Q1 2023 CAE Inc Earnings Call
The pair of three 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 trading revenue and adjusted segment operating income.
We delivered 10 full flight simulators.
First quarter average training center utilization was 71%.
Up from 56% last year.
Training demand in the Americas continues to be strongest.
Followed by a much improved Europe and.
And it's still lagging Asia Pacific, which remained at 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 defence, we booked orders for training and mission support solutions valued at $488 million for $1, one eight times book to sales.
And although we were expecting some key orders that pushed rightward. This quarter. This represents a record level of order intake for defense in the first quarter.
That 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 131 times is to me a very good indication of the trend in order momentum.
We continued to build.
On that momentum in the quarter, winning orders across all five battlespace debate.
Air domain, we entered a contract with the Netherlands Ministry of defense to provide a training system in support of the NH 90 training program.
And land the U S Army synthetic training environment cross functional team or did CAE, a task order to develop a soldier virtual trainer prototype with immersive capabilities.
That empowers soldier led training at the point of deed meeting that is deployable.
In the sea domain in partnership with Lockheed Martin.
We were awarded the design support contract on the Royal Canadian Navy's next generation frigates.
In space we.
Award a contract from the U S Air Force Research lab.
As part of the Starfish initiative.
To develop prototypes software that enables simulation of current and future capabilities.
Operating across a multi domain environment.
Finally in the cyber domain as part of a larger team we secured a position on the approximately $1 billion <unk> three <unk> contract vehicle.
And while defenses order activity was generally positive in the quarter.
Financial performance was clearly not.
The loss incurred a $21 2 million.
Was driven mainly by unanticipated charges on a legacy CAE training program with the U S Navy and the legacy <unk> Harris military Crane classify U S program.
The disc.
These two discrete charges totaled $28 $9 million in the quarter. A result from a reassessment of cost estimates following discussions with our customers. This past June .
The reassessment 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 cut.
Customer utilization trends have exceeded our estimates, resulting in cost growth on a fixed price.
Fixed firm fixed price contract and our expectations.
For contract adjustments and extension at more favorable terms have changed.
The programming question is the chief of Naval Air training or Sinatra contract with <unk>.
Contract instructional services.
We're see provides classroom simulator instructors at five naval Air stations to support primary intermediate and advanced pilot training for the United States Navy.
The second charge stems from a classified U S program. That's also structured on a firm fixed price basis and involves the initial phases of a large long term opportunity.
The program is a complex national defense priority and our current work positions us well to capture significant future opportunities on the program.
Now given the nature of the work.
Which is 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 that program's 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 proceed we're working towards meeting our commitment to the customer and positioning defense for future work.
I would add that while we are 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 haven't included any of those in our expectations. I'd also add that we have a clear understanding of the specific issues that resulted in the charges taken on both programs.
And after thorough analysis, we consider these provisions capture adequately the expected cost overruns and I'm confident that there is no more negative surprises like this one in our backlog.
And beyond the two program charges.
<unk> performance was still below our expectations for the quarter.
Across the company, we've 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 at <unk>.
To a wide staffing shortages led to less billable work on cost plus contracts and inefficiencies on other work.
Supply chain challenges, we're also more severe than anticipated, which pressured scheduled.
We also experienced delays on a few key orders were expecting to commence work on in the quarter.
Excluding the charges and the impact of these additional challenges defense performance would have been more consistent with our expectations for the full year plan, which also considers a more elevated level of bids and proposal costs as we pursue several large awards that are in our pipeline.
And finally in healthcare.
We continued to drive double digit revenue growth with our innovative solutions.
Health care leadership team transitioned from Heidi wood during the quarter, we're grateful for her contribution and wish her well in future endeavors.
Health care is now being led on an interim basis by Jeff Evans, who was 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 of expanded its strategic relationship with the Mayo Clinic College of Medicine and science.
Finalizing a partnership for its learning Space Center management solution for Mayo simulation Center in Rochester, Rochester, Minnesota.
Health care also increase its presence and visibility in the U S. The wafer supported by Cares Act funding and Lawn Health Hospital system to address West Virginia has increased demand for nurses with the deployment of mobile training units.
With that I'll now turn the call over to Sonya, who will provide additional details about our financial performance I'll return at the end of the call to comment on our outlook Sonya. Thank.
Thank you Mark and good afternoon, everyone.
Holiday did revenue of $933 $3 million was 24% higher compared to the first quarter last year.
<unk> segment operating income was $60 9 million compared to $98 $4 million last year and quarterly adjusted net income was $17 6 million or <unk> <unk> per share compared to 19 in the first quarter of last year. This.
This quarters result includes $28 9 million in unfavorable contract profit adjustments in deferred which equates to a <unk> <unk> negative EPS impact.
We incurred restructuring integration and acquisition costs of $21 $5 million during the quarter, including $16 million related to the gallery Harris military training and Air Centre acquisition.
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.
This 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 reverse 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 with 500.
$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.
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 the rate we use to determine the adjusted net income of $17 $6 million and adjusted EPS of <unk>.
Our net debt position at the end of the quarter was approximately $3 billion or net debt to adjusted EBITDA of four one times at the end of the quarter. The more elevated that ratio. This quarter reflects the impact of the two noncash charges in defense.
We continue to expect net debt to adjusted EBITDA of below three times within the next 15 months.
Now turning to our segmented performance.
In civil first quarter revenue was $484 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 of 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 lifecycle support services and a less favorable program mix.
We also incurred higher R&D investments to support our innovation pipeline.
In defence first quarter revenue of $413 $3 million was up 43% over Q1 last year due to the integration of the <unk> 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 aforementioned contract profit adjustments and a more acute challenges than we expected stemming for staffing shortages supply chain pressures and slower Order award.
These additional challenges had an approximately $20 million impact on adjusted segment operating income.
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 they are linked to our pursuit of larger opportunities pipeline, but they were more impactful given the other defense headwinds.
And in health care, 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 year's results included a higher level of investment tax credit 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.
Thanks Sonya.
As we looked at the period ahead, despite the prevailing macroeconomic headwinds that added defense sector related challenges.
We continue to see a clear multi year path to becoming a larger and more resilient and more profitable fee.
Civil.
Our outlook is as bright as ever.
We're in the early stages of <unk>.
Cycle with near record margins with plenty of room to grow beyond that.
We've invested both organically and inorganically to expand our training network globally.
Leveraging our position.
As the world's largest civil aviation training company.
A greater desire by airlines with trustee with their critical training and digital operational support and crew management needs acute pilot demand and strong business jet travel demand, our enduring positives underpinning a secular growth market.
Now the unevenness. This unevenness of the global recovery is likely to continue for some time, but we're ultimately in an excellent position to benefit from the multiyear cyclical market recovery. That's 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 <unk>.
Exclusive long term training agreements with security in recent quarters with virtually all major airlines in the Americas.
We're 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 post foresee.
In defence.
Despite the additional challenges that we encountered in the quarter.
Positive long term outlook that we shared at our Investor day in June is unchanged.
We're on a multiyear journey to become a bigger and more profitable in the first and more critical link in that chain involves winning orders.
Our record order intake last year and for the first quarter confirm that we are indeed on the right path to growth.
And critically the orders that we've won over the last year and a half bear a profitability profile that is consistent with our long term view to returning to a low double digit margin in defense.
Furthermore, a record $9 billion of defense bids and proposal is result of bidding more and bidding larger.
An important element of our strategy involves strengthening our strategic relationships with Oems.
And then.
Memorandum of understanding we signed last month with Boeing is a great example of how the major Oems recognize <unk> unique expertise in training.
We agreed to expand our international teaming a 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 have become more acute than but we believe temporary.
Current geopolitical events have galvanized national defense priorities in the United States and across NATO.
Expect increased spending as specific prioritization on defence readiness to translate into additional avenues for CAE 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 and a short term.
And taking all these factors into consideration we are lowering our expectations for defense for the current fiscal year to account for the two U S program charges that we just incurred and to reflect a more acute sector wide headwinds that we're 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 defence This fiscal year and as we manage through the effects of a protracted period of less than one time sales and begin to ramp up new orders in the second half.
The additional defense headwinds have made this waiting 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 is for it to become a more material and profitable business within C. As it gained share in healthcare simulation and training market and continues to build on its double digit revenue growth momentum.
For <unk> overall, we are reducing our outlook for the current fiscal year to mid 20% consolidated adjustment segment operating income growth from the mid thirties, previously, which largely reflects our revised expectation for defense.
We greatly enhanced our position in it.
Expanding our addressable market over the last couple of years and I have complete confidence in our team's ability to maintain a strong order momentum and drive superior and sustainable growth in profits over the long term.
Broadly speaking the.
The underlying trend lines of a multi year progress are very much intact and my conviction is <unk> long term growth outlook is resolute.
We continue to target a three year earnings per share compound growth rate.
The mid 20% range with that I. Thank you for your attention and we're now ready to answer your questions.
Thanks, Mark Operator, we'll now open the line too.
Members of the investment community for their questions.
Thank you.
If you would like to register a question. Please press the one four on your telephone.
You will hear a three pronged technology a request.
If your question has been answered and you would like to withdraw your registration. Please press. The one followed by three once again to register a question. Please press the one four on your telephone one moment. Please for the first question.
Our first question comes from Kevin Chiang with CIBC. Please proceed.
Oh, hi, thanks, Thanks for taking my question and good afternoon everybody.
We want to dig into.
Some of the details you gave in terms of what happened to defense.
Mark It sounds like you're confident that.
The provisions you've taken only relate to these two contracts but.
I guess historically when we looked at these type of issues a lot of times it ends up being a lot more systemic than.
One or two contracts, maybe you can give us a sense of why you're confident that the issues that you found are isolated to these two contracts maybe what may be some contracts unique and why it's not most of the stomach of your backlog and maybe any changes in your bidding process that might have occurred as a result of maybe to reevaluate.
Reevaluation.
Yes, maybe I'll take it in two parts Kevin.
Look I'll.
That'd be the first one to tell you that the performance in the quarter, certainly doesn't meet our expectations or my expectations for defense business as a whole and it look I'll start with maybe the specific charges that we took that again I'm 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.
Cause that caused us to recognize these but we re baseline both programs. Following the customer discussions we had in June and I think we've taken appropriate approach.
Going forward and having to recognize the charge that we took it to.
To give you a little bit more color on them just to tell you that.
I feel pretty darn confident that you can isolate these programs.
Because you would have you would imagine they're just taking a step back a second win when you get impacts such as we've seen here. It forces a complete review of everything in your portfolio you would've expected me to do that so just to go back on the program.
On the first one on the Navy training contracts Sinatra.
This is where you are a customer demand has really outpaced our expectations I mean, we train.
As I said in your remarks, we trained at five naval Air stations that one of them being corporate Christie Corpus Christi and the Navy has been trading at very very high rate higher and it'll be very frankly higher than we bid at and we did this years ago. So legacy legacy contract now we have put we had put cost reduction measures in place.
To improve the profitability on that program, but what's happened now is a shrinking time to realize the benefit.
Because the contract comes to an end at the end of this fiscal year not yet your asphalt.
That would be well what 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, there is less than nine months left and you appear to performance.
Yes somewhat.
Very surprisingly, we have yet to get an RFP.
Frankly, as I said, it's pretty counterintuitive.
Given the very high customer usage to date, I mean, you're flying really that.
Really really trying very hard now given the shortened period.
We just have no runway left to take any.
To take account of any equitable adjustments any measures that we've taken reduced cost of just on the time. So we had to take the charges now we haven't factored that.
These.
Any extension of contract, which I fully tend to happen. So that's one to stay tuned on but we have ticketing benefit of it.
So I think we've taken a conservative prudent approach here now on the other contract 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 don't like the Costco fund that program, but I can tell you that.
Because of what's happened here I was on site.
On that program, just less than two weeks ago and I.
I'd like to be able to look at the whites of the eyes of the program managers of engineers or people working on a program and I feel very confident about the Rebase line program and I can promise you that.
This team is extremely diligent and it will be even more so in evaluations of our schedule and not only this program in all of our programs.
And.
And not just a valley if I go back to this program itself not just to validate our cost estimates, which we've done but to make sure that we're positioning ourselves to capture the long term opportunity that this program sets up on this program because it.
Intimated in my remarks.
Follow on work on this contract is very large I'm talking on an order of magnitude here with the potential for very attractive margins when it reaches a mature state.
Production.
So look I mean.
Yeah, I'm not happy performance, but look none of this to meet changes our long term outlook for the defense business that we outlined for example at the Investor Day.
Our orders that you've seen have been outstanding.
We're tracking some very large opportunities.
And with respect to the short term costs at Baxter.
We have.
Number of very specific actions in place.
Already to address the challenges on each of us in each category would it be manpower would it be parts.
Other factors affecting us.
I can tell you personally.
<unk> 35 years in aerospace industry, having managed very large programs in the past full aircraft. The aircraft developer programs I've seen this kind of thing before.
Big work.
Introduces is very very specific challenges, but I can tell you I'm all over it.
Teams all over it.
And youre going to see us, making progress in the margin rates in a coming efforts as those efforts take hold and that's what we've reflected in our outlook.
So that's that's helpful color and maybe just like you just had an investor day, let's call them.
In the middle of the quarter, a little of the previous quarter.
I guess I guess he wishes.
Evidence at that time I go to the states.
The obvious when you reaffirmed I'll look at that point in time I guess at what point did you realize that you have to start taking provisions.
Late June late June that's when it happened that yes, it did come as a surprise.
Yes.
I don't like surprises <unk>, we don't like surprises and become but.
That's what happened and as I said there.
This has.
As we highlighted in our Martha discrete charges, they are noncash or onetime in nature.
We've re baseline every program in our portfolio, we've taken very specific actions on the rest of our programs.
So I'm quite confident going forward, but.
By expanded look.
And even in a I'm sure of the fall one follow up question might be that.
And I think we've intimated in your remarks that even if you even if you take those two charges out discrete charges.
Profitability.
The ability of our defense business in the quarter is still very low.
And.
I think we expected that we expected that that would tell you I didn't expect that much to be very Frank with you. We you would be back half.
So we hit.
If it wasn't for that the charge that we've taken here I think we largely could've probably maintained our outlook, but what we've had here.
We just can I can I could.
To expand upon that.
Super helpful. I'll leave it there. Thank you for taking my questions. Thanks.
Our next question comes from Savi <unk> with BMO. Please proceed.
Yes. Thank you good afternoon.
I guess I got a couple of question one.
The.
The guidance for mid 20% EBIT growth.
If we're assuming civil is still on track to be maturity.
EBIT growth really implies very strong.
Performance in the defense and the next nine months, you would have to be doing almost 45% growth in EBIT and defend some of the next nine months.
To basically be.
B b in that mid 20% EBIT performance for core so I just want to make sure I'm understanding this because excluding the charges the underlying profitability and defense was only 2% then you seem to suggest.
Yeah.
The headwind that's kind of.
Margin will continue at least into the second quarter.
Well it will it'll gradually abate, but we're 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.
Our outlook, but.
Pronounce my I think look I'm not going to break it down from a sector standpoint fatty 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 it's not it.
We are taking actions that only not only affected defense business, but their business as a whole to maintain that.
<unk> profitably growth profile that we've indicated in our outlook and the other thing I would tell you is that I talked about somebody or although we don't really I would say really well in the quarter on orders and especially on defense orders.
I think we've said in the past that not all orders are created equal and there are some orders with you.
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 I've talked about which convert into revenue faster is products orders and therefore that when you take all of that into the into fact.
<unk>.
The consideration you will get to the outlook that talked about.
Okay.
And then maybe as a follow up.
You are always around them.
Kind of fixed cost contract business.
I think the majority of your revenues are fixed contract business remember you had with types of.
You know contract issues in the past.
Uh huh.
Is there.
What's different toughened.
Recently to kind of.
Neve.
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 of what you're thinking on these contracts.
Increases the risk of margin in defense or is this just a unique onetime kind of event here.
No look I think I think you're right look.
First of all Youre, absolutely right that we haven't seen as before it and get all the time that I've been at.
We have never seen this magnitude of impact in one quarter.
Right and we haven't had a habit of running out of contingency on a program like that and as I mentioned before the <unk> one.
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 that's one factor.
Just maybe give you an idea of you talked about the firm fixed price, but 80% of our contracts are about firm fixed price now that's actually.
That's that's a much better picture than we were when.
When we were before to L. Three Harris transaction, now and I wouldn't be overly perturbed by that number because remember there's a lot of service contracts and their service contract, we're very very high predictability and all of the others as I talked about.
Again, you get an event like this it forces you to that.
Saying that we werent monitoring the programs before but clearly there is an extra level of scrutiny that occurs when a program like this happens.
And when.
When we look at the contract.
The fixed price contract.
That we have for.
Classified program that I visited just a couple of weeks ago. This is a very complex program and.
To be.
<unk>.
We inherited contracts through the acquisition.
Veltri Harris would I wish that this contract, which is a development program had been bid differently as you know 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 had literally.
Literally over 60.
Highly cleared personnel working on this contract.
We're off on Covid for a long time and finding it very hard to replace them because they are cleared personnel.
We have seen this thing better in hindsight I would tell you yet.
And I would tell you the measures that we've put in place for increased level of program management oversight at all levels of the company are there so.
I'm pretty confident in terms of extra factors what's changed.
I would tell you that's what's changes is that what you see.
We're not alone in this case.
You will see across the industry labor shortages supply chain pressures contracting delays, but and thats impacted our results significantly.
We anticipate some of those they were worse than we thought now one of them is is labor and there is labor 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 we have the labor we need to be able to execute the contracts pretty assumptions that we've made so maybe I'll stop there.
Okay I appreciate it thank you.
Our next question comes from.
Cameron Derksen with National Bank financial Please proceed.
Yes, thanks very much.
I guess a question on the healthcare business I mean, I appreciate it's still pretty small, but there's been I guess.
Maybe this is not the right term, but a bit of a revolving door on leadership at that business. So I'm. Just wondering if you could 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.
Well.
Yeah.
What can I say Cameron.
Absolutely absolutely.
<unk>. This is a show we story what I would tell you. It is the show me starts with six consecutive quarters of double digit revenue growth now that has to translate into bottom line growth.
I've said it before and it's true.
It has to be true that we've invested substantially in R&D.
And SG&A immediate meeting sales force to be able to get the results that we have.
I would tell you the change that we had a leadership of.
Health care has gone very very well I'm not going to comment although I will agree with you that we have had somewhat of a revolving door.
Scott.
Cannot debate that with you.
I can tell you that I'm very very happy with the performance of Jeff Evans Who's leading the business at the moment. He is acting as interim at the moment, but I can tell you I'm very satisfied with the performance so far and I would tell you Jeff himself Who's a 19 year veteran of GE healthcare.
We're running large P&L for GE.
He is the architect.
Or the main architect has head of sales for the run up in revenue that you've seen.
I can tell you as well that we've taken significant steps to improve the profit profile by reducing costs in the business and as you've 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 part shortages. So what you have is if you were to go into a facility down in Sarasota, which I've been quite a few times you would see basically three quarters built products medical mannequins for example.
And then when we get the parts, we complete them, we take them out of storage will put the parts and we retest them. When we ship that you can imagine that that causes a lot of inefficiencies over time.
<unk> quality issues all kinds of issues that are are not great for your profitability profile, but I'm quite confident that a lot of those are abating themselves and so I'm quite happy with the way forward and I think I think you will see some progress in the quarters to come.
I agree market, that's a great summary, and I'll, just add a little bit of.
Additional color on some <unk>.
Drivers of variability.
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 was that it was actually a tailwind this quarter was actually a headwind. So on the larger organization that doesn't have a lot of impact but on a health care. That's much smaller P&L these kind of variability hopper.
Larger impact on the quarter over quarter. So in addition to everything that Mark just walked through there is we have to consider a little bit of I guess non routine variability coming from R&D investment tax credits.
Okay great.
The additional information and I'll leave it at one question. Thanks very much. Thank.
Thank you.
Yes.
Our next question comes from <unk> Gupta with Scotiabank. Please proceed.
Good afternoon, and thanks for taking my question. So just wanted to follow up on the defense.
This year, so just trying to understand Mark how do these two.
Adjusted contracts impact the margin mix for our defense segment over the next three quarters as well as your long term outlook for double digit margin.
Well I think the first thing I'll tell you is as I said in my remarks that.
Although we bid them that way, we're quite confident the rebased signing of the programs that we've won.
All the programs that we've that we've won in recent time.
Certainly since we've had the new organization in place under Dan Gilson, the profitability profile of that backlog supports.
Our objective of low double digit bars in defense Thats. The first thing I would tell you I would tell you as well that we have a very firm handle on that.
The inefficiencies and other impacts that we had that effect the profitably of our business.
And I am tuck in taken a two programs charges to decide for one second I'm, just saying the inherently low.
<unk>.
Percentage of profitability defense in this quarter.
This results from again, the inefficiencies that we had on <unk>.
Labor on parts, sometimes lead times on parts of doubled doubled in a cost themselves have changed and introduced all kinds of initiatives.
Inefficiencies that you would get on overtime and things like that now again, I would say that again.
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 what I would say is that were worse than we anticipated it took us longer to get back higher cleared personnel than we thought.
Chargers.
<unk> more than we thought.
But we have a pretty good handle on it and are quite confident in that these factors as they affect us will abate in the second half so.
Again, leading into defence contribution to the outlook that we've given.
The other factor I would say as well is if you look at the amount of bids and proposal money now.
Our bid proposal cost this quarter are up very materially materially as we track some very large opportunities in our bid pipeline.
We've talked about some of this in our Investor day now.
It's not very different from our internal expectations that we will get higher but some of these programs are 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 up there are so large so that causes a disproportionate amount of business proposal costs.
In this quarter, which.
It's not necessarily going to be the same as we go throughout the year.
Again.
I hope you understand the quantum here the expenses on bigger proposals roughly again doubled over last year and are up pretty much. The same thing this year, but what youre seeing here is the pre work that we're doing to capture the opportunities that down that that Dan gilson outlined at our Investor day.
We're attacking it was hard and I think all of that answers. Your question is where are we going in defense and in terms of its profitability.
That's great I appreciate the detail and transparency Mark Thank you.
Our next question comes from Ben Walk Party with digital banking capital markets. Please proceed.
Yes, thank you very much and good afternoon, everyone.
Just to come back to healthcare given the favorable valuation for health care companies. These days in light of the good performance would you consider potentially divesting these assets and just searching for a new leader what are the qualification.
That's you're looking for in terms of a new leader for care.
Well I'll take.
Your second one is basically a lever that's going to go to drive the property growth of our health care business going to basically make it a more.
Sizable contribution and accretive contribution to <unk> results, that's the minimum.
Minimum threshold for that and as I said before I think so far Jeff Evans has demonstrated to me.
That that is the case, so more to see on that front.
And look as I've said before I am very confident in how healthcare fits into C. As overall portfolio and its very much supports our noble mission and there is substantial synergies across our organization in terms of facilities in terms of people technologies.
It's part of our portfolio and have no no there's.
No thought about changing that.
Okay, and just looking at the civil EBIT margin came in below our expectation.
On the back of a higher utilization rate and the lower equipment deliveries where margins tend to be lower so could you provide more color on what's putting pressure on margin, whether it's more equipment commercial.
Business jet and how we should expect as civil margins due to bounce back throughout the year.
Well look I would tell you that civil it certainly met my expectations.
So I think I said I think I've said this many times before had been way.
Part of our business I would look at this quarter to quarter, but having said that I'm very very bullish and very satisfied have always seen the civil business in the quarter and of course, the indicators lead to the outlook.
You look at the orders you'll look at training utilization is 71%, 71% there that is.
In prior to Covid, we said, that's a pretty good utilization.
We're seeing it.
If you look at the results.
And I am sure you are you looking at our results with a fine tooth comb youre seeing.
That the the the.
Cost reductions translate into our results and we were already even at 18% that may be down for your expectation, but don't look at it quarter over quarter because utilization, we said it before is not a perfect measure.
Always have product mix that may be less favorable in the quarter. This quarter, we had higher R&D expenses to support some of our innovations like for example, <unk> like we spoke about at Investor day. So in this quarter, it's really down to mix and I fully expect you might look at next quarter might be the other way around so look I'm I remain.
Very firm that this business is going to realize strong results in the future and our results.
To me when I see supports that very bullish okay.
Thanks for the color Mark.
Operator, we don't hear you.
Operator are you still there.
Could it be could it itself.
Hello.
Okay.
Thank you. Our next question comes from the line of Ben <unk>.
Of Bank capital markets. Please proceed with your question.
Thank you very much.
Okay.
Yeah.
Our next question comes from the line of Tim James of <unk>.
<unk> Securities. Please proceed with your question.
Thanks, Good afternoon, everyone.
I just wanted to.
Changing the discussion a little bit here.
Although sticking with kind of the defense side of the business Mark I'm, just wondering if you could kind of update us on.
Any evidence that you are seeing.
Growing demand for.
Virtual military training over ly or just new applications.
In the in the simulation industry that support the secular growth story for simulation based training and I'm thinking of aviation more specifically.
Okay.
Yeah.
Yeah.
Yeah.
Hello.
Pardon me. This is Frank I can introduce the next question from Tim James from TD Securities.
Yes go ahead.
Okay can you can you hear me okay Mark.
Yes, sorry, we don't know what happened there Tim <unk> will discuss the radiosonde, Brian we probably lost line.
Alright.
And my question.
Okay I will have my question, so well I don't know if I can do it as well again here.
Just wondering.
I'm wondering if you can update us on.
Any evidence you're seeing whether it's in this most recent quarter or maybe the last couple of quarters.
Growing demand for virtual military training relative to ly or just new applications for.
For stimulation and the technology that support.
That secular growth story for simulation based training and I'm thinking of aviation more specifically.
When you say <unk> was specifically.
Just expand on that what you mean there.
Military aviation training as opposed to some of the other sort of field. The other other the other domains that you've gotten involved in recent years I'm just speaking specifically.
Aviation applications.
I would tell you that.
The trend that we've seen increased use of simulation for training in the military to continues and continues to increase for for very real reasons that.
The what does the military do and when.
They're not in operations as they train for operation, that's 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.
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 that's what you're intimating.
We are investing in significantly and are deploying in some cases.
To like for example, <unk>.
Just as an example, one of the contracts that.
We announced this this quarter.
Goes to that point, where we're deploying a.
We're actually developing using RBR, a deployable trainer for people to be able to train <unk> operations or even down to a local sheriff's office.
Doing for example, what they would've done.
Gunnery range.
So rather than having a full gunnery range with real guns. For example, then you can do it virtually and you can do it deploy it. That's just one example, there is plenty of that to go and some of the when I look at some of the very real opportunities that are in our pine Bluff pipeline represent that again I would point to.
<unk>.
To you at the macro level look at the bid pipeline the amount of bids that we have there that we have out there is increased quite substantially and the orders that are at five year highs in terms of our.
If I look at our book to Bill.
It's the highest Ben and the other 12 months trailing.
That's our basis, which as I say I always look at that look at the 12 month trailing basis on our Orange is the highest it's been in five years, I think thats, demonstrating where we're going here and growth in defense.
Okay. That's helpful. Thank you my other question just turning to the year Center.
Acquisition.
At the time of the transaction it was indicated that sort of pre pandemic that was.
Our U S $150 million.
I believe it was annual revenue business and it was $55 million in EBITDA.
As well.
How should we think about kind of the.
Should we be wildly off if we kind of thought about that business is 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 as it simply lagging kind of as the rest of the commercial aviation business is relative to sort of pre pandemic I'm just trying to get a bit of a sense for what the contribution is in the quarter.
No.
I'll ask Tony if you want to tell you what the contribution is but I would first of all I would tell you. It's still very early in the integration we're still.
Basically.
In the very early innings on that but we are on track and feel very very comfortable the reaction of customers specific airlines.
Meetings, what airlines specifically most recently at <unk>. They are very happy with <unk>, having doing this business and.
Yourself can tell him we read it every single day right about the amount of inefficiencies that are out there youll gazed baggage hires pilots okay.
Aircrew being in the right locations would airplane, that's all things that our software solutions are help our offer to help manage and optimize for greater efficiency and yield Heaven, who is that that's going to be and we're seeing an increased demand for C. In this field, so I'm very optimistic.
In this regard.
Again, the integration is on track and.
Everything that we said in terms of how this business and contribute to see but to me is right on track.
I'll just add.
For the quarter itself it was not necessarily overly sickman insignificant that we're working through the <unk>.
Integration on track and we expect that to ramp up nicely to the fiscal year now.
Benchmarks on Premier.
Pre COVID-19.
<unk> are an indication of what this business can do.
At a more recovery rate than before even us adding to the investment in elevating this with our bundled sales. So so ultimately as the recovery plays out we can't we're very confident we can get to those numbers and even beat them as of recovery grows over the next couple of years.
Yes.
Great. Thank you very much.
Our next question comes from Noah <unk> with Goldman Sachs. Please proceed.
Hello, everyone.
Okay.
Alright.
Yes.
The two programs that took a charge in defense.
When were those contracts when do those programs start.
Well there are legacy contracts that we took over one of the one that we call. The classified program was signed.
2018 odd.
Sinatra.
Prior to US Miami, we took over a contract where we acquired <unk>.
Sinatra contract was the legacy C contracts 2018, I know that for sure.
Okay.
Actually cost more was the cost overrun.
Well in the case of Sinatra, specifically as I said.
This is a contract specifically where the customer is training them more than we bid it as simple as that okay, and we had cost mitigation and other actions to euro.
Year old lessen the impact of that I would tell you miss bit missed with at the time, though I can tell you we don't bid that way now we have complete.
In the past couple of years, we've refined the how we look at risk and in how we bid military programs, but this is one specifically that because this situation where we were with the customer was is is still utilizing those training assets thats five basis at a much higher level.
The man that was anticipated at the time.
We're really that's that's what we're facing here now again, we've put mitigating factors in reductions to improve efficiency to improve that program and we fully expected that the contract we'd get an RFP to be able to extend that contract or to renew that contract because it ends in about less than <unk>.
Nine months now.
As I said somewhat very surprisingly in calendar intuitive because of the fact that they are using it so high.
Yes, basically we didn't get not only did we not get.
The contract renewal, but.
The Iq or getting a bit technical on this the <unk> number.
What's changed in which case basically what it says is we had no additional period of performance, which for our cost reductions or other measures.
We put in place to improve the profitability of the program.
To take hold we just ran out of time, so basically you have to recognize.
The loss at that point and Thats what happened now do.
Do I think that that contract will go forward.
Navy needs. This needs. This training is going to happen. So to me, we havent baked in any upside on that but again stay tuned on that one.
Okay.
If those two yes.
<unk> categorized as mis bid.
What your the way you run the business today, you don't bid that way.
What percentage of the revenue base at this point is.
Stage, two possibly having been misfit.
Well I would tell you that.
As I said before when you when you get.
Something like this you take very specific actions and then again I'm not going to say, we werent looking at our progress before of course, we were.
But we've taken some very.
Specific actions, including I would tell you the establishment of a centralized program management organization that centre of excellence, if you will and.
This was always part of our <unk> Harris merger integration plan, but we've accelerated to bolster it.
Basically company program Companywide program excellence so.
We have re baseline and triggered a complete top down review of our portfolio.
All of our programs to make sure that we have the right staffing the right contractual provisions and maximum visibility transparency to make sure. We don't get surprised again I'm never going to say never.
But what I would tell you though is that.
All of the program, including the ones that were bid prior had been looked at to make sure that we have the right provisions and the rice <unk> and our rate assumptions that we don't get surprised.
Hey, Mark that that review is complete that review is impractical.
The review is complete.
And did I hear you correctly earlier.
Committing to a 10% operating margin in this business in your fiscal 'twenty four or did I hear that incorrectly no. No you Didnt hear me say that you. Two have you heard you've heard me say I believe that if not I will stand corrected that our target for this business is.
Low double digit returns at data and that the.
If I look at the programs that we've signed up that in our backlog they support a double that they support that that backlog supports that goal that we obviously have to execute.
And that's where that's where the measures that we've taken.
This centralized program management organization. For example gives me that confidence again, I think as I said before I have seen this kind of thing before running major programs.
You get this kind of.
It will impact you just two things are slightly different.
I would tell you have got this and I feel very confident.
But the team in place to defense to make it happen.
Got it.
Thank you.
Thank you operator, thank you, we're 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.
Yes.
As a reminder to register a question to please press the one four.
Okay.
We have a question from Allison Lampert with Reuters. Please proceed.
Thanks, guys, Mark you talked a bit about some of the supply chain challenges you've had could you be a little bit more specific have you seen issues with shortages of chip semiconductors.
Yes, we have in fact, that's been especially acute actually surprisingly in our in our healthcare business and I say surprisingly, that's where we we have our highest concentration I think on what an individual men again.
Chips, which had a specific shortage, but we've seen it now I would tell you that I think overall, we've managed it pretty well.
It's not just chips, but.
It's really what we're seeing across the board.
Lead times for parts have extended that in some cases literally more than doubled.
It makes it's not only issue.
The impact of the parts themselves not being there at the time that we need them is that obviously that shrieks habits habit 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 four for parts we have.
Conductor overtime, we have conducted out of sequence work, which introduce all kinds of inefficiencies.
I will just stand there Allison.
Okay fair enough and just a follow up.
Are you seeing what kind of demand are you seeing from Mac Gen stimulator.
For what similarities Im sorry.
Ken.
Following that.
10.
Okay Alright.
The Boeing or the Max I'm, sorry, I'm, sorry, the Max Okay.
I think demand for.
The simulator for the Max the Max aircraft overall basically break it down at the Max eight or Max 10. They are very strong very strong as is part of the.
Backlog that we've we've signed in simulated orders over the past as well as training that we've signed in the last 12 months.
Okay, and just a follow up on semiconductor would you say that the shortages youre seeing now are more acute on the chip side, whether it's in aviation specifically than in the past because we've seen historically more on the auto side than in aviation.
Look I can't comment about the other industries of detail, except for what I read the newspaper, but what I would what.
I would tell you is look the impacts have been real for us but.
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 for those parts of support.
Forecast that we have that we presented at <unk> that we take to support the forecast that we have today.
Okay. Thank you.
Great.
Operator, that's 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 <unk> website.
You.
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.