CAE Inc (CAE) 2008 Q2 法說會逐字稿

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. Please go ahead Mr. Arnovitz.

Good afternoon, everyone. Thank you for joining us today. Before we begin, I need to read the following. Certain statements made during this conference, including but not limited to statements that are not historical facts are forward-looking and are subject to important risks, uncertainties, and assumptions. The results or events predicted in these forward-looking statements may differ materially from actual results or events. These statements do not reflect the potential impact of any nonrecurring or other special items or events that are announced or completed after the date of this conference, including mergers, acquisitions, or other business combinations and divestitures.

You will find more information about the risks and uncertainties associated with our business in the MD&A section of our annual report and annual information form for the year ended March 31, 2007. These documents have been filed with the Canadian Securities commissions and are available on our website at CAE.com and on SEDAR. They have also been filed with the U.S. Securities and Exchange Commission under Form 40-F and are available on EDGAR. Forward-looking statements in this conference represent our expectations as of November the 8th, 2007, and accordingly are subject to change after this date. We do not update or revise forward-looking information, even if new information becomes available, unless legislation requires us to do so. You should not place undue reliance on forward-looking statements.

Robert E. Brown, CAE's President and Chief Executive Officer; and Alain Raquepas, our Chief Financial Officer, are participating on the call today. Following their remarks, we will invite questions from financial analysts and institutional investors. Once we have concluded the question-and-answer period with analysts and institutional investors, we will then invite questions from the media. For your convenience, this conference call will be archived on CAE's website. Let me now turn the call over to Bob.

Thank you, Andrew, and thank you, everyone, for joining us today. Let me begin with some comments about the second quarter and then Alain will take you through our results more specifically. Following that, I will conclude with some words about the way forward?

Our financial performance in the second quarter reflects a healthy level of diversification between market segments and geographies. Revenue this quarter increased 26% over last year to $354 million. Net earnings from continuing operations increased 25% to reach $39 million. This quarter, we received $354 million in new orders and we now have a backlog of approximately $2.5 billion. Over 90% of our business is conducted with customers outside Canada and our costs originate in a number of different currencies. The recent surge in the Canadian dollar has made this long-time challenge more topical, particularly since its symbolic rise above parity with its U.S. counterpart. The nature of our business is global and foreign exchange movements have always been a factor for us. Alain and I will provide some perspective on how we are affected by currency moves and how we manage our currency exposure.

First, I would like to review each of our business segments. In simulation products civil, we announced orders and commitments for seven full flight simulators during the quarter, with customers including Air France, Virgin Blue, Alteon, and Lion Air. This brings the total number of simulator announcements to 21 for the year-to-date. We recognized 33% more revenue this quarter compared to last year because of our higher than usual level of activity at the start of the year. This enabled us to get an early start on some simulator builds. Our operating margin reached 23.3% as a result of higher volume and a favorable mix of programs.

Training and service of civil on more than $165 million in new training contracts during the quarter, including a 15-year service agreement with Air Canada. We also announced that we will be expanding our global training network to include 16 additional business aviation training programs, planned to be deployed over the next two years and situated globally. Averaged annualized revenue per simulator in the second quarter was $3.4 million, on a base of 106 revenue simulator equivalent units. Demand for training continued to be strong, with revenue increasing by 15% year over year. Compared to the seasonally strong first quarter, revenue decreased by 5%, but most of this is accounted for by foreign exchange translation. Our operating margin for the quarter reached 16.2%, which is higher than last year, but reflects some drag caused by the ramp-up of our recently deployed training assets.

In the combined military segments, we secured $114 million worth of contracts for a range of programs, including the design and delivery of training systems and services to U.S. and British forces. On a combined basis, military revenue for the quarter was up 29% compared to last year, and operating margins reached 14.1%. With that I will ask Alain to take you through our financial results.

Thank you, Bob, and good afternoon, everyone. In the second quarter, consolidated revenue was $354 million, up 26% from last year. The consolidated backlog was $2.5 billion and our book to sales ratio was one time for the quarter and for the last 12 months. Net earnings were $38.9 million or $0.15 per share compared to $31 million or $0.12 per share in the same quarter last year. Income taxes were $17.7 million, representing an effective tax rate of 31% compared to 28% last year. The tax rate this quarter was higher because of changes in the mix of income from prior jurisdiction, but we still expect the average tax rate for fiscal 2008 to be around 30%.

Capital expenditure this quarter totaled $87 million, which included the repurchase of some simulators already in our network and previously financed as operating leases. Strong market conditions are providing us with more opportunities to grow with our customer. As a result, we expect to conclude the year with total CapEx of about $220 million. I should note that even with this higher level of expenditure, we expect to generate positive free cash flow at year end. We generated $98 million of net cash from continuing ops during the quarter and as we expected at the start of the year, we have begun to improve our non-cash -- sorry, our non-cash working capital position. We had the 33 million reversal this quarter. Our strong cash flow performance enabled us to offset the entire $87 million of CapEx, leaving us with $27 million of free cash flow.

Foreign exchange movements are a fact of life for CAE, and we've been successful at managing our business within this environment. We undertook a major initiative three years ago to restore CAE's profitability. At that time, we benefited from an $0.80 dollar. Since then, we've been effective at managing our foreign exchange exposure and at realizing gains through an ongoing program of cost reduction and productivity improvement. Commensurate with the higher aircraft delivery forecast, we expect to continue enjoying higher volume for our products. This provides additional leverage in terms of procurement and also helps to absorb overhead. In our product segment contract, are usually made in U.S. dollar or in euros while a significant portion of our costs are in Canadian dollar.

We've been following a practice of hedging revenues on a contract -- revenues on contract in our backlog to help derisk our short to medium term currency exposure. Hedging provides relief for a period of time, but ultimately we recognize the need to continuously find ways to drive greater productivity throughout our operation. A good portion of CAE's currency exposure is the result of the translation of our foreign currency into Canadian dollar for the purpose of Canadian dollar reporting. In our training operations, for example, revenues and costs are generally in the same currency. This means that from an operational standpoint, the EBIT margin percentage is relatively unaffected by FX movement. We recognize the magnitude of this challenge and while the speed of the dollar rise will not be easily overcome in the short-term, we continue to be proactive in order to help adapt to this new market reality. Thanks for your attention. I will now turn it back to you, Bob.

Thanks, Alan. The fundamentals of our business remain strong. On the civil side, aircraft manufacturer backlogs continue to build, suggesting that sustained, high levels of deliveries will extend past the end of the decade. Boeing and Airbus could very well enjoy another record year for order intake, with nearly 1800 planes added to backlog during the first nine months of the year. Business jet demand also remains exceptionally strong and for the first time more aircraft deliveries are forecast for markets outside of North America than within. With our extensive global reach, we are particularly well positioned to address this expanding market demand.

We are now building and deploying simulators to grow our training network in order to keep pace with the growth of our customers and to address developing markets. Pilot shortages are becoming increasingly more acute and we are developing our pilot provisioning initiative to address demand globally.

In business aviation, the 16 new training programs that we recently launched are intended to round out our fleet coverage and will enable us to address the majority of active aircraft types from our global locations. Demand for our civil full flight simulators has been good so far, with 21 deals announced year-to-date. The continued momentum we see in the market is encouraging and we now believe 34 sales for the year to be possible.

On the military side, we expect to conclude the fiscal year with a solid order book, which means that we expect the rate of order activity to pick up in the second half. The timing of military contract awards can be elusive, but we feel good about our position on a number of programs, which should materialize this fiscal year. Earlier this week, we announced that the government of Canada has qualified the CAE-led team for the C-130J and CH-47 air crew training capability. Public Works and Government Services Canada will release to CAE a request for proposal to acquire training equipment and services over the next 20 years for Canada's future tactical air lift and helicopter fleets. We are proud that our team has been chosen by the government of Canada and we applaud the government's decision to procure the air crew training capability outside of the aircraft acquisitions.

This approach will ensure that Canadian forces receive a modern, leading-edge training capability developed in Canada by specialist training service providers, while maximizing industrial and regional benefits across Canada. CAE and our Canadian-based industry partners are poised to benefit from a number of international opportunities related to training for these platforms.

Our response to the precipitous rise in the Canadian dollar over the past few months is similar to what we have been doing all along. The challenge is not entirely in our ability to adapt to the higher dollar, rather the velocity of the dollar's rise makes it difficult for any Company to keep pace over such a short period of time. To help close as much of the currency gap as possible, we have been accelerating our initiatives to reduce cost and drive additional productivity gains. We are fortunate to have a strong market position and healthy volumes. Overall, we are enjoying good market conditions in all segments of our business within a strong aerospace cycle. Thank you very much for your attention. We're now ready to take questions.

(OPERATOR INSTRUCTIONS)

Operator, before we open the lines, I would like to ask that in the interest of fairness that participants limit themselves to a single question. Thank you.

Thank you. The first question is from Ben Cherniavsky from Raymond James. Please go ahead.

Hello. Andrew, I'll respect your request and just ask if there can be any more color added to the foreign currency impact on the hedging? In particular, is there any way of indicating how much your hedges helped you in the third quarter -- or, sorry, the second quarter just reported and potentially giving us maybe where, some indication of where you would be hedged going forward on future contracts?

I think, Ben, the way that we would respond, I think there's some information in the MD&A that you can look at on amounts, but essentially our hedges carry us out a year or slightly more than a year, something like that, and this is the same as we've had over the last couple of years. And basically what, I think the judgment has to be made is are we going to be able to realize productivity gains related to cost cutting, related to the way we work and also related to the increased volumes we have now that are going to allow us to offset any of the benefits of hedging that we've had. And if we had been reporting this during the period of the restructuring, I guess the reporting requirements are different now, we would have been in exactly the same -- the exact same kind of position.

So all I can tell you is that from our point of view, we feel quite confident about the initiatives that we have in place. And the huge cultural change we've made in the organization to be able to allow us to make the changes that are necessary to make sure we can deliver results in the future to shareholders, and I would also add that the diversity of our business now, the diversification we have is very different than we were a couple of years ago. As we look at all of this, clearly the rate of change, the velocity of change is a challenge and will we be able to exactly match the change, I'm -- quite frankly, I'm not sure. I'm not that good at predicting it. But are we going to be able to work through this in the way that we worked through the restructuring, I think we'll be able to do that.

Andrew, can I just ask if that's -- as a follow-up. In terms of -- it's the timing I think that concerns everyone and you guys do deserve credit for what you've already done, but if you are able to adjust, as you are confident you will, how quickly can you do that and how much of a near-term challenge do you see the currency running to $1.10 being, as we close off the calendar year?

I don't really think that the -- I don't really think that the problem is short-term. I think more of the challenge is can we get our -- continue to keep our act together and deliver out sort of a year from now? We have time, is what I'm saying, because we're hedged in the way that we've done it and because of the nature of the contracts that we've got, and also because of the big increase in volume that we've got this year relative to previous years. So it's a mix of all of these things, how you view the -- where the OEMs are going to go with the production and delivery of aircraft, how the business aircraft producers are going to come with deliveries of aircraft in the next period, what's going to be the benefit of our -- the global reach we've got, the penetrations we're making in India and China and other emerging markets. So it's really a mixture of all of those facts and where -- when we started the restructures, I mentioned at $0.80 and I think if you looked at over a two-year period, it went to about $0.95, so we've got a similar kind of challenge. It's a little shorter period that we've got to make sure that we put all of our initiatives that we have in place right now and accelerate a few of them to adapt to those conditions. That's essentially what we're doing.

Okay. Thanks very much.

You're welcome.

Thank you. Your next question is from Daniel Kim from Paradigm Capital. Please go ahead.

Thank you. A question perhaps for Alain. Alain, could you give us a sense, remind us again, please, how many -- what your exposure is in terms of U.S. dollar inflows and other currencies and could you disclose, at least, what percentage of those cash flows are hedged and if you can give us the actual amount that you've hedged in terms of what exchange rate, please?

I do not have all of these numbers at my fingertips, but what I would refer you to, Daniel, is there's good information in the annual report in terms of the sensitivity at page 40 section 3.6, which is still accurate, so going to help you to figure out the flow that was hedged in terms of sensitivity and also in the new statement that is published since the beginning of the year, the comprehensive income statement. I think you'll see there's a lot of information there to help you to understand that impact.

Can you at least briefly explain your hedging strategy in terms of how far you are hedged?

Yes, in fact, all my backlog in Sim products civil is hedged, so as I'm getting in order or as I got ordered in the last 12 months or 14 months, I have hedged my total topline in Sim products civil as per the policy. And we've continued to do that in the last six months, so you can assume that the civil backlog is hedged.

Great. Thank you very much.

You're welcome.

Thank you. The next question is from Claude Proulx from BMO Capital Markets. Please go ahead.

Thank you. Good afternoon. First question is, I guess, it's about the margins in civil in the quarter, they were obviously very impressive and I was reading the paragraph in your MD&A, I'm not sure I understand. You talk about a concentrated number of deliveries for which some key performance risk has been mitigated and you talk about cost saving, partly due to the stronger Canadian dollar against the U.S. dollar. Can you give more color, explain more what these mean?

Yes. I think it all depends on the mix of products that you have in the quarter and your ability to deliver. I think the other thing that we've done is because of the very strong market and the short-term demand, we will build on a very limited basis, maybe A320 or a 737 and if a customer arrives and we get the contract, we can accelerate the revenue and the income related to that. There's a bit of that, but that's sort of an ongoing thing we're doing because we're in a strong market position right now. The other point that related to benefiting the Company through procurement, if you take a simulator, what you've basically got is about say 20% is profit, you've got about 40% that relates to labor and then you've got about 40% that relates to your bill of material. And you can assume that maybe two-thirds or whatever of your bill of material is U.S. dollars. So you can -- you're now paying with Canadian dollars that are worth a lot more, so you're paying less than you had planned to pay, and that's likely something that's going to go on into the future.

So when you take the mix of all of those things -- going forward, we're saying we did about 23% margin there. I said at the start of the year and I stick with it that our goal is to try and get to around 20%. So you're going to see some ups and downs, basically related to the mix of the products that come through for the year, but I hope that explains the approach and answers your question.

Just some follow-up. That means that from a material standpoint, when you hedge your revenue, you're hedging more than your true exposure to the U.S. dollar. You're exposing your hedging more than your true cash flow exposure.

No, because you have to pay in U.S. dollars -- sorry, you have to pay Canadian dollars for U.S. dollars, not what you anticipated you were going to pay when you won the contract.

Okay. Thank you.

Thank you. The next question is from Nick Morton from RBC Capital Markets. Please go ahead.

Good day. I just wanted to ask you about Project Phoenix and what kind of contribution you got in the period and how that affected your earnings?

Yes, I think it's laid out -- I'll ask Alain to answer that. It's less than I think we had in fourth quarter. It moves up and down, but--.

Contribution to income of Phoenix to this quarter was $8.6 million. You can see that in the note 9 of the financial statement.

Okay. And how did that compare to the prior period?

Year over year--.

Last quarter it was--.

Last quarter, I don't have the data in front of me, but last -- year over year, 13.7 was booked to income in the same quarter last year. So it went down.

And what division does that impact?

Sim products civil, Sim products military. When we do build a simulator in which we carried some development task similar that goes to the network, so a portion of the Phoenix contribution goes to training services also.

Okay. Great, well, I guess that's my one question. So thank you very much.

Thanks, Nick.

Thank you. The next question is from Richard Stoneman from Dundee Securities. Please go ahead.

Good morning, Bob.

Good morning.

I have a question on the multicrew pilot license training program that [Acayo] is putting forward. You mention it in your MD&A, how do you think that will affect your business and when do you think you'll see some impact from the new requirements?

Oh, boy. I don't know, precisely. I think on that one, Richard, that essentially -- normally it takes a little while to get these things into place. I think we're going to be very well situated with our global network to play in this. I would not expect anything to be coming in until sometime next year.

Thank you.

Thank you. The next question is from Tim James from CIBC World Markets. Please go ahead.

Thank you. Could you discuss a little bit further within the training and services civil segment of your business the strength of the different markets? We know both commercial and the business jet market are very strong. Can you talk a little bit about each specifically and whether one is contributing more to the strength than the other?

I think both of the areas are doing very well. However, I would say that on the business aircraft side, because we have more value-added by the provision of instructors and the courseware that we do, that you'd see that more of the margin coming from that particular area. And I think it will continue to grow and you've seen in what we've talked about and the comments I just made that we're moving very quickly to make sure that we can cover all of the in service aircraft are there to make sure that we can capitalize on the new models that are coming into the business aircraft segment and also the increased volumes. There's in fact, I think, over in the five-year period, there's more business aircraft being delivered than commercial aircraft. So we've got to make sure that we've stayed concentrated on that and now for the first time, a greater percentage of these airplanes are being delivered outside of North America, which also plays well to our global network.

Thank you.

You're welcome.

Thank you. The following question is from Marko Pencak from GMP Securities. Please go ahead.

Good afternoon. Bob, could you talk about competitive dynamics and with the focus particularly on pricing in both the civil equipment and the civil training side?

Yes. I think -- if you look at the big simulator sales business, third parties, Dallas is a strong competitor. They're basically in the same situation as we are as it relates to exchange. So they're having some adjustments and challenges that have to be made, but I can tell you the activity level on third party sales is very good and we see the sales going well for the two major OEMs as well, so I think all of that is encouraging.

As I look at the training side, really not much of a change in the dynamic here. I think we continue to compete against the airlines that are selling some third party work. We compete against Alteon, you know that it's primarily supporting their own customers. We compete against FSI in the business segment, but I think everybody there -- I mean, there's more work available than people can handle with the increased volume of aircraft going into the market. So I think that -- let's say pricing is stable in all of those particular markets and we see the utilization factor in those high 70s, 80%. So I think it's -- all of that, I think, reflects what's happening in the marketplace right now as it relates to where we are in the cycle and the greater diversity we have right now outside of North America in Europe, Asia, the emerging markets in China and India.

So if there's more work than people can handle, and particularly on the equipment side, if it's an effective duopoly, why aren't you guys taking pricing up?

Well, I think that you have to look at the fragility of the customers. Remember, the customers are still not entirely out of the woods and I think it is a competitive environment and it takes two to tango. As we've always said going along, that our advantage is not necessarily in jacking up prices, it's related to having a better technology, a better product support, and having a continual culture of reducing our costs and listening very carefully to the customer in terms of what they want to have. And we don't think changing that from them now is the thing to do.

Is it -- just finally, on pricing, I just want to go back to the comment you made about the short-term order intake and delivery on the civil equipment side where you said you might build an extra 320 or 737 simulator. Just to understand the impact on margins, are you saying that because you may build one quote/unquote on spec and you can deliver it quickly that you're getting the volume benefit that helps the margins, or are you actually able to preferentially price such a short-term delivery and that helps your margins?

No, it's basically relates to the mix of products that we can put out there and it's just not going to happen every quarter. You may get it in one quarter and not the next. It all depends on an opportunistic basis, if somebody comes along and you're able to do it.

Okay. Thanks very much.

Thank you. The next question is from Robert Fay from Canaccord Adams. Please go ahead.

Good. A couple questions, actually. In that comment that you made about the -- this is for Alain, the civil Sim products, can you quantify the hedge gain or the hedging revenues that you got from the hedging and can you also quantify the fact that you were able to purchase in Canadian dollars the goods on the other side? Can you actually get a number for those two items so we can get an idea on the impact on the margins?

FX is all over the place in the system, so it would be very difficult, Robert, to give you a very precise number.

Can you give it to us in a general sense over all of the business?

The general sense is what we've published in the annual report in terms of sensitivity. With the basket we add at that point in time and the future earnings -- the impact on earnings of $0.01 of the USD that was $1.4 million, that is what is published in the annual report. That's the best data that we have.

But in terms of the quarter, what was the hedge number in the revenues?

What do you mean by that?

The overall -- the hedge that you had. How much did it help revenues in the quarter? Just the hedging.

We don't know that. That's what I'm saying. As I'm getting a contract in a -- in U.S. or in euros, for instance, we hedge that at the specific rate, at the spot rate at that point in time and I do bring my revenue on the top line in Canadian dollar after that date. So it's difficult for me to monitor exactly how much more revenue I have, because I've hedged these contract at that point in time, my accounting system is not allowing me to monitor that, unfortunately.

Okay. In the military side, you recorded some milestone payments in the quarter on a year-over-year basis. What was the impact of those milestone payments, just so that we can sort of smooth out what to expect in terms of revenues and operating income in Sim products military.

Go ahead, Alain.

What was your question, Robert, again?

Well, I guess the commentary that you made in the Sim products business, military, you said that revenues were up resulting from the achievement of some milestones on U.S. programs and then you said that the operating income is there because of the achievement of some significant milestones on U.S. and U.K. programs, for which key performance risks had been mitigated and cost integration savings realized?

Yes, okay. So the milestone, when we do on military program, when we hit the milestone in which we have a significant subcontractor, we accrue the costs for these subcontractor that gives us the top line. And in regard of the bottom line, what we said there was because we were toward the end of the program, so when you're toward the end of the program, you derisk your program and that helps to explain the margin.

Well, I'm just trying to get some quantification of those milestone impacts on revenue and on the operating earnings, just from the milestones.

And we're not revealing that, Robert.

Okay. Thank you.

You're welcome.

Thank you. The following question is from Benoit Poirier from Desjardins Securities.

With the current Canadian dollar, I'm just wondering if it's changing your overall growth strategy and do you intend to benefit from the Canadian dollar to maybe look at making some acquisition in the U.S.?

The only thing I can say is it hasn't changed our growth strategy, we still have an aggressive growth strategy and it's clear that assets that we would buy would be less expensive where the dollar is now than where it was before. So we're continuing to -- we're continuing to look and see what possibilities would make sense as we bolt-on the various capabilities to our business. We're not going to go out and buy something that is large. We think that the incremental strategy that we've had of bolting things on and growing incrementally makes sense and I can only say with the dollar where it's at, that may be easier than it's been in the past.

And you talk about your competitiveness on the civil side, but could you maybe provide more details about your competitiveness on the military side?

I would say on the military side, it comes down very much to your technological capability. And we continue to work very, very hard to to improve our technology offering. And I think the second factor would be your ability to execute contracts in the way that you said you were going to do that and I think our record here has been quite good and of course price is important as well, but whether we're building into the U.S. market or into Europe, we have operations there where we can have natural hedges and do the business and be quite competitive.

Okay. Thank you very much.

You're welcome.

Thank you. The next question is from Brian Morrison from TD Newcrest. Please go ahead.

Good morning, Alain. Just with the purchase of the Sims back in the network, I see the impact on a training margin and on the interest expense, but can you just elaborate a little bit more on why you've done this or what is the benefit from it and then just, lastly, can you provide the present value of your off balance sheet debt now?

Brian, I'm not too sure we mentioned how many Sims we bought back in the MD&A, but in fact it was three operating leases that will be operated in Canada, so it probably 1/10 of the Sims that were off balance sheet to put it in perspective. You've seen the balance sheet. We had a lot of cash. Having them on the balance sheet or being the owner give us flexibility when we want to move these simulator and how it's earning interest income and paying interest expense and there was a net saving in doing this transaction. So it simply made sense to put them back on the balance sheet.

Okay. So in terms of off balance sheet debt, what would that be reduced to?

I do not have the data with me--.

Brian, I'll circulate that.

We can e-mail that to you.

Okay.

I may find it before the end of the call.

Okay. With the reallocation of your fleet now complete, though, is the flexibility such a huge benefit at this point in time?

Yes.

Okay.

Thank you.

Operator, we'll take one more question from the investors and then we'll open up the lines to the media.

Thank you. The next question is from Cameron Jefferies from Credit Suisse. Please go ahead.

Thanks, just housekeeping question. Most of my mine have been asked and answered. On the interest expense line, is 5 million, 5.5 million of interest expense a good number to use as a run rate going forward through the end of the year and into next year?

Yes, it's a good number.

Okay. Thanks.

Thank you.

Thank you. (OPERATOR INSTRUCTIONS) The first question is from Kurt Epstein from Aviation International News. Please go ahead.

You mentioned that there's going to be 16 additional training programs that you're going to be starting up. Can you give me some of those type aircraft that you'll be concentrating on?

No. We basically don't announce these until we get closer to when they're actually going to be deployed. We do this for competitive reasons and they're basically being deployed in North America and in Europe.

Thank you very much.

Mr. Arnovitz, there are no further questions registered at this time. I would now like to turn the meeting back over to you.

Thank you very much, operator, I would like to thank all of our participants this afternoon and to remind everyone that transcripts of today's call can be found at CAE's website at www.CAE.com. Thank you.

Thank you. The conference has now ended. Please disconnect your line at this time. We thank you for your participation and have a great day.