CAE Inc. (NYSE:CAE) Q3 2023 Earnings Call Transcript

CAE Inc. (NYSE:CAE) Q3 2023 Earnings Call Transcript February 18, 2023

Operator: Good day, ladies and gentlemen. Welcome to the CAE Third Quarter Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now proceed, Mr. Arnovitz.

Andrew Arnovitz: Good afternoon, everyone. Thanks for joining us on the call. Before we begin, I’ll remind you that today’s remarks, including management’s outlook and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, February 14, 2023, 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 in 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’ll open the call to questions from financial analysts. At the conclusion of that segment, we’ll open the lines to members of the media. Let me now turn the call over to Marc.

Marc Parent: Thank you, Andrew, and good afternoon to everyone joining us on the call. We had strong results in the third quarter, driven by Civil’s double-digit growth, Defense’s sequential improvement, and Healthcare’s increased profitability. We also ensured our path to future growth by securing over $1.2 billion in total adjusted order intake for a record $10.8 billion adjusted backlog and 1.22x book-to-sales ratio. In Civil, we booked $713 million of orders from a large opportunities pipeline, resulting in a 1.38x book-to-sales ratio. This is an especially noteworthy accomplishment, considering this is on revenue that’s 33% higher than last year. Orders include long-term commercial aviation training agreements with GOL Airlines and MESA Airlines, and a multi-year business aviation training agreement with Delux Public Charter.

We also made excellent progress with our flight operations software solutions, with notable agreements including a five-year contract with Ethiopian Airlines for our next-gen crew and operations manager solution suite, and since the end of the quarter, an agreement with Frontier Airlines for our next-gen operations solutions. Demand for full-flight simulators continued to be strong with 14 sales in the quarter, bringing our year-to-date total to 43. Civil’s financial and operational performance was also strong in the third quarter, with double-digit growth and near-record margins. We delivered nine full-flight simulators in the quarter, and average training centre utilization was 73%, up from 60% last year. Commercial aviation training demand continued to be strongest in the Americas, followed by a seasonal uptick in Europe and then Asia, which has improved with the ongoing easing of travel restrictions in China.

In business aviation, training demand continued to be robust throughout our network, reflecting a high level of pilot training to support business aircraft flight activity, which continues to exceed pre-pandemic levels. In Defense, the leading indicator of our progress towards a larger and more profitable business is order intake. This quarter, we booked orders across domains for training and mission support solutions valued at $477 million for a 1.05x book-to-sales ratio. This marks the sixth consecutive quarter this ratio has been above one, and situates us with a book-to-sales ratio of 1.25x on a trailing 12-month basis. Notable orders in the air domain include the provision of a flight training device and maintenance and logistics support for the Royal Canadian Air Force’s CH-149 Cormorant search-and-rescue helicopter, the continuation of aircrew training on the KC-135 Stratotanker and C-130H Hercules for the United States Air Force, and international flight training device upgrades for the F-16 fighter jet and CH53G heavy-lift transport helicopter.

In the Land domain, we were awarded funding for our Joint Terminal Control Training Rehearsal System solution, which builds on the success of our previous funding awards for a new virtual training capability for soldiers to the U.S. Army on the Soldier Virtual Trainer prototype contract. We also booked orders in the space and cyber domains, highlighted by the proliferation of CAE’s solutions for distributed, networked and cybersecure mission training via the US Air Force’s SCARS program. And since the end of the quarter, we booked orders in the sea domain with our ongoing work with Lockheed Martin on the Canadian Surface Combatant ship program. Defense also continued to build on its foundation of U.S. Army support with the successful competitive re-compete for the U.S. Army Aviation Fixed-Wing Flight Training Program, which involves a provision of comprehensive initial and recurrent training for more than 600 U.S. Army and U.S. Air Force fixed-wing pilots annually at the CAE Dothan Training Center in Alabama.

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The approximate total value of the base contract and options is US$250 million, with a period of performance through 2032. This was awarded to us with an effective date commencing in our fourth quarter and accordingly, will be reflected in our next quarter order intake. Also involving U.S. Army aviation, our prime partner on the U.S. Army’s Future Vertical Lift, Bell Helicopter, was awarded the FLRAA program, which will field the V-280 Valor tiltrotor to eventually replace the long-serving UH-60 Black Hawk helicopter. Pending protest resolution on this award, CAE will support Team Valor by delivering a range of training devices, solutions, and courseware for Bell’s family of systems. We’ve continued to place a strong focus on our operations and asset optimization in the face of the ongoing macroeconomic challenges impacting the defense industry as well as the broader economy.

As a result of these efforts, our financial performance for Defense in the quarter improved sequentially, and was largely in line with what we expected. With that, I’ll now turn the call over to Sonya who will provide additional details about our financial performance. Sonya?

Sonya Branco: Thank you, Marc, and good afternoon, everyone. Consolidated revenue of $1,020.3 million was 20% higher compared to the third quarter last year. Adjusted segment operating income was $160.6 million, compared to $112.7 million in the third quarter last year. Quarterly adjusted EPS was $0.28, compared to $0.19 in the third quarter last year. Adjusted EPS this quarter includes an approximate $0.02 positive impact as a result of gains on the reversal of impairment of non-financial assets following their repurposing and optimization. We incurred restructuring, integration and acquisition costs of $4.9 million during the quarter, relating mostly to the AirCentre acquisition, and this also includes a $9.8 million impairment reversal.

Net cash provided by operating activities this quarter was $252.4 million, compared to $138 million in the preceding quarter and $309.6 million in the third quarter of fiscal 2022. Free cash flow was $237.7 million, compared to $108.4 million in the preceding quarter and $282.1 million in the third quarter last year. The sequential increase was mainly due to a lower investment in non-cash working capital and a higher cash provided by operating activities, while the decrease compared to the third quarter last year was mainly due to a higher investment in non-cash working capital, which was partially offset by higher cash provided by operating activities. Capital expenditures totaled $63.4 million this quarter, with approximately 75% invested in growth, to specifically add capacity to our Civil global training network to deliver on the long-term training contracts in our backlog.

Income tax expense this quarter was $17.1 million, for an effective tax rate of 18%. The income tax rate was impacted by restructuring, integration and acquisition costs this quarter, and excluding these costs, the income tax rate this quarter was 19%. Our Net debt position at the end of the quarter was approximately $3.1 billion, for a net debt-to adjusted EBITDA of 3.74x at the end of the quarter. This 43 basis-point improvement from last quarter puts us solidly on track to meet our targeted leverage ratio of below 3x net debt-to-adjusted EBITDA by the middle of next fiscal year. Net finance expense this quarter amounted to $48.8 million, which is up from $41.3 million in the preceding quarter and $34.5 million in the third quarter last year.

Approximately 70% of our debt obligations are fixed rate, and the increased finance expense largely reflects the impact of higher interest rates on our variable rate debt instruments. For now, we’re assuming a go-forward quarterly run rate for this expense in the range of the current quarter. Now, turning to our segmented performance. In Civil, third quarter revenue was up 33% to $517.4 million, compared to the third quarter last year, and adjusted segment operating income was up 58% to $131.4 million vs. the third quarter last year, for a margin of 25.4%. Our strong year-over-year Civil performance was mainly due to higher training network utilization and the integration of AirCentre into our results, which represented approximately 10% of Civil revenue in the quarter.

In Defense, third quarter revenue of $452.5 million was up 6% over Q3 last year. Adjusted segment operating income was $25.4 million for the quarter, down from $32 million in the third quarter last year. The revenue growth stems from FX translation and a higher level of activity on programs, while the lower adjusted segment operating income reflects higher costs associated with inflation, supply chain disruptions and labor shortages. This was partially mitigated by a reversal of impairment on an intangible asset following their repurposing and optimization and cost reduction initiatives. And in Healthcare, third quarter revenue was $50.4 million, up from $32.1 million in Q3 last year, mainly due to increased sales of patient simulators and centre management solutions.

Adjusted segment operating income was $3.8 million in the quarter, for an adjusted segment operating income margin of 7.5%, compared to a loss of $2.7 million in Q3 of last year. With that, I will ask Marc to discuss the way forward.

Marc Parent: Thanks, Sonya. The strength that we saw in the third quarter gives us additional confidence in both our fiscal 2023 outlook, as well as our long-term targets. We’re excited about Civil’s prospects as we build on our industry-leading position with the most innovative training and critical operations support solutions, and we expect to see significant growth during and beyond the ongoing global aviation market recovery. We anticipate continued strong growth in commercial aviation training as flight capacity rises to meet travel demand, and as mobility restrictions abate in China, which remains a key driver for airlines, mainly operating in Asia Pacific, but also worldwide. In business aviation, flight activity has remained above pre-pandemic levels and we continue to see strong demand for business aviation pilot training.

We have been and will continue to deploy training capacity in lockstep with demand in this segment of the market. We continue to expect Civil performance to be strongest in the fourth quarter, with a mix involving about twice as many full-flight simulator deliveries as in the third quarter, which gets us to our estimate of 45-plus deliveries for the fiscal year. We also have more simulators coming online in our global training network, which makes for a larger base of revenue. We’ve done very well with full-flight simulator sales year-to-date, and we expect to maintain that momentum, winning our fair share. In Defense, despite the macroeconomic headwinds, order delays, and potential U.S. budget complexities, which are expected to extend into the next fiscal year, our continued sequential growth, along with positively trending bookings and backlog renewals, adds to our confidence in our multi-year view.

Defense represents a secular growth market for CAE, and we believe the sector is in the early stages of an extended up-cycle, driven by geopolitical realities and increased commitments to defense modernization and readiness. We’re now sustaining higher order intake, replenishing and renewing our backlog with new and more profitable defense contracts. We expect this trend to continue and for Defense to strengthen over a multi-year period to a low double-digit percentage segment operating income margin profile. We’re bidding more and we’re bidding larger, with a pipeline of multiple $100 million-plus programs, and a number of $1 billion-plus programs that we’re bidding over the next three years. We’re highly focused on execution, and as we look to the remainder of the current fiscal year, we expect further sequential improvements for Defense in the fourth quarter.

And in Healthcare, we are on a path to accelerate value creation by gaining share in the simulation and training market, and driving top and bottom-line growth. We have a strong team and I expect to see their positive momentum to continue. Our capital allocation priorities are unchanged, with a focus on organic investments that are made in lockstep with customer demand. We’re on track to meeting our leverage target by the middle of next fiscal year, which at that time, will further increase our financial flexibility. The CAE management and Board of Directors are also prioritizing returning capital to shareholders in a timely manner, which is a key aspect of our capital allocation strategy. In summary, the strength of our performance in the quarter and our current expectations for the balance of the year allows us to reiterate our outlook for mid-20% consolidated adjusted segment operating income growth for this fiscal year.

We’re also reiterating our long-term target of a three-year earnings-per-share compound growth rate in the mid-20% range. With that, I thank you for your attention. We’re now ready to answer your questions

Andrew Arnovitz: Operator, we’ll now take questions from financial analysts.

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Q&A Session

Operator: Thank you. We’ll now proceed with our first question on the line from Konark Gupta with Scotia Bank. Please go ahead with your question.

Konark Gupta: Thank you and good afternoon everyone. Just wanted to ask you on the Civil side first. The margins are already back to the pre-pandemic levels here in the fiscal Q3. Are you expecting the margins to be nearing the peak or would you expect further upside as Asia comes back?

Marc Parent: I’d say, look, we always have €“ if I look at this quarter, as I said in the remarks, we had quite a favorable mix this quarter and as I’ve said in the past, that can be an important factor to margin. I remember asking that question in Q1 when it was going the other way. And if I look at €“ I mean, not specifically addressing your question, I’ll get to it, but if you look at next quarter, we’re going to have a lot more full place similar deliveries, which will play a role in the margins because inherently, product sales are although profitable, they’re not as profitable as training. So, and we’re deploying a lot of training, stuck a lot of training in the fourth quarter. So, you’d expect €“ although we still see a very strong performance in Civil, I wouldn’t expect it to see a high margin in the fourth quarter.

I would like to be surprised, but I don’t, certainly don’t expect it. But long-term, look, at the end of the day, as the market comes back, as you said, with Asia coming €“ I’m quite encouraged by what I see in Asia Pacific, and it’s been the longest drag on recovery. We’re continuing to see the positive effects in our travel recovery. We’re seeing in terms of utilization in our training centers. But it’s going to take some time. As we saw in Europe and in Americas, it takes a while for it to pick up. I think we’re several quarters away from being fully back in my opinion. But make no mistake, when I look at fiscal 2025 and beyond, I think we’re seeing the pieces here of a total recovery taking shape. So, if you factor that plus all the cost savings that you’re seeing flow through our results, I think we can expect that margins can continue to increase over the long-term.

Konark Gupta: Okay. That’s good for the market. And as a kind of a follow-up. There was a recent announcement, I guess, by one of the U.S. airlines, given they are struggling with pilot shortage, they’re trying to reduce the number of hours required for pilots to train on turbine engine. What does that really mean for CAE?

Marc Parent: Well, look, I think I’ll leave that to the regulators, but everybody is always focused very much on safety. So, at the moment, I would tell you that the €“ we barely meet the demand that’s out there, and we’re in growth mode. So, to me, I don’t see that being a factor one way or another to result to CAE.

Konark Gupta: Okay. I appreciate the color. Thank you.

Operator: Thank you very much. We’ll go to our next question on the line is from James McGarragle with RBC Capital Markets. Please go ahead.

James McGarragle: Hey everyone. Hope everyone is well and congrats on the strong quarter.

Marc Parent: Thanks, James.

Sonya Branco: Thank you.

James McGarragle: So, on the defense margins in the quarter and some of the long-term targets the team established at the Investor Day, are you able to help quantify the bridge between those two? So, I know the supply chain is kind of unknown at this point and really anyone’s guess as to when that improves, but are you able to talk to the items that you do have a line of sight into over the next few quarters, such as potentially certain low-margin business rolling off, any high-margin contracts upcoming or specific cost savings related to cost synergies?

Marc Parent: Well, I think it’s all of the above. Look, as we said before, what we’re doing here is, we’re basically doing very well on order intake. You could see like six consecutive quarters now of book-to-bill is higher than 1. You have a trailing book-to-bill over the last 12 months of 1.25, which points to strong growth. And the important thing about that is the team with Dan Gelston at the helm is signing contracts that are accretive to a long-term goal. So, what you see is here is with these orders doesn’t happen overnight. And it depends if they’re products or services, products contributing to results faster. But those contracts €“ those new contracts are replacing contracts in our backlog, some of them that are drag programs that have been very much impacted by the headwinds that we faced the supply chain, as we said, as you mentioned, and on labor.

And in some cases, although we’ve done very well on order intake, not all the orders are created equal in terms of their timing. So €“ but look, we have a pretty good line of sight of those factors. So as we go €“ so that’s what allows me to reaffirm not for Q4, for sure, and then having enough line of sight of how we’re doing in terms of abatement of those factors to give the optimism that I have for its continuous sequential improvements all through next year along the way to our long-term target of double-digit growth €“ double-digit profitability.

James McGarragle: Appreciate that. Thanks for the color and I also wanted to ask a question on Civil and the potential impact of a slowdown in Europe. I know pilot trainings are regulated and that insulated from macro to a certain extent, but can you talk to how your conversations with customers in Europe are evolving given some of the macro headwinds in the region? And any steps your team is taking to prepare for a potential slowdown in that region? Thank you.

Marc Parent: Well, I think I would tell you is that we’re not seeing a slowdown from where we were at. And certainly, in Europe and in the Americas, definitely. And we’re seeing things pick up, as I mentioned in our previous question in Asia Pacific. So at the moment, we’re in growth mode and we’re forecasting to be more for at least the consumable future. So, obviously, what people talk about risk of recession in Europe, it certainly bears watching, particularly as a result, if it’s faced with a potential energy crisis, which really hasn’t occurred, materialized. But look, we’re watching it, but we’re certainly not seeing it, and we’re not forecasting it anytime soon. at least as a result of CAE.

James McGarragle: Appreciate the color and I’ll turn the line over. Thank you.

Operator: We’ve get to our next question on the line, it is from Kevin Chiang with CIBC. Go ahead.

Kevin Chiang: Hey, thanks for taking my question. Good afternoon everybody. Congrats on a good fiscal Q3 here. Maybe just on defense. In your outlook, you mentioned there’s a little bit of uncertainty here with U.S. government budget appropriation issues. I’m just wondering, do you see that primarily impacting, I guess, the timing of awards being allocated? Or does that also impact because I believe you are pursuing some cost recovery initiatives with the government on just given how inflation has played out here. Do these appropriation issues also will impact the timing of some of those cost recovery initiatives for you?

Marc Parent: Look, on the second part of your question, on regards to that specific point in the recent DoD budget, and I would tell you, we influenced this in no €“ not an insignificant way. Funding was granted specific to address inflation. That’s public. And I can tell you, we’re working with our customers to address the inflationary items that have been €“ and I’ve mentioned this on previous calls that has definitely been a factor. And that results in €“ for us submitting requests for what’s called equitable adjustments or REAs. And we’ve submitted quite a bit, and it’s early in the process. Well, I could tell you, we have received some small adjustments, nothing material, I would say. And so, going back to what I mentioned with regards to budgets being approved and disruptions there.

To me is, look, we could see a prolonged continuous resolution environment defense. So look, that has a potential for delays to new program starts because if you’re in that, kind of environment, you can’t have a new program starts. So, we’re watching that. But I would tell you that even with that factor, it may affect the exact timing, but it doesn’t change my view with regards to sequential growth next year .

Kevin Chiang: Thank you. That’s very helpful. And maybe my second question here. You’ve alluded to now the past couple of quarters looking to return cash to shareholders, and it sounds like you like in a position to provide more details in the next fiscal year, but is there a framework we should be thinking about like are you looking at a targeted payout ratio on the dividend or in terms of buyback? Are you looking to return to what you were doing pre-pandemic. Is there any framework you can share with us or is it still being contemplated at the Board level still?

Sonya Branco: Yes. I think as we said, the first priority is really to de-lever. And we saw really good progress in Q3, bringing down the leverage ratio by almost half a turn and continue to be on track to our guidance. So then, we believe we’ll be in a better position to consider the return of capital to shareholders. I think it’s too soon to speak about a framework or form at this point.

Kevin Chiang: Okay. Actually just one last question for me. Just given the sequential increase in full-flight simulator deliveries expected in the fiscal Q4, any risks around supply chain or all the parts and things that you need to build and deliver those all, I guess, all in-house now and you’re just kind of ready to deliver this stuff by quarter end here?

Marc Parent: Well, you can never say zero risk because you never know what can hit you. But all those simulators are at customer sites as we speak. So, they’re built. So, it’s not an issue. So, as you know, we’re pretty experienced at delivering and certifying full-flight simulator. So, I’m marking some factor that I would qualify almost as an act of God, I think pretty good on us getting those simulators certified. And as I said, are no longer a factor when you consider there’s about six weeks left in the year.

Kevin Chiang: That’s super helpful. Thank you very much. Congrats again.

Marc Parent: And that’s by the way I got to shout that out €“ thanks to the €“ shout out to the hundreds of people that we have working in customer sites around the world doing that as we speak. And I applaud them because they are the heroes making this happen.

Operator: Thank you very much. We’ll get to our next question on the line is from Cameron Doerksen with National Bank Financial. Go ahead.

Cameron Doerksen: Thanks, good afternoon. I wonder if you can just talk a little bit about the progress that you’re seeing with the air center business. You’ve sort of indicated a couple of new airline awards here. It sounds like you’ve got some kind of a new next-gen solution there. Just sort of talk about what the investments required, what kind of progress you’re making with customers on that new solution and where the business I guess has recovered to at this point?

Marc Parent: Well, look, the business is doing exactly what we thought it would do, maybe even slightly ahead at this very moment. Very, very happy what’s happening there. I also €“ and maybe I’ll let Sonya after talk about where we are investments, I would say it’s largely in-line with what we had anticipated when we announced the acquisition. Look, I’m very excited about this. And I’ll talk about it because we talked about what our ambitions were for what is an adjacent market for us. And this is playing out. This is playing out. You remember that we have an extremely large overlap of customers between our training and simulator business and this flight services business. And we’re seeing €“ we continue to see very, very high receptivity of our traditional customers to us being in this market.

And it comes at a time that we’re seeing €“ look, we’re seeing as airlines ramp up capacity now, it’s obviously very challenging times. And you can see from recent evidence that airlines in many cases, have really outgrown their technology infrastructure, and they need to reinvest €“ so you can be well assured that we’re engaged with all of our customers to help them as they shake their technology and needs of the future, you can be sure of that. So, I fully expect that we’re going to be part of the solution over time. And it’s not going to be a near-term P&L impact because at the moment, we’re focused on integration. And remember, in this, kind of business, it’s kind of like, I use a term like an ERP implementations take extended periods of time, but once you have them, you have them for an extended period of time as well.

So look, I’m very happy with . The next-gen solution is all about Software as a Service versus legacy on-premises. We have a pipeline. That pipeline is growing. It’s going to take time, but I’m very happy about how we’re progressing here.

Sonya Branco: Yes. I’ll just add on the investment part. So, to elaborate on, Marc, we’re seeing the ramp up. We’re seeing it flow through. That represents about 10% of Civil’s revenue this quarter. So, that’s very good. In terms of investments, we never laid out the exact amount, but it’s in the tens of millions, but €“ and has started since the acquisition and is part of the investments that you see through the results.

Cameron Doerksen: Okay. That’s great color. If I could squeeze in a second one, just quickly on the defense side. Now that Canada has formally signed a contract for the F-35. Can you update us on, I guess, what your expectation is for the training solution for that and how you think you’re positioned for that?

Marc Parent: Well, I think we’re well-positioned, obviously, because €“ I mean, that’s what we do. We do it around the world every single day. We talked about the, for example, signing F-35, that we won another F-16 contract recently. So, we know how to do this. We’ve done an F-18 and majority of fighters out there in the world. So, I could tell you, I personally and members of my team are in discussions with all levels of government in Canada and with the customers in the United States. We’ve met with the F-35 joint program office who provide management support for the F-35 program. And we’re confident that they’d be highly receptive to a proposal by Canada to embed additional training and simulation capacity in Canada’s domestic F-35 program.

And I was encouraged by the fact that when the Canadian government announced the F-35, they announced that simulation-based training will be done that Airforce base and Cold Lake. So, I think it’s a natural for CAE to be involved here. And look, I think this is a generational moment for Canada’s national security, I think Canada has chosen well in terms of the fighter for men and women in uniform and for Canada’s national sovereignty. But here many clean jobs in Canadian innovations at . Canada needs to seize this opportunity of the investment we’re making here. And we can’t afford to miss this unique opportunity to create and protect the next generation of aerospace dollars in Canada as well. We’re part of that, and I fully expect us to be part of that.

Cameron Doerksen: Okay. That’s great. Thanks very much.

Operator: Thank you. Our next question on the line is from Fadi Chamoun with BMO. Go ahead.

Fadi Chamoun: Good afternoon. Thanks for taking my question. Marc, if business aviation flight hours end up being down 5%, 10% this year because of the economy or in the next 12 months, I guess, is there levers within CAE based on, kind of the recent acquisitions you’ve done and your positioning on to continue to grow in that side of the business?

Marc Parent: Absolutely, Fadi. Look, the fleet is still growing. The amount of new pilot demand, we can €“ we have trouble meeting it now. I can tell you, you know I’m a pilot. I can see it myself, but our training centers, want to exaggerate, we can’t find a parking space 7 days a week. So, I’m not overly concerned about a slight drop in the flight hours. I mean, we’re seeing a very, very hot market for business heavy training. We’re continuing to add capacity. Our Las Vegas training center has just come online. So is Singapore. Savanna will be online next year. We have a training center Orlando opening up with our JV partner, Directional Capital, which is our SIMCOM training center opening up in Orlando. And I can tell you that we have demand focused for coming into those training centers. So, I’m not too worried about that just dropped in flight hours that could occur.

Fadi Chamoun: Okay. That’s great color. The second follow-up question is really on defense. I mean, we have six quarters now of expansion in terms of the order levels and the outlook is positive for that to continue. When do we start to really experience this, kind of demand momentum into the margin with a greater, kind of influence. Is this more of a fiscal 2025 story or fiscal 2024? Just trying to understand the trajectory of how these headwinds from supply chain and mix in the backlog, kind of come off versus returning to a more normal margin in that segment?

Marc Parent: Well, look, it’s going to be steady progress. That’s what I see. The headwinds that we see €“ I mean as you will imagine, we’re not sitting on our hands not doing anything about it. We’re doing something about it, but it takes time. It takes time to hire people. It takes time for them in the defense sector to get the proper security clearances that we need for them to be able to execute on some of the programs we have. This is going to take several quarters to abate and it gets, but it gets better every quarter. We know what parts we need on the contracts that we have. But when you need €“ when you get new contracts, you need new parts, okay? Now we get better at forecasting those things, but it’s still an issue because the supply chain is not as fast as it once was.

And at the same time, we’re factoring potential delays in orders because of things like I talked about, the U.S. defense procurement. But make no mistake. I’m seeing steady improvements in our business in terms of we’re managing it. We have a very happy with €“ in terms of the execution of our programs and the level of contingency in those programs that we have, execute them well. As you know, there was a factor in Q1. And I mentioned that it has not happened in . I don’t see that happening again. Not with the rigor that we put into it. So look, I expect €“ when you talk about when we recover back to low double digits. Look, it’s going to be €“ we’re on that road Fadi. And I think that you’re going to see that over the next couple of years to get into it.

Fadi Chamoun: Great. Thank you.

Operator: Thank you very much. We’ll get to our next question on the line is from Tim James with TD Securities. Go ahead.

Tim James: Thanks. Good afternoon. Thank you for taking my questions. My first question, I guess, I just want to return actually to that last topic, Marc, I’m just wondering if you could comment on or characterize any particular pinch points in the supply chain that are more problematic than others? Any sort of particular parts or aspects of the supply chain that are a little bit more problematic. And I’ll open it up to either your civil business or your defense business.

Marc Parent: Well, I think I’d start off by saying it hasn’t really been a factor on our Civil business and mainly because we’ve done a good job over the years to design a product that is highly repeatable, highly standard. And our teams in global sourcing, for example, in operations have done a very, very good job forecasting and being able to obtain those parts. So, I think that’s been the case. In defense, look, I think the issue is, I would say characterize any single part. It’s basically longer lead times on many parts. That’s what really is the factor here. Obviously, we’ve had issues like everybody has on the electronic parts, those kind of things. But today, it’s really longer lead times, repeating myself on inventory many parts and what that cut does, it’s not only the fact that you missed the part itself is it’s the fact that in the meantime, you either can’t progress on that contract or you’re having to do workarounds and work around is inherently inefficient you have maybe people being idle or installations they’re having to work around them.

They therefore causing delays. So all those things cause inefficiencies that weighs down on our margins. And it has, I would say, a double effect because traditionally, we are able to execute contracts and get ahead of ourselves to execute the programs faster and therefore, generate efficiencies. And we’re in the contrary situation right now. And the same effect with labor, you don’t necessarily have the software engineers that you need because of some of the factors I talked about the time to get them the time to get them basically certified with the right clearances they need. Now that gets that is getting better because obviously, demand in the high-tech market for software engineers, specific has cooled. So we are a bit of a benefit of that.

We’re seeing that. But it’s going to take a few quarters for that to abate €“ to the extent that we get back to the margins that we have targeted in our long-term defense business.

Tim James: Okay, that’s very helpful. Thank you. My second question, I’m just wondering if there are any areas of your civil business, either on the business aviation side or the commercial side, where you think pricing is particularly strong as we sit here today due to the incredible, sort of demand conditions and how quickly air travel has ramped up. And therefore, pockets of pricing that could come under pressure when we get past this very strong ramp-up period or do you think as some of the other areas that still remain weak, such as China, et cetera, maybe sort of make up for any of that potential moderation in pricing, or do you not see any kind of particularly strong pricing at this point?

Marc Parent: Well, I think I’d start by saying that in our Civil business, in a large part, let’s say, the training business is long-term training contracts. And that’s our specific strategy, as you know. And they typically are fixed percentage or CPI-based escalators that are built in. So, that has a moderating effect going up and going down, right? So, you don’t really see big spikes. We have been able to pass on some of the inflationary aspects that we’ve seen over time when contract renewals come up. And don’t forget, our business €“ our vision always has been, and it’s the way we operate is to delight our customers. And the correlator to that is, we don’t bulge them when the market is going up, and they don’t begrudge us a fair margin. So, I think all of that comes out to say that I’m quite comfortable in the outlook that is given with regards to margins in civil going forward.

Tim James: Okay. Thank you very much.

Operator: Thank you. We will to our next question on the line. It is from Benoit Poirier from Desjardins Capital Markets. Go ahead.

Benoit Poirier: Good afternoon everyone. Just based on your comments on the recovery trajectory for defense margin. Would it be fair to say that high single digits next year might be a bit too optimistic and mid-single digits would be more realistic?

Marc Parent: I’m not going to give you the specifics at this time, Benoit. I want to say, as I said, we’re working through the headwinds that we €“ and that we’re going to continue to see improvement going forward on a sequential basis, for sure.

Benoit Poirier: Okay. That’s great. And looking at health care capital employed was mostly flat versus last quarter, how should we expect capital employed to evolve or to be deployed going forward for health care? And do you see any opportunities to monetize these assets given the rich valuation and all the spin-off that we’ve seen recently, Marc?

Marc Parent: Well, look, I think in health care, we’re focused on translating to great top line success that we’re seeing. I mean you look at the revenue this quarter and the €“ which is historical, it’s translating into bottom line. I’m sure you’ve noticed that. We’re quite happy with that. Six quarters in a row of pretty strong growth at the top line, two consecutive quarters positive side. And we have a great team. I would say we have Jeff Evans at the helm of the business. He’s built a very strong team, we have the strongest team we’ve ever had in health care, and they’re hard charging, they’re winning in the market and that’s what we’re focused on. And healthcare is still funding. So, that’s a trajectory that we’re on, Benoit.

Benoit Poirier: Okay. That’s great. And with respect to Asia Pacific, where are you in terms of recovery versus pre-pandemic level? Are you back to halfway through below or still above the?

Marc Parent: Well, I wouldn’t say halfway through, look, how would I characterize it? We’re in the low 70% utilization in that approximately right now. It does have seasonal variations. I’ll give you some maybe data points. In terms of simulator deliveries or orders typically prior to the pandemic, we typically sell maybe 6 to 8 full-flight simulators a year to China, okay. And I would say over the last couple of years, we’ve only sold 2 or 3 in total. So that gives you an idea in terms of simulator sets. The more near-term recovery comes in training. And that mainly because we don’t have any training centers in China, but it’s all the training centers that we have in the region. Of course, we have a lot of training centers in the region.

The anchor customers that we train in those regions, a lot of their €“ a good proportion of their flights are in and out of China. So, as that recovers, we see the utilization in our training centers ramp up. I expect that to materialize over the next few quarters as the recovery takes hold.

Benoit Poirier: Okay. Thank you very much for the questions.

Operator: Thank you. We’ll get to our next question on the line from Matthew Lee with Canaccord Genuity. Please go ahead.

Matthew Lee: Hey, good afternoon. Happy Valentine’s Day. On the Civil side, when I think about new pilots coming through training, is that a higher-margin program and a margin benefit than usual annual pilot training? And maybe you can quantify kind of the growth you’re seeing in just given how many pilots need to be trained right now?

Marc Parent: It’s actually a lower-margin business than €“ when we look at our mix, it’s on the lower end. It’s really the €“ we look at what that drives it, it drives increasing capacity in our training center network. And it’s part of our offering to airlines, which is very important. Airlines are looking for pilots, they need pilots. And CAE has I think, the largest network of pilot training centers in the world. And we don’t basically take people off the street. I mean we only do it for airlines themselves. So, it’s an important part of the offering that we give the airline as a complete solution, — but if I take it by itself, it would be, if you like, lower than the average margin that we get in our civil business.

Matthew Lee: That’s very helpful. And then on the defense side, you pointed out that delayed orders coming to fruition as a potential margin driver. Are those contracts naturally high margin with more product in the mix? Or is there another reason why those orders in particular are positive for margins?

Marc Parent: I would say that €“ I wouldn’t say all because sometimes it’ll go strategic, but the great majority of the contracts that we’re signing and we’re bidding today are accretive to our objective of low double-digit margins in interest business.

Matthew Lee: Okay. That’s very helpful. I’ll pass the line.

Operator: Thank you. We’ll turn to next question on the line from Fai Lee with Odlum Brown. Please go ahead.

Fai Lee: Hi, it’s Fai from Odlum. Marc, you mentioned that CAE has submitted a request for equal adjustments. And I’m just wondering if you can comment on the process, for example, are there set deadlines for the customer to respond back to you? Is it a negotiated process? What happens to the customer said no €“ do you have like an ability to appeal the decision.

Marc Parent: Well, it’s case by case. It depends on what I mean by that is sometimes, the request for equitable adjustment may be submitted to the government itself and sometimes to an intermediary, which we contract with on behalf of the government. So again, case by case, we do have to, as you might expect, we do have to make our case and a lot of documentation related to that, but we have that documentation. We are putting those cases forward. There is no specific time line for them to recovery. As I said, one thing that encourages me very much is and as I said previously, we had a lot to do with it ourselves, our government affairs people in Washington did a very good job on this that in recent DoD budget, there is funding specifically granted to address inflation in the industry.

So, we’re working with our customers and working to prepare our own claims with regards to that increased budget. So, but again, there’s no timing on that, but I fully expect some of that will come fruition.

Fai Lee: Okay. And would you describe the rest or the response has been reasonable or conversations like they haven’t been unreasonable. Have they?

Marc Parent: No, I don’t think there’s anybody being unreasonable, but you have to make your case. But yes, we have made our case. We have simulators that were literally delivering across the country in one contract. It’s about 180 transport trucks with armed guards crossing in the United States that were bid when gas was $2 a gallon, but we all know that not gas is not $2 a gallon anymore. So, you could just imagine that just on that basis alone, you say, well, let’s be fair here. That’s not exactly a 2%, kind of natural growth in the contract and they’re receptive to that kind of thing.

Fai Lee: And then my second question, back in Q1, what are the charges that you took with for a Navy contract, I believe it was that expired and have been extended? And if I remember correctly, you were hoping to have it re-contracted in better terms. I’m just wondering, has that happened? Has it been re-contracted on better terms? Or are you still waiting?

Marc Parent: We’re still waiting on that one. And to me, we can’t really talk about that. I mean, in the end it’s a contract that we’ve submitted the bid and they haven’t selected anybody as far as I know.

Fai Lee: Okay. Thank you.

Operator: Okay. Thank you very much. And we’ll proceed to our next question on the line from Anthony Valentini with Goldman Sachs. Go ahead.

Anthony Valentini: Hey all. Thanks so much for taking my question . I’m looking at the utilization rates in the 73% here in the quarter, comparing that back to pre-pandemic levels, and it looks like you guys are actually at or in some cases above where you were. I’m curious in terms of how you guys think through like the capital allocation process of how high that number can go, right? Because I think there needs to be some sort of slack in the system. And when you get to that number, whatever it is, how you think through putting new simulators into your network, if that makes sense?

Marc Parent: Yes. Look, the short answer is, as we said in the remarks, we deploy capital and lock step with demand. You can well imagine because we’re the market leader here and have been for a long time, both in simulators and simulator-based training, we know the market very well, and we know our customers very well, and we’re in constant dialogue with them both in the airline sector and the business aviation sector. So, we have a pretty good and informed idea of how much demand will be required because remember, it’s a regulated market. People €“ there’s a €“ you can just look at how many flights people expect to make, how many deliveries are coming out of the OEMs, and you will be able to establish what is the demand requirement across the world approximately.

So, that’s how we deploy it. And we €“ in terms of what is the practical capacity, look, I’ll tell you, I was our training center in Minneapolis about three weeks ago, where we are anchor customers are some of the largest regional carriers in the United States, like Endeavor, for example. And I can tell you, our training centers there are operating above 100%. And teams are doing a great job. So, when you talk about practical capacity, you can get up there and you can sustain it when you need too. And that’s I believe you me to support the training of regional carriers in the United States right now, they need us to be operating at that level. So, we can do it. So, there’s elasticity there now in practical reasons. When we define 100% for airlines, get you a little bit detailed here, but that’s 6,000 hours a year, which is 16 hours a day.

So, that’s what we consider a practical limit. But again, we’re doing higher than that. So, there’s flat. If the demand is there, that’s what we do. And when we get to those kind of levels, well, yes, what? In Minneapolis, there was a bunch of good nice tractor trailers or backhaul is building two new simulator base in Minneapolis, while I was there because clearly, demand is there. And we secure long-term contracts. We’re not speculative on how we deploy that capital.

Anthony Valentini: I’m curious how long the lead times are once you decide you need to add a simulator to a facility? How much time does it take for you guys to build that SIM and then deliver it to be up and running?

Marc Parent: It depends on where it’s going. And that’s the big factor. But typically, if we make a decision on an airline a typical simulator, it’s probably one we built before. It’s typically between 12 and 14 months, I would say.

Anthony Valentini: Last one for me on defense. You highlighted a future vertical lift. I’m curious, and I’m sure you have hundreds if not thousands of contracts, but where does that kind of rank in terms of the large programs that you have? And should we be thinking through that contracts being negotiated in the old strategy or the new one, which is that kind of targeting the double-digit percentage margins? The new one…

Marc Parent: Does that question?

Anthony Valentini: Yes. And then just how €“ in terms of rank how

Marc Parent: It’s a large contract. But I said in the remarks that we have a lot of contracts that we’re bidding in a $100 million range, and we have a lot of contracts in the $1 billion range over the next three years. This is one of the ones that clarified in the second category of $1 billion without getting specific. So, it’s a large opportunity over time, but it’s not the only one. So, it doesn’t disproportionately affect my view on the fortunes we would have next year. It’s important, but it’s definitely not the only one.

Operator: We’ll get our next question on the line is from Kristine Liwag from Morgan Stanley. Please go ahead.

Kristine Liwag: Good afternoon everyone. I just want to follow up on a pilot shortage and like the bigger picture. I mean pre COVID pilot shortage is already an issue and then the mandatory retirements coming up in the U.S. will likely exacerbate the issue. I mean, when you look at the programs that your customers are undertaking, like the and things like that, how much of these actions solve like the bigger shortage problem? And if not, what should they be doing to support industry growth? Because it just seems like there’s not enough urgency in terms of actions that they should be taking. So, I just want to get an idea of how much you think that kind of solved up actions today? And if not, how do you think that gets resolved?

Marc Parent: Look, I think it’s going to take time. It’s going to take investment €“ pilots are not the only issue that you’re facing the industry right now. I mean it’s been exacerbated by the fact that the industry was extremely finely honed before the pandemic , then we went back to . And so, we’ve been gradually rebuilding that industry every part of it. So, pilots are one part of it that important parts of one we play in a very big way. And we’re doing our part by helping our customers. We’ve been deploying new demand in terms of flight school activity. We’ve been signing core contracts with them. We’re operating our training centers as mentioned on the previous answer at levels that are on hurdle at least certainly in the United States right now.

So look, I think it’s going to take time, it’s going to take investment. And that’s why I think in terms of our business, I think it’s going to be a good business for a period of time. I’m quite confident in next few years in civil aviation.

Kristine Liwag: Yes. It just seems like there’s no urgency. If I could sneak a second one on…

Marc Parent : I would tell you €“ Sorry to interrupt you, I would tell you that if you were talking with some of the airline CEOs that I talked to a , but sorry, go ahead, Kristine.

Kristine Liwag: If I could ask another one on M&A. When you look at what you’ve acquired over the years, part of that was attributed to your success in some of your competitors basically feeding their territory back to you. If such opportunities exist out there, would you consider levering up the balance sheet even more today? I mean some of those out, are there even any assets available for sale that you could consolidate like you’ve done in the past decade? And if so, to what leverage are you comfortable?

Marc Parent: Sonya, won’t let me. No seriously. Seriously. You see €“ we’re focused on deleveraging right now. We don’t see any gaps in our portfolio. We did very well during the pandemic make the play office during the downturn. I think you’ve seen that we’ve done quite a nice job of deleveraging in this quarter. I see that continuing along in the past that we said that we’ll get to a level 3. So look, we never passed up the opportunity that would be that’s too good to pass. But I think we’ve done a good job. And that’s €“ we’re focused on deleveraging right now, looking to start returning cash to shareholders and continue to be the one priority is to continue to grow in lockstep with demand and that’s largely inorganic.

Kristine Liwag: Great. Well, thank you Marc.

Marc Parent: So operator, that’s all the time we have for financial analysts. I’d now ask you to open the queue to members of the media, if there are any questions.

Operator: Certainly. And we do have a question queued up from .

Unidentified Analyst:

Marc Parent:

Unidentified Analyst:

Marc Parent:

Unidentified Analyst:

Marc Parent:

Unidentified Analyst:

Marc Parent:

Unidentified Analyst:

Marc Parent: Operator, if there are no more questions from members of the media, I want to thank all participants, investors, and members of the media. I would like to remind everyone that a transcript of today’s call will be posted later today on CAE’s website. Thank you.

Operator: Thank you very much. And that does conclude the call for today. We thank you for your participation as you disconnect your lines. Have a good day everyone.