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CAE Inc. (NYSE:CAE)
Q2 2019 Earnings Conference Call
November 13, 2018, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen. Welcome to the CAE second quarter conference call. Please be advised that this call is being recorded. I would now like to turn the call over to Mr. Andrew Arnovitz. Mr. Arnovitz, you may now proceed.

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 19 and answers to questions contain forward-looking statements. These forward-looking statements represent our expectations of today, November 13th, 2018 and 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 risks, factors, and assumptions that may affect future result is contained CAE's annual MDNA available on our corporate website and in our filings with the Canadian Securities Administrator on CDAR and the US Securities 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 will take questions from financial analysts and institutional investors. Following the conclusion of that Q&A period, we'll open the line to calls 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 had a good performance in the second quarter with 20% revenue growth, 15% earnings growth, and strong free cashflow. I'm especially pleased with the continued progress we've been making with our training strategy, as demonstrated by $986 million in orders in the quarter, giving us a record $8.7 billion backlog. Overall, our performance in the quarter and year to date supports our full year outlook.

Looking at civil, we generated double-digit growth during the quarter and we booked orders for $575 million for a record $4.3 billion backlog. These include a new five-year multi-crew pilot license cadet training program with Air Asia, exclusive training contracts with City Jet, Ocean Air, LOT Polish Airlines, and Air Busan, and a new long-term training contract with Starspeed.

In products, we sold 16 full-flight simulators in the quarter, which brings us to 34 sales of simulators in the first half of the fiscal year, tracking above our initial outlook. Training center utilization was 72%, which is up 2 percentage points from last year.

In defense, we generated high-single-digit growth during the quarter and we booked orders for $380 million, giving us a record $4.4 billion defense backlog. Orders included CAE's new 700MR Series simulator for the Royal New Zealand Air Force's NH90 helicopter. We also won the US Air Force C-130H aircrew training services contract. Adding to our training systems integration programs, we received orders for the Air Force, for additional C-130J simulators.

Also involving aircrew training services, we renewed a contract with US Air Force's KC-135 aerial tanker training devices, which include upgrades to our simulators. The integration of Alpha Omega Change Engineering, AOCE, which we acquired in the quarter, is progressing well and we're beginning to see benefits from our expanded access to higher level security programs in the United States.

Finally, in healthcare, we launched a redesigned, fully portable, CAE CathLabVR interventional simulator. Together with the American Society of Anesthesiologists, we launched the Anesthesia SimSTAT robotic surgery 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. I'll return at the end of the call to comment on our outlook. Sonya?

Sonya Branco -- Chief Financial Officer

Thank you, Marc. Good afternoon, everyone. Consolidated revenue for the second quarter was $743.8 million and quarterly net income was $60.7 million or $0.23 per share. This compares to $0.20 in the second quarter last year, excluding the gain of approximately $0.02 per share from the divestiture of the Zhuhai Flight Training Center.

Income taxes this quarter were $14.2 million, representing an effective tax rate of 19%, compared to 23% in Q2 last year before the gain on ZFTC. Free cashflow improved in the second quarter, reaching $137.7 million compared to $63.5 million last year. We had a lower investment in non-cash working capital and a higher cash from operating activity. As in previous years, we expect a portion of the non-cash working capital investment to reverse in the second half.

Uses of cash in Q2 included funding capital expenditures for $40.9 million, mainly for growth, and we distributed $25.7 million in cash dividends. We used another $37.2 million to repurchase stock under the NTIB program. Our financial position continued to be strong, with net debt of $795.1 million at the end of the quarter and net debt to total capital ratio of 25.8%. Also, a return on capital employed increased to 12.8% this quarter compared to 12.6% last quarter, excluding the impacts of the Fiscal 2018 income tax recovery related to the US tax reform and net gains on strategic transactions relating to our Asian joint ventures.

Now, looking at our segmented performance -- in civil, second quarter revenue was up 24% year over year to $393.1 million and operating income was up 19% to $63.3 million for a margin of 16.1%, excluding the gain on divestiture of ZFTC of last year. On the order front, the civil book to sales ratio for the quarter was 1.46 times and for the trailing 12-month period was 1.49 times.

In defense, second quarter revenue was $323.3 million was up 18% over Q2 last year, while operating income was up 2% to $34.1 million for an operating margin of 10.6%. Excluding the impact of reorganizational and integration costs related to the purchase of AOCE, defense segment operating income would have been $36.1 million or 11.3% of revenue, which is up 8% compared to the second quarter last year.

The defense book to sales ratio was 1.19 times for the quarter and 1.03 times for the last 12 months. In healthcare, second quarter revenue was up $30.4 million, up from $28.3 million in Q2 last year. Healthcare segment operating income was $1.3 million in the quarter, down from $2.2 million in Q2 of last year as a result of higher investment in selling, general, and administrative expenses and higher research and development expenses to support recent product launches.

To sum up, we had a good performance overall this quarter with solid year over year growth in civil and defense, which would have been even stronger if not for the impact of the five weeks' work disruption in our Canadian manufacturing operations this summer. The interruption reduced the number of product deliveries we could achieve in the quarter and also affected our ability to reach milestones on a number of programs.

We had already expected revenue recognition to be more back end loaded this year as a result of IFRS 15 implementation. The interruption makes it even more so. We implemented a recovery plan in the second and current third quarter with several measures designed to accelerate production capacity, including establishing a second assembly line for high-volume full-flight simulators, the net result with that extra capacity running in parallel.

We will reach a substantially higher level of delivery milestones in the fourth quarter compared to the current third quarter. Accordingly, delivers in Q3 are anticipated to be more closely resembled to levels we saw in the first two quarters of the year. The overarching positive is that our recovery plan is on target and with these measures, our full-year outlook for growth is intact. With that, I will ask Marc to discuss the way forward.

Marc Parent -- President and Chief Executive Officer

Thanks, Sonya. We continue to see good momentum with our training strategy, as evidenced by the importance developments announced last week, which further strengthened our long-term growth investment thesis. We continue to be highly positive about our prospects in civil.

In business aviation training, we're well positioned to provide an excellent customer experience with our global reach and industry-leading solutions. The announcement that we've agreed to acquire Bombardier Business Aircraft Training further solidifies our position. The acquisition will expand our ability to address the business aviation training market and give us greater leverage across our training network. It fits right into our core and aligns very well with our strategic objective to grow recurring revenues. It also gives us the ability to leverage our expanded position on Bombardier Business Jet platforms across the entire CAE global network.

The acquisition gives us a bigger position in the largest and fastest-growing segment of the business aviation training market, which involves medium and large-cabin business jets. It gives us a broad portfolio of customers, an established recurring training business, highly talented people, and a modern fleet of business jet full-flight simulators.

We also signed an agreement to extend CAE's Authorized Training Provider status for flight and technician training to 2038. Taken together, this is a major step forward in the progression of our growth strategy in aviation training and will have a positive impact on our performance. In its full year following the closing of the transaction, which is expected by H2 of calendar 2019, the acquisition is expected to provide CAE high-single-digit percentage earnings accretion and is also expected to be accretive to free cashflow.

We also expect to continue making good progress in commercial aviation training. The announcement last week at the European Airline Training Symposium of a long-term training outsourcing agreement with EasyJet is an example of the kinds of opportunities in our pipeline to increase our share of the airline training market and form new enduring customer partnerships.

Under the $170 million 10-year agreement, all of EasyJet's pilots will soon be training at CAE in three European pilot training locations, including a new state-of-the-art training center at London-Gatwick with a dedicated wing for EasyJet. In civil products, based on our level of success in the first six months, we're on track for our best year ever.

In defense, we expect to continue winning our fair share of programs, building on our successes as a Training Systems Integrator. We have good momentum with our recent wins of the US Air Force C-130H aircrew training system and the New Zealand NH90 programs. Our acquisition of AOCE positions CAE as a training partnership to the United States Air Force's Special Operations Command, training aircrews on variants of the C-130J and HH60 Pave Hawk helicopter as well as a platform that is new to CAE, the CV22 tilt-rotor aircraft.

The AOCE acquisition has also us working with other platforms new to CAE, providing training for the United States Air Force aircrews on the F-15, F-16, and F-22 fighters.

We recently signed a strategic agreement with the government of New Zealand to work together to address its long-term defense training needs. CAE is excited to be part of the team selected as the preferred bidder for the new Royal Canadian Navy Canadian Surface Combatant Program. While too soon to quantify, both avenues present potentially sizable opportunities for CAE over the longer term. Overall, we're continuing to pursue a large defense market with over $4.9 billion of proposals in the hands of customers pending decisions.

Finally, in healthcare, our new products like CAE Juno and CAE Ares are being well-received by customers, giving us greater access to some of the larger value pools in the existing market. We expect to see the healthcare business ramp up to a more meaningful scale and I continue to be optimistic about its potential as CAE's innovative training solutions become more broadly adopted.

In summary, we have good momentum in all of our markets and we are on track to deliver on our growth outlook. With that, I'll thank you for your attention and we're now ready to answer your questions.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Thanks, Mark. Operator, we'd now like to open the lines to take questions from members of the financial community, financial analysts, and institutional investors.

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, if you would like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. If you are using a speakerphone, please lift your handset before entering your request. One moment please for the first question.

Our first question is coming from the line of Kevin Chang with CIBC. Please proceed with your question.

Kevin Chiang -- CIBC -- Analyst

Hi, good afternoon. Thanks for taking my question here. Maybe just a clarification question in regards to the acquisition of the Business Aircraft Training Division from Bombardier -- you've noted that it will add about 100-150 basis points to your margin within civil. I'm just wondering how I should think about that flowing through seasonally within the divisions.

When I look back over the last four or five quarters, your margins run between 16% to 21%. Should I think of it just lifting everything by the 100-150 basis points or does it have a greater seasonal impact in your low quarters because there's more training involved and the top end sticks around 21%? I'm just trying to get a sense of how this works through the year for you.

Marc Parent -- President and Chief Executive Officer

Let me see if I can help you with that. I think our reference is always on an annual basis. So, when we're looking at what civil achieves on a yearly basis, figure on about a 100-150 basis points lift from the acquisition. We've seen with our experience in business aviation that our fourth quarter tends to be a big quarter for business aviation. So, I'm not sure it's important enough to establish as a seasonal trend, but that's probably something that I would take into consideration.

Kevin Chiang -- CIBC -- Analyst

Okay. That's helpful. Then just in terms of the back half of the year, you noted some integration costs with AOCE. Are there additional integration costs to consider in the back half or are you basically through most of that now?

Sonya Branco -- Chief Financial Officer

Integration is progressing well and working through all the synergies. We do expect some remaining integration costs in the back half, about $1 million to $2 million.

Kevin Chiang -- CIBC -- Analyst

That's helpful. Lastly for me, turning to healthcare, you're bouncing around $30 million in revenue pretty consistently here. I know you're very positive on the long-term outlook, but do you have a sense of when this revenue hits an inflection point that drives to a much improved margin profile or is this a situation where you're holding steady and eventually the market will come to you and you get that big revenue look that you're expecting? Do you have a sense of when revenue gets better or is this more of a longer-term trend outlook?

Marc Parent -- President and Chief Executive Officer

I think our expectations, as you might expect, are reflected in the outlook we've given. So, I do expect a lift. I think what we're seeing is that we have a bit of an inflection occurring in our business where we've been shifting our strategy over the past year toward what we call the larger value pool in this business, which is nursing training. So, we've focused our R&D on coming up with new products that were specifically destined to enter this market. Those are CAE Juno and CAE Ares.

Those products -- we see those products being well-adopted by the market, where we're increasing the sales of those. They're at a lower cost points, less complexity, but ideal for that market. We see those progressing, but at the same time, what we see is in our existing market, with high fidelity, a bit more of a flat situation. What we see is us overcoming the -- just the time it takes to penetrate that market. It's really going after penetrating share in that market. We're confident the market exists. Products are resonating. I think that it will come up in what we expect is the revenue will follow the expectations we have in our outlook.

I won't go further down the road on that one in additional years except that I continue to be confident that this is a growth story scaled for CAE. I'm still confident based on what I'm seeing. Admittedly, the numbers don't reflect that at the moment.

Operator

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

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

Yes, thank you very much and good afternoon, everyone. I just wanted to ask a question about the contract with EasyJet. You mentioned that EasyJet will take a portion of your capacity at the new facility in London-Gatwick. I was wondering how much excess capacity will you have to devote to training new contracts with new customers?

Marc Parent -- President and Chief Executive Officer

You mean in Gatwick specifically?

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

Yeah, please.

Marc Parent -- President and Chief Executive Officer

I don't know the number off-hand, but we're basically sizing a new facility there. We already have facility at Gatwick. We always size our opportunities to walk a tightrope between having enough capacity to be able to serve the market that's there. At the same time, we want to utilize the assets at a very high level.

So, the short answer is we basically size our capabilities, buildings, numbers similar to the market. It's a very large market in Europe specifically. We have a number of training centers in Europe. I think we would have capacity. I can't tell you exactly how much. Frankly, I would hope it's not too much right now because we'd have assets that wouldn't be fully utilized, but I think we're market led.

Whatever market is out there, you can expect that CAE will size itself to be able to handle it. We can do it pretty fast because we usually size our buildings on the land that's associated with them to have capacity for growth. The way we architect our centers because we have a lot of centers out there around the world, we architect them in a fashion that is pretty simply for us to have existing similar base by having it feel like a plug and play approach to the extra, if you like, annex that we'd have in the building and we'd secure beforehand.

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

Thank you. Maybe again, on that contract, I just wondered if you could provide the split between the incremental portion of that contract hat will be for CAE.

Sonya Branco -- Chief Financial Officer

The incremental growth from that contract?

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

Exactly.

Sonya Branco -- Chief Financial Officer

So, the contract is a 10-year full outsourcing with EasyJet. We are already serving EasyJet, but essentially what it serves is about a 40% increase in growth.

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

Perfect. Thank you very much.

Sonya Branco -- Chief Financial Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Ronald Epstein with Bank of America Merrill Lynch. Please proceed with your question.

Christine Liwag -- National Bank Financial -- Analyst

Hi, good afternoon. It's Christine Liwag. Marc and Sonya, you guys have now acquired Locheed's commercial flight training business and you've acquired these assets from Bombardier. Are there opportunities like this out there where you can acquire more training business from the OEMs and is there a consolidation that you can do?

Marc Parent -- President and Chief Executive Officer

I think what we said in the past is this is our business. This is our focus. Our vision is to be the training partner of choice for our customers. So, you would expect that if there are opportunities out there and they fit our criteria for the type of business, the type of assets and of course the financial viability of that, we would be open to it.

I can't talk for any OEMs particularly or anybody else who have their business, but certainly we seem to form partnerships with those OEMs and if an acquisition works out, we would certainly be receptive. It has to make sense for us financially, for how we can serve our customers and grow our business along the lines to achieve the vision we have.

Christine Liwag -- National Bank Financial -- Analyst

As OEMs walk away from these businesses, can you discuss how that's affected the pricing environment?

Marc Parent -- President and Chief Executive Officer

Well, I don't think that's accurate in the pricing environment, to be very frank. All of these businesses are still very competitive. The margins that we would have is the one that we've talked about in our outlook. I don't think these particular deals in itself would affect one way or another the margin expectations that we would have.

Christine Liwag -- National Bank Financial -- Analyst

Shifting to margins, can you discuss what you saw in margins in the quarter? They were a little bit weaker than we expected. With such strong growth and strong book to bill, how do these orders compare with your existing business today? Should we expect these orders to be accretive to margins as they convert to revenue?

Marc Parent -- President and Chief Executive Officer

I'll take the latter. Definitely, the order should be accretive to revenue for sure. In terms of the margin profile, I wouldn't read too much about margins in the quarter, to be very frank. Because a couple of factors -- number one, if you take training part of our business, airlines are flying a lot in the summer months and when they train, the aircraft are full and literally, they're not training. They're flying. Our utilization typically in our training centers is low and you see that.

At the same time, in our products business, that is the time where we usually have a summer shut down of our activities, where people take vacation. We have time to refurbish the plan. So, we basically are in activity, earning revenue and profit out of our full-flight simulator. Then this quarter, you had the additional effect of we have a five-week work stoppage as a result of a strike at our main facility in Montreal.

It all points to the fact of the absolute number -- I think civil is up 19% overall in earnings in this quarter. I think that we're quite happy with the number itself. In defense, I think you have to consider -- maybe Sonya could provide additional color -- you have to really take into account that we acquired AOCE. There's a couple million of acquisition costs in there that are in the quarter. Sonya, you want to add any thoughts?

Sonya Branco -- Chief Financial Officer

Just to complement that -- overall, I wouldn't read anything too meaningful. Strong year over year growth on the operating income and holding on the outlook for each of the segments, but just to complement what Marc was saying on the defense side, you did see a bit of impact of the integration costs and also, as AOCE acquisition kind of ramps up, although it's positive and contributed in the quarter, it has a bit of margin dilution in the quarter.

Marc Parent -- President and Chief Executive Officer

Just to finish off, none of this is highly unexpected. It was highly unexpected when we reiterated our outlook this quarter. Basically, the numbers would give you reiterating our full-year outlook for all of the businesses.

Christine Liwag -- National Bank Financial -- Analyst

Thank you, Marc. Thank you, Sonya.

Operator

Thank you. Our next question comes from the line of Cameron Doerksen with National Bank Financial. Please proceed with your question.

Cameron Doerksen -- National Bank Financial -- Analyst

Thanks. Good afternoon. Sonya, I wonder if you could walk through particularly in civil how the quarters kind of look. You mentioned it's going to be a back end-loaded year. But if you could give some color around individually Q3 into Q4, so if you could reiterate what you said there on what we should expect in Q3 and Q4. It sounded to me like we'd have a much strong Q4, maybe Q3 more typical from what you did last year.

Sonya Branco -- Chief Financial Officer

As I mentioned in my remarks, we had to invest to create additional parallel assembly line. This will increase our production capacity to make up for the work stoppage. We do expect increase on the delivery milestones in the second half a bit in Q3, but that one should look a bit like Q1 and Q2. The majority of the remaining delivery is probably in Q4.

So, I would expect there to be more deliveries in Q4. When comparing to previous year, you'll note on the IFRS adjusted profile that Q3 was actually the strongest quarter last year because it had kind of peak deliveries. So, we expect that to be a little bit different this quarter and the peak deliveries in Q4.

Cameron Doerksen -- National Bank Financial -- Analyst

That's helpful. Just on the full-flight simulator market, like you said, you're on pace to have basically a record year for new orders for full-flight simulators, could you just talk about what you're seeing out there as far as market share? Is this something where you think you've gained some share against some of the other manufacturing OEMs for full flight simulators or is it just that the pie is much bigger this year versus last year or previous years?

Marc Parent -- President and Chief Executive Officer

I think it's the pie, really.

Cameron Doerksen -- National Bank Financial -- Analyst

Okay.

Marc Parent -- President and Chief Executive Officer

We're still maintaining our leadership in market share. I think you use 70%, that's probably not right. Again, I don't know if you heard, but to me, it's the size of the pie, lots of activity this year.

Cameron Doerksen -- National Bank Financial -- Analyst

That's all for me. Thanks.

Operator

Thank you. Our next question comes from the line of Tim James with TD Securities. Please proceed with your question.

Tim James -- TD Securities -- Analyst

Thank you. Good afternoon. Looking ahead to Fiscal 20, I'm just wondering if you could talk about any potential headwinds that there might be to margin expansion in both the civil segment and the defense segment, whether it's contract mix, competitive changes, anything like that. I want to make sure I'm taking into account or thinking about anything that might moderate any margin expansion that we could see next year.

Marc Parent -- President and Chief Executive Officer

We haven't given any guidance that far out. I'm not going to give some here, Tim. Based on the backlog that we have and the dynamics that we see in our markets in all the segments, to me, what we see is strong tailwinds everywhere. So, I'm not expecting something not to work. I can't predict the future. The future is not that far away but based on the future I see, it's good.

Tim James -- TD Securities -- Analyst

That's helpful. That's kind of the way I was thinking about it. I wanted to make sure I was missing something that might be a bit of a headwind. That's helpful. Can you tell us approximately what percentage of current civil revenue comes from business aviation before taking into account the future Bombardier biz app training acquisition?

Marc Parent -- President and Chief Executive Officer

Okay. We haven't really broken it out that way, but training makes up a good two-thirds of our business and business aviation is probably the 40% of that. So, just some sense of order of magnitude.

Tim James -- TD Securities -- Analyst

Okay. That's helpful. Then my last question, just looking at the AOCE acquisition, could you tell us how much of the backlog or how much backlog was acquired with that transaction?

Sonya Branco -- Chief Financial Officer

We acquired about $500 million Canadian worth of backlog there. Now, that doesn't flow through any order intake. It's adjusted into the funded and unfunded backlog, but not necessarily added on as order intake in the book to bill metric.

Tim James -- TD Securities -- Analyst

Okay. Great. Thanks very much, Sonya. That's everything.

Operator

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

Chris Murray -- AltaCorp Capital -- Managing Director

Thanks, folks. Good afternoon. My first question just going back to civil and looking at the delivery, I'm trying to understand, you had a fairly significant stepdown in the quarter and I guess, if anything, I was a little surprised that the revenue actually held in better than I thought.

I guess the way to think about it or how should we think about the proportion of simulators that are being recognized on a completed contract versus still on some sort of percentage of completion, I guess what I'm trying to do is figure out what the magnitude of the step jump is going to look like when we get to the back half of the year.

Sonya Branco -- Chief Financial Officer

So, the revenue growth, first of all, is driven by not only the product business but the training the business, so good growth on both sides. Now, it might be a little bit counterintuitive given the deliveries because they are the major drivers of revenue on the product side and the majority of the simulators are accounted for at delivery.

Now, despite the lower number of deliveries, the mix of simulators had an impact. So, we had a higher proportion of simulators that included DP&E, which is data parts and equipment. That's where CAE flows through the OEM data parts and equipment. So, higher revenue but same operating income. So, that had an impact on the margin as well and the revenue growth.

So, those were the major drivers. In addition, there's still some development and customized simulators, which are accounted for under POC, but the proposition is much less than at delivery.

Chris Murray -- AltaCorp Capital -- Managing Director

Okay. That's helpful. Just thinking about your production rate then, is it fair to think that with the booking numbers that you're doing, it's really to bring it to a one to one book to bill or is it that you're just trying to build some extra backlog just to give you some more flexibility.

Marc Parent -- President and Chief Executive Officer

You mean because of anticipated higher deliveries? Is that why you're asking the question?

Chris Murray -- AltaCorp Capital -- Managing Director

I guess what I'm trying to think of, Marc, you've had some pretty strong order intake over the last little while. If we even look at your trailing quarters, you're certainly trailing behind that one -time book to bill, basically because you're not pushing it out. I'm just wondering if the changes you've made in the process are intended to speed up your production rate, so we should expect a step up into next year on deliveries. That would be maybe dragging down book to bill a little bit, but more on a catch-up basis.

Marc Parent -- President and Chief Executive Officer

I'm not sure where you're coming from. Maybe I don't understand on the dropping book to bill because I don't see that. Our new process that's fully in place that has been for quite a number of quarters that was started in what we call a quest program a couple years ago, which is complete, allows us to be able to manufacture simulators in less time. So, we have increased our production rate.

Right now, in the last half of the year, it's going to be much higher because we're recovering from the strike that we had this summer. So, we're accelerating deliveries. We have actually a parallel line on simulators running at a high volume, a separate facility producing simulators. That's why we think we can catch up but we expect that we'll catch up in the second half because we want to make sure we don't disappoint our customers and expect these simulators.

So, look, we'll match our delivery rate to the numbers of orders we could expect in the market. We're not production limited. We can get the personnel that we need. We're not capacity limited in terms of what we can do. Maybe if you look at the number of sales we had, don't forget that they don't all deliver in the next year. Some may be delivering over two or three years, for example. I don't know if that helps, but that's what I would say to that question.

Chris Murray -- AltaCorp Capital -- Managing Director

Then if I can, just two quick questions around the transaction with Bombardier -- first of all, with the increased training mix and just some geographic changes, any thoughts about how this changes your tax profile?

Sonya Branco -- Chief Financial Officer

Well, the business jet training is a high margin and high cash generating. So, as we've guided, we expect our earnings accretion in the first year and also free cash flow accretion. So, it should contribute to the cash generating of the company.

Chris Murray -- AltaCorp Capital -- Managing Director

I'm thinking about does it change your tax rates or anything like that with the source of income in the US or anything like that?

Sonya Branco -- Chief Financial Officer

The operations are here in North America, so we will increase our exposure in North America, but one of the benefits of this acquisition is really expanding through the newest platforms and a halo effect across our global network. I believe I'll it will change the mix throughout the world. So, right now, it doesn't really change my view on tax, but as we close, if it changes materially, we'll guide.

Chris Murray -- AltaCorp Capital -- Managing Director

Okay. That's fair enough. Then the last question for me is just on the royalty agreement. I'm assuming because you're taking a discount on I would assume to be kind of recurring payments, just lump sum it and depreciate it over the life of the agreement. What kind of margin impact should we be thinking about in terms of the civil margin once you've got that in place?

Sonya Branco -- Chief Financial Officer

So, you're right. This was basically future cashflows that we've discounted back and prepaid in exchange for an APP agreement up until 2038 at an attractive discount rate above our cost of capital. What we'll see is, of course, I guess, capitalization and we'll call it depreciation over time in the P&L. Now, the impact of this transaction has been included in our guidance, which is the high single digit earnings in the first year in the first 12 months after the closing.

Chris Murray -- AltaCorp Capital -- Managing Director

The guidance included the royalty impact as well as the training impact.

Sonya Branco -- Chief Financial Officer

Absolutely. Yes.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Operator, I think we'll now want to use the time remaining to open the lines to members of the media. I want to thank all of the participants from the investment community for their questions. Operator, if you will, please open the line to members of the media.

Operator

Thank you. Ladies and gentlemen, as a reminder, to register for a question, please press the 1 followed by the 4. One moment please... There are no questions from the media at this time.

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Okay. Well, I want to take this opportunity once again to thank all participants on the call today and as a reminder, a transcript of the call can be found on CAE's website. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference for today. We thank you for your participation and ask that you please disconnect your line.

Duration: 47 minutes

Call participants:

Andrew Arnovitz -- Vice President, Strategy and Investor Relations

Marc Parent -- President and Chief Executive Officer

Sonya Branco -- Chief Financial Officer

Kevin Chiang -- CIBC -- Analyst

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

Christine Liwag -- National Bank Financial -- Analyst

Cameron Doerksen -- National Bank Financial -- Analyst

Tim James -- TD Securities -- Analyst

Chris Murray -- AltaCorp Capital -- Managing Director

More CAE analysis

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