Cargojet Inc.

Good day and welcome to the CargoJet conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Pauline Dillon. Please go ahead.

Good morning, everyone, and thank you for joining us today on this call. With me at the office are Jamie Porteus, our Chief Commercial Officer, and John Kim, our Chief Financial Officer. A.J. Vermani, our President and Chief Executive Officer, is joining us remotely. After opening remarks about the corridor, we will open the call for questions. I would like to point out that certain statements made on this call, such as those relating to our forecasted revenues, costs, strategic plans, and forward-looking within the meaning of applicable securities laws. This call also includes references to non-GAAP measures like adjusted EBITDA and adjusted EBITAR. Please refer to our most recent press release and MD&A for important assumptions and cautionary statements relating to forward-looking information and recommendations of non-GAAP measures to GAAP income. I'll now turn over the call to Ajay.

Thank you, Pauline, and thank you everyone for joining us this morning. 2020 has been a year for the history books in many ways. When I first talked about the pandemic at our Q1 earnings calls, there was a very high degree of anxiety, shortage of PPEs, COVID cases were rapidly rising, and the world was literally on the edge. Eight months later, as the winter approaches, the case count is on the rise again. but we have learned a great deal. We are better prepared on PPEs. Medical professionals and scientists have developed better treatments for these serious outcomes, and as human beings, we have developed personal safety protocols and survival skills. We have changed many of our day-to-day habits, including our shopping habits. There has been many acts of kindness, and we have come together as a community to help each other. I continue to be amazed by the human spirit, and I want to thank everyone who is making a difference and is serving in the front lines to keep our economy going. Now, turning to our third quarter results, we continue to benefit from the strong tailwinds of e-commerce fueled by the work-from-home culture. While the initial surge in volumes was driven by temporary change in consumer behavior, We are now seeing structural changes in the retail industry that is shifting investment and resources from bricks and mortar stores to digital e-commerce at a much larger scale. E-commerce as a percentage of overall retails has gone up from around 7% to well over 11% in Canada. The trend in U.S. and U.K. markets is even steeper, touching nearly 30%. The prolonged pandemic has forced virtually all retailers to deploy resources towards digital commerce, and we expect Canada to follow U.S. and U.K. trajectory. The implications for the shipping and logistic industry means two to three times increase in volumes over the next three to five years as we see a strong comeback of B2C business and B2C remaining strong. This trend was clearly visible in our revenue growth of 38% in third quarter and strong growth in our domestic overnight network and continued strength in our ACI segment. While quarter-on-quarter growth of our charter business was somewhat slower compared to last quarter, this was expected due to fewer PPE shipments from China and other parts of the world, and the governments have been shipping enough inventories on hand for the time being. Having enough inventories on hand for the time being, we posted a strong growth over prior year in our charter business. All of our key metrics on revenue, gross margin, and EBITDA continue to show strong growth and demonstrate the operating leverage of our business model. Adjusted EPS for the third quarter was 1.72 compared to 0.09 for the prior year. With back-to-back strong quarters, CargoJet generated $59.3 million in adjusted free cash flow during Q3 and $144.8 million year-to-date, allowing us to further reduce our overall leveraged to approximately 2.1 times 12 months trailing EVITAR. We are also continuing to invest in growth opportunities while prudently strengthening our balance sheet with an overall reduction of $92 million in net debt on a year-to-year basis. Moving on to operations, the number one priority for us remains the health and safety of our employees. We have been operating at our nearest peak volumes for the past previous months. This means our teams are working extremely hard to keep the supply chains moving safely and securely, especially as the weather gets colder. But with the holiday season on the horizon, we are deploying additional resources to make sure that we deliver the peak season safely and on time for all of our customers. We continue to provide the best in PPE medical advice along with enhanced sanitization measures to our team. Our increased fleet and asset utilization continue to demonstrate additional operating leverage as demonstrated in improved margins. We took delivery of a Boeing 737-300 last month and are in the process of deploying an additional aircraft in the fourth quarter to support peak volumes. One thing that has clearly differentiated is our people. We are so incredibly proud of each one of our team members on a daily basis. We see stories of heroic effort every night from ramp maintenance or pilots who are going well beyond the call of duty and operating safely to serve our customers during these challenging times. We are closely monitoring the changing shipping habits shipping and shopping habits, trends in the domestic and international market, and spending the necessary time to understand and adapt to these dynamics. As we have noticed, the wide-body passenger business is still ways and years away from becoming normal. This also opens up opportunities in the international shipping arena as well. While we face some uncertain climate in the near future, we believe the key to success will be resilience and adaptability. We have now diversified into not only charters that are a big part of our business, but also ACMI that has helped us reduce our dependence on domestic overnight business. Let me say this, that we are all positioned to handle the changing transportation and logistics landscape. We have a great team, strong set of assets, a highly flexible fleet, and we are well capitalized to continue to capture growth opportunities in this changing environment. We have positioned ourselves with over $600 million of liquidity in case the economy runs soft on us. Once again, thank you for joining us this morning, and we will open the call to questions now.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question, and we will pause for just a moment to allow everyone an opportunity to signal. And our first question comes from Mona Nazir with Lauren Branch. Please go ahead.

Good morning. Congratulations on the quarter, and thank you for taking my questions. Good morning. Good morning. So in your outlook, or in your commentary at least, you stated that you are focused on ensuring strong long-term growth in the ACMI and charter business, and then you even just touched on your diversification into those two areas. I'm just wondering if you could speak a little bit more about that and how it's shifted for more ad hoc short-term demand and what kind of visibility do you have into the next quarter and even 2021?

Well, I think as our domestic gets stronger, our other businesses are also getting stronger. So if you're deploying more plane on domestic overnight, that gives us additional flexibility of fleet during the weekend, during the days. So what that shows is that, you know, with domestic, obviously which has been of a core and still is one of the core businesses, as that demand grows, we can certainly look at utilizing the same assets over the weekend and during the days to do the charters and some ACMI work. And the second part of it is the ACMI business. We are now operating... three flights to Mexico, a day out of U.S. We're operating a daily flight to Bermuda and New York. We are operating a weekly flight into Havana. We are operating two of our own flights into Cologne. And we continue to grow that ACMI segment business because we feel that there is a lot of opportunity that exists not only in Canada but also across the border where we have some licenses that allow us to fly to another third country from the U.S., not within the U.S., but out of the U.S. And that part of the business is strictly growing because the integrators are not now going to depend on for at least the next three to five years on commercial lift by passenger carriers coming back because the confidence in flying 777s and 787s for passengers is very low at the moment. And even if it takes three to five years of that recovery, that leaves a big gap and hole in cargo that was being traditionally shipped on passenger aircraft. So that lift needs to be replaced, and that's where we see we have grown in the ECMI business, and we will continue to make strides in that.

Perfect. That's great, Paula. Thank you. And just lastly for me, I mean, you've seen tremendous growth over the last nine months. I'm just wondering if you could provide some insight into how you've been coping to meet increased demand and really where any potential bottlenecks bottlenecks exist or you need to make further investments, if at all? Thank you.

Well, the investments, I mean, how we've been able to cope is trying our best to keep our people safe. You know, we have the challenges of the PPEs are much better now, like availability, and we've been stockpiling because we can never depend on the marketplace and the governments to supply us with that. So that has been our biggest challenge to keeping our team and resources ongoing. We have hired additional, I would say in the past six months or so, over 300 employees that were available from other airlines because of the layoffs in the aviation sector. So we were fortunate to find great people to work on a short notice and The learning curve was also not as long. So those resources were hired recently. We have then added a couple of planes in the past. The one which we had converted on SPAC would have been a spare plane, so that's been put in use already, and there's another one on the way. So besides that, we have also looked at our ground support equipment, and we have made a significant investment to make sure that while these flights land and these flights are there, that they're not waiting to be offloaded. So, you know, stuff like loaders, for example, is a very simple thing, but you need operators to load those, operate those loaders. So there's not been an area, including expanding our facilities. Like in Edmonton, we are building a 10,000-square-foot, you know, portable temporary shed to accommodate the growth. So those are some of the examples that we are going to... and we're making sure that all hands are on deck and any resource that is needed to make sure to handle the growth is being handled. But our biggest challenge still remains, as you asked me, is to keeping our people safe and making sure that they don't become victims of the ongoing pandemic.

Thank you. That's it from me.

Thank you. Our next question comes from David Ocampo with Cormark Securities. Please go ahead, sir.

Good morning, AJ. Just building on Mona's last question there, but I want to focus more on the domestic side of the business. Historically, you guys have pointed that your sort of base fleet from, say, 2019 was able to grow volumes up that 4% to 5% range. And obviously, you guys have added a bit more aircraft here. So I was just wondering how should we think about future volume growth on the domestic side of the business and what changes have you made to sort of your fleet schedule that can make you extract a little bit more on the volume growth side?

I'll just take this question and then I'll get Jamie to address it in a second. Well, the business on domestic side remains solid and strong. At the end of the first quarter and the beginning of the second quarter, we saw some slowness in the domestic side of the business, which was the B2B business because most of the businesses started closing down. And that trend shifted to business-to-commerce customers where there were smaller packages and residential deliveries. It doesn't make a difference to us whether it's 10 small packages or one big package is. But we saw that trend, and now we've also seen lately that as business is open, the business segment also picked up, and hence we saw some tremendous growth on the domestic side of the business. So that's a big part of our business. We continue to focus on that as much as it needs, and I think that business sector will continue to grow as more businesses People buy online and more people stay at home working so that the supplies are shipped to them at home. So, Jamie, you want to add something to that?

Sure, AJ. Good morning, David. Yeah, just to add to AJ's comments, and the other benefit that we have, as we've noted in previous quarters, is increased utilization of our existing aircraft assets, particularly on the domestic network. With the growth, particularly the growth of e-commerce, it's allowing us to add additional flights as we've added a Saturday flight earlier in September, October timeframe to meet the demand of that e-commerce volumes. We're running two flights a week now for the last several months, two flights a Sunday for the last several months, utilizing existing aircraft that were operating during the overnight, primarily on the business nights during the week. E-commerce, Again, as we saw in October with Amazon's Prime Week that was delayed from July until October, we were able to handle those significant increases in volumes by utilizing aircraft during the day without having to bring in additional capacity. So a combination of, as Adrian noted, we have two other aircraft that are coming, one that just came into the fleet at the end of September, one that's literally coming online early next week that will give us additional overnight capacity, but then will contain the additional e-commerce volume on weekends and during the day and You may have noted yesterday, some of you probably saw PureLater's press release indicating that they were expecting a 20% increase in volumes in the holiday season this year. In the last couple of weeks, I've seen similar commentary from our other customers, whether it's UPS or FedEx, all predicting record peaks, not to mention Amazon with significant double-digit growth. So we think we're well-positioned in terms of capacity to handle it.

Yeah, you just took my next question, Jamie, but perhaps if we see volumes continue at this rate and at this clip, I mean, for Q3, the domestic side was up 18% year over year, and you guys deferred some heavy maintenance. If the demand is there, can you guys meet that looking into next year? Is that the right way to think about it?

Yeah, we don't see an issue with the, I mean, consistent, although the volumes obviously are heavier than what we had predicted a year or so ago for the last, I think we've been consistent in the last couple of years saying that we didn't think we would need to add necessarily another aircraft to the domestic fleet to meet the, particularly the B2C e-commerce growth. You know, that's changed a little bit, but with the aircraft that we brought online, we're confident that we have enough capacity for the domestic network, at least for 2021. And we continue to pursue and look for other aircraft because, as we've noted before, there are other opportunities, not just on the domestic, but on the ACMI side of the business that we think we may be able to take advantage of.

And last one for me here, just more on maintenance questions. How should we be thinking about CapEx as we head into 2021?

It's John. I can take that question, AJ. Yeah, go ahead. With the delivery of the last 767-300 this year, that brings us to about 150 million of CapEx for the full year. We are looking at potentially buying some additional feedstock and engines So that may bring us up to about 190 for the full year because we want to be well positioned because we want to put more aircraft into conversion. So of that 190, the additional in Q4, about 50 to 60 of that will be lease debt. So it's the last aircraft that's being delivered as we speak. That's on a finance lease. And then we've extended, you'll notice in our In our fleet plan in the MD&A, we've extended the one operating lease that we have on the 767-200. That's a two-year extension. We'll probably throw up about $10 million to $12 million Canadian as lease debt. And then we don't have any other acquisitions, new CapEx plan for next year other than maintenance.

Okay. That's it for me. Thanks, guys.

Thank you. Our next question comes from Konar Gupta with Scotiabank. Please go ahead.

Thanks, and good morning, everyone. Congrats on a great quarter. So just maybe first one on the margin. So looking at the EBDA margins, they took a big jump in Q2 and expanded further in Q3. I'm guessing that's ACMI in the mix that probably expanded the margin sequentially in Q3. But do you see further margin expansion in Q4 sequentially as utilization typically increases in Q4?

I don't think we're going to see a big jump in Q4 on the margins on that side because obviously when we add routes and when we add and get more business, you know, obviously – the pricing is going to get adjusted. As you know, in quarter two, there was not a lot of wide-body lift available outside, so that resulted in a lot of ACMI revenue. And in quarter three, we saw some of the lift come back, so the price of the charters that were sky-high in quarter two and beginning of quarter three, they kind of declined and became more realistic as Internationally, keep in mind, yes, we compete with the passenger side of the business that is non-existent or is very little right now, but also people have been stockpiling with ocean freight and surface transportation so that they don't have to spend a lot of expensive air. So while everybody was caught with no PPEs at all, that's why the air margins were so high, and we have seen steadily decline and more realistic levels of margins. So I don't think that we'll see a big expansion in quarter four for the margins.

Okay, and if we can just go forward to 2021 in modeling out these margins. So, I mean, this year has been a pretty big jump in margins, clearly. But what are the various puts and takes you would point out for us to consider when modeling out these margins in the next year or so? I mean, margins are at a new normal level, would you say, that sustains or builds up from here? Or do you expect them to normalize somewhere between 2019 and 2020 levels?

Yeah, I would say that's a better way of saying that they will, depending on how quick the vaccine comes in, for example, if you're shipping vaccine, which we're ready to do, obviously there's going to be some higher margin business because it requires a lot of specialized handling business. So I would consider that sort of a normal day-to-day business. But depending on how quickly the passenger side of the business recovers. A lot of airlines and IATA is calling for three to five-year recovery. And if that three to five-year recovery is a gradual step-by-step recovery, I would say that your estimate or your comment about somewhere between 2019 and 2020 would be a good starting point to look at towards normalization of margins.

Thanks. And then perhaps on the domestic side, if you look at the pricing, so I'm looking at volume growth in domestic. It's been faster than revenue growth in the last two quarters, which suggests obviously overall pricing has softened a bit. So I'm just trying to understand if you can provide any color as to why pricing mix or pricing overall would be softer and deviating from CPI like inflation? I mean, is it spot versus the contract mix? Is it the B2B versus B2C mix? Or is it fuel playing into that pricing weakness?

Yeah, I think the fuel plays a big part into it. And that kind of brings the whole margins down on the domestic side. Definitely.

Okay, thanks. And last one for me. On the fleet side, so I see you have extended the lease on 767, and I think you have acquired a few aircraft recently as well. Now, I understand your point on you don't need much more capacity to be added in domestic for the next year or so. But given the opportunities you pointed out in charter and ACMI, if you need to add another fleet, a few dedicated aircraft for ACMI. What are your options at this point? I'm like, are you looking externally? If so, is there enough capacity and, you know, you might get aircraft on time? Or are you looking internally? You have maybe a couple aircraft that are placed with third parties. Would you like to internalize them? Or how are you thinking about that?

Well, actually, you know, we do, we are reviewing three aircraft for acquisition for ACMI. 2021, and if at all, they should be converted by third quarter of 2021. So we do have tentative offers out there subject to due diligence on at least three aircraft right now at the present time. But obviously, there's a lot of record checking that goes on when you buy an aircraft. So those aircraft are probably going to help us with our growth on ACMI charters and also somewhat of domestic as well. On the domestic growth, as Jamie had pointed out, we have the ability, we have the crews and infrastructure to turn these aircraft around. For example, if an aircraft lands in Western Canada or coming back from Western Canada, we land at 3 or 4 in the morning, we have the ability to turn it around at 5 o'clock in the morning and be in Vancouver for 7 o'clock the same day. So not everything is required at 4 or 5 in the morning, so you can have a second tier sort of delivery around 6.30, 7.30 in the morning to keep up if the demand continues to grow on the domestic side as well.

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

Thank you. Our next question comes from Walter Spracklin with RBC Capital Markets. Please go ahead.

Yeah, thanks very much. Good morning, everyone. Good morning, Walter. Good morning, Walter. So when I look at the ACMI at 37 million in the third quarter, you booked a couple, I think you said, at least two new contracts late in the quarter. What is roughly the exit rate on your quarterly, roughly this quarterly cadence on the exit rate out of Q3 from the contracts that you already have in place?

I can answer that, AJ. So we had a full quarter in Q3 of the two additional routes that we added earlier this year, Walter, you know, the ones to Europe. So I think by adding, and so Q3 is a good run rate for sort of the new ACMI routes that we started earlier this year. We've added one more route at the end of September. So incrementally in Q4, you should see the effect of that one route for the entire quarter. And like the guidance that we gave on the other Mexican routes, somewhere around 10 million annualized ACMI. So that's what you should expect for Q4. So an additional 10 million on top of the 7. Yeah. So if you take our Q3 as a run rate, another 10 million per year when we add another route. Right. Got it. So 2 to 3 billion on top of what we had in Q3 and Q4.

Yeah, just be aware that in 2021, we are going to enjoy some premium pricing in quarter three and quarter four, Walter, for ACMI, just because of the peak and lack of availability. But coming back to quarter one, 2021, you know, the premium pricing that we have for ACMI is going to come down by at least 15% or so on average, so. While we enjoy those because of the peak period, it will normalize in 2021. In 2021.

And then back up again, you said as you go in the peak of 2021, is that right?

Yeah, then it would pick up a little more.

Okay. So really, I mean, you're, like you said, AJ, I mean, you know, ACMI is about $150 million a year. is tracking almost half of your domestic network. Now you add in an all-in charter, and you do indeed have a well-diversified kind of base there.

Yeah, that was our aim all the time, to sort of be in all the aviation, sort of cargo aviation type of businesses, not just an overnight business.

And is there any ACMI contracts now that you're looking at that are out for tender that could be additive to next year? And specifically, is $150 million your absolute capacity with your current fleet, or could you go much, much higher than that in terms of ACMI revenue?

Look, with the current fleet, I think we can always increase the capacity by 5% to 10% by rejigging schedules and sometimes doing additional flights on the weekend or doing extra turns. So, yeah, I would say between 5% and 10% with the existing fleet. As for your questions, if you're looking at additional routes, I mean, there's not a day goes by where we don't go out and quote and hunt for business. So, That's our job, and we continue to do that. But do we have anything that we feel we can get it? We have already, as we said, there's opportunities while the international air cargo capacity is down because of the passenger side of the business. So more and more integrators are looking at adding their own capacity, and we continue to... provide them with quotations, and sometimes it works out, sometimes it doesn't. But also, at times, it's also the ad hocs that we expect are going to go up as well.

And how long are you locking these customers in for, AJ? Is it longer now that you have the opportunity? People sound like they're more desperate for international air freight capacity. Are they willing or wanting to lock in for longer terms here, and what would be the term?

So all the ACMI contracts are, you know, they're not as hard as domestic contracts. The industry in ACMI and CMI works on, you know, typically three to four year contract with certain outs at six months or, you know, average six months. Some of them are 90 days. Some of them are a year. But most of these are also that we have flexibility where they can switch from one route to another. So you might lose some hours into Europe and pick up in South America or the Caribbean. So I think that to ask for a five-year or seven-year contract, just like the domestic side of the business, ACMI does not operate like that because people need flexibility in redeploying their aircraft. So that is just the nature of the business.

And your current customer base, I guess, your big ones are up to 2025. Has there been any movement or have those customers wanted to extend beyond 2025? I know you have three-year renewals with one of them that are being exercised early. Is there any avenue for an early exercise of a contract extension with any of your major customers on the domestic side?

I mean, because of the pandemic, those discussions haven't even started yet. So, you know, somewhere in 2021, you know, when you have four years, four and a half years remaining, normally, typically, these kind of discussions start closer to two and a half to three-year mark rather than a four and a half-year mark, so... But at some stage, you know, next year we'll certainly start talking to people.

That's all my questions. Congratulations on a great quarter. Thank you, Walter.

Thank you. Our next question comes from Kevin Chang with CIBC. Please go ahead.

Good morning, Gavin. Good morning, everybody. Just taking myself off mute here. Thanks for taking my questions and just echoing Walter's congratulations on a good quarter. Um, maybe if I could just look at peak season specifically, um, you know, if I look at historical and I just kind of do a simple, uh, you know, domestic network or your previous overnight network, uh, revenue divided by, uh, operating days, you typically see about a 20% sequential lift in that unit metric in Q4 versus Q3, just reflecting that peak season, just given how strong Q3 was this year. How should we be thinking about that kind of revenue for operating day within that domestic network? Should we think of that seasonal pattern holding, so that typical 20% sequential lift, or do you see some of that flow into Q3, just given how strong e-commerce has been, especially during the pandemic here?

Jamie? Go ahead.

Yeah, good morning, Kevin. I think it would be realistic to think that our typical Q4 volumes, we already started to experience those late in Q2, but particularly in Q3. And the volumes that you've seen that we reported today are reflective of what we would normally, actually, in fact, a little higher than what we would normally report in Q4. I don't think you'll see quite the 20% bump from a typical Q3 to Q4, because I think we've already seen some of that growth in Q3. Although I still, to my comments earlier, when you when you read and see some of the comments of some of our customers, including as recent as yesterday with PureLator, they were predicting actually a 20% increase in their total packages, but that includes their ground volume. We're going to see a significant and a record peak season. I'm not sure it would be quite the 20% bump from a traditional Q3 to Q4.

Okay, that's helpful. And then you did note in your revenue commentary that it looks like B2B volumes exiting the quarter had... and essentially come back to kind of at least pre-pandemic levels or what it looked like the prior year. Just wondering how those B2B volumes shaped in October as parts of the Canadian economy went back into lockdown. But at the same time, you guys are lacking easier comps. So any commentary there would be helpful.

Yeah, I can take that, AJ. As we reported there, Kevin, we did, you know, at the tail end of Q2, we started to see some of the B2B business come back. And again, I think we explained before that some of it we have some direct visibility to, some of it's mixed because we have customers like PureLighter, obviously, that are very heavy in both B2B and B2C, and they don't report, you know, and we don't physically know the difference between the two different products when we're handling it. But I know in the dialogue with them, and again, with some of the, as we reported, another strong indicator, some of our customers, if you look at some of the transfers group of companies, some of them are just strictly in the B2B business. So we saw significant declines there. But those in Q3, for the most part, have come back to sort of pre-COVID-19 pandemic levels. And we expect those to continue going into Q4, barring any you know, other significant shutdowns of the economy anywhere. We haven't seen anything yet that's impacted it.

Okay, that's great, Tyler. And just last one for me on ACMI, obviously a great result in the third quarter here. Just confirming this new route, this new U.S. to Mexico route, I suspect it's with DHL. And then when you look at your overall ACMI customer footprint, Any concerns of just the customer concentration with DHL? Is part of your ACMI growth strategy to diversify the customer base? Any comments there?

Yeah, so we obviously, because if you look at UPS and FedEx, they're licensed American carriers, and their ACMI needs are more ad hoc because they have their own fleet. whereas DHL is not a registered airline in the U.S., and so there's more opportunities with that, hence the concentration. Yes, you're absolutely right. We are looking to expand our relationship with not only DHL, but other South American and Caribbean carriers. We are looking at our own commercial flights into places like Mexico as there is less passenger flights going in. We just could not do any of that because of the lack of fleet. And when you got your planes fully chartered and occupied, those commercial decisions took a backseat. So we are actively pursuing international flights. They wouldn't be certainly ACMI, but they would be maybe more like block space agreements, just like our domestic stuff going into the international arena. So it'll be kind of You know, the ACMI, yes, because of the licensing issues, the concentration is there with one customer, but we're looking at expanding those relationships with other international carriers which are based in South America and the U.S. that need additional lift because they cannot service for what they have. So that is ongoing at the moment.

Perfect. That's it for me. Thank you very much.

And our next question comes from Chris Murray with ATB Capital Markets. Please go ahead.

Yeah, thanks, guys. Good morning.

Good morning.

Just turning back to the charter business, ATB, last quarter you gave us some really good color around how you thought it was going to evolve as we came through, call it the Q2 pandemic. And you've also made the comment about wanting to build maybe some longer-term stability in that area. So I guess a couple parts of this question. First of all, how do you think Q4 charter is going to be and do you think that while historically it's been a very choppy type of business and even at one point we were talking about maybe moving away from it a little bit, how do we think about that business as we go into 21 and your ability to maybe put together longer term contracts or even more stable contracts period to period?

Yeah, Jamie, you want to cover that? Sure. Good morning, Chris.

I think we would expect that Q4, the all-in charter, would be less than we experienced. In Q3, I think we predicted we'd run about 25% to 30% of what we experienced in Q2, which is about bang on what we actually achieved. I think it's realistic to expect less than that in Q4 for a couple of reasons. One, the demand has lessened a little bit. although the capacity has tightened up and rates of yields and rates are going up in Q4 just because of the seasonality and demand, but also because we need our aircraft to meet the demands of both of our domestic business and the peak season volume growth demands that we're going to have there, as well as on the ACMI business. Customers like DHL also experience peak seasonality, and they're going to have requirements for additional block hours flown during the quarter, which is going to prevent us. We've always... Even in normal years, we've always restricted the amount of aircraft and crew availability we have for ad hoc charters during the quarter because we know that we're going to need those crews and we're going to need those aircraft to meet the domestic and the ACMI demand. So I think you'll see a slight drop in that in Q4. In 2021, I think there's going to continue to be significant changes demand for international all-in charters, not just because of PPE, obviously, you know, there's a whole question about vaccines and, you know, second or third resurgence of the pandemic driving more PPE, but certainly the continued lack of belly capacity from mobile passenger carriers is going to present, continue to present significant opportunities for charter for us in 2021 and I believe 2022 as well.

Okay, that's helpful. And then my other question is just really around capital structure. Really a tremendous job of deleveraging through the year and in a lot of ways you've kind of hit what we thought was going to be a tough target to get to at about 2.1 times net debt to EBITDA. How do we think about capital employment from this point forward? I mean it does sound like, I think John alluded to, you know, capital spending for a couple of aircraft and just maybe some spare engines as we go through. But, you know, how do we think about things like dividends or share buybacks or anything like that?

Well, certainly, you know, we have not considered and looked at the share buyback at this stage, certainly because obviously the price and also secondly, you know, we're priority remains to keep the debt as low as possible and clear it. And would like to be that in the next five to seven years be relatively debt-free so that when we are coding on some of the major contracts that come up, that we remain competitive and a debt-free company can certainly outbid and outweigh any other competitive threat. So that's why it's very important to reduce that leverage you talked about to 2.1%. and that's our key area. So any time we have met with institutional investors, everybody has given us an indication that priority is not, they would be more happy to see us retire debt and get ready for the next round of bidding and RFPs that would come out in general rather than a few cents increase in dividends. We continue to once a year increase our dividend, which we have been doing, but certainly we have not considered a big dividend payout because, as I said, the demand for aircraft and the demand for resources are up. So we are going out and investing in that area. And secondly, whatever is left over, we want to concentrate on that. Dividends, although, is an important part of any kind of investment, but I think we'll see a lot of that as the debt retires.

Okay. And do you have any maturities coming due? I know, I appreciate you've got the revolver that you can just pay down debt, but do you have any other maturities or other, you know, either sale, purchase of leased aircraft or anything else that you could maybe be thinking about deploying capital in 21 on?

John, you can maybe.

Yeah, Chris, I think we've mentioned in previous calls, we do have a number of finance leases that will be coming to the end of their term. So over the next 18 to 24 months, we'll be paying out all of our finances. With the idea of just keeping those aircraft in the fleet? Oh, yeah. Yeah. I mean, basically, it was just a form. It's a lease with a buyout option, which we're planning to exercise. So I think those buyouts are about $100 million Canadian roughly over the next 18 to 24 months.

Fair enough. All right. Thank you, folks. Good quarter.

Thanks, Chris. Thanks, Chris. Thank you.

And our next question comes from Cameron Dorkson with National Bank Financial. Please go ahead.

Yeah, thanks. Good morning. I guess really just a clarification question or just to confirm. I think you mentioned that you were looking to potentially add or looking to add three feedstock aircraft in Q4. I just want to make sure that that is correct and that you would expect those to be converted by Q3 2021, assuming everything goes as you expect. Is that correct?

Yeah. Cameron, just in terms of the feedstock purchases in Q4, I think that's correct. In terms of converting those aircraft next year, there are not a lot of slots available for conversion. We're trying to secure a couple. And so I would expect at least one of those three would be converted and brought into the operations by this time next year.

Okay. Okay. So maybe one more addition. And just to get an idea on the CAPEX impact as we look ahead to 2021, what's What's, I guess, the cost of a conversion these days? I know the feedstock, I guess, expense has probably come down, but the conversion cost, what is that about?

Yeah, all in for, you know, $600,000, $700,000, $200,000, or $300,000, you're talking $15 million to $18 million U.S. But a lot also has to do with condition of engines and whether you have to do an engine, any engine work. But the conversion themselves, you know, with heavy maintenance and aviation upgrades, you're looking at 15 to 17, say U.S., depending on the condition of the aircraft.

Okay, no, that's helpful. And I assume that the aircraft that you're looking at would all be 767s, is that correct?

Yes. Any thoughts, I guess?

Okay. And, you know, you've been asked this question in the past, but just one of your updated thoughts on it, just as far as additional fleet types, you know, especially if you're thinking about going out and pursuing some additional international kind of charter work. Does it maybe start to make sense to get a longer-range aircraft into the fleet?

Well, certainly, you know, I mean, two 777s, if I had them today, they would be a great addition, and we can fill them in every other direction. The 777s are extremely expensive because they're only factory-built right now, as they stand. There is no conversion available. sub-license or STCs yet to convert those aircraft. Although Boeing has announced with Israeli aircraft industries to start converting them in about a three-year time frame, there are a number of other private companies that are trying to get that license as well to convert that. So we, even with the speeded up, we don't see the first aircraft coming out for at least three years. And I think that would be a perfect timing for us to consider replacing, let's say, at least two 767-200s or phasing out 757s. And 757s, once they're phased out, they'll be replaced by 767-200s and then 767-300s with 777s. Yes, that is definitely some of the considerations and meetings we've had, and we continue to keep an eye on as a lot of 777s are parked. Feedstock is not an issue today. It's just that the conversions are not there at the time by Boeing or any of the licensed outputs by the Boeing company. So we continue to monitor that situation, and I think the conversion might even be speeded up since... There's a lot of feedstock out there that is sitting there right now.

Right. Okay. No, that's very helpful. That was all for me. Thanks very much.

Thank you. And our next question comes from Alana Yontas with BMO Capital Market. Please go ahead.

Thank you so much. I just had a question about market strength. So do you worry about this type of market strength allowing a new entrant to establish a foothold? And how do you ensure that you aren't committing capital to unsustainable revenues longer term while ensuring you serve the market and minimize the risk from new entrants?

Well, look, I mean, you know, it's a free market. If people are going to enter the market because they think it's very lucrative, you know, obviously they will. Just keep in mind that what we built, it took us 20 years to build this organization. You know, there is a lot that goes on, just not a license. It is developing, you know, programs that you're continuously training, hiring people. You know, you have ground support equipment and operators. You have the maintenance team, which we have a strong maintenance team of 200 engineers. Domestically, we serve 15 cities every night. If somebody wants to fly into a domestic market and offer, let's say, Toronto-Vancouver or Hamilton-Vancouver service and back or throw in the Calgary in between, they still need to service 13 major cities in Canada. So We welcome any competition. We are not against competition. I think competition keeps everybody healthy, but I think the cargo jet culture is of such that we treat our customers, we treat our employees, we treat our suppliers well to ensure that we never feel that yes, we do have a major market share of the overnight business, but we are not free of any competitive issues at this time. We certainly have competition, and although we can't stop anybody from entering the market, but on the other hand, we do not give an opportunity in terms of service pricing or our culture or how we handle things for people to compete with us as well. It's really in our hands at the end of the day as to how we handle ourselves in the marketplace. Cargadget was the result of a very bad service that previous 15 airlines had provided from 1985 to the year 2000. There were 14 of them that tried the business, undercapitalized, no commitment to service, and that's why Cargadget was born. And CargoJet totally realizes why those carriers never survive. So, you know, we have a great access to capital. We are very well capitalized. Anybody who's starting a new business like this has to look at at least $600 to $800 million worth of investment in this business today, plus hiring a whole bunch of people. It is, although for a big company to put in a billion dollars, it's not difficult, but also making sure that the stuff gets handled on a priority basis and services provided, it is certainly a challenge in this country, especially this country is one way as well because a lot of product moves from east to west and center to east, but hardly anything comes back. And balancing those acts on a daily basis is also a challenge for any new entrant.

Okay, thank you. And just one last question actually on service now. Are you still trending at high 90s for on-time performance this year?

Yeah, so our on-time performance has not gone below 98.5%. These are the carrier controllable delays. I mean, taking the weather and other uncontrollable delays out. We are already... You know, this year we were filling certainly over 98.5%, and we are one of the best maintenance and dispatch reliability. We are not one of the best. We are the best when it comes to 767 and 757s, according to Boeing statistics.

That's great. Thank you so much for your time today.

Yeah, thanks. Thank you. And our next question comes from Doug Taylor with Canaccord Ingenuity. Please go ahead. Thank you.

Good morning, and thanks for squeezing me in. I'm curious, given everything that you just said about the competitive dynamics, your track record, the amount of capital required, why you think that reducing your leverage to zero or near zero net debt is a necessary milestone to hit to eliminate or reduce the threat of competition and who you think that competition would potentially be when you do get around to that point where you're renewing these kind of foundational contracts?

Well, look, first of all, we don't know. Competition can come from anywhere, right? So we're not sure where the competition is going to come from. We don't know of any at this stage. Why the debt reduction is necessary is because Our whole model was built on buying and owning these aircraft and pay them off in seven to eight years. And we certainly, and this is one of our philosophies, that when the renewal time comes in five to seven years, we do want to share some of that free cash flow. And I'm not saying that we're going to give it away, but certainly the customers that have helped us pay off the debt customers that have stuck with us, customers that have given us loyalty, and customers that have helped reduce our debt, deserve, you know, when they renew their contract and we have paid off the debt, so we have extra cash that goes towards certainly shareholders and dividends. But some of it should go back to the customers, and that's the philosophy that I've always believed in sharing with our customers, And that's what differentiates us from a lot of other companies that might not find it necessary that they have to share with customers, but that's what is the difference between us and a lot of other companies out there.

Okay, that's helpful. Just a couple of questions there on the charter business. You've given some color as to the linearity of that business going to Q4 and into next year. Just to help me understand, I mean, how much of that extra business right now is still PPE government type business as opposed to, I guess I would say, other commercial charter business? It's not necessarily tied directly to pandemic provisioning and is more tied to you know, regular commercial business, just trying to find a different way of getting overseas.

Yeah, Jimmy would take that question. Yeah, good morning, Doug. Probably the best way to look at it is that, you know, the PPE we sort of restricted to weekends going forward into Q4 just because of availability of aircraft. So you're probably looking at, depending on demand, a maximum one to two flights per week. So call it, you know, eight to ten flights at the most per month going forward. And I would say less than that in the month of December, because as I noted earlier, we significantly reduce our ad hoc charter availability during the month of December, and particularly this year with what we expect to be record domestic volumes, we're going to need the aircraft and crews pretty much seven days a week.

And has your visibility on charter demand and profile improved? I mean, typically it was only a couple of weeks out, you'd have requests for charter. I mean, have people attempted to go out there and book ad hoc charters further out into the future, which gives you that confidence starting into next year and things like that?

Not on the ad hoc side. It's typically a fairly short window in terms of booking. Definitely, we're seeing, as I noted before, coming into November and towards the middle of Q4, we're seeing a significant increase in pricing for ad hoc charters. And you see that on Internationally, pricing levels are going up because capacity is being reduced. Demand is still there. It might be a little less than it was in Q2 on the PPE side, but certainly with virtually no global passenger international flights back, providing that belly cargo capacity and going into a traditional peak season for international cargo, not just for domestic cargo, demand is being squeezed and pricing, therefore, is going up.

And just to add to that, when you ask, there is a lot of requests for future bookings. To be honest with you, we have received a lot of requests for January, February, March for charters and charter pricing and availability and possibility of contracts. We believe that's basically to do people protecting their position, as you probably have read, that around the world 8,000 cargo flights would be needed for the transportation of vaccine and vaccine-related equipment that would be needed. So a lot of countries have asked and availability and some have even offered to see if we are interested in doing a deal for a whole year. But Doug, our philosophy is that being a Canadian cargo airline, our priority is to look after the Canadians first. And that's why we are holding out to make sure that Canadians' needs are met before we offer lift to other countries.

Well, as a Canadian, I've got to say I appreciate that. Thanks for answering my questions.

Thank you. Thanks, Fred. Thank you. And our next question comes from Ahmad Shatz with B Securities. Please go ahead. Thank you.

Good morning, guys. Congrats on the significant quarter. Just quickly on the charter side, AJ, you just mentioned customers are trying to discuss longer-term contracts. Any terms that came out of that in terms of what are they discussing – in terms of commitment and that ability to back out? What are your senses that they're just flying to lock themselves in and then if they don't need the capacity, they're trying to protect themselves to back out? Just a little bit more color on the terms that have been discussed.

Well, the terms that have been discussed are basically pre-buying certain number of flying hours, whether the flights will be to Europe, whether they'll be to Asia, whether they'll be to Mexico, and whether they'll be to U.S. or U.K., You know, nobody knows where the vaccines are going to be coming out of at this stage. So everybody's kind of, as you can see, the government has bought vaccines from four or five different suppliers from various parts of the region. So everybody's kind of spreading or at least taking a position that you can't put all your eggs in one basket. So similarly, people have inquired about the charters. People have offered us charters. People have offered to buy ours. And, you know, So they would commit to a certain number of hours in a year or six months. Again, nothing has been formalized, nothing has been sort of discussed, because we have not sort of seriously listened, but we have not gone into nitty-gritty or discussed with any of the, let's say, American carriers or Europeans who are looking for cargo lift. And the reason, partly as explained, although the Canadian government has started some discussions with various parties about shipping a vaccine. There's nothing finalized. But as you know that since we are a Canadian company and we're going to keep a lot of capacity available to Canadians and the Canadian government and Canadian people, so we haven't gotten into the nitty-gritty of the contract, but basically, You know, as happened in PPE, we were offered a lot more money by other foreign governments to divert flights into their countries for the charters. And we didn't take that opportunity because this country really needed PPE. So, you know, we could have had better margins had we taken some more American flights or more European flights at that time. But we decided, no, Canada is our priority. This is where we are based. And this is what, you know, Canadians depend on. And we did not go for the short-term huge increases that we were being offered. So I think similar thing, we can see similar trends developing in vaccine at some stage as well.

That's great. And just one follow-up on the charter for me. In normal season, let's say Q1, Q2, and some of Q3 going forward, in light of the current network design that you guys have, how should we think about the maximum theoretical revenue generation on the charter business? Is Q2 this year achievable again, given what your plate is currently right now, or what we kind of have a nice number to use for if you're able to utilize it?

This year is certainly a unique year because Every government, including our government, was caught with no PPE. So the pricing was never an object. I think there's a lot more planning going on for next year. People know what the shortfalls are. People know how much capacity is needed. There's slightly more competition on that. So I think that we will not see the craziness that went on this year because nobody was expecting a pandemic. I wouldn't say that everybody and every government is 100% prepared, but at least they're 60% to 70% prepared with what carriers to choose and what aircraft to deploy and more time to negotiate the deals, fuel prices lower. So I think a lot more is planned this year, and I think the margins that we got on charters, in spite of that we took the lower margins, are probably not something that are, in my view, sustainable for, you know, 2021. We will have pretty good margins, but as, you know, I remember talking to Konark about, you know, somewhere settling between 2019 and 20 would be a good way to sort of consider that question.

That's great. That's it for me. Thanks for answering my questions.

Thank you.

Thank you. And we have no additional questions at this time.

Okay. Thank you, Rich, everybody for joining. And we look forward to having some chats with individuals beyond the conference call and appreciate the support for everybody. Thank you. And this concludes today's call. Thank you all for your participation.

You may now disconnect.