CAE Inc (CAE) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the CAE second quarter conference call. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now proceed, Mr. Arnovitz.

Good morning and let me begin our call by reading the following statement. The statements in this conference call that are not reported financial results or other historical information are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. They include for example statements about our business outlook, assessment of market conditions, strategies, future plans, future sales, prices for our major products, inventory levels, capital spending and tax rates.

These forward-looking statements are not guarantees of future performance. They are based on management's expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. The risks and uncertainties relating to the forward-looking statements in this presentation include those described in CAE's filing with the Securities and Exchange Commission.

With me this morning are Derek Burney, President and Chief Executive Officer; Paul Renaud, our Chief Financial Officer; and Don Campbell, President of the Military Simulation and Training Group at CAE.

Before we get started, I would like to say a few words about our decision to release our quarterly results after market trading hours. Following the Q1 release, and after discussion with the Toronto Stock Exchange, we concluded that more and more firms were moving to release results outside of market hours. We have adopted what we believe now constitutes best practice in the industry. In future we intend to release our results early in the morning and convene this call right afterward.

The format this morning will be as follows. Derek Burney will begin with an overview of second quarter results. Paul Renaud will provide you with a detailed review of financial performance for each business unit. And Don Campbell will discuss the performance and the prospects of the Military unit. Mr. Burney will conclude the formal part of this presentation with CAE's outlook for the remainder of the fiscal year. We will then invite questions from financial analysts. Following which, Art Perron, CAE's VP of Government and Media Relations, will open a question period for journalists. This conference this conference call will be archived on the CAE web site.

Let me now turn the call over to Derek.

Thank you, Andrew, and good morning. Our results in the second quarter are essentially an extension of those in the first quarter, revenues of $246 million versus 243 million in the first quarter and 252 million last year. Earnings are down sharply from last year, but are constant with first quarter.

To put matters in context, our earnings per share of 7 cents for the quarter fell 1 cent short of our internal plan, due primarily to lower results from Civil, foreign currency adjustments and increased corporate costs. These were partially offset by the operating income performance by our Military unit, which was actually ahead of our plan.

Operating earnings were up $3.5 million from the first quarter, while overall margins increased to 11 percent. The positive impact on the bottom line was reduced by a tax rate of 27 percent, which was three times higher in percentage than that in the first quarter.

We appreciate that some analysts have not been able to update their estimates due to restrictions stemming from the distribution of our recent equity offer. Therefore, what constitutes the "market consensus" for Q2 is based on a limited number of forecasts, and does not reflect any discussions with the Company.

Civil's performance was affected by fierce pricing pressures and foreign exchange adjustments on the equipment segment, which reduced normal operating margins by more than 50 percent. Pricing pressures are also a fact of life for CAE in some training locations. It is, a real sense, a buyer's market. Nonetheless, Civil generated more than $100 million in equipment orders during the quarter. And these will pay top and bottom line dividends during the balance of this fiscal year and into next.

Two additional full-flight simulator orders from US Airways announced earlier this week, mean that we already have as many orders at this point as were obtained in all of last year, 11. The Airbus 8380 orders are strategically significant as they represent prototype simulators for the world's largest new aircraft. The contract also includes a series of CAE's Infinity products underscoring what we see as the leading nature of our technology for Web based training.

On the training side, the seasonality of July and August, along with a delay in the resolution of the Dornier 328 aircraft program, which in turn curtails Web training activity, and the continuing difficulties being experienced by Air Canada all impacted negatively on the income side of an otherwise solid growth performance.

Air Canada's training needs declined as they reduced their fleet. And their financial circumstances have generated additional challenges on pricing. Obviously, a decision by Air Canada and the Star Alliance more generally to purchase new aircraft could turn a negative into a positive.

While utilization was down in the quarter because of seasonality, and stands at 61 percent year-to-date, we made good progress in reducing cost, notably costs per sim per month. And revenue growth on training, with a constant foreign exchange rate, met our 20 percent objective.

I believe that the joint venture with Iberia announced last month represents a strategic win for CAE. This constitutes in effect an outsourcing agreement on training with Europe's fourth-largest airline. It confirms that the value proposition from CAE on training is advantageous compared to an "in source" solution. Also, adding the capacity of six more training simulators with a very small net investment is a good combination for future growth. We expect this joint venture to begin in January following Spanish regulatory approval.

The agreement with Aeroflot gives us a training foothold in Russia, and is further proof of the advantage of our cooperative agreement with Airbus. We completed our second sale on leaseback transaction of the year during the second quarter, bringing total funds raised to $123 million to date this fiscal year. We continue to see these as highly efficient financings for CAE. However, they do attach a burden of about 6 percentage basis points to Civil's margins.

Along with the sale leasebacks, we also concluded an equity financing deal during the quarter which raised $168 million for CAE. What this means is that our net debt has been reduced to about $550 million, which is 40 percent less than at the beginning of the calendar year. We believe that we did the right thing in accepting and concluding this financing. Our balance sheet is now much stronger, and that was a primary objective for us this year.

However, somewhere along the way, the risk part of the risk reward balance in equity investment in general, and bought deals in particular, seems to have gotten lost in the interpretation. Obviously, we would prefer to see all investors gain from their investment whenever it is made, but market prices go up-and-down daily. Our overriding objective is to create long-term value for all shareholders. And we know that a strong balance sheet is essential to that objective. We also know that tangible market success also helps.

The loss of our bid for Flight School 21 did not help market perceptions, and was disappointing in its own right. Don is going to elaborate later on this, as well as on Military's performance in the second quarter. Nonetheless, as he will explain, subsequent events have already proven that we are by no means shut out of the U.S. defense market.

Incidentally, the implications of this lost bid on our production levels at our Montreal facility will be minimal this year. We still expect roughly the same unit production in total as last year. Had we won, we would have rehired or recruited about 300 employees next year, and we would have subcontracted much more work than now.

Our marine business with revenue of $34.4 million and earnings of $5.6 million during the quarter would have met plan and delivered consistent results with the prior year, if you exclude the impact of foreign exchange. The most significant award during the quarter was a $16 million Indian landing ship program.

We also signed a strategic agreement with the Ping (ph) shipyard in Italy, which will provide scope for access to both naval and commercial programs in Italy. And we anticipate including significant change orders before year end on the Astute program.

Overall, I would say that these results confirm that the worst is indeed over in the commercial aerospace sector. There are signs of recovery, albeit, very gradual. As well, they attest to the continuing validity of our balance expansion into training and our underlying commitment to profitability, despite the unprecedented turbulence in one of our key markets.

I will now turn the call over to Paul.

Thank you, Derrick, and good morning everyone. As Derek mentioned, second quarter results were similar to those of our first quarter. Earnings from continuing operations were identical at 15.1 million, or 7 cents a share, with higher margins and lower interest expense offset by an increase in the income tax expense, due to the higher tax rate this quarter.

In terms of comparison with the prior year, second quarter and year-to-date earnings from continuing operations are down 35 percent and 50 percent respectively, all business segments having been affected by foreign currency fluctuations and higher pension and long-term incentive compensation expenses, in addition to market specific factors for each segment.

Relative to last year, foreign exchange fluctuations caused earnings per share to fall by 2 cents for the quarter and 6 cents year-to-date, while the higher pension and long-term stock based incentive compensation costs reduced earnings by 2 cents this quarter and 3 cents year-to-date.

Interest expense is lower this quarter by 2.4 million, or 26 percent, and by 3 million, or 18 percent, for the year-to-date. This excludes the benefits that will be derived from the September 30th, 2003 quarter end date equity issue, and the sale and leaseback financing.

Income tax expense amounted to 5.5 million, 3.5 times higher than the first quarter, with the income tax rate of 27 percent this quarter versus 9 percent in the prior quarter. The cumulative rate for the six months is 19 percent. And CAE's overall tax rate for the year should approximate 25 percent.

Consolidated revenue for the quarter was 246.1 one million, 2 percent lower than the 252.3 million reported last year. Excluding the effect of foreign currency fluctuations, revenue would have exceeded last year's amount by 5 percent. For the year-to-date, revenue reached 489 million, 7 percent below last year, with a decrease attributable to foreign currency fluctuations.

Before reviewing the results of each segment, a few comments on cash flow and the strengthening of our balance sheet. The second quarter cash flow was much better than the first with a positive cash flow from operating activities of 14.9 million compared to cash utilized of 58.4 million in the first quarter. More significant was the 262 million in cash raised on September 30th from a combination of the equity issue for 468 million after fees and expenses, and 94 million from the sale leaseback of 5 simulators, a twenty-year financing at an all in cost of 5.5 percent, confirming a cost-effective for a long-term financing for CAE.

Lastly, capital expenditures remained well below last year's level at 33.5 million this quarter and 58.7 million year-to-date. The year-to-date total is 55 percent below last year, as the Company maintains a strict discipline to limit expenditures pending an improvement in the market.

The sum of these initiatives resulted in a reduction of CAE net debt, defined as long-term debt less cash and short-term investments, to just below 550 million, compared to 781.9 million as at June 30th, and 791.7 million as of March 31, 2003. Committed principal repayments on long-term debt over the next 24 months for the Company amount to $47 million, 11 million in the next 12 months, and 36 million in the subsequent 12 months.

CAE's funded order backlog at September 30th, 2003 was 2.2 billion, constant compared to the amount reported last quarter, which also the excludes all the recent Military and Civil announcements.

I will now briefly review the financial performance of each business segment. Civil Simulation and Training reported second quarter operating earnings of 9.9 million compared to 6.6 million in the first quarter, and 19.9 million in the prior year period. First-half operating earnings were 16.5 million compared with 57.6 million last year. In addition to the foreign currency impact and the higher pension and long-term compensation costs, the reduction in operating earnings relative to the prior year is attributable to, first, equivalent market conditions and the weight of September 2001, reduced training with Air Canada since their CCAA filing, and on the Dornier 328 aircraft pending resolution of the future use of the aircraft in inventory, and lastly the accounting implications for the sale and leaseback financing whereby rental payments under the operating leases include an interest component in determining operating earnings.

Revenue for the second quarter increased slightly from the first quarter at 7 percent from the prior year to 111.3 million. Excluding the foreign currency effects, revenue in the second quarter would have exceeded last year by 17 percent. The 7 percent year-over-year increase in Q2 revenue is attributable to a 10 percent increase in training revenue, 20 percent excluding the currency effect, to 61.7 million, despite challenges arising from Air Canada and the Dornier 328. Year-to-date revenue of 224.4 million would have equaled last year's amount of 239.9 million, excluding the foreign currency impact.

Training revenue year-to-date of 131.8 million represented an increase of 15 percent over last year, 23 percent when you adjust for foreign exchange, with training accounting for about 60 percent of Civil's revenue in the first half of this fiscal year compared to approximately 50 percent in the prior year. The Civil backlog has increased to 362 million as of September 30th from 339 million as at June 30th.

Military Simulation and Training generated second quarter operating earnings of 11.8 million compared to 12.3 million in the first quarter and 16.2 million in the prior fiscal year. For the six months period ending September 30th, operating earnings were 24.1 million compared with 34.8 million.

Second-quarter revenue of 100.4 million was constant relative to the first quarter, while decreasing 8 percent from the prior year. Year-to-date revenue of 200 million would have matched last year's amount of 214.6 million, save for the foreign exchange impact.

Operating income margins of 12 percent compared with Military's record margins of 16 percent for the same six months at this time last year. In addition to the previously mentioned factors of foreign exchange and pension and long-term incentives, Military margins were also impacted by higher startup costs on new projects, higher bid and proposal costs, and the inclusion in last year's results of a onetime incentive payment for early delivery on a particular program. The funded backlog for Military remains unchanged from last quarter, and at 1.2 billion.

Marine Controls sent generated second quarter operating earnings of 5.6 million compared to 4.9 million in the first quarter and 7.2 million in the prior year. Year-to-date operating earnings were 10.5 million compared to 13.6 million last year. Revenues of 34.4 million compared to 34.2 million in the first quarter and 39.3 million in the prior year.

For the six-month period revenue was 68.6 million versus 73.6 million last year. The reduction in year-over-year operating earnings of revenue are attributable primarily to foreign exchange impacts, and to a certain degree from lower volumes for power systems, and some delays on the Astute submarine training program. Backlog at 618.2 million rose modestly from the June 30th 2003 level.

With that, let me hand the floor over to the head of Military unit, Don Campbell.

Thank you, Paul, and good morning everyone. The Military unit strives to achieve two complimentary business objectives in any given quarter. One is to optimize recurrent results by delivering on contractual commitments in the most efficient and effective way possible. A second is to secure new business that will come online and impact our financial performance in the future.

Paul has just taken you through the results and the key factors behind the variances. As you heard, Military's top line was constant and our bottom line was down very slightly from the first quarter, while both were down relative to last year. I should stress however, that our income performance was actually ahead of our plan.

Let me turn into the impact of business development in the Military units, including the Flight School 21 situation, and then offer some thoughts on the way ahead. Flight School 21 is a U.S. $1 billion 20 year program, with revenue ramping up in fiscal years of '05 and '06 to some US50 million in '07, and staying constant thereafter for the next 17 years.

As you know, the contract was awarded to the self-described All-American competing consortium. We have been debriefed by the U.S. Army Procurement authorities and have launched a formal appeal of the decision based on a legal counsel advice that we have good and sufficient reason to do so. The appeal process through the U.S. government's General Accounting Office takes 100 days, and should be completed by January 15. Although there is a possibility of a thirty-day extension.

In the meantime, the execution of the contract has been suspended pending the outcome of the appeal. Council has advised it would not be appropriate to discuss at this time the basis of our appeal. However, it is a matter of public record that our price was 159 million U.S. dollars, less than the amount of the competing consortium. We believe strongly in our technical competence. We're proud of our track record. And I'm confident that our solution provided the best value for money.

Given the time, resources and effort we have put into the project, not to mention the merits of our case, we considered it important to our employees and to our shareholders to pursue every avenue of redress open to us.

The decision on Flight School 21 had no impact on Military second quarter performance, nor is it expected to make a significant financial contribution during the balance of the year. Overhead rates have been calculated without taking the contract into account. What the units and the Company would lose is the growth opportunity for the future, one that we fully intend to make up with future wins.

We're obviously disappointed with this decision, and we are under no illusion about the current political environment in the U.S. We're entering an election year with the trade deficit and the loss of manufacturing jobs becoming major concerns. There are widespread protectionist and national sentiments afoot. There are Congressional initiatives underway to introduce more restrictive buy American legislation on defense procurement that are being resisted by the Administration and U.S. industries themselves. But the atmosphere is not a healthy one for fair and open competition.

Nevertheless the U.S. is the most single important market for defense procurement. The budget continues to grow and will do so for the next few years. We intend to capture new business in that market. As you know, we have just announced two important new contracts in this key market. One involves the deepening of our relationship with an already very important customer, the U.S. Army Special Operations Forces. With the selection of CAE for an initial contract of US$5 million for sole source negotiation for further contracts with potential value exceeding US$80 million over the next 12 months. These will include the provision of two combat mission helicopters for the Chinook and Black Hawk helicopters.

Major funds are flowing for the U.S. Special Operations Forces for equipment and for training. And I believe we're well placed for significant ongoing business with this customer, provided of course that we continue to earn their respect for the quality of our technology and our performance.

The second contract involves our long-standing relationship with Lockheed Martin and our leading global position in C-130 Hercules training. Lockheed Martin has been awarded a US$287 million U.S. Air Force C-130 training program. Our contract to the provision of both equipment and services exceeds US$100 million. The contract includes designing and manufacturing eight new trainers and training support services. This program follows two earlier major programs we have done with Lockheed Martin for the U.S. Air Force. And we expect further C-130J contracts as the Marine Corps, in their turn, start to take delivery of their own aircraft.

These recent awards strengthen our expectation that we will more than double our first half order intake of CAN$220 million for the second half.

The outlook for the second half orders does not include the oft delayed AVTS Armored Vehicle Training System Program in the UK. The British government has decided to change some of the requirements following their experience in Iraq, and has asked the three bidders to rebid by February next year for a preferred bidders selection now expected next summer. We believe our chances on this program are as good as either of the other two bidders.

Our market is global. We're involved with military organizations in over 30 countries around the world. However, access to the U.S., the huge U.S. defense market is obviously key. With major procurement programs ahead in the Air Force, the Army, the Navy and the Marine Corps, all of which we can attack in concert or with partners -- in concert with partners or on our own. Our tactics will be determined by what gives us the greatest chance of success in each competition.

Looking ahead, there are a few points I would like to leave you with. First, we know we have to win more new business, both here come in Canada and abroad, including the key competitions for the CF 18 and the European NH 90 helicopter programs. Second, we are committed to maintaining our technological leadership. Third, we are driving to contain costs wherever and whenever possible, without compromising our ability to deliver on existing programs, or to securing new opportunities. And fourth, our financial performance in the second half will be stronger based primarily on our ability to execute and to optimize our performance on existing contracts.

Thanks very much, Don. In terms of outlook, we continue to believe that the second half of our fiscal year will be stronger than the first half, especially as the aerospace recovery takes hold. While we expect more from all of our units, we know that we will need a particularly robust performance from Civil and from Military. The market environment in commercial aerospace is improving, but it is, as mentioned earlier, very much a buyer's market with intense competitor pressure on price. The increasing value of the Canadian dollar only exacerbates the pressure on pricing.

What is promising is that we are continuing to grow in this tough market, winning we believe more than our fair share of new opportunities both for equipment and for training. The full flight simulator orders to date and the two new training ventures with Iberia and AeroFlot attest to that.

Infinity products certainly helped differentiate the CAE offer in the training market, but we are in a daily dogfight for business. What I can say is that it is a fight we're determined to keep winning.

During the balance of the year, Civil will see more financial benefits from the equipment orders already in place. The training component will benefit from the Iberia joint venture and from other newly deployed simulators, including the G4 and the G5 in Dubai, as well as from increased utilization following the seasonal summer slowdown, and bringing us closer to our 65 percent target for the year as a whole. Incidentally, October was a record month for business aviation training at CAE SimuFlite, a trend we hope November will emulate.

The challenge for our Military business is of a different order. Politics is a fact of life in most defense markets. That is why we have a global platform for operations. But despite the discouraging decision on one major U.S. contract that Don has explained, and as this week's announcement confirm, we continue to see upside potential for our products and services in the U.S. and in other military markets. In fact, military's order book as of today, including the two U.S. orders announced this week already exceeds the total achieved last year. We expect more new orders, and as well a stronger revenue and earnings performance in the second half, based as Don has said, primarily on performance from existing contracts.

CAE's technology is highly recognized in the military training and simulation sector. We also continue to see prospects for our software in the modeling and simulation segment of military business, which in itself has excellent growth potential. It is worth noting that while our backlog stood at $2.2 billion at the end of the quarter, we have already added about $300 million worth of new orders since that day. That is further evidence, I believe, that the worst is over.

We're determined to bolster our market success in all three businesses during the balance of the year. So that, along with a much stronger balance sheet, our performance will enhance shareholder value. We recognize that the only sure way to do that is to produce equipment and training solutions of value to our customers.

With that, we will now welcome questions from the financial analysts.

(OPERATOR INSTRUCTIONS) Pierre-Yves Therisse, DesJardins Securities.

Paul, two questions for you. First of all when you talk about the foreign exchange impact in the quarter on a year-over-year basis, you're comparing that to a gain in the second quarter of 2003. Is that correct?

What we're doing is we are really comparing what foreign exchange impact had, based on the rates we booked our second quarter business versus how it affected our operating earnings versus the same quarter of the prior year. Without necessarily a gain, even though we did have a gain in the first quarter of last year on a year-to-date basis in the Civil business, but it is trying to look at the impact of where -- mainly it is the Canadian dollar, where the Canadian dollar stands today against the U.S., and how that affected our operating results for each one of the businesses in Q2 and year-to-date versus last year.

If I look on a quarter to quarter basis foreign exchange increased by about a penny, if I'm correct. And that should have had an impact of roughly 500,000 on the bottom line. Is that correct?

What we say a one cent impact is between 6 to 700,000 on the bottom line.

In terms of free cash flow or cash from operation after Capex, you were negative in Q1 and negative in Q2. Can you give us a sense of when do you expect to be free cash flow positive?

Certainly for the balance of the year. And that is a combination of -- our working capital we expect to be much stronger in the second half of the year. As you see, it was only slightly negative in Q2, but we expect that to turn in Q3, Q4 based on where we see some milestone payments, particularly on the military side. So we hope to get that number close to getting down to zero reversed, and the -86 million over the balance of the year.

And our capital expenditures I think previously we had said somewhere around up to 125 or between 125 million this year. Our estimate right now is to be at the lower end of that range for the year.

In terms of utilization for your training centers in Q2, can you give the specific number, or you don't disclose that?

I think it was 57, Pierre. But what I did give you was the number year-to-date, so it is whenever the balance is.

Okay, the difference between the two?

Yes.

One last question. The Lockheed Martin contract you announced this week. When do you expect that contract to have an impact on your results?

I'm sorry, when the contract will (multiple speakers). It will start having a -- it will have a small impact this current fiscal year, more next year, and the majority over the next three years.

Jacques Kavafian, Octagon Capital.

At your AGM, and also when you report the first quarter earnings, you said that the worst was over, and that you see business picking up. Yet, obviously, business hasn't picked up for you. Why are you confident that now the worst is over, and that in the second half business will pick up?

Well, Jacques, what I think what I said was we believe that the worst was over in August. And I think the results that we are now seeing today, which take us to the end of September, show a marginal, operational improvement in the second quarter over the first quarter. Not dramatic, but I also said in August that we expected the second half of the year to be stronger than the first half. So it is in that sense that we're saying that we believe the second quarter has demonstrated a small improvement over the first quarter on the operating side, especially in Civil, where the margins improved and the income improved. And we expect a more significant improvement in the balance of the year.

I think that is a very consistent with what was said. We think that the order book announcements that have come in October, both from Civil and from Military are already indicators that there's reason to believe the second half will be stronger. I mentioned, as well, the Business Aviation Training performance at SimuFlite in October was at a record level. So if we add all those ingredients together, I think it is very consistent with what we said.

What I really said in August was, we may not see the light at the end of the tunnel, but we at least feel like the tunnel has a floor. Well, I think as I said, the performance for the remaining weeks of August and the month of September confirm that. So I don't see anything inconsistent with what I said then and what we're seeing and saying today.

Well, the thing is in the first quarter you had the war in Iraq, you had SARS, and you had a huge increase in the value of the Canadian dollar -- things that did not exist in the second quarter.

And we had a tax rate of 9 percent. And now we have a tax rate of 27 percent. You add it altogether, and as I said, on a pure operating performance we saw some improvement second quarter over first. If there was a further deterioration, that would be proof that the worst wasn't over.

Final question is, you alluded to the fact that your internal budget was 8 cents for the quarter. So you were bit shy of that. Would you mind sharing with us what your budget is for the full year?

We don't give guidance on the full year, as you know. We will report it to you at the end of the year. And we will tell you exactly what our plan was.

I thought if you said to everyone on the conference call like this, it would be full disclosure, so you could do it.

It is very tempting, Jacques, and I appreciate the invitation, but I'll get back to you when the year is over.

You are allowed the disclosure on your segments is not -- I find it a bit lacking in being able to come up with adequate estimates. Is there any other way you can help us then?

It hasn't prevented you from coming up with estimates thus far.

Well, we have been wrong so far, so I am trying to get a more accurate estimate.

I would hope that you would take from Paul's comments in particular that we're giving more and more information on what we see as the area of greatest interest to the analysts, and that is the performance of our training initiative. And I hope you'll take from what was said today that we are providing more information on that.

You have to remember, we are in a very intense competitive market on Civil. And information that we disclose that gives up some of our negotiating leverage on either equipment or training, we have to be -- we have to strike the right balance between what we can disclose and what we regard as commercially sensitive information. But I think --.

Okay, well, if you change your mind, I'm going to be on the conference until the end, so --.

You got up early this morning, Jacques, didn't you?

Marko Pencak, GMP.

My question for you, Derek, is just given your year-to-date 51 percent utilization implies for the back half of the year in the training business to hit your 55 percent target. On utilization, you would have to do -- I am just going to throw out a number of about 68 percent. And I just want to -- as you look across your business, what gives you the sense that that is going to be achievable number for you?

Well what I could only tell you, and all kidding aside Marko, if October becomes the benchmark for the balance of the year, we will have no difficulty getting there. But I can't say that with any great assurance, because October and November should be strong months for training, just as July and August tend to be soft months for training.

You're absolutely right. For us to get to the 65 percent, we're going to have to do something in the order of 67, 68 percent for the balance of the year. Can I give an outright assurance that we're going to do it? No. But it remains the target that we're shooting at. And it will remain the target that we're shooting at for the balance of the year.

Was there anything specific in October that could perhaps caused that utilization rate to be particularly strong, or is it just sort of a broad demand?

Well, in the business aviation market, keep in mind. And as you know, that is primarily a wet training market for us, which has dividends that go beyond utilization. We haven't had a chance to examine it in-depth with our Civil group yet, the results of October. We have just seeing what I call the flash results. So I can't really say much more than it is encouraging to see that it was a very strong month. And it was strong not only on aviation training, but I believe it was also a record month in terms of maintenance training. And, as you know, we're trying to do both increasingly.

A question for you on the Airbus 8380. One of the beautiful things about a new aircraft being introduced, of course, is that there aren't any pilots that exist, and that means that the training have to precede the delivery of the aircraft. Can you just give us an update in terms of the discussions you have been having with the airlines that have placed orders for that aircraft? And when you might expect them to make training decisions in that regard?

I can tell you that we're in discussions with all of the airlines that have committed to orders to date. Obviously, some of those discussions I would say are in a more advanced stage than others. And I would say that our discussions with Emerick are probably the most advanced, but that doesn't suggest that we're at the point of a decision. I think all of these airlines will have an open competition to serve their training needs.

But you should assume that we're looking at all the ones who have placed orders. And we have already talked to them, and we have already shown them what it is we're doing for Airbus. And that we're keeping very close tabs on the ones that are thinking about placing orders, but first and foremost, is the delivery of the two for Airbus.

What is your expectation -- what is the minimum amount of time required for them to place an order with you prior to taking delivery of a first aircraft? So if you know when they are scheduled to take delivery of your first aircraft, how many months or quarters prior to that do they have to make a decision do you think?

I would say it is in the order of a year to year and a half, to give you a range. But obviously it depends on the success we hope to have on the prototype. That is the one that will set the table for the timing of any future orders.

A question on the Astute delay. What is your sense in terms of when that might get back on track? And what sort of caused that? And what is the magnitude of that financially from a revenue standpoint?

Well, you can assume we are going to hold their feet to the fire to see it flow back in the second half. And as I mentioned, we're also expecting for the end of the year some change orders, in other words additional elements to the Astute program. So that I am sure that the combination is going to more than compensate for the delay to date, Marko.

And how much would that be, just ballpark?

I can't give you a figure because I don't have it in my head. We can get back to you with more precision on that.

Last question, for Paul. During this quarter were there any percentage of completion catch-up accounting items in the (indiscernible) your financial?

No.

James David, Scotia Capital.

Three questions. First on the gross backlog growth, Derek, you mentioned that if we include recent events, you are at about $2.5 billion. Don mentioned order intake of 220 in Military. I'm just curious, does that 220 also include the recent events? And if not, what has been Military's gross backlog growth this year?

The 220 that he mentioned was at the end of the second quarter, and the recent orders came in November.

So they would be incremental to that?

They are part of my 300, but they're not part of his 220. And where he is today, as I said I think, is that his order book as of today when you include those, is already ahead of his total order book last year.

Okay. Gross backlog growth in Civil year-to-date?

I think Paul gave you that number.

Well, we're up to -- we went from 338 to 362. So I can't remember quite offhand -- hang on one second (technical difficulty).

This is year-to-date, Paul?

Yes. At the end of -- where we stand now at the end of September is 362. At the end of Q1, we were at 339. And at the end of last fiscal year we were at 418. So we're down a bit from where we were at the end of '03.

That is Civil?

That is Civil.

Including any long-term training?

Yes, to the extent that we sign a long-term training contract. There is it very little of that. As you know, all of the business and all that, there is nothing in backlog. And as training picks up a higher share of our revenue, that backlog number in Civil is really driven more by the equipment side.

Fair enough.

But James, that does not include either Aeroflot or Iberia. Even though Aeroflot is a long-term training deal, it will be in the backlog -- is in the 300 million that I mentioned. And if I can get back to Jacques, I am sure he's still on the line. I think if you look at that Civil order book that is further evidence that the second quarter was stronger than the first. And further evidence, in my opinion at least, that the worst is over.

Second question on Civil margins. You're at 7.5 percent run rate for the first half. And clearly you speak to improving profitability in the second half in Civil. Any thoughts at all on the potential magnitude of the second half improvement that could play through if things go as planned?

Well, I've got thoughts, but I share them with the Civil group, James, on a regular basis. No, I think you have to see what I said. We are expecting greater financial benefits from the orders that we took in the second quarter. I mean, that by itself is going to help on the margins. If we get the utilization up in the 65 to 70 percent range, which is what we're aiming at, that will have an impact on margins. We have seen an improvement in margins from the first quarter to second, which is, again, I think proof that the worst is over. But I want to quantify it yet. You will get it at the end of the third quarter, and I think that that will be a bit of indicator for the year as a whole.

Okay. Fair enough, Derek, last question. The Iberia, which by all appearances is sort of the first major Western world outsource, if you will. What was ultimately the trigger that compelled them to do that? And so that we can sort of evaluate who else might try to do something like that?

That's a good question. Number one, I think -- I don't want to give commercials for airlines, but I think Iberia has demonstrated in a variety of ways a progressive attitude about managing their business. I think that was characterized by the previous CEO. It is being reinstated by the new CEO. In other words they made some fairly dramatic changes to the way they operate in order to get away from the traditional model and get into a more efficient model.

For them, I can tell you when we signed the agreement, they said this is a difference for us of going from fixed costs to variable costs. And they see an advantage on that. They say, it is more important that guys like you make the investment in the technology and ensure that that training is state-of-the-art than that we try to do that while we're trying to run a very efficient airline.

The reason why we think it is strategic is precisely because of what you said. They are the fourth-largest European airline. It is an outsourcing for all intents and purposes. There were lots of sensitivities that had to be dealt with, specifically on the labor side. But they are a forward-looking airline. This thing took two years to conclude. That give you some indication of the challenge we face in changing what I would call the cultural attitude of airlines on this issue.

But I can tell you one thing, having one in your pocket means that the next time you go to a customer, you're not talking about a concept, you're talking about something that somebody else has already accepted. And for those who have said that we haven't demonstrated that our model is more efficient, I think -- I hope, this will be at least looked out as an example of the opposite. And that is that we have been able to demonstrate to one airline that we can provide a more efficient, as well as a higher quality, training solution to them than they could on their own.

Derek, are you aware of any specific concession made by the pilots in that instance?

No, I wasn't involved in negotiations with the pilots. I think when I talk about the labor situation, I'm talking more about the employees at their training center. And I think that was a sensitive issue for them.

Steve Arthur, RBC Capital Markets.

Just a couple of quick follow-up. Just to quantify a couple of things on the training center utilization rates are there any particular pricing pressure? Can you quantify that in anyway or comment on whether it is getting better worst as time is going on later in the year? Or if there are specific markets where that is impacting you or (indiscernible) equipment. Just where are you feeling the pricing pressure most?

Yes. Well, the pricing pressure, as I have said in the past Steve, is primarily -- it is not something that you can say exists in one market and not another. It applies to specific simulators in specific locations, where you either have a surplus of capacity versus demand or you have other circumstances that are putting pressure on available pricing. So it is not by any means a general point. It is a specific per simulator, per location point.

So it is really -- I guess it is most evidence on the CRJs, on the Airbus 320s, and on what I would characterize as the older business jets. And the way we're trying to come at that is not to compete on price alone. We're trying to offer, as you know, a more integrated training solution that we think represents a better value proposition for the customer rather than the flat hourly rate, if I can put it that way.

Are you at the point in any of these situations where it would make sense just to shut down a simulator in one of the centers, or is there a point at which you would consider that?

No, we're not at that point. And I don't want to give you the impression that the pricing pressure is that severe, that we are seeing no use of simulators. Obviously the Dornier 328 program, the lag there is having an impact overall on our performance. And there's no question but that is way behind the schedule that we had anticipated. And it represents a major drag on training performance as a whole, because we had virtually the exclusive market for that kind of training. So that has had a direct impact on our Dornier 328 simulators, but they are still our customers out there. Iland (ph) Airlines is one of the -- probably the biggest customers, and they are still flying existing planes and they have existing needs. The problem there is with aircraft that are being built, but for which there are not yet customers who require training. That is the problem.

Just a second point -- just to clarify the impact on Civil margins from sale leaseback payments. Did you say that that was about 6 percent?

Yes, 6 percentage basis points. I have to be very careful with my language here. It is not a 6 percent difference. It is a 6 percentage point. So if you assume that margins were 12, you deduct 6 and get to 6, I think.

And thirdly, just one thing we haven't touched on recently is the power plant simulation. We saw a number of contracts earlier this year, I guess it was. Can you just comment on activity levels there, pipeline, outlook in that space?

Well, we did have -- I guess, in the first quarter we had some significant announcements both in United States, I know, and in Europe. I am not aware of anything pending. It is not a huge market, as you know. And it is certainly not a huge percentage of our marine market. I think represents about 20 million roughly, Paul?

Yes.

20 million on an annual basis of Marine's performance. If I can get more on that, I will come back to to you. I don't have a fresh view of what the outlook on power is today.

Ihor Danyliuk, Merrill Lynch

I've got a question. Derek, with regards to the training utilization, you mentioned something about 20 percent of something had been adjusted. Can you just go through that? (multiple speakers)

I think what I said was that our revenue growth on training was 20 percent with a constant FX. And that that met our initial objective for the year. So revenue growth was what I was talking about.

Okay. In terms of comparing first quarter to second quarter, you had mentioned that there was fierce pricing pressure on equipment that was reducing margins by 50 percent. That is comparing Q2 '04 to Q2 '03. If that correct?

No, I'm really -- what I said was -- I'm trying to give you a general comment that the combination of pricing pressures and foreign exchange impacted our margins by more -- what I said was by more than 50 percent. And so what I'm saying, Ihor, to put it in plain English is that where ordinarily on the equipment side we were looking at two years ago, say, 25 to 30 percent margins. You are now looking at margins that are in the 8 to 12 percent range as a result of the combination of price pressures and foreign exchange.

Now those pressures have been more evident in the first and second quarter of this year then in the previous year, because in the previous year, even though you may have had those pressures, you are also still working on the volume that you had taken orders on previously, if you follow me.

So we are now dealing totally -- we're now dealing with orders all of which were affected by pricing pressures, and most recently by foreign exchange. So it is a combination of the pricing pressure from last year and the pricing pressure and foreign exchange this year, which is having the combined effect of reducing margins from the 25 to 30 percent category where they were two years ago, down to something in the order of 8 to 10, 8 to 12 this year, this quarter as opposed to the first quarter.

How do those margins compare between the first quarter this year and the second quarter of this year?

They're better in the second quarter than the first.

On equipment side?

On both.

On both --?

Well sorry, on equipment in particular. I don't have the number in my head on training, so let me just stay with equipment and say that the margins on equipment were better in the second than the first.

Now is that a margin reason, or is that just because -- from what I estimate your equipment sales have gone from approximately 39 million in Q1 to about 50 million in Q2. Is it a volume --?

It is partly volume, sure.

Now in terms of --.

It is partly efficiency, too.

I'm just trying to get an overall -- even though you don't break down those margins, we all try to figure them out. Overall your Civil margins went from 6 percent in the first quarter to 8.9 in the second. Can we assume that given that capacity utilization on the training side decrease, that the training margins actually declined?

You can assume that, yes.

And if that -- that being the case, and you are at about 10 percent margin, let's call it, on the equipment side. Is it roughly a 50-50 break down in terms of contributing to your 9.9 million?

I think we said that the training revenue was 60 percent. So you can do the math, Ihor.

I can do the math. I'm talking (multiple speakers).

But we don't give margins on training for the reason I gave earlier in answer to another question. We think we're taking most of our clothes off as it is, in what is an extremely competitive price market. And we're not going to say much more than I have said.

Derek, there's no secrets in anyone's industry.

Well, I know that you have no secrets that you don't share.

Greg Smith, Haywood Securities.

Six percent of sales margin related to sale and leaseback. What is the total standing, liability there on off balance sheet?

Just over 525 million. We have 35 simulators today under sale and leaseback of our installed base.

Capex, you said -- any idea for the next year what your Capex plan is, given all these new market conditions? Can you still sustain 100, 120 a year?

Well, obviously, it will be driven more by the market factors. And it is early to tell yet because we haven't finalized a plan, but if the demand is there, we could see it being slightly higher than this year. But is got to be by an upturn in the market. So I think we are saying in the low end of 100 to 125 this year. I don't expect it to be much higher next year, but obviously let's see how the market develops.

What is the plan to sale leaseback over the next six months and next year?

We're really not doing any in the -- our goal this year was to raise 100 million. And we got 123, so when I said we were pretty comfortable doing about one-third of our installed base. We really don't have any plans right now to do anything right now.

Can I get a little more color on that pension long-term compensation expense in the quarter?

What color would you like on it? (multiple speakers) It's driven by two things. As you know, midway through last year we reduced the return on asset assumption in our pension plan. We went from 9 percent to 6.5 percent. That happened at the midway point last year. And so when you do the year-over-year comparison, the first half of this year is impacted a lot, where the balance of the year will now have the same assumption on a going forward basis.

And then the balance is a combination of we are expensing stock options this year. And we do use deferred share, again, this is a form of our long-term compensation. And what we have seen is the share price appreciation this year has increased our cost, where last year we had a share price depreciation.

Ben Cherniavsky, Raymond James.

I did have a question on the working capital, but that was answered. Now that I've got the floor though I have a couple of other items that came to mind. One, I'm just wondering if you can comment on your Benson facility? I saw you got the Canadian Air Force in there, although that looked like a very small contract. But I know that there is a lot of operating leverage there by getting more people signed up to use that facility. And I wonder if you can give an update on what you see there in terms of maybe a 12 to 24 month outlook for opportunities?

And then the second question, more housekeeping. Paul, I wonder if you can just comment on what the -- provide me with what the annual rent expense is on all your sale leasebacks in your orders at this point?

Don Campbell speaking. On the bench note, the base contract is with the British Royal Air Force. The recent Cameron contract that we have signed with the Canadian forces is actually the second one. Not a large contract, but an important one for research rescue for the H101.

We also have signed a long-term contract which was announced a little while ago with the royal Dutch Armed Forces and their training there. We have three or four other customers. Singapore has been there. The Jordanians have done some training there. And we have three or four other prospects. So the third party training that we anticipated from the beginning in Benson is certainly coming about.

We have also announced a change order in the requirement for the equipment business, an upgrade in terms of some of the changing configuration of the aircraft, which brings more revenue to us. And we are currently working on a possible financial restructuring of the Benson facility, which maybe you'll hear about more about later.

So the outlook there for getting other participants would be more like a numbers of onies and twoies, rather than another big --?

Yes, you've got to remember that 70 percent of the capacity is already booked by the British alone.

And, Ben, with respect to our annual lease payments under our sale and leaseback. On an annualized basis, it is just under 49 million. Obviously, this one was done halfway through the year, so it would be pro rata, but that is on an annual basis.

Operator, we have time for one more question from financial analysts, and turn the call over to the media. One more question, please.

Robert Faye (ph), Canador (ph) Capital.

A couple of questions. Paul, just from a point of view of housekeeping, can we go through some of these little one time items that occurred in the quarter, just to get an order of magnitude? The Air Canada reduced training, for instance. The one time cost in the military side, those types of things?

Well, I don't have the total impact of Air Canada training, but I think if you looked at the last year on the military side, the one time payment I think that was, on a Canadian dollar basis, it was probably close to CAN$4 million.

What about the higher bid cost this quarter and the startup cost on the new projects?

I don't have the absolute amount, but the startups on the new project was really a function, Bob, in that last year we had a lot more maturing contracts. And as you know, using percentage of completion accounting, as you get to the maturing stage of the contracts, you have a greater certainty on your cost. And at the end of the day if you had over -- you took your conservative estimate you can tend to get higher margins at the end of the program, where this year, which is consistent with what we articulated at the beginning of this year as we got more contracts coming in, that we are at the early stages of these programs and we tend to take a more conservative view in terms of what our costs are going to be.

Don, do you want to comment on bid costs?

I said bid costs have been significant with these large programs. We have spent in excess of CAN$3 million on the Flight School 21 bid cost, which we are currently not able to capitalize. We have also spent -- and that is an ongoing issue on the British AVPS program. We have spent over $2 million on that program to date. Those are significant big costs.

When you look at the backlog in Military and Marine, how much of the backlog is equipment and how much is training?

Well, speaking for the -- on the Military about half of the backlog is the Benson MSH program, which is training. And there is the contract that we signed with the Australian government for engineering services, about $70 million over ten years training. The remainder is significantly equipment.

And on the marine --?

On the Marine side the biggest training one is the Astute thirty-year program. That probably takes about 60 percent of the backlog. The balance is made up of mainly on the equipment on the control side.

In the Asture contractor you are still -- you're getting additional change order now to add to the control systems. Where are you on the training facility, the actual equipment sales on that?

We're still building, so if you were to look at the key elements of our capital expenditures right now, outside of the completing Sims for Arsible (ph), the other major program going on is the building of the actual training facility for the Astute. So it is not even up and running yet. That is sometime next fiscal year.

Will that be the first half or second half?

I don't know exactly, but I would suspect somewhere in the middle of next year. Because there is still some tail end Capex going into the next year to complete the program.

I think it is the year from now. I think it is November.

On the Civil side, when you're looking at the potential competition or bidding that is going on the market right now, can you give us an order of magnitude of how many types of situations you are bidding on right now on the Civil side?

Several. But to give you an indication of how much more intense the pressure has become, FSI is back in the market competing on equipment sales. That is a market they vacated five or six years ago, but they are now back in. And they competing along with Talus (ph) in virtually all of the opportunities that we're chasing.

No, Robert, we wouldn't give you a precise number on the ones that we're chasing. I can only tell you that having achieved 11 orders to date, we're confident that we're going to do more of that -- more than that in the balance of year. How many more, that will depend on how successful we are in competitions, some of which are already very much underway.

So when you are saying more, does that mean you have opportunities to win more than 11 more sims in the back half of the year?

Yes, we have opportunities to increase the 11 in the back half of the year. That is what I'm saying.

Sorry, in the back half, is that 11 more in the back half?

No, no, no, no. I'm saying more than 11.

Last question on the hedging -- or sorry, second to last question on hedging. Did you have any hedge gains in the quarter?

No, we do really have much on hedge gains. What we have -- we have got some of our future cash flows hedged. And take the Jet Blue contract, now that we've signed the contract, we've hedged that. The issue where we -- on the hedging that we were using in the first quarter is we had some excess U.S. dollar borrowings that were used as a hedge against our cash flow position. But with the equity issue and the sale leaseback, we have eliminated that now.

So we are now looking at hedging on a contract by contract basis, also gearing up for the new accounting rules. So as we sign a contract, you've got to really hedge contract by contract. So that is what we're doing.

The last question, the union contract you signed, the five-year contract. Does that have any job protection in their language?

I don't what know what you mean by job protection. There is no flat guarantees, but there are obviously union concerns about seniority in that that are fully respected in the contract. So in terms of any potential layoffs, the protection they have us is from the seniority status that they have.

So you still have some flexibility (multiple speakers)?

There is no (indiscernible) in there, absolutely.

Okay, that is all time we have for questions from financial analysts. I will now turn the call over to Art Perron who'll invite questions from the media.

Good morning, ladies and gentlemen. It is a pleasure to welcome the representatives of the media this morning. I certainly assure you that Mr. Burney and Mr. Campbell and Mr. Renault look forward to answering your questions. (French translation) If we can take the first question now, we look forward to that. Well, if there are no other questions --.

We have received a question from Financial Post, Paul Zera (ph).

I just wanted to check on -- I know you mentioned Jet Blue, your contract with them. Are there any more opportunities to be had with the discounts/low-cost carriers in North America, because they seem to be the only ones adding airplanes and expanding in the current commercial aviation market?

Well Southwest has been a pretty consistent customer of ours in the recent years. And I'm not sure -- I don't have in my head right now whether they have any additional needs for this year, but you can assume that is a customer that we would be the watching very carefully to see what needs they might have.

I am not aware of prospects with any others at the moment. But as you know, Jet Blue has an exclusive contract with us for the next ten years. There are discount airlines in other parts of the world, where there are opportunities that we're chasing. I can tell you that.

The reason I ask because a lot of them are looking at the Embriere (ph) 170 and the 190 family, particularly West Jet is now looking at adding that plane onto their fleet.

Well, West Jet has been a consistent customer of ours for their 737s, and given the -- I wouldn't say advantage we have on the Embriere, but certainly given the success we've had with selling Embriere simulators as to US Airways, we would certainly put up a good fight for any business on that front as well.

Paul, I know I am not going to get an answer on this, but has there been any indications from some of your bigger rivals, such as L3 (ph) about a possible -- acquiring CAE?

Well, it is a very small industry when you get to that. But the short answer is, no. But you know there is always lots of talk going on in the industry, especially in the defense industry, which you may read various reports recently about BAE and its attempt to join up with an American company. There is talk about this kind of stuff going on all the time. But the short answer to your question is no.

Mr. Burney, you indicated in a recent letter that your retirement is perhaps in the offing shortly. Have there been any plans made by the Board about succession planning or looking for a new CEO?

Well, yes, I can confirm that, number one, that I'm turning 65 next year, which is the normal retirement date, and was certainly the retirement date I contemplated when I came to CAE. And, yes, you may assume that the Board is fully conscious of its responsibilities in terms of planning for a succession. And that is an event that I would be very involved with. And it will be done in what would be regarded as an orderly manner, in order to ensure a smooth transition. And you can assume that once a selection is made, and the timing is set, that the Company will be making an announcement.

(OPERATOR INSTRUCTIONS) Andrew Bell, Robert Tevey (ph).

Andrew Bell of Report on Business Television. I missed these remarks earlier. I wonder could you just repeat briefly -- you're still going after the flight school contract? Could you explain how that works? I'm seeing a headline on Bloomberg, but actual execution of that contract has been suspended. So do you still have a chance of winning the big U.S. helicopter training contract?

Well, when the decision was taken by the U.S. Army procurement authorities, we requested a debrief. On the basis of that debrief, we have launched a formal appeal with the General Accounting Office of the United States based on the advice of our legal counsel that we have good and sufficient reason to launch an appeal.

As part of that appeal process the performance of the contract has been suspended, depending the hearing of that appeal, which is expected within a thirty-day period by January 15th, with the possibility of -- I'm sorry, 100 days with the possibility of a 30 day extension.

So it could take up 130 days before you even get a hearing on this thing?

Not before we get a hearing, before a decision is taken.

I see, a decision. So a decision within the next few months.

The hearing process is underway now.

Right. Can you give us some indication as to why Computer Sciences and L3 would have this contract yanked away from them?

I don't think it would be appropriate for me to comment on the issues that are involved in the case, other than to say that we've got good and sufficient -- we think we have good and sufficient cause on the basis of the debrief which we had. We continue to consider we offered the best value. Our price was $159 million cheaper than the opposition.

What is the total value of the contract? Is it $1 billion?

The total value of the contract is slightly over US$1 billion.

Thanks very much. Sorry, is that Mr. Burney talking?

No, Don Campbell speaking.

There are no further questions. I would like to turn the meeting back over to Mr. Arnovitz.

Thank you listeners and participants. I would like to remind you that today's remarks and additional information about CAE can be found on our website located at CAE.com. Thank you.

Thank you, Mr. Arnovitz. At this time we would like to thank all participants for joining us today. The conference has now come to the end. Thank you for using the Bell Conferencing Solution, and I wish you all a great day.