Good morning, ladies and gentlemen, and welcome to the Cargojet conference call. I would now like to turn the meeting over to Pauline Dhillon. Please go ahead, Pauline.
Thank you, operator. Good morning, everyone, and thank you for joining us on this call today. With me on the call today are Ajay Virmani, President and Chief Executive Officer, Jamie Porteous, Chief Strategy Officer, Scott Calver, Chief Financial Officer, Sanjeev Maini, Vice President, Finance. After opening remarks about the quarter, we will open the call for questions. I would like to point out that certain statements made on this call, such as those relating to our forecasted revenues, costs, and strategic plans, are forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measures like adjusted EBITDA, adjusted earnings per share, and Return on Invested Capital. Please refer to our most recent press release and MD&A for important assumptions and cautionary statements related to forward-looking information and for reconciliations of non-GAAP measures to GAAP income.
I will now turn the call over to Ajay Virmani, CEO of Cargojet.
Good morning, everybody. Thank you, Pauline. Thank you, everybody, for joining the second quarter Cargojet earnings call. As we entered 2023, it was very clear to us that the transportation industry was entering a slower economic cycle. In my four years in the industry, I know for sure that booms follow busts and busts follow booms. The airline industry is highly capitalized and very capital-intensive industry. We have always seen stronger players with lower debts fare better through these economic cycles. What sets Cargojet apart is our ability to react and adapt rapidly to the changing environment. Right from the start of the year, we have been focused on preserving cash, curtailing CapEx, managing costs, and sustaining profitability. It is worth noting that well before the current cycle of high interest rates kicked in, we solidified our balance sheet, reduced debt, and drove all-time low average ratios.
We have dramatically cut our growth CapEx plans and rightsized the network and focused on driving our costs down in every area to ride out the current economic cycle. Following my remarks, Scott will share more details about our cost management program. With a new mindset of operational efficiency and discipline, we expect to emerge even stronger on the other side of the economic cycle. Our strong financial position allows us the advantage of being able to maintain a slightly larger fleet than the current network requirements. This makes us a unique player that can take advantage of not only the opportunist charter market, but ready to grab new growth opportunities as the market turns. We believe this will create the right conditions for Cargojet to further strengthen its leadership position.
Our long-term customer relationships, along with minimum volume guarantees, provide us a unique opportunity to maintain a strong network as well. With the addition of new customers over the past few years, our run rate revenues and EBITDA are twice the size what we had before the start of the pandemic. On the macro front, consumer spending on goods is down. There's no doubt that consumers are prioritizing travel, entertainment over buying goods over the past year or so. We expect this imbalance to return back to normal by the end of the year. Inflation seems to be trending downwards, and employment remains all-time high. The market is increasingly talking about a soft landing. It was great to see one of our customers and one of the biggest e-tailers, Amazon, reported positive growth in Q2. We remain confident in our business model and its resilience.
In the meantime, we are squarely focused on serving our customers while driving efficiencies. One way to ensure success is to look after our customers through these tough times. I want to thank my entire team for rising to the occasion and addressing costs, just as it was to manage the rapid growth we saw during 2021 and 2022. I also want to thank the team, Cargojet, for a record on-time performance of 99.6% for quarter two. That concludes my personal comments, and I will turn it over to Scott Calver for an update on the business.
Thank you, Ajay, and good morning, everyone. I will focus my remarks on three topics today. The first one being the strength of our balance sheet, followed by the progress made on our cost management initiatives, and I'll close with a couple comments on the resiliency of our business model. Our leverage or our debt-to-EBITDA, as defined by our lenders in our credit agreement, closed the quarter at 1.28x , which is well below the maximum covenant of 4.75x . When you include the hybrid debentures for total debt, we closed the quarter at 2.3x leverage, which is slightly higher than our internal target. The primary reason for this slight increase was an unforeseen delay in the second quarter for selling two 777 feedstock, which you will find in the CAD 81.2 million that is reported in our assets held for sale in our current assets.
Had we not experienced hail damage that required repairs, which postponed the closing date for these sale proceeds, the leverage would have closed the quarter at 2.05 x. Cargojet has unused committed borrowing capacity of CAD 800 million, which is more than sufficient to support our long-term strategic plan that includes both our capital expenditures and the refinancing of the hybrid debentures. The capital expenditure program is unchanged from when we released our results in the first quarter. We expect the current year to come in between CAD 200 million and CAD 225 million for combined maintenance and growth CapEx. Our estimate for 2024 in total is approximately CAD 300 million- CAD 350 million.
The total deferral opportunity of CAD 350 million for general growth is still a lever that Cargojet can pull if the growth CapEx part of our strategic plan needs to be adjusted, thus allowing Cargojet to pull forward the point of inflection to normalize to free cash flow. At this time, Cargojet has retained all conversion rights that has been previously disclosed. Cargojet continues to generate strong operational cash flow as defined by the CAD 74 million in EBITDA or the adjusted free cash flow of CAD 52.3 million in the second quarter. For the second point, let me touch on cost management and cost optimization. For cost optimization, there were two changes made in the quarter. Early in the quarter, we were able to rationalize a direct flight between Hamilton and Edmonton.
Late in the second quarter, we were also able to consolidate volumes and temporarily eliminate one of the direct flights between Calgary and Vancouver. In both cases, we rationalized a direct flight and replaced a lane with a triangulated route by adding an additional stop. Both these changes should be viewed as temporary, and they will be reversed once the volumes return. Another nuance with the Cargojet strategy is the fungibility of our fleet for both the Boeing 757 and the wide-body Boeing 767. We have often commented on the flexibility of our pilots being trained to fly both the 757 and the 767. This is critical so that we can substitute aircraft to optimize costs, and it goes both ways for all the right reasons. On a given lane, if the volume is reduced to a certain level, we will replace a wide-body 767 with the smaller 757.
In other cases, we may need to upgrade from a 757 to a 767 to handle an increase in aggregate volume as we pivot from a direct flight to our triangulated route. We review our network plan daily to ensure that we optimize these costs. We are also pleased with the performance of overtime training costs, the reduction in headcount by not filling vacant positions, and the reduction in the use of temporary employees. These initiatives are well underway. Direct expenses, excluding fuel and depreciation and amortization, are down CAD 5.4 million in the quarter compared to the prior year, or a reduction of 6.1%, which compares favorably compared to the revenue before fuel surcharges. This is the primary reason for the increased EBITDA margin in the quarter.
We are confident that these cost reductions are sustainable and that there are further opportunities that have not fully settled into our run rate on a quarterly basis. Other opportunities are in the early stages of implementation for the third quarter impact. The third topic, while we have frequently talked about the resiliency of our business model, it becomes extremely relevant during economic times like today. Approximately 75% of our revenues are reoccurring. Our customer base is blue-chip, who themselves are motivated to drive growth. We do not take fuel price risk as this is a pass-through cost, and our strategic contracts have minimum volume guarantees. This makes Cargojet an integral part of our customers' network and value chain. While demand remains soft, the combination of our business model and the cost optimization initiatives will allow us to continue and maintain margins and profitability.
With all these initiatives, Cargojet will be better positioned to come out of the other end of this economic cycle. This concludes our prepared remarks. I will hand the call over to Ajay for Q&A.
Operator, we'll take questions now.
Thank you. We will now take questions from the telephone line. If you have a question and you are using the speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your device keypad. You may cancel your questions at any time by pressing star two. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions. We thank you for your patience. Our first question is from Matthew Lee from Canaccord. Please go ahead.
Hi. Can you maybe talk a little bit about charter revenues? It was higher this time, especially this quarter, and helped offset some of the weakness in domestic. I was wondering if you can talk about what drove that strength and whether you can continue to find opportunities to strengthen charter if domestic remains challenged.
Good morning, Matthew. It's Jamie. I can answer that. Ad hoc charter demand remains strong. A more recent, just this past week, and I think we're on our third flight for FEMA to provide relief to Hawaii for the wildfires in Maui. The overall demand has stayed strong throughout the past quarter, combined with the availability of aircraft. Typically, I think we've indicated that a normal run rate per quarter for ad hoc charter and international would be about in the CAD 15 million-CAD 20 million range. We're well above that, I think at CAD 27 million in Q2, a big contributor to that is the availability of aircraft and crews. Traditionally, we restrict ad hoc charter business to weekend.
We don't have any dedicated aircraft that are exclusively purchased for that revenue segment, and typically use these aircraft that are part of our domestic network or part of our ACMI flying when those aircraft are available during downtimes, either during the day or on weekends. With additional aircraft that we have in our fleet, we really have availability 24 hours, seven days a week, and that's what's led to the growth in the quarter, and we expect that demand to continue in Q3 and Q4.
All right. That's helpful. In terms of domestic revenues, can you maybe delve into a little bit between rate growth and volume decline that drove that 2% decrease this quarter?
Yeah. It's Jamie again, Matthew. On the domestic, I'd take into consideration a couple of things. Obviously, fuel surcharge revenue is significantly lower overall quarter-to-quarter. I think our average fuel price was about CAD 1 a liter in Q2 of this year versus CAD 1.50 last year. Last year, there was an indirect impact on our domestic revenues with an increase in ad hoc business that was related to international charters that we were doing, particularly out of Vancouver to China, both ourselves and with our ACMI partner, DHL, and we were feeding those flights on our domestic network, and that portion of the revenue was associated with the domestic.
If you took that off, and as Ajay mentioned, with the growth, we don't obviously report individual customers' revenues, but with the news that you saw with Amazon's growth in the quarter, that's reflected well for. We look at it, the domestic was where we expected it, somewhat flat, maybe down a single percentage point.
Okay, that's helpful. In terms of your guidance that you previously provided on domestic being down low single digits, that's still where you feel comfortable at the time?
Yeah, we think so. Certainly for the third quarter, although we've had some customers that have expected or forecasted the second half of the year should be a little stronger than the first half of the year. We don't expect the year. Q4, we expect to be similar to the peak season last year, which was a very muted peak season compared to the previous years.
Okay, thanks. I'll pass the line.
Thank you. Following question is from Konark Gupta from Scotiabank. Please go ahead.
Thanks, operator. Good morning, everyone.
Morning.
Good to see the margin expansion, Ajay, after almost, I think, two years of year-over-year declines in the team. My question is, what can you do more on a cost side here?
Well, cost side, what we have achieved is not a destination, it's a journey. Konark, there's not a day goes by where we're not looking at what expenses. These are not expenses that affect the service, as you can see. Our service was all-time high at 99.6 on-time performance. Our service, anything other than the service, we're looking at every expense. Whether we are cutting back on temporary labor, whether we are shipping our parts overnight or whether we are using ground services more. You name it. There is not an area. I'll give you a small example. We are fine-tuning our de-icing operations, our GSE, our container repairs. All these little areas that add up to millions of dollars.
To be honest with you, past three years, because of the COVID growth and COVID demand, it was basically getting the job done at any cost because we didn't have the time. Now we are sitting back and reflecting that all these things can be fine-tuned, costs can be reduced without impacting the service, bring in more efficiencies. When we do enter a good economic cycle, hopefully in the next few months or the fourth quarter or after, we'll come out a much stronger, leaner, greener, and more profitable organization at the end of it.
Yeah, that makes sense, Ajay. Thanks for the color. In terms of potential rebound, I think one of the points you made in the press release was you expect some normalization to happen in the consumer spending behavior by the end of this year. If the business rebounds in 2024, with the cost management going on, how would you prepare to support that rebound?
We're not cutting where it comes to service. We're not reducing, for example, we are still hiring pilots. We're still not reducing the maintenance personnel. We're not reducing where it comes to the growth areas. Where we are gaining efficiencies is cost management, better negotiations with the suppliers, getting better credit terms, stuff that is not required. One of the things we have undertaken is, we used to have CAD 92 million worth of spare parts inventory, and we have cut at least CAD 10 million, CAD 15 million out of it. We are managing efficiencies, as I said, and not sort of taking away that if the volumes came up tomorrow, that we would be suffering. All operating people, all operating systems, all operating costs and everything are still in place, so that we don't short-change ourselves.
Let's say we had less pilots, less maintenance people, or less dispatchers, it wouldn't make any sense because there's six months to eight months to a year lag and a lot of training costs. We are aware of those. Basically, I hate to use the word, but we're getting rid of overspending that was done to meet the COVID demands, which would be considered, in today's terms, a waste. The waste portion is going because there is no panic about COVID, but the cost still remains. Sometimes it takes a while because of the commitments and certain other market considerations to do it slowly. Just to assure you guys, we're not here to cut so deep that our growth gets impacted.
As a matter of fact, as I mentioned, if the growth happens with today's cost structure, we've come out much better ahead than we were one year ago.
That's good color, Ajay. Thanks. One last one from me. Stock's kind of going to come off, I think, even below where it started the pandemic. I know you guys pointed out the business has kind of still doubled despite all the kind of volatility I've seen over the last two, three years. Any strategic actions or plans in the works to take advantage of the stock's weakness?
Look, we are always thinking, how can we do the best for our shareholders and take advantage of the low stock price, whether it could be buying back stock, whether it could be doing some strategic stuff. There's never a dull day. We've consulted with three or four main bankers as to what is the best strategy going forward, and although we don't have a defined or agreed-upon strategy, but there's not a day goes by where we don't think about it and not in the boardroom thinking about what do we need to do. As far as the stock price is concerned, you can imagine that in 2019, we had CAD 150 million EBITDA, and now we have over CAD 300 million run rate. The revenues have doubled, but the stock price has remained the same.
The macro trends probably, or the fear of recession, probably those are two things that are scaring people away. General cargo trends, when you see United Airlines, American or Delta, reporting 25%, 30% less cargo revenues. I want to remind everybody that we're not in the same market. I think there's some nervousness about cargo markets there, and we're a well-diversified company that has an overnight network on pay-to-play contracts, number one, with built-in escalations for CPI. Number two, we also diversified into ACMI and charters. I think that painting every cargo with the same brush with all the results going on, is a bit unfair and a bit uncalled for. Hey, look, we understand this is a market. We're not short-term organization. We look for longer term planning.
If we didn't have the longer term planning, I'll tell you, we would not have had the revenues and profitability. We were carrying three or four extra planes for growth, and they worked out great for COVID rush and volumes. We are always prepared for these things, and I can assure you that we are always thinking strategic options on the financial side when the stock price is concerned.
Fair enough. Thanks for the time. Appreciate it.
Thank you. Our following question is from Chris Murray from ATB Capital Markets. Please go ahead.
Thanks, folks. Maybe going back to kind of the revenue and the revenue outlook a little bit. Sounds like you talked a little bit about the trend in domestic is going to be kind of negative, but it sounds like charter is doing a little bit better. A couple questions on this one. First of all, how is ACMI doing right now? Maybe a different way to think about this, can you maybe talk a little bit about what you're thinking about block hour trends for Q3 and maybe Q4 are going to be, just as all the moving parts kind of materialize?
Hey, Chris, it's Jamie. Good morning. I would say, the domestic revenue, probably flat to a little bit down. Temper that with, as Ajay noted and I mentioned before, Amazon's reported fairly healthy growth in the quarter globally. Overall, we've seen some increase and we'll continue to see some increase in Canada. We recently started operating a new 40,000 sq ft facility in Vancouver exclusively for them, which has allowed them and us to extend one of the CMI aircraft that we operate out of Hamilton direct to Vancouver. Both aircraft operate into Vancouver now, which adds volume and adds block hours to the CMI flying. That will continue to trend positively in Q3 and Q4 and contribute to the overall domestic revenues. ACMI is up a little, up what we expected, a few percentage points in the second quarter.
As we indicated before, the aircraft that we're operating primarily for DHL, we added three aircraft in 2022, as you recall. We're getting the full annualized impact of the additional aircraft this year, albeit with a little bit of an offset on the number of block hours that those aircraft flew, because two of them flew some significant monthly block hours on average when we were flying out of Cincinnati to Vancouver and Shanghai for eight or nine months in 2022, where when demand fell out of China in the latter part of the fourth quarter, they had to shift those aircraft in North America operating between either Cincinnati and Central or South America. Although the overall hours are still above the minimums, the actual hours are below what we experienced in 2022.
We should see sort of the similar growth levels, flat to single-digit percentage for the balance of the year in Q3 and Q4.
All right. Overall, just trying to tie this together. Block hours down about 6% in the quarter. Would you think that we'd start to see that come off that -6 number as we go into Q3 then? With the mix or just maybe hold there?
No, it should go down a little bit more because we're going to see, particularly on the domestic side, as Scott noted earlier, there were some additional block hour reductions in consolidations in the domestic schedule that took effect only at the beginning of July. You'll see the impact of those compounded with the results that we saw here in Q2 and Q3 and Q4. As well, the ACMI hours, you should also see coming down a little bit, reflecting the different flying that I just mentioned that we're doing specifically for DHL.
All right. That's helpful. Maybe it costs a little bit more. Couple maybe specific questions. At this point, I think you talked a little bit about taking out some temp labor, and I think Ajay made a comment about maybe excess costs that were there to support the COVID bump. I guess first on labor, do you think you're in the right place with where you are with full-time employees, and you will have that excess labor to absorb? The other question, just very quickly, you had talked, I think last call about having another simulator in place to help you with some training needs. That was supposed to arrive, I think, sometime in Q3. Is that still on schedule? Should we be expecting that to have an impact maybe into Q4 and maybe 2024?
Hi, Chris. It's Scott. I'll get into some of the details on the direct expenses. That is where most of our efficiencies have come from, obviously, to have our EBITDA margin increase. Really, if you look at the quarter, the crew is down CAD 1.3 million compared to prior year. That CAD 1.3 million, most of that is the simulator. When you look at the training line in there and the travel, and that's where we're seeing those efficiencies from having that simulator, and that's sustainable. That's only going to improve as well when we add our second simulator later this year. Ground services down CAD 3.5 million compared to prior year. That's where you're going to see most of the savings from vacant positions, and there's all kinds of line items in there. Generally speaking, most of them are down, and that's sustainable.
There's another CAD 1.5 million in the other direct expenses, CAD 800,000 in airport services, another CAD 700,000 in navigation and insurance. At the end of the day, what we're doing here is managing our cost per block hour. When I look at the direct expenses, I exclude the fuel, because obviously that-