Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Chorus Aviation Inc.'s second quarter 2019 earnings analyst call - conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. Thank you. Natalie McGinn, Vice President of Investor Relations and Corporate Affairs, you may begin your conference.
Thank you, Denise. Hello, and thank you for joining us today for our second quarter 2019 conference call and audio webcast. We apologize as we had some technical difficulties posting our MD&A and financial statements to SEDAR. However, that has been rectified, and the documents are also available now on our website. With me today from Chorus are Joe Randell, President and Chief Executive Officer, and Gary Osborne, Chief Financial Officer. We'll start by giving a brief overview of the results and then go on to questions from the analyst community. Because some of the discussion in this call may be forward-looking, I direct your attention to the caution regarding forward-looking statements and information, which are subject to various risks, uncertainties, and assumptions that are included or referenced on page 50 of our Management's Discussion and Analysis of the results and operations of Chorus Aviation, Inc.
For the period ended June 30th, 2019, the outlook section, and other sections of our MD&A, where such statements appear. In addition, some of the following discussion involves certain non-GAAP financial measures, including references to EBITDA, adjusted EBITDA, adjusted EBT, and adjusted net income. Please refer to Section 17 of our MD&A for a discussion relating to the use of such non-GAAP measures. I'll now turn the call over to Joe Randell.
Thank you, Natalie, and good morning, everyone. I'm pleased with our progress in the second quarter and how this year is progressing as we continue to make significant advancements in transforming Chorus into an international player in regional aviation. My comments will be brief and focused on our leasing business, given our stable and predictable operations under the CPA and at Voyageur. In the second quarter, our group of companies delivered net earnings per basic share of CAD 0.25, inclusive of an unrealized foreign exchange gain of CAD 16 million on net income of just under CAD 40 million. On an adjusted basis, net income reduced by CAD 4.9 million to CAD 24 million, or CAD 0.19 per basic share.
As I mentioned, I'm pleased with our performance and particularly with the traction we're gaining in the regional aircraft leasing space, having announced commitments on 11 additional aircraft in the period. Since the launch of Chorus Aviation Capital in early 2017, we have built our portfolio to an impressive 56 aircraft, 13 of which we expect will deliver in the third quarter and 2 in the fourth quarter. When combined with the aircraft lease commitments under the CPA, our fleet of leased aircraft reaches a value of over $2 billion, with $2 billion also in future contracted dry and wet lease revenue.
This solid growth trajectory has led to a very strong portfolio of brand name carriers with aircraft type and geographic diversity, and we continue to deliver on our growth strategy, having fully committed our leasing growth capital almost a year in advance of our mid-2020 target. This is a significant milestone and a strong indicator of the opportunities that exist in this sector. We're not changing our strategy of conservatively and profitably building scale in this business. We have several options available to us for growth capital, some of which were not available to us before now, and we're committed to ensuring additional value creation to our shareholders. Gary will share more insight on this in his commentary. Regional aviation is a resilient sector of the industry, and we are well-positioned to bring our organization to the next level.
Over 90% of our revenues are derived from leasing, a combination of flying operations, also characterized as wet leases and in third-party dry leases. We take a process-driven, conservative approach to building our leasing business. Our objective is to maintain a diversified customer base with good prospects, seek geographic diversification, and limit aircraft type concentration. Due to the predictable nature of our contracted revenues, the quality of our customers, and our resilient market sector, we are well-positioned to seize new opportunities to profitably grow and diversify. I extend my sincere thanks to the 5,200 Chorus employees, whose hard work contributed to another solid quarter. Thank you, and I'll now pass the line over to Gary to take you through the second quarter financial results.
Thank you, Joe, and good morning. Our group of companies had a strong performance in the second quarter, and our financial results came in as anticipated. Here's how the quarter compares to the same period last year. We reported adjusted EBITDA of CAD 85.7 million, an increase of CAD 1.6 million, or 1.9% relative to the second quarter of 2018. The regional aircraft leasing segment's adjusted EBITDA increased by CAD 10.4 million due to the growth in aircraft earning leasing revenue. The regional aviation services segment adjusted EBITDA decreased CAD 8.8 billion, offsetting the previously described increase.
... These results were expected as they reflect the 2019 amendments to the CPA, which reduced the fixed margin and performance incentive revenue when we moved to market-based compensation rates earlier this year. These reductions were partially offset by the implementation of the controllable cost guardrail that mitigated the expected second quarter CPA margin shortfall related to reduced fees. Beyond these changes related to the amended CPA, the second quarter results were impacted by increased stock-based compensation of CAD 3.5 million due to the strengthening of the share price, offset by increased aircraft leasing under the CPA and increased capitalization of major maintenance overhauls on own CPA aircraft over the previous period.
Adjusted net income was CAD 24.7 billion for the quarter, a decrease of from 2018 of CAD 4.9 million or 16.5%, due to an increase in depreciation of CAD 4.2 million, primarily related to additional aircraft in the regional or the regional aircraft leasing segment, an increase in interest costs of CAD 4.5 million, primarily related to additional aircraft debt, including financing of CAD 95 million related to the acquisition of six aircraft previously acquired with cash, as well as standby fees on the revolving warehouse facility in the regional aircraft leasing segment, and an increase in other costs of CAD 2.2 million related to foreign exchange losses on working capital, offset by gain on the property on the disposal of property and equipment, again offset by CAD 1.6 million increase in adjusted EBITDA previously described, and a CAD 4.4 million decrease in income tax expense related to lower adjusted EBT.
Net income was CAD 38.9 million, an increase of CAD 22.6 million over the 2018 period. The increase was primarily due to the quarter-over-quarter change in unrealized foreign exchange gains on long-term debt of CAD 28.7 million, offset by the previously noted CAD 4.9 million decrease in adjusted net income and increased employee separation costs of CAD 1.2 million. As Joe mentioned, the growth capital we have on hand has been fully committed. We're very pleased with that and are maturing as a business. Since the launch of the business, we have grown the regional aircraft leasing segment by an average of approximately 20 aircraft per year.
In the near term, we have the capacity to fund comparable organic growth in the leasing business through a combination of additional debt enabled by our repayments of our rapidly amortizing debt and internally generated cash flows. Looking ahead to the balance of this year, capital expenditures for 2019, excluding those for the acquisition of aircraft and the ESP and including capitalized major maintenance overhauls, are expected to be CAD 34 million-CAD 40 million. Capital expenditures for ESP and aircraft acquisitions are expected to be between CAD 428 million and CAD 433 million in 2019. This does not include capital for future to-be-announced aircraft acquisitions. We've changed our schedule of planned ESPs to align with the CPA amendments, and as such, we anticipate conducting 4 ESPs this year, 5 in 2020, with the balance completed before the end of 2022.
As a result of the CPA amendments, amendments and the fixed fees, we'll no longer provide the number of departures or block hours, starting with our third quarter report out, as they are no longer relevant to our earnings. For additional supporting, for additional information supporting our projected guidance for the balance of this year, I'll refer, refer you to Section Four of the 2019 Outlook section of our MD&A for the period ended June 30, 2019. That concludes my commentary. Thank you for listening. Operator, we can open the call to questions from the analyst community when you are ready.
At this time, I'd like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Doug Taylor with Canaccord Genuity. Your line is open.
Yes, thank you. Good morning. I'd just like to dig in a little bit into your comments about comparable capital deployment with sort of a, I guess, I'll call it, an organic capital sources being internally generated cash flow and how we should think about what you consider to be the excess capital available for reallocation to the, you know, the growing the leasing portfolio. Can you help us, you know, frame that up and what you see as the available capacity currently?
I guess when you look at the cash flow statements and that on the debt, you can see that we're paying down our debt pretty rapidly. When you look at the metrics of the leasing business and the regional jet aviation services business, there's leverage left that we can put back into the business. So you know, on the debt side, you can look to the cash flow statement, and then you can also look at what we're generating from the business there.
Okay, you continue to expect, so 3-to-1 debt-to-equity, between 3-to-1 to 4-to-1 on the incremental leases that you'd be adding. Is that a fair statement?
Yeah, 75% loan-to-value would be what we would expect on the aircraft acquisition, and the capital we would raise that we've alluded to would help us fund the equity portion.
Right.
With that, we should be able to continue to grow at the rate that we've been growing at since we launched the company. Yeah.
And then on that statement, I mean, it's been an impressive growth profile for the regional aircraft leasing business. It has been lumpy at times, you know, one year to the next. Should we use the current year's capital deployment as the benchmark for what you aspire to continue to deploy at, or, you know, some sort of average of the previous couple of years?
Well, I guess what we're saying is around 20 a year for next year. You know, as far as the timing goes, you could, you know, smooth it out during the year, but that's yet to be determined.
And that 20 is based on, you know, the same, sort of unit price that we've-
Mm-hmm
-been, you know, buying these aircraft, up to now. Yeah.
Okay. All right. Obviously, interest rate, you know, projections have rolled over pretty hard for the broader economy, especially the U.S., interest rate, which is important for leasing, or aircraft. Can you talk about whether there's been any impact on the lease factors or the pricing out there at the kind of regional class aircraft level?
Well, as you know, on the lease rate factors, there's always an adjustment for interest rates that gets factored in. So from that perspective, the lease rate factors have been moving with those. So we haven't seen really any impact on the margin that we're earning.
Understood. Okay, last question for me. I mean, as we look into Q3 here, 13 aircraft entering the fleet and the portfolio is obviously a pretty meaningful amount relative to the size of that portfolio. So, I was hoping you could help us with kind of the weighting or the timing, if they're front or back-end loaded, to help us kind of dial in the Q3 expectations.
I don't really have the exact timing by month, but, you know, I'd probably just average it out through the quarter.
Fair enough. Thanks. I'll pass the line.
Your next question comes from Cameron Doerksen with National Bank Financial. Your line is open.
Thanks. Good morning. Maybe you can just give us kind of an update on what you're seeing out there as far as opportunities. I mean, it sounds to me like we've got plenty of opportunities still for adding aircraft to the leasing fleet. But maybe if there was a larger transaction or portfolio transaction out there, that would be when you might need some additional capital beyond kind of internal sources. Maybe just talk about maybe opportunities you might see on sort of the larger transactions.
Sure. Well, you know, we continue to have a fairly robust pipeline, you know, and of good customers and good jurisdictions, et cetera. You know, we do look at portfolios, et cetera. But of course, you know, that would require, if it was very large, a different approach. But, you know, we're not anticipating that at this time, but, you know, we are mindful of opportunities that may arise. But we are also mindful that any way that we finance this or what we do is actually to the benefit of our shareholders and their earnings.
Okay. And, you know, I'm sort of interested in one of the more recent transactions you did with, with, with Flybe. These are, I guess, more midlife aircraft, whereas I guess previously you were largely targeting younger aircraft. I mean, I know it's not necessarily a change in strategy, but just, you know, maybe talk about your interest in maybe doing more midlife aircraft. And, and how do the returns on, on those types of transactions compare with, with newer aircraft?
Well, you know, the returns are, I'd say, fairly comparable. We look at these assets a little differently in terms of their life. You know, in the case of Flybe, that company has been successfully restructured and, you know, we feel has a good, has a good future in the marketplace now with the new ownership, et cetera. With those airplanes, you know, when we have midlife aircraft, we also, aside from either selling the asset or releasing, we look at part-out possibilities as well. So, you know, I think it's, it's quite reasonable for us to add that type of aircraft to our portfolio. It tends to balance it out, and, you know, so we're, we, we're very pleased to look at midlife aircraft for that reason.
Okay, and maybe just a last one for me. Just on the, the CRJ, I mean, obviously, Bombardier, or I guess, soon to be Mitsubishi, is going to end production of that aircraft. I mean, you still have some additional CRJ-900s coming next year. I'm just maybe wondering what you think about, from a value concern, on, on that aircraft type. I mean, an out-of-production aircraft, is that more difficult to re-lease when, you know, some of those leases come up?
Well, there have been aircraft that have been discontinued in the past, and they continue to, you know, the production discontinued, continue to have a, a pretty good market. And, you know, in Mitsubishi, purchasing the program, they, you know, they, they purchased the marketing and the product support, and I think that's critical to their success. And we expect the support for the in-service CRJs to continue, you know, during the transition, et cetera. And, so it's fully supported by Mitsubishi, and I think that will be the case for decades in the future. You know, their reputation as a manufacturer, as they move into their own, MRJs, I think is, is critical.
So, you know, we have six within CAC, and they're all young aircraft on long-term leases in Europe, so we don't expect any disruption there. And of course, we have five CRJs under lease to Air Canada, with nine more coming, but those are supported by very long-term leases, and, you know, very little of our value comes from the residual side. So, you know, our contracted leasing revenues for the CRJs is actually, you know, pretty healthy and long term. So we don't see any residual value risk for us, certainly in the near term, at all. And, you know, we see these aircraft as being continued to be deployed and, you know, are successful within the regional business, primarily in North America.
But, you know, I think we're not at all panicked about the residual values at this time.
Okay, great. Thanks very much.
Your next question comes from Konark Gupta with Scotiabank. Your line is open.
Thanks, and good morning, everyone. Just wanted to ask you on the CapEx side first. So there was a CapEx increase of, I think about CAD 200 million. Is that all related to third-party leasing?
Yeah, on the growth CapEx, it's, yeah, it's for, it's third-party leasing.
Perfect, thanks. And, as the CAC becomes the key player in the market with the growing portfolio, are your customers still focusing on the same aircraft types that you're leasing right now? Or is there kind of an ask, maybe not demand, but like, there is maybe a discussion about more aircraft types?
Well, I think we've said before that, you know, we are generally within the leasing, regional leasing segment, 75 seats and greater. I think we've commented that, you know, the A220 is an aircraft which is interesting to us. It is, you know, to be operated, we believe, in both the regional and mainline environment. So it's, an aircraft that is, you know, straddles both segments, but, you know, I think there are opportunities there. And of course, with the Embraer product now, with the E2s, which is the next generation of Embraers, those aircraft are, interesting to us as well.
We are very triple-profit oriented, which up to this point, which we're quite happy a bit about, you know, with no real technological obsolescence and great residual values and good demand for these aircraft because of their unique capabilities. So, you know, we're fairly broad. We are not at all heavily exposed with respect to the Embraer Classics or the CRJs, as I mentioned. But, you know, so they're all really within our scope.
Okay, that's clear. And then, lastly for me, so on the leasing portfolio, you said you have about 56 commitments now. So in terms of the contracts there, in terms of the length and terms and the aircraft that you expect to come back to you over the number of years, what do you see the replacement cycle to look like for the aircraft? Because some of these aircraft are obviously slightly older than you would typically want, right?
Yeah, these, you know, most of these airplanes are still on very long-term leases, and we have few aircraft coming back in the near term. And the ones that are, we continue to be engaged on that. So, you know, we're very optimistic that, you know, the number of aircraft that we would have sitting on the ground and not deployed would be very, very little, if any.
Okay. That's it for me. Thank you so much.
Your next question comes from Tim James with TD Securities. Your line is open.
Thank you, good morning. I just want to return to Doug's question earlier. Am I correct in interpreting your answer to mean that you expect to generate total free cash flow after dividend payments that's approximately equal to the equity that's required to buy about 20 aircraft per year at a 75% loan-to-value ratio?
No, no, that's not what we're saying. What we're saying is between a combination of acquiring new debt and the cash flows from the operations, that we can continue to grow.
At 20 aircraft per year?
Yeah. Well, in many years-
Yeah, sorry, sorry. Maybe I didn't word it properly. That, that's exactly what I was asking. That, that's helpful. Thank you. And then, maybe you could just talk about sort of your long-term aspirations for the leasing business in terms of, you know, the global market size, you know, being a top player in the industry. I'm just thinking kind of longer term, what's driving your thoughts?
Yeah, well, you know, we're still quite bullish on the segment and believe that we have developed a very good niche within the market. And, you know, we're seeing growth in general in regional aircraft, even in the turboprop side, for instance, with the ATR 72, et cetera. So, you know, we're, I think we've become a fairly significant player in the market, already close to being number two in the world, but, you know, still a very small part of the overall regional aircraft portfolio out there. So a lot of growth opportunity, but for us, you know, we're approaching it cautiously in a measured way and, you know, at a rate that will make sense for our shareholders. And, that's the approach that we're taking.
But the good news is a lot of opportunity there, and that's what we're looking to exploit. You know, we've gotten to this place in the last two and a half years, and I think we're well-known in the business now. You know, most proposals that regional carriers look for and manufacturers, et cetera, we're on the list.
Okay, great.
Sorry, it's Gary here. Just to clarify and make sure we're clear on the debt piece. So the debt and the cash generation would fund the equity portion of the investment into the aircraft, and then we would still continue to do the loan-to-value of 75%, or thereabouts, on any acquisition. Just to be clear.
...So maybe I, maybe a simpler way I should have asked the question is, you expect to generate the equity going forward, that will allow you to grow at approximately 20 aircraft per year without requiring external equity. Is that correct?
Yeah, we don't require external equity. We see in the near term, you know, the next year, that we can, you know, put more debt onto the balance sheet and then through the internal cash generation, you know, fund up to 20 aircraft a year.
Right.
External equity is not required to grow at that rate.
Yes, perfect. Thank you very much.
Again, to ask a question, please press star, then the number one on your telephone keypad. Your next question comes from Kevin Chiang with CIBC. Your line is open.
Hi, good morning, and thanks for taking my question here. Maybe just to, I guess, also to follow on, Doug's earlier question, around the lower interest rate environment. Maybe if I were to ask a different way, there's a lot of cheap capital out there. I guess, there's probably a decline in some of that capital working its way through the narrow body market, given what's happened to the MAX. So just wondering, when you look at the competitive environment, while you're not seeing any margin compression, are you seeing more competitors when you're bidding on potential leasing opportunities, or has the number of competitors stayed generally static the past, let's say, six to nine months here?
Yeah. I don't think we've seen a particular increase in the number of competitors. It is competitive. You know, we do bid against a number of others each time and et cetera, but we've not seen any significant influx at this point. So, I think a lot of the larger lessors continue to focus on the narrow body and wide body aircraft. And of course, I think they're pretty focused on the MAX these days and very busy with Airbus products, so.
That's helpful. And then when you look at, you know, your positioning, and I appreciate the comment around, you know, you're the second biggest player, but it's still quite a distance between you and the number one player. Like, when you look at the total available market for you, is there a sense of how big this is? It feels like it's a lot bigger than you originally anticipated, say, three years ago. You know, is there a finite size to this market that you get to, that at some point in time, you start looking at other aircraft types, or it just kind of hits a glass ceiling, and that's as big as you're gonna be, and you just kind of churn through the portfolio at that point in time?
Is there a sense of, you know, when you get to that point?
I think, you know, in the narrow body side, for instance, roughly 50% of the world's fleet is leased. Under the regional side, today, it's probably 20-25%. And, you know, we see no reason as to why the regional fleet should not achieve the same level of penetration. And, you know, we, right now, you know, we're small, but we've grown to this point in two and a half years, and just to compare ourselves to the largest player in the market, they're, I guess, a little over three times our size at this point. So we're almost a third of that large player that's in the business for quite some time.
So, you know, we've been growing very quickly, but still, you know, there are most of the proposals that we look at, we do not go forward with. So, ample supply of opportunity.
Okay. And maybe just last one for me. When you know, you've talked about having this diverse portfolio of aircraft and partners in terms of where the airlines are geographically positioned. When you look at things now, you know, you have a lot of stuff in the kind of the Asia Pacific region, Europe, maybe less in North America and South America. Do you think of things that way? Do you think of your portfolio and say, "We should over-index more now, a little bit over the next year into North America, where we might have less exposure?" Or does that not, or is that not how you look at it?
Well, I guess you could say that we are significantly in North America, given the leases that we have with Air Canada.
With Air Canada, okay.
We're in Mexico, et cetera. And, you know, the growth in the business has largely been, and the demand for new airplanes in particular, has largely been in Asia. And of course, we are in Africa as well. But in these jurisdictions, generally, we lease to the strongest operators in these jurisdictions. And, so that's been our approach up to now, in terms of being very selective. You know, we are in South America as well. You know, and the economies in South America are generally doing better. Well, not all economies, I guess Brazil is doing better. And, you know, so we're- we continue to look outside.
In North America, generally, you know, a lot of the regional airplanes are leased or owned by the mainline carriers, and, you know, that creates a very, competitive environment with respect to, to lease rate factors, et cetera. So for us, it's about balancing off the risk and the returns. We'll continue to explore opportunities in North America, but, you know, then we're also, now in, in Europe in a significant way with a number of carriers. So, it's all about balance. It's all about, you know, having a diversified portfolio.
That's for me, and congrats on a solid quarter there.
Thank you.
There are no further questions queued up at this time. I turn the call back over to Natalie McGinn.
Thank you, Denise, and thank you, everyone, for being present on the call this morning, and we look forward to speaking with you again in the near future. Have a great day.
This concludes today's conference call. You may now disconnect.