Q1 2023 CAE Inc Earnings Call
I.
Good day ladies and gentlemen. Welcome to the CAE first quarter conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnabas.
Good day ladies and gentlemen. Welcome to the CAE first quarter conference call. Please be advised that this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnavitz. You may proceed Mr. Arnavitz.
Thank you. Good afternoon everyone and thank you for joining us today. Before we begin, I'd like to remind you that today's remarks, including management's outlook and answers to questions, contain forward-looking statements.
These forward-looking statements represent our expectations as of today, August 10, 2022, and accordingly are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially and listeners are cautioned not to place any reliance on these forward-looking statements. Not in the interest of knowing nichuala street, myth dagger lady, still?
The description of the risk factors and assumptions that may affect future results is contained in CEE's annual MVNA, available on our corporate website and on our filings with the Canadian Securities Administrators, CDAR, and the US Securities and Exchange Commission on EDGAR.
On the call with me this afternoon are Mark Peron, CEA's President and Chief Executive Officer, and Sonia Branko, our Chief Financial Officer.
After the remarks from Mark and Sonia, we'll take questions from financial analysts and institutional investors, and following the conclusion of that Q&A period, we'll open the call to questions from members of the media. Let me now turn the call over to Mark.
Thank you Andrew and good afternoon to everyone joining us on the call.
We had a mixed performance in the first quarter, with civil delivering results in line with our view for strong annual growth and increased market share momentum.
Defense results were disappointing.
coming in very well short of our expectations. The shortfall was mainly due to unanticipated, discrete charges on two of our legacy programs and the increased intensity of the defense sector-wide headwinds that we're facing in this early stage of our multi-year growth journey.
Now we'd already factored into our prior outlook that the second half of the fiscal year would be stronger than the first, mainly because we're still working our way through the lag effects of a protected period of less than one book one time book to sales. And it takes time for new programs awards to ramp up. We also expected some of the additional headwinds in the first half, but they were significantly more acute than we thought they'd be.
Now order activity is the best indicator of our future growth and despite a challenging global environment for CA overall, we secured over a billion dollars in orders for a record $10 billion backlog and 1.12 book to sales ratio.
In civil, we made excellent progress converting our large opportunities pipeline into $522 million of orders for a 1.09x book-to-sales ratio.
Now these include long-term training agreements with airlines, business aircraft operators, and 11 full-flight simulator sales.
Notable training contracts for the quarter involve several exclusive training agreements in the Americas, which add to the long list of exclusive training agreements that Civil has signed in the last year and a half, with the vast majority of major airlines in the region.
This quarter, they include a three-year extension to a long-term exclusive training agreement with Mesa Airlines, a five-year exclusive training agreement with United Airlines, a five-year exclusive training agreement with JetBlue, and a 10-year exclusive training agreement with another major North American airline.
In the UK, CIVIL expanded its existing 12-year exclusive commercial aviation training agreement with Virgin Atlantic to include the Boeing 787 platform, now covering all their existing aircraft platforms under the training exclusivity.
In business aviation, CIVIL concluded a pair of three-year training agreements with TAG Aviation Holdings and the NATO Support and Procurement Agency.
Civil's year-over-year financial and operational performance was also strong in the quarter, with double-digit growth in training revenue and adjusted segment operating income.
We delivered 10 full flight simulators in first quarter average training center utilization with 71%, up from 56% last year.
Training demand in the Americas continues to be strongest, followed by a much-improved Europe , and is 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 defense, we booked orders for training and mission support solutions valued at $488 million for a 1.18 times book to sales.
And although we were expecting some key orders that push rightward this quarter, this represents a record level order intake for defense in the first quarter.
Now we normally see some variability in quarterly defense results and so performance is best evaluated on an annual basis.
And to that point, our trailing 12 month book to sales ratio of 1.31 times is to me a very good indication of the trend in order of momentum.
We continued to build.
on that momentum in the quarter, winning orders across all five battle space domains.
In the air domain, we entered a contract with the Netherlands Ministry of Defence to provide a training system in support of the NH90 training program.
In LAN, the US Army Synthetic Training Environment Cross-Functional Team awarded CAE a task order to develop a soldier virtual trainer prototype with immersive capabilities that empower soldier-led training at the point of need meeting that is deployable.
in the C 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 prototype software that enables simulation of current and future capabilities operating across a multi-domain environment. And finally in the cyber domain, as part of a larger team, we secured a position on the approximately $1 billion ACT3 IDIQ contract vehicle.
And while defense's order of activity was generally positive in the quarter,
Financial performance was clearly not.
The loss incurred of $21.2 million was driven mainly by unanticipated charges on a legacy CAE training program with the U.S. Navy and a legacy L3Harris military training classified U.S. program.
These two discrete charges totaled $28.9 million in a quarter and result from our reassessment of cost estimates following discussions with our customers this past June .
The reassessments are due in part from delays in meeting customer requirements of scope and timing as well as a change in expectation for the expansion of the program requirements.
In the case of the US Navy contract
Customer utilization trends have exceeded our estimates, resulting in cost growth on a fixed firm price.
a firm fixed-price contract and our expectations...
for contract adjustments and extension at more favorable terms have changed.
The program in question is the Chief of Naval Air Training or Sinatra Contract with Contract Instructional Services, where she provides classroom and simulator instructors as five Naval Air Stations to support primary, intermediate and advanced pilot training for the United States Navy.
The second charge stems from a classified US program that is 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 word
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.
after a rebaseline review of the program's critical schedule elements and deliverables with the customer in June .
the costs to complete were revised upwards. Due to the critical nature of this program and the strategic long-term value it holds for C8, we're working towards meeting our commitment to the customer and positioning defense for future work.
I'd add that while we're 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 that these provisions capture adequately the expected cost overruns, and I'm confident that we'll be able to address them in the future.
that there's no more negative surprises like this one in our backlog. And beyond the two program charges.
Defense 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 observe in the broader economy. However, in defense these challenges were more acute as sector-wide staffing shortages led to less billable work on cost plus contracts and inefficiencies on other work.
Supply chain challenges were also more severe than anticipated with pressure schedules.
We also experienced delays on a few key orders we are expecting to commence work on in a quarter.
Excluding the charges and impact of these additional challenges, Defence performance would have been more consistent with our expectations and 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.
Finally, in healthcare.
We continue to drive double-digit revenue growth with our innovative solutions.
Healthcare Leadership Team transitioned from Heidi Wood during the quarter. We're grateful for her contribution and wish her well in her future endeavors.
Health care is now being led on an interim basis by Jeff Evans, who is formerly head of sales and has been instrumental in driving the business extended period of double-digit growth.
Now notable during the quarter, healthcare has expanded its strategic relationship with the Mayo Clinic College of Medicine and Science.
finalizing a partnership for its Learning Space Centre management solution for Mayo Simulation Centre in Rochester, Minnesota.
Health care also increases presence and visibility in the U.S. through efforts supported by CARES Act funding and MonHealth Hospital System to address West Virginia's increased demand for nurses with the deployment of mobile training units.
With that, I will turn the call over to Sonia who will provide additional details about our financial performance. I will return at the end of the call to comment on our outlook. Sonia?
Thank you, Mark, and good afternoon, everyone.
Consolidated revenue of $933.3 million was 24% higher compared to the first quarter last year. Adjusted segment operating income was $60.9 million compared to $98.4 million last year. And quarterly adjusted net income was $17.6 million or 6 cents per share compared to 19 cents in the first quarter last year.
This quarter's result includes $28.9 million in unfavourable contract profit adjustments in defence, which accretes to a $0.07 negative EPS impact.
We incurred restructuring, integration and acquisition costs of $21.5 million during the quarter, including $16 million related to the Yeltri-Harris military training and Air Center acquisition.
Free cash flow is negative $182.4 million compared to negative $147.6 million in the first quarter last year.
The decrease was mainly due to lower cash provided by operating activity. The decrease was partially offset by a lower investment in non-cash working capital.
We usually see a high level of investment in non-cash working capital accounts during the first half of the fiscal year and tend to see a portion of these investments reversed in the second half.
Growth and maintenance capital expenditures totaled $73.9 million this quarter, mainly for growth and specifically to add capacity to our global training network to deliver on the long-term, exclusive training contracts in our backlog.
Income tax recovery this quarter was 500.
$0.5 million.
for a negative effective tax rate of 16% compared to a positive effective tax rate of 18% for the first quarter last year.
The income tax rate was impacted by restructuring integration and acquisition costs this quarter and excluding these costs, the income tax rate this quarter was 21%, which is a rate we used to determine the adjusted net income of $17.6 million and adjusted EPS of 6 cents.
Our net debt position at the end of the quarter was approximately $3 billion for a net debt to adjusted EBITDA of 4.1 times at the end of the quarter. The more elevated debt ratio this quarter reflects the impact of the two non-cash charges in the Fed. We continue to expect net debt to adjust at EBITDA of below 2 times within the next 15 months.
Now turning to our segmented performance.
In civil, first quarter revenue was $480.4 million versus $432.9 million in the first quarter last year, and adjusted segment operating income was up $16.9 million of the first quarter last year to $86.6 million for a margin of 18%.
Our civil performance reflects a mix of higher training revenue in the quarter, offset by lower revenue from simulator deliveries, lifecycle support services, and a less favorable program mix.
We also incurred higher R&D investments to support our innovation pipeline.
In defense, the first quarter revenue of $413.3 million was up 43% over Q1 last year due to the integration of the L3Harris military training into our financials.
Adjusted segment operating loss was $21.2 million for the quarter compared to an adjusted segment operating income of $23.7 million in the first quarter last year.
The loss this quarter was driven mainly by the aforementioned contract profit adjustment.
and the more acute challenges than we expected stemming from staffing shortages, supply chain pressures, and slower order award.
These additional challenges had approximately $20 million impact on the Justice Segment operating income. It backlash has come to a close.
We also had higher SG&A costs for bids and proposals that were approximately $6 million greater than what we had in Q1 last year. The higher bid costs were expected as they are linked to our pursuit of larger opportunities pipeline, but they were more impactful given the other defense headwinds.
And in healthcare, the first quarter revenue was $39.6 million, up from $31.6 million last year. And just the 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 Mark to discuss the way forward. Thanks, Sonya.
As we look to the period ahead, despite the prevailing macroeconomic headwinds and added defense sector related challenges, we continue to see a clear multi-year path to becoming a larger, more resilient and more profitable CE.
Our outlook is as bright as ever. We're in the early stages of an upcycle 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 to entrust CE with their critical training in digital operational support and crew management needs, acute pilot demand and strong business jet travel demand are enduring positives underpinning a secular growth market.
Now the unevenness of the global recover is likely to continue for some time, but we're ultimately in an excellent position to benefit from the multi-year cyclical market recovery that's currently underway. We continue to expect strong roles in civil this fiscal year, driven by high demand for pilot training as evidenced by robust full flight simulator sales and the 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 holds for CE.
In defense, despite the additional challenges that we encountered in the quarter, the positive long-term outlook that we shared on our investor day in June is unchanged.
We're on a multi-year journey to become bigger and more profitable, and the first and more critical link in that chain involves winning orders.
Our record order intake last year and for the first quarter confirmed that we're indeed on the right path to growth.
And critically, the orders that we won over the last year and a half bear a profitability profile that's consistent with our long-term view to returning to a low double-digit margin in defense.
Furthermore, a record $9 billion of defence bids and proposals is the result of bidding more and bidding larger.
An important element of our strategy involves strengthening our strategic relationships with OEMs. And the memorandum of understanding we signed last month with Boeing is a great example of how the major OEMs recognize CEAs unique expertise in training.
We agreed to expand our international teaming and supplier networks to provide solutions that support both customer and regional development.
The external environment for defense remains largely favorable.
with some near-term headwinds having become more acute than what we believe temporary.
Current geopolitical events have galvanized national defence priorities in the United States and across NATO. We expect increased spending and specific prioritization on defence readiness to translate into additional avenues for CA to support our defence customers in the years ahead.
Although somewhat counterintuitive, the immediate priority on operational needs is actually contributing to training program or delays in the short term.
And taking all these factors into consideration, we're lowering our expectations for defence for the current fiscal year to account for the two US program charges that we just incurred and to reflect the more acute sector-wide headwinds that we're now experiencing, namely supply chain pressures, labour shortages and a slower defence contracting environment.
We had previously indicated our expectation for a back half weighted performance in defense this fiscal year, and as we managed through the effect of a protracted period of less than one time booked sales and begin to ramp up new orders in the second half.
The initial 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 healthcare.
The long-term potential continues for it to become a more material and profitable business within CE, as it gains share in the healthcare simulation and training market, and continues to build on its double-digit revenue growth momentum.
For CEA overall, we are reducing our outlook for the current fiscal year to mid-20% consolidated adjustment segment operating income growth from the mid-30s previously, which largely reflects our revised expectation for defence.
We greatly enhanced our position and expanded our addressable market over the last couple of years, and I have complete confidence in our team's ability to maintain a strong order of momentum and drive superior and sustainable growth in profits over the long term. Broadly speaking, we have a strong commitment to maintain a strong order of momentum and drive superior and sustainable growth in profits over the long term. We greatly enhanced our position and drive superior and sustainable growth in profits over the long term.
The underlying trend lines of our multi-year progress are very much intact and my conviction in C's long-term growth outlook is Resolute and as such we continue to target a three-year earnings per share compound growth rate in the mid 20% rate
With that, I thank your attention and we're now ready to answer your questions.
Thanks Mark. Operator will now open the line to members of the investment community for their questions.
Thank you.
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Our first question comes from Kevin Chang with CIBC. Please proceed.
Hi, thanks for taking my question and good afternoon everybody.
Maybe I could dig into some of the details you gave in terms of what happened in defense.
Mark, it sounds like you're confident that the provisions you've taken only relate to these two contracts.
I guess, you know, historically when we look at these type of issues, you know, a lot of times it ends up being a lot more systemic than...
than just one or two contracts? Maybe even give us a sense of why are confident that the issues that you found are isolated to these two contracts. Maybe what made these two contracts unique and why it's not more systemic in your backlog. And maybe any changes in your bidding process that might have occurred as a result of maybe this reevaluation.
Yeah, maybe I'll take it in two parts, Kevin.
I'll be the first one to tell you that the performance in the quarter certainly doesn't meet our expectations or my expectations for the defence business as a whole. I'll start with maybe...
the specific charges that we took. Again, I'm not happy with them and these were, I will tell you these were surprises to us that occurred in June as a discrete.
customer-led events that caused us to recognize these, but we re-baseline both programs following the customer and discussions we had in June . And I think we've taken an appropriate approach.
you know going forward and having to recognize the charge we took.
to give you a little bit more color on them just to tell you that you know we you know I feel pretty darn confident that you know you can isolate these programs.
because you would imagine, taking a step back a second, when you get impacts such as we've seen here, it forces a complete review of everything in your portfolio. You would have expected me to do that. So just to go back on the program.
on the first one on the Navy training contract Sinatra.
This is where customer demand has really outpaced our expectations. We train, as I said in their remarks, we train at five naval air stations, one of them being Corpus Christi, and the Navy has been training at very, very high rates, and very frankly, higher than we bid at. We bid this years ago. It's a legacy contract. We have put cost reduction measures in place.
to improve the profitability on that program. But what happened now is a shrinking time to realize the benefit.
because the contract comes to an end at the end of this fiscal year. And you ask, well, how could that be? Well, what happened here is that we, and we had very good reason to believe this, we anticipated that the customer would have extended this particular contract at updated terms. As I said, there's less than nine months left in the period of performance.
But, somewhat to us very surprisingly, we have yet to get an RFP.
which frankly, as I said, is pretty counter-intuitive.
given the very high customer usage to date, I mean, they're flying really, they're really, really trying very hard. Now, given the shortened period of performance, we just have no runway left to take any, to take account of any equitable adjustments, any measures that we've taken, reduced costs, we just don't have time. So we had to take the charges. Now, we haven't factored that, you know, these, you know, any extension of contract, which I fully intend to happen, so that's one to stay tuned on, but we have to take it.
I was on site on that program just less than two weeks ago. And I like to be able to look in the whites of the eyes of program managers, of engineers, of people working on a program. And I feel very confident about the re-baseline program. And I can promise you.
that this team is extremely diligent and will be even more so in the evaluations of the schedule and not only this program and all of our programs.
And you know, and not just to validate, 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, as I intimated in my remarks.
The following work on this contract is very large. I'm talking an order of magnitude here with the potential for very attractive margins when it reaches a mature state of production.
So look, I mean we...
Again, I'm not happy to inform this, but look, none of this to me changes our long-term outlook for the defense business that we outlined, for example, at the investor date.
Our orders that you've seen have been outstanding. We're tracking some very large opportunities.
And with respect to the short-term cost impacts, we have put a 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? The other factors affecting us.
I can tell you personally, my 35 years in aerospace industry having managed very large programs in the past, you know, full aircraft, the aircraft development programs, I've seen this kind of thing before. You know, big work, you know, introduces its very, very specific challenges. But I can tell you, I'm all over it, the team's all over it, and you're going to see us making progress in the margin rates in the coming efforts as those efforts take hold and that's what we've reflected in our outlook.
That's helpful. And maybe just like you just had an investor day, let's call it a day.
in the middle of the quarter, the middle of the previous quarter.
I guess these issues weren't evident at that time, I guess, just to state the obvious. When you look at that point in time, I guess at what point you realize that you have to start taking these provisions.
Late June , late June that's when it happened and yes it did come as a surprise.
I don't like surprises, you don't like surprises, we don't like surprises. But that's what happened. As I said, as we highlighted in the remarks, the discrete charges they're not cached at one time in nature.
We've rebase-lined every program in a portfolio. We've taken very specific actions on the rest of our programs. So I'm quite confident going forward. But if I expand it, look at it.
Even, I'm sure, the follow-on question might be that...
And I think we've anticipated in the remarks that even if you take those two charges out, this recharges.
the profitability of our defence business in the quarter is still very low.
and
I think we expected that. We expected that. Now, I would tell you I didn't expect that much, to be very frank with you. So you would be that half.
So we had, but if it wasn't for the charges that we've taken here, I think we largely could have probably maintained our outlook. But what we've had here, we just can't, I could expand upon that.
No, that's super helpful. I'll leave it there. Thank you for taking my question.
Thank you for taking my question. Thanks.
Thank you.
Our next question comes from Fadi Shamoun with BMO. Please proceed.
Yes, thank you. Good afternoon.
I guess I have a couple of questions. One-
it's the
In the guidance for mid 20% EBIT growth
If we're assuming civil is still on track to be mid-30, EBIT grows, it really implies a very strong.
performance in the defense in the next nine months. Like you would have to be doing almost 45% growth in EBIT in defense in the next nine months.
to basically be
be in that mid 20% EBIT performance for the year. So I just wanna make sure I'm understanding this because excluding the charges, the underlying profitability in defense was only 2% and you seem to suggest that.
you know
the headwind that kind of pressured that margin will continue at least into the second quarter.
Well it will gradually abate but we're still going to see it in the second quarter and as I said we see you know more of a substantial uplift in the second half which has always been our outlook but you know it'll pronounce my... I think look I'm not going to break it down from a sector standpoint Fadi. We purposely did not do that. You would expect I think that when you have you know issues like we had in the quarter...
we are adopting a company-wide effort on this. It's not, you know, we are taking actions that not only affect the defense business, but the business as a whole to maintain the profitably growth profile that we've indicated in our outlook. The other thing I would tell you is that, you know, I talked about somebody or although we've done 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's some orders that we really, frankly, totally expected to happen in Q1 that did not happen. Now, some of those orders, we have won them subsequently, I can tell you. And those turn into, because once I'm talking about which convert into revenue faster.
is products orders and therefore that when you take all of that into into consideration you will get to the outlook that talked about.
Okay, maybe the follow-up is you've always run a very fixed cost contract business in the defense. I think the majority of your revenues are fixed contract business. We've never really had this type of contract issues in the past.
Is there like
Is there, like, what's different that happened?
kind of recently to kind of make these, you know, cost performance deviate so much from your assumption. I guess you gave some explanation on the US Navy contract.
But is there anything changing in how the business is being awarded or the risk profile that you're taking on this contract that increases the risk of margin and defense or is this just a unique one-time kind of event here?
No, look, I think you're right. First of all, you're absolutely right that we haven't seen this before. All the time I've been at C, we have never seen this magnitude of impact in one quarter. No, you're absolutely right. And we haven't had a habit of running out of contingency on a program like that. And as I mentioned before, the Sinatra one, which is part of the chart, very specific in nature because the contract 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, you talked about the firm fixed price. About 80% of our contracts are about firm fixed price. Now that's actually, you know, that's a much better picture than we were, you know, before the L3Harris transaction. And it wouldn't be overly perturbed by that number because remember, there's a lot of service contracts in there. Service contracts were very, very high predictability and all of the others.
as I talked about, again, you get an event like this, it forces you. I'm not saying that we weren't monitoring the programs before, but clearly there's an extra level of scrutiny that occurs when a program like this happens. When we look at the contract, the fixed price contract,
that we have for this classified program that I visited just a couple weeks ago. This is a very complex program.
to be, you know, this we inherit this contract through the acquisition of Eltree 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 for the 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, you know, you know, literally over sixty-
you know, very highly cleared personnel working on this contract that were off on COVID for a long time and finding it very hard to replace them because they're cleared personnel. Could we have seen this thing better in hindsight? I would tell you yes.
I would tell you the measures that we put in place for increased level of program management oversight at all levels of the company are there. I'm pretty confident. In terms of extra factors, what's changed? I would tell you that what's changed is that what you see, we're not alone in this case, you see across the industry, labour shortages, supply chain pressures, contracting delays, and that's impacted our results significantly.
We anticipate some of those. They're worse than we thought. Now, one of them is labor, and it's labor.
When I look at our labor hiring in the last couple of months...
We have reversed the curve or actually, yeah, actually we're on the positive trend now. So we have the labor we need to be able to see through the contracts for the assumptions that we've made. So maybe I'll stop there, Fattie.
Okay, appreciate it. Thank you.
Our next question comes from Cameron Dirksen with National Bank Financial. Please proceed.
Yeah, 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 of that business. So, I'm just wondering if you can maybe talk about the change there. Why should investors think that this business is now going to be on track to ultimately getting to more consistent profitability?
Well, you know, I...
What can I say Cameron? I absolutely understand this is a show me story. What I would tell you 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 continues to be true that we've invested substantially in R&D and SG&A meaning Salesforce to be able to get the results that we have.
I would tell you the change that we had at leadership of healthcare 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 at healthcare. I 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's 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 that Jeff himself, who's a 19-year veteran of GE Healthcare and running large P&Ls for GE, he is the architect of, or the main architect, as head of sales for the run-up in revenue that 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 healthcare 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 shortage. What you have is, if you were to go to our facility down in Sarasota, which I've been quite a few times, you would see basically three quarters built products, medical mannequins, cardstock on better- extras, Songsets. Gotcha, sick O- M. Maybe Diane whoaks. Okay.
for example, and then when we get the parts we complete them, we take them out of storage, we put the parts in, we retest them, we ship them. You can imagine that causes a lot of inefficiencies over time. You know, basically quality issues, all kinds of issues that are not great for your profitability profile. But I'm quite confident that a lot of those are abating themselves. So I'm quite happy with the way forward and I think you'll see some progress in the course to come. Yeah, I agree, Mark. It's a great summary. I'll just add a little bit of a...
this walkthrough, we have to consider a little bit of, I guess, non-routine variability coming from R&D investment tax credits.
Okay, no, a great deal. Appreciate the additional information. I'll leave it at one question. Thanks very much. Thank you.
appreciate the additional information. I'll leave it at one question. Thanks very much. Thank you.
Our next question comes from Connor Gupta with Scotiabank. Please proceed.
Thanks for taking my question. Just want to follow up on the defense mix here. Just trying to understand, Mark, how do these two adjusted contracts impact the margin mix for 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 your remarks, that the
Although we bid them that way, we're quite confident the rebase finding of the programs that we've won, all the programs that we've won in recent time, certainly since we've had the new organization in place under Dan Gelson, the profitability profile of that backlog supports our objective of low double digit partisan defence. That's the first thing I would tell you. I would tell you as well that we have a very firm handle.
on the inefficiencies and other impacts that we had that affect the profitability of our business. And I'm talking, I've taken the two programs charges to decide for one second. I'm just saying the inherently low percentage in profitability defense in this quarter, this results from again, the inefficiencies that we had on labor, on parts, sometimes lead times on parts have doubled, doubled in the cost.
themselves have changed and introduced you know all kinds of inefficiencies that you would get on overtime things like that. Now again I would say that again I get a bit repeating myself that we had always anticipated.
that the first couple of quarters of this year in defense would be challenging for some of these factors that we could see. What I would say is that we're worse than we anticipated. It took us longer to get back and hire clear personnel than we thought. Part shortages impact us 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.
Again, leading into defense 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 costs this quarter are up very materially as we track some very large opportunities in our bid pipeline. We talked about some of this in our investor day. Thanks for your time and your help.
It's not very different from our internal expectations that we would bid higher, but some of these programs, I can tell you a couple of big Canadian programs, came at the same time in the quarter, and we cannot afford not to bid them. They are so large. So that causes a disproportionate amount of business proposal costs in this quarter, which is not necessarily going to be the same as we go throughout the year. Again, just to explain...
help you understand the quantum here. The expenses on big proposals roughly again doubled over last year and are up, you know, pretty much the same thing this year. But what you're seeing here is the pre-work that we're doing to capture the opportunities that Dan Gelson outlined at our investor date. We're attacking those hard and I think all of that answers your question as where we're going in defense and in terms of its profitability.
Looks great. I appreciate the details and transparency Mark. Thank you. Our next question comes from Benoit Poirier with Desjardins Capital Markets. Please proceed.
Yes, thank you very much and good afternoon everyone. Just to come back to healthcare, given the favorable valuation for healthcare companies these days and in light of the performance, would you consider potentially divesting these assets and just searching for a new leader, what are the qualifications that you're looking for in terms of a new leader for healthcare?
Well, I'll take your second one. It's basically a lever that's going to drive the profit and growth of our healthcare business, going to basically make it a more sizable contribution and a creative contribution to CA's results. That's the minimum threshold for that. And as I said before, I think so far, Jeff Evans is demonstrating to me that that is the case. So there's more to see on that front.
And look, as I said before, I am very confident in how healthcare fits into CA's overall portfolio, and it very much supports our noble mission, and there's substantial synergies across our organization in terms of facilities, in terms of people and technologies. So it's part of our portfolio, and there's no thought about changing that.
Just looking at the civil EBIT margin that came in below our expectation on the back of a higher utilization rate and lower equipment deliveries where margins tend to be lower. 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 civil margins to bounce back throughout the year? Thank you.
Well, look, I would tell you that civil is certainly my expectation. I think I've said this many times before Benoit, in any part of our business I would look at this quarter to quarter, but having said that, I'm very, very bullish and very satisfied of what I see in the civil business in the quarter and of course the indicators lead to the outlook. You look at the orders, you look at training utilization, it's 71%. 71% that is...
Prior to COVID, we said that's a pretty good utilization. And we're seeing, if you look at the results, and I'm sure you are, you look at the results with a fine-tooth comb, you're seeing that the cost reductions translate into a result. I mean, we're already, even at 18%, that may be down to your expectation. But don't look at it quarter for quarter because utilization, we said it before, is not a perfect measure.
You always have product mix that's maybe less favorable in a quarter. This quarter we had higher R&D expenses to support some of our innovations. For example, eVTOLs, we spoke about the investor days. In this quarter it's really down the mix and I fully expect you might look at next quarter, it might be the other way around. I remain very firm that this business is going to realize strong results in the future. Our results, to me, what I see, supports that. Very bullish.
Thanks for the call, Remar. Operator, we don't hear you.
Thank you.
Operator, are you still there?
Could it be could have it itself.
Hello?
Thank you. Our next question comes from the line of Benoit Poirier of Desjardins Capital Markets. Please proceed with your question.
Thank you very much.
Our next question comes from the line of Tim James of TD Securities. Please proceed with your question.
Thanks. Good afternoon everyone. I just want to change 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 of growing demand for virtual military training over live or just new applications record?
you know, in the simulation industry that support the secular growth story for simulation-based training. And I'm thinking of aviation more specifically.
Hello?
Pardon me, this is Frank. I can introduce the next question from Tim James from TD Securities.
Yes, go ahead.
Okay, can you hear me okay, Mark?
Yeah, sorry we don't know what happened there Tim. We just got radio silence for end we thought we lost line. All right.
I will have my question so well. I don't know if I can do it as well again here. I just want to, I'm wondering if you can update us on any evidence you are seeing, whether it's in this most recent quarter or maybe the last couple of quarters, of growing demand for virtual military training relative to live, or just new applications for simulation and the technology that support that secular growth story for simulation-based training.
increased use of simulation for training in the military continues and continues to increase for very real reasons that...
What does the military do when they're not in operations? They train for operations. That's all that they do. 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.
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 where you're intimating, which we are investing in significantly and are deploying in some cases, like, for example, AR, VR. As just an example, one of the contracts that we announced this quarter goes to that point where we're deploying a...
we're actually developing using ARVR a deployable trainer for people to be able to train you know when they're in operations or even down to a local sheriff's office of you know doing for example what they would have done in a 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 that's just one example there's plenty of that to go and some of the
You know, when I look at some of the very big real opportunities that are in our pipeline, represent that. Again, I would point to
to you at a large macro level, look at the bid pipeline, the amount of bids that we have out there has increased quite substantially and the orders that are at five-year highs in terms of our book to bill, it's the highest been in out of 12 months trailing basis, which I say always look at that, look at the 12 months trailing basis on our order.
it's the highest it's been in five years. I think that's demonstrating where we're going here in growth and defense. Okay, that's helpful. Thank you. My other question, just turning to the air center acquisition, at the time of the transaction it was indicated that sort of pre-pandemic that was a US$150 million dollar, I believe it was annual revenue business and about $55 million in any bit US as well. How should we think about kind of the or would we be wildly off if we
I'll ask Sonny if he wants to tell you what the contribution is, but first 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're on track. I'm feeling very, very comfortable. The reaction of customers, specifically airlines, I had meetings with airlines specifically, most recently at Barbril. They're very happy with doing this business. You yourself can tell him, we read it every single day, right?
the amount of inefficiencies that are out there, you know, gates, baggage hiders, pilots, you know, air crew being in the right locations with airplanes. That's all things that our software solutions offer to help manage and optimize for greater efficiency. And you know, heaven knows that that's going to be and we're seeing an increased demand for, you know, sea in this field. So I'm very optimistic. I just regard the, again, the integration is on track and
everything that we said in terms of how this business can contribute to CAE, to me, is right on track. I'll just add, you know, for the quarter itself it was not necessarily overly sequenced, but is significant, but we're working through the integration on track and expect us to ramp up nicely to the fiscal year. Now, you know, those benchmarks on pre-COVID are an indication of what this business can do at a more recovery rate and before even us
adding to the investment and elevating this with our bundle sales. So ultimately as the recovery plays out, we're very confident we can get to those numbers and even beat them as the recovery grows over the next couple of years.
Great, thank you very much.
Our next question comes from Noah Poponak with Golden Sacks. Please proceed.
Hi everyone.
Bye everyone.
All right. Hey.
The two programs that took a charge in defense
When were those contracts written? When did those programs start? They were, well they were legacy contracts. We took over one, the one that we called the classified program was signed to...
2018 on that that's it sent Sinatra prior to us by Emily we took over that contract when we acquired l3 this is a Sinatra contract with the legacy C contracts 2018 I know that for sure
Okay, and what actually cost more? Where 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 on. It's as simple as that. We had cost mitigations and other actions to make less of the impact of that, I would tell you, misbid. We did miss bid at the time.
I can tell you we don't bid that way now. In the past couple of years we've refined how we look at risk and how we bid military programs. This is one specifically that because this situation where we were with the customer is still utilizing those training assets at five bases at a much higher level of demand than was anticipated at the time.
That's what we're facing here. Now, again, we put mitigating factors in, the reductions in efficiency to improve that program, and we fully expected that the contract, we get an RFP to be able to extend that contract or to renew that contract because it ends in about less than nine months.
as I said, somewhat very surprisingly and counterintuitive because of the fact that the using is so high.
You know, basically we didn't get, not only did we not get...
… the contract we dual, but…
the IDIQ, getting a bit technical on this, the IDIQ number was changed, in which case, basically what it says is we had no additional period of performance in which for our cost reductions or other measures that we put in place to improve the profitability of the program to take hold. We just ran out of time. So basically, you have to recognize the loss at that point. And that's what happened. Thank you.
Do I think that contract will go forward? The Navy needs this training. It's going to happen. So to me, if we haven't baked in any upside on that, but again stay tuned on that one.
contract will go forward, the Navy needs this training. It's going to happen. So to me, we haven't baked in any upside on that, but again, stay tuned on that one.
So if those two are categorized as misbid, the way you run the business today, you don't bid that way.
What percentage of the revenue base at this point is exposed to possibly having been misbid?
Well, I would tell you that, as I said before, when you get something like this, you take very specific actions. And again, I'm not going to say we weren't looking at our programs 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, a center of excellence, if you will. So this was always part of our L3Harris merger integration plan.
But we've accelerated to bolster a company-wide program. Excellent.
we have re-baselined and triggered a complete top-down review of our portfolio on all of our programs to make sure that we have the right staffing, the right contractual provisions, and maximum visibility and transparency to make sure we don't get surprised again. I'm never going to say never, but what I would tell you, Noah, is that if you tackle the
All the programs, including the ones that were bid prior, have been looked at to make sure that we have the right provisions and the right cost to mess with and the right assumptions.
that we don't get surprised.
That's what we put in place. And Mark, that review is complete, or that review is in process? So that review is complete.
And did I hear you correctly earlier?
committing to a 10% operating margin in this business in your fiscal 24? Or did I hear that incorrectly? No, you didn't hear me say that. 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 in DNS. 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 goal, that backlog supports that goal. That we obviously have to execute them and that's where the measures that we've taken, you know this centralized program management organization for example gives me that confidence.
Again, I think as I said before, I've seen this kind of thing before run major programs. When you get this kind of impact, you just do things that are slightly different. I would tell you, you've got this and I feel very confident about the team in place of Defence to make it happen.
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.
As a reminder, to register a question, to please press the 1-4.
We have a question from Alison 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 semiconductors? Yes we have. That's been especially acute actually surprisingly in our in our healthcare business and I say surprisingly that's where we we have a highest concentration I think on what you know in an individual mannequin of chips which had a specific shortage but we've seen it.
Now, I would tell you that I think overall we managed it pretty well. So it's not just chips, but it's really what we're seeing across the board. It's that lead times for parts have extended and in some cases are literally more than doubled. It's not only an issue of the impact of the parts themselves not being there at the time that we need them, is that obviously that wreaks havoc to schedules.
So in order for us to maintain schedules, we have to do all kinds of things like, for example, paying expedite charges for parts. We have to conduct overtime. We have to conduct out-of-sequence work, which would reduce all kinds of inefficiencies. So maybe I'll just stand there, Allison.
Okay, fair enough. And just to follow up, what kind of demand are you seeing for Max 10 simulators? Just one If you could just
For what simulators? For what simulators?
Thank you.
Oh the MAX, I'm sorry, I'm sorry the MAX. Okay, no look, I think demand for the simulator for the MAX aircraft overall, and that is basically breaking down to MAX 8 or MAX 10. They're very strong, very strong, and it's part of the backlog that we've signed in simulator orders over the past, as well as training that we've signed in in the last 12 months.
Okay. And just to follow up on semiconductors, would you say that the shortages you're 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 in detail except for what I read in your newspaper, but what I tell you is the impacts have been real for us, but as I said, we know where they are, we know what our bill of materials is, and we know when we need the parts to support our schedule. So let me talk here quickly a little bit more boss, but before the Fed Science Committee
We have harmonized schedules for those parts of support in the forecast that we have, that we take to support the forecast that we have today.
Okay, thank you.
Great. So 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 SEAS website. Thank you. And that
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.
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