CAE Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
February 14, 2024

There are 13 speakers on the call.

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.

Operator

Mr. Arnovitz, you may now proceed.

Speaker 1

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 and answers to questions contain forward looking statements. These forward looking statements represent our expectations as of today, February 14, 2020 forward 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.

Speaker 1

A description of the risk factors and assumptions may affect future results is contained in CAE's annual MD and A available on our corporate website and in our filings with the Canadian Securities Administrators on CR Plus and the U. S. Securities and Exchange Commission on EDGAR. With the expected divestiture of our CAE's Healthcare business, which is subject to closing conditions, including customary regulatory approvals, all comparative figures discussed here and Our financial results have been reclassified to reflect discontinued operations. On the call with me this afternoon are Marc Perron, President and Chief Executive Officer and Sonia Brenco, our Chief Financial Officer.

Speaker 1

After remarks from Mark and Sonia, we'll open the call to questions from analysts. At the conclusion of that segment, we'll open the lines to members of the media should time permit. Mark, over to you.

Speaker 2

Thank you, Andrew, and good afternoon, everyone joining us on the call. Our performance in the 3rd quarter reflects The continued strong demand for our civil market solutions and points to the ongoing progress to transform our defense business. We generated strong free cash flow in the quarter, enabling us to further bolster our financial position in line with our leverage targets. We also made excellent progress to secure CA's future with nearly $1,300,000,000 in total order intake for an $11,700,000,000 backlog. In Civil, we had strong financial performance that reflected the quarterly mix that we anticipated with demand for Commercial and Business Aviation Training Solutions continuing to be robust across all regions.

Speaker 2

Operationally, we delivered 13 full flight simulators to customers during the quarter And our average training center utilization was 76%, which is up from 73% last year. We booked $845,000,000 of orders with customers worldwide for an impressive 1.36 times book to sales ratio, which is even more remarkable on revenue that's 20% higher than Q3 of last year. We also had strong order activity in our JVs this quarter, representing another approximate $135,000,000 of training services orders, which are not included in the order intake figure, but are reflected in the record $6,100,000,000 total Civil backlog. We received orders for 20 full flight simulators in the quarter, bringing our tally for the 1st 3 quarters of fiscal year to 57. Notable wins including penetrating more share of the existing market with long term training services contracts with marquee airlines, including Air France KLM Group and we renewed a flight services contract with Azul of Brazil.

Speaker 2

We continue to have very strong momentum in Business Aviation as well with over $300,000,000 of order intake in the quarter, driven primarily by training services agreements, which U. S. Based customers including Solaris Aviation and Clay Lacey Aviation. The continued high level of order activity this quarter across all Civil segments underscores our ability to win share in a large Secular Growth Market, which sees highly differentiated training and flight services solutions. In Defense, our financial performance was consistent with our expectations at this point on our path toward being able to generate higher margins in the business.

Speaker 2

Defense performance was lower than the Q3 last year As we continue to retire risk on a group of distinct legacy contracts, which Sonia will describe in more detail in her section. We booked orders for $429,000,000 for a 0.9 times book to sales ratio, giving us a $5,600,000,000 defense backlog, which is up from $5,100,000,000 in Q3 of last year. They include a maintenance contract with the United States Air Force for the F-sixteen training devices and the continuation of training services on the C-1 hundred and thirty eight transport and KC-one hundred and thirty five tanker platforms. Defense orders also included an option exercise for the U. S.

Speaker 2

Army for fixed wing flight training and support services at the CA Dothan Training Center. With that, I'll now turn the call over to Sonia, who'll provide you additional details about our financial performance. Sohyan?

Speaker 3

Thank you, Mark, and good afternoon, everyone. Consolidated revenue of $1,090,000,000 was 13% higher compared to the Q3 last year, while adjusted segment operating was $145,100,000 compared to $156,800,000 in the 3rd quarter last year. Our quarterly adjusted EPS was $0.24 compared to $0.27 in the Q3 last year. We incurred restructuring, integration and acquisition costs So $23,500,000 during the quarter relating to the AirCentre acquisition. Expenses related to the AirCentre integration, which is progressing as planned, are expected to wind down by midfiscal 2025.

Speaker 3

Net finance expense this quarter amounted to $52,400,000 is up from $47,100,000 in the preceding quarter and up from $47,700,000 in the Q3 last year. This is mainly the result of higher finance expense on lease liability. Income tax expense this quarter was $8,200,000 for an effective tax rate of 12%. The adjusted effective income tax rate was 15%, which is the basis for the adjusted EPS. As Andrew indicated at the outset, Healthcare is now classified as a discontinued operation, and our net loss from discontinued operations was $1,900,000 this quarter compared to a net income from discontinued operations of $2,100,000 in the Q3 of fiscal 2023.

Speaker 3

The decrease to the Q3 of fiscal 'twenty three was mainly attributable to the transaction cost of $2,200,000 incurred in the Q3 of fiscal 2024 In relation to the expected sale of the health care business. Net cash from operating activities this quarter was $220,800,000 compared to 250 $2,400,000 in the Q3 of fiscal 2023. Free cash flow was $190,000,000 compared to $239,800,000 in the Q3 last year. The decrease was mainly due to a lower contribution from noncash working capital and higher payments to equity accounted investees to invest in the civil training network expansion In support of our long term customer agreements, free cash flow year to date was $227,000,000 compared to $185,000,000 year to date last year. The increase was mainly due to a lower investment in noncash working capital and higher cash provided by operating activities, partially offset by some maintenance CapEx and again, higher investments in joint ventures to support growth.

Speaker 3

We continue to target 100% conversion of adjusted net income to free cash flow for the year. Capital expenditures totaled $85,600,000 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. Our net debt position at the end of the quarter was approximately $3,100,000,000 or net debt to adjusted EBITDA of 3.16x at the end of the quarter. We expect to close the sale of our health care business before the end of the fiscal year, subject to closing conditions, including customary regulatory approvals. We intend to apply a significant portion of the net proceeds of the transaction to reduce debt.

Speaker 3

As we have said in the past, The Healthcare sale transaction is a milestone towards the reinstatement of cash returns to shareholders, and the Board is now actively evaluating options in terms form, quantum and timing of such return. We're prioritizing a balanced approach to capital allocation, including funding accretive growth, continuing to strengthen our financial position commensurate with our investment grade profile and returning capital to shareholders. Now turning to our segmented performance. In Civil, 3rd quarter revenue was up 20% to $622,100,000 compared to the Q3 last year, and adjusted segment operating income was down 5% to $124,200,000 versus the Q3 of last year for a margin of 20%. This is right in line with our expectations for the quarter and our full year outlook for Civil.

Speaker 3

As expected, there were a few differences in the quarter compared to last year, mainly from the mix of stimulation products revenue and flight services activity, which offsets a higher training utilization and increased volume from recently deployed simulators in our network. In defense, Revenue was up 4% to $472,400,000 while adjusted segment operating income was down 18% to $20,900,000 giving us an adjustment segment operating income margin of 4.4%. The Defence margin this quarter included the negative impact of the ongoing retirement of 8 distinct legacy contracts that have completion dates mainly within our next 2 fiscal years. What these contracts have in common and why we're monitoring that they were all entered into prior to the COVID-nineteen pandemic and our firm fixed price infrastructure with little or no provision for cost escalation. These contracts are only a small fraction of the business but have disproportionately impacted overall defense profitability as they have been the most significantly impacted by execution difficulties and the broader economic headwinds we've discussed in past quarters, such as the compounding effects of inflationary pressures and disruptions to supply chain and labor.

Speaker 3

To be more precise, the execution of these 8 legacy contracts has an approximate 2 percentage points negative impact on the defense segment operating income margin in the 3rd quarter. With that, I will ask Mark to discuss the way forward.

Speaker 2

Thanks, Sonia. Looking ahead at each one of our segments, in Civil, we expect to continue our above market growth momentum for training and flight services solutions, Underpinned by strong secular passenger traffic growth, continued success penetrating shared returning market and a high level of demand for pilots and pilot training across all segments of AV East. For the current fiscal year, We continue to expect Civil to deliver adjusted segment operating income growth in the mid to high teens percentage range. For the year as a whole, we continue to expect the Civil adjusted segment operating income margin to be in the range of fiscal 2023, which naturally implies an especially strong margin for Civil in Q4. In addition to growing our share in training and Expanding our position in digital flight services, we expect to maintain our leading share of Full Flight Simulator sales and to deliver approximately 50 for the year.

Speaker 2

We have considerable headroom for growth in the civil aviation market and our continued positive momentum Underscores the strong demand for Sea's highly differentiated trading and flight services solutions and our ability to win share within this large and secular growth market. Turning to defense, we'll continue transforming our business by replenishing our backlog with more profitable work and by retiring the legacy contracts that Sonia highlighted. These two trend lines remain positive and we expect them to culminate in a substantially bigger and more profitable business. Since augmenting the scale and capabilities of the defense business approximately 2 years ago, We've grown the defense backlog by over 20%. This sets us up very well for sustainable growth and includes the strategic and generational wins on next gen platforms that we've talked about in recent quarters.

Speaker 2

Still to come and not yet in backlog are the Canadian FACT and RPAS programs that are currently in contract negotiations and are also generational in size. The progress that we're making that we've been making to replenish and grow the backlog with higher quality profitable programs is the best indication of what the future holds for Sea's Defense Business. Together with a $9,500,000,000 pipeline of bids and proposals outstanding, we continue to see positive signs of the transformation underway. As we look to the remainder of fiscal 2024, We expect Defense to keep winning high quality profitable programs. And in the Q4, we expect to further accelerate the retirement of risks associated with the legacy contracts to the extent that we can.

Speaker 2

Clearly, we want to get them behind us as soon as it's reasonably possible And we're closely monitoring them as a separate group. We're highly focused on execution I expect to substantially reduce the negative impact from these legacy contracts over the next 6 to 8 quarters as they're gradually retired. The extent to which the ongoing risk retirement on these programs might impact defense margins in the coming quarters really depends on the actual timing of program closeouts and our ability to mitigate these risks. Our dedicated teams are working to Rebaselines and contracts seek equitable adjustments on others and to find program efficiencies overall. And for CE overall, we continue to be highly encouraged by the demand backdrop that we're seeing in all segments and the growth that we expect by harnessing our global market and technology leadership and the power of 1CE.

Speaker 2

These factors combined with highly focused execution and a solid financial foundation portend continued good growth momentum and an excellent future for Steve. And with that, I'll thank you for your attention now and I'll ready to answer your questions.

Speaker 1

Thanks, Mark. Operator, we'll now open the lines to members of the investment community.

Operator

Our first question comes from Fadi Chamoun with BMO. Please proceed.

Speaker 4

Thank you, operator. Thanks, guys. So I'm trying to kind of see how to best think about the trajectory of Defense Margins. Mark, you mentioned the focus on accelerating the retirement of risk associated with these legacy contract, which I understand that this quarter the impact was 200 basis points. And there's also The idea that the backlog growth and top line growth and kind of implementing higher margin contract should be margin accretive as we go forward.

Speaker 4

Like does the margin start to improve from the current level that we're at right now? Or are we stuck at this kind of lower level for some time? The other thing, what exactly you mean by accelerating the retirement? Are you able to exit these contracts earlier or is it a cost action that you're taking to improve the performance of these specific contracts?

Speaker 2

Okay. Okay. Lots there, Fady, but fair questions for sure. Look, yes, I'm going to go right to the end of your last question because I remember right off the bat. When we talk about accelerating retirement, what we're really talking about here is that we're likely going to incur potential costs on a faster put it this way, a faster timeline As we work through the execution on these contracts or even take actions like, for example, close out some of these contracts ahead of time and I can give you examples of that.

Speaker 2

But let me just end it right now Because whatever we do, we're going to offset it by mitigating efforts that we try to limit the cost growth. But let me just basically we talked about. We might decide to de scope a contract. What does that mean? That means we close it out and we're looking at this in at least one specific contracts, potentially incur liquidated damage.

Speaker 2

If that makes sense for us to cut off a future tail of programmatic risk on that program. So better to take that pain now than take a lot more later, if you know what I mean. But of course, That depends on the negotiations specifically that we have underway under with that specific customer. Other things we might do is we might agree to alternative terms or schedule and then we'll look at that on some of these programs as well. Or we might incur a follow on contract say an addendum and engineering change proposal on any one of these contracts that we're looking at that and that's the potential of some of these contracts that what we'll do is give us more work, in which case we can spread the costs around over a bigger quantum, less than the impact of any individual progress.

Speaker 2

So we're doing all of that. So if I look back to your maybe the margin question and I will quickly go to Sony on this one. Look, we saw that we talked about 200 basis points this quarter and I'm going to go straight to Sony on that one, not going too deep on that But what we're there's going to be variability from quarter to quarter for the reasons I talked about. This is not going to be linear, Because we are taking active steps to try to retire these contracts as soon as we can and especially retire the risk, Take the right actions. And mind you, we're never going to give up on our customers.

Speaker 2

That's not what we do at CAE. We will deliver the products and services that we committed to our customers that sees culture and don't forget that's the mission that we have in defense. So, we're not going to do that. But I mean that's the way I look I would look at this. And Fani, before I give it to Sonia, the one thing I would tell you is there's nothing new here relative to disclosure that we gave you last quarter in terms of the quantum.

Speaker 2

What we're trying to do here is to give you a little bit more precision on the number of contracts that are dragging our performance, these legacy contracts, the duration, how long they last and the steps that we're taking to actively mitigate them. Now maybe I'll stop there, but turn it over to you so you can just expand on the 200 basis at least for this quarter anyhow.

Speaker 3

Absolutely. Thanks, Mark. Hi, Fadi. So what we've done this quarter is endeavored to ring fence the few contracts that have a disproportionate negative impact on the business. In doing so, As you can appreciate, this is a process.

Speaker 3

There's a strict definition, and we're committing to continuing disclosure to report back on these legacy contracts and our progress on them. So you can see that in this quarter, there was an impact of 2%, 200 basis points this quarter. But by the way, there's also an impact of an under absorption of costs needed to achieve scale and support of all of the business, Like R and D and SG and A, that can be up to another 100 basis points, so which makes the impact slightly higher at around 300 basis points. Now That's a snapshot for Q3. Now I can't say that the next 6 to 8 quarters will look exactly like this as we're constantly working to All the different levers to mitigate these risks and work with our customers, as Mark has highlighted.

Speaker 3

So while there will be some variability quarter to quarter, This quarter's impact is a rough baseline of the headwind that we face on average.

Speaker 4

Okay. Okay. That's great. So basically, You're talking about a scenario where you can take these losses upfront and ultimately kind of exit some of that Contract risk earlier, so that's what's going to be lumpy. The comment about the 100 basis point absorption, is this tied to Backlog deployment and how quickly you deploy the backlog to get improvement in that cost Absorption?

Speaker 4

Is that what you mean by that?

Speaker 3

Yes. As you drive volume and profitability, you have a better volume to support all of these costs that are needed to scale and support a business of this size and growing. So now at this level, there's an under absorption That you can assume has about 100 basis points added to the other 200 basis points.

Speaker 4

Okay. So The timeline of 6 to 8 quarters, that's kind of the most, I want to say the pessimistic kind of timeline. Hopefully, you can deal with some of these contracts earlier, take some of these losses maybe earlier and then move on from that? Yes,

Speaker 2

that's the label we're going to be seeking to do.

Speaker 4

Okay. Thank you. Appreciate it.

Operator

Our next question comes from Cameron Doerksen with National Bank Financial. Please proceed.

Speaker 5

Yes, thanks. Good afternoon. Maybe I'll ask a question on the Civil business. The utilization rate in the quarter was really strong 76%, which I don't have it going all the way back, but it seems like maybe that's one of the best Q3s you've had. I'm just wondering if you can maybe discuss what you're seeing as far as demand across the various the components.

Speaker 5

Are you seeing any changes there? Or is it continuing to be strong in the Q4 like we saw in Q3?

Speaker 2

You know, what Cameron, what we're seeing is very strong demand. I can tell you, I look out my window here at the parking lot in Montreal, I can tell you it's full. I keep saying that, but perversely that's a pretty good indicator of what we see as utilization of training centers and that's across all the training centers. I see no softening of demand. And as we said before, as you can do the math, we fully expect a pretty darn good And we have very good visibility on that, because obviously we are pretty close to the end and we know which competitors we have to deliver.

Speaker 2

And again, we have some very strong bookings in our train center. And these days, I can tell you nobody is looking to cancel bookings.

Speaker 5

Okay. No, that's good to hear. And just maybe just a very brief, just follow-up to Fadi's questions on the defense. You mentioned you may be seeking I guess, equitable adjustments. I know there's something you've discussed in the past.

Speaker 5

Have you had any success there? I mean, are you optimistic at all that you'll get some relief from your customers With some maybe some pricing adjustments within these legacy contracts?

Speaker 2

I am optimistic, but I am not optimistic on the timing, meaning, because I can't I have been wrong every time, okay. So, I could tell you that the bulk of it, we have gotten a bit, I would tell you about You ever take about 10% of what we believe that we have very, very strong cases as documented evidentiary reports claims into customers. But again, there is this depends on so many things that I don't control that I would tell you we have made some assumptions, I would say conservative assumptions with regards to we looked at mitigations on some of these legacy contracts That some of that is included, but certainly not

Speaker 4

the full quantum.

Speaker 5

Okay. That's helpful. Thanks very much.

Operator

Our next question comes from Kevin Chiang with CIBC. Please proceed.

Speaker 6

Thanks for taking my question. I know you don't have multiyear guidance for or targets Defense. But if I just kind of if I rewind, let's say, back to fiscal Q2 and you provided an update On defense at that point in time, I think the market read it as you have around mid single digit EBIT margin for the remainder of this year, maybe get up to higher single digits in fiscal 2025 and then you can normalize to a run rate closer to your target of low double digits sometime in fiscal 2026. The fact that you haven't changed your 3 year EPS target, I'm just trying to level set. Is that still the trajectory you think you can do as you roll off some of these contracts?

Speaker 6

Or is it like the double digit EBIT margin maybe cloudier here today given the new disclosure you provided?

Speaker 3

So clearly, there's some dependency on the timing of the risk retirement on those legacy contracts and the pace of the new programs ramping up, and we're working this as indicated. At the same time, our outlook for Civil remains robust. We need to close out on the Healthcare transaction that we expect to do so in by the end of the fiscal year and finalize that impact as well. So We'll be providing more insight on all of these in Q4 as we usually do.

Speaker 6

Okay. That's I'll look forward to that. Maybe strategically, you're running about 21, I guess, these past Few quarters, you've been running kind of low to mid-twenty million operating income. I'm just wondering, do you think the business is big enough to absorb these type of hiccups? And what I mean by that, it doesn't look like the absolute dollars The impact from these legacy contract issues is large, but it's also coming off a smaller base.

Speaker 6

I'm just wondering, I mean, this risk seems to be something you always have to deal with when you deal with the government and fixed price contracts. Just how do you think about the ability to absorb even small developments that weren't planned, that end up being a little bit more negative than you anticipated and not having any kind of sideswipe margins where they have the past year or so?

Speaker 2

Well, I think the way I look at it is When we talk about your legacy contracts that we're dealing with here, they're not particularly large individually in terms of Either revenue or backlog, but to your point, they can and they are and they have introduce disproportionately large costs in a given period as we work through them, Especially if you do like active efforts that we have to reach a customer settlement or agree to change in terms things like that. So But we have to remember as well that the business is not as where it's not the size that we want it to be. So, in the end of the day, When you have a hit in any of the quarters, it has material impact because of the small quantum that you have in the absolute number.

Speaker 6

That's a fair point. Thank you very much and best of luck as you close-up the fiscal year.

Operator

Our next question comes from James McGyrickel with RBC Capital Markets. Please proceed.

Speaker 7

Hey, good afternoon and thanks for having me on. So my question is with regard to how you're looking at deploying capital in the defense segment. It seems like returns on that business right now, they're below your target. Do you think there's enough room to improve margins to bring returns in defense within your internal targets? Or any other thing to consider with regard to how you intend to deploy that capital that's tied up in the defense business?

Speaker 3

Yes. So we always look at a balanced capital allocation strategy, James, and the first priority is continue as we obviously continue to deleverage and drive towards a flexible balance sheet is to invest in accretive growth. And our top priority is to serve the demand that we see on the civil market. And that organic CapEx is highly accretive and drives returns of 20% to 30% incremental pretax returns within 3 to 4 years. So wherever We have those opportunities.

Speaker 3

That is the first priorities in terms of capital allocation. Sometimes we do deploy Some CapEx on the defense side. Ultimately, if we are to do so, we expect That to be on commercial terms and driving commercial like margins.

Speaker 2

Yes. And then maybe I'll just add to that, Sonia. And We've already talked about some of those like, for example, the U. S. Army Hades contract that we'll be deploying a Global 6,500 simulator in our existing facilities in the dotes and training center where we already deliver the fixed wing training for the U.

Speaker 2

S. Army. So And in that case, as Sonia said, we are because it's a commercial solution, which we deploy in Business Aerograph, we can Enter into what's called a commercial contract with the U. S. Army, which of course in that case would be Capital that's well deployed because it's going to be the service with margins more like we get in kind of civil environment.

Speaker 2

So you can imagine that's accretive to our term. Another example I would give you, that is a contract that we've talked about for what was previously called the Flight 4 21 contract, but we call it is the FTSS contract where we will be deploying capital to replace all the simulators used by the U. S. Army at what we call Port Rucker's, Port Novocel. Not that again, we'll be very accretive capital deployment in defense because we will be able to enter the service contracts on delivery training to Charmey on Again, commercial contracts, which are more favorable to us than traditional contracts in defense.

Speaker 7

And then if we look at the book to bill on the defense side, it came in below 1%. You did point to some unfunded backlog. So kind of within that backdrop, how should we be thinking about growth in this segment looking ahead? Is it fair to say You expect top line in defense to be higher in fiscal 2025 versus 2024?

Speaker 2

Claudia, you want to take it?

Speaker 3

So to your point, the order intake at 0.9 is slightly below 1, but I would look at the overall total backlog because there is a dynamic of kind of the 1st year funding and so on. So you could see the growth in the backlog. We're expecting some big Q4 awards, Mark Q4, Q1 awards that Mark spoke about, some large Canadian contracts that we've been selected and then we're expecting those to come in and that will drive some significant order intake and backlog growth.

Speaker 2

Look, defense is a growth business. As I said in the remarks, we have 20% backlog growth in the last 2 years And that doesn't include contracts that we've been selected on, like the future aircrew training in Canada and the RPAS training contract, We've misselected. Those two contracts are really generational in size. We're not under contract yet, so you got to figure it, okay, we got to get under contract, fully expect that to be in the first half of next year and then we got to turn those start turning those to revenue. So there'll be timing involved.

Speaker 2

But I mean there's no doubt that's a growth business.

Speaker 7

And sorry, just one quick follow-up on the defense side before I turn it over. Are the low margin contracts that are rolling off The eight contracts you've identified, are those EBIT positive? I guess, as those contracts roll off, although they might be accretive to margin, Is it EBIT neutral? Or are those losing money right now?

Speaker 3

We don't necessarily give the details of the contracts individually. I think it's a mix. And so they will be they're not particularly large on the revenue, but have that disproportionate impact On the cost, but I think the best measure to kind of look at it is the margin.

Speaker 7

Okay. Thank you very much.

Operator

Our next question comes from Konark Gupta with Scotiabank. Please proceed.

Speaker 4

Thanks, operator. Good afternoon, everyone. Maybe just to follow-up on defense, Mark. What has the dedicated team that you have deployed for these legacy contracts achieved so far, if you can give Concrete examples and what is their mandate going forward?

Speaker 2

A mandate is a successful execution of the contracts to deliver What we committed to deliver to our customers, that's 1st and foremost, all that because that's what Steve is about and we have a critical mission defense, which It goes without saying what to do. That's 1st and foremost. And of course, deliver it under the best financial terms that we can and that's what their mandate is. So, execute on the contracts and get us to the softest landing that we can with regards to retirement of risk on those contracts, Work with our customers to try to establish win wins to rescope those programs, descope those programs, Move the schedule to provide us some scheduled aviation, get request for equitable adjustments where we definitely are entitled to get them because of the extremely high inflationary environment that we've had that disproportionately affected our costs, those are all some of the things that our team is doing. And I could tell you, we didn't just put these teams on overnight.

Speaker 2

These teams have been working for some time and they have had good progress in executing and reducing the burden that we are facing here in defense already. So we're already seeing the fruits of our labor here, which allows us to give the more precision that we give you today.

Speaker 4

Okay. That's great color. Thanks. And if I can just quickly follow-up on civil. Is there any change in discussion or language from customers, some airline customers, especially in light of the A320 engine issue that we saw recently as well as now the Boeing 737 problems?

Speaker 2

The thing I would tell you is no, no, because airlines are scrambling to meet the demand that they see out there. Now, I mean the impact is real. The impact of the engine issue that you talked about is real. You can have 100 of airplanes Grounded at any given time would not having some effect. So we're watching that.

Speaker 2

I would tell you it hasn't affected our business. The airlines that We operate with it, which is great majority of airlines in the world, but are scrambling to be able to get alternate lift, whether it be keeping older airplanes on station rather than new ones, leasing old ones, that kind of thing. So we're watching that. We're also watching the delivery delays specifically because the math is simple, right? I mean, we've talked about it many times before, but For every about 30 narrow body deliveries that because it's a regulated market, it fills up once simulators were for demand.

Speaker 2

So clearly, if this was to go on for a long, long time, then that would add effect. But for now, based The discussions that we have with customers, there's still a lot of unmet demand in this market. And you can just see it with regards Again, to the order intake this quarter, I mean, we're talking a very strong book to bill on top of 20% growth in revenue and what you see there is the testimony to our success in more outsourcing. I'm Very, very happy to join another marquee customer like Air France KLM, which historically has not outsourced, outsourcing a portion of their training requirements to us. The growth they have is very large contracts with Business Aviation.

Speaker 2

So look, to me, We're seeing no we're basically seeing no softening demand. And going back to your question, the conversations that we have with Airlines and Business Aviation customers are essentially like the one I just described.

Speaker 4

Okay. That's great color. Thanks for the time again.

Operator

Our next question comes from Benoit Poirier with Desjardins Capital Markets. Please proceed.

Speaker 8

Yes. Thanks very much and good afternoon. Just to come back on the defense margin, if we strip out the 200 bps impact from the legacy crack, it implies that the base is running at around 6.4%, which is Obviously, far from double digit level. So could you maybe give us more color on actions to be taken to bring the base to double digit, is it related to delays in funding? Is it a matter of scale, Revenue loss since the acquisition of L3 or higher bidding costs these days to support the high bidding environment?

Speaker 3

Yes, Mehmed. So a couple of points here. So first, on your point of the 200 basis points. As I mentioned earlier on the call, There is the 200 basis points as a reflection of the impact of those legacy contracts, but there's also the impact of the under absorption that we should consider. These are the costs needed to achieve scale and support the business like R and D and SG and A.

Speaker 3

So that could be another up to 100 basis points. So I used that basis, the $200,000,000 in total. In addition, as we've mentioned in the past, The delay of the ramp up of new expected orders and especially the transformational ones because they move the needle. So as these start to come in and start to really reflect through the revenues, we spoke to it last quarter, it was 3%. It's really still minimal representation in the revenue, but 20% of backlog.

Speaker 3

So as these start to ramp up more materially, that So we expect that to step up and drive a meaningful impact.

Speaker 8

Okay. And what is the strategy within defense business now to ensure that you don't run into contract issues like this in the future?

Speaker 2

Well, I can tell you, Benoit, there's a lot of tuition values where we've lived this in the last 3 years. So there's lots, But and they're well implemented. I think the first thing and foremost, which is obvious and we have a lot commonality with our peers in the defense industry across the board here is we're certainly not getting into firm fixed price development contracts, Because in a lot of cases, that's what got us into this situation in the first place, where you have development contracts That I guess fixed firm price, you incur delays because of well, first we went through COVID with everything that goes Along with that, with regards to part shortages, with manpower shortages, on top of everything escalating, basically compound escalation with regards to inflationary environment where we have no protection. So those are some of the things that obviously we're not doing. There's other things that we're doing like, for example, making sure that we ban the service contracts, establish a bit tighter pricing bands, So on utilization, so we don't get caught out that if the customer uses more or less of the demand that we somehow are disproportionately affected.

Speaker 2

So, I would tell you there's a number of things, but that's what we're doing and a very tight monitoring of execution at all levels.

Speaker 8

Okay. And just looking at the civil margins, you reached 20% EBIT margin this quarter, which is a step down versus to the 25.4% achieved a year ago despite having stronger revenue, greater utilization rate. Could you please let us know what drove that and what makes you confident to achieve the implied 26% plus EBIT margin in Q4 in order to reach the mid double digit growth for the year?

Speaker 2

Okay. I will separate up to say, I didn't tell you 26 you said that. But hey, okay, we said you can do the math. But look, I think if You go back to what I think what I said to you in the last conference call in the last quarter, I tried to point to that. So I would tell you the margins, As I said, are there where we expected them to be?

Speaker 2

And I'll give you some of the components here. It's very there's mix is very much at play here. And we've talked about mix before. And yes, this mix looks kind of high. And on the base of it is high.

Speaker 2

But I would point to last year in Q3, The mix was very favorable from a couple perspective. It was from our products business and it's also what From kind of the new segment that we have, but not a segment, but it's part of Civil, which is our software business, because Last year, we had a lot of what we call very favorable on premise work. And I'll tell you what we mean by that. In our software business, we are actively as a strategy going to winning contracts. We're trying to move customers from on premise work to software as a service.

Speaker 2

So let me make you an analogy on that. If I was to say on premise work, it would be like us In the core business to sell simulator, you sell simulator, you get the revenue, you get the contract literally very fast. Now contrast that with the training market going through software as a service is kind of like we're doing in training We're basically we're going to get paid over time. So from a much better recurring standpoint, much more longer term, Very attractive work, but obviously it's not going to give you a big SOI bump in 1 quarter. That's what we see.

Speaker 2

And when we look at the upcoming quarter in Q4, we expect that kind of that particular dynamic to be very favorable again. And that's really coupled with a number of simulators we will deliver And utilization in our training centers, that's why we're basically saying we expect a strong Q4 reflecting in the heightened guidance that we gave for Civil last quarter.

Speaker 8

Okay. And maybe last one for me. If we look at Air center, it looks like that there's about $1,000,000 of integration and acquisition costs taken so far. Obviously, the valuation multiple was very attractive and you knew that it would be a 2 or 3 year journey. You just mentioned that IT infrastructure integration will be substantially complete by mid fiscal year 'twenty five.

Speaker 8

I'm just wondering if you could give an update on the remaining cost to be taken and how much air center could be incremental in terms of margin and whether it's meeting the any color about the return on capital employed specifically so far? Thanks.

Speaker 3

Yes, Benoit. So we continue the integration of our customers on our systems to our network. And as I mentioned in the remarks, we expect to be done by mid next year. So there's really good, great ramp up of migrating our customers out of the previous network into our network. And so great progress done last quarter, and we expect a lot of great progress this quarter as well.

Speaker 3

So while we won't necessarily kind of give an outlook on the cost, we expect that to be pretty much finished during in the next first half of next year. Okay.

Speaker 8

Thank you very much for the time.

Operator

Our next question comes from Tim James with TD Cowen. Please proceed.

Speaker 9

Thanks very much. Good afternoon. Most of my questions have been answered, but I just maybe had one quick one for Sonya. Just looking at some detail here, The depreciation expense in the Civil business jumped surprisingly significant amount in the quarter relative to the Q2, I'm looking at in particular just the sequential change. Is there any particular reason for that?

Speaker 9

Is this new or the reported the Q3 rate a good proxy going forward?

Speaker 3

Well, I think the headline is growth, right? So we deployed 20 plus simulators last year, 13 year to date this year, And we've onboarded several training centers, whether it's Las Vegas, Savannah came online this quarter. We have another extension of our Phoenix training center that came online also this quarter. So you'll see that driving That depreciation expense and some of the interest that I spoke to on the lease liability. It's really deployment of new simulators and new training centers.

Speaker 9

Okay. So it is just a natural step up then in relation to the assets in the business?

Speaker 3

Yes.

Speaker 4

Great.

Speaker 9

Thank you very much.

Operator

Our next question comes from Kristine Liwag With Morgan Stanley. Please proceed.

Speaker 3

Hey, good afternoon, everyone.

Speaker 1

Hi. Hi,

Speaker 3

Christine. Hey, Mark. You just reiterated the margins for the next quarter. I mean, it seems like for 4Q 40.24 to get to your guidance that implies about 16% revenue growth for the quarter year over year and margins a little bit north of So with all the mix headwinds that you highlighted this quarter and it seems like some of that goes away next quarter, How do we think about the run rate for fiscal year 'twenty five? Is 26% the starting point?

Speaker 3

And how do we think about that for next year?

Speaker 2

Well, I'm not going to question your math, but we've given you enough. But Look, we are not guiding for 25 now. But clearly, I mean, you look at the order intake that we have, the book to bill that we have and I think you are going to see strong growth.

Speaker 3

Great. And Mark, in terms of the software business, I mean, software as a service, especially Sabre historically would be a very accretive margin. I mean, when you look out a few years For the composition of software within Civil, how large could that be?

Speaker 2

Well, boy, again, you're asking me for guidance that we're not ready to give at this time. But obviously, we built we bought this business to grow it. And I've been very happy with the order intake that we've had from customers. There's a lot of interest from Sea Airline customers. They see and I've been quite satisfied with the assumption that we had from day 1 that people would be various airlines specific will be very receptive for us bringing Sea's culture into this business.

Speaker 2

And we are seeing, I said customers that have basically moved away from legacy Sabre and once we bought it and with the efforts that we have had, The customer outreach, the product development we've had, the investment that we've made in business that they've come back to us. So, look, without giving you any precise precision number, I see this growing and I see that a very strong interest in us delivering what we call our next gen solution, which is software as a service and that's going to be pretty good for recurring revenue going forward. Obviously, we got to get through the time it takes to move to on premise to a software as a service and there's a lot of history of other companies that do that, but suffice to say, I'm very optimistic.

Speaker 3

Great. Thank you.

Operator

Our next question comes from Anthony Valentini with Goldman Sachs. Please proceed.

Speaker 10

Hey, guys. You got Anthony on for Noah today. Thanks so much for taking my question. So I just wanted to ask on the defense business. We're hearing from a lot of the U.

Speaker 10

S. Defense primes that they're shifting their strategy in terms of how they are bidding on contracts, getting away from fixed price and going more towards cost plus. Is that something that you guys are also implementing into your strategy? Can you just talk about that a little bit?

Speaker 2

Absolutely, absolutely. I mean, look, the impact that we've had on fixed firm price contracts That our development type contracts going through the period that we've had through COVID has been very, very and impactful and we see them in our results and we're going to see them as we talked about in these legacy contracts. Now having said that, we're going to work with our customers all the time. So, although we might not do that, we're going to be imagining there and working with our customers to give you an example that in some cases and we have entered into new contracts where the government specifically has said, okay, We agree that with you that we don't necessarily have to take the costs, which have a lot of inflation relative and consider them as pass through contracts. So basically, the cost will be what the cost will be.

Speaker 2

So, yes, I think we are basically we are impacted by the same thing that a lot of our legacy peers are across the industry and I think we're taking the same kind of actions.

Speaker 10

Okay. That's helpful. As a follow-up there, Sonia, you had mentioned 200 basis points basically of like a drag from these challenge programs and then another 100 basis points of like the overhead absorption. So If I just kind of use those numbers and that implies something like a 7.5% margin, what's remaining that's going to drive this business to get to those double digit percentages that you guys have historically talked about?

Speaker 3

Well, as I mentioned, it's really the ramp up of the new contracts that we've signed and especially those transformational ones. They're large in size, accretive, and they will have a meaningful impact on the margin as they ramp up. They're really nominal right now in terms of our revenues. And so as those ramp up, they'll have a more meaningful impact.

Speaker 10

Okay. Thanks so much guys. Appreciate the time.

Speaker 6

Thank you.

Operator

Our next question comes from Jordan Leerne with Bank of America. Please proceed.

Speaker 11

Hey, good afternoon. Thanks for taking the question. So just hopefully a final one on defense margins. With the double digit target, how confident are you in that timeline being 2025 where you start to see that accretion from new contracts. If we still continue to operate under a continuing resolution for this year, how much Downside risk do you guys look at if we go through a sequestration?

Speaker 2

Let me just start it off. Look, again as I said, what we are talking about this quarter is no different than we have been talking about Certainly in the previous quarter, we've moved we've already admittedly moved things out. What we're giving today is more precision on these legacy contracts to give you an idea of what this represents by itself also to give you a feeling that we are quite confident in the core of this business. This is a strong business that we are working through these legacy contracts. So if I try to maybe give you a little bit more color specifically to the question, there continues to be 2 pieces here.

Speaker 2

The growth in the core business, which I see is very strong and which is influenced by the ramp up in the transformative new business that we've talked about, the 20% growth in the backlog that we've had in the last couple of years. At the same time as the retirement of these legacy contracts, which drag against the overall margin. So we clearly see, as we said Even before that, there's going to be an inflation where these two curves meet. And what we still predict is that's going to happen in the latter half of next year. There's no change there.

Speaker 2

But I think maybe we're giving a little bit more precision is actual drag impact in this quarter and introducing the fact that this isn't going to be linear. There's going to be variability Because of the specific actions that we are taking to retire risk, but depending on the timing of the requirement at risk and our efforts to retire them as quick as possible is going to affect that. But the trend line drive the inflection is the one we've been talking is very much intact.

Operator

Our next question comes from Fai Lee with Odlum Brown. Please proceed.

Speaker 12

Thank you. Thanks for taking my questions. Mark, your 3 year EPS compound growth rate target hasn't changed from the mid-twenty percent range. And I know you don't really want to talk about the 2025 guidance since you haven't provided, but that target implies pretty strong gross next fiscal year. And I just wanted to get a sense of how you see that target right now in terms of Whether it's a stretch or you think you're pretty confident that you'll achieve it.

Speaker 12

Can you just maybe comment around that?

Speaker 2

Well, look, I'm going to turn it over to Sunny. And he answered that question, I think, a little bit a while ago. But The bottom line is just we're not ready to give that guidance right now. We give it at the same time every year. That's going to be next quarter.

Speaker 2

But And clearly it's going to be some dependency on their timing and the risk retirement depends and the pace of new programs ramping up that when we actually sign these generation contracts such as the one fact that I talked about. At the same time, the outlook for Civil remains Very robust. You just saw the order intake that we signed this quarter on top of 1.3 over 1.3 percent on top of 20% growth in our revenue. So all of that has got to be factored. Anything you want to add to this, Sunny?

Speaker 3

No, you covered it. And we'll provide more insight in Q4 like we usually do.

Speaker 12

Okay. And just another question on the defense outlook. It basically sounds like Relative to your expectations and your outlook going forward, nothing really changed from the previous quarter, Yet you've provided additional guidance and markets reacting very negatively or additional, sorry, information on the legacy contracts, markets reacting very Negatively around that, what's your thoughts around how the market is interpreting that additional information?

Speaker 2

Well, Longo stopped predicting that one. All we could do is run our business. And Just I have got to repeat everything I said, but I feel very confident about that we have a business in defense. I'll just go with that point. This is not a business that's broken.

Speaker 2

This is a business that's growing With contracts that are going to be accretive to the margin expectations we have, we have a lot of backlog. In my experience in all my career, The one thing you want to have is backlog, because you have backlog as long as your backlog is profitable and it is profitable, it's profitable the aims that we have. We're attacking very specific contracts here that are all very similar. Although the contracts themselves are different, they all to the same kind of thing, pre COVID, fixed firm price and we're attacking a laser focus with dedicated tire teams, while at the same time not keep getting Keep our eye off the ball of the hundreds of other contracts that we execute in defense at any given time, Make sure we continue to execute those on plan, which we fully expect to do. So with all that, That's basically forms my confidence in the defense business, albeit we are where we are.

Speaker 3

Okay. Thank you.

Operator

Thank you, operator.

Speaker 1

Thank you, operator. We have no

Speaker 2

questions at this time.

Speaker 1

Operator, thank you. Given that we're on the hour, I'd like now to open the lines to members of the media, should there be anyone with questions

Powered by Quartr

Key Takeaways

  • CAE’s Civil segment delivered 20% revenue growth year-over-year, with 13 full-flight simulators delivered, 76% training centre utilization, $845 million in orders (1.36 x book-to-sales) and a record $6.1 billion backlog.
  • Defense revenue rose 4% to $472 million, but adjusted operating income fell 18% to $20.9 million, reflecting a ~200 bps margin drag from eight pre-COVID firm-fixed-price legacy contracts; orders totalled $429 million for a $5.6 billion backlog.
  • CAE generated $190 million of free cash flow in Q3 (YTD $227 million), drove net cash from operations of $220.8 million, and ended the quarter with net debt of $3.1 billion (3.16x EBITDA), targeting 100% conversion of adjusted net income to free cash flow.
  • The Healthcare business is now classified as discontinued operations, with its sale expected by fiscal year-end; proceeds will be used to reduce debt and support the resumption of shareholder cash returns.
  • Looking ahead, Civil is expected to grow adjusted segment operating income by mid-to-high teens with margins in line with FY 2023 and ~50 simulator deliveries, while Defense will continue to retire legacy contract risks over the next 6–8 quarters and pursue higher-margin program wins from a $9.5 billion bid pipeline.
AI Generated. May Contain Errors.
Earnings Conference Call
CAE Q3 2024
00:00 / 00:00