in 2018, continue to generate strong EBITDAR and reflect debt payments of approximately $70 million per quarter. Now I'd like to turn it back to Bill.

Bill Flynn -- Chief Executive Officer

Thank you, Spencer. Moving to Slide 11, so 2018 was another great year for Atlas. We drove substantial growth in the scale, diversity and profitability of our business. We are a leader in global aviation outsourcing, and we're excited about our future and the future of airfreight.

Our focus is on express, e-commerce and fast-growing markets. We are capitalizing on the scale and scope of our domestic and worldwide operations. We're building on the growth in our business mix, customer base and operational capabilities. We have the aircraft and provide the services that customers want, and we are grateful to our dedicated team that delivers them.

Heidi, may we have the first question, please? 

Questions and Answers:

Operator

Certainly. Your first question comes from the line of Bob Labick with CJS Securities. Please go ahead.

Bob Labick -- CJS Securities -- Analyst

Good morning, and congratulations on a nice year and nice outlook. I wanted to start with -- Spencer, I think, you did touch on this a little bit. But I want to dig in a little bit deeper on the direct contribution from ACMI. I think going into the quarter, we'd expected a little bit more growth.

And I know you talked about heavy maintenance being a little higher, I guess, due to allocation and crew cost. But if you could elaborate on the, I guess, flatness in direct contrition there? And then talk about next year within your guidance, not specifically, but do you expect ACMI direct contribution to grow?

Spencer Schwartz -- Chief Financial Officer

Sure, Bob. So looking at ACMI direct contribution, it's really driven by a couple of things. One is that we had higher -- heavy maintenance cost. We had incremental engine overhauls during the fourth quarter that were driven by operational requirements.

And then, we have an allocation methodology. So for engines, when there are engine overhauls, our methodology is to expense those overhauls as they are put into shop for the overhaul. And then we have to allocate the maintenance expense between our segments, ACMI and Charter. So for engines, they're generally pretty fungible and they move between aircraft to aircraft.

So our location methodology that we've used consistently is we base it on the number of block hours during the period when the maintenance occurred. So it's unusual for us to have so many engine overhauls during December. But we did this year to help us prepare for peak and also for 2019 flying. So as a result, December, we always have the most ACMI hours versus Charter hours.

And so a lot of that engine overhaul, heavy maintenance, more of that gets allocated to ACMI as opposed to Charter. So that happened during the quarter as well. And then we also had the crew increased. As we talked about, we enhanced the Southern pilot's wages and work rules with the interim agreement.

And then, Bob, I think you asked whether for 2019, yes. We think that in 2019 with all the things, I think, that we've talked. In 2019, we expect our overall segment profitability in ACMI to grow. In fact, grow significantly.

Bob Labick -- CJS Securities -- Analyst

OK, super. And then just.

Spencer Schwartz -- Chief Financial Officer

Long answer.

Bob Labick -- CJS Securities -- Analyst

No, no it's great. It's very helpful. I appreciate it. I guess for my follow up just, could you give us a sense of the growth in the fleet or for the ballpark that's within your guidance as well? I know there's a three new CMI coming on? Are you contemplating in your guidance any additional fleet at this point?

Spencer Schwartz -- Chief Financial Officer

There is some growth that's built into our plan, but we're not providing details on that at this point, Bob. Most of the growth from 2018 to 2019 in our plan is from the aircraft that we've added throughout 2018 and the benefits that we'll get from that. And it will also be the first year of the accretion from the full 20 767s operating for Amazon this year. And there's a little bit more in there, but nothing too expensive.

Bob Labick -- CJS Securities -- Analyst

Great. OK. Thanks so much.

Operator

Your next question comes from the line of Jack Atkins with Stephens. Please go ahead.

Jack Atkins -- Stephens -- Analyst

Hey, guys. Good morning, and congratulations on a great quarter.

Bill Flynn -- Chief Executive Officer

Thank you, again.

Jack Atkins -- Stephens -- Analyst

So Bill, I guess this is a question for both you and Spencer. But if I could just start maybe with just a high-level question for you and then would love to get Spencer sort of take on how it impacts the 2019 guidance, or what's assumed in the 2019 guidance. But obviously, there's just a ton of potential outcomes on the macro front whether it's Europe, or we're talking Brexit or just the economic outlook there, or China to U.S. trade.

I would be curious to get your sense for, how all of those are playing together? And what's happening in the minds of your customers right now as they're planning for their business for 2019? And then Spencer, just as we sort of think about that all together. What is the guidance assumed for those items in terms of sort of how do we bracket what's good, what's bad for your guidance if we were to see a potential hard Brexit, for example, or no China to U.S. trade deal. Just trying to think about the potential outcomes and how it impacts 2019 for you guys.

Bill Flynn -- Chief Executive Officer

Yes. Thank you, Jack. I think that's a very good question and there are several elements to it. So first of all, we step back maybe a little bit.

One of the questions we're often getting is well with the discussions and kind of the push and shove going back and forth between China and the U.S., what have you seen so far? And the answer is, from the tariffs that have been imposed and announced, we haven't seen a large impact yet. Now that doesn't mean there wasn't any impact or that there may not be should the U.S. and China failed to reach some agreement even with the talks that are going on now that there wouldn't be. But we haven't seen it yet.

And when I think about our customers, we're not seeing made an impact in the schedules that they're giving us to fly both near term and as we think about the schedules and deployment into 2019. So it doesn't mean that there won't be. But we can't point to significant impact at this point. There is that cloud of uncertainty that kind of sits on top of these kinds of considerations, we just haven't seen that.

We haven't seen that yet. Thinking more broadly, what does Brexit mean? Well, near term and, specifically for us, we, actually, don't have very large operations in the U.K. at present. We haven't had large U.K.

operations for quite some time now since VA got out of freighters years ago. We do have substantial operations in the continent. So to the extent that flows change or we see more flows coming in and out of Europe, that's potential an upside for us or and/or an upside for our customers overall. And the other point that I do want to make, Jack, and we've said this a number of times.

The way to think about Atlas in many ways is to think about our customers, because the vast majority of our customers are publicly traded companies. So another way to kind of triangulate on impact, maybe what are the customers, our customers are saying about themselves and their growth plan, given our large position we have with DHL, the 20 aircraft that we're operating for Amazon, the overall strength of the Charter market, the customers that we've added and the fleet growth we've had. So we've incorporated that into our guidance, and Spencer will, perhaps, add framework. Spencer has a few more comments to add.

So as we sit here today, we've tried to incorporate the uncertainty that exists out there coupled with what our customers are telling us about their business plans and the schedule they want us to fly for them.

Spencer Schwartz -- Chief Financial Officer

And Jack, it's Spencer. I don't have a whole lot to add to that. But when we put together our plan for the year, we work closely, as Bill said, with all of our customers. And so our plan reflects their plans and their expectations for the year and the flying that we expect to do with them.

So all of that is built in. The other thing that we talked about, I think during our last earnings call, is that we just don't see there being that big of an impact for airfreight overall from the tariffs. And the beauty of our business is that we operate airplanes and they can move anywhere we want at any given time. And so if manufacturing, for example, were to move out of China to somewhere else, we can operate it from there.

And so just by the nature of our business we expect our business to continue strong.

Bill Flynn -- Chief Executive Officer

Yes. And I would just add, in our military segment, we talked about it in my remarks we are expecting higher levels of activity in military in '19 over '18 as well.

Jack Atkins -- Stephens -- Analyst

OK. That's helpful. And I guess for my follow-up, Spencer, the change in lease accounting standards, which I think took effect on January 1st, how will that impact the balance sheet for you guys, if at all? And should we expect to see some moving pieces, perhaps on the income statement in 2019 with rental expense perhaps moving net interest expense, trying to think, how that's going to flow through your income statement this year?

Spencer Schwartz -- Chief Financial Officer

Sure. Thanks, Jack. So the new lease accounting standard will be adopted as of January 1st. so you'll seen in the first-quarter results.

As a dry lessor, the new guidance really doesn't expect our Dry Leasing revenue as it's consistent with the current guidance. As a lessee, it requires the recognition of a right-of-use asset and then offsetting right-of-use liability. The good news is that we don't expect any impact to our income statement. So for the balance sheet, you will see a right-of-use asset and then a right-of-use liability.

The liability will be about $650 million. And that is really consistent, if you look at how we calculate our net leverage ratio, you can see that we always include the present value of leases, and that has been somewhere around $600 million, $650 million. So this is very consistent with what we've been using previously and now it'll just be on the balance sheet with an offsetting asset and liability.

Jack Atkins -- Stephens -- Analyst

OK. That's great. Thank you for the color, guys.

Bill Flynn -- Chief Executive Officer

Thank you, Jack.

Operator

Your next question comes from the line of Helane Becker with Cowen and Company. Please go ahead.

Helane Becker -- Cowen and Company -- Analyst

Thanks, operator. Thank you for the time guys. So my two major questions on China and Brexit you answered. The other question I had, I think, Spencer or Bill you referred to you know your numbers including some amount of growth this year.

So I have two questions related to that, if you don't mind. The first question is when you think of growth, how are you thinking about that? Are you thinking about additional new customers? Or are you thinking about increased flying for current customers? And I know you don't like to speak about the Amazon contract specifically, but I'm just wondering if there are opportunities to add aircraft for them since a much like your competitor did recently? And then the other question I have is with respect to -- completely unrelated with respect to military flying. I know you don't break that out anymore, but I'm just kind of wondering with all the changes that we see happening, how should we think about that going forward if we need to think about that at all? So kind of a lot there, but you can pick and choose.

Bill Flynn -- Chief Executive Officer

OK. Well, thanks, Helane. Well, a couple of things. I think, just kind of in Marketing 101, it's considered to be somewhat easier to get more business from current customers than to bring on new customers.

But I think we're in a position where we're going to see growth across all of our customers. I think we have growth opportunities and we're always discussing growth opportunities with all of our current customers. You saw that in 2018 and at the end of 2017, we brought new customers in. We've had good growth with those customers as well.

We took on additional assets other than six sevens to serve those customers in 2018. And Michael Steen, our chief commercial officer and his team are in ongoing discussion with a broad array of customers for growth. As we both noted, this is our full year of operating the 20 aircraft for Amazon that we put into service over the last two years and so we look forward to those operations. And beyond that we're not going really comment on any one specific customer other than to say we see good growth potential for the company overall.

In terms of the military, I think, we have said it's about half of our commercial Charter operations in terms of hours, the combination of passenger and cargo. I've also said earlier that we expect '19 to be at higher levels than '18. And some of that is levels of activity. But there's another point to make as well.

The military has a large fleet of C-17s and a smaller fleet of C-5s. But not a lot of new, at least, announced plans for additional new mobility aircraft. And so what we've seen in growth over the last several years is, certainly volume. But in addition, the military has elected to put more flying into the commercial operators for a time or some time, because in their program view, they've overflown their C-17 fleet for about a 10-year period and are looking to, if not rest, to minimize utilization of that fleet to extend the program life of the asset and use a higher-rated commercial aircraft to accomplish that.

So that's another important factor that's driving growth in our military flying.

Spencer Schwartz -- Chief Financial Officer

And Helane, I'll just add that our military entitlement remained fairly steady around 53%, 54%. And that we continue to see higher cargo demand and modest increases in rates. And during the fourth quarter, we flew around 87% one-way missions and almost all of those eastbound. So really continued great flying for the military.

Helane Becker -- Cowen and Company -- Analyst

OK. Thank you very much.

Operator

Your next question comes from the line of David Ross with Stifel. Please go ahead.

David Ross -- Stifel Financial Corp. -- Analyst

Thank you. Good morning, gentlemen. How are you doing? When we look back on 2018, certainly there was a cost associated with putting all of those planes up for Amazon. Could you quantify, I guess, how much of a headwind, the ramp-up cost, start-up cost, training cost, however you want to describe it, was in 2018? Because presumably, I guess, that disappears this year?

Spencer Schwartz -- Chief Financial Officer

Correct. It disappears. We had start-up costs in '16, '17 and '18. All throughout those periods, we had to bring on pilots.

Before they started flying, we had to train those pilots. We had to bring in trainers. And so there are start-up costs related to all of that, but we haven't quantified that. But we did had to start those costs in advance of the actual flying taking place.

The majority of it really took place in 2016 and '17. And then of course, as we added more planes, earnings overtook the start-up cost, but they did continue throughout the period. And then '19 will be the first full year that doesn't have those start-up costs related to the 767-300s.

David Ross -- Stifel Financial Corp. -- Analyst

So if I'm hearing you correctly, there were fewer start-up costs in '18 then they were in '16 and '17?

Spencer Schwartz -- Chief Financial Officer

Correct. Yes. Plus higher earnings as well.

David Ross -- Stifel Financial Corp. -- Analyst

Oh, of course. I was just trying to separate out the two. And then, Bill, some of the other airfreight-related companies, you've been talking about Europe, specifically in terms of a macro weakness. I don't know how much Charter business you do over there if that's more ACMI flying for DHL or other customers.

But to the extent you have any comments on where you see growth or softness in global activity? Is Europe softer than Asia Pacific, U.S., South America, any commentary there will be helpful?

Bill Flynn -- Chief Executive Officer

Yes. I think the majority of our operations in and out of Europe are both ACMI, CMI and military, because of the flights we operate in and out of Germany, either as a destination or as a intermediate point between Germany and operations into set common, that's a large part of our flying overall. We certainly have some Charter operations in and out of Europe, but I wouldn't say it's the majority of our commercial Charter operations. And as we've talked about and commented several times now, our focus is really on those faster growing markets in Asia as both origin and destination and certainly, South America.

Coming out of Lunar New Year, which is where we are now, it does seem a little bit slower in terms of the recovery coming out of new year, our Lunar New Year on volumes into Europe out of Asia more broadly than it is on the Transpac. So obviously, something we need to watch and understand what Brexit means. It's kind of hard for all of us to predict what that means. As I mentioned earlier, we don't have a big position in U.K.

flows either way. So we're somewhat insulated from that impact. Not sure what it means for the rest of the Europe.

David Ross -- Stifel Financial Corp. -- Analyst

Thank you for the color.

Operator

Your next question comes from the line of Seldon Clarke with Deutsche Bank. Please go ahead.

Bill Flynn -- Chief Executive Officer

Operator, we've got to go to the next one.

Operator

Yes. Your next question comes from the line of Kevin Sterling with Seaport Global Securities. Please go ahead.

Kevin Sterling -- Seaport Global Securities -- Analyst

Thank you. Good morning, gentlemen. So Bill and Spencer, you guys have talked about 2019 and growth with existing customers and new customers. How does the feedstock situation looks? So if I'm a new or even existing customer and I come to you and say, hey I need 10 to 15 planes, are you constrained by the feedstock availability or do you think you can get aircraft to convert to freighters?

Bill Flynn -- Chief Executive Officer

Well, a couple of things. You've seen our ability to acquire aircraft and convert where we needed to do that. We've also been able to go into the market and lease-in aircraft to take advantage of opportunities as well. There was aircraft available in the market, it depends on the type.

And also a good part of our growth has been CMI where customers have provided the aircraft for one or another reasons and have elected us, selected us to operationalize and fly the aircraft for them. So I think there are several, depending on the customer, the aircraft type, I think, there are several avenues of growth for us in '19 and beyond, Kevin.

Kevin Sterling -- Seaport Global Securities -- Analyst

OK. My second question revolves around labor cost. How should we think about this cost turning into 2019? And how we should think about maybe a new labor agreement with your pilots? I know you talked about the higher cost you had in Q4 with Southern pilots, but how should we think about 2019 and then new labor agreement with your existing pilots?

Bill Flynn -- Chief Executive Officer

So overall, Kevin, our goal is to get to a new joint collective bargaining agreement with our pilots, an agreement that works for really for our pilots, works for us as a company and certainly works for our investors. And we continue in discussions with our pilots, with their union representatives now. I mean, obviously, it's key for us as a company to be able to attract and retrain -- retain excuse me, and grow our pilots. And the good growth that we've had over these last several years, we've been able to do that to bring pilots on board, but also because of the diversification and the growth, provide meaningful opportunities for people to join as a first officer and then in a relatively short period of time, move over to the left seat and become a captain.

As I said, we're in discussions now. It really takes two parties to get to a new agreement, we're in that process. But we're not providing perspective on what those increases in cost may look like and that we'd be negotiating in public if we did. But we continue in those discussions and look forward to get into that agreement.

Kevin Sterling -- Seaport Global Securities -- Analyst

I gotcha. But we can assume or assume that higher labor cost are somewhat -- at least some cost are baked into your 2019 guidance, is that a fair assumption?

Bill Flynn -- Chief Executive Officer

What's in the 2019 guidance, Kevin, is we entered into the interim agreement with our Southern pilots in September. And so there was an impact in September and then in the fourth quarter. Well, that impact is there throughout all of 2019. So you'll see that throughout 2019.

That part is baked in. Otherwise, just sort of standard increases.

Kevin Sterling -- Seaport Global Securities -- Analyst

OK. Well, that's all I had. Thanks for your time. Congrats on a great quarter and 2018.

Bill Flynn -- Chief Executive Officer

Thank you.

Operator

And your next question comes from the line of Seldon Clarke with Deutsche Bank. Please go ahead.

Seldon Clarke -- Deutsche Bank -- Analyst

Hey, guys. Thanks for the question. Wanted to ask about free cash flow for next year. Just given what you've commented to right now in terms of aircraft purchase, do you expect free cash flow to be positive in 2019? And just, could you give us a sense of maybe what you're targeting for net leverage ratio along the time?

Spencer Schwartz -- Chief Financial Officer

Sure. Seldon, it's Spencer. So our free cash flow for 2018 versus '17 grew 29%. So phenomenal jump.

Based on our earnings, in 2019 we expected to continue to improve as we'll have all of the Amazon aircraft operating and continuing to grow the business and enjoy the rest of the 18 aircraft that we added for the full year. So yes, we expect free cash flows to continue to grow. And then, with regard to the net leverage ratio, we expect both as we pay down debt, as well as grow our EBITDAR. We've expect that leverage ratio to continue to decline getting to somewhere around the mid-three level.

So we were at about 4.9 or five times, not to long ago and expect to be at mid-threes by the end of this year, a really important initiative for us.

Kevin Sterling -- Seaport Global Securities -- Analyst

OK. And just to clarify on that in terms of free cash flow, I'm talking about like net of additional aircraft purchases. So whatever you've committed to in terms of like the Nippon aircraft for this year not the kind of adjusted free cash flow number that you guys provide?

Spencer Schwartz -- Chief Financial Officer

Well, the Nippon Cargo aircraft that's a CMI basis, and so those are not our aircraft. As far as aircraft capital expenditures, we really don't have sort of committed expenditures at this point. We do, however, have core capital expenditures and we've provided that number earlier. We expect that to be about $135 million to $145 million for 2019.

And that really reflects the requirements for parts inventory for the 747-400s that were leased in 2018, the incremental Amazon 767's and then just general fleet requirements for the 747-400s and 747-8.

Seldon Clarke -- Deutsche Bank -- Analyst

Got it. That's helpful. And then just, I'm asking in a little bit different way in terms of your guidance for block hour growth, could you give us the sense of how that breaks down from an organic perspective versus what you're getting from some of the new aircraft you're adding?

Spencer Schwartz -- Chief Financial Officer

Block hour growth is generally driven by the incremental aircraft that we added throughout 2018. The military flying is growing. We also, as we talked about, we took two aircraft that were operating in ACMI for a CMI customer. We bought those aircraft.

We moved them into Charter and they fly for the NFL. So the utilization in the block hours were actually down just given the nature of the NFL flying, but continued sort of similar earnings on those aircraft. So overall, and looking at block hours, it really is the aircraft, we added 16 aircraft throughout 2018, all throughout the year, and so we'll enjoy the block hours from all the flying. Otherwise, utilization generally, pretty consistent 2019 versus '18 other than the military, which is going to increase, as Bill talked about.

Seldon Clarke -- Deutsche Bank -- Analyst

OK, appreciate it. And then just last one kind of a longer term. So that maintenance expense come down a little bit on like per block hour basis after 2019, just given something like the timing of your aircraft purchases and things like that?

Bill Flynn -- Chief Executive Officer

Well, line maintenance expense is the vast majority, it's about two-thirds of our overall maintenance expense. And that varies based on block hours, it's basically a variable cost. And the line maintenance on a per block hour basis generally grows similar to inflation. It grows couple of percent, 2%, 3% per year.

So you should expect to continue to see that for line maintenance. And then heavy maintenance really depends on when engines need to be overhauled and when calendar letter checks are due on the airframes. We did have a number of engine overhauls in December and as a result of that we're forecasting that we have three fewer CF6-80 engines, those are the engines that we operate in our 747-400s and 767s where we will have three fewer of those in 2019 versus 2018 as a result of some of the overhauls that happened during the fourth quarter.

Seldon Clarke -- Deutsche Bank -- Analyst

Well, that's helpful.

Bill Flynn -- Chief Executive Officer

Appreciate the questions.

Operator

[Operator instructions] And your next question comes from the line of Chris Stathoulopoulos with Susquehanna International.

Chris Stathoulopoulos -- Susquehanna International -- Analyst

I've got two questions here. So looking at the competitive landscape there's been a few notable events in the recent months, competitor ATSG expanded their agreement with Amazon. KKR made a billion-dollar investment with lessor Altavair, I think part of which is going to be used to buy six wide-body, cargo jets and last week, 3PL, operator XPO suggested a key customer likely Amazon, walked away from a piece of their business. So I was wondering if you could give us kind of a broad strokes, your thoughts on, perhaps, Amazon, the potential to expand that business or what you're seeing with regards to increased competitions from lessors Altavair or someone who's been more of a traditional competitor, ATSG or colder air?

Bill Flynn -- Chief Executive Officer

Yes. Let me take that. This is Bill, I'll answer the first one. So the KKR -- let me talk about the leasing side of it first.

So KKR investment and with Altavair, looks like to me that the Altavair team found an additional source of capital investment to grow their fleet. Altavair is a longtime player in aircraft leasing. They were Guggenheim at onetime, despite the same leadership team over there. And they've been a longtime participant and freighter.

So I don't see that as a new introduction. I think what it points to is that there is a -- airfreight is anticipated to grow. Assets will be required to support that growth and KKR, I guess, all the opportunity to work with team at Altavair and participate in that overall. We're not going to comment on Amazon specifically.

And we don't specifically comment on any one customer or for that matter on competitors, generally. I think, just a couple of thoughts, Chris, that we've added 45 aircraft in three years. We've averaged about one aircraft every three weeks. We've added a great book of customers, certainly Amazon is an important customer and we're now finally at the full 20.

But we've added other customers that we've talked about, creative ones like NPA where it's all CMI. To the earlier question we're not putting our balance sheet at work to fly those aircraft. We added SF Express, they are the largest express operator in China today. With their own fleet domestically of north of 40 aircraft and our operation for them is their first international operation over several continents.

So when I look at our position, we've got a great book of customers and diversity among those customers. Overall, there's some background there and I think our growth opportunities with current customer, an earlier question that we had, and potentially new customers is, we're really well situated to be able to do that.

Spencer Schwartz -- Chief Financial Officer

And Chris, this is Spencer. I will just add briefly that Altavair, in particularly, is a key business partner of ours. We have a nice relationship with the company and their management team.

Bill Flynn -- Chief Executive Officer

We've leased an aircraft for them.

Spencer Schwartz -- Chief Financial Officer

That's right. And they are a good source of aircraft for us.

Chris Stathoulopoulos -- Susquehanna International -- Analyst

And then my follow up question. I think with regards to the block hours it works out to imply growth for around 15% and then depending on the utilization levels that we've plug in there we can kind of back into a fleet total. But how should we be thinking about headcount growth for 2019 if we assume a similar sort of trend of around 19 or 20 heads per aircraft? Is 10% sort of like the right number to think about headcount for this year?

Bill Flynn -- Chief Executive Officer

With regard to crew, yes, it really just depends on the aircraft, the aircraft type, the operations for the aircraft. So that's with regard to crew. With regard to ground staff, it depends on how many stations we'll be opening. And then we also have ground staff that are supporting our overall fleet initiatives and fleet growth and so we'll be adding there as well.

Chris Stathoulopoulos -- Susquehanna International -- Analyst

OK. Thanks, Bill.

Bill Flynn -- Chief Executive Officer

Thank you, Chris.

Operator

And there are no further questions in the queue.

Bill Flynn -- Chief Executive Officer

Well, thank you, Heidi. And Spencer and I would like to thank you all of on the call today for your interest in Atlas Air Worldwide. We certainly appreciate your spending and sharing your time with us today and we look forward to speaking again with you soon. Thank you, operator.

Operator

[Operator signoff]

Duration: 51 minutes

Call Participants:

Ed McGarvey -- Treasurer

Bill Flynn -- Chief Executive Officer

Spencer Schwartz -- Chief Financial Officer

Bob Labick -- CJS Securities -- Analyst

Jack Atkins -- Stephens -- Analyst

Helane Becker -- Cowen and Company -- Analyst

David Ross -- Stifel Financial Corp. -- Analyst

Kevin Sterling -- Seaport Global Securities -- Analyst

Seldon Clarke -- Deutsche Bank -- Analyst

Chris Stathoulopoulos -- Susquehanna International -- Analyst

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