Cargojet Inc.

CargoJet Canada Limited conference call hosted by Mr. A.J. Vimani, which was held on Thursday, May 7, 2020, at 8.30 a.m. Eastern Time. At any time during this conference, please type in your... Good morning, ladies and gentlemen. Welcome to the CargoJet conference call. I will now extend the meeting over to Pauline Dillon. Please go ahead, Mr. Dillon.

Thank you, Operator. Good morning, everyone, and thank you for joining us today on this call for the first quarter of 2020. With me on the call today are A.J. Vermani, our President and Chief Executive Officer, Jamie Porteus, our Chief Commercial Officer, and John Kim, our Chief Financial Officer. After opening remarks about the quarter, we will ask the operator to open the lines for questions. I would like to point out that certain statements on the call, such as those relating to our forecasted revenues, costs, and strategic plans, are forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measures like adjusted EBITDA and adjusted EBITDA. Please refer to our most recent press release, NMDNA, for important assumptions and cautionary statements relating to forward-looking information and for reconciliations of non-GAAP measures to GAAP income. I'm going to turn the call over to A.J. now.

A.J. Thank you, Pauline, and thank you, everybody, for joining us this morning. Before I speak to Cargadget's first quarter performance, I want to take a moment to talk about this once-in-a-lifetime moment we are all living in. COVID-19 has disrupted lives, businesses of billions of people around the globe. Sadly, over 4,300 Canadians have lost their lives. Our hearts go out to the families and their loved ones. As a business that has been declared an essential service We've had the opportunity to be in the center of this fast-changing environment. While I've always been proud of my team, but watching them swing into action and put in place new processes to protect our employees, customers, and cargo in record time and still operate at full capacity has been nothing short of remarkable. CargoJet provided a detailed update on our COVID response in our March 19th press release. We are managing unprecedented volumes, often at short notice and not changes, but our team continues to shine every day, just like thousands of other frontline heroes who are serving our country at this difficult time. We have had a long history of working shoulder to shoulder with the courier, freight forwarders, and postal industries. While everyone is being asked to stay home, frontline delivery workers, postal, courier, employees, and e-commerce delivery personnel are busy delivering essential packages to households, allowing them to safely stay home, allowing us to stay home. Being able to support the vital industry during this pandemic has been a real privilege. I salute each one of the frontline heroes. And now let me turn to the targeted first quarter results. We had a very strong start to the year, with revenue growth of 11.4%, gross margin growth of 52%, and adjusted EBITDA growth of 24.5%. of our business is demonstrating strong operating leverage. While I'm particularly proud of the fact that our growth was not concentrated in just line of business, while domestic overnight held its own, ACMI and all in charter and all of our other businesses posted strong year-over-year growth. With over $29 million in adjusted free cash flow, we posted our best ever quarter in the free cash flow generation. We are well capitalized and have sufficient liquidity to meet our day-to-day future growth needs as we navigate these uncertain times. Moving on to operations, we are experiencing some unexpected surge in business-to-commerce, sorry, business-to-consumers e-commerce volumes. But these are being offset by significant declines in business to business volumes. This is due to the national shutdown of virtually all types of businesses. We expect business to business volumes to come back slowly as the provinces allow businesses to reopen again. As a matter of fact, we have started to see some turnaround in the last one week already. While it is fair to say that nothing prepares you to face a challenge like COVID-19, it is worth noting that our ability to rapidly adapt to the new reality is the result of many years of hard work. We've been putting in place the building blocks of our growth strategy and have allowed us to manage extremely variability in volumes as well as the flight network. The foundation of our business is built in five core strategies that I have mentioned on my previous calls. Number one, build the best overnight cost-effective air network. Number two, maximize fleet and asset utilization. Be relentless about our on-time performance. Build a unique cargo jet culture leading to the best employer in aviation. And last of all, financial discipline to build long-term shareholder value. As we move forward, we will continue to be guided by these priorities. While the long-term implication of the full impact of COVID-19 remains unknown, CargoJet is working hard to adopt to this fast-changing environment and the new norm. We have a great team, strong set of assets, highly flexible fleet, and we are well-capitalized to continue to capture growth opportunities in this changing environment. I want to conclude by once again thanking from the bottom of my heart each and every one of our frontline workers. and I feel privileged to be part of an essential service that are keeping our country's supply chain moving. Once again, thank you for joining us this morning. We'll open the lines for questions at this time.

Thank you. We will now take questions from the telephone lines. If you have a question and you're using the speakerphone, please leave the answer before making your selection. If you have a question, please press star 1 on your telephone keypad. If at any time you wish to answer a question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register for questions. We thank you for your patience. The first question is from David Ocampo with Cormac Securities. Your line is open. Please go ahead.

Good morning, everyone.

Good morning.

AJ, last quarter you kind of indicated that you expected for volumes to pick up in the back half of the year and to sort of end up up mid-single digits. I understand that the pandemic changes everything, but kind of based on what you see today and in your seat, is mid-single digits still achievable?

I think if we look at, like I said, B2B businesses are... were down, but we saw some upward trend in the last one week. B2C is up substantially, and I certainly feel that what you just asked for, like in the mid-single digits, is certainly feasible. And sort of on... Combining all the lines of business.

Right. And on the incremental chart of business that you've been doing, How is the pricing on that, say, versus your base business and even compared to passenger airlines that are completing those charter-only flights?

So the charter demand is extremely high. You know, our first priority is to provide these charters to the government of Canada and some of the provinces who are chartering on their own. Yes, they have a pretty good margin, but we're not into... price gouging or profiteering at this time as some of the other carriers are. We have a fair margin on it, but certainly not to the level where we're taking advantage of the situation that is out there right now.

And this may be a bit early, but we're seeing passenger airlines retire some of their older carriers. older aircraft, notably even 767s. Do you guys take that opportunistic view and look to acquire an aircraft in this environment?

So, yes, a number of airlines are retiring 757s and 767s. We will look at those opportunities as they present themselves because there is going to be quite a few aircraft that will be available in the market that are being retired by these airlines. We We only take on aircraft when we have a use for it. We are always working to add aircraft. If there is demand for it, if we can find customers who are willing to take this aircraft, yes, we will go out and buy them. At this stage, we don't have any plans, but there is also opportunities when these aircraft become available that if they're not to be used as aircraft, they can always be cut up for parts and the engines utilized on our aircraft. So those strategic opportunities we have always taken advantage of, and we're still looking for those in the market.

Thanks. I'll hop back in the queue.

Thanks.

Thank you. The next question is from Doug Taylor with Conoco Genuity.

Yeah, thank you. Good morning. Further to that last question, can you update us on your capital expenditure planning for this year and whether there's been any changes here since your last update in light of the current environment?

We don't have any major changes in the plans that we presented. We have frozen all unnecessary... When I say every capital expenditure is necessary, but I would say defer... Most of the capital expenditures, if we can shift them to the following year or the following quarter, our strategy has been to preserve cash during this crisis, and we are managing that very well. Outside of, as I said, any other opportunities that come along are extremely great, like in terms of acquiring parts or engines or aircraft that can be cut into parts and utilized in our fleet over the next one year or two years. we are open to those opportunities. And so we are not, we haven't changed any of our capital expenditures from where we were at the last time.

Okay. Thank you. You've mentioned in prior calls in your prior update related to COVID-19 that you'd received some relaxation on some maintenance requirements for this year i guess i'll ask you if you can talk about you know the regular scheduled maintenance how far that can be deferred whether or not you know we're going to hit a point where your fleet's just been running flat out for you know for too long and you need to put some aircraft uh you know on the sidelines just to to do regularly scheduled maintenance and things like that or if you can defer you know all of this a whole year

So we're working with Transport Canada just to make sure that, number one, our safety and security of our equipment is paramount to us. So what we're doing is we are, aircraft by aircraft, we are deferring some of the major items that we call our, you know, sea check items that are normally done every two years. So some of them could be deferred. up to 20 to 30% of the total time that it takes. We're not deferring anything that's essential. We're doing it in-house. You know, Transport Canada has also been very vigilant in making sure that any of the safety items that are being done, we do it whenever the aircraft is down. So It's kind of a mix of both. Some items have been deferred and some items are being done early and some items are being done now. So the key is to operate these planes safely and also the domino effect, like you asked, what would happen if we had to take a whole bunch of them out at one point and not have anything to fly? That won't happen because our planning team is at it. They're in touch with Transport Canada almost on a daily basis and any deferment of any major sea checks is conjunction with doing some work early, going along rather than doing it all at once. We're doing some work early, a few weeks late, and there will be some work that will be deferred. But at one point, this will have a domino effect into next year, and those aircraft are also being planned at the same time. So the planning is key to this, and we are hard at it.

Okay, last question for me. You've mentioned the strength in the B2C ACMI charter business, B2B a little bit slower, although starting to potentially come back here. Can you give us, for the benefit of the listeners, can you provide a relative proportion of your revenue that comes from the B2B versus B2C within the core overnight so that we can help understand those countervailing trends?

Well, we don't have kind of a segregation because we don't look into what the customers are shipping in their containers. You know, we get a container to Vancouver, we ship a container to Vancouver. But after speaking to our customers, we've been told and advised and watching the trends that B2B is down but B2C is up. So the net result of us is not that we are down as a result of this. One thing I can tell you, Doug, is that B2C being up means people are now more used to e-commerce solutions rather than going out to the stores. And we think the trend will continue. And that would certainly balance any decline in B2B. And I think, as I mentioned in my previous calls, that we are about 7% to 8% of total retail sales prior to COVID on e-commerce and the rest was all still traditional sales. I can tell you that after talking to many customers, everybody feels that this will certainly enhance and speed up Canada catching up to U.S. where 15 or 16% of the sales are on e-commerce and in Europe and Asia over 20%. So we see that this trend will continue on. As a matter of fact, more Canadians are going to be buying online. And many people that we have talked to have told us that they're now so used to buying at home, sitting at home for the past six weeks, that this trend, they have had a taste of this and they really like this. So we think this would enhance and get us closer to what the U.S. and worldwide percentages are for e-commerce. Thank you, AJ. I'll pass the line. Thanks.

Thank you. The next question is from Cameron Dawkinson with National Bank. Your line is open.

Thanks. Good morning. I wonder if you could just talk a little bit about the Acme business. What are your customers seeing there? I presume they're also pretty busy with e-commerce-related volumes. I'm just wondering if you see any additional opportunities, either flying the existing aircraft on more routes or potentially new routes with your Acme clients.

Yeah, Jamie, you want to answer?

Sorry, how are you? Thanks, Cameron. Sorry, on what customers specifically were you asking?

Yeah, just on the Acme business. I'm just wondering what your customers are seeing as far as volumes. I presume they're also seeing pretty strong volumes today.

Yeah, they are actually very strong and so equally sort of having the same impact on that part of the business as we see in the core overnight where obviously the B2C business is up significantly, B2B down a little bit. One of the things that we've been able to do to take advantage of some of both the ACMI growth and strength and the charter business is through a little bit of a combination of a bit of re-engineering of our domestic network flight schedule and and combined with, as AJ noted, with Transport Canada allowing us to defer some of the heavy maintenance until 2021. And they've allowed us to free up 4, 7, 6, 7, 300 aircraft out of our fleet, two of which we've dedicated to doing relief charters to Shanghai from China back to Canada for the Canadian government and various provincial governments that are literally, since late March, early April, have been flying daily flights from Shanghai back into Canada. The other two aircraft that we freed up, we've been able to add to our ACMI flying with DHL to take advantage of a shortage of capacity between North America and Europe and have been flying some dedicated routes between Cincinnati and the UK initially, and we've just expanded that for another four or five months to Brussels and London.

And do you think, I mean, obviously with an ACMI route, you have to, you know, long-term, you have to add an additional aircraft. But, I mean, do you think some of this business will become more permanent longer term?

I mean, we think so. I think the spike in volume that we've seen right now and certainly the lack of demand has increased yield significantly. You know, all indications are when you listen to, and you guys probably know better than we do in terms of what the passenger industry is going to do, but all indications are that as passenger travel starts to come back, and depending on how many years it takes to do that, I think the last thing to come back is going to be global international passenger traffic. So we think there's going to be a significant reduction in belly cargo capacity as compared to what there was pre-COVID-19, and I think we're well positioned to take advantage of that opportunity.

Okay, excellent. Thanks very much.

Thank you. The next question is from Chris Murray with Altasoft Capital. Your line is open.

Yeah, thanks, Des. Good morning. So just moving maybe on that point, Jamie, can you talk a little bit about, you know, you talk a little bit about volume. Can you talk a little bit about yield and the pricing environment and how much do you think that's going to be longer-term structural with that amount of capacity now permanently out of the market?

Yeah, I think it's going to be significant for a long period of time. I think depending geographically, in terms of international cargo, I think as passenger airline and belly capacity comes back, there's certainly going to be an impact on yields, lowering them a bit. But I think that, as I noted, I think global, I don't know what the percentages are, but if you look at total global air cargo demand, I think it's down by 56, or not demand, capacity is down 50% or 60%. globally because of virtually no passenger aircraft, especially wide-body, long-range aircraft operating around the world, I think that some of that, assuming some of that's going to come back, obviously economically it's cheaper to put cargo in the belly of passenger aircraft than it is on dedicated freighters, but I think there's strong confidence that yields are going to stay, you know, sufficiently high enough to justify cargo operators. There's just not enough cargo operators to meet the demand today, and I think we're going to see that for the next couple of years.

And so how does that, I guess going forward, how does that change your approach to kind of price volume trade-offs? Like, is there a point where you just start pricing higher and keeping capacity down, or do you start maybe increasing capacity and moderating price. How do we think about the trade-off on a go-forward basis?

I think you look at it two ways. I'm speaking specifically more about the international cargo opportunities. I think our domestic net worth pricing is pretty stable. It's contractual, so we don't have a lot of impact on that. Internationally, I think where yields and pricing are at a level now where it makes total sense for dedicated cargo operators like ourselves to take that commercial risk to fly international routes. It depends on how much those yields come down. At level pre-COVID-19, it didn't make economic or commercial sense for somebody like cargo jet to put a scheduled route on at, you know, other than selective basis, like we did, we've done for the last eight or 10 years to Cologne because yields just didn't justify dedicated cargo operations. If you look at, you know, as an example, our Cologne flight today, you know, the yields out of Europe coming back into Canada are probably three to four times what they were pre COVID-19. I don't expect that those would continue long-term, but I don't think they'll go back to pre COVID-19 levels anytime soon.

Okay, fair enough. And then just thinking about maybe potential for growth, you still have the one aircraft, I believe, that's still due September or something like that, out of conversion. Just in your discussions around that aircraft, is that still on schedule? And I guess the other question is, I would have to think the capacity is going to get tight to be able to do conversions. But do you guys have any opportunities, if you wanted to do conversions, Is there capacity with the shops to actually be able to get that done?

Yeah, there is, you know, obviously when you say the capacity is going to get tighter to convert, the Israeli aircraft industry that does conversions in Tel Aviv has also opened a facility in Mexico where they can do two aircraft at a time. I think Yes, there will be a higher demand for the aircraft, but I don't think that it will be an unmanageable conversion situation. We have an aircraft coming in September that will meet our needs and some growth opportunities at the same time. We also have access, if you want at least a bigger aircraft, those are available as well. I think we'll have to, you know, and there are some converted 767s in the market as well. So there will be, you know, aircraft's pricing will decline. I don't know whether the conversion pricing will hold at this time or it will go down. But initially, short term, they'll probably hold and then eventually come down. So I think we're well prepared that within the existing fleet and the next aircraft coming in, we will have sufficient capacity to service the business on hand.

Thanks. Those are all my questions.

Thank you. The next question is from Norman Patsy with Low Engine Bank.

Hi, good morning. Good morning. So my first question is with regards to the demand that you guys can manage. I understand that your flight time per aircraft is less than what the industry practices, but I was just wondering if there is any bottleneck or anything that you guys are concerned about that can sort of hamper this management of this demand.

Well, you know, we're always concerned about the overall economic condition of the world and especially the country. I think that if there is nobody buying any product anywhere, whether it's e-commerce or stores, then obviously we will get impacted at some point. But right now, the way trend is, the way it's looking like, that, you know, there will be people are returning back to normal, Obviously, if you look at the CBC headlines today, which talks about people are being pushed back into normal, which three weeks ago we were told is not normal. So there's obviously a mixed messaging. This will all depend on how the market performs. We think that the e-commerce demand certainly will be, on the domestic side, will definitely be higher. we also feel that international charters and international opportunities will be strong because the passenger airlines have always, or in the past two weeks, whoever has declared results has openly said they don't expect that this will be normal for three years. So if it's not going to be normal, then we know that the white-body aircraft that fly internationally and carry cargo are not going to be doing that, which means cargo aircraft will have higher demand. So in the short term and in the medium term, it certainly looks like that the demand for both the e-commerce and the domestic side and also the international charters is not slowing down.

Fair enough. And if I rightly recall, do you have the option to purchase the aircraft that you guys are releasing in October 2020? Is that something that you still plan on doing, or are you going to continue the lease with them for another three years or so?

No, I think that's a capital lease on that aircraft. We already own that aircraft. The one that we are getting in September, October is already owned by us.

Fair enough. And just if you could provide an update on the pilot... Hiring, I understand you had to hire more pilots because of the... Yeah, so because of the, you know, two reasons.

We started hiring additional pilots because of the pilot fatigue rules coming in December 2020. But also that helped us with additional businesses that additional flying we're doing. And we have been able to hire at least 20 additional pilots at this time And there's a number of them being interviewed and training, which should be able to. So our plan is to, within the next week to two weeks, to have about 40 additional pilots that we will need for two reasons. One is the access flying. One is that we do want a buffer of at least 15 to 20 pilots on hand to mitigate if any of the pilots, unfortunately, test with COVID being positive. We will need to maybe ground two or three or four and put them in quarantine. So we would not have the flexibility of the pilots that we have today. So it's sort of a two-way thing that we're doing. One is to mitigate to make sure that we have enough people on hand if that risk ever arises. And the second part of it is to continue meeting the demand and doing charters that we're doing. So, we are well positioned on that.

James McGarigal Yeah, thank you. That's it for me.

Thank you. The next question is from Walter Sparkling with RBC Capital Markers. Please go ahead, Janice, open.

James McGarigal Hi, everyone. This is James McGarigal. Actually, I'm on for Walter today. Thanks for taking my question.

Thank you. The next question is from Amina DiRegi with Scotiabank. Your line is open.

Please go ahead. Amina DiRegi Hi, this is Amina. Hornax Gupta's associate. I would like to know the progress on your ACMI contracts with DHL and other customers.

So we already have customer contracts for DHL that we are flying into two flights a day into Mexico. We also have four or five flights that cover between Cincinnati and Canada every day. Uh, present DHL flying that we are doing is on an ad hoc basis, uh, into, into Europe, a couple of flights a day. And, uh, those are for a period of time. They're not, uh, they're not long term contracts at the present time. Uh, but I'm sure that there will be some opportunities for us within the DHL system to expand. So, uh, There's not much of an update on it other than at this time we have stepped up for them and we have been able to reconfigure our network to provide capacity to them on two additional flights that are badly needed to Europe.

Thank you.

I don't have any more questions. Thank you. Once again, please press call 1 on your telephone keypad if you have a question. The next question is from Walter Stracklin with RBC Capital Markets, United Japan.

Hey, everyone, can you hear me now? Yeah, yeah. Hey, this is James McGregor. I'm on for Walter. I appreciate you taking my question. So when we're looking at your customer conversation due to COVID-19, are your customers looking to change in any meaningful way the structure of your contract?

No, we have not had any sort of indication from any of the customers to change any of the contractual terms at this time.

Okay, and... With regards to Air Canada's reconfiguration, how do you guys see this affecting your business?

We are actually not seeing any impact to them because they have, keep in mind, they have $800 million of the cargo business that they need to. So they're servicing only a portion of their business by doing what they're doing. As a matter of fact, with them getting into the business, that's taken some pressure off us to do some extra charters for them. our existing customers that we could not, we had to say no to. So they're actually helping us and helping the marketplace and helping everybody in this country to keep the supply chain going. With them converting, keep in mind, they're not full conversions. They're strictly taking the feets out and put the nets in so they can put some more boxes in there. And these boxes are mostly, from what I understand, are for PPE and medical supplies and stuff like that. So not one company can handle the load this country needs. So they are technically trying to maintain their customers and help their customers and help us all at the same time. So we don't see any significant change in our business because of that.

Okay, does that make sense? And on the domestic business, is there going to be any impact to mix due to the new volume that you guys are bringing on in Q1?

No, not really. We don't think that will impact us in any way.

Okay, and my last question here is how can we think about volume and capacity heading into Q2? I know obviously e-commerce is strong. We're seeing a reduced capacity due to the lower passenger aircraft demand. So how does your team viewing the demand outlook in the near term and kind of related to that, how much capacity do you guys have available to meet that demand?

Well, we could, you know, at any given night, I mean, to give you an example, if you're handling half a million pounds from here to Western Canada, we could, at any given night, increase that by 100,000 to 150,000 pounds at a flip-up switch. And we can turn around these aircraft in the mornings again to not maybe get there at 4 or 5 at the destination, but certainly do it by 7, 8 in the morning. So if that was the case, we do have, as I said, we have recruited a number of additional pilots. We do have the capacity to do early morning departures in addition to what we do. We can do an additional flight at night, and we can also, we have all day to turn the aircraft around if there was a demand that needed daytime service as well. So we're well equipped to handle, I would say, on any given night or given during the day, at least 50% of our additional capacity if we needed to.

Awesome. That's it for me. Thank you. Thanks.

We have no questions registered at this time. I'd like to turn the call back to Ms. Pauline Dillon. Please go ahead.

Thank you, everyone, for joining us on the call today. Wishing everyone a safe and happy and healthy day. Thank you. Thank you.

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.

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