CAE Inc.

Good day, ladies and gentlemen, and welcome to the CAE first quarter conference call. Please be advised that this call is being recorded today. I would now like to turn the meeting over to Mr. Andrew Arnovitz. Mr. Arnovitz, please go ahead.

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 20 and answers to questions contained forward-looking statements. These forward-looking statements represent our expectations as of today, August 14, 2019, 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 risks, factors, and assumptions that may affect future results is contained in CEA's annual MD&A, available on our corporate website, and on our filings with the Canadian Securities Administrators on CDAR and on the U.S. Security Exchange Commission EDGAR site. On the call with me this afternoon are Marc Perrin, C's President and Chief Executive Officer, and Sonia Branco, our Chief Financial Officer. After remarks from Marc and Sonia, we'll take questions from financial analysts and institutional investors. Following the conclusion of that Q&A period, we'll open the call to questions from members of the media.

Let me now turn the call over to Mark. Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss some highlights of the quarter, and then Sonia will review the detailed financials. I'll come back at the end to talk about our outlook. CE had a good start to the fiscal year with double-digit revenue and operating income growth and $940 million of orders for a 1.14 book to sell. Sea's total backlog at the end of the quarter was $9.4 billion. Performance was led by Civil, which delivered strong operating income growth and continued to add significantly to backlog. I'm especially pleased with our market momentum, winning the confidence of our airline and business jet customers with our innovative training solutions. Defense is more variable on a quarterly basis, and first quarter results reflect this tendency as well as an income growth profile that's more heavily weighted to the second half of the fiscal year. And in healthcare, the revenue momentum we saw at the end of last year continued into the first quarter. Looking more closely at civil, we booked $694 million of orders in Q1, including multi-year pilot training agreements with airlines including LATAM, SAS, and Air Europa. We also signed five new five-year pilot training contract with Philippines AirAsia, which incorporates our highly innovative and data-driven CAE RISE training system. Sybil sold nine full-flight simulators during the quarter, including three to Southwest Airlines for the Boeing 737 MAX, one to Korean Air for the Airbus 330, and one to Hawaiian Airlines for the Boeing 787. Overall, training center utilization remains strong at 76%. on our network of nearly 300 full-flight simulators deployed. In defense, we booked orders for $220 million, including contracts with Lockheed Martin for C-130J simulators for the U.S. Air Force and the U.S. Marine Corps. Other notable orders include a contract with L-3 MAS to continue providing in-service support for the Royal Canadian Air Force CF-18 fleet and contracts to upgrade the German Eurofighter and Tornado aircraft simulators. New awards also included contracts for naval training solutions for the Canadian Surface Combatant Program and upgrades to the Swedish Navy's naval warfare training system. And in healthcare, we continued to pursue larger segments of the healthcare simulation market with our expanded sales force. We announced a new CAE Center of Excellence for simulation-based training, at ESBA Montreal, which is an innovative healthcare education and industry partnership designed to improve patient care. We also developed and delivered a simulation solution to medical device company Bayless Medical to support one of its cardiovascular systems for physicians. As well, we collaborated with the Canadian Association of Schools of Nursing to develop courseware for student nurses practicing what are CA Juno mannequins. With that, I'll now turn the call over to Sonia, who will provide you a detailed look at our financial performance. I'll return at the end of the call to comment on our outlook. Sonia?

Thank you, Mark, and good afternoon, everyone. Consolidated revenue for the first quarter was $825.6 million, up 14% compared to $722 million in the first quarter of last year. In segment operating income, the four specific items was $113.3 million, up 15% from $98.5 million last year. Quarterly net income before specific items was $63.2 million, or 24 cents per share, which is 8% lower than the 26 cents we reported in the first quarter last year. Net finance expense for the first quarter was $34.9 million, up from $16 million in the first quarter of fiscal 2019. We had higher interest resulting from the long-term debts we issued at the end of last year to fund the acquisition of the Bombardier BAT business, as well as we had higher interest on lease liabilities because of the adoption of IFRS 16. Income taxes this quarter were $13 million, representing an effective tax rate of 17%, which is up from 13% for the first quarter last year. The higher tax rate was mainly due to the impact of tax audits in Canada last year, partially offset by a change in the mix of income from various jurisdictions. Cash provided by operating activities this quarter was up 18% to $137.8 million compared to $117.2 million in the first quarter of fiscal 2019. Free cash flow was negative $102 million in the quarter compared to negative $86 million last year. We had a higher investment related to work-in-progress inventory for simulator products to be delivered over the balance of the year, and we had lower payables. We usually see a higher investment in non-cash working capital accounts in the first half of the year, and 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 Q1 included funding capital expenditures for $89 million, mainly for growth, and specifically to add capacity to our global training network to deliver on the long-term exclusive training contracts in our backlogs. We continue to expect total capital expenditures for the year to be modestly higher than the prior by about 10% to 15%. Other uses of cash include a distribution of $25.5 million in cash dividends, and we use another $2 million to repurchase stock at a weighted average price of $34.41 per common share under the NCIB program. Our financial position can continue to be solid with a net debt of $2.3 billion at the end of the quarter for a net debt to total capital ratio of 49.4%. This reflects the issuance of the unsecured senior notes for the Bombardier business acquisition and the higher usage of cash to fund working capital in the first half of the year. Since we adopted IFRS 16, effective April 1st, 2019, net debt now also includes obligations under lease contracts, which were previously accounted for as operating leases, and therefore not included in debt. Excluding this impact, the net debt to capital ratio would have been 46.3% this quarter. Return on capital employed before specific items and excluding the impacts of IFRS 16 was 12% this quarter, a bit lower than the 12.6 last year. As we ramp up the large Bombardier-backed business acquisition, we continue to target 13% return on capital employed by fiscal 2022. Now looking at our segment performance. In civil, first quarter revenue was up 11% year-over-year to $477.6 million, and operating income before specific items was up 29% to $101 million. for a margin of 21.1%. From a mixed standpoint, simulator product deliveries were lower compared to the first quarter last year, as we expected, while training services growth was especially strong with our expanded capacity. On the order front, civil book to sales ratio for the quarter was 1.4 times, and for the trailing 12 months was 1.54 times. In defense, first quarter revenue of $320.5 million was up 19% over Q1 of last year, while operating income was down 30% to $15.1 million for an operating margin of 4.7%. In defense, product margins are typically higher than services, and the strong revenue growth in the first quarter was skewed to nearly two-thirds services. And I'd add, mainly on new awarded service programs, they're in the early stages of profitability ramp-up. The lower segment operating income in the first quarter reflects this mix, as well as the second-half weighted timing of product program milestones we plan to achieve on the higher margin product contracts already in our backlog. The mix and balance in the quarter also reflects some variability in the timing of new product orders, so we expect to conclude during the course of the year. The defense book-to-sales ratio was 0.68 times for the quarter and 0.83 times for the last 12 months. Lastly, in healthcare, we continue to ramp up scale with the first quarter revenue of $27.5 million, which is 21% higher than the $22.8 million in Q1 of last year. Healthcare segment operating loss was $2.8 million in the quarter, compared to a loss of $1.3 million in Q1 of last year, mainly because of a higher investment in SG&A to support a larger business. With that, I will ask Mark to discuss the way forward.

Thanks, Sonia. We continue to see good momentum with our training strategy, which is supported by secular growth trends across all of our markets, and underpins CE's investment thesis. In civil, market fundamentals remain supportive, with long-term passenger traffic growth and expanding global in-service fleet of aircraft. Civil aviation is a highly regulated industry, and the aviation safety imperative underscores the criticality of pilot training. It also brings to bear the essential role that C8 plays in helping to maintain the safety of the global air transportation system. We're a pure-play aviation training company that's well-defined As an innovation leader, our airline customers face ever more complex challenges that require new approaches and comprehensive solutions. We have the largest and broadest global training network, coupled with market-leading simulation products and support. And as we look ahead, we expect to see more airline outsourcing opportunities materialize from a large pipeline of long-term training partnerships. With worldwide demand for approximately 300,000 new first officers forecast for the next decade, CAE is increasingly the partner of choice offering the industry's most comprehensive cadet-to-captain training solutions. And we do this on a global scale. We're actively taking a leadership role to ensure that our industry has the qualified pilots it requires. With women accounting for only 5% of all commercial pilots, We're determined to draw in the full available talent pool. Among several other initiatives underway, the CA Women in Flight Scholarship Program encourages women to become professional pilots. We recently announced the launch of a cadet pilot training program where CA will train more than 700 new professional pilots over the next 10 years for Southwest Airlines as part of their Destination 225 program. Our collaboration with Southwest is yet another great example of our commitment to source, train, and maintain pilots to support the industry's demands over the long term. For civil overall, we continue to expect operating income to grow in the upper 20% range on continued strong demand for our training solutions, including maintaining a leading share of full-flight simulator sales. and the integration of the first full year of the Bombardier business aircraft business. We expect to complete the integration of this business over the coming quarters, and we continue to expand our market addressability with the operators of the nearly 5,000 Bombardier business jets worldwide. In defense, we're continuing to pursue a large market with over $4.2 billion of defense proposals, in the hands of customers pending decisions. Like civil aviation, defense forces around the world also face the challenge of training and maintaining sufficient numbers of critical personnel, specifically pilots. I remain encouraged by the large pipeline of opportunities to support our defense customers, and we expect to continue winning our fair share by building on our successes as a training systems integrator. As in previous years, The full year will be more representative of the defense segment performance. We'll continue to expect defense to generate mid to high single-digit percentage operating income growth this year as we deliver from backlogs and continue to win orders. And finally, in healthcare, I'm pleased that our new products and strengthened front-end organization are bearing fruit, and I'm confident that this will continue. For the year, we expect double-digit percentage growth and we remain confident of the long-term prospects for health care to become a more material part of CAE. In summary, we remain on track to deliver on CAE's growth outlook for the year. We have the benefit of an increasingly recurring base of business and markets with significant headroom for CAE to expand its share, and we look forward to superior top- and bottom-line growth in the years ahead. Before I conclude, I want to thank Kate Stevenson, who retired from CAE's Board of Directors today. Kate is stepping down, having reached her 12-year term limit. During her tenure as director, she has transformed herself and becomes the world's largest civil aviation training company. I also want to welcome Marianne Harrison, who was appointed today as a new CA director. Marianne is president and CEO of the John Hancock Life Insurance Company and is a chartered accountant and fellow of the profession. She brings a wealth of financial and strategic action to the role. And we look forward to benefiting from our insight and good governance. With that, I thank you for your attention, and we're now ready to answer your questions.

Thank you, Operator. We're now ready to take questions from financial analysts and members of the financial community.

Thank you very much. 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'd like to withdraw, you may press the 1 followed by the 3. Once again, ladies and gentlemen, for questions, please press the one followed by the four. One moment, please, for the first question. And our first question is from Kevin Chang with CIBC. Please go ahead.

Hi. Good afternoon, and thanks for taking my question here. Maybe just turn to civil. I was wondering, if we were to back up the Bombardier training acquisition, what would organic revenue growth, both on the operating income line and the revenue line, look like? Or maybe conversely, if our What did that contribute to both those line items, both civil revenue and civil operating income, if you could share that?

Well, I think if you're trying to maybe back out, which I assume is to back out the benefits of the Bombardier business aircraft training business, I'll start by saying that that business is going very well, and the integration, if anything, is going ahead of plan. I was quite happy with that. And I think when you look at the numbers, what we can tell you is that Business is performing very well organically. Training business itself is going, as we expected, by double digits, top and bottom line. When you look at the results, I would ask you to bear in mind that in the quarter, we delivered a lot less simulators in the quarter. Maybe it's just because of timing of the deliveries of customers. We delivered five in the quarter relative to 12 last year. As you know, the way we account for those, we only account for them at delivery. So I think, going back to the question organically, the business is performing very well.

Okay, that's helpful. Actually, do you have a sense, is the idea to basically deliver a similar number of simulators for the full year 20 as fiscal 2019? Yes. Yes, okay. And then, a bit of a nitpicky question, but utilization was down about four points year over year. Just wondering what drove that. Was it a mixed issue because you had folded in the Bombardier assets, or is there something else at play there to drive that four-point decline?

I think that the main issue that drives that is, first of all, I'll say the utilized use is quite high, and what you're not seeing there to your question is because we've deployed from about 260 to 294 systems you know, in the past year with several of those deployed in the last two quarters. So what you're just basically seeing is just a ramp-up of SIMs that have just been put in that are operating low, but the network itself is operating very, very highly like this.

Okay. That's great color. And maybe just more of a clarification point. I did not see it in your MDNA, so I apologize if it's there. Did you provide – or did the impact of IFRS 16 have any material impact on the reported EBIT relative to – relative to the year-over-year comp? I don't think I saw anything in the MD&A.

So, Kevin, I don't think on the whole it did not have a material impact on the SOI or EPS. It's a little bit of a headwind, but for the year, what we had said last quarter is that we'd have a bit of a headwind of that $0.01 EPS for the year. Now, in the comparisons year to year, I think on the balance sheet is where you see the most impact with the increase on the right of use assets and the debt, but we've given you the metrics adjusted for the IFRS 16 elements on the balance sheet.

Perfect. That's it for me. Thank you for taking my questions.

Thank you. Thank you.

Our next question is from Cameron Dirksen with National Bank. Please go ahead.

Yeah, thanks. Good afternoon. Just really two quick ones from me. Sonia, you mentioned or talked about the working capital investment in Q1. It does seem as though it was sort of larger than what we would normally see in a Q1 significant working capital investment. Was there anything unusual in Q1 that would have driven that?

No, nothing overly unusual. I mean, we always usually see a negative free cash flow investment in working cap in Q1, in fact, for H1. What I called out in the remarks was a higher level of work-in-progress simulators. So these are simulators that are going through production, tagged to clients, and given that we had lower deliveries this quarter, hence they didn't turn into revenue and, of course, AR and cash flow. We expect those to be delivered over the next few quarters, so really just a question of timing.

Okay, no, that's great. And just sort of secondly, just really as a modeling question, just maybe talk about the depreciation run rate. The number that we saw in Q1, is that actually a good run rate to use kind of on a quarterly basis for the full year?

I think, yes, it's quite indicative. Ultimately, you have two factors in there. You have the impact of IFRS 16 and the added depreciation because the assets are now on balance sheets. And, of course, the impact of the intangibles from the acquisitions from last year, namely the Bombardier Business Jet training acquisition. So I think you can use that as a good run rate.

Okay, perfect. That's all for me. Thanks.

And our next question is from Konark Gupta with Scotiabank. Please go ahead.

Good afternoon, and thanks for taking my questions. So on the civil side, just wanted to touch base on the margin side. Can you hear me okay, Andrew?

Yeah, we hear you.

Yeah, so on the civil side, the margins are pretty strong, and I guess Bombardier acquisition helped there. So just wanted to understand, this is 21% in Q1, and it's already pretty strong. And seasonally, you always have second half much stronger. So what are your expectations around this civil segment margin for the full year? Can we see something like 22%, 23%? Is that a possibility over time?

Well, I think that, like Renard, I think what you're seeing, again, in the Q1 in terms of the margin is the proportion that's coming from training, which is higher margin than products. You'll remember I was saying when answering Kevin's question that, you know, we only delivered five simulators in the core versus 12 last year. So although it's good margins and products, not as good as service, as training. So I think you're seeing a bit of that. And I think for a full year, I think we continue to just guide to absolute operating income growth rather than margins. Notwithstanding, I think margins will be good.

The only thing I would add to that is, as we said when we introduced the Bombardier business jet training business, is that that would have the effect of about 100 to 150 basis points of margin accretion.

Okay, that's great. And just want to clarify, was there any impact of Boeing 737 MAX in the civil segment? Because obviously they're still grounded and the airlines are not taking deliveries right now. So is there any reduction in training in MAX and that there's an offset in training other aircraft types?

Not really. It's not much of an impact for us, positive or negative. I think in the court of materiality, I think we continue to deliver maxims. I think we'll deliver this quarter, you know, eight or how much we think we'll deliver? Yeah, we'll expect to deliver about eight 737s in the next quarter. So we've already delivered a bunch, so that's not slowing down. You saw we've sold four MAX simulators in Q1, which is about what you would expect when you're considering the number of aircraft that have been sold in odd order. So bottom line, it's not really materially affecting our results one way or another right now.

Okay, that's great. And then lastly on defense, so I think there was a note in the MD&A that you had some dilutive impact of fair value revaluation of share-based payments. So can you clarify what is that? And is that non-recurring in nature, or can we expect something in the next quarter as well?

Well, it's not indicative of a continued run rate. There was a bit of a timing spike in the quarter because of the appreciation or the steep appreciation in the long-term incentive plans with get mark-to-market with the share price. So there was a bit of a steeper timing on those costs for the quarter.

Okay, that's great. And the European services programs continue to show weakness, I think, in the defense side. Any thoughts there, Mark, why Europe is weak here? Is it particular programs you see or is it general market weakness?

Where do you see European markets? In the MD&A. Oh, in the MD&A. Okay, well, I think mainly we're talking about timing on orders. I think the whole situation that you see with regards to why we back up – You know, we said that the year would be back and loaded, and we're seeing it. You know, when you look at what we've done this quarter on defense, you have about two-thirds of our revenue in the quarter coming in from services, which is lower margins, and the programs going through are still in the early stages of profitability ramp-ups. And, you know, we just haven't been able to make the progress in the quarter on certain programs, either because we weren't able to achieve the milestones that we needed to be able to book a good portion of the revenue for a variety of reasons. I'll give you one. The aircraft program is not a reach there milestone, so we can't reach ours, or we don't have the information we need, whatever. A lot of times, all you need to do is to miss the end of the quarter, and that's it. It moves to the next quarter. Some orders that we expected to get were delayed, and we're getting them later. I think in terms of Europe itself, it's not a European phenomenon. It's timing.

Okay. Thanks for the call. Thank you.

The only other thing I'll tell you is that in terms of backing up our optimism on why it's back-end loaded is that, of course, we know what the backlog is, and we have a pretty good idea of when we'll be able to achieve the milestones at which we book revenue and earnings. And also, we need to – we always – need to continue to win orders in a year, particularly on products, because a portion will materialize in a year. We're pretty confident about that because the great majority, over 90% of what we need to generate from orders that we don't have in our hands right now, we've already been selected. So it's not a question of whether we'll win or not. It's just the uncertainty of when exactly is the contract going to be signed. So we don't have full control of all of that, but we've made some pretty fair assumptions that we feel confident about, which gives us, those two factors give us the confidence, having done an exhaustive detailed analysis, of course, of why we feel comfortable with the outlook that we've maintained.

Perfect. I appreciate it. Thank you.

And our next question is from Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Yeah. Good afternoon. Just to come back on defense margins, you seem quite confident that the revenue mix will be more favorable going through the second half. Could you maybe provide some color with respect to how much of the products, the revenues are already booked in the backlog right now or whether you need still to gain a lot of business to achieve this milestone?

I don't think we can give the amount in absolute terms, but the confidence comes from what I was just saying there to Konar is that the amount of uncertainty we would have with regard to the products order that we need to get this year, the confidence we get is because we're selected. We're already selected on over 90% of those orders. So, you know, we're going to get that business. So the only uncertainty that remains is when you're actually going to sign the contract. So, I mean, we're not totally, obviously, in control of that, right? The customer is in the hands of the customer as well as ourselves. But the assumptions we've made are based on, you know, very good intel of what we know, you know, because these things are near term. The other thing as well is that doesn't include the fact that the orders we haven't been selected on, but we have a very strong... backlog of pipeline, I should say. I mean, we've got $4.2 billion of proposals that are out there that are waiting decisions. So some orders that, you know, potentially that we'll win, that will just add to the confidence that we have of meeting the outlook that we have. So those are reasons we're confident. And, you know, I'll tell you, Benoit, we saw this last year, and we saw this year before as well. And I think that we're kind of at the same place, except that I would say that If I just look compared to last year, we're picking up this up earlier in the year, so I think it gives us even more time to materialize the outlook that we have.

Just to add to your question on how we make it up, there's order intake, but we have a very detailed plan to make up the advancement on the product programs during the course of the year with more weight on the second half, and given the higher margins of these programs, the contribution is disproportionate and we'll make up on the operating income and the margin.

Okay, that's a great caller. And related to the Boeing 737 MAX, there's a lot of discussion on whether there will be a requirement for additional training. So I was wondering if you could maybe provide some color about what would you expect in the next 12 to 24 months and how much 737 MAX simulators do you have in your backlog right now?

Well, I think that, you know, look, we'll have to wait to see what the regulators say when airplanes start coming back when they're cleared to fly in the various jurisdictions. We sold the great majority of the simulators that are out there. We certainly expect to continue to be successful like we have on the rest of our platforms. So I think it's a wait and see. Clearly, There's going to be a lot of training to be done when the simulators, when the aircraft are cleared. So I would see pent-up demand there when airlines start to fly. That I would expect. But I have no color more than anybody else does on what the authorities will ultimately decide on what training is done on what simulators.

Okay, that's perfect. And on the civil aviation side, Marc, you mentioned that you expect more outsourcing opportunities with the airlines. So are there any particular region where you expect CAE to be more active? And in terms of simulators order, do you still feel confident that you can achieve 60 plus this year in terms of booking?

Benoit Tendreux. Actually, what we've said, as we've said in previous years, is that we'll maintain a leading share. I think what I would look to is aircraft deliveries, which are still at a relatively high rate, x the temporary setback in max deliveries. And that simulates a certain level, sustained high level of demand for full-flight simulators. So What that will precisely be, I guess, will become clearer as the year progresses, but we see a pretty good run rate.

Okay, that's great. And on DL Care, we saw a nice pickup in revenues. Margin negative, but I assume it's typical seasonality, so do you still feel confident that the double-digit growth can also be achieved on the operating income side?

Yes, absolutely. Okay, perfect. Quite encouraged with, you know, the progress that our new leader, Rekha Ranganathan, is making with her team and the experience that she brings, you know, from our senior leadership or senior levels in Philips and other companies. So, you know, definitely we're seeing the momentum there, and I would expect that to continue.

Okay. Thank you very much for the time.

And ladies and gentlemen, we welcome your questions. Please press the 1 followed by the 4 on your telephone keypad. 1-4 for questions. One moment, please.

Operator, if there are no more questions from members of the financial community, we'll conclude this part of the session and open the line to questions from members of the media.

There are no other questions on the phone lines from participants, sir.

Okay, then. Well, I'll thank all participants for joining us this afternoon and remind you the transcript of Today's call will be made available on CAE's website at cae.com. Thank you.

Ladies and gentlemen, that concludes the call for today. We thank you for your participation, everyone. Have a great rest of your day. You may disconnect your line.