CAE Inc.

Q1 2025 Earnings Conference Call

8/14/2024

speaker
Operator
Good day, ladies and gentlemen. Welcome to the CAE first quarter financial results for fiscal year 2025 conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity for analysts to ask questions. To join the question queue, you may press star, then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star, then zero. I would now like to turn the conference over to Mr. Andrew Arnovitz. Please go ahead, Mr.
speaker
Andrew Arnovitz
Arnovitz. Good morning, everyone. Thanks for joining us. Before we begin, I'd like to remind you that today's remarks, including management's outlook and answers to questions, contain forward-looking
speaker
Arnovitz
statements.
speaker
Andrew Arnovitz
These forward-looking statements represent our expectations as of today, August 14, 2024, and accordingly, our subject to change. Such statements are based on assumptions that may not materialize in our subject to risks and uncertainties. Actual results may differ materially unless there's a caution of undue reliance on these forward-looking statements. A description of the risks, factors, and assumptions that may affect future results is contained in CAE's annual MB&A, available on our corporate website and our filings with the Canadian Securities Administrators on CDAR+, and the U.S. Securities and Exchange Commission on EDGAR. With the divestiture of CAE's healthcare business in fiscal 2024, all comparative figures discussed here and our financial results have been reclassified to reflect this continued operation. On the call with me this morning are Marc Perron, CAE's president and chief executive officer, and Sonia Branco, our chief financial officer. Nick Lehan Titus, CAE's chief operating officer, is on hand for the question period. After remarks from Marc and Sonia, we'll open the call to questions from financial analysts. Let me now turn the call over to Marc. Thank you,
speaker
Marc
Andrew, and good morning to everyone joining us on the call. Our performance in the first quarter reflects a continued healthy level of demand across our civil market solutions with some softness in commercial aviation training and certain regions compared to last year. Our results also demonstrate our ongoing progress to move our defense business forward from the rebaselining last year, which sets us up on a clear path to margin improvement. Testimony to our strong position in secular growth markets, we booked nearly $1.2 billion in total orders this quarter for a record $17 billion in adjusted backlog. In civil, we delivered eight full flight simulators to customers during the quarter, and our average training center utilization was down to a percentage point from last year to 76%. We saw year over year growth in business aviation training, including the expected contributions from our more recent capacity additions like our new Savannah, Georgia training center for Gulfstream pilots, which we inaugurated in June. In commercial aviation training, utilization was three percentage points lower than last year on average, which is still robust, but it was lower still in the Americas where we saw some incremental pressure on initial training and pilot churn as several airlines paused pilot hiring. This was mainly the result of the supply side constraints on new narrow body aircraft. For example, in the US, it was a nearly 80% reduction in pilot hiring among notable carriers in a month of June compared to last year. That being said, recurrent training is up year over year as the in-service fleet and pilot population continue to grow. Commercial training utilization was lower in Europe too, with seasonality being more pronounced than usual because of an extended summer flying season. This also relates to aircraft supply side constraints and special events, namely the Euro cup and the Paris Olympics that altered normal travel behavior this season. Training demand in Asia and the Middle East has been tracking well, and we're seeing solid growth there in line with our expectations. We'll continue to demonstrate our ability to win our fair share in a large secular growth market, which sees highly differentiated training and flight operations software solutions. We booked $771 million in orders with civil customers worldwide for an impressive 1.31 times booked to sales ratio, which is on revenue that's 9% higher than Q1 of last year. We also have strong order activity in our JVs this quarter representing another approximate $103 million of training service orders, which are not included in the adjusted order intake figure, but are reflected in our record $6.6 billion total civil adjusted backlog. We received orders for 11 full flight simulators in a quarter and signed long-term training services and next generation flight operations and crew management software solutions contracts with commercial and business jets operators worldwide. In defense, our financial performance was in line with our expectations at this point on our path towards margin improvement this year. And I'm quite pleased with the progress that our team has made to deliver on our commitments. We booked orders for $422 million for a 0.87 times booked to sales ratio, giving us a $10.4 billion defense adjusted backlog, which is up markedly from $8.4 billion in Q1 last year. Notably, included in the adjusted backlog, but not the defense adjusted order intake, is CE's share of the $11.2 billion 25 year contract for Canada's future air crew training program that was awarded to the CE Skyline joint venture. We're now in the process of finalizing CE's subcontract work under the JV for simulation based training solutions that will be delivered by CE. With that, I'll now turn to call to Orisonia who will provide additional details about our financial performance. So yeah.
speaker
Andrew
Thank you, Mark. Good morning, everyone. Consolidated revenue of $1.07 billion was 6% higher compared to the first quarter last year, while adjusted segment operating income was $134.2 million compared to $143.3 million in the first quarter last year. Our quarterly adjusted EPS was 21 cents, or 34 cents in the first quarter last year. We incurred restructuring integration and acquisition costs of $25.6 million during the quarter. This is comprised of $10.8 million for the integration of air centers, which is expected to be completed in the second quarter, and $14.8 million in addition to the restructuring program to streamline CE's operating model and portfolio, optimize our cost structure and create efficiency. We expect to record approximately $20 million of additional restructuring expenses in the second quarter in light of the expanded scope of the organizational and operational changes that have been action. They are intended to further strengthen our execution capabilities and drive additional cost optimizations and synergies to CA defense and civil aviation businesses. This primarily involves the removal of management layers and the consolidation of several shared services across the organization. We expect to fully achieve an annual run rate of approximately $20 million by the end of next fiscal year. Net finance expense this quarter amounted to $49.5 million, which is down from $52.4 million in the preceding quarter and down from $53.1 million in the first quarter last year. This is mainly the result of lower finance expense on long-term debt, partially offset by higher finance expense on lease liabilities in support of training network expansion. Income tax expense this quarter was $8.3 million for an effective tax rate of 14%. The adjusted effective tax rate was 17%, which is the basis for the adjusted ETF. Net cash from operating activities this quarter was negative $12.9 million compared to negative $49.3 million in the first quarter of fiscal 2024. Pre-cash flow was negative $25.3 million compared to negative $110.3 million in the first quarter last year. The e-brief was mainly due to lower investment in non-cash working capital and lower maintenance capital expenditures. Pre-cash flow performance in the quarter was in line with our expectations outlook. We usually see a higher investment in non-cash working capital accounts in the first half of the year. And as in previous years, we expect a portion of this to reverse in the second half. We continue to target an average 100% conversion of adjusted net income for pre-cash flow for the year. Capital expenditures totaled $92.6 million for this quarter with approximately 75% invested in growth, mainly to add capacity to our global training network to deliver on the long-term training contracts and our backlog. As a reflection of our agility and disciplined approach to investing, we have adjusted our total capex outlook in fiscal 2025 to the low end of our previously indicated range of 50 to $100 million higher than fiscal 2024, which totalled $330 million. Our net debt position at the end of the quarter was approximately $3.1 billion for net debt to adjusted EBITDA of 3.5 long time at the end of the quarter. For the impact of legacy contracts, net debt to adjusted EBITDA went 3.11 times. During the quarter, CAE repurchased and canceled the total of 463,500 common shares on their normal course issuer bid, which began on May 30th, 2024 and at a weighted average price of 25.21 per common share for a total consideration of $11.7 million. Now turning to our segmented performance. In civil, first quarter revenue was up 9% to $587.6 million compared to the first quarter last year and adjusted segment operating income was down 11% to $106.4 million versus the first quarter last year for a margin of 18.1%. The two main differences in our financial performance this quarter compared to last year involve an approximate $10 million lower adjusted segment operating income contribution this quarter from site operation services or software defense as we are now going to an expectedly more intensive period of fast conversion. The second main difference comes from the incrementally lower demand in the short term for initial type training in the Americas that Mark alluded to and the extended summer flying season in Europe that has made the seasonal dip in training activity more pronounced than usual. We enjoy a highly recurring revenue profile and significant degree of operating leverage in the training business. And we expect a meaningfully positive impact on margins as volumes increase in the second half of the fiscal year. In defense, revenue was up 3% to $484.9 million while segment operating income was up 14% to $27.8 million, giving us an adjusted segment operating income margin of 5.7%. It's right on plan and the team is executing well. On the legacy contracts, we are right on cost and schedule and anticipate being able to close out a couple of them in the near term. With that, I'll ask Mark to step away.
speaker
Marc
Thanks, Sonja. For civil, the secular demand picture for aviation training solutions remains very compelling. It's underpinned by growth in air travel, demand for pilots and the need for them to stay current with always advancing aviation technology and regulations. Our business is driven primarily by the regulated training required to maintain the certification of pilots and crews who operate the global in-service fleet of commercial and business aircraft. It's notable that both Boeing and Airbus recently published their latest 20-year commercial aviation forecast and they project that the number of in-service commercial jets will approximately double over the next two decades. The demographic realities of an aging pilot population, mandatory age-based retirements and the continued secular growth outlook for air travel are immutable and they really underlie our continued confidence in the long-term outlook for CAE. As for the short-term, the airline industry is currently managing to what we believe represents the peak of narrow-body aircraft supply headwinds and we assume the industry will begin to benefit from some easing of these supply constraints and that we're also seeing pilot hiring begin to resume in the second half of our facility. We're already seeing enough training bookings for the third and fourth quarters that are consistent with that view. And as we think about what else underpins our expectations for a stronger second half of the fiscal year, I think it's important to consider that these factors have been affecting only a portion of our commercial aviation training subsegment and that we've taken initiatives to drive additional operational cost efficiencies to partially mitigate the effects of incrementally lower initial training demand in the shorter term. At the same time, we expect the second half to benefit from seasonality and to show continued strong performance in business aviation training, higher profitability in flight operations solutions and higher volume and profitability from full flight simulator delivery. Within that context, we expect approximately 10% civil annual adjusted segment operating income growth in fiscal 2025 with an annual adjusted segment operating income margin between 22 and 23% with ample room to grow beyond the current year on volume, efficiencies and mix. Our growth and our margin expectations this year also account for the ongoing ramp up of our newer training centers and recently deployed full flight simulators which are performing well. In defense, we're also in a secular growth market as the sector enters an extended up cycle marked by rising budgets across NATO and allied nations. Key trends include the heightened focus on near peer threats, greater government commitments to defense modernization and readiness amid geopolitical tensions and a growing demand for the training and simulation solutions that we provide. Our expertise in both civil aviation and defense positions us well to meet these needs. We're seeing a consistent demand driver across regions for our training solutions, a shortage of uniform personnel for defense which has led militaries to rely on industry partners like CE for training solutions to ensure readiness. The Canadian FACT and our past programs are prime examples and we're well positioned with the next year on several similar strategic programs across the Indo-Pacific regions, Europe and in the United States. These programs require the type of technologies and proficiency that are C strength. And we intend to leverage our position on these generational programs in Canada to enable multi-domain training in secure synthetic environments across our global network. Our expectations for fiscal 2025 reflect the rebaselining of the business and the enhanced visibility that this has given us. We're highly focused on simplifying the organization and driving more operational excellence and we'll continue to prove it through execution in the coming quarters. We continue to expect annual revenue growth on the low to mid single percentage range and annual defense segment operating income margin to increase to the six to 7% range and like civil, be more heavily weighted to the second half. As Sonia mentioned, our chief operating officer, Nikole Antides is already having a great impact on the business and has identified even more opportunities than originally thought to further streamline our organization, remove duplication and optimize C's cost structure. As COO, he now has purview over all the five C's divisions which enabled us to remove management layers in both civil as well as our defense businesses. We've also further streamlined support functions, engineering services and our footprint to drive additional synergies across the enterprise. Before opening the call to questions, on behalf of myself, C's board of directors and the entire executive management committee, I wish to express my sincere appreciation to Sonia Branco, our outgoing CFO for her numerous contributions to C's success over the last 17 years. I and we have benefited greatly from Sonia's stewardship, her insightful mentorship of her colleagues and her deep commitment to our great company. At the same time, I wish to welcome Constantino Malatesta or Dino to the role of interim CFO. Dino has worked closely with Sonia for many years and he has the deep knowledge of C's business and an extensive background in finance that will provide continuity and stability at CA. I have full confidence in his ability to oversee the company's financial operations and strategy as we move forward with our search for the CFO role for which we'll consider both internal and external candidate. With that, I thank you for your attention. We're now ready to answer your questions.
speaker
Andrew Arnovitz
Thank you, Mark. Operator, we'll now take questions from financial analysts.
speaker
Operator
Certainly. We'll now begin the question and answer session. To join the question queue, you may press star then one on your telephone keypad. You'll hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star then two. Our first question is from Sadi Shimon with BMO Capital Markets. Please go ahead.
speaker
Matty
Yes, good morning. Thank you. Sonia, congratulations and all the best. And a couple of questions. One, if I look at the civil guidance of 10%, and I assume this quarter that we're in right now, it's kind of your seasonally most weakest quarter. It feels like you need almost 65% of the EBIT growth to happen in the second half of this year, which is highest that we've seen in 10 years, I think outside of COVID year. How much visibility do you have into this growth in the back half of the year? And maybe a little bit on this commercial aviation issues. It feels like a lot of it maybe deferred revenues at this stage. Is it kind of coming back quickly or is it kind of more protracted in how it comes back?
speaker
Marc
Well, thanks, Matty. Let me take that. I think we said last quarter that the factors that are affecting the civil business, mainly commercial, maybe we factor some of this when we gave our guidance last year. We anticipated some OEM related challenge in the overall guidance. And you've seen hiring has slowed. We talked about more significantly specifically in this fourth quarter. It was slightly more than we anticipated in the Americas. But really pertaining to the rest of the year, this is how we see it breaking down. And number one, the second half, as you well know, we always have a stronger second half. And that's been proven out year after year for quite a long time. And that's really, we expect that this year. That's gonna come from an expected stronger performance in business aviation. And that's gonna be throughout the year, bigger in a second half. And we always have a strong fourth quarter and that's expected this year as well. In terms of similar deliveries, we expect more full flight similar deliveries in the back half. That's usual as well. We have obviously very high visibility on that because it's a production line and we have committed delivery dates to customers. Another factor here is not insignificant is the cost optimization efforts that are gonna begin to flow through more significantly obviously in the second half. As well, we got a hit, as I said, by about 10 million a year over year from our software business. Now we're anticipating a stronger profit contribution from the software business, especially the Q4 will have a more on-premise work at that time, as we continue at the same time to move to our fast conversion in this business. And lastly, I think that's probably, you're going back to our assumptions about the market here that you mentioned. Our guidance is predicated on seeing some recovery in initial training in the America specifically. As I mentioned on the call, we saw many carriers in the United States really is halting in some cases pilot hiring in June. Now we're seeing some of that recovery and that's driven by some improvements that are anticipated in their bodies, deliveries and availability of aircraft. Now we're seeing that materialized in our bookings already. I mean, that could change, and if it does, we'll keep you updated. But I think those are all the factors that underpin our confidence in the full year.
speaker
Matty
Okay, that's great, Mark. Maybe quick one for Nick. I mean, you've been in the seat now for a little while, Nick. Maybe if you can provide a little bit more kind of insight into the opportunities that you see to improve efficiency as you try to kind of streamline the operations and streamline kind of the shared operation across the CAE or five segments.
speaker
Nick
Well, I think as Mark made comments in his remarks, so now the way you need to think about that, there's five segments that we manage. By doing it that way, in particular in defense, we have taken out a couple of layers of alcohol overhead, which were related to the fact that we had a combined segment in the defense world. Right now, there's support functions, there's some corporate costs. I mean, there's some things that have been addressed. Now, as Mark said, this is kind of coming through, it's starting to come through the results. Some of it is gonna be directly impacting improvements in defense, some of it's gonna help the whole company because these costs are spread. And so from a cost perspective, I think we just need to let the cost savings flow through. Now the focus is more around us doing things one way between civil and defense, supporting each other in programs where we have commonality. I think you may have heard a program called HADES that is essentially a Bombardier 6,500 training program for the Air Force that the civil guys and the defense guys are cooperating in. So things like that that allow us to leverage the investments we make in these programs and simulators across the two businesses. So there's a number of these on the list and we're tackling all of them one at a time. And we should start to see more improvements in the results. That's part of the reason we think there's better improvements in the results because some of this was when the plans were built, the assumptions that were made were that these were gonna be separate investments and we were gonna have to essentially spend money on certain things twice, which at the time, I guess made sense, but obviously with our austerity, we wanted to be honest.
speaker
Matty
Okay, thank you.
speaker
Operator
The next question is from Sheila Kayago with Jeffries. Please go ahead.
speaker
Sheila Kayago
Thank you, Mark, and congratulations, Sonia and Andrew for all the help with initiations. In terms of the civil guidance, I just wanted to follow up on the first question. This says we think about the second half margins. Is there one factor that really helps strive up margins? Mark, you mentioned a slew of things, whether it's the factor of just full flight simulators, the exposure in terms of the market or is it cost optimization? Is there any way you could quantify that? And as we think about the full year guidance, the exit rate implies about above 25%, 26%. And in the press release, you noted ample room for improvement. So is that sort of the new run rate we should think about?
speaker
Marc
Well, I won't get ahead myself on Tuchel Runway except to say that I expect it to trend higher, based on higher, based overall, flow through a revenue in our business as it grows. And that's what we fully expect as we ramp up more assets across the network. But that'll be going to next year. But look, it goes back to your question, Sheila. I think for this year, it's a little bit of everything that I talked about. And I don't think there's any one factor that really swings it. Obviously, pilot training has got to come back. We have visibility on that. The other factor I think that's very important is the cost savings are coming through. Some of which Nick just talked about, which is streamlined that we do the simplification of the business, which echo that Nick is doing a fantastic job eliminating complete management layers, which not only improves the cost structure, but simplifies the business and gives better velocity on improvement of everything across the board. But we're also doing quite a strong effort at reducing costs across the whole organization. And we're seeing some strong benefits of that. And that's reflected in the higher restructuring expense that we talked about. So it's going to be all of those factors. But again, what we're seeing now gives us the confidence to reiterate that outlook.
speaker
Sheila Kayago
Great. And if I could ask a follow up on the A320 comments you made, the AOGs at an industry level have held study for the past few months. Can you just provide color on how you're seeing the impact to your business and perhaps regionally?
speaker
Marc
Yeah, I'll start it off and maybe Nick, you can expand on our individual customers that are affected here. Look, our expectations on this from our view of the market and talking to our customers is that, we expect that we're at peak right now. We're at peak of the impact of the gear turbofan issues that are affecting the customers, EO specifically. And as a result for our customers, maybe Nick, I'll let you expand.
speaker
Nick
Well, we have obviously a number of customers that are being affected by the grounding of these aircraft, waiting for their slot to come for their engine check. So, for a while the airlines just continued to hire, but you can't hire pilots forever because they need the minimum number of hours, they need to be trained. So at some point you have to kind of say, okay, I'm gonna need to slow down my hiring. And that's what's happened to us. We, a lot of this information is probably, you can figure out who the customers are, but we have a lot of customers that have some pretty significant impact on these aircraft. Now, the good news is from what we see is the number is not getting any bigger. The industry is making headway in this area. And so this will be something that we'll see improvement over time now. I don't think, I mean, I think we've hit the peak now in terms of numbers of grounded aircraft and opportunity to improve.
speaker
Marc
Thank you.
speaker
Operator
The next question is from Konar Lugta with Scotiabank. Please go ahead.
speaker
Konar Lugta
Thanks, and good morning. And thanks Sonia for all the help over the past decade and all the best to you. First question for me, maybe it's on defense. You know, the margins started to rebound, I guess, like last quarter on normalized phases, and we saw that kind of continuing Q1. And it seems like it's heading in the right direction here. Obviously it's very gradual this year. I really want to understand like, Mark, what do you think, and maybe Nick, in terms of the legacy contracts and the timing for rolling off those contracts over the next two, three years, how much more visibility do you have today? And do you think within the next couple of years or three years, is there a possibility that as some exchanges, can you hit 10% margin defense, or that would be more sort of a long-term story?
speaker
Marc
Look, I'm sorry, the first part of your question, I mean, we haven't really specified the timing with regards to, you know, when we get to the 10%, it's certainly going to be around that timeframe, that's our anticipation without being overly specific on it. But I wouldn't say going back to legacy contracts, specifically the ones that we called out, the eight contracts we called out, we have very high visibility, as you would expect on those contracts. And with the effort that we have, not only on those, but obviously very specifically, on the ones that we highlighted. And what I would tell you, look, everything is on schedule, everything is on, we're achieving the milestones that we have. And if anything, I'm hoping that we're going to outperform our estimates. And that's what I'm seeing now. If I look at the eight contracts that we identified, we'll exit two of those pretty quickly, you know, within a short timeframe. And the rest are going to roll off, you know, as we expected them to over the next two quarters. So look, I couldn't be more pleased with the progress that our teams are making. And as well with the acceleration of the benefit through cost savings and streamlining that Nick has put in place.
speaker
Konar Lugta
Okay, that's helpful, Mark, thanks. And just switching gears to the civil, you know, I understand some of the weakness we are seeing lately, and it's not too much, I guess, but still coming from like the US and the Europe, kind of traditional markets you have. But you noted Asian Middle East are doing good. Is there any opportunity to redeploy some of the training assets back to Asian Middle East, which I think you got back over the pandemic, I guess. So any thoughts on how can you tap on this demand in Asian Middle East while you are in Europe a week?
speaker
Marc
Sorry, and going to your question, you're talking about, you were referring to moving assets, is that what you're referring to?
speaker
Konar Lugta
So yeah, moving assets to Asia and the East.
speaker
Marc
Sure, I mean, that's always things that we look at and we may move some and whatever we plan in that is factored into the outlook that we have. Look, I think what we're going through is some short term effects here. Like very specifically, if I was to look at our business and let's go back to when we think about our civil business, there's four components to it, as I said before. If you look at it by revenue, about a third of the business comes from delivering simulators, so third revenue comes from delivering simulators, a third comes from commercial aviation training, a third comes from business aviation training, and 10% comes from our software business. And if you're to look at it from a profit standpoint, without getting overly very specific, about half of the profit comes from business area. So as I look at what's happening now in 2.1, which explains the margin, let's say difference year over year, one part, as I talked about, is lower profit coming from our software business. That's one, and that's what we expected and that's what you should expect as we go through this SaaS conversion, going from on-premise work. But very specifically, when we look at the utilization, we're only like 1% down, but what that really masks the effect is what we're seeing in the United States specifically with airlines pausing hiring in the short term, what that results in is less initials pretty much almost immediately, because as the regionals themselves stop pausing hiring, and you see more recurring training, but the initial training, which occupies a lot of similar time in North America, specifically on aircraft, for example, such as CRJs, that activity has dropped disproportionately, three or four percentage points. But again, as soon as we see pilot training coming back and we see signs of bookings in that regard, that comes back. So it's important, but it's not all of our business commercial. And to your point, we're seeing very strong activity in other regions, for example, in Asia specifically.
speaker
Konar Lugta
Okay, that's very helpful, thank you.
speaker
Operator
The next question is from Kevin Chang with CIBC. Please go ahead.
speaker
Kevin Chang
Hi, thanks for taking my questions. I'm just wondering, you have some longer term margin aspirations and memory serves me correct. I think within civil, you saw a line of sight coming out of the pandemic into the kind of mid 20% SOI margin and obviously you continue to target kind of 10% or low double digit in defense. Just with the restructuring you're doing now and some of the synergies and cost savings associated with that, does that change the long term margin profile in either segment or any of these segments, just given the incremental cost savings?
speaker
Marc
Well, look, I think we don't wanna get into giving longer term guidance today, but clearly all things being equal, the cost savings that we're putting through are only gonna help our bottom line performance. Then it becomes a question of volume. And I think as I said, you look at what's happening in terms of aircraft deliveries over the next 20 years and I think with the position that we have in the market, I think that portends very well for margin improvements.