CAE Inc.

Gentlemen, welcome to the CAE third quarter conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now proceed, Mr. Arnovitz.

Good afternoon, everyone. Thanks for joining us on the call. Before we begin, I will 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 the 14th, 2023, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. The description of the risks, factors, and assumptions that may affect future results is contained in CA'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 Perrin, CEE's President and Chief Executive Officer, and Sonia Branco, our Chief Financial Officer. After remarks from Marc and Sonia, we'll open the call to questions from financial analysts. At the conclusion of that segment, we'll open the line to members of the media. Let me now turn the call over to Marc.

Marc Perrin Thank you, Andrew, and good afternoon to everyone joining us on the call. We had strong results in the third quarter, driven by CIVIL's double-digit growth, defense sequential improvement, and healthcare's increased profitability. We also ensured our path to future growth by securing over $1.2 billion in total order intake for a record $10.8 billion backlog and 1.22 times book-to-sales ratio. In CIVIL, we booked $713 million of orders from a large opportunities pipeline, resulting in a 1.38 times book-to-sales ratio. This is especially noteworthy accomplishment considering this is on revenue that's 33% higher than last year. Orders include long-term commercial aviation training agreements with Gold Airlines and Mesa Airlines and a multi-year business aviation training agreement with Deluxe Public Charter. We also made excellent progress with our flight operations software solutions, with notable agreements including a five-year contract with Ethiopian Airlines for our next-gen crew and operations managers solution suite, and since the end of the quarter, an agreement with Frontier Airlines for our next-gen operations solutions. Demand for full-flight simulators continues to be strong, with 14 sales in a quarter, bringing our year-to-date total to 43. Civil's financial and operational performance was also strong in the third quarter, with double-digit growth and near-record margins. We delivered nine full-flight simulators in the quarter, and average training center utilization was 73%, up from 60% last year. Commercial aviation training demand continued to be strongest in the Americas, followed by a seasonal uptick in Europe and in Asia, which has improved with the ongoing easing of travel restrictions in China. In business aviation, train demand continues to be robust throughout our network, reflecting a high level of pilot training to support business aircraft flight activity, which continues to exceed pre-pandemic levels. The leading indicator of our progress towards a larger and more profitable business is order intake. This quarter, we booked orders across domains for training and mission support solutions valued at $477 million for a 1.05 times book to sales ratio. This marks the sixth consecutive quarter that this ratio has been above one, resulting in a book to sales ratio of 1.25 times on a trailing 12-month basis. Notable orders in the air domain include the provision of a flight train device and maintenance and logistics support for the Royal Canadian Air Force's CH-149 Corbett search and rescue helicopter, the continuation of air crew training on the KC-135 Stratotanker and C-130 Hercules for United States Air Force, and international flight training device upgrades for the F-16 fighter jet and CH-53 heavy lift transport helicopter. In the land domain, we were awarded funding for our Joint Terminal Control Training Rehearsal System, which builds on the success of our previous funding award for a new virtual training capability for soldiers to the U.S. Army on the Soldier Virtual Trainer Prototype Contract. We also booked orders in the space and cyber domains, highlighted by the proliferation of CA solutions for distributed network and cyber secure mission training via U.S. Air Force SCARS program. And since the end of the quarter, we've booked orders in the sea domain with our ongoing work with Lockheed Martin on the Canadian surface combatant ship program. Defense also continued to build on its foundation of U.S. Army support with the successful competitive re-compete for the U.S. Army aviation fixed wing flight training program. which involves a provision of comprehensive initial and recurrent training for more than 600 U.S. Army and U.S. Air Force fixed-wing pilots annually at the C.A. Dolphin Training Center in Alabama. The approximate total value of the base contract and options is $250 million U.S. with a period of performance through 2032. This was awarded to us with an effective date commencing in our fourth quarter, and accordingly will be reflected in our next quarter order intake. Also involving U.S. Army aviation, our prime partner on the U.S. Army's future vertical lift, Bell Helicopter, was awarded the FLARA program, which will field the V-280 Valor tiltrotor to eventually replace the long-serving UH-60 Black Hawk helicopter. Pending protest resolution on this award, CAE will support Team Valor by delivering a range of training devices, solutions, and courseware for Bell's family of systems. We've continued to place a strong focus on our operations and asset optimization in the face of the ongoing macroeconomic challenges impacting the defense industry, as well as the broader economy. And as a result of these efforts, Our financial performance for defense in the quarter improved sequentially and was largely in line with what we expected. With that, I'll now turn the call over to Sonia, who will provide additional details about our financial performance. Sonia?

Thank you, Mark, and good afternoon, everyone. Consolidated revenue of $1 billion and $20.3 million was 20% higher compared to the third quarter last year. Adjusted segment operating income was $160.6 million, compared to $112.7 million in the third quarter last year. Quarterly adjusted EPS was $0.28 compared to $0.19 in the third quarter last year. Adjusted EPS this quarter includes an approximate $0.02 positive impact as a result of gains on the reversal of impairment of non-financial assets following their repurposing and optimization. We incurred restructuring, integration, and acquisition costs of $4.9 million during the quarter relating mostly to the Air Center acquisition And this also includes the $9.8 million impairment reversal. Net cash provided by operating activities this quarter was $252.4 million compared to $138 million in the preceding quarter and $309.6 million in the third quarter of fiscal 2022. Free cash flow was $237.7 million compared to $108.4 million in the preceding quarter and $282.1 million in the third quarter last year. The sequential increase was mainly due to a lower investment in non-cash working capital and a higher cash provided by operating activities, while a decrease compared to third quarter last year was mainly due to a higher investment in non-cash working capital, which was partially offset by higher cash provided by operating activities. Capital expenditures totaled $63.4 million this quarter, with approximately 75% invested in growth. To specifically add capacity to our civil global training network, to deliver on the long-term training contract in our backlog. Income tax expense this quarter was $17.1 million for an effective tax rate of 18 percent. The income tax rate was impacted by restructuring integration acquisition costs this quarter, and excluding these costs, the income tax rate was 19 percent. Our net debt position at the end of the quarter was approximately $3.1 billion for our net debts to adjusted EBITDA of 3.74 times at the end of the quarter. This 43 basis point improvement from last quarter puts us solidly on track to meet our targeted leverage ratio of below three times net debt to adjusted EBITDA by the middle of next year. Net finance expense this quarter amounted to $48.8 million, which is up from $41.3 million in the preceding quarter and $34.5 million in the third quarter last year. Approximately 70% of our debt obligations are fixed rates, and the increased finance expense largely reflects the impact of higher interest rates on our variable rate debt instruments. For now, we're assuming a go-forward quarterly run rate for this expense in the range of the current quarter. Now turning to our segmented performance, in civil, third quarter revenue was up 33% to $517.4 million compared to the third quarter last year, and adjusted segment operating income was up 58% to $131.4 million versus the third quarter last year for a margin of 25.4%. Our strong year-over-year civil performance was mainly due to higher training in our network utilization and the integration of Air Center into our results, which represented approximately 10% of civil revenue in the quarter. In defense, third quarter revenue of $452.5 million was up 6% over Q3 last year. Adjusted segment operating income was $25.4 million for the quarter, down from $32 million in the third quarter last year. The revenue growth stems from FX translation and the higher level of activity on programs, while the lower adjusted segment operating income reflects higher costs associated with inflation, supply chain disruptions, and labor shortages. This was partially mitigated by reversal impairment on intangible assets following its repurposing and optimization and cost reduction initiatives. And in healthcare, third quarter revenue was $50.4 million, up from $32.1 million in Q3 last year, mainly due to the increased sales of patient simulators and center management solutions. Adjusted segment operating income was $3.8 million in the quarter for an adjusted segment operating income margin of 7.5% compared to a loss of $2.7 million in Q3 of last year. With that, I will ask Mark to discuss the way forward.

Thanks, Sonia. The strength that we saw in the third quarter gives us additional confidence in both our fiscal 2023 outlook as well as our long-term targets. We're excited about Civil's prospects as we build on our industry-leading position with the most innovative training and critical operations support solutions, and we expect to see significant growth during and beyond the ongoing global aviation market recovery. We anticipate continued strong growth in commercial aviation training as flight capacity rises to meet travel demands and as mobility restrictions abate in China, which remains a key driver for airlines mainly operating in Asia Pacific, but also worldwide. In business aviation, flight activity has remained above pre-pandemic levels, and we continue to see strong demand for business aviation pilot training. we have been and will continue to deploy training capacity in lockstep with demand in this significant segment of the market. We continue to expect civil performance to be strongest in our fourth quarter, with a mix involving about twice as many full-flight simulator deliveries as in the third quarter, which gets us to our estimate of 45-plus deliveries for the fiscal year. We also have more simulators coming online in our global training network, which makes for a larger base of revenue. We've done very well with full-flight simulator sales year-to-date, and we expect to maintain that momentum, winning our fair share. In defense, despite the macroeconomic headwinds, order delays, and potential U.S. budget complexities, which are expected to extend into the next fiscal year, our continued sequential growth, along with positively trending bookings and backlog renewals, adds to our confidence in our multi-year view. Defense represents a secular growth market for CEE, and we believe the sector is in the early stages of an extended up cycle, driven by geopolitical realities and increased commitments to defense modernization and readiness. We're now sustaining higher order intake, replenishing and renewing our backlog with new and more profitable defense contracts, and we expect this trend to continue and for defense to strengthen over a multi-year period to a low double-digit percentage segment operating income margin profile. We're bidding more and we're bidding larger with a pipeline of multiple $100 million-plus programs and a number of $1 billion-plus programs that we're bidding over the next three years. We're highly focused on execution, and as we look into the remainder of the current fiscal year, we expect further sequential improvements for defense in the fourth quarter. And in healthcare, we're on a path to accelerate value creation by gaining share in the simulation and training market and driving top and bottom line growth. We have a strong team and I expect to see their positive momentum to continue. Our capital allocation priorities are unchanged with a focus on organic investments that are made in lockstep with customer demand. We're on track to meeting our leverage target by the middle of next fiscal year, which at that time will further increase our financial flexibility. The CE management and board of directors are also prioritizing returning capital to shareholders in a timely manner, which is a key aspect of our capital allocation strategy. In summary, the strength of our performance in the quarter and our current expectations for the balance of the year allows us to reiterate our outlook for mid-20% consolidated adjusted segment operating income growth for this fiscal year. We're also reiterating our long-term target of a three-year earnings per share compound growth rate in the mid-20% range. With that, I thank you for your attention, and we're now ready to answer your questions.

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

Certainly, thank you. And once again, on the phones, before we begin, to ask a question, you can press the 1 followed by the 4 on your telephone keypad, and you'll hear a three-tone prompt to acknowledge your request. If the question has been answered, I could draw your registration as the 1 followed by the 3. And we'll now proceed with our first question on the line from Kornak Gupta with Scotiabank. Please go right ahead with your question.

Kornak Gupta Thank you, and good afternoon, everyone. just wanted to ask you on the civil side first the margins are already back to the pre-dynamic levels here in the fiscal q3 are you expecting the margins to be nearing the peak or would you expect further upside as asia comes back well look i'd say look we always had i look at this quarter as i said in the remarks we we had a you know quite a favorable mix this quarter and uh

As I've said in the past, that can be an important factor to margins. I remember asking that question in Q1 when it was going the other way. And if I look at, I mean, not specifically addressing your question, I'll get to it, but if you look at next quarter, we're going to have a lot more, we'll play similar deliveries, which will play a role in the margins because inherently, you know, product sales are, although profitable, they're not as profitable as training. So, You know, as we're deploying a lot of training, we expect a lot of training in the fourth quarter, so you can expect, you know, although we'll still see a very strong performance in civil, I wouldn't expect to see, you know, a high margin in the fourth quarter. I would like to be surprised, but I certainly don't expect it. You know, but long term, look, at the end of the day, as the market comes back, as you said, with Asia coming, you know, I'm quite encouraged by what I see in Asia Pacific, and it's been the longest drag on recovery. We're continuing to see... The positive effects in our travel recovery we're seeing in terms of utilization in our training centers. But it's going to take some time. As we saw in Europe and in America, it takes a while for it to pick up. I think we're several quarters away from being fully back, in my opinion. But make no mistake, when I look at fiscal 25 and beyond, I think we're seeing the pieces here of a total recovery So if you factor that plus, you know, all the cost savings that you're seeing, you know, flow through our results, I think, you know, we can expect that, you know, margins can continue to increase over the long term.

Okay. That's good, Club Market. And if I can follow up, there was a recent announcement, I guess, by one of the U.S. airlines. given they are struggling with pilot shortage, they're trying to reduce the number of hours required for pilots to train on turbine engine. What does that really mean for CAE?

Well, look, I think I'll leave that to the regulators, but everybody's always focused very much on safety. So at the moment, I would tell you that we barely meet the demand that's out there, and we're in growth mode. So To me, I don't see that being a factor one way or another to the results of C8.

Okay. Appreciate the call. Thank you.

Thank you very much. We'll get to our next question on the line. It's from James McGarigle with RBC Capital Markets. Please go right ahead.

Hey, everyone. I hope everyone is well, and congrats on the strong quarter. Thanks, James. Thank you. So on the defense margins in the quarter, and some of the long-term targets the team established at the investor day. Are you able to help quantify the bridge between those two? So I know supply chain is kind of unknown at this point, and really anyone's guess as to when that improves. But are you able to talk to the items that you do have a line of sight into over the next few quarters, such as potentially certain low-margin business rolling off, any high-margin contracts upcoming, or specific cost savings related to L3H cost synergies?

Well, I think it's all of the above. Look, as we said before, what we're doing here is we're basically doing very well on order intake. You can see like six consecutive quarters now of booked bills higher than one. You have a trailing booked bill over the last 12 months of 1.25, which points to strong growth. And the important thing about that is You know, the team, you know, with Dan Gelson at the helm, is signing contracts that are accretive to a long-term goal. So what you see here is with these orders, it doesn't happen overnight. It depends if they're products or services, products, you know, contributing to results faster. But those contracts, those new contracts, are replacing contracts in our backlog. Some of them that are drag programs that have been very much impacted by the headwinds that we've faced in supply chains, as we said, as you mentioned, and on labor. And in some cases, although we've done very well on order intake, you know, not all orders are created equal in terms of their timing. So, you know, but look, we have a pretty good line of sight of those factors. So, you know, as we go, so that's what allows me to reaffirm, you know, not for Q4 for sure, and then having enough line of sight of how we're doing in terms of abatement of those factors to give the optimism that I have for its continuous sequential improvements all through next year along the way to our long-term target of double-digit profitability.

I appreciate that. Thanks for the call there. I also wanted to ask a question on civil and the potential impact of a slowdown in Europe. I know pilot training is regulated and that it's insulated from macro to a certain extent But can you talk to how your conversations with customers in Europe are evolving, given some of the macro headwinds in the region, and any steps your team is taking to prepare for a potential slowdown in that region? Thank you.

Well, I think I would tell you is that we're not seeing a slowdown for where we're at. And certainly in Europe and in America, definitely. And we're seeing things pick up, as I mentioned in our previous presentation, question in Asia Pacific. So at the moment, we're in growth mode, and we're forecasting being in growth mode for at least the conceivable future. So obviously, you know, when people talk about risk of recession in Europe, it certainly bears watching, particularly, you know, as a result, if it's, you know, faced with a potential energy crisis, which really hasn't occurred, materialized. But look, We're watching it, but we're certainly not seeing it. We're not forecasting it anytime soon, at least as a result of C-80.

Okay, I appreciate the caller, and I'll turn the line over. Thank you.

We'll get to our next question on the line. It is from Kevin Chang with CIBC. Go right ahead.

Hey, thanks for taking my question. Good afternoon, everybody. Congrats on a good fiscal Q3 here. Maybe just on defense, in your outlook, you mentioned there's a little bit of uncertainty here with U.S. government budget appropriation issues. I'm just wondering, do you see that primarily impacting, I guess, the timing of awards being allocated? Does that also impact, because I believe you're pursuing some cost recovery initiatives with with the government, just given how inflation has played out here. Do these appropriation issues also impact the timing of some of those cost recovery initiatives for you?

Well, look, on the second part of your question here, on regards to that specific point, in the recent DOD budget, and I will tell you, we influenced this in not an insignificant way. Funding was granted specifically to address inflation. That's public, and I can tell you, we're working with our customers to address the inflationary items that have been, and I mentioned this on previous calls, that have definitely been a factor, and that results in, for us, submitting requests for what's called equitable adjustments, or REAs, and We've submitted quite a bit, and it's early in the process. I can tell you we have received some small adjustments. Nothing material, I would say. And so going back to what I mentioned with regards to budgets being approved and disruptions there, to me, we could see a prolonged continuous resolution environment defense. So, look, that has a potential for delays to new program starts because if you're in that kind of environment, you can't have any new program starts. So, we're watching that, but I would tell you that even with that factor, it may affect the exact timing, but it doesn't change by view with regards to sequential growth next year in defense.

Okay. No, that's very helpful. And maybe my second question here, you know, you've alluded to now the past couple of quarters looking to return cash to shareholders, and it sounds like, you know, you might be in a position to provide more details the next fiscal year. But is there a framework we should be thinking about? Like, are you looking at a targeted payout ratio on the dividend or, you know, in terms of buyback, you know, are you looking to return to what you were doing pre-pandemic? Is there any framework you can share with us, or is it still being... contemplated at the board level still.

Yeah, I think as we said, the first priority is really to de-lever, and we saw really good progress in Q3, bringing down the leverage ratio by almost half a turn, and continue to be on track to the guidance. So then we believe we'll be in a better position to consider the return of capital to shareholders. I think it's too soon to speak about a framework or form at this point.

Okay, no, that's helpful. Actually, just one last question for me. Just given the sequential increase in full-fledged simulator deliveries expected in the fiscal Q4, any risks around supply chain or all the parts and things that you need to build and deliver those all, I guess, all in-house now and you're just kind of ready to deliver this stuff by quarter end here?

Well, you can never say zero risk because you never know what can hit you, but all those simulators are at customer sites as we speak, so they're built. So it's not an issue. So when, you know, we've, you know, we're, as you know, we're pretty experienced at delivering and certifying full-flight simulators. So I'm marking some factor that I would qualify almost as an act of God. I think pretty good on the, on, you know, us getting those simulators certified. And as I said, park shortages are not, are no longer a factor when you consider there's about six weeks left in the year, right?

No, that's super helpful. Thank you very much. I congrats again.

And that's, by the way, I got to shout that out. That's thanks and a shout out to the hundreds of people that we have working in customer sites around the world doing that as we speak. And I applaud them because they're the heroes making this happen.

Thank you very much. We'll get to our next question on the line. It's from Cameron Dorkson of National Bank Financial. Go right ahead.

Thanks. Good afternoon. What if you can just talk a little bit about the progress you're seeing with the air centre business? You've even sort of indicated a couple of new airline awards here. It sounds like you've got some kind of a new next-gen solution there. Just sort of talk about what the investments require, what kind of progress you're making with customers on that new solution, and where the business, I guess, has recovered to at this point.

Well, look, the business is doing exactly what we thought it would do, maybe even slightly ahead at this very moment. Very, very happy with what's happening there. I also, maybe I'll let Sonia after talk about where we are in investments, but I would say it's largely in line with what we had anticipated when we announced the acquisition. Look, I'm very excited about this, and I'll talk about it because You know, we talked about what our ambitions were for what is an adjacent market for us. This is playing out. This is playing out. You remember that we have an extremely large overlap of customers between our training and simulator business and this flight services business. And we're seeing, we're continuing to see very, very high receptivity of our traditional customers to us being in this market. And it comes at a time that we're seeing as airlines ramp up capacity now, it's obviously very challenging times. And you can see from recent evidence that airlines, in many cases, have really outgrown their technology infrastructure and they need to reinvest. So you can be well assured that we're engaged with all of our customers. you know, to help them as they shape their technology needs in the future. You can be sure of that. So I fully expect that we're going to be part of the solution over time. And it's not going to be a near-term P&L impact because, you know, at the moment we're focused on integration. And remember, in this kind of business, it's kind of like, I'll use a term, like an ERP. Implementations take extended periods of time, but once you have them, you have them for an extended period of time as well. So look, I'm very happy with the solution. The NextGen solution's all about software as a service versus legacy on premises. We have a pipeline, that pipeline is growing, it's gonna take time, but I'm very happy about how we're progressing here.

Yeah, and I'll just add on the investment part. So to elaborate on Mark, we're seeing the ramp up, we're seeing it flow through. That represents about 10% of CIVIL's revenue this quarter, so that's very good. In terms of investment, We never laid out the exact amount, but it's in the tens of millions and has started since the acquisition and is part of the investments that you see through the results.

Okay, that's great, Keller. If I could squeeze in a second one just quickly on the defense side. Now that Canada has formally signed a contract for the F-35, can you update us on, I guess, what your expectation is for the training solution for that and how you think you're positioned for that?

Well, I think we're well positioned, obviously, because, I mean, that's what we do. We do it around the world every single day. We talked about the, for example, it's on an F-35, and we won another F-16 contract recently. So, you know, we know how to do this. We've got all the F-18 and majority of fighters out there in the world. So I could tell you, I personally and members of my team are in discussions with all levels of government in Canada and with the customers in the United States that We've met with the F-35 Joint Program Office, who provide management support for the F-35 program, and we're confident that they'd be highly receptive to a proposal by Canada to embed additional training and simulation capacity in Canada's domestic F-35 program. And I was encouraged by the fact that when the Canadian government announced the F-35, they announced that you know, simulation-based training will be done at, you know, Canadian Forces Base Bag of Villa and Cold Lake. So I think it's a natural for CE to be involved here. And look, I think this is a generational moment for Canada's national security. You know, I think Canada's chosen well in terms of the fighter for men and women in uniform and for Canada's national sovereignty. But here, many Canadian jobs and Canadian innovations at stake here. You know, we've Canada needs to seize this opportunity of the investment we're making here, and we can't afford to miss this unique opportunity to create and protect the next generation of aerospace jobs in Canada. That's key as well. We're part of that, and I fully expect us to be part of that.

Okay, that's great. Thanks very much.

Thank you. We'll get to our next question. On the line is from Fadi Shamoun at BMO. Go right ahead.

Good afternoon. Thanks for taking my question. Mark, if business aviation flight hours end up being down 5, 10 percent this year because of the economy, or in the next 12 months, I guess, is there levers within CAE based on kind of the recent acquisition you've done and your positioning on some of the program to continue to grow in that side of the business?

Absolutely, Fadi. Look, the fleet is still growing. The amount of new pilot demand, you know, we have trouble meeting it now. I can tell you I'm a pilot. I can see it myself. But our training centers, I won't exaggerate, we can't find a parking space seven days a week. So I'm not overly concerned about a slight drop in the flight hours. I mean, we're seeing... a very, very hot market for business aviation training. We're continuing to add capacity. Our Las Vegas training center has just come online. So has Singapore. Savannah will be online next year. We have a training center in Orlando opening up with our JV partner, Directional Capital, which is our SimCom training center opening up in Orlando. And I can tell you that we have demand spoken for coming into those training centers. So I'm I'm not too worried about that drop in flight hours that could occur.

Okay, that's great, Culler. The second follow-up question is really on defense. I mean, we have six quarters now of expansion in terms of the order levels. And the outlook is positive for that to continue. When do we start to really experience this kind of demand momentum into the margin with a greater kind of influence? Is this more of a fiscal 25 story or a fiscal 24? I'm just trying to understand the trajectory of how these headwinds from supply chain and mix in the backlog kind of come off versus returning to a more normal margin in that segment.

Well, look, it's going to be steady progress. That's what I see. The headwinds that we see, I mean, as you can well imagine, we're not sitting on our hands, you know, not doing anything about it. We're doing something about it, but it takes time. It takes time to hire people. It takes time for them in the defense sector to get the proper security clearances that we need for them to be able to execute on some of the programs we have. This is going to take several quarters to abate. But it gets better every quarter. We know what parts we need on the contracts that we have. But when you get new contracts, you need new parts. Now, we get better at forecasting those things, but it's still an issue because the supply chain is not as fast as it once was. And at the same time, we're factoring potential delays in orders because of things like I talked about in U.S. defense procurement. But make no mistake, I'm seeing steady improvements in our business in terms of we're managing it. We have a very happy with, you know, in terms of the execution of our programs and the level of contingency in those programs that we have. Execute them well. As you know, there was a factor in Q1, and I mentioned that has not happened 17 years. I don't see that happening again, not with the rigor that we've put into it. So look, I expect full, you know, when you talk about when we recover back to low double digits, look, it's going to be, we're on that road, Fatty, and I think that you're going to see that over the next couple of years to get into it. Okay, great. Thank you.

Thank you very much. We'll get to our next question on the line. It's from Tim James with TD Securities. Go right ahead.

Thanks. Good afternoon. Thank you for taking my questions. My first question, I guess I just want to return actually to that last topic, Mark. I'm just wondering if you could comment on or characterize any particular pinch points in the supply chain that, you know, are more problematic than others. Any sort of, you know, particular parts or aspects of the supply chain that are a little bit more problematic? And I'll open it up to either, you know, your civil business or your defense business.

Well, I think I'd start off by saying it hasn't really been a factor on our civil business, mainly because we've done a good job over the years to design a product that is highly repeatable, highly standard. And our teams in global sourcing, for example, and operation have done a very, very good job forecasting and being able to obtain those parts. So I think that's been the case. In defense, look, I think the issue is I wouldn't say characterize any single part. It's basically longer lead times on many parts. That's what really is a factor here. Obviously, we've had issues, you know, like everybody has on, you know, the electronic parts, those kind of things. It's really longer lead times, repeating myself, on an inventory of many parts. And what that cut does is not only the fact that you missed the part itself, it's the fact that in the meantime, you either can't progress on that contract or you're having to do workarounds. And workarounds is inherently inefficient. You have maybe people being idle or installations, you're having to work around them and therefore causing delays. All those things cause inefficiencies that weighs down on our margins. And it has, I would say, a double effect because traditionally we are able to execute contracts and get ahead of ourselves to execute the programs faster and therefore generate efficiencies. And we're in a contrary situation right now. And the same effect with labor. You don't necessarily have the software engineers that you need because of some of the factors I talked about, the time to get them, the time to get them basically certified with the right clearances they need. Now, that is getting better because obviously demand in the high-tech market for software engineers is specifically has cooled, so we are a bit of a benefit of that. We're seeing that, but it's going to take a few quarters for that to abate to the extent that we get back to the margins that we have targeted in our long-term defense business.

Okay, that's very helpful. Thank you. My second question, I'm just wondering if there are any areas of your your civil business, either on the business aviation side or the commercial side, where you think, you know, pricing is particularly strong as we sit here today due to the, you know, the incredible sort of demand conditions and how quickly air travel has ramped up. And therefore, you know, pockets of pricing that could come under pressure, you know, when we get past this, you know, very strong ramp up period. Or do you think as some of the other areas that still remain weak, such as China, etc., maybe sort of make up for any of that potential moderation in pricing? Or do you not see any kind of particularly strong pricing at this point?

Well, I think I'd start by saying that in our civil business, in a large part, let's say the train business, it's long-term training contracts. And that's our specific strategy, as you know. They'll typically have fixed percentage or CPI-based escalators that are built in. So that has a moderating effect going up and going down, right? So you don't really see big spikes. We have been able to pass on some of the inflationary aspects that we've seen over time when contract renewals come up. And don't forget, our business... our vision always has been, and it's the way we operate, is to delight our customers. And the correlator to that is we don't gouge them when the market is going up, and they don't begrudge us a fair margin. So I think all of that comes out to say that I'm quite comfortable in the outlook that I've given with regards to margins and civil going forward.

Okay. Thank you very much.

Thank you. We'll get to our next question on the line. It is from Benoit Poirier from Desjardins Capital Markets. Go right ahead.

Good afternoon, everyone. Just based on your comments on the recovery trajectory for defense margin, would it be fair to say that high single digits next year might be a bit too optimistic and mid-single digits would be more realistic?

Oh, I'm not going to give it the specifics at this time, Benoit. I want to say, as I said, you know, we're working through the headwinds, and that we're going to continue to see improvement going forward on a sequential basis, for sure.

Okay, that's great. And looking at LCARE, capital employee was mostly flat versus last quarter. How should we expect capital employee to evolve or to be deployed going forward for LCARE and Do you see any opportunities to monetize these assets given their rich valuation and all the spin-off that we've seen recently, Mark?

Well, look, I think in healthcare, we're focused on translating the great top-line success that we're seeing. I mean, look at the revenue this quarter, which is historical. It's translating into bottom line. I'm sure you've noticed that. We're quite happy with that. Six quarters in a row of of pretty strong growth at the top line, two consecutive quarters positive as well. And we have a great team. I would say we have now Jeff Evans at the helm of the business. He's built a very strong team. I know each generation, we have the strongest team we've ever had in health care, and they're hard-charging, they're winning in the market, and that's what we're focused on. And health care is self-funding. So that's the trajectory that we're on now.

Okay, that's great. And with respect to Asia Pacific, where are you in terms of recovery versus pre-pandemic level? Are you back to halfway through the low or still above the... Well, I wouldn't say halfway through.

Look, how would I characterize it? We're in the low 70% utilization in that region approximately right now. It does have seasonal variations. I'll give you some maybe data points. In terms of simulator deliveries or orders, typically prior to the pandemic, we typically sell maybe six to eight full-flight simulators a year to China. And I would say over the last couple of years, we've only sold two or three in total. So that gives you an idea in terms of simulator sales. the more near-term recovery comes in training. And that mainly because we don't have any training centers in China, but it's, you know, all the training centers that we have in the region, and of course we have a lot of training centers in the region, the anchor customers that we train in those regions, a lot of their, a good proportion of their flights are in and out of China. So as that recovers, you know, we see the utilization of our training centers ramp up. You know, I expect that to materialize over the next few quarters. as the recovery takes hold. Okay, thank you very much for this time.

Thank you. We'll get to our next question on the line. This is from Matthew Lee with Canaccord Genuity. Please go right ahead.

Hey, good afternoon. Happy Valentine's Day. You know, on the civil side, when I think about new pilots coming through ab initio training, You know, is that a higher margin program and a margin benefit than usual annual pilot training? And maybe you can quantify kind of the growth you're seeing at the initial, just given how many pilots need to be trained right now.

It's actually a lower margin business than when we look at our mix that's on the lower end. It's really the, you know, when we look at what that drives, it drives, you know, it increasing capacity in our training center network. And it's part of our offering to airlines, which is very important. You know, airlines are looking for pilots. They need pilots. And, you know, CAE has one of, I think, the largest network of pilot training centers in the world. And don't forget, we don't, We don't basically take people off the street. I mean, we only do it for airlines themselves. So it's an important part of the offering that we give the airline as a complete solution. But if I take it by itself, you know, it would be, you know, if you like, lower than the average margin that we get in our civil business.

That's very helpful. And then on the defense side, you pointed out delayed orders coming to fruition as a potential margin driver. You know, are those contracts naturally high margin with more product in the mix, or is there another reason why those orders in particular are positive for margin?

I would say that, I wouldn't say all, because sometimes we'll go strategic, but the great majority of the contracts that we're signing and we're bidding today are accretive to our objective of low double-digit margins and objectives.

Okay, that's very helpful. I'll pass the line.

Thank you. We're going to turn to our next question on the line from Faye Lee with Olin Brown. Please go right ahead.

Yeah, it's Faye here from Olin. Thanks. Mark, you mentioned that CAE has submitted a request for equitable adjustments, and I'm just wondering if you can comment on this process. For example, are there set deadlines for the customer to respond back to you? Is it a negotiated process? What happens if the customer says no? Do you have, like... and ability to appeal the decision?

Well, it's case by case. It depends on what I mean by that. Sometimes the request for equitable adjustment may be submitted to the government itself and sometimes to an intermediary, which we contract with on behalf of the government. So again, case by case. We do have to, as you might expect, we do have to make our case and a lot of documentation related to that, but we have that documentation. We are putting those cases forward. There is no specific timeline for them to recovery. As I said, one thing that encourages me very much is, and as I said previously, we had a lot to do with it. Our government affairs people in Washington did a very good job on this. that in recent DOD budget, there is funding specifically granted to address inflation in the industry. So, you know, we're working with our customers and working to prepare, you know, our own claims with regards to that increased budget. But, again, there's no timing on that, but I fully expect some of that will come to fruition.

Okay. And would you describe the, you know, the request or the response has been reasonable or conversations? Like they haven't been unreasonable, have they?

No, I don't think there's anybody being unreasonable, but you have to make your case. But yeah, we have made your case. You know, we have simulators that, you know, we're literally delivering across the country. And one contract, it's about 180 transport trucks with armed guards crossing the United States. that were bid when gas was $2 a gallon. Well, we all know that gas is not $2 a gallon anymore. So you can just imagine that just on that basis alone, you say, well, let's be fair here. That's not exactly a 2% kind of natural growth in a contract. And they're receptive to that, that kind of thing.

Okay. And my second question, back in Q1, one of the charges that you took was for a Navy contract. I believe it was a Sinatra program that expired instead of being extended. And If I remember correctly, you were hoping to have it re-contracted on better terms. I'm just wondering, has that happened? Has it been re-contracted on better terms, or are you still waiting?

We're still waiting on that one. And to me, we can't really talk about that. I mean, in the end, it's a contract that we've submitted to BIN, and they haven't selected anybody as far as I know. Okay, great. Thank you.

Thank you very much. And we'll proceed to our next question on the line from Anthony. Valentini with Goldman Sachs. Go right ahead.

Hey, y'all. Thanks so much for taking my question, Aman, for NOAA today. I'm looking at the utilization rates in the 73% here in the quarter, comparing that back to pre-pandemic levels, and it looks like you guys are actually at, or in some cases above, where you were. I'm curious in terms of how you guys think through the capital allocation process of how high that number is can go, right? Because I think there needs to be some sort of slack in the system. And when you get to that number, you know, whatever it is, how you think through, you know, putting new simulators into your network, if that makes sense.

Yeah, well, look, the short answer is, as we said in a remark, we deploy capital in lockstep with demand. You will imagine because, you know, we're the market leader here and have been for, for a long time, both in simulators and simulator-based training. We know the market very well, and we know our customers very well, and we're in constant dialogue with them, both in the airline sector and the business aviation sector. So we have a pretty good and informed idea of how much demand will be required, because remember, it's a regulated market. You know, people, you could just look at how many you know, flights people expect to make, how many deliveries are coming out of the OEMs, and you will be able to establish, you know, what is the demand requirement across the world approximately. So that's how we deploy. And in terms of what is the practical capacity, look, I'll tell you, I was at a training center in Minneapolis about three weeks ago where our anchor customers are some of the largest regional carriers in the United States, like Endeavor, for example. And I can tell you, our training centers there are operating above 100%. And teams are doing a great job. So, you know, when you talk about practical capacity, you can get up there and you can sustain it when you need to. And that's, I believe you and me, to support the training of regional carriers in the United States right now, they need us to be operating at that level. So we can do it. So there's elasticity there. Now, in practical reasons... You know, when we define 100% for airlines, getting a little bit detail here, but that's 6,000 hours a year, which is 16 hours a day. So that's what we consider, you know, practical limit. But again, we're doing higher than that. So there's slack. If the demand is there, you know, that's what we do. And when we get to those kind of levels, well, guess what? In Minneapolis, you know, There was a bunch of nice tractor trailers or a backhoe was building two new simulator bays in Minneapolis while I was there because clearly demand is there. And we secure long-term contracts. We're not speculative on how we deploy that capital.

Okay, yeah, great. That's super helpful. I'm curious how long the lead times are once you decide you need to add a simulator to a facility and How much time does it take for you guys to build that sim and then deliver it to be up and running?

It depends on where it's going, and that's the big factor. But, you know, typically if we make a decision on an airline, a typical simulator, it's probably one we've built before, typically between 12 and 14 months, I would say.

Okay, helpful. Last one for me on defense. You highlighted a future vertical lift. I'm curious, and I'm sure you have, you know, hundreds, if not thousands of contracts, but where does that, you know, kind of rank in terms of the large programs that you have? And should we be thinking through that contract being negotiated, you know, in the old strategy or the new one, which is that, you know, kind of targeting these double-digit percentage margins?

The new one.

Does that answer the question?

Yeah, and then just how, in terms of rank, you know, how large is the program versus the other?

Well, no, it's a large contract. But, you know, I said in the remarks that we have a lot of contracts that we're bidding in $100 million range, and we have a lot of contracts in the billion-dollar range over the next three years. This is one of the ones that qualifies in the second category of billions. without getting specific. So it's a large opportunity over time, but it's not the only one. So it doesn't disproportionately affect, you know, my view on the fortunes we would have next year. It's important, but it's definitely not the only one.

Awesome. Thank you so much for your time. You're welcome.

Okay, our next question on the line is from Christine Lewat from Morgan Stanley. Please go right ahead.

Hey, good afternoon, everyone. You know, just want to follow up on a pilot shortage, like the bigger picture, I mean, pre COVID, you know, pilot shortage is already an issue. And then the mandatory retirement coming up in the US will likely exacerbate the issue. I mean, when you look at the program that your customers are undertaking, like the admin issue and things like that, how much of these actions solve, like the bigger shortage problem? And if not, you know, what should they be doing to support industry growth? Because it just seems like there's not enough urgency in terms of actions they should be taking. So I just want to get an idea of how much you think that's kind of solved with actions today. And if not, how do you think that gets resolved?

Look, I think it's going to take time. It's going to take investments. And don't forget, pilots are not the only issue that you're facing in the industry right now. The issue has been exacerbated by the fact that the industry was extremely finely honed before the pandemic. Then we went back to gold. We've been gradually rebuilding that industry, every part of it. Pilots are one part of it. An important part is the one we play in in a very big way. We're doing our part by helping our customers. We've been deploying new demand in terms of flight school activity. We've been signing core contracts with them. We're operating our training centers, as I was mentioning in a previous answer, at levels that are unheard of, at least certainly in the United States right now. So, look, I think it's going to take time. It's going to take investment. And that's why I think in terms of our business, I think it's going to be, you know, a good business for a period of time. I'm quite confident in the next few years in civil aviation.

Yeah. Thank you for the color. It just seems like there's no urgency, you know. If I could sneak a second one on M&A.

I would tell you that if you were talking with some of the airline CEOs that I talked to, you would feel that urgency. I guarantee you. But sorry, go ahead, Christine.

Yeah, great. If I could ask another one on M&A. You know, when you look at what you've acquired over the years, part of that was attributed to your success and some of your competitors basically feeding their territory back to you. If such opportunities exist out there, would you consider levering up the balance sheet even more today? I mean, some of those assets, are there even any assets available for sale that you could consolidate like you've done in the past decade? And if so, to what leverage are you comfortable?

Sonia won't let me. No, but seriously. Seriously, you see, we're focused on deleveraging right now. We don't see any gaps in our portfolio. We did very well during the pandemic to play offense during the downturn. I think you've seen that we've done quite a nice job of deleveraging in this quarter. I see that continuing along the path that we said that we'll get to a level of three. So look, we never passed up an opportunity that would be too good to pass, but I think we've done a good job. And we're focused on deleveraging right now, looking to start returning cash to shareholders And continue to, you know, the one priority is to continue to grow in lockstep with demand, and that's largely inorganic.

Great. Well, thank you, Mark.

Thank you. So, operator, that's all the time we have for financial analysts. I'd now ask you to open the queue to members of the media if there are any questions.

Certainly. As a reminder for the media, if you'd like to ask a question, You may do so now by pressing the 1 by the 4 on your telephone keypad. Once again, it is the 1-4 for any questions or comments you may have. And we do have a question queued up. It's from Stéphane Roland, La Presse canadienne. Please go right ahead. La parole est à vous.

Oui, bonjour, M. Parent. Merci de prendre le temps de prendre mes questions. Je voulais vous poser une question sur le segment de la défense. Ce que je vois, bon, les... Les résultats s'améliorent depuis les difficultés de l'été dernier, puis aussi depuis le dernier trimestre. Je me demandais un peu si vous pouviez me donner un peu plus de détails sur quelles sont les actions que vous avez prises pour améliorer la situation, puis quels défis, en fait, qu'est-ce qui reste à faire, quelle partie du travail reste encore à faire?

Merci de la question. La chose qui est, je pense, la plus importante, qui contribuent à l'augmentation de nos résultats, c'est que depuis les six derniers quarts, donc disons les 24 derniers mois, on a un ratio de commandes à nos livraisons qui sont en haut de 1. Si on regarde juste dans les derniers 12 mois, on est à 1.25. Donc disons 25% de plus de commandes qu'on a de ventes. Ce qui veut dire ça, c'est qu'on est en train de non seulement grandir la business en termes de revenus, OK.

Peut-être que vous avez parlé un peu avec les analystes, mais au sujet de la vigueur de l'industrie aérienne, vous y avez fait mention à quelques reprises. Est-ce que vous pouvez nous donner des exemples de la résilience de l'industrie en ce moment qui vous font croire que c'est ça que l'industrie résiliente en ce moment?

Vous parlez dans le secteur de l'aviation civile en général?

Oui, c'est ce que j'avais compris.

Ce qu'on voit, je vais commencer par l'aviation d'affaires. L'aviation d'affaires, la business d'affaires, on voit une très forte demande en termes d'activité dans ce secteur-là qui est très bon pour nous parce que nous, on a une business très, très importante dans l'entraînement des pilotes d'aviation d'affaires. Les niveaux de bols, and therefore the demand for pilots in the business aviation sector is considerably higher than the level it was before the pandemic. And I am convinced that it will continue in the future. So that's business aviation. If we look now at the commercial aviation sector, People have started to fly again, a lot, and we see it. Besides, with the enthusiasm that there is for air transport, it causes problems. When we see, let's say, that there are storms, things like that, we see that the industry is struggling to be able to meet the demand. But we see that people are starting to travel again. The commercial activity is strong all over the world. On voit, avec le secteur qui est en montée, ça se traduit pour nous en entraînement de pilote qui est de façon considérablement en hausse dernièrement. Puis on n'est pas loin, on n'est encore pas aussi haut qu'on était avant la pandémie, mais vraiment, le seul endroit qui reste vraiment the level of activity is lower than before the pandemic, it's in Asia. And that's really China, the fact that China was closed until recently, but now with the release of the zero-Covid policy in China, we see that the flights are starting to resume, which will make the air industry in Asia go up La plupart des compagnies aériennes en Asie ont beaucoup de vols qui vont en Chine, donc ça va se traduire à une activité accrue dans nos centres de formation. Tout ça sont des facteurs qui fait que moi je suis très positif sur l'activité aérienne civile et donc notre business pour les années à venir.

One last question from my side. You spoke well of the provisional chain, so it goes for me on that side. On the subject of the rarity of labor, do you always have challenges? Is it difficult to recruit at the moment?

We have. We see that especially, I would say, in our military activities in the United States. because there are two factors. One, there is the rarity of the workforce itself. There are software engineers, just to cite an example, but there is the additional complexity of the fact that they need high security classifications, and so it takes a time that is not negligible to have. So that's the factor that contributes. But in Montreal, I would say that we still have a lot of open positions, especially for technical personnel. I'm looking at 500 more in Montreal at the moment. But we have a lot of universities in Montreal, so we managed to fill them, but it's not a factor in our growth at the moment, but it could mean If we don't continue to do it, I don't see it. Okay.

Maybe a follow-up question in relation to that. In the manufacturing sector, manufacturers and exporters of Quebec worry that because of the lack of labor, they relocate activities elsewhere, not for cost reasons, but labor. Is that something you're considering with all the offices that are open in Montreal? Is that a challenge for you?

No. No, we... On est très verticalement intégré à CAE. C'est une stratégie qu'on a. Je suis très content de la main-d'oeuvre qu'on a ici à Montréal et de nos fournisseurs au Québec. Je ne vois pas aucun changement. On réussit à avoir des nouveaux employés qui sortent des écoles techniques. On est très content des nouveaux employés qui travaillent chez nous.

OK, parfait. Merci beaucoup de prendre les questions des médias. C'est très apprécié. Bonne journée. Plaisir. Merci.

Operator, if there are no more questions from members of the media, I want to thank all participants, investors, and members of the media. Merci beaucoup d'assister à notre conférence. I would like to remind everyone that a transcript of today's call will be posted later today on CA's website. Thank you.

Thank you very much. And that will conclude the call for today. We thank you for your participation as we disconnect your lines. Have a good day, everyone.