Exchange Income Corp (OTC:EIFZF) Q2 2016 Earnings Conference Call August 10, 2016 10:00 AM ET
Mike Pyle - CEO
Tammy Schock - CFO
Carmele Peter - President
Trevor Johnson - National Bank
Derek Spronck - RBC Capital Markets
Mona Nazir - Laurentian Bank
Tim James - TD Securities
Konark Gupta - Macquarie
Steve Hansen - Raymond James
Kevin Chiang - CIBC
Chris Murray - AltaCorp Capital
Raveel Afzaal - Canaccord Genuity
Good morning, ladies and gentlemen. Welcome to Exchange Income Corporation's Conference Call to discuss the financial results for the three and six months period ended June 30, 2016.
The corporation's results including MD&A and financial statements were issued on August 09 and are currently available via the company's website or SEDAR.
Before turning the call over to management, listeners are cautioned that today's presentation and their responses to questions may contain forward-looking statements within the meaning of the Safe Harbor provisions of Canadian Provincial Securities Laws. Forward-looking statements involve risks and uncertainties and undue reliance should not be placed on such statements. Certain material factors or assumptions are applied in making forward-looking statements and actual results may differ materially from those expressed or implied in such statements.
For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for this quarter, the risk factors section of the Annual Information Form and Exchange's other filings with Canadian Securities Regulators. Except as required by Canadian Securities Laws, Exchange does not undertake to update any forward-looking statements, such statements speak only as of the date made.
Listeners are also reminded that today's call is being recorded and broadcast live via the Internet for the benefit of individual shareholders, analysts and other interested parties.
I would now like to turn the meeting over to the CEO of Exchange Income Corporation, Mike Pyle. Please go ahead, Mr. Pyle.
Thank you, operator. Good morning, everybody. Also with me today are Carmele Peter, EIC's President and Tammy Schock, our CFO who will review our financial results in greater detail in a few moments.
Following on the heels of our best ever first quarter in our 12-year history, our performance in the second quarter was marked by record results across almost every major financial metric that we use to gauge the health of our operations.
Most notably, consolidated revenue grew by 16% to $226.9 million, EBITDA grew by 18% to $56.9 million, free cash flow plus maintenance CapEx grew by 28% to $25.5 million and our payout ratio was a strong 54% and this was in spite of a per share growth of the dividend of 14% and 38% growth in the total dividends paid as an result of an increase in the number of shares.
Q2s results have proved that our strategy is working. Given the number of new followers to the story, I would want to put some of Q2's results in perspective.
We were able to generate record results without a single major catalyst against a backdrop of volatile commodity markets and depressed manufacturing sector and a fluctuating Canadian dollar.
Our performance was in fact a combination of a number of factors, most notably our growth came from the strong contributions made by Regional One, Provincial and our Legacy airlines, each of which took advantage of pervious growth capital investments, which we made to accelerate our growth.
Ben Machine, which we acquired in July 2015 also contributed to our record results in Q2 and continued to fulfill our objective of our diversifying our revenue streams across multiple entities and geographies.
The diversity of our operations was in fact a key driver of our record results given the opportunities and challenges that each of our operating segments faced in the second quarter.
Let’s take a look at some of the factors driving our performance in more detail. During the second quarter, we invested $33.5 million in growth capital expenditures. The most significant investments were CRJ and other turbo propped aircraft purchase by Regional One to fuel their future growth together with the purchase of a Eurocopter 135, twin engine helicopter by custom.
Within the aerospace and the aviation segment, Regional One experienced strong growth as a result of the ongoing success at monetizing its expanded portfolio of aircraft assets. In the second quarter, Regional One generated strong revenue and EBITDA growth that was driven by aircraft under lease and the sale of assets and parts.
These asset sales of leases were largely drawn from previous investments made in the acquisition of a fleet of CRJ700 planes from Lufthansa CityLine Regional airline.
In other words our previous investments delivered a very healthy rate of return and helped to fuel our growth. Regional One's success with the CRJ700 has enabled to acquire expertise and a strong reputation with carriers around the world.
We are now providing this experience into the CRJ900 platform along the range in higher capacity plane, with new investments to grow the number of assets in our portfolio.
I will expand our growth CapEx and how we expect to capitalize on new market opportunities in my closing remarks. Also within the aerospace and aviation segment, Provincial made strong contributions in the second quarter.
Of particular note was the benefit from the five year in service support contract signed with a Middle East customer, I am sorry, late in November 2015.
Provincial's diversity of operations like EICs was a key to its success in the second quarter. Revenue and EBITDA contributions from its aerospace by division were partially offset by unfavorable economic conditions in Newfoundland and Labrador.
Austerity measures implemented by the Provincial government coupled with depressed oil and gas and mining sectors are causing a drag on Provincial’s aviation service performance. The impact was lower revenue and EBITDA contributions from its scheduled flight and cargo services.
Our Legacy airlines in contrast experienced continued growth in the second quarter. Their progress was largely due to the acquisitions of First Air, non-aircraft assets and previously investments we’ve made to streamline our fleet, optimize road schedules and benefit from a more coordinated procurement activity across our aviation entities.
While our legacy airlines continue to benefit from lower fuel cost in the second quarter these savings were partially offset by the lower value of the Canadian dollar. The declining value of the Canadian dollar negatively impact Legacy airlines and their EBITDA contributions in that replacement parts and flight training costs are generally paid in U.S. currency.
I should point out that the impact of these cost and the weak Canadian dollar are more than offset by the Regional One revenues and the balance of our U.S. based entities.
Turning briefly to our manufacturing segment, on a consolidated basis, the manufacturing segment grew revenue and EBITDA as a result of the acquisition of Ben Machines, which we completed in July of 2015.
Ben Machine’s contributions helped to offset the declines experienced by manufacturing segment entities, which continued to be challenged by weak and volatile markets.
Our Alberta operations in particular continue to be adversely impacted by the ongoing swap in commodity prices. Unfavorable market conditions in the second quarter were further exacerbated by wildfires that raged in Fort McMurray and surrounding areas, causing considerable economic disruption and lowering of demand for our customized steel tanks, pressurized vessels and field services.
West Tower by contrast experienced a modest recovery growing revenue and EBITDA in the second quarter. As in the recent period, West Tower experienced a reduction in new cell tower construction activity, but has benefited from a trend toward increased demand for higher more labor intensive equipment upgrade and service work. We anticipate this development to continue in the near term.
I will provide commentary on our outlook and prospects for growth in the future of my closing remarks. I would now like to turn the call over to Tammy who will review our Q2 financial performance in greater detail.
Thanks Mike. Good morning, everyone.
In the interest of time I'm going to focus my remarks only on our second quarter results. And I'd also like to point out that we have changed the name of one of our operating segments going forward, the Aviation Segment is now the Aerospace and Aviation Segment and that name change with done with the intention of better reflecting the diversity of our operation entities that are in that segment.
I should also remind you that our Q2 2016 results include the contribution from Ben Machine, which we acquired in July of 2015 and as a result there is no contribution from Ben reflected in the comparative figures for last year.
Turning to our income statement, consolidated revenue for Q2 was $226.9 million, up $30.6 or 16% from last year and that growth was largely driven by the contributions from Provincial, Regional One and Comair. Our manufacturing segment also contributed to our revenue growth as a result of the addition of Ben Machine as well as increased revenue from West Tower.
Our growth was tempered by the performance of other subsidiaries in the manufacturing segment, our Alberta operations in particular, which continue to be impacted by the decline in commodity prices and the forest fires there.
On a segmented basis, the aerospace and aviation segment generated $177.1 million in revenue and that’s up 18%. The manufacturing segment had revenue of $49.7 million and that's up 7% from last year. Again that's largely Ben Machine and West Tower driving that and that's offset by the weakness in other businesses.
The growth in aerospace and aviation segment's revenue reflects our diversification and to that end, significant growth capital investments have increased our revenue across our diverse number of products, services and geographies within our operations.
And as a result, those operations are much broader than they appear. There's 13 subsidiary doing business around the world and across a number of industries.
Consolidated EBITDA was $56.9 million up 18% from last year. The growth was due to a number of factors. As we have noted it was largely driven by the contributions from Regional One, Provincial and Ben Machine.
Our legacy airlines, which continue to benefit from lower fuel costs and previous efforts to streamline operations and profitability also contributed to that EBITDA growth and EBTIDA gains were offset slightly by performance of certain manufacturing segment entities as we've already noted.
On a segmented basis for EBITDA, the aerospace and aviation segment generated $54.5 million and that’s up 15% as EIBTDA margins were 30.8%, which is down slightly from 31.5%. The manufacturing segment generated EBITDA of $6.7 million, which is up 32% and its margins were 13.4% which is up from 10.9%.
We reported net earnings of $17.2 million or $0.63 per basic per share. These compare to net earnings of $13.4 million or $0.58 per share last year. The improvement was driven by factors already stated including strong performance of Regional One, Provincial and Legacy.
On a net adjusted basis, net earnings were $20.4 million or $0.74 basic pressure share for Q2 2016. These compare to $16.5 million or $0.71 for the comparative period.
Free cash flow was $42.7 million, which was up 13%, free cash flow on a per share basis was $1.54 down from $1.63 per share last year. The decline on a per share basis was due to the increase in the number of shares resulting from -- largely resulting from our shares that we issued upon the conversion of the Series J debentures.
Free cash flow, less maintenance CapEx was $25.5 million or $0.92 per share, these compared to $19.9 million or $0.86 last year. As our maintenance CapEx was relatively consistent with Q2 2015, the increase in free cash flow less maintenance CapEx was attributable to the increase in free cash flow.
Our free cash flow totals excluded the growth capital expenditures that we made totaling $33.5 million and as Mike mentioned, those growth capital expenditures included the purchase of additional CRJ and turbo craft aircraft and twin engine helicopter that custom barred.
Our payout ratio for Q2, 2016 was 54%. This compares to 51% last year. I should also point out that the increase was due to a 38% growth in total dividends paid during the quarter as a result of the dividend increase and the growth in the number of shares outstanding.
Our payout ratio in Q2 2016 was well within the range we used to determine the sustainability of our dividend and our ability to increase our dividend.
On the balance sheet we ended Q2 with a net cash position of $15.5 million and net working capital of $145.3 million, which results in a current ratio of 1.86 to 1. These compared to a net cash position of $15.5 million last year so we're very consistent and net working capital of $135.3 million and a current ratio of 1.74 to 1 at the end of 2015.
The strength of our balance sheet was solidified when we completed a convertible debenture offering of $69 million with a seven-year term late in Q2, the proceeds of that offering were used to reduce our credit facility and then to redeem the Series J debentures that were due to mature in the next two years.
And our offering provided a number of benefits, it essentially enabled us to reduce our average cost of borrowing, extend the term of our debt by five more years and increase -- it increased our liquidity by almost half of the debenture holders opted to convert their coupons into share at record price of $30.60.
So that concludes my review of our financial results and I'll turn the call back to Mike.
Thanks Tammy. Our outlook remains very encouraging and we're bullish about sustaining Q2s momentum through the second half of the year. In the short term, we expect continued opportunities for our organic growth for our aerospace and aviation segment and in our legacy airlines.
We anticipate similar opportunities for growth for Regional One as demand for its aftermarket parts are strong, since regional carriers around the world are taking advantage of lower fuel costs to keep our older aircraft in operation longer.
We also see growth opportunities within Provincial’s aerospace operations given this expanded services work in the UAE. Provincial’s potential for growth were in fact strengthened with the acquisition of CarteNav Solutions that we announced on Monday for a purchase price of up to $17 million.
While the transaction value was small relative to the size of our more recent acquisitions, we believe that CarteNav will deliver significant strategic value. The company which is based in Halifax develops software solutions used for intelligence, surveillance and reconnaissance activities by government and private sector customers around the world.
Bundling its capabilities with Provincial’s maritime surveillance solutions will deliver significant competitive advantage. As customers demand more sophisticated capabilities the combination of two best-in-class solutions provides product differentiation and market leadership.
The anticipated growth within the aerospace and aviation segment will help to offset some of the challenges that our manufacturing entities are experiencing due to decrease demand for products caused by lower commodity prices.
Q3 will not be without its challenges. An extremely wet summer in Manitoba and North Western Ontario has essentially eliminated the need for firefighting capability, which is a significant impact on custom helicopters.
It is also expected to be a busier than normal quarter in terms of maintenance capital expenditures. The nature of these capital expenditures is such they vary significantly from quarter-to-quarter and Q3 is anticipated to he higher than typical period.
I would point out however that there is no change in the average level of maintenance capital expenditures expected, but rather this is just a variance in the quarter-to-quarter now.
Before I open up the call to questions, I want to give some context about our recent focus on organic growth opportunities and take this opportunity to talk about our commitment to growth via acquisition.
Since taking our company public in 2004, our ability to grow has largely come from the disciplined execution of an acquisition strategy. We have only acted on the best opportunities paying fair price for companies that have helped us to diversify our operations and enter new geographic markets while complementing existing operations.
Increasingly, we are seeing a trend towards higher acquisition multiples for target companies, particularly in the United States. This trend is due to an environment of low interest rates and improved access to capital that are driving private equity to pay prices which are in our opinion, unsustainable.
Target companies are using this access the -- this lower price capital to fuel their own growth opportunity. Our acquisition team which is headed by Adam Terwin continues to actively evaluate a number of potential targets and as you've heard, we just completed the transaction of CarteNav as a result of our team's effort.
But our goal is not to make big deals just for the sake of growing, especially as multiples climb, we're not prepared to buy at any price. Being disciplined has led to our success over the last 12 years. We are not prepared to change what has worked for us.
Our last acquisition satisfy all of our criteria including the need that the price lend itself to an accretive return to our shareholders, we will walk away from deals. In fact we are quite prepared to keep our powder dry to acquisition conditions improved.
However, in response to conditions that are tempering our acquisition opportunities, we've recently focused our efforts at driving organic growth opportunity by using our deployable growth, capital forge investment within our business.
In Q2 we made a series of growth investments totaling $33.5 million. We're particularly excited by the investments made towards Regional ones, purchase or commitment to purchase 11 CRJ aircraft.
The fleet acquisition, which is made up of a combination of 200, 700 and 900 series aircraft expand Regional One’s portfolio of assets, consistent with the experience of the CRJ700 acquired from Lufthansa City line, Regional One will focus on the monetization of these assets through the sale of full aircraft parts or leases.
I want to make it clear that we anticipate some lumpiness to the EBITDA and revenue contributions of these aircraft in the future as complete aircraft sales do not always happen in every quarter.
We are also using our deployable capital towards the construction of a surveillance aircraft for our own inventory. This investment will allow Provincial to better demonstrate its capabilities to target customers.
Just as important, the aircraft will be used in quick response situations for surveillance opportunities as they emerge around the globe.
We see our world becoming a more dangerous place, we anticipated increase demand for surveillance solutions by governments and international companies and like and the addition of CarteNav’s capabilities Provincial’s ability to capture market leadership has improved considerably.
Another growth investment we made in the second quarter was the purchase of a twin-engine Eurocopter 135 for our custom helicopters company. Thanks to its more sophisticated flight capabilities, longer flight range, higher lift capacity and enhanced safety record the acquisition will allow custom to support a greater array of job types and renew customers. You see 135 is expected to go into service late in the second half of this year.
Clearly, we are optimistic about our future prospects. Our strong balance sheet and access to approximately $220 million and available capital makes us ideally positioned to act on an array of organic and acquisition growth opportunities in the quarters ahead.
As always, we remain focused on extending our track record, providing our shareholders with a dependable and growing income stream through the study, disciplined execution of our strategy.
I want to thank you very much for listening. We would now like to open the call for questions. Operator?
[Operator Instructions] Your first question comes from the line of Trevor Johnson from National Bank. Your line is open.
Hey. Good morning, folks.
Good morning, Trevor.
Just wondering about Regional One with the shift from the 700, which was very successful and has proved to generate a lot of IRR to the CRJ900 strategy, can you just maybe walk us through that shift and if there is any significant economic differences between the two that we can look to?
Thanks Trevor. It’s really the addition of the 900. We're still very interested in the 700 fleet. It’s going to be flying for a long time and as evidenced by our CityLine acquisition, most of those planes are under lease around the world which frankly heated our expectations, because we felt we part out in numbers the demand for them is operating aircraft was very strong.
The 900 is a slightly newer plane and as such, the values are still higher of those aircraft, but we're seeing the stage wherein some people are starting to trade out of them to upgrade into newer series of aircraft and so we’re slowly moving into that asset.
It’s a little bit different in that the prices of them are higher. So we would anticipate them being leased for a longer period of time before they are parted out but it’s really just the beginning of the next wave of aircraft.
We were in the 200s for a number of years, still are very active in that marketplace, moved into the 700s a few years ago and now are dipping our toe into the 900s. But it’s really just an extension of the strategy.
And to the extent the differences in finance is that they would tend to be more leased aircraft just as opposed to part out aircraft. So you would see a growth in our lease portfolio.
And Trevor I might add that, they have the exact same engines and there is about 85% compatibility with respect to their parts.
Okay, great. Newfoundland obviously there is going to be some challenges there just going forward, you highlighted some of that you're experiencing in terms of some of the demand drivers.
Just wondering if there is any opportunity to respond with some cost savings there to maybe squeeze a bit of EBITDA out of that business while it goes through a bit of a rationalization?
Yes. We've been working with Regional One strongly which has reduced our cost of our parts going in. And we've worked together with our other airlines to share fleets to give us access to aircraft in the short term opportunities for customer demand.
And while the economy in Newfoundland definitely is a decrement to that business, a significant part of our business in that area is under contract and services things like the hydro dam construction and things which are somewhat less variable than the general economy.
And so while it is a slightly more challenging environment, we are in fact prior to the extent that most of the people are in Newfoundland.
Got you. Great. And then I guess the other headwind you mentioned the fire suppression work, the weak in Q2 it seems like that’s going to bleed into Q3, if you can't share this, I understand but any sense to just size of an impact that we might be able to put a finger on?
I am not sure if I want to give you a precise number, but I think if you were to look at the Q2 last year versus Q2 the year before, you get a pretty good idea because I think we talked about it then.
Last year was a quotation marks typical Q3 versus two years ago. We've had two wide years, the two widest years in the last 20, this year and two years ago and so it’s not a massive impact, but it does cost us a couple million dollars.
The next question comes from the line of Derek Spronck from RBC Capital Markets. Your line is open.
Okay. Thanks for taking my questions. Any update on the Canada's fixed-wing search and rescue contract?
Slightly this has been -- and they've done the testing of the aircraft for both of the lead bidders and the government is now working on making their selection.
It’s our understanding that that’s going well and that they're in target for their far release of the winter late this year or early next year.
We remain cautiously optimistic. We think there are the most cost effective solution in our partnership with airbus, but if we didn’t think it was the best code, I think you would have problems. So we will wait and see what the government has to say later this year, but we're optimistic.
Okay, great. And does the acquisition of CarteNav will that provide any benefits should you win the contract or…
It may, I'm not sure that it's more for some of the other work we do. I think you'll see a more immediate impact if we upgrade the technology, for example on our East Coast surveillance that we do. More and more governments aren't really interested in flying you do for them per se. They want the data flow.
And so however you can get the data stream the most cost effectively is what they're looking for. And CarteNav is the industry leader in the technology, in the surveillance, and by using them within our Provincial platform it not only makes Provincial more competitive, it lets us upgrade our product faster and give us a competitive advantage.
While CarteNav still stands on its own, has its owned revenues, third party customers, that make the deal accretive from a historical point of view.
So it’s exciting from our end in that we've brought an industry leader on which will help our existing industry leader, when they work together, but we’ll also be able to provide a strong cash flow to support the company as a whole.
Yes, it’s a great color.
And there is also the opportunity to potentially use the CarteNav emission control system actually on the C295 Airbus aircraft which we have bit for six weeks, so it is a possibility.
Okay, and just from a trend perspective, are you seeing an increase in surveillance based contract tendering opportunities and just it is probably difficult to answer, but what would a typical size and margin profile of a surveillance contract be?
That question is -- that's not difficult to answer, it's actually possible to answer. The surveillance opportunities are growing. And they're growing from not just national security issues like people worrying about terrorism or illegal immigration.
They're also growing from health concerns with things like the Ebola crisis we went through a year ago, where people are -- smaller countries are petrified of sick people coming into the country, and creating health crisis that they can't deal with and so we're in discussions in a number of places around the globe.
But it's really important to understand that our participation could really be in one of three ways. One is they could simply contract us to provide them with data flow or provide them with surveillance, where we'll buy our own plane, we’ll fly at and provide them with the information they want. That's be highest margin work we do.
Alternatively, they could ask us to build the aircraft for them and then they would operate it. And so that tends to be lumpier business, because you build a project and then you’re complete or finally, you could where you build it and then maintain it for them, which is what's going on in the U.A.E. now earlier before we bought the company it had delivered two very highly technical surveillance aircraft and we've now taken over the maintenance of those aircraft for the government.
So in short, the margins are all over the place and the size of the projects are all over the place, but the general market demand is growing and that's why we're building that inventory plane where we're going to have our own line sitting there to be able to show people the surveillance capabilities, but also to be able to jump in when there's a requirement whether it's a missing plane, health crisis, you name it in a given location we'll have an inventory available to be able to move rapidly.
And your next question comes from the line of Mona Nazir form Laurentian Bank, Your line is open.
Good morning and congratulations on a great quarter.
Thanks Mona, good morning.
So, just a couple questions for me. Turning to the margin on the manufacturing side, would you say that the 250 basis point improvement year-over-year is mostly driven by Ben Machine. So if we were to strip out that acquisition, the legacy business would be down year-over-year?
Yes, the margin improvement is mostly driven by Ben Machine. That's correct. And the second part of the question was about legacy?
The legacy manufacturing.
Okay. Sorry, yeah.
The legacy manufacturing companies, the margins will be down as a percentage just because Alberta continues to suffer with the economy there.
In the other places that really hasn’t been a material change in margins, in our remaining manufacturing entities. They’ve strengthened slightly at less power with the move towards more higher value add work, but the declines really are driven by Alberta.
And you touched on the CarteNav acquisition, its small, but can you speak about the complementary nature of the business but really potential synergies, I saw that their base seems as pretty board U.K, Australia, New Zealand, do you expect some cross-selling opportunities on the customer side?
Yes, we do. I think the key thing the main synergy is the ability to improve the caliber of both company's products by access to the other -- the other company. When Provincial is doing surveillance work whether it’s building custom aircraft, designing a system or actually doing the flight ourselves, the information technology requirements change rapidly.
Provincial has had an internal department of that but it’s not their core business. This is CarteNav core business and so, what it’s going to do, its going to make us to be able to move more quickly, more cost effectively and be able to design things to meet our customer needs more rapidly.
And then with CarteNav as part of our family, we’re going to have the access to the capital and the opportunities to let them take advantage of their own direct growth opportunities we have with other subsidiaries.
I can also tell you it’s really the first year in quite a while where we've have done, where the strategic impact is more exciting than the financial one. It's accretive on a stand-alone basis. It’s a good profitable company, but what’s exciting to us is what it lets us do with our other companies by working in concert.
Hey Mona its Carmele, there is also potential of cross-selling each other's products which should be helpful for each of the companies as well.
Okay and just lastly for me before I step back, looking forward you spoke about acquisitions and how they must be accretive and meet your M&A criteria.
Given strong performance from your current business model and stability that it generates, would you preference be to make improvement in the current legacy business, investments in Regional One, internal efficiencies or would your preference be to tap into a new vertical if the price and segment is right?
I think the priority for us is to make accretive investment and you've seen with the returns that we've published and put out on Regional One and Provincial where those and the Legacy airlines were earning returns greater on those CapEx than we can possibly get in an acquisition in today’s environment.
And so our first focus is making sure we’re taking advantage of all the opportunities that are in front of our operating subsidiaries and that's not to say we’re not interested in acquisition and as our team is doing a lot of working, you got to do a lot of prospecting to find the one diamond, the one unique company that drives growth.
And we've bought those in difficult acquisition environments before we bought Provincial at a time when capital was low and we were able to buy it at accretive price.
So, I don’t want to give the idea that we’re not interested in acquisition. What we do know is the key to our success is if we don’t overpay for anything, we're able to grow the company, when we are right on the acquisitions is really accretive and when we have a challenge and everyone has challenges, you've got the flexibility to reach you, fix up the problem and continue to grow your dividend.
So, I think right now you achieve more of an emphasis on internal growth, but simply because the returns on internal growth are much higher than they are in acquisitions.
Our next question comes from the line of Tim James from TD Securities. Your line is open.
Thank you. Good morning I am just wondering in Q1 you had noted a significant improvement in small to mid size field projects being bid at stainless, is that not or is that expected to translate into revenue opportunities for the second half of the year, there wasn’t any mention of that in the most recent outlook?
Yes, we’ve been a bit disappointed in -- our bidding in the second quarter was very close to an all time high at stainless. The challenges is as companies are deferring decisions and if the decision process is longer, I’m not sure what the uncertainty is in the marketplace that’s causing that.
With the number of close we have out there our historical close rate is remarkably consistent. We would anticipate that as decisions are made on those, we’re going to see our order book start to grow perhaps later in the third quarter into the fourth and see our revenues start to expand early in 2017.
But in all honesty, I thought that would have happened sooner that we've been surprised by how slow the capital expenditure market has been to actually led out the projects. There's lot of people talking, lots of people getting us to bid things, but not a lot of work that's been let out.
Just to be echo that, we're not losing the work to competitors. It's just a close out ratio, it’s just aren't happening.
Okay. Thank you. And then just a quick housekeeping question here, the sequential increase in depreciation and amortization versus Q1, I think it’s up about $1.8 million or 8% sequentially. Just wondering if you could talk about what was the cause of that?
It’s all -- go ahead Tammy.
Well the big driver of that is as we get a larger lease portfolio in Regional One, those planes have a depreciation associated with them. So it growth CapEx on planes that have not been parted out that are flying around.
So that that sequential increase from the first quarter to the second quarter primarily related to those aircraft to come okay.
A - Mike Pyle
We depreciate the aircraft once they go into service, and as you can see in our numbers, the lease revenue grows at the same time as the depreciation does. The one other thing I'd like to point out just to make sure there's always people who have questioned about what's our maintenance CapEx.
One of the things we do to make sure we're absolutely conservative, when we look at that lease portfolio, is any amount that we experience in depreciation on our lease portfolio, we need to replace that asset value with purchases and so the first whatever amount we spend in Regional One up to our depreciation amount we show as a maintenance CapEx.
Because when you're leasing a plane you're effectively using it up to a certain extent. So we are very conservative in calculating what our maintenance capital investment is into that business.
Okay. What period are those when you when you buy pre-owned RJs in this case, what period are those amortized over?
Well they’ll typically -- the amortization is calculated differently on different components of the aircraft, so it's designed to be over a period that matches the lease.
So we're amortizing things like the engines have to find life. So those will be advertised at a greater rate than say something else like the airframe, which doesn't depreciate at nearly the same rate.
So we’ll calculate the amortization to bring it to what we believe the residual value is when it stops flying.
Right. Okay. All right, that's great. Thank you very much.
Your next question comes from line of Konark Gupta from Macquarie. Your line is open.
Thanks operator, and good morning and congrats on a good quarter guys.
Good morning, Konark, thank you.
So I have a few questions here, let me start with the second quarter first. So you probably benefited from the sold aircraft in the quarter just like the first quarter, and I'm also guessing maybe there was some impact to fire suppression and mix at Regional One on margins in aerospace and aviation?
Yes, the first part of the quarter was quite busy, the April-May period in the fire suppression business, and then for whatever reason the hose came on and the rain started and it stopped very quickly.
So those are bullish on margins and anything one time we increase our lease portfolio it's very strong for margins, because especially on an EBITDA basis, virtually all of the expenses are depreciation.
I see, okay.
The lease portfolio drives EBITDA. It's important to understand than the offset to that is when we look at free cash flow is we're subtracting off that depreciation as a maintenance CapEx to get down to what's the pure economic return we've generated.
Okay. And what was the EBITDA benefit from the aircraft sold in the quarter?
I'm not sure that I have that number. It wasn’t an exceptional quarter. We sold some smaller aircraft, but we didn’t sell any of the 700 or 900 aircraft.
Okay. I see. Thanks. And moving on to Regional One, so looks like the fleet has certainly grown a lot over the last couple of years here, and that probably would imply some more leasing revenue and some more part and fulfill down the road and obviously the mix gets changed as well because you have some CRJ200 type leave now and some CRJ900.
So, as we look forward on the Regional One, the growth rate has been pretty strong over the last few quarters here, how should we think about the business overall?
Should be think it as double-digit growth rate over the next at least few more quarters because of these initiatives or should we think the growth to fall back to single digit rate?
Not sure I would answer in terms of digits. I can tell you that we continue to be very actively looking for investment opportunities and there is a number of them. So I would anticipate continued growth.
And one of in front of me the analysis of our results point of view, the growth CapEx this quarter gives you a pretty good idea of what’s going to happen three or four months out is we’re getting aircraft it doesn’t immediately go into service.
We might have to do some work to have let to put it out on lease, but with a certain drag three months, fourth months, that’s going to generate revenue on a go-forward basis. So, when you see strong growth CapEx numbers this quarter it's reasonable to expect that a couple of quarters out you're going to see continued growth as a result of that.
The only thing I would say as you need to keep looking at what we talked about if we sold a bunch of aircraft when you sell them, you get a benefit one, when you recently take it over a period of time. Right now, we’ve been selling more than leasing. So, I would anticipate further growth as a result of the CapEx we’ve made.
As well particularly for the 900s that we've acquired to date, there is a lag time between not only from time we get them to lease them, but there is staggered acquisitions not all coming at the same time. You’ll see that spread out over the next the balance to quarter.
And our next question comes from the line of Steve Hansen from Raymond James. Your line is open.
Yes, good morning guys. Heard you talk on the results here, but I didn’t want to ask you a little bit about the risk management that you're deploying here as it relates to Regional One, you're certainly putting a lot amount of capital into business.
Just trying to get a sense for me may be just give us a broader perspective on the business as its growing specifically here the visibility that you have going forward, the total lease package at least term or tenure I guess that you're seeing in the portfolio as it stands today and then just how you think about what will rising oil prices might do to that business over time if indeed they come back and just get a broader sense of the risk management you're deploying here.
Yea, we'll we're looking at, we look at -- it's really important to understand how we do the investments Regional One experts on the value of the component parts of those aircraft and so we’re looking at the expected number of shop visits in the future from operating aircraft.
So were overhauls going to be required on engines why didn't they come back and then we’re looking at building our portfolio to make sure we’re available to take advantage of needs for engines for other people.
And so while low oil prices has helped, it keeps these planes in service longer. You would have to see a massive, massive increase before that would dramatically impact the value of those aircraft.
And so we’re looking and we're always looking to make sure what’s our exact strategy of the lease portfolio weakens, can we part it out, can we get our money back till we're in suitable return.
And so quite frankly, with the exception of the 900s, which are really flying aircraft they're not quite at a part out stage, that’s why we're dipping our toe in slowly. Most of the other aircraft, we buy them, we know we can part them out and make a profit.
And then if we can lease them out first, even better and increases our rate of return. So again we're looking at the demand portfolio of that type of aircraft and understand we can't do this for every type of aircraft.
We don’t have the expertise in 737, 400s as an example, which are coming out of other airlines. We don’t have the internal knowledge to be able to part those aircrafts out. So you don’t see us flying in those, but where we do know the aircraft, like the CRJ platform, Dash 8 platform, ATR platform are very active.
One of the things we’d like to do in the future quite frankly is to increase the number of platforms where we participate in.
I see that’s helpful and just one the acquisition side and the multiples that you're seeing certainly creep hirer to make sense. What though looking back at the manufacturing side here with some of the depressed metrics you've been seeing throughout the space?
Is there opportunities there where the multiples might still be lower or at least more appealing or is it just not our feasibility in the space to give enough capital to deploy capital.
That’s a good question. We're actively looking in the depressed markets to see if there is something available that can augment our business.
Alberta is a great example for us is every time we've gone through this in Alberta, we've come back with a bigger market share, because of our stability we’re able to maintain service through this and pick up customers and grow. This is the deepest trough we've ever experienced in the longest trough.
But we still love that business, and so where there opportunities to grow it in augmented in a down time would certainly be interested.
We're still very interested in growing the stainless steel tank business in the U.S. but in spite of the slowdown there really has been no appreciable downtick in the multiples people are looking for in that business. So it's been kind of a double whammy investing in that business, the overall market is softer, but the prices are higher.
Great, that’s it from me guys. Thanks.
Your next question comes from Kevin Chiang from CIBC. Your line is open.
Hi, thanks for taking my questions here. Just a couple – I guess maybe more housekeeping questions. You had mentioned in your prepared remarks maybe more of a focus on organic growth opportunities versus tuck-in acquisitions given the multiples out there.
Just wondering when you look at the capital intensity of your business then it has to creep lower as you harvest of the benefits of some of the growth CapEx in prior years.
Would you naturally see some of that capital intensity kind of increase, as you focus more on growth CapEx versus say capital being deployed for acquisitions, did you do you see that inching higher from here or maybe those things.
I don't think you'd see it is higher term, I think it's really the stuff we're already doing that you see in our statement. So the opportunities in Regional One and Provincial would be the main organic investment opportunities in front of us today.
There may be an opportunity here in there within our airlines to grow, but we two of those fleets a few years ago, a year and a half ago we finished.
And you see there are the margins growing in that business, but we're very almost market walk we very high market share where we are for us to go in and you’d have to see us move into a new marketplace, which would likely other than playing around the edges be done through an acquisition. We may move into northwestern Ontario or a different part of something should the opportunity arise.
But generally speaking the airlines are suitably capitalized and I don't see a significant amount of capital going in there, other than the ongoing maintenance investment obviously to maintain our fleet, whereas if we do have opportunities, we're earning returns and the high teens to low-20s in our investments in Regional One.
And quite frankly you cannot after maintenance CapEx, you can't come close to those returns not remotely close to the acquisition well. To the extent that they had cover opportunities, we're going to be aggressively pursuing them.
Having said that in line with the question earlier and our challenge when we went through West Tower unbridled growth we're going to make sure we're very comfortable with the markets for the planes of the parts before we go any further.
Okay. That’s helpful.
There's another comment on organic growth. There's a lot of opportunities where there is no significant capital require. Let me give an example of that, as we announced in November of last year Provincial was able to get the in support contract the PBL contract as we refer to it.
Part of the component of that was inventory supply and management and what they did there is bring in Regional One to provide the inventory and manage it as well. So we were able to grow the Regional One business through a provincial opportunity. So that's just kind of an example of where we're able to grow organically without any capital requirement.
That's helpful. And when you think of them maybe or the personnel you have and the executive team you put together. I think a lot of it's been around the strategy of kind of this tuck-in acquisition growth.
If the focus moves more towards organic growth opportunities or harvesting some of the slow hanging fruit, is there sensitive to build up the team further or you still leveraging the team on the ground where the Regional One of how just to find those opportunities for you?
I mean we're very comfortable with the executive team we have in virtually every one of our entities. As you grow obviously you're going to add people, but not disproportionately to the growth of the business. And one thing I just want to clarify, we're going still very active in the tuck-in acquisition market.
That part because it tend to be smaller deals, they tend to be a mom and pop companies, they tend to be people who care about how you’re going to treat the staff, price isn't the only criteria and CarteNav would be an example of that.
Those kinds of deals we're still fairly active in, so stuff on the smaller end of our range. If the bigger deals that tend to be auctions with private equity that are the ones that are really hard to do.
So the $200 million transactions are the ones that we find ourselves not being prepared to pay were private equity is prepared to pay. We just don’t -- not prepared to swallow that kind of risk.
So we're still active with the smaller transactions. It's the bigger transactions at this point that we find ourselves not being prepared to pay market price.
Fair enough. The discipline is obviously very important here. And just last one from me, you mentioned these high multiples, would that make you a potential seller of some of the assets you have if the multiple is high enough or is that off the table because then you're forced to redeploy that capital into high multiple world.
So you're -- and upholding on to what you have regardless of where the multiples are?
It's a really good question actually. I think we’re agnostic about ownership in that everything is for sale at a certain price. But we need to be able to redeploy the capital.
So I think if someone will be doing a rollup of an industry that we're involved in, where they were prepared to pay a strategic value as we are financial owner we would consider it. To date we really have had many of those opportunities.
Although I guess WesTower was that to an extent, in that we sold to other industry player turn to profit and redeploy their capital. But generally speaking unless someone is going to pay us a material premium to what we think is worth we like the businesses we’re in now. I don’t see that as a big part of our strategy.
Your next question comes from the line of Chris Murray from AltaCorp Capital. Your line is open.
Thanks, guys, good morning.
Good morning, Chris.
Just back to acquisition strategy, one of the things historically when you think about the way you've done acquisitions is part of the target has always been to take a 100% of the company.
Any thought with maybe some opportunities out there to maybe take less than a 100% of companies, maybe give the management with a higher percentage than you normally would or just looking at co-investments and joint ventures or stuff like that in order to calibrate the growth?
We actually regularly have looked at a couple of those, the trickiest structure and making sure we have control. Because where we want to make sure the funds flow the right way but in the right scenario, yes, we would take less than a 100%.
I don’t think that I should -- you never say, never. I don’t think we would take a minority position. I think we’re always going to be in a position where we want control. But picking less than a 100% absolutely is a possibility.
Okay, great. And then just back to thinking about growth capital, I understand tuck-in seem to be reasonably active, but just from your tone, maybe no big expectations on larger acquisitions at least in the near term, but any numbers you want to put around, any thoughts around growth capital from at least the balance in the year at this point?
I think the kind of dollars if you look over a number of quarters, where the sort of average what we're putting out is a reasonable barometer going forward.
It’s hard for me to answer it from quarter-to-quarter Chris, simply because we may get an opportunity to buy three aircrafts and its $20 million U.S. or we may buy one. And so it kind of bumps around quarter-to-quarter, but the kind of investments, the size of investments we're making on average I think is something we see continuing.
Our team at Regional One looks at a lot of opportunities. Not all of them are as accretive as others and so we don’t do everything, but the ones we do, we've earned high returns on. So I would continue to expect us to invest money in those businesses.
The acquisition stuff, you're correct, it’s currently more hit and miss, I am fairly -- I don’t want to come across these two negatives, because I am reasonably positive on the stuff that under $75 million it's when we get into the bigger deals, that the pricing is a bigger issue and even in some of those where it’s a unique market niche that other people may not understand the way we do, where we are very competitive that where we see most of the opportunity now would be in the smaller deals and in the organic investment in our core businesses.
Okay. That’s great. Thank you, guys.
Our next question comes from the line of Raveel Afzaal from Canaccord Genuity. Your line is open.
Yes. Good morning guys. Thank you for hosting the call. I just had a follow-up question on what was just said now for Regional One, every quarter we add in the growth capital that you're investing and that bumps up our forecast for Regional One looking forward and I understand growth capital in this business is an acquisition so difficult to forecast.
But can you give us some visibility on Q3, how your growth capital is looking for this business, now that we are pretty much in Q3?
We are continuing to close on planes if you're looking our MD&A, we talked about a total of 11 planes that we've purchased or committed to. There is a couple of those we'll close this quarter plus whatever we find as we shop around.
So we continue to invest Raveel, I assume competitive issues about revealing too much here because we’re in some negotiations on things that we may or may not ultimately decide to proceed but we clearly have already made commitments or things that we'll close in this quarter. So, you will see continued growth CapEx in this quarter.
Okay. And just following up on the last question assuming and I know we can’t do the hard and fast rule but assuming something like $30 million to $40 million in growth capital for this business on an annual basis, you think that’s a realistic redemption at least looking into 2017, or is that too high too low, I know you can’t give a good a number that we can have guidance but just some color on that.
If you're looking for 30 to 40 as an annual number I would say that’s low based on what we see today after looking at that on a quarterly basis, we’d have to find some bigger transaction to be able to meet that every quarter.
So, they say we’re not -- I can't put a forward looking number because we don’t use budgets or targets for doing acquisitions or investments we do when they meet our criteria and so I would anticipate continued growth $30 million would be on the low end on an annual basis.
Got it and then with the Canadian search and rescue contract, could you give us some more color in terms of and just remind us what the size of this contract would look like? How quickly could ramp up, what resources it might require from you in order to execute on this project?
From a big picture point of you, it may be awarded later this year, early next year. The delivery of the aircrafts start a couple years after that our role is not in the delivery of the aircraft, our role would be in the maintenance and the over side of the maintenance on an ongoing basis.
The contract by its nature, I think 25 or 26 years long and the maintenance on aircraft clearly they have to fly for a while before you need to fix things. So, our stuff would ramp up over the next five years once a contract was awarded.
And I’m not prepared to put a dollar value on it because how it’s being awards hasn’t been decided per say but we would be on the maintenance side, we are not going to buy and sell.
And as a result we’ve very little, unlike the [West] transaction where there was significant working capital required to fund accounts receivable and inventory, this project would not be that way. so, the investment required would be minimal.
Yeah and just to give you a little bit more color may be on the size, I can talk about the number of people that we have to add because it is primarily a labor driven contract for us.
We’re talking about around a 100 new positions and Mike answered it right, very little capital trends required there is a little bit of ground, equipment we need and some consumable inventory but that would be primarily it.
That’s it for me. Thank you guys.
And this does conclude our Q&A session I will now turn the call back over to Mr. Pyle for any closing remarks.
Given that there is no further questions, I would like to thank everyone for participating in today’s call and we look forward to updating you on our progress in the quarters ahead. Thank you.
And ladies and gentlemen, this does conclude today’s conference call. Thank you for joining us today. You may now all disconnect your lines.
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