CAE [CAE] Conference call transcript for 2022 q2
2022-08-10 22:46:17
Fiscal: 2023 q1
Operator: Ladies and gentlemen. Welcome to the CAE First Quarter Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may proceed Mr. Arnovitz.
Andrew Arnovitz: Thank you. Good afternoon everyone, and thank you for joining us today. Before we begin, Iâd like to remind you that todayâs remarks, including managementâs outlook and answers to questions contain forward-looking statements. These forward-looking statements represent our expectations as of today, August 10, 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 risks, factors and assumptions that may affect future results is contained in CAEâs annual MD&A, available on our corporate website, and in our filings with the Canadian Securities Administrators on SEDAR and the U.S. Securities and Exchange Commission on EDGAR. On the call with me this afternoon, are Marc Parent, CAEâs President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer. After the remarks from Marc and Sonya, weâll take questions from financial analysts and institutional investors. And following the conclusion of that Q&A period, weâll 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. We had a mixed performance in the first quarter with Civil delivering results in line with our view for strong annual growth and increased market share momentum. Defense results were disappointing. However, coming in very well short of our expectations. The shortfall was mainly due to unanticipated discrete charges on 2 of our legacy programs and increased intensity of the defense sector-wide headwinds that weâre facing in this early stage of our multiyear growth journey. Now weâd already factored into our prior outlook that the second half of the fiscal year would be stronger than the first, mainly because weâre still working our way through the lag effects of a protected period of less than onetime book to sales. And it takes time for new program awards to ramp up. We also expect that some of the additional headwinds in the first half, but they were significantly more acute than we thought theyâd be. Now order activity is the best indicator of our future growth. And despite a challenging global environment for CAE overall, we secured over $1 billion in orders for a record $10 billion backlog and 1.12 book-to-sales ratio. In civil, we made excellent progress converting our large opportunities pipeline into $522 million of orders for a 1.09x book-to-sales ratio. Now this includes long-term training agreements with airlines and business aircraft operators and 11 full-flight simulator sales. Notable training contracts for the quarter involved several exclusive training agreements in the Americas, which adds to the long list of exclusive training agreements that Civil has signed in the last 1.5 years, with the vast majority of major airlines in the region. This quarter, -- they include a 3-year extension to a long-term exclusive training agreement with Mesa Airlines, a 5-year exclusive training with United Airlines, a 5-year exclusive training agreement with JetBlue and a 10-year exclusive training agreement with another major North American airline. In the U.K., Civil expanded its existing 12-year exclusive commercial aviation training agreement with Virgin Atlantic to include the Boeing 787 platform, now covering all their existing aircraft platforms under the training exclusivity. In business aviation, Civil concluded a pair of 3-year training agreements with TAG Aviation Holdings, and the NATO Support and Procurement Agency. Civil year-over-year financial and operational performance was also strong in the quarter with double-digit growth in training revenue and adjusted segment operating income. We delivered 10 full-flight simulators in first quarter average training center utilization was 71%, up from 56% last year. Training demand in the Americas continued to be strongest, followed by a much improved Europe and is still lagging Asia Pacific, which remained at a much lower level due to travel restrictions. In Business Aviation, training demand continued to be robust, reflecting a sustained high level of business aircraft flight activity. Now turning to defense. We booked orders for training and mission support solutions valued at $488 million for 1.18x book to sales. And although we were expecting some key orders that pushed rightward this quarter, this represents a record level order intake for defense in the first quarter. Now we normally see some variability in quarterly defense results and so performance is best evaluated on an annual basis. And to that point, our trailing 12-month book-to-sales ratio of 1.31x is to me a very good indication of the trend in order momentum. We continue to build on that momentum in the quarter, winning orders across all 5 battle space domains. In air domain, we entered a contract with the Netherlands Ministry of Defense to provide a training system in support of the NH90 training program. In Land, the U.S. Army Synthetic Training Environment cross-functional team who ordered CAE a task order to develop a soldier virtual trainer prototype with immersive capabilities that empower soldier-led training at the point of deed meeting that is deployable. In the sea domain, in partnership with Lockheed Martin, we were awarded a design support contract on Royal Canadian Navyâs next-generation frigates. In space, we were awarded a contract from the U.S. Air Force Research Lab as part of the Starfish initiative. To develop prototype software that enables simulation of current and future capabilities operating across a multi-domain environment. And finally, in the cyber domain, as part of a larger team, we secured a position on the approximately $1 billion ACT 3 IDIQ contract vehicle. And while defense order activity was generally positive in the quarter, financial performance was clearly not. The loss incurred of $21.2 million was driven mainly by unanticipated charges on a legacy CAE training program with the U.S. Navy and a legacy L3 Harris military training classified U.S. program. These 2 discrete charges totaled $28.9 million in the quarter, a result from our reassessment of cost estimates following discussions with our customers this past June. The reassessments are due in part from delays in meeting customer requirements of scope and timing as well as a change in expectation for the expansion of the program requirements. In the case of the U.S. Navy contract, customer utilization trends have exceeded our estimates, resulting in cost growth on a fixed price -- firm fixed price contract and our expectations for contract adjustments and extension at more favorable terms have changed. The program in question is the Chief of Naval Air Training or Sinatra contract with contract instructional services, where CAE provides classroom and simulator instructors as 5 naval air stations to support primary, intermediate and advanced pilot training for the United States Navy. The second chart stems from a classified U.S. program thatâs also structured on a firm fixed price basis and involves the initial phases of a large long-term opportunity. The program is a complex natural defense priority, and our current work positions as well to capture significant future opportunities on the power. Now given the nature of the work, which has performed in close quarters, COVID-19 related staff shortages of cleared professionals have been highly disruptive to the program schedule. In addition, logistics and shipping costs, which are significant for this contract increased our estimated cost to complete. And after a re-baseline review of the programâs critical schedule elements and deliverables with the customer in June, the cost to complete were revised upwards. And due to the critical nature of this program and the strategic long-term value it holds for CAE, weâre working towards meeting our commitment to the customer and positioning defense for future work. Iâd add that while weâre hopeful that the customer will work with us in the future for equitable adjustments that could help to offset some of the charges taken this quarter, at the moment, we havenât included any of those in our expectations. Iâd also add that we have a clear understanding of the specific issues that result in any charges taken on both programs. And after thorough analysis, we consider these provisions capture adequately the expected cost overrun, and Iâm confident that there is no more negative surprises like this one in our backlog. And beyond the 2 program charges, defense performance was still below our expectations for the quarter. Across the company, weâve been managing through labor and supply chain challenges that have been consistent with what we observed in the broader economy. However, in defense, these challenges were more acute as sector-wide staffing shortages led to less billable work on cost-plus contracts and inefficiencies on other work. Supply chain challenges were also more severe than anticipated, which pressured schedules. We also experienced delays on a few key orders we are expecting to commence work on in the quarter. Excluding the charges and impact of these additional challenges, defense performance would have been more consistent with our expectations of the full year plan, which also considers a more elevated level of bus and proposal costs as we pursue several large awards that are in our pipeline. Finally, in health care. We continue to drive double-digit revenue growth with our innovative solutions. Health care leadership team transitioned from Heidi Wood during the quarter. Weâre grateful for her contribution and wish her well in the future endeavors. And health care is now being led on an interim basis by Jeff Evans, who is formerly head of sales and has been instrumental in driving the business extended period of double-digit growth. Now notable during the quarter, health care expanded its strategic relationship with the Mayo Clinic College of Medicine and science finalizing a partnership for its learning-based center management solution for Mayo simulation center in Rosseter, Minnesota. Healthcare also increased its presence and visibility in the U.S., the efforts supported by Cares Act funding and Monhealth hospital system to address West Virginiaâs increased demand for nurses with the deployment of mobile training units. With that, Iâll now turn the call over to Sonya, who will provide additional details about our financial performance. Iâll return at the end of the call to comment on our outlook. Sonya?
Sonya Branco: Thank you, Marc, and good afternoon, everyone. Consolidated revenue of $933.3 million was 24% higher compared to the first quarter last year. Adjusted segment operating income was $60.9 million compared to $98.4 million last year. And quarterly adjusted net income was $17.6 million or $0.06 per share compared to $0.19 in the first quarter of last year. This quarterâs results includes $28.9 million in unfavorable contract profit adjustments in defense, which accretes to a $0.07 negative EPS impact. We incurred restructuring integration and acquisition costs of $21.5 million during the quarter, including $16 million related to the Else-Harris military training and AirCentre acquisitions. Free cash flow was negative $182.4 million compared to negative $147.6 million in the first quarter last year. The decrease was mainly due to lower cash provided by operating activity. The decrease was partially offset by a lower investment in noncash working capital. We usually see a high level of investment in noncash working capital accounts during the first half of the fiscal year and tend to see a portion of these investments reversed in the second half. Growth and maintenance capital expenditures totaled $73.9 million this quarter, mainly for growth and specifically to add capacity to our global training network to deliver on the long-term exclusive training contracts in our backlog. Income tax recovery this quarter was $0.5 million for a negative effective tax rate of 16% compared to a positive effective tax rate of 18% for the first 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 21%, which is a rate we use to determine the adjusted net income of $17.6 million and adjusted EPS of $0.06. Our net debt position at the end of the quarter was approximately $3 billion for a net debt to adjusted EBITDA of 4.1x at the end of the quarter. The more elevated debt ratio this quarter reflects the impact of the 2 noncash charges in defense. We continue to expect net debt to adjusted EBITDA of below 3x within the next 15 months. Now turning to our segmented performance. In Civil, first quarter revenue was $480.4 million versus $432.9 million in the first quarter last year, and adjusted segment operating income was up $16.9 million of the first quarter last year to $86.6 million for a margin of 18%. Our civil performance reflects a mix of higher training revenue in the quarter, offset by lower revenue from simulator deliveries, life cycle support services and a less favorable program mix. We also incurred higher R&D investments to support our innovation pipeline. In Defense, the first quarter revenue of $413.3 million was up 43% over Q1 last year due to the integration of the L3 Harris military training into our financials. Adjusted segment operating loss was $21.2 million for the quarter compared to an adjusted segment operating income of $23.7 million in the first quarter last year. The loss this quarter was driven mainly by the aforementioned contract profit adjustments and the more acute challenges than we expected, stemming for staffing shortages, supply chain pressures and slower order awards. These additional challenges had approximately $20 million impact on adjusted segment operating income. We also had higher SG&A costs for bids and proposals that were approximately $6 million greater than what we had in Q1 last year. The higher bid costs were expected as theyâre linked to our pursuit of larger opportunities pipeline, but they were more impactful given the other defense headwinds. And in Healthcare, the first quarter revenue was $39.6 million, up from $31.6 million last year. Adjusted segment operating loss was $4.5 million in the quarter compared to an income of $5 million in Q1 of last year. Last yearâs results included a higher level of investment tax credits, while this year, we had a higher level of SG&A expenses to support growth. With that, I will ask Marc to discuss the way forward.
Marc Parent: Thanks, Sonya. As we look to the period ahead, despite the prevailing macroeconomic headwinds and added defense sector related challenges, we continue to see a clear multiyear path to becoming a larger, more resilient and more profitable CEA. In civil, our outlook is as bright as ever. Weâre in the early stages of an up cycle with near record margins with plenty of room to grow beyond that. Weâve invested both organically and inorganically to expand our training network globally, leveraging our position as the worldâs largest civil aviation training company. A greater desire by airlines to a trust with their critical training and digital operational support and crew management needs, acute pilot demand and strong business jet travel demand are enduring positive underpinning a secular growth market. Now the unevenness of the global recovery is likely to continue for some time, but weâre ultimately in an excellent position to benefit from the multiyear cyclical market recovery thatâs currently underway. We continue to expect strong growth in Civil this fiscal year, driven by high demand for pilot training as evidenced by robust full-flight simulator sales and exclusive long-term training agreements with security in recent quarters with virtually all major airlines in the Americas. Weâre poised to continue growing market share from an expanded pipeline of civil training opportunities. And I believe these successes provide a compelling blueprint for what a broader global market recovery holds for CEA-- in Defense, despite the additional challenges that we encountered in the quarter, the positive long-term outlook that we shared at our Investor Day in June is unchanged. Weâre on a multiyear journey to become a bigger and more profitable and the first and more critical link in that chain involves winning orders. Our record order intake last year for the first quarter confirm that weâre indeed on the right path to growth. And critically, the orders that we won over the last 1.5 years bear a profitability profile thatâs consistent with our long-term view to returning to a low double-digit margin in Defense. Furthermore, our record $9 billion of defense business proposal is the result of bidding more and bidding larger. An important element of our strategy involves strengthening our strategic relationships with OEMs and the memorandum of understanding we signed last month with Boeing is a great example of how the major OEMs recognize CAEâs unique expertise in training. We agreed to expand our international teaming and supplier networks to provide solutions that support both customer and regional development. The external environment for defense remains largely favorable with some near-term headwinds having become more acute than -- but we believe temporary current geopolitical events have galvanized national defense priorities in the United States and across NATO. And we expect increased spending in specific prioritization on defense readiness to translate into additional avenues for seeds to support our defense customers in the years ahead. Although somewhat counterintuitive, the immediate priority on operational needs is actually contributing to training program award delays in the short term. And taking all these factors into consideration, weâre lowering our expectations for defense for the cures fiscal year to account for the 2 U.S. program charges that we just incurred and to reflect the more acute sector-wide headwinds that weâre now experiencing, namely supply chain pressures, labor shortages and a slower defense contracting environment. We had previously indicated our expectation for a back half weighted performance in defense this fiscal year. And as we manage through the effect of a protracted period of less than onetime book sales and begin to ramp up new orders in the second half. The additional defense headwinds have made us weighting even more pronounced, and we expect them to largely continue into the next quarter and then gradually abate during the course of the fiscal year. As the year progresses, we expect to be able to partially offset these impacts through new internal cost reductions and efficiency initiatives that are currently underway. And lastly, in health care. The long-term potential continues for it to become a more material and profitable business within CAE as it gains share in health care simulation and training market and continues to build on a double-digit revenue growth momentum. For CAE overall, weâre reducing our outlook for the current fiscal year to mid-20% consolidated adjustment segment operating income growth from the mid-30s previously, which largely reflects our revised expectation for defense. We greatly enhanced our position and expanded our addressable market over the last couple of years, and I have complete confidence in our teamâs ability to maintain a strong order momentum and drive superior and sustainable growth in profits over the long term. Broadly speaking, the underlying tread lines of our multiyear progress are very much intact. And my conviction in CAEâs long-term outlook is resolute. And as set, we continue to target a 3-year earnings per share compound growth rate in the mid-20% range. With that, I thank you for your attention, and weâre now ready to answer your questions.
Andrew Arnovitz: Thanks, Mark. Operator, weâll now open the line to members of the investment community for their questions.
Operator: Our first question comes from Kevin Chiang with CIBC.
Kevin Chiang: Maybe I could dig into some of the details you gave in terms of what happened in defense. Marc, it sounds like youâre confident that itâs the provisions youâve taken only relate to these 2 contracts. But I guess, historically, when we look at these types of issues, a lot of times, it ends up being a lot more systemic than just 1 or 2 contracts. Maybe you can give us a sense of why youâre confident that the issues that you found are isolated to these 2 contracts. Maybe what may these 2 contracts unique and why itâs not more systemic in your backlog? And maybe any changes in your bidding process that might have occurred as a result of maybe this revaluation?
Marc Parent: Yes. Maybe Iâll take it in 2 parts, Kevin. Look, Iâll be the first one to tell you that the performance in the quarter certainly doesnât meet our expectations or my expectations for the defense business as a whole. And look, Iâll start with maybe the specific charges that we took. Again, Iâm not happy with them. And these were -- I would tell you, these are surprises to us that occurred in June as a discrete customer-led events that caused us to recognize these. But we re-baseline both programs following the cautionary discussions we had in June. And I think weâve taken an appropriate approach going forward and having to recognize the charge that we took. And to give you a little bit more color on them, just to tell you that I feel pretty darn confident that can isolate these programs, because you would imagine just taking the step back a second, when you get impacts such as weâve seen here, it forces a complete review of everything in your portfolio. You would have expected me to do that. So just to give -- go back on the programs. On the first one, on the Navy training contracts, Sinatra. This is where the customer demand has really outpaced our expectations. I mean we train, as I said in our remarks, we train at 5 naval air stations that want to be in corporate and the Navy has been trading at a very, very high rate, higher -- will be very frankly, higher than we did at and we did this years ago. Itâs a legacy contract. Now we have put -- we have put cost reduction measures in place to improve the profitability on that program. But whatâs happened now is a shrinking time to realize the benefit because the contract comes to an end at the end of this fiscal year, as ball, how could that be? Well, what happened here is that we and we have very good reason to believe this, we anticipated that the customer would have extended this particular contract at updated terms. As I said, thereâs less than 9 months left in the period of performance. But somewhat to us, very surprisingly, we had yet to get an RFP, which, frankly, as I said, itâs pretty counterintuitive, given the very high customer usage to date, I mean, theyâre flying really, really tracking very hard. Now given the shortened period of performance, we just have no runway left to take -- to take account of any equitable adjustments, any measures that weâve taken reduce cost thereâs just not enough time. So we had to take the charges. Now -- we havenât factored that these -- any extension of contracts, which I fully intend to happen. So thatâs one to stay tuned on, but we have taken a benefit of it. So I think weâve taken a conservative prudent approach here. Now on the other contracts on the classified contract that I mentioned, this is really initial work on, I would tell you, an area of opportunity for us that really got impact on COVID-19 most recently. Again, I donât like the cost go on that program, but I can tell you that I -- because of whatâs happening here, I was on site on that program just less than 2 weeks ago. And I like to be able to look in the whites of the eyes of program managers of engineers or people working on the program. And I feel very confident about the rebaseline program. And I can promise you that this team is extremely diligent and will be even more so in evaluation of the schedule and not only this program in all of our programs. And not just to vali -- if I go back to this program itself, not just to validate our cost estimates, which weâve done, but to make sure that weâre positioning ourselves to capture the long-term opportunity that this program sets up on this program because as I intimated in my remarks, the follow-on work on this contract is very large. Iâm talking an order of magnitude here with the potential for very attractive margins when it reaches a mature state of production. So look, I mean we -- again, Iâm not happy to perform it. But look, none of this, to me, changes our long-term outlook for the defense business that we outlined, for example, at the Investor Day. Our orders that youâve seen have been outstanding. -- weâre tracking some very large opportunities. And with respect to short-term cost impacts, we have put a number of very specific actions in place already to address the challenges on each of our -- in each category, whether it be manpower, whether it be parts, any other factors affecting us. I can tell you personally, in my 35 years in the aerospace industry having managed very large programs in the past, full aircraft, aircraft developer programs Iâve seen this kind of thing before. Big work introduces is very, very specific challenges. But I can tell you, Iâm all over it. The teamâs all over it. And youâre going to see us making progress in the margin rates in the coming efforts as those efforts take hold, and thatâs what we reflected in our outlook.
Kevin Chiang: And maybe just like you just had an Investor Day was call in the middle of the quarter, the middle of the previous quarter. I guess, these issues werenât evident at that time, I guess, just to state the obvious, when you agree from the outlook at that point in time, I guess, at what point did you realize that you have to start taking these provisions?
Marc Parent: Late June, Late June. Thatâs when it happened. And yes, it did come as a surprise. I donât like surprises. You donât like surprises. We donât like surprises. And -- but thatâs what happened. And as I said, the -- as I highlighted by mark, the discrete charges, theyâre noncash or onetime in nature. Weâve rebaselined every program in the portfolio. Weâve taken very specific actions on the rest of our programs. So Iâm quite confident going forward. But if I expanded, look, even -- and Iâm sure the follow-up question might be that -- and I think weâve intimated in the remarks that even if you take those 2 charges out, the profitability of our defense business in the quarter is still very low. And I think we expected that. We expected that. Now weâd tell you I didnât expect that much to be very frank with you, we you would be back half. So we -- but if it wasnât for the charge that weâve taken here, I think we largely could have probably maintained our outlook. But what weâve had here, we just can I could expand upon that.
Operator: Our next question comes from Fadi Chamoun with BMO.
Fadi Chamoun: I guess I got a couple of questions. One is the guidance for mid-20% EBIT growth, if weâre assuming Civil is still on track to be mid-30% EBIT growth really implies a very strong performance in the defense in the next 9 months. Like you would have to be doing almost 45% growth in EBIT in defense in the next 9 months. to basically be in that mid-20% EBIT performance for the year. So I just want to make sure Iâm understanding this because excluding the charges, the underlying profitability in Defense was only 2%, and you seem to suggest that the headwind that kind of pressure that margin will continue at least into the second quarter?
Marc Parent: Well, it will gradually abate, but weâre still going to see it in the second quarter. And as I said, we see more of a substantial uplift in the second half, which has always been our outlook, but I donât pronounce. I think, look, Iâm not going to break it down from a sector standpoint, Fadi. We purposely did not do that. You would expect I think that when you have issues like we had in the quarter, we are adopting a company-wide effort on this. Itâs not -- we are taking actions that not only affected the defense business, but the business as a whole to maintain the profitable growth profile that weâve indicated in our outlook. The other thing I would tell you is that I talked about some of the -- although weâve done really, I would say, really well in the quarter on orders and especially on defense orders, I think weâve said in the past that not all orders are created equal. And there are some orders that we really, frankly, totally expected to happen in Q1 that did not happen. Now some of those orders, we have won them subsequently, I can tell you. And those turn into because the ones Iâm talking about, which convert into revenue faster is products orders. And therefore, that -- when you take all of that into fact into consideration, you will get to the outlook that I talked about.
Fadi Chamoun: Okay. Maybe the follow-up is -- I mean youâve always run a very kind of fixed cost contract business in the defense, I think the majority of your revenues are fixed contract business. Weâve never really had the types of contract issues in the past. Is there -- like whatâs different that happened kind of recently to kind of make these cost performance deviate so much from your assumption. I guess you gave some explanation on the U.S. Navy contract. But is there anything changing in how the business is being awarded or the risk profile that youâre taking on these contracts that increases the risk of margin in defense? Or is this just a unique onetime kind of event here?
Marc Parent: No. Look, I think youâre right. Look, first of all, youâre absolutely right that we havenât seen this before. And again, all the time that Iâve been at CEA, we have never seen the many of impact in one quarter. No, youâre absolutely right. And we havenât a habit of running out of contingency on a program like that. And as I mentioned before, the SENATRO-1, which is part of the chart, very specific in nature, we -- because of the contract being not being renewed at the time that we thought it would. We still think it would. So thatâs one factor. And just maybe to give you an idea of your talked about the firm fixed price. About 80% of our contracts are about firm fixed price. Now thatâs actually -- thatâs a much better picture than we were when we were -- before the L3 Harris transaction now. And I wouldnât be overly precured by that number because, remember, thereâs a lot of service contracts in there, service contract, we are very, very high predictability. And all of the others, as I talked about, again, you get an event like this, it forces you. Iâm not saying that we werenât monitoring the program before. But clearly, thereâs an extra level of scrutiny that occurs when a program like this happens. And when we look at the contract, the fixed price contract that we have for the classified program that I visited just a couple of weeks ago, this is a very complex program. And to be -- this -- we inherited this contract through the acquisition of Ultra Harris. Would I wish that this contract, which is a development program had been bid differently as not a firm fixed price contract Yes, I would. Do I think we could have done a better job, I think, in hindsight of seeing that the fact that we have literally over 60 very highly cleared personnel working on this contract that weâre off on cold for a lifetime and finding it very hard to replace them because theyâre cleared personnel. Could we have seen this thing better in hindsight, I would tell you, yes. And I would tell you the measures that we put in place for increased level of program management or sight at all levels of the company are there. So Iâm pretty confident. In terms of extra factors, whatâs changed? I would tell you that what changes is that what you see -- I mean weâre not alone in this case, you see across the industry, labor shortages, supply chain pressures, contracting delays, but -- and thatâs impacted our results significantly. We anticipate some of those. Theyâre worse than we thought. Now one of them is labor and as labor out. Now when I look at our labor hiring in the last couple of months, we have reversed the curve or actually yes, actually, we are on the positive trend now. So we have the labor we need to be able to secure the contracts pretty assumptions that weâve made. So maybe Iâll stop there, Fani.
Operator: Our next question comes from Cameron Doerksen with National Bank Financial.
Cameron Doerksen: I guess a question on the health care business. I mean, I appreciate itâs still pretty small, but thereâs been, I guess -- maybe this is not the right term, but a bit of a revolving door on leadership of that business. So Iâm just wondering if you can maybe talk about the change there. Why should investors think that this business is now going to be on track to ultimately getting to more consistent profitability?
Marc Parent: Well, like I said, Cameron, I absolutely understand this is a show me story. What I would tell you is the show me with 6 consecutive quarters of double-digit revenue growth. Now that has to translate into bottom line growth. Iâve said it before and itâs true, it continues to be true that weâve invested substantially in R&D and SG&A, meaning sales force to be able to get the results that we have. I would tell you the change that we had at leadership of health care has gone very, very well. Iâve not got a comment, although I will agree with you that we have had somewhat of a revolving door at a health care cannot debate that with you. I can tell you that Iâm very, very happy with the performance of Jeff Evans, whoâs leading the business at the moment. Heâs acting as interim at the moment. But I can tell you, Iâm very satisfied with the performance so far. And I would tell you that Jeff himself, who is a 19-year veteran of GE Healthcare, and Iâve been running large P&Ls for GE. He is the architect of -- or the main architect as Head of Sales for the run-up in revenue that youâve seen. I can tell you as well that weâve taken significant steps to improve the profit profile by reducing costs in the business. And as youâve heard me say before, and continues to be true, the profitability of the products that we have in health care are very good, are very good. We are suffering -- and perhaps this is not surprising. We are suffering from inefficiencies because we have a high degree of parts shortage. So what you have is if you were to go to our facility down in Sarasota, which Iâve been quite a few times, you would see basically 3/4 built products, medical medicine, for example. And then when we get the parts, we complete them, we take them out of stores, we put the parts and we retest them and we ship that. You can imagine that, that causes a lot of inefficiencies over time, basin quality issues, all kinds of issues that are not great for your profitably profile. But Iâm quite confident that a lot of those are abating themselves. And so Iâm quite happy with the way forward. And I think youâll see some progress in the quarters to come.
Sonya Branco: Yes, I agree, Marc. Itâs a great summary. Iâll just add a little bit of additional color on some drivers of the variability. So -- there is some R&D funding investment tax credits that go through health care as well as the rest of the business. And these things can be lumpy. So last year, it was actually a tailwind this quarter was actually a headwind. So in the larger organization that doesnât have a lot of impact, but on health care thatâs much smaller P&L, these kind of variabilities have a larger impact on the quarter-over-quarter. So in addition to everything that Marc just walked through, there is -- we have to consider a little bit of, I guess, nonroutine variability coming from R&D and investment tax credits.
Operator: Our next question comes from Konark Gupta with Scotiabank.
Konark Gupta: So I just wanted to follow up on the defense mix here. So just trying to understand, Marc, how do these 2 adjusted contracts impact the margin mix for Defense segment over the next 3 quarters as well as your long-term outlook for double-digit margin?
Marc Parent: Well, I think the first thing Iâll tell you is, as I said in the remarks that although we bid in that way, weâre quite confident the rebased lining of the programs that weâve won, all the progress that weâve won in recent time, certainly, since weâve had the new organization in place under Dan Gelston, the profitability profile of that backlog supports our objective of low double-digit margin defense. Thatâs the first thing I would tell you. I would tell you as well that we have a very firm handle on the inefficiencies and other impacts that we had that affect the profitability of our business. And Iâm talking -- Iâve taken the 2 programs charges to decide for 1 second. Iâm just saying the inherently low percentage of profitability and defense in this quarter, this results from, again, the inefficiencies that we had on labor, on parts, sometimes lead times on parts have doubled, and the cost themselves have changed and introduced all kinds of inefficiencies that you would get on over time, things like that. Now again, I would say that -- and again, a bit repeating myself that we had always anticipated that the first couple of quarters of this year in defense would be challenging for some of these factors that we could see. What I would say is that weâre worse than we anticipated. It took us longer to get back hired clear personnel, than we thought. Part shortages impacted us more than we thought. But we have a pretty good handle of it and quite confident in that these factors as they affect us will abate in the second half. So again, leading into defense contribution to the outlook that weâve given. The other factor I would say as well is if you look at the amount of bid and proposal money. Now our bid proposal costs this quarter are very materially as we track some very large opportunities in our bid pipeline. And we talked about some of this in our Investor Day. Now itâs not very different from our internal expectations that we would bid higher. But some of these programs, I can tell you a couple of big Canadian programs came at the same time in the quarter, and we cannot afford not to bid them. They are so large. So that causes a disproportionate amount of business proposal costs in this quarter, which is not necessarily going to be the same as we go throughout the year. And just again, to help you understand the quantum here. The expenses on big and proposals roughly, again, doubled over last year and are up pretty much the same thing this year. But what youâre seeing here is the prework that weâre doing to capture the opportunities that Dan Gelson outlined at our first Investor Day, weâre attacking those hard. And I think all of that answers your question as where weâre going in defense and in terms of its profitability.
Operator: Our next question comes from Benoit Poirier with Desjardins Capital Markets.
Benoit Poirier: Just to come back to Healthcare. Given the favorable valuation for health care companies these days in light of the performance, would you consider potentially divesting these assets and just searching for a new leader, what are the qualification that youâre looking for in terms of a new leader for health care?
Marc Parent: Well, Iâll take your second one is basically a leader is going to drive the profitable growth of our health care business going to basically make it a more sizable contribution and accretive contribution to CEAâs results. Thatâs the minimum threshold for that. And as I said before, I think so far, Jeff Evans is demonstrating to me that, that is the case. So thereâs more to see on that front. And look, as Iâve said before, I am very confident in how health care fits into CEAâs overall portfolio, and it very much supports our noble mission, and there is substantial synergies across our organization in terms of facilities, in terms of people and their technology. So itâs part of our portfolio and have no thereâs no thought about changing that.
Benoit Poirier: And just looking at the Civil EBIT margin that came in below our expectation on the back of a higher utilization rate and lower equipment deliveries where margins tend to be lower. So could you provide more color on whatâs putting pressure on margin, whether itâs more equipment, commercial business jet and how we should expect Civil margins to bounce back throughout the year?
Marc Parent: Well, look I will tell you civil margins certainly met my expectations. So I think I said this many times before, Benoit, in every part of our business I would look at this quarter-to-quarter, but having said that Iâm very, very bullish and very satisfied with both the civil business. In the quarter and of course the indicators the reads the outlook. you look at the orders, you look at the training utilization that is 71% that is prior to COVID, that is a pretty good utilization. And weâre seeing if you look at the results and Iâm sure you are, you look at the results with a fine tooth comb, youâre seeing the cost reduction translate into a result. And weâre all ready, even at 80%. Donât look at it quarter for quarter because utilization we said it before is not a perfect measure. You always have product mix that is less favorable in the quarter. This quarter we have higher R&D expenses to support some of our innovations like for examples eVTOL that we spoke at Investor Day. So in this quarter pretty down the mix and I fully expect we might look the next score the other way around. So I remain very firm that this business is going to realize strong results in the future. And our results -- to me what I say supports that very bullish.
Operator: Our next question comes from the line of Tim James of TD Securities.
Tim James: I just want to change the discussion a little bit here although sticking with kind of the defense side of the business. Iâm wondering if you can update us on any evidence you were seeing, whether itâs in this most recent quarter or maybe the last couple of quarters, a growing demand for virtual military training relative to Live are just new applications for simulation and the technology that support that secular growth story for simulation-based training, Iâm thinking of aviation more specifically.
Operator: Pardon me, this is Frank. Can I introduce the next question from Tim James from TD Securities.
Tim James: Iâm wondering if you can update us on any evidence youâre seeing whether itâs in this most recent quarter or the last couple of quarters a growing demand for virtual military training relative to live, are just new applications for simulation and the technology that support that secular growth story for simulation-based training, Iâm thinking of aviation more specifically.
Marc Parent: When you say aviation sports specifically, can you just expand on that, what you mean there?
Tim James: Well, I mean, military aviation training as opposed to some of the other sort of fields, the other domains that youâve gotten involved in recent years. Iâm just thinking specifically of aviation applications.
Marc Parent: Well, I would tell you, look, the trend that weâve seen increased use of simulation for training in military and continues to increase for very real reasons that -- what does the military do and when theyâre not in operations, they train for operations. Thatâs all that they do and in order to maintain readiness. And they need to do that, and they need to do that in an environment where costs are always an issue, cost ae an issue. So there is still plenty of room to grow the use of simulation-based training not only, I would say, using full-flight simulators, but using new technologies, and I think maybe thatâs what youâre intimating do, which we are investing in significantly and are deploying, in some cases, to like, for example, AR/VR, as just an example. One are the contracts that we announced this quarter it goes to that point where weâre deploying weâre actually developing using AR/VR, a deployable trainer for people to be able to train when theyâre in operations or even down to a local shares office, for example, what they would have done gunnery range. So rather than having a full gun rate range with real guns, for example, then you can do it virtually, and you can do it deploy. Thatâs just one example. Thereâs plenty of that to go. And some of the when I look at some of the very big real opportunities that are in our pipeline represent that. Again, I would point to you at the macro level, look at the bid pipeline, the amount of bids that we have there that we have out there has increased quite substantially and the orders that are at 5-year highs in terms of our -- if I look at our book-to-bill, itâs the highest been out of 12 months trailing basis, which is, I say, I always look at that and look at the 12-month trailing basis on our order intake. Itâs the highest itâs been in 5 years. I think thatâs demonstrating where weâre going here is growth in defense.
Tim James: My other question, just turning to the Air Center acquisition. At the time of the transaction, it was indicated that sort of pre-pandemic, that was a USD 150 million, I believe it was annual revenue business and with $55 million in EBITDA U.S. as well. How should we think about kind of the -- or we would be wildly off if we kind of thought about that business as contributing a similar amount sort of today at this point if we think about the first quarter? Is there anything specifically different relative to kind of pre-pandemic? Is it simply lagging kind of as the rest of the Commercial Aviation business is relative to sort to pre-pandemic? Iâm just trying to get a bit of a sense for what the contribution is in the quarter.
Marc Parent: No, look, Iâll ask Soni, if she wants to tell you what the contribution is. But I would -- first, I would tell you, itâs still very early in the integration. Weâre still basically in the very early innings on that, but weâre on track. I feel very, very comfortable with the reaction of customer-specific airlines. I had meetings with airlines specifically, most recently at Farma, theyâre very happy with CEA having doing this business. And you yourself can tell it, we read it every single day, right, about the amount of inefficiencies that are out there, gates, baggage hiders, pilots, aircrew, being in the right locations with airplanes. Thatâs all things that our software solutions are help offer to help manage and optimize for greater efficiency. And having to that, thatâs going to be, and weâre seeing an increased demand for CAE in this field. So Iâm very optimistic in this regard -- again, the integration is on track. And everything that we said in terms of how this business would contribute to CAE, to me, is right on track.
Sonya Branco: Iâll just add, for the quarter itself, it was not necessarily overly significant, but weâre working through the integration on track, and we expect it to ramp up nicely through the fiscal year. Now those benchmarks on pre-COVID are an indication of what this business can do at a more recovery rate than before even us adding to the investment and elevating this with our bundled sales. So ultimately, as the recovery plays out, weâre very confident we can get to those numbers and even beat them as the recovery grows over the next couple of years.
Operator: Our next question comes from Noah Poponak with Goldman Sachs.
Noah Poponak: The 2 programs that took a charge in defense. When were those contracts written, when did those programs start?
Marc Parent: Theyâre legacy contracts, they were -- we took over one -- the one that we call the classified program was signed 2018 odd that Sinatra. Prior to us by -- we took over that contract when we acquired L3, the Sinatra contract with the legacy contracts in 2018. I know that for sure.
Noah Poponak: Okay. And what actually cost more? Where was the cost over in?
Marc Parent: Well, in the case of Sinatra specifically, as I said, this is a contract specifically where the customer is training more than we bid it on. Itâs a simple event, okay? And we had cost mitigations and other actions to make less impact of that, I would tell you, missed bid at the time. Now I can tell you, we donât bid that way now. We have complete -- in the past couple of years, weâve refined the -- how we look at risk and how we bid military programs. But this is one specifically that because of this situation where we were with the customer is still utilizing those training assets at 5 basis at a much higher level of demand that was anticipated at the time, weâre really -- thatâs what weâre facing here. Now again, we put mitigating factors in the reduction to improve efficiency to improve that program, and we fully expected that the contract, we get an RFP to be able to extend that contract or to renew that contract because it ends in and about less than 9 months. Now that, as I said, somewhat very surprisingly and counterintuitive because of the fact that theyâre using is so high. Basically, we didnât get -- not only did we not get the contract renewal, but the IDIQ or getting a bit technical on this, the IDIQ number was changed. In which case, basically what it says is we had no additional period of performance in which for our cost reductions or other measures that we put in place to improve the profitability of that program to take hold. We just ran out of time. So basically, you have to recognize the loss at that point. And thatâs what happened. Now do I think that, that contract will go forward. The Navy needs this train. Itâs going to happen. So to me, we havenât baked in any upside on that. But again, stay tuned on that one.
Noah Poponak: So if those 2 are categorized as misbid what youâre -- the way you run the business today, you donât bid that way. What percentage of the revenue base at this point is exposed to possibly having been misbid?
Marc Parent: Well, I would tell you that, as I said before, when you get something like this, you take very specific actions, and again, Iâm not going to say we werenât looking at our programs before, of course, we were. But weâve taken some very specific actions, including, I would tell you, the establishment of a centralized program management organization, a center of excellence, if you will. And we -- this was always part of our L3 Harris merger integration plan, but weâve accelerated to bolster basically company program -- company-wide program excellence. So we have re-baseline and triggered a complete top-down review of our portfolio on all of our programs to make sure that we have the right staffing, the right contractual provisions and maximum visibility and transparency to make sure we donât get surprised again. Iâm never going to say never, okay? But what I would tell you, though, is that -- all the programs, including the ones that were bid prior have been looked at to make sure that we have the right provisions and the right cost investments and the right assumptions that we donât get surprised. Thatâs what we put.
Noah Poponak: And Marc, that review is complete or that review is in process?
Marc Parent: No, that review is complete.
Noah Poponak: And did I hear you correctly earlier committing to a 10% operating margin in this business in your fiscal â24 -- or did I hear that incorrectly?
Marc Parent: No. No, you didnât hear me say that. You -- youâve heard me say, I believe, that if not, I was an corrected, that our target for this business is low double-digit returns in the US. And that the -- if I look at the programs that weâve signed up that in our backlog, they support a double -- that they support that that backlog supports that goal. Now we obviously have to execute on them. And thatâs where the measures that weâve taken, the centralized program management organization, for example, gives me that confidence. Again, I think as I said before, Iâve seen this kind of thing before running major programs. When you get this kind of impact, you just 2 things are slightly different. And I would tell you youâve got this, and I feel very confident about the team in place Defense to make it happen.
Andrew Arnovitz: Operator, thank you. Weâre now going to use the last minute or so that we have here, unfortunately, not a lot of time to open the call to members of the media, if there are any questions.
Operator: We have a question from Allison Lampert with Reuters.
Allison Lampert: Marc, you talked a bit about some of the supply chain challenges youâve had. Could you be a little bit more specific? Have you seen issues with shortages of semiconductor?
Marc Parent: Yes, we have. In fact, thatâs been especially acute actually surprisingly in our health care business. And I say surprising and thatâs where we have the highest concentration, I think, on a -- in an individual Madigan of chips, which had a specific shortage. But weâve seen it. Now I would tell you that I think, overall, we managed it pretty well. So itâs not just chips, but itâs really what weâre seeing across the board. Itâs that lead times for parts have extended it, in some cases, a little bit more than double which it makes -- itâs not only issue the impact of the parts themselves not being there at the time that we need them is that, obviously, that REITs have it to schedules. So in order for us to maintain schedules, we have to do all kinds of things like, for example, paying expedite charges for parts. We have to conduct over time. We have conducted out-of-sequence work which introduce all kinds of inefficiency. So maybe Iâll just stand there, Alison.
Allison Lampert: And just to follow up, are you seeing -- what kind of demand are you seeing for MAX 10 simulator?
Marc Parent: Oh, the MAX. Iâm sorry. Iâm sorry, the MAX. Okay. No, look, I think demand for the simulator for the MAX aircraft overall and not basically break it down to MAX8 or MAX10 theyâre very strong, very strong, and itâs part of the backlog that weâve signed and simulated orders over the past -- as well as training that weâve signed in the last 12 months.
Allison Lampert: And just to follow up on semiconductors. Would you say that the shortages youâre seeing now are more acute on the chip side, whether itâs in aviation specifically than in the past because weâve seen historically more on the auto side than in aviation.
Marc Parent: Look, I canât comment about the other industries in detail except for what I read in your newspaper. But what Iâd tell you is, look, the impacts have been real for us. But weâre -- as I said, we know where they are. We have -- we know what our bill of materials is and we know when we need the parts to support our schedule. So we have harmonized schedules for those parts to support the forecast that we have that we presented that we take to support the forecast that we have today.
Andrew Arnovitz: Great. So operator, thatâs all the time we have for today. I want to thank all of our participants for joining us on the call and remind you that a transcript will be available on CAEâs website. Thank you.
Operator: That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line. Have a great day, everyone.