Good day. My name is Steve, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Chorus Aviation Inc. third quarter results 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 would like to ask a question during this time, simply press star, then number one on your telephone keypad. If you'd like to withdraw your question, please press the pound key. Thank you. Nathalie Megann, Vice President, Investor Relations, please go ahead.
Thank you, Steve. Hello, and thank you for joining us today for our third quarter 2018 conference call and audio webcast. With me today from Chorus are Joe Randell, President and Chief Executive Officer, and Jolene Mahody, Executive Vice President and 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 38 of our management's discussion and analysis of the results and operations of Chorus Aviation for the period ending September 30, 2018, the outlook section and other sections of our MD&A where such statements appear.
In addition, some of the following discussions involve certain non-GAAP measures, including references to EBITDA, adjusted EBITDA, and adjusted net income. Please refer to section 17 of our MD&A for a discussion relating to these such non-GAAP measures. I'll now turn the call over to Joe Randell.
Thank you, Nathalie, and good morning, everyone. Thank you for joining us. In the third quarter, we generated over CAD 87 million in adjusted EBITDA, up CAD 3.4 million or 4% over the same period last year. Adjusted EBITDA came in below our expectations due to added CPA costs related to increased component repair maintenance, primarily on the Classic Dash 8 fleet and CPA on-time performance challenges. Historically, the third quarter is the most challenging from an operations perspective due to high passenger demand, weather, construction, tight flight schedules, and congested airports. This makes it difficult to turn aircraft quickly, causing flight delays that persist throughout the day due to the inability to recover operations effectively. Rate performance varies from quarter to quarter, depending upon a number of changing operational factors.
From a year-to-date perspective, our rate performance on controllable costs is consistent with the same period of 2017. While progress in completing leasing transactions slowed in the second and third quarter, we regained momentum with the recent announcement of several multi-aircraft transaction agreements and have grown our fleet of leased aircraft to 80. The fourth quarter will start to reflect additional lease income associated with these aircraft placements, while others will start to generate profits in 2019 as the lease arrangements take effect. We are very pleased to welcome Philippine Airlines, the Lion Air Group, and Jambojet Airlines to our expanding customer portfolio of leading regional operators. These mark our first transactions in Southeast Asia, a market we believe has good potential for future aircraft placements.
Once these recently announced transactions are completed, we will have acquired aircraft valued at approximately $730 million to date, excluding the CPA aircraft, and secure additional long-term lease revenue streams with average lease rate terms of approximately 8 years. To date, we have commitments for placing 33 aircraft with 12 customers operating in 12 countries on 6 continents. We are regularly engaging with current and prospective customers on new opportunities and remain confident in the growth prospects of our leasing business. That said, we are not wavering from our conservative and prudent approach to building this business and will not grow for the sake of growth. As I've said before, this growth is going to be lumpy, and some transactions will take longer to finalize than others.
Given the breadth of our experience and capabilities in regional aviation, we remain confident the balance of this capital will be committed by mid-2019. The addition of Q400 spare parts to our supply chain sales inventory is another step in this direction. This is our first part- out of an in-production aircraft and is an aircraft type, of course, that is highly utilized around the world. Our ability to provide this service to operators is a synergy we can leverage with our lessees. This, in addition with our ability to now conduct heavy maintenance on Embraer 135 and 145 series regional jets, expands our range of services. In the quarter, we also secured a new contract with airBaltic of Latvia to conduct airframe heavy maintenance on 12 Q400s. The first aircraft has been completed, and the second is now in the hangar.
Our expanded service program on Dash 8-300 is progressing as scheduled, with the completion of 2 more since our last report out, bringing the total to 8, now generating leasing revenue under the CPA. We have extensive experience in managing every facet of an aircraft's life, from origination to disassembly and turn out and every stage in between. This is where our strengths differentiate us from our competitors. I'd like to take this opportunity to congratulate our Jazz employees for being recognized again this year for outstanding achievement in employment equity and receiving the Sector Distinction Award from Employment and Social Development Canada. Jazz also received the Silver Award in the Transportation category of Canada's Safest Employers. There's been a great deal of productive activity and solid milestones achieved. I sincerely commend and thank the core team for their hard work and dedication to our vision.
I'll now turn the call over to Jolene, and she will take you through the financial results. Thank you.
Thanks, Joe, and good morning, everyone. In the quarter, we generated total revenue of CAD 367 million, versus CAD 344 million in the same period of 2017, an increase of CAD 23 million or 7%. Adjusted EBITDA came in at CAD 87 million, an increase of CAD 3.4 million over third quarter of 2017. There were a few one-time adjustments impacting our financial performance this quarter relative to the third quarter of 2017. They are detailed in our disclosure documents, but here's a quick summary of what transpired. We had a CAD 1.5 million reduction in the other cost category in the third quarter of 2017 for a contingent consideration payable.
We had a CAD 1.2 million adjustment to our supplemental defined benefit pension plan occurring in this quarter, and we also had a change in tax rate for the first nine months of 2017 that had the effect of increasing Adjusted Net Income in the third quarter of last year by CAD 12.6 million. When the first two items I mentioned are removed, third quarter 2018 Adjusted EBITDA was up CAD 6.1 million over the same period last year.
This was due to a CAD 8.6 million increase related to the growth in third-party regional aircraft leasing and increased aircraft leasing earnings under the CPA of CAD 2.5 million, offset by increased CPA costs of CAD 5 million, which resulted from increased component repair costs of CAD 3 million, primarily on the Classic Dash 8 fleet, and CAD 2 million in additional costs associated with CPA on-time performance challenges. Adjusted net income was CAD 31 million for the quarter, a decrease from 2017 of CAD 18 million, mainly because of the change in tax rate I mentioned earlier, and foreign exchange losses on debt and working capital, which amounted to CAD 3.3 million.
When you exclude these two items, Adjusted Net Income declined by CAD 2 million quarter-over-quarter due to an additional CAD 2.8 million in depreciation, primarily related to new aircraft, and an increase in interest costs of CAD 2.4 million related to additional aircraft debt, offset by the CAD 3.4 million increase in Adjusted EBITDA previously described. Net income was CAD 43.7 million for the period, a decrease of CAD 35.6 million, or 45%, from the same period of 2017. The decrease was primarily due to a quarter-over-quarter change in foreign exchange of CAD 17.1 million related to unrealized losses on U.S.-denominated debt. Previously noted CAD 18 million decrease in the Adjusted Net Income and also increased Employee Separation Program costs of CAD 0.5 million.
Looking ahead to the balance of this year, capital expenditures for 2018, excluding those for the acquisition of aircraft and the ESP, and including capitalized major maintenance overhauls, are expected to be between CAD 41 million and CAD 48 million. Capital expenditures for ESP and aircraft acquisitions are expected to be between CAD 217 million and CAD 220 million in 2018. This does not include capital for future to-be-announced aircraft acquisitions. Based on scheduling information from Air Canada, billable block hours for 2018 are expected to be between 364,000 and 370,000 hours, and this is based on 116 covered aircraft as at December 31, 2018.
The actual number of billable block hours for 2018 may vary from this anticipated range due to a number of factors, and you can see Section 10, Risk Factors, in our disclosure. For additional information supporting our projected guidance for the balance of this year, I'll refer you to Section 4, the 2018 Outlook section of our MD&A for the period ended September 30, 2018. We are very near to being able to roll out segmented earnings to the market. We are finalizing internal procedures and plan to provide a comprehensive information package to help the market understand our new method of reporting very soon. We will issue an advisory with conference call details and directions to download the information. This concludes my commentary. Thank you for listening. Operator, we can now open the call to questions from the analyst community.
At this time, I would like to remind everyone, in order to ask a question, press star and then the number one on the telephone keypad. We'll pause for just a moment to compile the question master. And your first question comes from Cameron Doerksen with National Bank Financial. Please go ahead.
Yeah, thanks, thanks very much. Good morning. Just, just a couple questions for me. I just wondering if you can, you know, you talked a bit about the on-time performance in Q3 is always a more challenging period. Is, is there anything as we look ahead kind of to, you know, to next summer, where you potentially would face the same kind of, tight scheduling, that you would do differently or anything you're sort of expecting that you might, fix, as we look ahead to next year?
... Yeah, sure. I can, I can speak to that. I think, what we've seen, you know, third quarter, as Joe indicated in his remarks, is our most challenging quarter for sure, given all the reasons he outlined. And much of that is, I think, outside of our control. You know, we can work to, improve, improve where we can, but I think when you look at the performance incentives and modeling, kind of what the performance incentives are gonna look like on a go-forward basis, given the tightness of the schedule, you know, higher utilization, high passenger loads, we're expecting from a performance incentive side, probably to be in the range of achieving 60%-65% of our, available attainments, kind of on a go-forward basis.
Okay. Just on the leasing business, we've had some, I guess, some news out of Bombardier last week, just regarding the divestiture of their Q400 program. And also, you know, there's probably some increased uncertainty over the CRJ program at Bombardier. I'm just wondering if you can maybe comment on, you know, what you think the impact might be on the leasing market for those aircraft, both today and maybe in the future, and whether you see there's any potential impact on, you know, the values of the aircraft that you're operating?
Yeah, that's something that we're certainly looking at and considering here, Cameron, and it is very early in the transaction, so it's early to tell what the impact of this may be. You know, from what we understand, Longview is taking a business as usual approach and committed to a seamless transition with no interruption in the production schedule out to, I think, 2021. And, you know, Longview has had a successful track record of revitalizing the market demand for legacy aircraft, you know, such as the Twin Otter and the Canadair Water Bomber series. And, you know, and there may be potential for the Dash 8 aircraft production as well here.
And, you know, I think Longview has certain advantages in the marketplace, in terms of their overhead levels and the focus that they can provide on that type of equipment. So, you know, I don't think it's necessarily at all bad news. You know, I think you know Bombardier obviously has had some struggles with the Q400 program, et cetera. And, we really believe in the asset itself and its potential and its application, and the fact that the aircraft is very much a niche airplane in the marketplace.
So, you know, like I said, it is really early on, and we're watching it closely, as we are with the CRJ program as well, because, you know, these are very important assets that that are unique and, you know, and we see these assets, a demand for them continuing. So, steady as it goes. We've not seen, you know, any violent reaction in the marketplace from operators or lessors, that I've seen so far. And, you know, I think as Longview takes hold here of the program and, you know, and looks to relocate, some aspects of the program, you know, I believe that they will make some progress with respect to reducing the costs associated, with the Q400.
The costs have been, I think, an issue here. So, I think there's an opportunity to address it and to make the asset stronger, even in the marketplace. But, like I said, it's really too early to tell at this point.
Okay. Very good. Thanks very much.
Okay.
Your next question comes from Doug Taylor from Canaccord Genuity. Please go ahead.
Yeah, thank you. Good morning. I think we've all seen the deployment of capital announcements pick up of late, as you mentioned. Anything to point to about what made these transactions more attractive or get them across the line? Was there any change or movement in the market or pricing that contributed to the re-acceleration of capital commitments?
No, other than, you know, these were commitments that I think we couldn't refer to by name in past quarters as being term sheets and, you know, close to, to being arranged. But, you know, each of these is its own negotiation, and delivery time frames are, you know, vary as well. Quite often, what really drives the finalization of the deals is if the delivery of the aircraft is going to be very, is imminent. I, I think that's what we've seen here, because, you know, these airplanes are being, the early ones are being delivered, sort of as we speak. So, you know, on sale and lease backs like this, that's the nature of the transaction. Whereas, of course, a portfolio transaction is a little different, in terms of buying the assets from another lessor.
So, nothing unique. You know, we still see the market in the same way as we have with respect to the opportunities that are out there. You know, there's certainly, with the world economy and various currencies, some volatility with that. We're watching that very closely as well. But, you know, it's, I think we've said it's gonna be a little lumpy, Doug, and, you know, we can anticipate that. But, you know, overall, the business is, I think, conducting itself as we had expected.
Okay. And then is it fair to say that, you know, given the outlook you just provided, the current debt market and that the returns on equity, you know, you're achieving at least modeling on the assets that you're bringing into your portfolio here are still hitting the, I think you talked about a mid-teen kind of hurdle that you'd originally targeted?
We've not, we've not changed any of our targets, and, we're not making any adjustments in terms of our expectations. You know, we're still, we're still very much focused on what we've said before.
Okay. You mentioned several positive announcements related to the MRO operation. Can you just remind us of whether there is a capacity for meaningful revenue expansion there with the existing infrastructure you have? Or should we look at some of these announcements as more, you know, extending and diversifying the current revenue profile for that business?
Yeah, I think you're right. Some of those are more an extension of the current profile. I think where we see our kind of more significant, and that's all relative, but our larger growth opportunity on the MRO side is in the parts business. So that's that would be incremental. But, you know, the contracts that we have here in Halifax for airframe, some of those that we had last year came to an end, and we've replaced that with the airBaltic, expanding our capabilities certainly to Embraer, but it's more of extension on a go-forward basis than a real lift.
As far as trying to kind of get a sense of what it looks like, you know, I'd say from an overall perspective, we're likely looking at, would be fair to say 10%-12% growth on that line on a revenue basis.
That's very helpful. Thank you. I'll pass the line.
Your next question comes from Kevin Chiang with CIBC. Please go ahead.
Hi, thanks for taking my question. Maybe just going back to the, to, to your leasing growth opportunity. When you look to mid-2019, which isn't too far away, and you know, you're still committed to having the current capital you've raised deployed, how should we think about the next phase of growth here? Do you need to raise additional capital to grow the fleet beyond what you'll deploy by 2019 or mid-2019? Or will the internally generated free cash flow be enough to support continued investment into your lease portfolio here?
Yeah, I mean, we, you know, firstly, I guess I'd say the, the additional funds that we have, we, we see being committed by, by mid-next year, as, as you said. We do have some of those deliveries that are taking place later on, already announced deliveries taking place later on in the half, back half of next year. But as, as to kind of future capital raises, you know, kind of remains to be seen at this stage, how we go about the growth with, with the business. You're right that we are generating added cash flow, kind of, with the current business, and with the new leasing business will in itself generate added cash flow that we can deploy into leasing.
So I would say, you know, we're still to be determined, I guess, with respect to how we grow after we spend this current raise. But you're right, Kevin, there is internal generation there that is spinning off, and we intend to deploy into growing the leasing business.
And correct me if I'm wrong, I think some of, you know, in the early years or months of Chorus Aviation Capital, you know, your ability to, I guess, get into a data room or to speak with potential sellers or airlines was maybe impacted by the lack of initial capital. And I guess you hadn't built out the reputation you've built out now. Given where you sit today, is that still an impediment in the sense that do you need to have the capital in place ahead of time before having these negotiations moving forward? Or are you big enough today that you can effectively have transactions lined up and then have...
And then determine your funding method post these deals, getting further down, further down the line?
Well, you know, as you grow the business, you obviously get a lot more traction in the market, and we're seeing that in terms of, you know, the opportunities that are there and some of the portfolio, acquisition opportunities we have, et cetera. And, you know, and as we move forward, we look at our different financing options, including, you know, a lot of leasing companies use warehouses and things of that nature. So, the flexibility, that we will have going forward in you know, in terms of making commitments, I think, will be greater as time goes on, as we mature. And, so, you know, I, I think we're in a far better place than where we started out.
As well, you know, a lot of the banks, and especially European banks and others we've been talking to, are very familiar with this segment and this industry, the leasing industry, and, you know, we've had a lot of really good discussions there. So we're making progress in a lot of areas. I think we are gonna have more flexibility. I think, you know, that our aperture will increase as time goes on. You know, but as Jolene said, in terms of raising capital, in terms of the equity that we put in this business, it's always under consideration in terms of what we do, and there are a lot of considerations for it in terms of our debt levels, the cost of our equity.
et cetera. So, it's, it's really a work in progress. But, you know, I think generally, certainly, more opportunity, more known, more flexibility than we had in the initial time period.
That's excellent. And just a clarification question for me, and last one is, I think you said 60%-65% available attainment of the performance fees. Jolene, were you talking about specifically just in the third quarter, given the challenges, or is that something we should be contemplating for a full year?
Yeah, I think if you kind of looked at the trends this year, like, the third quarter was certainly, you know, not good, for all the reasons we outlined. But if you look kind of overall how we've been performing on the performance incentives relative to past years, you know, there were years there where we had very high attainment rates up in kind of the 80% plus, attainment. Which, as we move forward, you know, I don't believe that's kind of realistic for your modeling any longer, just given we're in a lot of higher gauge equipment now than we were then and tighter schedules. So I think somewhere in the 65% range is probably more realistic, not only for the current quarter, but on a go-forward basis.
Yeah, we had historically, you know, a fair bit of white space in the schedule for pickup, if airplanes were late, et cetera. But in particular, for the larger aircraft, and for instance, for the CRJ900s, utilization is among the highest in the industry right now. So we're doing a lot of long-haul flying into the U.S. for Canada, into U.S. hub airports, and that's having an impact as well. And, you know, I think while that's been going well, from a demand perspective, and, you know, I think the performance generally has been good, it does stress the operation in terms of on-time performance.
The other thing, Kevin, is just, you know, as a, you know, an employee incentive program in place, so a lot of those performance incentives do end up being paid out from an employee perspective. So as that goes down, the expense goes down as well. So it's not all kind of flow-through impact on a bottom line basis at all.
Thank you very much.
Again, to ask a question, please press star one on your telephone keypad. Our next question comes from David Tyerman with Cormark Securities Inc. Please go ahead.
Yes, good morning. So I want to pick up on your last point, Jolene, that I think is the important thing. So did the CPA on-time hit of CAD 2 million actually have an EBITDA impact on Q2 or Q3?
So, the performance incentive hit actually was consistent with last year's performance incentive levels, right? So we didn't perform any better last year on the performance incentives than we did this year, achieving kind of the same revenue level. We did, as you know, have some additional CPA costs in the quarter, related to aging, you know, some aging aircraft and incremental component repair costs that we didn't expect, as well as with the operational challenges kind of being at the level that they were, we did see incremental costs related to direct labor, mainly overtime driven. Kind of when you get off schedule and you have crew and aircraft out of place, it drives overtime for maintenance employees, drives overtime for crew, et cetera. So that was the big hit.
When we kind of look forward to Q4, you know, I would say, given we're on a year to date, on a year to date basis, those, those CPA cost differentials wash even to last year. When we look forward to Q4, we don't expect to see kind of any significant differences or any surprises. We, we believe we'll be, you know, at or better than last year's performance on, on the CPA cost rate side.
Okay. So sorry, I just wanted to clarify: Did you just say, like, all these things, like the maintenance issues and the ops challenges, the overtime, et cetera, they are a wash relative to last year, so there's really not a profit hit year-over-year from this?
Yeah, on a quarterly basis, they, they are. But when you look at our year to date numbers, you know, we're fairly consistent with last year, 2017 year to date. So we would have had earlier benefits relative to rate in the earlier quarters of the year.
Okay. So just to make sure I understand, and some maybe misunderstanding your, your wording. Q3, it was a hit, but Q1 and Q2, it might have been a benefit, net-net over the first nine months, you're kind of on track?
You got it. Yes.
Okay, perfect. And then Q4, you kind of expect more like last year?
Yes.
Okay. Okay, that's very helpful. Thank you. And then on the MRO, the ten to twelve percent growth that you mentioned, is that in revenue, EBITDA, and what are the bases on this? Does—like, is this material or not?
So that's on revenue. I would say overall, you know, not significant numbers. It goes into the other revenue line, as you know, on our P&L, right? So if you look at that other revenue line, it's split between, we have MRO and third-party leasing in there.
Sure.
I'd say about 2/3 is third-party leasing, and the remainder would be MRO. So if you want to use that for your base.
Okay. That's helpful. Okay, and then just going back to the question on the Q400 and moving over to Longview. Do you have any examples, maybe Joe, of other aircraft that haven't obviously gone out of service yet, but where there's been a major change and what that's done to the values of the aircraft? Maybe something like the BAE RJ100, or something like that?
Well, in those situations, generally the aircraft line will shut down, like in the case of the 146 or even Fokker airplanes.
Yep.
But, you know, I think the best example is probably the Viking itself, when it took the Twin Otter and continued to invest in the aircraft, upgraded the cockpit. You know, and the aircraft is still in production today, and, you know, it first started production years and years ago. Has a niche in the market, still there, and they seem to have been successful in doing that. And, you know, I'm hopeful that something like that will be replicated in this situation, because, you know, as a product line, it's a great product, but as well, each product line needs to have continued investment in terms of upgrades and, you know, and looking at different markets, et cetera. And I think there's opportunities for the Q400.
But that I don't want to speak for Longview in terms of of what they see here, but you know, this is what we're, we're hopeful of. So we certainly, while we're concerned and watching it closely, you know, we're, we're not really at this point feeling that it's gonna have a significant impact one way or the other. It's really too early to tell.
Okay, understood. And then last question for me. I'm just going back to the normalized results. So, could you provide any insight into what normalized Q3 would be like? And I guess maybe related, is the first nine months figure kind of a normalized number for both years? Like, does that give us an idea of what the run rate should be?
So, I think we've laid it out pretty well in kind of our disclosure with respect to one-time adjustments and then the CPA differences. So we had a CAD 5 million difference related to the CPA cost that I just outlined. And we would have had a CAD 1.2 million one-time adjustment related to a pension expense. And our 2017 Q3 results would have been, the adjusted EBITDA level would have been CAD 1.2 million higher than expected because of a contingent consideration payable amount. So, what's that? Like, almost CAD 8 million, almost CAD 8 million dollars. Does that help?
Yeah, yeah. No, that's, that's fine. So the, so if I take those into account, that gives me the normalized kind of run rate.
Mm-hmm. Yeah.
Okay, very good. Thank you.
You're welcome.