Good morning, ladies and gentlemen. Welcome to Exchange Income Corporation's conference call to discuss financial results for the three-month period ending June 30, 2018. The corporation's results, including MD&A and financial statements, are available via the company's website or SEDAR. Before the call is turned over to management, listeners are cautioned that today's presentation and the 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 law, 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, everyone. Also with me today are Carmele Peter, EIC's President, Tammy Schock, our CFO, who will review our financial results in greater detail in a few moments, and Dave White, our VP of Aviation. We are happy to be with you this morning to discuss the second quarter results for 2018 and to update you on a number of initiatives which we're excited about and will facilitate our strong performance in the future. The second quarter of 2017 was an exceptionally strong period for EIC, and 2018 improved on that performance. Revenue grew by 15% to CAD 313 million. EBITDA increased by 7% to CAD 75 million. Adjusted net earnings increased by 4% to CAD 0.80 per share. The payout ratio, when calculated as a percentage of free cash flow plus maintenance capital expenditures, improved significantly to 58% from 75% in 2017.
The trailing 12-month payout ratio calculated on the same basis also improved significantly to 64% from 80% in 2017. The payout ratio as a percentage of adjusted net earnings was unchanged for the quarter at 68% and declined to 77% from 87% on a trailing 12-month basis. It is important to realize that these improvements in payout ratio were achieved after increasing the dividends by 4% to an annual rate of CAD 2.19 per share. Of particular note is the fact that revenue, EBITDA, and adjusted net earnings and free cash flow less maintenance cap expenditures per share all established new second-quarter highs for EIC. I will leave the more detailed analysis of the financial results to Tammy, but I would like to spend a moment talking about the environment in which these record results were achieved.
Our aviation and aerospace segment generates a significant majority of the revenue and profit for the company. This sector faced material headwinds in the second quarter as fuel prices rose significantly, while labor markets for pilots remain very tight. We managed modest growth in our legacy and provincial operations driven by the acquisition of Moncton Flight College. This would not have been sufficient to generate the results we've announced today. The solid growth in our manufacturing segment drove the second quarter for EIC. Revenues grew 73% to CAD 80 million and increased to 26% of EIC's total from 17% last year. The impact on EBITDA was even greater as manufacturing increased to 19% of the corporate total from only 7% last year. This improvement was driven by the performance of Quest and by improvements in the results of the other companies in this segment.
I have said it for the last 15 years. I will repeat it again here. Diversification works. We have generated record results with better balance between our segments while reducing the reliance on any single subsidiary. The biggest factor driving our results is the addition of Quest, which has continued to perform at a level which has exceeded our expectations. When we announced the acquisition of Quest late last year, we stated that the acquisition had based on a historical EBITDA of approximately CAD 15 million. We also stated that if the purchase price would increase to CAD 100 million if certain performance targets were hit. We fully expect the company to grow and grow significantly. We would pay out the earn-out following the 2018 fiscal year. It would be disingenuous, however, to say that we expect it to perform at the level it has thus far.
In the first six months of the year, it has generated approximately CAD 15 million in EBITDA, an amount approximately equal to the last fiscal period before we purchased it. While I would caution against simply extrapolating this figure for 12 months, as a number of factors have lined up to enable our existing facility to operate very near its absolute capacity, it is clear Quest will generate earnings well in excess as was is necessary for the vendors to receive the full CAD 100 million purchase price. The growth being delivered at Quest is just the first stage of the program. With the increase in our order booked over CAD 300 million that we announced last quarter, we have committed to opening a new manufacturing facility in Texas. We have signed a lease on a building with over 300,000 sq ft of space.
Equipment will begin to arrive later in this quarter. By the end of the year, we believe we will be in a position to begin initial product runs in the first quarter of 2019. It will clearly take a few quarters to ramp up the plant. When complete, it will provide us the capability to more than double our existing production. We knew Quest was an exciting acquisition when it was announced. The organic growth it has generated under the leadership of Martin and Jody Cash has exceeded all expectations. The balance of the manufacturing portfolio also performed well. EBITDA increased by 49% as a result of strong demand and more efficient operations. It was a challenging quarter for our aviation segment as labor shortages, combined with rapidly increasing fuel prices, put upward pressure on costs.
We have strategies in place to deal with both of these situations and began their implementation in the second quarter. Many of our contracts allow for a direct flow through of fuel price changes. While this makes sure we are not exposed in the medium term, there are often lag times before the increases take effect. As such, in times of rapid increases, we experience a drag on our margins until the higher price kicks in. Other revenue streams require us to take direct steps to increase prices. It is very important to realize that most of the communities we service receive their fuel over winter roads once per year and therefore do not experience the fluctuations in fuel prices that more southern centers do with regular deliveries.
It is therefore imperative that we give notice of fuel price surcharges and take the time to speak with community leaders explaining why they are necessary. This also creates a lag before price changes are realized. We took steps late in the second quarter and into the third to pass on our higher cost to our customers, but we incurred a reduction of margins in the second quarter. Our ticket and fuel prices now largely reflect the current fuel pricing, the drag on margins will be reduced in the third quarter. Should prices continue to escalate, further action may be required. Provincial Aerospace faced headwinds in the quarter in addition to the industry-wide price increases and labor shortage. A strike at one of our major customers shut down their operations at the facility we service, as such, reduced their demand.
The strike has now been settled, demand has returned to pre-strike levels. We announced and closed the acquisition of Moncton Flight College in the first quarter. MFC is one of the world's leading flight schools, offering intense pilot training in a university-like setting, allowing pilots to achieve full certification in approximately one year. MFC met all of our acquisitions criteria as a standalone investment, it was the internal synergies with our existing airlines that made it such a strategic opportunity. The worldwide pilot shortage is worsening, by acquiring an internal training capability, we are now able to implement a strategy to train pilots and then retain them longer by providing increasingly senior positions within our group of airlines. This will take some time to implement as the business is running near capacity and growth in demand is already anticipated from third-party customers.
It is a rare opportunity that is both accretive and highly strategic. MFC performed as expected in the second quarter, which was our first one under our ownership. Regional One had another strong quarter, generating approximately $22 million USD in EBITDA, which is approximately a million and a half less than the exceptional performance of 2017. Very strong sales of parts, engines, and full aircraft was offset by delays in the lease-up of some of the CRJ-900 fleet and the lack of lease return settlements that occurred in the preceding year. The demand for the CRJ-900s has grown, we now have agreements in place that will see all of the planes on lease by the end of the year. Some of the initial leases expire in 2019, we anticipate re-leasing them before or shortly after their current leases expire.
We continue to diversify our aircraft offerings at Regional One. During the second quarter, we acquired a fleet of 28 ERJ-145 aircraft. Some of the aircraft were leased to third parties and/or sold outright. Some of these transactions have already been completed, but most will be torn down and sold as parts. This transaction is evident in our quarter-end balance sheet, where inventory increased as a result of the purchase of these aircraft. Subsequent to quarter end, we completed the purchase of 2 ERJ-170s. The expansion into this ERJ platform increases the opportunities for Regional One to continue to grow in the future. There have been some who hypothesize that EIC in general and Regional One in particular could not maintain the cash flow they generate without large investments in growth capital expenditures. The first six months show the fallacy of that argument.
The first six months, EIC capital expenditures, including both maintenance and growth, totaled CAD 62 million, down approximately 58% from the CAD 149 million invested last year. This decline is entirely explained by growth investments, which were nominal at CAD 2 million this year versus CAD 92 million last year. Maintenance capital expenditures actually increased slightly to CAD 60 million from CAD 57 in the preceding year. It is important to note, this in no way represents a change in EIC's strategy, and in fact supports what the strategy has always been. Which is, where investment opportunities are developed that are accretive and meet the rest of our criteria, we will pursue them, whether the opportunity is an acquisition or a capital asset purchase. When we don't uncover these type of opportunities, we will wait for our standards to be met.
The consistent and material investment in maintenance capital expenditures preserve the earning power of our subsidiaries. Growth investments are just that, investments to grow our company. Before I hand the call over to Tammy, I want to focus on the significant improvement in our payout ratio. This improvement is evident whether you calculate them based on free cash flow, less maintenance capital expenditures, or based on adjusted net earnings per share. It is also evident whether you calculate them for the most recent quarter, the six-month year to date, or the 12-month period. This reduction in the payout ratio is even more significant with the dividend increase of CAD 0.09 to CAD 2.19 earlier this year, and maintains our over 14-year dividend CAGR of over 5%. A track record which few, if any other TSX listed companies can match.
The quarterly and trailing 12-month ratios are discussed in detail in our MD&A released yesterday. I'd like to take a moment to focus on the payout ratio improvement in the first six months of this year. Our payout ratio, when calculated as a percentage of adjusted net earnings, fell from 103% last year to 89% in 2018. Our payout ratio when calculated on a free cash flow, less maintenance capital expenditure basis, fell even more dramatically from 115% to 86%. I should point out that the ratios for the first six months are always higher than they are for the full year because they include the seasonally weak first quarter where winter roads compete with our airline business. The comparison of 2018 to 2017 for the six months, however, shows the dramatic improvement even with the increase in dividends implemented this year.
I will now hand the call over to Tammy, who will give you a more detailed look at our financial statements.
Thanks, Mike, and good morning, everyone. As usual, I will focus my comments on the three-month results ended June 30th. Consolidated revenue for Q2 was CAD 313.4 million, which is up CAD 40.3 million or 15% from Q2 last year. Of the increase, CAD 6.4 million was generated in our aerospace and aviation segment and CAD 33.9 million in our manufacturing segment. The aerospace and aviation segment generated CAD 233.4 million in revenue, an increase of 3%. Revenue in the Legacy Airlines and Provincial increased by CAD 10 million or 7%. In our Legacy Airlines, the increase reflects the benefit of the Kitikmeot medevac contract, which commenced in Q4 of 2017, higher fire suppression revenue, and higher passenger volumes in Ontario. Provincial's revenue was positively impacted by the acquisition of Moncton Flight College. Revenue generated by Regional One declined by less than 1% in US dollars.
In Canadian dollars, Regional One's revenue declined by approximately 5%, reflecting the impact of the stronger Canadian dollar. I would note that the second quarter of 2017 was a record quarter for Regional One. The decline in revenue is primarily related to the lease business in Regional One. The lease revenue in Q2 of 2017 included a significant redelivery settlement, which did not recur in Q2 2018. Sales and service revenue was essentially flat, although there was a shift in the mix between parts revenue and aircraft sales revenue. The manufacturing segment had revenue of CAD 80 million, up 73% or CAD 33.9 million from Q2 last year. The largest contributor to the increase is Quest, which was acquired on November 14th, 2017. Also contributing to this increase is the collective growth of all of our other manufacturing entities, with the exception of Stainless, which had a slight decline in revenue.
Both Ben Machine and WesTower had significant increases in revenue this quarter. High levels of defense spending worldwide is driving Ben's revenue increases, and WesTower is now realizing the benefit of operational changes that they have made in response to the lower levels of demand for their traditional services. Consolidated EBITDA was CAD 75.1 million, up 7% or CAD 5 million from the second quarter last year. The growth was driven by our manufacturing segment through both organic growth and through the acquisition of Quest. EBITDA was negatively impacted for the quarter by prevailing foreign exchange rates. If exchange rates had remained consistent with Q2 2017, EBITDA would have been CAD 2 million higher. EBITDA in our aerospace and aviation segment was CAD 67.3 million, a decrease of 4% or CAD 3 million.
The stronger Canadian dollar put significant downward pressure on the translated results of our foreign entities and Provincial U.S. dollar contracts. EBITDA contributed by the Legacy Airlines and Provincial was essentially flat in comparison to the second quarter of last year. The benefit of increased revenue in these entities did not fall through to EBITDA. The results of our aviation entities were impacted by rapid increases in fuel costs. We are able to mitigate our exposure to rising fuel costs through fuel escalation clauses that are embedded in many of our contracts and through the implementation of fuel surcharges on non-contractual revenue streams. There is a time lag in deploying these mitigation measures. In circumstances where fuel prices rise rapidly, as was the case during the second quarter, our results can be negatively impacted. Industry-wide labor shortages caused increased overtime, contractor, and training costs in our airlines.
Our airlines are actively working to develop and implement initiatives to mitigate the impact of these issues. These initiatives will take time before becoming fully effective. Moncton Flight College, which was acquired in February, is a key part of our strategy in this area. Regional One's EBITDA in U.S. dollars was down 7%. The decline reflects the lower levels of lease revenue that I discussed a few moments ago and a higher proportion of aircraft sales, which have lower margins associated with them in comparison to the margins that we achieve in relation to parts sales. The stronger Canadian dollar caused a CAD 1.1 million reduction in EBITDA. The manufacturing segment EBITDA grew by 204% or CAD 9.8 million to CAD 14.5 million. The acquisition of Quest drove CAD 7.4 million of that increase. Quest performance continues to be ahead of the expectations that we set when we did the acquisition.
EBITDA from the remaining entities in the manufacturing segment was 49% higher or CAD 2.4 million higher in comparison to the prior period. As I've noted, foreign currency rates did create headwinds for us in the translation of our foreign subsidiaries into Canadian dollars. On a consolidated basis, if we used exchange rates consistent with those prevailing in 2017, EBITDA would have been higher by approximately CAD 2 million. That was the consolidated impact of currency. Our Canadian subsidiaries also have exposure to the U.S. dollar. Because there are a variety of U.S. dollar inflow and outflows, such as the cost associated with aircraft parts and the U.S. dollar revenue contracts that certain of our subsidiaries have, the net exposure in relation to our Canadian operations is not typically large. The decline noted is flowing from translated results of foreign subsidiaries primarily.
We reported net earnings of CAD 19.5 million, or CAD 0.62 a share. These compare to net earnings of CAD 25.8 million or CAD 0.83 a share in Q2 2017. Earnings per share reflects an increase of 2% in the average shares outstanding during the quarter. The majority of the decrease in net earnings was driven by two items. First, that is the CAD 3.9 million after-tax gain on the disposal of our partnership interest in Innu Mikun, which was included in Q2 2017's results. The second item relates to our decision to redeem a series of convertible debentures early. Although the actual redemption occurred subsequent to the quarter end, upon making the decision to redeem non-cash interest, which was being accreted over the term to contractual maturity, was accelerated, causing an increased interest expense of CAD 2.2 million.
Interest costs increased by CAD 5.9 million as a result of the non-cash interest accretion that I just noted and as a result of increased benchmark interest rates and an increase in the outstanding debt balance. Depreciation increased by CAD 1.5 million or 5% as a result of capital asset purchases in 2017 and the acquisitions of both Quest and Moncton Flight College, for which there is no comparative amount. Amortization of intangibles also increased by CAD 1.6 million, which was due to the intangible assets that we recorded with the acquisition of Quest. Income tax expense decreased by CAD 3.9 million and the effective rate of tax also decreased to 23.7% from 27.9%. That has positively impacted income tax expense. We also benefited from the reduction in U.S. tax rates that was passed at the end of 2017.
On an adjusted basis, net earnings were CAD 25.2 million or CAD 0.80 a share for Q2 2018. That compares to CAD 23.9 million or CAD 0.77 a share for the comparative period. Adjusted net earnings exclude the amortization of intangibles, net of taxes, which increased as a result of the acquisition of Quest. Also excluded is the non-cash interest accretion that I just discussed. The gain on disposal of our partnership interest in Innu Mikun was excluded from adjusted net earnings in the prior year. We use both an adjusted earnings-based payout ratio and a free cash flow less maintenance CapEx-based payout ratio to make decisions regarding dividends. Our payout ratio for Q2 2018 on an adjusted earnings basis was 68%, which is unchanged from the same quarter last year despite an increase in dividends. Our trailing 12-month payout ratio in the quarter was 77%, down from 87%.
This improvement reflects the increase in adjusted earnings, which was in excess of our increase in dividends. Free cash flow for the quarter was CAD 58.8 million, up 14%. Free cash flow on a per-share basis was CAD 1.86, which is up from CAD 1.66 per share last year. Our free cash flow less maintenance CapEx payout ratio was 58%, a significant improvement from 75% in Q2 2017. Our trailing 12-month payout ratio also improved from 80% to 64%. Investments in the maintenance of capital assets, primarily aircraft-related assets, decreased by about CAD 800,000 in the second quarter of 2018 to CAD 29.1 million. CAD 8.9 million of this total is related to depreciation on Regional One's portfolio of aircraft and engines, which is in line with the second quarter of 2017. The Legacy Airlines and Provincial had CAD 19.3 million in maintenance capital expenditures compared to CAD 20 million in the second quarter last year.
Growth capital expenditures during the quarter were nominal. We continue to expect growth capital expenditures to be much lower in 2018 overall than they were in 2017. At the current time, our planned expenditures for the remainder of 2018 include the new plant in Texas for Quest and aircraft and ground facilities for Keewatin to service its medevac contract in the Baffin region of Nunavut. During the quarter, we completed our partnership transaction with Wasaya Group. EIC has invested CAD 25 million in Wasaya, of which CAD 12 million was an equity investment and CAD 13 million is a loan. Our share of Wasaya's results are included in the results of our Legacy Airline and are consistent with our expectations when we made the investment. The equity investment is included in the other assets on our balance sheet.
Turning to our balance sheet, we ended the quarter with a net cash position of CAD 85.5 million and working capital of CAD 297.1 million, which represents a current ratio of 1.98 to 1. This compares with a net cash position of CAD 72.3 million and a working capital of CAD 240 million and a current ratio of 1.91 to 1 at the end of 2017. The consolidated cash position at both June 30 and December 31 included cash held to fund the impending redemptions of convertible debentures, and I'll discuss that further in a moment. The increase in our working capital at June 30, 2018 in comparison to year-end is primarily related to three items. An increase in Quest working capital because of the growth in its business volumes and its expansion into the U.S.
An increase in inventory at Regional One as a result of the purchase of 28 ERJ aircraft, 17 of which were classified as inventory for resale. Lastly, an increase in the accounts receivable in Regional One due to the sale of an aircraft with an extended term. The receivable is secured by a letter of credit from the customer. Other changes in our working capital are typical for the second quarter as business volumes in many of our subsidiaries are higher in the summer months. As I noted a few moments ago, the debentures that were due in March 2020 were redeemed early on July 17, 2018 for approximately CAD 65 million. The redemption was funded with the proceeds from the offering of a new series of unsecured debentures.
In June, the syndicate of underwriters exercised their full over allotment option on our debenture offering. We issued CAD 80.5 million of seven years, 5.35% convertible debentures. As a result of this offering and the subsequent redemptions of the March 2020 debentures, we are now positioned such that we have no debt maturing until 2021. We have also reduced liquidity risk as the maturity dates of our outstanding debentures are staggered across a number of years. Additionally, we have mitigated the potential dilution from conversions through a material increase in the conversion price relative to the convertible debentures that were redeemed. In spite of a much longer seven-year term of these debentures, the interest rate remained unchanged at 5.35%.
During the quarter, the credit facility was amended to increase its size by CAD 250 million, extend its term to May 2022. Add a new financial institution to the syndicate, increasing the number of syndicate members to 11. At the same time, pricing was amended favorably. The covenants within the facility were amended to allow us greater flexibility to take advantage of growth opportunities quickly. The end result of these financings and redemptions is that the company's balance sheet and capital resources are strong. Our leverage ratios are well within our target range and the available capacity within our credit facility now sits at approximately CAD 350 million. We are very well positioned to take advantage of growth opportunities when they are identified. That concludes my comments on our financial results, and I'll turn this call back to Mike for some closing remarks.
Thank you, Tammy. In our first quarter, we announced that Keewatin Air had been successful in winning the RFP for the Baffin medevac contract. This left Kivalliq, which expires later this year as the only contract that was under a long-term arrangement. I am pleased to inform you that Keewatin Air recently entered into a new five-year contract for this region. This marks the first time all three Nunavut contracts have been held under long-term contracts by Keewatin Air. The provincial government has issued an RFP for the three components of Government Air's operations: medevac, including the Lifeline program, which specializes in very emergent cases, firefighting, and general charters. We are very interested in the medevac contract. Currently, the less emergent cases are handled by all four carriers on a rotational basis.
Under the RFP, all of this work together with the Lifeline program, which is currently handled by Government Air, will be awarded to a single carrier. Perimeter Aviation has served the province in this area for decades, and the new combined format will very closely resemble the service that Keewatin Air provides in all of Nunavut. We are excited about this opportunity and believe we have a proven track record. We will pursue the RFP and expect significant competition. We are also examining the other two areas of this RFP. We have been working on our short-term rental maritime surveillance aircraft, the Force Multiplier, for over a year and are very excited that it is on the verge of completion. We are in the final stages of certification process and expect it to go into service by the end of this quarter.
In fact, we completed a project in the second quarter using one of our King Air surveillance aircraft, where the original inquiry was for the Dash 8 Force Multiplier. We used the staffing and processes set up for the multiplier and an existing aircraft to meet a customer request. The mission was very successful and bodes well for the launch of the multiplier later this quarter. Our investment in growth CapEx in the first six months has been very modest. We expect that it will be somewhat higher in the second half of the year as we complete the new factory for Quest Window Systems and the investment in Keewatin Air for its enhanced Baffin medevac contract.
At this time, our expectation is the Quest Window Systems and Keewatin Air programs are our only planned investment outside of normal activity or Regional One. We have strengthened our balance sheet over the first six months of this year by replacing existing convertible debentures with a new series that have longer maturities, lower interest rates, and lower potential dilution as a result of higher strike prices for conversion. We extended and expanded our secured credit facility with lower interest rates and more flexible covenants. As a result, our balance sheet is in excellent shape, with CAD 350 million of liquidity and no debt maturing until 2021. We are in an excellent position to be able to execute on our model with no need for capital in the foreseeable future.
We have seen some of the companies in the airlines sector experience challenging quarters and reduce their guidance for future quarters. While there is no doubt we have felt the effects of higher fuel costs in Q2, and to a lesser extent in Q3, and that the stronger Canadian dollar has reduced the value of our profits of our U.S. operation. I am pleased to tell you that there is no such reduction in our guidance. At the beginning of the year, we stated that we expected both EBITDA and adjusted net earnings per share to grow between 10% and 20% this year. We also guided that there would be a significant decline in growth capital expenditures and that maintenance capital investment would increase slightly. I am pleased to affirm all of this guidance.
In spite of the challenges with higher fuel costs and a very tight labor market for pilots, we fully expect to deliver on the guidance previously provided. The strength of our diverse operations has never been more evident. We would now like to open the call to questions. Operator?
Thank you. Ladies and gentlemen, we will now conduct the question and answer session. If you do have a question, please press the star followed by the number 1 on your touch-tone phone. You will hear a tone acknowledging your request. Your questions will be pulled in the order they are received. Please ensure you lift your handset if you're using a speakerphone before pressing any keys. Your first question comes from Mona Nazir with Laurentian Bank. Your line is open.
Your next question.
Good morning, thank you for taking my questions.
Good morning, Mona.
My first question, you kind of touched on this in your remarks, there was another quarter of no growth capital investment, yet consolidated results remain strong and even over a longer-term trailing 12-month basis, we saw growth CapEx down 80%, yet Regional One performed with CAD 75 million in revenue this quarter. There's been a strong correlation or belief that growth CapEx is driving your revenue and EBITDA, looking at the last few quarters, there seems to be a disconnect. I just wanted to firstly confirm the statement that I think I just heard that there would be no significant growth CapEx for R1 this year. If that's the case, what kind of revenue and EBITDA could we expect from R1 with the minimal spend? Just speak about the dynamic between growth CapEx and your revenue and EBITDA generating power. Thank you.
Thanks, Mona. R1's a complicated beast because we're buying and selling assets at the same time as we're investing in long-term assets. When you look at our CapEx, the aggregate CapEx is the sum of our maintenance CapEx and our growth CapEx. We use depreciation as a proxy for our maintenance CapEx because when we're flying our lease fleet, we're using it up over time, and we need to replace that. The first CAD 8 million or so we invest is just replacing what we use up. If that's all we did for the foreseeable future, the EBITDA would grow, but grow modestly without further investment. We're very opportunistic on when we invest in Regional One. When the right deals are there, we will move. I wouldn't go so far as to say there'll be no growth capital investments in Regional One.
When the right opportunities come, we'll jump on them, but there is absolutely no expectation in the near term of returning to the sort of CAD 100 million plus investments we've made in the couple of years before, where we invested in a fleet of CRJ-900s. Bottom line is that all we need to do is invest in our maintenance CapEx to maintain the cash flow that that company generates. When the opportunities come and we do put something into growth, that will allow us to grow to a new level in the future.
Okay, just to confirm, we shouldn't expect really any material trend down in R1 performance?
Absolutely not. The only star I put on that is the Canadian dollar affects how we convert that. When I talk about it, I speak of it in USD. If the Canadian dollar weakens, it improves the financial statement presentation of their profits. If the Canadian dollar strengthens, it weakens it. Absent that, there's no reason to expect a decline in their performance.
Okay, thank you. Just secondly from me, you're keeping your guidance unchanged at 10%-20% EBITDA and EPS growth, despite having over 70% aviation aerospace exposure, the significant increase in jet fuel prices, and also some of the aviation peers recently revising down the guidance. This may connect your ability to pass through fuel surcharge, but I'm just wondering if you could speak to the business model and your reiteration of guidance. Also, you quantified that FX translation had a CAD 2 million negative impact on quarterly EBITDA, but I'm just wondering if you could quantify the same for jet fuel. Thanks.
We haven't published recently a precise calculation on jet fuel on the cost because we're in the midst of putting price increases through in the quarter. It's in the low single digits of CAD millions, the net cost to us in the second quarter. It's important to understand, because of our market position and who we service and the vast majority of where we service, the relative price inelasticity, we can push the price increases through when our costs go up. It's a matter of doing it in a politically appropriate manner. When it's under contract, as an example, our contract with the government in Nunavut for passenger service has a quarterly escalator or de-escalator depending on fuel, but you have to go through the whole quarter of the increase before the following quarter, you get to change your prices.
We get hit in times of rapid expansion of fuel prices. It takes us a while to catch up. Conversely, if prices fall, it takes us a little bit before we reduce the prices. Net-net, it's pretty efficient. You could see there would've been a couple or three CAD million of net fuel price impact in the quarter. I think the other piece of this is, quite frankly, is that because of our diversity, not everything moves in the same way at the same time. You see it in these results. The aviation had a tougher quarter, not unlike you see with the WestJet, Air Canada of the world, although we had nowhere near the impact they had on their performance. The strength of manufacturing right now easily carried the day and the continued growth of Quest helped a ton.
I'd point out that Quest is still doing that with one factory, and it will be till next year, but it's tracking to do If you double the CAD 15 million, it's CAD 30 million, which is double what we bought it off of. That may be a little aggressive simply because we had the factory running at almost absolute capacity in the first six months of the year. Hopefully, we'll be able to do the exact same thing in the second half, but even if it's slightly less than that, the organic growth in that is just spectacular. We're super excited about adding a 300,000 sq ft facility in Dallas next year.
That was very helpful. Thank you. I'll step back.
Thanks.
Your next question comes from Steve Hansen with Raymond James. Your line is open.
Morning, Steve.
Yeah. Hey, guys. Morning. Just a quick one on Quest, Mike. Can you just describe how the sales pipeline is evolving there as you continue to advance this new plant? I'm just trying to get a sense for how the book relates to the new capacity that you're building.
Yeah. We are booking stuff for the new factory, but on a very limited basis for the beginning part of next year. There's always challenges when you ramp up a new facility. As we book out later in 2019 and into 2020, we're taking orders for that factory. The order backlog continues to grow. Notwithstanding, we're using up CAD 25 million of it, roughly a quarter in new revenue. As we get moving into the new factory, it gets ramped up in the first half of next year, you will see the sales grow significantly in the back half as we start booking sales into that plant. We're very reticent to book it too quickly, Steve, simply because if we're late, we shut down a developer's project. We can't be late. For us, the relationship with the developers and the architects is paramount.
We're going to make sure that that factory is fully ready to go and we ease it into production because notwithstanding it's all the same technology we have in Toronto, you don't just turn a plant on and have it run. We have to get the bugs out first.
No, understood. That seems prudent. Just quickly, if I jump over to the Provincial side-
Yep
The Force Multiplier in particular. Ready for certification entry into service. That's great. Are you going to start to give us some sort of sense as to how the bookings for that platform is going to look as we think about our model a little bit? Just as a broader question, you described the King Air opportunity, I think, as well, and should we think about this being a growing portfolio over time?
I think there has to be a but to that. The short answer is yes, I think you should think of it as a growing portfolio over time, but we want to prove it out before we put the money out. All I can tell you is the demand for that aircraft is exceptional. We're not taking a hard date booking until we have full certification. The last parts of that, we could think could take a day, and they could take three weeks. When it's done later this month, we have a strong degree of interest both within North America and outside of North America. I think by the time we report Q3, we'll give you an idea of what actual flying we did this quarter and then an outlook into Q4 and ongoing of what it looks like.
We were ecstatic that we were able to jump up and look after a contract. It wasn't for the Canadian government, it was for another government. I can't disclose which one it was. They were looking for the Force Multiplier. We took one of our Canadian surveillance aircraft that had extra time and ran a multi-week mission for them and was a tremendous success. Where we build that portfolio over time, it's a growth engine for Provincial. Having said that, you'll see the results before you see any more investment.
Understood. Thanks. That's helpful.
Your next question comes from Cameron Doerksen with National Bank Financial. Your line is open.
Good morning, Cameron.
Yeah, thanks. Good morning. Just a couple of questions, I guess, on contracts as well. Thinking about this Manitoba Government Air Services opportunity, I am just wondering, anybody sort of size that? You mentioned that Perimeter is doing some of the existing work now that is shared with some other airlines. I guess, how big could it be if you were to win that business, and what would potentially be the impact if somebody else wins it and you sort of lose that portion that you currently have?
Cameron, I am going to be very careful on how I answer this, just because I do not want to put ourselves at a competitive disadvantage by giving other people numbers that are not readily available.
Yeah.
I think it is safe to say there are four other, there are three other main players in the medevac business in Manitoba. The majority, something like three-quarters of the work is already done by private people. If you said we were an average player, we are probably slightly better than that. We have got about 20% of this market. If you had it all, you would have four or five times as much. We do slightly in excess of CAD 10 million of medevac work in Manitoba now.
Okay. No, that is very helpful.
The interesting part about it is, like I say, there's a lot of competition, so we don't want to get ahead of ourselves, and the government has to realize significant savings, or I'm not sure they'll even award the RFP. It's going to depend on what the government thinks of all of our bids. What makes us excited about this is we're one of the few carriers in Canada that has experience in emergent cases. We've worked in Nunavut, where we've provided all the medevac services in various regions for over a quarter century, so we're used to dealing with the most extreme, most emergent, unstable patients, which is a skill set which is very limited in Canada and we think puts us in a great position to work with the province of Manitoba.
Having said that, we've got good competitors. It's going to be a competitive situation. We'll see if the government even awards the contract.
When do you expect a decision by the government?
I think that the schedule has it later, towards the end of this year, beginning of next year. It's a very complicated process. It wouldn't shock us if it got pushed out a little bit, but we're busy working away on our bid as we speak.
Okay. Just second question on the, I guess the Department of Fisheries and Oceans. I think there's some commentary in the MD&A here, I'm just wondering if you can comment on when the timing is for a decision there, and assuming that you were able to win that work again, does the size of it change at all, or is it basically the same as what you're doing now?
You're winning the contest for the most complicated question. The bid for the Maritime Work Canada will be awarded sometime, we think end of this year, beginning of next year. We have a contract through most of 2019. There will be two or three very good competitive bids on that. We've held it for a long time, so we're cautiously optimistic, but every time you bid, you're bidding there's going to be other people trying to do it. We think in all likelihood over time, the scope of work will increase. The RFP isn't as simple as an all in one, this is the way we do it. We've given the government options, and so we believe there's upside for growth in that over time. We'll have a better flavor for that probably early in the new year.
Okay. That's great. Maybe just last quick one, hopefully less complicated. Just on the latest medevac, I guess, win here. Nice to see that you've got all three of these in Nunavut. I guess the question is that an expansion at all of the business that you're doing there, or is it essentially just kind of a renewal at the same kind of rate?
The Kivalliq one is very similar. In Baffin, we added an extra base, and it grew the size of the contract. The Kivalliq one, it's basically the same contract with sort of inflation-adjusted pricing.
Got it. Okay. Perfect. That's all for me. Thanks very much.
Your next-
The guys have sort of kicked me a bit here. Why use 10? It may be a little closer to the mid-teens on our existing share of the market. It may be something more like CAD 15 million.
Your next question comes from Konark Gupta with Macquarie. Your line is open.
Thanks, good morning, everyone.
Morning, Konark.
Mike, on Quest, I just wanted to understand, what would be the factors that keep you from annualizing that EBITDA, the CAD 15 million we saw in the first six months? Any sense on the timing of doubling the annualized EBITDA with the new Texas facility? Would that be a 2019 thing, you think, or it could be a late 2019 thing?
I answer your second question first. It wouldn't be a 2019 thing because what we'll run through there in the first half of the year would be a fraction of its capacity. We have deliberately not booked it full because we want to make sure we get the bugs out and don't delay any of our customers. I think you're looking at kind of, we'll hit a run rate by the end of 2019 that you'll see in 2020. In terms of why we wouldn't extrapolate it's just because we ran the plant at 100% capacity. We didn't have any breaks between jobs. We were able to maximize what runs through there. When I say extrapolating it might be aggressive, I'm not suggesting there would be a material decline, but seven and a half per quarter with one facility is effectively our maximum capacity.
Depending on whether we're doing a U.S. job or a Canadian job, the margins are slightly different. The product mix could change quarter to quarter, depending on which building we're doing at a given time. All I'm saying is that it's not a slam dunk that because we did it for two quarters, we'll do it for two more quarters, but we're sold out for the foreseeable future, there's no reason to expect a material difference.
Okay, that's helpful. On Moncton, it's obviously embedded in Provincial. Any sense on what the contribution is looking like? What is your expectations right now, and what is the growth strategy there? Can you give us any sense on timing or magnitude there?
I'll give you qualitatively, yes. Quantitatively, we haven't released that, and I'm not sure I'm comfortable doing that. It was slightly ahead of our projections for the quarter when we gave you the historical rates. It's growing off of that. We would expect a more significant growth in 2019 based on the contracts we have in hand for international pilots. That's what drives its earnings right now. What we're trying to spend most of our time working on is bolting on to the core business our internal training so that we can help ourselves with the strategic part of the business. We're confident based on the contracts in hand, that we'll see good growth in that business in 2019.
I can provide a little additional color on that. The limitations for growth is certainly not demand, nor getting the airplanes needed to provide the training. It's really the pilots. Part of the strategy, which will take some time, is to grow our pilot training pool so that we have the instructors available to be able to grow up to the students that we can provide training to.
Okay, that's great, Carmele. Last thing on the capital priorities, Mike. You have this Quest now, Force Multiplier is almost done. Then obviously there's few other contracts you might be spending on. Where do you see the capital priorities after these investments?
I think for the balance of the year, you're going to see us finish the Quest plant. You're going to see us do a little bit of stuff for Keewatin. In the grand scheme of the magnitude, that's a much smaller number. If there's any opportunistic things in Regional One, I think those are all we really see in the current year. Things can always change, I think you're going to see modest investment. We're always looking for opportunities with Regional One or with some of these contracts. If we're successful, for example, on the maritime surveillance contract with Provincial next year, we will invest in that contract and build more infrastructure because the contract's bigger. For the balance of this year, I think you'll see continued modest spending on CapEx outside of the two projects we've told you about.
The M&A is not really in the near term thing you're looking at, is that still on?
We are looking at M&A. Thanks, Konark. I didn't answer that part of the question. Adam's very busy. We've got some unique stuff, some exciting stuff in our pipeline. With the number of deals we closed earlier this year, we're sort of at earlier stages. We're ramping back up. We used most of our horsepower for us to do the Quest deal last year, then the Flight College, then Wasaya. We burnt most of our horsepower closing those deals. Now we're ramping back in. We're sort of in the beginning to middle parts of those transactions. There could be stuff happen by the end of the year on the M&A front, but I wouldn't expect anything closing in the third quarter.
Okay. No, that's very helpful. Thank you.
Thank you.
Your next question comes from Chris Murray with AltaCorp Capital. Your line is open.
Thanks, guys.
Morning, Chris
folks.
Morning. Turning back to capital spending, maybe we can walk through this a little bit, because maybe I'm a little confused on Regional One. You think about the quarter, you acquire 28 smaller aircraft. I guess you sell them back out again. I'm thinking, call it CAD 4 million-CAD 5 million a copy maybe for those aircraft. Help walk us through how that business is changing and where exactly are you starting to source that kind of volume of aircraft at this point?
Okay, well, first of all, while I'm not going to give a precise number for the ERJ-145s, they're nowhere near that per copy. They're less than CAD 1 million an aircraft that we bought. Some of them had been parked for a while. We divided them up. Tammy gave the breakdown, I think it's 17 and 11. I think 17 of them are in inventory and 11 of them are in capital assets. We actually leased and then sold some of them in the quarter, so they were in and out of the capital asset number. The rest are in inventory. They will take a while to work through as we park them out and sell them off.
I think that I don't have that precise number in front of me, but I think we had about a CAD 4 million or CAD 5 million increase in our inventory at Regional One in the quarter, which was the net impact of those 17 aircraft.
Okay.
[Tammy has] showed me four or five. I just want to finish off your question, Chris, because I don't think I answered the other half of it. The business really hasn't changed at all. It's just the opportunities for fleets. This was a unique one where we had worked with some groups on ERJs and developed some comfort and then developed a plan to deal with that fleet. If you tried to buy one or two or four or five of those aircraft, you'd have paid a lot more than what we paid for them. Because we took the whole fleet off the hands of, I believe that was from an investment bank that didn't really know what to do with them. They'd been sitting for a while, we had a plan to turn some of them into flyers and some of them into parts.
There aren't many opportunities to buy 28 aircraft at once. That was a unique opportunity, we jumped on it. More typical is one or two aircraft at a time. Again, typically the older the aircraft, the more fleet opportunities there are. The CRJ200s, you're more likely to get five or six of those at a time than you would on, say, CRJ900s. We continue to be opportunistic. We basically maintained our maintenance reinvestment over the year, we haven't found enough to turn it into growth investment simply because not only are we depreciating the existing ones, we're selling some of them. Just to stay in the same place, we invest CAD millions of dollars each quarter.
Okay. Fair enough. I guess the ERJ170s you're bringing in, the two of those will just go to the lease pools. Is that fair to think?
Well, potentially, or we may remarket them. They're certainly not part-outs. Those are either lease aircraft or resale aircraft. They're not part-out aircraft. They're materially more expensive.
Yeah. No, fair enough. Just trying to wrap my head around back half capital spending. Fair to think, I'm even thinking into 2019, just the seasonal pattern, your maintenance CapEx should come down, I guess, Q3, Q4. Should we expect, again, front half loaded into 2019 for maintenance and repairs like you've done? Or is there something changing in your availability over Provincial to do your time and maintenance right now?
You're bang on in terms of the seasonality. In Q3 when we report, I'm going to give you a guidance for next year. Big picture, at this point, we don't expect any material increase in maintenance investment next year. We had a big year for engines this year, so potentially it could be a little less next year, but we're not in a position to give any sort of meaningful guidance on that yet. We'll do that at the end of the next quarter. In terms of the trend and the seasonality, you're bang on, Chris.
Okay, great. I guess one of the other contracts or other investments that we haven't talked about too much was with Wasaya. Can you maybe walk through the logic behind doing that? Was that just maybe to reduce some competition in that Northern Ontario region or anything you want to add, in terms of understanding what the opportunity is there?
Sure. It's slightly different than what we've done in the past because it's the first time we didn't take 100% of an acquisition. We took approximately half of the CAD 25 million was a recapitalization. I think it's fair to say that Wasaya had some financial difficulty. They needed to be recapitalized. We were competing with them in certain parts of the market. Other people were competing in other parts. One of the great strengths of that company is the support it has from its component First Nations. We made the decision that we're trying to expand into Northwestern Ontario. In those communities, it's hard to go in where they're competing with their own airline. For us, by partnering with them and helping that grow, it was win-win. It enhanced our relationship with the First Nations in Northwestern Ontario.
We helped them recapitalize to take advantage of growth opportunities. We're in the process of rationalizing service between the two carriers, both to reduce costs and to improve the schedule for the customer. It makes no sense for Perimeter Aviation and Wasaya to fly a flight right on top of each other, where we both fly out of the community at 9:00 A.M. side by side. We're better off to provide service at two different times of the day to improve it for the customer. We're working together on streamlining the cost by us providing services for them and vice versa. We've started to supply them with some parts and fuel in certain situations, and they actually have helped us back us up when we had some fire work in Manitoba where we didn't have enough capacity. They came in and helped us out.
You can see it in our Perimeter numbers. There's some growth because of the transaction there. In terms of Wasaya's numbers, it's not material at this point, but as we rationalize their business with them and help them return to growth, you'll see it in the future. Carmele is kind of the champion of this project. I'll maybe see if I've missed anything.
I think Mike covered the main parts. The only thing I'll add is the partnership that we formed also gave them access to our aviation experience and our buying power as a kind of aggregate group of airlines and the sharing of resources and best practices, et cetera. It's certainly a win-win transaction.
I guess my last question, this is about the Force Multiplier. Just thinking about this contract with the government, should you win it, would that require you to start building multiples? Would that contract actually essentially commit the Force Multiplier to that program and you're then left thinking about, do you build another one for other opportunities, or do you need additional aircraft just to support that opportunity as it stands?
It's hard to say specifically because there's more than one option for the government under the bid we put forward. It will require further investment in new aircraft. Some of this aircraft we use for the existing contract are smaller than what they want, and we may upgrade the technology, so there will be an investment. The existing Force Multiplier plane will not play a role in that contract other than maybe in ramp up, helping us get the capacity faster, depending on how much capacity the government chooses for us to have. This plane is more for short-term, unique opportunities around the world or to help out governments who are looking at making a purchase of a fleet and want to try this out first.
The way I would describe it, if you go to an auto dealer, they have a demonstrator you can drive. That's what this is, except we charge you for the demonstration.
Okay. Just wondering along these lines, is there anything you can leverage around your relationship with Airbus that they could maybe work into this space? Or are you fairly committed to wanting to stay on the Q300 platform?
That's a good question. Those are discussions we're having internally. We haven't reached any kind of conclusion. We're very busy with Airbus right now on fixed-wing STARS, and they're beginning to deliver those aircraft next year. We're working with them hand in glove. I think if we do the job that we've historically done, the opportunity to do more work with Airbus will be there following that. I think very much in the near term, that's where our focus on is standing up that program and doing what Airbus needs us to do and what the Government of Canada needs us to do.
All right. Fair enough. Thanks, folks.
Your next question comes from Nav Malik with Industrial Alliance. Your line is open.
Thank you. Good morning. Just actually want to ask on Regional One, the mix of business, it shifted a bit more to the parts service portion this time around. What would you expect going forward, that kind of ratio going forward? Or maybe let us know what was behind that and how you see that unfolding.
Well, there's two things. We mentioned on the call that we had some 900s that weren't fully utilized. That should improve, which would drive lease revenue over time. The other thing in lease revenue, and it's almost at the stage where I don't like the word lease. It's more like rental income or where we're using up green time on aircraft because we don't put out a plane for six years and then just take a lease payment and we're a bank. We're much more transactional than that in our lease portfolio. Sometimes the leases are returned planes at the end. They have lease return conditions where there could be an overhaul required by the lessee before they turn it back.
If we're going to part the aircraft out anyway, we may monetize what the cost of that overall would've been and taken in a payment. That makes the lease stuff a little bit bumpy, and that's really the main biggest driver between this year's lease payments and last year's, is we had lease returns last year on powered aircraft that we didn't have this year. I don't think that I could tell you that there's a new normal or that there even is a normal. You'll see oscillations between the two. One of the things I've always said about Regional One is don't worry so much about the revenue and don't worry so much with the breakdown.
It's the trend in EBITDA in aggregate that's relevant, because some quarters we sell more, and we may sell parts, or we may sell whole planes, or we may lease out aircraft. I think last year was a great year for lease returns, and that inflated that number a little bit compared to what we would have in this year or a typical year. I don't think there's a strategic difference in-
Okay
what the breakdown is.
The base parts sale was consistent quarter-over-quarter. Then we have the decline in lease revenue that we've discussed. Then the sale of aircraft and engines will always move around depending on what the opportunities are.
Okay. Okay, maybe just to, if I could clarify, I know you've already talked about the fuel issue and the cost. If I understand correctly or if I maybe just clarify, you're maintaining your guidance for the year despite increase in fuel. Does that mean you have that, I guess, margin pressure under control? I guess in future quarters. Like this quarter, you had maybe a couple of percentage point drop in your margins in the aerospace segment. Going forward, how would we expect to see that on a year-over-year basis, margin wise? Or, yeah.
I'm comfortable answering that as it relates to the fuel. There's product mix has a big impact on margins. If you have higher or lower, as an example, firefighting stuff in the summer, that's a very high margin business, that can skew percentages.
Lease rentals.
Lease, yeah. The lease versus sale stuff at Regional One. In terms of the fuel, the extra fuel costs that have been in the CAD 2 million-CAD 3 million range in the quarter that we didn't recover back.
Okay.
By Q3, we'll have the majority of that fixed. We'll still have some fuel drag, again, assuming fuel prices have plateaued. If they go up again, we're going to have to
Right
the same process, and we'll have a catch-up process. Conversely, if they decline a little bit, we'll do better than this. I would expect that by the time we get to Q4, we're very close to fully absorb the cost of the fuel prices. The impact we'll have on Q3 will be materially less than in Q2.
Okay. Then just moving to Quest, I know in the past you've quantified the backlog. I know it's strong, obviously, from your comments, but you didn't quantify it this time. Is there a reason, or would you quantify that or?
Yeah. We said after Q1 it was over CAD 300 million. It's over CAD 300 million, and it's continued to grow. I don't want to get into tracking an exact number in this every quarter.
Okay.
It has grown. It won't grow materially until we get the plant up and running because we're not going to promise production we don't have. Once we get the thing up and running, both the throughput will go through and the ability to take more orders in the end of 2019, 2020, 2021 period will come to fruition. The demand in that business shows no signs of abatement.
Yeah. Okay.
We are still turning down orders simply because we don't have the capacity to build them.
Okay. Then just lastly from me, on the Quest, the earn-out, is that payable in cash or in stock?
Cash.
Okay. Thanks very much.
Thank you.
Your next question comes from Tim James with TD Securities. Your line is open.
Morning, Tim.
Good morning. Thank you. My first question is on the Moncton Flight College and the opportunity there for that to relieve some of the pilot pressures throughout the organization. I'm just wondering if you could talk about the timeframe that you expect that to benefit. I know in the MD&A it indicates it will take a bit of time. Is this something by the time we get to the start of next year that that could be providing some relief and that pressure should be dissipated, or is this a multi-year process?
Well, it depends on whether we're talking about whether the pilots are in training or out of training, because even in the tensive situation, it's a year-long process. We will have more people in training by the end of this year. By the time they get out, it's the second half of next year anyway, and we'll ramp that growth over time. I think the bigger part of it, Tim, is not just training the pilots, but a whole program to retain them. We're going to bring people in and say, "Come to Moncton, get your training. We're going to guarantee you a job as a trainer when you come out of there.
You'll train other pilots for a period of time, then you'll move to one of our smaller airlines and then ultimately to one of our bigger airlines." We have unions, so we have to make sure everyone's on side with how we flow the people between the various companies and the complications of those things. That's the part that takes a little while. In terms of as simple as putting pilots in, that will happen this year. Carmele, again, she's the champion of this.
Yeah. Part of the other issue is not simply a shortage of pilots. It's actually a shortage of pilots that have sufficient hours/experience in order to move into the left, right seats of various aircraft. EIC- We have a destination that we can offer pilots to get them through smaller aircraft, become captains, move to larger aircraft. We're in the process of obviously ensuring that folks know that the other part of the strategy is taking pilots who have 250 hours and getting them sufficient or increased hours by putting them back in Moncton Flight College to become an instructor. That builds their hours. We can preserve their seniority back at our airlines. As they're building up hours, they're then able to immediately come in and slot into one of our aircraft, which is then fulfilling the need that we urgently have on an ongoing basis.
It's an overall strategy. It will take some time, but we're attacking it in a several-pronged basis.
Okay. That's helpful. My next question, maybe for Tammy, just regarding the disposition of assets in the quarter. I'm just wondering if you could provide some additional color on that. I think it was approximately CAD 24 million. Am I correct in assuming that was the sale of aircraft or engines from the leasing portfolio?
Yes. Capital asset disposals from the lease portfolio, is that what the question you're asking?
Yeah, No, it was approximately CAD 24 million there in the cash flow statement. I just want to make sure that I'm understanding it correctly.
Yep, that's correct. That's where it's coming from.
Yeah. When we talk, it's important, when we talk about that net CapEx number, so it's total purchases, less our divestitures, less our maintenance CapEx, what's left is growth. We said in there that Regional One was slightly negative growth CapEx in the quarter, and it was simply because the level of purchases was not high enough to cover both the maintenance CapEx and all the assets that we sold out of fixed assets. Which is a normal part of the business. We regularly buy and sell aircraft.
Okay. If my math is right, I can think about the gross growth CapEx, if you will, as I can deduct that from that kind of CAD 24 million in dispositions and the approximately CAD 8 million or CAD 9 million in maintenance CapEx. Is that right?
Well, yeah. If you take the dispositions, and I don't know that every one of those is in Regional One, I think the bulk of it certainly is. If you take that, you add our maintenance CapEx for Regional One, that will give you a gross number, and then you add or subtract the growth CapEx to that to get the total purchase. Because like I say, we're constantly buying and selling on a regular basis. The CapEx numbers we present to you in growth are a net number. They're positives less negatives.
Right. Okay.
Purchased less that.
I can't remember, could some of that disposition have been sold, maybe sold isn't the right I guess, transferred into inventory, or was all of that CAD 24 million effectively sold to an outside party?
Yeah, that is cash. That is to a third party.
We do sometimes transfer assets when a plane's at the end of its life. What you're talking about are the cash part of the business.
Yeah.
That amount is purely to outside as opposed to a transfer.
That's right.
Okay.
The transfers this quarter between capital assets and inventory were trivial.
Okay, that's perfect. Thank you very much.
Your next question comes from David Tyerman with Cormark Securities. Your line is open.
Morning, Dave.
Good morning. First question is just on the working cap. I was wondering if you could give us an idea of the outlook for the remainder of the year and into next year on that.
Yeah, that's a good question. Assuming there's no aircraft sales with terms like we did earlier this year, which is not the norm. It happens occasionally where we have someone has a letter of credit and has a reason they don't want to do it. We had a ramp up at Quest for two reasons. One was we used to do CAD 15 million a month, and now they're doing CAD 25 million a month. Just the sales growth there and at some of the other places affects our working capital. That's fully into the statements now, so you shouldn't see that. On top of that, Quest has a bunch of working capital tied up in prepaids. All the deposits we put on equipment for the new plant, we can't record those as a capital asset until they're delivered.
You'll see that reverse in Q3, or some of them will balance in Q4 as the equipment is delivered. Aggregate working capital in the balance of the year, there should not be any significant increase in the working capital requirement.
Okay. Helpful. Thank you. Then the second question, just kind of looking out to 2019 on EBITDA growth. I see a few growth drivers here, the CRJ-900 leases, the Force Multiplier, the Moncton Flight College. Are there other things besides that, and are these material, as in greater than 5% in total?
We haven't given any guidance, David, out into 2019 yet. The Moncton Flight College growth is expected to be significant. Bearing in mind that it started at eight.
Yeah.
If you doubled it would be 16. I'm not suggesting you double it, I was just trying to give.
Magnitude
order of magnitude of it. The Force Multiplier will be material when it's out. Again, you're talking about a CAD 40 million, CAD 50 million asset, and we regularly talk about the returns we want. You can work that out. There's the beginning of the fixed-wing STARS next year. We'll start to have some revenue in it in 2019, but more materially in 2020. Quest, you're going to see in the back half of the year, you're going to see the new plant kick in, which will also be material.
Would Quest be positive next year? You'll, I would imagine, have some startup costs first half.
I think you'll see more startup costs in Q4.
Yeah
than you'll see in Q1. I wouldn't expect to make any money in the first part of the year, but I'll expect to be positive on that plant before the end of the year for sure.
Okay. The 900 leases, are they material or?
It's not a huge number, but again, you're talking a couple million CAD here or there, it makes a difference.
Yeah.
The interesting thing with Regional One is we know what we think we're going to do each quarter, but how we get there changes every time. We think we're going to sell a big aircraft.
Sure.
We don't. We sell more parts or we lease something, or our lease revenue's down, we flip more planes. It's a very transactional business, which is why forecasting revenue, even internally for us, is hard.
Yeah.
EBITDA, we're pretty good at getting to where we think we're going to be.
Sure. When I add all those things up, I'm thinking the descriptions you just gave, it doesn't sound like any of them are really large numbers, meaning even over CAD 10 million individually. It sounds like it would all add up to not a big number. Am I off track there, or?
I think you may be a touch on the conservative side.
Okay.
Like I said, we haven't given guidance yet.
Yeah
I'm hesitant to give big numbers. Take the Quest plant as an example. Take whatever you think we're going to make out of the existing plant here and say we're going to make half of that next year in the other plant.
Okay
Whatever number you choose to put in there. Quest in and of itself could be double digits.
Okay
In terms of EBITDA.
That's a lot bigger.
If we don't invest anything, it's not going to grow by 25% a year with no investment.
Yeah. Sure.
We've got to do things. Our organic growth rates are still healthy.
Yeah. Okay, that's helpful. Just continuing on Regional One, can that grow? Oh, it can always grow, but you've made some pretty big fleet purchases in the last couple of years. You're parting out a lot of that stuff, or it's in lease fleets. I'm just wondering whether the part-out fleet and the lease fleet can grow much from here. Should we really be thinking of it as more of a static business, or it may be even declining at times as these bulges go through the python?
Well, certainly we don't view it as declining in any stretch. In any given aircraft type, there may be the opportunity, or there may not be the opportunity to grow in a given period. What we're excited about is our movement into the ERJ market, which gives us just that much more opportunity, that much more field to run in.
Yep.
We certainly don't expect the investment level that we had in 2016 and the first half of 2017 in that business. We still expect to invest in the business, and we still expect it to grow. Just not at those rates.
Right. Thinking that way, that is sort of the pig and the python because you did have a huge bulge there.
Yeah.
As that stuff is parted out, wouldn't that imply the business might shrink a little bit unless you can find that much business again?
You're really close, David, except the one piece you're missing in that assumption is that when we calculate our maintenance investment and our inventory, we're assuming we replace all that stuff. Growth CapEx, we don't get to growth CapEx till we've replaced all that stuff.
Yeah.
As those 900s get used up or the More likely, those are going to be around a while because they're newer aircraft.
Sure.
As the 200s get used up, we have to buy new 200s. I forget the number. We bought five or six of them already this quarter.
Yes.
Yeah, I saw that.
Yeah. It might even be more than that. There's a risk when you look at our financial statements, you see the net number, and there's this idea that we haven't bought anything, and so we're using stuff up. That's a net number. We're reinvesting constantly. We're taking that cost to sales money we got when we sold off and reinvesting it in buying new equipment.
Yep.
New to us. Used equipment.
Okay. I get the idea here. Just last quick question. The Canada Fisheries contract, you have that now. How big is that?
I don't know that we've ever.
No, we have not
published something that would give you a basic idea. I don't have it in front of me, David, to be honest, but I think it's between CAD 10 million and CAD 20 million in revenue.
Okay. That's helpful. It just gives me an idea roughly.
Yeah, it just gives you an order of scale.
Yeah.
I don't have an exact number in front of me.
Okay.
Plus, from a competitive point of view, I'm not sure I want to publish that.
Yeah, no, that's fine. The rough magnitude's very helpful. Okay, that's super. Thanks very much.
Your next question comes from Scott Fromson with CIBC. Your line is open
Hi, folks. Most of my questions have been answered. Just one thing on the Middle East. It's been in the news lately with respect to Canada. How does this affect your business prospects in the region, particular maintenance and surveillance? I'm thinking of the prospects for the Force Multiplier.
Canada's reputation always matters, so I don't want to say that it's not something at all. We don't deal directly with the Saudi government on anything, so there's no direct impact to us. Most of our work in the region is done through UAE, who's a very serious partner of Saudi. Our relationship, we're built in with long-term maintenance contracts, and we do stuff with them, and our relationship is great. We're always very sensitive to political stuff in the region. At this point, we don't see any impact on our business.
Thanks. That's helpful and good to hear.
Thank you.
Your next question comes from Raveel Afzaal with Canaccord. Your line is open.
Morning, Ravi.
Morning. First on dividends, it appears that you guys are approaching close to the lower end of your targeted payout ratio. Is there a possibility of further dividend increases, or how are you thinking about potential additional dividend increases going forward?
That's a good question, Ravi. Our view on dividends is twofold. We've invested a long time in that 5% CAGR we've had. We just increased our dividend. We want to make sure that we fully fund the next one before we make a change. We watch that regularly. I think you're going to see us, as we continue to grow our ability to pay the dividend, spend it two ways. Part of it on actually just permanently reducing our payout ratio, and part of it in increasing the dividend. We've increased our dividend already this year, so I wouldn't anticipate anything barring exceptional performance in the next quarter or two. We're always looking at it, and I think our track record speaks for itself in terms of our desire to share it with our shareholders.
I think over time, you're going to see us tightening up that payout ratio a little bit at a time.
Got it. Thank you. With respect to those CRJ 900s that are going back on, you mentioned that some are coming off leases in Q1 2019. When you are signing the contracts right now for the CRJ 900s, is it for all of these CRJ 900s, even the ones that are coming off lease in early 2019?
There is negotiations on the ones, about the ones coming off of lease, whether that be to extend the lease or a new lease. I'm talking about there's some now that were only under power by the hour leases, moving those to traditional straight monthly leases with reserves. Next year, it's a constant ongoing thing. The leases don't all line up at once, we're always renewing leases. My point when I talked about it was is that the demand for them has strengthened. We're getting close to, by the end of the year, we expect to have leases in place for all of them, and then we'll continue to work on the ones that come due next year.
Perfect. If possible, can you quantify what sort of an increase we have seen in the inventory over the last 12 months associated with Regional One, given the record performance that it continues to deliver?
I could tell you that in the last quarter, it was about a CAD 5 million increase. The net change in inventory over the last 4 quarters there, if I take Q3 and Q4 of last year and Q1 and 2 of this year, would've been something in the range of CAD 6 million or CAD 7 million.
Perfect. Yeah
exact number in front of me.
$17 million.
That's for US dollars for the last 12 months on a trailing 12 basis.
Sounds great. Thank you so much for taking.
It bounces around. The biggest impact on that is when we do bigger fleet transactions. I don't think we've ever bought 17 aircraft or 28 aircraft at the same time before, and 17 of them went into inventory, so it'll take us a bit to chew through that. I don't see a material change, like if we're looking at what is our, like we do with our growth CapEx, what is our inventory levels to maintain our free cash flow? They'll plateau. They'll go up CAD 3 million this quarter, down CAD 3 million the next quarter. When you're buying and selling, it's not like we're buying shoes, and we can just go to our manufacturer and pick them up. We have to be opportunistic in buying. When I say it stays flat, it bounces around, but there won't be a material trend absent an opportunity to grow.
It's really important, we haven't really talked about it a lot yet on this call, there was a real theory put out by some of the shorts that we couldn't maintain this EBITDA level without massive investment. The last 12 months have proved that that's essentially nonsense. Our EBITDA has stayed very close to where it was at record levels last year, our growth CapEx has actually been negative, if you include the inventory stuff, we're basically flat.
Exactly. Yep. Perfect. Sounds good. Thank you for taking my questions.
Thanks, Ravi.
Your next question comes from Mona Nazir with Laurentian Bank. Your line is open.
Hey, Mona.
Hi. Just looking at the year-to-date Quest EBITDA performance, it's in line with the annualized 2017 figures. I'm just wondering, is there anything that you've done that previously they've been unable to achieve? Was utilization really low when you purchased it? Did you change the sales process? Hence there was the impact on demand. Was there ever a time when the company was able to achieve a CAD 15 million kind of EBITDA run rate during a six-month period? Thank you.
They've never been remotely close to that. I would love to say it's because of our genius guidance. That would be a massive lie. The reason was quite simply is they were building the order book before we took over, we knew there was a ramp-up. That's why there was an earn-out. The ability to generate strong margins by having the plant run at absolute capacity has been better than we anticipated it would be. Because of our ability to invest in a new plant, they've had the confidence to take orders farther out and fill the order book tighter than they otherwise would have had they not built that. The drivers of the business that have led to this kind of performance are the order book, the strength of the company, and what they were doing before we bought it.
We've given them the financial stability to look out and plan to grow further. What we see here is work that was largely done before we bought it.
Thank you.
Your next question comes from Scott Thompson with CIBC. Your line is open.
Hi, Scott. Maybe this is a question for Tammy, just to get a better sense of the accounting. Just taking the 28 ERJ-145 aircraft purchase, can you run through how it works through the cash flow? Like what gets put into inventory and what gets put into capital assets? Just trying to get a sense of the cash flow accounting, please.
Okay. When we buy the aircraft, we make our best estimate of what we're ultimately going to do with each aircraft in the fleet, which does change. That's why we can have transfers between capital assets and inventory. Right now, we've got 17 of them that have gone into inventory, the purchase price associated with those 17 is going to our working capital line. The ones that are classified as capital assets are showing up as a cash flow from the purchase of capital assets down in the investing section.
Okay, thanks. That's very helpful. Thank you very much.
It's just standard accounting. There's nothing unusual about it.
Okay.
The only art form to it is when you buy 28, saying that we're going to sell or that we're going to part out 17 or 15 or 19. It depends on what the opportunities are. That's why you sometimes see some movement between the two. Absent that, it's pretty straightforward. We put the full value of whatever the planes we're parting out are into inventory, and the full value of the other ones goes into capital asset.
That makes sense. Must be tough to know when you take possession.
Yeah. Some it's easy, like if you buy a CRJ-900, we know that a CAD 10 million plane's not getting parted out in the short term. It's going to go into the lease pool, whereas you buy a CAD 700,000 plane, there's a lot of things that could happen. You could put CAD 1 million into it and lease it out. You could put CAD 1 million into it and sell it, or you could just part it out. That's where the art form of the business is.
I would assume also on a new platform, it takes a while to understand the dynamics of the market and what you can sell and what you can lease and what you can part out.
You're bang on, Scott. The secret sauce of Regional One is knowledge. Their ability to understand what the part-out value is and the demand and who needs engines and what can we do with these aircraft is what enables them to earn the margins that they earn. As we ramp into a new type, like the two 170s we bought, you have to get your feet wet slowly and build up that knowledge base. You're bang on.
That's it. Thank you.
Once again, if you would like to ask a question, press star, then the number one on your telephone keypad. Next question comes from Derek Spronck with RBC Capital Markets. Your line is open.
Thanks, guys. I know that a lot of questions have been asked. Just quickly, thinking of growth CapEx in the back half of the year, the two ERJ-170s, I would assume would be growth CapEx, and then the 11 CRJ-200s would be inventory?
No, I wouldn't make that assumption.
Yes.
Certainly the two 170s are fixed assets. understand.
They may not be growth
They may not be growth depending on what other sales we have. They may just replace other assets. When we talk about those, it's really always important to say that we sell aircraft every quarter. We buy aircraft every quarter. You got to get to the end and it's the net number that matters. Clearly the 170s are capital assets and the CRJs would be a combination depending on what we choose to do with them.
Okay. The plant for Quest, would that be recorded in the back half of this year or would it flow through into 2019?
I would think the vast majority of it will be in the back half of this year.
Just moving on to the Legacy Airlines. You fly into some remote locations where effectively, I would assume it's very little competition out there. Are there any regulatory caps in terms of what you can implement from a fare pricing perspective?
In terms of a regulatory thing, no. In some areas it's contracted, so we have a contract with the government of Nunavut for what tickets cost for their travel. That has a straight flow through mechanism. Whereas in places like Manitoba or Northwestern Ontario, those are typically what the market price is. Those would be what's reasonable and appropriate. Like I said, we take great pride in the fact that we move slowly, and we make sure we inform our customers what's going on. Bill Worley, the founder of Perimeter, for 50 years and was with us for 10 till he passed recently. When we took over the province and basically consolidated it into one, I suggested a price increase and Bill says, "No, I think we should do the opposite.
I think we should look at reducing fares." He says, "We want to make a little bit of money for a long time, not a lot of money all at once." I'm always a bit uncomfortable when I talk about our market position that enables us to pass fuel price increases along. We can do that, but it's important we're responsible. We're the sole source of people's travel in and out of a community, and we take that very seriously. When we pass fuel price increases on, we make sure it's reasonable, and sometimes it takes us a while, and that's that headwind we had in this quarter and maybe a little bit into Q3. Conversely, we get it back when the prices come down.
We've been servicing these communities for decades. We're long-term partners with our stakeholders, and we want to keep it that way, so we are very sensitive to this.
Makes sense. Just lastly, any update around the competitive environment in your Legacy Airlines business, just with some of the new incumbents, low-cost incumbents, and just wanted an update if you're seeing any changes in the competitive environment.
The only change in the competitive environment we have seen in the last quarter would be in northern Manitoba. A small airline from Alberta started flying with one King Air into one or two of our communities. The impact at this point has been negligible. We have great relations with the communities in that region, and we've had great support from them. Outside of that, there really hasn't been much change. North Star, which is the subsidiary of The North West Company, continues to grow its internal freight business, as we mentioned earlier, we had largely lost most of that business a year ago. We had continued to help them with a couple of markets. That's largely complete now. Like I say, that's not a material impact in any way, shape, or form on our business.
Okay, what's stopping other airlines, though, making a more aggressive move into some of your markets? Does it just not financially make sense for them and the infrastructure?
Most of the markets we're servicing don't support two airlines over any kind of period of time. When you've got six or eight or 10 people moving at a time, or even 20 people moving at a time, when you split that over two aircraft, there isn't enough. We've got all the infrastructure. We've got fuel farms in the north. If you want to fly to pick a community, Shamattawa, you have to take return fuel. We have fuel in the community, so we don't have to. We have separate terminals at the Winnipeg Airport, so you don't have to go through the international terminal. There are no other separate terminals. There's a whole bunch of infrastructure we've built to ensconce our position with those communities. It doesn't mean people don't come and try, like Northern Air has, it doesn't mean they won't continue to try.
In the long run, we've been there 50 years, and there's a reason. It's because we have the right planes and the right model. While we don't love new competition, we don't really worry that much about it.
Could the community, though, push back and say they want competition or another service provider?
We have community partnership agreements with most of them where they do precisely the opposite. They say they want to deal with us as their airline because we put money back into the community. We take our position very seriously. We do profit sharing with the communities. We give them discounted funeral and bereavement services. We do economic development. We're working with the Island Lake communities on helping them establish a local fishery. We're partners in the communities, Chris, we keep our prices as low as we possibly can. We listen to them on service issues, and we put back into the community. Could they ask for one? Sure. I think the track record's the best. Take a look at Perimeter for the last 10 years.
Okay. All right. That's great. We're having this Derek, Chris thing again, that's okay. Thanks for taking my questions, Mike.
Again.
I was going to
Once again, if you would like to ask a question, please press star, then 1 on your telephone keypad. We do not
You can ask any more questions. I promise to call them by the right name.
We do not have any questions at this time. I will turn the call over to the presenters.
Given that there's no further questions, I want to thank everyone for participating on today's call. I'd like to thank our stakeholders for their support over the last quarter, and I look forward to updating you on our progress in quarters in the future. Thanks for calling, and have a great day.
This concludes today's conference call. You may now disconnect.