CAE Inc.

Good day, ladies and gentlemen, and welcome to the CAE third quarter conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. Please go ahead.

Good afternoon, everyone, and thank you for joining us today. Before we begin, I'd like to remind you that today's remarks, including management's outlook and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today February 11, 2022, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risks, factors, and assumptions that may affect future results is contained in CAE's annual MD&A, available on our corporate website and on 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 Ferrand, Chief 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 Marc.

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'm very pleased with our third quarter performance, especially in the context of a still challenging global environment. We delivered double-digit growth, strong free cash flow, and we nearly doubled order intake compared to the third quarter of last year. On a consolidated basis, we grew revenue by 15%. before the contribution of our ventilator humanitarian initiative last year. We also grew adjusted segment operating income by 16% and delivered 19 cents of adjusted earnings per share. Underscoring the cash generative profile of our business, we delivered a healthy $282 million of free cash flow. We also made excellent progress on the orders front, billing even more for momentum with nearly $1.4 billion in orders for a book-to-sales ratio of 1.62 times and a backlog of $9.2 billion. In civil, we have strong performance with double-digit growth in training and segment operating income, and with margins break above 20% for the first time since the start of the pandemic. Third quarter average training center utilization was 60%, up from 50% last year, and with seven percentage points higher than last quarter. To me, this is an impressive result, considering the wide-ranging disparity in commercial flight activity and training demand across regions, and because Omicron began to spread in the last month of the quarter. As we've been seeing since the start of the fiscal year, demand in the Americas was by far the strongest while Europe and especially Asia Pacific continued to lag their recovery, leaving significant headroom to return to pre-pandemic levels. In business aviation, training demand was also robust, reflecting the high level of flight activity, which was above 2019 levels in the United States and Europe. We had very strong order activity in civil in the third quarter, booking training solutions contracts valued at $753 million, or a 1.93 book to sales ratio, including 19 full-flight simulator sales. This is in sharp contrast to the 11 full-flight simulator orders that we booked for the entire fiscal year, last year, and brings our full-flight simulator sales for the first nine months to 33. Since the end of the quarter, we signed orders for another four, bringing the year-to-date tally to 37 full-flight simulators sold. Consistent with the more advanced air travel recovery in the Americas, over 60% of the year-to-date totals are from customers in that region and include full-flight simulator orders from major U.S. carriers, actually all major U.S. carriers, including orders for multiple full-flight simulators for some of the largest United Airlines this quarter. Our airline customers in the Americas have been adding back flight capacity and actively ramping up pilot hiring. In order to secure the training capacity that they require, they've been working with CEE as their training partner of choice, entering new long-term training agreements and acquiring additional simulators. We think this makes for a compelling preview of what an eventual broader global market recovery holds for CAA. Notable training contracts for the quarter include five-year extensions of commercial aviation training agreements with Endeavour Air in Avianca, a nine-year commercial aviation training agreement with Norwegian, as well as five-year business aviation training agreements with Global Jet Luxembourg, Exojet, and Vistajet. In defense, We also had double-digit growth in the quarter with the contribution of L3 Harris Military Training, and as we expected, we surpassed the $30 million mark in adjusted segment operating income. I'm especially pleased with our order intake, which totaled $593 million in the quarter for a 1.39 times book-to-sales ratio and a $4.6 billion backlog. We seized on the opportunity of the temporary relaxations in pre-Omicron COVID-19 restrictions, and as a result, our international book-to-sales ratio was above one for the first time since the start of the pandemic. In addition to the positive book-to-sales, we're also seeing more conversion on our defense strategy to pursue multi-domain training and mission support solutions. Orders to date included competitive prime awards, recompense, and contract expansions across all five domains, air, land, sea, space, and cyber. In the air domain, we strengthened our international presence with the German Air Force's competitive selection to provide ab initio pilot training, replacing the 60-year incumbent. Along with this new live flight training program, we also expanded our relationship with the United States Navy's Chief of Naval Air Training for Sinatra by adding T45 live flight training to our instructional services contract. Beyond live flight training, we were awarded the 19-year base plus options contract from an Australian customer to provide integrated support and training on a range of strategic platforms. Other contract expansions including forward task orders on our Simulator Common Architecture Requirements and Standards, or SCARS, Single Award IDIQ, as the U.S. Air Force accelerates the integration and standardization of approximately 2,400 simulators across 300 locations. Since the end of the quarter, we've made additional notable progress to broaden our position beyond our core defense, air, land, and sea programs by winning our first competitive prime contract in cyber and space. We were selected by Canada's Department of National Defense to expand cyber intrusion detection capabilities on the Innovation for Defense Excellence and Security, or IDEAS program, and we were awarded our first prime simulation contract in the space domain with a key U.S. customer. These strategic cyber and space prime contracts, along with our first U.S. intelligence community competitive prime win in the second quarter, are great examples of how we're building our defense business for the future by establishing it as the world-leading platform-agnostic training and simulation pure plate, ensuring mission readiness by integrating solutions across all five domains. And finally, in healthcare, We delivered our fourth consecutive quarter of double-digit year-over-year revenue growth, excluding the ventilators, as we ramp up our re-energized organization with a clear focus on achieving greater scale. We launched updates to expand the feature set and functionality of some of our main product solutions, including Learning Space, our Simulation Center Management System, and Vimedix, our ultrasound education platforms. We also introduced 11 new on-demand online digital courses featuring virtual simulation in collaboration with the British Columbia Institute of Technology. With that, I'll now 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. We delivered double-digit year-over-year growth and strong free cash flow during the third quarter, notwithstanding the ongoing challenges of the pandemic. Our performance reflects CAE's resiliency and the strength in some of our end markets, as well as our excellent progress to expand our reach and lower our cost structure. Consolidated revenue of $848.7 million was 2% higher compared to the third quarter last year and was 15% higher excluding the $93.5 million of revenue in the third quarter last year from a contract to provide the Canadian government with ventilators as part of our COVID-19 humanitarian initiative. Adjusted segment operating income was $112.7 million compared to $97.2 million last year. And quarterly adjusted net income was $60.7 million or 19 cents per share compared to 22 cents per share in the third quarter last year. We incurred restructuring integration and acquisition costs of $47.2 million during the quarter related to the L3 Harris military training acquisition and the enterprise-wide restructuring program underway. Cash provided by operating activities this quarter was up 32% to $309.6 million compared to $234.8 million in the third quarter of fiscal 2021. Free cash flow was also higher at $282.1 million compared to $224 million in the third quarter last year. The increase was mainly due to a lower investment in non-cash working capital, partially offset by cash payments of approximately $38 million related to the integration and acquisition costs of our recently acquired businesses and costs associated with our restructuring program. Growth and maintenance capital expenditures totaled $76.9 million this quarter, mainly for growth, and specifically to add capacity to our global training network to deliver on the long-term exclusive training contract in our backlog. Our growth CapEx is directly linked to our opportunities to invest incremental capital with attractive returns and free cash flow. With several attractive market-led expansion investment opportunities on the horizon, we continue to expect total capital expenditures to be more than $250 million in fiscal 2022. Income tax expense this quarter was $2.6 million for an effective tax rate of 8% compared to an effective tax rate of nil for the third quarter last year. The income tax rate was impacted by restructuring integration and acquisition costs this quarter, and excluding these costs, the income tax rate this quarter was 20%, which is the rate used as a basis to determine the adjusted net income of $60.7 million and adjusted EPS of 19 cents. Our net debt position at the end of the quarter was approximately $2.3 billion for a net debt to total capital ratio of 36.5%, and net debt to adjusted EBITDA was 3.23 times at the end of the quarter. We continue to expect interest expense of about $35 million as a quarterly run rate going forward. Now turning to our segmented performance. In civil, third quarter revenue was $390.1 million versus $412.2 million in the third quarter last year. and adjusted segment operating income was up $21.4 million over the third quarter last year to $83.4 million for a margin of 21.4%. This highly improved performance was driven by higher training utilization, predominantly in the Americas, and including our interest in joint ventures, civil training services revenue was approximately 10% higher compared to the third quarter last year. The higher revenue in training was offset by lower products revenue with a delivery of seven simulators this quarter compared to 10 last year. The lower number of scheduled deliveries in the quarter was expected and is consistent with our outlook for approximately 30 deliveries for the year. In defense, third quarter revenue of $426.5 million was up 42% over Q3 last year. This includes $127.9 million from the integration of L3Harris military training into our financials We indicated on the call last quarter that we would expect a segment operating income to cross into the $30 million range, and indeed it did by reaching $32 million for the quarter, including $19.6 million from the acquisition for a margin of 7.5%. The organic defense business grew sequentially this quarter, but remained lower compared to last year because of prior period COVID-19 impacts on orders and program interruptions, particularly internationally, which have been persistent since the onset of the pandemic. And in healthcare, third quarter revenue was $32.1 million, down from $120.9 million in Q3 last year on a statutory basis, but was up 17% excluding the ventilator contract last year. Adjusted segment operating loss was $2.7 million in the quarter, compared to an income of $12.9 million in Q3 of last year. The decrease from last year was mainly due to the contribution from the ventilators in the prior period and COVID-related labor disruptions and higher costs. We're also running a higher level of SG&A expenses to help accelerate top-line growth with a view to sustainable scale and profitability. With that, I will ask Mark to discuss the way forward.

Thanks, Sonia. As we look to the period ahead, we continue to see a clear path to emerge from the pandemic a larger, more resilient, and more profitable CA than ever before. Testimony to that, we're already delivering stronger financial performance, expanding and optimizing our position, and booking substantial orders. Pandemic-related headwinds may persist for some time, including supply chain disruptions, employee and customer absenteeism due to COVID-19 infections, operational constraints imposed by local authorities and intermittent border restrictions. The emergence and rapid spread of the Omicron variant this past December has certainly extended the timeline to a broad global recovery, but has not changed our position and our positive view of these potential as our end markets eventually open up more broadly as we emerge from the pandemic. In 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 demand are enduring positives underpinning a secular growth market. The global recovery continues to be narrowly led by the Americas, which means significant upside remains for a more global recovery. And we think the Americas provide a preview of the kind of demand to follow in other regions when conditions permit. Since the end of the quarter, we've had to contend with Omicron-related employee and customer absenteeism. However, the Americas are still strongest, and we're currently seeing some increased demand for training solutions in Europe as COVID-19-related travel restrictions begin to ease and airlines plan for what they expect will be a more robust summer travel season and beyond. As an example, EasyJet just recently announced the drive to hire 1,000 new pilots over the next five years with CAE as their training partner of choice. Asia Pacific is currently the most challenging region with relatively low levels of flight activity and training demand as Omicron now makes its way through that region. Overall, Since the end of the quarter, our training centers have been holding at about 60% average utilization levels globally. In business aviation, we remain bullish on the long term, and we believe that the market is experiencing a structural expansion with 3.3 million flights worldwide in 2021, the most on record for a single year. COVID-19 headwinds bear mentioning here as well, as Omicron and quarantine requirements were disruptive to our schedule in January for both our customers and CA instructors. But we look to be back on trend, and we're seeing strong demand for trending propelled by robust flight activity in the United States and Europe. And in simulation products, we're encouraged by the higher projected delivery rates of new aircraft coming off manufacturers' production lines, as one of, of course, the main drivers for full-flight simulator sales. We're seeing higher demand, as evidenced by this quarter's full-flight simulator order intake, coming mainly from customers in the Americas and Europe, and we expect to maintain our leading share of the market. The unevenness of the global recovery is likely to continue for some time, but we're ultimately in an excellent position to benefit for the multi-year cyclical market recovery that's currently underway. We continue to expect strong growth in civil for the current fiscal year overall. 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 across all five domains in national defense are tailwinds that favor C's business. Given the increasing relevancy of training simulation, our defense unit is also on a multi-year path to becoming a larger and more profitable business. We're currently focused on the successful integration of L3Harris military training, and we're on track to fully realize their 35 to $45 million of cost synergies that we laid out by fiscal year 2024. The pandemic continues to make international opportunities slower to materialize, but this headwind is temporary, and we have a strong pipeline with some $6.2 billion of bids and proposals pending customer decisions. Our increased orders in the quarter puts defense on the path to achieving over one-time book to sales for the first time in the last three fiscal years. Our U.S. defense business was also impacted impacted by pandemic-related employee S&Ts in January, and it currently faces a temporary budgetary headwind on contract expansions and new program starts as a result of the continuing resolution. Defence is indeed managing through its share of ongoing challenges, but we're moving in the right direction, and we remain confident that we'll deliver strong annual growth for fiscal year 2022. And lastly, in healthcare, We're focused on achieving greater scale by gaining share in the simulation training market, and we're targeting some of the largest pools of value like nursing. Supply chain restrictions, disruptions, and staffing shortages are a near-term headwind for the business too, but we continue to expect a double-digit growth in the fiscal year, excluding the ventilator contract. On the ESG front, I want to highlight that CE was included in the 2022 Bloomberg Gender Equality Index for the fourth consecutive year. This award recognizes that CAE is committed to support gender equality through policy development, representation, and transparency. We're proud to continue building an inclusive workplace every day. In summary, we've been adeptly playing offense during this period of market disruption by investing organically and seizing on nine acquisitions to enhance our position and broaden our market reach. We've also strengthened CE by permanently reducing our cost base across the enterprise. The timeline for a broad global recovery is more extended, but our actions and our performance to date give me even greater confidence. that we're on the path to strong cyclical recovery and secular growth as our markets eventually open and we all emerge from the pandemic. We're delivering on what we said we would do, and I expect CA to continue driving higher levels of profitability on a significantly larger base of business and with a post-pandemic capital structure that will allow us to sustain ample flexibility to further invest in our future. Our opportunity set continues to look very attractive, and I've never been as confident about CAE's future as I am today. With that, I thank you for your attention, and we're now ready to answer your questions. Thank you.

Thank you, Mark. I'm sorry. Operator, before we open the lines to questions, I want to highlight that Mark last month was honored with one of the world's most prestigious aviation awards, having been named industry leader of the year by the living legends of aviation. We're very proud of him and how this reflects positively on all of us at CAE, so please do join me in congratulating Mark. We'd now be pleased to take questions from analysts and institutional investors.

Thank you. If you would like to register a question or comment, 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 would like to withdraw your registration, please press the one followed by the three. One moment, please. And our first question comes from Kevin Chang of CIBC. Please go ahead.

Thanks for taking my question, and I echo Andrew's congratulations there, Mark. Maybe if I could start with the civil margin performance. As you noted, first time during the pandemic, north of 20%, despite utilization still tracking below pre-pandemic levels. If I look at it quarter over quarter, it looks like incremental margins were about 65%. Just trying to get a sense of where you think the margin trajectory goes here as utilization get back to kind of pre-pandemic levels of 70%, 75%. Could this be a mid-20s SOI margin business given all that you've done within the mix of revenue there?

I had trouble catching the last part of your question, Kevin, but I think I get the gist. Maybe I'll try it and you let me know if I've answered it. Look, I think I'm very pleased, obviously, with the margin performance that we had in the quarter in civil, 21.4% margin driven off. essentially similar revenue that we had last year. And maybe just I'll pause on that. When you look at the revenue, it looks like it's slightly down relative to last year for good reasons of the mix, the environment, the fact that we had lower deliveries in our products. But remember that we don't consolidate JV revenue, and that's not an insignificant number, and that's because of accounting. If you were to add back the jv revenue you what you'd be seeing is training revenues about up about 10 percent year over year but coming back to the margin look i'm as i said i'm pretty pretty happy about that you're going like uh 18 i think to 21 21.4 i think what you're seeing there is uh first of all the the mix of business you have business aircraft which i've always said is that's an attractive margin profile we have a very good Very nice position in Mark in business aircraft. Business aircraft is doing great. You're seeing that transpire. You're seeing commercial aviation training in the U.S. doing pretty well. And really, the big way what you're seeing is our cost savings, which are structural, coming through the numbers. So that's what you're seeing. And, of course, we've always said that we fully expect that margins, because of all those reasons, that margins going forward should track higher costs. than we've achieved in the past. I think our peak civil margin was just about 22% historically. I would certainly expect to blow through that on a sustained basis. I mean, obviously the one quarter doesn't make a year variable, but that would, to me, that would be the trend as you get more utilization. And I think the last thing I'll add, of course, I said in the remarks is all of that is achieved on a pretty narrowly led recovery that's really United States. So I think that's why you sense my confidence and excitement as the broader recovery across the globe comes to bear.

That makes sense. Just turning to defense, I just wanted to clarify something. So if I look at the time that you acquired the L3 Harris military training business, if memory serves me correct, I think at that time you had called out EBITDA margins of roughly 15%. 100%, I think. And if I look at what those margins look like since you've acquired it, it looks like it held them pretty well. Whereas your legacy margins have tracked about half, if not a little bit below pre-pandemic level. It sounds like you're talking about primarily a lot of international restrictions. Is that primarily the reason for the underperformance in margins and you need to see these travel restrictions get eliminated before they can you know, get back to 10%? Or is there anything else kind of holding those margins back?

Well, I think there's a few things in there. I mean, you're absolutely correct, as we cited. The defense business is not immune to COVID, both in the L3 Harris business, particularly in the international side of that business. I mean, the international portion of L3 Harris business, or the one we've inherited through our practices, is lower than our organic business, but it's still affected nonetheless. And so it's seen its share of impact there, as you couldn't travel to a lot of those locations. We've also seen some effects of, as I mentioned, the continuous resolution in the United States that prevents us from having new program starts or expansion of our existing programs. So that has definitely been a headwind, and we hope to see that being resolved pretty quickly. I could point to contracts that we're on. Like I mentioned, the SCARS contract, in the United States and the GBSD, the ground-based strategic deterrent contract that we're on in the United States for our health-rehearsed business, our ex-health-rehearsed business. Those are big contracts and, you know, because you have the CR, continuous resolution, you're not, I mean, the contractors themselves, if I think about the prime contractor on GBSD, are not able to make progress in enlarging that contract, so that affects us. And I don't know, I think maybe that's funny. You want to add anything to that?

Yeah, I'd probably kind of talk to the organic-based business and what we talked to, and this is still the case. The base business, first of all, it did sequentially increase both top and bottom line since last quarter. But as you know, our organic business has a higher proportion of international business. And as Mark just talked, that's the one that's been the most disrupted by COVID, especially international product programs. So a couple which are usually higher margins for us. So first, interrupting execution of existing backlogs, you know, so in certain regions where contract execution is slowed or even stopped. And as restrictions lift and programs can restart, that will help advance on both revenue and contribution, but also the impact of delays in order intake, especially on the international side. We've gone several years at least definitely since pandemic, with book-to-sales less than one, as contracts are selected, et cetera, but not necessarily moved to awarded. Now, we've seen some good advancement in the quarter with the book-to-sales and the international side going above one. And so as those take traction, whether it's the restrictions lifted and we secure those delayed orders on the product and international side, And then, of course, to layer on the continued synergies that we're starting to ramp up with the acquisitions. These will contribute to growing both on the top line and the profitability.

That's helpful. And then just last one for me. I appreciate the pipeline of opportunities you see in healthcare, and I think there are a lot of synergies with your core competency in terms of what you're trying to do there. Maybe explain to me, like, when you have an incremental dollar of capital, why health care would be an appropriate place to put that versus what you're seeing within civil and defense? It just feels like, you know, you've got better scale in those businesses. You can generate, I would imagine, better incremental returns. I guess explain to me why a dollar to health care would make sense versus the other two.

Well, I think the first thing I'd point to, other than the fact that Kadeem is strong and believe in that, health care will become a more material part of C in the not too distant future. I'm quite confident of that. But I think the thing I would point you to specifically the question of capital deployment is that the business is largely self-funding. I think essentially all is self-funding. And so the question that you asked, there is really no decision to be made with regards to that. Okay.

That's it for me. Thank you very much.

Thank you.

Thank you. The next question comes from Konak Gupta of Scotiabank. Please go ahead.

Thanks, and good afternoon, everyone, and congrats, Mark, on your accomplishments. Thank you. So maybe my first question, just following on the back of Kevin's question on civil margin. Obviously, Emily, you saw a pretty strong performance here. I understand there's business chair training, which is high-yielding, and then cost savings as well is going through. Anything sort of non-recurring in nature you think are not going to recur again in Q4 or the future quarters you saw in Q3 perhaps that you can speak to?

No, Karnak, this is just really, you know, I think a step up in operations, really, you know, a 35% increase in SOI on 60, still 60% utilization and lower deliveries that are It's really the mix. You see the operating leverage that's coming from that increase in utilization and the cost savings. So I think there's no non-recurring items, just strong performance on the civil side.

It's all good stuff.

Okay. I was just kind of more curious about seasonality in the business. Obviously, you have probably business jet training is stronger in the fourth quarter of And then it kind of drops off in the first half sequentially. So, like, does business chat make seasonality actually more pronounced in margins because of, you know, these dynamics?

I think, well, we still have the normal seasonality, although it's not as pronounced this year just because there's so much disruption across areas. Look, it's too early to say, but I wouldn't expect so. I wouldn't – based on the mix that we have, I don't expect – that we'll see a profound change. At least I don't see any so far. Would you add anything?

Well, I would just caution that, you know, there is always volatility on quarter-to-quarter margins, right, because of the mix and so on. So we always kind of give it a view on an annual basis. But, you know, I think there's no significant ups or downs there.

Okay. That's helpful. Thanks. And a couple of things on defense side of things. So it rebounded sequentially, certainly with both margins and revenue. And I think last quarter, Sonia, I think you probably would have mentioned that you expect something in the 30s shortly and then eventually in the 40s in terms of SOI. What's your visibility now with the kind of recent order intake at defense? Does it give you more confidence in that 40-plus SOI number shortly, or are you still thinking that's a ways out?

Well, so I think a great performance on the order intake. And of course, that gives you confidence to build on future growth. And what we like is that it's both on the US and international side, both over one time. And so like we spoke about it last quarter, we expect it to be in Q3. And then based on a few factors, securing delayed orders, especially on the product international side, as restrictions lifts enough and consistently to be able to advance programs that we have in backlog and then layering on the synergies that that gives us kind of line of sight at around 40 now great order intake but it does take a while to ramp up these orders so at the end and the average life of these orders are over several years so yes it's it's the greatest refills the backlog gives us better confidence for the quarter but we'll see a lot of that ramp up maybe just the start of that ramp up in Q4 and the rest for the upcoming years.

One thing I want to just point out there, go back to your previous question there, or at least the first part of this question, is that bizjet training is usually the strongest for us in our Q4. I don't expect that to change. The one thing, as I mentioned, we were impacted like most everybody else in January with a lot of instructors off. with COVID-related sickness, but we're having a strong shorter and we're back on trend.

That's helpful, Mark. And actually on the defense, I wanted to ask you another question on L3. It showed some sequential improvement in margins. So I'm just kind of wondering, is there some feasibility to that margin or was there any synergies that you kind of realized early on?

Yes, on the synergies. We started seeing synergies come through.

and i guess what i would say is yeah i've always said in defense it is no different uh one quarter does not make a year it's always been lumpy i will expect it to remain lumpy but you are seeing some synergies come through yeah just i'll just add mark uh you know we've wrapped we're ramping up the integration efforts uh there were some redundancies actions uh consolidation efforts etc so you're starting to see uh some of those synergies flow through and And depending on where those synergies lie, because they could lie in the organic or the inorganic basis, it will drive from volatility. In this case, it fell more on the inorganic side. But to Mark's point, that can drive from volatility in the quarters and so on in between. But essentially, that's the synergies starting to come through.

Great. I appreciate that. Thank you.

Thank you. The next question comes from Sadi Shamoon of BMO. Please go ahead.

Good afternoon, and thanks for taking my question. Again, around the margin, Sonia, you know, you were talking about 65% incremental margin this quarter. Is there a reason why you can't sustain this level of incremental margin going forward? I'm just kind of triangulating a little bit. You still have low utilization, travel, recovery is still in the early stage, and that training network typically have very high incremental margin. Is that the right framework to think about the aviation business in the next few years as you kind of move up that utilization curve?

We're also starting – we see, obviously, the mix from business jet, which helps on the margins, and that mix will vary, especially as we hopefully see CAT appreciating on the margins as well. But you're right. The operating – we're starting to see the operating leverage on the utilization kind of flow through and also a big chunk, a significant part of cost savings. Now, the slope on those cost savings will start to slow, but it'll just kind of continue to help on the operating margins. So on the operating leverage rather. So, you know, I think it's a very good performance. And, you know, like Mark said, we see this with volume contributing to exceeding prior pre-pandemic peak

Don't forget, Fatih, of course, that the future revenue will include a greater proportion of full-flight simulator deliveries and ab initio kind of work or park aviation kind of work. So that is a different margin profile. So you can't obviously consider it's all training revenue. So yes to your incremental margin, but certainly not straight line, right?

Okay. Okay. That's helpful. The follow-up question is on... the air mobility market, the eVTOL market, I guess. You're dabbling in it. You have some partnerships kind of coming through right now. I'm just trying to understand what exactly you're helping these partners, like I guess you've got Jaunt and a couple of others. What exactly is he involved with these partnerships? partners in terms of helping them cut up the training, I guess, going into these big launches? And two, what does this market look like three to five years down the road? Does it look like more business aviation where you're providing full turnkey solutions? And if you have any color around what kind of size market are you potentially looking at over the medium-longer term?

Yeah, thanks for the question. I think, Fadi, the first thing I would object to is the word dabbling. We're not dabbling in this market. We definitely intend to be a major player in this market. I think it's a very exciting market. I've said that before. I think it's a market that will materialize before anybody thinks it does because it's so compelling. In the history of aviation, I'm a bit of a history, as I think you know, a bit of a history buff, and especially in aviation specifically. And what has always stimulated the growth of aviation is newer power plant technology. And what you have here is new power plant technology, specifically distributed electric power plants and the advanced software systems that permit you to have these very complex vehicles that are inherently unstable to be able to be economically produced. So that's why you see a plethora, a large number of these companies coming through to produce vehicles of all types to serve this air mobility market. So, per se, we're not picking winners and losers here in this market. What we're doing is we're getting involved. And by the way, Yesterday we became involved. I went to a major conference, and I say major, an invitation-only conference about four years ago in this market. It was held in Texas where all of the players at that time were getting together and really saw the potential for this market. So short answer to go back to your question is that I certainly believe that this market is going to be needing about over 60 000 pilots over the next 10 years and there's no way that these pilots that are going to fly these vehicles are not going to be have to train to a high level uh in order to operate in the airspace that we have today in congested airspace because by definition these vehicles will fly in and around cities so they're going to have to be trained so what you see is us positioning ourselves as the company we are. We can help, first of all, define the kind of training infrastructure and kind of training standards that will be required by training these pilots of these vehicles, working with the companies, working with the regulators, and offering the service. And as you say, it may be a business aircraft type construct, or it may be involving selling devices. It will be a combination of both. It is being defined today just as this market is being defined today. But, you know, make no mistake, I fully expect us at CAE to be a major part of that market.

Okay, that's great. You know, maybe the last question. You mentioned about kind of how the aviation demand has been led by North America, U.S., I guess, in particular. wouldn't kind of a pickup in travel in Asia and some of these markets that still are behind in the recovery be more attractive to you because you tend to do a little bit more wet training or a little bit more turnkey solution in those markets?

Well, I think if you have to look at the overall market for us in training, We've seen business aviation itself, you know, training doing very, very well. Of course, you know that's all wet. That's very good. The rest of the world, I think when I point to when the recovery comes back in Asia Pacific, we tend to do, you know, on average a bit more wet in that region. But I think I would point to training in commercial aircraft as a whole, you know, Today, Asia-Pacific is operating at about 50% where it was in pre-pandemic. So there's a lot of recovery left to have in that market. So definitely, I think that any expansion going back to normal 2019 levels, whether it be wet or being dry, is going to be good for CE. And whether it be Europe, whether it be Asia-Pacific, again, look back at what's happening in the U.S. In the U.S. today, it's a narrow lead recovery. People are scrambling to train their pilots. They're buying more simulators. You look at the recovery in the simulators that we've had just this year relative to last year. It's quite impressive. Largely driven by the United States and some in Europe. So imagine that rolling over into Europe and Asia Pacific. And I think there's a large potential for that. And I think that leads us to where our asset base is. Today, about 33% of our simulators are about 54 simulator equivalent units, already Americas. In Europe, they're about 44%, about 72%. In Asia Pacific, 36%. What's interesting, though, is as we talked about during the pandemic, we moved... Simulated a lot of simulators that we launched a lot of simulators to go where we thought, you know using the Gretzky analogy analogy where the puck was going where a puck was going where training demand will be and No surprises being led by the United States. So if you look at going into next year where simulators are we're going to have about the same number an absolute number of similar equipped equally equivalent units of in the Americas as in Europe. So we're shifting our asset base to where the demand is. I think that's going to be pretty attractive. And that's impressive, especially considering that we acquired FSC in Amsterdam, so inherently we've added a lot of simulators in Europe itself. So the fact that we're beyond par, I think, is a very good move that we've made, guaranteeing the future for us. Okay, thank you. I appreciate the call, Omar.

Operator, if I could just interject for a second here. We still have quite a few people on the line wishing to ask questions, and we'd like to get to all of them if we can. Maybe at this point we would restrict to one or two part questions so that everybody gets a chance.

Thank you. The next question comes from Cameron Dorkson of National Bank Financial. Please go ahead.

Yeah, thanks. Good afternoon. I'll stick to one question. Obviously, we've got maybe a little more visibility today on how the airlines are going to recover. Maybe there's certainly some markets that are a little more uncertain, but I guess maybe given that greater visibility by many airlines, can you talk a little bit about what you're seeing on, I guess, the potential for outsourcing? I think one of the issues the last couple of years is that airlines just didn't know what their fleets were going to look like and when the market was going to recover, but You know, as I said, there's probably a little more visibility today, so I'm wondering if any of those kind of talks around outsourcing deals have picked up at all.

Well, there's definitely, again, a high volume of conversations occurring, and there's contracts occurring, and you're seeing that as a testimony to the amount of simulators that we've deployed in the United States specifically. You know, I was pointing in answer to Fatih's question, the fact that we've been increasing the number of simulators you know, quite substantially in the United States. And some of that is for business aviation, which is growing. But, you know, another large part of that is for the commercial aviation training network. And all of those simulators are going essentially to either new airlines that are starting, which are going straight to an outsourcing model, or to airlines, including legacy carriers, that are trusting CE with long-term contracts for training. So that's not de facto a complete outsourcing, but it is definitely a different trend that you see where airlines, in order to be able to secure the training need that they have on an acute basis, they're willing to, and they're seeing the attractiveness of going into long-term contracts with us. So that is a difference. But there is continuing conversation, and, you know, I would say that we're certainly not in a steady state. I mean, with with yeah there was maybe uh better than we were you know last year but omicron has you know turned a bit of a monkey wrench into you know any kind of steady state in the airline business right now okay no that's uh that's helpful thanks very much thank you the next question comes from christian luwak of morgan stanley please go ahead hey thanks um uh mark you know our domestic u.s air traffic had a very steep recovery

So if global air traffic follows a similarly steep recovery, let's say second half of the year, I mean, we don't know, but should it happen? Can you discuss any labor or supply chain constraints that could slow down your ability to meet a potentially roaring demand? Because with the footprint that you have there, it sounds like it should be a pretty good year should we see that air traffic come in.

I don't see it. I don't see any. Certainly, I don't see any kind of parts related issues that way. Labor I don't see it. I think that we're well positioned. We spent a lot of time during the pandemic, especially the first year. If you go back to some of the things I was saying in the beginning, I said we would take advantage of the period that we have of lower demand, lower demand environment to optimize our training network. And that's where you see a lot of recurrent and permanent cost reduction coming through. But we also said that we keep our powder dry. And power to drive meaning that, I said it right from the beginning, people are not going to give up the freedom they have to travel. And we see that. We see that certainly in the domestic flying in the United States. So we're going to see that. And I see no structural reason that we will not benefit from that recovery. And when that timeline is, certainly I think the Omicron is – likely extended that recovery timeline maybe, but that'll be measured in months, certainly not in years. So call us very confident in the long term.

Thanks, Mark. And if I could squeeze a second question on the max here. I mean, in December, we finally saw the airworthiness director from the CAC saving the return to service on the max. Are you seeing any acceleration and training activity on the max from China?

Well, we're definitely seeing training for the MAX. Training for the MAX is at high levels. It has been for a while on the return to service, even before the return to service, as people could see the airplane is going to go back into the sky. So I would just say it's a high level of activity, and I foresee that continuing as more and more MAXs are being delivered.

Thanks, Mark.

And in China, I think what you'll see is that will manifest itself largely in full-flight simulator sales.

Thank you. The next question comes from Benoit Poirier of Desjardins Capital Markets. Please go ahead.

Good afternoon and congratulations, Mark, for your prestigious award. Mark, we've seen some M&A among the airlines with Spirit and Frontier. Any thoughts on whether M&A could slow down or accelerate outsourcing opportunities? Will you foresee more M&A activity among the airlines, Mark?

Well, I'm not going to predict it. Inevitably, whatever that kind of event happens, it's usually a catalyst for us to have a discussion with them because the airline itself is looking for new ways of doing things. So I think, to me, that's where I would leave it. You know, I can't be a predictor of how much M&A they would have, but certainly there's a lot of opportunity in the airline business today. Perversely, it continues to be a number, quite a number of new airline starts, and that's a good opportunity for us as well because, you know, we offer a ready-made international, you know, or actually a global network of training solutions. So offering them a solution that was never developed there before, so I think that's good for us.

Okay, that's great. My follow-up is for Sonia. You provided great color about the booking for defense, the fact that it's been spread out on the global scale. Anything particular to highlight on what drove the big change in momentum during the quarter? And for the free cash flow generation, was there anything unusual in the quarter, or should we expect another strong fourth quarter?

I'll start on the free cash flow. I think it's just very, very strong performance in the quarter with $282 million. That's on strong operational performance. And as you know, it's a very cash generative business. It's also driven with a solid non-cash working cap reversal in the quarter with over $200 million of reversal. And that's really continued persistent focus on working capital, improved collections, conversion of work in progress into ARN cash and a reflection of higher orders. So higher orders come in with milestone payments and deposits on contract. So that contributes to a really good performance of free cash flow. And that's despite continued cash payments on the restructuring program, which was about $38 million in the quarter. So nothing unusual, just strong performance and good reversal of warranty cap. And we've guided to continued 100% free cash flow conversion of net income to free cash flow. Now, on your first question, I didn't quite hear on the defense side.

Just in the sense, there's been a big change in the booking for defense. I was curious to get more color about what drove the big change, positive tone in terms of booking with respect to defense, Sonia.

Well, maybe I can answer that, Benoit. Look, we... it's the big pipeline of orders that we've talked about, the bids that we have that are waiting for customers to pull the trigger. Really, you see a lot of that. We took the advantage, especially internationally, where, you know, right before VKong, we had a period of time there we could finally start traveling and people were willing to meet us. So I can tell you, we took our international teams, took the opportunity to really go after it and fill the pipeline. And they did, you know. I talked about a defense book to build above one. I can tell you it's well above one. And I think they did a very, very nice job. And that reverses the trend that we've had that are largely caused by COVID of the, you know, the orders gap in that segment, particularly internationally. And in the U.S., look, I think it's just good work by our teams. Great work by our teams. I love the orders. As I said at In my remarks that are coming across on all five domains, the first prime contract in the space domain, the first prime contract in cyber, on top of the great wins, like, for example, the ab initio win that we had there for doing all the training for the Luftwaffe in Germany, beating a 60-year incumbent. I think it's great work by the teams in defense and working in collaboration, I would say, for example, in that last contract with their colleagues in civil, leveraging the full power of what we like to call as 1C.

Thank you very much for the time.

Thank you.

Thank you.

The next question comes from Tim James, TD Securities. Please go ahead.

Thanks very much. Good afternoon, everyone. Mark, congratulations on that fantastic award. It's a real accomplishment. Having said that, I'm going to save some time here. Actually, all my questions have been answered, so thank you. Well, thank you, Tim. Appreciate it.

Thank you. The next question is from Anthony Valentini of Goldman Sachs. Please go ahead.

Hey, y'all. You got Anthony Valentini on for NOAA today. Thanks for the time. My first question is on the 10% training growth that you guys put out, inclusive of the JVs. I think it's super helpful, and the investment community is going to welcome that metric going forward. I'm curious what that's looked like over the last few quarters, if you can provide it, and even sequentially, I think would be really helpful. And then my second part for Mark, I'm just curious what you think the next catalyst is going to be here for the global recovery, specifically in Asia. I know that you mentioned the new variant, but I know we've been having, you know, kind of this conversation on these calls for the last few quarters now. Is it a matter of us just learning or just in Asia, like us learning to live with, you know, the pandemic or is it an event like the end of the Olympics? Your call there would be great. Thanks.

Look, I think it's just basically lifting of COVID restrictions. I mean, they're, they're real, they're really impediment to travel and, uh an air goal uh revenue for us in training is not largely because people are afraid of getting on airplanes it's because people can't go anywhere or they have to wait like for example in asia pacific in some cases still up to 21 day up to 21 days you know of you know having to quarantine after you come back that makes you got to be you know you're going to want to travel when you have something like that so to me it's all tied to the lifting of those restrictions. The great news is I think that we're seeing, for example, I don't know where you are, I think you're in New York, but I mean, here in Quebec, we're seeing lifting of essentially all restrictions here in Quebec by the end of March. I think that's a very positive news. Doesn't do much for air travel, but I mean, it's an indication. We're seeing European countries literally one by one basically calling an end to restrictions That's going to be the catalyst. So ultimately, I think that's what we got to see in Asia, Asia Pacific. And, you know, I'm I'm not a government employee. I can't tell you when that's going to happen, but inherently I know it will happen. So barring any new variants, hopefully not. But I mean, I'm optimistic that we're on a good we're on a good trend here. Okay, Anthony? Okay, yeah. Yeah, the first part of my question. Yeah, you had another question, yeah, on the JV revenue. I think Sonia can give it, yeah.

Yeah, so 10% including, so training growth including the contributions for JV. I don't necessarily have the last quarter on hand because there's a couple of different elements But what I would say is higher, because obviously you see the utilization, and we saw a really nice wrap-up on certain regions where we have joint ventures, but we can get back to you with the numbers.

Okay, great. Thank you.

Great. Operator, it looks like we've run out the hour. I do want to still use a couple minutes, if we can, for members of the media. Is there any questions? from members of the media.

As a reminder, via the phone lines, you may press the 1 followed by the 4 on your telephone keypad to register a question or comment. Once again, the 1 followed by the 4. The first question comes from Stéphane Roland of La Presse Canadienne. Please go ahead.

Yes. Hello, Mr. Parent. Thank you for taking my question. Je me demandais, vous avez parlé justement du air mobility, j'imagine c'est le taxi aérien, puis que vous étiez, que vous croyez que ça allait débloquer plus rapidement que les gens pensent. Est-ce que vous pouvez me donner un peu plus de commentaires par rapport à votre impression? Qu'est-ce qui vous fait dire que ça va débloquer plus rapidement, puis dans quel horizon on pourrait voir ça arriver?

Well, as I said, I definitely believe that it will happen faster than people think. First of all, the impression is based on the fact that I think that no one really expects it to happen. There are a lot of people who are not in the field, who have not really heard of these famous air taxis. In fact, that's what we're talking about. But it's because I've been in the field for years, I'm aware, I'm very close. the development of all these different devices around the world. There are some that are very close to us. For example, there is our partner Beta. Beta is just here in Burlington, south of Montreal. They also have an office here at the Montreal airport, not far from us, where they take care of engineers, among others here in Montreal. So they fly their taxi, if you want to call it that. It's a design that, for me, will be able to be certified in an area that is not very far away, because it's not revolutionary. So, we'll see it happen. And they already have orders. They have orders with government agencies in the defense, and they have orders for companies that deliver fees, like FedEx, UPS, for example. So, that's why I think we'll see it happen. par définition, c'est des véhicules à propulsion électrique. Ça fait que c'est très éco-énergétique et c'est très silencieux par rapport à, disons, un hélicoptère. Ça fait que pour moi, je vois une excellente, une grande opportunité pour nous dans le développement des pilotes, entre autres. Ça fait que c'est pour ça qu'on est très excités du domaine du texte aérien. We were also able to help the companies in the certification of these apparitions. And I think that, among other things, I was saying in our last call, I think it's an excellent, also, it offers excellent perspectives for Montreal in general, because we have a graph here in Montreal that is almost unprecedented across the planet. So, it offers excellent perspectives for our engineers, for our technicians who leave our schools, our people in software development, to participate in the development and growth of this industry. Excellent, thank you.

And maybe one last question, if you have time. What would be the next step for the development of this industry? Est-ce qu'on doit encore développer la technologie? Est-ce qu'on n'est pas plutôt du côté réglementaire, d'accorder les corridors aériens, d'établir un cadre réglementaire? C'est quoi la prochaine étape pour l'industrie?

Les deux. Les deux. Ça dépend des appareils. Étant donné que c'est le marché lui-même, ce qu'on appelle communément encore le taxi aérien, est stimulé par le bénéfice que nous permet cette nouvelle propulsion électrique On voit des dizaines et des dizaines de différents manufacturiers qui sont en train de développer des prototypes. La première chose, dépendant du prototype, ça va effectivement dépendre de la certification de ce véhicule-là. Deuxièmement, effectivement, ça va prendre des nouvelles réglementations pour savoir comment vont s'intégrer ces nouveaux véhicules-là dans l'environnement aérien qu'on a maintenant. Les deux vont être des étapes à franchir dans le développement, mais ça va se faire au cours des prochaines années. Je m'attends autour des dix prochaines années qu'on va voir, disons pour notre industrie, un potentiel d'au moins 60 000 pilotes qui vont être obligés d'être développés et formés pour pouvoir piloter ces nouveaux appareils-là.

Excellent. Merci. Bonne journée. Merci.

Okay, operator. We'll conclude the call at this time as we've overrun the hour. I want to thank all participants again for joining us today. Merci beaucoup tout le monde. C'est notre appel de comparance. I would remind you the transcript of the call can be found on CAE's website at cae.com.

Thank you. This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.