CAE Q2 2024 Earnings Call Transcript

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Provided by Quartr
November 14, 2023

There are 11 speakers on the call.

Operator

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

Operator

You may now proceed, Mr. Arnovitz.

Speaker 1

Good afternoon, everyone, and thank you for joining us. 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, November 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 Due reliance on these forward looking statements, a description of the risks, factors and assumptions that may affect future results This contains NCEA's annual MD and A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR Plus And the U.

Speaker 1

S. Securities and Exchange Commission on EDGAR. On the call with me this afternoon are Marc Perron, CEE's President and Chief Executive Officer And Sonia Branko, our Chief Financial Officer. After remarks from Mark and Sonia, we'll open the call to questions from financial analysts. And at the end of that segment, we'll open the line to members of the media should there be any questions.

Speaker 1

Let me now turn the call over to Mark.

Speaker 2

Thank you, Andrew, and good afternoon to everyone joining us on the call. We delivered a good performance overall in the 2nd quarter with Double digit top and bottom line growth, driven mainly by continued strong momentum in Civil and higher contribution from Defense compared to quarter last year. We made excellent progress to Secured CE's future with nearly $1,200,000,000 in total adjusted order intake For a record $11,800,000,000 of adjusted backlog, we further bolstered our financial position on the path to meeting our short term leverage target. In Civil, we had another quarter of excellent performance with demand for our training and flight operations solutions continue to be robust across all regions and notably in Asia, which has lagged in the global recovery in air travel. We booked $618,000,000 of orders with customers worldwide for a 1.08 times book to sales ratio.

Speaker 2

We received orders for 15 full flight simulators, Including a multiyear purchase of 8 new Boeing 737 MAX simulators for Ryanair 2 Airbus A320 simulators to United Airlines. In Commercial Aviation and Training, we signed a multiyear training agreement with Delta Airlines. And in Business Aviation, we signed a multiyear agreement with Winroad Air Jet Charter. In flight operations, we signed long term next generation solutions agreements with Wizz Air and Air India. We delivered 11 full flight simulators to customers during the quarter and our average training center utilization was 71%, which is up nicely from 66% last year.

Speaker 2

The year over year increase points There is strength of the underlying commercial and business aviation train demand across all regions. Anyone who's traveled by air this Several will know just how busy the airlines have been trying to meet passenger demand. The sequential decrease in training center utilization That we experienced during the summer is a direct reflection of the seasonality we expect we typically see We booked orders for $527,000,000 or a 1.1x book to sales ratio, giving us a record $5,900,000,000 of adjusted defense backlog. They include strategic opportunities Like the formalization of our contract with Bell Textron as part of Team Valor to provide simulation and training solutions for the all important V-two eighty tiltrotor, The platform for the next generation U. S.

Speaker 2

Army Future Long Range Assault Aircraft Program. Other notable wins include the previously announced Simulation based training contract for the U. S. Army's key next generation airborne ISR system, which is called the High Accuracy Detection Exportation System or HADES, which is based on Bombardier Global 6,06,500 Business Jet. Defense also received an order to provide the U.

Speaker 2

S. Army with support services for the advanced helicopter flight train support services contract for Air Crew and Non Air Crew personnel. Additionally, Defense was awarded a contract for a modification and maintenance of F-sixteen training devices for United States Air Force as well as for the upgrade of ARRIS training device. With that, I'll now turn the call over to Sonia to provide additional details about our financial performance. Sonia?

Speaker 3

Thank you, Mark, and good afternoon, everyone. Consolidated revenue of $1,090,000,000 was 10% higher compared to the Q2 last year and adjusted segment operating income was $138,500,000 compared to $124,700,000 in the Q2 last year. Our quarterly adjusted EPS was $0.27 compared to $0.19 in the Q2 last year. We incurred restructuring integration acquisition costs $37,900,000 during the quarter relating to the Air Center and the L3 Harris Military Training acquisition. Net cash from operating activities this quarter was $180,200,000 compared to $138,000,000 in the Q2 of fiscal 2023.

Speaker 3

Free cash flow was $147,500,000 compared to $108,400,000 in the Q2 last year. The increase was mainly due to a higher contribution from non cash working capital. We usually see a higher investment in non cash working capital accounts in the first half of the fiscal year. This year, I'm pleased that we've already begun to see a reversal in the second quarter, and we expect that positive trend to continue into the back half of the fiscal year. We continue to target 100 percent conversion of adjusted net income to free cash flow for the year.

Speaker 3

Capital expenditures totaled $61,900,000 this quarter Approximately 60% invested in growth to specifically add capacity to our civil global training network to deliver on the long term training contract in our backlog. Income tax recovery this quarter was $8,500,000 for an effective tax rate of negative 16%. The adjusted effective income tax rate was nil, which includes the recognition of previously unrecognizable tax assets, which had an approximate $0.05 positive EPS impact this quarter. Net finance expense this quarter amounted to $48,000,000 which is down from $54,100,000 in the preceding quarter And up from $41,300,000 in the Q2 last year. Our net debt position at the end of the quarter was approximately $3,200,000,000 for net debt to adjusted EBITDA of 3.16 times at the end of the quarter.

Speaker 3

Following the end of the quarter, we announced a definitive agreement to sell healthcare for an enterprise value of $311,000,000 a decision which better positions CAE to efficiently allocate capital and resources To secure growth opportunities in our large core stimulation and training market, we intend to apply a significant portion of the net proceeds to reduce debt. The transaction is expected to close before the end of the current fiscal year subject to closing conditions, including customary regulatory approvals. With leverage having decreased to a ratio of approximately 3 times, we will consider reinstating capital returns to shareholders following the closing of the Healthcare sale transaction. We are 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.

Speaker 3

In Civil, 2nd quarter revenue was up 13% to $572,600,000 compared to the Q2 last year and adjusted segment operating income was up 9% to 114 $300,000 versus Q2 last year for a margin of 20%. Both solid improvements over last year And as Mark referenced, CA's 2nd quarter is normally seasonally softer with respect to training center utilization, which typically has some impact on business mix. In defense, 2nd quarter performance was better than the same period last year with revenue up 8% to $477,400,000 And adjusted segment operating income up 16 percent to $21,300,000 giving us an Adjusted segment operating income margin of 4.5%. The year over year growth came mainly from a higher level of activity on programs, partially offset by higher SG and A expenses from higher bid and proposal costs associated with the pursuit of larger pipeline of defense program opportunities. Defense performance was lower than the preceding quarter as we managed through the ongoing retirement of legacy programs from backlog.

Speaker 3

We also had lower revenue than we expected from newer and more profitable programs due to recent funding and award delays. And in Healthcare, 2nd quarter revenue was $38,500,000 down from $43,600,000 in Q2 last year. Adjusted segment operating income was $2,900,000 in the quarter for an adjusted segment operating income margin of 7.5%. This is up nicely from Q2 of last year. With that, I'll ask Mark to discuss the way forward.

Speaker 2

Thanks, Sonia. Our outlook for CE continues to be positive for the fiscal year and beyond. Our strong momentum is translating to robust order flow and a record backlog, which portend an excellent future for CAE. In our core civil and defense markets, our customers increasingly require innovative training and operational trends that we see and in the growth that we anticipate by leveraging our global market position as well Our technological expertise and the strength of our 1 seat cluster portends to our optimism. In Civil, We expect to continue growing at above market rate, driven by the growth and recovery in air travel, increased penetration Of the existing addressable market for training and flight services solution and a sustained high level of demand for pilots And pilot training across all segments of AVs.

Speaker 2

For the current fiscal year, we now expect Civil To deliver growth in the mid to high teens percentage range of adjusted segment operating income and given a profile of our planned simulator deliveries In the normal seasonality of training demand, performance will be mostly weighted to the 4th quarter. The higher expected annual growth is based on our strong performance year to date and the visibility that we have in a highly regulated aviation training market. In addition to continuing to grow our share of the aviation training market 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 full flight simulators for the year. Approximately half of those deliveries are slated for the Q4. Turning to defense.

Speaker 2

We expect to We are making good progress transforming our business by replenishing our backlog with more profitable programs And by retiring low margin legacy contracts, which we expect to culminate in a substantially bigger and more profitable business. We strengthened our future position in recent quarters with strategic and generational wins, including next gen platforms, giving us a record $5,900,000,000 adjusted backlog. Together with a record $9,500,000,000 Pipeline of bids and proposals outstanding, we continue to see positive signs of the transformation underway. And as we look at the remainder of fiscal 2024, the positive inflection that we expected this year in defense Has been delayed because of impacts associated with the retirement of our low margin legacy contracts, specifically those awarded prior to COVID and current new program delays. And while the inflationary impacts on these Contracts are known and finite in nature.

Speaker 2

They continue to be the most significant factor contributing to the Current low margin performance of the business, it does not reflect its underlying potential. The essential trend lines of replenishing our backlog with larger and more profitable programs, while simultaneously Retiring legacy contracts remain positive. However, the prevailing U. S. Government budget appropriation uncertainty is slowing the ramp up The new and higher margin defense programs that we've been awarded.

Speaker 2

This is also impacting the conversion of our bid pipeline to orders We expect it to generate higher margin revenue for this fiscal year. As a result, we now expect second half Defense adjusted segment operating income margins to remain in the current single digit percentage range. We expect to see Defense segment performance improvements materialize next fiscal year, but this will ultimately depend on the duration and magnitude of delays The new programs in the current environment. We're firmly focused on retiring legacy contracts as soon as possible and mitigating the margin pressures associated with them. We remain pleased with the accretive margin profile on our newly awarded contracts, Which should be the best indication of where the future performance of Defense is headed.

Speaker 2

We maintain our condition that the ongoing retirement Of legacy programs and the new order backlog growth will result in a low double digit percentage margin business at a steady state. Lastly, on Healthcare, I want to thank Jeff Evans and the entire Healthcare team for their dedication and excellent performance. We're proud of the significant contribution to patient safety that CAE Healthcare has made And I believe that Madison Industries is the right home to take the business to the next level. Like CE, Madison's mission is rooted in making the world safer, And I believe it will be ideally positioned to support the future growth of the business, which will continue to focus on evolving simulation to drive patient safety and quality outcomes. For CAE overall, we continue to be highly encouraged by the secular tailwinds With that, I thank you for your attention.

Speaker 2

We're now ready to answer your questions.

Speaker 1

Operator, we'll now take questions from financial analysts.

Operator

Thank One moment please for the first question. Our first question comes from Fadi Chamoun with BMO. Please proceed.

Speaker 4

Yes, good afternoon, everyone. Thanks for taking my question. So first question I have is, is the mid-twenty percent EPS growth guidance that you reaffirmed take into account the The divestment of Healthcare. And secondly, I guess, I'm just trying to square off the Pushback in the defense margin inflection point and the maintaining of the guidance for fiscal 2025 effectively, So are you still expecting defense margin to bounce back Kind of in 2025 and to what level are you still thinking the double digit is achievable Kind of in the back half of 2025, I was just trying to square off the maintenance of this guidance in the context of the divestment of Healthcare and the weaker results in defense.

Speaker 2

Okay. Yes, thanks for the questions, Fady. Look, our 3 year guidance continues to be our target. We continue to see strong growth and profit improvements across the portfolio. I think it's safe to say obviously that as you point out that we see incremental risk in defense related to the factors we talked about new program ramps up, The timing of risk environment, the environment that we're in, in terms of the budgetary issues that we see in the United States specifically.

Speaker 2

But as I mentioned, we're very focused on closing out the work on legacy contract as soon as we can. So I'm not giving guidance today fiscal 2025, but as we get closer to fiscal 25, if there's more color to provide on that, we'll do so. But target is the same. And with regards to the healthcare, I would say that the impact, I mean, It's not nothing, but it's relatively minimal in terms of its impact to the guidance that we've given and the results coming out of the sale.

Speaker 4

Okay. And maybe one follow-up. Like, I think we understand kind of the budgetary issues and Some of the ramp up on the new business that you have been like the backlog obviously has been growing. You reported Few quarters of increasing backlog and outlook for defense quite positive. But if we put aside this budgetary issue and How can we kind of understand what is the Margin impact today from these legacy contracts that are eventually going to move out of the P and L, whether that happens next year or the year after, But is this 300 basis points, 200 basis points, just trying to kind of understand what is the core profitability Kind of run rate of defense and notwithstanding whatever delays are happening on the ramp up of new business.

Speaker 2

Okay. Well, let me try to get to the answer to your question by pointing out some of the factors and hopefully we get there. Look, First of all, when we talk about these lower margin drag programs, we're talking about a relatively small number. We're talking about a relatively Small number of contracts here, a fraction, a small fraction of our overall backlog. And I think it's important to note as well that None of those contracts are recent awards.

Speaker 2

In fact, I look at the whole list of these finite programs And they were all awarded before COVID. So we imagine that the impact that we see, Although it's a small number of programs, the impacts of inflation, where we're seeing inflation at 2% escalation, Clearly, we're seeing inflation at 10%, 15% compounded has an impact. Staffing shortages had an impact. And those are the programs that were most impacted by those factors as well as the manpower shortage that we have. So Those programs are more profoundly affected and those are the ones that are weighing on the profitability of the business.

Speaker 2

And at the same time, there's other factors. We see the impact of this inflationary environment. And part of it is Some of those programs, we have very, very strong business cases to be reimbursed for the actually egregious cost increase that we've seen. But in this kind of environment, there is no appetite for anything but very we've been comfortable with a very small portion Well, we think we should be. I mean, as well, I'm not to pile on, but in this kind of budgetary environment that we see Well, we have a normal kind of end of budget year, what we call sweep up money of defense budget, we haven't seen this quarter.

Speaker 2

So I mean, that's what's kind of happening with these drag programs. But when I think about the new programs coming up, first of all, And what we call our transformational programs, the ones that we talked about in the releases, programs like FTSS, like PAC, Like Hades, I think a noteworthy point to make when you think about the Profitability impact and when that they start impacting is that if I look at ChuChu, those when I think about the revenue coming from those Only 3% of that was in our revenues for this quarter. So 3% of those transformational programs We're in the quarter, but yet they make up 20% of our backlog. And those programs have transformational programs Or at very accretive margins that basically give us strong confidence in the targets that we put to our business, which is low double digit profitability. So those are the elements that are at play here.

Speaker 4

Okay. Appreciate the color. Thanks.

Operator

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

Speaker 5

Thanks very much. Just have one question here, and I'm just wondering if you could give us an update on Progress with AirCentre, how it's performing versus expectations and sort of year over year comparisons. I know there was some Integration costs in the quarter, maybe just some details on what those costs were around and what that provides for the business going forward?

Speaker 2

Well, look, I think the first one is, thanks for the question, Tim. What I would tell you, I'm very happy with the business, the progress that we're making. We are especially when I think about the success we're having in the market, You look at I mean, you've seen that going back to Paris Air Show, there's strong very strong orders that came out, for example, of airlines in India that specifically saw Air India. Well, we just signed a major contract with Air India with our Air Centers' suite of products. And Considering that Air India is bringing together a number of airlines together as part of Air India Group, that is very, very Promising in terms of business.

Speaker 2

As well, I was just recently in Budapest and the CEO and his team at Wizz Air And they selected us for our Center Suite. So and that's just a couple. So from a business a front end standpoint, I'm Quite happy with the business. And I should say that's the only thing I'm satisfied with. I'm very, very happy with the impact that we're making With our customers with regards to how they see CEE, which is something CEE as the national owner of this business.

Speaker 2

Look, it's taking It will take time to recognize revenue because this is software as a service. Well, remember that we bought AirCentre at 7 times EBITDA. So when I think about that and the money we're spending, we are making the investments that we wanted to make at the rate we want to make To develop that business, look, we're attracted where we want it to be and it's contributing positively to this quarter.

Speaker 5

Okay. Thanks, Mark. That's really helpful. I will just actually ask one more question, if I could. The working capital in the quarter was great, really impressive.

Speaker 5

Just wondering Maybe if you can talk a little bit about were there surprises in there? What drove that? Is that kind of more indicative of what second quarters might look like going Or just any details on that strong performance?

Speaker 3

Hi, it's Tim. Thanks for the question. Yes, no, like I said in the remarks, very Pleased to see a strong reversal in working capital in the quarter. And really, it's not a surprise. This is really the outcome of continued Focus on optimizing capital and our metrics.

Speaker 3

So we saw good improvements across the board, whether it's On our day sales outstanding, contract assets and deposits on contracts, and so these all contributed To the positive reversal of working capital, we expect that to continue that momentum to continue in the second half as it usually does.

Speaker 1

Great. Thank you.

Operator

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

Speaker 6

Yes, thanks. Good afternoon. Just a

Speaker 7

couple of questions on the restructuring activity. We see that ongoing in Q2. Can you just maybe update us on where we are in that Structuring program and how much of that at this point is reflected in your cost base?

Speaker 3

So, I would like to thank Kamen. I wouldn't necessarily call it a restructuring program anymore. The restructuring program we closed out last This is really continued integration of the 2 acquisitions. So the Flight Services Mark just spoke of it. We bought this at 7 times EBITDA knowing that there would be investments to harmonizing and monitoring the structure.

Speaker 3

And what we're seeing is investments in our more modernized IT infrastructure and migration of customers, which We expect to complete by mid next year. On the Altery Harris military training, this is really a second phase of our integration, which was Which we had as a catalyst was a major ERP implementation to harmonize all of those businesses, the legacy and the new businesses together. So this triggered a second phase of further planned integration and synergies on that side and that's relatively

Speaker 7

Okay. So we should expect, I guess, sort of the outcome of these Sort of integration activity to have maybe a more meaningful impact on margins as we look ahead to 2025. Is that fair?

Speaker 3

Sure. Yes.

Speaker 7

Okay. And maybe just secondly, just wondering if you could maybe talk about, I guess, what you're seeing as far as opportunities to deploy additional capital into the training network. Deploy additional capital into the training network. What are you seeing on outsourcing opportunities, JV opportunities?

Speaker 2

Lots of opportunities out there, Cameron. And you've seen what we're doing. I think we've from the outset, We came into this with a lot of dry powder. I mean, when we think about what we did, going back a little bit through the through COVID, We didn't reduce the asset size. We put it at the right place.

Speaker 2

And in doing so, we took a lot of structural costs Back in the neighborhood of $70,000,000 structural hard cost out of business and we're seeing a lot of that Come to 4 today. Since then, we've been seeing the opportunity that the market gives us. And you've seen that in the Business Aviation Training Centers that we've We had Singapore, we're opening up at Savannah. Very soon, we open up Las Vegas, which has been very successful Thus far, we have Orlando together with Symcom opening up and we've announced it in Vienna next year. Outsourcing, look, I can tell you The progress is pretty much as I indicated in the past.

Speaker 2

I'm very happy for Obsidian. We've talked about Qantas before. I was just in last month, I was in Athens with the CEO and his team at AGM and They're the largest carrier in Greece and we've done a deal with them. There's other deals that I can't really talk about right now, but I can suffice to say that We're traveling a lot. We're meeting a lot of customers and we see opportunities to continue to grow and efficiently Deploy capital, particularly in the civil network, which as you know is very accretive to margins.

Speaker 6

Right. Okay. I appreciate the color. Thanks very much.

Speaker 2

Thank you.

Operator

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

Speaker 8

Sure. Maybe just turning back to defense, maybe if I look at it at a high level, and I know this math is overly Simplistic. But if I just look at your run rate, I guess, adjusted segmented operating income and I look at the capital employed into defense, Your returns there are kind of 3%, 4%, presumably if margins double or a little bit more Double, you'll get high single digit returns on that capital employed. That still feels Like relatively low to me, just thinking about the margin cadence you've kind of laid out over the medium term. Just wondering how do you think about Driving that return higher, is it kind of being able to grow revenue while keeping that capital employed relatively static?

Speaker 8

Do margins need to actually get closer to the mid teens over time to maybe drive better returns? Just trying to think of the cadence of these returns the returns on capital here over Maybe over a longer period of time.

Speaker 2

Well, as I said, over a long period of time, we feel very comfortable about this business And achieving the target that we've given up low double digit margins. Look, it's clear that we're not where we want to be today. We'd rather not be here, but it's finite, it's temporary, it's not reflective of the long term potential business. And again, there's the same factors are at play here. I mean, really, the 2 overall factors that are work.

Speaker 2

Number 1, it's on risk retirement. And risk retirement are what we call these drag programs and We're making progress. In some cases, we're actually moving to accelerate it. I can tell you, like in this past quarter, there are few programs that we've shifted to 7 day work week To basically accelerate the schedule and get these behind us. Obviously, when we do that, we incur extra cost.

Speaker 2

But I think it's worth it To make sure that we exercise contractual opportunity obligation to meet the schedules on those contracts. In the case of new programs, as I talked about in my remarks, we remain Very bullish about the profitability of those new programs they're winning for all kinds of reasons and such as some that I've talked about on previous calls like Being able to leverage and exercise what we call commercial rates on government contracts. And that's so it's going to be a mix of programs, but in aggregate, the property of those new programs that we're winning They are very accretive to the margin obligation that we give. So that's really what's happening here. And as I said, Where we are today, those transformational programs, again, in the second half, they make only 3% of our revenue.

Speaker 2

Next year, that's probably going to be about 15% and obviously accelerating as we go through the year. As you get into the end of the year, You're going to have more of basically the revenue has been driven throughout the business that's going to be from those transformational programs. And at the same time, We'll be substantially down the curve of retrying the risk on the DRiD program. So that's what's at play here. And of course, what's affecting Those who trend lines are some of the factors I talked about like basically contracts moving to the right In terms of us being able to execute our contract, in a lot of cases, no fault of our own, if I should say, like in some cases, we've been selected for Training contracts, we've been delaying as much as 6 months because the customer is not getting the airplanes on time Because the OEMs have been themselves affected by supply chain challenges and are not able to meet the production rates.

Speaker 2

And of course, That means delays for us. So all of those factors are at play here. But again, from a long term standpoint, we're very comfortable about the business.

Speaker 8

I appreciate the color there, Mark. Maybe just trying to Civil, we've been reading more, obviously, there's a pilot shortage And airlines are doing all they can to fill that backlog here. One of the things we've been reading about is just the advancements of pilots, pilots are moving 1st officer to captain much faster. And I'm just wondering, does that create more training opportunities for you? Does that shift how you think about wet versus Dry hours, like if an individual can kind of move through their career faster than maybe what it looked like pre pandemic, Does that impact maybe the mix of that commercial revenue between wet and dry or even the number of events you're typically seeing over a 1 year period with an airline or with a specific pilot?

Speaker 2

Well, I think it does a few things. I think first of all, to your question about Anything that causes a pilot to change airplanes or change the position from being a first officer to being captain, That by necessity and by regulation and that's on a global basis requires retraining. And our business is training and we're the By far largest in the world. So obviously, that's going to be a first order catalyst for us. So for us, It's a positive catalyst for business.

Speaker 2

There is no doubt about that. The other component about this is that we this the growth Everyone is focused as you would expect to make sure that we do that safely, Everything is outstanding. That in higher that basically plays to see strength because no one Trains more pilots in the world than we do. And that's where you see, for example, agreements that we have with, for example, we announced last Order with Boeing that we signed at the Paris Air Show with and we're immensely proud of the partnership with Boeing because that Partnership is all about Boeing selecting us to deliver their competency based training program Starting the one we announced it and going to announce it starting in India. And to me, That's UCC bringing technology to bear, bringing the sheer size of the footprint that we have, The amount of training hours that we do, the technology we bring to be able to give objective database insights To OEMs such as Boeing and to airlines across the world to make sure that they can efficiently basically bring on pilots, New plants move plants to different positions at a earlier age, while still maintaining the safety of the skies that we enjoy.

Speaker 2

That's what we do.

Speaker 8

Thank you for taking my questions.

Operator

Our next question comes from Christine Lagarde with Morgan Stanley. Please proceed.

Speaker 3

Hey, good morning, everyone or good afternoon.

Speaker 2

Good morning.

Speaker 3

Good afternoon. Mark, Sonia, maybe going back to the healthcare business, the past few quarters we finally see that to be profitable. Can Can you just give us a little background of why now for the sale? And then also as a follow on, I mean, the healthcare business was supposed to be An industry in which you had low market share that you had opportunity for growth. Now that you won't have healthcare anymore, Are you thinking about another potential leg to the business as a strategic area for growth?

Speaker 2

Well, let me start with Healthcare. Look, together in concert with the Board, obviously, we're always looking at a portfolio to make sure that we're maximizing The value and that's the value to all stakeholders. And so with the specific data health care, we find ourselves in a place today And we've been looking at this firm, not overnight obviously, but that the next wave of investment that's going to be required for this business It's probably best made by new capital providers so that we at CE can drive more focused investment and synergy in our core. So we think now is the right time. And I absolutely convinced that Madison Industries is 100 The right order for this business, I've had opportunity to talk with the CEO a couple of times.

Speaker 2

Our shared values and Our similar cultures to me make this transaction a perfect fit, again, for all stakeholders. And so That's really how I see that. With regards to another leg, I mean, what you've seen is we've already done the other leg and that software. So to a certain extent here, we're changing

Operator

Our next question comes from James McGarigle with RBC Capital Markets, please proceed.

Speaker 6

Hey, good afternoon and thanks for taking my question.

Speaker 2

Welcome.

Speaker 6

So I just wanted to ask another question on the defense margins with regards to that low margin business rolling off. So I'm just trying to better understand how these contracts get retired. Is it as simple as that on a specific date, these contracts come off the books And then the day after that, the margin profile improves by a certain percentage basis? Or is there a little bit more nuance than that? I'm just trying to get a better understanding of these contracts get retired and then what visibility, I guess, that you guys have into margin improvement on the backs Are these contracts coming off the books?

Speaker 2

It's really a question of finishing the contracts. There are a number of contracts where that we're executing that To deliver products and services to specific customers without getting the specific nature of each one. Each one has a contractual end date And your assumptions on our part with regards to the cost is going to take us to be able to complete those programs and deliver What we promised to the customers on time. So and literally on a weekly basis, we manage that to make sure that We basically can achieve what we said we were going to do, complete on time at the schedule A cost that we assume and that's really what we're talking about and with regards to the assumptions we've made with our For us to be able to do that portends the outlook that we deal with.

Speaker 6

Okay. And are you able to provide some color on those dates when those are going to be coming off the books?

Speaker 2

Look, I think that to me, it's again in aggregate, it's the trend lines What we've said, look, I think if I look at overall the programs that we have, I think it's safe to say that we'll be substantially complete With those in total by the end of next year. That's what I mean. Obviously, they will close on

Speaker 6

Not all at

Speaker 2

the same time, but again, substantially complete by the end of next fiscal year.

Speaker 6

Okay. And then just to turn to the other civil side of the business, and I'm not asking for Our fiscal 2025 guide, but more so thinking about how much room there is to recover to pre pandemic levels of activity Just looking at the most recent IATA data, still has passenger kilometers down 10% in Asia, down 4% in Europe. International travel is still down 7% versus pre pandemic. So on a high level basis, is the right way to think about growth in fiscal 2025, Whatever we assume that the base business can do in Civil in a normal environment, plus then a continued recovery to pre pandemic levels in Asia, Europe and international travel?

Speaker 2

I think, well, it's for sure that we're going to write it above pre pandemic levels. No doubt about that. And again, as I was saying a while ago, when About the cost savings that we've taken out of the business, just by itself, even at pre pandemic levels would mean a higher margin, Which you're already seeing in the results. A couple on to that. There's Business Aviation is very, very strong And that's a very good part of our business from a profitability standpoint.

Speaker 2

You saw the outsourcings that we're making. There's more coming down that path. So, Yes, I'm quite comfortable with it as well as a very strong demand environment that we're seeing across the whole business. So we don't have a target today for margins. They're going to go higher.

Speaker 6

Thank you very much. I'll turn it over.

Operator

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

Speaker 9

Yes, good afternoon. Just to come back on the transformational program that you were awarded. Marc, you mentioned that there was only 3% contribution in the quarter and this will go up to about 15% next year. Could you maybe provide some color about the profitability early days for those transformational programs? Just wondering about the accretion early days, whether they still contribute at a good profitability level or it takes Towards 3 years before ramping up at a good profitability level?

Speaker 2

It depends on the program, Okay. Benoit, Dave, because it's a service contract typically, they will it will take longer to because obviously, delivering service over time, Rubber products, which tends to do it tends to turn into revenue faster. In both cases, they're going to be accretive to the double digit goals that we have. So that will happen right from the get go, right from the start. So you won't have to wait long for that Just start being accretive to the numbers that we see.

Speaker 9

Okay. And just based on the comments Earlier about the pace for the legacy programs to ramp down, you mentioned Mostly completed at the end of fiscal year 'twenty five. Consensus is currently expecting defense margin to high single digit next year, almost Pretty close to double digit. Is that fair to say that it might be difficult to achieve based on the comments made earlier?

Speaker 2

Well, as I said, we're not giving guidance for fiscal 2025 today. So I'll keep it what we say throughout the presentation here, Not any new guidance from what I've said.

Speaker 9

Okay. Okay. And last one for me, capital deployment. Sonja, you made great color about reinstating returns to shareholders. In the opening remarks, you mentioned the focus On growth, debt repayment, investment grade and then return to shareholders, are there any optimal ratio you would like to operate going forward?

Speaker 3

I think like we mentioned in the past, the 3x was not necessarily the goal, but a waypoint. So really, what we're seeing is that we continue on the balanced capital deployment with deploying accretive capital, especially in the civil network, Whether it's the training centers and the simulators to address demand, and these are highly accretive within 24 to 6 months as we've seen in the past, and we'll continue to delever to kind of remain very comfortably investment grade. So ultimately, it's a balance of those and an ongoing conversation with the Board on potential capital returns

Operator

Our next question comes from Ronald Epstein with Bank of America. Please proceed.

Speaker 10

Good afternoon, everyone. This is Mariana Perezmora So my first question is about utilization rates. You have been growing a lot and penetrating in the civil training Market and with all these training centers and utilization rate is up to 71%, but you keep opening like new sites. What is the sweet utilization rate kind of like spot when you think about both profitability, but also being able to Capture these opportunities and when do you think you could achieve those type of like peak utilization sweet spot rates?

Speaker 2

Well, look, I think basically it's tough to answer your question specifically because You could I mean, we can theoretically go up to 100% utilization or higher on any individual training center. And you know what, we actually do that today On the number of training centers, but you can't maintain it there for the co fleet as a whole because obviously you got to Spend time for maintenance things like that. And I would say that 100% is not like every hour of a year. I mean in terms of our Commercial aviation training is about 6,000 hours a year. Our business aviation training centers are 4,500 Hours a year, which is more reflective of the kind of schedules we can do with Business Aircraft.

Speaker 2

But look, our utilization here is going Higher on average, we saw seasonality in Q2 because airlines have been flying a lot. If I look at Europe, this summer, it was very, very busy and our utilization was substantially low in Europe this summer, That's actually normal. We're back to seasonal rates and that's bled a little bit on to Q3. As we look forward, that's recovering in a quite substantial way. So, our focus is on maximizing utilization And the demand is there for us to be able to do that.

Speaker 2

So I think watch for increased utilization. And last thing I would say is, While we're opening up these new training centers and deploying a number of simulators, obviously they're taking time to ramp up. So that's affecting utilization that you see because they may be half empty or a quarter empty or Not full at all, yes. So that would affect the overall utilization that you see.

Speaker 10

And is it fair to think about 80% kind of level Whenever you get to this like normalized ramp up?

Speaker 2

Well, we can achieve 80%. We've done it in the past. So we don't have a target to stop. We'll maximize the utilization. There really is no Sweet spot.

Speaker 2

And we're continuing all training centers are different, different whether it's business aircraft or commercial aircraft. Again, for us, it's about meeting the unmet demand that's out there and ramping up to satisfy it. And We are deploying a lot of efforts and a lot of resources, both financial and human resources to as part of our digital transformation To improve the efficiency and the return that we get and maximize the schedules on the simulators in those training centers, So we can increase the amount of training we do and increase the returns on those assets. That's part of what we're doing here.

Speaker 10

Okay. Thank you. And then I'll dig a little bit deeper on capital deployment and shareholder friendly capital deployment. Getting to these like net leverage targets, how are you thinking about this? Like are you thinking about a regular dividend again or more Opportunistic kind of like special dividends or share buybacks?

Speaker 3

So we haven't come out With that view yet, we're on ongoing discussions and so won't necessarily get ahead of our Board today, but I can I assure you that we're focused on, 1st of all, closing the transaction, the sales transaction, continuing to generate cash? As a result, we'll continue that discussion and come back with Quantum and Vehicle in the future.

Speaker 10

All right. Thank you very much.

Speaker 2

Thank you.

Operator

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

Speaker 4

Thanks, operator. Good afternoon, everyone. Just stick to one question. A lot of U. S.

Speaker 4

Airlines Talking about their domestic demand is kind of plateauing or coming down, but they are kind of reallocating some capacity to wide body aircraft for international travel. I'm curious if you are seeing any significant changes in reassignment training with pilots, especially with respect to your North American customers.

Speaker 2

No. All of those factors are just adding to what I talked about, Sark, in terms of the what we call the churn, churn pilots moving from either narrow bodies to wide bodies or copilot to pilot Or from one plane to another from a regional to anything like that triggers Demand for training. And I could tell you there's a lot of unmet demand out there, both in commercial aviation and business aviation. And As I said before, we're ramping up to satisfying it and that is part of what really gives me the optimism for the future and Basically, the reality of YC that leads me to raise the outlook that we have for Civil in the back half of the year.

Speaker 4

Thank you.

Operator

Mr. Arnovitz, there are no further questions at this time.

Speaker 1

Thank you, operator. I want to thank all participants on the call

Operator

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

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Earnings Conference Call
CAE Q2 2024
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