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 2020 and answers to questions, contain 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 CAE's annual MD&A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR and on the U.S. Securities and Exchange Commission 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. 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 Marc.
Thank you, Andrew. Good afternoon to everyone joining us on the call. I'll first discuss some highlights of the quarter, and then Sonya will give you the detailed financials. I'll come back at the end to talk about our outlook. CAE had a good start to the fiscal year with double-digit revenue and operating income growth and CAD 940 million of orders or a 1.14 book-to-sales. CAE's total backlog at the end of the quarter was CAD 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. 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. 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 CAD 694 million of orders in Q1, including multi-year pilot training agreements with airlines including LATAM, SAS, and Air Europa. We also signed a new 5-year pilot training contract with Philippines AirAsia, which incorporates our highly innovative and data-driven CAE Rise training system. Civil sold 9 full flight simulators during the quarter, including 3 to Southwest Airlines for the Boeing 737 MAX, 1 to Korean Air for the Airbus A330, and 1 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 CAD 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 L3 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. In Healthcare, we continue 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 ESP in 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 Baylis 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 with our CAE Juno manikin. With that, I'll now turn the call over to Sonya, 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. Sonya?
Thank you, Marc, good afternoon, everyone. Consolidated revenue for the first quarter was CAD 825.6 million, up 14% compared to CAD 722 million in the first quarter of last year. Segment operating income before specific items was CAD 113.3 million, up 15% from CAD 98.5 million last year. Quarterly net income before specific items was CAD 63.2 million or CAD 0.24 per share, which is 8% lower than the CAD 0.26 we reported in the first quarter last year. Net finance expense for the first quarter was CAD 34.9 million, up from CAD 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 CAD 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 CAD 137.8 million, compared to CAD 117.2 million in the first quarter of fiscal 2019. Free cash flow was negative CAD 102 million in the quarter, compared to negative CAD 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 CAD 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 backlog. We continue to expect total capital expenditures for the year to be modestly higher than the prior, by about 10%-15%. Other uses of cash include the distribution of CAD 25.5 million in cash dividends, and we used another CAD 2 million to repurchase stock at a weighted average price of CAD 34.41 per common share under the NCIB program.
Our financial position continued to be solid, with a net debt of CAD 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 Business Aircraft Training business acquisition, we continue to target 13% return on capital employed by fiscal 2022. Looking at our segment performance. In civil, first quarter revenue was up 11% year-over-year to CAD 477.6 million, and operating income before specific items was up 29% to CAD 101 million for a margin of 21.1%. From a mix 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 CAD 320.5 million was up 19% over Q1 of last year, while operating income was down 30% to CAD 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 that are 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 program milestones we plan to achieve on the higher margin product contracts already in our backlog. The mix imbalance in the quarter also reflects some variability in the timing of new product orders that 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 continued to ramp up scale with a first-quarter revenue of CAD 27.5 million, which is 21% higher than the CAD 22.8 million in Q1 of last year. Healthcare segment operating loss was CAD 2.8 million in the quarter compared to a loss of CAD 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 Marc to discuss the way forward.
Thanks, Sonya. We continue to see good momentum with our training strategy, which is supported by secular growth trends across all of our markets and underpins CAE'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. The aviation safety imperative underscores the criticality of pilot training. It also brings to bear the essential role that CAE 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.
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. 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 CAE Women in Flight Scholarship Program encourages women to become professional pilots. We recently announced the launch of a cadet pilot training program where CAE 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 and great example of our commitment to source, train, and maintain pilots to support the industry demand 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 CAD 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. 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 continue to expect Defense to generate mid to high single-digit % operating income growth this year as we deliver from backlogs and continue to win orders. 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 % growth, and we remain confident of the long-term prospects for Healthcare 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. We look forward to superior top and bottom-line growth in the years ahead. Before I conclude, I want to thank Kate Stephenson, 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, CAE has transformed itself to become the world's largest civil aviation training company. I also want to welcome Marianne Harrison, who was appointed today as a new CAE 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 acumen to the role, and we look forward to benefiting from her 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 are 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 one followed by the four 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 one followed by the three. Once again, ladies and gentlemen, for questions, please press the one followed by the four. One moment please for the first question. Our first question is from Kevin Chiang with CIBC. Please go ahead.
Hi. Good afternoon, thanks for taking my question here. Maybe just turn to Civil. I was wondering if we were to back out the Bombardier training acquisition, what would have organic revenue growth, both on the operating income line and the revenue line look like? Maybe conversely, 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. I think when you look at the numbers, I think 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, mainly just because of timing of the deliveries with 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. 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 2020 as fiscal 2019?
Yes.
Yes. Okay. A bit of a nitpicky question, utilization was down about four points year-over-year. Just wondering what drove that. Was it a mix 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 utilization is quite high. What you're not seeing there to your question is because we deployed from about 260 to 294 in the past year, with several of those deployed in the last two quarters. What you're just basically seeing is just a ramp-up of sims that are just being put in that are operating low. The network itself is operating very, very high utilization.
Okay. That's great color. Maybe just more of a clarification point. I did not see it in your MD&A, so I apologize if it's there. Did the impact of IFRS 16 have any material impact on the reported EBIT relative to the year-over-year comp? I don't think I saw anything in the MD&A.
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, for the year, what we had said last quarter is that we'd have a bit of a headwind of that CAD 0.01 EPS for the year. 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, 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 Doerksen with National Bank. Please go ahead.
Yeah, thanks. Good afternoon. Just really two quick ones for me. Sonya, 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. 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. These are simulators that are going through production tagged to clients. 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. Really this is a question of timing.
Okay. No, that's great. Just sort of secondly, just really like a modeling question, just maybe talk about the depreciation run rate. Would the number that we saw in Q1, is that actually a good run rate to use 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 sheet. Of course, the impact of the intangibles from the acquisitions from last year, namely the Bombardier Business Aircraft Training acquisition. I think you can use that as a good run rate.
Okay, perfect. That's all for me. Thanks.
Thanks.
Our next question is from Konark Gupta with Scotiabank. Please go ahead.
Good afternoon, and thanks for taking my questions. On the civil side, just wanted to touch base on the margin side. Can you hear me okay, Andrew?
Yeah, we hear you loud and clear. Go ahead.
Yeah. On the civil side, the margins look pretty strong, and I guess Bombardier acquisition helped there. Just wanted to understand, this is 21% in Q1, and it is already pretty strong, and seasonally, you always have second half much stronger. 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 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 we only delivered five simulators in the quarter versus 12 last year. Although it's good margins and Products, not as good as Training. I think for the full year, I think we've continued to just guide to absolute operating income goals 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. Just want to clarify, was there any impact of Boeing 737 MAX in the civil segment? Obviously they're still grounded, and airlines are not taking deliveries right now. Is there any reduction in training in MAX, and if 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 quarter of materiality, I think we continue to deliver MAX sims. I think we'll deliver this quarter, eight or how much we think we'll deliver? We'll expect to deliver product 737s in the next quarter. We've already delivered a bunch, so that's not slowing down. You saw we 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 and on order. Bottom line, it's not really materially affecting our results one way or another right now.
Okay. That's great color. Lastly, on defense. I think there was a note in the MD&A that you had some dilutive impact of fair value revaluation of share-based payments. 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, which gets marked to market with the share price. There was a bit of a steeper timing on those costs for the quarter.
Okay, that's great. The European services programs continue to show weakness, I think, in the defense side. Any thoughts there, Marc, why Europe is weak here? Is it particular programs you see, or it's general market weakness?
Where do you see European market?
In the MD&A.
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 on why we backed up. We said that the year would be back-end loaded, and we're seeing it. 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 up. 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.
The aircraft program is not able to reach their milestones, so we can't reach ours, so 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, that said, 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 color. 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 where 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. Also, 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. 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.
We don't have absolute control of all of that, but we've made some pretty fair assumptions that we feel confident about. 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 maintain.
Perfect. I appreciate it. Thank you.
Our next question is from Benoit Poirier with Desjardins Capital Markets. Please go ahead.
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 of that in absolute terms, but the confidence comes from what I was just saying there to Konark, is that the uncertainty we would have with regards to the products order that we need to get this year, is with the confidence we get is because we're selected. We're already selected on over 90% of those orders. We're going to get that business. The only uncertainty that remains is when you're actually going to sign the contract. I mean, we're not totally, obviously, in control of that, right? That's in the hands of the customer as well as ourselves. The assumptions we've made are based on very good intel of what we know, because these things are near term.
The other thing as well is that doesn't include the fact that there are orders we haven't been selected on, but we have a very strong backlog of pipeline, I should say. I mean, we got CAD 4.2 billion of proposals are out there that are awaiting decision. Some orders that potentially that we'll win, that will just add to the confidence that we have of meeting the outlook that we have. Those are the reasons we're confident. 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. I think it gives us even more time to materialize the outlook that we have.
Yeah. Okay.
Just to add to your question on how we make it up, this order intake. 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. Given the higher margins of these programs, the contribution is disproportionate and will make up on the operating income and the margin.
Okay. That's great color. Related to the Boeing 737 MAX, there's a lot of discussion on whether there will be a requirement for additional training. 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, look, we'll have to wait to see what the regulators say when the 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. I think it's wait and see. I mean, clearly, there's going to be a lot of training to be done when the aircraft are cleared. I would see pent-up demand there when airlines start to fly. That I would expect. 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. On the civil aviation side, Marc, you mentioned that you expect more outsourcing opportunities with the airlines. Are there any particular region where you expect CAE to be more active? In terms of simulators order, do you still feel confident that you can achieve 60+ this year in terms of booking?
Benoit, Andrew. 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 ex the temporary setback in MAX deliveries. 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. On Healthcare, we saw a nice pickup in revenues margin, negative, but I assume it's typical seasonality. 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 the progress that our new leader, Rekha Ranganathan, is making with her team and the experience that she brings from our senior leadership or senior levels in Philips and other companies. Definitely we're seeing the momentum there, and I would expect that to continue.
Okay. Thank you very much for the time.
Ladies and gentlemen, we welcome your questions. Please press the one followed by the four on your telephone keypad, one, four 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 for questions from members of the media.
There are no other questions on the phone lines from participants, sir.
Okay. Well, I'll thank all participants for joining us this afternoon and remind you that 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.