CAE Inc.

Good day, ladies and gentlemen. Welcome to the CAE second quarter financial results for fiscal year 2026 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. Arnovitz.

Good morning, everyone, and thank you for joining us today. Remarks including management's outlook and answers to questions contain forward-looking statements which represent our expectations as of today, November 12, 2025, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risks, factors, and assumptions that may affect future results is contained in CA's annual MD&A, an MD&A for the three months ended September 30, 2025, available on our corporate website and in our filings with the Canadian Securities Administrators on CDAR+, and the U.S. Securities and Exchange Commission on EDGAR. On the call with me this morning, From CAE are Kaelin Rovinescu, the company's executive chairman, Matthew Bromberg, president and chief executive officer, and Constantino Malatesta, our interim chief financial officer. Nick Leontidis, chief operating officer, is also on hand for the question period. After formal remarks, we'll open the call to questions from financial analysts. Let me now turn the call over to Kaelin.

Thank you, Andrew, and good morning, everyone. Q2 was a solid quarter, all things considered, and Matt and Constantino will comment on it shortly. More importantly, since Matt's appointment, we have started to build out the transformation plan for the next chapter of CAE's evolution with a focus on, one, sharpening our portfolio, two, disciplined capital management and capital allocation, and three, improved performance through operational excellence and cost transformation. We expect this plan to lead to sustained value creation and long-term shareholder returns. The first order of business for Matt as he took the reins as CEO was to undertake a comprehensive review of CAE's business and operations, and my focus has been on ensuring continuity, providing counsel, and engaging with stakeholders as we chart the transformation plan that Matt will set out in a few minutes. Matt and I have also met with many investors and prospective investors and equity analysts, both to take their feedback as well as to discuss the huge opportunities in front of us, especially as regards the defense business, which will remain a key component of CAE going forward. In fact, I recently participated in a Bloomberg conference panel in New York focused on Canada's generational defense investment push, a discussion that underscored the market's confidence in the opportunity ahead for CAE. Canada's creation of the new Defense Investment Agency is an important step toward renewed emphasis on capability, modernization, and industrial sovereignty, priorities that align closely with CAE's global position and core strengths. Last week's federal budget reinforces that direction with a total of $81.8 billion in new defense spending projected over the next five years and substantial incremental amounts over the next 20 years. As you'll hear from Matt, we're making meaningful progress on the first stages of the transformation plan, which has already resulted in some important organizational changes. Having led several successful programs to unlock shareholder value in the past, I'm confident we're on the right track, challenging the status quo while protecting what is core to CAE. We selected Matt as our CEO because he has the operational depth and proven record of building and leading high performance teams that drive value in some of the world's leading aerospace and defense companies. And he has the full support of the board as we embark on this next phase of CAE's journey. CAE's culture has centered primarily on growth over the last two decades, and it is time now to harvest that growth and extract even greater bottom line profitability. And that is what our transformation plan will seek to do. With that, I'll turn the call over to Constantino to provide some financial highlights, and then to Matt to share his perspective from his first 90 days, outline the high-level approach to the transformation plan, and discuss the organizational changes that we announced today. Constantino, over to you.

Thank you, Caitlin, and good morning. Consolidated revenue of $1.24 billion was 9% higher compared to the second quarter last year, while adjusted segment operating income was $155.3 million, up 4% compared to $149 million in the second quarter last year. Our quarterly EPS, adjusted EPS, was 23 cents compared to 24 cents in the second quarter last year. Net finance expense this quarter amounted to $56.9 million, up from $52.9 million in the second quarter last year, mainly because of additional financing costs associated with the acquisition of the rest of SimCom in business aviation, which took place in Q3 last year, and additional lease expenses related to training center expansions in our global network. The increase was partially offset by lower finance expense on long-term debt on a lower level of borrowings during the period in line with our ongoing deleveraging undertakings. Income tax expense this quarter was $22.3 million for an effective tax rate of 23% on a statutory and adjusted basis compared to an adjusted effective tax rate of 18% in the second quarter of fiscal 2025. We continue to expect a run rate effective income tax rate of approximately 25%, reflecting the expected geographic mix of earnings and ongoing tax legislation reforms from various jurisdictions. Net cash from operating activities increased this quarter to $214 million, compared to $162.1 million in the second quarter of fiscal 2025. Similarly, we had strong free cash flow, which increased by 44% to $201 million compared to $140 million in the second quarter last year. The increase was mainly due to higher net income adjusted for non-cash items and higher dividends received from equity-accounted investees. With continued expected reversals and non-cash working capital investments and our outlook for operations, we expect to generate strong free cash flow for the year with a conversion of adjusted net income of approximately 150%. Capital expenditures totaled $87.6 million this quarter, with approximately 85% invested in growth. About 40% of growth capital expenditures this quarter were for simulators deployed to the FSTSS program in support of U.S. Army helicopter training in Alabama. We continue to expect total capital expenditures in fiscal 2026 to come in lower than last year, and now even below what we previously guided. More precisely, we are expecting a roughly 10% year-over-year decrease in capex, reflecting about a 25% reduction in civil spending, with the remaining investments focused on market-driven growth, supported by multi-year customer contracts and simulator deployments across CAE's global training network. Our net debt position at the end of the quarter was approximately $3.2 billion for a net debt to adjusted EBITDA of 2.66 times at the end of the quarter. We continue to expect to reach 2.5 times net debt to adjusted EBITDA by the end of the fiscal year. In civil, second quarter revenue grew 5% year over year to $670 million, while adjusted segment operating income decreased 6% to $108.7 million, resulting in a margin of 16.2%. Training center utilization came in at 64%, down from 70% in the prior year. We also delivered 12 full-flight simulators compared to 18 last year. This performance reflects the normal seasonal slowdown in training activity, along with lower commercial training utilization than in the same period last year. In defense, revenue grew 14% year-over-year to $566.6 million, while adjusted segmented operating income increased 41% to $46.6 million, delivering an 8.2% margin, thanks to higher activity on new higher margin program awards and the ramp-up of recently awarded contracts in the U.S. and Canada. With that, I will turn the call over to Matt.

Thanks, Dino. And good morning, everyone. Before I get started, I want to acknowledge yesterday, November 11th, Veterans Day and Remembrance Day. It's something that's very important to me and the over 10% of our employees that are veterans. And given that almost 45% of what we do is to serve the warfighter, it's an important time to take a moment and reflect. Since stepping into the CE role in mid-August, I have spent time with our customers, our partners, our shareholders, and our employees across the company. These first few months have confirmed what those of you who follow the company already know. CAE is a strong business with strategic advantages and compelling industry fundamentals that support growth. We have world-class technology and a leading share of the markets in which we participate. CAE has very strong customer relevancy with airlines, OEMs, governments, and defense services. and the CAA brand commands respect, not only for our capabilities, but for what we stand for, safety, quality, and mission readiness across both civil aviation and defense. Looking forward, the task is now to leverage our team, our technology, our customer relationships, and our strategic assets to not only grow the top line, but also improve cash flow and our return on assets. We will build on our strategic advantages to further unlock value in our markets. And that's what our transformation will seek to do. We are a world leader in flight simulation and training. I have discovered firsthand that we have an entrepreneurial culture and a highly passionate employee base who all recognize the importance of what they do. It shows in our engagement surveys and in our customer satisfaction surveys. The key now is to harness that drive and align it behind a coherent strategy supported by disciplined capital management and tighter operational controls. That same drive is reflected in the technology that powers our business. We have industry-leading capabilities embedded in our products and in our services. What is unique about CAE is that innovation here is built into how we think, how we design, and how we execute. Our ability to simulate complex environments and scenarios is unmatched. And our model-based system engineering capability is world-class. Our expertise in hardware software integration is a key differentiator. An unique database or knowledge base of aircraft, airports, pilot performance, environmental effects, and sensor responses is a strategic asset. That innovative edge runs through everything we do. For example, the new CAE Prodigy image generator is the world's first third generation level D certified image generator. Prodigy is redefining realism and efficiency by narrowing the gap between virtual and real worlds with ultra realistic visuals and high fidelity motion and flight dynamics. And for the first time, we are applying the same image generator technology across both commercial and military training systems It has been certified for commercial aircraft use and is already operational on multiple Eurofighter and CH-53C stallion simulators, with dozens more in the pipeline. To me, it is a clear expression of CAE's technology differentiation. Through capital, sorry, excuse me, through disciplined capital allocation and a deep engineering culture, we can deliver dual-use technologies with lasting strategic and financial impact. Another example is the NH90 Sea Lion program in defense, which demonstrates our ability to deliver highly integrated mission-level simulation environments at scale. It is a fully immersive, multi-role training ecosystem that mirrors the operational complexity of naval helicopter missions and is powered by more than 3,000 CPUs, 50 GPUs, and over 100 terabytes of data. The system rivals the computational scale of enterprise-grade defense networks. It is able to link multiple training devices together, from full mission simulators to tactical and procedural trainers. This provides the flexibility for our users, the warfighter, to operate independently or together in coordinated scenarios. What also sets it apart is the depth of its domain modeling, from advanced sonar acoustics to ship deck wind and wave dynamics, capturing the full realism of naval aviation operations. These are just two of many examples of how CIE's technology leadership translates directly into customer value, competitive advantage, and long-term growth. The technology advantage spans both civil and defense. The majority of what we do in each business is training and simulation, and I believe there is real potential to create greater synergy and shared innovation between them. So looking forward, the task at hand, the opportunity is to protect and leverage the great technology, people, and customer relevancy that has propelled CAE over the past decade, while at the same time to sharpen how we operate with a focused portfolio, a simplified organizational structure, and a higher bar for performance and returns. We are therefore embarking on a transformation plan, a transformation plan that will include several key drivers. To start, we have begun to align our organization and leadership for greater clarity of responsibilities and sharper execution. Nick Lee and Titus will retire at the end of the calendar year and transition to the role of special advisor to the CEO. Nick's 37-year contribution to CAE has been extraordinary, building CIVIL into a global leader, stabilizing our defense operations, and helping set the foundation for our next phase. And Nick is sitting here with me today and having gone through many transitions. I want to tell you, Nick, thank you personally as a mentor and as a friend over the past 90 days. It has been a pleasure to spend time with you and get to know you. And I look forward to working with you until the end of your retirement. With his retirement, we are reducing a management layer by limiting the chief operating officer role and moving to a more streamlined business-led production model organized around driving excellence and quality across product and service delivery. To that end, we've consolidated leadership of the civil business with the appointment of Alexandre Prévost as its president. By doing so, we are combining commercial and business aviation to accelerate the transformation and to optimize utilization and efficiency on a global scale. This move also establishes a single integrated service excellence organization designed to best serve the needs of our civil aviation customers. As many of you know, Alex most recently led our business aviation training division after heading commercial aviation training in Asia Pacific. He has an excellent customer relationship portfolio and brings a strong operational track record and financial acumen, having started his CA career in structured finance and M&A. In defense, we've consolidated from three PNLs into two. Merrill Stoddard will continue to lead our U.S. defense business, while Francais Baer will have the responsibility for Canada International. In doing so, we will sharpen focus and improve coordination across our global defense organization. Together, these changes create two comparable segments with the technology, scale, and reach to capitalize on growing defense market opportunities. I want to thank Marc-Olivier Saberon, who will be leaving CAE in December, for his decades of dedication to the company and for his instrumental role in developing our international defense presence. We are deeply grateful for his many contributions and wish him continued success in his future endeavors. We are also welcoming Juan Arrojo. Juan will join CAE in January as our new Senior Vice President, Operations. Juan brings over 25 years of global aerospace and industrial experience with companies including Raytheon, Pratt & Whitney, and Hamilton Sunstrand, and has a proven record of driving operational excellence. Juan will focus on productivity, quality, cost, and continuous improvement across our product organization. In a typical year, CAE designs, manufactures, and services over 300 training devices for the civil and defense markets, making this a prime opportunity to unlock further efficiencies and value. Juan's mandate is to unite several previously dispersed functional areas into a single end-to-end products team. In doing so, we will strengthen execution and product quality while lowering product cost and driving greater supply chain efficiency for both civil and defense segments. Today's leadership announcements are only the first step in creating a leaner, more focused organization, one that has fewer layers, eliminates redundancies, and is aligned to deliver sustainable value creation. In addition to the leadership changes, the transformation will focus on three priorities. Our portfolio, our capital discipline, and our performance. First, let me comment on our portfolio. We have a strong, balanced portfolio across civil and defense, two businesses powered by long-term secular tailwinds. Our defense segment provides durable, predictable growth largely insulated from the broader economy with sovereign-backed contracts that generate steady cash flow. That cash gives us flexibility to fund the highest return opportunities across the company. And as I discussed a few moments ago, there is real technology and capability overlap between civil and defense that strengthen both sides of the portfolio. In addition, our operations team was focused on unlocking value across both segments. However, we are taking a bottom-up look at every business, every investment, and every partnership within our two segments to ensure that our capital and management attention are concentrated where CAE has the greatest advantage and the greatest potential return. Our portfolio assessment is in its early stage, but I fully expect decisions and actions to be made over the next few quarters. Second, our capital discipline. One of my first actions as CEO was to review our capital approval and operating policies. While our previous practices were successful at supporting growth, we need to also reflect return on capital and free cash flow. We have already tightened policies around capital and operational expenditures, introducing sharper filters for returns, strategic fit, and execution certainty. All material capital projects, again, all material capital projects and commercial proposals are reviewed by me to ensure that they meet the heightened return thresholds. We also standardize how we bid, how we track, and how we evaluate projects, shifting from discrete investment reviews to a more holistic, rigorous portfolio approach that looks ahead and links directly to our strategy, to our risk appetite, and to our expected returns and cash flows. Through these enhancements, we expect to identify certain businesses and contracts that no longer align with our long-term objectives, a healthy outcome of this review. We also invest significantly in research and development. Here, too, we are taking a pragmatic, data-driven approach, evaluating initiatives not only against their budgets but also their original business case. the assumptions or market dynamics have shifted we have already identified projects for wind down and as a result we expect r d spending to moderate later in the year ultimately our goal is to be more selective not less ambitious just more selective the opportunity set in our end markets is large and growing and that allows us to drive profitable growth while raising our standards for return on capital in short we'll be more disciplined, more selective, and more demanding in all our commercial bids and all our capital projects and all our research and development programs. Likewise, any acquisition will be considered only within our core markets. And finally, our performance. We are already taking actions to simplify our structure, consolidating where it makes sense, and aligning the organization around speed, around accountability, and around execution. Today's leadership changes are the first steps towards driving that next level of operational performance We are reviewing every aspect of the company from our real estate footprint and our asset utilization to cost transformation and go to market strategies. We are taking a thorough and pragmatic approach to ensure that every part of CAE operates at its full potential. One of our most powerful assets is our global aviation training network comprised of over 85 locations and 360 full flight simulators built over the past two decades. We deliver 1.3 million hours of training annually, far more than anyone else. Our global training network spans more than 6 million square feet, and we occupy roughly another 5 million square feet company-wide, which intuitively feels large relative to the scale of our output. We are looking for opportunities to better optimize that footprint so that we have the right simulators in the right locations and the network is sized appropriately to serve customer needs and optimize returns. We will also ensure that we are being more selective on future expansions, matching supply with demand. The team is engaged and we will look to unlock significant value through this effort. On the product side, we manufacture more full-flight simulators than anyone else, by far, and our factory operations will also be an important area of focus. The simulator production environment is a high-mix, low-volume business, and our facilities need to reflect that reality through more modern processes and a stronger integration with product management. But performance is not just about scale and structure. It is also about the whole system works together. My philosophy is that great organizations require collaboration between people, processes, tools, and purpose. Every improvement we make, whether in governance, decision rights, or measurement, will be tied with our focus on capital and performance and measured with respect to impact on growth, profitability, cash flow, and return on capital. With that in mind, we're also putting in place stronger governance over how performance is measured and managed after every investment is launched, ensuring projects deliver what they promised, not just an exception, but through their entire lifecycle. Furthermore, to align incentives with this philosophy, we are assessing our executive compensation plans with the intent, bidding next fiscal year to make capital efficiency and free cash flow metrics more prominent. There are multiple work streams and initiatives underway. This transformation will take time. However, the time and investment will unlock greater value from CA's powerful platform, enabling us to delight our customers, drive higher returns on invested capital, and generate stronger free cash flow. So let me take a moment to walk you through how we see the transformation developing over the next few quarters. We are focused on implementing the organizational changes announced today, as well as conducting a portfolio and project review, establishing baselines and setting the metrics that'll guide us forward. By the end of the fiscal year, we expect to share a clear blueprint of the broader transformation plan with prioritized initiatives and financial and operational targets, as well as our approach to monitoring and reporting on our progress. We are driving the work methodically, deliberately, pragmatically, and with a results-focused mindset. So now that we've talked about the transformational plan, let me switch gears and talk briefly about current operations. In civil, financial performance in the quarter was in line with our expectations, reflecting, as Dino mentioned, typical seasonality and some short-term softness in commercial training. Adjusted order intake was 593 million, and we added seven new full flight simulator orders, bringing the total to 12 for the first half of the Cisco year. And that 12 still maintains our market share, although historically a soft number. Order activity was lighter than we anticipated at this stage, consistent with a slow recovery in pilot hiring, particularly in the U.S. As a result, the civil book-to-sales ratio was 0.88 times for the quarter, a temporary dip, or remaining above 1 at 1.22 times on a trailing 12-month basis. We believe pilot hiring activity has passed the trough and is currently improving, as indications from airlines in the U.S. are that pilot hiring has commenced again and will ramp in the second half of the year and into 2027. Notwithstanding the lighter activity, CAE continues to maintain its leading market share and is well positioned to leverage the inevitable market recovery. We ended the quarter with a civil adjusted backlog of $8.5 billion, up 27% from last year, providing a strong foundation as market conditions continue to normalize. Building on that base of solid fundamentals, we signed a 15-year training agreement with WestJet, announced but not yet reflected in the Q2 adjusted backlog for the establishment of the Alberta Training Center of Excellence for Aviation and Aerospace in Calgary, which is scheduled to open in 2028. It is a great example of an infrastructure-like investment that strengthens our recurring revenue and cash flow profile and builds long-term strategic partnerships with airlines as they plan future growth. Also encouraging is that OEM production and deliveries have accelerated, driving renewed pilot demand and simulator sales. As I said, we are seeing indications of recovery and growth across the civil market. U.S. Airlines, most of whom have recently reported encouraging results, are ramping up pilot hires for the second month in a row. And even in business aviation, customers at last month's MBAA reported a higher pilot turnover as commercial carriers resume recruitment. Global business jet activity is at record levels, up 20% in the U.S. and 12% in Europe compared to 2019, led by fractional fleets that have expanded more than 60% over the same timeframe. These dynamics reaffirm the long-term trajectory of CAE. However, given the slower near-term cadence, we now expect civil performance for the year to be roughly in line with the prior year. Consistent with that, as you heard from Dino, we are further reducing capital expenditures to reflect both the moderate pace of demand recovery and our disciplined approach to cash management and efficiency. We expect the benefits of the underlying market recovery to be more pronounced in fiscal 2027 and beyond. In defense, financial performance was also in line with our expectations, with steady margin improvement and double-digit growth, and we are maintaining our full-year outlook. Momentum continues to build as we renew and strengthen the adjusted backlog with higher-value, longer-duration programs. Second quarter adjusted order intake totaled $556 million, reflecting the continued success across key franchise platforms. This contributed to a book-to-sales ratio of 0.98 times for the quarter and 1.19 times over the last 12 months and resulted in an adjusted defense backlog of $11.2 billion. The defense pipeline also continues to be robust with some $6.1 billion of orders pending customer decisions. In the U.S., we awarded a contract for two new F-16 mission training centers to be deployed to the Air National Guard Base at Sioux Falls, South Dakota, and the Joint National Guard Base at McIntyre, South Carolina. The F-16 program is a great example of CAE's enduring role on long-life defense platforms. Over its nearly five decades of production, more than 4,600 aircraft have been built, with roughly 3,100 still in active service across 29 nations, making it the most widely operated fighter jet in the world. The fleet has logged over 19 million flight hours and flown more than 13 million sorties. And CAA has delivered more than 280 high-fidelity F-16 pilot mission training devices worldwide. Including recent awards, the total will be over 300. We have delivered more than 90% of all high-fidelity F-16 simulators in service today, supporting over 15 nations. This installed base represents a significant opportunity for modernization and upgrades as operators look to bring their training devices up to the latest configuration. Since inception, the F-16 franchise has generated roughly $2.5 billion in cumulative sales for CAE and remains one of our largest defense product lines. And the F-16 is just one of several key platforms on which CAE continues to play a critical role in training and mission readiness across some of the most enduring and widely deployed military platforms in the world. So you can see across both civil and defense, what defines our portfolio is the quality and sustainability of our revenue base from long-term infrastructure like training partnerships that generate highly recurring cash flows to enduring platform franchises that anchor multi-decade defense programs. So to summarize my take on current operations, both civil and defense are performing broadly as expected, and our near-term focus remains on discipline execution, operational efficiency, and free capital generation as we advance the company-wide transformation. Looking ahead, the outlook across CA remains strong. We are uniquely positioned at the intersection of two enduring global growth markets, civil aviation and defense. In defense, momentum continues to build across allied markets, supported by sustained modernization programs, including those underway in Canada. And we are well positioned to capitalize on that growth through our proven capabilities in mission readiness and training systems. And in civil aviation, while near-term cadence remains uneven, the fundamentals are powerful. Structural pilot demand and record OEM backlogs continue to support the compelling long-term growth story. And across CAE, our focus remains on execution, driving higher margins, stronger free cash flow, and better returns on invested capital. These priorities are the foundation for sustained value creation and long-term shareholder returns. As I look forward, the same three priorities that are informing our transformation, sharpening our portfolio, strengthening capital discipline, and elevating performance will serve as my philosophy as CEO and as CAE's North Star going forward. This defines how we will operate, how we will invest, and how we will measure success. This is a deliberate and disciplined journey, and the direction is clear. We are aligning CAE structure, resources, and incentives around performance, capital efficiency, and accountability. I'm excited to lead CA forward with a world-class team, an unmatched training network, and a clear strategic vision. With discipline, focus, and the continued support of Kaylin and our board, I am confident in our future and energized by the opportunity ahead. We are powered by leading edge technology and strong secular growth tailwinds in both civil and defense. It gives us tremendous runway to deliver sustained performance and long-term shareholder value. Thank you, and I look forward for your questions.

Thank you for that, Matt. Operator, we'd now like to open the lines to questions from financial analysts.

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 will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then two. One moment, please, for your first question. Your first question comes from Fadi Shamoon with BMO Capital Market. Your line is now open.

Good morning. Thank you. Nick, I just want to say first, congratulations on your retirement and appreciate all the insight and help over the years. Just a couple of questions, maybe around this capital efficiency focus, obviously. So, You've talked a lot about harvesting capital after a period of growth. Can you share a little bit how the threshold to approve capital has changed? And I'm curious, when you look at the business and you look at the opportunity to streamline the portfolio that you talked about and to sweat the asset more, What is the order magnitude return on capital this business is able to generate over the medium-longer term? Not looking for economic guidance here, but you were at one point in the past, CAE generated double-digit ROIC, mid-teens ROIC in a few years as well. is this older magnitude possible still to kind of look at over a period of three four five years potentially to see that kind of leap forward in the roic performance body thank you for the question it's good to hear your voice first let me just give nick the mic and then i'll i'll approach your questions

Yes. Hi, Fadi. Thanks for the kind words, and it's been a pleasure to work with you all of these years.

Thanks again, Nick. So, Fadi, you had several questions there, and I want to make sure I answer them in the right order. Why don't you slow down and ask the first one, and I'll make sure I answer it correctly.

Yeah. First, I'm curious if you can share how The threshold to approve capital has changed. You talked about kind of changing the mechanism within CAE and the threshold, how you approve capital. How has that changed? What does the threshold look like now?

Yeah, so I appreciate the question, Fadi. Yeah, we're evaluating all of our prior investments to make sure that the assumptions that went into them are still true. And that is a lens that we'll use to look at the current network and make sure it's located and optimized for today's performance. We're also reflecting today's market conditions. So when we make new investments, we want to affect the reality of where airlines are and what their growth prospects are. And through those two lenses, we're going to make a more disciplined approach going forward. Again, we have a world leading network, one that we're very proud of, one that's a strategic advantage. And we think there's tremendous opportunity for us to leverage that network going forward, given that we have the largest training network in the world.

And the other question was around return on invested capital. This business did double digit ROIC not very long ago. And through all this work that you're looking at in terms of portfolio streamlining and threshold and more capital discipline, do you see a vision where we can get back to that type of double-digit ROIC in the next few years?

Yeah, Fadi, it would be premature for me to answer that question precisely today, but that is the top focus of me and the entire leadership team, looking at how we've invested capital over the past five years and how we will invest capital over the next five years, and so how we can make better decisions for future investment and maximize return on the current investment. So that's exactly what we're going to spend the next few months unpacking. We'll be able to share that with you as we talk about next year's financial outlook.

Okay, I appreciate it.

Your next question comes from Christa Friesen with CIBC. Your line is now open.

Hi, thanks for taking my question. I was just wondering if maybe you can speak to us about any surprises you've encountered so far. I appreciate you've only been in the seat for about three months now, but you've made some early changes. I'm just wondering if you've encountered anything unexpected.

Thank you for the question. I think there have been only positive surprises. The level of energy across the organization, the entrepreneurial focus, and the strong customer relevancy is something I've seen in every part of the franchise. And so that has been an incredible reassurance. I knew that coming in, but it's a pleasant surprise. I also think the depth of our technology and how we can better leverage defense and civil is an opportunity I hope to unlock and quantify over the next few quarters. So all that's been very reassuring.

Okay, great. And as you've mentioned in your opening remarks and in the press release, there have been some initial organizational changes. Are there any opportunities you see in the near term, in the next quarter or two, for additional changes you can implement before maybe we get your full blueprint for the company?

Yeah, I appreciate the question. So the focus now is on giving the new team time to assess the responsibilities and create the strategic path going forward. And as that team is in place, we'll be able to share the objectives and the measurements we're going to use to chart the progress forward. So give us a few quarters. I have led transformations like this many, many times over my 25 years. And it's about identifying the opportunity, putting a team in place, identifying the measurement objectives, and then letting them run, and that's what we intend to do.

Okay, great. Thank you. I'll jump back in the queue.

Your next question comes from Konar Gupta with Scotiabank. Your line is now open.

Thanks, Arthur. Good morning, and I echo congratulations, Nick, for the remarkable career you had at CAE. My first question is on the CapEx side. I think you guys announced a 10% reduction in CapEx versus last year. How much of that is market condition driven as opposed to your capital allocation decisions you have taken early on? And of that CapEx, how much is that one large defense contract that you can share?

Good morning, Conrad. Thank you for the question. It's good hearing from you. So what I think is important to reiterate effectively is that we are reducing capex by 10% compared to last year. About one third of that is maintenance and two third of that is growth. um and driven really by 25 reduction in civil complex so that is a reflection of um really a disciplined approach to capital um so it is a reflection of the slow down the lull at the temporary lull in the in the activity and so we have adjusted and used the agility that we've implemented here to adjust the CAPEX on a growth-forward basis. About 40% of the growth CAPEX this quarter was for the FSTSS program specifically on the defense and security side of the business.

Thank you. And on the leverage ratio side of things, you know, I think it's more sort of a, you know, broader to the question long term. But, you know, you guys are on very much track on 2.5 times leverage ratio by the end of this fiscal year. And this is when the civil market is not running full steam at this point. And you've just started the transformation plan, Matt. So if you're disciplined on capital allocation, my guess is you might have an under-levered balance sheet over time. So how do you bring that to a reasonable level?

Yeah, thanks for the question. So our first and primary focus on the balance sheet is going to continue to delever. And secondly, as we look at investing for some transformation, because it does take investment, we'll ensure that it meets our return thresholds going forward. And that'll be the objective for the foreseeable future. Any change in a capital allocation strategy will be something we take up with the board, but that's not in the near-term horizon.

Okay, I appreciate that. Thank you.

Your next question comes from Benoit Poirier with Desjardins. Your line is now open.

Yeah, thank you very much, and good morning, everyone. Just looking at the capital employed for civil, Matt, it reached $6 billion at the end of Q2, which was up basically from $5.1 billion a year ago and has basically doubled over seven years. And if I look at civil revenue, it was up about only 50% over this timeframe. So could you talk about the potential opportunity to maybe optimize capital employed? And when we look at the utilization rate of 64% in the quarter, if we put aside the pandemic, it looks like it's almost a trough level that was reached during the great financial crisis and also during the pandemic. September 2001. So any optimal level that you would consider for the overall training network? Thank you, Matt.

Yeah, it's a great question, and I appreciate you asking it. As we look over the past five years, we've made significant investments in acquisitions and building out our network and some of our research and technology. And so what we're doing now is charting the path going forward. I can tell you there's some strategic advantages to the investments of the past. One, we have this fantastic defense portfolio, which is timed perfectly with a worldwide increase in defense spending, a once-in-a-generational opportunity. And on the civil side, we have the world's largest training network, one that's poised for the recovery, which is inevitable. So we're going to leverage both of those. But we will come back at the end of the year and talk about how we'll allocate capital going forward between M&A, between capital allocation in the civil network, and our research and development. In general, I think that the amount we spend on capital and the amount we spend on research and development is high for a company of CAE's size. And I see opportunity to reduce it, but that'll be something we talk about as we get into next year's guidance.

Okay. And Matt, maybe any thoughts about the potential training opportunity for the sizable BISJET order placed by Bonn Aviation and whether any new investment would be required or the current training network can support such a training opportunity?

Yeah, I'll turn that over to Nick. Yeah, so Bond is going to be a customer. This is a Bombardier win with a large order. So as they start to ramp up the deliveries, you know, we're going to be training Bond as a customer.

That's great. And maybe last one for me, Matt, you attended the Canadian Aerospace Summit in Ottawa toward the end of October. I suspect you met several industry participants. So any key takeaways from your meeting and what are the next steps for building Canada's defense industrial strategy? Thank you.

Yeah, thank you for the question. I enjoyed the conference, and I'm just getting to know all the defense industrial base participants here in Canada. And as Caitlin commented on the remarks, this is a once-in-a-generational opportunity for Canada to grow its defense industrial base. And my message to the participants in the conference and to the team internally is this is our moment as a Canadian company to participate in the growth of a Canadian-based defense industrial base that will not only be important for Canada, to be important for the world. So that was my message to the conference. That was the topic of my speech. And that's something that I'm very committed to drive from the CAE standpoint.

Ben, it's Caelan here. So I'll add one thought to that as well. One of the potential additional opportunities here is that when Canada purchases equipment, aircraft capabilities from other international providers where Canada doesn't have current capabilities, If there's a training footprint that attaches to that, if there's a mission readiness footprint that attaches to that, there are opportunities for CAE and frankly, for other Canadian companies to participate in some of those opportunities globally, almost as a requirement. of the Canadian government. So the Canadian government is more open to that than they've been in the past, given, you know, the focus on promoting from an industrial policy perspective, Canadian companies. So there's an opportunity inside Canada for Canadian defense spending. And there's an additional opportunity outside Canada, where Canada purchases international capabilities. So that's a secondary interesting opportunity that will play out with the fullness of time.

That's great, caller. Thank you very much for the time.

Your next question comes from Christine Lang with Morgan Stanley. Your line is now open.

Hi, good morning, everyone. Matt, I wanted to understand a little bit better where you are in the process of the new ROIC threshold. It sounds like it's going to be higher than where it is, but I want to understand better, are you in the process of identifying and firming up where this new level should be, or have you already identified it and will share at a later date? Any more information on this and your process would be helpful.

sorry uh mike uh thanks for the question uh the answer is yes we've done at higher thresholds but our capital base is large and doesn't move quickly and we need to take time to sort out how we can drive top line performance out of the existing investments and ensure we make the right decisions going forward for future investments We're not going to miss opportunities to grow our business. We're committed to growing our core markets, but we need to figure out how to leverage this capital base, which is a strategic asset. So all that guidance will come out as we announce financial guidance for 2027 and beyond. So thanks for the question.

Great. Thank you very much.

Your next question comes from Cameron Dirksen with National Bank. Your line is now open.

Yeah, thanks very much. Good morning. Just, I guess, a question on the timeline of when we should expect to see margin improvement, free cash flow improvement. Certainly, we can appreciate that you've got a lot of initiatives here that you've talked about today that are going to take some time, but is it To be expected that we see some benefit to the bottom line as we get into fiscal 2027 from these initiatives, or is it something that you think might take longer than that to really realize some of the benefits?

Yeah, thank you for the question. As I've said earlier, we're not going to be giving 2027 guidance today. But having led transformations like this in the past, some initiatives will be shorter term and yield immediate results, and some will take quarters or years to develop. But that's what we're going to spend the next couple quarters refining and then articulate that at the end of the year. So I commit to providing you more guidance and more visibility as we present 2027 guidance.

Okay, fair enough. On the portfolio, you've talked a little bit about some of the contracts you have, long-term contracts, and perhaps some of them don't fit the return profile anymore. What's the ability to either reprice some of these contracts or get out of them earlier? Is this something that we would have to see those contracts run off before we'd see the bottom-line benefits? Any thoughts on how that might play out?

Yeah, it's a great question, and it is an approach we look pragmatically with all options on the table. Some contracts we can go renegotiate because we see long-term strategic value. Others we have to attrit out. And so there's not a single answer to that, but it's one that I've challenged a team to put everything on the table, and we'll look at each one and find the right answer. And that'll create that ladder of opportunity that we'll start to articulate at the end of the year.

Okay. Appreciate the time. Thanks very much.

Your next question comes from Matthew Lee with Canaccord Genuity. Your line is now open.

Morning, guys. Most of my questions have already been answered, but maybe just on the civil side, can you expand on what about concrete signs you're walking for that would help indicate a turn in simulated orders? And, you know, when should we expect that to show up first, or where rather, utilization or new FFS orders? Thanks.

Yeah, it's a great question. I thank you for asking it. I've been watching this energy for 25 years, and a quarter or two of movement is not something that concerns me. The long-term fundamentals are what really matter here. The demand for air traffic will continue to grow. Eighty percent of the world's population hasn't flown. The major airframers have eight to ten years of backlog, and there's a year of aircraft on the ground. So as all those things start to recover, and they will, we're the world leader in both full-flight flimulator sales and training. And so we will benefit. From a lead time perspective, when an airline hires, it could be about six months before they start training, depending on their indoctrination and onboarding process. And when someone orders a full flight simulator, it's a year to 18 months lead time. So that's one of the reasons why we adjusted the second half of the year. We're seeing softness that we won't see recover in this fiscal year. And we're looking into next year and we'll provide that guidance here towards the end of the year. So thanks for the question.

Yeah, that's helpful. Just a clarification here. It sounds like your growth guidance reduction in civil was mainly due to lower deliveries for the year. My understanding was that usually deliveries are a bit of a lower margin business than trading. So if so, shouldn't margins be better year over year? And if not, maybe there's some factors I'm not considering.

Hi, Matthew. So I'll take that question. The reality is that we see both lower deliveries, yes, anticipated also in the second half, but also the utilization rate. There is a ramp up effectively as the softness increases. comes back as the overhang essentially comes back, and we'll see utilization increase. And so it's actually a mix of both, full-flight simulator deliveries, annualization in CAT, and as well a little bit in the back to business as well. As things pick up, we'll see a ramp-up of margins going forward into 27 and beyond. Understood. Thank you very much.

Your next question comes from Anthony Valentini with Goldman Sachs. Your line is now open.

Hey, guys. Thank you so much for the question. Matt, I just want to put a little bit of a finer point on this. I think that the company historically had talked about pre-tax returns on capital of 20% to 30% within two years for each simulator that was deployed into the network. Given the focus on the operational excellence and removing costs, I'm curious if now that target is higher or if that the company just, you know, kind of got away from some discipline of achieving those returns. Um, and you feel like you can get the company back to those levels.

Thank you for the question. What really matters to me is what we're going to do going forward. And we have this world-class network. It's a field of strawberries that are going to continue to grow, and we want to harvest it. And we will be more diligent about where we put simulators in the future. And that's based on higher return thresholds. And we're current simulators. And they were made with the right intention, the right investment, the right business case in the past. But the world has changed. And we'll make decisions on whether we relocate them or whether we retire them. And that's the activity that's underway. And so as we come out at the end of the year, what matters is not where we've been, but what we do with this fantastic strategic asset and the decisions we make going forward.

Okay, totally fair. Last one for me is I would just love to get your view on, you know, the evolving defense environment. You know, obviously the macro is really strong, but it seems like there's a push to get, you know, more autonomous systems and drones into the hands of the warfighter. How does that impact CAE's business? I mean, is there less training that is involved for those types of systems or, you know, is there still a lot of training that needs to happen?

Yeah, I appreciate the question. And the space of drones and collaborative combat air and remote piloted vehicles is a very important growing market opportunity. And we're actively participating. And the short answer is yes. When you train pilots, whether they're remote or operating systems of aircraft, training is required. And we have a fantastic partnership, for example, with General Atomics. And we do their predator training platform. that supports not only the U.S. operator, but the international operators as well. So drones, remotely piloted vehicles is a big part of the future for the defense services. It's something we're very well positioned in with our modeling capability and something we're continuing to grow as we look forward. Thanks for the question.

Great. Thank you, Matt.

Your next question comes from Connor Walters with Jefferies. Your line is now open.

Hi, guys. Thanks for taking my questions, and congrats to Nick on a great career here. I wanted to follow up on DNS. In your prepared remarks, you guys attributed the 14% year-over-year growth to the ramp-up of new margin-accretive contracts. When we look sequentially, margins remain flat, and the guide is kind of calling for them to remain in this ballpark. you know, that favorable macro backdrop and demand environment, how sustainable do you think that level of growth could be? And how should we be thinking about the underlying mixed dynamics through the year here?

Hi Connor, this is Dean and I'll take that question and thanks for asking it. So I think effectively what we're seeing now is those higher margin contracts ramping up and being signed and executed. And we're seeing some of the lower margin contracts kind of get completed and done. There's also this, I think, opportunity that we're looking at for cost optimization. One of the offsets to the profitability in this quarter is higher SG&A. That kind of offsets some of that profitability, even as those margins are coming on. So as Matt, I think, talked about, we're looking at all angles to optimize our structure, look at better ways to be more efficient, and we'll drive that margin higher. as we go forward and as we continue to sign those higher-margin contracts when they come on board.

Perfect. Thanks so much.

Your next question comes from Jordan Leonaire with Bank of America. Your line is now open.

Hey, good morning. Thanks for taking the question. I just wanted to follow up on defense. So the product revenue in the quarter was really strong year over year. How much of that should we expect will just continue throughout the rest of the year? And then also, too, on the defense business, for where you want to take it, push margin growth, how are you looking at that post-HEGSF comments about reducing cost-plus contracts, companies taking on more of their own developmental risk, and what... Is your protection against taking on other fixed price contracts that could go awry again?

Yeah, thanks for the question. Let me answer the last one and then I'll turn Dean over to answer the first. What's unique about CAE is we have the size and capability to respond to what all the defense departments are looking for. We are commercially organized entity with a defense business, which means we can go after fixed price contracts and have the ability to execute. or if it's necessary to a cost type development contract. I've been doing this for 15 years, and I've never seen a more nimble, capable company than CAE. We're also very flexible in how we go to market around the world. I think all those are really what Hegseth is trying to encourage from the large defense companies, and we have the opportunity to participate in that arena. So I'm looking forward to leveraging our skills, our technology, our operational base to answer the needs of both the U.S., Canada, and the rest of the world. Dino?

yeah thanks matt so um i'll talk about that first part of the question so effectively there is a higher percentage or proportion of product revenue on the defense side this quarter this year to date and effectively on the defense side product businesses tend to have higher margins than the training business What's driving that is effectively new contracts and recently signed contracts ramping up this year. The big ones, as we had talked about previously, is the Canadian FACT contract, the one that's been subcontracted to CAE, where the first five years we're delivering mainly products, and then in the last 20 years it's essentially sustainment. And there's a couple of other contracts in the U.S. that we've signed in the quarter that's allowed us to recognize good margins as they ramp up. Got it. Thank you both.

Once again, if you have a question, please press star, then one. Your next question comes from James McGarragill with RBC. Your line is now open.

Hey, thanks for having me on. I just wanted to ask a follow-up question on the lower capex guide. You referenced a step down due to the slower pace of demand in civil. But that said, is this the appropriate level of capex that we should expect going forward? And You know, should we interpret this reduction in CapEx as a signal of potentially lower growth in 2027? Or, you know, do you think you can drive growth just through improving utilization in that segment? Just trying to understand how that aligns with your longer term outlook for the civil segment.

Yeah, James, I guess we saved the best question for last, and I appreciate it. As I mentioned earlier, the amount we invest in capital, growth capex, maintenance capex, I view them together, and research and development is high for a company of our size. And what we're going to do is determine what that level should be. But we will make the right investments to continue growing. We'll make them in the right place and in the right segments. And as I said earlier, we have a world-class network. We produce more full-flight simulators than anyone else in the world, and we have fantastic customer relevancy. So as we moderate and come out with guidance in 2027, we'll provide full visibility to where we think the next few years will come. And I really appreciate the question from you and everyone else this morning.

Thank you, Matt.

Thanks, all. I'll turn the line over.

Thank you, and thank you, Matt and team. We seem to have run the hour here. Operator, we'll conclude the call here. I want to thank all the participants who joined us this morning and all the financial analysts for their questions. I remind you that a transcript will be available later today on CE's website. Thank you, and have a good day.

This brings to a close today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.