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Edited Transcript of CAE.TO earnings conference call or presentation 13-Nov-19 6:00pm GMT

Q2 2020 CAE Inc Earnings Call

SAINT-LAURENT Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of CAE Inc earnings conference call or presentation Wednesday, November 13, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew Arnovitz

CAE Inc. - VP of IR & Strategy

* Marc Parent

CAE Inc. - President, CEO & Director

* Sonya Branco

CAE Inc. - VP of Finance & CFO

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Conference Call Participants

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* Amina Djirdeh

Scotiabank Global Banking and Markets, Research Division - Associate

* Benoit Poirier

Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst

* Cameron Doerksen

National Bank Financial, Inc., Research Division - Analyst

* Fadi Chamoun

BMO Capital Markets Equity Research - MD & Analyst

* Krista Friesen

CIBC Capital Markets, Research Division - Associate

* Kristine Tan Liwag

BofA Merrill Lynch, Research Division - VP

* Julien Arsenault

* Ross Marowits

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Presentation

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Operator [1]

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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. You may now proceed, Mr. Arnovitz.

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [2]

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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 '20 and answers to questions contain forward-looking statements. These forward-looking statements represent our expectations as of today, November 13, 2019, and accordingly, are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially and listeners are cautioned not to place undue reliance on these forward-looking statements.

A description of the risks, factors and assumptions that may affect future results is contained in CAE's annual MD&A available on our corporate website and 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. And following the conclusion of that Q&A period, we'll open the lines to calls from members of the media.

Let me now turn the call over to Marc.

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Marc Parent, CAE Inc. - President, CEO & Director [3]

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Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss some of the highlights of the quarter, and then Sonya will review the detailed financials. I'll come back at the end to talk about our outlook.

CAE had good growth in the second quarter, with revenue up 21%, segment operating income up 28%, and we secured nearly $1 billion of orders for 1.11x book-to-sales ratio. CAE's total backlog at the end of the quarter was $9.2 billion. Performance continued to be led by Civil, which delivered very strong operating income growth, higher margins and continued to have strong order intake. The integration of the Bombardier Business Aircraft Training acquisition has gone very well and is substantially complete. And we're continuing to win the confidence of our airline and business jet customers with our expanded and highly innovative training solutions.

Defence performance improved from last quarter, however, it reflects continued delays of orders for our higher-margin defense products and the timing of program milestones on contracts that we're currently working on from backlog. These are largely timing issues, and I'm encouraged by the 1.08x book-to-sales ratio for the quarter, which gives confidence to our view a stronger second half in Defence.

And in Healthcare, our expanded sales force secured a higher level of interest in our latest products, which will begin delivering over the next few quarters.

Looking more closely at Civil. We booked $603 million of orders in Q2, including new long-term training agreements with Sunwing Airlines, Loganair and Flightworks. We also sold 11 Full Flight Simulators during the quarter for a total of 20 for the first half of the year.

To address the global demand for new pilots, we launched a new cadet pilot training program to train more than 700 new professional pilots over the next 10 years for Southwest Airlines, Destination 225 program. And just this week, we signed a long-term exclusive training agreement with easyJet to train more than 1,000 new easyJet cadet pilots under a Multi-Crew Pilot License program. Also involving easyJet, we inaugurated new training facilities during the quarter in Gatwick, Manchester and Milan in support of our comprehensive 10-year training agreement.

In Business Aviation, we entered a strategic partnership and exclusive 15-year training outsourcing with Directional Aviation Capital and its affiliates. Directional is one of the largest, fastest-growing and most innovative corporate aviation service companies globally. And in connection with this agreement, just last week, we concluded the acquisition of a 50% stake in SIMCOM Holdings.

Overall training center utilization was 69% this quarter on our network of nearly 300 full flight simulators. Airlines train a bit less during the busy summer travel months, and we've used this opportunity of this usual seasonality to perform some similar updates and relocations, coincident with the opening of our new 3 training centers during the quarter. The utilization rate also reflects the effect of some of our recently added capacity that's just beginning now to ramp up.

In Defence, we booked orders for $362 million including KC-135 aircrew training services and simulator updates for the U.S. Air Force and additional fixed-wing flight training and support services for the U.S. Army at the CAE Dolton Training Center. We also received orders to upgrade the U.S. Navy's MH-60 Seahawk helicopter simulators and to provide aircrew training on the navy's T-44C aircraft.

Other notable orders include a contract with Boeing to provide upgrades on P-8A simulators, a contract to upgrade the German Eurofighter and Tornado aircraft simulator and a contract for Abrams tank maintenance trainers for the United States Army. As well to further bolster our position in the United States, we entered a strategic collaboration with Leonardo to offer integrated helicopter training solutions together.

And in Healthcare, we continue to pursue larger segments of the Healthcare simulation market with our expanded sales force. In line with our strategy to expand our reach within hospitals, we've entered into an agreement with Premier, a leading healthcare improvement company, aligned with approximately 4,000 U.S. hospitals and health systems. We also launched new products, including Vimedix 3.0 ultrasound simulator, and together with the American Society of Anesthesiologists, we launched a new anesthesia SimSTAT module, which is latest in a series of interactive screen based courses approved for Maintenance of Certification in Anesthesiology credits.

Now I'll now turn the call over to 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?

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Sonya Branco, CAE Inc. - VP of Finance & CFO [4]

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Thank you, Marc, and good afternoon, everyone. Consolidated revenue for the second quarter was $896.8 million, up 21% compared to $743.8 million in the second quarter last year. And segment operating income before specific items was $126 million, up 28% from $98.7 million last year. Quarterly net income before specific items was $74.7 million or $0.28 per share, which is 22% higher than the $0.23 we reported in the second quarter of last year.

Net finance expense for the second quarter was $34.3 million, up from $19.9 million in the second quarter of the fiscal 2019. We had higher interest resulting from the long-term debt that we issued at the end of last year, higher interest on lease liabilities because of the adoption of IFRS 16 as well as higher investment in noncash working capital in the first half of the year. Income taxes this quarter were $15.5 million, representing an effective tax rate of 17%, which is down from 19% for the second quarter last year. The lower tax rate was mainly due to a change in the mix of income from various jurisdictions.

Free cash flow was negative $7.1 million in the quarter compared to positive $137.7 million last year. Cash provided by operating activities increased compared to second quarter last year, while free cash flow decreased mainly from a higher investment in noncash working capital accounts. Most of the increase is timing related, as we usually see a higher investment in noncash working capital accounts in the first half. This increase reflects the timing of cash flows involving accounts payable and contract liabilities, it also reflects higher inventory from recent strategic investments in simulator backfills to preempt customer demand that we anticipate for certain simulator products.

As in previous years, we expect a significant portion of the noncash working capital investment to reverse in the second half. Uses of cash in Q2 included funding capital expenditures for $58.8 million, mainly for growth, and specifically to add capacity to our global training network to deliver on the long-term exclusive training contracts in our backlog.

We continue to expect total capital expenditures for the year to be about 10% to 15% higher than in prior year. Other uses of cash include a distribution of $28.4 million in cash dividends and we used another $18.2 million to repurchase stock at a weighted average price of $34.06 per common share under the NCIB program. Our financial position continued to be solid with a net debt of $2.4 billion at the end of the quarter for a net debt-to-capital ratio of 51%. This reflects the issuance of the unsecured senior notes for the Bombardier BAT business acquisition and the higher uses of cash to fund working capital in the first half of the year. Since we adopted IFRS 16 effective April 1, 2019, net debt now also includes obligations under lease contracts, which were previously accounted for as operating leases and, therefore not included in debt. Excluding this impact, the net debt-to-capital ratio would have been 47.5% this quarter. We continue to expect to be at the lower end of our target leverage range, which is 35% to 45% on a pre-IFRS basis within the next 18 to 30 months.

Return on capital employed before specific items and excluding the impacts of IFRS 16 was 11.7% this quarter compared to 12% last quarter and 12.8% last year. As we ramp up the large Bombardier BAT business acquisition and our other growth investments, we expect to reach 13% return on capital employed by fiscal year 2022.

Now looking at our segmented performance. In Civil, we had strong double-digit organic growth in the second quarter. And in addition, we benefited from the integration of the Bombardier Business Aircraft Training business, which also performed very well. Second quarter revenue was up 35% year-over-year to $529.9 million on 18 full flight simulator deliveries and continued strong demand for our training services with our expanded capacity.

Operating income before specific items was up 60% to $101.4 million for a margin of 19.1%. On the order front, the Civil book-to-sales ratio for the quarter was 1.14x and for a trailing 12-month period, it was 1.45x.

In Defence, second quarter revenue of $336.5 million was up 5% over Q2 last year, while operating income was down 24% to $26 million for an operating margin of 7.7%. In Defence, product margins are typically higher than Services, and while we did see a more balanced mix compared to last quarter, it was still more weighted for Services. The lower segment operating income in the second quarter also reflects delays on product orders that we expect to conclude this year as well as timing related factors related to reaching program milestones on some of the product contracts in our backlog. These include our execution on R&D programs and external factors, including customer inputs and the readiness of their training facility.

The Defence book-to-sales ratio was higher this quarter at 1.08x and was 0.81x for the last 12 months.

Lastly, in Healthcare, second quarter revenue was $30.4 million, was stable compared to Q2 last year, and segment operating loss was $1.4 million in the quarter compared to segment operating income of $1.3 million in Q2. We had a higher investment in SG&A to support a larger future business, and we also have some higher expenses related to launch of new products.

With that, I will ask Marc to discuss the way forward.

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Marc Parent, CAE Inc. - President, CEO & Director [5]

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Thanks, Sonya. We continue to see good momentum with our training strategy, which is supported by secular growth trends across all of our markets, which underpins CAE's investment thesis. In Civil, the market fundamentals for commercial aviation remains supportive with continued long-term passenger traffic growth and expanding global in-service fleet of aircraft, and specific to our business, a significant need to attract and create new pilots to meet long-term demand. CAE is the world leader in civil aviation training, and is a brand that's become synonymous with training and increasingly with pilots. We're maintaining very good momentum in a large addressable market. And as we look ahead, we expect to see more airline outsourcing opportunities materialize from a large pipeline of long-term training partnerships. We expect another good year for full flight simulator sales and to maintain our leading share of the market.

In Business Aviation, we significantly bolstered our position with the successful integration of Bombardier Business Aviation training, and with our recent strategic partnership with Directional Aviation Capital. In this market segment, CAE's business is driven mainly by the ongoing training requirements that involve the already in-service fleet of business aircraft globally. We also expect to benefit from demand for training involving the entering of service of major large cabin business jets.

For Civil overall, we expect to perform a bit better than our original outlook now with operating income growth closer to 30% for the year on strong demand for our training solutions, as underscored by a 1.4x trailing book-to-sales ratio and a continued high ratio going forward, even on a growing revenue base.

In Defence, we continue to expect a stronger second half, which is a view supported by a healthy book-to-sales ratio in the quarter and a robust pipeline. Our revised outlook for modest growth for the year takes into account our progress year-to-date and our current expectations for reaching milestones on programs in backlog. We also expect to conclude several more contracts in the remainder of the year. And although we don't control the timing of government decision-making, I take confidence in knowing that we've already been down selected for most of them. Our long-term prospects in the large addressable defense market remains positive, and I'm encouraged by approximately $4 billion of defense proposals we've already written that are currently in the hands of customers pending decisions.

Finally, as previously announced, the news of Gene Colabatistto's upcoming retirement, we're actively in the process of recruiting a new Group President, who will be responsible for defense growth strategy and execution in our global markets.

And lastly, in Healthcare, I'm encouraged by the potential for CAE to leverage our leadership in Aviation training and make healthcare safer. We're positioning the business to leverage the growing opportunities with hospitals, which now have major incentives in the United States specifically, to address preventable medical errors and they see simulation as a logical way to ensure their practitioners are adequately trained in procedures. The increased imperative on patient safety recently highlighted in no small way by the World Health Organization, initiating the world's first Patient Safety Day is just 1 important factor that gives me confidence in the long-term prospects for CAE in this market. We're continuing to roll out the most innovative products in the market and with our strengthened front end organization and new team in place, we continue to expect double-digit percentage growth this year.

In summary, our overall outlook for CAE this fiscal year is largely unchanged, with expected higher growth in Civil, offsetting the lower expected growth in Defence. We benefit from a strong position in secular tailwinds in each of our core markets, and we look forward to superior top and bottom line growth in the years ahead.

With that, I thank you for your attention, and we're now ready to answer your questions.

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [6]

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Thanks, Marc. Operator, we'd now like to open the line to members of the financial community.

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Questions and Answers

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Operator [1]

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(Operator Instructions). Our first question coming from the line of Konark Gupta with Scotiabank.

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Amina Djirdeh, Scotiabank Global Banking and Markets, Research Division - Associate [2]

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This is Amina, Konark Gupta's associate. I do have a question on the Defence segment. You revised the guidance, which implies a strong EBITDA growth in the second half. Do you expect growth to be skewed in the third quarter or the fourth quarter? As well, should revenue growth accelerate at the same time as delayed orders materialize in the second half?

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Marc Parent, CAE Inc. - President, CEO & Director [3]

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Well, I think that we're guiding on the outlook for the growth of the business in line with what we've talked about in the remarks. And yes, we expect a stronger Q3 and Q4 in providing more Q4 than Q3. But overall, we would expect a much stronger second half, as you would expect, to be able to -- as you said, achieve the modest growth that we highlighted in our outlook for sure.

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Amina Djirdeh, Scotiabank Global Banking and Markets, Research Division - Associate [4]

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I do have a question on working capital. Do you expect a reversal in working capital in the third quarter? And are there any other one-timers this year that wouldn't drag on to working capital changes next year?

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Sonya Branco, CAE Inc. - VP of Finance & CFO [5]

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So as we see historically, there's usually an investment -- a higher level investment in the first half of the year in noncash working capital account. And usually, we see a partial reversal in the second half and that's no different this year. We don't really call it out on a quarterly basis. We look at this on an annual basis. And a lot of that investment entirely last year was driven in part by timing impact on accounts payable and contract liabilities. But in addition, we've called out higher deliberate investment in inventories. Some of it is work in progress inventory. And that's inventory that's tagged to customer orders and deliveries, which is in line with our view on expected deliveries, which is higher in the second half. But we've also invested deliberately on some pre-builds, so some white tails to address expected demand. Most of these are 737 MAX simulators. And when the situation and timing of [product] deliveries are clarified, we are positioned to address that customer demand. Okay?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [6]

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Operator?

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Amina Djirdeh, Scotiabank Global Banking and Markets, Research Division - Associate [7]

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Can you hear me now?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [8]

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Yes.

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Amina Djirdeh, Scotiabank Global Banking and Markets, Research Division - Associate [9]

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Sorry, I do have a question on the Civil segment. What is the cadence for the simulator deliveries for the next 2 quarters? And do you expect EBITDA growth in the second half to be driven by joint ventures? Or can we expect material margin expansion to take place in the first half -- that took place in the first half?

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Marc Parent, CAE Inc. - President, CEO & Director [10]

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Well, I'll just start with deliveries. I think we don't expect the market drivers to be different with regards to simulator sales, which are basically -- the strong catalyst is delivery of aircraft out of the OEMs. And notwithstanding, I think you only -- maybe, if you like, anomaly in the market right now is the delayed deliveries of 737 Maxs. Whether or not, I think, there's no reason to expect that the markets will be different, and we're not seeing that. We're seeing that simulator orders in line with, as I said, delivery of aircraft. That is [approximately] anyway. Do you want to add anything?

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Sonya Branco, CAE Inc. - VP of Finance & CFO [11]

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On your question on EBITDA. Ultimately, our revised, I think, our revised outlook speaks to our view on operating income, that's a little higher than what our previous outlook and with operating income growth coming closer to 30%.

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Operator [12]

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Our next question coming from the line of Kevin Chiang with CIBC.

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Krista Friesen, CIBC Capital Markets, Research Division - Associate [13]

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This is Krista on for Kevin. If I could just go back to Defence. You're calling for a strong second half. I'm just wondering how this plays into 2021? I know you're not providing guidance, but any reason not to expect the growth rate in Defence to return to a normalized level?

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Marc Parent, CAE Inc. - President, CEO & Director [14]

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Well, I think -- I don't think we called out normalized level. We specifically, we call out an outlook every year. But yes, we had continued good growth in Defence because it is -- because the market fundamentals and our position in the market and the demand for our services, and probably most importantly, on the pipeline of opportunities that we see. As I mentioned, we have about $4 billion of proposals that we submitted to customers already. So those -- as I would say, we don't control the pan of decision-makers as to when they decide, but I think that -- a lot of them will materialize in the next few months. So that gives me confidence in our own prospects in the market. And when you look as well the market itself, market itself is growing, and we continue to expect to exceed the organic market growth for the longer term in Defence.

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Krista Friesen, CIBC Capital Markets, Research Division - Associate [15]

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Great. And if I could also just ask another one. With the addition of Bombardier's business aviation training assets and the strategic partnership with Directional. How does that shift the mix of wet hours and dry hours versus what we've seen historically?

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Marc Parent, CAE Inc. - President, CEO & Director [16]

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Well, I don't have the numbers, but we certainly have them, but no, I don't -- we do, but clearly, Bombardier is essentially all -- essentially all wet. So clearly, it will increase the amount of wet hours we do.

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [17]

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Yes, Business Aviation represents about 1/3 of our civil activity, Krista. It's all wet. And of the commercial activity that we do about -- probably about 1/3 of it is wet and growing.

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Krista Friesen, CIBC Capital Markets, Research Division - Associate [18]

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Perfect. And then if I could just ask one on Healthcare. Margins have been impacted by elevated costs related to growth and launching new products. When do you think you'll lap these costs? And should we expect this for the remainder of fiscal 2020?

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Marc Parent, CAE Inc. - President, CEO & Director [19]

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Well, I think we expect it to reverse, it has continued to increase this year as testimony by our outlook for double-digit growth. Obviously, that implies a strong second half, and that's what we see in front of us.

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Operator [20]

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Our next question coming from the line of Benoit Poirier with Desjardins Capital Markets.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [21]

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Yes. Could you provide more color with respect to the Civil guidance that has been revised upward and what are the main drivers for the guidance increase?

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Marc Parent, CAE Inc. - President, CEO & Director [22]

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Well, I think its performance year-to-date, Benoit, and orders going forward. If you look at, as I mentioned, just in terms of orders and the trailing book-to-bill is 1.45x on top of quite exceptional revenue growth. So even though we're growing a lot we are just continuing to fill the pipeline quite substantially. And so that's -- so we know what capacity we have, we are not capacity limited. So we can see that we're going to be able to generate more business and the associated profits in the second half. That's a large part. The other parts that we've been very happy with the integration of our Bombardier Business Jet business, but I think we're honestly firing on all cylinders there. And so we feel confident in the second half with regards to that business. So that's really where we're coming from to be able to confidently increase that outlook.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [23]

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Okay. That's perfect, Marc. And are you confident to still deliver a similar number of full flight simulators this year comparable to last year, which was around 58, Marc?

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Marc Parent, CAE Inc. - President, CEO & Director [24]

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Certainly. Deliveries now, Benoit?

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [25]

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Yes, yes, yes.

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Sonya Branco, CAE Inc. - VP of Finance & CFO [26]

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Yes, so what we see is that it will be higher in the second half as it was last year, probably in the 50s, and that's been incorporated into our outlook and -- our outlook of closer to 30% operating income growth year-over-year.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [27]

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Okay, perfect. And could you provide an update on the 737 MAX. Whether you have more color on the upcoming training requirement and the impact so far we've seen for CAE?

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Marc Parent, CAE Inc. - President, CEO & Director [28]

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Not really. We don't have any more because -- I mean the aircraft has returned to service. So I think we don't know nor does anybody else, exactly what the training requirements will be. I think it's -- in terms of our position that we're continuing to support our operators and to support Boeing and support the regulators to the extent that we -- that they want our support in all jurisdictions. So our assumptions that there obviously is going to be a lot of pent-up demand when those airplanes start flying and that emphasizes a number of white tails that we've created to be able to secure that demand. And also, sales will continue to do well of the MAX simulators and deliveries as well. I mean so far this year, if you look at maybe remind me the numbers we've covered.

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Sonya Branco, CAE Inc. - VP of Finance & CFO [29]

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5 orders to date and delivered 9 deliveries to date on the 737 MAX and expect a similar number in the second half as well.

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Marc Parent, CAE Inc. - President, CEO & Director [30]

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And if you look at -- we've sold 48, 737 MAXs so far, and that's the majority of market share. So hopefully, the airplane will flag in relative -- in the near future, but we're well positioned when that happens.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [31]

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Okay. That's great color, Marc. And with respect to the utilization rate, the 3% decline year-over-year. Is it fair to say that it was mostly driven by the acquisition of BAT that typically where business jet utilization is typically lower, given the nature of the business, Marc?

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Marc Parent, CAE Inc. - President, CEO & Director [32]

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That's certainly part of it. And there's a normal seasonality, as you know. But I mean, even if you look at last year, 72%. Some of it is what you said, this is our cup for sure, because we -- they will train in the midnight hours. However, caution that we don't assume them to do when we estimate a utilization. We don't necessarily assume full utilization like that on a business aircraft. A lot of it has to do as well with -- remember, we opened up 3 new training centers, Milan, Manchester, Gatwick. So we've relocated a bunch of simulators and updated. We are taking the advantage of the summer months to update simulators and while we're doing that, they are either in transit or an update. They're not earning revenue, and they're not part of that utilization. So -- and some of it 737 pilot train deferrals. So all of that, I think, gives you the 69%, which, to me, is not surprising with everything we've done this quarter.

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Benoit Poirier, Desjardins Securities Inc., Research Division - VP and Industrials, Transportation, Aerospace, Industrial Products & Special Situation Analyst [33]

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Okay, that's perfect. And last one for me, Sonya, in terms of working cap, you expect a good reversal in the second half. But in terms of working capital usage for fiscal '20. Could you provide maybe a range or what kind of dollars we could expect for the full year in fiscal '20, Sonya.

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Sonya Branco, CAE Inc. - VP of Finance & CFO [34]

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Well, tentatively we expect a significant part of that to reverse in the second half. So that will be, as we kind of continue to optimize on cash working capital converts on that inventory investment in the second half. But we will have some investment. One, some of that inventory won't necessarily will convert completely before March 31, but also as we continue to see strong growth on the services side, that services model drives the investment in AR, which is usual because the services get billed and collected after the services are under. So we'll not necessarily give a range, but it's a substantial proportion that will be reversed in the second half.

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Operator [35]

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Our next question coming from the line of Fadi Chamoun with BMO Capital Markets.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [36]

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Maybe first on -- quickly on Directional Aviation. Can you offer up kind of how you think about the contribution you would expect from this, once you close it? Is it kind of consistent with what would it be attributing kind of ROIC for this business, like a low double-digit ROIC basically on that $85 million. Is that a fair way to think about it?

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Marc Parent, CAE Inc. - President, CEO & Director [37]

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Well, I'll start by saying maybe it's slightly accretive. We expect it to be slightly accretive in the next 12 months as we open up our new training center. We start populating it with simulators as we go through the integration. Andrew do you want to add on that?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [38]

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Yes. No, I think that it really begins to take loss year 2, year 3 and beyond. The biggest value in that, Fadi, is really the 15-year exclusive with Directional, which is a really large fleet in aggregate with all its affiliates, is about 175 business jet aircraft. So it's almost like a really large airline outsourcing. So for us, the returns really begin to take hold, year 2, 3 and beyond. First full year will be sort of modestly accretive.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [39]

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Okay. And is there any contribution assumed for this year from Directional?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [40]

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Well, it's very small, and it's already in the near 30% growth outlook that we provided.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [41]

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Okay. My second question on Defence. I mean, I can appreciate the lumpiness quarter-over-quarter and these kind of things. But if I think kind of look at the last few years in Defence the -- you've had a very strong improvement in revenue as you've deployed over $300 million of capital in that division. But the incrementals have been kind of in the low single digit, both in terms of ROIC and margin. Can you offer up any kind of -- any kind of insights into what's really kind of driving this? Is it all mix? And whether there is an opportunity that can improve over the next couple of years, I guess, if these are programs that are in early ramp-up stage.

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Marc Parent, CAE Inc. - President, CEO & Director [42]

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I think maybe just a high level, definitely, I think what you've seen a large -- on a macro level, is increasingly a shift to services and product services mix that's changed, and that's causing a lot of that shift to lower margins overall. Now going forward, I would tell you that we stick to -- argue that we should be able to deliver an 11%, 12% range. That would be our expectations for the longer term. And that's -- and in terms of accretive to the overall return to CE. So certainly not dilutive and contributing to value creation. That's our position, and that's the way we're bidding in the market. Sonya, you want to add anything to it?

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Sonya Branco, CAE Inc. - VP of Finance & CFO [43]

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Yes, it's really there is a reflection in transition between the products and services mix. But as you grow the size, scope on services and drive the product programs, it will drive higher margins and contribution on return.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [44]

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Okay, great. And maybe one last question. Are you prepared to share how many white tails have you built for MAX or.

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Sonya Branco, CAE Inc. - VP of Finance & CFO [45]

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Well, I think, we...

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Marc Parent, CAE Inc. - President, CEO & Director [46]

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We won't share the number. We think that is competitively sensitive, but maybe I don't know you...

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Sonya Branco, CAE Inc. - VP of Finance & CFO [47]

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No, I was going to say the same. So no.

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Operator [48]

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Our next question coming from the line of Cameron Doerksen with National Bank Financial.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [49]

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Just a follow-up on the 737 MAX and the white tails. I mean, I guess, maybe I'm reading too much into this, but the fact that you've maybe built some white tail, 737 MAX sims. Is that suggestive that maybe airlines are telling you that they might have a requirement for new SIMs as opposed to using their existing 737 NG SIMs?

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Marc Parent, CAE Inc. - President, CEO & Director [50]

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Well, I think, well look, I'll tell you, I think it's prudent to say that given you have both 737 MAX operators and a lot of airplanes sitting on the ground right now. And they're going to have to come up to speed with regards to pilot training, and you just don't ramp that up overnight, okay? So we want to be there, being able to support all of the demand. And the long-term prospects of this aircraft are very good. Boeing has got a very strong backlog of aircraft. This will get fixed in the short term. So we want to be ready, and we're taking assumptions with regards to what training happens in what jurisdiction. But I think we have no crystal ball anymore than you do. Anyway that we would share our assumptions on what training will be done. But no, customers aren't guiding us one way or another. I think, the -- our experience, though, is that airlines rarely do just what there is the minimum that the regulators will ask them. So we fully expect that as has already happened. Some -- even should the training requirements be exactly the same as before, I fully expect that some airlines, a lot of airlines will move beyond that because they'll want to have dedicated 737 MAX simulators for their own reasons. So we'll be ready for that.

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Cameron Doerksen, National Bank Financial, Inc., Research Division - Analyst [51]

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Okay. No, that's great. And just secondly, just on M&A. I mean, you've done a couple of acquisitions here in the last 12 months, just in the Business Aviation training segment. I'm just wondering if there's anything else out there that maybe you feel under represented either Civil or Defence that could be an M&A opportunity?

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Sonya Branco, CAE Inc. - VP of Finance & CFO [52]

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Well, the way that we look at M&A, is really focusing on training outsourcings and partnerships and whether they become organic opportunities like the easyJet outsourcing or M&A like this recent Simcom transaction really develops with that partnership. So we continue to focus on outsourcing and continue to have a good pipeline of conversations with airlines and partners and if there are any other strategic opportunities that enable expanded market access, some technology capabilities or client programs, we keep an eye out for these and all this kind of a value buyer, if there's something that is of interest.

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Marc Parent, CAE Inc. - President, CEO & Director [53]

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Picking up on Cameron's last question I would also add that, even though it's hard to pick out is our Defence results to date, I would tell you that we're quite happy with the acquisition we've done in Defence last year in the top secret world. I think that's performing very -- quite nicely, and a lot of the revenue growth, you're seeing -- a good portion of that is actually coming from that business. So we feel good about that.

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Operator [54]

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Our next question coming from the line of Ronald Epstein with Bank of America Merrill Lynch.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [55]

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It's Kristine Liwag. For the 737 MAX, since the aircraft hasn't been recertified yet, how does the timing work for when you get the final software package from Boeing? And when you can deliver your first full flight simulator?

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Marc Parent, CAE Inc. - President, CEO & Director [56]

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Look, I think it will be -- it will probably be coincidence. I think we're working in lockstep with Boeing, and I'm quite confident as soon as the software loads that we need to be able to upgrade the simulators come from Boeing, and we're -- as I mentioned, we're lockstep with them. And I don't expect any delay with regards to having to update sims from that standpoint.

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [57]

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And in fact, Kristine, we've delivered 9 MAX so far in the first half of the year. So even what we're delivering currently will have to be updated with the new aircraft system load. A lot of that is software. Software, which can be done pretty fast.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [58]

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I see. And for the simulator advanced builds that you're doing right now. How many of those already have basically indication from your customers that they will order it versus a speculative build on your part?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [59]

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Yes, I think -- well, basically, when we say white tails, it means that it's not contributed, it's not tagged to a customer. So we're building them and they wind up either in our training centers, so we can serve the market. As I said, for customers buying 737 MAX are offered in our trained network or we'll have airlines buying simulators, and we'll deliver to them. But when we talk about white tails, we mean they have been attributed at this moment.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [60]

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So not even a soft indication of interest. So it's all purely speculative, just to confirm?

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [61]

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It isn't that unusual for us to do some advanced building, especially on high-volume platforms like the A320 or for the MAX. But here, yes, we are making some calls in terms of their being pent-up demand given the fact that the aircraft has been out of commission for as long as it has been and the deliveries as well. So that's what we see. So it's not a particularly bold measure on our part. We think it's just smart preempting the demand that we expect.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [62]

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That looks helpful. And maybe switching gears to Healthcare. Marc, can you walk us through what you need to achieve for Healthcare to be profitable in the long term?

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Marc Parent, CAE Inc. - President, CEO & Director [63]

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Well, I think it's a question of revenue growth. It's not -- I said this before, but it's not the question of the profitability of our products and services, they're actually very profitable. In fact, more profitable on a unit basis than probably -- there's certainly a lot of the products that we have in rest of our business. The issue is volume. We need to grow the business, and that's why you see us investing in new products and investing in sales force, SG&A, which is mainly sales force and I would say a stronger team. And we started with Rekha Ranganathan, who is a seasoned executive from the Healthcare sector. We're now growing the team, the leadership team, and that's part of the -- part of what we're doing that we're seeing reflecting in cost. There's been change in our strategy with the new team in place, which is really going after the hospital business. You look at value-based care in the United States that is driving, as we said in our remarks, that is driving hospitals to be able to have to invest more into training to make sure that they reduce the amount of medical errors that are happening as a result of, if you like, less than perfect training. And that's -- we demonstrated that in Space and Aviation Industry. And I've said many times before, the healthcare industry is writ large is looking to aviation as the model as they look at this. So that's really where we're at. And when we look at the -- certainly, short term, rest of the year, we certainly expect that, based on the orders we've gotten to date. I mean we don't monitor, we don't report out the size of the business we hope to build in the healthcare business. But I can tell you, already in this quarter, we're seeing, if we report backlog, we'd be showing a backlog that's increasing. Now it's not all delivering for a number of reasons. The time to basically complete an order on the hospital sector is a bit longer than it is in our traditional teaching hospitals, for example. So that's reflected. But having said all that, we feel confident in the growth outlook that we set on top of bottom line double-digit growth this year, implying a stronger second half. And it's certainly a stronger -- larger business going forward or else we wouldn't be in this business.

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Kristine Tan Liwag, BofA Merrill Lynch, Research Division - VP [64]

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Sure. And I don't want to hold you to some sort of long-term guidance. But I kind of just want to get a perspective from how you think about this business, if -- do you think this business will be $100 million revenue business on a quarterly basis in the next 2, 3 years? And then also, I'm just understanding the size that this could be? And then at what point do you have a threshold in which you decide to sell it and walk away from Healthcare?

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Marc Parent, CAE Inc. - President, CEO & Director [65]

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Well, on the large part, we're committed to the business. And so I'm not going to comment that. We're sticking to it. But as we've done in any business, that you saw in mining a few years ago. But if we feel that there's going to be -- it's not going to be the market opportunity we expect, or that we think it's going to take too long then we'll reevaluate our options in that regard. But that's certainly not our thinking at this moment. And so at the end, I say, right now, I'm not going to commit to in terms of any kind of certainly quarterly the revenue targets at this moment. I can tell you that we won't be satisfied until this business is substantially -- ordered is now in concert with our expectations of the market. Certainly not bloody minded about it, though. (inaudible) this market, and I think that we're very confident that there's a societal need here, and we're the ones that are best positioned to be there to support the increase in patient safety.

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Operator [66]

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Our next question is a follow-up question coming from the line of Fadi Chamoun with BMO Capital Markets.

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Fadi Chamoun, BMO Capital Markets Equity Research - MD & Analyst [67]

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Sonya, on the working capital, if I look at the $300 million working capital investment so far this year, half of it is declining kind of liabilities and payables and half is kind of from the asset side, including inventories. And what's the driver behind this liability and payables decline? I'm just trying to understand how much of that really comes back in the back half of the year.

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Sonya Branco, CAE Inc. - VP of Finance & CFO [68]

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Yes. So on the inventory, we spoke about that, it's a combination of work in progress, and that's inventory that takes to customers. And that's -- as we build the simulators to deliver in the back half as well as the white tails that we've invested is preemptive for demand that we see. Now on accounts payable side, it's really a question of timing on different types of payments. So there's some annual payments that get paid in the first half of the year that are higher than last year and then some new payments that are largely related to kind of interest and so on new profiling, so that get paid out in the first half of the year. And there's always a bit of variation that's driven by the shift in volume, where the second half usually has a higher volume than the first half. So it kind of contributes to that investment in the first half. So all to say that it's a slightly higher investment, but we do expect a substantial part of all of that coming from payables, the inventory and liabilities, probably around, call it, 3 quarters of that to reverse in the second half of the year.

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [69]

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Operator, we'll now conclude the session with investors and open the lines to members of the media should there be any questions.

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Operator [70]

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(Operator Instructions). We do have a question coming from the line of Ross Marowits with the Canadian Press.

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Ross Marowits, [71]

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I'm wondering if you could talk a little bit about what the impact, both financial and otherwise has been, say, from the MAX issues in the grounding?

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Marc Parent, CAE Inc. - President, CEO & Director [72]

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Well, I think it's mainly -- in terms of the impact, it hasn't been really consequential to date in our numbers. In terms of deliveries of our simulators, they are continuing, we've delivered a number of them this year already in line with our expectations. But we fully expect to deliver, actually, the number total is 19 that we've delivered to date. So we fully expect to continue to deliver this year because airlines will need them in the -- as the MAX comes back. So I don't -- so the impact hasn't been as I mentioned, consequential to CAE's results. And we don't expect them to be based on what is expected to be the return to service data, it is not public. What you read is public regards in terms of when that aircraft will start flying again. So I think that's what -- basically, that's kind of what I've characterized it.

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Ross Marowits, [73]

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And I guess, the flip side to that or addition is what impact will -- are you expecting you built some white tails. So what impact are you expecting once it resumes?

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Marc Parent, CAE Inc. - President, CEO & Director [74]

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Well, I think -- and I should have said actually because we repeated in the -- repeating what we said during the analyst question. I mean one impact, obviously, is working capital because we have these simulators that we built that are white tails, which means that they are sitting in work-in-process inventory. And then what will happen is when the airplanes start to deliver and start entering service back in or reflying with airline, obviously, some of those will deliver because we fully expect people to order some and we will be in a position to put -- add those simulators to our training network and expect the -- that extra capacity to be useful to make sure the airplane regains service flying status quickly as the need to retrain a lot of pilots come to fore.

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Ross Marowits, [75]

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And all of them will require software updates?

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Marc Parent, CAE Inc. - President, CEO & Director [76]

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Well, the simulators that are done, certainly will have to be, as is always the case, will have to be representative of the aircraft. So whatever the final configuration of the aircraft, we will be supplied that -- those changes by the manufacturer, and we'll incorporate them. So every simulator will have to represent the final configuration. So yes, we'll have to update them all. But as I said, I wouldn't expect -- because we've been updating as we go along, I wouldn't expect that to be a long process.

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Operator [77]

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Our next question coming from the line of Julien Arsenault with La Presse.

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Julien Arsenault, [78]

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(foreign language)

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Marc Parent, CAE Inc. - President, CEO & Director [79]

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(foreign language)

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Julien Arsenault, [80]

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(foreign language)

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Marc Parent, CAE Inc. - President, CEO & Director [81]

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(foreign language)

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Julien Arsenault, [82]

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(foreign language)

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Marc Parent, CAE Inc. - President, CEO & Director [83]

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(foreign language)

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Andrew Arnovitz, CAE Inc. - VP of IR & Strategy [84]

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Operator, that's all the time we have for the call today. I want to thank members of the media and, of course, members of the investment community for joining us this afternoon. A transcript of today's call will be made available later today on CAE's website. Thank you very much.

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Operator [85]

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That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.