CAE [CAE] Conference call transcript for 2021 q4
2022-02-11 18:56:04
Fiscal: 2022 q3
Operator: Good day, ladies and gentlemen, and welcome to the CAE Third Quarter Conference Call. Please be advised that the call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. Please go ahead.
Andrew Arnovitz: Good afternoon, everyone, and thank you for joining us today. Before we begin, I’d like to remind you that today’s remarks including management’s outlook and answers to questions contain forward-looking statements. These forward-looking statements represent our expectations as of today, February 11, 2022, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially and listeners are cautioned not to place undue reliance on these forward-looking statements. A description of the risk factors and assumptions that may affect future results is contained in CAE’s Annual MD&A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR and the US Securities and Exchange Commission on EDGAR. On the call with me this afternoon are Marc Parent, CAE’s President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer. After remarks from Marc and Sonya, we’ll take questions from financial analysts and institutional investors. And following the conclusion of that Q&A period, we’ll open the call to questions from members of the media. Let me now turn the call over to Marc.
Marc Parent: Thank you, Andrew, and good afternoon to everyone joining us on the call. I'm very pleased with our third quarter performance, especially in the context of a still challenging global environment. We delivered double-digit growth, strong free cash flow and we nearly doubled the order intake compared to the third quarter of last year. On a consolidated basis, we grew revenue by 15% before the contribution of our ventilator humanitarian initiative last year. We also grew adjusted segment operating income by 16% and delivered CAD 0.19 of adjusted earnings per share. Underscoring the cash generative profile of our business, we delivered a healthy CAD 282 million dollars of free cash flow. We also made excellent progress on the orders front, billing even more forward momentum with nearly CAD 1.4 billion in orders or book to sales ratio of 1.62 times and a backlog of CAD 9.2 billion. In Civil, we have strong performance with double-digit growth in training and segment operating income, and with margins break above 20% for the first time since the start of the pandemic. Third quarter average training center utilization was 60%, up from 50% last year and with 7 percentage points higher than last quarter. To me, this is an impressive result, considering a wide ranging disparity in commercial flight activity and training demand across regions, and because Omicron began to spread in the last month of the quarter. As we've been seeing since the start of the fiscal year, demand in the Americas grew by far the strongest. While Europe and especially Asia Pacific continue to lag the recovery, leaving significant headroom to return to pre-pandemic levels. In business aviation, training demand was also robust, reflecting the high level of flight activity, which was above 2019 levels in the United States and Europe. We had very strong order activity in Civil in the third quarter, booking training solutions contracts valued at CAD 753 million or a one 1.93 book-to-sales $753 million for a 1.93 book-to-sales ratio, including 19 full-flight simulator sales. This is in sharp contrast to the 11 full-flight simulator orders that we booked for the entire fiscal year last year and brings our full-flight simulator sales for the first nine months to 33. Since the end of the quarter, we signed orders for another four, bringing the year-to-date tally to 37 full-flight simulators sold. Consistent with the more advanced air travel recovery in the Americas, over 60% of the year-to-date total are from customers in that region and include full-flight simulation orders from major US carriers, actually all major US carriers, including orders for multiple full-flight simulators for some of the largest United Airlines this quarter. Our airline customers in the Americas have been adding back flight capacity and actively ramping up pilot hiring. In order to secure the training capacity that they require, they've been working with CAE as their training partner of choice, entering new long-term training agreements and acquiring additional simulators. We think this makes for a compelling preview of what an eventual broader global market recovery holds for CAE. Notable training contracts for the quarter include five-year extensions of commercial aviation training agreements with Endeavor Air and Avianca, a nine-year commercial aviation training agreement with Norwegian, as well as five-year business aviation training agreements with Global Jet Luxembourg, XO Jet, and Vista Jet. In Defence, we also had double-digit growth in the quarter with the contribution of L3Harris military training. And as we expected, we surpassed the CAD 30 million mark in adjusted segment operating income. I'm especially pleased with our order intake which totaled CAD 593 million in the quarter or 1.39 times book-to-sales ratio and a CAD 4.6 billion backlog. We seized on the opportunity of the temporary relaxations in pre-Omicron COVID-19 restrictions that as a result, our international book-to-sales ratio was above 1 for the first time since the start of the pandemic. In addition to the positive book-to-sales, we're also seeing more conversion on our Defence strategy to pursue multi-domain training and mission support solutions. Orders to-date included competitive prime awards, recompetes and contract expansions across all five domains – air, land, sea, space and cyber. In the Air domain, we strengthened our international presence with the German Air Force's competitive selection to provide Ab Initio pilot training, replacing the 60-year incumbents. Along with this new live-flight training program, we also expanded our relationship with the United States Navy's Chief of Naval Air Training or CNATRA by adding T-45 live-flight training for instructional services contracts. Beyond live-flight training, we were awarded the 19-year base plus options contract from an Australian customer to provide integrated support and training on a range of strategic platforms. Other contract expansions, including four task orders on our Simulator Common Architecture Requirements and Standard or SCARS single award IDIQ as the US Air Force accelerates the integration and standardization of approximately 2,400 simulators across 300 locations. Since the across 300 locations. Since the end of the quarter, we've made additional notable progress to broaden our position beyond our core defense air, land and sea programs by winning our first competitive prime contracts in Cyber and Space. We were selected by Canada's Department of National Defense to expand cyber intrusion detecting − detection capabilities on the Innovation for Defence Excellence and Security or IDEaS program and we were awarded our first prime simulation contract in the space domain with a key US customer. These strategic Cyber and Space Prime contracts, along with our first US intelligence community competitive prime win in the second quarter are great examples of how we're building our defense business for the future by establishing it as the world's leading platform agnostic training and simulation pure play, ensuring mission readiness by integrating solutions across all five domains. And finally in healthcare, we delivered our fourth consecutive quarter of double-digit year-over-year revenue growth excluding the ventilators as we ramp up our reenergized organization with a clear focus on achieving greater scale. We launched updates to expand the feature set and functionality of some of our main product solutions, including learning space, our simulating − simulation center management system and Vimedix our ultrasound education platform. We also introduced 11 new on demand online digital courses featuring virtual simulation in collaboration with the British Columbia Institute of Technology. With that, I'll now turn the call over to Sonya, who will provide additional details about our financial performance. I'll return at the end of the call to comment on our outlook. Sonya?
Sonya Branco: Thank you, Mark, and good afternoon, everyone. We delivered double digit year-over-year growth and strong free cash flow during the third quarter, notwithstanding the ongoing challenges of the pandemic. Our performance reflects CAE’s resiliency and the strength in some of our end markets as well as our excellent progress to expand our reach and lower our cost structure. Consolidated revenue of $848.7 million was 2% higher compared to the third quarter last year and was 15% higher excluding the $93.5 million of revenue in the third quarter last year from a contract to provide the Canadian government with ventilators as part of our COVID-19 humanitarian initiatives. Adjusted segment operating income was $112.7 million compared to $97.2 million last year. And quarterly adjusted net income was $60.7 million or $0.19 per share compared to $0.22 per share in the third quarter last year. We incurred restructuring integration and acquisition costs of $47.2 million during the quarter related to the L3 Harris Military Training Acquisition and the enterprise wide restructuring program underway. Cash provided by operating activities this quarter was up 32% to $309.6 million compared to $234.8 million in the third quarter of fiscal 2021. Free cash flow was also higher at $282.1 million, compared to $224 million in the third quarter last year. The increase was mainly due to a lower investment in non-cash working capital, partially offset by cash payments of approximately $38 million related to the integration and acquisition costs of our recently acquired businesses and costs associated with our restructuring program. Growth and maintenance capital expenditures totaled $76.9 million this quarter, mainly for growth and specifically to add capacity to our global training network to deliver on the long term exclusive and specifically to add capacity to our global training network to deliver on the long-term exclusive training contract in our backlog. Our growth CapEx is directly linked to our opportunities to invest incremental capital with attractive returns and free cash flows. With several attractive market-led expansion investment opportunities on the horizon, we continue to expect total capital expenditures to be more than $250 million in fiscal 2022. Income tax expense this quarter was $2.6 million for an effective tax rate of 8% compared to an effective tax rate of nil for the third quarter last year. The income tax rate was impacted by restructuring, integration and acquisition costs this quarter and excluding these costs, the income tax rate this quarter was 20%, which is the rate used as a basis to determine the adjusted net income of $60. Million and adjusted EPS of $0.19. Our net debt position at the end of the quarter was approximately $2.3 billion for a net debt to total capital ratio of 36.5% and net debt to adjusted EBITDA was 3.23 times at the end of the quarter. We continue to expect interest expense of about $35 million as a quarterly run rate going forward. Now turning to our segmented performance. In Civil, third quarter revenue was $390.1 million versus $412.2 million in the third quarter last year, and adjusted segment operating income was up $21.4 million over the third quarter last year to $83.4 million for a margin of 21.4%. This highly improved performance was driven by higher training utilization, predominantly in the Americas and including our interest in joint ventures, Civil Training Services revenue was approximately 10%percent higher compared to the third quarter last year. The higher revenue in Training was offset by lower products revenue with the delivery of 7 simulators this quarter compared to 10 last year. The lower number of scheduled deliveries in the quarter was expected and is consistent with our outlook for approximately 30 deliveries for the year. In Defence, third quarter revenue of $426.5 million was up 42% over Q3 last year. This includes $127.9 million from the integration of L3Harris Military Training into our financials. We indicated on the call last quarter that we would expect this segment operating income to cross into the $30 million dollar range. And indeed it did by reaching $32 million for the quarter, including $19.6 million from the acquisition for a margin of 7.5%. The organic Defence business grew sequentially this quarter, but remained lower compared to last year because of prior period COVID-19 impact on orders and program interruptions, particularly internationally, which have been persistent since the onset of the pandemic. And in health care, third quarter revenue was $32.1 million, down from $120.9 million in Q3 last year on a statutory basis, but was up 17%, excluding the ventilator contract last year. Adjusted segment operating loss was $2.7 million in the quarter compared to an income of $12.9 million in Q3 of last year. The decrease from last year was mainly due to the contribution from the ventilators in the prior period and COVID-related labor disruptions and higher costs. We are also running a higher level of SG&A expenses to help accelerate top-line growth with a view to sustainable scale and profitability. With that, I will ask Mark to discuss the way forward.
Marc Parent: Thanks, Sonya. As we look to the period ahead, we continue to see a clear path to emerge from the pandemic a larger, more resilient and more profitable CAE than ever before. Testimony to that, we're already delivering stronger financial performance, expanding and optimizing our position and booking substantial orders. Pandemic-related headwinds may persist for some time, including supply chain disruptions, employee and customer absenteeism due to COVID-19 infections, operational constraints imposed by local authorities and intermittent border restrictions. The emergence and rapid spread of the Omicron variant this past December has certainly extended the timeline to a broad global recovery but has not changed our position in our positive view of these potential as our end markets eventually open more open up more broadly as we emerge from the pandemic. In civil, a greater desire by airlines to entrust CAE with their critical training and digital operational support and crew management needs, higher expected pilot demand and strong growth in business jet travel demand are enduring positive underpinning a secular growth market. The global recovery continues to be narrowly led by the Americas, which means significant upside remains for a more global recovery. And we think the Americas provide a preview of the kind of demand to follow in other regions when conditions permit. Since the end of the quarter, we've had to contend with Omicron-related employee and customer absenteeism. However, the Americas are still strongest and we're currently seeing some increased demand for training solutions in Europe as COVID-19 related travel restrictions begin to ease and airlines plan for what they expect will be a more robust summer travel season and beyond. As an example, easyJet just recently announced the drive to hire 1,000 new pilots over the next five years with CAE as their training partner of choice. Asia Pacific is currently the most challenging region with relatively low levels of flight activity and training demand as Omicron now makes its way through that region. Overall, since the end of the quarter, our training centers has been holding at about 60% average utilization levels globally. In business aviation, we remained bullish on the long term, and we believe that the market is experiencing a structural expansion with 3.3 million flights worldwide in 2021, the most on record for a single year. COVID-19 headwinds bear mentioning here, as Omicron and quarantine requirements were disruptive to our schedule in January for both our customers and CAE instructors. But we look to be back on trend and we're seeing strong demand for training propelled by robust flight activity in the United States and Europe. And in simulation products, were encouraged by the higher projected delivery rates of new aircraft coming off manufacturers production lines, as one of the, of course, the main drivers for full-flight simulator sales. We're seeing higher demand, as evidenced by this quarter’s full-flight simulator order intake coming mainly from customers in the Americas and Europe, and we expect to maintain our leading share of the market. The unevenness of the global recovery is likely to continue for some time, but we're ultimately in an excellent position to benefit for the multiyear cyclical market recovery that's currently underway. We continue to expect strong growth in Civil for the current fiscal year overall. In Defense, the paradigm shift from asymmetric to near peer threats and a recognition of the sharply increased needs for digital immersion based synthetic solutions across all five domains in national defense are tailwinds that favor CAE’s business. Given the increasing relevancy of training simulation, our defense unit is also on a multi-year path to becoming a larger and more profitable business. We’re currently focused on the successful integration of L3Harris Military training and we’re on track to fully realize their $35 million to $45 million of cost synergies that we laid out by fiscal year 2024. The pandemic continues to make international opportunities slower to materialize but this headwind is temporary and we have a strong pipeline with some $6.2 billion of business proposal pending customer decisions. Our increased orders in the quarter puts defense on the path to achieving over one time book-to-sales for the rate for the year for the first time in the last three fiscal year. Our US defense business was also impacted by pandemic-related employee absenteeism into January, and it currently faces a temporary budgetary headwind on contract expansions and new program starts as a result of the continuing resolution. Defense is indeed managing through its share of ongoing challenges but we're moving in the right direction and we remain confident they will deliver strong annual growth for fiscal year 2022. And lastly, in health care, we're focused on achieving greater scale by gaining share in the simulation training market. And we're targeting some of the largest pools of value like nursing. Supply chain restrictions, disruptions and staffing shortages are a near-term headwind for the business too. But we continue to expect a double digit growth for the fiscal year excluding the ventilator contract. On the ESG front, I want to highlight the CAE was included in the 2022 Bloomberg Gender Equality Index for the fourth consecutive year. This award recognizes that CAE is committed to support gender equality through policy development, representation and transparency. We're proud to continue building an inclusive workplace every day. In summary, we've been adeptly playing offense during this period of market disruption by investing organically and seizing on nine acquisitions to enhance our position and broaden our market reach. We're also strengthened – we've also strengthened CAE by permanently reducing our cost base across the enterprise. The timeline for a broad global recovery is more extended, but our actions and out performance to-date give me even greater confidence that we're on the path to strong cyclical recovery and secular growth as our markets eventually open and we all emerged from the pandemic. We're delivering on what we said we would do, and I expect CAE to continue drive – driving higher levels of profitability on a significantly larger base of business and with a post-pandemic capital structure that will allow us to sustain ample flexibility to further invest in our future. Our opportunity set continues to look very attractive. And I've never been as confident about CAE’s future as I am today. With that, I thank you for your attention and we're now ready to answer your questions.
Operator: Thank you. …
Sonya Branco: Sorry. Operator, before we open the lines to questions, I want to highlight that Marc last month was honored with one of the world's most prestigious aviation awards, having been named Industry Leader of the Year by the Living Legends of Aviation. We're very proud of him and how this reflects positively on all of us at CAE. So please do join me in congratulating Marc. We’d now be pleased to take questions from analysts and institutional investors.
Operator: Thank you. And our first question comes from Kevin Chiang of CIBC. Please go ahead.
Kevin Chiang: Hi. Thanks for taking my question, and I echo Andrew's congratulations there, Marc. Maybe if I could start with the Civil margin performance, as you noted, first time during the pandemic north of 20% despite utilization still tracking below pre-pandemic levels. If I look at it quarter-over-quarter, it looks like incremental margins were about 65%. Just trying to get a sense of where you think the margin trajectory goes here as utilizations get back to a kind of pre-pandemic levels of 70%, 75%. Could this be a mid-20s SOI margin business given all that you've done with business and the mix of revenue there?
Marc Parent: I had trouble catching the last part of your question, Kevin, but I think I get the gist, and maybe I'll try, and let me know if I've answered it. Look, I think I'm very pleased, obviously, with the margin performance that we had in the quarter in Civil, 21.4% margin, driven off essentially similar revenue that we had last year. And maybe just I’ll pause on that. When you look at the revenue, it looks like it's slightly down relative to last year, for good reasons, so the mix, the environment, and the fact that we had lower deliveries in our products. But remember that we don't want to consolidate JV revenue, and that's not an insignificant number, and that's because of accounting. If you were to add back the JV revenue, you’d – what you'd be seeing is training revenues is about – up about 10% year-over-year. But coming back to the margin, look, as I said, I'm pretty happy about that. You're going like 18%, I think, to 21% – 21.4%. I think what you're seeing there is, first of all, the mix of business. You have business aircraft, which I've always said is – that's an attractive margin profile. We have a very good – very nice position in marketing business aircraft. Business aircraft is doing great. You're seeing that transpire. You're seeing commercial aviation training in the US doing pretty well. And really in a big way, what you're seeing is our cost savings, which are structural coming through the numbers. So that's what you're seeing. And, of course, we've always said that we fully expect that on margins because of all those reasons that margins is going forward to track higher than we've achieved in the past. I think our peak civil margin was just about 22% historically. I would certainly expect to blow through that on a sustained basis. I mean, obviously, the one quarter doesn't make a year a variable, but that would – to me, that would be the trend as we get more utilization.
Kevin Chiang: That’s…
Marc Parent: And…
Kevin Chiang: That’s helpful.
Marc Parent: I think the last thing I'll add, of course, as I’ve said in the remarks, is all of that is achieved on a pretty narrowly led recovery. That's really the United States. So I think that's why you sensed my confidence and excitement as the broader recovery across the globe comes to bear.
Kevin Chiang: No. That makes sense. Just turning to defense, I just want to clarify something. So if I look at the time that you acquired the L3Harris Military Training business, if memory serves me correct, that – I think at that time you had called out EBITDA margins of roughly 15%, I think. And if I look at what those margins look like since you've acquired it, it looks like it held on pretty well. Would you like to see margins tract about half, if not a little bit below pre-pandemic levels? It sounds like you're talking about up to primarily a lot of the international restrictions. Is that primarily the reason for the underperformance in margins? And you need to see these travel restrictions get eliminated before they can get back to 10% or there anything else kind of holding those margins back?
Marc Parent: Well, I think there's a few things in there, I mean, you're absolutely correct as we say the defense business is not immune to COVID, both in the L3 Harris business, particularly in the international side of business. The international portion of L3 Harris business, the one we've inherited that's where it's lower than our organic business but it's still affected nonetheless. And so it seen its share of impact there as you couldn't travel to a lot of those locations. We've also seen some effects of, as I mentioned, the continuous resolution in United States that that prevents us from having new programs starts or expansion of our existing programs. So that is definitely been a headwind and we hope to see that being resolved pretty quickly. Yeah, I could point to contracts that we're on. Like I mentioned, the SCARS contract in the United States and the GBSD, the ground based strategic deterrent contract that we're on a United States for L3Harris business, our ex L3Harris business. Those are big contracts. And, because you have the CR, just resolution, you're not. I mean, the contractors themselves if I think about the prime contractor on contractor on GBSD are not able to make progress in enlarging their contracts. So that affects us. And I don't know. I think maybe add that, you want to add anything further?
Sonya Branco: Yeah, it's probably kind of talk to the organic base business to the organic base business and what we talked to, and this is still the case. The base business, first of all, it did sequentially increase both top and bottom line for us since last quarter. But as you know, our organic business has a higher proportion of international business. And as Marc just talked, that's the one that's been the most disrupted by COVID, especially international product programs. So a couple, which are usually higher margins for us. So, first, interrupting execution of existing backlogs in certain regions where contract execution is slowed or even stopped, and as restrictions lift and programs can restart, that will help advance on both revenue and contribution but also the impact of delays in order intake, especially on the international side. We've gone several years, at least definitely since pandemic, with book-to-sales less than 1 as contracts are selected, et cetera, but not necessarily move to award it. Now we've seen some good advancement in the quarter with the book-to-sales in the international side going above 1. And so, as those take traction, whether that's the restrictions lifted and we secure those delayed orders on the product and international side, and then, of course, and layer on the continued synergies that were starting to ramp up with the acquisition. These will contribute to growing both on the top line and the profitability.
Kevin Chiang: That's helpful. And then, just last one for me. I appreciate the pipeline of opportunities you see in health care, and I think there are a lot of synergies with your core competency in terms of what you're trying to do there. But can you explain to me like when you have an incremental dollar of capital, why health care would be an appropriate place to put that versus what you're seeing in Civil and Defence. It just feels like you've got better scale in those businesses. You can generate, I would imagine better incremental returns. I guess, I guess just explain to me why dollar to health care would make sense versus the other two?
Marc Parent: Well, I think the first thing I'd point to other than the fact that because you're just trying to believe in that health care will become a more material par C policy in the, in the not too distant future that I'm quite confident of that. But I think the thing I would point you just specifically the question of capital deployment is that business is largely self-funding. I think essentially all are self-funding. And so it's – the question that you asked there isn’t is really no decision to be made with regards to that.
Kevin Chiang: Okay. That's it for me. Thank you very much.
Operator: Thank you. The next question comes Konark Gupta of Scotiabank. Please go ahead.
Konark Gupta: Thanks and good afternoon, and good afternoon, everyone, and congrats Marc on your accomplishments.
Marc Parent: Thanks.
Konark Gupta: So maybe my first question just coming on the back of Kevin's question on civil margin, obviously, I mean you saw a pretty strong performance here. I understand this business jet training, which is high yielding and then cost savings as well is going through. But anything non sort of nonrecurring in nature you think are not going to recur again and in Q4 or the future quarters we saw in Q3, perhaps that you can speak?
Marc Parent: This is just really I think a step up in operations really a 35% increase in SOI on – 60%, still 60% utilization and lower deliveries. It's really the mix. You see the operating leverage that's coming from that, that increase in utilization and the cost savings. So I think there's no nonrecurring items, just a strong performance on the civil side.
Sonya Branco: It's all good stuff, Konark.
Konark Gupta: Okay. No, I’m just kind of like more curious about seasonality in the business, right, all the time that you have probably business jet training. It's the stronger in the fourth quarter. And then it kind of drops off in the first half like sequentially. So like, does it – does business jet make seasonally – seasonality actually more pronounced in margins because of that these dynamics?
Marc Parent: I think we still have the normal seasonality, although it's not as pronounced this year, just because there's so much disruption across areas. Look, I – it's too early to say, but I wouldn't expect, so I wouldn’t – based on the mix that we have, I don't expect that we'll see a profound change. At least I don't see any so far. Would you add anything there?
Sonya Branco: Well, I would just caution that there is always volatility on quarter to quarter margins, right, because of the mix and so on. So we always you can give it a view on an annual basis. But I think there's no significant ups or downs there.
Konark Gupta: Okay. That's helpful. Thanks and a couple of things on the Defence side of things, so it's rebounded sequentially, so only with both margins and revenue. And I think last quarter, Sonya, I think you probably would have mentioned that you expect something in the 30s shortly and then eventually in the 40s then consult SOI. What's your visibility now with that kind of recent order intake at Defence? Does it give you more confidence in that 40-plus SOI number shortly or you still think that it will be about?
Marc Parent: Well. So I think a great performance on the order intake, and of course, that gives you confidence to have – to build on future growth. And what we like is that – it's both on the US and international side, both over one time since there are likely, we spoke about it last quarter, we expect to be in the 30s in Q3. And then, based on a few factors securing delayed orders, especially on the product international side, as restrictions lifts, enough and consistently to be able to advance programs that we have in backlog and then learning around the synergies that gives us kind of line of sight at around 40. Now, great order intake, but it does take a while to ramp up these orders. So at the end, and the average life of these orders are over several years. So, yes, it's great it refills the backlog, gives us better confidence for the quarter, but we'll see a lot of that ramp up – maybe just the start of that ramp up in Q4 and the rest for the upcoming years.
Sonya Branco: And Konark, one thing I want to just point out, if we go back to your previous question there, or at least in the first part of this question is that, a business training is usually the strongest for us in our Q4. I don't expect that to change. The one thing, as I mentioned, we were impacted like most everybody else in January, with a lot of instructors off with COVID related sickness. But we're having a strong order and we're back on trend.
Konark Gupta: Yeah. That's something to look at, and actually on the Defense, I wanted to ask you another question on L3Harris, if it’s short some of the sequential improvement in margins. So I'm just kind of wondering is there some seasonality to that margin or was there any synergies that we cannot realized early on?
Marc Parent: Yes, on the synergies. We’re starting to see the synergies come through. And I guess what I would say is, I've always said in Defense, it is no different. One quarter does not make a year, it's always been lumpy. I will expect it to remain lumpy, but you are seeing some synergies come through.
Marc Parent: Yeah. If I could just – I'll just add, Marc. We've ramp – we're ramping up the integration efforts. There were some redundancies of actions, consolidation efforts, etcetera. So you're starting to see some of those synergies flow through. And depending on where those synergies lie, because they could lie in the organic or the inorganic basis it will drive some volatility, in this case it fell more on the inorganic side. But to Marc's point, that can drive some volatility in the quarters and so and between. But essentially, that's − the synergy starting comes through.
Konark Gupta: Great color. Thank you.
Operator: Thank you. The next question comes from Fadi Chamoun of BMO. Please go ahead.
Fadi Chamoun: Good afternoon, and thanks for taking my question. Again around the margin Sonya, you’re talking about 65% incremental margin this quarter. Is there a reason why you can't sustain this level of incremental margin going forward? I'm just kind of triangulating a little bit. You still have low utilization travel, recovery still in the early stage and that training network typically have very high incremental margin. Is that the right framework to think about the aviation business in the next two years as you kind of move up that utilization curve?
Sonya Branco: We're also saying we see the − obviously the mix from business jet which helps them on the margins and that mix will vary, especially as we hopefully see CAT appreciating on the margins as well. But you're right, the operating − we're starting to see the operating leverage on the utilization kind of flow through and also big chunk − a significant part of cost savings. Now the slope on those cost savings will start to slow but it'll just kind of continue to help on the operating margin so − on the operating leverage rather. So, I think it's a very good performance. And like Marc said, we see this with volume contributing to exceeding prior pre-pandemic peaks.
Marc Parent: Don't forget Fadi, of course, that the future revenue will include a greater proportion of full flight simulator deliveries, work or a Parc Aviation kind of work. So that a different margin profile. So you can't obviously consider it all a trading revenue. So yes, to your incremental margin, but certainly not straight line, right?
Fadi Chamoun: Okay. Okay, that's helpful. The follow-up question is on the air mobility market, the eVTOL market, I guess, you're dabbling in it. You have partnerships kind of coming through right now. I'm just trying to understand, like what exactly you're helping these partners like, I guess we've got John and a couple of others. What exactly is CAE involved with these partners in terms of helping them head up the training, I guess going into these big launches? And two, what does this market look like three to five years down the road? Does it look like more business aviation where you're providing its full turnkey solutions? And if you have any color around what kind of size market are you potentially looking at over the medium and longer-term?
Marc Parent: Yeah, thanks for the question. I think Fadi, the first thing I would object to is the word dabbling, dabbling in this market. We definitely think we’re – we definitely intend to be a major player in this market. I think it's a very exciting market. I've said that before. I think it's a market that will materialize before anybody thinks it does because it's so compelling. In the history of aviation, I'm a bit of history – as I think you know, a bit of a history buff and especially in aviation specifically. And what has always stimulated the growth of the aviation is newer power plant technology. And what you have here is new power plant technology, specifically distributed electric power plant, and the MAT software systems that permit you to have these very complex vehicles that are inherently unstable to be able to be economically produced. So that's why you see a plethora, a large number of these companies coming through to produce vehicles of all types to service air mobility market. So see, we're not picking winners and losers here in this market. What we're doing is we're getting involved. And by the way, we have – it's not – yesterday, we became involved. I went to a major conference with – and I say major invitation only conference of about four years ago in this market, it was held in Texas where all of the players at that time were getting together, and really saw the potential for this market. So short answer to go back to your question is, I strongly believe that this market is going to be needing about over 60,000 pilots over the next 10 years. And there is no way that these pilots that are going to fly these vehicles are not going to be have to train to a high level in order to operate in the airspace that we have today – the congested airspace because by definition these vehicles will fly in and around cities. So they have – going to have to be trained. So what you see is cost positioning ourselves as the company we are. We can help, first of all, define the kind of training infrastructure, the kind of training standards that will be required by training these pilots of these vehicles working with the companies, working with the regulators, and offering the service. And as you say, it may be a business aircraft-type construct, or it may be involving selling devices. It will be a combination of both. It is being defined today just as this market is being defined today. But make no mistake, I fully expect this – CAE to be a major part of that market.
Fadi Chamoun: Okay. That's great. Maybe the last question, you mentioned about kind of how the aviation demand has been led by North America, US, I guess, in particular. Wouldn’t kind of a pickup in the travel in Asia and some of these markets that still are behind in the recovery be more attractive to you because you tend to do a little bit more wet training or a little bit more turnkey solution in those markets?
Marc Parent: Well, I think the – I think if you happen to look at the overall market for us in training, we've seen business aviation itself training doing very, very well. Of course you know that's all wet. That's very good. The rest of the world, I think when I point to – when the recovery comes back in Asia Pacific, we tend to do, on average, a bit more wet in that region. But I think I would point to training in commercial aircraft as a whole. Today, Asia Pacific is operating at about 50% where it was in – pre-pandemic. So there's a lot of recovery left to have in that market. So, definitely, I think that any expansion going back to normal 2019 levels, whether it be wet or being dry, is going to be good for CAE. And whether it be Europe, whether it be Asia Pacific, again, look back at what's happening in the US. In the US today, it is – it’s a narrow-led recovery. People are scrambling to train their pilots, to buy more simulators. If you look at the recovery in the simulators that we've had just this year relative to last year, it’s quite impressive, largely driven range by the United States and from Europe. So imagine that rolling over into Europe and Asia-Pacific, and I think there's a large potential for that. And that – I think that leads us to where our asset base is. Today, about 33% of our simulators are about 54 for simulator equivalent units in the Americas. In Europe, there are about 44%, about 72; in Asia-Pacific, 36. What's interesting though is, as we talked about during the pandemic, we moved simulator – a lot of simulators that we launched a lot of simulators to go where we thought using your Gretzky analogy, where the puck was going. Where the puck was going? We're training demand will be. And no surprise is being led by the United States. So if you look at going into next year, where our simulators are, we're going to have about the same number in absolute number of simulator equipped equivalent units in the Americas as in Europe. So we're seeing – we're shifting our asset base to where that demand it. I think that's going to be pretty attractive and that's impressive, especially considering that we acquired FSC in Amsterdam. So inherently, we've added a lot of simulators in Europe itself. So the fact that we would be on par, I think is a very good move that we've made guaranteeing the future for us.
Fadi Chamoun: Okay. Thank you. Appreciate the color, Marc.
Operator: Thank you.
Andrew Arnovitz: Just to interject for a second here, we still have quite a few people on the line which needs to ask questions and we’d like to get to all of them if we can. Maybe at this point we would restrict to one or two part questions just so that everybody gets a chance.
Operator: Thank you. The next question comes from Cameron Doerksen of National Bank Financial. Please go ahead.
Cameron Doerksen: Yeah, thanks. Good afternoon. I'll stick to one question. Obviously, we've got maybe a little more visibility today on how the airlines are going to recover. Maybe there's certainly some markets that are a little more uncertain. But I guess maybe given that greater visibility by many airlines, can you talk a little bit about what you're seeing on, I guess, the potential for outsourcing? I think one of the issues the last couple of years that airlines just didn't know what their fleets were going to look like and when the market was going to recover. But as I said, there's probably a little more visibility today. So I'm wondering if any of those kind of talks around outsourcing deals have picked up at all.
Marc Parent: Well, there's definitely, again, a high volume of conversations occurring and there's some contracts occurring and you're seeing that a testimony to the amount of simulators that we've deployed in the United States specifically. I was pointing – answer the fattiest question. The fact that we've been increasing the number of simulators quite substantially in the United States and some of that is for business aviation, which is growing. But another large part of that is for the commercial aviation training network. And all of those simulators are going essentially to either new airlines that are starting, which are going straight to an outsourcing model or to airlines including legacy carriers that are sea with long-term contracts for training. So that's not a de facto, a complete outsourcing, but it is definitely a different trend that you see where airlines have -- in order to be able to secure the training need that they have on a queued basis, you're they’re willing to and they're seeing the attractiveness of going into long term contracts with us. So that is a difference. But there is continuing conversation. And I would say that we're certainly not in a steady state. I mean with yeah there were maybe better than we were last year but Omicron is turned a bit of a monkey wrench into any kind of steady state in the airline business right now.
Cameron Doerksen: Okay, no, that's, that's helpful. Thanks very much.
Operator: Thank you. The next question comes from Chris Stellwag of Morgan Stanley. Please go ahead.
Chris Stellwag: Hey, thanks. Marc, our domestic US air traffic had a very steep recovery, so if global air traffic follows a similarly steep recovery, let's say second half of the year and we don't know but should it happen? Can you discuss any labor or supply chain constraints that could slow down your ability to meet a potentially boring demand? Because with a footprint that you have there, it sounds like it should be a pretty good year or should we see that air traffic come in?
Marc Parent: I don't see it, I don't see it. Certainly, I don't see any kind of parts for related issues that way. Labor, I don't see it. I think that we're well positioned. We spend a lot of time during the, during the pandemic, especially the first year we –p- if you go back to some of the things I was saying at the beginning, I said we will take advantage of the period that we have of lower demand as lower demand environment to optimize our training network and that’s where you see a lot of recurring and permanent cost reduction coming through. But we also said that we keep our powder dry and powder dry meaning that -- I said it right at the beginning, people aren’t going to give up the freedom they have to travel and we see that. We saw – we see that in certainly the domestic flying in United States. So we’re going to see that and I see no structural reason that we will not benefit from that recovery. And when that timeline is, certainly, I think the Omicron is likely extended that recovery timeline, maybe, but that will be measured in months, certainly not in years. So call us very confident in the long-term.
Chris Stellwag: Thanks, Marc, And if I could squeeze a second question on the MAX here. I mean, in December, we finally saw the airworthiness directive from the CAC paving the return to service on the MAX. Are you seeing any acceleration in training activity on the MAX from China?
Marc Parent: Well, we’re definitely seeing training for the MAX. Training for the MAXs is at high levels. It has been for a while on the return to service, even before the return to service has, people could see the airplane is going to go back into the sky. So, I would just say it's a high level of activity and I foresee that continuing as more and more MAXs are being delivered.
Chris Stellwag: Thanks, Marc.
Marc Parent: And in China, I think what you'll see is that'll manifest itself in largely in full flight simulator sales.
Operator: Thank you. The next question comes from Benoit Poirier of Desjardins Capital Markets. Please go ahead.
Benoit Poirier: Good afternoon and congratulations, Marc, for your prestigious award. And Marc, we've seen some M&A among the airlines with Spirit and Frontier. Any thoughts on whether M&A could slow down or accelerates outsourcing? And…
Marc Parent: Well, look…
Benoit Poirier: Do you foresee more M&A activity if among the airlines, Marc?
Marc Parent: Well, I'm not going to predict it. I'll let inevitably, what the – whatever that kind of event happens, it's usually catalyst for us to have a discussion with them because the airline itself is looking for new ways of doing things. So I think to me, that's where I would leave it. I can't be a predictor of how much M&A they would have. But certainly there's a lot of opportunity in the airline business today. Perversely, it continues to be a number, quite a number of new airlines starts. And that's a good opportunity for us as well because we offer a ready-made international, or actually a global network, a training solution. So offering them a solution that was never there before, so I think that's good for us.
Benoit Poirier: Okay. That's great. And my follow up is for Sonya. You provided great color about the booking for Defence the fact that it's been spread out on the global scale. Anything particular to highlight on what drove the big change in momentum during the quarter? And for the free cash flow generation, was there anything unusual in the quarter or should we expect another strong fourth quarter?
Sonya Branco: I'll start on a free cash flow. I think this very, very strong performance in the quarter of CAD 280 million, that's on strong operational performance. And as you know, it's a very cash generative business. It's also driven with a solid non-cash working cap reversal in the quarter with over CAD 200 million of reversals. And that's really continued persistent focus on working capital, improve collections, conversion of work in progress into AR and cash and the reflection of higher orders. So, higher orders come in with milestone payments and deposits on contract. So that contributed to a really good performance of free cash flow. And that's despite continued cash payments on the restructuring program, which was about CAD 38 million in the quarter. So, nothing unusual, just a strong performance and good reversal of market cap. And we've guided to continued 100% free cash flow conversion of net income to free cash flow. Now, on your first question, I didn't quite hear on the Defence side.
Benoit Poirier: Oh, just in the sense there's been a big change in the booking for Defence. I was curious to get more color about what drove the big change, positive tone, in terms of booking with respect to Defence, Sonya.
Marc Parent: Well, maybe I can answer that, Benoit. Look, we – it's the big pipeline of orders that we've talked about, the bids that we have that are waiting for customers to pull the trigger. Really, that's – you see a lot of that. We took the advantage, especially internationally, where, right before Omicron, we had a period of time we could finally start traveling and people were willing to meet us. So I can tell you, we took our international teams, took the opportunity to really go after it and fill the pipeline. And they did. I talked about a Defence book-to-bill above 1. I can tell you it's well above 1, and I think they did a very, very nice job, and that reverses a trend that we've had that’s largely caused by COVID of the orders gap in that segment, particularly internationally. And in the US, look, I think it's just good work by our teams, great work by our teams. I love the orders, as I said it in my remarks, that are coming across on all five domains, the first prime contracts in the space domain, the first prime contract in cyber, on top of the great wins, like, for example, the ab initio win that we had to for doing all the training for the Luftwaffe in Germany, beating a 60-year incumbent. I think it's great work by the teams in Defence and working in collaboration, I would say, for example, in that last contract with their colleagues in the civil, they’re leveraging the full power of what we like to call as CAE.
Operator: The next question comes from Tim James, TD Securities. Please go ahead.
Tim James: Thanks very much, good afternoon, everyone. Marc, congratulations on that fantastic result and accomplishment. Having said that, I'm going to save some time here, actually all my questions have been answered, so thank you.
Marc Parent: Well, thank you, Tim. Appreciate it.
Operator: Thank you. The next question is from Anthony Valentini of Goldman Sachs. Please go ahead.
Anthony Valentini: Hey, all. You got Anthony Valentini on for Noah today. Thanks for the time. My first question is on the 10% training growth that you guys put out because of the JVs, I think it's super helpful, the investment community is going to welcome that metric going forward. I'm curious what that look like over the last few quarters, if you can provide it and even like sequentially, I think would be would be really helpful. And then my second part for Marc, I'm just curious what you think the next catalyst is going to be here for the global recovery, specifically in Asia? I know that you mentioned the new variant but I know we've been having kind of this conversation on these calls for the last few quarters now. Is it a matter of us just learning or just in Asia like us learning to live with the pandemic or is it an event like the end of the Olympics? Your color there would be great. Thanks.
Marc Parent: Look, I think it's just basically lifting of COVID restrictions. I mean, the real impediment into travel and air goal revenue for us in training is that largely because people are afraid of getting on airplanes is because people can't go anywhere or they have to wait. It’s because the people can’t go anywhere or they have to wait. Like, for example, in Asia Pacific, in some cases filled to 21 day – up to 21 days of having to quarantine after you come back. That means you got to be – you're going to want to travel when you have something like that. So to me, it's all tied to the lifting of those restrictions. The great news is, I think, that we're seeing, for example, I don't know where you are. I think you're in New York, but I mean, here in Québec, I mean, we're seeing lifting of all, essentially all restrictions here in Québec by the end of March. I think that's a very positive news. It doesn't do much for air travel, but I mean, it's an indication. We're seeing European countries literally one by one basically calling an end to restrictions. That's going to be the catalyst. So ultimately, I think that's what we got to see in Asia Pacific. And I'm not a government employee. I can't tell you what else is going to happen, but inherently I know it will happen. So barring any new variants, hopefully not, but I mean, I'm optimistic that we're on a good trend here.
Sonya Branco: Okay. Well, Anthony.
Anthony Valentini: Yeah. Yeah. The first part of my question.
Marc Parent: Oh, so that if you – yeah, you have another question, yeah, on the JV revenue. I think Sonya can get it, yes.
Sonya Branco: Yeah. So 10% including – so training growth including the contributions for JV. I don't necessarily have the last quarter on hand because a couple of different elements. But what I would say is the higher because obviously you see the utilization and we saw a really nice ramp-up on under certain regions where we have joint ventures, but we can get back to you with the numbers.
Anthony Valentini: Okay. Great. Thank you.
Andrew Arnovitz: Great. Operator, it looks – it looks like we’ve run it looks like we've run out the hour. I do want to still use a couple of minutes, if we can, for members of the media, if there are any questions from members of the media?
Operator: The first question comes from Stephan Ohala . Please go ahead.
Unidentified Analyst:Andrew Arnovitz: Okay. Operator…
Operator: Thank you. Our…
Andrew Arnovitz: We’ll conclude the call at this time as we've overrun the hours. I want to thank all participants again for joining us today. I would remind you, the transcript of the call can be found on CAE’s website at cae.com.
Operator: Thank you. This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a good day.
