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

Q2 2019 Exchange Income Corp Earnings Call

Winnipeg Aug 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Exchange Income Corp earnings conference call or presentation Thursday, August 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 Research for Diversified Industries & Senior Analyst

* David Ocampo

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

* Kyle Brock

RBC Capital Markets, LLC, Research Division - Associate

* 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

* Scott Douglas Fromson

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research 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 Exchange Income Corporation's Conference Call to discuss the financial results for the 3-month period ended, June 30, 2019. The Corporation's results including the MD&A and financial statements were issued on August 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 Laws. Forward-looking statements involve risks and uncertainties and undue reliance should not be placed on such statements.

Certain material factors or assumptions are applied in making forward-looking statements and actual results may differ materially from those expressed or implied in such statements. For additional information about factors that may cause actual results to differ materially from expectations and about material factors or assumptions applied in making forward-looking statements. Please consult the MD&A for this quarter the Risk Factors section of the Annual Information Form and Exchange's other filings with Canadian Securities Regulators. Except as required by Canadian Securities Law, Exchange does not undertake to update any forward-looking statements. Such statements speak only as of the date made.

Listeners are also reminded that today's call is being recorded and broadcasted 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 the 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 CFO; and David White, our EVP of Aviation. Before we begin, I would like to highlight our upcoming Investor Day on September 18th, which is a Wednesday. The event will take place at Quest Window Systems newly operational U.S. production plant in Garland, Texas. The Investor Day will include a tour of the new 330,000 square foot facility, which commenced production runs late in the second quarter. Members of both the EIC and Quest senior leadership teams will be in attendance. Timely registration is required as space is limited.

We have also arranged for a block of hotel rooms, which are available to attendees at their expense. If you are interested in a room, please speak with Dianne Spencer when you register for the Investor Day.

Our consistent focus on long-term value creation through investing in and growing solid companies, delivered another strong quarter of operational and financial performance. This included do second quarter records for revenue, EBITDA and adjusted earnings. Our trailing 12-month payout ratio calculated of a free cash flow basis, less maintenance CapEx fell to 54%, which is a new all-time best.

With our continued growth in earnings and cash flow, yesterday, we announced our 14th dividend increase in the past 16 years, further solidifying one of the best track records of dividend growth on the TSX. The $0.09 per share increase on an annualized basis beginning with our August dividend brings our dividend to $2.28 per annum and extends our cumulative annual growth rate since inception of approximately 5%. I will leave it to Darryl to discuss our financial performance for the quarter in detail, but I would like to stress that after 6 months of fiscal 2019, vast majority of our businesses are delivering excellent results.

Importantly, these results are largely due to the decisions and investments we have made in prior periods. It also points to the future, where investments made recently, we will further grow our results where we win those assets come into production. That shouldn't come as a surprise to anyone who has been following us over the years, as our focus has always been on making investments that would pay dividends over the long term.

Already in 2019, we have executed upon several initiatives that further enable us to continue our impressive track record of growth in 2020 and beyond. We made investments to support the new materially expanded Fisheries and Oceans Canada contract awarded to provincial back in March. PAL has been providing aerial surveillance for Canada's inland, coastal and offshore waters on behalf of the Government of Canada since 1990.

These new investments will ultimately improve the product and the service we provide to the government and provide the foundation for further growth over the next decade. This is just another example of our modus operandi invest now for investments in the -- for benefits in the future. This contract goes into force in the second half of 2020. The Legacy Airlines began -- recently began flying for the Manitoba provincial government under the new general transportation contract awarded in the second quarter. This contract will ramp to full capacity during the third quarter of this year. Production of the Quest Canadian facility remains at full swing and we continue to grow our order book, which has grown by approximately 50% since Quest Window System was acquired in late 2017, and now stands at approximately $375 million.

By the end of the second quarter, Quest commence production runs at its new facility in Garland, Texas, I will discuss the ramp up of the new facility later in the call. Earlier in the year, Regional One expanded its relationship with SkyWest by entering into an investing in a joint venture to acquire lease and sell CF34 engines. Last week, the joint venture announced an agreement to lease out its current portfolio 14 CF34 engines and I should point out that these engines are being paired up with Regional One's CRJ700 airframes and will be leased for 10 years to a U.S. operator.

We expect these assets to enter lease in phases between now and next summer, with the first one coming this fall. Again, those are just a few of the recent examples of investing now for benefits in the future. To be clear, none of those investments have generated cash flow in the current results. While the investment has been made, it sets the table for future growth next year and beyond. We are excited that Calm was a successful bidder in the new to that government RFP for passenger service in Kivalliq and [sending] Kivalliq. We are finalizing a new contract, which will see Calm's 30-year track record continue for many more years under the contract, which will go into effect later this year.

I would now like to turn the call over to Darryl to discuss our second quarter financial results. I will update you on our outlook later in the call. Darryl?

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Darryl Bergman, Exchange Income Corporation - CFO [3]

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Thank, Mike, and Good morning, everyone. I'll begin with a quick reminder that our 2019 financial results include the impact of IFRS 16, which the corporation adopted using the modified retrospective approach. Since our financial results prior to 2019 were not prepared on this basis, the comparability of our EBITDA, net earnings and adjusted net earnings for the quarter and year-to-date to prior periods are impacted. As Mike mentioned earlier, yesterday, we reported the highest second quarter revenue, EBITDA and adjusted net earnings in our history as a public company.

On a consolidated basis, we generated revenue of $325.9 million, which is up $12.5 million or 4% over the second quarter of last year. Of the increase $5.5 million was generated in our Aerospace & Aviation segment and $7 million was in our Manufacturing segment. Aerospace & Aviation segment revenue was up 2% to $238.9 million for the quarter, as 8% growth from the Legacy Airlines and Provincial was partially offset by 10% lower revenue from Regional One. The revenue from the Legacy Airlines and Provincial increased by $13.4 million, the gains at the Legacy Airlines and Provincial were attributed to higher volumes in Newfoundland, Labrador and Quebec increased passenger and medevac volumes in the Kivalliq region and contributions from the rotary-wing operation due to growth in new services, including emergency medical services.

Regional One -- for Regional One, the comparable period had higher than typical levels of aircraft and engine sales. With that said, these revenue for Q2 2019 was up 21% as a result of higher utilization of aircraft and an increase in the number of assets in the portfolio on lease compared to Q2 a year ago. The whole fleet of CRJ900 aircraft has been on lease since Q4 2018, in addition, the 10 CRJ200 aircraft we've leased to SkyWest is positively impacting lease revenue in 2019. The $7 million increase in manufacturing revenue represented an increase of 9% for the segment, the total revenue for this segment was $87 million, the segment benefited from increased and custom manufacturing, elevated levels of defense spending worldwide and higher spending from Canadian telecom companies.

Consolidated EBITDA was up $12.2 million or 16% to $87.2 million for the quarter, excluding the impact of the adoption of IFRS 16, EBITDA was up 9%. The growth was mainly attributed to strong EBITDA growth of 32% or 23%, excluding IFRS 16 from the Legacy Airlines and Provincial, which in addition to their higher revenue achieve cost savings associated from operational efficiencies and reduced third-party charter costs as a result of capacity sharing across airline subsidiaries and investment in additional aircraft in prior periods.

EBITDA from Regional One was down marginally by $700,000 or $1 million, excluding the impact of IFRS 16, an increase in high margin lease revenue was more than offset by lower profits on aircraft and engine sales. Manufacturing segment EBITDA was up $1.2 million or 8% to $15.8 million ,however, when excluding the impact of IFRS 16, the segment's EBITDA was down marginally by $600,000 or 4%.

In the second quarter, EBITDA Quest was relatively flat over the prior period. That said, Quest Canada continue to operate at full capacity and delivered their best quarter ever with $8 million in EBITDA. This was offset by anticipated losses at the new Dallas plant, we are prudently moving forward in getting the Dallas plant online as we take the appropriate amount of time to ensure production quality is up to Quest's strict standards.

The balance of the segment collectively continue to experience growth in EBITDA, the segment benefited from an increase in custom manufacturing, high levels of defense spending worldwide, increased spending from telecommunications companies across Canada, and operational efficiencies.

We reported net earnings of $21.9 million or $0.68 per share for the quarter compared to $19.5 million or $0.62 per share in Q2 2018, excluding the impact of IFRS 16, net earnings increased by 13%. We had adjusted net earnings of $26.6 million for the quarter, representing an increase of $1.4 million or 5%, excluding the impact of IFRS 16, adjusted net earnings were up 7%. Adjusted net earnings per share increased 4% to $0.83 compared to $0.80 in Q2 of last year, excluding the impact of adoption of IFRS 16, adjusted net earnings increased 5% to $0.84 per share. Free cash flow which is unaffected by IFRS 16 improved by 12% to $65.7 million or $2.05 per share. Free cash flow less maintenance capital expenditures, improved 16% to $1.8 per share from $0.94 per share in Q2 2018.

It should be noted that the weighted average number of shares outstanding increased by 1% over the prior period, which partially offset to the increase in both adjusted net earnings and free cash flow. Our adjusted net earnings payout ratio and our free cash flow less maintenance capital expenditures payout ratio growth improved despite the negative impact of IFRS 16. Our adjusted net earnings payout ratio improved to 66% from 68%. Our free cash flow less maintenance capital expenditures payout ratio improved to 51% from 58%. As we have noted in previous calls, the trailing 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 to 74% from 77% at the June 30, 2018, while on a free cash flow less maintenance capital expenditure basis it improved to 54% from 64%. The improvement in free cash flow less maintenance capital expenditures payout ratio was driven by 2 separate items. The first was an increase in the cash flow generated by the company, and the second was a decrease in maintenance capital expenditures compared to prior period.

Taking a look at our balance sheet. We ended the quarter with cash equivalents of $33 million and working capital of $320 million. This compares to a cash composition of $43 million and working capital of $301 million at the end of Q2. -- I'm sorry, at the end of 2018.

The change in working capital can be attributed to a few factors, which include the inclusion of the current portion of right-of-use lease liabilities from the adoption of IFRS 16, the payment of the full earn out to the vendors of Quest, seasonality within our airlines and investments made by Regional One in inventory. Our leverage ratios remain within our target range and we have approximately $315 million of available capital, which continues to position us well to take advantage of future growth opportunities as they arise. During the quarter, the corporation exercised its right to call its 7-year at 6% convertible debentures, which were due on March 30, 2021. The redemption of the debentures was completed with cash on hand from the corporation issuance of its March 2019, 5.75% convertible debenture offering. Prior to the redemption date, $24.7 million principal amount of debentures were converted into 780,112 common shares at a price of $31.70 per share.

On April 26, 2019, the remaining outstanding debentures in the principal amount of $3.1 million were redeemed by the corporation. In addition, in the second quarter, the Corporation entered into a interest rate swap with certain members of its lending syndicate, whereby the corporation its fixed interest rates on $190 million of its Canadian credit facility debt for a period of 4 years. That concludes my review of our financial results for the second quarter of 2019.

I will now turn the call back to Mike to provide comments on our outlook for the balance of the year. Mike?

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

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Thanks, Daryl, I would like to comment on the guidance that we previously provided to the market for fiscal 2019. When we reported our 2018 year end results, we communicated that our expectations for 2019 included EBITDA growing between 10% and 15% and adjusted net earnings per share to grow between 8% and 12%.

In addition, we communicated our longer-term guidance that we intend to lower our free cash flow less maintenance capital expenditure payout ratio over the next 3 years to 50%. This guidance does not include the impact of IFRS 16 changes that went into effect in 2019, which resulted in all material leases being shown on the balance sheet. Also our 2019 guidance is based on our existing business today. Any new acquisitions, RFP awards or major capital investments would expectedly generate growth above and beyond our guidance for the year.

For the first 6 months of 2019, our EBITDA is up 17% compared to a year ago or 9% excluding the impact of the adoption of IFRS 16. Our adjusted net earnings per share over this time were up 2% despite the IFRS -- adoption of IFRS 16, excluding this adoption, the adjusted net earnings increased 5% to $1.27. The increase in adjusted net earnings was partially offset by the 1% increase in the weighted average number of shares outstanding compared to 2018.

In short, we're in a good position to meet our guidance. Looking at our outlook for the balance of the year and beyond, our Aerospace & Aviation segment continues to face industry wide labor shortages, which have resulted in continued higher overtime contractor and training costs, the implementation of our Life in Flight pilot program will mitigate the impact moving forward, but will require time to take effect.

We are also developing similar strategies to adjust -- to address maintenance labor challenges. On the subject of Moncton Flight College, we continue to implement the Life in Flight program, we're up and running it will enhance our profitability to MFC and provide a source of well-trained pilots to our airlines. We're pleased to announce that the Force Multiplier, who its inaugural mission and began generating revenue in July, we continue to experience strong demand for the Force Multiplier and additional missions are already booked for the second half of this year.

We are also pleased to announce that Calm Air International was chosen as a successful candidate in the Government of new event medical transfer RFP. Calm Air has been doing this work for the past 30 plus years and we are happy to be able to continue. The contract is in the midst of being finalized that will take affect later this year. In the interim, we continue to operate under the previous contract.

And our newly operational Quest facility in Texas will continue ramp through the balance of the year. Once the full production throughput the additional plant will essentially we have more than doubled Quest production capacity. Well, Darryl had mentioned that there was a delay in getting new facility up and running, it was important for us to ensure the Quest unparalleled production standards were adhered to, this meant taking extra time to get things right and to hire and train the people, and I would point out, that the plant is in full production or in production less than a year after the announcement of the expansion. The team at Quest has done an awesome job, on standing up this plant and we will continue to grow it over the balance of the year and into 2020, and we are really looking forward to showing this plant off to you at our Investor Day later in September.

Going forward, we will continue to make solid investments to enhance future growth. Our acquisition pipeline remains as strong as ever. We don't have anything to report yet, but we continue to look at lots of great opportunities and remain very selective, as we always have. The corporation has made significant strides in the first half of 2019 towards a 3-year goal of a 50% free cash flow less maintenance capital expenditure payout ratio. The increased cash flow generated was the fruit of prudent investments in prior periods. When we announced of our 50% target, we were very clear that we intended to hit this target, while still increasing our dividends to shareholders during the period. We have kept that promise. And as a result of strong current results and investments made in 2019 that will generate cash flows in the future, we are pleased to reward shareholders at the 14th dividend increase EIC's history.

Finally, before moving on to questions, I want to thank all of our stakeholders for their ongoing support. 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 Raveel Afzaal with Canaccord.

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Raveel Afzaal, Canaccord Genuity Corp., Research Division - Analyst [2]

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Congratulations on the commercialization of Force Multiplier. Can you give us some sense of what the economics look like for the second half of this year and how we should be thinking about potential EBITDA contribution from this -- from Force Multiplier for the following year?

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

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Sure. Force Multiplier has been a long-term project of ours and it's exciting to finally get it to the point where it's generating revenue. And it's really a great microcosm of our business strategy. We've invested tens of millions of dollars in this platform because we saw an opportunity and we had to design the aircraft, build the aircraft, get the aircraft certified and then, quite frankly, the process to -- for governments to being able to take advantage of it through procurement was longer than we thought it was -- would take. But now we're through that process, we've flown inaugural flights in Canada, we're in discussions with 3 or 4 other countries for projects in the balance of 2019 and into 2020. And I think you'll see it contributing at a material rate that exceeds our 15% threshold for return on capital. It was really like the switch was turned on in July, when we took the first order.

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Raveel Afzaal, Canaccord Genuity Corp., Research Division - Analyst [4]

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That's helpful. And you've made so many investments in different organic growth initiatives. Can you help quantify those, how -- I'm trying to understand the relationship between net debt that you have right now, and the EBITDA that's going to come from these investments in the future. So can you quantify these investments that you've made so far that have not yet contributed to your results and should start contributing in the second half of this year or 2020?

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

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Thanks, Raveel. That question is, really goes to the core of our growth strategy, where we're investing money in current periods for returns in future periods. When you look at the projects we have underway that haven't contributed anything. And in fact, in some cases, we've incurred losses while we ramp them up. We've got Force Multiplier which has no revenue in the current period. We have -- the partnership we announced with SkyWest where we've got engines in the partnership and airframes from us directly that haven't generated any revenue yet, and will start in Q3, and grow through the next couple of quarters.

We have Quest new production plant. We have the fisheries contract, which we continue to invest in which will be go into service in the second half of next year. And we have the Manitoba government charter services work, which we're doing. In aggregate, the capital that's already in those is well in excess of $125 million that contributed nothing to our earnings. But will contributing cash flows for years and in some cases decades to come as they come into production. And so when you look at our aggregate debt to EBITDA ratio of approximately $3.3 million -- 3.3x, that includes both secured debt and debentures.

When you -- if you exclude the investments that have been made for future earnings that we don't have the earnings yet, that falls to below 3x, which is right out our core level that we like to be at.

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Raveel Afzaal, Canaccord Genuity Corp., Research Division - Analyst [6]

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Super helpful. And just final question for you, can you tell us like about the Quest ramp up, first of all, the new plant, like how much did it contribute in terms of negative EBITDA if you can go into that detail? And then how many employees do you have at the moment in your Dallas facility?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [7]

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The negative contribution would have been in the low single digits, $1 million or $2 million of a loss, as we ramp up. We would currently have approximately 150 employees in the plant. We continue to grow that, we made a decision that we're going to train up the core first group before we add to many more because it's too slow a process when you're training too many people at the same time. So the plant will move from negative contributions to positive contributions through the balance of the year. And I think by early in the next year, you'll see it getting to a kind of more normal run rate maybe by the end of the first quarter. Simple fact is that we announced that plant about a year ago and it's in production, we're super proud of it, and we're well on our way. Like I said, we have approximately 150 employees and that number will continue to grow as the initial employees are trained up to meet Quest's standards.

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Operator [8]

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Your next question comes from the line of Steve Hansen with Raymond James.

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Steven P. Hansen, Raymond James Ltd., Research Division - SVP [9]

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Can you maybe just elaborate a little bit on the new JV announcement in the deployment of the airframes and engines? Just trying to sense for the timeline at which those assets will be deployed, actually think about it over a couple of quarters or they get almost immediately given there is a deal done. Just trying to get a sense of the rollout there?

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Carmele N. Peter, Exchange Income Corporation - President [10]

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Steve, I'll take that question. It's Carmele. So the rollout is going to start this month August and then you will see we got 9 airframes going in and the 14 engines. We're going to see that rollout in about the next 8 or so months. There's modifications that are required to the aircraft for the specific purpose. It is being used by the U.S. operator. So that's why they're going in phases because we send them over these modifications and then they get put in service. So look at it over that period of time.

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Steven P. Hansen, Raymond James Ltd., Research Division - SVP [11]

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Okay, that's helpful. And just on that just sticking to the same venture, just I noted in the release, you've talked about still looking for additional deals, are there additional business -- should we expect that to continue to grow from there into next year in terms of the asset pool size? Or how should we think about the cadence of the rollout after this initial deal here is deployed?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [12]

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Absolutely, Steve. We anticipate putting more assets into the partnership, quite frankly, we didn't expect to have every setting we rolled in at the beginning to be fully spoken for at this point. So we're a little bit ahead of our initial plan. So we're now looking for more assets to put in, and then redeploy in the future. We don't have anything that's imminent. But we're -- between SkyWest and Regional One, we're very actively looking for the right kind of assets that we could redeploy.

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Operator [13]

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

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

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I just want to follow up on, I guess, the investments that you made, you mentioned $125 million in capital for growth that's coming. I just wonder if you can talk about I guess CapEx and maybe working capital investment that's required for the remainder of the year? And just wondering if we've kind of been passed the peak here or there still some additional aircraft you have to buy to support these new contracts?

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

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It's a good question. Thanks, Cameron. In terms of working capital, there are seasonal changes, but there is no material change to working capital with one exception as Quest ramps up, obviously, if you take a facility from zero revenue to ultimately when it matches the Canadian revenue of $100 million it will be an investment in working capital there. That notwithstanding, there should be no material changes in working capital. And I would point out a Regional One they buy and sell things, so you could have a quarter where it pops up and you could have a quarter where it jumps down depending on what assets we sell in that quarter. But in terms of a systematic ongoing investment, there is no expectation of a change in working capital other than Quest.

In terms of assets for the contracts we have, the only contract that we're still working on being fully ready for is the fisheries contract and so there will still be investment in that through probably Q1 of next year, so we're fully deployed. But the balance of everything else we talked about Quest is fully done. The aircraft for Manitoba, the Manitoba charter thing is fully done, and so those are all up and ready to go now, without further investment. I would hope to find something new and exciting to invest at this point, that's our plan. So the investment through the balance of the year should be modest. CapEx -- maintenance CapEx are likely to be slightly higher than last year, simply because of the growth in the business of the timing of some engines that were originally thought to be done early in the year and will be done later on in the year. But even that's not a material difference.

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

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Okay. So just [absent] any new opportunities we should think about growth CapEx in Q3, Q4 being lower than what we saw in the first half of the year, is that fair to say?

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

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Yes.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [18]

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Okay. And just maybe one quick update on the status of the Manitoba government services contract, you've got a piece of that now, but just wondering what the -- about the medevac portion of that -- where that I guess RFP process stands?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [19]

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Yes, the government didn't get all the way through. They had 3 tenders that they put out to privatize the Manitoba government services aviation business. The first was a forest fire fighting contract, which we didn't bid on. We're not in that business, that was awarded first. Then we were awarded the general charter services contract and then they were still working on the medevac one when it's quite clear. Well, there hasn't been a formal call, there is an election coming in September in Manitoba. So that one is not likely to be awarded until post the election, assuming the same government stays in power, I think you'll see them continue with that project and it's always a bad idea for me to estimate how long the government will take to do something, but I believe it's a priority for the government, and I think you'll see something in the first quarter or 2 after the election. Should a different party form government, I have no idea what they will do with that RFP.

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Operator [20]

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

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Navdeep Malik, Industrial Alliance Securities Inc., Research Division - Research Analyst [21]

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I just want to ask first on the backlog at Quest. Could you just maybe comment on how does that backlog split out in terms of -- or do you split out I guess in terms of the Canadian and the U.S. facility or is it -- are you basically operating the 2 facilities to manage business as it comes in or maybe give us a sense of that?

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

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Well, we look at aggregate production capacity when we're looking at taking orders, and so, while we are ramping up the majority of the orders are processed in Canada. Once we get that U.S. facility to serve to full production. We will then tend to move the projects to which one is better equipped for the project. Currently a little over half of our revenues is driven in the U.S., but at the current time as we're ramping up the plant, we don't produce U.S. projects only in the U.S. and Canadian projects only in Canada. Over time, we'll move towards generating most of the projects, we -- country where their -- of origin where they're being sold, but that will take us another year to get to that position.

And then in terms of how we view our overall capacity? One of the biggest mistakes we could make us to take too many orders, and so we're very cautious in what we're putting in there through there in the next number of months as we wrap it and then we've got a little more runway, when you get into 2021 the plant is fully operational.

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Navdeep Malik, Industrial Alliance Securities Inc., Research Division - Research Analyst [23]

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Okay, that's great. And then I also just wanted to ask on the revenue mix at Regional One. Could you just maybe remind us, I mean it's lower sales and service revenue this quarter. But that's kind of the opposite of what it was last quarter. So is there a way that we should think about this segment moving forward? Or it's just the nature of the business in terms of with the period that you're in and what you see in terms of engine sales, part sales, versus lease revenue or is there a better way or any way that we can kind of model it out?

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

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In the heart -- the way -- is the way to look at Regional One you almost have to do it the opposite of the way you look at normal company and most companies you take the revenue and then drive down the EBITDA. In Regional One, our EBITDA is reasonably predictable and as we invest in assets, you see money going into growth you should expect to see subject to a lag the EBITDA growth, our parts revenue is fairly consistent as is our lease revenue, although, there is a seasonality to our lease revenue because some of our assets are deployed with carriers, whose businesses are seasonal. And as a result when they're busier, they're paying more for the lease than they are when they're not busy. So there is a seasonality aspect to that, but the lease revenue is pretty predictable, the parts revenue is pretty predictable. The part that varies quarter-to-quarter and to be honest with you, it's very difficult. We can't forecast it and is when we're going to sell a full aircraft or engines. And that can -- to be clear, we sold as an example, a DASH 8 this quarter, DASH 8-100, which is USD 6 million or USD 7 million asset. We may sell another of those this quarter. And so you can see very big sales as a result of that, but the EBITDA that's generated from those big sales in terms of percentages is always lower than it is on our part sales were at higher.

So when you look at the aggregate margin on that, it's fairly predictable as well. So I'm sorry that I can't give you a good way to get to the top line, but I think the bottom line when you look at EBITDA and compare it to the previous quarter end of the quarter in the previous year is reasonably predictable.

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Operator [25]

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

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David Ocampo, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [26]

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In your prepared remarks you talked a little bit about the ongoing pilot shortage and kind of alluded to the new hours of service regulations. I was just wondering if there would be a hit to margins in 2019 or 2020. Or have you had discussions with your customers kind of pass through those higher costs?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [27]

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I have to answer that in sort of the 2 ways, has there been an impact to our expenses, absolutely there has. But that's already there in spite of that we've been able to increase our margins in the business, part of it through efficiencies, part of it through additional assets we bought in the past, and part of it through higher revenues. So I don't anticipate that you'll see a decline in margins on a go-forward basis as a result of that, because the cost is already in our financial statements. It does increase what we pay the pilots, but quite frankly that's a smaller part of the cost of the training cost. When we will lose pilots more quickly to large airlines, we have to retrain the pilots onto that aircraft type and that could be a $25,000, $30,000, $40,000 cost to re-train a pilot. So it's the movement the pilots that creates the stress not the change and start to see the changes in wages as is an important as is, but it's the -- if you change over and turnover a pilots, that's a bigger driver of cost, and that is already fully reflected.

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David Ocampo, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [28]

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Okay. And just on that, can you remind us on some of the incentives that you're offering Life for Flight program to keep pilots on it?

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

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Yes, the Life in Flight program is aimed at people who want to become a pilot. And so historically, most people want to become a pilot, the training takes a long period of time because it requires buying flight time which is expensive. So most people are doing it on a part-time basis, while they work in other jobs to pay for their training. Life in Flight is a program where you go from never having flown an aircraft to being fully licensed just over a 12-month period.

What we're doing there is we're arranged financing. So the pilots regardless of financial resources to join the program, the financing pays for all the training at the end of the year, they're going to start working for us in training and gaining hours, so they are training other pilots, which is a strange part of aviation. Most businesses trainers are people who have been in the business for a very long time. In aviations, most trainers are new pilots who don't have pilot in command time, so they build that through training.

So they work for us for a fair period of time, as a trainer, following which they have a guaranteed job with us in the airline business, with one of our airlines. And if they stay with us Carmele or Dave, maybe you can help me what the period is at the end of it. They have paid down their loan significantly and then we forgive the balance at the end.

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Carmele N. Peter, Exchange Income Corporation - President [30]

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Approximately $25,000.

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

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So about a quarter of that we forgive and that's if they stay and work with us as a pilot for...

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Carmele N. Peter, Exchange Income Corporation - President [32]

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So approximately in total from the time that they've got their licenses 4 years that includes the time that they're an instructor, as well as the time that they spend with our airlines and of course, the hope is, of course, having been through our system. And we provide mentorship as well that they actually become long-term employees of EIC enjoying our family permanently.

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

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The other piece we're doing with that is we're specifically targeting our customer groups, the [EU] and other First Nations, to try and develop a pilot pool, a people from the community to service the communities. Historically they're underrepresented in the pilot world. And so we're hoping that with this program and the access to the capital, quite frankly at the end of -- if a student comes out of high school at 19, by the time they are through the 4-year period with us and the 1 year of school, so 5 years, about the same time you'd have a university degree, they'd be pretty close to making $100,000 a year and their debt fully paid off, which when you compare that to a graduate with science degree and starting work, you'd be nowhere near the same financial position. And so we think it's going to be attractive to young people coming out of high school who don't see themselves as going to school time.

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Operator [34]

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

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Tim James, TD Securities Equity Research - Research Analyst [35]

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I'm just wondering if you could tell me what the approximate value of assets were that were transferred to inventory at our Regional One in the quarter and year-to-date?

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

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Just give me a second. I've got to come up with that number. The net changed inventory at R1, I think when I look at this, it's I'd just point out, I think it's a U.S. number was about $10 million, which was largely driven by a single aircraft that's being held for resale and we expect to sell in Q3. And then for the full year Carmele, I think that number is

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Carmele N. Peter, Exchange Income Corporation - President [37]

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$16 million.

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

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$16 million, so there was about USD 6 million in the first quarter and about $10 million in the second quarter, the $10 million being largely made up of the, of a single asset for resale.

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Tim James, TD Securities Equity Research - Research Analyst [39]

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Okay. And then just looking at the joint venture here. So the 14 CF34 engines will be leased by the joint venture aero engines that you have a minority interest. But the airframes themselves are getting leased by Regional One and so, yes you will record 100% of that revenue and expenses, is that correct?

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

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That's exactly right. Yes.

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Tim James, TD Securities Equity Research - Research Analyst [41]

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Okay. And then the 3 CRJ700 airframes that were purchased for inventory, which are not part of the lease transaction, were those included in inventory purchases in the second quarter of '19? And then I guess...

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [42]

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There may have been one in the first quarter, I don't have that right in front of me, Tim, but they are included in the purchases in the first or in the second quarter.

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Carmele N. Peter, Exchange Income Corporation - President [43]

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But they're in inventory.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [44]

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But they're in inventory. They're are not fixed assets because we're tearing them apart for sale.

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Operator [45]

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Your next question comes from the line of Nauman Satti with Laurentian Bank.

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Nauman Waqar Satti, Laurentian Bank Securities, Inc., Research Division - Associate of Research [46]

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Yes. So just going back to Regional One, I understand the lease business is doing well. Do you have any idea or if you could guide us, what the duration of your lease assets are? And is that something which is going to grow because of the JV that you have now?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [47]

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Yes, clearly. We -- last year we leased 10 CRJ200's to SkyWest on medium-term leases. We have a balance of CRJ700's and 900's which are medium-term leases and those churn like we -- and we put and stagger they're not all on the same length. Typically those leases would broadened between 1 year and 4 years and we will renew some of them, some of them will come out and be part it out, some of the planes will be solved, but new planes will go into it. So as long as we invest in the maintenance capital expenditures that we have, that lease pool will stay equal. If we put money into grow the capital in the lease program that lease pool would expand. As it relates to the stuff in the joint venture both our airframes and then the engines, where we have a minority interest in, those are 10-year leases. So those are much longer than we typically enter into.

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Nauman Waqar Satti, Laurentian Bank Securities, Inc., Research Division - Associate of Research [48]

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Fair enough. And just going back to the Moncton Flight College, if I understand or I remember correctly, you're expanding the campus. Is that still happening and how is the progress on that front?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [49]

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So we've expanded within our 2 facilities that we have now and they will over the next quarter or 2 or 3 reach capacity. We're now looking for the opportunity to open a third base it would likely be in a different geographic area. Just to give us diversity on the weather having 3 in exactly the same weather increases volatility. And the beauty of that business is the capital intensity is much lower than normal for aviation, the cost of training aircraft is relatively low. The key piece for us is going to be Carmele and Dave White knocking the ball out of the park are Life in Flight program to give me more trainers, the more trainers we have, the faster we could grow that business. The restriction really is human capital, not financial capital.

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Operator [50]

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Your next question comes from the line of Chris Murray with AltaCorp Capital.

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [51]

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We're aggressively looking at it's been a while and this is where we think we'll get to in this initial phase of where we're going from a…

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

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Chris are you with us?

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Christopher Allan Murray, AltaCorp Capital Inc., Research Division - MD of Institutional Research for Diversified Industries & Senior Analyst [53]

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…perspective. And I should clarify when I say leaning out of the organization, really meaning at all is higher level...

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

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Operator, maybe we can move. I think Chris is on another call.

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Operator [55]

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Yes, certainly. Sorry about that. Your next question comes from the line of Kyle Brock with RBC Capital Markets.

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Kyle Brock, RBC Capital Markets, LLC, Research Division - Associate [56]

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This is Kyle on behalf of Derek. Out of $375 million in Quest backlog, what's the timeline on the conversion of that? And is there any risk to meeting the existing obligations if the Dallas facility doesn't ramp as quickly as expected in the second half of the year?

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

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We don't publish the exact breakdown. But it's over the sort of the next 3-year period. We've built into our model the ramp up of Quest and clearly our Toronto plant is running at full capacity now and the Quest plant in Dallas is on track. If there was a catastrophic failure there, it would put pressure on our Toronto plant to keep up, but we're comfortable with the way we've staggered our work. And the interesting thing about Quest that makes it more challenging is, the developers tell us that they're going to need windows in a given period, but they could easily have delays, whether it'd be with getting the appropriate zoning, whether it's giving the site work done and so it's not a precise science. So we're always juggling moving some orders forward, some orders back to meet the needs of our customers, and that will continue now and after the plant being up, but we're in a good position.

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Kyle Brock, RBC Capital Markets, LLC, Research Division - Associate [58]

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Okay. Great. I appreciate the color. And just as a follow-on, are you seeing any wage inflation in the Dallas area given that tight labor conditions?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [59]

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Not really. We expected it, the wage costs are in line with what we anticipated to pay. The cost of acquiring the employees. The upfront cost is a little bit higher because you have to chase harder to get the employees in a really low at 1%-ish unemployment area, but the margins that will generate from the plant are in line with our expectations.

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Operator [60]

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

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Tim James, TD Securities Equity Research - Research Analyst [61]

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Just a very quick follow-up question, I just want to confirm when you think about your return on invested capital and you're kind of 15% rule of thumb or target. Are you using EBIT, is operating earnings the kind of the numerator in that calculation?

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

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Yes. Other than in aviation, it might be, we're taking our EBITDA and subtracting maintenance CapEx. So in some cases maintenance CapEx is higher than the [done]. Some cases it's less. So it's really the way we calculate our payout ratio that we're using. So it's EBITDA minus interest -- pardon me, before interest because we use an unlevered model. So it's a return on aggregate capital as a return -- as opposed to a return on equity.

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Operator [63]

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Your next question comes from the line of Ace Mirali with CIBC.

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [64]

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It's Scott Fromson. I got cut off. So dialed back in. On the topics of decreasing the dividend payout ratio over the next 3 years. Can you talk about where you might cut back on CapEx, assuming there continues to be a timing lag on capital deployment and cash flow returns?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [65]

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I don't. I would suggest that the future reductions are sort of baked into the money we've already deployed, Scott, with you take a $125 million that it's actually a little more than that and employ our typical returns on that and given that some of those investments, Quest in particular, are going to generate higher than 15% returns. The ability to pay -- to reduce the payout ratio was based on investments we've already made. So that's part of the reason...

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [66]

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You're going to cut back at least on the quantum of acquisitions?

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [67]

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No, not really. It means we'll do acquisitions where the returns are sufficient. But we've already got enough investments in the bank that will help us deliver on our 3-year commitment. And quite frankly, when you look at our payout ratio it's gone from 71% in 2017 to 61% last year, to 54% on a trailing 12. So we're making great progress on that and then as the assets come into production, you see a decline in the debt to EBITDA, because the EBITDA naturally goes up. Right now we've got the debt but not the asset. If you were to look at it like an acquisition, most people would pro forma the cash flow from the acquisition. Because it's a CapEx that's not done. And so that's why I tried to give some color on the amount of investment that's been made that doesn't have a return in our statements yet.

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Operator [68]

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And there are no further questions at this time. I turn the call back over to our presenters.

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Michael C. Pyle, Exchange Income Corporation - CEO & Director [69]

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Given that there is no further questions, I'd like to thank everyone for participating in today's call. I look forward to updating you on our progress again next quarter. And we're excited about meeting some of you at our Investor Day in Dallas. Have a great day.

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Operator [70]

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Ladies and gentlemen, this concludes today's conference call. You may now disconnect.