Andrew Arnovitz - VP, Strategy and IR Marc Parent - President and CEO Sonya Branco - VP, Finance and CFO.

Cameron Doerksen - National Bank Financial Benoit Poirier - Desjardins Capital Markets Tim James - TD Securities Konark Gupta - Macquarie Capital Market Kevin Chiang - CIBC Turan Quettawala - Scotia Bank Chris Murray - AltaCorp Capital.

Good day ladies and gentlemen, and 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..

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 '17 and answers to questions, contain forward-looking statements.

These forward-looking statements represent our expectations as of today, November 10, 2016, 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 risk factors and assumptions that may affect future results is contained in CAE's annual MD&A available on our corporate Web-site and in our filings with the Canadian securities administrators, on SEDAR at www.sedar.com and with the U.S. Securities and Exchange Commission at EDGAR.

On the call with me this afternoon are Marc Parent, CAE's President and Chief Executive Officer, and Sonya Branco, our Chief Financial Officer. After remarks from Marc and Sonya, we will take questions from financial analysts and institutional investors.

Following the conclusion of that Q&A period, we will open the call to questions from members of the media. Let me now turn the call over to Marc..

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'm pleased with our performance in the second quarter, and we're on track to deliver our full year outlook for growth.

Our customers continue to depend on CAE as their training partner of choice and for the Company overall we received $747 million in new orders contributing to a record $6.5 billion backlog. We continue to make progress in executing our growth strategy in all three of our business segments.

Specifically in Civil, utilization was up 6 percentage points to 70% which translated into steady operating income growth. We saw continued robust demand for our training solutions, with new civil orders totaling $458 million for a book-to-sales ratio of 1.29 times.

We signed long-term training services agreements with airlines including Air Georgia and Japan Airlines. And in business aviation, we signed two notable deals with major aircraft management companies in Europe including TAG Aviation.

We also sold 12 more full-flight simulators in the quarter bringing us up to 21 for the first half and we ended the quarter with a new record $3.3 billion civil backlog.

In Defense, we had modest operating income growth and $262 million in new contracts enabling us to sustain a healthy $3.2 billion defense backlog and a book-to-sales ratio above one-time.

Notable awards included continuing training systems and services support on enduring platforms such as the MQ-1 Predator and MQ-9 Reaper unmanned aerial systems, the KC-135 aerial refueling aircraft, the MH-60R/S helicopter and the T-44 light transport aircraft.

We also expanded CAE's role on these platforms with training system, modifications, upgraded training material and increase in structure support. These contracts are good examples of the increasingly recurring nature of our business and CAE's ability to increase market share within its broad established customer base in Defense.

And in Healthcare, we saw year-over-year revenue growth and high profitability. We continue to see positive signs that corroborate our market thesis and where CAE can add the most value in healthcare simulation.

Notable during the quarter was the sale of our training solutions to a major medical device manufacturer in the United States and the collaboration with another medical device manufacturer for point-of-sale ultrasound training.

And more recently, our Vimedix ultrasound simulator was used as part of an echo examination process for physicians in Europe. With that, I'll now turn over the call to Sonya who'll provide a more detailed outlook and our financial performance. I'll return at the end of the call to comment on our outlook.

Sonya?.

Thank you, Marc, and good afternoon everyone. Consolidated revenue for the second quarter was 635.5 million, and quarterly net income before specific items of 7.2 million was 55.5 million or $0.21 per share.

Specific items involved restructuring completed this quarter related to the process improvement program that we introduced last year as well as restructuring, integration and acquisition costs related to the purchase of Lockheed Martin Commercial Flight Training.

Our process improvement program led to the standardization of certain types of commercial aircraft simulators, and so we began recognizing revenue upon completion for such simulators this year. As we make this transition, there'll be some differences in the timing of the revenue and net income recognition between the two accounting methods.

For the current second quarter, this change resulted in the deferral of 15.3 million of revenue and approximately $0.01 of earnings per share. A full reconciliation of these timing differences can be found under additional financial highlights in this morning's second quarter press release.

Free cash flow from continuing operations was 27.3 million for the quarter and for the first half of the year it was 42.8 million, which is up from 40.5 million for the first half of last year.

As we had a somewhat higher investment in non-cash working capital in the first half, the increase in free cash flow owes mainly to higher cash from continuing operating activity. As is usually the case for CAE, we expect the portion of the non-cash working capital investment to reverse in the second half of the fiscal year.

Usage of cash during the quarter involved funding capital expenditures for 58.8 million mainly in the support of growth. We also distributed 20.3 million in dividends and repurchased and cancelled 829,000 common shares under the NCIB program for another 14.3 million.

We continue to maintain a strong balance sheet with net debt of 922.7 million at the end of September, for a net debt to total capital ratio of 32.1%. The effective tax rate in the quarter was 16%, which compares to 21% for the second quarter last year excluding one-time tax item.

The lower rate is mainly due to a change in the mix of income from various jurisdictions. Now turning briefly to our segmented performance highlights, Civil revenue was 354.7 million and operating income was up 8% to 54.2 million for a margin of 15.3%.

On an apples-to-apples basis, the standardized Civil simulators have been accounted for under the percentage of completion method. Civil revenue would have been 15.3 million higher to 370 million while operating income would have been 3.9 million higher or 16% to 58.1 million.

On the same basis, the civil operating margin for the quarter would have been 15.7% which is a 200 basis points increase year-over-year. In Defense, revenue grew by 12% over Q2 last year to 253 million and operating income grew by 2% to 29 million for an operating margin of 11.5%.

And in healthcare, second quarter revenue was 27.6 million compared to 25.4 million in Q2 last year while segment operating income was 2.6 million compared to 1.5 million in Q2 of last year. With that, I will ask Marc to discuss the way forward..

Thanks, Sonya. Our results for the second quarter and first half of the year add to our confidence in our outlook for growth for the year as a whole.

We continue to make good progress on our training partner of choice vision and our strategy, which is focused on bolstering our competitive mode and growing recurring revenue to achieve superior results over the long-term.

In Civil, we’ve continued to see potential for superior growth and more recurring revenue as we penetrate a greater share of the $3.3 billion global Civil training market.

Demand for training the largest part of our business in civil is driven primarily by the regulatory requirement associated with the global active commercial fleet and by passenger traffic growth which continues to track the historical rate of about 4% to 5%.

Demand for full-flight simulators also continues to be strong on the back of aircraft deliveries. With another five full-flight simulator orders from a major Chinese airline announced today, we’re at 26 year-to-date.

In the business aviation segment, the overall market as measured by the level of activity of the existing business aircraft fleet has in aggregate been relatively stable.

That said, we’re continuing to make very good progress as demonstrated by our recent wins with large business aircraft operators in Europe to increase our share within the existing business jet training market and we see more opportunity for gains ahead.

Overall for Civil, we’ve continued to expect higher demand for training this year to translate into higher annual utilization of our civil training network.

We also look forward to seeing the benefits of our process improvement program and continuing to expect Civil operating income to grow at a low double-digit percentage rate for the year as a whole. In Defense, activity remains strong with nearly $4 billion of bids and proposals currently submitted and pending with customers.

Our backlog involves a higher proportion of longer term training services program which augments the recurring revenue nature of our defense business and our position on long-term enduring programs provides opportunities for us to increase scope within our broad range of capabilities.

We continue to expect modest growth this fiscal year in the defense segment. And longer term, we see significant headroom for growth in the Defense supported by secular trends for increased use of simulation-based training and more outsourcing. Given the size of the market and our potential to increase share, CAE is certainly not market constraint.

The landscape is positive with Defense budget stabilizing in the West and customers in the Middle East and Asia monetizing and recapitalizing their defense systems. These actions drive the need for training and we believe the CAE is well positioned.

And finally in Healthcare, we're seeing continuous signs that our solutions are becoming increasingly relevant to healthcare perpetual as they look for ways to improve safety and efficiency.

Just last month, CAE Healthcare together with the American Society of Anesthesiologists began to promote our latest innovation at the ASA's Annual Meeting in Chicago. By leveraging CAE's expertise, we developed a simulation-based training solution called Anesthesia SimSTAT, which is due for release in 2017.

This unique solution has the potential to become a valuable tool for practicing anesthesiologists to earn credits for continuing medical education.

We remain encouraged by the long-term prospects for CAE in the developing healthcare simulation market, and in the short term our pipeline continues to support our outlook for double-digit growth this fiscal year. With that, I thank you for your attention and we're now ready to answer your questions..

Operator, we would now be pleased to take questions from analysts and institutional investors..

Thank you. [Operator Instructions] Our first question is coming from the line of Cameron Doerksen with National Bank Financial. Please proceed with your question..

I guess my question is just on the process improvement program in Civil, I think that that was completed in Q2, I'm just wondering if we saw any benefit on the margins in the quarter and whether we'll see the full impact starting in Q3?.

So, yes, the process improvement plan has been completed in the quarter, and while there's a little bit of savings that have started really -- we'll see them ramp up in the last half. So, what we had guided to was $15 million to $20 million of annual recurring savings, and we should expect to see about half in the second half of the year.

And we've incorporated that into our forecast of low double-digit percentage operating income growth for Civil..

And maybe I could just get a quick clarification question, just on the foreign exchange impact on revenue.

Is there any way you can disaggregate what the maybe negative impact was between Civil and Defense from specifically the depreciation of the UK pound? I know you've generated some revenue there that might have impacted revenue growth in both those segments..

So, overall there was a negative impact on revenue growth on the revenue and $1.1 million on net income for the year. However, I don't necessarily have the splits between civil and currency, so we can come back to you on that.

So what we saw in this quarter was, not only in terms of the translation, it did provide a little bit of a headwind $1.1 million on the net income, but also on the non-cash working capital where we saw an expense of $5 million..

Thank you. Our next question is coming from the line of Benoit Poirier with Desjardins Capital Markets. Please proceed with your question..

If we look on the military side, the margin has been a little bit below the 12% threshold in the quarter.

Was just wondering, if you could provide more color about whether you see it's related to some volume in Middle East? Or is it related to the integration of MAT or again more mix towards services? I am just wondering, and if you could provide more color going forward?.

Well, MAT does effect a little bit because the profitability -- profile of that program where we went into it anyway, but it's largely mix Benoit. Today, we’re seeing per strategy, actually growing order intake and in the service sector, and right now I think our mix about 50/50 in terms of products and services.

And depending on what we execute what we win, again kind of skews where the margin actually percentage winds up. On the lower end, if you get into more service contracts and vice versa, I mean all of that is we’ve taken into account where we continue to guide for the outlook that we have for defense and security this year..

And just with respect to the U.S.

election, any thoughts on what could be the impact you foresee down the road so far?.

Look, I don’t think it changes anything in the long-term, but I think the upcoming this administration I mean typically a republican administration is positive for Defense from a historical standpoint.

I don’t think this will be any different and I think if you've seen some of the dialogue during the election, the run up to the election, I think we would be left to believe that, that would be the case.

But I think that the trends don’t lie, I mean we’ve seen that just currently situation right now is that Defense budget that stabilized certainly in West and we see increasing budgets in Asia and Far East.

And certainly over a planned period, three or five years, what we’re seeing for Defense overall is I guess a kind of climate that we haven’t seen in a long-time, which is that not only does -- what is still like, in some cases, call the war on terror continues with the fight against ISIS on the one hand.

And you see the pivot that Asia continuing because of reps there, and now you have the threat of the research in Asia. So all of that is leading to inevitable budget increases over the period that we’re talking about our plan.

And I think for us specifically as well a lot of this is leading to recapitalization, monetization of platforms, lease to more training, lease to more out. We see continued trends of outsourcing of non-core activities such as training because the focus on active duty troupes for example.

And finally, for all of this, the forces want to maintain readiness and simulation-based modeling is seen as a very cost effective way of doing that. So, I think all that's positive and I think the election itself I think just adds to that positive..

And related to the U.S.

Army Fixed-Wing Flight Training program, is the CapEx ramp up mostly in line with initial expectation?.

Yes, Benoit, it is. We've spent around little over 20 million on the U.S. Army Fixed-Wing in the quarter. So in line with our expectations, there was also bit of a ramp up on the Civil side, so hence slightly heavier CapEx in the first half of the year, we should see a rundown in the second half of the year..

And just for the tax rate it's 16%, how should we be thinking going forward in terms of percentage, Sonya?.

So, 16% is a little lower, but there continues to be some volatility, but really there's nothing unusual in the rate this quarter. It really is just the factor of where that income was earned in which country. What we continue and I continue to use is 22% as the benchmark and I expect that going forward..

Thank you. Our next question is coming from the line of Tim James with TD Securities. Please proceed with your question..

Sonya, I'm just wondering sort of a housekeeping question here, could the new accounting treatment for full-flight simulators manufacturing actually benefit revenue in some quarters relative to your earlier period? I realize it was actually sort of the new treatment had the net negative impact this quarter, but I'm wondering if the reverse could happen as well in future quarters?.

So, the change here is with these new standardized products, you recorded all that completion rather that throughout the build. So, as we transition and build out -- we find and build out, it'll have a negative effect like we called out this quarter.

Now to the extent we start delivering these simulators and finding new ones, they'll have kind of a net effect ultimately.

So, yes, there could be some quarters where if the deliveries are higher than that could be positive, but ultimately what we'll see as a driver for these products is that the deliveries metric will be much more terms of good metric to follow for revenue..

And my next question regarding the Healthcare segment, I'm wondering are there any capabilities, additional product lines or anything that you believe are required to take Healthcare growth where you think it should be here longer term whether that's the high teens in terms of the growth rate or do you think small acquisitions maybe required?.

Look, I think on the -- acquisitions always possible, I mean it is a pretty fragmented market. As you know we've done a couple on the way here, valuation assumptions the people have are still pretty high. And so, our view has been -- it's rather mixed rather in line, and I don't see that changing very much.

I think really the answer to your question is the real potential for this business is greater adoption of simulation for the certification of medical practitioners either both from an initial and a recurrent standpoint.

And I get pretty encouraged when I see things like we’ve seen in this quarter where we see some societies specifically the one I mentioned in my example in the outlook of the American Society of Anesthesiologists where at their convention, Annual Meeting in Chicago.

We develop a course for them and now that course or online course can be used for certification credits for continuing medical education. I mean just us presenting that at that conference, and another one that was held for another society at the Hong Kong recently. We’re seeing people have big aha moment when they see that.

And not just a couple of societies, there are hundreds of these societies. So to me, when you see a course like this be used for as credits for continuing medical education, well, that is in regulation. So, it’s not the same regulation for example that we see for Civil in terms of the FAA or EASA, but it is adoption of regulations.

So, I think that really is what going to drive this business in terms of disproportion of growth..

Thank you. Our next question is coming from the line of Konark Gupta with Macquarie Capital Market. Please proceed with your question..

Just a question on guidance first, when you say low double-digit growth on Civil EBIT, does that reflect accounting changes that have taken place and currency impact?.

It’s ultimately on the absolute number, yes. So what we repot that’s what we’re providing the outlook on..

And then on the Defense revenue, it was up very strong in the first half 21%, I guess.

So does your guidance of modest growth reflect the BMAT acquisition? Because I guess that's one of the bigger drivers there, if it is reflected then do you expect basically flat to negative growth in the second half? Because even with the flat growth in the second half on Defense side, you’re full year revenue would be up 9%, which I don’t think looks really modest?.

No, I think we’ve retained the same outlook for the year as a whole that we mentioned. I think that, and we don’t expect flat to negative in the second half.

I think we just look at and probably starting to provide more color, but I think we have to look at in your comparison that is that, look for not extraordinary, but things that we pointed out last year, as that you really should look at when you're comparing both years.

But definitely we don’t see, we don’t anticipate, negative or flat in the second half. And really when you talk about the growth, I think really confident, revenue is one thing, but I'm really talking about SOI here..

And then just following up on Defense, Marc, on your big pipeline, can you please repeat the number that you mentioned in the outlook? And what’s the expected timing of some of those bids and contractual bidding on right now, coming to fruition? And how much of your expected full year revenue is in the backlog right now?.

Okay, I'll try to answer those questions in order of it. I think number we set it about $4 billion of bids and proposal that are currently submitted and pending with customers; meaning that there's official RFPs out there, we responded to with bonafide proposals; and they're in the hands of those customers.

I mean decision timeline in Defense I would not hazard to guess. But I think if you take two of these three years, you probably won't be off too much.

And what was your last question? Yes, how much we've done in backlog I think right?.

How much currently your revenue is in the backlog, like how much do you expect?.

I don't know the answer to that question. We would have started the year, Konark, with better than 70% coverage of our expected revenue..

Okay. Thanks..

It'll be the high percentage at this point..

Yes..

Thank you. Our next question is coming from the line of Kevin Chiang with CIBC. Please proceed with your question..

Maybe just following up on the questions before, it looks like your business proposal amount 4 billion is also awfully higher than it was in the previous years.

I'm wondering, if the conversion rates you're seeing is also similar to previous years, so you're bidding more but you're converting maybe add or maybe even above historical rate as well?.

I think it's pretty stable. Our criteria for how we bid military program hasn't changed. We've a pretty stringent bid-no-bid kind of criteria and a bid-to-work process.

In the military, if anything [Indiscernible] and he was the Head of Defense and his team have fine tuned that process over the past few years for the simple reason that we don't go after military contract unless we think we have a pretty good chance at winning because it's quite costly to bid these military programs because they tend to take weeks to months to prepare and involving a lot of paperwork, lots of tots and dots to [Indiscernible] see it across, so we haven't changed.

And I wouldn't expect our probability of win to change either, it hasn't in the past and certainly in the past year and we wouldn't expect it to change going forward.

But it's on that wouldn't be our assumption and the other thing to look at is that when you look at that backlog increasingly we're going after training services contract, which tend to be more longer in terms of years of duration. So, that'll affect the size of the backlog as well..

And maybe secondly from me, again a next pick pickup in margin as you mentioned in Civil this quarter on a year-over-year basis.

Utilization was up nicely, but I was wondering if the mix also played a role what impact mix may have had in terms of wet hours versus dry hours and commercial versus business jet flying? Was there material difference in mix year-over-year?.

We had a higher mix of wet revenue versus dry and that affected things, but I think the biggest impact that you see is the higher level of utilization and it's quite high in this quarter.

When you consider that the summer months are the months at least in western world where airlines are flying and typically not flying very much, so for us to have that level of utilization in the quarter is testimony to us being able to fill more revenue across those assets. Some of that is what you've been asking, it's more wet training.

So, I think it's a good trend which is what we've been looking for and which portends our outlook for growth in the periods ahead and so..

Thank you. Our next question is coming from the line of Turan Quettawala with Scotia Bank. Please proceed with your question..

I guess my first question just wondering if after the Lockheed acquisition that you guys have made, have you started to see any change or improvement in the competitive market on the Civil side?.

I think it hasn't changed in the past since we talked about last time, I think the -- I would qualify that the competitive environment is stable. I think it's still competitive, it's still a lot of competitors for the size of this market but I think that -- I don't know anything to say except to say it's really stable.

It's still highly competitive, but I think if you had to see the margins we're making. I think we're able to maintain our market share and still deliver pretty good margins. And then that's, we play our game the competitors play theirs, but I feel pretty good about us the competitive modes.

And if you look we've announced another five more today, 26 at this stage I think we're doing pretty well, and as I mentioned that's not making any compromises on our margins..

Perfect that's great thank you. And then I guess just one more on depreciation. It seems you have dropped quite a bit on the defense segment on a sequential basis, just wondering if there's anything going on there that's specific to the quarter..

Yes, so that drop in depreciation was really related to a contract extension which had some related intangible, and so the monetization was extended along with it. So the depreciation drop, but what you don't see is also that there's some deferred revenue associated with that same contract. So, it also got extended.

So on a net basis on the P&L for the quarter, the impact was marginal..

Perfect, that's helpful, so I guess going forward then, Sonya, should we expect that DNA number to stay lower because of the contract?.

Yes..

Thank you. Our next question is coming from the line of Chris Murray with AltaCorp Capital. Please proceed with your question..

Yes, thanks. Just turning back to just the revenue recognition policy I guess I had a couple of questions just trying to understand, how this will flow through maybe into '18.

Can you let us know of the revenue you actually delivered this quarter, what percentage of that revenue would have actually been for simulated recognized in a completed contract? And then I guess the other thing I'm trying to figure out as well, are any of the standardized simulators you're building currently, would they be, are they all destined for customers?.

Okay, so we'll walk through a few of those questions. So, these are new products that we've started signing this year and enhance the transition period and the deferral of revenue. So, we've recognized none of that revenue in the current period or in this year. We will recognize it as we start to deliver it.

And so, we expect to start delivering some of them in this year, but the average cycle time on simulators about 12 to 14 months, so these should materialize over that time period as we go forward. And in terms of the remainder, so the simulator of the simulator is being accounted for on percentage of completion..

So, I guess when we think about revenue in the '18, is it fair to think that there'll be a change in your mix where accounted for as your percentage of completion will be coming down as these products displace older products?.

That is what we'll see. So the shift between kind of more standardized and less we'll see a higher shift towards revenue at completion, rather than percentage of completion; however, we do have still a very significant backlog. So, we will continue to see a good portion of revenue on the percentage of completion; however, there'll be an ongoing shift.

Now, if that helps at all, we do see for the rest of the year maybe the impact of this timing of deferral revenues to be between $0.00 to $0.01 to $0.02 per quarter..

I think part of your question asked and I think you asked whether they were destined for customers I believe? Yes, they're all destined for customers..

I guess what I'm trying to understand is that if you're starting to build call up stock simulators or whitetail simulators, it just have the inventory to respond the customer need quickly?.

No, we do that typically for high volume simulators, but it's a small proportion. And usually, we try to sell them in the quarter. You shouldn't see them in -- I mean you'll see some, sometimes but what -- the airlines or the manufacturers or the OEMs would call whitetail.

We do very little of those although we do some just be able to react to your quick delivery..

Okay. Thank you..

Great. Operator, that's the time we'll take for questions from the investment community. I'd like now if you would please open the call to questions to members of the media..

Thank you. [Operator Instructions].

Okay, operator if there're no questions from members of the media, I want to thank all participants for their time today and to remind you that a transcript of today's call can be found on CAE's Web-site at www.cae.com..

Ladies and gentlemen, that does conclude the conference for today. We thank for your participation and ask that you please disconnect your lines. Have a great day..