Exchange Income Corp
TSX:EIF
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Exchange Income Corp
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Good morning, everyone. Welcome to Exchange Income Corporation's conference call to discuss the financial results for the 3- and 12-month period ended December 31, 2019. The corporation's results, including the MD&A and financial statements were issued on February 20, 2020 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 security 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 laws, 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 of the benefit of the 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.
Thank you, operator, and good morning, everyone. Joining me this morning are Carmele Peter, EIC's President; Darryl Bergman, our CFO; and David White, our EVP of Aviation. 2019 was a great year for EIC as we generated strong financial results and invested in our future. 2019 was the seventh consecutive year of double-digit EBITDA growth for EIC. This performance allowed us to increase our dividend for the 14th time in our history, while reducing our payout ratio. I will leave the detailed analysis of the results to Darryl. But I would like to give a few financial highlights for the full year and for the fourth quarter. Revenue grew 11% to $1.34 billion. EBITDA grew 18% to $329 million. Net earnings grew 18%, while earnings per share grew 15% to $2.58. Adjusted net earnings grew 11%, while adjusted EPS grew 7% to $3.15. Free cash flow less maintenance capital expenditure payout ratio fell to 57%, while the adjusted net earnings payout ratio declined to 71%. Our fourth quarter was equally strong. Revenue grew 15% to $363 million. EBITDA grew 28% to $89 million. Net earnings grew 37%, while EPS grew 25% to $0.74. Adjusted net earnings grew 21%, while adjusted EPS grew 11% to $0.88. Free cash flow less maintenance capital expenditure payout ratio was essentially flat at 52%, while the adjusted net earnings payout ratio improved to 65%. I should point out that both EBITDA and earnings were affected by the implementation of IFRS 16. IFRS 16 serves to increase EBITDA, while reducing earnings and adjusted earnings. It has absolutely no impact on cash flow. The impact of IFRS 16 has been detailed in previous financial periods, and I will not repeat it here, other than to remind listeners of its implementation. EIC has a number of significant achievements in 2019 that contributed to these results and will drive growth in the future as well. Adam and his team followed up the acquisition of Quest of late 2017 and Moncton Flight College in 2018, with the acquisitions of AWI and LV Control in the fourth quarter of 2019. AWI is the first vertical integration acquisition for Quest. AWI is a glazer, who installs Quest products in the Northeastern United States. This will provide Quest customers with a single point of contact for the purchase and installation of product. This matches how Quest operates in Canada. Not only will the acquisition of AWI simplify things for our customers, it will generate returns for Quest on installations as revenues continue to grow in this geography. LV Control is a dominant Western Canadian electrical systems integrator in the agricultural, material handling segment with a strong margin profile. Its services include maintaining grain, uploading elevators, systems to grade grain by quality and put in appropriate silos and automatically updating credit to farmers' accounts while updating inventory positions and financial statements for the grain company. They have a great relationship with many of Canada's grain companies and a track record of profitability. Both acquisitions will strengthen our Manufacturing segment and fuel growth in 2020 and beyond. Our existing operations had a gear of contract renewals and new contract wins. Not only will this fuel growth in 2020 and beyond, it provides great stability for our earnings. While we do have some smaller customer contracts, largely in the mining sector, which are negotiated on an annual basis. We do not have a material aviation contract in North American Aerospace & Aviation segment that expires in either 2020 or 2021. A sample of the new -- renewed, new or expanded contracts include the ramp-up of Canada's Fixed-Wing Search and Rescue program, where PAL will provide in-service support. The new medical passenger transport contract. The significantly expanded Canadian Department of Fisheries contract awarded in 2019 for late 2020 implementation. The government of Manitoba charter services contract and the maritime surveillance contract based at Curacao. You'll also recall that all of new medevac contracts were reviewed in recent periods. Regional One entered into a joint venture with SkyWest, North America's largest regional carrier to lease engines for regional jets. The joint venture subsequently announced that the initial assets of the partnership, at least on a long-term basis to a regional operator -- to a U.S. operator, where Regional One will be leasing the airframes as well. This initial placement will drive returns in the second half of 2020 as the aircraft go into service and beyond. The relationship with SkyWest is expected to provide other opportunities in the future. We also took steps to strengthen our balance sheet and provide liquidity to enable us to move quickly with an opportunity as identified. We completed 2 market fundraisings, a convertible debenture offering in March, replacing a debenture, which it was called by EIC and largely converted into equity, and an offering of common shares in October. Both were very well accepted by the markets, and were over-sold, resulting in the underwriters fully exercising their full over-allotment options. Finally, we increased the size of our syndicated bank facility while reducing interest costs and improving the flexibility of the covenant package. I will leave it to Darryl to detail these initiatives, but I'm pleased to report that in aggregate, these initiatives, together with our strong operating performance has served to reduce leverage while increasing liquidity and access to capital and increasing our earnings on a per share basis. A wager between one of my EIC team members and a friend of his, came to its 10-year end in November of this year. My team member believed that EIC would consistently generated an average all-in return to our shareholders of at least 10%. His friend believed that this was not achievable, given that the TSX as a whole generated only approximately 7% in average returns. When the final calculation was completed, it showed that yes, it had not only generated the return of far higher than the 10% threshold. It, in fact, had a dividend reinvested average annual return of 21%, 3x the average of the TSX generated over the same period. He won his bet, and it was not even close. I decided that the calculations redone as at December 31, in order to make them more readily comparable to the TSX as a whole or other component companies. We calculated the dividend reinvested return to our shareholders for 1 year, 5 years, 10 years and 15 years as well as since our inception. In all of these periods, the return exceeded 21% annually. This is a level of shareholder return that very few can match at a level of consistency that even fewer have achieved. The absolute level of return to the consistency, speak to the success of the EIC model. And I would like to take a moment to discuss 5 reasons why I believe we're able to achieve this. Firstly, we have maintained a consistent long-term strategy since our IPO in 2004. EIC is driven by building a portfolio of strong companies, which will enable the company to provide a reliable, growing dividend to our shareholders. While we invest significant effort in examining and refining our business model each year, we are committed to being an income story. That has enabled us to increase our dividend 14x and maintain a dividend CAGR of 5% since inception. We are a dividend story when income is in vogue in the markets, but we are an income story with growth is what the market desires as well. But our plan to provide a growing dividend, provides growth with income, as is evidenced by our consistent 21% aggregate return. Our shareholders know exactly who we are and what we are trying to achieve. Secondly, we maintain a long-term focus. One of the great challenges of being a publicly traded company is the market's focus on quarter-to-quarter results. We pride ourselves on looking towards the horizon and focus on generating long-term sustainable success rather than simply maximizing our profit in the next quarter. Two quick examples of this strategy in action would be the Force Multiplier program, which required us to invest significant amounts of capital, years before revenues and profits can be proven out. The design, construction and certification took over 2 years to complete, but we are now realizing the benefit of the project. A second example is the slow, measured ramp up of the Quest Dallas facility. A choice was made to ramp its production slowly in order to make sure that the quality of the product matched that from our first plant. This choice meant losses would be incurred during the ramp-up. But the long-term reputation of the company is preserved and, in fact, it has. Third, we believe in a balanced approach to growth, utilizing both acquisition and organic investment. Many people saw EIC or many people view EIC as simply an acquisition company, but that is not correct. Since our inception, we've invested approximately $0.75 billion in our platform acquisitions, while at the same time, investing over $1 billion in tuck-in acquisitions and growth capital into those platforms. We maintain the same expected return threshold for both acquisition and growth capital opportunities, which enables us to grow our subsidiaries and maximize the returns we generate. EIC needs to make sure that we have the capital available to fund the opportunities uncovered by our subsidiaries and any new acquisition opportunities we uncover. The high standard of returns on all investments ensures that growth is accretive on a per share basis and not just growth for the sake of growth. The all-time high EPS and adjusted EPS evidence is fact. Fourth, and perhaps most importantly, culture. We buy strong companies with proven market niches and established management teams. Our culture allows these companies to be led by these management teams who understand the business better than a new owner to possibly understand it. We don't buy broken companies. EIC provides oversight and the capital necessary to implement their business plan. But we do not over -- take over day-to-day management. As a result, our management teams remain motivated and entrepreneurial. We've been able to keep the management teams in place in our subsidiaries for years. Maintaining that knowledge and expertise enables EIC to pursue its diversification strategy that would be absolutely impossible without these talented people. The final driver of our success is social responsibility. There has recently been a significant increase in focus on environmental and social responsibility by the capital markets. EIC has always believed that these matters were fundamental to long-term sustainability of the company, which is why since our inception has been a significant part of what we do and who we are. From funding economic development in the First Nations communities we serve, to providing employment opportunities through programs like Life in Flight, to providing life-changing experiences to First Nations children through our barmer and jet programs or improving our environment by building greener plants, like Quest zero-waste facility in Dallas. Investing in our environment, investing in the communities we serve, investing in the people who are our customers. Our current and future employees may not have immediate results, but consistent with our corporate strategy of a focus on long-term growth, we have a commitment to social and environmental responsibility. Not just today, but yesterday, today and tomorrow. We know it works not only from our financial results, from -- but -- from the quality of people we attract, the companies we are able to buy and the support of our customers. I would now like to turn the call over to Darryl to discuss our 2019 results. Darryl?
Thank you, Mike, and good morning, everyone. Before I present the results, I would like to take a minute to speak to some financial highlights from 2019. 2019 has been a year where we saw many all-time quarterly highs, including in the third quarter, where adjusted net earnings reached a quarterly high of $1.3, which was the first time in the company's history that adjusted net earnings exceeded $1 per share in a quarter. To wrap up the year, EIC reached a new milestone with regards to annual adjusted net earnings per share, where it broke through the $3 threshold, reaching $3.15 per share. 2019, also a year where we demonstrated our ability to maintain a strong balance sheet, with modest leverage and good liquidity to allow us to be ready when opportunities arise. The outcome of transactions in 2019 lends well to our ability to access capital going forward. And at levels, which is the best the company has experienced. In Q4, we entered into a new credit facility that improved our access to available capital by $500 million, inclusive of the accordion feature. While at the same time, providing lower interest on borrowed and unborrowed amounts, increasing allowable leverage from 3.25x to 4x, minimizing security requirements, providing much more flexible covenants and brought new members into our syndicate of lenders that can support growth. Syndication of the facility was materially oversubscribed. The improvement to our credit facility, as we have stated before, does not, in any way, change our approach to our balance sheet strategy, which is a supporting principle of our business model. We take and will continue to take a disciplined approach to our aggregate leverage, which includes both secured debt and convertible debentures and is adjusted for full year impact of acquisitions, keeping it between 2.5 and 3.5x, which we have kept consistent since inception. One of the key tenets of utilizing convertible debentures is managing maturities and retiring these debentures at the first appropriate time. That said, we decided to exercise the right to call the 7-year 6% convertible debentures, which were due on March 31, 2021, and were in the money. The result of this decision was $24.7 million principal amount of debentures that were converted into 780,112 shares at a price of $31.70 per share, with a very small amount of remaining outstanding debentures redeemed. When the debentures were initially issued in February 2014, shares were trading around $21.70. As an overall result, the effect on dilution of equity was approximately 358,000 shares less than if we had decided to elect to issue equity in 2014. We replaced the aforementioned convertible debenture issuance with the new one. The new debentures featured a lower interest rate of 5.75%, and a higher strike price of $49. The offering was oversubscribed, and the underwriters exercised their over-allotment, which brought the gross proceeds to $86.25 million. The proceeds of the offering were used to pay down long-term debt. Looking at the combined impact of the 2 convertible debenture transactions, it resulted in a conversion to common share equity with lower dilution and paid down secured debt, which improved both our liquidity and leverage. In the fourth quarter, in concert with 2 accretive acquisitions, we chose to complete an offering of common shares. The capital raise further reduced leverage and received strong support from the market. The offering was materially oversubscribed, and the underwriters exercised their full allotment option. The gross proceeds of the offering at $37.65 per share was $80.5 million. Before I move on, I should point out that even with the new shares issued as part of the common share offering and the debentures converted earlier in the year, that all of our per share measurements improved. This demonstrates the accretive nature of the use of these funds. Finally, it is worth highlighting another principle that guides our strategy. In Q3, we increased the dividend for the 14th time in company history, solidifying one of the best track records of dividend growth on the TSX. Even with this increase in the dividend, we continue to improve on our payout ratios. Overall, we are very pleased with the outcome of 2019. As I've noted on previous calls, our 2019 financial results include the impacts of IFRS 16, comparability to results from prior periods with respects to EBITDA, net earnings and adjusted net earnings are impacted. Now turning to our financial results. I will initially focus my discussion on our annual results, and then I will continue with a shorter discussion on our 2019 Q4 results. Consolidated fiscal 2019 was another great year for EIC. We generated revenue of $1.3 billion, which is up $138 million or 11% over last year. Aerospace segment revenues increased $91 million and Manufacturing segment revenues increased to $47 million. Aerospace & Aviation segment revenue was up 10% to $975 million. The revenue for the Legacy airlines and Provincial increased by $60 million. Aerospace revenue increased with the deployment of the Force Multiplier aircraft and greater in-service support revenues, as overseas maritime surveillance flying hours increased. The segment also benefited from new revenues coming from long-term contract to provide general transportation support to the judicial system in Manitoba. The Regional One revenue increased in 2019 compared to the prior year by $31 million. Sales and service revenue increased by 12%, which can be attributed to investments made in working capital in prior years. Lease revenue increased by 8% year-over-year despite a customer bankruptcy at the end of the third quarter of 2019. The increase is a result of higher utilization of aircraft and an increase in the number of assets in the portfolio on lease. Notably, the assets related to the joint venture with SkyWest are currently being phased-in and did not contribute in a material way in 2019. The deployment of these assets will be phased in throughout 2020. Turning now to our manufacturing segment. Revenue grew by $47 million over the prior period, benefiting from the commencement of production of the Quest Dallas plant, and continued increases in custom manufacturing and high levels of defense spending. The revenue for this segment was $367 million. Moving to EBITDA. Consolidated EBITDA was $329 million, up 18% or $51 million for the year compared to the prior period. This includes the $6 million onetime bad debt write-off at Regional One because of an airline customer bankruptcy, which decreased EBITDA during this period and the adoption of IFRS 16, which increased EBITDA compared to the prior year. Despite the write-off, EBITDA performance in the year was strong, and EIC was still able to meet guidance provided. This is a further testament to EIC's diversified investment strategy working as intended. EBITDA in the Aerospace & Aviation segment in 2019 was $299 million, an increase of $51 million compared to the prior year. EBITDA generated by the Legacy airlines and Provincial increased by $48 million. The increase in EBITDA for the Legacy airlines and Provincial was driven largely by the same underlying conditions, as noticed -- as noted, with the increased revenue previously discussed. Again, our EBITDA grew despite industry-related challenges, industry-wide labor shortages resulted in continued higher overtime, contractor and training costs. The implementation of the EIC Life in Flight program will help mitigate the impact moving forward, but it's acknowledged that it will require time to take full effect. EIC also now began -- has now also began to implement similar strategies to address maintenance labor challenges. EBITDA from Regional One increased by $4 million over the year -- over the prior year. Excluding the impact of the onetime $6 million bad debt write off, EBITDA increased by $10 million over the prior year. In Manufacturing segment, EBITDA was $56 million, an increase of $4 million compared to the prior year. EBITDA at Quest was lower than the prior year as a result of costs incurred with the ramp-up at the Quest -- at Quest new Dallas facility, where management continues to proceed in a responsible manner, balancing production with important quality requirements and risk management. The balance of the Manufacturing segment collectively experienced growth in EBITDA. Driven by increased revenues and operational efficiencies. Growth capital expenditures made in the current and previous periods, enabled the segment to respond to increased demand from customers, resulting in increased EBITDA. Turning to earnings. Net earnings was $84 million, an increase of $13 million. The adoption of IFRS 16 in 2019 negatively impacted net earnings compared to the 2018 year. Net earnings per share increased by 15% in comparison to the prior period to $2.58. It should be noted that during the year, the weighted average number of shares increased by 3%, partially offsetting the increase on a per share basis, and net earnings, adjusted net earnings and free cash flow. We had adjusted net earnings of $102 million for the 2019 year, representing an increase of $10 million or 11% compared to the prior year. Once again, EIC reached a new milestone with regards to adjusted net earnings per share, seeing it increase to above $3. For 2019, adjusted net earnings per share increased to $3.15 compared to $2.94 last year. In 2019, free cash flow improved by 10% over last year to $246 million or $7.58 per share. The main reason for this increase is the increase in EBITDA and the decrease in current tax expense, partly offset by increased interest costs and principal payments on right-of-use lease liabilities. Free cash flow was impacted by the onetime bad debt write-off, as previously noted. Free cash flow less maintenance capital expenditures per share increased 7% to $3.89 per share from $3.64 per share in the prior year. Growth in adjusted net earnings drove the improvement in adjusted net earnings payout ratio over the year to 71% from 74%. The stronger free cash flow less maintenance capital expenditures compared to the prior year led to an improvement in the free cash flow less maintenance capital expenditures payout ratio to 57% from 60%. In 2019, the corporation announced its intention to reduce the adjusted net earnings and free cash flow less maintenance capital expenditures payout ratios to 60% and 50%, respectively, over the 3-year period. The improvement in both payout ratios this year shows positive progress towards the corporation meeting these goals, and it shows that reaching these targets does not preclude the dividend increases when results warrant. Turning to working capital. During 2019, the corporation invested $45 million in working capital across several entities to support our organic growth, resulting from various contract awards, the ramp-up of Quest Dallas plant and increased operations. During the fourth quarter, the corporation was also affected by a slow payment of receivables from a significant government customer as a result of a cybersecurity breach. Expectations are, for this receivable, to be collected in the first quarter of 2020. Our leverage ratios remain within our target range and within our covenant with lenders. In addition, now with the new credit agreement under our belt, we have access to approximately $580 million of available capital and another $300 million. In addition to that, in an accordion feature, should we choose to exercise it. Now turning to Q4 2019 results. Consolidated Q4 was another good quarter for EIC. We generated revenue of $363 million, which is up $48 million or 15% over the comparative period. Of the increase, $19 million was generated in our Aerospace & Aviation segment and $29 million was in our Manufacturing segment. The primary explanations for financial results and changes in the quarter were largely consistent with drivers for the year-to-date, where there are notable differences, I will provide some further commentary. Aerospace & Aviation segment revenue was up 8% to $253 million for the quarter. The revenue from Legacy airlines and Provincial increased by $21 million over the comparative 3-month period. For Regional One, revenue decreased slightly in the fourth quarter 2019 compared to the prior period by $3 million due to higher-than-average sales of aircraft and engines in the comparative period. Notably, sales of parts are a consistent portion of sales and service revenues and it increased by 17% from the comparative period, helping to offset the lower engine and aircraft sales. Lease revenues at Regional One were down marginally by 2%, the lease revenues in the fourth quarter of 2019 were impacted by the bankruptcy of a customer in the previous quarter. This resulted in some larger assets not being leased. Now turning to our Manufacturing segment. Revenue grew by $29 million for the fourth quarter versus the comparative period. The total revenue for the segment was $111 million. Moving to EBITDA. Consolidated EBITDA was up $19 million or 28% to $89 million for the fourth quarter of 2019 versus the comparative period. EBITDA in the Aerospace & Aviation segment, in the fourth quarter of 2019, was $81 million, an increase of $18 million compared to the prior period. EBITDA generated by the Legacy airlines and Provincial increased by $16 million. EBITDA from Regional One was up slightly in the fourth quarter of 2019 versus the prior period by $1 million. The Manufacturing segment EBITDA was $14 million, an increase of $3 million in the fourth quarter of 2019 versus the prior period. Turning to earnings. Net earnings in the period was also strong, coming in at $25 million, which is an increase of $7 million compared to the prior period. Net earnings per share increased by 25% to $0.74. We had adjusted net earnings of $30 million in the fourth quarter of 2019, representing an increase of $5 million or 21% compared to the prior period. Adjusted net earnings per share increased to $0.88 compared to $0.79 in Q4 of last year. It is also -- it should also be noted that in the period, the weighted average number of shares increased by 8%, partially offsetting the increases on a per share basis in net earnings, adjusted net earnings and free cash flow. During the fourth quarter of 2019, free cash flow improved by 15% over the prior period to $696 million or $2.02 per share. The main reason for this increase is the $19 million or 28% increase in EBITDA in the quarter, partially offset by the principal payment on right-of-use lease assets liabilities. Free cash flow less maintenance capital expenditures improved by 9%. On a per share basis, it is up slightly to $1.09 -- to $1.09 per share from $1.08 per share in Q4 2018 as maintenance capital expenditures were higher in the fourth quarter as a result of certain -- timing of certain aircraft upgrades. Maintenance capital expenditures were up 22% in the fourth quarter, but were in line with expectations for the full year. The higher investment in the fourth quarter simply offsets lower levels earlier in the year. On a quarterly comparative, our adjusted net earnings payout ratio improved to 65% from 69% in the prior year -- prior period, sorry. The free cash flow less maintenance capital expenditures payout ratio was pretty much flat period-over-period at 52% compared to 51%. Subsequent to year-end, we applied and received approval from the TSX with regards to the renewal of our normal course issuer bid for common shares. Before I pass the call back to Mike, I would like to make a couple of concluding comments. First, a general comment. As I come to the end of my first year with EIC, I would like to share how impressed I am with the depth of talent I have met throughout the organization. You just need to turn to what is being achieved over the course of just this year not to mention prior years. It would be very difficult for any organization to achieve what EIC has achieved without some pretty talented people from within. EIC's depth can be attributed to efforts around recognition of internal individual development opportunities and succession planning, equally, as noted within our investment strategy, one of our key parameters in assessing a potential acquisition is strengthened management. This has definitely been a success in adding great value, both in talent and depth. My final comment would be with regards to guidance that Mike will further elaborate on in his subsequent comments. We provide guidance on an annual basis. That said, there are certain conditions throughout any given year that may vary results from quarter-to-quarter, things like seasonality in our Aviation segment, where winter roads provided temporary alternative means to our airlines and affect passenger volumes and cargo. Timing of aircraft and engine overhauls, timing of investments in purchased inventory at R1 and slower lease revenues in certain periods as utilization of aircraft by customers is generally higher in busier summer months. That concludes my review of our financial results and comments. I will now turn the call back to Mike to wrap up. Mike?
Thanks, Darryl. We are excited about 2020. Investments made in previous periods will begin to generate new profits. While our acquisition pipeline is robust, and we examine opportunities for organic growth. We closed 2 acquisitions in late 2019. And as such, some of the opportunities we're examining are nearing the final stage of the process. The capital market in the U.S. remains very liquid. And as a result, purchase multiples are higher than we think are sustainable in the long term and are higher than we are prepared to pay. Our pipeline is strong, however, and we remain a preferred buyer for companies with paternalistic ownership who have reservations of the purchase and resale model of private equity. We currently have opportunities in both of our operating segments, but the larger portion of the transactions under consideration are in our Manufacturing segment. The investments we've made in previous years will bear fruit in 2020. The Quest factory in Dallas will increase production and begin to contribute to the bottom line. The ramp-up of production will climb throughout the year. AWI has performed as expected since its acquisition in Q4, and we'll also grow Quest results in 2020. Investments to Provincial will also kick in, in 2020. The aircraft for the first -- for the fixed-wing search and rescue support contract will begin to be delivered in 2020 and continue for the next 2 years. The revenue for that contract will continue to grow as the aircraft go into service and need to be maintained, although revenue has already begun as we are required to have the infrastructure in place for the first deliveries. The new expanded Fisheries contract goes into effect in the third quarter and will contribute late in the year. The Force Multiplier has completed several missions and discussions with several countries about longer-term deployments are occurring. Investigations developing a second aircraft are also underway. LV Control has performed as expected since its acquisition and will also contribute to our growth in 2020. As a result of these factors and other factors, I am pleased to tell you that we expect EBITDA growth of 10% to 15% in 2020. This will mark the eighth consecutive year of double-digit growth. Maintenance capital expenditures are expected to grow at roughly the same pace as the low end of our EBITDA guidance. This is unchanged from previous information. I should point out, however, that the seasonality of maintenance capital expenditures will be different than in 2019. We have more heavy aircraft overhauls, that's a mouthful, in 2020, which will be completed in the first half of the year. And as such, a much higher proportion of the annual investment will be incurred in the first half of the year. We try to complete this work in the slower winter period in order to maximize our capacity in the busy summer period. This contrasts with 2019 where the significant part of our capital program was engine overhauls, which can be completed at any time during the year as they can be completed without taking the aircraft out of service for more than a day or 2. Given that maintenance capital expenditures are front-end loaded, while growth will ramp through the year, we expect payout ratios will rise in the first 2 quarters before declining in the second half of the year. Before moving on to questions, I'd like to make a quick comment about the coronavirus. EIC is fortunate that we have little exposure to this pandemic. Our exposure is currently limited to MFC, where we train pilots for Chinese airlines. These pilots arrive regularly and stay for approximately 1 year. Should the flow of pilots be interrupted, it would have reduced revenue at MFC. But unless this -- unless the interruption would go on for a prolonged period where current classes of pilots have graduated and no new pilots have replaced them, the impact will not be material. To date, there's been no impact. Finally, before moving on to questions, I want to thank all customers, employees, shareholders and all stakeholders for their ongoing support. We'd now like to open the call to questions. Operator?
[Operator Instructions] And your first question here comes from the line of Mona Nazir with Laurentian Bank.
So my first question just has do with the Manufacturing segment and kind of the root of the lower margin? Is it primarily all due to Quest? And can you just speak about how the ramp-up is progressing, some of the growing pains or why a decision to do a slower ramp? And then I just have a follow-up that -- now that we're into the end of February, how things are sitting now?
Sure. Those fit together pretty well. Quest builds windows for projects. We don't build inventory. And so to a certain extent, every project we do is a custom project. And so we want to make sure when we started rolling this -- the production into our Dallas facility, that we made sure that the product matched what came out of Toronto. And because of -- a delay with our windows delays the whole project. And so we slowly ramp where we get a higher level of testing in Dallas of each production unit until we were confident that it matched the products from Toronto. It actually goes a step further than that. We had to build up the -- we call it, tribal knowledge of our workforce. Because they haven't build certain types of windows. And so each time they do it, it's a complete start from 0. We've seen a material increase in the throughput of production. It continues to grow, and we anticipate by later in the year, the throughput on a per employee basis should be close to matching that in Toronto. As a result, you'll see profitability begin to rise through this year. And you'll see the full impact of it in the second half of the year. As for so far this year, Quest is performing as expected in the first 6 weeks of the year.
Okay. Very helpful. And I know that there's an ongoing pilot shortage, which is further pressurized by new fatigue regulations but aside from that, I'm just wondering, if you could speak about what other areas you are seeing any labor shortages and how things are trending for 2020, do you expect similar pressures?
I'm going to let Dave White, our EVP of the Aviation take that one.
Mona, thanks for the question. And you are on target. As we monitored the pilot challenges over the last couple of years, we've seen increases in other areas, inclusive of the maintenance area with aircraft maintenance engineers. So we're working on a project. We've actually already got some people into the pipeline for similar approach to bring trained and again, experienced engineers through an apprenticeship program that takes about 4 years for licensing to put people into our airlines. This program, which is a little different than the pilots allows us to focus the experience in the airlines as apprentices at the same time that they're doing their training. So that's an initiative that we brought on this year. As well, we use the initiatives. We're lucky to have 9 different independent companies to be able to attract the pipeline from various sources. So we got a good reputation how to run our company. We've been able to hire maintenance people and the different companies reach out to their networks to also bring in more applicants. So we continue to monitor it. There are some pressures in there but we've taken those proactive steps as well as not putting ourselves in a box and saying that's the only solution. We always have to find multiple solutions to the pipeline.
Mona. Just one thing I'd add is we built our Life in Flight program. We built it with a platform that we could leverage so that we easily could address that -- a shortfall that we knew existed on, for instance, the aircraft mechanics so having that platform readily available to address other needs is obviously very useful for us, and that's what we're going to use going forward, not only for that, but other shortages that we see in the industry.
Okay. That's very helpful. And just lastly for me. Mike, you touched on seasonality of CapEx so that in your prepared remarks, I'm just wondering if you could speak about the upcoming year, on what kind of ebbs and flows or variants are you expecting quarter-to-quarter. And just for my confirmation, is it that the annual CapEx shouldn't be too much different than 2019. It's just the quarterly split?
It -- well, we anticipate that as the business grows, the CapEx grow with it. So I'd anticipate maintenance CapEx growth of high single digits to around 10%. But the more material change is the fact that in the first quarter and early second quarter, we have a number of heavy aircraft overhauls where we take aircraft out of service for weeks at a time while they're effectively torn down to their frames and rebuilt. We don't want to do that during the summer and fall seasons where we're very busy. So that get moved forward in the year. And I think you'll see a material increase, particularly in Q1 but also in Q2, versus last year. And then in the back half of the year, you'll see a decline. We had $40 million in maintenance CapEx in Q4 of this year. I don't have Q1 in front of me, but it was materially less than that. And that's not typical for us. It's 2019 that was actually kind of atypical in terms of the breakdown of maintenance CapEx. 2020, we'll return to a sort of a more normal cycle where it's front-end loaded and then reduces as the year goes on.
Your next question comes from the line of Raveel Afzaal with Canaccord.
I'll start off with Quest. Is it possible to quantify the margin impact and ramp-up costs for Quest on your manufacturing divisions 2019 EBITDA?
I'm not sure I want to get that granular with it, Ravi. What I can tell you is that we incurred actual losses in Quest, Dallas, for the first 3 quarters of the year before effectively breaking even in the fourth quarter. But the impact is largely on Toronto, where we effectively put so much stress on our production capacity there to keep up. We have made promises to customers that you have to deliver on time. So that meant we were running projects through on overtime and in less than the most efficient manner. And so that reduced margins, particularly in Q4 in Toronto. You'll see that slowly recover in Q1. And by Q2, I'd expect to see Toronto back to its more normal margin profile and then continued growth in Dallas through the end of the year.
Yes, Ravi, the other thing to consider is we've also -- are investing today to make sure that we have the infrastructure for the kind of large order book that exists. So as production grows, we'll see the absorption grow as well, which will help with margins.
That's very helpful. Just one follow-up on that. What portion of Dallas product are you guys testing now versus, say, in Q3 '19 and how that compares with the Toronto facility, just so we see how that ramp-up is coming along?
Sure. It depends on the product itself. So it's not a precise number, but that Toronto number would be in the low single digits, less than 5% of product is physically tested, whereas in Dallas for -- through Q3, it was 100%. We're now down to about 25%, and we intend to wrap that down here shortly, again, towards single digits. So we're making great progress on that. And I really -- I'm nervous when I talked about this that it comes across as apologetic because it really shouldn't be. It's not. What we want to do, is we have a standard in the marketplace that's given us our $300 million and $400 million order book. We want to maintain that standard. Ramping the facility, the profit in the next 10 minutes isn't material to the value we create with that business. It's no different than with Force Multiplier, where we took the time, got it certified so that all governments around the world can use it. And now we're seeing a great demand. And quite frankly, we're excited about that, as it may mean building another one. But it's the investment in making sure you do it right. And so it's the hard part of being public, where people want to know how you did last in the last 10 minutes, and then extrapolate it. And we're fortunate to have a group of analysts that look at our longer-term prospects. But for us, we want to make sure people know that we're taking the time to do it right.
Makes a lot of sense. And I'd like to speak about Force Multiplier, congratulations. It's been getting a lot of media attention for its work in Mozambique. Can you directionally speak to the split between Provincial's Airline & Aerospace division. I know you guys don't provide it, but any directional help on that would be helpful. And how you expect that to change based on these visible growth drivers for this vertical?
Sure. When we bought it several years ago, the segments were very close to equal between Aviation and the Aerospace. But in the intervening period, we had 2 major things that have grown the Aviation space. So our Air Borealis partnership with the Inuit in Labrador, increased the size of that business. And then the acquisition of Moncton Flight College, which we lumped in with our Aviation as opposed to our Aerospace. Have it today that about 2/3 of power would be in the airlines, and about 1/3 would be in aerospace. But as we move forward, the growth goes the other way with the contracts we've talked a lot. So you'll see the percentage of aerospace grow. And while aviation will continue to grow, we don't anticipate, at least in 2020, it will keep pace with aerospace.
And just one more for me. I mean, your payout ratio remains below your long-term target of 60% to 80% despite these recent dividend increases. Does the Board have a medium-term target that we should be thinking about with respect to additional dividend increases as we look out to 2020 and 2021?
Yes, we're definitely well within our comfort zone in terms of dividend payout ratio. We set a 3-year target for -- to get to 50% on a free cash flow basis, and 60% on an adjusted net earnings basis. And so we've made significant progress towards that. And we will, over the next couple of years, get the rest of the way. But it's important that people understand, this isn't an either/or with dividend increases. You've seen this year that not only did we issue stock, so some people go, that's dilutive. Well, no. The use of proceeds was such so we created more earnings as it's actually accretive. So even with that, and an increase in the number of the monthly dividend, we've been able to pay down the payout ratio. And I think over the next 2 years, you'll see us do both, but working towards that goal of 50% and 60%, respectively.
Your next question comes from the line of Cameron Doerksen from National Bank.
Just want to follow-up on the earlier CapEx question. I mean, we understand the maintenance CapEx going up and the timing there. But you just read through the MD&A, it does sort of sound like growth CapEx expectations for 2020 should be that they would be lower year-over-year, and I guess, firstly, if I got that correct? And secondly, if you are able to win a couple of these contracts that are overbid, the one you've mentioned in Europe and also the medical and medevac. What does that mean for CapEx this year? Or is that more of a 2021 CapEx event?
First of all, if I've led people to believe that maintenance CapEx will go down, that's incorrect. I wouldn't -- CapEx expected to go up by 10%. But what should go down is maintenance CapEx in the second half of the year relative to this year because of the timing and the shift to the first half of the year. As it relates to those major contracts, most of them the possible exception of that would be the Manitoba medevac contract, which is tied into the government's held in a ban. So I suspect that's going to go active again very shortly. And that could go into effect before the end of the year, which would result in some growth investment for that. But the other major opportunities on the Aerospace side, our net -- would be next year and even later than that, investments. Growth CapEx this year, the only real major initiatives we have is the finishing off of the additional aircraft for the Fisheries contract, and we're going to buy a couple of extra aircraft for our aviation business, its growth rate consistently exceeds what we expected to. And to me, do a good job of looking after our customers, we need to add some more aircraft. So we will buy 2 or 3 more aircraft in the Aviation segment.
Okay. So just so I'm clear, I mean, maintenance CapEx goes up, I heard that, but just sort of total CapEx, what should we expect for 2020, absent having to make additional investments for new contract wins?
If there's no new initiatives that are not -- that we don't have today, growth CapEx will decline.
Okay, okay. That's good. That's clear. And just maybe just secondly for me, just talking about the M&A pipeline. You mentioned that on the manufacturing side is where you're seeing more opportunities right now. I'm just wondering, if you could maybe talk about your -- I guess, are there opportunities there that are -- fits with existing manufacturing operations that you have? Or are you looking at new potential verticals here that you might look to invest in?
It's a bit of both. We definitely have a couple of vertical integration opportunities with existing businesses. We find those exciting because once we understand the segment and the management teams in there identify something that they think makes their business stronger, our team puts that to the top of the list, and we do have a couple of those opportunities. And we also are looking at a couple of -- I'm not sure I'd go quite as far as new vertical, but that are -- that would have different customers or slightly different characteristics, but they would all be in that niche specialty Manufacturing segment, where we can explain to you guys when we buy it, what the secret sauce is and why we think this is a great opportunity. So nothing grossly different. But there are a couple that are producing slightly different products that we have today. Again, who knows whether we'll land any of those. And then on the Aviation side, the stuff we're looking at is all directly related to what we do. It may be exactly the same. It'd be a geographical expansion or it could be vertical integration to help us control costs, but there's nothing new and Air Canada doesn't have to worry about us buying an A320 to fly to Las Vegas, we'll stick to what we know.
Your next question comes from the line of Chris Murray with AltaCorp Capital.
A quick question for you. Yesterday, the government of Manitoba started talking about perhaps moving some of the northern airports to some of the local indigenous banks. And I was wondering, with all your operations with Perimeter and Calm, does that create challenges or opportunities for you? Because I know you have a lot of facilities on those sites. I'm thinking also about operational things like fuel facilities and fuel storage. Any thoughts around that, that could see some changes in your business over the next year or 2?
I got to be forthright on this, that we weren't particularly involved in that initiative. So we're still learning exactly what it means. But quite frankly, if it gives the First Nations control over the airports in that area that's probably a good thing. They've got boots on the ground, and they can see what's going on in their individual communities. It's going to require the build off of a significant management infrastructure for them to be able to manage those. And so I suspect this will take a little bit of time. In terms of our business, if we can provide guidance and help, we'll be glad to do so. But I don't think it's going to have much of an impact because those airports are overseen by Transport Canada. Dave, maybe if you've got a comment or 2 on that?
Yes. Well, thanks, Mike. At the end of the day, it is early stages. We just saw the announcement with Toronto. At the end day, the airports are a regulated entity and there's minimum standards that have to be maintained at the airports, regardless of who's in control or owns those. So as far as our carriers going in there, we always look after our responsibilities. We have the same expectations for the airports to be maintained to those responsibilities and which company or organization or corporation, those -- they still have to meet the standards set by Transport Canada to ensure safe operations for the public.
So that was a whole bunch of "we're not sure yet, but we don't think it has a big impact on us."
Yes.
Okay. No, that's fine. It's just -- you're worried about your assets on the ground and stuff like that and who's going to have to pay to maintain those kind of things. I guess, the other question for you...
I don't think that profile is going to change. We're paying for it now and we'll have to pay for it in the future. I think the bigger discussion will be, who's going to pay to maintain the airports because they're typically, right now, owned by the province, maintained by the province, but the MOU implies that it's going to be tripartite between the First Nations, the province and the Feds. And so we'll see.
Mike, I'll just add one thing. We do have assets there, but they are very limited in comparison to what we would have in the major centers, like Winnipeg or Thompson or St. John's. So while we have some assets materially, when you compare it to where we operate, it isn't a great deal of assets there. We'll manage it, but we have to...
They'd largely be freight hangers and fuel farms we would have up north.
Yes, fair enough. And then Mike, just thinking about pay ratio and dividend growth over the next couple of years. I mean, as you kind of alluded to, you're kind of at the bottom end of your range right now. Sure, you're going to -- you've got some time on maintenance CapEx. So take your payout ratios up a little bit, but then you come back in. How do we think about your dividend evolution over the next couple of years. Because as you've already alluded to, a lot of your growth is already prebaked. You've already got a lot of the -- I guess, some pretty good confidence in the fact that, that growth is going to be evident in 2020, and likely 2021, just given the nature of the contracts. Is it something that you want to get these programs into a more mature stage and get some more proving on them before you start wanting to move? Because if I look at it, you're going to end up in the 40s pretty soon, just on a kind of a run rate basis without changing anything.
I think, I'm going to bring you to the Board meeting to help me with these discussions with my Board. But the key thing is that we want to maintain and ensure that we're continuing to grow because sustainability is first, growth is second. But there's one of our investors that regularly says that I'd rather cut off my arm than cut the dividend. And while that's probably not true, it's reasonably close. So the key thing for us is that we want to be able to move it reliably and regularly. And I don't think we need to not grow the dividend to reduce the payout ratio. If you look where we've come over the last 3 or 4 years, we've cut our payout ratios from the 70s to the 50s. And for us to drive it the rest of the way while maintaining modest dividend growth, I think, is entirely achievable. We'll want to see us deliver on what we think we're going to do in Q1, and then we'll take a peak. Our Board discusses payout ratio every quarter. I'm not suggesting that we're making a payout change in Jan -- after Q1. I'm saying that we look at it every quarter. And if we deliver on our plan, we'll do everything to maintain that 5% dividend CAGR we've had for 15 years. We're proud of the fact that we're the only ones on the TSX that have that.
Okay. So there's no thought as you grow to just start changing the range and ratching it back down? Because, I mean, historically, when, you're a trust, you were -- you're like 70 to 80 and it's now sort of 50 to 60. So as you get larger, it's not something to think about like 40 to 50 is the right band?
I think we've talked about getting to 50, I think that's the right stuff. And we will keep you informed if we change it beyond that. But for now, the goal of 50 on the cash flow basis and 60 on the earnings basis are where we're working towards.
Your next question comes from the line of Konark Gupta with Scotiabank.
So let me just dig in a little bit more on the Quest. So you mentioned the taxes broke even in Q4. Just wanted to understand, to be sure, the breakeven level is going to sustain in the first half of this year, and then you will see profits in the second half? Or is that -- do you see a profit ramp-up throughout the year, every quarter?
Are you negotiating on behalf of [ Joe ] down in my Dallas plant? No, we expect them to make money in Q1, but the amount we make will grow as the number of windows processed per day goes up. That's really what drives it , I mean. and the other thing that I don't want to get lost in the wash is something Carmele mentioned a couple of minutes ago, is there's the kind of shift of size that we have from what Quest was to what it is, to what it's going to be, quite frankly, we've invested in infrastructure and head office and people and systems. And so we need to put out more windows to absorb those kind of head office costs, for lack of a better term. So you'll see that get absorbed. Where the bigger improvement will come is when we let Toronto run at more normal rates of capacity as opposed to taking every window out of there we possibly can, and you'll see that subside over the first half of the year. So I guess what I'm saying is, you'll see improvement in each quarter, not -- it won't take until the back half of the year, but it will be more evident as we get later in the year.
Okay. No, that's helpful. And then what do you think about from like -- just for the Texas plant, like when do you anticipate in terms of timing, the steady-state margin to be reached? Will that be something like next year, or could be the year after?
No, I think towards the end of this year or the beginning of next year, we should be there. Now I caution the word about steady state because, quite frankly, I'm more aggressive than that. We built 330,000 square feet. So we've kind of talked to our Quest guys about 2 things. When does Dallas become Toronto, because Toronto is operating out of 200,000 square feet. But we're -- I don't -- we didn't build 330,000 to build 200,000 square feet worth of product. So I expect further ramp-ups. We may add pieces of equipment in the future, and that's probably 2021 by the time we get to that. And then quite frankly, the Toronto plant is in 2 buildings in -- which are both leased which the leases expire in 3 years. The next phase of this is to put Toronto into one building and do that. So that's probably -- that's 3 years from now. So steady state will refer for a short period of time. But as long as the market demand is where we've seen it so far. We anticipate further growth.
Okay. And then you mentioned Toronto lease expiring in 3 years, right? And so I mean, is there any kind of evaluation to kind of move the plant before 3 years? Or you want to wait until the lease expires on that?
Yes, by the time something -- the size of building we need, Konark, is probably going to have to be built. Never say never. So it's likely that it's at the expiry of those leases. And then how we would dovetail production, there's a whole bunch of work that isn't finished yet about how we will do this because what we don't want to do is take a plant out of production and put the stress on Dallas that we've put on Toronto, while Dallas is wrapped up. So we'll keep you guys informed in future quarters as to how that plan's coming. And you'd see it's baby steps phases right now. The most important thing to us is getting our Dallas plant cooking. Some of you have had the opportunity to see it. It's a very impressive place. And I'm pretty confident on what we can kick out of that place.
Okay. No, that's great. And then on the Regional One. So can you remind us where are you on SkyWest deal at this point? On like how many aircraft and engines are waiting to be placed and then any similar opportunities like SkyWest that's cooking right now?
Sure. So when we did the joint venture with SkyWest, there was 14 engines that were placed in the joint venture. All of those are under contract to be leased together with 10 of our airframes that Regional One has on its own. We announced shortly after the formation of the joint venture that everything that we have were being leased to a U.S. operator. And that they were going to be on lease or going into lease in phases starting in Q4 of 2019. And then continuing on for the first half of the year. So that for the second half of 2020, they should all be unleased. That's still as per plan. I believe we had 4 of our airframes going into lease in Q4 of 2019, the balance will be this year. With respect to additional opportunities with SkyWest, yes, we're looking to transfer additional assets into that joint venture for leasing to the same program that the current assets are going on lease for and in relation to similar opportunities like a SkyWest joint venture, yes, we have arrangements whereby we have jointly invested in assets where Regional One uses its management capabilities to leverage their know-how. And in fact, under that -- those arrangements, we have over $100 million of assets under management.
Okay. No, that's great. And then lastly on the Legacy airlines. So any contract renegotiations that could happen over time that you're looking at? And any new bidding opportunities, you mentioned, obviously, one of the medevac flight? But anything else beyond those?
This is the most fun answer. No, there's nothing I have to renegotiate. We have small, little things here and there with a specific mine or things like that. But in terms of our big picture contracts, no, they're all in place for the foreseeable future. We're excited about the opportunity with the Manitoba provincial government, but so are some of our competitors. So we'll work hard to win that when the opportunity is there. But outside of that, there really isn't a lot going on in the Legacy other than looking after our customers and doing a good job.
Okay. And on the fuel surcharge, Mike, any sense on the recent volatility in fuel price. Obviously, it's been down. Any adjustments that you need to make or you have made already?
We think our fuel prices are largely in line. When they bumped up a few weeks ago, several weeks ago, we were getting close to the point where we wanted -- would have considered putting on a fuel surcharge. But again, we are -- because of the nature of who we're serving in our First Nations, we want to make sure that we need to put the fuel surcharge on before we do. And so patience paid off, the fuel surcharge is about right for now. If fuel prices change, we'll adapt in the future. But for now, we're in the right spot.
Your next question comes from the line of Tim James with TD Securities.
Just back to Quest, just want to confirm the reference in your report to relatively flat EBITDA there relative to the prior period, which I assume means Q4 of '18. Is that reference include any contribution that would have come in the quarter from AWI? I realize that was probably -- relatively immaterial. But was it at least sort of a positive contributor?
Yes, in aggregate, including AWI, it was about flat. On its own, it was down. And that's, again, because of the factors I've mentioned before. A rough breakeven in Dallas, combined with lower margins in Toronto because of how fast we were running it and the extra infrastructure built to facilitate Dallas. So that was offset somewhat by the profits in AWI.
Okay. Okay. And then turning to Regional One. The reference to investing $6.6 million in inventory through the year, I just want to confirm that's a net number or another way of thinking about that is that inventory went up by $6.6 million, the balance, the year-end balance relative to the end of 2018. Is that correct?
That's exactly the way to look at it. Inventory at R1 is -- it moves every day. We're constantly selling stuff. We're buying pools of inventory, and we're parting out some of our own planes. So it goes in and out. So we talk about those things. Our investment there is really 3 things. It's the net investment in inventory after the cost of sales go through and how we've replaced it. It's maintenance capital, which maintains the aircraft in the lease fleet and then if any amount invested in excess of maintenance to grow the lease fleet. So those are the 3 numbers. When you look at the inventory, it was relatively flat at $6 million. That -- the sale of one engine or one airframe could spin that. So it will bounce around like that forever.
Okay. And then my final question, more of a big picture question. As Exchange continues to grow, are there any sort of the smaller businesses that you would contemplate selling as maybe their size doesn't justify the ownership? And I'm not asking for specific names of businesses. I'm just wondering if your ideal and optimal average investment size is changing at all.
In terms of new investment, you couldn't be more right. I mean, we aren't buying things that make $3 million or $4 million anymore, unless we're folding them into a business that we already have. We still do tuck-in things. But in terms of stand-alone businesses, we do have some that we wouldn't buy today, but we understand those businesses pretty well. And we've got great management teams in place. So there's no pressing requirement to make any changes. Quite frankly, I view it as all of our stuff, well, they're not quite children, they might be stepchildren, then we have to have quite a good buy offer to sell them. And the smaller ones are the same. We know them. There's no great need to sell them. Quite frankly, part of our secret sauce is vendors knowing that we buy the whole. And so I hold that reputation pretty close to me. We would sell a business if the offer is right, but the offer would have to be right.
And I'm showing no further questions at this time. I will turn the call back over to Mike Pyle for concluding remarks.
Thank you, everybody, for joining us today. We're excited about what's coming up in 2020. I look forward to talking to you in May. Have a great day.
And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.