Good day, ladies and gentlemen. 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. Mr. Arnovitz, you may now proceed.

Good afternoon, everyone, and thank you for joining us. 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 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. With the expected divestiture of CAE's 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 Marc Parent, CAE's President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer. After remarks from Marc and Sonya, we'll open the call to questions from financial analysts. At the conclusion of that segment, we'll open the lines to members of the media should time permit. Marc, over to you.

Thank you, Andrew, and good afternoon to everyone joining us on the call. Our performance in the third quarter reflects the continued strong demand for our Civil market solutions and the ongoing progress to transform our Defense business. We generated strong free cash flow in the quarter, enabling us to further bolster our financial position in line with our leverage targets. We also made excellent progress to secure CAE's future with nearly $1.3 billion in total order intake for an $11.7 billion backlog. In Civil, we had strong financial performance that reflected the quarterly mix that we anticipated, with demand for 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 an impressive 1.36x 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 JVs this quarter, representing another approximately $135 million of training services orders, which are not included in the order intake figure, but are reflected in the record $6.1 billion total Civil backlog. We received orders for 20 full flight simulators in the quarter, bringing our tally for the first three quarters of the fiscal year to 57. Notable wins included 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 Azul 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 Solairus Aviation and Clay Lacy Aviation. The continued high level of order activity this quarter across all Civil segments underscores our ability to win share in a large secular growth market with these highly differentiated training and flight services solutions. In Defense, our financial performance was consistent with our expectations at this point on our path toward being able to generate higher margins in the business. Defense performance was lower than the third quarter last year, as we continue to retire risk on a group of distinct legacy contracts, which Sonya will describe in more detail in her section. We booked orders for $429 million for a 0.9x book-to-sales ratio, giving us a $5.6 billion Defense backlog, which is up from $5.1 billion in Q3 of last year. They include a maintenance contract with the United States Air Force for the F-16 training devices and the continuation of training services on the C-130H transport and KC-135 tanker platforms. Defense orders also included an option exercise for the U.S. Army for fixed wing flight training and support services at the CAE Dothan Training Center. With that, I'll now turn the call over to Sonya, who'll provide you additional details about our financial performance. Sonya?

Thank you, Marc, and good afternoon, everyone. Consolidated revenue of $1.09 billion was 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. Our quarterly adjusted EPS was $0.24 compared to $0.27 in the third quarter last year. We incurred restructuring, integration, and acquisition costs of $23.5 million during the quarter relating to the AirCentre acquisition. Expenses related to the AirCentre integration which is progressing as planned 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 liability. 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 '23 was mainly attributable to the transaction cost 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 $220.8 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 of last year. The decrease was mainly due to a lower contribution from non-cash working capital and higher payments to equity accounted investees to invest in the 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 non-cash working capital and higher cash provided by operating activities partially offset by some maintenance CapEx and again, higher investments in the 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 to specifically add capacity to our Civil global training network to deliver on the long-term training contracts in our backlog. Our net debt position at the end of the quarter was approximately $3.1 billion or net debt to adjusted EBITDA of 3.16x at the end of the quarter. We expect 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 a 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 volume from recently deployed simulators in our network. In Defense, revenue was up 4% to $472.4 million, while adjusted segment operating income was down 18% to $20.9 million giving us an adjustment segment operating income margin of 4.4%. Defense margin this quarter included the negative impact of the ongoing retirement of 8 distinct legacy contracts that have completion dates mainly within our next two fiscal years. What 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 are firm fixed price and structured with little or no provision for cost escalation. These contracts are only a small fraction of the business but have disproportionately impacted overall Defense 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 8 legacy contracts had an approximate 2 percentage point negative impact on the Defense segment operating income margin in the third quarter. With that, I will ask Marc to discuss the way forward.

Thanks, Sonya. Looking ahead at each of our segments, we anticipate continuing our above-market growth momentum for training and flight services, driven by strong passenger traffic growth, success in the shared attorney market, and high demand for pilots and pilot training across all aviation sectors. For the current fiscal year, we project that Civil will achieve adjusted segment operating income growth in the mid to high-teens percentage range. Overall, we expect the Civil adjusted segment operating income margin to align with fiscal 2023, indicating a strong margin for Civil in Q4. In addition to growing our share in training and expanding our digital flight services position, we aim to maintain our leading share of full flight simulator sales, with an expected delivery of approximately $50 million for the year. There is significant potential for growth in the Civil aviation market, and our ongoing positive momentum highlights the strong demand for CAE's distinct training and flight services solutions and our capacity to gain share in this expansive growth market. Turning to Defense, we will continue transforming our business by replenishing our backlog with more profitable work and retiring legacy contracts as Sonya mentioned. These trends remain favorable, and we anticipate they will lead to a larger and more profitable business. Since enhancing the scale and capabilities of the Defense business approximately two years ago, we have increased the Defense backlog by over 20%. This positions us well for sustainable growth and includes significant wins on next-generation platforms we've discussed in recent quarters. Upcoming programs not yet in the backlog include the Canadian FAcT and RPA programs, which are in contract negotiations and also substantial in size. The progress we've made in replenishing and growing the backlog with higher quality, profitable programs strongly indicates a bright future for CAE's Defense business. Alongside a $9.5 billion pipeline of active bids and proposals, we continue to observe positive signs of transformation within the sector. Looking towards the rest of fiscal 2024, we expect Defense to keep securing high-quality, profitable programs. In the fourth quarter, we aim to further accelerate the retirement of risks associated with legacy contracts as much as possible. We seek to clear these contracts from our portfolio as soon as it's feasible, closely monitoring them separately. We are committed to execution and expect to significantly lessen the negative impact from these legacy contracts over the next 6 to 8 quarters as they are gradually phased out. The extent to which the ongoing risk retirement of these programs affects margins in coming quarters will depend on the timing of program closures and our ability to manage these risks effectively. Our teams are revising and rebalancing certain contracts, seeking equitable adjustments where necessary, and striving for overall program efficiencies. For CAE overall, we remain encouraged by the demand environment across all segments and the growth we foresee by leveraging our global market and technology leadership coupled with the unified strength of CAE. These factors, along with focused execution and a robust financial foundation, suggest continued growth momentum and a promising future for CAE. Thank you for your attention, and I am now ready to answer your questions.

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

Our first question comes from Fadi Chamoun with BMO.

I'm trying to kind of see how to best think about the trajectory of Defense margins. Marc, you mentioned the focus on accelerating the retirement of risk associated with these legacy contracts, which I understand that this quarter, the impact was 200 basis points. And there's also the idea that the backlog growth and top line growth and implementing higher margin contracts should be margin accretive as we go forward. Does the margin start to improve from the current level that we're at right now or are we stuck at these kind of lower levels for some time? The other thing, what exactly do you mean by accelerating the retirement? Are you able to exit these contracts earlier or is it a cost action that you are taking to improve the performance of these specific contracts?

Lots there, Fadi, but fair question for sure. Look, yes, I'm going to go right to the end of your last question, because I remember right off the bat. 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 timeline as we work through the execution on these contracts or even take actions like, for example, close out some of these contracts ahead of time. And I'll give examples of that, but let me just end it right now. Because whatever we do, we're going to offset it by mitigating efforts that we try to limit the cost growth. But let me just tell you some of the things that we might do. Look, we might decide to de-scope a contract. I'm talking about these 8 legacy contracts that we're referring to. We might decide to de-scope a contract. What does that mean? That means we close out, and we're looking at this in at least one specific contract, potentially incur liquidated damages if that makes sense for us to cut off a future tail of programmatic risk on that program. So better to take that pay now; it'll take a lot more later, if you know what I mean. But of course, that depends on the negotiation specifically that we have underway with that specific customer. Other things we might do is we might agree to alternative terms, course schedules, and we're looking at that on some of these programs as well. Or we might incur a follow-on contract, say, an addendum, and an engineering change proposal on any one of these contracts, and we're looking at that. The potential is that some of these contracts will give us more work, in which case we can spread the cost around over a bigger quantum, lessening the impact of any individual product. So we're doing all of that. So if I look back to your maybe the margin question, and I'll quickly go to Sonya on this one. Look, we saw that we talked about 200 basis points this quarter, and I'm going to go straight to Sonya on that one, not going too deep on that. 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 retire the risk, take the right actions. Now mind you, we're never going to give up on our customers. That's not what we do at CAE. We will deliver the products and services that we committed to our customers at CAE's culture, and don't forget that's the mission that we have in defense. So we're not going to do that. But that's the way I would look at this. And finally, before I give it to Sonya, the one thing I would tell you, there's nothing new here relative to disclosure that we gave you last quarter in terms of the quantum. 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, the duration, how long they last, and the steps that we're taking to actively mitigate them. Now maybe, I'll stop there, but I'll turn it over to you, Sonya, to expand on the 200 basis at least for this quarter.

So what we've done this quarter is endeavor to reassess the few contracts that have a disproportionate negative impact on the business. In 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 impact of 2%, 200 basis points this quarter. But by the way, there's also an impact of under absorption of costs needed to achieve scale and support for all of the business, like R&D and SG&A, that can be up to another 100 basis points, which makes the impact slightly higher at around 300 basis points. Now that's a snapshot for Q3. Now, I can't say that the next 6 to 8 quarters will look exactly like it as we're constantly working to all the different levers to mitigate these risks and work with our customers as Marc has highlighted. So while there will be some variability quarter to quarter, this quarter's impact is a rough baseline of the headwind that we face on average.

So, basically, you're talking about a scenario where you can take these losses upfront and ultimately kind of exit these contract risks earlier, so that's what's going to be lumpy? The comment about the 100 basis point absorption, is this tied to backlog deployment and how quickly you deploy the backlog to get improvement in that cost absorption? Is that what you mean by that?

Yes. 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's an under absorption that you can assume has about 100 basis points added to the other 200 basis points.

So the timeline of 6 to 8 quarters, that's kind of the most, I want to say, pessimistic kind of timeline. Hopefully, you can deal with some of these contracts earlier, take some of these losses maybe earlier and then move on from that?

Yes. That's definitely what we're going to be seeking to do.

Our next question comes from Cameron Doerksen with National Bank Financial.

Maybe I'll ask a question on the Civil business. The utilization rate in the quarter was really strong, 76%, which I don't have it going all the way back; it seems like maybe that's one of the best Q3s you've had. I'm just wondering if you can maybe discuss what you're seeing as far as demand across the various training components. Are you seeing any changes there or is it continuing to be strong in the fourth quarter like we saw in Q3?

Well, Cameron, what we're seeing is very strong demand. I can tell you, I'd look out my window here at the parking lot in Montreal, I can tell you it's full. I keep saying that, but perversely, that's a pretty good indicator of what we see as utilization of training centers, and that's across all the training centers. I see no softening of demand. And as we said before, as you can do the math, we fully expect a pretty darn good and we have very good visibility on that because, obviously, we're pretty close to the end, and we know what scenarios we have to deliver. And again, we have some very strong bookings in our training center. And these days, I can tell you nobody is looking to cancel bookings.

And maybe just a very brief follow-up to Fadi’s questions on Defense. You mentioned you may be seeking some, I guess, equitable adjustments. I know there's something you've discussed in the past. Have you had any success there? I mean, are you optimistic at all that you'll get some relief from your customers with some maybe some pricing adjustments within these legacy contracts?

I'm hopeful, but I'm uncertain about the timing since I've been wrong in the past. Most of what we've managed to secure is about 10% of what we believe to be very strong and well-documented claims with our customers. However, this is dependent on many factors that are beyond my control. We've made some conservative assumptions regarding mitigations for some of these legacy contracts, and while some of this is included, it's certainly not the entire amount.

Our next question comes from Kevin Chiang with CIBC.

I know you don't have multiyear guidance for targets or Defense. But if I just kind of, if I rewind, let's say, back to fiscal Q2 and you provided an update on defense at that point in time. I think the market read it as you 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-digits sometime in fiscal 2026. The fact that you haven't changed your three-year EPS target, I'm just trying to level set. Is that still the trajectory you think you can do as you roll off some of these contracts? Or was it like the double-digit EBIT margin maybe cloudier here today given the new disclosure you provided?

Sonya?

Yes. So clearly, there's some dependency on the timing of the risk retirement on those legacy contracts 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.

Maybe strategically, you're running about '21, I guess, these past 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 type of hiccups? And what I mean by that, it doesn't look at the absolute dollars the impact from these legacy contract issues is large, but it's also coming off a smaller base. I'm just wondering, I mean, this risk seems to be something you always have to deal with when you deal with the government and fixed-price contracts. Just how do you think about the ability to absorb even small developments that weren't planned, that end up being a little bit more negative than you anticipated and not having any kind of sideswipe margins where they have the past year or so?

So, I think the way I look at it is, when we talk about your legacy contracts that we're 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 disproportionately large costs in a given period as we work through them. Especially if you do active efforts that we have to reach a customer settlement or agree to change in terms, things like that. So but we have to remember as well that the business 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 quarters, it has material impact because of the small quantum that you have in the absolute number.

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

My question is with regard to how you're looking at deploying capital in the Defense segment, it seems like returns on that business right now, they're below your target. Do you think there's enough room to improve margins to bring returns in Defense 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?

We consistently aim for a balanced capital allocation strategy, with our primary focus on investing in growth that is financially beneficial. Our main goal is to meet the demand we observe in the Civil market, as our organic capital expenditures yield significant returns of 20% to 30% pretax within 3 to 4 years. Therefore, these opportunities are our top priority for capital allocation. Occasionally, we do invest in the Defense sector, but if we choose to do so, we expect those investments to be based on commercial terms and to generate margins similar to those in commercial ventures.

Yes. And then maybe I'll just add to that, Sonya. And we've already talked about some of those, like, for example, the U.S. Army, HADES contract that we'll be deploying a global 6,500 simulator in our existing facilities in the Dothan Training Center where we already delivered the fixed wing training for the U.S. Army. And in that case, as Sonya said, because it's a commercial solution, which we deploy in business aerograph, we can enter into what's called a commercial contract with the U.S. Army, which of course, in that case would be capital that's well deployed because it's going to be the service with margins more likely to get in it's a kind of civil environment. So you can imagine that's accretive to our term. Another example I would give you is the contract that we've talked about for what was previously called the flight school 21 contract, but we call it the FTSS contract where we will be deploying capital to replace all the similarities used by the U.S. Army at what we call Fort Rucker or Fort Novosel. Not that, again, we'll be very accretive capital deployment in Defense because we will be able to enter the service contracts on delivering training to the U.S. Army on again, commercial contracts, which are more favorable to us than traditional contracts in Defense.

And then if we look at the book-to-bill on the Defense side, it came in below 1%. You did point to some unfunded 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 the top line in defense to be higher in fiscal 2025 versus '24?

To your point, the order intake at 0.9% is slightly below 1%, but I would look at the overall total backlog because there is a dynamic of kind of the first-year funding and so on. So you could see the growth in the backlog. We're expecting some big Q4 awards, Marc, Q4, Q1 awards that Marc spoke about some large Canadian contracts that we've been selected on, and then we're expecting those to come in, and that'll drive some significant order intake and backlog growth.

Now look, Defense is a growth business. As I said in the remarks, we have 20% backlog growth in the last two years. And that doesn't include contracts that we've been selected on like the future aircrew training in Canada and the RPA training contract, we've misselected. Those two contracts are really generational in size. We're not under contract yet. So you got to figure, 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 those to revenue. So there'll be timing involved. But I mean, there's no doubt that's a growth business.

And sorry, just one quick follow-up on the Defense side before I turn it over. Are the low margin contracts that are rolling off this, the eight contracts 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 losing money right now?

We don't necessarily give the details of the contracts individually. I think it's a mix. And so they will be, they're not particularly large on the revenue but have that disproportionate impact on the cost. But I think the best measure to look at it is a margin.

Our next question comes from Konark Gupta with Scotiabank.

Maybe just to follow-up on Defense, Marc, What has the dedicated team that you have deployed for these legacy contracts achieved so far, if you can give any concrete examples? And what is their mandate going forward?

A mandate is a successful execution of the contract to deliver. What we committed to deliver to our customers, that's first and foremost, all that because that's what key is about and we have a critical mission in Defense, which goes without saying we want to do. That's first and foremost and of course, deliver it under the best financial terms that we can. And that's what their mandate is. So execute on the contracts and get us to the softest landing that we can with regards to the risks of retirement on those contracts. We work with our customers to try to establish win/wins, to rescoped those products, descope those products, move the schedule to provide us with scheduled aviation, and get requests for equitable adjustments where we definitely are entitled to get them because of the extremely high inflationary environment that we've had that disproportionately affected our costs. Those are all some of the things that our team is doing. I can tell you, we didn't just put these teams on overnight. These teams have been working for some time, and they have had good progress in executing and reducing the burden that we're facing here in Defense already. So we're already seeing the fruits of our labor here, which allows us to give you more precision that we give you today.

And if I can just quickly follow-up on several. Is there any change in discussion or language from customers, from airline customers especially in light of the A320 engine issue that we saw recently as well as now the Boeing 737 problems?

The thing I would tell you is no, no, because airlines are scrambling to meet the demand that they see out there. Now, I mean the impact is real. I mean the impact of the engine issue that you talked about is real. You can have hundreds of airplanes grounded at any given time with not having some effect. So we're watching that. I would tell you it hasn't affected our business. The airlines that we operate with, which is the great majority of airlines in the world, are scrambling to be able to get alternate lift whether it be keeping older airplanes on station rather than new ones leasing, leasing O1, 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, it fills up one simulator worth of demand. So clearly, if this was to go on for a long, long time, then that would have an 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 about a very strong book-to-bill on top of 20% growth in revenue. And what you see there is a testimony to our success in more outsourcings. I'm very, very happy to join another marquee customer like Air France KLM, which historically has not outsourced, outsourcing a portion of their training requirements to us. The growth we have is very large contracts in business aviation. So, look, to me, we're seeing no threatening indicators.

Our next question comes from Benoit Poirier with Desjardins Capital Markets.

Just to come back on the Defense margin, if we strip out the 200 bps impact from the legacy frac, it implies that the base is running at around 6.4%, which is obviously, far from double-digit level. So could you maybe give us more color on actions to be taken to bring the base to double-digit? Is it related to delays in funding? Is it a matter of scale, revenue loss since the acquisition of L3 or higher bidding costs these days to support the high bidding environment?

Yes, Benoit. So a couple of points there. First on your point of the 200 basis points, as I mentioned earlier on the call, there is a 200 basis point 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 the business like R&D and SG&A. So that could be another up to 100 basis points. So I use that basis, the 300 in total. In addition, 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. As these start to come in and start to really reflect through the revenues, we spoke to it last quarter, it was 3%. It's really still minimal representation in the revenue, but 20% of backlog. So as these start to ramp up more materially, that's we expect that to step up and drive a meaningful impact.

There's a lot we've learned from our experiences over the last three years. One key takeaway is that, similar to our peers in the defense industry, we will avoid entering into firm fixed price development contracts. These types of contracts contributed to our previous challenges, especially with delays arising from issues related to COVID, such as part shortages and manpower shortages, compounded by an inflationary environment where we have no protection. We are also taking measures like banning service contracts and establishing tighter pricing bands to ensure we are not adversely affected if customer demand fluctuates. Overall, we are closely monitoring execution at all levels and implementing a variety of strategies to navigate these challenges.

And just looking at the Civil margins, you reached a 20% EBIT margin this quarter, which is a step down versus the 25.4% achieved a year ago despite having stronger revenue and greater utilization rate. 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 mid-double-digit growth for the year?

I didn't mention 26%. You did. But you can do the math. I think if you recall what I mentioned in the last conference call, I highlighted that margins are in line with our expectations. I'll provide some details on this. The mix of our offerings is playing a significant role here. We've discussed mix in the past, and while it appears quite high, you should consider that last year's Q3 mix was very favorable for various reasons. This was especially true for our product business and for a new segment involving software, which benefited from a lot of advantageous on-premise work last year. In terms of our software strategy, we're actively pursuing contracts and aiming to transition customers from on-premise work to Software-as-a-Service. To illustrate, on-premise work is like selling simulators where you quickly receive revenue and contracts. In contrast, transitioning to a Software-as-a-Service model, similar to our training efforts, means we receive payments over time, providing a more sustainable stream, but it won't lead to a significant revenue spike in one quarter. Looking ahead to Q4, we anticipate this dynamic to be beneficial again, along with the number of simulators we deliver and the utilization at our training centers. This is why we expect a strong Q4, consistent with the increased guidance we provided for Civil last quarter.

If we look at AirCentre, there have been approximately $1 million in integration and acquisition costs incurred so far. The valuation multiple was very appealing, and it was understood that this would be a 2- or 3-year process. You mentioned that the integration of the IT infrastructure will be mostly complete by the middle of fiscal year '25. Could you provide an update on the remaining costs and how much AirCentre could contribute to margin, as well as any insights on the return on capital employed so far?

We are continuing to integrate our customers into our network, and as I mentioned earlier, we expect to complete this process by mid next year. There's been significant progress in migrating customers from the previous network to ours, and we made great strides last quarter. We anticipate continued progress this quarter as well. While we won’t provide specific forecasts on costs, we believe the integration will largely be completed in the first half of next year.

Our next question comes from Tim James with TD Cowen.

Most of my questions have been answered. But just maybe one quick one for Sonya. Just looking at some detail here. The depreciation expense in the Civil business jumped surprisingly significant amount in the quarter relative to the second quarter, I'm looking at, in particular, just the sequential change. Is there any particular reason for that? Is this new or the report of the Q3 rate a good proxy going forward?

Well, I think the headline is growth, right? So we deployed 20 plus simulators last year, onboarded several training, whether it's Las Vegas, Savannah came online this quarter. We have another extension of our Phoenix training center that came online also this quarter. So you'll 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 new training centers.

So it is just a natural step-up then in relation to the assets in the business?

Yes.

Our next question comes from Kristine Liwag with Morgan Stanley.

Marc, you just reiterated the margins for the next quarter. I mean, it seems like for 4Q '24 to get to your guidance, that implies about 16% revenue growth for the quarter year-over-year and margins a little bit north of 26%. So 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 '25? 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, if you look at the order intake that we have, the book-to-bill that we have, and I think you're going to continue to see strong growth.

And Marc, in terms of the software business, I mean Software-as-a-Service, especially Sabre, historically would be a very accretive margin. I mean when you look out a few years for the composition of software within Civil, how large could that be?

We're not ready to provide guidance at this moment, but we acquired this business with the intention of growing it. I'm pleased with the order intake from customers, and there is significant interest from airline clients. They are receptive to integrating CAE's culture into this business, which aligns with our expectations from the beginning. Customers who had moved away from legacy Sabre have returned to us due to our efforts in customer outreach and product development. While I can't give you a specific number, I am confident that we will see growth. There is strong interest in our next-gen solution, which is Software-as-a-Service, and this will positively impact recurring revenue in the future. We need to navigate the transition from on-premise to Software-as-a-Service, but I remain very optimistic about our prospects.

Our next question comes from Anthony Valentini with Goldman Sachs.

You got Anthony on for Noah. 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 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?

Absolutely. The impact of fixed firm price contracts, particularly development-type contracts during the COVID period, has been significant, and we can see this reflected in our results. We anticipate that these legacy contracts will continue to have an influence. That said, we remain committed to collaborating with our customers. For instance, we have taken on new contracts where the government has acknowledged that we won’t necessarily absorb costs that have risen due to inflation, treating them as pass-through contracts instead. Essentially, costs will be determined by what they are. Therefore, we find ourselves affected by the same challenges as many of our legacy peers in the industry and are responding with similar strategies.

As a follow-up there, Sonya, you had mentioned 200 basis basically like a drag from these challenged programs and then another 100 basis points of like the overhead absorption. So if I just kind of use those numbers, that implies something like a 7.5% margin, what's remaining that's going to drive this business to get to those double-digit percentages that you guys have historically talked about?

As I mentioned, it's really the ramp-up of the new contracts that we've signed and especially those transformational ones. They're large in size, accretive, and they will have a meaningful impact on the margin as they ramp up. They're really nominal right now in terms of our revenues. And so as those ramp up, they'll have a more meaningful impact.

Our next question comes from Jordan Leone with Bank of America.

So just hopefully, a final one on Defense margins. With the double-digit target, how confident are you in that timeline being 2025 where you start to see that accretion from new contracts if we still continue to operate under a continuing resolution for this year? How much downside risk do you guys look at if we go through a sequestration?

Let me begin by reiterating that what we're discussing this quarter is similar to what we addressed in the last quarter, where we acknowledged some delays. Today, we are providing more specific insights, particularly regarding these legacy contracts, to illustrate their impact independently and to convey our confidence in the core of our business. We believe this business is strong as we navigate these legacy contracts. To give you further context regarding your question, there are two main elements at play: the robust growth in our core business, which is benefiting from the accelerated development of our transformative new business and a 20% increase in backlog over the past couple of years. Concurrently, we are also seeing the retirement of legacy contracts that are negatively impacting our overall margins. We have previously indicated that there would be a point where these two trends would converge, and we still anticipate this will occur in the latter half of next year. Our perspective remains unchanged. What we are clarifying now is the extent of the negative impact in this quarter and that the process will not be linear. Variability will occur due to our specific actions taken to mitigate risk, which will also depend on the timing of the risks involved. Our goal to expedite this process may influence that variability. Nonetheless, the upward trend we discussed remains firmly intact.

Our next question comes from Fai Lee with Odlum Brown.

Marc, your three-year EPS compound growth rate target hasn't changed from the mid-20% range. And I know you don't really want to talk about the 2025 guidance since you haven't provided it, but that target implies pretty strong growth next fiscal year. And I'm just wondering to get a sense of how you see that target right now in terms of whether it's a stretch or do you think you're pretty confident that you'll achieve it. Can you just maybe comment around that?

I'm going to hand it over to Sonya to address that question. However, we are not ready to provide that information at this time. We will share it when we know more about the next quarter. It's clearly dependent on the timing of risk retirement in defense and the pace at which new programs ramp up as we sign generation contracts. Meanwhile, the outlook for Civil is very strong. You saw the order intake we achieved this quarter, which shows over 20% growth in our revenue, and the performance reflects that demand. I'll let that speak for itself. Do you have anything to add on that?

No, you covered it, and we'll provide more insight in Q4 like we usually do.

I have another question regarding the defense outlook. It seems that, based on your expectations and outlook going forward, nothing has really changed from the previous quarter, yet you have provided additional guidance. The market is responding negatively to the additional information regarding the legacy contract market. What are your thoughts on how the market is interpreting this additional information?

I stopped trying to predict that a long time ago. Clearly, this runs our business. I don’t want to repeat everything I've said, but I feel very confident in our defense business. To be direct, this is not a broken business. It is growing, with contracts that will positively impact our margin expectations. We have a substantial backlog. From my experience, having a backlog is essential, and ours is profitable. It aligns with our goals. We are focusing on specific contracts that, despite being different, share a common theme of pre-COVID, fixed firm pricing. Our dedicated teams are concentrating intently on these, while also ensuring we don’t lose sight of the many other defense contracts we manage simultaneously, which we fully intend to execute as planned. All of this supports my confidence in our defense business, despite our current circumstances.

There are no more questions at this time.

Operator, thank you. Given that we're on the hour, I'd like now to open the lines to members of the media should there be anyone with questions for Marc or Sonya.

We have a question from Stephane Rolland from La Presse Canadienne.

So with all that, that basically forms my confidence in the defense business, albeit we are where we are. There are no more questions at this time. Operator, thank you. Given that we're on the hour, I'd like now to open the lines to members of the media should there be anyone with questions for Marc or Sonya. We have a question from Stephane Rolland from La Presse Canadienne.

Thank you. Given that we're on the hour, I'd like now to open the lines to members of the media should there be anyone with questions for Marc or Sonya. We have a question from Stephane Rolland from La Presse Canadienne.

Marc Parent|CEO|

Marc Parent, CEO, responded in French.

There are no more questions at this time. Thank you, Operator. Since we're at the hour mark, I would like to invite any members of the media to ask questions for Marc or Sonya. We have a question from Stephane Rolland from La Presse Canadienne.

Thank you, Operator. Now that we have reached the hour mark, I would like to invite questions from the media for Marc or Sonya. We have a question from Stephane Rolland from La Presse Canadienne.

Thank you, Operator. Since we're at the hour mark, I'd like to open the lines for any questions from the media for Marc or Sonya. We have a question from Stephane Rolland from La Presse Canadienne.

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.