Q3 2024 CAE Inc Earnings Call

Speaker Change: [music].

Okay.

Good day, ladies and gentlemen, welcome to D. C H E third quarter conference call.

Please be advised that this call is being recorded.

I would now like to turn the meeting over to Mr. Andrew <unk>. Mr. <unk> you May now proceed.

Good afternoon, everyone and thank you for joining us today.

Before we begin I'd like to remind you that today's remarks, including management's outlook and answers to questions contain forward looking statements. These forward looking statements represent our expectations as of today February 14, 2024, and accordingly are subject to change such statements are based on assumptions that may not materialize and are subject to risks and uncertain.

Actual results may differ materially and listeners are cautioned not to place undue reliance on these forward looking statements.

A description of the risk factors and assumptions that may affect future results is contained in Cae's annual MD&A available on our corporate website and in our filings with the Canadian Securities administrators on SEDAR, plus and the U S Securities Exchange Commission on Edgar.

With the expected divestiture of our healthcare business, which is subject to closing conditions, including customary regulatory approvals.

All comparative figures discussed here and our financial results have been reclassified to reflect discontinued operations.

On the call with me. This afternoon are Mark <unk>, President and Chief Executive Officer, and Sonya Branco, our Chief Financial Officer.

After remarks from Marc and Sonya, we'll open the call to questions from financial analysts.

At the conclusion of that segment, we will open the lines to members of the media should time Curtis.

Mark over to you.

Thank you Andrew and good afternoon, everyone joining us on the call.

Our performance in the third quarter reflects the continued strong demand for our civil market solutions and points due to the ongoing progress to transform our defence business.

We generated strong free cash flow of the quarter, enabling us to further bolster our financial position in line with our leverage targets.

Also made excellent progress to seekers, she's future with nearly $1 $3 billion of total order intake for an 11 $7 billion backlog.

In civil we had strong financial performance that reflected the quarterly mix than we anticipated with demand for our commercial and business aviation training solutions continuing to be robust across all regions.

Operationally, we delivered 13 full flight simulators to customers during the quarter.

And our average training center utilization was 76%, which is up from 73% last year.

We booked $845 million of orders with customers worldwide for.

For an impressive 136 times book to sales ratio.

Which is even more remarkable on revenue.

That's 20% higher than Q3 of last year.

We also had strong order activity in our JV this quarter, representing another approximately $135 million.

Our training services orders, which are not included in the order intake figure, but are reflected in our record $6 1 billion.

Total civil backlog.

We received orders for 20 full flight simulators in the quarter, bringing our tally of for the first three quarters of fiscal year to 57.

Notable wins, including penetrating more share of the existing market with long term training services contracts with marquee Airlines, including Air France KLM group.

And we renewed a flight services contract with Azure all of Brazil.

We continue to have very strong momentum in business aviation as well with over $300 million of order intake in the quarter driven primarily by training services agreements with U S based customers, including Solaris aviation at Clay Lacy.

The continued high level of order activity this quarter across all civil segments underscores our ability to win share and a large secular growth market with <unk> highly differentiated training <unk> services solutions.

In defence.

Our financial performance was consistent with our expectations at this point on our path towards being able to generate higher margins in the business.

Defence performance was lower than the third quarter last year as we continued to retire risk on a group of distinct legacy contracts, which still here will describe in more detail in her section.

We booked orders for $429 million for a <unk> nine times book to sales ratio.

Giving us a $5 6 billion defence backlog, which is up from $5 1 billion in Q3 of last year.

They include a maintenance contract with United States Air Force for the F 16 train devices.

And the continuation of training services on the C 138 transport a KC 135 tanker platforms.

Defence orders also included the option exercise for the U S Army for fixed wing flight training and support services at the CAE Dolton training Center.

With that I'll now turn the call over to Sonya, who will provide you additional details about our financial performance. Thank you Mark and good afternoon, everyone.

Consolidated revenue of one point or a $9 billion with 13% higher compared to the third quarter last year, while adjusted segment operating income was $145 1 million.

Compared to $156 $8 million in the third quarter last year.

Quarterly adjusted EPS was <unk> 24 cents compared to 27 in the third quarter of last year.

We incurred restructuring integration and acquisition costs of $22 $5 million during the quarter relating to the Air Centre acquisition.

Spencer related to their center integration, which is progressing as planned and are expected to wind down by mid fiscal 2025.

Net finance expense this quarter amounted to $52 $4 million, which is up from $47 $1 million in the preceding quarter and up from $47 7 million in the third quarter last year. This is mainly the result of higher finance expense on lease liabilities <unk>.

Income tax expense this quarter was $8 $2 million for an effective tax rate of 12%. The adjusted effective income tax rate was 15%, which is the basis for the adjusted EPS.

As Andrew indicated at the outset healthcare is now classified as a discontinued operation and our net loss from discontinued operations was $1 $9 million this quarter compared to a net income from discontinued operations of $2 1 million in the third quarter of fiscal 2023.

The decrease to the third quarter of fiscal 'twenty, three was mainly attributable to transaction costs of $2 2 million incurred in the third quarter of fiscal 2024 in relation to the expected sale of the healthcare business.

Net cash from operating activities this quarter was $228 million compared to $252 $4 million in the third quarter of fiscal 2023 free cash flow was $190 million compared to $239 $8 million in the third quarter last year.

The decrease was mainly due to a lower contribution from noncash working capital and higher payments to equity accounted investees to invest in our civil training network expansion in support of our long term customer agreements free cash flow year to date was $227 million compared to $185 million year to date last year the increase was.

Mainly due to a lower investment in noncash working capital and higher cash provided by operating activities, partially offset by some maintenance capex and again higher investments in joint ventures to support growth.

We continue to target a 100% conversion of adjusted net income to free cash flow for the year.

Capital expenditures totaled $85 $6 million this quarter with approximately 75% invested in growth.

Specifically add capacity to our civil global training network to deliver on our long term training contracts in our backlog.

Our net debt position at the end of the quarter with approximately $2 1 billion, our net debt to adjusted EBITDA of $3. One six times at the end of the quarter.

To close the sale of our healthcare business before the end of the fiscal year subject to closing conditions, including customary regulatory approvals, we intend to apply a significant portion of the net proceeds of the transaction to reduce debt.

As we have said in the past the healthcare sale transaction is a milestone towards the reinstatement of cash returns to shareholders and the board is now actively evaluating options in terms of form quantum and timing of such return.

We're prioritizing our balanced approach to capital allocation, including funding accretive growth continuing to strengthen our financial position commensurate with our investment grade profile and returning capital to shareholders.

Now turning to our segmented performance.

In civil third quarter revenue was up 20% to $622 1 million compared to the third quarter last year and adjusted segment operating income was down 5% to $124 2 million versus the third quarter of last year for a margin of 20%. This is right in line with our expectations for the quarter and our full.

Year outlook for civil as expected there were a few differences in the quarter compared to last year, mainly from the mix of stimulation products revenue and flight services activity, which offset the higher training utilization and increased volumes from recently deployed stimulators and our network.

In defence revenue was up 4% to $472 $4 million, while adjusted segment operating income was down 18% to $29 million, giving us an adjusted segment operating income margin of four 4%.

<unk> margin. This quarter included the negative impact of the ongoing retirement of eight distinct legacy contracts that completion date, mainly within our next two fiscal years, but these contracts have in common and why we're monitoring them separately is that they were all entered into prior to the COVID-19, pandemic and our firm fixed price and structure with little or.

No provision for cost escalation. These contracts are only a small fraction of the business, but have disproportionately impacted overall defence profitability as they have been the most significantly impacted by execution difficulties and the broader economic headwinds we've discussed in past quarters, such as the compounding effects of inflationary pressures and disruptions to supply chain.

And labor to be more precise the execution of these eight legacy contracts had an approximate two percentage point negative impact on the defence segment operating income margin in the third quarter.

With that I will ask Marc to discuss the way forward.

Thanks Tanya.

Looking ahead at each one of our segments in civil we expect to continue our above market growth momentum for training and flight services solutions.

Underpinned by strong secular passenger traffic growth continued success penetrating shared returning market.

At a high level of demand for pilots pilot training across all segments with aviation.

For the current fiscal year, we continue to expect civil to deliver adjusted segment operating income growth in the mid to high teens percentage range.

For the year as a whole.

We continue to expect a similar adjusted segment operating income margin to remain in the range of fiscal 2023.

Naturally implies an especially strong margin for civil in Q4.

In addition to growing our share in training and expanding our position in digital flight services, we expect to maintain our leading share of full flight simulator sales and to deliver approximately 50 for the year.

We have considerable headroom for growth in the civil aviation market and our continued positive momentum underscores the strong demand for <unk> highly differentiated trading in flight services solutions and our ability to win share within this large a secular growth market.

Turning to defence.

We will continue transforming our business by replenishing, our backlog with more profitable work and by retiring their legacy contracts at Sarnia highlighted.

These two trend lines remain positive and we expect them to culminate in a substantially bigger and more profitable business.

Since augmenting the scale and capabilities of the defence business approximately two years ago.

We've grown the defence backlog by over 20%.

This sets us up very well for sustainable growth and includes a strategic and generational wins on next gen platforms that we've talked about in recent quarters.

Still to come and not yet in backlog are the Canadian fact in our pass programs that are currently in contract negotiations and are also generational in size.

The progress that we're making that we've been making to replenish and grow the backlog with higher quality profitable program is the best indication of what the future holds for fees defence business.

Together with a $95 billion pipeline of bids and proposals outstanding we continue to see positive signs of the transformation underway.

As we look to the remainder of fiscal 2024.

We expect defence to key pointing high quality profitable programs and in the fourth quarter, we expect to further accelerate the retirement of risks associated with the legacy contracts to the extent that we can.

Clearly, we want to get them behind us as soon as reasonably possible and we're closely monitoring monitoring them as a separate group.

We're highly focused on execution and expect to substantially reduce the negative impact from these legacy contracts over the next six to eight quarters as youre gradually retire.

The extent to which the ongoing risk retirement on these programs might impact defence margins in the coming quarters really depends on the actual timing of program Closeouts and our ability to mitigate these risks are.

Our dedicated teams are working to revise re baseline of some contracts seek equitable adjustments on others and defined program efficiencies overall.

And foresee overall, we continue to be highly encouraged by the demand backdrop that we're seeing it all segments and the growth that we expect by harnessing our global market and technology leadership in.

And the power of one see these factors combined with highly focused execution and a solid financial foundation for <unk> continued good growth momentum and then excess future for Steve.

And with that I'll. Thank you for your attention.

Ready to answer your questions.

Thanks, Mark Operator, we'll now open the lines to members of the investment community.

Thank you.

Ladies and gentlemen, if you would like to register a question. Please press the one four on your telephone you will hear a threefold prompt to acknowledge your request as to your question has been answered and you would like to withdraw your registration. Please press the one followed by the <unk> III.

One moment please for the first question.

Okay.

Yes.

Our first question comes from <unk> <unk> with BMO. Please proceed.

Yeah.

Thank you operator.

Thanks, guys.

So.

Trying to kind of see how to best think about the trajectory of defence margins.

Mark you mentioned.

The focus on accelerating the retirement.

Of risks associated with these legacy contracts.

Which I understand that this quarter the impact was 200 basis points.

And Theres also.

The idea of the backlog.

Growth in topline growth.

Kind of implementing higher margin contracts should be margin accretive as we go forward.

Does the margin.

Start to improve from the current levels that we're at right now or.

Are we stuck at these kind of lower level for some time.

The other thing what exactly you mean by accelerating the retirement of Bob you're able to.

To exit this contract earlier or is it a cost action that youre, taking to improve the performance of these specific contracts.

When we talk about accelerating retirement.

What we're really talking about here is that we're likely going to incur potential costs.

On a faster.

Yes.

Put it this way a faster timeline as we worked through the <unk>.

Execution on these contracts or even take actions like for example.

Our closeout somebody's contracts ahead of time.

And I can give you examples of that but let me just end it right now.

Because whatever we do we can offset it by mitigating efforts that we tried to limit the cost growth.

Let me just basically tell you some of the things that we might do look.

We might decide to D scope of contract and I'm talking about these eight legacy contracts that we've talked about we might decide that this scope of contracts what does that mean that means we coal hill and.

And we're looking at this in at least one specific contract.

Lean crude liquidated damage.

If that makes sense for us to cut off of future tale of programmatic risk on that program. So better to take that pain now it takes a lot more leaders given what I mean, but of course that depends on negotiations specifically that we have on <unk>.

Underway under the with that specific customer.

Other things, we might do as we might agree to alternate alternative terms or schedule and then we'll look at that on some of these programs as well.

We might incur a follow on contracts see an addendum.

Engineering change proposal on any one of these contracts they were looking at that and then that is a potential of some of these contracts that what we will do is give us more work in which case, we can spread the cost around over a bigger quantum lessening the impact of any individual products. So we're doing all of that so.

If I look back to your maybe the margin question.

Real quick to go to Sony on this one.

Look we saw that.

About 200 basis points, a quarter, but it was certainly on that without going too deep on that one but.

There's going to be variability from quarter to quarter for the reasons I talked about this is not going to be linear because we are taking active steps to try to retire. These contracts as soon as we can especially retired the risk take the right actions now might you were never going to give up.

On a customer that's not what we do see we will deliver the products and services that we committed to a customer that <unk> culture and don't forget that's the mission that we have in defence. So we're not going to do that but.

I mean, that's the way I look I would look at these centers.

Finally, before I give it to the Sony is the one thing I would tell you.

Is there is nothing new here.

Relative to the disclosure that we gave you last quarter in terms of the quantum of what we're trying to do here is to give you a little bit more precision on the number of contracts that are dragging our performance. These legacy contracts deterioration how long they last and the steps that we're taking.

Interactively mitigate now maybe.

Stop there turn it over to you. So can you just expand on the 200 basis at least for this quarter I mean, absolutely. Thanks, Marc Hi, Paddy.

What we've done this quarter has endeavored to ring fence. The few contracts that have a disproportionate negative impact on the business and doing so.

As you can appreciate this is a process there's a strict definition and we're committing to continuing disclosure to report back on these legacy contracts and our progress on them. So you can see that in this quarter. There was an approximate impact of 2% 200 basis points this quarter, but by the way. There's also an impact of an under.

Absorption of costs needed to achieve scale and support of all of the business like R&D and SG&A that can be up to another 100 basis points, So which makes the impact slightly higher at around 300 basis points now that's a snapshot for Q3.

Now I can say that the next six to eight quarters will look exactly like this is we're constantly working to all the.

Currently versus to mitigate these risks and Westwood work with our customers is as Mark has has highlighted so while there will be some variability quarter to quarter. This quarter's impact as a rough baseline of the headwind that we face on average.

Okay. Okay. That's great. So basically you are talking about a scenario where you can take these losses upfront then ultimately.

On the exit.

I don't know if that contract risk earlier, so thats whats going to be lumpy.

The the comment about the 100 basis point absorption as this guide too.

Backlog deployment and how quickly you deploy the backlog too.

<unk> cost absorption.

I mean by that.

As you drive volume and profitability you have a better volume to support all of these costs that are needed to scale and support a business of this size and growing so now at this level there is an under absorption.

That that you can assume has about a 100 basis points added to the 200 basis points.

Okay. So the timeline of six to eight quarters, that's kind of the most.

I want to say the pessimistic kind of timeline hopefully you can deal with some of these contracts earlier to take some of these losses may be earlier.

And move on from that.

Yes, that's definitely able would it be seeking to do.

Okay. Thank you I appreciate it.

Yeah.

Our next question comes from Kamran Dirkson with National Bank Financial Please proceed.

Hey, Thanks, good afternoon.

Maybe I'll ask a question on the civil business.

The utilization rate in the quarter was really strong, 76%, which I.

I don't have it going all the way back when it seems like maybe that's one of the best Q3's, you've had.

I'm just wondering if you could maybe discuss what youre seeing as far as demand across the various training components are you seeing any any changes there or is it continuing to be.

Drawn in the fourth quarter like we saw in Q3.

Camera, we're seeing very strong demand I can tell you I look out my window here.

The parking lot material I can tell you it's full.

Saying that but.

Perversely Thats a pretty good indicator.

What we say as utilization of our training centers and that's across all of the training centers I've seen no softening of demand then, yes, we said before.

So you can do the math, but we fully expect a pretty darn good Q4, and we have very good visibility on that because obviously, we're pretty close to the end and we know it's familiar with we have to deliver.

And again, we have some.

Very strong bookings at our training center and these days I can tell you nobody is looking to cancel bookings.

Okay. That's good to hear and just maybe just a very brief follow up to <unk> question just on the defence.

Mentioned, you may be seeking some I guess equitable adjustments I noticed something you've discussed in the past have you had any success. There I mean are you optimistic at all that Youll get some some relief from your customers with some maybe some pricing adjustments within these these legacy contracts.

I'm optimistic, but I'm not optimistic on the timing meeting because I can't.

I've been wrong every time.

I can tell you that.

The bulk of it we've gotten a bit I would tell you about give or take about 10% of what we believe that we are very very strong cases have documented.

Evidentiary.

Report claims into customers, but again there is this dependent on so many things that I don't control that and I would tell you. We have made some assumptions I would say conservative assumptions with regard to as we looked at mitigation on some of these legacy contracts that some of that is included but certainly not the full quantum.

Okay. That's helpful. Thanks very much.

Yeah.

Our next question comes from Kevin Chiang with CIBC. Please proceed.

Thanks for taking my question.

I know you don't have multiyear guidance or targets.

But if I just kind of weak if I rewind.

Let's say it back to fiscal Q2, and you provided an update on defence at that point in time, I think the market write it as you'd have around mid single digit EBIT margin.

For the remainder of this year, maybe get up to higher single digits in fiscal 2025.

And then you can normalize to a run rate closer to your target of low double digit sometime in fiscal 2026.

Yeah.

The fact that you haven't changed your.

Through your EPS target I'm, just trying to level set is that still the trajectory I think you can do.

Roll off some of these contracts or.

Despite the double digit.

EBIT margin, maybe Claudia here today, given the new disclosure you provided.

So clearly there is some dependency on the timing of the risk retirement.

On those legacy contract and the pace of the new programs ramping up and we're working this as indicated at the same time our outlook for civil remains robust we need to close out on the healthcare transaction that we expect to do so.

By the end of the fiscal year, and finalize that impact as well so we'll be providing more insight on all of these in Q4 as we usually do.

Okay.

I'll look forward to that.

Maybe strategically.

You're running about 21.

These past.

Okay.

Few quarters, you've been running kind of low to mid $20 million operating income.

I'm just wondering do you think the business is big enough to absorb these couple of pickups, what do I mean by that it doesn't seem like the absolute dollars impact from the legacy contract issues is large, but it's obviously coming off of.

A smaller base I'm just wondering.

I mean, this seems to be something you'll always have to deal with them to deal with the government at a fixed price contract.

How do you think about the ability to absorb even small.

Developments.

And.

To that end up being a little bit more negative than you anticipated and not having any kind of thoughts what margins.

Where they have the past the past year or so.

So I think the way I would look at it is.

What are we totally legacy contracts that were dealing with here.

They're not particularly large individually in terms of either revenue or backlog, but to your point.

They can and they are and they have introduced a disproportionately large costs.

In a given period as we work.

As we work through them.

If you do.

Active efforts that we have to reach a customer settlement are agreed to change in terms things like that so, but we have to remember as well that the.

Business is not as is not.

The size that we want it to be so in the end of the day. When you have a hit in any way the corners. It has a material impact because of the small small quantum that you have an absolute number.

That's a fair point, thank you very much and best of luck youre going to close out the fiscal year here.

Our next question comes from James Mcgarrigle with RBC capital markets. Please proceed.

Hey, good afternoon, and thanks for having me on.

So my question is with regard to how Youre looking at.

Deploying capital in the Defence segment at Sea.

Seems like returns on that business right now that they are below your targets.

Do you think there is enough room to improve margins to bring returns in defence within your internal targets or.

Any other things to consider with regard to how you intend.

To deploy that capital that's tied up in the defense business.

Yes, so we always look at a balanced capital allocation strategy James and the first priority is continue as we obviously continue to deleverage and drive to a.

Our flexible balance sheet is to invest in accretive growth and our top priority is to serve the demand that we see on the civil market and that organic capex.

Is highly accretive and drive returns of 20% 30%.

Incremental pre tax returns within three to four years. So wherever we have those opportunities that is the first priorities in terms of capital allocation now, sometimes we do deploy some capex on the <unk> on the defense side. Ultimately if we are to do so we would expect that to be on commercial terms.

<unk> been driving commercial like.

Margins.

Yes, maybe I'll just add to that so again and we've already talked about some of those like for example, the U S Army <unk> contract.

We will be deploying a global 6500 simulator.

In our existing facilities and the Dolton training center, where we already deliver the fixed wing training for the U S Army.

So and in that case as Tony said, we are because it's a commercial solution, which we deploy in business aircraft we can.

Enter into what's called a commercial contract with U S Army, which of course in that case would be capital, that's well deployed because there's going to be able to service.

With margins more like we get in kind of civil environment. So you can imagine thats accretive to return. Another example, I would give you that that is a contract that we've talked about for what was previous call. The place for 'twenty one contract with the we call. It is the ft SaaS contract, where we will be deploying capital to replace all of the simulators used by <unk>.

The U S Army.

What we call Port Rockers Port <unk>, not that again will be very accretive capital deployment in defence, because we will be able to enter into service contracts on delivery training curious army.

Again, commercial contracts, which are more favorable to us than traditional contracts in defence.

And then if we look at the book to Bill on the defense side. It came in below one.

You did point to some.

Funded backlog.

So kind of within that backdrop, how should we be thinking about growth in this segment.

Looking ahead is it fair to say you expect topline in defence to be higher in fiscal 2025 versus <unk> 24.

Hey, guys.

So.

To your point the order intake is <unk> nine.

It's slightly below one, but I would look at the overall total total backlog because there is the dynamics of kind of the first year funding and so on so you can see the growth.

In in and the backlog that we're expecting some big Q4 Awards, Mark Q4 Q1 Award.

That mark spoke about some large Canadian.

Contract that we have been selected.

And then we're expecting those to come in and that will drive some significant order intake and backlog growth.

Yeah look defenses defensive growth businesses as I've said in the remarks.

We have 20% backlog growth in last two years and that doesn't include contracts that we've been selected on like that.

Aircrew training in Canada, and in Europe as traded contracts. We've missed selected those two contracts are really generational advise we are not under contract yet. So you got to figure out Okay. We got to get under contract fully expect that to be in the first half of next year and then we got to turn those start turning to revenue. So there'll be timing involved but there's no doubt this is a growth business.

And sorry, just one quick follow up on the.

The defense side before I turn it over or low margin contracts that are rolling off this.

Contract you've identified are those EBIT positive I guess.

As those contracts roll off although they might be accretive to margin is it EBIT neutral or are those are losing money right now.

We don't necessarily give the details of the contracts individually I think it's a mix.

So they will be they are not particularly large on the revenue, but have that disproportionately impact on.

On the <unk>.

The costs are.

But I think the best measure to kind of look at it is a margin.

Okay. Thank you very much.

Our next question comes from <unk> Gupta with Scotiabank. Please proceed.

Thanks, operator, and good afternoon, everyone.

Just to follow up on defence marks.

What has been dedicated theme that we have deployed for these legacy contracts achieved so far if you can give any concrete examples what is their mandate going forward.

Oh mandates a successful execution of the contrast to deliver what we committed to deliver to our customers first and foremost with all of that because thats what fees about and we have a critical mission defence, which.

It goes without saying what to do and Thats first and foremost and of course deliver it under the best financial terms that we can and thats. What they are mandated so execute on the contracts and get us to that softness lending than we can with regards to retirement of risk on those contracts work with our customers to try to do so.

This win wins.

To.

Re scoped to shrug off these go to.

Move the schedule to providers of scheduled aviation get request for equitable adjustments, where we definitely are entitled to get them because of the extremely high inflationary environment that we've had to disproportionately.

Affected our costs those are all things that are that our team is doing and I would tell you.

Just put these teams on overnight based teams have been working for some time and they have had good progress in executing and reducing the reducing the burden that we're facing here in defence.

Already we're already seeing the fruits of our labor here, which allows us to give them more precision that we gave you today.

Okay. That's great color, thanks, and if I can just quickly follow up on <unk>.

Any change in discussion on language from customers from airline customer, especially in light of the <unk> hundred 20 engine issue that we saw recently as well as now the Boeing seven selling problems.

The thing I would tell you is no no because airlines are scrambling to meet the demand that they see out there now.

<unk> is real.

The impact of the engineers could you just talk about Israel, you get hundreds of airplanes grounded at any given time would not having some effect. So we're watching that I would tell you it hasn't affected our business the airlines.

We yes.

We operate with it which is a great majority of airlines in the world, but are scrambling to be able to get altered list whether it be keeping.

Older airplanes.

On station rather than you was leasing this thing or was that kind of thing.

So we're watching that we're also watching the delivery delays specifically because the math is simple right I mean, we've talked about it many times before but for every about 30 narrow body.

Deliveries that because it's a regulated market.

Fills up once simulators, where for demand. So clearly if this was to go on for a long long time, then that would add effect, but for now based on the discussions that we have with customers. There's still a lot of unmet demand in this market.

You can just see it with regards again to the order intake this quarter I mean, we're talking to a very strong book to bill on top of 20% growth in revenue.

And what you see there is a testimony to our success and more outsource things.

Very happy joined another marquee customer like Air, France Air, France, KLM, which historically have thought of how stores outsourcing a portion of their training requirements to us the growth they have a very large contracts and business aviation so look.

To me where we're.

We're seeing no.

Basically seen a softening demand and going back to your question the conversations with with it that we have with <unk>.

<unk> lines of business aviation customers are essentially like the one I just described.

Yes, that's great color. Thanks.

At the time again.

Okay.

Our next question comes from Bill <unk> with <unk> capital markets. Please proceed.

Yes, thanks, very much and good afternoon.

Just to come back on the defence margin, if we strip out the 200 BP impact from the legacy product. It implies that the base is running at around six 4%, which is obviously far from double digit level. So could you maybe give us more color on occupancy to be taken to breathe.

The base to double digit.

Is it related to delays in funding is it a matter of scale revenue loss since the acquisition of L. Three or all European caused these days too.

To support the Hyatt bidding environment.

Yes, perhaps a couple of points there. So first on your point of the 200 basis points as I as I mentioned earlier on the call. There is a 200 basis points as a reflection of the impact of those legacy contracts, but there's also the impact of the under absorption that we should consider so these are the costs needed to achieve scale and support.

Business like R&D and SG&A, so that could be another up to 100 basis point, so I'd use that basis of 200 to 300 in total.

Additionally, as we've mentioned in the past the delay of the ramp up of new expected orders and especially the transformational ones because they move the needle.

So as these start to come in and start that really reflect to the revenues that we spoke to it last quarter. It was 3% its really still minimal representation in the revenue, but yes.

20% of backlog so as these start to ramp up more materially that so we expect that to step up and drive a meaningful impact.

Okay, and what is the strategy within defence business now to ensure that you don't run into contract issues like this in the future.

Well I can tell you that.

There's a lot of tuition validates what we've lived this for the last three years so those lots.

And they were well implemented.

I think firstly and foremost which is obvious and we have a lot of commonality with our peers in the defense industry across the board here is were certainly not getting into firm fixed price development contracts because a lot of cases.

What got us into this situation in the first place where you have development contracts.

That fixed price you incur delays because well first of all we went through COVID-19 with everything that goes along with that with regards to.

Part shortages with manpower shortages on top of everything escalating.

Basically compounded escalation with regards to an inflationary environment, but we have no protection.

A lot of things that obviously, we're not doing there's other things that we're doing like for example, making sure that we band service contracts.

Established will be tighter pricing bands. So utilization. So we don't get caught out that if the customer uses more or less of the demand that we somehow are disproportionately affected.

I would tell you there's a number of things, but thats what were doing.

And a very tight monitoring of execution at all levels.

Okay, and just looking at the civil margins you reached 20% EBIT margin this quarter, which is a step down versus $2 25, 4%.

Could you. Please let us know what drove that and what makes you confident to achieve the implied 26% plus EBIT margin in Q4 in order to reach the.

Double digit.

Growth for the year.

Okay, I'll separate up to say I didn't tell you 2000, <unk> said that but hey, Okay. We said you can do the math, but look.

I think if you go back to what I think what I said to in the last conference call in the last quarter I tried to point to that so I would tell you the margins as I said are there, where we expected them to be and I'll give you. Some of the components here does it vary there's mix is very much at play here and we've talked to.

Mix before and yes. This mix was kind of high.

On the base of it is.

I would point out last year in Q3, the mix was very favorable from a couple of perspective. It was from our products business and that's also what from.

Kind of the new segment that we have but not a segment that is part of <unk>.

Civil which is our software business because last year, we had a lot of what we call very favorable on premise work and I'll tell you what we mean by that in.

In our software business, we are actively as a strategy.

Winning contracts, we're trying to move customers from on premise work to software as a service. So let me make you an analogy that if let's just say on premise where it would be like us in the core business to sell simulators. Just so simulator you get the revenue to get the contract.

Literally very fast.

Contrast that with the training market going through a software as a service is kind of like we're doing in training, where basically we're going to get paid overtime. So.

Much better recurring standpoint, much more long term very attractive work, but obviously, it's not it's not going to give you a bit soi bump in one quarter, that's what we see and when we look at the upcoming quarter in Q4, we expect that kind of digest that.

<unk> dynamic to be very favorable again, and thats really coupled with a number of simulators.

Ever and utilization in our training centers, that's why we're basically saying we expect a strong Q4 Q4, reflecting the heightened guidance that we gave for civil of last quarter.

Okay, and maybe last one for me if we look at are center. It looks like that there was about 1 million of integration and acquisition costs. They can so far obviously the valuation multiple was very attractive and you knew that it would be a two or three year journey.

You just mentioned that infrastructure integration will be substantially complete by mid fiscal year 'twenty five. So I'm just wondering if you could give an update on the remaining cost to be taken and how much are center could be incremental in terms of margin and whether it's meeting.

Any color about the return on capital employed specifically so far thanks.

Yeah. So we continue the integration of our customers on our systems to our network and as I mentioned in the remarks, we expect to be done.

By by mid next year, So there's really good great ramp up of migrating our customers out of the.

Previous network into our network and so great.

Progress done last quarter, and we expect a lot of great progress this quarter as well so while we weren't necessarily kind of give an outlook on the costs, we expect that to be pretty much finished.

During.

And the next first half of next year.

Okay. Thank you very much for the time.

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

Thanks, very much good afternoon.

Most of my questions have been answered, but I just had one quick one for Sonya just.

Looking at some detailed here.

<unk>.

Depreciation expense in the civil business.

Jumped surprisingly significant amount in our in.

In the quarter relative to the second quarter I'm looking at in particular, just the sequential change was there any particular reason for that is this new.

The reported the Q3 rate a good proxy going forward.

Well I think the headline is growth right. So we deployed 20 emulators last year 13 year to date this year and we've on boarded.

Overall training center with its Las Vegas, Havana came online this quarter.

We have.

Another extension of our Phoenix Training Center that came online also this quarter, so youll see that.

Driving that depreciation expense and some of the interest that I spoke to on the lease liability, it's really deployment of new simulators and a new new training centers.

Okay. So it is just a natural step up then.

<unk> to the assets in the business.

Yes.

Great. Thank you very much.

Yes.

Our next question comes from Kristine <unk> with Morgan Stanley. Please proceed.

Hey, good afternoon, everyone.

Hi, Christine.

Hey, Mark.

You just reiterated that the margins for that for the next quarter I mean, it seems like for <unk>.

40, 24 to get to your guidance that implies about <unk>.

16% revenue growth for the quarter year over year and margins, you know a little bit north of 26%.

With all the mix headwinds that you highlighted.

This quarter and it seems like some of that goes away next quarter, how do we think about the run rate for fiscal year 'twenty five is 26% the starting point.

And how do we think about that.

For next year.

Well I'm not going to question your math.

But we've given you enough, but look we're not guiding for 25 now, but clearly I mean, you look at the order intake that we have the book to Bill that we have and I think you're going to see strong growth.

Great and Mark in terms of the software business I mean, it's all sort of software as a service, especially the neighbor historically you know would be.

Very accretive margin I mean, when you look out a few years for the composition of software within civil how large could that be.

Well again, you're asking me for.

Very guidance that we're not ready to give that at this time, but obviously, we built we bought this business to grow it and I've been very happy with the order intake that we've had from customers. There's a lot of interest from key airline customers.

They see.

And I've been.

We're quite satisfied with the assumption that we had from day, one that people would be various airline specific will be very receptive for us, bringing six culture into this business and we're seeing I would say of course customers that are basically moved away from legacy Sabre and.

And once we bought it and that then with the efforts that we've had the customer outreach the product development. We've had the investment that we've made a bid that they've come back to us. So look without giving you any precise decision on number I see this growing and I see.

That's a very strong interest in us delivering what we call our nextgen solution, which is software as a service and thats going to be pretty good for recurring revenue going forward. Obviously, we've got to get through the the time it takes to move to on premise to a software as a service and Theres a lot of theirs.

There's a lot of history from other companies to do that but suffice to say that I'm very optimistic.

Great. Thank you.

Our next question comes from Anthony Valentini with Goldman Sachs. Please proceed.

Hey, guys you got Anthony on for Noah today. Thanks, So much for taking my question.

Other.

So I just wanted to ask on the defense business. We're hearing from a lot of the U S defense primes that they're they're shifting their strategy in terms of how they are bidding on contracts.

Getting away from fixed price and going more towards cost plus.

Is that something that you guys are also implementing into your strategy can you just talk about that a little bit apps.

Absolutely absolutely I mean look.

The impact that we've had.

Fixed firm price contracts that.

Our development type contracts.

Going through the period that we've had through Covid has been very very good conventional and impactful and we see them in our results and we're going to see them as we've talked about any of these legacy contracts now having said that we're going to work with our customers all the time.

Although we might not do that we're going to be imaginative and working with our customers to give you. An example that in some cases and we have entered.

Two new contracts, where the government specific instead okay.

We agree with you that you don't necessarily necessarily have to take the costs, which have a lot of inflation relative to revenue due to them and consider metal pass through contracts. So basically the cost of what the cost will be so so yes, I think we are basically.

We're impacted by the same thing that a lot of our legacy peers across the industry and I think we're taking the same kind of actions.

Okay. That's helpful. As a follow up there. So now you had mentioned.

200 basis points basically like a drag from these challenge programs and then another 100 basis points.

Like the overhead absorption. So if I just kind of use those numbers and that implies something like a seven 5% margin.

What's remaining thats going to drive this business to get to those double digit percentages that you guys have historically talked about.

Well as I mentioned, it's really the ramp up of the new contracts that we signed and especially those transformational one.

They are large in size accretive and they will have a meaningful impact on the margin as they wrap up their really.

Nominal right now in terms of our result, our revenues and so as those ramp up the bill.

Have a more meaningful impact.

Okay. Thanks, so much guys I appreciate the time.

Yes.

Our next question comes from Jordan <unk> with Bank of America. Please proceed.

Hey, good afternoon. Thanks for taking the question so just.

Hopefully a final one on defence margins.

Yeah.

Our double digit target.

How confident are you in that timeline being 2025 are you starting to see that accretion from new contracts.

If we still continue to operate under a continuing resolution for this year.

Much downside risk to you guys look at if.

If we go through sequestration.

Let me let me just started off look again as I said.

What we're talking about this quarter is no different that we've been talking about it.

Certainly in the previous quarter, we've moved we've already got busy move things out.

What we're giving today is more precision specific on these legacy contracts that give you an idea of what this represents.

By itself and also to give you a feeling that we're quite confident in the core of this business. This is a strong business that will work through these legacy contract.

If I try to maybe give you a little bit more color specifically the question yet.

There continues to be two pieces here.

The growth in the core business, which is very strong and which is influenced by the ramp up in the transformative new business that we've talked about the 20% growth in the backlog that we've had last couple of years at the same time as the retirement of these legacy contracts, which dragging.

Again, the overall margin.

So we clearly see as we said we were before that theres going to be an inflation, where these two curves meek.

And while we still predict is that something that happened in the latter half of next year. There's no change there, but I think may happen, but I think maybe where it gives me a little bit more precision as actual drag impact in this quarter and introducing the fact that this isn't going to be linear theres going to be variability because of the spin.

The actions that we're taking to retire risk, but depending on the timing of their private at risk at our efforts to retire them as quick as possible is going to affect that but the trend. The trend line driving inflection is the one we've been talked to is very much intact.

Great. Thank you.

Awesome.

Our next question comes from Lee with <unk> Brown. Please proceed.

Thank you thanks for taking my questions.

Mark.

Sure.

Three year EPS compound growth rate target hasn't changed from the mid 20% range.

I know you don't aren't really when I talk about the.

2025 guidance since you have a private but.

Target implies pretty strong growth next fiscal year and I just wanted to get a sense of how.

How you see that target right.

Right now in terms of whether it's a scratch or do you think you are pretty confident that you'll achieve it can you just maybe comment around that.

Well I'm going to turn it over to the Sunny and as you answer that question I think a little bit a while ago, but look its got it.

The bottom line is just we're not ready to give that guidance right now would give it at the same time a year, that's going to be next quarter.

But clearly it's going to be some dependency on the timing of the risk retirement defence and the pace of new programs ramping up when we actually sign these generation contracts such as the one fact that I talked about.

At the same time the outflow for civil remains very robust and you just saw the order intake that we signed this quarter on top of one three.

Over $1 three on top of 20% growth in.

In.

And our revenue so.

All of those have been factored anything you want to add the same now you've covered it and we'll provide more insights in Q4 like we usually do.

Okay and just another question on the defense outlook.

Basically it sounds like relative to your expectations and your outlook going forward and nothing really changed from the previous quarter.

You've provided additional guidance the market's reacting very negatively.

Additional information on the legacy contract market's reacting very negatively around that what's your thoughts around how the market's interpreting that.

<unk> got additional information.

Long go stopped predicting that one I think we do.

Run our business and.

And just.

I know that repeat everything I said, but I feel very confident about that we have a business in defence.

I would just go with the point this is not a business thats broken. This isn't this is a business thats growing with contracts going to be accretive to the margin expectations. We have we have a lot of backlog in my experience in all my career.

The one thing you want to have is backlog because you have backlog as long as your backlog is profitable and it is profitable as profitable. The aim is that we have we're attacking very specific contracts here that are all very similar although the contracts themselves are different they all point to the same kind of thing pre COVID-19 fix.

Firm price and were attacked him when laser focus with dedicated tier teams while at the same time not keep getting keep our eye on.

Our eye off the ball of the hundreds of other contracts that we executed defence at any given time make sure we continue to execute execute those.

On plan, which we fully expect to do so with all that.

Yes.

That's basically performance my confidence.

In the defense business, albeit we have.

Where we are.

Okay. Thank you.

Yeah.

Thank you operator questions at this time.

Operator, thank you given that were on the hour I'd like now to open the lines to members of the media should there be anyone with questions for Mark Estonia.

As a reminder to register a question. Please press the one four on your telephone.

We have a question from Stefan <unk>.

From that price can adjourn. Please proceed.

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Operator.

All the questions, we have I want to close the call here and thank all participants on today's call and remind you that a transcript will be available shortly on <unk> website.

Yeah.

Speaker Change: Spot on.

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Yes.

Ladies and gentlemen that does conclude the conference call for today, we thank you for your participation and ask that you. Please disconnect. Your line. Thank you.

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