Earnings Call Transcript - CAE Q1 2025

Operator, Operator

Good day, ladies and gentlemen. Welcome to CAE's First Quarter Financial Results for Fiscal Year 2025 Conference Call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity for analysts to ask questions. I would now like to turn the conference over to Mr. Andrew Arnovitz. Please go ahead, Mr. Arnovitz.

Andrew Arnovitz, Senior Vice President, Investor Relations

Good morning, everyone, and thanks 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, August 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, in our filings with the Canadian Securities Administrators on SEDAR plus and the US Securities and Exchange Commission on EDGAR. With the divestiture of CAE's Healthcare business in fiscal 2024, all comparative figures discussed here and our financial results have been reclassified to reflect discontinued operations. On the call with me this morning are Marc Parent, CAE's President and Chief Executive Officer; and Sonya Branco, our Chief Financial Officer; Nick Leontidis, CAE's Chief Operating Officer is on hand for the question period. After remarks from Marc and Sonya, we'll open the call to questions from financial analysts. Let me now turn the call over to Marc.

Marc Parent, President and Chief Executive Officer

Thank you, Andrew, and good morning to everyone joining us on the call. Our performance in the first quarter reflects a continued healthy level of demand across our civil market solutions with some softness in commercial aviation training in certain regions compared to last year. Our results also demonstrate our ongoing progress to move our defense business forward from the rebase landing last year, which sets us up on a clear path to margin improvement. Testimony to our strong position in secular growth markets, we booked nearly $1.2 billion in total orders this quarter for a record $17 billion in adjusted backlog. In Civil, we delivered eight full-flight simulators to customers during the quarter, and our average training center utilization was down a percentage point from last year to 76%. We saw year-over-year growth in business aviation training, including the expected contributions from our more recent capacity additions like our new Savannah, Georgia training center for Gulfstream pilots, which we inaugurated in June. In Commercial aviation training, utilization was 3 percentage points lower than last year on average, which is still robust. But it was lower still in the Americas, where we saw some incremental pressure on initial training and pilot churn as several airlines paused pilot hiring. This was mainly the result of the supply-side constraints on new narrow-body aircraft. For example, in the US, there was a nearly 80% reduction in pilot hiring among notable carriers in the month of June compared to last year. That being said, recurrent training is up year-over-year as the in-service fleet and pilot population continue to grow. Commercial training utilization was lower in Europe too, with seasonality being more pronounced than usual because of an extended summer flying season. This also relates to aircraft supply constraints and special events, namely the Euro Cup and the Paris Olympics, that altered normal travel behavior this season. Training demand in Asia and the Middle East has been tracking well and we're seeing solid growth there in line with our expectations. We continue to demonstrate our ability to win our fair share in a large secular growth market with CAE's highly differentiated training in-flight operations software solutions. We booked $771 million in orders with Civil customers worldwide for an impressive 1.31 times book-to-sales ratio, which is on revenue that's 9% higher than Q1 of last year. We also had strong order activity in our JVs this quarter, representing another approximate $103 million of training service orders, which are not included in the adjusted order intake figure, but are reflected in our record $6.6 billion total Civil adjusted backlog. We received orders for 11 full-flight simulators in the quarter and signed long-term training services and next-generation flight operations and crew management software solutions contracts with commercial and business jet operators worldwide. In Defense, our financial performance was in line with our expectations at this point on our path towards margin improvement this year, and I'm quite pleased with the progress that our team has made to deliver on our commitments. We booked orders for $422 million for a 0.87 times book-to-sales ratio, giving us a $10.4 billion Defense-adjusted backlog, which is up markedly from $8.4 billion in Q1 last year. Notably, included in the adjusted backlog but not the Defense’s adjusted order intake is CAE's share of the $11.2 billion, 25-year contract for Canada's Future aircrew training program that was awarded to the CAE SkyAlyne joint venture. We're now in the process of finalizing CAE's subcontract work under the JV for simulation-based training solutions that will be delivered by CAE. With that, I'll now turn the call over to Sonya, who will provide additional details about our financial performance.

Sonya Branco, Chief Financial Officer

Thank you, Marc, and good morning, everyone. Consolidated revenue of $1.07 billion was 6% higher compared to the first quarter last year, while adjusted segment operating income was $134.2 million, compared to $143.3 million in the first quarter last year. Our quarterly adjusted EPS was $0.21 compared to $0.24 in the first quarter last year. We incurred restructuring, integration, and acquisition costs of $25.6 million during the quarter. This is comprised of $10.8 million for the integration of AirCentre, which is expected to be completed in the second quarter, and $14.8 million in connection with the restructuring program to streamline CAE’s operating model and portfolio, optimize our cost structure and create efficiencies. We expect to record approximately $20 million of additional restructuring expenses in the second quarter in light of the expanded scope of the organizational and operational changes that have been actioned. They are intended to further strengthen our execution capabilities and drive additional cost optimizations and synergies between CAE’s Defense and Civil Aviation businesses. This primarily involves the removal of management layers and the consolidation of several shared services groups across the organization. We expect to fully achieve annual run rate cost savings of approximately $20 million by the end of next fiscal year. Net finance expense this quarter amounted to $49.5 million, which is down from $52.4 million in the preceding quarter and down from $53.1 million in the first quarter last year. This is mainly the result of lower finance expense on long-term debt, partially offset by higher finance expense on lease liabilities in support of training network expansions. Income tax expense this quarter was $8.3 million, for an effective tax rate of 14%. The adjusted effective income tax rate was 17%, which is the basis for the adjusted EPS. Net cash from operating activities this quarter was negative $12.9 million, compared to negative $49.3 million in the first quarter of fiscal 2024. Free cash flow was negative $25.3 million compared to negative $110.3 million in the first quarter last year. The increase was mainly due to a lower investment in non-cash working capital and lower maintenance capital expenditures. Free cash flow performance in the quarter was in line with our expectations and outlook. We usually see a higher investment in non-cash working capital accounts in the first half of the year, and as in previous years, we expect a portion of this to reverse in the second half. We continue to target an average 100% conversion of adjusted net income to free cash flow for the year. Capital expenditures totaled $92.6 million this quarter, with approximately 75 percent invested in growth, mainly to add capacity to our global training network to deliver on the long-term training contracts in our backlog. As a reflection of our agility and disciplined approach to investing, we have adjusted our total CapEx outlook in fiscal 2025 to the low end of our previously indicated range of $50 million to $100 million higher than fiscal 2024, which totaled $330 million. Our net debt position at the end of the quarter was approximately $3.1 billion, for a net debt-to-adjusted EBITDA of 3.41 times at the end of the quarter. Before the impact of Legacy Contracts, net debt-to-adjusted EBITDA was 3.11 times. During the quarter, CAE repurchased and cancelled a total of 463,500 common shares under its normal course issuer bid, which began on May 30, 2024, at a weighted average price of $25.21 per common share, for a total consideration of $11.7 million. Now turning to our segmented performance. In Civil, first quarter revenue was up 9% to $587.6 million compared to the first quarter last year, and adjusted segment operating income was down 11% to $106.4 million versus the first quarter last year, for a margin of 18.1%. The two main differences in our financial performance this quarter compared to last year involve an approximate $10 million lower adjusted segment operating income contribution this quarter from Flight Operations Services, our software business. As we are now going through an expectedly more intensive period of SaaS conversions. The second main difference comes from the incrementally lower demand in the short term for initial type training in the Americas, that Marc alluded to, and the extended summer flying season in Europe that has made the seasonal dip in training activity more pronounced than usual. We enjoy a highly recurring revenue profile and a significant degree of operating leverage in the training business, and we expect a meaningfully positive impact on margins as volumes increase in the second half of the fiscal year. In Defense, revenue was up 3% to $484.9 million, while adjusted segment operating income was up 14% to $27.8 million, giving us an adjusted segment operating income margin of 5.7%. This is right on plan and the team is executing well. On the Legacy Contracts, we are right on cost and schedule and anticipate being able to close out a couple of them in the near term. With that, I will ask Marc to discuss the way forward.

Marc Parent, President and Chief Executive Officer

Thanks, Sonya. For Civil, the secular demand picture for aviation training solutions remains very compelling; it’s underpinned by growth in air travel, demand for pilots, and the need for them to stay current with always advancing aviation technology and regulations. Our business is driven primarily by the regulated training required to maintain the certifications of pilots and crews who operate the global in-service fleet of commercial and business aircraft. It’s notable that both Boeing and Airbus recently published their latest 20-year commercial aviation forecasts, and they project that the number of in-service commercial jets will approximately double over the next two decades. The demographic realities of an aging pilot population, mandatory age-based retirements, and the continued secular growth outlook for air travel are immutable, and they really underlie our continued confidence in the long-term outlook for CAE. As for the short-term, the airline industry is currently managing through what we believe represents the peak of narrowbody aircraft supply headwinds and we assume the industry will begin to benefit from some easing of these supply constraints and that we’re also see pilot hiring begin to resume in the second half of our fiscal year. We’re already seeing an uptick in training bookings for the third and fourth quarters that are consistent with that view. And as we think about what else underpins our expectations for a stronger second half of the fiscal year, it’s important to consider that these factors have been affecting only a portion of our commercial aviation training subsegment and that we’ve taken initiatives to drive additional operational cost efficiencies to partially mitigate the effects of incrementally lower initial training demand in the short term. At the same time, we expect the second half to benefit from seasonality and to show continued strong performance in business aviation training, higher profitability in Flight Operations Solutions, and higher volume and profitability from full-flight simulator deliveries. Within that context, we expect approximately 10% Civil annual adjusted segment operating income growth in fiscal 2025, with an annual adjusted segment operating income margin between 22% and 23%, with ample room to grow beyond the current year on volume, efficiencies, and mix. Our growth and margin expectations this year also account for the ongoing ramp-up of our newer training centers and recently deployed full-flight simulators, which are performing well. In Defense, we’re also in a secular growth market, as the sector enters an extended up-cycle marked by rising budgets across NATO and allied nations. Key trends include a heightened focus on near peer threats, greater government commitments to defense modernization and readiness amid geopolitical tensions, and a growing demand for the training and simulation solutions that we provide. Our expertise in both civil aviation and defense positions us well to meet these needs. We’re seeing a consistent demand driver across regions for our training solutions, a shortage of uniformed personnel for defense, which has led militaries to rely on industry partners like CAE for training solutions to ensure readiness. The Canadian FACT and RPAS programs are prime examples, and we are well positioned over the next year on several similar strategic programs across the Indo-Pacific region, Europe, and in the United States. These programs require the type of technologies and proficiency that are CAE’s strengths. We intend to leverage our position on these generational programs in Canada to enable multi-domain training in secure synthetic environments across our global network. Our expectations for fiscal 2025 reflect the re-baselining of the business and the enhanced visibility this has given us. We’re highly focused on simplifying the organization and driving more operational excellence and will continue to prove it through execution in the coming quarters. We continue to expect annual revenue growth in the low to mid-single-digit percentage range and annual Defense segment operating income margin to increase to the 6% to 7% range, and like Civil, be more heavily weighted to the second half. As Sonya mentioned, our COO, Nick Leontidis is already having a great impact on the business and has identified even more opportunities than originally thought to further streamline our organization, remove duplication, and optimize CAE’s cost structure. As COO, he now has purview over all five of CAE’s divisions, which enabled us to remove management layers in both Civil as well as our Defense businesses. We’ve also further streamlined support functions, engineering services, and our footprint to drive additional synergies across the enterprise. Before opening the call to questions, on behalf of myself, CAE’s Board of Directors, and the entire executive management committee, I wish to express my sincere appreciation to Sonya Branco, our outgoing CFO, for her numerous contributions to CAE’s success over the last 17 years. I and we have benefitted greatly from Sonya’s stewardship, her insightful mentorship of her colleagues, and her deep commitment to our great company. At the same time, I wish to welcome Constantino Malatesta, or Dino, to the role of interim CFO. Dino has worked closely with Sonya for many years, and he has a deep knowledge of CAE’s business and an extensive background in finance that will provide continuity and stability at CAE. I have full confidence in his ability to oversee the company’s financial operations and strategy as we move forward with our search for the CFO role, for which we will consider both internal and external candidates. With that, I thank you for your attention. We’re now ready to answer your questions.

Andrew Arnovitz, Senior Vice President, Investor Relations

Thank you, Marc. Operator, we’ll now take questions from financial analysts.

Operator, Operator

Certainly. We'll now begin the question-and-answer session. Our first question is from Sadi Simon with BMO Capital Markets. Please go ahead.

Unidentified Analyst, Analyst

Yes, good morning. Thank you, Sonya. Congratulations and all the best. And a couple of questions. One, if I look at the Civil guidance of 10%, and I assume this quarter that we're in right now is kind of your seasonal weakest quarter, it feels like you need almost 65% of the EBIT growth to happen in the second half of this year, which is the highest that we've seen in 10 years, I think, outside of the COVID year. How much visibility do you have into this growth in the back half of the year? And maybe a little bit on this commercial aviation issues, it feels like a lot of it may be deferred revenues at this stage. Is it kind of coming back quickly or is it kind of more protracted in how it comes back?

Marc Parent, President and Chief Executive Officer

What I mentioned earlier, let me address that. We indicated last quarter that the factors impacting the Civil business, particularly the commercial sector, were accounted for in our guidance last year. We anticipated some challenges related to OEMs in the overall guidance. You may have noticed hiring has slowed down; we discussed this more noticeably in the fourth quarter, which was slightly greater than we expected in the Americas. However, looking at the overall year, this is how we expect it to progress. Firstly, as you are aware, we traditionally have a stronger second half, and that trend continues year after year. We expect that this will be the case again this year, primarily driven by improved performance in business aviation. This improvement will be spread throughout the year but will be particularly significant in the second half, as we typically see a strong fourth quarter. Regarding simulator deliveries, we anticipate an increase in full-flight simulator deliveries in the latter half of the year, which is typical for us. We have excellent visibility on this due to our production line and the committed delivery dates we have with our customers. Another important aspect here is the cost optimization efforts that will begin to show more substantial effects in the second half. Additionally, we expected a $10 million year-over-year impact from our software business. However, we anticipate a stronger profit contribution from this business, especially in the fourth quarter, as we will have more on-premise work while simultaneously transitioning towards faster conversions. Lastly, referring back to the market assumptions you mentioned, our guidance is based on an expectation of some recovery in initial training in the Americas. As I noted on the call, many carriers in the United States halted pilot hiring in June, but we are starting to see signs of recovery, which are being driven by anticipated improvements in narrow-body deliveries and aircraft availability. We are already noticing this reflected in our bookings. Things could change, and if they do, we will keep you informed. Those are the main factors supporting our confidence for the full year.

Unidentified Analyst, Analyst

Okay, that's great, Marc. Maybe a quick one for Nick. I mean you've been in the seat now for a little while, Nick, maybe if you can provide a little bit more kind of insight into the opportunities that you see to improve efficiency as you try to streamline the operations and streamline kind of the shared operation across CAE's five segments?

Nick Leontidis, Chief Operating Officer

Well, I think, as I think Marc made comments in his remarks. Now the way you need to think about us is, there's five segments that we manage. By doing it that way in particular in defense, we have taken out a couple of layers of overhead, which were related to the fact that we had a combined segment in the Defense world. Right now, there are support functions; there are some corporate costs. There are some things that have been addressed. Now, as Marc said, this is kind of coming through; it's starting to come through the results. Some of it is going to be directly impacting improvements in Defense, some of it's going to help the whole company because these costs are spread. And so from a cost perspective, I think we just need to let the cost savings flow through. Now the focus is more around us doing things one way between Civil and Defense, supporting each other in programs where we have commonality. I think you may have heard of a program called HADES, that is essentially a Bombardier 6500 Training Program for the Air Force that the civil guys and the defense guys are cooperating in. So things like that allow us to leverage the investments we make in these programs and these simulators across the two businesses. So there's a number of these on the list, and we're tackling all of them one at a time, and we should start to see more improvements in the results. That's part of the reason we think there's better improvements in the results, because some of this was when the plans were built, the assumptions that were made were that these were going to be separate investments, and we were going to have to essentially spend money on certain things twice, which at the time, I guess, made sense, but obviously with our austerity, we wanted to be more efficient.

Unidentified Analyst, Analyst

Great. Thank you.

Operator, Operator

The next question is from Sheila Kahyaoglu with Jefferies. Please go ahead.

Sheila Kahyaoglu, Analyst

Thank you, Marc, and congratulations, Sonya, and Andrew, for all the help with initiations. In terms of the Civil guidance, I just wanted to follow up on the first question. Just as we think about the second half margins, is there one factor that really helped drive that margin? Marc, you mentioned a slew of things, whether it's a factor of just full-flight simulators, the exposure in terms of the market, or is it cost optimization? Is there any way you could quantify that? And as we think about the full-year guidance, the exit rate implies about above 25%, 26% and in the press release, you noted ample room for improvement. So is that sort of the new run rate we should think about?

Marc Parent, President and Chief Executive Officer

Well, I won't get ahead of myself on future runway, except to say that I expect it to trend higher, based on a higher basic overall flow through of revenue in our business as it grows and that's what we fully expect as we ramp up more assets across the network. But look, it goes back to your question, Sheila. I think for this year, it's a little bit of everything that I talked about. I don't think there's any one factor that really swings it. Obviously, pilot training has got to come back. We have visibility on that. The other factor I think that's very important is the cost savings that are coming through, some of which Nick just talked about, which is streamlined that we do the simplification of the business, which echoed that Nick is doing a fantastic job, eliminating complete management layers, which not only improves the cost structure, but simplifies the business and gives better velocity on the improvement of everything across the board. But we're also doing quite a strong effort at reducing costs across the whole organization, and we're seeing some strong benefits of that, and that's reflected in the higher restructuring expense that we talked about. So it's going to be all of those factors. But again, what we're seeing now gives us the confidence to reiterate that outlook.

Sheila Kahyaoglu, Analyst

Great. And if I could ask a follow-up on the A320 comments you made, the AOGs at an industry level have held steady for the past few months. Can you just provide color on how you're seeing the impact to your business and perhaps regionally?

Marc Parent, President and Chief Executive Officer

Yes, I'll start it off and maybe, Nick, you can expand on our individual customers that are affected here. Look, our expectations on this from our read of the market and talking to our customers is that we expect that we're at peak right now. We're at peak of the impact of the geared turbofan issues that are affecting the customers, Neo specifically, and as a result, our customers may, Nick, I'll let you expand.

Nick Leontidis, Chief Operating Officer

We have several customers affected by the grounding of these aircraft as they wait for their engine checks. While airlines have been continuing to hire personnel, they cannot hire pilots indefinitely due to the need for a minimum number of flight hours and training. Eventually, they must slow down their hiring, which is what we've experienced. Much of this information is publicly available, and you can identify the impacted customers, but many of them are facing significant challenges with these aircraft. The good news is that we do not see the numbers increasing; the industry is making progress in this area, and we expect to see improvements over time. I believe we have reached the peak regarding the number of grounded aircraft and the opportunities for improvement.

Sheila Kahyaoglu, Analyst

Thank you.

Operator, Operator

The next question is from Konark Gupta with Scotiabank. Please go ahead.

Konark Gupta, Analyst

Thanks and good morning. And thanks, Sonya, for all the help over the past decade and all the best to you. First question for me maybe is on Defense, the margins started to rebound, I guess like last quarter on a normalized basis and we saw that kind of continue in Q1. And it seems like it's heading in the right direction here. Obviously, it's very gradual this year. I really want to understand, like, Marc, what do you think, and maybe, Nick, in terms of the legacy contracts and the timing for rolling off those contracts over the next two, three years, how much more visibility do you have today? And do you think within the next couple of years or three years, is there a possibility that as mix changes, can you hit 10% at a margin defense or that would be more sort of a longer-term story?

Marc Parent, President and Chief Executive Officer

I'll address the first part of your question. We haven't provided a specific timeframe for reaching the 10%, but we expect it to occur within that general period. Regarding the legacy contracts we mentioned, we have strong visibility on those and are focused on them. Everything is progressing according to schedule, and we're meeting our milestones. In fact, I believe we may exceed our estimates. Of the eight contracts we've identified, we expect to complete two of them soon, while the others will conclude as anticipated over the upcoming quarters. Overall, I'm very satisfied with the progress our teams are making, especially with the cost savings and streamlining initiatives that Nick has implemented.

Konark Gupta, Analyst

Congrats. That's helpful. Marc, thanks. And just switching gears to the Civil, I understand some of the weakness we are seeing lately, and it's not too much, I guess, but still coming from like the US and the Europe kind of traditional markets you have. But that Asia and Middle East are doing good. Is there any opportunity to redeploy some of the training assets back to Asia and Middle East, which I think you got back over the pandemic I guess? So any thoughts on how can you tap on this demand in Asia, Middle East, while US and Europe are weak?

Marc Parent, President and Chief Executive Officer

Sorry, going to your question you're talking about, you referred to moving assets, is that what you start referring to?

Konark Gupta, Analyst

So, yeah, moving assets to Asia and Middle East.

Marc Parent, President and Chief Executive Officer

Sure. We always consider the possibility of moving some resources, and any plans we have are included in our outlook. Currently, we are experiencing some short-term impacts. Looking specifically at our Civil business, it consists of four main components. In terms of revenue, a third comes from delivering simulators, another third comes from commercial aviation training, a third from business aviation training, and 10% from our software business. When examining profit, approximately half comes from business sectors. In Q1, the margin difference year-over-year can be attributed, in part, to lower profits from our software business, which was anticipated as we transition to SaaS from on-premise solutions. Utilization is only about 1% down, but this figure conceals the larger impact we're observing in the U.S., where airlines are currently pausing hiring. This situation leads to a decrease in initial training almost immediately, as regional airlines halt their hiring, although recurring training continues. The initial training, particularly for aircraft simulations like CRJs, has seen a more significant drop of three to four percentage points. However, we expect this will rebound as pilot training resumes and we notice an increase in bookings. It's essential to note that while this aspect is important, it doesn't encompass our entire commercial business. Additionally, we are experiencing robust activity in other regions, particularly in Asia.

Konark Gupta, Analyst

Okay, that's very helpful. Thank you.

Operator, Operator

The next question is from Kevin Chiang with CIBC. Please go ahead.

Kevin Chiang, Analyst

Hi, thanks for taking my questions. I'm just wondering, you have some longer-term margin aspirations. And if memory serves me correct, I think within Civil, you saw line of sight coming out of the pandemic into the kind of mid-20% SOI margin. And obviously, you continue to target kind of 10% or low double-digit in Defense. Just with the restructuring you're doing now and some of the synergies and cost savings associated with that, does that change the long-term margin profile in either segment or any of these segments, just given the incremental cost savings?

Marc Parent, President and Chief Executive Officer

Well, look, I think we don't want to get into giving longer-term guidance today. But clearly, all things being equal, the cost savings that we're putting through are only going to help our bottom line performance. Then it becomes a question of volume. And I think, as I said, you look at what's happening in terms of aircraft deliveries over the next 20 years, and I think with the position that we have in the market, I think that portends very well for margin improvements, still.

Kevin Chiang, Analyst

Okay, that's helpful. And then I apologize if I missed this, but did you disclose what percentage of your Defense revenue was from the legacy contracts? And then just with the significant increase in your backlog, quarter-over-quarter, reflecting the addition of your proportion of the new Canadian defense win, does that specific contract have a different margin profile than what you'd be targeting for overall Defense? Is that something we need to be thinking about?

Marc Parent, President and Chief Executive Officer

Well, let me, maybe I'll just turn over to Sonya. I think the first part of your question is we don't disclose that the revenue; it is relatively small.

Sonya Branco, Chief Financial Officer

Yes. So we don't necessarily disclose, but as Marc said, on cost, on schedule. What we have disclosed is that it continues to have, although it's on target, a dilutive impact, because essentially these are costs at relatively breakeven, and that was 0.2% this quarter. So which gets us to a margin of close to 6% for the quarter and ultimately on facts, would you want to add that, Marc?

Marc Parent, President and Chief Executive Officer

Yes, go ahead.

Sonya Branco, Chief Financial Officer

In fact, very much aligned with the accretive target that we have for the FAcT. So this is a highly accretive, generational program that will be contributors right out of the gate.

Marc Parent, President and Chief Executive Officer

Yes, I'd like to add a bit to what Sonya mentioned. I may have misspoken regarding the backlog. There was a significant increase in the backlog we reported, which rose to $5.4 billion last quarter. This considerable change highlights the demand from governments for outsourcing their military flight training. We anticipate many such opportunities in the coming years. The initial portion of that backlog will unfold over the next three to four years as we focus on recapitalizing the entire training infrastructure. This will involve constructing several simulators and training devices here in Montreal to meet that demand. These will be located in Winnipeg and other bases where the Canadian military conducts pilot training. Additionally, as Sonya pointed out, the margin profile associated with this product is very beneficial to our margin expectations.

Kevin Chiang, Analyst

That is very helpful. Thank you very much. And Sonya, best of luck as you move on to your new endeavors there. Thank you.

Sonya Branco, Chief Financial Officer

Thanks, Kevin.

Operator, Operator

The next question is from James McGarragle with RBC Capital Markets. Please go ahead.

James McGarragle, Analyst

Hey, good morning and thank you for having me on.

Marc Parent, President and Chief Executive Officer

Hi James.

Sonya Branco, Chief Financial Officer

Hi James.

James McGarragle, Analyst

So under the defense margin guide, it implies a pickup in margin in the back half of the year. So can you just provide some additional color on what's driving that seasonality or that operating improvement? Just trying to better understand what the margin exit rate is into fiscal 2026? Then, as a quick follow-up to that, is that $20 million in savings highlighted in the press release, is that incremental to that margin guide into fiscal 2026?

Nick Leontidis, Chief Operating Officer

Hi, this is Nick. To address your first question, the improvement in defense margins in the second half is due to both cost savings and the backlog that we will be working on. It is a significantly better backlog, leading to the execution of normal business operations, which will also benefit from cost savings. Regarding the cost savings, I wouldn't categorize them as incremental, but they will enhance our confidence in what we need to achieve in the second half.

James McGarragle, Analyst

Thanks for the color. And then I had a question on some of the additional restructuring expenses that you guided to in Q2. We've seen these restructuring expenses here the past few quarters. So when we're looking at free cash flow, trying to model out for the rest of fiscal 2025, can you just provide some color on potentially the magnitude of these expenses, kind of after Q2 into the remainder of the year, and after that I can turn the line over? Thank you.

Sonya Branco, Chief Financial Officer

Regarding the restructuring expenses, last year a significant part of those were non-cash, approximately half. For this upcoming quarter, the majority will be cash costs, which is accounted for in our continued free cash flow guidance. As Nick mentioned, some of the savings will impact this year and contribute to the pickup in the second half. Overall, the payback period for that investment is around a year and a half.

Operator, Operator

The next question is from Benoit Poirier with Desjardins Capital Markets. Please go ahead.

Benoit Poirier, Analyst

Yes. Good morning, everyone. Just to come back on the software business, it's been almost 2.5 years since the closing of the transaction. You incur obviously some restructuring costs. You made some investment to turn into a SaaS business. So could you talk about what remains to be done? What kind of growth we should expect from that business in terms of operating income? And maybe if you could share some color on the return on capital employee target in light of those additional investments, that would be great.

Marc Parent, President and Chief Executive Officer

Okay. Let me start, Benoit. There's still significant work to do regarding our SaaS conversion, which aligns with our previous discussions. This transition from on-premise to SaaS has been in motion for the past couple of years. The positive aspect is that we have a growing pipeline, and we're witnessing the results. Our expectation that airlines would view CAE as a trusted partner has exceeded my already high expectations. This is evident in our order intake, as we've secured approximately $700 million in contracts over the past few years, indicating substantial growth in both revenue and profit following implementation. We anticipate a timeline of about 18 to 24 months for these conversions, and we have engaged with major carriers; for instance, the $700 million includes contracts from Air India and Wizz Air. Nick, do you want to add anything else? That's my perspective on this.

Nick Leontidis, Chief Operating Officer

Yes. The way this works is that these contracts are now in the backlog, and we need to convert them into revenue. This conversion happens by implementing the signed contracts, which creates a revenue stream moving forward. All of this needs to be processed. As Marc mentioned, we have good visibility and order intake. We are well aware of the contracts we have secured and what they are expected to deliver each year. Looking ahead, we will start to see revenue growth.

Benoit Poirier, Analyst

Okay. And with respect to defense, we saw some program delays impacting the liberal government's budget cuts. I was wondering if there's any cuts that was impacted at CAE? And also in terms of ramp-up of those transformative contracts, Marc, you've been talking about the big improvement towards the 15% revenue contribution. If you could provide an update on this opportunity, that would be great? Thanks.

Marc Parent, President and Chief Executive Officer

Regarding the Canadian defense contracts that involve us, I do not perceive any delays; rather, I see acceleration. I recently met with our Minister of Defense, Blair, and he's very focused on the funds they have allocated for initiatives like supporting Ukraine. The programs that impact us are increasing. For instance, the FAcT contract is one example, but we have also been chosen to handle all the training for the fleet of remotely piloted aircraft that the Canadian government has procured from General Atomics. We are their partner for training related to all international deliveries of that platform, which is significant and comes with high expectations and substantial contracts in Canada. In recent years, Canada has also acquired the P-8 aircraft, and we are Boeing's partner for that as well. We've created every P-8 simulator that exists, also selected during the same contract for Canada. However, this particular contract isn't reflected in our backlog yet because even though the Canadian government has purchased the P-8, our agreement with Boeing also includes projects in Norway and Germany, where they sold the aircraft. We expect to see that contract realized soon. To sum up, I am very encouraged by the resources, effort, and funding that the Canadian government is allocating for defense, and I believe we are securing a significant portion of it as the largest Canadian-owned defense contractor, with a strong position globally in virtual space training for aircraft.

Benoit Poirier, Analyst

That's great information, Marc. And just one more thing. Congratulations on the FAcT being on track for over 25 years. Sonya, could you provide some details about the timing regarding the ramp-up and the size of the CapEx associated with this contract?

Sonya Branco, Chief Financial Officer

So first question, there is no CapEx. So this is a capital alike. No CapEx to deploy here. We are finalizing the subcontract and other contracts with the joint venture, and we don't have any contribution yet from FAcT, but it's part of the ramp-up in the second half that we expect.

Operator, Operator

With less than 10 minutes remaining, callers are asked to limit themselves to a single question. The next question is from Cameron Doerksen with National Bank Financial. Please go ahead.

Cameron Doerksen, Analyst

Yes, thanks. Good morning. You talked a little bit about this off the start as far as the visibility and outlook into the second half of the year, but I'm wondering if you can go into a little more detail on what you're seeing in the business aviation training market. It sounds like things are still pretty strong there, but anything that's notably changed from the last quarter? and I know you've got a few newer training centers there in business aviation that maybe still be ramping up. Could you just update us on the progress that you're seeing there in ramping up those centers?

Marc Parent, President and Chief Executive Officer

You're correct. A significant part of our growth is coming from the ramp-up of those centers, and we are very pleased with the progress. Las Vegas is performing exceptionally well, just as we anticipated. It's an excellent location for a trade center. We are also ramping up operations in Orlando through our joint venture with Directional Capital and SIMCOM. We recently held a successful opening ceremony for our Savannah Training Center about three months ago. All the simulators are ramping up nicely, and activity levels remain very high, even surpassing pre-pandemic figures. While there has been a decrease, which we expected, I’ve noticed that the parking lots are quite full. There is an impact from reduced pilot hiring because when airlines hire less, it affects the business aviation sector overall. We are monitoring this closely. However, the activity and bookings remain very strong. Nick, since you are closer to this, would you like to add anything?

Nick Leontidis, Chief Operating Officer

Yes. I think business aircraft has had a good quarter, and we're seeing a slight change in the mix of the business, but overall, it continues to perform as expected.

Marc Parent, President and Chief Executive Officer

Actually, what I think we should point out is the level of order intake in Civil has been, again, very strong this quarter and disproportionately in business aircraft. It has quite the number, very much.

Nick Leontidis, Chief Operating Officer

Yes, correct. Part of the driver for the order intake this quarter being at 135 Wizz business aircraft. So we have a lot of long-term contracts that got signed that created a disproportionate back order intake for Civil.

Cameron Doerksen, Analyst

Okay. That's great detail. I'll keep it to one question. Thanks very much.

Operator, Operator

The next question is from Kristine Liwag with Morgan Stanley. Please go ahead.

Kristine Liwag, Analyst

Good morning, everyone. Sonya, I wish you the best of luck in your new endeavor; we'll miss you. Marc, I want to follow up on the first question from today's call regarding the risks to the Civil outlook for the rest of the year. First, when you mention bookings are improving, how much of your guidance for the second half of the year is already secured, meaning you have full visibility and minimal risk? Additionally, it appears that the slowdown in hiring new pilots is linked to the pace of new airplane introductions. If we experience further delays in aircraft deliveries, should we expect a continued slowdown in new pilot hiring? How should we assess that in terms of potential downside risks? Thank you.

Marc Parent, President and Chief Executive Officer

Let me begin, and then I'll ask Nick to elaborate on the key factors that shape our outlook, including what we can control and what we cannot. As for the aspects within our control, deliveries of simulators stand out. We are fully aware of our production line, the status of our simulators, and which customers are taking delivery. While there is always a chance that one or two deliveries might be postponed, we do not anticipate that at present because we are in contact with those customers. They are aware that they will receive their aircraft, giving us high confidence in that regard. Regarding business aircraft, which we just discussed, the demand for bookings remains strong. As a pilot myself who has trained at air training centers, I can tell you that once a booking is secured, it typically won't be canceled. If training sessions are missed, which generally must occur every six months, it can lead to complications in renewing licenses and flying. Therefore, cancellations are rare. There is strong demand, which strengthens our outlook for business aircraft. Another factor that impacts our outlook is our transition to a software as a service model within our software business, which presents some challenges. However, we have clear visibility on this, and we expect that the $10 million drag we experienced in Q1 will decrease by year-end, primarily due to increased on-premise work scheduled for the second half. In terms of downside risks, we anticipate a resumption of pilot hiring in the Americas, supported by our current bookings. While bookings can be rescheduled, our discussions with airlines indicate a positive outlook based on their expectations for aircraft deliveries, whether from Boeing's narrow-bodied aircraft or from planes returning from engine overhauls. Lastly, it's crucial to note that we are working to manage our own future through proactive cost-saving measures. We were realistic last year when we anticipated certain developments, which is why we took a conservative approach regarding our growth and margin projections. We have also adjusted our CapEx range as we reflect on the conservatism we employed, which was well-grounded at that time.

Kristine Liwag, Analyst

Great. Thank you very much.

Andrew Arnovitz, Senior Vice President, Investor Relations

Operator, we have our AGM today as well, so we will have to be a bit more of a stickler in terms of sticking to schedule. I want to thank all of the participants who joined us today and remind you that a transcript will be made available later on CAE's website of the call.

Marc Parent, President and Chief Executive Officer

Thank you.

Operator, Operator

This brings to a close today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.