Good morning, ladies and gentlemen. Welcome to the Exchange Income Corporation's conference call to discuss financial results for the three-month period and full year ended December 31, 2016. The corporation's results, including MD&A and financial statements, were issued on February 22 and are currently available via the company's website on SEDAR. Before turning the call 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 security laws. Forward-looking statements involve risks and uncertainties. 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 results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements, please consult the MD&A for this quarter. The risk factors section of the annual information form and Exchange's other filings with Canadian securities regulators, except as required by Canadian securities laws. Exchange does not undertake to update any forward-looking statements. Such statements speak only as of the date made. Listeners are reminded that today's call is being recorded and broadcast live via the internet for 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, our President, and Tamara Schock, our CFO, who will review our financial results in greater detail in a few moments. I've always been a believer in the saying that past performance is the best predictor of future success. While no one could have accurately predicted what we are about to achieve in 2016 at the start of the year, we felt confident that if we stayed true to our business strategy, we would be able to sustain the momentum of recent years and then some. We started 2016 on the heel of 2015's record results, with several transactions that further diversified our operations and another dividend increase, which at the time marked our 10th since becoming a public company in 2004. Our business model has driven our success since our IPO in 2004. 2016 was no different.
We stayed true to our strategy of discipline, diversification, and dividends, and delivered, quite frankly, the best year in our history. We ended the year with new record results, increased our dividend twice, completed two very strategic acquisitions, and were added to the S&P/TSX Composite Index. More specifically, revenue grew by 10% to CAD 891 million. EBITDA was up 19% to CAD 213 million. Net earnings climbed to CAD 61 million, or CAD 2.18 a share. Our payout ratio for the year was 61%, despite four dividend increases in the last two years. We grew our dividend twice by an aggregate of 9% for an annualized dividend of CAD 2.10 per share.
We achieved these milestones for one simple reason: We stayed true to our strategy, a strategy that is focused on making disciplined acquisitions, investing in our businesses, and becoming more diversified and maintaining a rock-solid balance sheet, which allows us to regularly grow our dividend to our shareholders on a sustainable basis. Our record financial results for the year were largely driven by the strong performance of our aerospace and aviation segment. Regional One, in particular, took advantage of approximately CAD 140 million of growth capital expenditures to grow its portfolio of aircraft and make them available for sale or lease around the world to customers. Regional One has developed a very strong reputation and expertise in the CRJ platform in particular, and recently entered into a strategic relationship with its manufacturer, Bombardier. In 2016, we committed to purchase 13 CRJ-900 aircraft.
We closed on eight of these in 2016, and the balance will be purchased in the first half of 2017. After aircraft sales, Regional One ended the year with 16 additional aircraft that it will monetize in the coming quarters and beyond, with an expected return on investment in excess of 15%, which is consistent with our track record. Regional One's success and expertise in its existing platforms were the factors in our decision to acquire Team JAS for CAD 10 million. Despite extremely liquid market conditions that have limited our ability to find companies that meet our purchase price criteria, particularly in the U.S., we were able to complete an acquisition that will add considerable strategic value to Regional One and allow it to lever its proven competitive advantages.
Team JAS is a parts and maintenance repair services company that has specialized in the Twin Otter platform for more than 30 years. The company is being integrated into the operations of Regional One. The result will be an expansion into a new aircraft type, building on Regional One's expertise with the CRJ, Dash 8, and ATR platforms. The diversity of our operations was in fact a key driver of our record results, given the opportunities and challenges that faced certain subsidiaries in 2016. Also within the aerospace and aviation segment, Provincial made strong contributions throughout 2016. In particular, it realized on the benefits from the five-year, CAD 150 million in-service support contract with a client in the Middle East, signed in November of 2015.
Late in 2016, Provincial was awarded part of the winning consortium bid along with Airbus, that was awarded the fixed-wing search and rescue contract in Canada's Far North. Provincial will provide in-service support for up to 20 years or more. This contract win is significant and speaks to Provincial's strong reputation with government agencies for its search and surveillance capabilities. I want to stress that while this contract will provide strong revenue and EBITDA contributions for an exceptionally long time, these contributions will likely be limited in the next couple of years until the first planes are delivered and put into service. Provincial's diversity of operations, like EIC's, was a key to its success. Increased revenue and EBITDA contributions from the aerospace contract and maritime surveillance activities were partially offset by unfavorable economic conditions in Newfoundland and Labrador.
Recent austerity measures implemented by the provincial government, coupled with depressed oil and gas prices and mining sectors, caused a drag on Provincial's airline and aviation service performance. It experienced lower revenue and EBITDA contributions from its scheduled flight and cargo services, as well as from its fixed-base operations. This was more than offset by strong aerospace performance. Our legacy airlines, in contrast, experienced strong profitability growth for much of the year. Their progress was largely due to previous investments we made to streamline our fleet, optimize our route schedules, and benefit from more coordinated procurement activities across the aviation entities. This progress was muted somewhat by wet weather this summer. These wet conditions resulted in considerably lower demand for fire suppression services provided by Custom Helicopters, and as a result, lower EBITDA for that subsidiary.
Inclement weather was more acute for Perimeter during the busy Christmas season, which resulted in flight delays and cancellations. These issues were compounded by equipment shortages and delays that led to the hiring of third-party charter aircraft to ensure our customers and their freight were looked after in the busy Christmas season. December is always a challenging month as volumes are very high northbound, but limited on southbound trips. This period has always had lower margins because of this unbalanced flow of traffic. Unlike more traditional southern carriers who are not obligated to add capacity when there's excess demand, our market position in the North is such that we need to make sure all people and all freight get to their destinations.
The combination of poor weather, which resulted in canceled flights, and the shortage of equipment on certain days, resulted in service delays, which were not in line with our track record nor our expectations. We made the decision to bring in equipment from as far away as Alberta and Newfoundland to meet our customers' requirements. Given the one-way nature of this seasonal demand, this reduced our EBITDA by approximately CAD 4 million in the fourth quarter from our expected level. With ongoing climate change, the challenging weather is becoming the norm and not the exception. As such, we will be adding capacity to enable us to meet these challenges in the future. The first of two Dash 8 aircraft has already been acquired early in the first quarter, and the second will be acquired later this year.
For our manufacturing segment, largely because of the continued softness in the oil and gas sector, our Alberta Operations in particular was adversely impacted by the ongoing slump in commodity prices. Unfavorable market conditions were exacerbated by the aftereffects of the wildfires that ravaged the Fort McMurray and surrounding areas in 2016. The fires caused considerable economic disruption and lowered demand for our customized steel tank and field services. Conditions for the manufacturing segment and our Alberta Operations and Stainless Fabrications in particular are starting to improve, however. In fact, recent sales backlog trends suggest the recovery is well underway. Being diversified allowed us to address these challenges directly and still generate record results. This has enabled us to increase our EPS, our earnings per share, by 34% to CAD 2.18, and to increase our free cash flow after maintenance capital expenditures to 8%, to CAD 3.25.
This operating performance enabled us to increase our dividend twice in 2016 by a combined 9% growth to CAD 2.10 per share on an annualized basis. The increase marked our fourth in the last 24 months and our 12th over 13 years. It has also resulted in a 25% increase in the dividend over this period. This pace puts us in a very exclusive group of yield investment plays and was a contributing factor in EIC surpassing the CAD 1 billion market cap during 2016. The decision to grow our dividend was based largely on our solid performance, especially when measured by our payout ratio of 61% for the year. Our confidence in being able to sustain recent momentum was another factor.
At 61%, our payout ratio for the year is particularly impressive given the number of dividend increases we have had in the past two years, and the fact that we have experienced a growth in the average number of shares by approximately 14%, largely because of the conversion of debentures into equity by investors and our equity raise late in 2015. Even with the impact of these developments, our payout ratio for 2016 was well below our historical range. In order to maintain the necessary liquidity to continue to execute on our business plan, we announced an equity issue in late 2016, which closed early in 2017. Demand for this offering was strong, and our I-bank partners fully exercised their over-allotment option. We subsequently increased the size of our credit facility by CAD 200 million to CAD 750 million.
While our aversion to leverage is unchanged, the growth in our EBITDA, combined with the equity proceeds, support this new larger facility. Between the increased debt and equity, we have increased our liquidity by approximately CAD 300 million, which will fuel our growth in 2017 and beyond. Clearly, we ended the year on a very solid footing, with a strong balance sheet and well-positioned to capitalize on new growth opportunities. I'll expand on our outlook in more detail in my closing remarks. Now I'd like to turn the call over to Tammy, who will review our financial results in greater detail. Tammy?
Thanks, Mike. Good morning, everyone. In the interest of time, I'm going to focus my remarks on our Q4 results, as Mike has already commented on our annual performance. Consolidated revenue for the fourth quarter was CAD 221.7 million, which is down 1% from Q4 last year. The decrease was due to a combination of factors, including adverse weather conditions impacting certain of our legacy airlines, Perimeter in particular, and continued soft market conditions for our manufacturing segment. These declines offset the revenue gains made by Regional One and Provincial Aerospace, as well as the accretive contributions that came from the acquisitions of CarteNav and Team JAS. On a segmented basis, the aerospace and aviation segment generated CAD 173.9 million in revenue, which is essentially flat from last year. The manufacturing segment had revenue of CAD 47.7 million, which is down about 5% from last year.
Consolidated EBITDA was CAD 51.3 million, which is up 11% from last year. This growth was driven largely by the aerospace and aviation segment, particularly by Regional One, which is realizing the benefits of investments made in aircraft, and in Provincial, which is benefiting from its 5-year agreement with a customer in the Middle East. EBITDA was negatively impacted by a couple of factors. As Mike mentioned, weather and equipment issues during the busy holiday period caused a drag on the performance of Perimeter. To ensure that our customers were served during this very important season, third-party chartered aircraft were hired to clear the backlog. This resulted in significantly higher operating expenses. The manufacturing segment in our Alberta Operations, in particular, was impacted by continued low commodity prices that resulted in soft product demand.
WesTower continues to effectively address the impact of soft market conditions as customers are continuing to delay their technology investment decisions. While the manufacturing segment experienced declines on a consolidated year-over-year basis, we are starting to see signs of recovery and a growing pipeline of product demand. EBITDA on a segmented basis, aerospace and aviation segment generated EBITDA of CAD 48.6 million, which is up 10%. Its EBITDA margins were 27.9%, up from 25.3% in the prior year. The manufacturing segment generated EBITDA of CAD 6.2 million, which is down from CAD 6.8 million in the prior year. Its EBITDA margins were 13%, which is slightly down from 13.4% in 2015. We reported net earnings for the quarter of CAD 13.8 million, or CAD 0.48 a share. That compares to net earnings of CAD 9.9 million or CAD 0.36 a share in the prior year.
The improvement was driven by factors already covered, including the strong performances by Regional One and Provincial. On an adjusted basis, net earnings were CAD 16.6 million, or CAD 0.58 per share for Q4 2016. That compares to CAD 12.6 million or CAD 0.46 per share for the comparative year. Adjusted net earnings exclude acquisition costs relating to the acquisitions of CarteNav and Team JAS, as well as the amortization of intangibles net of tax. Our other key financial metrics, free cash flow was CAD 40.8 million, up 13%. Free cash flow on a per-share basis was CAD 1.42, which is up from CAD 1.31 in 2015. Free cash flow, less maintenance capital expenditures, was CAD 22.8 million or CAD 0.80 a share. That compares to CAD 20.5 million or CAD 0.74 per share for 2015.
The increase in maintenance CapEx in the fourth quarter was primarily related to increased depreciation at Regional One. That is the result of the growth in their portfolio of leased assets. I should point out that our free cash flow totals exclude growth capital investments totaling CAD 44.8 million in Q4. Those were principally earmarked for the expansion of Regional One's portfolio of assets, particularly for the ongoing purchases of the CRJ900 aircraft. In Q4, Regional One acquired six operating aircraft and sold one, ending the quarter with a net addition of five. The balance of growth capital investments were related to the development of a capability demo aircraft for Provincial. Our payout ratio for the fourth quarter was 65%, which is essentially the same as Q4 last year.
Given that we increased our dividend distributions twice over the past year and grew the number of shares, our payout ratio performance in Q4 puts our strong results into perspective. Turning now to our balance sheet. We ended the year with a net cash position of CAD 26.5 million and net working capital of CAD 170.6 million, which results in a current ratio of 1.96:1. This compares to a net cash position of CAD 15.5 million in the prior year and net working capital of CAD 135.3 million, which was a current ratio of 1.74:1 at the end of 2015. The increase in working capital was primarily due to the sale of an aircraft just prior to year-end and the working capital positions acquired that came with the acquisitions of Team JAS and CarteNav. This concludes my review of the financial results. I'll turn the call back to Mike for some closing remarks.
Thanks, Tammy. Our outlook remains positive. We are particularly bullish about sustaining our track record of growth through 2017 and beyond. As I mentioned in my opening remarks, past performance is usually a good indicator of future success. Q4's momentum has carried over into 2017. The start of the year saw us complete a bought deal financing that generated gross proceeds of CAD 98 million. We also increased our debt facility to CAD 750 million, which combined with the equity proceeds, have increased our deployable capital by a further CAD 300 million. While the acquisition opportunities may be limited due to a current environment of higher than traditional valuation multiples, particularly in the U.S., we remain very committed to growing via acquisition. Our last three acquisitions, namely Ben Machine, CarteNav, and Team JAS, should reflect this commitment.
Even though the transactions were relatively small in size, representing a combined total value of approximately CAD 70 million. Our goal is not to make big deals for the sake of making deals. We are not prepared to buy at any price. Being disciplined has led to our success. We're not prepared to change what has worked for us in the past 12 years. In fact, we are very willing to keep our powder dry until the right opportunity becomes available, one that is consistent with the criteria we have traditionally used in the past. Given the strong rate of return on invested capital that we've experienced to date, we will continue to provide growth capital for our subsidiaries, particularly at Regional One and Provincial. Historically, our return on invested capital has been in excess of 15% on an unlevered pre-tax basis after maintenance reinvestment.
We expect this trend to continue with our latest investments. We expect to generate sustained cash flow gains, particularly with recurring revenue opportunities through aircraft leases. Regional One's strong prospects were also behind our decision to expand our leasing business in Ireland, which is home to most of the world's leading aircraft leasing companies. This will give us access to large pools of industry experts, lower tax rates, and perhaps most importantly, opportunities to participate in accretive transactions. Closer to home, we are recovering from some of the challenges that Perimeter faced in December. We are moving ahead with our expansion of passenger services into Northwestern Ontario, which should result in material growth opportunities. I should remind everyone, however, that the performance of the Legacy airlines in Q1 will be impacted by winter roads that typically lessen demand for cargo transportation services. This is a normal seasonal variation.
Maintenance capital investments in general and aircraft overhauls in particular are not consistent from period to period. We have attempted through the increased use of our internal overhaul capability at Provincial to complete as much of this work as possible in the first half of the year, which has lower demand. As such, we expect maintenance capital expenditures to be higher than normal in the first few months of 2017 before returning to normal levels. The anticipated growth that we expect from the combined aerospace and aviation segment, together with the recovery that is underway at our manufacturing businesses, will drive increased profitability in 2017. We expect a gradual and consistent improvement in our operations driven by the improvement in oil prices. The order book at Stainless Fabrication has strengthened significantly and will fuel improved results in 2017. Over the longer term, we're very bullish about our prospects.
Provincial's five-year in-service contract in the Middle East and its up to 20-year in-service contract for Canada's Far North will produce strong contributions for a very long time. In the interim, we remain focused on extending our track record of providing our shareholders with dependable and growing income streams through the steady, disciplined execution of our strategy and a rock-solid balance sheet. Thank you very much for listening, and we would now like to open the call to questions. Operator?
At this time, I would like to remind everyone that in order to ask a question, please press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from Derek Spronck with RBC. Your line is now open.
Okay. Thank you for taking my questions. Just on Perimeter and the cost and having to put on a couple of Dash 8s there to support that business, could you have taken aircraft from Regional One and utilized that for Perimeter, or were there no aircraft suitable for that at the time?
That's a good question, Derek. The answer is yes, there were, and yes, we did. The challenge we faced at Perimeter was really a perfect storm of things that went on at the same time. The fall was very late and as a result, most of the places we're flying into are on islands or very close to water, and fog is the single biggest cause of delays at this time of year. We had a significant backlog before the weather turned very cold, which created certain equipment issues. The combination of those things, combined with the fact that it was our very heavy December season with heavy traffic going north, resulted in us just not having sufficient aircraft to catch up. We brought in aircraft from Provincial, we brought in extra aircraft from Calm, but that simply wasn't enough.
We rented aircraft with crews from third parties in addition to Provincial and Calm. I think the key thing to understand there and what we're going to do about it was historically, the falls were a little more predictable and freeze up sooner and not as close to the busy winter season. The issue we have, quite frankly, is when we get delayed at this time of year, we don't have an option of not selling more tickets or not delivering more freight. We are the sole provider into some of these communities, and that means it's our responsibility to make sure everything gets there.
To make sure we can do that, and quite frankly, to take advantage of other opportunities at other times during the year, we're going to bump up the size of our Dash 8 fleet, which will give us flexibility and it will provide backup for other airlines during their busier seasons. It was really just a perfect storm in December, we're going to prevent that by adding some extra capacity to our fleet.
What was the issue with the aircraft, Mike? I don't know if you touched on that or not.
Well, again, every year when you go through freeze up, the planes sit outside. When things freeze hard for the first time, there's water vapor that's in various parts of the plane and results in all kinds of small snags that you have to fix in the aircraft before you take off. The weather changeover was very extreme this year, from warm and wet to extremely cold, which exacerbated that problem. In addition to that, as part of our Transport Canada audit, we made a decision to run all of our aircraft through an additional inspection. We thought we had time to do it during the downtime of this fog, and it took us longer than we thought it would to do the additional inspection. In hindsight, we should have staged that over a longer period of time.
We made a difficult situation with weather worse by a decision to accelerate an inspection, which we should have done over a longer period.
Okay, I see. With the Dash 8, you have a little bit more capacity, a little bit more flexibility now as well to take advantage of some additional opportunities. By and large would you say that issue is largely behind you outside of switching over to these two new Dash 8s over the-
Yeah, once those two are both in service, that will be the case. We've acquired one. We're working on acquiring the second one. It takes a little bit to get them into service. But like I said, it's hard to use these words, but it was almost kind of a little bit of bad luck in Q4 how many things happened at the same time. We simply said, "You know what? We're going to eliminate the potential for that happening in the future by adding more capacity." We've grown and increased the margins dramatically in the legacy airlines. By adding this extra equipment, that will give us room to continue to do that as we move into Northwestern Ontario.
We will now move on to the next question. Trevor Johnson, the line is now open, National Bank.
Hey, morning, folks. How you doing?
Good. Good morning, Trevor.
Hey. I'm just curious about how you guys view the Regional One productive capacity. Obviously, you're jamming a lot through the system there in terms of throughput. Can you just talk about the staffing levels there and maybe just in terms of how you view that business on a go-forward basis, just given the amount of volume you're looking to put through it?
Yeah. We continue to grow it. That's part of the reason we've opened the Ireland operation, Trevor, is that as we grow the lease portfolio. People tend to think of Regional One as a North American company. While our head office has been in Miami, we have sales representatives around the world putting those planes out together with the people that are purchasing them. By setting up our shop in Ireland, we have access to tremendous industry expertise, particularly as we look to, in the future, over time, grow the number of platforms that we have exposure to. We clearly need to continue to add people as we grow, but we aren't limited at this point in any way by our personnel capabilities.
Trevor, we have, over the years of growth, certainly added capacity both in Miami, Canada, and in fact around the world to assist and support the growth.
Perfect. Mike, you mentioned about.
Just to point out here that we, just as it relates to Regional One, something maybe we should've mentioned in the speech. Part of the slight decline in sales we had year-over-year was just simply an anomaly that we sold 2 big, expensive aircraft in Q4 of last year, and we only sold one this year. We have more out on lease. You see that the lease revenue drives EBITDA, we continue to be more profitable, but revenue declined slightly because we liquidated one less aircraft.
Yeah. We have, as a result, had fewer parts to sell, because we're keeping the aircraft obviously flying and on lease, driving that EBITDA.
Got you. Okay. No, that's helpful. Thank you. You mentioned the relationship with First Nations and in a lot of these communities where you had some of the challenges with weather and some equipment in Q4. Just curious, if that relationship, I'm guessing it's still obviously relatively tight, and how has their response been to maybe some of the challenges that you had throughout the quarter and on a go-forward basis?
Our relationship is still good with our First Nations customers. They held our feet to the fire when we were slow and quite frankly, I don't think we met our own expectations at certain points in the year. Part of it was because of the weather, part of it was because of the number of planes we had available, and part of it because it was our inspection capabilities. In December, the First Nations leaders were on us, and justifiably so. We solved the problems. Everything got to where it had to be by Christmas, and my Perimeter team continues to work with our customers there. We had an airline from Northwestern Ontario, at that time, say they were going to come to Manitoba. That hasn't happened. It may well happen. I raise it simply because I'm not particularly concerned.
That's happened in the past, it'll happen in the future, and we're moving into their territory. We have the right business model, and we have the right people to execute it. We just needed a couple more airplanes, which we have now or will have very shortly.
Got you. Great. Last one from me is just looking at the probably most constructive commentary. I realize it's cautiously optimistic on the manufacturing side of the portfolio. Given that you've got a lot of assets and close to the ground there, curious if there's any opportunities for some tuck-in M&A on the manufacturing side. I know we saw Ben Machine, which is more complementary on the aviation side. Is there any kind of pure play manufacturing that you can maybe scoop up on the cheap, just given what's happened in the patch or any of your other markets for that matter?
We're looking particularly on the stainless side of the business. We hope to find something to be able to increase capacity. It's strange, we've talked about how slow things are there. Our order book in that business in particular has reached the stage where we're talking about how do we add capacity on an efficient basis. The only part where I would kind of disagree, Trevor, is there's not much on the cheap anywhere in the U.S.
Yeah.
We might be able to find some stuff at an acceptable price. In Canada, there may be a bargain here or there. In the U.S., our experience right now is that everything is full value. We continue to look because that business has been great to us. Even in its slowest times, like a year ago, it's generated exceptional returns. We are going to grow it one way or another, and whether that means we buy capacity or build capacity, time will tell.
Your next question comes from Kevin Chiang with CIBC. Your line is now open.
Hey. It's been a very busy 2016 for you and the team there, so I'm sure you're glad you've gone through that.
Good morning.
Good morning. I had a quick question on the aerospace. I think you touched on it a little bit here. When I looked at the margin profile for the quarter, up by almost 28%, it looks like it's the best Q4 you've put up. I know you walked through some of the puts and takes there. If I had to back out Perimeter and some of the challenges there, I'm just wondering, are we at a new run rate for Q4 profitability in aviation? If are you thinking of long-term seasonality, how that impacts your full run rate annual profitability of this division?
Yeah. Perimeter truly was an anomaly. The results we had there are nothing like what we've had any time in the last five years in that business. It'll take us into the beginning of this quarter to get rid of the extra capacity we rented. If you normalize for that, I think what you see is a normal Q4 with the balance of the companies. There's been a material improvement in Calm Air's performance, and that's as a result of the big investment we made there over the last couple of years in aircraft and then buying out our competitor in the far north, and then rationalizing the operation that enabled us to actually increase service to our customers and increase margins at the same time. I think you're looking at a new normal there.
The only asterisk I'd put beside it, Kevin, is just when we sell aircraft. They're big number sales, and we make good money on it, but in terms of percentages, it can move it up or down. Like a year ago, we sold two CRJ700s. This quarter year, we sold one. That can make a difference of between CAD 5 million and CAD 10 million a plane.
When you look at that can move our margin by a couple points here or there. I think the key thing is to focus on the trend within the segments in terms of EBITDA, because that's remarkably consistent. Whether we get it through leasing or flipping a plane or selling parts, that can change quarter-to-quarter, but the bottom line should be pretty reliable.
Right.
I would just add that in the absence of volatility caused by whole aircraft sales, as that lease portfolio grows in Regional One, you'll see upward push on margins because the margins associated with that revenue are higher.
Yeah. It seems like there's been a step up here in the profitability of this segment. Maybe my second question and more of a just clarification point. You talked about, I guess the Transport Canada audit, and maybe that was ill-timed. Just confirming that's been completed, if there's any additional monitoring from them or are you basically done with whatever review Transport Canada was doing?
Kevin, I would love to be finished with Transport Canada. I'm being facetious. Transport Canada's an ongoing thing with all airlines all the time.
Right. Okay.
That audit is complete. We continue to work on the improvements that are always suggested. I think we had, in the last year, four Transport Canada audits.
Okay.
You see them in most airlines most years. They're not there every year on a full audit basis. I hesitate to use words like over or whatever because we're in constant discussion with them. That audit is over.
That audit's over. Okay. That's great. Maybe my third question here. When you look at the investments you're making in Regional One, there's a lag between when you put money to work to when you start seeing that cash coming in the door from a ROI, return on invested capital perspective or return on equity perspective. How should I think about that lag, and has that changed? Investments you made in 2015, are they showing up in 2016 right away? Stuff you're making in 2016, are they showing up in 2017? Or has that lag changed here given the portfolio you have? Really the reason why I ask is, I think if you look back over the past 10 years, your dividend growth has matched your EBITDA growth pretty closely here, at least from a 10-year CAGR perspective.
I'm just wondering if that trend should hold, if that lag has changed recently given the portfolio you have has changed.
That's a really good question. The lag with the aircraft depends on which ones we buy. Generally speaking, we said six months is a pretty good rule of thumb for when, I still think that's accurate. The last deal we announced when we announced the special arrangement with Bombardier, that was an eight-plane deal, which I think three we closed on last year. I think we've closed on one or two already this year. Some of those are earmarked for places where we're in final negotiations. Others, we're still working on where they're going to go. We always have an idea when we buy the plane, but we generally don't always have a lease set up. As we put those into service throughout this year, I think that six-month lag is a pretty good rule of thumb.
Sometimes we can do a little better, but it depends on the aircraft, and it depends on just what's going on exactly at that time.
Your next question comes from Ravi Alsal with Canaccord Genuity. Your line is now open.
Morning, Ravi.
Thank you.
Good morning. Thank you for hosting the call. You mentioned personnel is not a risk for Regional One, and I'm wondering, is availability of regional aircraft a constraint for this business? If you can just speak to the market opportunity available to you, what your current penetration is, anything to that effect? I just want to see how big this business can eventually get to.
Well, I don't have the numbers at hand, but I can certainly get them for you in terms of the size of the various number of planes in service of those various markets. We have room to grow in all of them. One of the things we learned a couple of years ago with our WesTower U.S. experience is we're not going to put too much capital into any one thing or any one market. The beauty of the CRJ market is we're leased to airlines around the world with no real customer concentration. Having said that, we're going to limit how much we put into any given platform type. At this point, we really aren't at any of the limits. What happens with these aircraft, Ravi, is when they go from tier 1 to tier 2, that's what starts the opportunity for Regional One.
It's the arbitrage availabilities with what you do with these aircraft. You see that we've been in the 200s for quite a long time, and those tend to be shorter-term transactions if we lease them or buy them or resell them or part them out. They go more quickly. The 700s are in sort of mid-phase. There's a lot of those still under lease. Our 900s we're just moving into, and you can see that because the price of them is much higher, and we tend to lease them for slightly longer periods. It's really an ongoing turnover of which platforms we're in. Three or four years from now, the 900s will be starting to be parted out, and we'll be buying the next generation.
Plus, we also look at other platforms, such as the ERJs, for not just focused on any one particular manufacturer. We like to diversify.
Great, thank you very much for this. I'm not sure how much details you can get into, but can you speak a little bit about potential surveillance contracts for Provincial? I'm just trying to see, maybe you're in discussions with five, six other companies on this front. Any color on potential contract wins for this business for 2017, 2018?
It's going to be very general, Ravi. There's opportunities in different parts of the world for different kinds of surveillance. Quite frankly, that's the reason for the spec plane we're building. Quite often, there's opportunities, things that come up very quickly, like as an example, the Ebola crisis of a couple of years ago, where people had surveillance aircraft that had been very busy preventing illegal immigration. We want to have that plane available for short-term opportunities, but more importantly, to show people what we can do. Quite frankly, it's an exciting opportunity. Our suppliers have partnered with us, the people who provide various parts of the equipment, they want to show off their capabilities as well. We're excited about that plane, and that should be ready towards the end of this year. It's in the shop now, we're busy installing parts to it.
I really can't give you any great clarity on what contracts where, largely because they're not public discussions. The one thing about that business is, typically the lead times are quite long and negotiations are ongoing. When we have something we can tell you, we will.
Perfect. Thank you very much. That's all for me, congratulations on the 2016.
Thanks, Ravi.
Your next question comes from Chris Murray with AltaCorp Capital. Your line is now open.
Thanks. Good morning, folks. Mike, just turning back to the leasing business. You've talked about, it seems like a fairly substantial opportunity. I guess a couple of parts to this. First, can you give us a little more detail about what the agreement with Bombardier does for you other than just the first 13 aircraft? Second, can we talk a little bit about the absolute magnitude you've actually let this thing get to? It sounds like it's got a pretty decent return profile. To your point about WesTower Communications, does this actually become almost a business unto itself, like an entire division unto itself?
I'll start with the deal with Bombardier. Essentially, it's well known that Bombardier has a significant buyback guarantee program when they put planes out that they provide to lenders, so the lenders know residual values a number of years out. In the next few years, Bombardier has CAD billions worth of commitments on that. As a result of the last transaction we did, we struck an arrangement where we will have the opportunity to look at all those transactions with Bombardier, in a way sort of like a last right of refusal, but not quite that simple. It gives us access to a myriad of transactions to see what we want to participate in. There's lots of people who buy the used aircraft, whether for use for themselves or for parting them out. There's the odd group that will buy them as financial plays for leases.
There's not many players like us with our financial depth who can participate to the level we can, so we view Bombardier as a key partner on that. In terms of the size of this, could it become a segment to itself? That's not impossible. At some point, it could grow to the stage where we report it that way. In terms of the absolute size, I don't know that we have a specific number. Regional One in its aggregate today is still about 25% of our overall business, maybe slightly more than that. The leasing business is a part of that, and other businesses continue to grow. I don't see concentration as a risk in the near term in the next 12 or 24 months. Quite frankly, as we add other aircraft type, that's just another form of diversification.
The big difference between this and WesTower Communications was WesTower Communications was one company supplying one company. AT&T got to the point where they were almost 50% of our sales. I'm not sure who our biggest customer is at Regional One, but they might have five or six planes. They're not going to have any kind of concentration that's similar. We will limit what we do, but we're nowhere near that limit yet.
Okay. Thinking about just, it's kind of funny, but the leasing business, it's a bit of a different capital structure when run. Do you start thinking about leveraging your returns? I mean, you've talked about a 15% after maintenance cap on leverage return, but can you actually put leverage injected against either the aircraft or some sort of SPE in order to actually increase your return on equity on the leasing portfolio?
Can we? Absolutely, we could. It's not something we're prepared to do at this point in time, nor are we really considering. It's a different business model. The key thing when you look at most of our leases, they're short to medium term. We're never going to be a financial lease player where it's a capital game where we borrow at X, and we effectively lend it out at X plus something. We're in the business because of the arbitrage and our ability to park it out and create returns because of that. Long-term financial leasing is a different business than what we're in. We're in the business of maximizing the value of used aircraft that we have a high degree of knowledge of.
Unequivocally, if you were to roll out our lease portfolio and just put it in a separate entity, could it take more than the two times leverage we carry on our balance sheet? Unequivocally. That would change our risk profile and that would change what happens if there's a downturn or a problem. The bottom line is, our first goal is make sure our dividend is stable, and leverage is the enemy of dividend.
Okay, great. Thanks, folks.
Your next call comes from Mona Nazir with Laurentian. Please go ahead.
Morning, Mona.
Good morning, and thank you for taking my questions. Firstly, the CAD 4 million EBITDA quantification of weather and aircraft equipment issues was helpful. I am just wondering, if margins are in and around the 20% range, would that revenue impact be about CAD 20 million in the quarter, or is it hard to say because you did store some third party aircraft?
Yeah, the revenue aircraft difference is de minimis. You have to understand, Mona, that for us, because of who we are serving, we do not have an option of not taking. We cannot say we are not shipping your Christmas presents or we are not taking you to your doctor's appointment. More importantly, not taking you home from your doctor's appointment. So when we have these problems, while there is some revenue leakage, it is really not the issue. The real problem is the cost of delivering the service. So that CAD 4 million predominantly is extra cost. It is not really revenue.
Yeah. Secondly, on the federal government's fixed wing contract, you did say that you do not expect a significant contribution up front, just given the type of work which you will be doing, which is more maintenance. Once the contract gets going in a few years, I am just wondering what kind of contribution can we maybe expect? I do understand that that will trend up with time. Just the second part of that, you also signed a JV with Airbus. Could that fuel additional revenue, and could you speak about that partnership a little bit?
Sure. We are excited. In the last three or four months, we have cut deals with Airbus and with Bombardier, two of the biggest players in the business. We absolutely want to work with Airbus on projects like this in other parts of the world. The aircraft that we are using for Northern Search and Rescue is well used in other parts of the world, and we would like to examine other opportunities with them. Yes, we are cautiously optimistic. How fast that happens, hard for me to answer. In terms of what the financial contribution once we get up and running, it is a secret. I am being facetious. We are still in discussions of exactly what we are going to do, and I think, give me a quarter or two and we will try and give a little clarity to that.
I'm just not in a position yet with our discussions with both Airbus and the government exactly how to estimate that for the marketplace. We will come to the market with clarity when we're in a position to do it.
Okay. Just lastly from me before I step back in queue, you've made a number of acquisitions, PAL, Ben Machine, Team JAS, CarteNav. We don't really touch on it a lot because Regional One takes up a lot of the space and a lot of the growth, the integration has seemed pretty seamless. I'm just wondering, looking where you're sitting now, is that true, and how has the integration been going? Can you quantify what the contribution of Team JAS and CarteNav has been this quarter or even since you acquired them?
I'm not really prepared to give a precise number. I will tell you that the returns have been at or above what we expected, we've been very clear on what our thresholds are in the marketplace. In terms of the integration, I think it's like the duck analogy in my CEO's message. Above the water, everything looks calm. Underneath the water, there's a whole bunch of stuff going on. Generally speaking, things have been good. Each of those businesses came with strong standalone management teams. One of the advantages of our integration is we're not reinventing the wheel. We're trying to get benefits and synergies by putting them together. Because of the strong management teams in place in each of those places, EIC doesn't have to do a lot to continue on with what those businesses do.
The next question comes from Konark Gupta with Macquarie. Your line is now open.
Thanks. Good morning, everyone. Mike Pyle, congrats for continued strong results here. A few questions here, Mike Pyle. First is on growth CapEx. It remained relatively high in the fourth quarter, which I'm guessing is mostly related to Regional One. You have five more CRJ900s coming this year, and I know things can change any time. At this time, do you expect the growth CapEx to sort of normalize to about CAD 50 million-CAD 60 million this year? Would that be mostly for Regional One, Provincial and Perimeter?
Good question. The growth CapEx in the legacies will be modest. We're going to buy a couple aircraft, but you're talking about something in the range of CAD 10 million. We continue to expand in Northwestern Ontario, maybe it's a little bit more than that, but it's not a huge number. We've already committed to five CRJ900s, which will eat up a big chunk of the CAD 50 million number you threw out. I would anticipate it being higher than the CAD 50 million you're speaking of. I don't anticipate it being as high as an annualized Q4, though. Tamara, how many did we close on in Q4 of those CRJs? In Q4, we closed on three of the 900s and then some additional ones. That's a big quarter for us. Yeah. I would expect it to be higher than the CAD 50 or CAD 60.
How much higher depends on how many great deals Hank Gibson and his team can uncover. We're only going to buy them when we think we can get the returns we want. Quite frankly, our job is to have the liquidity to jump on those opportunities when we've had them, and that's what's enabled us, in all honesty. We've grown that business almost four times in three years.
Okay, that.
It's more than three times as large as we had it when we bought it. I would anticipate continued capital going into that.
Okay, that leads me to my second question, Mike, on the leverage ratio. If I calculate correctly, it looks like your leverage ratio, net debt to EBITDA, is about two and a half times after the equity financing, and that seems to be a low point in many years. Are you comfortable with that scale right now? Do you mind if it goes to, let's say, three times as you execute on more growth opportunities?
What I would say is that we kind of break that leverage in two pieces. The convertible piece, we're comfortable with about, in round numbers, one turn of EBITDA in convertibles. Those tend to cycle because I think we're on Series N of convertibles. I think we are now. Yeah, we do. We're almost through the alphabet. As those mature, turn into equity, we tend to replace them to keep the absolute level reasonably constant. Then on our secured debt, our covenant with our bank is three times debt to EBITDA. We're comfortable around two, and we've been operating lately in the one and a half to two times range. If you take, we're comfortable at two, and yet the way you're calculating it, you're including our Converts.
That would take it, we're comfortable around three, we're typically going to operate below that unless something we've made a significant investment. We aren't the highest payers for a lot of the things we do, we need to make it easy for people to sell to us, and part of that is liquidity and the ability to close and have the cash available. That's why we've raised almost CAD 300 million in the last six weeks, simply to make sure we have the ability to move quickly when we want to.
Last one for me, Mike. Looks like the fuel cost headwind will be strongest in the first quarter at Legacy Airlines, then it'll hopefully taper down from here. Can you please elaborate on the three items you mentioned in the MD&A, the operational improvements, price increases, and automatic fuel price adjustments, in terms of when do they start offsetting the fuel headwind?
If we work backwards on that, it depends on the contract. Some of them work prospectively, where next quarter is based on this quarter's fuel prices. Some of them have hurdles that you have to cross a certain increase in fuel before you adjust, or a certain decrease in fuel before you adjust. In general, the part of the business that's tied to that moves pretty quickly with fuel. We may have 30 or 45-day lags, but they're not big ones, one way or the other. In terms of price increases, we have the ability to move prices when we need them. We have a significant market share and price increases tend to stick. We're also very cognizant of the fact that we're dealing with First Nations communities, and we're going to make sure that we've absorbed what we can absorb.
We reduced prices when the fuel prices fell, and so we're in a position to increase them when we need to. At this stage, they haven't increased to a level where we feel the need to do that. Other efficiencies will absorb those challenges.
Your next question comes from Tim.
Go ahead.
Your next question comes from Tim James with TD Securities. Your line is now open.
Morning, Tim.
Thank you. Good morning. Just want to look at the long-term kind of thinking as far as the dividend goes. I think your payout ratio you said on free cash flow was about 61% for 2016. Should we take kind of our own views of the free cash flow, of our free cash flow forecast and think about a 60% payout ratio as a good way to kind of forecast the dividend over the longer term?
We don't have a precise number, Tim, like 60, that I can say that's exactly the right number, but that's the right range. We've always said we're comfortable in the 60%-70% range, and we'll phase increases. We took two last year, so even though we're at 60%, we'll wait and make sure we're performing as we expect and continue to do that. In the long run, that's kind of the thought process. One other thing I'd point out is we've always talked about it in terms of the free cash flow capability, but as we grow and the percentage of our costs that are tied up in intangible asset amortization and other sort of Non-replacement kind of amortization shrink. The percentage of our earnings payout moves closer and closer towards the free cash flow payout.
I think you'll see a material, like this year was the first year, where we distribute, I think about 90% of EPS. I think you'll see a material increase in that percentage this year.
Improve?
Improve and not increase.
Yeah.
A decrease. Over time, I think you'll see those two move towards one another.
Okay, great. That's very helpful. Next question, just thinking about the Middle East in-service support contract that Provincial has. Has that reached what we should think of as a pretty steady state level now going forward on a quarterly basis for the duration of that contract?
Yes. Yes, it has. We had a full 12 months of a stable contract there. I think steady state is a good way to describe that.
Okay.
Yeah, there was a slight uptick at the very beginning as we built up a little bit of inventory. Thereafter, the balance of the term, you should expect what you've seen this year.
Okay, great. Just my last question, I want to return to the discussion that I think Kevin brought up, just thinking about the great margin performance in the aviation segment. If I think about the gross margin, I think it was up about CAD 9 million on a year-over-year basis. That's even before taking into account the challenges that Perimeter had. That's on a flat revenue. It sounds like we can allocate or think about a big chunk of that improvement, or I don't know whether it's half of the improvement or not, because of the fact that one aircraft was sold in Q4 of 2016 versus two last year.
Is there any way you can provide a little additional color on where those CAD came from and maybe how much of that approximately relates to the aircraft sales and how much, I assume the bulk of the rest of it by the commentary in the report is related to the legacy airlines and what's going on there. I'm just wondering if you can maybe provide some more flavor on that improvement in CAD terms on a year-over-year basis.
I think the way to look at this, I think percentages are dangerous because I can't tell you when we're going to sell planes. What is reliable on the aerospace part of the business is the growth and the return on investments. When we, as an example, purchase those eight aircraft and we're going to put those out on lease, we've given the market pretty good indications of what we expect, which is that 15% return. You should be able to layer that on. The issue is with leases, virtually all of that flows through into EBITDA. The free cash flow less maintenance CapEx 15% contribution is the key number. Sometimes we'll sell some of those planes, so you'll see revenue spike up in a quarter and EBITDA will move in that quarter.
The key thing is the consistent growth as we're taking those CapEx and putting them into leases. In terms of the legacy airlines, until Q4, it was a very good year in terms of increased margins, largely driven by Perimeter partially, Calm Air as well, in terms of improvements in our efficiency of delivering our service. If you normalize for some of the challenges at Perimeter, I think the future looks very much like this year. I think the key thing when you're modeling forward is to just take what you think we're going to invest and adjust the bottom line of free cash flow by the returns we expect to make on those aircraft additions.
Okay. Thank you very much.
The next question comes from Steve Hansen with Raymond James. Please go ahead.
Hi, Steve.
Good morning, guys. Mike, your ability to sign a strategic relationship or MOU with Bombardier does strike me as a competitive advantage, I guess, in terms of sourcing future aircraft to grow the portfolio for Regional One. I guess two-part question. Does that relationship extend beyond just sourcing aircraft? Does it extend into the aftermarket for parts as well with some of their customers? That'd be part one. Part two, is there similar relationships you can strike with the other OEMs, presuming they also have considerable buyback programs in place, whether it's Embraer or others? Thanks.
Our arrangement largely relates to aircraft, the relationship is bigger than the agreement. I think the relationship is more significant than the agreement, quite frankly. We've worked with them. We helped them put planes in place. Typically, when an airline is going to liquidate an entire type, like an aircraft type, they're also going to want to move their parts inventory, so we will help them with that. On the other hand, when they're still running a plane that's supported by Bombardier and they're buying new parts, they're always going to deal directly with Bombardier. We don't add anything to that value equation. It's more the ability to liquidate the surplus parts inventory, for lack of a better term, when they move out of an aircraft type.
I would describe our relationship with Bombardier as bigger than the residual value issue, but not really related to the parts business per se, because they deal with that directly. In terms of other manufacturers, of course, we'd love to extend our relationships where they have buyback obligations and those kinds of things to see if we can assist in remarketing those aircraft.
Okay, great. Just one follow-up for me is, you mentioned earlier that you're starting to see some improvements on the manufacturing backlog. Predominantly in the Stainless business? Or can you help quantify that for us? Should we really expect that business to start growing again off of a solid base, or where are we at?
The biggest improvements are at Stainless. They're by far and away the most dramatic improvements. There were so many projects that we bid on throughout the end of 2015 and most of 2016, where we didn't lose them to our competitors, they just weren't awarded. The companies delayed the projects, now there's sort of been a surge of awards, and we've certainly gotten our share of those awards. A quarter from now, I'll be in a better position to tell you whether it was really the backlog clearing or whether the demand's at this new constant level. I can tell you our backlog for the balance of this year is good. In two of our other manufacturing entities at Ben and Overlanders, they weren't really as impacted. They were much more consistent through the downturn than Stainless and Alberta Ops were.
Our Alberta Operations are showing significant signs of life, but it's not a business that has backlogs in the same way as Stainless does because the projects are smaller. We've had a couple much better months, and we're obviously up against weaker comparatives. I think you'll see improvements in that. I think we'll have a lot better clarity as to how much a quarter or two from now once the sort of pent-up demand has cleared the marketplace.
Very helpful. Thanks, Mike.
There are no further questions at this time. I'd now turn the call back over to management.
Given that there's no further questions, I really want to thank everyone for participating in today's call. 2016 was a very exciting time for EIC and our shareholders, and we look forward to updating you on our progress in the quarters ahead. Thanks, and have a great day.
This concludes today's conference call. You may now disconnect.