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CAE Inc. (NYSE:CAE)
Q1 2019 Earnings Conference Call
Aug. 14, 2018, 1:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the CAE First Quarter Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may proceed, Mr. Arnovitz.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Good afternoon, everyone, and thank you for joining us today. Before we begin, I'd like to remind you that today's remarks, including management's outlook for fiscal year 2019 and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, August 14, 2018, and accordingly, are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risk factors and assumptions that may affect future results is contained in CAE's annual MD&A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR at www.sedar.com and the US Securities and Exchange Commission on EDGAR.

On the call with me this afternoon are Marc Parent, CAE's President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer. After remarks from Marc and Sonya, we'll take questions from financial analysts and institutional investors. And following the conclusion of that Q&A period, we'll open the line to questions from members of the media.

Let me now turn the call over to Marc.

Marc Parent -- President and Chief Executive Officer

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss some highlights of the quarter, and then Sonya will review the detailed financials. I'll come back at the end to talk about our outlook.

CAE's performance in the first quarter was led by Civil, which had double-digit growth and saw a strong customer demand for our innovative training solutions. Defence and Healthcare are more variable on a quarterly basis and that first quarter reflects this tendency. Overall, we had solid order intake at CA$689 million, giving us a total CAE backlog of CA$8 billion at the end of the quarter. We grew revenue by 10% on a year-over-year basis, and earnings per share of CA$0.26 was up 18% over Q1 last year. Our overall performance in the quarter supports our outlook, which was further reinforced by some of the positive developments since the end of the quarter.

Looking specifically at Civil, we booked CA$499 million of orders in Q1, plus additional contracts involving joint ventures, including exclusive long-term pilot training agreement with Asiana Airlines. We also announced the new joint venture in training outsourcing for Avianca Airlines in Colombia, and an exclusive training agreement with Volaris of Mexico. In business aviation, Civil signed an exclusive long-term pilot training contract with OJets and in products, we sold 18 full-flight simulators to customers across all regions. Training center utilization during the quarter was 80%.

Turning to Defence. During the quarter, we booked orders for CA$166.9 million, including a contract from the US Navy to provide instruction at five Naval Air Stations to support primary, intermediate, and advanced pilot training. We also signed contracts involving training for the Brunei Ministry of Defence S-70i Black Hawk simulator, upgrades on German Air Force Tornado simulators, and support solutions for the Royal Canadian Air Force's CF-18 aircraft.

And finally, in Healthcare, we launched the CAE Ares emergency care manikin during the quarter, which is designed to meet the life support training requirements of emergency care providers worldwide. As well, Healthcare, together with the American Society of Anesthesiologists launched the Anesthesia SimSTAT-Appendectomy module, the latest in a series of interactive screen-based courses approved for Maintenance of Certification credits.

With that, I'll now turn the call over to Sonya, who will provide a detailed look at our financial performance, and I'll return at the end of the call to comment on our outlook. Sonya?

Sonya Branco -- Chief Financial Officer

Thank you, Marc, and good afternoon, everyone. Consolidated revenue for the first quarter was CA$722 million, and quarterly net income was CA$69.4 million or CA$0.26 per share. This compares to CA$0.22 in the first quarter of last year. Income taxes this quarter were CA$10.9 million, representing an effective tax rate of 13% compared to 16% for the first quarter last year. Excluding the effect of tax audits in Canada, the income tax rate would have been 19% this quarter.

Free cash flow was typical of CAE's start of the fiscal year, in the sense that we usually see a higher level investment in non-cash working capital during the first half. The investment this quarter was higher than in Q1 last year, and I would note the five-week manufacturing work stoppage in Canada that began in June caused some delays in reaching billing and cash collection milestones. As such, first quarter free cash flow from continuing operations was negative CA$85.8 million compared to negative CA$37.9 million last year. As in previous years, we expect the portion of non-cash working capital investment to reverse in the second half. Uses of cash in Q1 included funding capital expenditures for CA$53.1, million mainly for growth, and we distributed CA$23.1 million in cash dividends. We used another CA$6.5 million to buy back stocks under the NCIB program.

Now looking at our segmented performance. In Civil, first quarter revenue was up 16% year-over-year to CA$430.9 million and operating income was up 14% to CA$78.3 million for a margin of 18.2%. On the order front, the Civil book-to-sales ratio for the quarter was 1.16 times and the trailing 12-month period, it was 1.45 times. Civil backlog at the end of the quarter was CA$4.1 billion.

In Defence, first quarter revenue of CA$268.3 million was up 3% over Q1 last year, while operating income was down 10% to CA$21.5 million for an operating margin of 8%. The timing of milestones and product service mix often causes quarterly variability in Defence. And in the first quarter, we incurred a relatively higher level of R&D expenses on active program. The Defence book-to-sales ratio was 0.62 times for the quarter and 1.2 times for the last 12 months. Defence backlog at the end of the quarter was CA$3.9 billion.

And in Healthcare, first quarter revenue was CA$22.8 million, down from CA$23.9 million in Q1 last year. Healthcare segment operating loss was CA$1.3 million in the quarter compared to a loss of CA$1.6 million in Q1 last year.

Before I turn the call back over to Marc, I'll say a few words about our expected revenue and profit profile this fiscal year, which is more heavily weighted to the second half. The new accounting standard IFRS 15, which CAE adopted as of April 1, 2018, changed the way we recognize revenue for certain customer contracts, impacting mainly the timing of revenue recognized for our Civil simulator products. Under the new standard, revenue for these products is recognized upon completion and we expect more of our simulator product deliveries to take place in the second half of the year, which is especially so in light of our efforts now to mitigate the impact of the five-week work interruption that began in June. We are pleased to have maintained CAE's competitiveness with the successful negotiation of a new collective agreement of four years plus one year options with CAE's manufacturing employees in Canada and we are maintaining our growth outlook for the year.

With that, I will ask Marc to discuss the way forward.

Marc Parent -- President and Chief Executive Officer

Thanks, Sonya. Our outlook continues to be positive and we are well-positioned for sustainable and profitable growth over the long term. In keeping with our capital allocation priorities and echoing our positive long-term outlook, CAE's Board of Directors this morning approved a CA$0.01, or 11%, increase to CAE's quarterly dividend, which become CA$0.10 per share effective September 28, 2018.

Over the last several quarters, we've made reference to our increased momentum as a credible training partner for our customers. We've recently made significant inroads with our training strategy, as evidenced by several new and expanded customer outsourcing agreements. And we continue to see a large pipeline of training opportunities to increase our share of the market and to form new enduring customer partnerships.

In Civil, our customers value the fact that we're a pure play training company and they recognize CAE as an innovation leader with the largest and broadest global training network and the most comprehensive offering of cadet to captain training solutions. As testimony to our momentum, in recent months, we've signed a series of important long-term airline training partnerships, which taken together, speak to CAE's credibility and market reach.

To recap our progress, these include our joint venture with Singapore Airlines, which is now operational and our new joint venture in Colombia with Avianca Airlines, which further strengthens our position in Latin America. We signed long-term exclusive training agreements with Jetstar Japan and Asiana Airlines, both of which selected CAE as an innovation leader, offering capabilities like the CAE Rise training system. These wins serve to give CAE increased recurring revenue and cash flows and the opportunity to make accretive growth investments right in our core market of training. Our pipeline of airlines outsourcing opportunities remains highly active and I believe our well differentiated position and recent successes give us even greater potential for more long-term recurring training partnerships at CAE.

We are continuing to have a solid momentum in business aviation as well and we are well-positioned to provide customers with an excellent experience and a continued gain in market share. And in simulator sales, we're off to a strong start with 26 full-flight simulator sales already signed halfway through the second quarter. We expect to continue to lead the simulator products market this year and for Civil, overall, our outlook for low double-digit percentage operating income growth this year remains unchanged.

In Defence, we're also making good progress with our training systems integration strategy and I'm especially pleased with the acquisition of Alpha-Omega Change Engineering announced earlier this month, which expands our position in the US defence market. Much like our acquisition a few years ago of the NATO Flying in Canada or NFTC contract, this acquisition enhances our core capabilities as a training systems integrator and grows our position on enduring platforms such as fighter aircraft.

Last quarter, I mentioned that we had just established a new proxy structure to be able to pursue higher level security programs in the United States. As an extension of this initiative, the pure-play services business we just acquired, AOCE, fits under our new proxy structure and will help us to open a nearly CA$3 billion larger addressable market. CAE's global addressable market in defence now stands at about CA$17 billion. So we are feeling confident about CAE's potential to grow inside this large market.

Another important measure is the level of our current bids and proposals pending customers decisions, which is currently over CA$4.5 billion. Governments of the world are placing a high priority on mission readiness and we continue to be successful converting bids into orders to serve our customers' needs. Just last week, we announced a new contract of over CA$50 million including options to provide the Royal New Zealand Air Forces with CAE's latest 700MR Series simulator and related support services for the NH90 helicopter. We continue to expect Defence to generate mid to high single-digit percentage operating income growth in fiscal 2019 as we deliver on contracts in our backlog and continue to win our fair share of orders from a now expanded pipeline.

And finally, in Healthcare, our new products are being well received by the market and we continue to expect double-digit growth this year with the benefits of our broader market reach and expanded products offering. One of CAE's main areas of strategic priority is innovation. And our latest horizon of innovation is focused on digital technology. CAE is the market leader in aviation training with a 70-year track record of industry first. We are now developing digital-enabled solutions to transform the way aviation training is done. These solutions enable us to deliver the best possible customer experiences and to grow our share in large and growing markets with even greater differentiation as the worldwide training partner of choice. Our latest digital innovation CAE Rise is a revolutionary new training system that enables the objective assessment of pilot competencies using live data during training sessions. The system harnesses the power of cloud-based computing and analytics to provide CAE with deep insights that bring our customer's aviation training experience to new levels.

Just last week, we announced a partnership with the government of Canada and the government of Quebec, Project Digital Intelligence, which is a digital innovation project to develop our next generation training solutions. By seizing new technologies such as Artificial Intelligence, Big Data, and augmented reality and applying them to the science of learning, CAE will continue to revolutionize our customers' training experiences. It's a great time to be CAE and I'm highly encouraged by the progress we continue to make with our training strategy. We have a high degree of credibility with our customers and good momentum, winning new partnerships and training outsourcing.

In addition to sustainable and profitable financial performance, investors expect companies like ours to model social responsibility and to benefit society. I'm very proud to say, we are such a company and we believe CAE's noble purpose and profits go hand in hand. As an example of our leadership at the recent Farnborough Airshow, we introduced the CAE Women in Flight scholarship program, demonstrating our commitment to promoting the advancement of women in the aviation industry. Women currently represent less than 5% of civil aviation pilots and instructors and given the industry challenges, it makes perfect sense to be tapping into the wider talent pool. CAE's program encourages passionate and exceptional women to accomplish their goal of becoming professional pilots. I would also encourage you to have a look at CAE's new Annual Activity and Corporate Social Responsibility report, which is available on our website.

Before we open the line to questions, I want to express my sincere gratitude to Jim Hankinson, who retires today from CAE's Board of Directors and steps down as its Chairman. Jim served as Chairman for the past five years, and as a Director for 23 years. He leaves CAE a financially strong company with rigorous governance processes and he provided invaluable strategic counsel as CAE transformed into the aviation training leader it is today.

Also departing the CAE Board is retired US Army General, Pete Schoomaker, who reached the mandatory term limit for a CAE Director. General Schoomaker first served as a Director of the CAE USA Board and then on the CAE's Board of Directors for the past nine years, which benefited greatly from his insights, which helped to shape CAE's defence strategy and to position the company in the US defense market in particular. We thank the General for your excellent counsel.

Turning from retirements to appointments, I'm very pleased to add my welcome to CAE's new Chairman, The Honorable John Manley, who has been a CAE Director for the past 10 years and brings extensive company knowledge and continuity to the fore, and we have every confidence that CAE will continue to thrive under his strong leadership. John serves as President and Chief Executive Officer of the Business Council of Canada and is a former Deputy Prime Minister of Canada.

Also named to the CAE Board today is retired United States Air Force General Norton A. Schwartz, who was previously a Director on the CAE USA Board. General Schwartz is currently President and CEO of Business Executives for US National Security, and he served as the 19th Chief of Staff of the United States Air Force. He was responsible for the organization, training, and equipping of nearly 700,000 service members and was an advisor to the Secretary of Defense, National Security Council, and the President. His deep industry knowledge and extensive experience, especially in the area of defence aviation training akes him a truly great addition to the CAE Board.

And finally, the vacancy created by General Schwartz on the CAE USA Board, I want to welcome General Frank Gorenc, a highly decorated retired General in the United States Air Force, who rose to the highest levels of leadership in the United States Military as one of 12 Air Force 4 Star Generals. He also reached the highest levels of NATO as one of the six commanders within the NATO command structure.

With that, I thank you for your attention, and we're now ready to answer your questions.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Operator, I would ask that you now please open the line to questions from members of the financial community.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from the line of Cameron Doerksen with National Bank Financial. Please proceed.

Cameron Doerksen -- National Bank Financial -- Analyst

Thanks, and good afternoon. I guess, my first question is just on the R&D program that you announced recently. I mean, CAE always spends a lot of money on innovation and R&D, but this maybe feels a bit like an acceleration of the spend, and I'm just wondering if there's going to be any sort of noticeable impact on, I guess, the cash flow or margins as a result of that.

Sonya Branco -- Chief Financial Officer

Hi, Cameron, it's Sonya. So great announcement, I think great for continued investment in CAE and in Canada and Quebec. Now, while this is really a focus of our R&D resources and skill set to more digital technology and innovation, in terms of level of R&D, it will not necessarily have a significant impact on our run rates and pretty much incorporated into our outlook. In terms of cash flow, this will not have an impact on the run rates.

Cameron Doerksen -- National Bank Financial -- Analyst

Okay, very good. And just maybe just quickly a question about the AOCE business that you just recently purchased, wonder if you can just talk a bit about the margin profile at that business as it does look like it's, I guess, predominantly a services business.

Sonya Branco -- Chief Financial Officer

So this is a great bolt-on acquisition and it's a great strategic fit and that brings along a backlog of contracts that broaden the spectrum of defence platforms like the fighter aircraft and higher security contracts. General run rate about CA$100 million plus of revenue, it is a pure-play services entity and therefore margins reflect that. It's expected to be accretive in its full year of operations. For the year, it will be slightly accretive, but we will be taking into account some integration costs and costs to synergize into our own operations. For the year, it will be just slightly accretive.

Cameron Doerksen -- National Bank Financial -- Analyst

Okay, thanks very much.

Operator

Our next question comes from the line of Chris Murray with AltaCorp Capital. Please proceed.

Chris Murray -- AltaCorp Capital -- Analyst

Thanks. Good morning or good afternoon. Just looking at defence margins, they were a little bit lighter than I think we would have expected and I think part of that was maybe some of the higher R&D expenses. Can you just maybe walk through kind of the moving parts on margins in defence and how we should think about mix as we move through the year?

Marc Parent -- President and Chief Executive Officer

Maybe I will start it off. This is Marc. I think what you're seeing here, I mean part of the answer is what you just mentioned as higher R&D spend in the quarter. The bulk of it is -- we've said in the past and I think we've come to hit it in space [ph] in the quarter, but this business is better looked at on a 12-month basis, because in an individual quarter you can have programs being executed or in this case, just we missed some milestones for a completion on a couple of programs and that makes the big difference in terms of how much income -- revenue and income you can basically generate in the quarter. I mean, you recuperate that because program is not lost, it just booked in a different quarter and that's what happened here. There is lumpiness in the quarter, that's the bulk of it. And you throw on top of that the lack of the revenue and income on those programs, coupled with a higher level of R&D spending, and you kind of get the result . But when we look at the year as a whole, we are not concerned about the outlook that we've given. It's really through the mix that we had in the quarter, programs that we executed. And I don't know if you want to add anything on that, Sonya?

Sonya Branco -- Chief Financial Officer

And really it was the mix added with the timing on certain R&D expenses, which were a little bit higher this quarter. But overall, if we take the backlog as a whole, we continue to see 12%, but it will vary as it flows through income. So we continue to see essentially our outlook, which is mid to high single digits. It will, given some timing and some disturbances from the work stoppage, be more back-ended in the second half.

Chris Murray -- AltaCorp Capital -- Analyst

Okay. And that was my next question. Sorry, go ahead, Marc.

Marc Parent -- President and Chief Executive Officer

No, I was just going to talk about, specifically when we talk about mix on the defence, we're really talking about -- at least I was talking about the mix between products and services, because the ones that are more lumpy are the products one, and they tend to be typically higher margin as well. So that also explains the result in the quarter on defence, specifically.

Chris Murray -- AltaCorp Capital -- Analyst

Okay. And I guess that brings into my next question. Just, how should we think about the shifts around the strike and the impact of the strike? It kind of feels like you talked about working capital a little bit being impacted, should we think about that there was perhaps some revenue that's getting shifted either into Q2 or into further quarters, is that the right way to think about it? And is there any sort of lost revenue or lost earnings or is this just going to be, as you said, more timing issues in the quarter?

Marc Parent -- President and Chief Executive Officer

Well, the bulk of it is going to be shifting into the second half that we set it into our outlook. If you think about it for a couple of reasons, as Sonya was saying on the call, if you think about -- we were stopped for the better part of five weeks. So we were not -- we shipped a couple of products out the door during that time, nevertheless. So we have accelerated or we have a recovery plan under way that's making up for that time, working -- we will work over Christmas, for example, we will have more shifts on those kind of activities to recover. So when we look at the year as a whole, we think we have high confidence that we can recuperate the revenue and profits that we've lost. But if you look at -- now with IFRS 15, specifically on Civil simulators, for example, we will only be able to recognize revenue or profit at delivery now. So rather than in the past where we were on a percentage of completion, which is what our defence contracts largely are on, which means that if we were stopped, then those simulators are -- that are on a recovery plan now are going to be delivered probably more in the back half, in Q3 and Q4, rather in Q2, Q3. And that's really the bulk of what you're going to see. I don't know if you want to add a bit more color to that?

Sonya Branco -- Chief Financial Officer

Yes. So whatever revenue and profit that we would have generated in those five weeks is delayed and essentially shifted to the back half. And that's in addition to the already [ph] delivery completion which was already back half due to the new revenue recognition.

Chris Murray -- AltaCorp Capital -- Analyst

All right. Right, that helps. Thank you very much.

Marc Parent -- President and Chief Executive Officer

And I think I don't know if I answered this specifically, but I don't think I'm -- going specifically, I don't see -- I don't think we see any revenue and profit that is lost as a result of this.

Sonya Branco -- Chief Financial Officer

No.

Chris Murray -- AltaCorp Capital -- Analyst

Thank you.

Operator

Our next question comes from the line of Jean-Francois Lavoie with Desjardins Capital Markets. Please proceed.

Jean-Francois Lavoie -- Desjardins Capital Markets -- Analyst

Yeah. Thank you very much. I was wondering if you could provide us with a little bit more details about your expectation for the Healthcare business in terms of revenue toward the back end of the year, please?

Marc Parent -- President and Chief Executive Officer

Well, I think, as we said in our remarks, we're still feeling very confident that we will achieve the outlook that we have for this year, which is double-digit growth, both in top and bottom line. And as I look at the order profile this quarter, I mean this is not a backlog run business, I mean it relies on our visibility that we have with customers on their expected buying behavior this year. And based on what we see and I could tell you, it's a pretty detailed analysis, we feel pretty good about -- very good actually that we'll achieve that outlook that we have. We've invested even more in this business in terms of R&D, we've launched a new product in the market just recently, last few weeks, CAE Ares in the mid-fidelity market. And so far the receptivity of our products in that market has been very good and that's what we see -- that is where the bulk of this -- the revenue is being spent in this business is in the mid-fidelity market. So, again, we're feeling very good about the outlook that we have.

Jean-Francois Lavoie -- Desjardins Capital Markets -- Analyst

Great, thank you very much. And maybe a last one for me. You had a very strong first quarter in terms of full-flight order -- full-flight simulator order, so I was wondering what is your outlook or your expectation for the second half in terms of order?

Marc Parent -- President and Chief Executive Officer

Well, if you look at where we are at, as you said, we're at 26 simulators halfway through the second quarter, so I think it's suffice it to say, we'll have a good year. It's a bit early for me to get outside what we've said already. I think we've said in the 40s I think and I think that's where we expect to be at the moment.

Jean-Francois Lavoie -- Desjardins Capital Markets -- Analyst

Okay, perfect. Thank you very much.

Marc Parent -- President and Chief Executive Officer

It's a strong markets and we have strong -- the market continues to be strong on the simulator sales in terms of the opportunities that we're bidding on. So we feel good about the outlook.

Jean-Francois Lavoie -- Desjardins Capital Markets -- Analyst

Great, thank you very much.

Marc Parent -- President and Chief Executive Officer

Thank you.

Operator

Ladies and gentlemen, we will now proceed to questions from the press and media. (Operator Instructions)

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Operator, if there are no questions --

Operator

Mr. Parent, there are no further questions at this time.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Thank you very much, operator. I want to thank all participants for joining us on the call today and to remind you that a transcript of the call will be available on CAE's website.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day, everyone.

Duration: 31 minutes

Call participants:

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Marc Parent -- President and Chief Executive Officer

Sonya Branco -- Chief Financial Officer

Cameron Doerksen -- National Bank Financial -- Analyst

Chris Murray -- AltaCorp Capital -- Analyst

Jean-Francois Lavoie -- Desjardins Capital Markets -- Analyst

More CAE analysis

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