CAE Inc.

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. You may now proceed, Mr. Arnovitz.

Good afternoon, everyone, and thank you for joining us. Before we begin, I'd like to remind you that today's remarks include a notebook for fiscal year 21 and answers to questions contained following statements. forward-looking statements represent their expectations as of today, November 10, 2020, and accordingly, our subjects 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 should caution not to place undue reliance on these forward-looking statements. A description of the risks, factors, and assumptions that may affect future results is contained in the annual MD&A, available on our corporate website and in our filings with the Canadian Securities Administrators on CDAR at www.cdar.com and the U.S. Securities and Exchange Commission on EDGAR. On the call with me this afternoon are Marc Caron, the President and Chief Executive Officer, and Sonia Branco, our Chief Financial Officer. After remarks from Marc and Sonia, we'll take questions from financial analysts and institutional investors. And following the conclusion of that Q&A period, We'll open the call to questions from members of the media. Let me now turn the call over to Mark.

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss some of the highlights of the quarter, and then Sonia will provide additional details about our financial performance. I'll come back at the end to talk about our outlook. We began the fiscal year just as the brunt of the pandemic wore down, And while we're managing through a still difficult environment eight months later, we're starting to see the results of our cost and cash actions and our initiatives to strengthen our market position. We drove solid sequential improvements in our second quarter, which is testimony to these efforts and to the resiliency of our business, which is largely recurring and driven by regulations. We delivered 13 cents of earnings per share and we generated $45 million of free cash flow, which is a good reflection of the cash generative nature of CAE's business. We also booked $668 million in new orders for 0.95 times the book to sales ratio. We saw sequential improvements across all business segments in the quarter, most notably in civil, where revenue increased 47% compared with the first quarter. This was driven by 49% average training center utilization and the delivery of 10 full-flight simulators. Demand improved in both commercial and business aviation training, with the latter recovering more rapidly, driven by the relatively higher level of activity involving the global installed fleet of business aircraft. Civil enjoys a high degree of operating leverage in training, and the higher volume helped drive his operating margin back to the double digits, coming in at 14.2%. We also continued to book new orders, with Civil signing training solutions contracts valued at $353 million. These included three full-flight simulator sales, a five-year business aviation training agreement with a charter company in the United States, a five-year exclusive training extension with Virgin Atlantic, a two-year business aviation training with ExoJet Aviation, and a two-year business aviation training extension with VistaJet. In defense, we also began to see a more positive picture than the first quarter, with some movement on programs impacted by COVID-related restrictions and a resumption of certain training operations. Defense revenue grew 8% over the last quarter, and operating margins improved to 8%. Notwithstanding a still challenging environment, defense booked orders for $278 million, including contracts to continue providing fixed-wing flight training and support services to the U.S. Army at the Sea Dozen Training Center and to support Leonardo with AW139 and AW169 full-flight simulators. other notable contracts, including providing the United States Air Force with upgrades and enhancements to both the KC-135 and C-130H Air Crew Training System programs. Defense also received orders for maintenance and logistics support services for the German Air Force's Eurofighter training devices, and to support the development of a single synthetic environment for the UK Strategic Command. In addition, we were awarded a prototyping contract to support the US Special Operations Command's Global Situational Awareness Program, which will leverage synthetic environments to fuse data into a common operational picture for improved planning and decision support. And in healthcare, revenue grew by 66% compared to last quarter and was 22% higher than last year. With the benefit of additional volume and the commitment commencement of CA air one ventilator deliveries, healthcare's margin reached 8.6%. I'm very proud to say that we're continuing to support healthcare workers in the fighting against COVID-19 with complimentary webinars and learning modules for clinicians. We recently developed a pathogens of high consequence learning module to help prepare clinicians for infectious disease outbreaks. Not only is this the right thing to do, being there for customers and frontline workers in this difficult time. I also believe it cements TE as a leader in developing training content in the healthcare space. With that, I'll turn the call over to Sonia, who will provide additional details about our financial performance. I'll return at the end of the call to comment on our outlook. Sonia?

Thank you, Mark, and good afternoon, everyone. Consolidated revenue of $704.7 million was up 28% compared to the first quarter and is 21% lower compared to the second quarter last year. Segment operating income was $79.3 million compared to a loss of $2.1 million before specific items in Q1, and an income of $126 million before specific items last year. Quarterly net income before specific items was $34.2 million, or 13 cents per share, which on the same basis compares to negative 11 cents in Q1 and 28 cents in the second quarter last year. Free cash flow was $44.9 million in the quarter, which is an improvement over the negative 7.1 million free cash flow result last year. The increase results mainly from a lower investment in non-cash working capital, the suspension of the dividend, and lower maintenance capital expenditures, partially offset by a decrease in cash provided by operating activities. We expect to be free cash flow positive for the year based on our expectation for continued positive operating cash flow and the expected timing of reversals in our non-cash working capital accounts. Return on capital employed for four specific items was 7.2% this quarter compared to 8% last quarter and 11.5% last year. Growth and maintenance capital expenditures totaled $15.2 million this quarter and for the first half of fiscal year, total $33.2 million, relative to our outlook of approximately $50 million. We expect total capex of approximately $100 million for the year, commensurate with our opportunities to invest incremental capital with accretive returns and free cash flow. Income tax recovery this quarter was $1 million, representing an effective tax rate of 14%, compared to 17% for the second quarter last year. The tax rate was lowered due to the impact of restructuring costs, partially offset by the change in the mix of income and losses from various jurisdictions. Excluding the effect of the restructuring, the income tax rate would have been 25% this quarter. Our net debt position at the end of the quarter was $2.4 billion, for a net debt to capital ratio of 50.1%, and net debt to EBITDA before specific items was 3.16 times at the end of the quarter. All told, between cash and available credits, we continue to have approximately $2 billion of liquidity. We are making good progress with our recently announced restructuring program intended to enable CAE to best serve the market by optimizing our global asset base and footprint, adapting our global workforce and adjusting our business to correspond with the expected level of demand, and enduring structural efficiencies that we will drive. These measures include the introduction and the acceleration of new digitally enhanced processes, such as remote installations and certification, and work-from-home practices. We continue to expect to record the restructuring expenses of approximately $100 million for the entire program, which will be carried out for Fiscal 21 and into Fiscal 22, consisting mainly of real estate costs, asset relocations, and other direct costs related to the optimization of our footprint and employee termination benefits. Actions include the consolidation of some facilities so that we gain efficiencies from operating from larger centers, and we'll also be relocating several training assets to optimize utilization. Taken together, these measures are expected to enable CAE to emerge from current periods from a position of strength, and we expect to fully realize our annual recurring cost savings of approximately $50 million starting in our fiscal 2022. We began executing a restructuring program this quarter, and at the end of September, we had incurred $51.1 million of restructuring expenses. With that, I will ask Mark to discuss the way forward.

Thanks, Sonia. The COVID-19 pandemic continues to be a day-to-day global reality, and we're encouraged to have learned yesterday on the progress being made to discover a vaccine to this terrible affliction that has so deeply affected the lives of so many. As we consider the step-change improvement in quarterly performance that we just delivered, we recognize that the continued pace of CE's recovery from this point forward will be highly correlated to the rate at which travel restrictions and quarantines can be safely lifted and market activities resume. Short-term visibility in that context remains limited, however, I take confidence in the fact that we're in a better position now than we were at the start of the fiscal year, and we continue to expect a stronger second half. Looking beyond the current period, we remain encouraged by CAE's long-term prospects. We're seizing opportunities to strengthen CAE internally during this period, and as you've heard from Sonia, our restructuring program currently underway is on track. We're also well-positioned to bolster our standing as the global market leader in our field through the application of advanced technologies and by expanding the aperture of our market reach. We're continuing to invest in CE's capabilities to revolutionize our customers' training and critical operations with digitally immersive solutions and to increase our market share. And we remain confident that CE will emerge from the current period as an even stronger company. looking at each of our business segments. In civil, as the global fleet gradually recovers and daily flights resume service, we expect to continue to expand our market share and secure new customer partnerships with our innovative training and operational solutions. We continue to have discussions with airlines about potential outsourcing and partnerships. And while we don't control the timeline of those agreements, we expect some of our pipelines to come to fruition in the period ahead. At a steady state, business aviation training represents about a third of our civil business, and based on global aircraft fleet activity levels, we expect this segment to continue recovering faster than commercial aviation. Demand for civil full-flight simulators is driven by new aircraft deliveries, and while the total market is currently much smaller, we expect to maintain our leading share of available full-flight simulator sales. We benefit from a large backlog of customer-funded full-flight simulator orders and we expect to substantially deliver this backlog over the next couple of years, including 35 to 40 this fiscal year. In defense, we're managing through a transition year as we work our way through the short-term challenges brought by the pandemic and as we ramp up new leadership. The long-term outlook for defense continues to be for growth, supported by a large addressable market for our innovative solutions and the realization of the benefits of our bolstered team that we'll bring to bear. I'm very encouraged by our recent competitive wins at large pipeline, which bode well for defense in the long term. Despite near-term headwinds, we're maintaining our leading position as a training and mission support partner thanks to our leading-edge capabilities in translating the physical world into the synthetic world. We're expanding beyond training to become a leader in digital immersion and the application of its synthetic environments to support analysis, planning, and operational decision-making. With our expertise in the integration of live, virtual, and constructive training, along with capabilities to address mission and operations support, we believe will make inroads into the broader defense market in the period ahead. And in healthcare, we've also bolstered our leadership to enable CAE to fully capitalize on the greater market appreciation of the benefits of healthcare simulation and training to improve safety and to help save lives. The pandemic is serving as a catalyst to accelerate digital transformation across the enterprise. And in healthcare, we see an emerging growth vector with the ramp-up of distance learning this fall. While still early, I'm encouraged by our progress including new tools we just recently introduced on how to deliver training using our platforms, Maestro and CA Learning Space, which offer remote and distance learning capabilities for virtual clinical examination and telehealth training. In closing, I'd like to thank all of the employees at CAE who are collectively responsible for these solid results against the macro backdrop that has been complex. And of course it goes without saying under higher than usual uncertainty. Our employees have conducted themselves through this challenging last eight months with true professionalism and teamwork, retaining an impressive and singular focus on serving our customers as their partner of choice. I'm truly inspired and humbled to lead this great team of people here at CE, and I couldn't be prouder of how we rose up against an incredible macro event that's almost been like a wartime effort and are arising from it stronger and even more aligned together. With that, I thank you for your attention, and we're all ready to answer questions.

Operators, have you received any questions from analysts and institutional investors?

Absolutely. Thank you. We'll now begin the question and answer session for our analysts. Please note, if you would like to register for a question, press the 1 followed by the 4 on your touchtone phone. You'll hear a three-tone prompt to acknowledge your request. If your question has been answered and you'd like to withdraw your registration, press the 1 followed by the 3. One moment, please, for a first question. Our first question comes from the line of Steve Arthur with RBC Capital Markets. Please go ahead.

Great. Thank you very much. Just a couple of questions. First, on the training center utilization, the 49%, I realize, is an aggregate of many different training centers, different simulator types. But just wondering if you can expand a little bit more on the dynamics within there. for example, the utilization at business jet training versus commercial, or in addition to the recurrent training, any signs of more transition training as pilots move around for different aircraft types?

Okay, Steve, I think that maybe a little slightly higher in business aircraft. It's been doing somewhat better based on the fact that business aircraft has been less affected overall in terms of the flight activity, which is the driver for us. Commercial, I think it's kind of plateaued, and as we said last quarter, it's pretty much in line with the activity on the aircraft, the commercial aircraft that are being utilized right now. If you look at the market right now, it's been, overall for commercial aviation, there's been an approximate 50% recovery in daily flight activity, which is obviously well off the lows, you know, back in April, which explains, you know, part of the explanation for our sequential performance here. But, you know, it's more or less plateaued in recent months, you know, as we went into the fall with the second wave and everything. Business aviation, as I mentioned, has been recovering faster than commercial. And, you know, I continue to be bullish on that because it does represent about a third of our civil business. And if you just look, put some numbers around, the business jet cycles in the United States and Europe are within about 10% or 15% of pre-pandemic levels, which is pretty impressive when you think about it. And anecdotally, and I provided a little color last quarter on this, our charter operator customers are seeing significant volume in business aircraft from customers who are new to private jet travel. And in my experience, again, from nearly 35 years in this industry, once people experience private jet travel, there tends to be a high retention rate. So that's the kind of color I would give you right now with regard to utilization.

Okay. And it's still the same dynamic within the two, more and more wet training with business jet training and a lower but growing amount in commercial? Yeah, that's about right, yes. I guess just related to that, just any updates at all on the nature of the potential outsourcing agreements with airlines? Of course, you can't get into any customer specifics, but are those kind of conversations still advancing, and what's the reception with the airline customers?

No, absolutely. There's several discussions on the way. That hasn't changed yet. The dynamic continues that airlines are more amenable to partnering with us to become more resilient and have flexibility in their training operations by turning a fixed cost into a variable cost. You can well imagine that airlines are pretty busy these days in terms of managing their operations, but I do believe that some of these deals will come to fruition soon. You know, and it's just natural for us. So, but, you know, we'll keep you informed as the, you know, we don't control the timeline, certainly, and we're patient.

Okay. And I guess just a final one for me, just on the healthcare segment. Any color you can provide on the contribution from the ventilators in the revenue in the past quarter or the sense of the scale of that 10,000-unit order? Sure.

Well, in the quarter, we had approximately $7 million of revenue that came from the healthcare sector that came from the ventilators. It's modestly profitable. That's what we expect. We've been deliberate not to create expectations on the profitability of those ventilators because although I do expect them to be profitable and cash generative, I mean, you can well imagine that You know, what we're doing here is reacting primarily to what really is a biological wartime effort here to do our fight against COVID-19. And I'm extremely proud of what we've been able to do. But our top priorities on the contract are really making sure of the quality of those devices and the speed to market, because obviously we want to put it in the hands of the public health authorities as quick as we possibly can. Does that answer your question, Steve?

Yeah, no, I think it does. I understand that and appreciate it. Okay, thank you.

Thank you for your question. Our next question comes from the line of Konark Gupta with Scotiabank. Please proceed.

Thank you, and good afternoon. So maybe just wanted to follow up on the utilization. TransU spoke about commercial versus business aviation. Within commercial, obviously, there are multiple silos there as well, like narrowbody, widebody, as well as cargo. I wanted to understand, given, obviously, widebody fleet still remains pretty much grounded by 50% or so, narrowbody might be doing better. So any sense you can provide on utilization rates for you guys on narrowbody side, as well as cargo, given a lot of airlines and operators are accelerating cargo, passenger to freighter conversions these days. So how are you leveraging those opportunities? Thanks.

Well, I wouldn't break it down right down to that level, but I can tell you, as we've said before, about two-thirds of our training footprint is narrow. Oh, actually, it's about 75%, actually, of our fleet is narrow body. So we're well exposed to that. And Actually, a lot of aircraft, those that we do have on wide-body, some of them are being used for cargo, and we're actually seeing actually a lot of narrow-body airplanes being used for cargo and being converted to that end.

Right. But are you seeing any significant increase in cargo training, Mark? No.

Well, definitely there's more. I'm not saying that you don't know. There's a lot more cargo activity. And to the extent that we train cargo, yes, we have seen improvement in the training that's related to training of cargo aircraft crews, for sure. I just wouldn't break out the number for you.

Okay, no problem. That's good, Khalid. Then moving on, on the commercial side on MAX, Obviously, MAX is getting quite close to its recertification, I guess. A couple of airlines in the North American market have spoken about ungrounding them pretty shortly. And Boeing has disclosed the backlog is sitting around about 3,300 aircraft. So my question is really on, you know, if you can help us understand the size of the potential opportunity for CAE from MAX in terms of, you know, what is the incremental demand potential for simulators as well as training as MAX comes back, or do you see maybe a pent-up demand after they have delivered maybe a couple hundred or so aircraft?

Well, I don't think, look, obviously there's a short-term dynamic that's occurring here, but I think, Anand, I would get, when you look at all of the The whole order book that you mentioned that's Boeing, I mean, it's got a very solid order book, as we know, very large. And when you look at the basically excluding lessors, there's about 73 operators at the moment who account for about 1,300 of those orders on max that we know they don't currently have a max train solution. So that gives you an idea of the opportunity for us over time. And I think that the dynamic will be similar in a steady state to other narrow body deliverers that we've had. So in the past, we've given you the market driver statistic that we use that every about 30 narrow body deliveries necessitates a simulator in the market. And now that it's clear that the MAX will require simulation-based training, you expect that airlines that previously were going to be able to, let's say they had an NG fleet and were going to transition to a MAX, well, maybe then they're going to be, well, most likely they're gonna be less using their NG simulators because it'd be more advantageous to them to move to a permanent solution using MAX simulators or outsourcing their training you know, to providers like ourselves, you know, which offer max training. So that gives you some of the, like I said, as a steady state, I expect this to be just like another narrow body type.

Right. And I think Boeing was recently mentioning about some updated pilot training requirements that the regulators from the U.S., Canada, Europe have mapped out. Have you been involved in those discussions at all, or do you expect discussion going forward?

Well, I wouldn't break it down. I'll leave it. Boeing answer the overall questions that are asked, but I can tell you, though, that we have high-level meetings. I personally am on a call every month with senior leadership of return to service at Boeing. We're a partner to them to get the fleet back in the air and to support the authorities and our customers because we have you know, the great majority of sales of simulators for 737 MAX we have. So you can well imagine that we're involved, but in terms of the decision-making is coming out of the authorities.

Okay, thank you for that. That's all my questions.

Thank you. Our next question comes from the line of Fadi Shamoon with BMO. Please proceed with your question.

Yes, good afternoon. Thank you. Sonia, we're getting a lot of question about this Canada wage program, I guess, and I think it's collected year to date, somewhere around 80 million. And I think in this quarter, around 35 million. Should we consider these as income that would have otherwise basically subsidizing or offsetting what could have been wage reduction or headcount reduction or things like that? Or is there a bottom line impact from these wage subsidy program on the first half results? And if you can, if you have visibility, if you can give us an idea, what do you expect from those kind of programs in the second half of the year?

No, so you should absolutely look at it as ultimately an offset, as you mentioned. Part of the mitigation measures we sought out, different government programs globally, and we sought about, I think, 20 different countries. The lion's share is really in the Canadian program. So the other countries, sometimes it's literally just a flow-through that the government's used to subsidize the employees. The Canadian program is slightly different. So in total, as you mentioned, $35 million in the quarter. But as you'll remember, some of the measures that we took quite early on was highly impactful. 2,400 people furloughed or reduced work weeks and so on. And so what this program essentially allowed us to do is to call back those furloughs and employees and work weeks. So essentially neutralizing the impact. So it's relatively neutral. As for the future, you know, the program is continually being changed. It's still there until June, and a lot of moving parts to really kind of be able to answer that question.

Okay. Okay, that's great. The other question I had is on the cadet training program. I think you have a number of cadet training program with various airlines. have these programs been kind of scaled back? I'm just trying to understand how kind of airlines are looking at some of their ab initio training requirements going forward that they're scaling back, or are you seeing them kind of remain with their original plan despite the pandemic?

Well, that's exactly the case, Fadi. People have maintained their original plans. Don't forget it takes at least, you know, near about two years create a pilot. And actually, we came out with our, you know, speed pilot forecast just yesterday. If you have a look at it, I still think it's a good career to become a pilot. And because we were in a pilot shortage situation, as you will recall, in the not so distant past. And, you know, although obviously, you know, the pilot profession has been affected significantly in the shorter term because of COVID. Right. the wave of retirements as well as, you know, basically movements in the workforce will recover, and we will need, you know, quite a number of pilots going forward. So going back to your question, all of our programs have been maintained. In fact, we've won more business. We won, for example, with Boeing. We announced that last quarter a contract to deliver pilots for them. So I haven't seen any impact. In fact, our flight – Our flight hours are basically the same. The only effect that we've had is where we've had to close centers temporarily, like, for example, in Australia, in Melbourne, because of COVID, and that's affected our flight operators. But at the end of the day, going back to our applied demand forecast, what we forecast is demand for 27,000 new pilots by the end of 2021. And if you think about it, it takes two years to – to make a pilot, you want to make sure that you maintain it, and that's what our airline partners are doing.

Okay, that's great, Carlos. Thank you. And maybe one last question. You said 35 to 40 deliveries full flight simulator this year. If you have enough visibility, can you give us an idea what kind of orders run rate do we expect this year?

What kind of runway you meant? Sorry, I missed that.

A run rate on new order sales.

Go ahead, Sonia, to answer the question.

I think, you know, what we've said is that we expect order intake or order sales, the number of them, to be lower this year reflecting the environment. Okay, that's the orders. We'll keep and expect to keep a market-leading share of that.

Yeah, that's exactly right, Betty. Thank you.

And thank you. Next, we have a question from the line of Kevin Chang with CIBC. Please go ahead.

Hi. Good afternoon. Thanks for taking my question here. And thanks for the color on the cues and how you think about it, Sonia. So if I look at, you know, in the quarter, you did a mid-teen margin with utilization of 49%. You know, the last time we saw your margins around these levels, utilization of somewhere in the 60s, and I know MIPS plays a role, and you've obviously taken a lot of cost-cutting measures here, but do you think you can get back to pre-pandemic civil margins at a significantly lower utilization rate than you were seeing, I guess, pre-crisis, just given where your revenue mix sits today?

I think I'll maybe comment on the quarter first. And, you know, we're comparing a highly kind of impacted Q1 versus kind of maybe a little bit, I guess, more stabilized dynamics in Q2. And what it highlights is that the model has really good operating leverage, right? So we saw more volume through the utilization. And also, like you said, mix matters and has an impact. So there's a higher proportion, a faster recovery on VAT, which is generally higher yield. But also, there was a higher volume on the product side. So you'll remember that there was only two deliveries last quarter. So revenue is driven on the delivery side. And so 10 in this quarter, you know, helped also on the volume and drive the leverage there. Going forward, I think, listen, it's a bit early to kind of give outlooks for the future – for upcoming years. But, you know, that's the reason we've engaged in this restructuring program and really kind of focusing on internal processes, the optimization of our asset base footprint, really focusing on digitally enhancing processes. and kind of taking the lessons learned of the pandemic and more and becoming even more efficient, right? And so driving $50 million of recurring structural savings for FY22 and on. And so that will be part of that conversation because the volume doesn't necessarily have to come up at the same level or at the same speed to drive a higher level of profitability.

I appreciate the color there. Maybe just turning to healthcare, it looks like a little bit of a leadership change there with Heidi Wood taking over as president or being appointed as president. And I think, Mark, you mentioned some of the opportunities that you see within healthcare that may have materialized here during the pandemic. Just wondering, as you look at those opportunities, do you see those as being complementary to the previous strategy you had within healthcare or Or should we think about this segment now kind of pivoting towards another direction? And it feels like this division has been in a bit of an incubation phase for, I guess, quite a while now. Just wondering when you think it hits an S-curve within its growth trajectory and it kind of breaks out of this kind of 30-some-odd million of quarterly revenue that seems to generate pretty consistently right now.

Well, look, I tell you, I am very bullish on Heidi Wood leading our medical division. We're absolutely sure about that. I think if anything has been, is going to be propelled going forward, you know, post-pandemic, one of them is going to be the propensity for simulation-based training in healthcare. And I think what We're quite happy, and I know I just had a review with Heidi with regards to the healthcare division, and she's very, very complimentary of the people in the organization, the products and services suite that we have. As I've mentioned before, the products that we have in the healthcare division are very profitable, and in a lot of cases, more profitable than in our core services. more core divisions, and it's a question of volume. It's a question of volume. We know that we expect that the volume is there. She's been meeting with a lot of customers and came away from very encouraged. So I would basically say that we're putting an executive in charge here, an executive with a lot of bandwidth, a lot of experience, and a lot of business experience, and that is singularly going to propel our products and services and lead the workforce to what I know is the growth that's out there in this business, which is only going to get better in this post-pandemic world.

That makes sense. Maybe just the last one for me. I think you're in the midst of kind of repositioning some of your assets, just given all that's happening in the world today, and you did put out your pilot outlook yesterday. I'm just wondering, when you think of repositioning your – your assets, do you think of positioning them based on kind of decade outlook of where you see pilot demand and where you see, you know, various growth rates across various continents, or are you taking a more near-term approach and trying to position those assets where you see maybe near-term growth where, you know, Asia-Pac, you know, might be returning faster to travel and some other markets are a little bit more constrained because of travel restrictions?

No, look, just like the rest of our business, we always take a strategic view on it, and it's certainly not a short-term consideration. And as I mentioned when we talked about the restructuring and, you know, the asset relocations and some of the trade center consolidations that we're having, some of them that we've announced already, is mainly looking at the, you know, what is going to be the market demand or sort of the demand that we expect to be out there based on the forecast of the industry's recovery. And, of course, the conversations that we have with airlines around the world and business operators. I mean, this is one of, again, crisis, you know, favors, like this one favors the leader. And one of the, you know, consequences of that or, you know, maybe an artifice of that is the fact that we have conversations with the majority of the world's airlines because they are our customers in one way or form. So we're able to get a pretty good view of what training activities should be like over the next two to five years. And that plus the IATA forecast is what we use to basically plan our footprint going forward.

That's it for me. Thank you very much for taking my questions.

Thank you. And we now have a question from the line of Cameron Dorkson with National Bank Financial. Please proceed.

Yeah, thanks. Good afternoon. Question on defense. Mark, you had some prepared remarks on the defense business there. I'm just wondering if you can go into maybe a little more detail on what the game plan is going forward to improve the profitability in defense because, as you know, it has been lagging for a number of quarters.

Yeah, well, look, first and foremost, I think it's, you know, I always say there's nothing wrong with the defense business that a few hundred million dollars of orders weren't fixed. I say that, and I say that to the team all the time. So, clearly, it's about growth, and you throw more growth, and of course, when we bid on projects, we certainly bid to be able to go into the contract with a market that will be creative to CAE. I mean, obviously, it depends if it's a service or a products contract. So, first and foremost, get more volume and more volume, of course, that affects your profitability, because you lower your your overhead rates that in which case that helps you the even better makes you more profitable and more marketable going forward. In terms of winning bid, at the same time, we can absorb more SG&A. And that's where we get multi year service contracts that helps because you don't have to eat what you kill every year. And we have a project underway, which is part of our overall restructuring and the approval programs that we've launched and learning to do things differently with some of the insights that we've gained during the pandemic and before. And, you know, we call those internally Project Phoenix, Project Crossroads. And those, to me, a couple more growth will be the result in better execution, coupled with growth will result in what I certainly expect to be double-digit margins in defense.

Okay, so that's good. Thanks. And just secondly on, I guess, maybe a capital allocation question, I think the free cash flow is probably trending a little better than what you might have expected earlier in the fiscal year. So I'm just wondering if you can comment on when the decision will be made to reinstate the dividend, if that's something that we should potentially expect in the next couple of quarters.

Well, I tell you that capital allocation priorities haven't changed. We always take a balanced approach to invest in Our first priority, which is a creative and sustainable growth opportunities while maintaining a solid financial position. That's what we're going to be doing. The current return to shoulders, you know, have been there in the past, obviously. And it's always been a function of level of excess free cash flow. And it's an ongoing discussion that we have with the board. So I think we have to, you know, look at things on a case-by-case basis as we go. But there's a lot of, we see, you know, pretty interesting growth opportunities in front of us right now.

Okay, fair enough. That's all for me. Thanks very much.

Thank you. And we now have a question from the line of Benoit Poirier with Desjardins Capital Markets. Please go ahead, sir.

Yeah, good afternoon and thank you. Just on defense, could you provide maybe an update on the large project contract that were in pack early in the pandemic and maybe the mix between equipment and services you're seeing these days?

Well, I think, Benoit, as we said, this year in defense is a transition year because of some of those issues that we have on large contracts, contracts in the Middle East, which we were – literally tools down, and in some cases, still tools down, and the level of less traffic in some of our training centers because of pandemic-related restrictions. Certainly beyond this current year, we see a growth business, and I'm quite encouraged with our new defense leader, Dan Galston, and the amount of insight he's driving into business, the amount of leadership and energy he's driving here, so I'm quite confident in that In terms of product-service mix, it's pretty similar to what has been the past.

That's when you want to add to... Yeah, it's still, I think, a higher proportion on the services side than the product side, and that's being reflected in the margins also.

At the moment, about two-thirds, I think.

Yeah.

Yeah, two-thirds, yeah.

Okay, that's great. And maybe could you share any thoughts about your expectation for the new leadership under Daniel Gelson? And maybe if you could give an update related to your active bidding proposal, the amount that you tend to disclose every quarter. Thank you.

Well, I think I can sit in previous question. I'm very pleased to have, you know, someone of Dan's caliber on board at C8. Dan has very positive energy that he brings to the team in defense. And, you know, I'm very, very confident he's going to do great things to bring out the full potential of our business. which, you know, going back to the question that was previously said, admittedly was not the case for, you know, the last couple of years. So he brings a wealth of knowledge and experience, you know, specifically in the kind of business that we have in running an SSA company and a special security agreement. You know, we're a tech company needing that to be able to sell, for example, to all branches of the U.S. military, which we do. He understands the landscape within the current requirements in defense for, you know, multi-domain warfare and the real, you know, going forward, what is going to be training to deal with near-peer threats that are out there, which is different. He understands the technological capabilities of C80 and really how to leverage them into high-value areas like the contract that I mentioned during my remarks, the single synthetic environment or special operations command, just as using that example. So, look, we've made some structural improvements in defense. And so, look, I think stay tuned. We're confident that defense is a solid growth business the longer term. And the latter end of your question, I think the number that we have right now is $4.8 billion.

Okay, that's great. And the last one for me, you talk about the growth opportunities. How should we be thinking about CapEx post-fiscal 21 as there might be some catch-up given the growth opportunities you foresee?

Benoit, I think we just came out with guidance for this year. So CapEx to date at $33 million was tracking a little under the $50 million that we provided as guidance. And and planning for $100 million for the year. Beyond that, I think we'll wait until March and May. So some of that CapEx is related to footprint optimization as we consolidate training centers. And, of course, we'll pace investments with the level of demand in line with customer contracts. But essentially, where we have and we continue to see some opportunities for some platforms where there's demand, where there's these opportunities, CapEx deployments drive nicely accretive returns and really, you know, within the five-year horizon are driving 20% to 30% incremental returns and it's a good prospect for cash. So where we have, if we continue to see those opportunities, we'll be acting on them.

Okay, thank you very much for your time.

Thank you. And now we have a question from the line of Doug Taylor with Canaccord Genuity. Please proceed.

Yeah, thanks. Good afternoon. And thanks for taking my questions. Just a couple for me. Firstly, with respect to the restructuring benefits, the $50 million that you were targeting, and I'm sorry if I missed it, but can you update us on where you are, what was recognized within the quarter or how you now expect the remaining benefits to ramp over the coming quarters?

So we incurred $50 million of costs this quarter, and it'll kind of go into Q1 of next year, but the bulk of those charges we expect this year. But there's some longer lead items with asset relocations and facilities optimizations. Now, in terms of the benefits, the guidance and the info is $50 million of recurring structural savings starting fiscal 22th. So we just started the program, and a good part of that program is footprint asset optimization. It would require some bit of time to consolidate the facilities. And also, you know, Mark was talking about all the digital process enhancements, et cetera, that are underway and so on and ongoing throughout the year. So we'll really start seeing the benefits come through next year, maybe some a little bit this year, but really next year, $50 million of recurring structural savings.

That's helpful clarification. My second question is with respect to the types of deals that you're looking to potentially cut with some of your airline customers for outsourcing training, and that's certainly an exciting growth vector during this pandemic. So when and if that happens, can you speak to whether there are incremental investments that would be required on your part, or will you be taking on additional capacity to Or would all, you know, the potential business you would be outsourced to you, you'd be able to service within your existing portfolio and infrastructure? That'd be helpful. Thank you.

I think it depends on the deal, obviously, that we look at. But, you know, if we look at past airline outsourcings, the way we've done them, you know, there's been quite a number of different types. But the In a lot of cases, what we take over, for example, the partner's existing assets. Think about what we did with Japan Airlines, Singapore Airlines. So, they basically contribute their existing training assets or simulators. So, that's one way of doing it. So, either way we look at it, our view, it has to be accretive to go for a picture and And I would expect that sometimes we're going to be combining assets to be able to do that. Okay. So is there any – go ahead.

Go ahead. Carry on. I was just going to ask, I mean, given the pandemic is, you know, obviously a new phenomenon for the airlines, if, you know, that has changed the, you know, the decision-making with respect to outsourcing to favor a certain – type of outsourcing arrangement versus prior cycles?

I don't think so. No, I think, look, in the end, it's usually the same kind of dynamic. If you're an existing airline and you have a training operation, you still have – don't forget, and that's a great thing of our business. It's a regulated business. Every six months, typically, pilots have to go back for training. So if you're an airline – you have to either have the capacity for all your pilots to be able to train on a regular basis and to take advantage or necessitate initial training as you basically have pilots retire or pilots furlough, so you have movement in your pilot workforce. So, you need the infrastructure. So, if you're already an airline, then most likely you have that infrastructure. So, typically what you bring into the deal is that those assets and we're very good about, because that's our business and we do it for a very large number of airlines to tune of a million flight hours a year, a million training hours a year. We're very good at extracting maximum utilization by efficient scheduling, efficient delivery of the courses. So typically what we would do is have less of a need and then we're able to offload some of that capacity and sell it for third-party training. So I wouldn't expect the dynamic to change very much from that standpoint, except to say that in this kind of environment, we have more discussions because, you know, people want, you know, really want to understand that because if they can make their cost structure lower, which you could certainly do, and more, and perhaps even better, make it variables only use You know, you only pay for what you use and when you use it because typically, for example, the Western world, in a normal year, which, of course, this is not a normal year, but seasonal patterns are you don't train in the summer because you're flying. But if you have your training infrastructure, then you're paying for it, the air goal being an advantage. And the only thing, of course, is that these days, obviously with the pandemic, you know, still very much out there. You know, airlines have a lot under place these days, and this is typically the same themes. So hopefully that gives you a bit of a broader color. That's very helpful. Thank you very much.

Thank you.

Thank you.

I want to thank all the members of the investment community for their questions. With the time remaining, I'd like to now open the call to members of the media. Should there be any questions from members of the media? Yeah.

Thank you. Now we're going to continue on. This is a question and answer session for the press and media. If you would like to register for a question, press the one followed by the four. Members of the press and media, we welcome you to register your questions. Press the one followed by the four. One moment, please. The first question from the press and media comes from Ross Marowitz with the Canadian Press. Please proceed with your question.

Hi, Mark. I have two questions for you. One is you talk about how the recovery is going to be closely tied to the lifting of travel restrictions. Do you have any sense of timing of that, or has your view on the timing changed recently?

Well, I have the same view as everybody else, but To be very frank, it hasn't changed. I mean, we model our planning based on the IATA forecast at the highest level, and that's complemented with discussions that we have with individual airlines because it's no exaggeration that the bulk of the world's airlines are our customers one way or another. So I think that way that translates is IATA – forecast about a 66% reduction in passenger traffic this year. So that's what we would use overall. And that it also calls for air passenger traffic to recover to 2019 levels and late 2023, early 2024. You know, maybe that gets better because of, you know, news we had yesterday, maybe, but you know, to hopefully does that would be great. But our our planning is hasn't changed. from those statistics I just mentioned.

Okay. And the second thing is, I'm wondering, in terms of defense spending, with the new administration in the U.S. coming in, are your expectations of orders or business going to change?

No, no. And the reason I would tell you, two reasons. Number one is that, first of all, I would tell you that the day that the orders that we can get at CAE being a proxy to the size of U.S. Defense Department, I would be very happy. I think we have lots of opportunity to grow within the defense budgets that are out there today and are foreseen to be out there under any reasonable scenario going forward. The other thing is that the products and services that we provide, we, by definition, align ourselves to the defense strategy and the expected defense, where the money is going to be spent over the next few years. And the great thing about, for example, governments, and specifically if I was to use the largest defense market in the world, the U.S. Defense Department, basically they tell you what they're going to spend on over the next few years. So our investments in research and development and bidding activity are very much aligned to those national defense priorities. So I feel very good about our prospects for growth in the next few years. And then we – and I think one thing that's obvious in there to understand is what we do in simulation-based training, that actually saves money relative to, for example, training which – you have to do, you have to continue to do. So if we can move more of that training, assimilation-based training, well, obviously that reduces costs. You're on the sphere of goodness there.

So you're not concerned about new government reducing spending on defense?

No.

Okay. Thank you.

Thank you. And up next, we have Alison Lampert with Reuters. Please proceed.

Hi. So when would you expect non-US regulators like Transport Canada and EASA to lift the MAX grounding compared with the FAA? And as a follow-up, are you, so what kind of timing are you seeing in terms of bookings for the MAX training?

Well, starting with your first question, Alison, look, I can't answer for the regulators, but, you know, the comments that I've seen, you saw probably news from the FAA literally today, positive comments from the head of the FAA today, I would expect Transport Canada to not be far behind, typically just because, you know, they've been doing their, you know, their certification testing in lockstep. But again, I can't speak for them. And, you know, the comments that I've seen from the head of EASA, Patrick Key, most recently on the recovery, the certification of the 737 MAX has been positive. So I would expect that would come sometime behind. But again, I'm not the guy that, really can answer with any certainty with regards, except that it's all looking very positive at this stage. With regards to MAX orders, we're booking them now. We have, again, the lion's share of the simulators for the MAX have been won by CE, and I would expect that we're going to continue to do well there, and we're continuing to deploy MAX simulators for our own training centers in that regard.

And what about bookings for the training centers? When are you seeing those? When are people coming in?

Well, actually, people are training now. I'll give you an idea. Well, for example, here in Canada, Air Canada has two of our MAX simulators, and I can tell you that even though the fleet has been grounded, as it has been around the world, Air Canada has maintained the training of their pilots. I think they had about Remember, he serves about 500 pilots that were trained on the 737 MAX, and they've continued to keep those pilots trained. So training activity has not stopped. It's continued during this whole time because of the time it takes to ramp up pilots. So it may take only a day or two to take an airplane out of mothballs, but if you haven't prepared for it, it could take you literally months to get your pilots back up to speed to be able to fly them.

Okay, operator, that's all the time we have for questions this afternoon. Again, I want to thank members of the investment community and the media for their time listening to us and for their questions and remind you that a transcript of today's call can be found on CA's website. Thank you and good afternoon.

Thank you. And that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your line. Thank you once again. Have a great day, everyone.