Significant Customers

9 Months Ended

Sep. 30, 2020

SIGNIFICANT CUSTOMERS

DHL

The Company has had long-term contracts with DHL Network Operations (USA), Inc. and its affiliates ("DHL") since August 2003. Revenues from aircraft leases and related services performed for DHL were approximately 13% and 12% of the Company's consolidated revenues from continuing operations for the three and nine month periods ending September 30, 2020, respectively, compared to 13% and 14% for the corresponding periods of 2019. The Company’s balance sheets include accounts receivable from DHL of $11.0 million and $12.7 million as of September 30, 2020 and December 31, 2019, respectively.

The Company leases Boeing 767 aircraft to DHL under both long-term and short-term lease agreements. Under a separate crew, maintenance and insurance (“CMI”) agreement, the Company operates Boeing 767 aircraft that DHL leases from the Company. Pricing for services provided through the CMI agreement 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 Company provides DHL with scheduled maintenance services for aircraft that DHL leases. The Company also provides additional air cargo transportation services for DHL through ACMI agreements in which the Company provides the aircraft, crews, maintenance and insurance under a single contract. Revenues generated from the ACMI agreements are typically based on hours flown. The Company also provides ground equipment, such as power units, air starts and related maintenance services to DHL under separate agreements.

Amazon

The Company has been providing freighter aircraft and services for cargo handling and logistical support for Amazon.com Services, LLC ("ASI"), successor to Amazon.com Services, Inc., a subsidiary of Amazon.com, Inc. ("Amazon") since September 2015. On March 8, 2016, the Company entered into an Air Transportation Services Agreement (the “ATSA”) with ASI, pursuant to which CAM leases 20 Boeing 767 freighter aircraft to ASI, including 12 Boeing 767-200 freighter aircraft for a term of five years and eight Boeing 767-300 freighter aircraft for a term of seven years. The ATSA also provides for the operation of those aircraft by the Company’s airline subsidiaries, and the management of ground services by the Company's subsidiary LGSTX Services Inc. ("LGSTX"). The ATSA became effective on April 1, 2016 and had an original term of five years.

In conjunction with the execution of the ATSA, the Company and Amazon entered into an Investment Agreement and a Stockholders Agreement on March 8, 2016. The 2016 Investment Agreement calls for the Company to issue warrants in three tranches which will grant Amazon the right to acquire up to 19.9% of the Company’s outstanding common shares as described below. The first tranche of warrants, issued upon the execution of the 2016 Investment Agreement granted Amazon the right to purchase approximately 12.81 million ATSG common shares, with the first 7.69 million common shares vesting upon issuance on March 8, 2016, and the remaining 5.12 million common shares vesting as the Company delivered additional aircraft leased under the ATSA. The second tranche of warrants, which were issued and vested on March 8, 2018, grants Amazon the right to purchase approximately 1.59 million ATSG common shares. The third tranche of warrants vested on September 8, 2020, and grants Amazon the right to purchase an additional 0.5 million ATSG common shares to bring Amazon’s ownership, after the exercise in full of the three tranches of warrants, to 19.9% of the Company’s pre-transaction outstanding common shares measured on a GAAP-diluted basis, adjusted for share issuances and repurchases by the Company following the date of the 2016 Investment Agreement and after giving effect to the warrants granted. The

exercise price of the 14.9 million warrants issued under the 2016 Investment Agreement is $9.73 per share, which represents the closing price of ATSG’s common shares on February 9, 2016.

In accordance with the 2016 Investment Agreement, on September 8, 2020, the final number of shares issuable under the third tranche of warrants was determined to be 0.5 million common shares. As a result, under US GAAP, the value of the entire grant was remeasured on September 8, 2020, and their fair value of $221 million was reclassified from balance sheet liabilities to paid-in-capital. This group of warrants for 14.9 million common shares of ATSG is fully vested and expires on March 8, 2021. Amazon has the option to settle the warrants for cash of $145 million and receive all 14.9 million shares, or it may choose a cashless settlement option and receive a lesser number of shares equivalent in market value of the stock's appreciation above the exercise price.

On December 22, 2018, the Company announced agreements with Amazon to 1) lease and operate ten additional Boeing 767-300 aircraft for ASI, 2) extend the term of the 12 Boeing 767-200 aircraft currently leased to ASI by two years to 2023 with an option for three more years, 3) extend the term of the eight Boeing 767-300 aircraft currently leased to ASI by three years to 2026 and 2027 with an option for three more years, and 4) extend the ATSA by five years through March 2026, with an option on the part of ASI to extend for an additional three years. Through September 30, 2020, the Company leased nine of the 10 aircraft to Amazon and the 10th lease was executed in October 2020. All ten of these aircraft leases are for ten years.

In conjunction with the commitment for ten additional 767 aircraft leases, extensions of twenty existing Boeing 767 aircraft leases and the ATSA described above, Amazon and the Company entered into another Investment Agreement on December 20, 2018. Pursuant to the 2018 Investment Agreement, Amazon was issued warrants for 14.8 million common shares, of which 13.9 million common shares have vested as existing leases were extended and nine additional aircraft leases were executed and added to the ATSA operations through September 30, 2020. The remaining warrants vested in October 2020 upon the execution of the lease for the 10th aircraft. As a result, under US GAAP, the value of the entire grant for 14.8 million common shares will be remeasured to fair value and reclassified from balance sheet liabilities to paid-in-capital. These warrants will expire if not exercised by December 20, 2025. They have an exercise price of $21.53 per share.

On May 29, 2020, Amazon agreed to lease twelve more Boeing 767-300 aircraft from the Company. The first of these leases began in the second quarter of 2020 with the remaining eleven to be delivered in 2021. All twelve of these aircraft leases will be for ten year terms. Pursuant to the 2018 Investment Agreement, Amazon was issued warrants for 7.0 million common shares of which 0.6 million common shares have vested. These warrants will expire if not exercised by December 20, 2025. The exercise price of these warrants is $20.40 per share.

Additionally, Amazon can earn incremental warrant rights under the 2018 Investment Agreement by leasing up to five more cargo aircraft from the Company before January 2026. Incremental warrants granted for Amazon’s commitment to any such future aircraft leases will have an exercise price based on the volume-weighted average price of the Company's shares during the 30 trading days immediately preceding the contractual commitment for each lease.

Through the 2016 and 2018 Investment Agreements, Amazon can potentially own approximately 39.9% of the Company if all the issued and issuable warrants vest and are settled in full with cash. For all warrants vested, Amazon may select a cashless conversion option. Assuming ATSG’s stock price at the time of conversion is above the warrant exercise price, Amazon would receive fewer shares in exchange for any warrants exercised under the cashless option. Instead, Amazon would receive a lesser number of shares equivalent in market value of the stock's appreciation above the strike price near the time of conversion. Outstanding warrants are summarized below as of September 30, 2020:


		Common Shares in millions
	Exercise price	Vested	Non-Vested	Expiration

2016 Investment Agreement	$9.73	14.9	0.0	March 8, 2021
2018 Investment Agreement	$21.53	13.9	0.9	December 20, 2025
2018 Investment Agreement	$20.40	0.6	6.4	December 20, 2025

The Company’s accounting for the warrants has been determined in accordance with the financial reporting guidance for financial instruments. Warrant obligations classified in liabilities are marked to fair value at the end of each reporting period. The value of warrants is recorded as a customer incentive asset if it is probable of vesting at the time of grant and further changes in the fair value of warrant obligations are recorded to earnings. Upon a warrant vesting event, the customer incentive asset is amortized as a reduction of revenue over the duration of the related revenue contract.

As of September 30, 2020, the Company's liabilities reflected warrants from the 2018 Amazon agreements having a fair value of $210.3 million. As of December 31, 2019, the Company's liabilities reflected warrants from the 2016 Amazon agreements and the 2018 Amazon agreements having a fair value of $383.1 million. During the three and nine month periods ended September 30, 2020, the re-measurements of all the warrants to fair value resulted in net non-operating losses of $55.9 million and $48.3 million before the effect of income taxes, respectively, compared to gains of $93.4 million and 72.7 million for the corresponding periods of 2019.

Revenues from Amazon comprised approximately 29% and 29% of the Company's consolidated revenues from continuing operations for the three and nine month periods ending September 30, 2020, respectively, compared to 26% and 21% for the corresponding periods of 2019. The Company’s balance sheets include accounts receivable from Amazon of $42.5 million and $50.1 million as of September 30, 2020 and December 31, 2019, respectively.

The Company's earnings in future periods will be impacted by the re-measurements of warrant fair value, amortizations of the lease incentive asset and the related income tax effects. For income tax calculations, the value and timing of related tax deductions will differ from the guidance described above for financial reporting.

DoD

The Company is a provider of cargo and passenger airlift services to the DoD using its fleet of freighter, passenger and combi aircraft. Combi aircraft are capable of carrying cargo containers and passengers on the main flight deck at the same time. The DoD awards flights to U.S. certificated airlines through annual contracts and through temporary "expansion" routes. Revenues from services performed for the DoD were approximately 33% and 33% of the Company's total revenues from continuing operations for the three and nine months periods ended September 30, 2020, respectively, compared to 34% and 36% for the corresponding periods of 2019. The Company's balance sheets included accounts receivable from the DoD of $49.2 million and $44.5 million as of September 30, 2020 and December 31, 2019, respectively.