CAE Inc.

Good day, ladies and gentlemen. Welcome to the CAE second quarter conference call. Please be advised that the call is being recorded. I would now like to turn the meeting over to Andrew Arnovitz. You may now proceed.

Good afternoon, everyone, and thank you for joining us today. Before we begin, I'd like to remind you that today's remarks, including management's outlook and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, November 11, 2021, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risks, factors, and assumptions that may affect future results is contained in C's annual MD&A. available on our corporate website and in our filings with the Canadian Securities Administrators on CDAR and the U.S. Securities and Exchange Commission on EDGAR. On the call with me this afternoon are Marc Perrin, SEAS 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. Let me just start by reminding all of us that today is November 11th, Veterans Day in the United States, Remembrance Day in Canada. So let me just start by saying thank you for all veterans for their service. You know, on this November 11th, we honor members of the military, both past and present, veterans of all conflicts, those who made the ultimate sacrifice for our freedom, and those who serve our countries today. I can tell you at CAA, we're privileged to work every day with many veterans. We have over 2,000 in employee of CAA. And I can tell you, I'm honored to work and be in the company of heroes. They bring a unique point of view and skill set to our company and a pride that allows us to achieve new heights. Now onto the quarter. In an environment where we continue to experience an uneven recovery in the various markets and geographies where we operate, CAE delivered year-over-year growth in the second quarter. On a consolidated basis, we drove 16% year-over-year revenue growth and 17 cents of adjusted earnings per share. These results came mainly from the strengthening of our civil training business, the continued progress of our structural cost savings program, and the integration of L3Harris military training into our defense results. We also built continued momentum with $871 million in orders for a positive book-to-sales ratio of 1.07 times and an $8.8 billion backlog. Second quarter average training center utilization was 53%, up from 49% last year and 3% lower than last quarter, reflecting usual seasonality, but also the varying global realities with respect to the COVID-19 Delta variant and the measures taken to contain its spread. For example, in the Americas, with the benefit of high vaccination rates and easing travel restrictions, we saw near pre-pandemic demand during this period in both commercial and business aviation training. While at the same time, Asia Pacific took a step back and remained at low levels of countries, including Malaysia, Thailand, and Vietnam, renewed lockdowns. On the orders front, we signed civil training solutions contracts valued at $409 million for a 1.13 times book-to-sales ratio, including nine full-flight simulator sales and a five-year aircraft maintenance training partnership with Air Canada, a three-year exclusive agreement with Brussels Airlines, a five-year agreement with Envoy Air, a four-year agreement with PGA Portugalia, and finally a five-year agreement with Alaska Airlines. We also announced new partnerships and relationships, including a strategic partnership with Banda Technologies to design and develop a best-in-class pilot and maintenance technician program for the Aliaf eVTOL aircraft as well as a relationship with Star Insurance Companies for a first-of-its-kind program that combines a rigorous training regimen and insurance for single-pilot jet owners. Additionally, Inateck Exacair Aviation Group has become the launch partner for CE's innovative suite of digital services specific to the business aviation market. On the expansion front, we deployed a Boeing 737 MAX full-flight simulator in Europe at our Amsterdam Training Center, and we announced a new flight training location in Las Vegas, Nevada, in order to meet higher demand and expand our business aviation footprint, which is expected to open next summer in Las Vegas. In defense, we closed the acquisition of L3 Harris military training on July 2nd, and it delivered solid revenue with double-digit margins in the quarter, in line with what we expected. I had the pleasure to visit our new employees and facilities in Texas and Colorado in August to inaugurate the closing, and I can tell you I'm highly impressed by the technologies we've acquired and the potential for even greater differentiation of our defense training and mission support solutions. I'm also extremely pleased by the great cultural fit with CE. We live and breathe simulation and training in support of our customers' most critical missions. The energy and excitement of our combined teams that they have for the future is really palpable. And since the acquisition, we've retained, and I think this is a fantastic feat, all 67 members of the senior leadership team, which is a very strong statement in and of itself about the strength of our shared vision and the mutual passion for what we do. The organic defense business was negatively impacted this quarter by delays in orders and program execution, particularly international. which have been largely due to the pandemic. And notwithstanding those headwinds, we've booked defense orders for $428 million in a quarter, representing a booked sales ratio of 1.02 times. Those orders included our recently announced first-ever prime contract award from the U.S. intelligence community with the Beyond 3D prototype for the National Geospatial Intelligence Agency. We'll be integrating our capabilities across digital technologies, big data architectures, machine learning, and artificial intelligence, making this a prime example of CAE at the forefront of modeling and simulation expertise for mission and operations support across the multi-domain environment. Other notable defense orders are in the quarter. involve a range of contracts for support services, similar upgrades and modifications in support of customers, including the U.S. Army, Navy, Air Force, and Air National Guard, and internationally for the German Armed Forces. In healthcare, we also experienced COVID-related headwinds during the quarter, particularly in Florida, where our business is based. In light of the added challenges, I continue to be very encouraged by the dedication and achievements of our teams to deliver double-digit year-over-year top-line growth in the quarter, excluding the ventilator contract from last year. Notably, this marks the third quarter of year-over-year revenue growth for health care as it ramps up an expanded and re-energized organization. With that, I'll now turn the call over to Sonia. I'll provide additional details about our financial performance, and I'll return at the end of the call to comment on our outlook. Sonia.

Thank you, Mark, and good afternoon, everyone. We delivered year-over-year growth during the second quarter, and our results continue to reflect the success of the measures that we have taken to strengthen the company, both externally in terms of expanding our reach and adapting to dynamic market conditions, and internally by lowering our cost structure. Consolidated revenue of $814.9 million was 16% higher compared to the second quarter last year. Adjusted segment operating income was $90.7 million compared to $79.3 million last year. Quarterly adjusted net income was $53.2 million, or 17 cents per share, compared to 13 cents in the second quarter last year. Cash provided by operating activities this quarter was down 32% to $30.9 million, compared to $45.6 million in the second quarter of fiscal 2021. Pre-cash flow was $19.4 million, compared to $44.9 million last year. The decrease was mainly due to the increasing cash provided by operating activities due in part to cash costs for restructuring, integration, and acquisition costs this quarter, which amended to approximately $52 million. We usually see a higher investment in non-cash working capital accounts in the first half of this fiscal year, as in previous years. We expect a portion of that non-cash working capital investment to reverse in the second half. Also, we continue to target a 100% conversion of net incomes and free cash flows for the year. Growth and maintenance capital expenditures totaled $46.7 million this quarter, mainly for growth and specifically to add capacity to our global training network to deliver on the long-term exclusive training contracts in our backlog. Our growth capex is directly linked to our opportunities to invest incremental capital with attractive returns and free cash flows. With several attractive market-led expansion investments on the horizon, we continue to expect total capital expenditures to be more than $250 million this for fiscal year 2022. Income tax recovery this quarter amounted to $13 million, which, normalized through structuring integration and acquisition costs, represents a rate of negative 1% compared to an effective tax rate of 14% for the second quarter of last year. On this basis, the decrease in the tax rate was due to impacts of changes in tax laws on tax assets, positive impacts of audits, and the mix of income from various jurisdictions. Our net debt position at the end of the quarter was $2.48 billion for a net debt to capital ratio of 38.2%. And net debt to adjusted EBITDA was 3.55 times at the end of the quarter. All told, between cash and available credit, we have approximately $2.2 billion of available liquidity. The increase in net debt this quarter was mainly attributed to the closing of the L3 Harris military training acquisition and the execution of the related finance package. We see this increase Going through to interest expense should continue at about this $35 million quarterly run rate going forward. Now turning to our segmented performance. In civil, second quarter revenue was stable compared to Q2 last year at $362.1 million, and adjusted segment operating income was up $13.4 million over the second quarter last year to $65.3 million for a margin of 18%. This was the result of higher training utilization in the Americas, offset by lower product revenues with a delivery of only five simulators this quarter compared with 10 last year and 11 last quarter. The lower simulator delivery number this quarter was on plan, and we continue to expect to deliver north of 30 simulators for the year. Our ability to drive an 18% margin on just 53% training utilization shows the benefits of the higher mix-in training and the solid progress we're making to ramp up our recurring cost savings initiative. In defense, second quarter revenue of $417.9 million was up 38% over 2-2 last year. This includes $135.1 million from the integration of the L3 Harris military training in our financials, adjusted segment operating income was $26.7 million, including $16.2 million from the acquisition, for a margin of 6.4%. on an organic basis, our defense business decreased this quarter, mostly in terms of the justice segment operating income. And as Mark pointed out, this was mainly driven by delays in product-related orders and program interruptions and delays, particularly internationally as COVID impacts persisted in several regions. Underlying the quarterly defense book-to-sales ratio of 1.02 times were international orders, which continued to lag at 0.75 times book-to-sales, and orders from the U.S., which were higher, at 1.15 times. We closed the acquisition early, and synergies realized in the quarter were nominal. We are progressing well with integration efforts and are on track for the $35 to $45 million of total cost synergies by the end of year two following our closing of the transaction. And in healthcare, second quarter revenue was $34.9 million, up 17%, excluding the ventilator contract last year, Adjusted segment operating loss was $1.3 million in the quarter compared to an income of $3.2 million in Q2 of last year. Segment operating income reflects growth in SG&A expenses in preparation for higher revenue growth and the impacts of the quarter related to the severe COVID conditions in Florida, which affected supply chain and limited the team's ability to execute on orders. With that, I will ask Mark to discuss the way forward.

Thanks, Sonia. As we looked at a period ahead, We're confident that we'll emerge from the pandemic a larger, more resilient, and more profitable C8 than ever before. I'm very confident of that. Until then, we must manage in an environment with disparate rates of recovery in our markets and the geographies where we operate, something that will likely continue to be a factor for several more quarters until a more uniform global recovery takes hold. We have additional reason for optimism with the reopening of the U.S. border this week to vaccinated international travelers and the latest news about the potential of antivirals to mitigate the effects of COVID-19. Ultimately, the slope of our recovery to pre-pandemic levels and beyond rests on the timing and rate at which border restrictions and quarantine measures around the world can safely be lifted. We certainly have been standing still waiting for the recovery to happen. and we've been focused on the things that we can control. Specifically, we've been getting stronger by playing offense in a downturn, and I'm very encouraged by everything that we've done to reinforce CAE's base over the last year and a half to expand our horizons for long-term sustainable growth. The pursuit of an expanded growth opportunities pipeline has so far netted CAE nine accretive acquisitions, including the most recent announcement of our agreement to acquire Sabre's Air Center Airlines operations portfolio, a highly valuable suite of flight and crew management and optimization software solutions designed to enable airlines to operate their businesses with efficiency and precision. And we've continued to secure highly attractive opportunities to deploy organic growth capital, including our recent expansion of business aviation training in Las Vegas, Nevada. And at the same time, as expanding C is reached externally, we're substantially lowering our cost structure and achieving even greater levels of operational excellence. In fact, we're on track to reach a run rate of $65 to $70 million of annual recurring cost savings by the start of the next fiscal year in April 2022. It's civil. A greater desire by airlines to entrust CAE with their critical training in digital operational support and crew management needs, higher expected pilot demand, and strong growth in business jet travel are enduring positives underpinning a secular growth market. There's considerable pent-up demand for commercial passenger air travel, and once unleashed, drives higher flight activity and training demands. We're seeing this chain of events manifest itself already in the Americas, where we're experiencing a near total recovery in training utilization and a strengthening pipeline of full-flight simulator order activity. We believe that this provides a blueprint for what a broader global recovery in air travel should look like. And since the end of the quarter, the market has improved, with average training center utilization trending to upwards of 60% globally, again with the highest utilization rates currently in the Americas, combined with still relatively depressed levels in Asia and the Middle East. In business aviation, we're seeing strong demand for training across the network, propelled by flying activity in the United States and Europe that is now well above 2019 levels. The uneven nature of the global recovery is likely to persist for a while. but we're ultimately in an excellent position to benefit from the multi-year cyclical market recovery that's currently underway. And for the current fiscal year, we expect continued strong growth in civil weighted more heavily to the second half. In defense, the paradigm shift from asymmetric to near-peer threat and a recognition of the sharply increased need for digital immersion-based synthetic solutions in national defense are tailwinds that favor CA's business. Given the increasing relevancy of training and simulation, our defense unit is also on a multi-year path to become a larger and more profitable business. We're currently focused on the successful integration of L3 Harris's military training business and expect to fully realize the $35 million to $45 million dollars of cost synergies that we laid out by fiscal year 2024. Defense is now more closely aligned with our defense customers' utmost priorities and is established as the world's leading platform-agnostic global training and simulation defense pure play business. This is expected to bring increased potential to capture business around the world, accelerated with expanded capability and customer success that we now possess. The pandemic has made international opportunities slower to materialize in a current environment, but this headwind is temporary, and we have a strong pipeline with some $6.5 billion of bids and proposals pending customer decisions. We continue to expect to deliver strong annual growth for fiscal year 2022 with sequential quarterly improvements in revenue and adjusted segment operating income expected in the second half. Supporting our view is our expectation for a re-acceleration in order intake, especially from bids involving international programs as pandemic-related disruptions ease. And with that, we also expect the defense book sales ratio for the fiscal year to exceed one for the first time in the last four years. Other drivers in the second half and beyond include higher levels of execution on programs, specifically those involving higher margin products, as well as the progressive realization of synergies as we integrate L3Harris military training. And lastly, our outlook for healthcare is continued quarterly year-over-year growth as we ramp up our expanded and re-energized organizations. Over the long term, we believe healthcare is on track to become a sustainably material and profitable business And for the current fiscal year, we project double-digit growth compared to last year, excluding the ventilator contracts. In summary, while there's no doubt that COVID-related impacts continue to affect all of our business units, we increasingly see a clearer path to recovery and a larger, more resilient, and more profitable CAE in the future. Specifically, we're currently targeting to reach a consolidated adjusted segment operating margin of approximately 17% by the time our markets are generally recovered, with steady room for further improvement after. We expect to reach this level of profitability on a significantly larger base of business with a post-pandemic capital structure that will allow us to sustain ample flexibility to further invest in our future. We continue to play offense during this period of destruction, as evidenced by our nine accretive acquisitions and continued growth capital deployment since the pandemic began. As business conditions continue to improve further, we look to extend this posture as it relates to both organic and inorganic growth investment. Our opportunity set continues to look very attractive, and personally, I've never been as excited about CA's future as I am today. With that, I thank you for your attention. We're now ready to take your questions.

Thank you, Mark. Operator, I'd ask that you please open the line to members of the financial community.

Thank you. If you'd like to register for a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you'd like to withdraw your registration, please press the one followed by the three. Our first question is from Fadi Shamoon from VMO. Please go ahead.

Thank you. Good afternoon, everyone. My first question on the kind of legacy defense business, It seems like we've been in this 7%, 8% EBIT margin for the past several quarters. This quarter, we dropped to 3.7%. I know you offered up some explanations towards what's going on there. I'm not sure if you can maybe elaborate a little bit, give us a couple examples of what's really kind of happening in that business. And what do you expect in the second half of this year? Do we see... step back to where we were in past quarters, or is this more of a gradual recovery that we should expect from this, you know, I guess organic defense business?

Well, you know, thanks, Paddy. Look, as I said in the remarks, we're continuing to expect strong year-over-growth in this year. So clearly we're going to have to have a pretty good second half. And that's, and I talk for defense of the whole, but which is obviously combining the integration of L3 Harris. I mean, the story with the legacy business, or shall I call it, I hate using that term, but we'll use it for the moment here, organic business, is one of continued COVID-related disruptions, both on order intake and impacting our execution. And I can tell you that there's at least five international orders that I fully expected, I'm not going to lie to you, I fully expected to come in this quarter, but did not happen. And because of Delta, for example, inability to access customers in the least, in the far east, five at least internationally. Other factors I could point to, like, for example, Florida during the summer was one of the hardest hits, if not the hardest hit, as well as Texas, which is another big state for CAE, in terms of the COVID effects and the variants attacking that. So clearly that had an effect. And, you know, just as testimony that I said before, the Florida Training Center, we train international customers of C-130H. You know, you can well imagine there's no customers coming. And I... But the situation is changing. You know, borders are opening. International travelers come back. The COVID situation is incredibly much better, not only across the United States, but in Florida specifically. So those are the kind of things that we can see near term, which gives us more confidence in the outlook. And when you look at the business as a whole, you know, for defense, I'm talking about organic plus the integration, you know, we're starting, we're going to be starting rolling out of the benefits of our synergies. You see, I mean, the Most of that was started, you know, like, for example, reductions in force that happened at the post end of the quarter. So for all these reasons, you know, it really is COVID-related impacts that we've seen that really drove that because our book to bill for the last few quarters, as you know, in the organic defense business has been below one. And eventually, you know, you run out of backlog that you can execute in an efficient manner. And that's really the situation that we're seeing here. But, again, those orders are coming. We've been selected on these orders. So I've always expected a back half in defense to be the strong order. And that's what I said last quarter. I mean, but we've lost, you know, because of COVID, you know, we've lost some that I would have liked to have gotten in the second quarter, no doubt. But it doesn't change my view of the full year. Maybe I could just, Sonny, you want to add something?

Yeah, if I just, you know, just a quick recap and laying it out, the way we see it on the organic business with delivering, as you mentioned, Patty, kind of in the 7% to 8% range, that's in the 20s on SOI. And then so, as Mark explained, as we see those delayed orders ramp back up, as we advance the programs that we do have in backlog that have been disturbed by COVID, either interrupted or fully stopped, something in the Middle East. So as those ramp back up, as the pandemic-related disruptions ease, then you layer on the contribution of the acquisition as well as starting to ramp up the synergies. You know, that will take us to the 30s and 40s in the upcoming quarters.

Okay. Okay. So that comment, 30s, 40s, you're talking about SOI in dollar terms, right? Yeah, SOI in dollar terms. Okay, okay. That's helpful. The other question I wanted to ask is on the leverage, the M&A and the opportunities you're seeing. You're up to 3.55%. probably go up a little bit with this saber acquisition closing in a couple of quarters um like how comfortable are you with this type of leverage given the pipeline of maybe opportunities you're seeing at this point is is mma in the back burner now until you kind of get this profitability level back to deliver the balance sheet or how are you kind of thinking about this leverage level, given the pipeline of acquisition and the opportunities you're seeing?

Well, I'll start out with I'm very comfortable. So the quarter closed at 38% net debt to cap, 3.55 times net debt to adjusted EBITDA, with all the financing related to the L3 Harris military training acquisition. And with the expected closing of the air center operations, probably in our Q4, we'll be using our existing liquidity, which will drive – Our net debt's a cap higher, probably a little above the 40%, but we're expecting quickly leveraging in the next six to a year with the highly cash-generative business, organic business, and the cash flow accretiveness of this new acquisition. Now, you'll remember all the previous cash flow raises that we did in FY21, and that was exactly to provide the flexibility to support the organic and inorganic growth opportunities that we saw. So, you know, we've seen some great opportunities come out of all of this disruption, and it allows us to seize on them, creating long-term value and strengthening the company to become bigger and more profitable. We continue to have a pipeline, but as you've seen, we're patient, we're disciplined, We'll wait for the right opportunities at the right value, as we've done with Air Center, L3 Harris, and even Bombardier Training. So, you know, very comfortable, and ultimately, you know, it goes back to our capital allocation priorities, balance accretive growth, organic, inorganic, with a solid financial position.

Okay. I appreciate the feedback. The 17% target, can you offer up what's the mix behind this? Like, how much is defense representing? How much is aviation representing? That's it for me, thanks.

I think that we're providing that guidance on a consolidated basis, really to underpin the messaging that all of these internal, external measures is really to drive a larger business, a more profitable business. So what we're guiding us is that once we do hit that recovery level, that not only will we exceed pre-pandemic measures, but on a much larger scale base of business.

Yeah, I think maybe I would add that. I mean, there's no doubt that that's going to be made up, you know, new highs and civil margins for sure. Some of that, a lot of that with leverage, as you said, plus the acquisitions that we've made, and as well, you know, double-digit margins and defense. That's what's going to comprise that mix.

Thank you. Our next question is from the line of Konark Gupta from Scotiabank. Please go ahead.

Thanks, and good afternoon, everyone. Good afternoon. So I have a few questions just on defense and civil, perhaps. Maybe it's sticking to defense for now. Like, if I look back when you acquired L3 Harris, I think it was $500 million in the U.S., I think, to have a new business. or so annually, and what you did in the second quarter obviously was below that run rate. So, A, I'm kind of wondering if there was some sort of a transitionary impact in Q2 where we will see probably more, you know, contribution from L3Rs going forward as you integrate them? And then with LC Harris together with the defense organic business, assuming it kind of rebounds to the 8%, 9% margin level or so, and the synergy, is this 11%, 12% kind of range kind of an acceptable margin profile for the defense business for you guys? Thanks.

Yeah, we missed some of it, but just the last part of your question, just say it again, Conor.

Yeah, I was wondering, I mean, on the margin profile, if defense organic business goes back to 8%, 9% margin, and then L3 Harris plus Synergy, you know, obviously they are double-digit margins right now. The overall defense business seems like it's going towards 12% EBIT margin with all those.

Oh, yeah. As I said before, 11%, 12% is a good number to plug in longer term for sure. I mean, that's where we're headed. No doubt about that.

Right. And on the first part of the question about LC Harris, is there an ability to ramp up revenue here given it's below their run rate before you acquire them?

certainly days with L3 Harris, but I'm quite confident with what I'm seeing that we're going to deliver or, you know, the L3 Harris, the legacy L3 Harris business and the synergies that together that we're going to generate, we're going to be achieving the margins that we talked about when we acquired the business. And I definitely see that. I'm quite happy with what we're seeing in the first quarter and more of that coming.

Right. Thanks for that. And then on the civil side, so you touched upon the utilization levels, and clearly America are doing better. Asia Pacific are lagging. Where are you in Europe, and what are you seeing there? And then as we head into sort of the seasonally stronger second half with both commercial and business aviation, should utilization levels kind of go to 60% plus, you think, or we are kind of stuck in the 50s right now?

Well, you read what I read in terms of the COVID recovery. Look, the thing I would tell you is, as we said in the remarks, that I like what I see in America right now, specifically in the United States. You know, we're seeing... utilization rates in the United States back in the levels of COVID, prior to COVID-19, we're seeing very high rates of utilization in business aircraft. This summer, obviously, we talked about the seasonal effect and the fact that Europe kind of missed the whole summer because of Delta. But going forward, look, to me, utilization rates are very much correlated by vaccination rates. And if you look at, if you extrapolate vaccination rates, and of course that comes with lifting of restrictions on borders that governments have to do, and the ability for people to travel, we've seen the pent-up demand and how that's driving business. I can tell you, I was at, in the early part of the month of October, I was at the, I had a general meeting in Boston, and I can tell you, I met a lot of airline CEOs, and I can tell you there's a palpable optimism there. out there as vaccination rates, you know, are increased. And that's just one U.S. And when we're basically talking to airlines specifically in those areas like the United States where we are seeing that, you know, that increase in activity, because the vaccination rates are high and the level of infection is low, we can see a lot of activity as testimony by the rise in sales activity, which is not only testimony to the orders that we've announced so far, but in terms of the activity that I see, which is quite nice at the moment. So really, look, in terms of going back to the root of your question, to predicting... Again, I'll go back to what I said. You read what I read. I mean, we have a situation that seems to be degrading in Germany right now. We still have a very low level of vaccination in the Far East. So I think those have to, but I think on the long-term trend is getting better. So we will get better utilization in lockstep with the increase in flighting activity driven by vaccination rates. We're not going to get ahead of it because we don't know. We don't know. I mean, in the end, if you look at, there's a wide variety of estimates out there. You know, since the beginning, we said, well, look, we'll follow the IATA forecast of what, that seems to be a pretty, you know, good one. Although, I would tell you, I think the U.S. has beat that, you know, as soon as vaccination rates pull up. So, long answer to your question, but coming back to say, all I can say is when we do come across it, when the traffic does come back, which it will, with all the actions that we've taken, I'm extremely confident that we're going to be a much bigger, a much stronger, and a much more profitable business. That's where we're headed.

Right. That makes sense. If I can just follow up on the comment you mentioned about the airline CEOs being optimistic. A lot of airlines have come out recently saying they are scrambling for pilots. This is kind of counterintuitive. I'm like, the industry loves a lot of pilots. So do you know what's happening there? Are people not willing to train as pilots here? Is that where the shortage is coming from? Or there's not enough supply to train pilots as much as the airlines want?

Well, I think I've said before, there's no doubt in my mind that there was a pilot shortage before the pandemic, and there's going to be a pilot shortage after. We're part of the solution to that problem. I think I've said this in a number of conference calls before, the level of activity in our flight schools, and remember, we're the largest network of flight schools in the world for training people to become airline pilots. And the level of activity there has not reduced throughout the pandemic except for when our schools were shut down because we couldn't operate because of COVID. I can tell you carriers, including legacy carriers across the world, have not only, in most cases, kept operating, They're orders with us for a number of paths they want from us, but in large case, increase them. And that's the trend that we see. I think become a pilot is a great career right now. I can tell you that. That's my view for darn sure. And I think that's a great thing for us as a business.

Makes sense. Thanks for the answer. Thank you.

Thank you. Our next question is from the line of Kevin Chang from CIBC. Please go ahead.

Thank you. Good afternoon, and thanks for taking my question. If I could ask a utilization question, maybe just focus on the Americas. Mark, you mentioned it looks like these are basically back to maybe pre-pandemic levels or close to, given the recovery in commercial aviation there. Are you seeing a difference in maybe the split between what was in-source training versus third-party training? Because I guess there's a thesis out there that, you know, as we come out of the pandemic, there will be a greater opportunity for you to capture maybe more third-party training as airlines might look to outsource some of this to reduce their costs. Are you seeing that in the U.S. as they bring back training much more aggressively?

The answer is yes. Yes, we are seeing it. The fact is, a lot of the contracts that we've announced in this quarter, previous quarters, are just testimony to that. For a number of reasons. Number one is that people are seeking capacity, and they're looking for capacity for trainer pilots, and we can offer that capacity. Part of the activity we've been doing is moving simulators into the United States from other locations and actually what we increased our forecast on capital deployment this year that we announced at the beginning of the year, some of that was going exactly towards this. So, to me, that is a trend. We predicted that trend, that this is an environment where there's going to be a lot more opportunities for people considering us as the really only viable global third-party option. In fact, because pre-COVID, you do a million hours plus a year of training, we offer a very, very good alternative. To me, we have a lot of discussions. We had a lot of discussions at IATA. We have a lot of discussions ongoing, and we're signing contracts. We're signing contracts for new airlines. We're signing contracts for overflow training agreements where people want excess capacity right now. In a lot of cases, they need it right now or they want to ensure that they will have it as they ramp up operations to be able to seize the opportunity afforded by increased passenger traffic. And when we do that, we're signing people to longer-term contracts so that that activity for us will sustain.

That makes sense. I'm not sure. Do you have a sense of maybe what that breakdown is or was maybe pre-pandemic between pilot training that would have been in-source versus outsourced versus what it looks today? I suspect it's probably pretty fluid and maybe it's tough to pin down at the moment.

I can't give you a hard number right now because, first of all, it's not steady, and it would be very hard to compare it apples to apples or number. Maybe in future quarters we can give it, but right now I couldn't give you in certainty a number on that. But I can tell you this more. You look at the contracts that we've got, traditional carriers that we're ordering simulators, and now they say, no, we'll basically – just sign up a contract for you to provide the simulator and position that. We did that recently with SAS. We did it with WestJet. We did it with Air Canada. So there's definitely more, but again, I can't give you a precise number right now in terms of breakdown.

Okay. And maybe just on the Air Centre transaction you announced maybe a week or two ago, Can you just speak to how you feel about your broader crew management, flight management portfolio? Do you feel like you have all the tools now to kind of capture the higher TAM that you put out there, or do you think you need to kind of backfill some of that product line still? And then I guess when you look at the air center client base or the customers that they're dealing with versus the ones that you're dealing with, I guess I'd be interested in knowing, I guess, where the opportunities to cross-sell are. Do they have a large subset of customers that you don't deal with or vice versa that maybe offers an ability to maybe capture revenue synergies?

Well, all of that. To me, I'm extremely excited about this acquisition, as I said, when we first departed in our first release. Reason being, first and foremost, and we said this at the time we acquired Merrill at Rosterbuster, The Civil Aviation Plant operations software market, it's over $2 billion. Over 50% of that spend is outsourced. And what we're acquiring now, we are acquiring a huge stake, a leadership stake in that market. So to me, this is a crowning achievement in that strategy. And really what we're doing here, you've seen us over the year move from what was a few years ago, certainly when I joined CE, moved from being a really assimilator partner to airlines, moving deliberately towards being a training partner to the airline, leveraging in the past few years our digital offerings to make ourselves essential to customers, providing them insights on their business that really that we could deliver to them using the data that we have on our operations. And now what we're doing is we're moving from being this training partner to becoming a technology partner. And that's really just about, you know, growing the amount of work that we could do with this airline. And I can tell you, it's very well received. Again, I was talking about my meetings with CEOs at the IATA general meeting, and they Obviously, we weren't talking about Sabre at that time because we hadn't announced the acquisition at that time, so we certainly weren't talking about it. But we did have Mellow, a much smaller but differentiated offering in that market. And I can tell you, there was no pushback whatsoever with regards to airline CEOs, which are our customers, about bringing our expertise as a partner in crew resourcing, in flight planning, In fact, it was seen as a natural extension of what we do with them because it's all about delivering essential services to the airline, just like we do in train. So, look, this is a great asset. You know, we have pretty much almost all of Sabre's customers are our customers. We are getting more customers. There's for sure. So, to me, there's a lot of opportunities there. to liberate those relationships, to cross-sell. And as well, don't forget, I really believe that this morning by a contract, the first contract we announced this quarter, literally, is a contract with Inateck Exit Care. I really believe that there is an opportunity set here for rolling us out across business aircraft, which is an untapped opportunity. So, again, you know, and by the way, leading testimony to my confidence in this business. I put one of our most senior executives in the company to lead this business, Pascal Grenier, working, and I have very, very high confidence that with Pascal working with the fantastic people that I've seen so far that have been met at this part of Sabre Air Center, I think we'll do well in this business.

That's a great call. That's it for me. Thank you for taking my questions.

Thank you. Our next question is from Cameron Dirksen from National Bank Financial. Please go ahead.

Yeah, thanks very much. Good afternoon. I just want to come back to the, I guess, sort of the longer-term margin target that you've got out there, 17%. Obviously, that would imply some nice improvement from where you were pre-pandemic. I wonder if you could talk a little bit about how you see the returns on capital evolving as your end markets normalize? Because, you know, obviously the capital base has changed here with the acquisition of L3 and also with the pending air center acquisition, which presumably has, you know, a lower capital base. So any comments around the return on capital you would expect to see as things normalize?

You know, we expect the return, those increased margins to flow through as increasing on the return on capital. So you saw a few years ago, before the pandemic, we had driven more than 300 basis points improvement in just a few years, and that's on capital. optimized, you know, discipline deployment of organic and inorganic capital, right? So the CapEx that we're deploying, the organic capital, all have, you know, significant incremental returns driving 20 to 30% incremental returns within just a few years. And as we've seen, we've got very interesting and accretive acquisitions in inorganic. So as those deliver on our expectations, they'll be driving improved free cash flow. All of these are free cash flow accretive and return on capital.

Okay. And I guess maybe a second question from me just on the restructuring activity. Just wondering if you can update on where we stand there. I'm particularly interested in the status of the kind of the training network reorganization, you know, some of the training centers have been consolidated, things like that. So where are we in that process?

Absolutely. So some great progress in optimizing the footprint. And as Mark mentioned, relocating SIMs, so taking them where there's lesser demand and deploying them in the Americas and so on to serve market demand. So really kind of optimizing that use of capital and matching up demand or capital with the demand. So in this quarter, we incurred about $13 million of costs. $20 million year to date on the restructuring program. And ultimately this quarter, we did finalize some additional UK consolidation. So the UK is pretty much done. And we've got the bulk done. However, a couple of remaining consolidations in Europe and in South America that we'll see closing out in Q4. But we already are seeing significant amount of savings, as you've seen that in the quarter with a really good step up on the savings on a year-to-date basis and in the quarter, and you see that on the civil margin, right? So what I'll note is that despite the timing of the delivery revenue on the product, because of the lower deliveries, the SOI margin expanded to 18%, so that was the impact of the higher training revenue with an utilization of only 53% and really highlights the great progress on the structural cost savings that were delivered in the quarter.

Okay, and would, I guess, the consolidation activity and the moving of simulators into the U.S., as you mentioned, would that have had a negative impact on the utilization rate in the quarter?

Well, absolutely. When you're moving a simulator, you turn it down, and it takes a few months to bring it down, to move it, and then to start it back up. So that does have some noise in the utilization metric, yeah.

Okay, perfect. That was it for me. Thanks very much.

And don't forget seasonality, Cameron. This was a different effect, but, you know, very similar in terms of business aircraft this year, as well as commercial aircraft centers.

Right, right, for sure. Thanks.

Thank you. Our next question is from Noah Poponak from Goldman Sachs. Please go ahead.

Noah Poponak Hi. Good afternoon, everybody. Good afternoon. Mark, I'm struggling a little bit to follow the explanation of the utilization rate and the attribution to the geographic difference. Because if I look at the progression in the utilization rate, you know, it made it to this kind of 50%, approximate 50% level for the first time in the September 2020 quarter. And since then, global ASMs have nearly doubled. And I understand you have the different geographic exposures with the weighting to Europe, then Asia Pacific, then North America, and that North America has been strongest, but, you know, Seat miles flown in Europe in that period of time have also almost doubled. They've grown a lot in Asia Pacific. I think your simulator network is more exposed to narrow body than wide body. I understand you have these exposures outside of North America, but there have been decent recoveries there. If I just take a weighted average of those geographies relative to your exposure, it doesn't really explain that utilization rate being flat. Can you help me square that circle?

Well, I wish I had a model that was that simple, to be honest. It's really, you can't take a weighted average to look at our business just because the number of training centers that we have across the world. I mean, in the end of the day, and don't forget that when you look at Europe, what you're talking about there, when people are flying a lot, they're not training a lot. And that's why we always have a seasonal dip in the quarter. So really, really, where you get the big training activity is when they're preparing their crews. When you have a steady state, I was talking about, they're preparing their crews, making sure that they can ramp up. I mean, what we see right now is we have utilization rates currently in the Americas that are in the mid-70s range, and that someday is higher. And we're following by Europe, which has been approaching 60s, and in Asia and the Middle East, which is still at pretty depressed levels. I mean, it's a fact. It's obviously moving to around 50%. But, you know, I can't stop that, you know, and the fact that it's, It's really, you know, except for the United States, which is pretty darn, you know, like I said, recovered to pre-pandemic levels, you just can't take the weighted average as a perfect correlation to ASM. You just can't.

Is there an element where, you know, in a very severe downturn like we had, when you're working your way back up, you know, you have airlines that do their own simulation and training, those that have outsourced it, and then those that do a combination. that you just have airlines that want to use all their own capacity before they then move back to outsourced capacity.

Is that an input? Absolutely. Absolutely. People do that. They would do that, but I would tell you, though, that people that have all that capacity – in the end of the day, that they still have to drive a lot of pilot demand. Those areas that they have to ramp up, like the United States, they have to ramp up a huge amount of pilot in a short amount of time. Now, that's been somewhat mitigated in the Americas by the fact that because of the government's support, they haven't, by and large, reduced the level of activity to a depressed level. So they had, if you like, some power that they... you know, to not get into that situation. But even with that, and that testimony by higher levels of simulator sales, you know, so far this year, and the activity level I see on full-flight simulators makes me pretty darn optimistic. And that, as well, I would basically correlate that with all the conversations I have specifically with CEOs of airlines across the world, which is really what gives me the confidence that what I'm seeing in the United States is a blueprint for what's going to happen elsewhere.

That's the confidence. That makes sense. And then just last one, can you square us up on where your business jet revenues and margins are at this point on a run rate basis compared to pre-pandemic? They're high. Are they above pre-pandemic? They're high.

We're doing well. We're doing well. Look, I think we're, no, I'm not being flippant here, but, you know, the activity levels that we see is, you know, we're higher than pre-COVID levels. In America, certainly, we are right now. And I think we're doing well in terms of, now, I don't think I want to get too much ahead of that prediction, except that that's factored into the outlook that we give with regard to our margin going forward. And, you know, it's no surprise that you wouldn't be – you know, it's a question of leverage. You know, we're throwing more level of training activity at a quasi-fixed base of business. You know, the major expense is depreciation. I mean – In this, in fact, it's somewhat different because we're not selling dry time. We're selling courses. So we have to ramp up with instructors, that kind of thing. And at the end of the day, I think, look, as Sony was saying, consider the fact that we're making an 18% margin with 53% utilization. And I think when you look at that, that's got to underscore the progress that we're making.

Yeah. No, that's fair. Okay. Thank you so much.

Thank you. Our next question is from Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Good afternoon, everyone. Given the current utilization rate, do you see further opportunities to reshuffle or redeploy the simulator fleet around the network?

We've done a lot of that already, I would tell you. But it's not to say we won't do more. We're always doing some. But for the past couple of quarters, we've been moving everything that's not tied down to the United States, figuratively speaking. But no, there's been a lot of opportunities there. So we've done that. But I don't think that's a huge factor going forward.

Okay, okay, that's a great caller. And obviously with Merlo and also Sabre, you're kind of entering a big addressable market for flight and crew management and optimization solution. So it seems that you're running at about $180 million in terms of exposure versus a market that you're calling close to $2 billion. So I would be curious to know more about the opportunity to capture market share among the $2 billion market within the next five years, whether you see opportunities to increase your market share on the organic basis and maybe through further M&A.

Look, I think it's too early to talk about that. I would tell you I'm very confident in the business, as I said. Our first order of business is to transition the business. I mean, as you well know, this is a business that is extremely critical to the airlines today, just like training is, perhaps even more. So for us, it's make sure that we transition the business very well without skipping a beat with regards to our customers. At the same time, and that's factored into the price that our business case on this acquisition, we've factored money to basically solidify and differentiate the business with airlines. And that alone, I think, has a lot of potential. And then, yeah, then you're talking about the organic, organic growth just testimonied by the growth of aviation by itself, which will be double-digit for quite a few years, just recovering from the pandemic. Then comes, you know, market share gains. And don't forget what I said about there's opportunities to me on business aircraft, which to me is virgin territory. But that's directionally, in terms of quantitatively, I think it's way too early. We haven't even closed it yet.

Okay. And last one for me, maybe for Sonia. In terms of net debt EBITDA from the four-time post, the Sabre acquisition, what about the timing to get back to 2.5 times? And assuming there are still further M&A opportunities on the horizon, what would be kind of the max level you would feel comfortable with?

Listen, we always balance a solid balance sheet, which is accretive investments. And so, you know, the timing of whether it's organic or inorganic investments will drive some of that. So, you know, we're at an investment-grade profile, and that's where we stay comfortable, which is in the 35% to 45% net debt cap. So what I'll say is We expect it to go a little higher in Q4 and then to deliver quickly as we generate cash and generate cash out of these new acquisitions and as our EBITDA ramps up quickly and so drives an improved net debt to EBITDA ratio.

Okay. Thanks for the time.

Thank you.

Operator, I see we've run a little longer than usual here. I think we'd like to use the last few minutes, if we can, to open the line to members of the media, should there be any questions from media.

Certainly. As a reminder, if you'd like to register for a question, please press the 1 followed by the 4 button. Our first question is from André Allard from Les Ailes du Québec. Please go ahead.

Yes, hello everyone. Congratulations for the good results again. I would like to know, in terms of acquisitions to come, I imagine that you have set a limit on the amount of acquisitions per company or in total acquisitions. Can you give me an idea of what it might look like?

We don't have a magic number on acquisition. It's case by case. We have a strategy. We are patient. We go with the opportunities that we have in front of us. We are going to seize the opportunities. There have been many during the crisis that we are still living in.

In some cases, we have done two. And it was all acquisitions that were good from the point of view of advancing our strategy and contributing to our results.

So, we're going to keep looking. We still have what I would call a good range of possibilities in front of us. But, again, we're going to be patient. And we don't necessarily have numbers.

Financially, the capacity to borrow from CE is still good, so if you need it, you will have access to a loan to make your acquisitions? We have a good capacity to borrow. Sonia, do you want to elaborate on that?

Yes, it's always a good balance to invest in growth and maintain a very solid financial position.

So, we are in a comfortable position, and we continue to have the capacity, yes. Okay.

Well, if you allow me, I will continue with a question. In terms of research and development, you maintain your level of investment in research and development. Can we expect in the next two years

Oh, no, no. Listen, we announced a program this year with the federal government and the provincial government, where I was there with the announcement with Prime Minister Trudeau, with Prime Minister Legault, and we announced a big program of investment in research and development for the next few years. And it's certain that there will be great achievements that will be associated with that, in addition to electric planes, You know, developments in everything that is digital, on the enterprise side, the planes, like, if there is an agreement with Beta, Beta is a company that makes planes, electric planes, well, not electric planes, but new vehicles that we call, in English, eVTOR, urban mobility, not air taxis, nothing like that. And we are very excited about this partnership, which is not the only one. We have several already that we have announced. So, to answer your question, it is certain that the innovations, the research and development that we are going to do will result from announcements and innovations on which we will talk. They will make a lot of noise as far as I know.

And do you have an idea of the timeline, the time frame in which it's coming? It's not yet advanced enough for that? No, we wouldn't really give pressure for that.

For competitive questions, obviously, we wouldn't want to do it. Okay. Well, I don't have any other questions. So, thank you very much for answering, Yann.

Merci. Merci. Thank you, operators. So that's all the time we have for the call today. I want to thank all participants. Merci beaucoup à tous ceux qui ont participé. And I'd like to remind listeners that a transcript of today's call can be found on CE's website at CE.com. Thank you.

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