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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.
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 risks, 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 U.S. 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.
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 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 $689 million, giving us a total CAE backlog of $8 billion at the end of the quarter. We grew revenue by 10% on a year-over-year basis, and earnings per share of $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 $499 million of orders in Q1, plus additional contracts involving joint ventures, including an 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 $166.9 million, including a contract from the U.S. Navy to provide instruction at 5 naval air stations to support primary, intermediate and advanced pilot training. We also signed contracts involving training for the Brunei Ministry of Defense 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 model -- module, sorry, 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?
Thank you, Marc, and good afternoon, everyone. Consolidated revenue for the first quarter was $722 million, and quarterly net income was $69.4 million or $0.26 per share. This compares to $0.22 from the first quarter of last year.Income taxes this quarter were $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 of investment in noncash working capital during the first half. The investment this quarter was higher than in Q1 last year, and I would note, the 5-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 $85.8 million compared to negative $37.9 million last year.As in previous years, we expect a portion of noncash working capital investment to reverse in the second half. Uses of cash in Q1 included funding capital expenditures for $53.1 million, mainly for growth. And we distributed $23.1 million in cash dividends. We used another $6.5 million to buy back stock under the NCIB program.Now looking at our segmented performance. In Civil, first quarter revenue was up 16% year-over-year to $430.9 million, and operating income was up 14% to $78.3 million, for a margin of 18.2%. On the order front, the Civil book-to-sales ratio for the quarter was 1.16x, and the trailing 12-month period, it was 1.45x. Civil's backlog at the end of the quarter was $4.1 billion. In Defence, first quarter revenue of $268.3 million was up 3% over Q1 last year, while operating income was down 10% to $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 0.62x for the quarter and 1.2x for the last 12 months. Defence backlog at the end of the quarter was $3.9 billion.And in Healthcare, first quarter revenue was $22.8 million, down from $23.9 million in Q1 last year. Healthcare segment operating loss was $1.3 million in the quarter compared to a loss of $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 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.This is especially so, in light of our efforts now to mitigate the impact of the 5-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 4 years plus 1-year option 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.
Thanks, Sonya. Our outlook continues to be positive and we're 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 $0.01 or 11% increase to CAE's quarterly dividend, which becomes $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 have 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 airline 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 continue to have solid momentum in business aviation as well, and we're well-positioned to provide customers with an excellent experience and to continue gaining 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 U.S. defense 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 $3 billion larger addressable market. CAE's global addressable market in defense now stands at about $17 billion. So we're 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 customer decisions, which is currently over $4.5 billion. Governments in 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 $50 million, including options, to provide the Royal Navy's -- the Royal New Zealand Air Forces with CAE's latest 700MR series simulator for related -- as it relates to 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 our 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 innovation -- horizon of innovation is focused on digital technology. CAE is a market leader in aviation training, with a 70-year track record of industry firsts. We're 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 customers' 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'd 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 5 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 U.S. Army General Pete Schoomaker who reached the mandatory term limit for a CAE Director. General Schoomaker first served as a Director of CAE USA board, and then on the CAE's Board of Directors for the past 9 years.We benefited greatly from his insights, which helped to shape CAE's Defence strategy and to position the company in the U.S. defense market in particular. We thank you, 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 U.S. 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 adviser to the Secretary of Defense, National Security Council and the President.His deep industry knowledge and extensive experience, especially in the area of defense aviation training, make 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 Frank -- 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 6 commanders within the NATO command structure.With that, I thank you for your attention. And we're now ready to answer your questions.
Operator, I would ask that you now please open the line to questions from members of the financial community.
[Operator Instructions] Our first question comes from the line of the Cameron Doerksen with National Bank Financial.
I guess, my -- just first question, just on the R&D program that you announced recently. I mean, CAE has always spent 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?
Hi Cameron, Sonya. So great announcement, I think, great for continued investment in CAE and in Canada and in 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 in pretty much -- and incorporated into our outlook. In terms of cash flow, this will not have an impact on the run rate.
Okay. Very good. And maybe just quickly, a question about the AOCE business that you just recently purchased. I wonder if you can just talk a bit about the margin profile at that business because it does look like it's, I guess, predominantly a services business.
Yes. So this is a great bolt-on acquisition. 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. It -- as a general run rate, about $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 cost to synergize into our own operations. For the year, it'll be just slightly accretive.
Our next question comes from the line of Chris Murray with AltaCorp Capital.
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?
Maybe I'll start it off, it's Marc. I think what you're seeing here, I mean, part of it, the answer is what you just mentioned is 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 -- we've hit it in spades 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 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'll recuperate that because the program's not lost, it's just booked in -- so in a different quarter. And that's what happened here 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 spend, and you kind of get the result. But when we look at the year as a whole, we're not concerned about the outlook that we've given, it's really 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?
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.
Okay. And that was my next question -- oh sorry, go ahead, Marc.
I was just going to talk about when, specifically, when we talk about mix on Civil -- on Defence, we're really talking about -- at least I was talking about the mix between products and service 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.
Okay. And I guess that brings me to 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 this is going to be, as you said, more timing issues in the quarter?
Well, the bulk of it is going to be shifting into the second half, as we said 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 5 weeks, so we were not -- we shipped a couple of product out the door during that time, nevertheless. So we have accelerated -- or we have a recovery plan underway that's making up for that time working, the work over Christmas for example. We'll 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, civil, the simulators, for example, we will only be able to recognize revenue and 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 and those simulators are -- that are in 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 maybe more color to that.
Yes. So whatever the revenue and profit that we would have generated in those 5 weeks is delayed and essentially shifted to the back half. And that's in addition to the already delivery completion which was already back half due to the new revenue recognition.
And I think -- I don't if I answered this specifically, but I don't think I misquote -- specifically, I don't see -- I don't think we see any revenue and profit that is lost as a result of this.
No.
Our next question comes from the line of Jean-Francois Lavoie with Desjardins Capital Markets.
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?
Well, I think, as we said in our remarks, we still feel 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 can 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 2 weeks, CAE Ares in the mid-fidelity market. And the -- 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.
Great. And maybe last one for me, you had a very strong first quarter in terms of full flight simulator order. So I was wondering what is the -- your outlook or your expectation for the second half in terms of order?
Well, if you look at where we're at, as you said, we're at 26 simulators halfway through the second quarter. So I think it's -- suffice to say we'll have a good year. It's a bit early for me to get outside what we said already. I think we said in the 40s, I think. And I think that's where we expect to be at the moment. It's a strong market 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.
Ladies and gentlemen, we will now proceed to questions from the press and media. [Operator Instructions] Mr. Parent, there are no further questions at this time.
Thank you very much, operator. I want to thank all participants for joining us on the call today, and to remind you that the transcript of the call will be available on CAE's website.
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.