CAE Inc.

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

Good afternoon, everyone, and thank you for joining us. Before we begin, I'd like to remind you that today's remarks, including management's outlook and answers to questions contained forward-looking statements, These forward-looking statements represent our expectations as of today, November 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. A description of the risks, factors, and assumptions that may affect future results is contained and sees annual MV&A available on our corporate website and in our filings with the Canadian Securities Administrators on CDAR Plus and the U.S. Securities and Exchange Commission on EDGAR. On the call with me this afternoon are Marc Perron, who is 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. And at the end of that segment, we'll open the line to members of the media, should there be any questions. Let me now turn the call over to Mark.

Thank you, Andrew, and good afternoon to everyone joining us on the call. We delivered a good performance overall in the second quarter with double-digit top and bottom line growth, driven mainly by continued strong momentum in civil and higher contribution from defense compared to the second quarter last year. We made excellent progress to secure CE's future with nearly $1.2 billion in total adjusted order intake for a record $11.8 billion of adjusted backlog. We further bolstered our financial position on the path to meeting our short-term leverage target. In civil, we had another quarter of excellent performance with demand for our training and flight operation solutions continued to be robust across all regions, and notably in Asia, which has lagged in the global recovery in air travel. We booked $618 million of orders with customers worldwide for a 1.08 times book-to-sales ratio. We received orders for 15 full-flight simulators, including a multi-year purchase of eight new Boeing 737 MAX simulators for Ryanair and two Airbus A320 simulators to United Airlines. In commercial aviation training, we signed a multi-year training agreement with Delta Airlines. And in business aviation, we signed a multi-year agreement with Windrow with Air Jet Charter. In flight operations, we signed long-term next-generation solutions agreements with Wizz Air and Air India. We delivered 11 full-flight simulators to customers during the quarter, and our average training center utilization was 71%. which is up nicely from 66% last year. The year-over-year increase points to the strength of the underlying commercial and business aviation train demand across all regions. Anyone who's traveled by air this summer will know just how busy the airlines have been trying to meet passenger demand. The sequential decrease in training center utilization that we experienced during this summer is a direct reflection of seasonality we typically see as pilots are actively flying during that period. In defense, performance was a bit lower than the first quarter, but still higher than the second quarter last year. We booked orders for $527 million for a one-time book-to-sales ratio, giving us a record $5.9 billion of adjusted defense backlog. They include strategic opportunities, like the formalization of our contract with Bell Textron as part of Team Valor to provide simulation training solutions for the all-important V-280 Tilt Rotor, the platform for the next-generation U.S. Army Future Long Range Assault Aircraft program. Other notable wins include the previously announced simulation-based training contract for the U.S. Army's key next-generation airborne ISR system, which is called the High Accuracy Detection Exportation System, or HADES, which is based on the Bombardier Global 6,065 business jet. Defense also received an order to provide the U.S. Army with support services for the Advanced Helicopter Flight Training Support Services Contract for air crew and non-air crew personnel. Additionally, Defense was awarded contracts for modification and maintenance of F-16 training devices for the United States Air Force as well as for the upgrade of various training devices. With that, I'll now turn the call over to Sonia to provide additional details about our financial performance. Sonia?

Thank you, Mark, and good afternoon, everyone. Consolidated revenue of $1.09 billion was 10% higher compared to the second quarter last year, and adjusted segment operating income was $138.5 million compared to $124.7 million in the second quarter last year. Our quarterly adjusted EPS was 27 cents compared to 19 cents in the second quarter last year. We incurred restructuring integration acquisition costs of $37.9 million during the quarter relating to the air center and the L3 Harris military training acquisition. Net cash from operating activities this quarter was $180.2 million compared to $138 million in the second quarter of fiscal 2023. Pre-cash flow was $147.5 million compared to $108.4 million in the second quarter last year. The increase was mainly due to a higher contribution from non-cash working capital. We usually see a higher investment in non-cash working capital accounts in the first half of the fiscal year. This year, I'm pleased that we've already begun to see a reversal in the second quarter, and we expect that positive trend to continue into the back half of the fiscal year. We continue to target 100% conversion of adjusted net income to free cash flow for the year. Capital expenditures totaled $61.9 million this quarter with approximately 60% invested in growth to specifically add capacity to our civil global training network to deliver on the long-term training contract in our backlog. Income tax recovery this quarter was $8.5 million for an effective tax rate of negative 16%. The adjusted effective income tax rate was nil, which includes the recognition of previously unrecognized deferred tax assets, which had an approximate $0.05 positive EPS impact this quarter. Net finance expense this quarter amounted to $48 million, which is down from $54.1 million in the preceding quarter and up from $41.3 million in the second quarter last year. Our net debt position at the end of the quarter was approximately $3.2 billion per net debt to adjusted EBITDA of 3.16 times at the end of the quarter. Following the end of the quarter, we announced a definitive agreement to sell healthcare for an enterprise value of $311 million, a decision which better positioned CAE to efficiently allocate capital and resources to secure growth opportunities in our large core stimulation and training market. We intend to apply a significant portion of the net proceeds to reduce the debt. The transaction is expected to close before the end of the current fiscal year, subject to closing conditions, including customary regulatory approval. With leverage having decreased to a ratio of approximately three times, we will consider reinstating capital returns to shareholders following the closing of the healthcare sale transaction. We are prioritizing a balanced approach to capital allocation, including funding accretive growth, continuing to strengthen our financial position, commences with our investment-grade profile, and returning capital to shareholders. Now turning to our segmented performance. In civil, second quarter revenue was up 13% to $572.6 million compared to the second quarter last year, and adjusted segment operating income was up 9% to $114.3 million versus second quarter last year, for a margin of 20%. Both solid improvements over last year, and as Mark referenced, CA's second quarter is normally seasonally softer with respect to training center utilization, which typically has some impact on business mix. In defense, second quarter performance was better than the same period last year, with revenue up 8% to $477.4 million and adjusted segment operating income up 16% to $21.3 million, giving us an adjustment score just its segment operating income margin of 4.5%. The year-over-year growth came mainly from a higher level of activity on programs, partially offset by higher SG&A expenses from higher bid and proposal costs associated with the pursuit of larger pipeline of defense program opportunities. Defense performance was lower than the preceding quarter, as we managed through the ongoing retirement of legacy programs from backlogs. We also had lower revenue than we expected from newer and more profitable programs due to recent funding and award delays. And in healthcare, second quarter revenue was $38.5 million, down from $43.6 million in Q2 last year. Adjusted segment operating income was $2.9 million in the quarter for an adjusted segment operating income margin of 7.5%. This is up nicely from Q2 of last year. With that, I'll ask Mark to discuss the way forward.

Thanks, Sonia. our outlook for CAE continues to be positive for the fiscal year and beyond. Our strong momentum is translating to robust order flow and a record backlog, which portend an excellent future for CAE. In our core civil and defense markets, our customers increasingly require innovative training and operational support solutions to perform at their best in mission-critical environments. And as we look ahead, we remain highly encouraged by the favorable secular trends that we see and in the growth that we anticipate by leveraging our global market position. As well, our technological expertise and the strength of our one key cluster portends for optimism. In civil, we expect to continue growing at above market rate, driven by the growth and recovery in air travel, increased penetration, of the existing addressable market for training and flight services solution, and a sustained high level of demand for pilots and pilot training across all segments of aviation. For the current fiscal year, we now expect civil to deliver growth in the mid to high-teens percentage range of adjusted segment operating income. And given a profile of our planned simulator deliveries and the normal seasonality of training demand, performance will be mostly weighted to the fourth quarter. The higher expected annual growth is based on our strong performance year to date and the visibility that we have in a highly regulated aviation training market. In addition to continue to grow our share of the aviation training market and expanding our position in digital flight services, we expect to maintain our leading share of full flight simulator sales and to deliver approximately 50 full flight simulators per year. Approximately half of those deliveries are slated for the fourth quarter. Turning to defense, we expect to continue making good progress transforming our business by replenishing our backlog with more profitable programs and by retiring low margin legacy contracts, which we expect to culminate in a substantially bigger and more profitable business. We strengthen our future position in recent quarters with strategic and generational wins, including next-gen platforms, giving us a record $5.9 billion adjusted backlog. Together with our record $9.5 billion pipeline of bids and proposals outstanding, we continue to see positive signs of the transformation underway. And as we look at the remainder of fiscal 2024, the positive inflection that we expected this year in defense has been delayed because of impacts associated with the retirement of our low-margin legacy contracts, specifically those awarded prior to COVID and current new program delays. And while the inflationary impacts on these contracts are known and finite in nature, they continue to be the most significant factor contributing to the current low-margin performance of the business and does not reflect its underlying potential. The essential trend lines of replenishing our backlog with larger and more profitable programs while simultaneously retiring legacy contracts remain positive. However, the prevailing US government budget appropriation uncertainty is slowing the ramp up of the new and higher margin defense programs that we've been awarded. This is also impacting the conversion of our bid pipeline to orders that we expected to generate higher margin of revenue for this fiscal year. As a result, we now expect second-half defense-adjusted segment operating income margins to remain in the current single-digit percentage range. We expect to see defense segment performance improvements materialize next fiscal year, but this will ultimately depend on the duration and magnitude of delays in new programs in the current environment. We're firmly focused on retiring legacy contracts as soon as possible and mitigating the margin pressures associated with them. We remain pleased with the accretive margin profile on our newly awarded contracts, which to me are the best indication of where the future performance of the fence is headed. We maintain our conviction that the ongoing retirement of legacy programs and the new order backlog growth will result in a low double-digit percentage margin business at a steady state. Lastly, on healthcare, I want to thank Jeff Evans and the entire healthcare team for their dedication and excellent performance. We're proud of the significant contribution to patient safety that CE Healthcare has made, and I believe that Madison Industries is the right home to take the business to the next level. Like CE, Madison's mission is rooted in making the world safer, and I believe it will be ideally positioned to support the future growth of the business, which will continue to focus on evolving simulation to drive patient safety and quality outcomes. For CAE overall, we continue to be highly encouraged by the secular tailwinds in all segments and the growth that we expect by harnessing our global market and technology leadership and the power of 1CAE. 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.

Thank you. If you are a financial analyst and would like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. One moment, please, for the first question. Our first question comes from Fadi Shamu with BMO. Please proceed.

Yeah, good afternoon, everyone. Thanks for taking my question. So, first question I have is, is the mid-20% EPS growth guidance that you reaffirmed take into account the expected divestment of healthcare and Secondly, I guess I'm just trying to square off the pushback and the defense margin inflection point and the maintaining of the guidance for fiscal 2025 effectively. So are you still expecting defense margin to bounce back in 2025 and to what level are you still thinking the double-digit is achievable kind of in the back half of 2025. I was just trying to square off the maintenance of this guidance in the context of the divestment of health care and the weaker results in defense.

Okay, yeah, thanks for the question, Fatty. Look, our three-year guidance continues to be our target. You know, we continue to see strong growth and profit improvements across the portfolios. You know, I think it's safe to say, obviously, that as you point out, that we see incremental risk in defense related to the factors we talked about. New program wraps up, the timing of risk environment, the environment that we're in in terms of the budgetary issues that we see in the United States specifically. But, you know, as I mentioned, we're very focused on closing up the work on legacy contracts as soon as we can. So, you know, I'm not giving guidance today about fiscal 25, but, you know, as we get closer to fiscal 25, if there's more color to provide on that, we'll do so. But, you know, the target is the same. And with regards to health care, I would say that, you know, the impact, I mean, it's not nothing, but it's relatively minimal in terms of its impact to the guidance that we've given and the results coming out of the sale.

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

Okay, well, let me try to get to, to answer your question by pointing out some of the factors and hopefully we get there. Look, first of all, when we talk about these lower margin drag programs, we're talking about a relatively small number, we're talking about a relatively small number of contracts here, a fraction, a small fraction of our overall backlog. And I think it's important to note as well that none of those contracts are recent awards. In fact, You know, I look at the whole list of these, you know, finite programs, and they were all awarded before COVID. So we can well imagine that the impacts that we see, although it's a small number of programs, the impacts of inflation, you know, where we're finding inflation at, you know, 2% escalation, clearly we're seeing inflation at, you know, 10%, 15% and compounded has an impact. Staffing shortages had an impact. And those are the programs that were most impacted. by those factors as well as, you know, manpower shortage that we have. So those programs are more profoundly affected, and those are the ones that are weighing on the profitability of the business. And, you know, at the same time, there's other factors. You know, we see the impact of, you know, this inflationary environment, and part of it is some of those programs, we have very, very strong business cases to be reimbursed for the actually egregious cost increase that we've seen. But in this kind of environment, there is no appetite for anything but, you know, we've been compensated for a very small portion of what we think we should be. I mean, as well, not to pile on, but in this kind of budgetary environment that we see, where we have a normal kind of end of budget year, what we call sweep up money of defense budget, we haven't seen this corner. I mean, that's what's kind of happening with these drag programs. When I think about the new programs coming up, first of all, what we call our transformational programs, the ones that we talk about in releases, programs like FTSS, like FACT, like Hades, I think a noteworthy point to make when you think about the profitability impact and when that they start impacting is that if I look at Q2, When I think about the revenue coming from those transformational programs, only 3% of that was in our revenues for this quarter. So 3% of those transformational programs were in the quarter, but yet they make up 20% of our backlog. And those programs, those transformational programs, are at very creative margins that basically give us strong confidence in the targets that we put to our business, which is low double-digit profitability. So those are the elements that are at play here.

Okay. I appreciate the call out. Thanks.

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

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

Well, look, I think the first thing I'd say, thanks for the question, Tim, What I would tell you, I'm very happy with the business, the progress that we're making. We are, you know, especially when I think about the success we're having in the market. You look at, I mean, you've seen that going back to the Paris Air Show, the strong, very strong orders that came out, for example, of airlines in India that specifically saw Air India. Well, we just signed a major contract with Air India with our Air Center suite of products. And Considering that Air India is bringing together a number of airlines together as part of Air India Group, that is very, very promising in terms of the business. As well, I was just recently in Budapest with the CEO and his team at Wizz Air, and they selected us for our air center suite. And that's just a couple. So from a business a front-end standpoint i'm quite happy with the business and and i shouldn't say that's the only thing i'm satisfied with i'm very very happy with the impact that we're making uh you know with our customers with regards to how they see ce which is something you see as the national owner of this business look it's taking it will take time to recognize revenue because this is software as a service well remember that you know we bought air center at seven times you know, EBITDA. So, you know, when I think about that and the money we're spending, we are making the investments that we wanted to make at the rate we want to make to develop that business. And look, we're attracted to where we want it to be. And it's contributing positively to this quarter.

Okay. Thanks, Mark. That's really helpful. I will just actually ask one more question if I could. The working capital in the quarter was great, really impressive. Just wondering maybe if you can talk a little bit about Were there surprises in there? What drove that? Is that kind of more indicative of what, you know, second quarters might look like going forward? Just any details on that strong performance?

Hi, Tim. Thanks for the question. Yeah, no, like I said in the remark, very pleased to see a strong reversal in working capital in the quarter. And really, it's not a surprise. This is really the outcome of continued focus on optimizing performance capital and our metrics. So we saw good improvements across the board, whether it's on our day sales outstanding, contract assets, and deposits on contracts. And so these all contributed to the positive reversal of working capital. We expect that to continue, that momentum to continue in the second half, as it usually does.

Great. Thank you.

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

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

So I want to thank Cameron. I wouldn't necessarily call it a restructuring program anymore. The restructuring program, we closed out last year. This is really continued integration of the two acquisitions. So the flight services one, you know, Mark just spoke of it. You know, we bought this at, you know, seven times EBITDA, knowing that there would be investments to harmonizing and modernizing the structure. And what we're seeing is, you know, investments in our you know, more modernized IT infrastructure and migration of customers, which we expect to complete by mid-next year. On the L3Harris military training, this is really a second phase of our integration, which we had as a callous with a major ERP implementation to harmonize all of those businesses, the legacy and the new businesses together. uh triggered a a second phase of further planned uh integration and and synergies on that side and that's uh relatively towards this end okay so so we should expect uh i guess so the outcome of these uh sort of integration activity to have maybe a more meaningful impact on on margins as we look ahead to to 2025 is that fair sure yeah

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

Lots of opportunities out there, Cameron. You've seen what we're doing. I think from the outset, we came into this with a lot of dry powder. I mean, when we think about What we did, going back a little bit through COVID, we didn't reduce the asset size. We put it at the right place. And in doing so, we took a lot of structural costs, back in the neighborhood of 70 million, structural hard costs out of business. And we're seeing a lot of that come to fore today. Since then, we've been seizing the opportunity that the market gives us. You've seen that in the business aviation training centers that we've deployed. You know, we had Singapore. You know, we're opening up in Savannah very soon. We opened up Las Vegas, which has been very successful, you know, thus far. We have Orlando together with Simcom opening up, and we've announced it in Vienna next year. Outsourcing, look, I can tell you, the progress is tremendous. Pretty much as I indicated in the past, I'm very happy what we've seen. We've talked about Qantas before. I was just in last month, I was in Athens with the CEO and his team at AGM, and they're the largest carrier in Greece, and we've done a deal with them. There's other deals that I can't really talk about right now, but I can suffice to say that we're traveling a lot. We're meeting a lot of customers, and we see opportunities to continue to grow Qantas. you know, and efficiently deploy capital, you know, particularly in the civil network, which, you know, as you know, is very credit margin.

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

Thank you.

Our next question comes from Kevin Chang with CIBC.

Please proceed. Hi, good afternoon. Thanks for taking my questions here. Maybe just turning back to defense, maybe if I look at it at a high level, and I know this math is overly simplistic, but if I just look at your run rate, I guess adjusted, segmented operating income, and I look at the capital employed into defense, your returns are kind of 3%, 4%. Presumably, if margins double or a little bit more than double, you'll get high single-digit returns on that capital employed. That still feels relatively low to me, just thinking about the margin cadence you've kind of laid out over the medium term. How do you think about driving that return higher? Is it kind of being able to grow revenue while keeping that capital employed relatively static? Do margins need to actually get closer to the mid-teens over time to to maybe drive better returns? Just, just trying to think of the cadence of these return, the returns on capital here over, maybe, maybe over a long, longer period of time.

Well, as I said, over a long period of time, we feel very comfortable about this business and, you know, and achieving the target that we've given of low double margins. And, you know, look, it's clear that, you know, we're not where we want to be today. We'd rather not be here, but it's finite. It's temporary. It's not reflected of the long-term potential of business. And there's, And again, the same factors are at play here. I mean, really, the two overall factors that are at work, number one, it's on risk retirement. And, you know, the risk retirement of what we call these drag programs, and we're making progress. In some cases, we're actually moving to accelerate it. I can tell you, like in this past quarter, there are a few programs that we've shifted to seven-day work weeks to basically accelerate the schedule and get these behind us. Obviously, When we do that, we incur extra costs, but, you know, I think it's worth it to make sure that we, you know, exercise, you know, contractual opportunity obligations to meet the schedules on those contracts. You know, in the case of new programs, as I talked about during my remarks, you know, we remain very bullish about the profitability of those new programs that are winning for all kinds of reasons. and such as some that I've talked about on previous calls, like being able to leverage, you know, and exercise what we call commercial, you know, rates on government contracts. And that's, you know, so it's going to be a mix of programs, but in aggregate, you know, those new programs that we're winning, you know, are very, you know, they are very creative to the margin obligation that we get. So that's really what's happening here. And as I said, you know, where we are today, of those transformational programs, again, in the second half, they make only 3% of our revenue. Next year, that's probably going to be about 15%. And obviously accelerating as we go through the year. As you get into the end of the year, you're going to have more of, you know, basically the revenue that's being driven throughout the business that's going to be from those transformational programs. And at the same time, we'll be substantially down the curve of retiring the risk on the drag program so that's what's at play here and of course what's affecting those two trend lines are you know some of the factors i talked about like basically contracts moving to the right in terms of us being able to execute on contract for in a lot of cases you know no fault of our own if i should say like in some cases we've been selected for you know training contracts but we've been delayed as much as six months because The customer is not getting the airplanes on time because the OEMs have been themselves affected by supply chain challenges and are not able to meet the production rates. And, of course, that means delays for us. So all of those factors are at play here. But, again, from a long-term standpoint, they're very comfortable about the business.

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

Well, I think it does a few things. I think, first of all, to your question about... Anything that causes a pilot to change airplanes or change the position, you know, from being a first officer to being a captain, by necessity and by regulation, and that's on a global basis, requires retraining. And, you know, our business is training. We're by far the largest in the world. So obviously that's going to be a first-order catalyst for us. So, you know, for us, you know, it's a positive catalyst for our business. There is no doubt about that. The other component about this is that, you know, we, this, the growth, you know, everyone is focused as you would, would expect to make sure that we do that safely. And that, that everything is us saving that in higher, that basically plays to see straight because no one trains more pilots in the world than we do. And that's where you see, for example, You know, agreements that we have with, for example, we announced last quarter with Boeing that we signed the Paris Air Show with, and we're immensely proud of the partnership with Boeing because that partnership is all about Boeing selecting us to deliver their competency-based training program starting, what we announced, and Boeing announced, is starting in India. You know, and to me, so that's, you know, that's UCC bringing technology to bear bring the sheer size of the footprint that we have, the amount of training hours that we do, the technology that we bring to be able to give objective database insights to OEMs such as Boeing and to airlines across the world to make sure that they can efficiently, you know, basically bring on pilots, new pilots, move pilots to different positions at an earlier age while still maintaining the safety of the skies that we enjoy. That's what we do.

Thank you for taking my questions. Our next question comes from Christine LeWong with Morgan Stanley. Please proceed.

Hey, good morning, everyone, or good afternoon.

Good morning.

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

Well, let me start with healthcare. Look, you know, together, in concert with the board, obviously, we're always looking at the portfolio to make sure that, you know, we're maximizing the value, and that's the value to all stakeholders. So in this specific case of healthcare, you know, we find ourselves at a place today, you know, and, you know, we've been looking at this for, you know, not overnight, obviously, but that the next wave of investment that's going to be required for this business is probably best made by new capital providers so that we at CE can drive more focused investment and synergy in our core. So we think now is the right time. And I absolutely am convinced that Madison Industries is 100% the right owner for this business. I've had opportunity to talk with the CEO a couple of times. Our shared values and our similar cultures, to me, made this transaction a perfect fit, again, for all stakeholders. So that's really how I see it. With regards to another leg, I mean, what you've seen is we've already done the other leg, and that's software. So to a certain extent here, we're changing healthcare for software.

Thank you, Mark. Really appreciate it.

Our next question comes from James McGarrickle with RBC Capital Markets. Please proceed.

Hey, good afternoon and thanks for taking my question.

Welcome.

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

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

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

Look, I think that, you know, to me, it's, again, In aggregate, the trend lines are, you know, what we've said. Look, I think if I look at overall the programs that we have, I think it's safe to say that, you know, we'll be substantially complete, you know, with those in totality by the end of next year. That's what I think. Obviously, you know, they will close, you know, not all at the same time, but, again, substantially complete by the end of next fiscal year.

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

I think, well, it's for sure that we're going to write it above pre-pandemic levels, no doubt about that. And again, as I was saying a while ago, when you think about the cost savings that we've taken out of the business, Just by itself, even at pre-pandemic levels would mean a higher margin, which you're already seeing in the results. Couple onto that, there's, you know, business aviation is very, very strong. And that's, you know, a very good part of our business from a profitability standpoint. You saw the outsourced things that we're making. There's more coming down that path. So, you know, I'm quite comfortable with it as well as a very strong demand environment that we're seeing across the whole business. So, you know, we don't have a target today for margins, except they're going to go higher.

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

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

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

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

And just based on the comments earlier about the pace for the legacy programs to ramp down, you mentioned mostly completed at the end of fiscal year 25. Consensus is currently expecting defense margin to high single-digit next year, almost pretty close to double-digit. Is that fair to say that it might be difficult to achieve based on the comments made earlier?

Well, as I said, we're not giving guidance of fiscal 25 today, so I'll keep it, you know, what we say, you know, throughout the presentation here. Not any new guidance from what I've said. Okay. Okay.

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

I think, like we mentioned in the past, the three times was not necessarily the goal, but a waypoint. So really what we're seeing is that we continue on the balance, capital deployment with deploying accretive capital, especially in the civil network, whether it's the training centers and the simulators to address demand. And these are highly accretive within 24 to 36 months, as we've seen in the past. And we'll continue to de-lever to kind of remain very comfortably investment-grade. So ultimately, it's a balance of those and an ongoing conversation with the board on potential capital returns, shareholder returns, yeah.

Okay, thanks very much for the time.

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

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

Well, look, I think basically it's tough to answer your question specifically because, you know, you could, I mean, we can theoretically go up to 100% utilization and higher on any individual training center. And you know what? We actually do that today on the number of training centers. But you can't maintain it there, you know, for the complete as a whole because obviously you've got to, spend time for maintenance, things like that. And I would say that 100% is not like every hour of a year. I mean, in terms of our commercial aviation training, it's about 6,000 hours a year. Our business aviation training center is 4,500 hours a year, which is more reflective of the kind of schedules we can do in business aircraft. But look, our utilization here is going higher on average. We still have seasonality. in Q2 because airlines have been flying a lot. If I looked at Europe this summer, it was very, very busy and utilization was substantially low in Europe this summer, but that's actually normal. We're back to seasonal rates and that's bled a little bit onto Q3. As we look forward, that's recovering in a quite substantial way. So our focus is on maximizing utilization, and the demand is there for us to be able to do that. So I think watch for increased utilization. And the last thing I would say is while we're opening up these new training centers and deploying a number of simulators, obviously they're taking time to ramp up. So that's affecting utilization that you see because, you know, they may be, you know, half empty or a quarter empty or not full at all yet. So that will affect the overall utilization.

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

Well, we can achieve 80%. We've done it in the past. So we don't have a target to stop. You know, we'll maximize the utilization, and there really is no – sweet spot and we're continuing all training centers are different different whether it's business aircraft or commercial aircraft again for us it's about you know meeting the unmet demand that's out there and ramping up to satisfy it and you know we are deploying a lot of efforts and a lot of resources of what's financial and human resources to as part of our digital transformation to improve the efficiency and the return that we get and maximize the schedules on the simulators in those training centers so we can increase the amount of training we do and increase the returns on those assets. That's part of what we're doing here.

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

So we haven't come out with that view yet. We're on ongoing discussions and so won't necessarily get ahead of our board today, but I can assure you that we're focused on, first of all, closing the transaction, the sale transaction, continuing to generate cash, The results will continue that discussion and come back with quantum and vehicle in the future.

All right. Thank you very much.

Thank you. Our next question comes from Conor Gupta with Scotiabank. Please proceed.

Thanks, operator. Good afternoon, everyone. I'll just stick to one question. A lot of U.S. airlines, are talking about their domestic demand is kind of plateauing or coming down, but they are kind of, you know, reallocating some capacity to wide-body aircraft for international travel. I'm curious if you are seeing any significant changes in reassignment training with pilots, especially with respect to your North American customers?

No, all of those factors are just, you know, adding to what I talked about, Tanark, in terms of what we call the churn. Churn, pilots moving from, you know, either narrow bodies to wide bodies or co-pilot to pilot or from one plane to another, you know, from a regional to anything like that, you know, triggers demand for training. And I can tell you, there's a lot of unmet demand out there, both in commercial aviation and business aviation. And as I said before, we're ramping up to satisfying it. And that, you know, is part of what really gives me the optimism for the future and basically the reality of what I see that leads me to raise the outlook that we have for civil in the back half of the year.

Thank you. Mr. Arnovitz, do I know further questions at this time?

Thank you, operator. I want to thank all participants on the call today and remind you the transcript of the call can be found later on CAU's website. Thank you and good afternoon.

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