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 2018 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 risks, factors and assumptions that may affect future results is contained in CAE's annual MD and 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 Peron, C's President and Chief Executive Officer and Sonia Branco, our Chief Financial Officer. After remarks from Marc and Sonia, we will take questions from financial analysts and institutional investors.
And following the conclusion of that Q and A period, we'll open the line to questions from members of the media. Let me now turn the call over to Mark.
Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first provide an overview of the quarter and then Sonia 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 Q3 and we remained on track to deliver on our growth outlook for the year as a whole. Some highlights included our order intake of $1,200,000,000 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 maintain our solid financial footing. Looking specifically at Civil, we booked $1,000,000,000 in new orders for our comprehensive training solutions, which marks a 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 Q3 and for the year to date, civil growth is on track with our outlook. In defense, 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 $966,000,000 of defense orders for the 1st 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 SeaLink's flight trainers. Service awards included an enterprise wide training systems maintenance contract for the Australian Defense Department. And in healthcare, we developed Lucina AR, the world's first augmented reality childbirth simulator, which we've 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 certification courses in certain markets.
With that, I'll now turn the call over to Sonia, 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. Sonia?
Thank you, Mark, and good afternoon, everyone. Consolidated revenue for the 3rd quarter was $704,000,000 and quarterly net income was 100 and $17,900,000 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 Center 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 $24,000,000 representing a negative effective tax rate of 25%, which compares to an effective tax rate of 14% for the Q3 last year. Excluding the effect of the U.
S. Tax reform and the tax impact related to the net ACE gain, the effective tax rate in the Q3 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 the United States where approximately a third of our revenue is generated and a similar proportion of our total workforce resides. The most significant element of the reform is a 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 $146,000,000 for the quarter compared to $124,700,000 in the Q3 last year.
The increase in free cash flow year over year results mainly from a lower investment in non cash working capital. As is usually the case for CAE, we continue to expect a partial reversal for the first half investment in non cash working capital in the second half of the year. Uses of cash in Q3 included funding capital expenditures for $43,000,000 and investing $99,700,000 to acquire the remaining 50 percent equity interest in ACE. We also invested 7,700,000 dollars to acquire 45 percent interest in Pelasys, forming a joint venture with this leading aviation training courseware developer. In terms of shareholder returns, we distributed $23,200,000 in cash dividends and we used another $21,800,000 to buy back stock under the NCIB program.
Of note, today, CA's Board of Directors approved the renewal of the NCIB under similar terms for another year. Our financial position continued to be strong with net debt of $712,000,000 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, 3rd quarter revenue was up modestly year over year at $413,700,000 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 Q3 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 $78,600,000 which includes a $4,000,000 gain on the fair valuation of Apes, 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 2.43 times and the trailing 12 month period, it was 1.43 times. Civil's backlog at the end of the quarter was $3,800,000,000 In defense, 3rd quarter revenue was up 8% over Q3 last year to 200 and $62,800,000 and operating income was up 9% to $32,700,000 for an operating margin of 12.4%. The defense book to sales ratio was 0.71x for the quarter and 1.22x for the 9 months year to date. The defense backlog at the end of the quarter was $3,500,000,000 And finally, in healthcare, 3rd quarter revenue was $27,900,000 compared to $26,200,000 in Q3 last year. Healthcare segment operating income was $1,500,000 in the quarter compared to nil in the same quarter last year.
With that, I will ask Mark to discuss the way forward.
Thanks, Sonja. 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 Q4. 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 first, we're also seen as a thought leader in aviation training. This past week at the Singapore Air Show, we launched our latest innovation, the CAE RISE training system. This is the 1st 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 defense, we're also encouraged by a large pipeline of opportunities in an environment of increasing defense 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. Here too, 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, Mark. Operator, we'd now be pleased to take questions from analysts and institutional investors. Thank
Our first question comes from the line of Fadi Chamoun with BMO Capital Markets. Please proceed with your question.
Thank you. 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 digit for the full year, would imply again kind of mid single digit growth in the 4th 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 growth in that. And of course, if you look at the quite substantial order intake we have in this quarter $1,000,000,000 in Civil, I think there's lots of room to grow within where we're at. I think look, I think it depends what where you're at in terms of our expected growth, it's 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 can always occur. But we usually have pretty good Q4. So I wouldn't expect that it would be any different this year. But Sonja, you want to add anything?
Yes. If I could 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. It's 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 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 announced them as we crystallize them. Of course, we're working on Singapore right now, we're tail end of that. That's going well. There's quite a number of those. 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 number one 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 and A kind of quasi M and A, which we're outsourcing or 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 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. I wouldn't expect that to change.
Our next question comes from the line of Steve Arthur with RBC Capital Markets. Please proceed with your question.
Great. Thank you. 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 yes, I mean, military is always specifically lumpy. We don't really control anything about when bids are actually decided upon. So all you've seen is just normal lumpiness. We've always said, I think, well, in that many years, Steve, that it's best to look at defense on a 12 months rolling picture like especially when you're looking at orders. Now the pipeline of potential opportunities for us is very strong.
It hasn't diminished. We still have about like, what is the number about 3.5 $5,000,000,000 to $4,000,000,000 of bids out there that in front of defense organizations, governments, military organizations 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. Thank you. And secondly, just on the civil side, the equipment business, 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 at the end of March or not there. It depends on which one crossed the line before, but I think we'll 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 it and some even are even talking to grow it to get out of these 8 to 10 year backlogs that they have. So 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, some of these 26, it's a good number.
Thanks for I'm glad it catches your attention. It certainly 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 of people buying ahead.
So there's a couple of orders in there that are multi units. But having said that, I do think we're looking at what from what I could see, some pretty good years of high SIM counts in front of us.
Okay. Good stuff. Thanks a lot.
Our next question comes from the line of Cameron Doerksen with National Bank Financial. Please proceed with your question.
Thanks. Good afternoon. 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 turning perspective?
Turning market has been pretty resilient for us. It's I'm not well, first of all, really what Vic takes us is really the utilization of the aircraft. The deliveries is good, but it's not like in simulator sales, it's not an immediate effect on the amount of training except whereas it stimulates people moving to a new aircraft, therefore you get training demand. But the 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 fortunes in our business there.
Okay. Maybe just second question, maybe bigger picture, just we keep hearing more and more stories about a pilot shortage. That's really kind of a global phenomenon. As it relates specifically to CAE, obviously, that's an opportunity from your demand side. But I'm just wondering from your perspective, trying to retain or hire instructors for your training business and whether you are needing to pay these guys a lot more to retain them.
I am just wondering if you can comment on how that's going for you?
Well, look, I think you're right to say. I mean, structures 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 that to specifically, fact, we launched a project about 3 years ago called Project Fin, which is fight and structure 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 structures in the world in our business.
And that's what and we're being pretty successful. I don't obviously, you have issues every too often here in 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. And but structures are important and a lot of our structures actually you'd be surprised are not just here pilots themselves, because it depends what we are actually trained. But I guess summarize it to say it hasn't been an issue, but something that we watch because that you're right to ask the question from a point of view of the worldwide demand.
Okay. Very good. Thanks very much.
Our next question comes from the line of churn katawala with Scotiabank. Please proceed with your question.
Yes, good afternoon. Thank you for taking my question. I guess I was wondering, Mark, if you could just comment a little bit about fiscal 2019. I know you 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 defense 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 did 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 say that?
Yes, I can stab at that We will provide to Ren our outlook for next year when we report next quarter more precisely. Defense, 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 responsibility. 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.
Thank you very much both of you. Thanks a lot for that answer. And I guess just one more quick one for Sonia. The D and A, I think, was quite a bit lower in defense 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 has 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 DNA for defense.
Thank you very much.
Our next question comes from the line of Benoit Poirier with Desjardins Capital Markets. Please proceed with your question.
Yes. Good afternoon. My question is more about the utilization rate of your training network. So if we go back in fiscal 2016, fiscal 2007, 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?
Well, 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 high 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 probably 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 Mike, I'll leave it at that, Benoit.
Yes. 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 two quarters? And also when we look at the valuation in the sector, the valuation is very favorable.
Healthcare?
Well, I'll start by the first one the second one, sorry. And no, look, we're still committed to this business and I feel very confident that the strategy we have, which was admittedly course corrected last year to focus and just to remind you remind the reader, the listeners to refocus our strategy on 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've launched new products. Basically, the first one is CA Juno to go specifically at that market. And so far, I'm pretty happy. I mean, it's taken 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 the Pacific dynamics and it's relatively small numbers. 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 forecast that you that we could generate a markedly different EBIT profile in terms of percentage.
Okay, very good. Thank you very much for the time.
Welcome. 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.
And our first question comes from the line of Julien Fonneau with La Creus Canadiens. 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.