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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, ladies and gentlemen, and welcome to the CAE Third 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 now 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 '18 and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, February 9, 2018, and accordingly, are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties.Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risk factors and assumptions that may affect future results is contained in CAE's annual MD&A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR and the U.S. Securities and Exchange Commission's EDGAR site.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 provide an overview of the quarter, and then Sonya will review the detailed financials. I'll come back at the end to talk about our outlook.We had year-over-year growth in all of our segments in the third quarter, and we remained on track to deliver on our growth outlook for the year as a whole. Some highlights included our order intake of $1.2 billion, which is testament to the good progress we've been making to expand our position with airlines, business aircraft operators and defense forces worldwide. We also generated strong free cash flow in the quarter and maintained our solid financial footing.Looking specifically at Civil. We booked $1 billion in new orders for our comprehensive training solutions, which marks the quarterly record for the Civil business unit. Orders included exclusive long-term training services contracts for AirAsia, Air Transat, Mesa Aviation and Jazz Aviation. We also won 26 full flight simulator orders from airlines including Ryanair, Air France, ATR, Lufthansa Flight Training and Air Canada, some of which involve multiyear deliveries. This brings our year-to-date tally to 45 Civil full-flight simulator orders, so we're on track for another pretty good year. Revenue and operating income were higher than last year's third quarter, and for the year-to-date, Civil growth is on track with our outlook.In Defence, momentum increased in the quarter with revenue and operating income growth in the high single-digit percentages. In terms of order activity, we continue to capture important training systems and service contracts, which puts us at $966 million of Defence orders for the first 9 months of the fiscal year. New awards in the quarter included flight simulators and training systems upgrades for the U.S. Navy's MH-60R helicopter, as well as the German Navy's P-3C and Sea Lynx flight trainers. Service awards included an enterprise-wide training systems maintenance contract with the Australian Defence Department. And in Healthcare, we developed LucinaAR, the world's first augmented reality childbirth simulator, which we just launched in January at the International Meeting on Simulation in Healthcare in Los Angeles. This new high-fidelity patient simulator incorporates mother-baby physiology and is the latest product to integrate the Microsoft HoloLens. Also of note, Healthcare announced a partnership this January with a leading scientific society, the American Heart Association, to deliver AHA certification courses in certain markets.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 third quarter was $704 million, and quarterly net income was $117.9 million or $0.44 per share. This includes approximately $0.13 per share attributable to the U.S. tax reform. Net income also includes a net gain of approximately $0.03 per share on the fair valuation of CAE's prior investment position in the Asian Aviation Centre of Excellence. This net gain was triggered by our acquisition of the remaining share of the investment and some reorganizational activities. Excluding these elements, earnings per share would have been $0.28, which is up from $0.26 per share last year, before specific items.Income tax recovery this quarter was $24 million, representing a negative effective tax rate of 25%, which compares to an effective tax rate of 14% for the third quarter last year. Excluding the effect of the U.S. tax reform and the tax impact related to the net AACE gain, the effective tax rate in the third quarter would have been 17%.Remaining on the subject of tax, we conducted a thorough assessment of the actual and expected future impact of the U.S. tax reform, and the good news is that it represents a net positive for CAE. A significant portion of CAE's business is conducted in United States, where approximately 1/3 of our revenue is generated and a similar proportion of our total workforce resides. The most significant element of the reform is the lower federal corporate income tax rate, which decreased from 35% to 21%, effective January 1.There are a number of puts and takes with respect to other elements of the tax reform, but in aggregate, these reforms will effectively lower CAE's income tax rate from an annual average of 22% to something more in the range of 20% to 21% as a rule of thumb.Free cash flow from continuing operating activities was $146 million for the quarter compared to $124.7 million in the third quarter last year. The increase in free cash flow year-over-year results mainly from a lower investment in noncash working capital. As is usually the case for CAE, we continue to expect a partial reversal for the first half investment in noncash working capital in the second half of the year.Uses of cash in Q3 included funding capital expenditures for $43 million and investing $99.7 million to acquire the remaining 50% equity interest in AACE. We also invested $7.7 million to acquire a 45% interest in Pelesys, forming a joint venture with this leading aviation training courseware developer. In terms of shareholder returns, we distributed $23.2 million in cash dividends and we used another $21.8 million to buy back stock under the NCIB program. Of note today, CAE's Board of Directors approved the renewal of the NCIB under similar terms for another year.Our financial position continue to be strong with net debt of $712 million at the end of the quarter for a net debt to total capital ratio of 24.6%. Also, return on capital employed increased to 11.7% this quarter, excluding the impact from the U.S. tax reform, compared to 11.2% last quarter. Now looking at our segmented performance. In Civil, third quarter revenue was up modestly year-over-year at $413.7 million. We had continued good momentum in training growth and a high level of simulator deliveries as well. Civil simulator deliveries were even higher in the third quarter of last year because we were also delivering from the additional simulator backlog that we acquired from Lockheed Martin. In terms of segment operating income, we generated $78.6 million, which includes a $4 million gain on the fair valuation of AACE, net of some one-time costs. Before the net gain, segment operating income was up 4% for a margin of 18%.On the order front, the Civil book-to-sales ratio for the quarter was 2.43x, and the trailing 12-month period, it was 1.43x. Civil's backlog at the end of the quarter was $3.8 billion. In Defence, third quarter revenue was up 8% over Q3 last year to $262.8 million, and operating income was up 9% to $32.7 million, for an operating margin of 12.4%. The Defence book-to-sales ratio was 0.71x for the quarter and 1.22x for the 9 months year-to-date. The Defence backlog at the end of the quarter was $3.5 billion.And finally, in Healthcare, third quarter revenue was $27.9 million, compared to $26.2 million in Q3 last year. Healthcare segment operating income was $1.5 million in the quarter compared to 0 in the same quarter last year. With that, I will ask Marc to discuss the way forward.
Thanks, Sonya. As I mentioned at the outset, we're on track to deliver on our growth outlook for the year and I feel very good about our long-term view as well. As is customary for CAE, we'll provide more on our outlook for the next fiscal year when we report our upcoming fourth quarter. The civil aviation training market is large and is growing, and we've got considerable headroom to expand our position. CAE offers the most comprehensive training solutions across the broadest global network, and we're widely recognized for our know-how in cadet-to-captain training. With more than 70 years of industry-firsts, we're also seen as a thought leader in aviation training. This past week at the Singapore Airshow, we launched our latest innovation, the CAE Rise training system. This is the first commercial offering of our next-generation training system. By leveraging the latest digital technology, we're able to use real-time data for instructors to objectively assess pilot competencies and gain deep analytical insights into training. We're in good position and we have ample opportunity to continue making accretive, market-led growth investments in our training core that align with our corporate goal of 13% return on capital. For the fiscal year, we still expect to generate low double-digit percentage segment operating income growth and to maintain our leadership position, again, in the Civil business. In Defence, we're also encouraged by a large pipeline of opportunities in an environment of decreased -- of increasing Defence spending and a greater tendency to outsource training. Our innovative solutions involving integrated live, virtual and constructive training are opening up a large addressable market. Hereto, we have plenty of headroom to grow our position. For the year, we maintain our outlook for mid- to high-single-digit growth on both top and bottom lines. And finally, in Healthcare, we're demonstrating that CAE is the clear innovation leader with a steady cadence of new product releases with which to tap into some of the largest value pools like nursing. We're still expecting a return to growth this year and to be positioned for double-digit growth beyond. With that, I thank you for your attention, and we're now ready to answer your questions.
Thank you, Marc. Operator, we'd now be pleased to take questions from analysts and institutional investors.
[Operator Instructions] Our first question comes from the line of Fadi Chamoun with BMO Capital Markets.
Quick question on Civil. So in the quarter, you had revenue up 3% and you had EBIT up 4%, and if I take the guidance of low double digits for the full year, would imply, again, kind of mid-single digit growth in the fourth quarter, which is quite a bit of a deceleration in the operating leverage versus what we've seen in the last few quarters. I'm just wondering, should we read into this that maybe we're getting to kind of a maximum or optimum point of the current assets of network, and potentially, we should see some improvement or increase in CapEx to support further growth? Or is this kind of just a mix issue? If you can talk a little bit about the factors behind the kind of lack of operating leverage this quarter.
Well, I don't think you should read anything into that we're using -- we're reaching any kind of plateau in terms of the yield that we can get out of the existing simulator network. I definitely wouldn't reach that conclusion at all. I think there's still room for that. And of course, if you look at the quite substantial order intake we have in this quarter, $1 billion in Civil, I think there's lots of room to grow within where we're at. I think, in Defence, where you're at in terms of our expected growth, it's in the outlook that we've given, so I think we'll get a good Q4, and I'll just leave it at that. I think it can be somewhat lumpy. And that, again, that can always occur, but we usually have pretty good Q4, so I wouldn't expect that to be any different this year. But Sonya, do you want to add anything?
Yes, if I can just add to your point on operating leverage, we continue to see that. And as I mentioned in my comments, still very good, solid training growth on the training side. Really, the story here is that while we had very good level of deliveries this quarter, there were more deliveries last year, actually, 3 more deliveries last year that basically generated revenue because they were all accounted for at completion, coming from the backlog that we acquired from Lockheed Martin. So that's really driving kind of some of that differential.
Okay. That's helpful. One more question on my end. So you're generating very strong free cash flow and kind of the balance sheet is in pretty good shape and, arguably, you have some debt capacity as well, if you needed it. But can you talk a little bit about kind of pipeline of opportunities that you see to invest capital, either via CapEx, like you did with AirAsia and some of the other JVs that you've done, or via kind of tuck-in acquisition in the aviation side?
Yes. I think, look, I think we -- in terms of pipeline of opportunities, there's quite a number in front of us that we're working on and we announce them as we crystallize them. Of course, you know we're working on Singapore right now. We're at the tail end of that. That's going well. There's quite a number of -- I see more of an appetite for people to consider the kind of complete training offerings that we have, so that's generating some interest. So look, I think you've seen us somewhat keep ourselves positioned to be able to seize those opportunities because our #1 priority remains growth in terms of our capital deployment. So I think that remains where we're at. I think that both CapEx and M&A, kind of quasi-M&A, which we're outsourcing, they're our JVs, that's how we consider it. And with the guys that those investments that we would make, either way, I think -- I don't think it will increase the level of relative capital -- CapEx intensity, all things being equal as our revenues go up. And I think the returns that we're getting on the capital that we are deploying is pretty good. And you could see it transpiring and we don't expect that to change.
Our next question comes from the line of Steve Arthur with RBC Capital Markets.
First, just on military bookings. They were down sequentially in the quarter. Am I right just to assume that, that's timing-related on specific programs you're looking at? Or has there been any material change, better or worse, in the level of bid activity or your win rate?
No, I think, it's just the -- military, they're always specifically lumpy. We don't really control anything about when bids are actually decided upon. All you're seeing is just normal lumpiness. We've always said, I think, going back many years, Steve, that it's best to look at Defence on a 12 months rolling picture, especially when you're looking at orders. Now the pipeline of potential opportunities for us is very strong, it hasn't diminished. I still -- we still have about like, what is the number, about $3.5 billion to $4 billion of bids out there that -- in front of defense organization, governments, military organization around the world for them to decide. So I think it's best to look at the book-to-bill on a 12 month-rolling forecast. And when you look at that, you're above 1.
Understood. And secondly, just on the Civil side, the equipment business. You usually don't talk about it as much, but 26 orders in the quarter got my attention, leading towards 3 strong years in a row of probably around 50 units plus. Is that the new norm for this market, would you think? I've always thought of this in the low 40s. So is that a timing-related thing again in this quarter? Or is that kind of where that market is heading?
Well, I think, look, we -- I think, certainly, we look at this year, we haven't provided a number, but clearly, I think we'll have a number in the 50s, I would expect. I mean, we don't decide on closing them depending if we get this side or of the end of March or not there, so it depends which one crosses the line before, but I think we will be in the 50s. Whether it's a new norm, I can't tell. I mean, as you know, the dynamic hasn't changed, it's really basically dictated, determined by the level of deliveries out of the OEMs. And as you know, the OEMs are maintaining a pretty strong cadence -- very strong record cadence, I should say, of deliveries. And that's forecasted to continue and some are even talking to grow it to get out of these 8- to 10-year backlogs that they have. And for us, it's about maintaining market share, which we're doing effectively while protecting margins. So look, I can't tell if that's the new norm, but I think it will be up there, for sure. I mean, somebody's 26 says it's a good number, thanks for -- I'm glad it catches your attention, so it catches our attention as well, we're happy about it. I can tell you that. But some of those, as I said in my outlook, are multiyear deliveries, so people buying ahead. So there's a couple of orders in there that are multi-units. But having said that, I do think we'll be looking at, from what I can see, some pretty good years of high sim count in front of us.
Our next question comes from the line of Cameron Doerksen with National Bank Financial.
I guess, maybe a question on the training market. I'm thinking specifically about the business aircraft training market. I mean, we've seen utilization of business jets ticking higher pretty much over the last year. But I guess, more recently, we've seen some of the OEMs feel a little more confident about order activity for business jets. I'm just wondering what you're seeing in the business jet market from a training perspective?
Training market has been pretty resilient for us. It's -- I'm not -- well, first of all, really, what dictates us is, really, utilization of the aircraft. The deliveries is good -- it's good, but it's not like in simulator sales, it's not an immediate effect on the amount of training, except where it stimulates people moving to a new aircraft, therefore you get training demand. But utilization is up so you can assume that, that translates into the numbers that we see. So it's not a big uptick, but definitely, things are moving in the right direction, both in the U.S. and in Europe this year. So I'm pretty -- I'm encouraged by that. But I think, we'll see. And certainly, I think, what we saw down south, the U.S. tax reform, will probably have an effect on stimulating demand. I mean, that's what industry experts predict and that's what we've seen in the past when the accelerated depreciation came in. So look, I think, our business -- aircraft business is doing well. It's stimulated by utilization so I think you can pretty much use that as a proxy for the fortune's in our business there.
Okay. Maybe the second question, maybe bigger picture. Just we keep hearing you have more and more stories about a pilot shortage, that's really kind of global phenomenon. As it relates specifically to CAE, obviously, that's an opportunity from your demand side, but I'm just wondering, from a premier perspective, trying to retain or hire instructors for your training business and then whether you're needing to pay these guys a lot more to retain them, I'm just wondering if you can comment on how that's going for you?
Well, I think, you're right to say. I mean, instructors, for us, is a very important demographic and it's key to our offerings, so it's something we pay a lot of attention to. I think what we -- ever since we've been in training business, we've focused on that, the instructor category specifically, so we've got programs in place, 2 specifically. In fact, we launched a project about 3 years ago called project FIIN, which is Flight Instructor Initiative, which is us putting in place initiatives, which include, obviously, what the financial incentives, but only part of it. What incentives do you have? Career and things like that which appeals to people, so that we can attract, retain and develop the best instructors in the world in our business. And that's what -- and we've been pretty successful. I don't -- obviously, you have issues every so often here and there in certain geographies, but as a whole, we haven't suffered from that as something that stopped or affected our growth or our financial performance in any way. But instructors are important. And a lot of our instructors, actually, you'd be surprised, are not pilots themselves because it depends what we actually train. But I guess, summarize it to say, it hasn't been an issue but something that we watch because that's -- you're right to ask the question from that point of view of the worldwide demand.
Our next question comes from the line of Turan Quettawala with Scotiabank.
I guess, I was wondering, Marc, if you could just comment a little bit about fiscal '19. I know you've said that you'll give guidance in the next quarter, but just wondering, based on what you're seeing right now out in the market for both Defence and Civil, is there any reason to believe that growth would be materially different from where you are right now?
Well, I'll go back to what you said that we haven't provided any guidance, and we usually do that in Q4, but I certainly don't think things are going down, that's for sure. And I think, look, in terms -- Andrew, did you want to add?
Yes, I'll take a stab at that one. We will provide, Turan, our outlook for next year when we report next quarter more precisely. But I think that what we're trying to get across is that the big macro drivers for the business are all running very well in the sense whether that's increased defense spending and a greater propensity to outsource training and services to companies like CAE. And in civil aviation, it's a large and growing market that also has a considerable amount of headroom in it for us to grow our position to gain a greater share of our customers' training responsibilities. So that lends itself to an expectation for continued good growth and also continued good areas of investment opportunity where we can get accretive rates of return and dovetail into our 13% return on capital expectation.
And again, just one more quick one for Sonya. The D&A, I think, was quite a bit lower in Defence in the quarter. I'm just wondering if there's a specific reason for that and how should we be thinking about that going forward?
You're right. It did decrease a little bit in the quarter, and that was due to an extension of a certain program that we have. And so, therefore, the amortization have taken over a longer period, but there is a corresponding deferred revenue, which you don't see on that table, which also gets amortized over a longer period. So net-net, not a huge impact in terms of contribution to the SOI, but it does provide a good view on the run rate going forward on D&A for Defence.
[Operator Instructions] Our next question comes from the line of Benoit Poirier with Desjardins Capital Markets.
My question is more about the utilization rate of your training network. So if we go back in fiscal '16, fiscal 7 (sic) [ '17 ], you basically have been able to increase the utilization rate by almost 8% over 2 years. If we look year-to-date, it's been flat to slightly down. So I was wondering if you could provide more color about the why it's more difficult to increase? And what is the potential going forward with respect to the utilization rate?
I think we're getting to a period, I think, that comparable is a little bit more difficult, mainly because of the change in the mix that we had, for example, getting out of our training center JV in Zhuhai, for example, which had a tendency that the training centers that we have in the Far East are running at very high levels of utilization, which tends to skew things to a certain extent. When you just look at the pure utilization number, that doesn't necessarily translate into the yield, I should say. So that comparable is different. But I think, look, I don't -- I still see that there's additional capacity in that -- in our sim network. We -- as you know, 75% is not 100%. 100% is quite not practical, obviously, but there's still some room to grow within that. Demand is high. And more and more, what we strive to do is to generate more yield across the existing network by increasing the level of wet training and other services that we could provide across that service center network. So look, I think that I'll leave it at that, Benoit.
Okay. Perfect. And when we look at the margin for Healthcare, you mentioned that the mix was less favorable in the quarter. So could you maybe provide some color on what type of mix we could expect in the next 2 quarters? And also, when we look at the valuation in the sector, the valuation is very favorable. So I was just wondering whether you see an opportunity to maybe crystallize some value for Healthcare?
Well, the first one -- the second one, sorry, and no. Look we're still committed to this business and I still very -- feel very confident that the strategy we have, which was, admittedly, course corrected last year. And just to remind you, remind the listeners, to refocus our strategy and going after the largest pools of value in this sector, in Healthcare simulation, which is really the education of nursing. Okay. We're very focused on that. It's a large end market that is being served today. Really, we launched new products, basically, the first one is CAE Juno, to go specifically at that market. And so far, I'm pretty happy. I mean, it's taken us some time to translate into the numbers, but we're quite confident it will and it's in our outlook, but the products that we have, Juno specifically, has been very well-received in the market. We don't actually separately report orders because -- in this market, because of the dynamics, and it's a relatively small number, but I can tell you that if I was to look at that metric, we're up 20% year-over-year just in orders of that product line and that's good margin product. So I think, it's really about the future here. It's about growing the top line by selling those products into that existing market. And with the margin profile of those products, it won't take long, it won't take much revenue growth, which we've forecast that we could generate a markedly different EBIT profile in terms of percentage.
Operator, that is all the time we'll take this afternoon for questions from members of the financial community. I'd like now to turn the call over to members of the media, if there are any questions from members of the media.
[Operator Instructions] And our first question comes from the line of Julien Arsenault with La Presse Canadienne.
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And we have no further questions on the audio lines at this time.
Okay. Operator, I want to close the call at this point. I want to thank all participants, members of the investment community, as well as from the financial press for participating with us this afternoon. And I would remind you that a transcript of today's call can be found on CAE's website at cae.com.
Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you kindly disconnect your lines.