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Edited Transcript of EIF.TO earnings conference call or presentation 8-May-19 12:30pm GMT

Q1 2019 Exchange Income Corp Earnings Call

Winnipeg Jul 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Exchange Income Corp earnings conference call or presentation Wednesday, May 8, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Carmele N. Peter

Exchange Income Corporation - President

* Darryl Bergman

Exchange Income Corporation - CFO

* Michael C. Pyle

Exchange Income Corporation - CEO & Director

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Conference Call Participants

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* Cameron Doerksen

National Bank Financial, Inc., Research Division - Analyst

* Christopher Allan Murray

AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries

* David Ocampo

Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research

* Derek Spronck

RBC Capital Markets, LLC, Research Division - Analyst

* Mark Neville

Scotiabank Global Banking and Markets, Research Division - Analyst

* Nauman Waqar Satti

Laurentian Bank Securities, Inc., Research Division - Associate of Research

* Navdeep Malik

Industrial Alliance Securities Inc., Research Division - Research Analyst

* Raveel Afzaal

Canaccord Genuity Corp., Research Division - Analyst

* Steven P. Hansen

Raymond James Ltd., Research Division - SVP

* Tim James

TD Securities Equity Research - Research Analyst

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Presentation

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Operator [1]

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Good morning, everyone. Welcome to the Exchange Income Corporation's conference call to discuss financial results for the 3-month period ended March 31, 2019. The corporation's results including MD&A and financial statements were issued on May 7, 2019, and are currently available via the company's website or 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 securities law. 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 call over to CEO of Exchange Income Corporation, Mike Pyle. Please go ahead, Mr. Pyle.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [2]

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Thank you, operator. Good morning, everyone. Joining me this morning are Carmele Peter, EIC's President; Darryl Bergman, our new CFO who joined EIC less than a month ago; and David White, our EVP of Aviation.

On our call this time last year, we announced record first quarter results which were impressive in and of themselves. But we focused the call on other initiatives, which were taken during and subsequent to the quarter end and how our focus on long-term investing would drive continued growth in the future.

The results for 2018, the first quarter of 2019 and our outlook for the balance of the year show how effective this strategy has been. Investments from Quest, Moncton Flight College and Wasaya, to name just 3, are already contributing to our results and will have an even bigger impact as we move through the year.

During the first quarter, we announced major RFP wins, a joint venture with SkyWest, Inc., one of America's most successful regional air carriers, as we continue to keep our eye on the future.

Before I briefly go over our record headline results, I would like to remind you that this quarter is the first where we will report after the implementation of IFRS 16 accounting policy, where leases are now recorded on the balance sheet. While this change has absolutely no impact on cash flow or on our ability to fund our dividend or future growth -- future dividend growth, it does change both EBITDA and our net earnings. When we announced our year-end 2018 results in February, we provided guidance that this accounting change would result in an increase in EBITDA of approximately $20 million for 2019 while decreasing both EPS and adjusted EPS by approximately $0.05 per annum. The results for the first quarter reflect additional EBITDA from the accounting change of $5 million and a reduction of both EPS and adjusted EPS of $0.02. Darryl will discuss IFRS 16 in more detail in his portion of the call.

Seasonally, the first quarter is always our slowest as winter roads provide a temporary alternative to our northern airlines. In addition, the first quarter is slower for Regional One's lease portfolio as the utilization of the aircraft at our customers is lower than in their busier summer months. As such, its important comparatives are to first quarters of other fiscal periods and not to sequential comparatives from previous quarters.

The first quarter of 2019 was another record period for EIC with both revenue and EBITDA hitting all-time first quarter highs. Revenue grew by 12% to $297 million. EBITDA before the IFRS change grew by 9% to $59 million. Under the new standard, it grew by 18% to $64 million.

Adjusted EPS before the impact of IFRS 16 grew 5% to $0.43 per share. Under the new standard, it's unchanged at $0.41 per share. EPS before the IFRS change was down 4%.

Free cash flow, which is not affected by IFRS 16, grew an impressive 9% to $44 million. Free cash flow less maintenance capital expenditures grew by 80% resulting in a quarterly payout ratio of 96% and a trailing 12-month payout ratio of 56%, down from 172% and 69%, respectively. The adjusted EPS payout ratio for the trailing 12 months improved to 75% from 77%. This calculation utilizes the lower adjusted EPS inclusive of IFRS 16 treatment.

We've been very transparent with the market of our desire to continue to reduce our dividend payout ratio over time. As such, we were very pleased with the progress we made on this front in the quarter. Our free cash flow less maintenance capital investments on a per share basis grew by 84% the first quarter to $0.57. Our trailing 12-month payout ratio fell from 69% to 56% as a result. This improvement is the result of 2 factors. Firstly, free cash flow grew by a strong 9% in the quarter. And secondly, maintenance capital expenditures declined by 14% to $27 million.

I want to point out that this decline in no way represents a change in our strategy to accomplish as much of the heavy maintenance as possible in the slower, earlier part of the year. Rather, it is the result of certain engine overhaul events, which were not completed during the quarter. These overhauls will still be completed in subsequent quarters. As such, our guidance for full year maintenance capital investment in unchanged.

We have always included managing our balance sheet as a key part of our disciplined approach to growth. We consistently look at leverage, liquidity, access to capital, and refinancing risk when we examine our balance sheet. Given that our 2014 convertible debentures were now in the money with the $31.70 strike price and available to be called, we announced that we would be redeeming them and issuing a new $75 million convertible debenture. The new issue featured a lower interest rate, a higher strike price and a 7-year term. We were very pleased that we extended our track record of capital raises that were well supported by the market. And as a result, the underwriters utilized the full overallotment option, bringing the offering to $86 million. At the same time, approximately 90% of the 2014 debentures that were outstanding at the 2018 yearend were converted into equity, thereby increasing our share capital by $25 million while increasing our liquidity after expenses by approximately $80 million.

We announced growth capital expenditures in the first quarter of $41 million. This number is larger than we had originally contemplated, but ties directly to the initiatives that were announced during the quarter. Approximately 10% of this investment was in the manufacturing segment and was tied to the completion of the Quest plant in Texas, while the remainder was in aviation and aerospace. Approximately $23 million was invested in Regional One. Regional One in turn made an initial investment in respect of the SkyWest joint venture and purchased a low time CRJ700 for our lease fleet. Approximately $15 million was invested in Provincial and the legacy airlines. The largest portion was utilized by Provincial as it begins preparation for the aerial surveillance contract which was won during the first quarter. The balance was spent on upgrades for the expanded key win contract for new Medevacs.

I would like to take a moment to talk about the aerial surveillance contract. It does not begin until August 2020 and has an additional term of 5 years with a 5-year renewal option and represents a major increase in scope from the current contract. We will be replacing our current older fleet of King Air aircraft with a combination of newer King Airs and longer-range DASH 8 aircraft. We anticipate investing a further $50 million in this project. We will not only be replacing the aircraft, which provide the service, but we will be upgrading the technological capabilities of the surveillance equipment which will be state of the art. It will improve the scope and accuracy of the information, which will be provided to the government. The intention to providing the best possible service to the government has been the backbone of our decades-long relationship and this investment will provide the foundation for future profitable growth for years to come. I would like to point out that this investment is in addition to the capital investment guidance we provided last quarter. At the time, we had not yet been awarded the RFP and this investment is directly tied to this enhanced contract.

Investment in our Quest plant is essentially complete. It was built on time and on budget. We spent much of the first quarter installing, testing and going through the learning curve, ramping up our facility. As expected, this added cost to EIC while we go through the ramp up. We are in the process of increasing staffing and training our people as production ramps. Our first customer product is expected to be shipped later this quarter and we further expect the plant to make a significant contribution to EIC's bottom line in the second half of the year.

The joint venture with SkyWest is off to a great start. We made additional investments in the first quarter due to the acquisition of a number of CRJ assets in the second quarter. I am pleased to state that we have reached a tentative arrangement to provide aircraft to a North American carrier on a long-term basis. The final negotiations are ongoing and we expect the assets to go into service later this year. We will provide greater clarity on this opportunity when the transaction is completed. The investment made in the partnership to date will be funded at a budgeted amount and will not increase beyond what was contemplated in our guidance.

We have opportunities for the first work on the Force Multiplier surveillance aircraft later this year. Discussions are ongoing with a number of countries for further work in 2019 and 2020. Although we remain very excited about this opportunity, the customers are governments, and as such, the purchase cycle is longer than we had originally thought.

Abnormally windy weather on the east coast slowed the operation of MFC in the first quarter. The flight training aircraft are lightweight and are not suited for very windy conditions. The training hours are not lost with these weather problems, however, only delayed. And as such, we expect strong results for MFC for the balance of the year. I will talk about our view for the balance of the year later in the call, but for now, I'd like to hand the call to Darryl who will walk you through our results in greater detail.

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Darryl Bergman, Exchange Income Corporation - CFO [3]

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Thanks, Mike, and good morning, everyone. Before I begin my remarks on our first quarter results, I would like to take a short moment to highlight the impact of our adoption of IFRS 16, the new standard that governs the accounting leases on the quarter's results. The opening consolidated balance sheet was impacted by the inclusion of a new right-of-use asset by $120 million and a new lease liability of $123 million, both current and long-term portion. The difference between the increase in assets and increase in liabilities result in a decrease of $3 million being charged to retained earnings. In addition, lease payments during the quarter were no longer recorded as an expense in EBITDA. Interest expense on new lease liability and depreciation on the new right-of-use asset were recorded outside of EBITDA as required. Because of these EBITDA changes, EBITDA increased by $5 million and earnings per share decreased by $0.02. It is also notable to add here that the adoption of IFRS 16 has no impact on cash flow. For further information on the adoption and adjustment recognized in the first quarter financials, please reference the notes to the interim condensed, consolidated financial statements, Note 3 - Significant Accounting Policies Adoption of IFRS 16 for Leases.

Moving onto our quarterly results, on a consolidated basis we generated revenue of $297 million, which is up $31 million or 12% over the first quarter of last year. Of the increase, $27 million was generated in our

Aerospace and Aviation segment, and $4 million was in our Manufacturing segment. The Aerospace and Aviation segment generated $217 million, an increase of 14%. Revenue from Legacy airlines and Provincial was up $10 million. The largest contributor to the increase for the quarter was the inclusion of a full quarter results for Moncton Flight College, compared to the first quarter last year where only one month of results were realized postacquisition.

Revenue at Regional One was up $17 million, compared to the first quarter of last year. Parts sales and full aircraft and engine sales were up 35% and 56%, respectively. Driving the increase were previous investments made to increase Regional One's portfolio of assets available for sale. The Manufacturing segment's revenue for the quarter was $80 million, which is up $4 million or 5% over the first quarter last year. Results in the Manufacturing segment this quarter can largely be attributed to West Tower where revenues were up 14% from prior year which is reflective of growth in traditional service revenues from telcos and growth in technical service revenue, and Ben Machine where revenues were up 25% from the prior year reflecting the continued increase in defense spending that the company is benefiting from.

Consolidated EBITDA was up 64%, or sorry, was $64 million, up 18% or $10 million from quarter one 2018. Excluding the impact of IFRS 16, EBITDA was 9% higher. Most of the increase can be attributed to the Aerospace and Aviation segment and was driven by a combination of significant organic growth and the impact of acquisitions. EBITDA in our Aerospace and Aviation segment was $58 million, up 23% from the prior year. Excluding the impact of IFRS 16, EBITDA in the quarter increased by $7 million or 15% from quarter one 2018.

Within the Legacy airlines and Provincial, increased EBITDA was driven by higher revenue, cost savings associated with operational efficiencies, stabilization in fuel prices and reduced third party charter costs achieved by sharing capacity across airline subsidiaries and investment in additional aircraft in prior periods. Regional One's EBITDA increased due to higher revenue from parts sales and full aircraft and engine sales as already discussed, along with improved lease revenue over the comparative period.

In the Manufacturing segment, EBITDA grew by $1 million or 4%. The adoption of IFRS 16 increased EBITDA by $1 million compared to the first quarter of 2018. Quest generated $6 million in the quarter, down $1 million in comparison to Q1 2018 excluding the impact of IFRS 16. The results were impacted in the quarter by production inefficiencies resulting from a flood at the plant caused by a broken water main during the Q4 2018. The impact of the flood was not fully remediated until the middle of March. The balance of the Manufacturing segment collectively experienced growth in EBITDA.

We reported net earnings of $7 million or $0.24 per share for the quarter compared to $9 million or $0.27 per share in Q1 2018. Excluding the impact of IFRS 16, net earnings were relatively flat. Higher long-term debt outstanding on our credit facility and increases in benchmark borrowing rates throughout 2018 resulted in slightly higher finance costs, which were up $2 million over the prior period.

Depreciation increased by $2 million because of the purchases of capital assets in the quarter and throughout 2018 and the acquisition of Moncton Flight College partway through the first quarter of 2018. Income tax expense was down $1 million. The lower expense was a result of a greater portion of earnings being taxed in lower rate jurisdictions in comparison to Q1 2018.

On an adjusted basis, net earnings were -- was unchanged at $0.41. When the impact of IFRS 16 is excluded, adjusted net earnings per share increased by $0.02 or 5% to $0.43.

Free cash flow, which is unaffected by IFRS 16, grew by 9% to $44 million or $1.41 per share. Free cash flow less maintenance capital expenditures improved 84% to $0.57 per share from $0.31 per share in Q1 2018. As a result, the quarterly payout ratio decreased from 172% to 96%.

Our payout ratio, when calculated as a percentage of adjusted earnings, increased marginally to 134% from 130% because of the adoption of IFRS 16. Excluding the impact of IFRS 16, the adjusted net earnings payout ratio for the first quarter improved slightly over Q1 2018. Keep in mind when comparing payout ratio results that due to the seasonality of the business, it's important that comparatives are to the same quarter of the previous fiscal periods and not sequential comparatives to previous quarters.

The 12-month payout ratio is a better barometer of payout ratios given the seasonality of our Aviation operations. On an adjusted net earnings basis, the trailing 12-month payout ratio improved from March 31, 2018, to 75%, while on a free cash flow less maintenance capital expenditures basis, it improved significantly to 56%. The improvement in free cash flow less maintenance capital expenditure payout ratio was driven by 2 separate items. The first is an increase in cash flow generated by the company, and the second is a decline in maintenance capital expenditures.

Looking at our balance sheet. We ended the quarter with cash of $40 million and working capital of $263 million, which represents a current ratio of 1.9. This compares with a cash balance of $43 million, working capital of $301 million and a current ratio of 2.26 at the end of 2018.

The change in working capital can mostly be attributed to a couple of factors. The first would be the inclusion of the current portion of right-of-use lease liabilities from the adoption of IFRS 16. Second being the announcement of the redemption of the March 2014 convertible debentures prior to the end of the quarter, which resulted in the outstanding debentures being recorded as a current liability.

Our leverage ratios remained within our target range and we have approximately $350 million of available capital, which continues to position us well to take advantage of future growth opportunities as they arise. During the quarter, we amended our credit facility to obtain favorable pricing and extended its term. Pricing improvements apply to both amounts borrowed under the facility and standby charges paid on the unutilized portion of the facility. The maturity of the facility has been extended to May 7, 2023. The improvements to the credit facility reflects the strong support and favorable relationships we have with our lending syndicates.

On March 26, 2019, we closed a bought deal offering of convertible, unsecured subordinated debentures. At the closing of the offering, the corporation issued $86 million principal amount of debentures including the exercise of the full $11 million overallotment option, which reflects a strong level of investor interest. Also within the quarter, it was announced that we would be exercising the right to call the 7-year 6% convertible debentures, which were due on March 31, 2020.

Finally, just a couple of comments towards subsequent events to the quarter. On April 26, we concluded exercising the right to call the 7-year 6% convertible debentures, which were due on March 31, 2021. The redemption of the debentures was completed with cash on hand from our issuance of the March 2019 5.75% convertible debenture offering. At March 31, 2019, there was just over $25 million in principle amount outstanding. Prior to the redemption date, $22 million of the principal amount of debentures were converted to roughly 708,000 common shares at a price of $31.70 per share. On April 26, 2019, the remaining outstanding debentures in the principal amount of $3 million were redeemed.

In addition, subsequent to the quarter end, we entered into a forward starting, fixed interest rate swap with lenders party to our credit facility. The fixed interest rate swap fixes $190 million floating rate credit facility debt for 4 years.

That concludes my review of our financial results, but before I hand the call over to Mike for closing remarks, I would like to thank Richard Wowryk for covering as interim CFO through the transition. Having someone like Richard available who can step up when called upon speaks volumes to the depth of the talent within the organization. Mike?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [4]

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Thanks, Darryl. 2019 is off to a good start and we are excited about executing on the opportunities in front of us, which will drive growth in the balance of the year. When we purchased Quest in late 2017, it had a very strong order book and a real opportunity to outperform the results, which we purchased it off of. Its performance to date has exceeded our most optimistic projections. Even in the first quarter of this year, with their existing plant operating without water service because of the water main break last year and management very busy opening a new production plant, it generated EBITDA of $6 million.

The Quest management team has been burning the midnight oil designing and opening a new facility in Dallas, which is 60% larger than the existing plant in Toronto. In less than a year, it has gone from a concept to operation. It has begun initial production runs and will deliver to the first customer later this quarter. It is expected to be contributing to EIC's bottom line in a meaningful way in the second half of this year. It is a testament to Marty, Jody, and their whole team that they have been able to open this facility on time and on budget in less than a year. As expected, labor market in Dallas is tight and staffing has been a challenge, but we are on track. We were excited about showing off this new facility.

To that end, we have completed a video showing off our largest manufacturing facility and will show it at our shareholders' meeting later this morning. I hope to see many of you there. I am pleased to announce that we will be holding an Investor/Analyst Day in Dallas in the first half of September to allow our stakeholders to see the new plant. We will announce more details on this in upcoming weeks.

With all the excitement about Provincial's new aerial surveillance contract, the previous win of the fixed wing search and rescue contract has slipped from many investors' mindsets. We are pleased that the planning phase is slowing coming to a close and the planes will soon be delivered. Provincial's role in this contract is to assist in the line maintenance and provide overall services. The revenue from this contract will ramp as the planes are delivered over the next 3 years and then plateau as the first planes that went into service begin their first overhaul cycle.

As we announced previously, we intend to operate the overhaul operation from Winnipeg. It is our plan that Provincial will take over an existing facility in Winnipeg currently utilized by Calm Air. We will build a new facility for Calm on the land immediately adjacent. Until recently, this line was occupied by the Western Canadian Aviation Museum who have recently moved out and are building a new facility themselves. This existing building was torn down in the first quarter. We expect construction to begin early in 2020 for Calm's facility. Not only will this allow Provincial to execute on the fixed wing search and rescue contract, it will provide space to enable Provincial to complete the overhauls of our own airlines' aircraft in Winnipeg, rather than ferrying them to the east coast. Our maritime location will then have the capacity to increase the third-party aerospace work, which they have built a reputation upon.

Provincial also won the RFP for the fisheries department for the Canadian government, which extended the relationship, which began in the 1980s. We will upgrade the entire fleet of aircraft for this work at a further cost of $50 million, which will enable us to service this materially expanded contract. This will improve the product we provide the government and provide the foundation to further growth over the next decade. This investment was not included in our guidance as we had not won the RFP at the time we made the guidance. It will not impact the revenue or profitability until the second half of 2020 when the new contract goes into force. It is, however, a great example of how we invest now to secure future growth philosophy.

MFC continues to grow organically and will contribute significantly to our growth in the second half of 2019. We are approaching capacity at our 2 bases in the Maritimes. We will begin looking for a new base in other geography within Canada soon. A third base is not imminent but will be considered in the future when the situation warrants. The capital investment for such an expansion is limited as the aircraft acquired are relatively inexpensive, and the rate-determining step on such an investment is having the necessary trainers and other human capital available. We will be making a significant announcement on our Pilot Pathway Program designed to provide a career path to our EIC airlines for aspiring pilots at our ATM later this morning.

We have submitted proposals for the Manitoba Government RFP for Medevac services and the Nunavut government RFP for passenger services. There will be significant competition for both. We are the incumbent for the Nunavut RFP and have held all or a portion of this work for 30 years and as such, are confident of the services that we provide. Competition will be significant and as such we must remain diligent in the RFP process. We have the required infrastructure for this bid and as such, should we be successful, it will not require any material capital investment. The Manitoba Medevac is currently spread between the government and 4 private carriers. We have a small portion of this work, less than 20%. We are excited about the opportunity and should we be successful, we will need to expand the size of our fleet. For competitive reasons, I will not disclose the proposed investment other than to say the return on it meets our well-publicized return expectations.

The joint venture with SkyWest is going well. We have made a capital investment in the first quarter and a subsequent investment in the second quarter. We have an agreement in principal with a regional carrier to place a number of CRJ aircraft on long-term leases. Through this arrangement, we brought to completion and will generate further earnings in the second half of 2019. I will not be providing any further detail on this arrangement for competitive reasons other than to say SkyWest has proven to be a great partner and we look forward to examining further opportunities with them in the future.

We provided guidance for fiscal 2019 on the February call. We confirm that we expect to meet that guidance. The additional shares issued as a result of the conversion of the 2014 debentures will add approximately 700,000 more shares to the balance outstanding at year-end which is an increase of approximately 2.5%. While this will make the per share guidance slightly more difficult to reach, we still anticipate meeting our original guidance. We also provided maintenance capital investment and growth capital investment guidance, which is also unchanged with the exception of the investment in the aerial surveillance contract. If we were to win the Manitoba Medevac RFP, it would also result in further growth investment.

I want to thank all of our stakeholders for their ongoing support. We're off to a great start in 2019 and are excited about the balance of the year. Taking a disciplined, long-term approach to investing has served EIC well for 15 years and we don't intend to change it now. I look forward to seeing many of you at the annual shareholders meeting later this morning and to speaking to all of you again following the release of our second quarter results in August.

We would now like to open the call to questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Steve Hansen from Raymond James.

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Steven P. Hansen, Raymond James Ltd., Research Division - SVP [2]

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First question relates to the SkyWest JV, Mike. I understand it is still early days here, but it sounds like the investments are stepping up and it sounds like SkyWest is keen on the program as well given their intention to put a number of engines into the JV. Could you just help us frame up what this opportunity looks like under sort of a successful scenario in your mind and what kind of investment levels you sort of see going forward? Just any sort of context around the agreement would be helpful I think as we go into year 2.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [3]

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I think it's a challenge for me to try and quantify it at this point. We're literally a couple of months into it. But I am excited that the initial assets, which are engines that we put into the facility, we believe we have a customer to put them with. And we're going to match those up with airframes that we have in our portfolio and put those out on a long-term lease. It's exciting for us because typically our lease portfolio turns over much faster. The nature of what we're looking at with SkyWest is a longer-term lease and so that gives us a more predictable long-term revenue stream.

But combining the capabilities of SkyWest, we're the unquestioned leader in the regional jet market. With our marketing capabilities around the world, I think adds tremendous opportunity to place aircraft in other places beyond our initial investment. I'm hoping by the time we report at the end of August we'll be able to give you a little more clarity on the impact of this initial investment and maybe some look forward into potential future investments. I need to drink less Starbucks before I start. But at this point, all I can say is that we're well on our way to monetizing the first assets we put into the joint venture.

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Steven P. Hansen, Raymond James Ltd., Research Division - SVP [4]

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Okay. That's helpful. And just the second one relates to the Force Multiplier. It sounds like the sales cycle has been a little bit longer than you expected there. Is there any read into this at all in the sense that there's less interest? Or should we just assume that the discussions are indeed taking longer? Just trying to make sure that the demand for the aircraft is unwavering and it's just more of a temporary stall on some of the sales cycle.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [5]

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No, it's really -- we were perhaps a little bit naive because some of the demand that came in before we had it was when there was a precise and very acute need for something and someone said we want it tomorrow. Now that it's available, it goes through government procurement programs and particularly in Canada, even though it's a rental, it's treated like capital. So there is a very defined process to schedule it. The opportunities, if anything, are greater than they were before. It's the process to get the governments to authorize the money and put the plane into service. So in terms of the program itself, no, there's no decline in the demand. It's just a little bit longer ramp up and perhaps we should have known this because we deal with a lot of governments, but the ramp-up process in terms of authorization takes longer.

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Operator [6]

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Your next question comes from the line of Raveel Afzaal from Canaccord.

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Raveel Afzaal, Canaccord Genuity Corp., Research Division - Analyst [7]

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Can you provide us with a little bit more clarity on the Medevac contract in Manitoba and the Nunavut air contract too? With respect to the timelines associated with it and where are we in the process? Because it looks like the process has been pushed back a little.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [8]

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The processes are very different between the 2. The Manitoba one is the government changing how they purchase Medevac services. Today, the government does the most acute cases themselves through their own air ambulance process. And then the majority of less acute cases are shared between approximately 4 private service providers. They put out an RFP to combine all of these providers under one contract. The government, it's a big changeover, and so they completed the general services contract which helps them with their flying around of the court system, which we were excited to win, and that will begin later this month. The firefighting work was awarded to a different group before that and Medevacs are next. For me to tell you exactly when is very difficult.

There's rumors of an election in Manitoba, which could slow this process, but I don't think it ultimately changes it. So I think we still have a little bit of wait while the government works through the material competition. Because I'm sure there's multiple bids involved and a fair bit of work for the province to go through to award that. In Nunavut, it's much more straightforward. It's an RFP for the work we already have. We've had all or part of it for 30 years. Again, there was significant competition in the thing.

There was a new competitor that we are aware has bid. We're not sure exactly which territories they bid on, but a northwest company has made the decision to enter the passenger business and they will be a strong competitor. We were slightly surprised by the decision given the $50 million to $100 million it will take to go into the business, but we've had competition before and we'll have competition again. We've been doing this for 60 years, it's not something that scares us. That contract is likely to be awarded sometime in the second quarter. We're in the middle of the process with them and we're excited about continuing to work with our partners in Nunavut.

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Raveel Afzaal, Canaccord Genuity Corp., Research Division - Analyst [9]

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Perfect. Just moving onto the payout ratio, now it's down to 56%, looks like even if you normalize for maintenance CapEx, it will still stay below 60%. Can you speak about your priorities for this year or dividend increase? Where does that sit in your priority list?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [10]

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We have built our reputation on a reliable, growing dividend, and nothing has changed with that. At Q4, we talked about a strategy of pushing, continuing to reduce our payout ratio, but not at the expense of dividend growth. So at each of our board meetings, we discuss with our directors the appropriate level of dividend. And as the dividend payout ratio falls, our ability to increase dividends in the future rises. So people shouldn't see reductions in our payout ratio as mutually exclusive with increasing dividends. We will balance the growth and our ability to pay dividends between those 2 things. In terms of when you'll see the next dividend increase, if I suggested anything on that, I think Mr. Filmon would chase me around the boardroom. So we'll wait and see what happens after the next quarter end.

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Operator [11]

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Your next question comes from the line of Cameron Doerksen from National Bank Financial.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [12]

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Just first question, just maybe a clarification on the JV with SkyWest. I guess the understanding I had was that at least initially the deal was really focused on engines and now I guess just based on some of the commentary you've got here in your press release and this morning, it sort of sounds like there's maybe aircraft also being in the JV. Have I got that correct or is this sort of 2 separate things here where it's Regional One doing the aircraft leasing and the JV is leasing the engines on those aircraft? Just maybe if you could just clarify that for me.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [13]

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The JV is at this point just engines. That could change in the future. We have also, as part of the opportunity here, acquired some airframes that we will lease in conjunction with the JV to turn engines and aircraft bodies into operating aircraft. But the JV itself at this point is purely engines. That may or may not stay that way in the future.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [14]

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That helps. Secondly, when you talk about the CapEx, and you've talked about the maintenance CapEx being relatively stable this year, it does sound like there's some incremental growth CapEx coming for the Fisheries contract. I'm just wondering if you can maybe talk about what you expect sort of total CapEx on the gross side kind of increase is going to be for this year. I guess presumably some of that $50 million for the surveillances contract will also flow into 2020?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [15]

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We're still working on the precise schedule, Cameron, but that's an astute point is that some of that may not occur this year. When you look at our guidance, we were pretty clear on where we thought maintenance and growth would be, and the only change to that guidance is that additional $50 million for the aerial surveillance contract. Like I said, if we were to be successful on the Manitoba Medevac bid, we would be buying additional aircraft for that. But at this point, we haven't won that contract, so it's hard for me to comment on that. But as of now, the only change to my guidance from Q4 is the Provincial Aerospace contract and we are very pleased to be investing that money.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [16]

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Absolutely, it's a good long-term potential from that for sure. Just one very quick thing, I just want to ask about the Quest. Is it safe to say that the new plant is going to be at full production in Q3 or is really going to kind of ramp up through Q3 and maybe full production in Q4?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [17]

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It's a ramping process, Cameron. There's 2 reasons. One is we don't want to turn it on -- we've got to make sure that we've got all the bugs out, that we're running efficiently. That's a whole bunch of new employees that are going there. The other thing is, while we managed to build this in a year, the sales cycle for most of our projects is more than a year. So we've just begun taking orders into that project, into that plant. So you will see the revenues in that plant grow through 2020. But in terms of our capabilities, by Q4 we will be able, we expect to be able to run the plant at capacity. Whether we place that many orders through in Q4, I think you'll see it ramp into 2020 simply because we only committed to building that 12 months ago. It was hard to take orders for a plant that we didn't have yet.

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Operator [18]

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Your next question comes from the line of Mark Neville from Scotiabank.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [19]

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I just want to follow-up on a couple of Cam's questions there. Just the $50 million investment for the surveillance contract, it's a pretty big number, so just maybe help us think about investment returns or investment multiples just to frame the size of this contract.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [20]

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$50 million is the sum total of 2 things. It's expanding the contract for the long-range capabilities, so we've got DASH 8 surveillance we've never had before. And part of it is replacing a couple of King Airs that were reaching the end of their life. Now that we know that we've got a 5-year term, and quite frankly the government usually exercises all of their options in terms of extension, so it's another 10 years. And so it's a little bit lumpy in terms of we decided to replace the King Airs at the same time. In terms of the overall return on this contract, it's roughly in line with our historical results with this contract.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [21]

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Is this something that you could use the Force Multiplier for?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [22]

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If we didn't have other demand for the Force Multiplier, we absolutely could roll that in. Now the Force Multiplier would be overbuilt for the fisheries contract because we've got more capabilities in that aircraft than we technically would need. But one of the things that's changed with the new fishing contract is that it now is sort of an overarching government procurement availability. So they can now add to it within the contract and we think it's likely that that plane will at times be working for the government under that contract when there's a special project that requires it. But as a dedicated aircraft, I'm not prepared to take away the other opportunities we built it for. Could we? Yes. Will we? A little bit probably. But will it be dedicated? No.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [23]

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Just to be clear, the $50 million, it's incremental to what you spent in Q1 or includes what you spent?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [24]

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It's incremental. [Not all of it] is likely to be in this year, as I think Cameron pointed out.

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Mark Neville, Scotiabank Global Banking and Markets, Research Division - Analyst [25]

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Yes. And maybe just, sorry, just a last one on the Quest plants. You said it's in production Q2, could be fully operational Q4, but in terms of breakeven and profitability, sort of what should be the expectations around that?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [26]

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We expect it to make money in Q3.

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Operator [27]

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Your next question comes from the line of Nav Malik from Industrial Alliance.

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Navdeep Malik, Industrial Alliance Securities Inc., Research Division - Research Analyst [28]

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So I just wanted to first ask on Regional One. Your sales and service revenue was a bit higher this quarter. Could you just maybe comment on that revenue mix and maybe how you see that trending for the balance of the year?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [29]

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Let's start with the revenue mix first and then work down to trends for the rest of the year. That business is inherently opportunistic. And so we bought and sold a large aircraft that would not be an aircraft type we would normally sell. It was a 767, but we had a customer and we had source. Bought and sold it in the quarter. And so for me to tell you when I'm going to do that again is remarkably difficult. What I can tell you is the investments we've made in inventory have resulted in a consistent, reliable growth in our parts business. And that will -- is going to continue. You will see an improvement in lease revenue over Q1 seasonally. So we expect continued growth in the business.

But the growth in our sales and of the engines, aircraft and that is directly tied to investments we've made in inventory in previous periods. The bigger the inventory pool, the faster we get, the more transactions we can do. The top line sales number is occasionally misleading because when you sell a large aircraft, you may sell a plane that has a $10 million sales price but $1 million in margin as opposed to you might sell $4 million worth of parts that have $2 million worth of margin. So the EBITDA we generate, the margin we generate on parts sales and aircraft sales is relatively consistent. The revenue bounces around depending on the components.

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Navdeep Malik, Industrial Alliance Securities Inc., Research Division - Research Analyst [30]

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Okay. Great. That's very helpful. And then just onto Quest with the delay that you had because of the flood, will you be making up some of that lost production? Like does that get pushed into future quarters? Or is that just sort of lost?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [31]

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I think -- I don't think I've done a very good job quite frankly of explaining the first quarter in Quest. First quarter at Quest, we generated $6 million there, which is bang on the average for what we generated for all of last year. In the first quarter of last year, we had a huge quarter at Quest and made over $7 million. Our actual revenue in Quest this quarter is higher than it was in the first quarter of last year. It was just that it was hard to operate at the same level of efficiency as we did last year with the water problem and product mix between different jobs and currencies and stuff change quarter to quarter. That's why we were trying to be really clear last quarter, don't multiply $7 million plus times 4 because that was absolute capacity and perfect margins.

I think when you look at Q1, it’s at $6 million. It's bang in line with what we generated last year. And so while could we have done a little bit better without those challenges? Yes. But did we delay production or miss anything for any customers? Absolutely not. Marty and Jody did an unbelievable job of keeping the throughput through the plant when it's not running the way it was designed to run. So in all honesty, the results at Quest were viewed quite positively internally.

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Navdeep Malik, Industrial Alliance Securities Inc., Research Division - Research Analyst [32]

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Okay. Fair enough. And then just lastly, on the guidance, I think you mentioned that it doesn't include the recently awarded RFPs. I think some of them don't really kick in or I think one of them doesn't kick in until next year, but I think a couple of the other ones do. Is there any way you could maybe give a sense of what that might contribute this year or quantify any of that or...

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [33]

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The one that kicks in this year is the government travel one and that's a modest contract. That's, again, the $5 million kind of revenue range, slightly less than that. So it's not a huge contract.

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Operator [34]

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Your next question comes from the line of Derek Spronck from RBC.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [35]

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When you look at your overall subsidiary portfolio, are you happy with your current mix? And are you still looking for a third leg? Or does Quest kind of fulfill that third leg profile?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [36]

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This is a very -- what we're talking about here is a really high-level discussion. In a perfect world, we'd probably like a little more balance between our manufacturing sector and our aviation sector. But we're not going to do transactions simply to balance the portfolio. So we'll continue to be opportunistic and it has to meet our standards. In terms of a third leg, we're always looking, but the bigger we get, the harder it is to find one that meets our return criteria. So while I'm cautiously optimistic, the Jets and the Leafs are cautiously optimistic about making the Stanley Cup finals too, so I don't anticipate anything in the near term on that.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [37]

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Okay, so the focus is primarily funding internally…

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [38]

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It's on growing what we have, yes. More related companies to what we have.

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Derek Spronck, RBC Capital Markets, LLC, Research Division - Analyst [39]

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How are the other businesses in manufacturing outside of Quest doing?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [40]

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If we break it down, there's kind of 3 baskets of companies within that. General manufacturing, which is steel manufacturing, which I would describe as our Overlanders business in BC, SFI in Missouri, and then machine in Toronto are doing well. Ben is exceptionally busy, SFI is good and Overlanders is doing well. They are all operating at or near capacity. So very pleased with those. West Tower has improved significantly over the last 18 months, but we're still in a cyclical low for their customers in terms of the rollout of new technology for the cell phone business. I don't see that changing in the next year or so.

When 5G becomes a reality instead of a theory, that will clearly buoy that business and enable us to return it back to sort of historical level of size. Then the other business would be our manufacturing business in Alberta, which has recovered from the depths of the oil challenges. But at $60 and no pipelines, Alberta is still struggling and such, while profitable, it's not as profitable as it has been in the past. And I would suggest that we'll see a slow, methodical return to historical levels in that business assuming no oil shocks positively or negatively.

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Operator [41]

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Your next question comes from the line of David Ocampo from Cormark Securities.

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David Ocampo, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [42]

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Just a quick one for me. On the Maritime Surveillance contract, are there certain milestones that you have to reach in order for the contract to be extended by another 5 years?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [43]

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No, it's at the option of the government. Typically, and it's difficult for me to speak on behalf of others, but typically these RFP processes are very complicated and a lot of work for the government. So typically, they are taking advantage of most of the extensions whether that be our contracts with the federal government, with the Nunavut government for our Medevacs, historically most extensions have been utilized by the governments. Clearly, if we do a bad job, they would be less likely to extend. But given that we've had that work for since Michael Wilson was the Finance Minister, so you're talking 3 decades, we're pretty confident in our ability.

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Operator [44]

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Your next question comes from the line of Tim James from TD Securities.

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Tim James, TD Securities Equity Research - Research Analyst [45]

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I just want to make sure I understand or clarify something on Quest and the ramp up here. You indicated, Mike, that it would grow again in 2020. I just want to make sure, is that a function of exiting the year at a higher revenue run rate? Or is there actual incremental, sequential revenue growth that you anticipate over the course of 2020?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [46]

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The answer is yes, we expect sequential revenue growth. Understand, we built a plant that is 60% bigger than what we have in Toronto and we're just starting it up now. So you'll see growth as we take it, and then as we get that closer to capacity, we will book it to higher and higher levels. But our order book continues to grow, we're north of $350 million, but we in our one plant we generated $100 million last year, we need to continue to take orders and growth the book now that we've got the plant up and running. So I anticipate continued growth through 2020 and 2021 while we take advantage of the big capacity that plant has.

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Tim James, TD Securities Equity Research - Research Analyst [47]

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So the way to think about the growth through Q4 of 2020, sorry, of 2019, that's really just kind of your initial ramp of getting it up and going to the ideal level, then it will…

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [48]

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We expect a material contribution in this year, but you're right, it's step 1, step 2, step 3. We built it and tested it in Q1, we're running initial stuff in Q2. We're not running enough through that it's going to be particularly profitable in Q2. Q3 it will be and Q4 more so. And so it's a ramp up.

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Tim James, TD Securities Equity Research - Research Analyst [49]

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My next question on Regional One, what was the value or approximate value of any transfers of assets out of the lease portfolio into the sales book in the first quarter? Was there a material amount there?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [50]

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Rich is just, he's in the room with me here. Give me a second and we'll look at that. Off the cuff, I don't believe we had material transfers. I believe we transferred one aircraft from our lease portfolio into our parts portfolio if I remember correctly. Just give us a second and we'll get you a factual answer on that.

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Tim James, TD Securities Equity Research - Research Analyst [51]

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Let me ask a second related question while you're doing that then. I'm just wondering, what's the approximate duration of the assets that you have on lease currently in the lease portfolio?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [52]

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They'd be somewhere, most of them would be in the sort of 1 to 3-year, 1 to 4-year range. And some of those may be extended. One of the things that has changed in our business, and it's changed in a good way, when we bought, you'll recall, Tim, when we did that big deal with Lufthansa in 2014 when we bought 2 dozen aircraft, we initially thought we were going to park those out. Today, 6 of them are still on lease. And the demand is so high, that we may well overhaul engines that we didn't think we were going to and keep those planes on lease because the demand is so strong. So some of those leases we may choose to reinvest in those aircraft and leave them on lease longer periods simply because the demand for the aircraft has exceeded our initial expectations. Guys, have we got anything on that or are we still looking? Still looking at it. Yes, the transfer was one aircraft, Tim, that went from our lease portfolio to our parts portfolio. It was approximately $3 million.

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Tim James, TD Securities Equity Research - Research Analyst [53]

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Right. You talk about Regional One not really being a leasing business per se, but more of an aftermarket sales business if you will. And yet it seems there hasn't been a lot of transfers out of the lease portfolio into the sales and service book. Is it fair to assume that therefore that will increase the amount of assets that are moving from one side of the business to the other as we go forward?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [54]

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Over time, yes, that's true, Tim. The one thing I would point out though is when you look at our financial statements, we sell a large number of full aircraft and engines and sometimes we sell them directly out of the lease portfolio. So if you look at last year's financial statements, and I'm doing this from memory which is always high risk, but I think we had divestitures straight out of our lease portfolio of over $30 million last year where we sold assets directly. That's specifically broken out in our reconciliation on the financial statements. So we don't -- if we break it down into parts and sell them individually as parts, we always transfer it. But sometimes if we've got an engine that's in the lease portfolio or an aircraft that we sell directly, they'll be sold directly out of the lease portfolio. I believe in this quarter we sold 2 aircraft directly out of the lease portfolio.

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Operator [55]

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And your next question comes from Nauman Satti with Laurentian Bank Securities.

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Nauman Waqar Satti, Laurentian Bank Securities, Inc., Research Division - Associate of Research [56]

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Mike, could you just speak to the new pilot [rules]? How is that going to impact your costs and how do you see it favorably impacting your flight college demand?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [57]

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Flight college demand right now is such that there is demand to train every pilot we have the capacity to train. So while it's good for us, there is already people standing in line, so it doesn't -- it's not going to change that business very much. Where it is going to change our business is if they reduce the number of pilots that can work by an hour or 2, that means I need more pilots to fill that process. So it will inevitably be inflationary to my costs. The nature of our business in most markets is such that we'll pass it onto the customer, which is in most cases, the government.

The key thing for us, and this is the fundamental, strategic part about Moncton Flight College to us and what we are going to talk about at our ATM today, is we are going to give pilots an opportunity for when they walk out of high school or walk out of their job at Earl's or as a construction worker or whatever they are, and say I want to be a pilot, they can sign with us and literally the day they sign they will know they've got employment for a number of years. Well, indefinitely if they want it, but through the training, they'll become a commercial pilot, they'll train for us other pilots at the flight college that move onto our airlines. So it's going to give us a big leg up in competing with other regional airlines who don't have that internal flow of pilots that we're going to have. And so notwithstanding Moncton, it's been a great investment from a financial point of view, the best is yet to come.

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Operator [58]

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And your final question comes from the line of Chris Murray from AltaCorp Capital.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries [59]

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Just, Mike, this is just a bit of a semantic question, but when we look at the CRJ program, Bombardier, there's certainly a lot of questions around longer-term longevity of that program, whether it gets sold off or something else happens with it. Do you have any thoughts or concerns about how that impacts the Regional One business over the next few years?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [60]

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I don't think the decisions Bombardier is making in the near term impact us in the next 5 years because the planes that are in service are going to stay in service. There's no alternative. You can see it in the demand for aircraft. CRJ-200s that everyone had predicted will be out of service by now, we just put 10 more of them on lease with SkyWest last December. So the demand at anything remotely close to current fuel prices I think stays strong.

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Carmele N. Peter, Exchange Income Corporation - President [61]

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I think it's evidenced as well by the kind of deal that we've reached for long-term leases for CRJ-700s. I think that's indicative of kind of the continued demand we'll see.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [62]

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And to the extent that there was ever an opportunity to invest in that program, we would be very actively examining that.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries [63]

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Okay. Like at the airframe level or at the component level?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [64]

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Yes. I appreciate that was vague. I don't know what opportunities will come. The simple fact being is nobody trades more of their parts than we do and nobody flies more of them than SkyWest does. So in terms of our intellectual kind of equity in that brand, we're very invested already.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Equity Research & Senior Analyst of Diversified Industries [65]

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Okay. Fair enough. I'll leave it there. Last question, and this is for Darryl, and welcome to the team. Just thinking about as you come in as a CFO looking at the balance sheet, any thoughts around -- you're starting from a decent financial position, but any thoughts about how you think about managing a balance sheet and tied to either your previous experience or some of the things that you see or the opportunities you might see coming into the company?

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Darryl Bergman, Exchange Income Corporation - CFO [66]

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Yes, actually, you're asking me to make a diagnosis with a very limited examination. But as I come into the company, I'm going to look at it from both stable working capital, stable leverage, definitely with respect to looking at the balance sheet, keeping strong controls around working capital. I'll definitely be focused on those areas.

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Operator [67]

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There are no further questions at this time. I would like to turn the call back over to Mr. Pyle for closing remarks.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [68]

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Thank you, everybody. If there's no further questions, I'd like to thank everyone for participating on today's call. I look forward to seeing some of you in an hour or 2 over at our Annual General Meeting and I look forward to speaking to everyone else in August with the results of Q2. Thanks, and have a great day.

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Operator [69]

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This concludes today's conference call. You may now disconnect.