CAE Inc

TSX:CAE

Earnings Call Transcript 2022-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the CAE 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 Arnovitz. Please go ahead.

[Andrew Arnovitz]

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 11, 2022, and accordingly, are subject to change. Such statements are based on assumptions that may not materialize and are subject to risks and uncertainties. Actual results may differ materially, and listeners are cautioned not to place undue reliance on these forward-looking statements.A description of the risks, factors and assumptions that may affect future results is contained in CAE's annual MD&A available on our corporate website and in our filings with the Canadian Securities Administrators on SEDAR and the U.S. Securities and Exchange Commission on EDGAR.On the call with me this afternoon are Marc Parent, CAE's President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer. After remarks from Marc and Sonya, 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 Marc.

[Marc Parent, President, CEO & Director]

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'm very pleased with our third quarter performance, especially in the context of a still challenging global environment. We delivered double-digit growth, strong free cash flow. And we nearly doubled the order intake compared to the third quarter of last year.On a consolidated basis, we grew revenue by 15% before the contribution of our ventilator humanitarian initiative last year. We also grew adjusted segment operating income by 16% and delivered $0.19 of adjusted earnings per share.Underscoring the cash-generative profile of our business, we delivered a healthy $282 million of free cash flow. We also made excellent progress on the orders front, building even more forward momentum with nearly $1.4 billion in orders or a book-to-sales ratio of 1.62x and a backlog of $9.2 billion.In Civil, we had strong performance with double-digit growth in training and segment operating income, and we had margins break above 20% for the first time since the start of the pandemic. Third quarter average training center utilization was 60%, up from 50% last year and was 7 percentage points higher than last quarter. To me, this is an impressive result, considering a wide-ranging disparity in commercial flight activity and training demand across regions and because Omicron began to spread in the last month of the quarter. As we've been seeing since the start of the fiscal year, demand in the Americas was by far the strongest, while Europe and especially Asia Pacific continued to lag the recovery, leaving significant headroom to return to pre-pandemic levels.In business aviation, training demand was also robust, reflecting the high level of flight activity, which was above 2019 levels in the United States and Europe. We had very strong order activity in Civil in the third quarter, booking training solutions contracts valued at $753 million or a 1.93 book-to-sales ratio, including 19 full-flight simulator sales. This is in sharp contrast to the 11 full-flight simulator orders that we booked for the entire fiscal year last year and brings our full-flight simulator sales for the first 9 months to 33. Since the end of the quarter, we signed orders for another 4, bringing the year-to-date tally to 37 full-flight simulators sold.Consistent with the more advanced air travel recovery in the Americas, over 60% of the year-to-date totals are from customers in that region and include full-flight simulator orders from major U.S. carriers -- from actually all major U.S. carriers, including orders for multiple full-flight simulators for some of the largest United States airlines this quarter. Our airline customers in the Americas have been adding back flight capacity and actively ramping up pilot hiring.In order to secure the training capacity that they require, they've been working with CAE as their training partner of choice, entering new long-term training agreements and acquiring additional simulators. We think this makes for a compelling preview of what an eventual broader global market recovery holds for CAE.Notable training contracts for the quarter include 5-year extensions of commercial aviation training agreements with Endeavor Air and Avianca, a 9-year commercial aviation training agreement with Norwegian as well as 5-year business aviation training agreements with Global Jet Luxembourg, XO Jet and Vista Jet.In Defense, we also had double-digit growth in the quarter with the contribution of L3Harris Military Training. And as we expected, we surpassed the $30 million mark in adjusted segment operating income. I'm especially pleased with our order intake, which totaled $593 million in the quarter or a 1.39x book-to-sales ratio and a $4.6 billion backlog.We seized on the opportunity of the temporary relaxations in pre-Omicron COVID-19 restrictions. And as a result, our international book-to-sales ratio was above 1 for the first time since the start of the pandemic. In addition to the positive book-to-sales, we're also seeing more conversion on our defense strategy to pursue multi-domain training and mission support solutions. Orders to date included competitive prime awards, recompetes and contract expansions across all 5 domains: air, land, sea, space and cyber.In the air domain, we strengthened our international presence with the German Air Force's competitive selection to provide ab initio pilot training, replacing the sixth year incumbent. Along with this new live flight training program, we also expanded our relationship with the United States Navy's Chief of Naval Air Training, or CNATRA, by adding T-45 live flight training to our instructional services contracts. Beyond live flight training, we were awarded a 19-year base plus options contract from an Australian customer to provide integrated support and training on a range of strategic platforms.Other contract expansions included 4 task orders on our Simulator Common Architecture Requirements and Standards, or SCARS, single-award IDIQ as the U.S. Air Force accelerates the integration and standardization of approximately 2,400 simulators across 300 locations.Since the end of the quarter, we've made additional notable progress to broaden our position beyond our core defense, air, land and sea programs by winning our first competitive prime contracts in cyber and space. We were selected by Canada's Department of National Defense to expand cyber intrusion detection capabilities on the Innovation for Defense Excellence and Security, or IDEaS, program. And we were awarded our first prime simulation contract in the space domain with a key U.S. customer.These strategic cyber and space prime contracts, along with our first U.S. Intelligence Community competitive prime win in the second quarter, are great examples of how we're building our defense business for the future by establishing it as the world leading platform-agnostic, training and simulation pure play, ensuring mission readiness by integrating solutions across all 5 domains.And finally, in Healthcare, we delivered our fourth consecutive quarter of double-digit year-over-year revenue growth, excluding the ventilators, as we ramp up our reenergized organization with a clear focus on achieving greater scale. We launched updates to expand the feature set and functionality of some of our main product solutions, including learning space by simulating -- simulation center management system and Vimedix, our ultrasound education platform. We also introduced 11 new on-demand online digital courses, featuring virtual simulation in collaboration with the British Columbia Institute of Technology.With that, I'll now turn the call over to Sonya, who will provide additional details about our financial performance. I'll return at the end of the call to comment on our outlook. Sonya?

[Sonya Branco, Executive VP of Finance & CFO]

Thank you, Marc, and good afternoon, everyone. We delivered double-digit year-over-year growth and strong free cash flow during the third quarter, notwithstanding the ongoing challenges of the pandemic. Our performance reflects CAE's resiliency and the strength in some of our end markets as well as our excellent progress to expand our reach and lower our cost structure.Consolidated revenue of $848.7 million was 2% higher compared to the third quarter last year and was 15% higher, excluding the $93.5 million of revenue in the third quarter last year from a contract to provide the Canadian government with ventilators as part of our COVID-19 humanitarian initiatives.Adjusted segment operating income was $112.7 million compared to $97.2 million last year. And quarterly adjusted net income was $60.7 million or $0.19 per share compared to $0.22 per share in the third quarter last year. We incurred restructuring, integration and acquisition costs of $47.2 million during the quarter related to the L3Harris Military Training acquisition and the enterprise-wide restructuring program underway.Cash provided by operating activities this quarter was up 32% to $309.6 million compared to $234.8 million in the third quarter of fiscal 2021. Free cash flow was also higher at $282.1 million compared to $224 million in the third quarter last year. The increase was mainly due to a lower investment in noncash working capital, partially offset by cash payments of approximately $38 million related to the integration and acquisition costs of our recently acquired businesses and costs associated with our restructuring program.Growth and maintenance capital expenditures totaled $76.9 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. Our growth CapEx is directly linked to our opportunities to invest incremental capital with attractive returns and free cash flow. With several attractive market-led expansion investment opportunities on the horizon, we continue to expect total capital expenditures to be more than $250 million in fiscal 2022.Income tax expense this quarter was $2.6 million for an effective tax rate of 8% compared to an effective tax rate of nil for the third 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 20%, which is the rate used as a basis to determine the adjusted net income of $60.7 million and adjusted EPS of $0.19.Our net debt position at the end of the quarter was approximately $2.3 billion for a net debt-to-total capital ratio of 36.5%. And net debt-to-adjusted EBITDA was 3.23x at the end of the quarter. We continue to expect interest expense of about $35 million as a quarterly run rate going forward.Now turning to our segmented performance. In Civil, third quarter revenue was $390.1 million versus $412.2 million in the third quarter last year. And adjusted segment operating income was up $21.4 million over the third quarter last year to $83.4 million for a margin of 21.4%. This highly improved performance was driven by higher training utilization, predominantly in the Americas. And including our interest in joint ventures, Civil training services revenue was approximately 10% higher compared to the third quarter last year.The higher revenue in training was offset by lower products revenue with the delivery of 7 simulators this quarter compared to 10 last year. The lower number of scheduled deliveries in the quarter was expected and is consistent with our outlook for approximately 30 deliveries for the year.In Defence, third quarter revenue of $426.5 million was up 42% over Q3 last year. This includes $127.9 million from the integration of L3Harris Military Training into our financials. We indicated on the call last quarter that we would expect the segment operating income to cross into the $30 million range, and indeed, it did by reaching $32 million for the quarter, including $19.6 million from the acquisition for a margin of 7.5%.The organic Defence business grew sequentially this quarter, but remained lower compared to last year because of prior-period COVID-19 impact on orders and program interruptions, particularly internationally, which have been persistent since the onset of the pandemic.And in Healthcare, third quarter revenue was $32.1 million, down from $120.9 million in Q3 last year on a statutory basis, but was up 17% excluding the ventilator contract last year. Adjusted segment operating loss was $2.7 million in the quarter compared to an income of $12.9 million in Q3 of last year. The decrease from last year was mainly due to the contribution from the ventilators in the prior period and COVID-related labor disruptions and the higher costs. We're also running a higher level of SG&A expenses to help accelerate top line growth with a view to sustainable scale and profitability.With that, I will ask Marc to discuss the way forward.

[Marc Parent, President, CEO & Director]

Thanks, Sonya. As we look to the period ahead, we continue to see a clear path to emerge from the pandemic a larger, more resilient and more profitable CAE than ever before. Testimony to that, we're already delivering stronger financial performance, expanding and optimizing our position and booking substantial orders.Pandemic-related headwinds may persist for some time, including supply chain disruptions, employee and customer absenteeism due to COVID-19 infections, operational constraints imposed by local authorities and intermittent border restrictions the emergence and rapid spread of the Omicron variant this past December has certainly extended the time line to a broad global recovery, but has not changed our position and our positive view of CAE's potential as our end markets eventually open up more broadly as we emerge from the pandemic.In Civil, a greater desire by airlines to entrust CAE with their critical training and digital operational support and crew management needs, higher expected pilot demand and strong growth in business jet travel demand are enduring positive, underpinning a secular growth market. The global recovery continues to be narrowly led by the Americas, which means significant upside remains for a more global recovery, and we think the Americas provide a preview of the kind of demand to follow in other regions when conditions permit.Since the end of the quarter, we've had to contend with Omicron-related employee customer absenteeism. However, the Americas are still strongest. And we're currently seeing some increased demand for training solutions in Europe as COVID-19-related travel restrictions begin to ease and airlines plan for what they expect will be a more robust summer travel season and beyond.As an example, easyJet just recently announced a drive to hire 1,000 new pilots over the next 5 years with CAE as their training partner of choice. Asia Pacific is currently the most challenging region with relatively low levels of flight activity and training demand as Omicron now makes its way through that region.Overall, since the end of the quarter, our training centers have been holding at about 60% average utilization levels globally. In business aviation, we remain bullish on the long term, and we believe that the market is experiencing a structural expansion with 3.3 million flights worldwide in 2021, the most on record for a single year.COVID-19 headwinds bear mentioning here as well as Omicron and quarantine requirements were disruptive for a schedule in January for both our customers and CAE instructors. But we look to be back on trend, and we're seeing strong demand for training, propelled by robust flight activity in the United States and Europe.And in simulation products, we're encouraged by the higher projected delivery rates of new aircraft coming off manufacturers' production lines as one of, of course, the main drivers for full-flight simulator sales. We're seeing higher demand, as evidenced by this quarter's full-flight simulator order intake, coming mainly from customers in the Americas and Europe. And we expect to maintain our leading share of the market.The unevenness of the global recovery is likely to continue for some time, but we're ultimately in an excellent position to benefit for the multiyear cyclical market recovery that's currently underway. We continue to expect strong growth in Civil for the current fiscal year overall.In Defence, the paradigm shift from asymmetric to near-peer threat and a recognition of the sharply increased needs for digital immersion-based synthetic solutions across all 5 domains in national defense are tailwinds that favor CAE's business. Given the increasing relevancy of training simulation, our Defence unit is also on a multiyear path to becoming a larger and more profitable business. We're currently focused on the successful integration of L3Harris Military Training, and we're on track to fully realize the $35 million to $45 million of cost synergies that we laid out by fiscal year 2024.The pandemic continues to make international opportunities slower to materialize, but this headwind is temporary. And we have a strong pipeline with some $6.2 billion of business proposals pending customer decisions.Our increased orders in the quarter puts Defence on the path to achieving over 1x book-to-sales for the rate for the year for the first time in the last 3 fiscal years. Our U.S. defense business was also impacted by pandemic-related employee absenteeism in January, and it currently faces a temporary budgetary headwind on contract expansions and new program starts as a result of the continuing resolution. Defence is indeed managing through its share of ongoing challenges, but we're moving in the right direction, and we remain confident that we'll deliver strong annual growth for fiscal year 2022.And lastly, in Healthcare, we're focused on achieving greater scale by gaining share in the simulation training market. And we're targeting some of the largest pools of value like nursing. Supply chain restrictions, disruptions and staffing shortages are a near-term headwind for the business, too, but we continue to expect a double-digit growth for the fiscal year, excluding the ventilator contract.On the ESG front, I want to highlight that CAE was included in the 2022 Bloomberg Gender-Equality Index for the fourth consecutive year. This award recognizes that CAE is committed to support gender equality through policy development, representation and transparency. We're proud to continue building an inclusive workplace every day.In summary, we've been definitely playing offense during this period of market disruption by investing organically and seizing our 9 acquisitions to enhance our position and broaden our market reach. We've also strengthened CAE by permanently reducing our cost base across the enterprise.The time line for a broad global recovery is more extended, but our actions and our performance to date give me even greater confidence that we're on the path to strong cyclical recovery and secular growth as our markets eventually open and we all emerge from the pandemic. We're delivering on what we say we would do.And I expect to see the continued driving higher levels of profitability on a significantly larger base of business and with a post-pandemic capital structure that will allow us to sustain ample flexibility to further invest in our future. Our opportunity set continues to look very attractive, and I've never been as confident about CAE's future as I am today.With that, I thank you for your attention, and we're now ready to answer questions.

[Andrew Arnovitz]

Operator, before we open the lines to questions, I want to highlight that Marc last month was honored with one of the world's most prestigious aviation awards, having been named Industry Leader of the Year by the Living Legends of Aviation. We're very proud of him and how this reflects positively on all of us at CAE. So please do join me in congratulating Marc.We'd now be pleased to take questions from analysts and institutional investors.

[Operator]

[Operator Instructions] And our first question comes from Kevin Chiang of CIBC.

[Kevin Chiang]

I echo Andrew's congratulations there, Marc. Maybe if I could start with the Civil margin performance. As you noted, first time during the pandemic, north of 20% despite utilization still tracking below pre-pandemic levels. If I look at it quarter-over-quarter, it looks like incremental margins were about 65%. Just trying to get a sense of where you think the margin trajectory goes here as utilization get back to kind of pre-pandemic levels of 70% to 75%. Could this be a mid-20s SOI margin business given all that you've done within the mix of revenue there?

[Marc Parent, President, CEO & Director]

I had trouble catching the last part of your question, Kevin, but I think I get the gist, and maybe I'll try it and let me know if I answered it. Look, I think I'm very pleased, obviously, with the margin performance that we had in the quarter in Civil, 21.4% margin driven off essentially similar revenue that we had last year. And maybe just I'll pause on that.When you look at the revenue, it looks like it's slightly down relative to last year for good reasons, so the mix environment and the fact that we had lower deliveries in our products. But remember that we don't want to consolidate JV revenue, and that's not an insignificant number, and that's because of accounting. If you were to add back the JV revenue, what you'd be seeing is training revenue is up about 10% year-over-year.But coming back to the margin, look, as I said, I'm pretty happy about that. You're going like 18%, I think, to 21% -- 21.4%. I think what you're seeing there is, first of all, the mix of business. You have business aircraft, which I've always said has an attractive margin profile. We have a very good -- very nice position in market in business aircraft. Business aircraft is doing great. You're seeing that transpire.You're seeing commercial aviation training in the U.S. doing pretty well. And really, a big way what you're seeing is our cost savings, which are structural, coming through the numbers. So that's what you're seeing.And of course, we've always said that we fully expect that margins -- because of all those reasons, that margins going forward should track higher than we've achieved in the past. I think our peak Civil margin was just about 22% historically. I would certainly expect to blow through that on a sustained basis. I mean obviously, one quarter doesn't make a year and will be variable. But that would -- to me, that would be the trend as you get more utilization.And I think the last thing I'll add, of course, as I said in the remarks, is all of that is achieved on a pretty narrowly led recovery that's really United States. So I think that's why you sense my confidence, the excitement me as the broader recovery across the globe comes to bear.

[Kevin Chiang]

That makes sense. Just turning to Defence. I just wanted to clarify something. So if I look at the time that you acquired the L3Harris Military Training business. If memory serves me correct, I think at that time, you had called out EBITDA margins of roughly 15%, I think. And if I look at what those margins look like since you've acquired it, it looks like it held in pretty well, whereas your legacy margins have tracked about half, if not a little bit below pre-pandemic levels.It sounds like you're talking about primarily a lot of international restrictions. Is that primarily the reason for the underperformance in margins and you need to see these travel restrictions get eliminated before they can get back to 10%? Or is there anything else kind of holding those margins back?

[Marc Parent, President, CEO & Director]

Well, I think there's a few things in there. I mean you're absolutely correct. As we cited, the Defence business is not immune to COVID, both in the L3Harris business, particularly in the international side of that business. I mean the international portion of L3Harris business, so the one we've inherited through our [indiscernible], is lower than our organic business, but it's still affected nonetheless. And so it's seen its share of impact there as you couldn't travel to a lot of those locations.We've also seen some effects of, as I mentioned, the continuous resolution in United States that prevents us from having new program starts or expansion of our existing programs. So that has definitely been a headwind, and we hope to see that being resolved pretty quickly. I could point to contracts that we're on. Like I mentioned the SCARS contract in the United States; and the GBSD, the Ground Based Strategic Deterrent, contract that we're on in United States for our L3Harris business, our ex-L3Harris business.Those are big contracts. And because you have the CR, continuous resolution, you're not -- I mean the contractors themselves, if I think about the prime contractor on GBSD, are not able to make progress in enlarging that contract, so that affects us. And I don't know, I think maybe that -- Sonya, do you want to add anything to that?

[Sonya Branco, Executive VP of Finance & CFO]

Yes, I'd probably kind of talk to the organic base business and what we talked to, and this is still the case. The base business, first of all, it did sequentially increase both top and bottom line for us since last quarter. But as you know, our organic business has a higher proportion of international business. And as Marc just talked, that's the one that's been the most disrupted by COVID, especially international product program. So a couple, which are usually higher margins for us.So first, interrupting execution of existing backlogs, so in certain regions where contract execution has slowed or even stopped. And as restrictions lift and programs can restart, that will help advance on both revenue and contribution, but also the impact of delays in order intake, especially on the international side.We've gone several years, at least definitely since pandemic, with book-to-sales less than 1 as contracts are selected, et cetera, but not necessarily moved to awarded.Now we've seen some good advancement in the quarter with the book-to-sales on the international side going above 1. And so as those take traction, whether there's the restriction is lifted and we secure those delayed orders on the product and international side and then, of course, on layer on the continued synergies that we're starting to ramp up with the acquisition, these will contribute to growing both on the top line and the profitability.

[Kevin Chiang]

That's helpful. And maybe just last one from me. I appreciate the pipeline of opportunities you see in Healthcare? And I think there are a lot of synergies with your core competency in terms of what you're trying to do there.But maybe explain to me like when you have an incremental dollar of capital, why Healthcare would be an appropriate place to put that versus what you're seeing in Civil and Defense. It just feels like you've got better scale in those businesses. You can generate, I would imagine, better incremental returns. I guess explain to me what, why a dollar to Healthcare would make sense versus the other 2?

[Marc Parent, President, CEO & Director]

Well, I think the first thing I'd point to, other than the fact that we continue to strongly believe in that Healthcare will become a more material part of CAE in the not-too-distant future, that I'm quite confident of that. But I think the thing I would point to, just specifically the question of capital deployment, is that the business is largely self-funding. I think essentially all of it's self-funding. And so the question that you asked, there isn't really no decision to be made with regards to that.

[Operator]

The next question comes from Konark Gupta of Scotiabank.

[Konark Gupta, Analyst]

Congrats, Marc, on your accomplishments. So maybe my first question, just following on the back to Kevin's question on Civil margin. Obviously, you saw a pretty strong performance here. I understand the business jet training, which is higher yielding and then cost savings as well going through. But anything sort of nonrecurring in nature you think are not going to recur again in Q4 or the future quarters you saw in Q3 perhaps that you can speak to?

[Marc Parent, President, CEO & Director]

No, no...

[Sonya Branco, Executive VP of Finance & CFO]

Konark, this is just really, I think, a step up in operations, really a 35% increase in SOI on still 60% utilization, lower deliveries. So it's really the mix. You see the operating leverage that's coming from that increase in utilization and the cost savings. So I think there's no nonrecurring items, just strong performance on the Civil side.

[Marc Parent, President, CEO & Director]

It's all good stuff, Konark.

[Konark Gupta, Analyst]

Okay. No. I was just kind of like more curious about seasonality in the business, right? Obviously, you have probably -- business jet training is stronger in the fourth quarter, and then it kind of drops off in the first half like sequentially. So like does business jet make seasonality actually more pronounced in margins because of these dynamics here?

[Marc Parent, President, CEO & Director]

I think we still have the normal seasonality, although it's not as pronounced this year just because there's so much disruption across [ everything ]. Look, it's too early to say, but I wouldn't expect so. I wouldn't -- based on the mix that we have, I don't expect that we'll see a profound change. At least I don't see any so far. Would you add anything, Sonya?

[Sonya Branco, Executive VP of Finance & CFO]

Well, I would just caution that there is always volatility on quarter-to-quarter margins, right, because of the mix and so on. So we always kind of give a view on an annual basis. But I think there's no significant ups or downs there.

[Konark Gupta, Analyst]

Okay. That's helpful. And then a couple of things on Defence side of things. So it's rebounded sequentially certainly with both margins and revenue. And I think last quarter, Sonya, I think you probably would have mentioned that you expect something in the 30s shortly and then eventually in the 40s in terms of SOI. What's your visibility now with the kind of recent order intake at Defence? Does it give you more confidence in that $40 million-plus SOI number shortly? Or you still think that it's ways out?

[Sonya Branco, Executive VP of Finance & CFO]

Well, so I think great performance on the order intake, and of course, that gives you confidence to have -- to build on future growth. And what we like is that it's both on the U.S. and international side, both over 1x. And so like we spoke about it last quarter, we expect it to be in the 30s in Q3.And then based on a few factors, securing the late orders, especially on the product international side as restrictions lift enough and consistently to be able to advance programs that we have in backlog and then layering on the synergies, that gives us kind of line of sight at around $40 million.Now great order intake, but it does take a while to ramp up these orders. So -- and the average life of these orders are over several years. So yes, it's a great -- refilling the backlog gives us better confidence for the quarter, but we'll see a lot of that ramp up maybe -- just a start of that ramp up in Q4 and the rest for the upcoming years.

[Marc Parent, President, CEO & Director]

Konark, one thing I want to just point out here, going back to your previous question there or at least the first part of this question is that biz jet training is usually the strongest for us in Q4. I don't expect that to change. The one thing, as I mentioned, we were impacted, like most everybody else in January, with a lot of instructors off with the COVID-related sickness. But we're having a strong [ start ] and we're back on trend.

[Konark Gupta, Analyst]

That's helpful, Marc. And actually, on the Defence, I wanted to ask you another question on L3Harris. It showed some sequential improvement in margins. So I'm just kind of wondering if there is some seasonality to that margin? Or was there any synergies that you kind of realized early on?

[Marc Parent, President, CEO & Director]

Yes, on the synergies. We're certainly seeing the synergies come through. And I guess what I would say is -- I've always said, in Defence, it is no different that one quarter does not make a year. It's always been lumpy. I would expect it to remain lumpy, but you are seeing some synergies come through.

[Sonya Branco, Executive VP of Finance & CFO]

Yes. I'll just add, Marc. We're ramping up the integration efforts. There were some redundancies actions, consolidation efforts, et cetera. So you're starting to see some of those synergies flow through. And depending on where those synergies lie, because they could lie in the organic or the inorganic basis, it will drive from volatility. In this case, it fell more on the inorganic side. But to Marc's point, that can drive some volatility in the quarters and so on in between. But essentially, that's -- the synergy is starting to come through.

[Operator]

The next question comes from Fadi Chamoun of BMO.

[Fadi Chamoun, MD & Analyst]

Again, around the margin, Sonya, you were talking about 65% incremental margin this quarter. Is there a reason why you can't sustain this level of incremental margin going forward? I'm just kind of triangulating a little bit. You still have low utilization. Travel recovery is still in the early stage. And that training network typically have very high incremental margin. Is that the right framework to think about the aviation business in the next 2 years as you kind of move up that utilization curve?

[Sonya Branco, Executive VP of Finance & CFO]

We're also starting -- we see the -- obviously, the mix from business jet, which helps on the margins, and that mix will vary especially as we hopefully see CAT appreciating on the margins as well. But you're right, the operating -- we're starting to see the operating leverage on the utilization kind of flow through and also a big chunk -- a significant part of cost savings.Now the slope on those cost savings will start to slow, but it will just kind of continue to help on the operating margin so -- on the operating leverage rather. So I think it's a very good performance. And like Marc said, we see this with volume contributing to exceeding prior -- pre-pandemic.

[Marc Parent, President, CEO & Director]

Don't forget, Fadi, of course, that the future revenue will include a greater proportion of full-flight simulator deliveries and ab initio kind of work or Parc Aviation kind of work. So that is a different margin profile. So you can't obviously consider it's all trading revenue. So yes, to your incremental margin, but certainly not straight line, right?

[Fadi Chamoun, MD & Analyst]

Okay. Okay. That's helpful. The follow-up question is on the air mobility market, the eVTOL market, I guess. You're doubling in it. You have some partnerships kind of coming through right now. I'm just trying to understand like what exactly you're helping these partners like -- I guess you've got Jaunt and a couple of others. What exactly you see involved with these partners in terms of helping them set up the training, I guess, going into these big launches?And two, what does this market look like 3 to 5 years down the road? Does it look like more business aviation where you're providing full turnkey solutions? And if you have any color around what kind of size market are you potentially looking at over the medium and longer term?

[Marc Parent, President, CEO & Director]

Yes. Thanks for the question. I think, Fadi, the first thing I would object to is the word doubling, doubling in this market. We definitely intend to be a major player in this market. I think it's a very exciting market. I've said that before. I think it's a market that will materialize before anybody thinks it does because it's so compelling.In the history of aviation, I'm a bit of -- as I think you know, a bit of history buff and especially in aviation specifically. And what has always stimulated the growth of the aviation is newer power plant technology.And what you have here is new power plant technology specifically distributed electric power plants and the immense software systems that permits you to have these very complex vehicles that are inherently unstable to be able to be economically produced. So that's why you see a plethora, a large number of these companies coming through to produce vehicles of all types to serve this air mobility market.So see, we're not picking winners and losers here in this market. What we're doing is we're getting involved. And by the way, we -- it's not -- yesterday we became involved. I went to a major conference, and I say major invitation-only conference about 4 years ago in this market, was held in Texas, where all of the players at that time were getting together and really saw the potential for this market.So short answer to -- going back to your question is I certainly believe that this market is going to be needing about over 60,000 pilots over the next 10 years. And there is no way that these pilots that are going to fly these vehicles are not going to be have to train to a high level in order to operate in the airspace that we have today, and congested airspace, because by definition, these vehicles will fly in and around cities. So they're going to have to be trained.So what you see is us positioning ourselves as the company we are. We can help, first of all, define the kind of training infrastructure and kind of training standards that will be required by training these pilots of these vehicles, working with the companies, working with the regulators and offering the service. And as you say, it may be a business aircraft type construct or it may be involving selling devices. It will be a combination of both. It is being defined today just as this market is being defined today. But make no mistake, I fully expect CAE to be a major part of that market.

[Fadi Chamoun, MD & Analyst]

Okay. That's great. Maybe the last question, you mentioned about kind of how the aviation demand has been led by North America, i.e., U.S., I guess, in particular. Wouldn't kind of a pickup in the travel in Asia and some of these markets that still are behind in the recovery be more attractive to you? Because you tend to do a little bit more wet training or a little bit more turnkey solution in those markets.

[Marc Parent, President, CEO & Director]

Well, I think the -- I think -- if you're able to look at the overall market for us in training, we've seen business aviation itself, training, doing very, very well. Of course, you know that's all wet. So that's very good. The rest of the world, I think when I point to -- when the recovery comes back in Asia Pacific, we tend to do on average a bit more wet in that region. But I think I would point to training and commercial aircraft as a whole.Today, Asia Pacific is operating at about 50% than it was in pre-pandemic. So there's a lot of recovery left to have in that market. So definitely, I think that any expansion going back to normal 2019 levels, whether it be wet or being dry, is going to be good for CAE. And whether it be Europe, whether it be Asia Pacific, again, look back at what's happening in the U.S. In the U.S. today, it's a narrow led recovery. People are scrambling to train their pilots. They're buying more simulators.If you look at the recovery in the simulators that we've had just this year relative to last year, it's quite impressive, largely driven by the United States and some in Europe. So imagine that rolling over into Europe and Asia Pacific. And I think there's a large potential for that. And I think that leaves us to where our asset base is. Today, about 33% of our simulators or about 54 simulator equivalent units are in the Americas.In Europe, they are about 44%, about 72. In Asia Pacific, 36. What's interesting, though, is as we talked about during the pandemic, we moved stimulated a lot of simulators and we launched a lot of simulators to go where we thought, using the Gretzky analogy, where the puck was going. And where a puck was going was where training demand will be. And no surprise, it's being led by the United States.So if you look at going into next year, where our simulators are, we're going to have about the same number -- an absolute number of simulator equivalent units in the Americas as in Europe. So we're seeing -- we're shifting our asset base to where the demand is. And I think that's going to be pretty attractive. And that's impressive, especially considering that we acquired FSC in Amsterdam. So inherently, we've added a lot of simulators in Europe itself. So the fact that we're going to be on par, I think, is a very good move that we've made, guaranteeing the future for us.

[Andrew Arnovitz]

Operator, if I just interject for a second here, we still have quite a few people on the line wishing to ask questions, and we'd like to get to all of them if we can. Maybe at this point, we would restrict to 1- or 2-part questions, so that everybody gets a chance.

[Operator]

The next question comes from Cameron Doerksen of National Bank Financial.

[Cameron Doerksen, Analyst]

I'll stick to one question. Obviously, we've got maybe a little more visibility today on how the airlines are going to recover. Maybe there's certainly some markets that are a little more uncertain. But I guess maybe, given that greater visibility by many airlines, can you talk a little bit about what you're seeing on, I guess, the potential for outsourcing?I think one of the issues in the last couple of years that airlines just didn't know what their fleets were going to look like and when the market was going to recover. But as I said, there's probably a little more visibility today. So I'm wondering if any of those kind of talks around outsourcing deals have picked up at all?

[Marc Parent, President, CEO & Director]

Well, there's definitely, again, a high volume of conversations occurring, and there are some contracts occurring. And you're seeing that as a testimony to the amount of simulators that we've deployed in the United States specifically. I was pointing an answer to Fadi's question, the fact that we've been increasing the number of simulators quite substantially in the United States.And some of that is for business aviation, which is growing. But another large part of that is for the commercial aviation training network. And all of those simulators are going essentially to either new airlines that are starting, which are going straight to an outsourcing model; or to airlines, including legacy carriers that are entrusting CAE with long-term contracts for training.So that's not de facto a complete outsourcing, but it's definitely a different trend that you see where airlines to -- in order to be able to secure the training need that they have on an acute basis, they're willing to and they're seeing the attractiveness of going into long-term contracts with us. So that is the difference. But there is continuing conversation.And I would say that we're certainly not in a steady state. I mean with -- yes, there we're maybe better than we were last year. But Omicron has turned a bit of a monkey wrench into any kind of steady state in the airline business right now.

[Operator]

The next question comes from Kristine Liwag of Morgan Stanley.

[Kristine Tan Liwag, Equity Analyst]

Marc, domestic U.S. air traffic had a very steep recovery. So if global air traffic follows a similarly steep recovery, let's say, second half of the year, I mean, we don't know, but should it happen, can you discuss any labor or supply chain constraints that could slow down your ability to meet a potentially roaring demand? Because with the footprint that you have there, it sounds like it should be a pretty good year, should we see that air traffic come in.

[Marc Parent, President, CEO & Director]

I don't see it. I don't see it -- certainly, I don't see any kind of parts or related issues that way. Labor, I don't see it. I think that we're well positioned. We spent a lot of time during the pandemic, especially the first year, we -- if you go back to some of the things I was saying at the beginning, I said we would take advantage of the period that we have of lower demand, a lower demand environment to optimize our training network. And that's where you see a lot of recurrent and permanent cost reduction coming through.But we also said that we keep our powder dry. And powder dry, meaning that I said it right from the beginning, people are not going to give up the freedom they have to travel. And we see that. We see that in certainly the domestic flying in the United States. So we're going to see that. And I see no structural reason that we will not benefit from that recovery. And when that time line is, certainly, I think the Omicron has likely extended that recovery time line maybe, but that will be measured in months, certainly not in years. So call us very confident in the long term.

[Kristine Tan Liwag, Equity Analyst]

And if I could squeeze a second question on the MAX here. I mean, in December, we finally saw the airworthiness directive from the CAAC stating the return to service on the MAX. Are you seeing any acceleration in training activity on the MAX from China?

[Marc Parent, President, CEO & Director]

Well, we're definitely seeing training for the MAX. Training of the MAX is at high levels. It has been for a while. On the return to service, even before the return to service, people could see the airplane is going to go back into the sky. So I would just say it's a high level of activity, and I foresee that continuing as more and more MAXs are being delivered. And in China, I think what you'll see is that will manifest itself in largely in full-flight simulator sales.

[Operator]

The next question comes from Benoit Poirier of Desjardins Capital Markets.

[Benoit Poirier]

Congratulations, Marc, for your prestigious award. And Marc, we've seen some M&A among the airlines with Spirit and Frontier. Any thoughts on whether M&A could slow down or accelerate outsourcing? Can you see more M&A activity among the airlines, Marc?

[Marc Parent, President, CEO & Director]

Well, I'm not going to predict it. I'll let -- inevitably, what the -- whenever that kind of event happens, it's usually a catalyst for us to have a discussion with them because the airline itself is looking for new ways of doing things. So I think to me, that's where I would leave it. I can't be a predictor of how much M&A they would have.But certainly, there's a lot of opportunity in airline business today. Conversely, it continues to be a number -- quite a number of new airline starts, and that's a good opportunity for us as well because we offer a ready-made international -- actually a global network of training solution. So offering them a solution that was never there before. So I think that's good for us.

[Benoit Poirier]

Okay. That's great. And my follow-up is for Sonya. You provided great color about the booking for Defence, the fact that it's been spread out on the global scale. Anything particular to highlight on what drove the big change in momentum during the quarter? And for the free cash flow generation, was there anything unusual in the quarter? Or should we expect another strong fourth quarter?

[Sonya Branco, Executive VP of Finance & CFO]

I'll start on the free cash flow. I think this very, very strong performance in the quarter of $282 million, that's on strong operational performance. And as you know, it's a very cash-generative business. It's also driven with a solid noncash working cap reversal in the quarter with over $200 million of reversal. And that's really continued persistent focus on working capital, improved collections, conversion of work-in-progress into AR and cash and a reflection of higher orders.So higher orders come in with milestone payments and deposits on contract. So that contributed to a really good performance of free cash flow. And that's despite continued cash payments on the restructuring program, which was about $38 million in the quarter. So nothing unusual, just strong performance and good reversal of working cap. And we've guided to continued 100% free cash flow conversion of net income to free cash flow.Now on your first question, I didn't quite hear on the Defence side.

[Benoit Poirier]

Just in the sense, there's been a big change in the booking for Defence. I was curious to get more color about what drove the big change positive tone in terms of booking with respect to Defence, Sonya?

[Marc Parent, President, CEO & Director]

Well, maybe I can answer that, Benoit. Look, we -- it's the big pipeline of orders that we've talked about, the bids that we have that are waiting for customers to pull the trigger really, that's -- you see a lot of that. We took the advantage, especially internationally, where right rig before Omicron, we had a period of time there we could finally start traveling and people were willing to meet us.So I can tell you, we took our international teams, took the opportunity to really go after it and fill the pipeline, and they did. I talked about a Defence book-to-bill above 1. I could tell you it's well above 1. And I think they did a very, very nice job, and that reverses the trend that we've had that are largely caused by COVID of the orders gap in that segment, particularly internationally.And in the U.S., look, I think it's just good work by our teams. Great work by our teams. I love the orders, as I said in my remarks, that are coming across on all 5 domains, the first prime contracts in the space domain, the first prime contract in cyber on top of the great wins, like, for example, the ab initio wins that we had there for doing all the training for the Luftfahrzeugführer in Germany, beating a 60-year incumbent.I think it's great work by the teams in Defence and working in collaboration, I would say, for example, in that last contract with their colleagues in Civil. They're leveraging the full power of what we like to call as One CAE.

[Operator]

The next question comes from Tim James, TD Securities.

[Tim James, Research Analyst]

Marc, congratulations on that fantastic award for your accomplishment. Having said that, I'm going to save some time here. Actually, all my questions have been answered.

[Marc Parent, President, CEO & Director]

Well, thank you, Tim. Appreciate it.

[Operator]

The next question is from Anthony Valentini of Goldman Sachs.

[Anthony Valentini, Associate]

You've got Anthony Valentini on for Noah today. My first question is on the 10% training growth that you guys put out, inclusive of the JVs. I think it's super helpful and the investment community is going to welcome that metric going forward. I'm curious what that looked like over the last few quarters, if you can provide it, and even like sequentially, I think, would be really helpful.And then my second part for Marc, I'm just curious, what you think the next catalyst is going to be here for the global recovery, specifically in Asia. I know that you mentioned the new variant, but I know we've been having kind of this conversation on these calls for the last few quarters now. Is it a matter of us just learning -- or just in Asia, like us learning to live with the pandemic? Or is it an event like the end of the Olympics? Your color there would be great.

[Marc Parent, President, CEO & Director]

Look, I think it's just basically lifting COVID restrictions. I mean they're really impediment to travel and [ air go ] revenue for us in training is not largely because people are afraid of getting on airplanes. It's because people can't go anywhere or they have to wait, like for example, in Asia Pacific, in some cases, still to 21 day -- up to 21 days of having to quarantine after you come back.That means you've got to be -- you've got to want to travel when you have something like that. So to me, it's all tied to the lifting of those restrictions. The great news is I think that -- we're seeing, for example, I don't know where you are, I think you're in New York, but I mean here in Quebec, we're seeing lifting of all -- essentially all restrictions here in Quebec by the end of March. I think that's a very positive news. It doesn't do much for air travel, but I mean it's an indication.We're seeing European countries, literally one by one, basically calling an end to restrictions. That's going to be the catalyst. So ultimately, I think that's what we've got to see in Asia Pacific. And I'm not a government employee, I can't tell you when that's going to happen. But inherently, I know it will happen. So barring any new variants, hopefully not, but -- I mean, I'm optimistic that we're on a good trend here.

[Anthony Valentini, Associate]

Yes. The first part of my question.

[Marc Parent, President, CEO & Director]

Yes, you had another question, yes, on the JV revenue. I think Sonya can give it, yes.

[Sonya Branco, Executive VP of Finance & CFO]

Yes. So 10%, including training growth, including the contributions for GV, I don't necessarily have the last quarter on hand because there are a couple of different elements. But what I would say is higher because obviously, you see the utilization and we saw a really nice ramp up on certain regions where we have joint ventures, but we can get back to you with the numbers.

[Andrew Arnovitz]

Great. Operator, it looks like we've run out the hour. I do want to still use a couple of minutes, if we can, for members of the media, if there are any questions from members of the media.

[Operator]

[Operator Instructions] The first question comes from [indiscernible] La Presse Canadienne.

[Unknown Attendee]

[Foreign Language]

[Marc Parent, President, CEO & Director]

[Foreign Language]

[Unknown Attendee]

[Foreign Language]

[Marc Parent, President, CEO & Director]

[Foreign Language]

[Andrew Arnovitz]

Okay, operator, we'll conclude the call at this time as we've overrun the hour. I want to thank all participants again for joining us today. [Foreign Language] I would remind you that a transcript of the call can be found on CAE's website at cae.com.

[Operator]

Thank you. This does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a good day.