CAE Inc. (CAE) Earnings Call Transcript & Summary

Good morning. This is Kartik Hariharan from Morgan Stanley Investment Banking. It is my great pleasure to welcome the senior leadership of CAE to join this fireside chat session. Joining me this morning are Marc Parent, the CEO of CAE; Sonya Branco, the CFO of CAE; and Andrew Arnovitz, Vice President of Investor Relations and Strategy. For those of you who are unfamiliar with CAE, the company is a global leader in training and simulation, focused on civil aviation, defense and security and health care end markets. The company is headquartered in the Québec region of Canada, has approximately 10,000 employees and a market cap of approximately USD 4 billion. Please note that this session is for Morgan Stanley clients and appropriate Morgan Stanley employees only. This session is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. In terms of format, I have a list of questions that are prepared that I'm planning to go through. I'm also logged into a web portal that allows me to see any investor-submitted questions. Unless the CAE team has any prepared remarks they would like to begin with, we can jump right in. And again, I anticipate the session lasting somewhere between 30 and 40 minutes. With that, Marc, Sonya and Andrew, welcome.

Thanks very much.

Thank you very much.

So Marc and Sonya and Andrew, do you have any prepared remarks? Or should we jump right in?

I think we probably could go straightaway into your questions, just given the limited time.

Got it. Okay. So again, just maybe beginning with the civil -- civil training segment, right? On your most recent earnings call, I think you mentioned that utilization, civil training center utilization had bottomed at 20% in April before gradually improving to 40% in August. So can you please give us a quick update on the rebound, where it is now, right, especially considering that global air traffic is still down significantly, 70%, 80% versus last year. So again, an update on your Civil business and utilization trends.

Yes. It's Marc. Yes, for sure, we were down in the loans you mentioned back in the beginning of pandemic. We're very confident that, that's the low. I think since then we -- utilization, you see, is more than double that. Just slightly higher in business aviation versus commercial aviation but both north of 40%. That makes sense because the active suite of aircraft has grown significantly during that time as well. If you look at mid-August, the active commercial passenger aircraft fleet was about 70% in mid-August. It's so obviously considerably down since a year ago, but when you look at relative to the lows of March, we're very much moved from beyond that, which were about 38%, lasted mid-April. And I think the metric to look at, for us, is the active fleet of aircraft. The active fleet of commercial aircraft, because ours is a regulated business. Whether an aircraft flies, whether 65% load factor or 85% load factor, it doesn't change the dynamic that you need only 2 crew members at the front to operate the aircraft. And those crew members have to go back to training depending on the jurisdiction, every 6 to -- every 6 months to maximum a year. So for us, I mean, things are much improved since then. Still obviously low and visibility, especially on commercial aircraft, is very -- I mean, it's very tactical at the moment because of what, I think, that's going on. For us, we're at a different level now in terms of stabilization of business.

Great. So Marc, as a follow-up to that. So you mentioned the active fleet of aircraft. Is that the metric that investors should be focused on? Because again, there's obviously tons of metrics that are available in commercial aerospace, IATA reports, global air traffic, RPKs, there's third-party data, right, which is flight schedules, right? So again, there's a lot of data in aerospace that other third-party providers publish on a regular basis. What metrics do you focus on? And what metrics should investors be focused on as they try and get a sense of the health of your business?

Well I think in normal times, which is any time before COVID, I mean, we would have looked at RPKs as well. But I think in this kind of context, you got to look at RPK as more of a metric as you would look at GDP. It's very indicative. Obviously, for an airline, it's very, very important. But again, for us, what's really the highest order macro driver is the active fleet of aircraft. It's the number of aircraft that are flying in commercial utilization today, passenger airlines, cargo airlines. Because at the end of the day, for us, what matters is the number of pilots flying those aircraft because, again, aircraft can be empty flying cargo. It can be passenger flying cargo. But for us, those pilots have to be trained, obviously. And it's -- again, it's a regulated business, so they have to go back on training on a regular basis. In the beginning of the pandemic, we saw some noise like some airlines around the world, we're getting dispensation on that requirement to go train. And remember, I think maybe a step back, that all of that timing has to be conducted with simulators. You don't do any training on the aircraft. And by and large, being the leader that we are in the market, by and large, that training is done on CAE simulators or in CAE training centers. So again, that's the metric to watch, the active fleet of aircraft. And as I said, because the fleet has more than doubled since April, it's -- I mean, we basically see a very high correlation factor between the utilization in our training centers, i.e., the number of people who are training in our train centers around the world. Remember, we have the, by far, the largest network of training center in the world in basically every major jurisdiction. So we directly benefit from that activity. So I think that -- maybe a business jet, I think to just touch on that one as well as -- what we see is training utilization there is averaging north of the 50% range. I certainly expect that this segment, to recover more quickly than commercial aviation. That's important for us because as half of the training business that we have in civil aviation is in business aircraft, and business aircraft has a higher-margin profile than commercial aviation. So that's very important for us as a business. The metric to watch there on business aircraft is very similar in it's -- we don't really look at as a first order driver, deliveries of aircraft coming out of like the business aircraft manufacturers. For us, again, it's the active installed fleet of business aircraft and how they're flying. So really, the metric to watch there is business jet cycles, take offs and landings. That's the good indicator to watch in there. And if you look at that, I mean, that's much more promising because when you look at business cycles, if you're in the New York area, I mean, you see some aircraft going out of Peterborough, coming out of Westchester or White Plains. Those business at cycles were down 75% in April. And if I just look at the numbers from July, they're 15% year-over-year -- they were down 15% year-over-year. So that's a heck of a jump. And to me, intuitively, and I've been around the industry for about 35 years of -- and know the business aviation sector very well. And I'm not surprised to see that. Once people get an experienced business aircraft and a lot more have experienced it, because a lot of this new flying that you see is people that haven't really experienced this business before, but by necessity or reasons of personal safety, they turn to business aviation. I think that bodes well for the future of our business because once people touch business aircraft and they can afford it, not a lot of them go back. And we all expect that -- I don't think any of us expect that, anytime soon, that lines are going to get shorter at airports or at that the convenience of traveling in commercial aviation especially, if you like, internally in the United States, because that's a big market. It is a daily issue. I don't expect that to get any better. And maybe just going back to -- at the end of the day, what we do is we train pilots. So yes, those 2 indicators, the active fleet of commercial aviation because we need pilot to fly them. In business jets, business jets take off and landings because that gives you an idea of how much flying is being done. And again, the number of pilots required to be able to fly those aircraft. And for us, we -- there's a driver for our business, which we call -- the 3 reporters. We report, in this kind of time and the times that we're likely going to face in the next couple of years. We call it, in our business, pilot churn. What that means is pilots either switching airplane or switching seats. And I'll just describe what I mean there. As I mentioned, ours is a regulated business. And how that work is if you're going to learn to fly a new aircraft -- I'm a commercial pilot myself. I have an airline pilot rating more as a hobby than anything else, but I just conducted the recurrent training recently. And you have to go through an initial course to fly the aircraft. That initial course can involve 9, 10 simulator sessions on average. You have to go through that. That's -- if you learn to fly to an aircraft or if you move, say, from a being a copilot back to a pilot, you get the idea. Now once you have that license, you have to go back to training every 6 months. So in a steady state, what you see is most pilot in the active fleet, whether in business aircraft or in commercial aircraft that are basically going to train every 6 months. Now when you have an environment where a lot of activity is going on, either as we see today, as we expect, airlines or retired fleets of aircraft. Airlines are furloughing pilots, senior pilots are retiring. That creates a huge amount, again, of movement or pilot churn in the overall commercial aviation sector because most -- by far, the airlines in the world are seniority based. They're very highly unionized. So when pilots get furloughed, you have to start from the bottom. So literally, that causes a huge amount of movement of pilots from 1 aircraft to another, 1 seat to the other. And for us, what that causes is a disproportionate amount of training demand because of the effect that you have to go back to initial training. And of course, that occurs if you're furloughing pilots. But the recovery restarts in earnest, which the cycle goes the other way. Pilots, senior pilots go back into -- moving to a larger aircraft, for example, so that causes what may be a turning bubble on the upside and on the downside. From there -- I will stop there.

Got it. Okay. That's super helpful. So Marc, on your last quarterly call, you talked about virtual training, right? I mean, obviously, this whole virtual experience has gotten a lot of play given all of us have learned how to work from home and the like, right? How does that work in civil aviation, right? What is does virtual training show up in reported utilization data? Can you just expand a little bit on what is virtual training? How it is progressing, right? Do customers like it? And does it have a long-term future at CAE?

Well I think when we think about virtual training, I think what we really refer to is that it's ways of differentiating the training we do using digital. And I'll talk about that. One thing it's not, just off the bat, just to make sure that there's no confusion on that. It doesn't affect when we talk about that, or actually, basically, virtual training is not replacing the training in simulators today. That in effect is virtual training because all the training -- again, all the training is done to train the airline pilots, business aviation pilots, it's done virtually, i.e., in a simulator. For us, what we are doing is we're basically leveraging the power of digital, again, to differentiate and improve our operations. So I'll give you an example. You will imagine that because we are the leader in our market, we -- and how does that translate itself? Well of course, we're the leader in the flight simulators. We had over 80% market share last year. We're a leader in, by far, in commercial aviation training and how that translates itself, Just as 1 metric. I would give you between 135,000 pilots last year, translating to over 1 million hours of flight training. So what does that mean? Well what does that mean is about 4 years ago, we started on our own digital transformation journey. And what we did there is we transformed our training devices, i.e., the simulators that are deployed around the world. We transformed them into the IoT devices, Internet of Things devices. Meaning that they send us back data in realtime. Very similar to what the engine manufacturers have been doing in aviation, where they get data sent back to them in realtime on as the aircraft fly. So what does that mean? So for us, in a nutshell, what we are doing is harnessing all of that data, processing it and being able to provide unique insights to our customers using that data on the safety of their operation, the efficiency of their operation. And of course, that's of high-value to them right off the bat. And that's 1 arrow in our quiver that is a very important one as we seek to enter a dialogue with them for outsourcing their training operations with us. The other angle, of course, is that's very much the fore during this pandemic is using all the power of digital and digital processes to and the ability that we've all learned, as you said, at the outset to work remotely, for example. I mean this has been turbocharged now. And for us, that has real advantages in us being able to do things like more distance-based learning. What -- the installations and maintenance for simulators virtually. And when we look at all that, how we've been able to accelerate that. And I think in this world, one thing you have to understand is aviation is a very, very conservative industry, which is good because that has resulted in the safety record, which is by far, the safest mode of transportation in the world. But the fact that this industry moves very slowly, it takes a big shock to do anything, especially with the regulators. And what this pandemic has caused, by necessity, is for us to be able to get approval for the FAA and other authorities to be able to do things like the distancing, learning, like remote installations, those kind of things, which we were basically seeking to do before, but couldn't get it done because just a sheer slowness of the industry. So that's being turbocharged, and that means real savings for us. And when we look at that, to get that and coupled with other measures means that I'm very confident that we've identified, and we're on the way to deploying over $50 million of recurrent savings that are structural now in how we run our business that -- and that's irrespective of volume. So the water line has gone down. So the market does need to come back. It won't soon. But the market doesn't come back -- It does need to come back to the level it was before for CAE to do much better. And finally, the icing on the cake in everything I talked about, the distance learning and ways of doing things virtually. The great news as well is not only this provide operational efficiency, but it provides great customer satisfaction as well. So I'd just maybe stop there.

Got it. Excellent. So this question came in from one of the investors. So the question reads, "Given the pilot churn and the skew towards business jet, do you expect to recover in your business ahead of RPK recovery?"

Ahead of RPK recovery. Well I think, that's -- again, the -- I think that the RPKs are going to be slower just because of -- until a real catalyst is there for people to get back on airplanes in earnest, meaning a widely available vaccine or other, I think that, again, the measure to watch is the active fleet of aircraft. So look at that, the number of flights, one thing I look at every day is I look at the number of the active flights on flight radar. That's -- and the number of business aviation cycles. I really go back and look at those. I mean for -- I think RPKs give you a very macro picture. And -- but what it doesn't capture, for example, is cargo flights. And cargo flights are a very, very important factor these days because a lot of airlines are making pretty good level of activity just on cargo initiatives using aircraft that before were passenger aircraft, like, say, a 737, for example, and using them for cargo. So even though that aircraft was not designed initially, it wasn't used in this area, the cargo aircraft, specifically. So again, look at the active fleet, at least in exit. In normal times before, I would have said RPKs because it's not much of a difference. These days, there's a big difference.

Got it. That's helpful. So Marc, you previously guided to delivering approximately 35 to 40 full flight simulators this fiscal year. There's about 2/3 of what you delivered last year. If airlines are financially challenged, grounding aircraft, deferring, canceling aircraft orders, why would they buy simulators, right? So that is one, right? So that's the first part of the question. And second part is, again, I think you report also backlog data, right? I think your most reported backlog was $8.6 billion. This backlog has gotten a lot of press, right? I mean everybody is tracking Boeing and Airbus and other companies' backlog. So how should we think of your backlog, right? I mean, just, what is the strength of this backlog? How quickly is it going to get converted from backlog to revenue?

Well I think, look, for us, first of all, the reason that you see the outlook that we've given for a number of deliveries of simulators is because we have a good backlog, very good backlog. And I was saying a while ago that we had last year about an 80% market share, which is very high, obviously. And typically, on any given year, we'll have 60%, 70% market share. So last 3 or 4 years, we've had a very strong market share. And a lot of those simulators were earmarked for not necessarily delivered in the next 12 months, but delivery in 2, 3 years. So what your -- what's inherent in the outlook that I've given with regards to deliveries of simulators this year is delivering off that backlog. So the backlog that we have is about just deliveries, just in front of us, in terms of numbers of simulations, about 90 simulators to be delivered. And although you see a lot of press about airlines canceling their orders of aircraft, moving air aircraft, things like that, this is not a factor that we've really seen in our business. We've never really seen that. But we haven't seen it in previous crises. Of course, COVID is a crisis that will be the largest we've ever seen. But for us, I haven't -- we've seen airlines want to move their simulators out as they move their delivery of aircraft out. But we haven't seen any cancelation. Actually, we've seen one, but it wasn't from an airline. It was from a third-party training center. I don't expect any cancellations. I mean we are in dialogue, as you might expect, with every one of our customers. I mean if you think about aviation, especially like you look at airlines, there's not that many airlines in the world. So because we've been the leaders so long, and that is our business, you can well imagine the relationships we have are very strong. So we would have a pretty good indication if simulators are going to be canceled. So although we've seen some movement in terms of delivery dates, the number of -- the deliveries that we talked about, I think, is pretty solid.

And I think...

Yes. I'll go ahead.