CAE - Q4 2023

Transcript

Operator (participant)

Good day, ladies and gentlemen. Welcome to the CAE fourth quarter and full fiscal year 2023 conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. Mr. Arnovitz, please proceed.

Andrew Arnovitz (SVP of Investor Relations and Enterprise Risk Management)

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 for fiscal year 2024 and answers to questions, contain forward-looking statements. These forward-looking statements represent our expectations as of today, May 31st, 2023, and accordingly, are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially. 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 CAE's annual MD&A, available on our corporate website 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 open the call to questions from financial analysts. At the conclusion of that segment, we'll open the lines to members of the media. Let me now turn the call over to Marc.

Marc Parent (President and CEO)

Thank you, Andrew. Good afternoon to everyone joining us on the call. I'm pleased with CAE's accomplishments in fiscal 2023, having seized opportunities to expand our position in growing markets with our digitally immersive training and operational support solutions. We did so while navigating through some macroeconomic and legacy-related challenges. Over the course of the year, we delivered sequentially stronger quarterly results. We had an excellent fourth quarter with over 40% adjusted segment operating income growth, leading to 23% growth for the year as a whole. As a testament to quality, we generated strong free cash flow with 120% conversion of annual adjusted net income. We also expanded our global reach. Secured future growth with a record CAD 5 billion in annual orders for a record CAD 10.8 billion of adjusted backlog.

In civil, we launched several new training centers and deployed 23 full flight simulators during the year to our global network to support the major customer outsourcing agreements we secured in the U.S., Europe, and Australia, and increased pilot training demand across all segments of aviation. Exemplifying our more efficient cost structure, we eclipsed prior peak civil margins even before the market fully recovers to pre-pandemic levels in key regions like Asia. We also booked a record CAD 2.8 billion in annual civil orders for a 1.3 times book-to-sales ratio, demonstrating the sustained high demand for pilot training solutions and our next-generation digital flight services. These included comprehensive long-term training agreements with airlines and business jet operators worldwide and a total of 62 full flight simulator sales for the year.

We also made excellent progress expanding our reach in digital flight services with the ongoing integration of AirCentre and the adoption of our next-generation solutions by our long-standing airline customers. Civil concluded the year with a record adjusted backlog of CAD 5.7 billion. Among the most more notable developments for civil in the quarter was the announcement of our joint venture with AEGEAN, Greece's largest airline. New center is expected to begin pilot and cabin crew training by the end of 2023 and will be the most advanced flight training hub in southeastern Europe, powered by green energy. Since the end of the quarter, we inaugurated our Las Vegas Business Aviation Training Center, and we announced plans for another new business aviation training facility, this time in Vienna, as a base in Central Europe, slated to open in the second half of calendar 2024.

Fourth quarter average training center utilization was strong at 78%, which is up from 69% from the same period last year. For the year, utilization was 72%, which is up from 60% the year prior. Training demand in the Middle East was the strongest in a quarter, followed by the Americas and Europe. Asia has been recovering rapidly since the start of the fiscal year, with Q4 training center utilization substantially improved in that region. In business aviation, training demand was also strong, reflecting a high level of training demand and pilot turnover in that segment. In products we delivered, we delivered 17 civil full-flight simulators in the quarter and 46 for the year, compared to 30 deliveries in the prior year.

In defense, we made good progress fueling our multi-year transformation with a record CAD 2 billion of annual adjusted order intake, involving training and simulation solutions for a 1.1 times book-to-sales ratio. This contributed to a CAD 5.1 billion of adjusted defense backlog. In the quarter, we had orders totaling CAD 565 million, including a US Navy foreign military sale to Korea for an MH-60R tactical operational flight trainer, as well as extensions and expansions with the U.S. Army for fixed-wing flight training at the CAE Dothan Training Center.

With the U.S. Air Force for initial flight training at the CAE Pueblo Training Center. We also delivered or entered a new agreement for comprehensive training and support services under the Australian Defence Force ASIST program. A few more recent wins since the end of the quarter really serve to underscore the progress that's being made to renew our Defense backlog with larger and more profitable programs. As an example of our continued growth and capabilities in connection with US Army Aviation, Defense was awarded a contract to support Flight School Training Support Services at Fort Novosel, Alabama. The FSTSS contract is the world's largest helicopter simulation training program, and our $450 million US training contract is for training and simulation capabilities that will be used to prepare initial entry-level and graduate-level rotary wing flight training.

By leveraging our expertise from our civil aviation training outsourcing business model, we'll be building and deploying CAE-owned full-flight simulators over the contract term for the CH-47F and UH-60M platforms to meet the U.S. Army Aviation Center of Excellence Rotary Wing Simulation Services requirement. Building on our prominent flight training position in Lower Alabama, Defense was competitively awarded the U.S. Air Force's Rotary Wing Introductory Flight Training contract, worth a maximum of approximately $111 million over the total contract term. Under the IFT-R contract, we'll be leveraging our existing training center in Dothan, Alabama. Another favorable development that supports future growth was the affirmation in early April of the Bell V-280 Valor and selection for the U.S. Army's Future Long-Range Assault Aircraft, or FLRAA.

This is noteworthy because CAE is part of Team Valor and is a key partner in the provision of training and simulation solutions for this next-gen platform. These program awards and developments demonstrate our expanded market reach with national defense departments and OEMs. We're able to achieve this by leveraging Defense's enhanced capabilities and scale vertically and by drawing technology, processes, and people laterally across the whole CAE enterprise. These are prime examples of the kinds of larger and more differentiated programs that will drive the multiyear defense transformation that's currently underway. Turning now to healthcare, we gained share in the simulation market and continued to deliver double-digit revenue growth with our dynamic team and highly innovative solutions. Here, too, we've been harnessing the power of our one CAE mindset with a joint civil and healthcare presentation on the parallels between aviation and healthcare training to elevate quality and safety.

Our teams recently collaborated at the industry's largest simulation event, the International Meeting on Simulation in Healthcare. It's a great demonstration of CAE's unique culture. Before turning the call over to Sonya, I want to highlight a notable development on the technology application front, which is a real-world example of what we mean when we say that we're revolutionizing aviation training in civil and defense markets. We conducted a field study with the Japan Air Self-Defense Force to validate the potential for more effective training by leveraging CAE's latest virtual reality and artificial intelligence-enabled digital solutions. The study revealed a near full grade of proficiency score improvement across all JASDF participants. Our innovative training solution incorporated CAE Rise, which we originally conceived for civil aviation, to provide more effective training through real-time objective assessment.

It also included a defense-patented biometric feedback technology, enabling instructors to modulate complexity based on student stress, engagement, and cognitive workload levels. These data-driven and AI-enabled technologies are important building blocks that will drive greater levels of training efficacy and safety. With these CAE innovations, we expect to further widen our competitive moat, unlocking a greater share of our addressable markets and developing new revenue streams. I'll now turn the call over to Sonya, who'll provide a detailed look at our financial performance, and I'll return at the end of the call to comment on our outlook. Sonya.

Sonya Branco (EVP of Finance and CFO)

Thank you, Marc Parent, and good afternoon, everyone. Looking at our results on a consolidated basis, revenue of CAD 1.3 billion was up 32% compared to the fourth quarter last year. Adjusted segment operating income was CAD 201.9 million, compared to CAD 142.7 million last year. Quarterly adjusted net income was CAD 110.9 million, or CAD 0.35 per share, compared to CAD 0.29 in the fourth quarter last year. For the year, consolidated revenue was up 25% to CAD 4.2 billion. Adjusted segment operating income was up 23% to CAD 548.1 million, and annual adjusted net income was CAD 279.2 million, or CAD 0.88 per share, compared to CAD 0.84 last year.

We incurred restructuring, integration, and acquisition costs of $15.3 million during the quarter, related mainly to the integration of AirCentre, acquired last year. Net cash provided by operating activities was $180.6 million for the quarter, compared to $206.8 million in the fourth quarter last year. For the year, we generated $408.4 million from operating activities, compared to $418.2 million last year. We had strong free cash flow in the quarter of $172 million, and $335.7 million for the year, for an annual cash conversion rate of 120%. We continue to target an average of 100% conversion rate going forward.

Uses of cash involve funding capital expenditures for CAD 62.9 million in the fourth quarter, and CAD 268.8 million for the year, driven mainly by the expansion of our civil aviation training network in lockstep with secured customer demand. These opportunities translate to some of our best returns as our simulators assets ramp up within the first two years of their deployment. With a record order backlog and the large number of agreements we announced over the last year to secure airline outsourcing and training network expansions in commercial and business aviation, we are expecting a higher level of organic growth investment in fiscal 2024. We currently expect total CapEx to be approximately CAD 50 million higher than last year, mainly in support of these accretive investments.

Our net debt position at the end of the quarter was CAD 3 billion, for a net debt to adjusted EBITDA of 3.4 times. This compares to net debt of CAD 3.1 billion and 3.7 times net debt to adjusted EBITDA at the end of the preceding quarter. Our leverage ratio has been improving rapidly since the middle of fiscal 2023, and we continue to expect it to be below three times by mid-fiscal 2024, taking into consideration our expanding EBITDA and ongoing funding of accretive organic growth investment. Income tax expense this quarter was CAD 33.3 million, representing an effective tax rate of 25%, compared to 6% for the fourth quarter of fiscal 2022. Normalized, the effective tax rate would have been 24% this quarter and 15% in the fourth quarter last year.

On the same basis, the effective tax rate for the year was 22%, which we continue to expect going forward. Net finance expense this quarter amounted to CAD 51.4 million, which is up from CAD 48.8 million in the preceding quarter, and CAD 32.5 million in the fourth quarter last year. Consistent with our growth investment priorities and non-cash working capital seasonality patterns for fiscal 2024, we expect quarterly finance expense run rate of approximately CAD 50 million, at least for the first half of the fiscal year. To briefly recap our segmented performance.

In civil, fourth quarter revenue was up 53% year-over-year to CAD 661.4 million. Adjusted segment operating income was up 69% year-over-year to CAD 162.9 million, for a margin of 24.6%. For the year, civil revenue was up 34% to CAD 2.2 billion. Adjusted segment operating income was up 54% to CAD 485.3 million for a record annual margin of 22.4%. The higher revenue for both periods was driven by higher training volumes and a higher number of FFS deliveries compared to the prior year period. We achieved a record margin for the year, despite, as Marc referenced, not having fully recovered to 2019 levels in all regions.

That's because of the excellent work that was done over the last couple of years to lower our recurring cost base. We're also benefiting from some mix improvements from the structural expansion of business aviation and a greater proportion of revenue coming from training services overall. In Defense, fourth quarter revenue of $536 million was up 14% over Q4 last year. Adjusted segment operating income was down 17% over last year to $30.5 million, for an operating margin of 5.7%. For the year, Defense revenue was up 15% to $1.8 billion, and adjusted segment operating income was down 55% to $53.1 million, representing a margin of 2.9%.

Over the course of the year, we had sequentially stronger quarterly results as a function of execution on legacy contracts, cost mitigations, and some gradual improvements in the economic headwinds that we've been facing. In healthcare, fourth quarter revenue was CAD 59.1 million, up 12% compared to last year. Adjusted segment operating income was CAD 8.5 million in the quarter, compared to CAD 9.6 million in Q4 of last year. For the year, healthcare revenue was CAD 192.7 million, up 27%, and adjusted segment operating income was CAD 9.7 million, for a margin of 5%. With that, I'll ask Marc to discuss the way forward.

Marc Parent (President and CEO)

Thanks, Sonya. We continue to have a highly positive outlook for fiscal 2024 and beyond, notwithstanding some of the macro level turbulence in the general economy. We see clearly defined secular trends that are highly favorable across all of CAE's business segments. In civil, we've shown over the last year that there's indeed a growing desire by airlines to entrust CAE with their critical training and digital operational support and crew management needs. Demand for air travel continues to thrive, and our business is driven primarily by the regulated training required to maintain the pilots and crews who operate the global in-service fleet of commercial and business aircraft. As an additional secular driver, we expect to sustain high level of pilot movements from the growth and replacement of the active pilot population.

According to our estimates, over half the commercial and business jet pilots who will be active in a decade from now have yet to even begin their training. Given that backdrop, we expect our civil business to continue growing at above market rate, driven by the remaining stages of cyclical recovery, primarily in Asia, and a sustained high-level demand for pilot and pilot training across all segments of civil aviation. In fiscal 2024, we expect low to mid-teen % annual growth in civil adjusted segment operating income, generated at the current higher margin level, and driven by higher training and product volumes, and the ongoing simulator deployments to expand our global training network. We expect to see a more typical seasonal pattern for training demand this fiscal year, weighted more heavily this second half.

We also expect about three-quarters of our approximately 50 annual full-flight simulator deliveries to occur in the second half. Turning to defense, the sector is already in the early stages of an extended upcycle, driven by increased commitments by governments to defense modernization and readiness, in support, and in response to geopolitical tension. Secular tailwinds that favor our business include the increased focus on near-peer threats and a greater need for the kinds of digital immersion-based synthetic solutions that draw from CAE's advances in civil aviation, simulation, and training. Our defense segment is in the process of a multiyear transformation, which we expect to culminate in a substantially bigger and more profitable business. It's already become the world's leading pure-play, platform-independent, training and simulation business, providing solutions across all five domains: air, land, sea, space, and cyber.

We're uniquely positioned to draw on CAE's innovations in commercial aviation to transform training with the application of advanced analytics and leading-edge technologies. This is expected to bring potential to capture business around the world, accelerated by an expanded capability and customer set. Our recent wins and a record-adjusted backlog, CAD 9.3 billion pipeline of business proposals outstanding, and trailing twelve-month book-to-sales ratio, demonstrate that our strategy is bearing fruit. In fiscal 2024, we expect defense to continue renewing its backlog with larger and more profitable programs, while simultaneously working its way through a critical mass of low-margin legacy contracts. We're highly focused on execution, and for the fiscal year, we expect defense to drive continued year-over-year quarterly performance improvements, with a heavier weighting to the second half, consistent with its historical seasonality.

Finally, in healthcare, we see potential to accelerate value creation as we gain share in the healthcare simulation and training market, and continue to build on our top and bottom-line growth momentum. In summary, I continue to be excited about our future. I'm pleased with the important progress that we made last year, and expect to continue making excellent progress in the year ahead and beyond. We're on a clear path to an even bigger, stronger, and more profitable CAE in the future. We remain well on track to our targeted three year EPS compound growth rate in the mid-20% range. With that, I thank you for your attention. We're now ready to answer your questions.

Andrew Arnovitz (SVP of Investor Relations and Enterprise Risk Management)

Thanks, Marc. Operator, would you now please open the call to questions from financial analysts?

Operator (participant)

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

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Thank you. Good afternoon. I have a couple on the defense segment. The 2024 outlook for improving quarterly results year-on-year, I'm guessing that's based on the 82 million, which is corrected for kind of the contract write-offs in the first quarter of last year?

Marc Parent (President and CEO)

I'm not... Well, I think what I'd tell you about defense, I'll maybe able to let the Sonya pipe in after, but what I'd say, Fadi, is look, when I look at defense, there's no doubt we're going to have strong growth in defense in the year. That's really, when we talk about continued year-over-year improvement, each quarter this year, it's exactly that. You know, we see a very good path to that. As you'll recall, I mean, it's all about working through the existing backlog of lower-margin legacy contracts that, you know, we executed during the time of, you know, with still some effects of, you know, manpower shortages, parts shortages, and delayed orders due to Ukraine. I mean, that's working itself through. We're quite well through it.

At the same time, refilling the backlog with larger, more profitable contracts. It takes phasing, it takes time. We're early in the year. I mean, again, I'm quite confident in that, you know, strong growth this year. I think, as I said many times before, in this business, look for the orders. Look at the orders, and you see the orders have been strong. We had another year of 1.1 book-to-bill, and since the end of the quarter, I can tell you, I'm very excited about the contracts that we've announced.

You know, I think, you know, one tidbit I'll give you now is that with the recent orders that we won with the Air Force on the IFT-R contract, with the U.S. Army, with the FSTSS contract, you know, which is as I mentioned, the largest simulation contract in the world for helicopter training with the U.S. Army, no exaggeration, we touched all 43,000 US military pilots at some point in their career. I think that's pretty exciting going forward. I mean, that's long, a long answer. I don't know if you want to add anything there. That's it, Fadi.

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Okay. Just to, you know, maybe a couple of follow-up on this. In the EPS CAGR guidance for 2025, you know, in the context that civil growth is now settling in somewhere in that low double digit to mid-teen, that implies defense, very significant ramp up in profitability of defense going into 2025 to somewhere near CAD 200 million EBIT contribution. I just want to understand, is this the framework that we are thinking about? Maybe what is the cadence of that improvement? Is it more weighted to 2025 when you look at kind of the backlog and how the renewal of the P&L and overcoming some of these legacy, you know, contract margin issues that you have right now? Is it more 2025 weighted?

Is it, kind of more spread out in a, in a linear fashion and the, this, improvement going into the next couple of years?

Marc Parent (President and CEO)

Well

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

One last point is on the on the contract you announced yesterday, which it's a great contract. Congrats on that, by the way. What is the CapEx, total CapEx that is required to invest towards that $455 million revenue that you expect?

Marc Parent (President and CEO)

I'll start by the first part of that question there. I think that when I look at, when I, you know, basically going back in every number you said there, in defense. What we're gonna see here, we'll see, again, strong growth in defense. We'll see more revenue improvement towards the second half. In terms of margins of defense, we'll start seeing a bigger inflection in the absolute margins themselves, as we get into fiscal 25. Inevitably, that's going to support the EPS guidance that we have, as you outlined. With regards to CapEx on FSTSS, look, we can't go into too much in terms of the contractual details, for a few reasons. I'm extremely excited about that contract.

I think it's important to note that it's got a similar financial profile to our civil training business. With respect to investment, you know, we'll start to make investments later this year, but it's gonna be spread over multiple year over the 12-year contract. It kind of looks like an airline training contract. That's what I would tell you at the moment.

Fadi Chamoun (Managing Director and Senior Equity Research Analyst)

Okay, thank you. That's helpful.

Operator (participant)

Our next question comes from Konark Gupta with Scotiabank. Please proceed.

Konark Gupta (Managing Director and Senior Equity Research Analyst)

Thanks, operator. Good afternoon, everyone. Just wanted to maybe follow up quickly on Defense segment. We saw the continuation of the SOI rebound sequentially in the fourth quarter, but what really kept the margin intact at 5.7%? It wasn't a huge improvement from the previous quarter sequentially. How do you see that margin to your point, Marc, you know, as you see growth and inflection point, do you see margin and Defense higher in fiscal 2024?

Marc Parent (President and CEO)

As I said, I think we'll get more of a bigger inflection in the actual margin performance, percentage margin, as we get closer to the end of this year into fiscal 2025. What I do see is, obviously, we're going to see growth year-over-year in the absolute numbers. Quarter-over-quarter, year-over-year, you're gonna see growth. I mean, we'll be margin itself. I would see depreciation. I can't be precise to you because there's a lot of timing to this, I would tell you. Timing of ramp up a few programs and wind down of ones we have. There'll be a crossover point, but, you know, it'd be hard for me to be more precise than that right at this moment in time.

Konark Gupta (Managing Director and Senior Equity Research Analyst)

Right. What was to my question on the Q4 margin not improving much, was there the same legacy issue still continuing, or was there any improvement?

Marc Parent (President and CEO)

Yes. I mean, it's essentially the same issues. As we said before, there's no surprises, and as I said before, there's not gonna be. We're continuing executing on the programs that we have, and, you know, we those are legacy programs that are being gradually replaced with the ones that we see as accretive to the margin objective that we have.

Konark Gupta (Managing Director and Senior Equity Research Analyst)

Okay, thanks. Just quick follow-up on civil. You guys are expecting a pretty decent growth here in fiscal 2024 on SOI for civil, low to mid-teen. But you're also saying the same time the percentage margin is going to be steady-ish, relatively at high levels where you are right now. Is there any change in mix that you anticipate in fiscal 2024, like business jet training is kind of maybe not growing as fast and the simulator sales are growing? Is there any change we should be mindful of with respect to mix?

Marc Parent (President and CEO)

Well, definitely it's not because business aircraft has been growing as fast, I can tell you that. Quite confident about that. It's really a question about the ramp-up of new simulator deployments. As you saw, we deployed, I think it's 23 full-flight simulators last year. We opened up our new training centers, for example, in Las Vegas. Very successful, you know, inevitably, I mean, they create great incremental margins within two to three years, but initially, they're low margin as we ramp them up. That's really what you're seeing right now, you know, there's room, there's room for margins to grow, beyond that's for sure. You know, I think margin, you know, 22% range is, I think, in the range that we would expect at the moment.

Konark Gupta (Managing Director and Senior Equity Research Analyst)

Great, that's it for me. Thanks for the color.

Operator (participant)

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

James McGarragle (Senior Equity Research Associate)

Hey, thanks for taking my question. I just wanted to ask a question on the civil outlook. You know, quarter came in great. The fiscal 2024 outlook was very strong as well. You know, I wanted to ask a question about, you know, the longer-term strategy, you know, where you potentially see some growth there, you know, post 2025, and, you know, more specifically, on your position in India. You know, what's your position in that country? If you can talk about some of the relationships you have with the country's major airlines and, you know, any color on your strategy there.

Marc Parent (President and CEO)

Well, I can tell you we have a very strong position in India. We, you know, we have training centers in multiple locations there. I, you know, I'm pretty sure that I'm correct in saying we have a strong relationship with every carrier that is in India. Of course, we have a long term partnership with IndiGo there, where we provide not only, you know, training for, but provide all of their ab initio cadets and you know, just right there, IndiGo is, like, 50% of the lift in India, for example. So I feel very comfortable.

In terms of the long term, look, there's going to be a need for pilots just to fuel the growth in civil aviation, both in whether it be in airline traffic, in business aircraft, for years to come. With, you know, the dominant position that we have in this market and the relationships that we have with the world's airlines, I, you know, I see it has very good growth potential. I'd put on top of that I'm very happy with what we're seeing as the growth of our flight services business, which remember that there's, in our flight services business, our training business, there's this huge amount, over 90% customer overlap.

As airlines, you know, seek to modernize their infrastructure, whether it be on crew management, on flight planning, and those kind of, you know, infrastructure needs, I think we're invested in that business at the right time.

James McGarragle (Senior Equity Research Associate)

You know, I appreciate the color. Just a kind of a longer-term question on the defense side as well. You know, one of the things that's come out of the Ukraine war is the need for some common standard, excuse me, you know, which NATO could potentially help set. You know, for example, I know you guys don't produce ammunition, but, you know, we have British tanks with certain types of guns, and they can't fire ammunition, you know, for a smooth-bore German or American tank, you know. I think this is really highlighting some of the growing importance of data and weaponry, you know, potentially some open architecture software that could potentially allow some plug-and-play kits.

Could you just share your thoughts on this opportunities, you know, for CAE, if NATO countries potentially move to more common standards, and how your business is set up to compete, if that were to be the case?

Marc Parent (President and CEO)

Well, I think what I would say at the aggregate level is that CAE's. You know, we got a long history of supporting allied forces and our support is training, and that's what we do. When you think about what do militaries do when they're not in operations, they train. That's all they do. They train for conducting their missions and accomplishing, you know, what we see as part of our noble mission is making sure that the men and women in uniform are able to execute their missions and return home safely. That's what we do. We do it across, you know, a host of platforms in aviation and in the army, on the naval side, in fact, in all five battle domains.

You know, maybe to a broader, you know, point to your question is that the nature of warfare is a lot more complex. It involves, you know, warfare in contested environments, and you need to be able to train in a very realistic manner. There is no better, more realistic way, the only real way to be able to do it, involving all five battlespace domains, than virtually. For us, being the dominant, you know, virtual training provider in the world, I think we're in a very good position to support that growth in the years to come.

James McGarragle (Senior Equity Research Associate)

Thank you, and I'll turn the line over.

Operator (participant)

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

Tim James (Managing Director and Senior Equity Research Analyst)

Thank you very much. Good afternoon, everyone. Maybe a question here for Sonya Branco, I suppose. Just thinking about the investments that the company's been making in intangible assets, and that's been kind of ramping up with company growth over the last four or five quarters, I'm just wondering how we should think about the cash requirements for intangibles in fiscal 2024 and beyond, and sort of what those investments will be focused on?

Sonya Branco (EVP of Finance and CFO)

Hey, Tim. Yeah, we have seen a bit of a ramp-up, and that was expected. It came along with our commitment to develop on the civil flight services business. As you'll remember, we bought it at quite an interesting multiple, knowing that, you know, we would develop and take and advance the technology on that front. That's been the driver, and I expect that to be similar this year.

Tim James (Managing Director and Senior Equity Research Analyst)

Okay. Thank you. My second question, just thinking about it, I'm not sure you can parse it out this way, but let me ask the question. Could you talk about your exposure to regional aircraft training, really where, you know, I think the pilot shortage is maybe most acute or maybe most evident? Are you seeing that drive ab initio enrollments or kind of, you know, demands throughout your business where you can kind of point specifically to that part of the market?

Marc Parent (President and CEO)

I can take it. I mean, I appreciate the question, because we're very strong in training regional airlines. I think we're by far the largest provider of training for regionals in the United States, all of them. As well, very, very strong on the flight services side. You've seen us just recently, the last few days, sign a landmark agreement with SkyWest. That was on top of a deal that we signed a few months ago with Frontier, which is not a regional airline, but you get the point. Look, I, if I could, if I could tell you if I could have another couple CRJ simulators ready today, I would put them in right now.

The amount of demand is quite unprecedented, and I can tell you our training centers supporting regional aircraft are very busy. Yes, to your point, that is driving activity from an FTO standpoint, flight training organization or ab initio.

Michael Kypreos (Equity Research Associate of Industrials, Transportation and Aerospace)

Great. Thank you very much.

Operator (participant)

Our next question comes from Kristine Liwag with Morgan Stanley. Please proceed.

Kristine Liwag (Executive Director and Head of Aerospace and Defense Equity Research)

Hey, thanks, and Marc, maybe going back to defense and security margins. You know, you've been very clear about you've been filling the defense backlog with more profitable contracts, but can you help us quantify, how much of these, the composition of the fiscal year 2024 revenue will be? How much of that is from legacy, less profitable contracts versus, the more profitable ones that you've been booking? Is that 50%, more or less? That would really help us understand the bridge, and then also any indication for what that looks like for fiscal 2025 would be really helpful.

Marc Parent (President and CEO)

Well, it's always getting much, much more in fiscal 2025 as there's, you know, some certain programs that we call drag programs that were executed years ago that, you know, are at, you know, low, quite low margins. I mean, it's offsetting itself over the next 12 months. Being more precise to you on exactly where does that happen, how much percentage? Look, I would hazard a guess at 50/50, and when I say guess, it's a pretty educated guess as I look at that. I think look at margins, you know, start getting towards our target as we get into the latter end of the year.

Kristine Liwag (Executive Director and Head of Aerospace and Defense Equity Research)

Thanks, Marc. If I could ask another one on civil. Last quarter, you mentioned that the Sabre AirCentre was about 10% of civil revenue. What was it this quarter? Also, how should we think about the margin composition for AirCenter versus the overall civil business? Is that accretive or dilutive to the segment margins?

Sonya Branco (EVP of Finance and CFO)

I'd say around, it's around 10% still, Kristine, so holding around that, and as we said before, it's accretive to the civil margins as well.

Kristine Liwag (Executive Director and Head of Aerospace and Defense Equity Research)

Great. Thanks, Marc. Thanks, Sonya.

Operator (participant)

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

Ron Epstein (Managing Director and Senior Aerospace and Defense Analyst)

Hey, good afternoon, guys. Just maybe a bigger picture question, looking at the longer term guide. How should we think about growth? You know, if we're in fiscal 2024, you're looking for mid-to-low teens growth in the civil segment, but then the longer term growth for the business you're looking at in the 20s. Does that mean we're seeing that kind of the growth is gonna be kind of rear-end loaded? I mean, how should we think about that transition from, you know, fiscal 2024 to your longer-term guide?

Marc Parent (President and CEO)

I don't see it back-end loaded, Ron. I'm not sure I derive that conclusion, but we definitely don't see it back-end loaded.

Sonya Branco (EVP of Finance and CFO)

No, it's going to be, you know, a progression in margins. We always said in that three-year guidance that civil margins would expand, but it's also volume. With all of these agreements, and outsourcing and the additional organic CapEx, it's also, it's higher margins on higher volume. Both take you there.

Ron Epstein (Managing Director and Senior Aerospace and Defense Analyst)

That gets you to that kind of mid-20 growth or wherever, kind of 20-plus growth?

Marc Parent (President and CEO)

Yes.

Ron Epstein (Managing Director and Senior Aerospace and Defense Analyst)

Okay, great. Thank you. That's all.

Marc Parent (President and CEO)

Thank you.

Operator (participant)

Our next question comes from Michael Kypreos with Desjardins Capital Markets. Please proceed.

Michael Kypreos (Equity Research Associate of Industrials, Transportation and Aerospace)

Hi, and thank you for taking my question. Maybe in defense, the active bids and proposals jumped from $7.3 billion to $9.3 billion over the last quarter. Maybe just any additional color on that, the bidding pipeline and maybe any delay expectations related to the current U.S. budget negotiations that are ongoing.

Marc Parent (President and CEO)

Look, I'm gonna answer the last part of your question, but what I always like to say is that the day that see a defense business is a proxy to U.S. government budget, I'll be very happy. Having said that, look, you could. The only concern that you would have that might be short term is if something dramatic happens that, it stops new orders from happening. I don't see that, but that would just be timing on short term. To me, the position we have in the market is very, very strong.

You know, we're the backlog that we see in terms of actually the bids outstanding, is just basically the fact that with our position in the market, we see opportunities to bid, you know, a much larger group of business, and that's right in our sweet spot. We, as I've said many times before, we don't prepare bids on U.S. military or any military contract unless we think that we have a pretty good chance to win, because preparing those bids is very manpower intensive, it's very labor intensive, it's costly. If we bid on them, it's because, as I said, we think the probability of win is high.

It's just reflection of what CAE looks like post the L3Harris acquisition, where we've really transformed this business to become the, you know, the large, the number 2, you know, OEM independent training provider in the world for simulation. The scale that we have is really unprecedented, and the number of platforms, I mean, a aviation platform and platforms of all segments are much higher than they were at any time before. Again, all of that contributes to the amount of biz that we can go out after with a reasonable and high level of probability of win.

Michael Kypreos (Equity Research Associate of Industrials, Transportation and Aerospace)

Thank you. That's very helpful. Maybe just a quick one on the flight operating solution contract you signed with SkyWest. There's been some other airlines in the US that are budgeting large budgets for IT overhauls. Do you see anything picking up in that space as maybe government regulation on cancellation service delays increases, or is it still a steady state as usual?

Marc Parent (President and CEO)

Well, we're seeing a lot of activity, and we have a lot of discussions with airlines as they want to renew and modernize their infrastructure. They all have to do it. They all realize that we have, in order to keep up with the enhanced demand that there is out there, they are having to modernize their platform. That's what we're seeing. You know, I, to me, I see lots of potential for growth in this, in this sector, you know, and we're doing well in it. I'm quite pleased, as I said, not only the results, where we are in integration and the timing of our investment in flight service.

Michael Kypreos (Equity Research Associate of Industrials, Transportation and Aerospace)

That's very helpful. Thank you.

Operator (participant)

Our next question comes from Noah Poponak with Goldman Sachs. Please proceed.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

Hello, Ron.

Marc Parent (President and CEO)

Hi, Noah.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

Marc, you answered to a prior question about the mix of defense this upcoming year. That's high-margin programs versus what you call drag programs, and you tossed out 50/50. Are you saying that half of the defense business is what you call a drag program? Or you're saying?

Marc Parent (President and CEO)

No.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

half of what's been a drag program is gone or is rolling off in 2024?

Marc Parent (President and CEO)

Definitely not half our programs are drag programs.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

That's what I wanted to clarify.

Marc Parent (President and CEO)

No, not at all. No.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

You're saying that half of what's been a drag is rolling off in 2024? What is, what does 50/50 mean in that context?

Marc Parent (President and CEO)

Yeah. You know, I think I'm gonna bring it back to what the outlook is, in defense, Noah, is that what we're gonna see is strong growth in a year defense. We're gonna have continued year-over-year improvement in the amount of SOI that we generate every quarter relative to the same quarter the year before. That's, we have a very good path on that, and that's why I'm comfortable guiding to that today, even though it's pretty early days in the year. You know, in terms of the margin itself, as new programs come on, replacing the other ones, that are dragging, and dragging doesn't mean zero necessarily. Just dragging to the margins that we're, that we're targeting to do. The margin reflection starts happening later in the year, and certainly as we begin in fiscal 2025.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

How many programs in defense, approximately, would you call a drag program at this point?

Marc Parent (President and CEO)

Well, I won't get into that, because then I have to define to you what exactly is a drag program. We execute, you know, literally, probably in the region of 500 or 600 programs at once in defense at any given time. That's about the number that we have, that we're executing at this moment in time, maybe leave it at that, Noah.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

Okay. Yeah, I mean, you know, it's been asked about a bunch. I don't want to keep asking the same question, but, my understanding of what happened there was you acquired a business, realized there were just a handful of bad contracts written, and that those just need to roll off. I appreciate the reasons you wouldn't want to get into all the detail of this on this call, but at the same time, you know, the kind of reluctance to give the specifics here, I think risks just leaving everybody still confused as to exactly what's going on and when it looks better, other than just kind of taking the high level word for it. Do you see what I mean?

Marc Parent (President and CEO)

It's not just the business we acquired. Don't forget that we've been winning contracts. We've been executing programs both from legacy CAE, whether it be U.S. and international, as well as the L3Harris contract, under an environment where we had, you know, just like the rest of the industry, pretty significant part shortages, issues, manpower shortages, and delays in orders, which we expected to get, that were literally delayed, because of, you know, focus on the Ukraine war. Which in the longer term, it obviously drives budgetary pressures higher, which is a good thing, but in the short term, certainly affected the amount of contracts that were worked on that we could translate into revenue for us, as we just got delays in orders.

I mean, in terms of specific, you know, drag programs as you might want to think about it, a very, I mean, very low profitability, you know, that's a very small number of contracts.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

That's helpful. The

Marc Parent (President and CEO)

Thank you.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

The capital expenditure increase this year, what's that for? Should we be thinking of that as a new base that you know, then grow off again beyond 2024, or is there a sort of one-time step up this year?

Marc Parent (President and CEO)

A lot of it has to do with the success that we've had in convincing airlines to convert, you know, more of their training to us. If you look at, for example, four out of four out of five major airlines in the U.S. are now training with us. That's a big step up, and, you know, once you do that, I've never seen it go the other way. At the same time, you see us deploy new centers for business aircraft, which are, you know, highly accretive, very good margin performance, in a market which, you know, I see as structurally higher going forward. That's really what you're seeing right now. I'm not gonna get beyond this year, but that's really the bulk of it.

Noah Poponak (Managing Director of Aerospace and Defense Equity Research)

Okay, great. Thank you so much.

Marc Parent (President and CEO)

Welcome.

Operator (participant)

Our next question comes from Fai Lee with Odlum Brown. Please proceed.

Fai Lee (Equity Analyst)

Thank you. Marc, I just have a couple of questions on civil aviation. The utilization rate this quarter was 78%, but Asia isn't fully recovered. I'm just wondering, in terms of how should we be thinking about where the utilization could settle in, under a more, I guess, call it, normal utilization in Asia?

Marc Parent (President and CEO)

Well, I think there's room to grow still in Asia. It has been recovering rapidly, you know, since the start of fiscal year, and our Q4 utilization in Asia was certainly substantially improved versus the start of the year. There's still room, gas in the tank, if I should say, on that one. I mean, utilization is not a perfect number, I would say, because don't forget, you know, as we ramp up new simulators, we've ramped up a lot of simulators, that will kind of serve to depress the utilization in the short term, because obviously, if you ramp a new training center or a new simulator up, it's not gonna be a full utilization right off the bat.

It may be just Asia Pacific, you know, in terms of China, I would add that that's mainly a simulator market for us. We typically, you know, sell maybe six to eight full-flight simulators a year to China. Over the last couple of years, you know, we've only sold three in total, but we're definitely seeing a pickup in the sales-related activity in China.

Fai Lee (Equity Analyst)

Okay. In terms of like, you know, I know there's some noise on the simulators, but in terms of like the utilization rate on a more normalized, longer term basis, it sounds like the scope for it to go up maybe in the 80s. Is that kind of the way to think about it, maybe mid-80s at a maximum or on a normal?

Marc Parent (President and CEO)

It certainly can. You know, we're operating at a very high level now, if you look at the global fleet, at those kind of levels. Yeah, we have training centers that operate at north of 100%.

Fai Lee (Equity Analyst)

Okay.

Marc Parent (President and CEO)

I mean, practically, you know, to operate the whole fleet of 300 odd simulators at that level, it would not be tenable because you have to have time to maintain them, that kind of, that kind of thing. You definitely could see it go up above 78%. That's definitely possible. Don't forget, we always work on making sure that we get the best returns out of utilization we can get.

Fai Lee (Equity Analyst)

Okay. just to follow up on, in the, you know, guidance, you mentioned that Civil is gonna continue growing at a "above market rate," I'm just curious what I know you gave guidance on the SOI and where you think that's going, but I'm just wondering, what is that market rate that you're talking about?

Marc Parent (President and CEO)

Well, we're talking about the underlying rate of growth of mainly airline passenger travel, RPKs.

Fai Lee (Equity Analyst)

Okay, got it. Thank you.

Marc Parent (President and CEO)

Operator, I think that's all the time we have for members of the analyst community. We'll now open the line to members of the media, if there are any questions there.

Operator (participant)

If you are part of the media and would like to register a question, please press the one four on your telephone. We have a question from Stéphane Rolland, from La Presse Canadienne. Please proceed.

Marc Parent (President and CEO)

Uh, but, uh,

on a aussi déployé plusieurs simulateurs dans notre réseau cette année. On a ouvert des nouveaux centres de formation pour l'aviation civile. On a fait des contrats, exemple, où aussi qu'on fait les partitions de l'entraînement pour des compagnies aériennes comme Qantas en Australie, comme AEGEAN, la plus grande compagnie aérienne en Grèce. On fait maintenant l'entraînement pour 4 des 5 plus grosses compagnies aériennes aux États-Unis, versus, on ne faisait pas du tout avant la pandémie. Tous ces facteurs-là font que, qui donnent la, si vous voulez, le parcours pour se rendre aux marges de et de la croissance dans le revenu, le profit par action dans 2025.

Stéphane Rolland (Journalist and Reporter)

OK. J'ai senti de la part des analystes, là, qu'il y avait une certaine partie qui n'était pas tout à fait claire pour leur part, là, qui leur manquait d'informations. Est-ce que, pour quelles raisons, cette information-là, vous pouvez pas leur donner ? J'ai compris que c'est à cause des secrets commerciaux dans la défense. Est-ce que j'ai bien compris ?

Marc Parent (President and CEO)

Définitivement, quand ça vient des questions sur des contrats où on demande combien exactement de capital qu'on va être obligé de déployer pour des certains contrats de défense, oui, ça fait partie des, je dirais pas des secrets, des secrets d'État, mais des secrets commerciaux, oui. On peut pas vraiment être transparent dans ce sens-là, en ce moment.

Stéphane Rolland (Journalist and Reporter)

OK, je comprends. Peut-être une question sur un autre sujet. Par le passé, vous aviez parlé du risque de pénurie de pilotes au Canada, puis ailleurs, je voulais me concentrer sur le Canada. Est-ce que la situation s'est rétablie depuis la pandémie? Je me pose la question avec la saison estivale en tête. Je sais que vous n'avez pas le contrôle sur tous les éléments, je me demandais, avec les informations que vous avez sur la pénurie de pilotes, est-ce que la situation s'est rétablie au Canada? Est-ce que ça vous préoccupe toujours?

Marc Parent (President and CEO)

Je pense qu'il y a encore une grosse demande de pilotes, pas seulement au Canada, mais un peu partout à travers le monde. Nous, on fait partie de la solution là. On est probablement dans les plus grands formateurs de pilotes au monde. On a des écoles, on fait des centaines d'avions. On est connu comme une compagnie de simulateurs, mais on a aussi beaucoup d'avions. Aussi, qu'on entraîne des pilotes. On a des ententes avec beaucoup de compagnies aériennes pour leur fournir des pilotes directement. Donc, on fait partie de la solution. Une des solutions aussi, moi, je pense toujours, c'est le fait que seulement 5% des pilotes dans le monde sont des femmes. Ça fait que nous, on encourage beaucoup.

On a des bourses, par exemple, on vient de faire un partenariat avec Air Canada, entre autres, pour augmenter le nombre de bourses et vraiment encourager des femmes à devenir pilotes aussi, parce que ça irait loin pour régler le problème.

Stéphane Rolland (Journalist and Reporter)

OK. Parfait. Ça complète mes questions. Merci d'être prendre le temps pour les questions des médias. C'est apprécié.

Marc Parent (President and CEO)

Merci.

Andrew Arnovitz (SVP of Investor Relations and Enterprise Risk Management)

OK, operators. Thank you. I want to thank all participants today, financial analysts and members of the media, for joining the call. Remind you that a transcript of today's discussion can be found on CAE's website. Thank you.

Operator (participant)

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