Good day, ladies and gentlemen. Welcome to the CAE second quarter conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. Mr. Arnovitz, you may now proceed.
Good afternoon, everyone. Thank you for joining us today. Before we begin, I'd like to remind you that today's remarks, including management's outlook for FY 2019 and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, November the 13th, 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. 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 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 will take questions from financial analysts and institutional investors. Following the conclusion of that Q&A period, we'll open the line to calls from members of the media. Let me now turn the call over to Marc.
Thank you, Andrew. Good afternoon to everyone joining us on the call. I'll first discuss some highlights of the quarter. Sonya will review the detailed financials. I'll come back at the end to talk about our outlook. CAE had a good performance in the second quarter, with 20% revenue growth, 15% earnings growth, and strong free cash flow. I'm especially pleased with the continued progress we've been making with our training strategy, as demonstrated by CAD 986 million in orders in the quarter, giving us a record CAD 8.7 billion backlog. Our performance in the quarter and year to date supports our full-year outlook. Looking at civil, we generated double-digit growth during the quarter. We booked orders for CAD 575 million for a record CAD 4.3 billion backlog.
These include a new five-year Multi-Crew Pilot License cadet training program with AirAsia, exclusive training contracts with CityJet, OceanAir, LOT Polish Airlines, and Air Busan, and a new long-term training contract with Stars peed. In products, we sold 16 full flight simulators in the quarter, which brings us to 34 sales of simulators in the first half of the fiscal year, tracking above our initial outlook. Training center utilization was 72%, which is up two percentage points from last year. In defense, we generated high single-digit growth during the quarter, and we booked orders for CAD 380 million, giving us a record CAD 4.4 billion defense backlog. Orders included CAE's new 700MR Series simulator for the Royal New Zealand Air Force's NH90 helicopter.
We also won the U.S. Air Force C-130H air crew training services contract, adding to our trained systems integration programs, and we received orders from the Air Force for additional C-130J simulators. Also involving air crew training services, we renewed a contract for the U.S. Air Force's KC-135 aerial tanker training devices, which include upgrades to our simulators. The integration of Alpha-Omega Change Engineering, or AOCE, which we acquired in the quarter, is progressing well, and we're beginning to see benefits from our expanded access to higher-level security programs in the U.S. Finally, in healthcare, we launched a redesigned, fully portable CAE CathLabVR interventional simulator. Together with the American Society of Anesthesiologists, we launched the Anesthesia SimSTAT robotic surgery module, the latest in a series of interactive screen-based courses approved for maintenance of certification credits.
With that, I'll now turn the call over Sonya, who will provide a detailed look at our financial performance. I'll return at the end of the call to comment on our outlook. Sonya?
Thank you, Marc, and good afternoon, everyone. Consolidated revenue for the second quarter was CAD 743.8 million, and quarterly net income was CAD 60.7 million or CAD 0.23 per share. This compares to CAD 0.20 in the second quarter last year, excluding the gain of approximately CAD 0.02 per share from the divestiture of the Zhuhai Flight Training Centre. Income taxes this quarter were CAD 15.2 million, representing an effective tax rate of 19%, compared to 23% in Q2 last year before the gain on ZFTC. Free cash flow improved in the second quarter, reaching CAD 137.7 million, compared to CAD 63.5 million last year. We had a lower investment in non-cash working capital and a higher cash from operating activities. As in previous years, we expect a portion of the non-cash working capital investment to reverse in the second half.
Uses of cash in Q2 included funding capital expenditures for CAD 40.9 million, mainly for growth, and we distributed CAD 25.7 million in cash dividends. We used another CAD 37.2 million to repurchase stock under the NCIB program. Our financial position continued to be strong, with net debt of CAD 795.1 million at the end of the quarter, our net debt to total capital ratio of 25.8%. Also, return on capital employed increased to 12.8% this quarter compared to 12.6% last quarter, excluding the impacts of fiscal 2018 income tax recovery related to the U.S. tax reform and net gains on strategic transactions relating to our Asian joint ventures. Now, looking at our segmented performance. In Civil, second quarter revenue was up 24% year-over-year to CAD 393.1 million, and operating income was up 19% to CAD 63.3 million for a margin of 16.1%, excluding the gain on divestiture of ZFTC last year.
On the order front, the Civil book-to-sales ratio for the quarter was 1.46 times, and for the trailing 12-month period was 1.49 times. In Defense, second quarter revenue of CAD 320.3 million was up 18% over Q2 last year, while operating income was up 2% to CAD 34.1 million for an operating margin of 10.6%. Excluding the impact of reorganizational and integration costs related to the purchase of AOCE, Defense segment operating income would've been CAD 36.1 million or 11.3% of revenue, which is up 8% compared to the second quarter last year. The Defense book-to-sales ratio was 1.19 times for the quarter and 1.03 times for the last 12 months. In Healthcare, second-quarter revenue was up CAD 30.4 million, up from CAD 28.3 million in Q2 last year.
Healthcare segment operating income was CAD 1.3 million in the quarter, down from CAD 2.2 million in Q2 of last year, as a result of higher investment in selling general and administrative expenses and higher research and development expenses to support recent product launches. To sum up, we had a good performance overall this quarter, with solid year-over-year growth in Civil and Defense, which would have been even stronger if not for the impact of the five-week work disruption in our Canadian manufacturing operations this summer. The interruption reduced the number of product deliveries we could achieve in the quarter and also affected our ability to reach milestones on a number of programs. We had already expected revenue recognition to be more back-end loaded this year as a result of IFRS 15 implementation. The interruption makes it even more so.
We implemented a recovery plan in the second and current third quarter with several measures designed to accelerate production capacity, including establishing a second assembly line for high-volume full flight simulators. The net result is that with that extra capacity running in parallel, we will reach a substantially higher level of delivery milestones in the fourth quarter compared to the current third quarter. Accordingly, deliveries in Q3 are anticipated to more closely resemble the levels we saw in the first two quarters of the year. The overarching positive is that our recovery plan is on target, and with these measures, our full year outlook for growth is intact. With that, I will ask Marc to discuss the way forward.
Thanks, Sonya. We continue to see good momentum with our training strategy, as evidenced by the important developments announced last week, which further strengthen our long-term growth investment thesis. We continue to be highly positive about prospects in civil and business aviation training. We are well-positioned to provide an excellent customer experience with our global reach and industry-leading solutions. The announcement that we have agreed to acquire Bombardier Business Aircraft Training further solidifies our position. The acquisition will expand our ability to address the business aviation training market and give us greater leverage across our training network. It fits right into our core and aligns very well with our strategic objective to grow recurring revenues. It also gives us the ability to leverage our expanded position on Bombardier business jet platforms across the entire CAE global network.
The acquisition gives us a bigger position in the largest and fastest-growing segment of the business aviation training market, which involves medium and large-cabin business jets. It gives us a broad portfolio of customers, an established recurring training business, highly talented people, and a modern fleet of business jet full flight simulators. We also signed an agreement to extend CAE's authorized training provider status for flight and technician training to 2038. Taken together, this is a major step forward in the progression of our growth strategy in aviation training and will have a positive impact on our performance. In its full year following the closing of the transaction, which is expected by H2 of calendar 2019, the acquisition is expected to provide CAE high single-digit percentage earnings accretion and is also expected to be accretive to free cash flow.
We also expect to continue making good progress in commercial aviation training. The announcement last week at the European Airline Training Symposium of a long-term training outsourcing agreement with easyJet is an example of the kinds of opportunities in our pipeline to increase our share of the airline training market and to form new enduring customer partnerships. Under the CAD 170 million 10-year agreement, all of easyJet's pilots will soon be training at CAE in three European pilot training locations, including a new state-of-the-art training center at London Gatwick with a dedicated wing for easyJet. In civil products, based on our level of success in the first six months, we are on track for our best year ever.
In defense, we expect to continue winning our fair share of programs, building on our successes as a training systems integrator. We have good momentum with our recent wins of the U.S. Air Force C-130H aircrew training system and the New Zealand NH90 programs. Our acquisition of AOCE positions CAE as a training partner to the United States Air Force's Special Operations Command, training aircrews on variants of the C-130J and HH-60 Pave Hawk helicopter, as well as a platform that is new to CAE, the CV-22 tilt rotor aircraft. The AOCE acquisition has also us working with other platforms new to CAE, providing training for the United States Air Force aircrews on the F-15, F-16, and F-22 fighters. We recently signed a strategic agreement with the government of New Zealand to work together to address its long-term defense training needs.
CAE is excited to be part of the team selected as the preferred bidder for the new Royal Canadian Navy's Canadian Surface Combatant program. While too soon to quantify, both avenues present potentially sizable opportunities for CAE over the longer term. Overall, we're continuing to pursue a large defense market with over CAD 4.9 billion of proposals in the hands of customers pending decisions. Finally, in healthcare, our new products like CAE Juno and CAE Ares are being well-received by customers, giving us greater access to some of the larger value pools in the existing market. We expect to see the healthcare business ramp up to a more meaningful scale, and I continue to be optimistic about its potential as CAE's innovative training solutions become more broadly adopted.
In summary, we have good momentum in all of our markets, and we are on track to deliver on our growth outlook. With that, I'll thank you for your attention, and we're now ready to answer your questions.
Thanks, Marc. Operator, we'd now like to open the lines to take questions from members of the financial community, financial analysts, and institutional investors.
Thank you. Ladies and gentlemen, 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 would like to withdraw your registration, please press the one followed by the three. If you're using a speakerphone, please lift your handset before entering your request. One moment please for the first question. Our first question coming from the line of Kevin Chiang with CIBC. Please proceed with your question.
Hi, good afternoon. Thanks for taking my question here. Maybe just a clarification question in regards to the acquisition of the Business Aircraft Training division from Bombardier. You've noted that it'll add about 100 to 150 basis points to your margin within Civil. Just wondering how I should think about that flowing through seasonally within the divisions. When I look back over the past four or five quarters, your margins run between, let's say 16%-21%. Should I think of it just lifting everything by the 100 to 150 basis points, or does it have a greater seasonal impact in your low quarters because there's more wet training involved, and the top end sticks around 21%? Just trying to get a sense of how this works through the year for you.
Okay, Andrew.
Hi, Kevin. It's Andrew. Let me see how I can help you with that. I think the way I would look at it is that our reference is always on an annual basis. When we're looking at what Civil achieves on a yearly basis, figure on about 100 to 150 basis points lift from the acquisition. Look, we've seen with our experience in business aviation that our fourth quarter tends to be a big quarter for business aviation. I'm not sure it's important enough to establish as a seasonal trend, but that's probably something that I would take into consideration.
Okay. That's helpful. Just in terms of the back half of the year, you noted some integration costs with AOCE. Are there additional, I guess, integration cost drags to consider in the back half, or are you basically through most of that now?
No, integration is progressing well, and working through all the synergies. We do expect some remaining integration costs in the back half, about CAD 1 million-CAD 2 million.
Okay, that's helpful. Just lastly for me, just turning to healthcare, you're bouncing around CAD 30 million in revenue pretty consistently here. I know you're very positive on the long-term outlook, do you have a sense of when this revenue hits an inflection point that drives to a much-improved margin profile? Is this a situation where you're holding steady and eventually the market will come to you get that big revenue lift that you're expecting? Just trying to get a sense of, do you have a sense of when revenue gets better, or is this more of a longer-term trend outlook?
I think that our expectations are, as you might expect, are reflected in the outlook that we've given. I do expect a lift. I think what we're seeing, look, is that we have a bit of an inflection that's been occurring in our business where we've been shifting our strategy over the past year towards what we call the larger value pool in this business, which is nursing training. We've basically focused our R&D on coming out with new products that were specifically destined to enter this market, and those are CAE Juno and CAE Ares. We see those products being well adopted by the market. We're increasing the sales of those. They're a lower cost point, but it's different market, less complexity, but ideal for that market.
We see those progressing, but at the same time, what we see is, in our existing market which was high fidelity, a bit more of a flat situation. What we see is us overcoming, if you like, maybe not overcoming, just the time it takes to penetrate that market. It's really going after penetrating share in that market. We're confident the market exists. Products are resonating. I think that, again, it'll come up in what we expect is the revenue will follow the expectations we have in our outlook. I won't go further down the road on that one in additional years, except that I continue to be confident that this is a growth story that will achieve meaningful scale for CAE. Yes, I'm still confident based on what I'm seeing, but admittedly, to your point, the numbers don't reflect that at the moment.
That's it for me. Thank you for taking my questions.
Thank you. Our next question coming from the line of Fadi Chamoun with BMO Capital Markets. Please proceed with your question.
Thank you. First, just congratulations on this deal for Business Jet. I thought it was pretty good.
Thank you.
I wanted to ask that in the recent quarters, we've seen a slew of announcements in civil aviation. Has something changed in the marketplace that have unlocked these opportunities, or is it just this is the fruit of a lot of work that got into it to get to this point? I'm just trying to understand if there's an underlying trend here where airlines have become a little bit more open to these kind of outsourcing deals to these kind of negotiations with you, or is this just a fluke that happened, all these deals happening in the last few quarters at the same time?
It's definitely not a fluke, Fadi. I think I was, in a couple of quarters at least on a call, I said that I used to say, going back two, three years, that when I looked at the market, that we had the credibility to be able to identify and secure one or two deals like this in any given year. That was about the market, that we could see. In the recent quarters, we definitely see more appetite for that, it's really because airlines are really concentrating on what their core business is, which is to efficiently fly passengers. We've offered them a very credible alternative because that's all we do. If you think about it, what we do in our pitch to airlines is, look, we'll take care of basically the pilot training part of your operation. We're very credible at it.
We have the capability. We have the scale. Because we train, I think our recent numbers are training more than 180,000 pilots a year. We've been able to develop an expertise in that and to do that very efficiently with the initiatives that we had, that we announced over this past summer about digital innovation, being able to provide unique insights to our customers on their flight crews. Obtaining pilots these days, able to secure that capability and manage it effectively becomes that much more important when pilot shortages are getting to be the norm around the world. That particular dynamic is a conversation starter at many airlines just by itself. It's not a fluke, I continue to see a good pipeline of those opportunities in the future.
Okay. I guess I wanted to ask, as far, like, the pipeline go, is it getting stronger compared to, say, a year ago, two years ago? I saw you raised your CapEx to handle some of that volume coming at you. With this acquisition, does this constrain your ability to go after some larger outsourcing deals because the CapEx need may be significant?
I think that the latter question, I would say, look, I think as you hopefully see in our results is that the CapEx we're deploying is highly accretive very soon to our numbers. We look at them on that basis. I think, Sonya, I know I always call you with Bob, but definitely, even including the acquisition that we've just announced and the CapEx that we've increased for this year, I don't think that puts a constraint on us being able to go after, definitely increase outsourcing and opportunities. Don't forget that Business Aircraft in itself generates a high degree of cash flow. It's all wet. As we've said, and it's highly accretive pretty fast. Sonya, do you want to add anything?
Yeah, just to maybe to add on to that. The pro forma leverage that we've guided to at closing expected to be at 42% net debt to total cap, which is comfortable within our target range for leverage. We expect to generate some good free cash flow out of the business jet operations, in addition to our own underlying cash flow, which allows for de-leveraging to the lower end of that range in 24-6 months. Between the cash flow generation, the strong balance sheet, it continues to provide good flexibility for us to capitalize on opportunities as they come along.
Okay. Thank you.
Thank you. Our next question coming from the line of Jean-Francois Lavoie with Desjardins Capital Markets. Please proceed with your question.
Yes. Thank you very much, and good afternoon, everyone.
Good afternoon.
I just wanted to ask a question about the contract with easyJet. You mentioned that easyJet will take a portion of your capacity at the new facility in London Gatwick. I was wondering how much excess capacity will you have to deploy toward new trainings contract with new customers?
You mean in Gatwick specifically or?
Yeah. Please.
I don't know the number offhand, but we're basically sizing a new facility there. We already had a facility at Gatwick and we always size our opportunities to be How can I say? We basically walk a tightrope between having enough capacity to be able to serve the market that's there. At the same time, we want to utilize the assets at a very high level. I think the short answer is, we basically size our capabilities, buildings, numbers similar to the market. It's a very large market in Europe, specifically. We have a number of training centers in Europe. I think we would have capacity. I can't tell you exactly how much, and frankly, I would hope it's not too much right now because that means we'd have assets that wouldn't be fully utilized. I think we're market-led.
Whatever market is out there, you can expect that CAE will size itself to be able to handle it. We can do it pretty fast because our turnaround, we usually size our buildings and the land that's associated with them to have capacity for growth. The way we architect our centers, because as you imagine, we have a lot of centers out there around the world. We architect them in a fashion that is pretty simple for us to add existing similar bays by having, if you like, a plug-and-play approach to the extra, if you like, annex that we have to the building, and we manage to secure the land beforehand.
Okay, great. Thank you very much. Maybe again on that contract, I just wanted to, if you could provide the split between the incremental portion of that contract that will be for CAE.
Did you get that one, sorry?
The incremental growth from that contract, is that your question?
Yeah, exactly.
The contract is a 10-year full outsourcing. We're exclusive to CAE with easyJet. We are already serving easyJet, but essentially what it serves is about a 40% increase in growth.
Okay, perfect. Thank you very much.
Thank you.
Thanks.
Thank you. Our next question coming from the line of Ronald Epstein with Bank of America Merrill Lynch. Please proceed with your question.
Hi, good afternoon. It's Kristine Liwag. Marc and Sonya, you guys have now acquired Lockheed's commercial flight training business, and you've acquired these assets from Bombardier. Are there opportunities like this out there where you can acquire more training businesses from the OEMs? Is there a consolidation that you could do?
I think what we've said in the past is that this is our business. This is our focus. Our vision is to be the training partner of choice for our customers. You would expect that if there's opportunities out there and they fit our criteria for the type of business, the type of assets, and of course, the financial viability of that, we would be open to it. I can't talk for any OEMs particularly or anybody else who have their business, but certainly we seek to form partnerships with those OEMs and if an acquisition works out, we would certainly be receptive under the proviso that I said, that it has to make sense for us financially, for how we can serve our customers and grow our business along the lines to achieve the vision that we have.
As OEMs walk away from these businesses, can you discuss how that's affected the pricing environment?
Well, I don't think that's a factor in the pricing environment, to be very frank. I mean, all of these businesses are still very competitive. The margins that we would have is the one that we've talked about in our outlook, I don't think these particular deals in itself would affect, one way or another, the margin expectations that we would have
Shifting, I guess, to margins, that's a good segue. Can you discuss what you saw in margins in the quarter? They were just a little bit weaker than we expected. Then also, with such strong growth and your strong book-to-bill, how do these orders compare with your existing business today? Should we expect these orders to be accretive to margins as they convert to revenue?
Well, I'll take the latter. Definitely, the orders should be accretive to revenue, for sure. In terms of the margin profile, I wouldn't read too much about margins in the quarter, to be very frank. Don't forget that Q2 is always, particularly in Civil, always the quarter where we have low absolute numbers and lower margins. Because of a couple of factors. Number one, airlines, if they take training, the training part of our business, airlines are flying a lot in the summer months. When they train, the aircraft are full and literally they're not training, they're flying. Our utilization, typically in our training center, is low, and you see that.
At the same time, in our products business, that is the time where we usually have, and again this year, we have a summer shutdown of our activities, where people take vacations, we have time to refurbish the plant. Basically, our activity in earning revenue and profit out of our full flight simulator business, that goes down as well. In this quarter, you had the additional effect of we have a five-week work stoppage as a result of a strike in our main facility in Montreal. You threw it all in, and you see the margins that you have. I'll point to the fact of the absolute number. I think Civil's up 19% overall in earnings in this quarter. I think that we're quite happy with the number itself. In Defense, I think you have to consider maybe less.
Maybe Sonya to add additional color, you have to really take into account that we acquired AOCE. There's a couple of CAD million of acquisition costs in there that are in the quarter. Sonya, you want to add any color?
Yeah, I guess just to complement that, overall, I wouldn't read anything too meaningful into the margin. Strong year-over-year growth on the operating income, holding on the outlook for each of the segments. Just to complement what Marc was saying on the Defense side, you did see a bit, well, of impact of the integration cost. Also, as the AOCE acquisition ramps up, although it's positive and contributed in the quarter, did have a bit of margin dilution in the quarter.
Again, just to finish off.
Thank you very much.
All of that. Just to finish off, maybe none of this is highly unexpected and was kind of factored in when we reiterated our outlook this quarter. Again, basically, the numbers we give you was reiterating our full-year outlook for all the businesses.
Great. Thank you, Marc. Thank you, Sonya.
Thank you.
Thank you. Our next question coming from the line of Cameron Doerksen with National Bank Financial. Please proceed with your question.
Yeah, thanks. Good afternoon. Sonya, I just wondered if you could maybe just sort of walk through, I guess particularly in civil, how the quarters kind of look. You mentioned obviously it's going to be a back-end loaded year. I think you gave some color around sort of individually Q3 and into Q4. Maybe if you could just sort of reiterate what you said there on what we should expect in Q3 and Q4. It sort of sounded to me like we'd have a much stronger Q4, maybe Q3, kind of more typical from what you did last year.
Yeah. We had to invest in, as I mentioned in my remarks, in Q2 and continue in Q3 to create an additional parallel assembly line, and this will increase our production capacity to make up for the work stoppage. We do expect to increase the delivery milestones in the second half a bit in Q3, but that one, as I mentioned, should look a bit like Q1 and Q2, and the majority of the remaining deliveries probably in Q4. I would expect there to be more deliveries in Q4. When comparing to previous year, you'll note on the IFRS-adjusted profile that Q3 was actually the strongest quarter last year because it had peak deliveries. We expect that to be a little bit different this quarter, and the peak delivery is in Q4.
Okay. That's helpful. Just on the full flight simulator market, like you said, you're on pace to have basically a record year for new orders for full flight simulators. Can you just talk about what you're seeing out there as far as market share? Is this something where you think you've gained some share against some of the other manufacturing OEMs for full flight simulators, or is it just that the pie is much bigger this year versus last year or previous years?
I think it's the pie, really.
Okay.
We're still maintaining our leadership in market sales. Market share, I think huge, 70%, that's probably about right. Again, I don't know if you heard, but to me, it's the size of the pie. Lots of activity this year.
Okay. Excellent. That's all for me. Thanks.
Thank you.
Thank you. Our next question coming from the line of Tim James with TD Securities. Please proceed with your question.
Thank you. Good afternoon. Looking ahead to fiscal 2020, I'm just wondering if you can talk about any potential headwinds that there might be to margin expansion in both the civil segment and the defense segment, whether it's contract mix, competitive changes, anything like that. I'm just trying to make sure I'm sort of taking into account or thinking about anything that might moderate any margin expansion that we could see next year.
We haven't given any guidance that far out, I'm not going to give some here right now, Tim. Based on the backlog that we have, and the dynamics that we see in our markets, in all the segments, to me, what we see is strong tailwinds everywhere. I'm not expecting something untoward. I can't predict the future. Future, admittedly, is not that far away, but based on the future I see, it's good.
Okay, great. No, that's helpful. That's kind of the way I was thinking about it. I just wanted to make sure I wasn't missing something that might be a bit of a headwind. Okay, that's helpful. Can you tell us approximately what percentage of current civil revenue comes from business aviation, before taking into account, obviously, the future Bombardier BizAv Training acquisition?
Okay. Before the acquisition.
Yes.
How much was it?
Tim, it's Andrew. We haven't really broken it out that way, but training makes up a good two-thirds of our civil business, and business aviation is probably about 40% of that. That gives you some sense of order of magnitude.
Okay. That's helpful. My last question, just looking at the AOCE acquisition, could you tell us how much of the backlog, or how much backlog was acquired with that transaction?
We acquired about CAD 500 million worth of backlog there. That doesn't flow through any order intake. It's adjusted into the funded and unfunded backlog. Not necessarily added on as order intake in the book-to-bill metric.
Okay, great. Thanks very much, Sonya. That's everything.
Thank you.
Thank you.
Thanks.
Thank you. Our next question coming from the line of Chris Murray with AltaCorp Capital. Please proceed with your question.
Thanks, folks. Good afternoon. My first question, just going back to civil and looking at the deliveries. I'm trying to understand. You had a fairly significant step down in the quarter, and I guess, if anything, I was a little surprised that the revenue actually held in better than I thought. I guess the way to think about it, or how should we think about the proportion of simulators that are being recognized on a completed contract versus still on some sort of percentage of completion? I guess what I'm trying to do is figure what the magnitude of the step jump's going to look like when we get to the back half of the year.
The revenue growth, first of all, is driven by not only the product business, but the training business. Good growth on both sides. Now, it might be a little bit counterintuitive given the lower deliveries, because they are the major drivers of revenue on the product side, and the majority of the simulators are, call it, accounted for at delivery. Now, despite the lower number of deliveries, the mix of simulators had an impact. We had a higher proportion of simulators that included DP&E, which is data, parts, and equipment. That's where CAE flows through the value of the OEM data, parts, and equipment. Higher revenue, but same operating income. That had an impact on the margin as well, and the revenue growth. Those were the major drivers.
In addition, there's still some development and customized simulators, which are accounted for under POC, but the proportion is much less than at delivery.
Okay, that's helpful. Just thinking about your production rate then, is it fair to think that with the booking numbers that you're doing, it's really to bring it to a one-to-one book-to-bill, or is it that you're just trying to build some extra backlog just to give you some more flexibility?
You mean in terms of because of the anticipated higher deliveries in the latter half? Is that why you're asking the question?
Yeah. Well, I guess what I'm trying to think of, Marc, is that you've had some pretty strong order intake over the last little while, and if we even look at your trailing quarters, you're certainly trailing behind that one times book-to-bill. Because you're not pushing it out. I'm just wondering if the changes you've made in the process are intended to speed up your production rate, we should expect a step up into next year on deliveries that would be maybe dragging down book-to-bill a little bit, but more on a catch-up basis.
I'm not sure where you're coming from, to be honest. I don't understand. I'll ask Tony on the dropping book-to-bill, I don't see that. Our new process that's fully in place, it has been for quite a number of quarters now, that was started in what we call a Quest program a couple of years ago, which is complete, allows us to be able to manufacture simulators in less time. We have increased our production rate. Right now, and in the last half of the year, it's going to be much higher because we're recovering from the strike that we had this summer. We're accelerating deliveries. We have actually a parallel line of simulators running for our high volume simulators. A separate facility producing simulators.
That's why we think we can catch up, or we expect that we'll catch up in the second half, we want to make sure that we don't disappoint our customers that expect these simulators. Look, we'll match our delivery rate to the numbers of orders we can expect in the market. We're not production limited. We can get the personnel that we need, we're not capacity limited in terms of what we can do. Maybe if you look at the number of sales we've had, don't forget that they don't all deliver in the next year. Some may be delivering over two or three years, for example. I don't know if that helps, that's what I would say to that question.
Okay, fair enough. If I can, just two quick questions around the transaction with Bombardier. First of all, with the increased training mix and just some geographic changes, any thoughts about how this changes your tax profile?
Well, the business jet training is a high margin and high cash generating. As we've guided, we expect our earnings accretion in the first year and also free cash flow accretion. It should contribute to the high cash generating of the company.
Yeah. I'm thinking about, does it change your tax rates or anything like that with the source of income in the U.S. or anything like that?
The majority of the operations are here in North America. We will increase our exposure in North America. One of the benefits of this acquisition is really expanding through the new platforms and a halo effect across our global network. I believe it'll change the mix throughout the world. Right now, it doesn't really change my view on tax. As we close, if it changes materially, we'll guide.
That's fair enough. The last question for me is just on the margin agreement, or sorry, on the royalty agreement. I'm assuming because you're taking a discount on, I would assume to be kind of recurring payments, and you'll just lump sum it and depreciate it over the life of the agreement. What kind of margin impact should we be thinking about in terms of the civil margin once you've got that in place?
You're right. This was basically future cash flows that we've discounted back and prepaid in exchange for an ATP agreement up till 2038 at an attractive discount rate above our cost of capital. We'll see is, of course, I guess, capitalization and we'll call it depreciation over time in the P&L. The impact of this transaction has been included in our guidance, which is high single-digit earnings in the first year, in the first 12 months after closing.
The guidance included the royalty impact as well as the training impact.
Absolutely. Yes.
Okay, thanks.
Operator, I think that we'll now want to use the time remaining to open the lines to members of the media. I want to thank all the participants from the investment community for their questions. Operator, if you will, please open the line to members of the media.
Thank you. Ladies and gentlemen, as a reminder, to register for a question, please press the one followed by the four. One moment, please. There are no questions from the media at this time.
Okay. Well, I want to take this opportunity once again to thank all participants on the call today and to remind you the transcript of the call can be found on CAE's website. Thank you very much.
Ladies and gentlemen, that does conclude the conference for today. We thank you for your participation and ask that you please disconnect your line.