CAE Inc (CAE) 2005 Q1 法說會逐字稿

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

Thank you. Good afternoon and welcome to CAE's fiscal-year 2005 first quarter conference call. Let me begin by reading the following statement. 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 expectation 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 filings with the Securities and Exchange Commission.

Participating in the first quarter conference call this afternoon are Derek Burney, President and Chief Executive Officer; Paul Renaud, Chief Financial Officer; and Don Campbell, Group President of Military Simulation and Training. The format will be as follows: Paul Renaud will present you a detailed review of financial performance for each business unit. Don Campbell will then offer additional insight into CAE's Military and Simulation and Training business, and provide his view of the business unit's recent performance and outlook. Derek Burney will conclude with a brief summary of remarks made at the AGM. Following these presentations, we will invite questions from the financial analysts. For your convenience, this conference call will be archived on CAE's website.

Let me now turn the call over to Paul.

Good afternoon. Earnings from continuing operations for the first quarter amounted to 24.3 million, or 10 cents a share compared to 15.1 million or 7 cents a share for the same period last year. Earnings benefited from the recognition of additional investment tax credits on research and development expenditures in prior years, a significant improvement in the operating results for both Civil and Marine and lower interest expense, which more than offset lower margins in Military and an increase in the tax rate to 30% this year versus 9% last year.

Consolidated revenue for the first quarter increased by 8% compared to the same period last year to reach 262.6 million. The increase is attributable to a 16% increase in Civil's revenues resulting from both a rise in training utilization, 73% for the quarter, and an increase in equipment sales due to higher orders during last fiscal year. Military's revenues increased by 4% as a result of higher service contract activity, while Marine's revenues declined by 7% due to lower activity on both the Astute and Royal Malaysian Navy programs, the former resulting from delays in the manufacturing of the actual submarine.

CAE's consolidated backlog as of June 30th, 2004, reached 3.1 billion, 149.1 million higher than the previous quarter, and 427.8 million higher than last year's level. More importantly, none of the following 5 programs are included in the Q1 backlog. The July order bookings for the Astute change contract, the sale of 3 full-flight simulators to Emirates. The contract to provide entitlement training on the new Falcon business jet from Dassault. The estimated value that we expect from CAE's preferred bidder selection on the NH-90 last fall. And our recent selection as the preferred bidder on the British Army's armored vehicle training services contract. The backlog would, as Derek stated to shareholders, provide a solid start to 2005.

Before speaking to the operating performance of each business, let me address the investment tax credit benefit that amounted to 16.1 million in the first quarter EBIT of which 9.8 million, 4.4 million, and 1.9 million are included in the operating earnings or EBIT earnings of the Civil, Military, and Marine business segments respectively. This amount was recognized into income as a result of the completion during the quarter of the federal income tax audit for 3 fiscal years, 2000, 2001, and 2002. This was a period that had an exceptional amount of R&D spending to support our next-generation of simulation technology in our move into training.

Based on the tax audit, CAE had underestimated, I should say conservatively estimated, the amount of investment tax credits which we were entitled to by 12.3 million. As a result of the tax audit, we reviewed our estimate of ITCs recorded for fiscal 2003 and 2004 resulting in an additional benefit of 3.8 million. It is important to note that the final outcome for 2003 and 2004 could vary based on the final tax audit that will occur in a year or 2, but the Company is confident that the tax audit for those periods will be well within our revised estimate. This should also provide an additional benefit for the future as well. The benefit, of course, depending on the level of expenditures.

Interest expense amounted to 5.3 million for the quarter compared to 7.2 million for the same period last year. The decrease is a result of reduced debt levels through the issuance on September 30th, 2003, of common shares which yielded CAE a net receipt of approximately 168 million, and from the proceeds of approximately 122.5 million from the sale/lease back of simulators during fiscal '04. The dilutive EPS impact from the share issue last September is just below 1% per share when comparing this year versus last year's first quarter earnings per share.

The income tax rate rose from 9%, 1.5 million last year, to 30%, 10.5 million, for the current quarter. The quarterly fluctuation in the income tax rate reflects a change to the mix of income for income tax purposes from various jurisdictions, as well as recognition last year of tax benefits recorded for prior-year's tax losses in Australia of 4.4 million. We anticipate our tax rate for the full year to approximate 30%.

CAE's net debt defined as long-term debt less cash and cash equivalents, increased by 103.2 million during the quarter to 678.2 million, approximately 50% of this increase, 51.2 million, resulted from the -- from completing the external financing of the CAE/Iberia training venture under which CAE has an 80% ownership and, therefore, consolidates the combined operation. An additional 43.4 million was used to support operations, mainly capital expenditures and noncash working capital, with the balance 8.6 million being the currency fluctuation on our foreign denominated debt, mainly U.S. debt resulting from a weakening in the first quarter of a Canadian dollar versus the U.S. dollar.

With respect to our cash flow, capital expenditures were higher than expected, however we are not changing our outlook for the year of between 100 to 120 million as the expected total. We had expected to be negative on noncash working capital in the first quarter, but still expect to be positive for the year. The major milestones on certain Military projects have slipped a few months, but we should still realize the major milestone payments during this fiscal year.

I will now provide more details on the financial performance of the 3 business segments. Civil's revenue increased by 18 million, or 16%, to 127.1 million compared to the same period last year. This growth was driven primarily by the significant increase in training utilization hours, a trend that began in the latter part of fiscal '04, mainly in the training centers located in the Americas. We also recorded higher revenue from equipment sales stemming from last year's increase in full-flight simulator orders. In addition, the Company's new training center with Iberia Airlines, 100% operational this fiscal year, contributed approximately 200 basis points to the 14% increase in training revenue.

Civil achieved significant EBIT growth compared to the same period last year to reach 21.9 million. This includes 9.8 million from ITCs related to expenditures of the prior years. Excluding the ITC benefit, Civil's operating margins improved to 9.5% from 6% in the prior year. The improvement stems mainly from the growth in training revenue that more than offset both a 1.8 million charge to reorganize its European training operations and the higher operating lease expenses associated with last September's sale and lease back.

Backlog for Civil consists of both equipment sales and training services. The training services portion includes revenues from customers under contractual arrangements, both long and short term, where training revenues are guaranteed or expected based on current customer requirements. Civil's comparative backlog for March 31, 2004, and June 30th, 2003, has been restated to reflect the above-mentioned methodology. Backlog at the end of the quarter totaled 1.1 billion, up 6% from March 31, 2004, and up 38% from a year ago.

For the 3 months ended June 30th, 2004, Military's revenues reached 103.6 million, an increase of 4% compared to the same period last year. Military service revenue was higher this quarter as a result of the increased contribution from the management and support of Australian Defence Force simulator and the C-130-J maintenance and air crew training systems contracts. Military's EBIT for the first quarter was down 1.9 million, 15% below last year for the same period. The shortfall is mainly attributable to higher costs incurred to complete certain programs and the mix of contracts. The increased costs amounted to $4 million on programs at or near completion.

On the medium support helicopter program, which represented half of this amount, the cost was related to foreign currency in connection with completing the change of the visual system. The balance involved higher costs on the CP-140 simulator program, it's an old aircraft type with salvaged components from crashed cock pits and an old FTD proving inadequate, as well as higher costs on their last deliverable under the Merlin program, our first ever brief/debrief station. With respect to the impact of the mix of contracts, the weighting of the contribution from the Eurofighter program contributed to a lower margin percentage. Like the German NTF program, Eurofighter has a high subcontract component that can vary significantly quarter by quarter and the impact was expected. The higher cost in changing program mix were partially offset by lower selling and marketing expenses in line with CAE's cost reduction initiatives, as well as the 4.4 million of additional IT recognition in the current quarter. Military's backlog was in excess of 1.3 billion at the end of the first quarter, an increase of 4% from March 31, 2004, excluding any amount for the NH-90 or AVTS programs.

Marine's first quarter revenues amounted to 31.9 million, 2.3 million lower than last year's first quarter revenues of 34.2 million. The shortfall can be attributed to a decline in new orders received in the prior year. However, Marine has recently signed major new orders that are expected to have a positive impact on revenues in future quarters. Marine also continued to experience customer delays in the Astute submarine program, which consequently led to delays in the recognition of revenues.

EBIT for the first quarter amounted to 7.8 million, including 1.9 million with respect to the ITC benefit from prior years, excluding the ITC benefit, EBIT margins rose to 18.5% compared with 14.3% in the prior year. The backlog increased by 6% from March '04 to reach 644.5 million. This amount excludes a previously mentioned Astute submarine change order of more than 200 million that was contracted subsequent to the quarter end.

With that, let me now turn the floor over to Don Campbell.

Thank you, Paul. Good afternoon, everyone. As Paul has just stated, the year-to-date has had both challenges and significant successes for the Military unit. Our financial performance in the first quarter was not what we would like it to be. Operating earnings were down because of the cost overrun on 3 programs in particular, as has been mentioned by Paul. Margins were also affected by the uneven flow and weighting of earnings for programs such as the Eurofighter, which will correct themselves over the course of the year. We are confident most of these cost issues are behind us and we'll return to more normal margins over the balance of the year.

On the positive side, we're confident we can at least match our last year 500 million-plus order book. We have won some important competitions year to date that underscore our ability to compete and order well for our future prospects. In particular, there are 2 wins that I think deserve to be highlighted. One was the selection of CAE USA by the Naval Air Systems Control, or NAVAIR of Orlando, to provide flight crew and back-end trainers for the U.S. Navy MH-60S, these are submarine hunter helicopters. The initial order, valued at 52 million Canadian, is for 4 trainers with an option to sole source 4 more for another 57 million, which is not yet in our backlog. This is our first contract with the U.S. Navy since returning to the U.S. market in 2001. It involved winning against some highly competent opponents, all the usual suspects like Lockheed Martin, Boeing, and L3 Com. And we believe it positions us well for the additional U.S. Navy business under the Navy aviation simulation master plan.

The second major win has occurred more recently in the United Kingdom where our landmark consortium has been selected as a preferred bidder on the armored vehicle training services, or AVTS, PFI. Again we were up against very stiff competition in Lockheed Martin and Thales for this 30-year program for the British Army Royal Army Corp. We're already in pre-contract and contract negotiations that we expect to complete successfully by June 30th of next year. Under the contract, our special purpose vehicle landmark training, 65% owned by CAE, 25 by Agusta/Westland, and 10% by Interserve. We'll first take over existing army, training equipment facilities and training programs on 17 Army bases in the U.K. and Germany. Landmark will be providing new training facilities over a 3-year period, as well as wet training including course ware and instructors. Under contract from Landmark, CAE will be building and subcontracting gunnery trainers, park fast [ph] and driving simulators. The consortium capital investment in this special purpose vehicle will be approximately 100 million pounds, the 240 million dollars Canadian, financed on a 90/10 debt/equity ratio.

The objective of the program is to achieve the optimum balance of live and synthetic training or simulated training to achieve successful graduates in the least amount of time at the lowest cost. The consortium will receive revenue from the beginning of the contract when we take over the Army's facilities, ramping up to between 30 million pounds, or 72 million Canadian, and 45 million pounds, or $108 million Canadian, approximately per year through the life of the contract. Until the precise structure is completed, we will not know when and how revenue will be recognized on the equipment portion of the contract. However, CAE will recognize 100% of the revenue from the ongoing operation of Landmark and 65% of the profit reflecting our ownership.

In announcing our selection, we indicated the value of this 3-year initiative at approximately 1 billion pounds, approximately 2.4 billion Canadian at current exchange rates. There is room for upside depending on whether we can progress simulation over live training beyond our commitment during that program. This major project will situate us in the U.K. in all 3 domains. Flight with our bench and medium support helicopter PFI, Naval with the Astute class submarine PFI, and now land with AVTS. Obviously, we're extremely pleased with our selection.

With that, I'd like to turn the floor back over to Derek.

Thank you, Don. I will now repeat the remarks made earlier today to our shareholders. Rather, I'll offer a few general observations in this, my final session with you. I sincerely believe CAE is transformed and now after weathering a perfect storm of adverse market conditions has a more focused, more balanced platform for future growth. I also believe we are well positioned to deliver with a large and growing backlog of work ahead of us and much of the heavy lifting and building our global training network behind us. There have been disappointments along the way and some things, obviously, we might have done differently or at different times. Despite the adverse market shock that were mostly beyond our control, we did remain committed to our strategy because we were confident it was the right path for CAE to follow.

I'm especially pleased by the steady growth of our Civil training operations. Clearly the most dramatic shift in strategy. And the success of our technology innovations which reinforced this move. I am relieved, as well as pleased by our AVTS win and I am happy at the steady performance throughout from our Marine unit that helped sustain our profitability through the turbulence in Civil aviation.

In terms of outlook, we expect Civil to continue to grow during the balance of the year, especially if it has market conditions and commercial aerospace continue to improve. We anticipate that the contribution of training, notably wet training, and the revenue per training simulator, will show steady increases. We fully expect Military's margins to be back on track, as Don mentioned, and another year of 500 million-plus in orders. That is without any contribution from AVTS. We expect another year of solid contribution from Marine, and recent contract awards in the United States and the Astute change order position the business for future growth. We expect positive cash flow from all 3 business units by the end of the year, reflecting both anticipated growth and further productivity gains. Our expanding backlog in itself provides a solid foundation for growth, but the overriding objective for all business units for the remainder of the year will be to contain costs in an increasingly competitive global market.

I consider it a privilege to have had the opportunity to lead this unique Canadian Company. As I told our global employees, CAE is now an indelible part of my DNA. I have every confidence in our new CEO, Bob Brown. He's well qualified to lead CAE to the next level of success and I am pleased to welcome him to the Company.

Thank you, Derek. Operator, we will now invite questions from financial analysts and investors.

Thank you. We will now take questions from the telephone lines. If you have any questions, please press star 1 on your telephone keypad. If you are using a speakerphone, please lift the handset and then press star 1. If at any time, you wish to cancel your question, please press the pound sign. Please press star 1 at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. First question from James David from Scotia Capital. Please go ahead.

Thank you. Good morning, or afternoon, pardon me. Paul, I just wanted a little bit of clarity on the investment tax credit issue. Every quarter you recognize some. When you identified the $16.1 million, is that entirely related to the tax audit, or is a portion of that related to the tax audit?

It all falls from the tax audit, but the tax audit covered years 2000, 2001, 2002, so those are final, and that triggered 12.3 million of the 16.1 million.

Yep.

2003 and 2004 have not yet been audited, but we have adjusted our accounting to reflect the results of the audit an estimated --.

The 3.8.

The 3.8.

Okay. Were there ITCs recognized in the quarter outside of this?

Well, generally, but not very much. It depends on the timing of expenditures that we have, but not much an impact for right now in Q1.

Okay.

But it will have a benefit say throughout the year as we go forward.

Sort of normal course, like what you --?

Yeah, exactly.

Okay. Was the CF-18 related costs, were they material in the quarter? Did you sort of write off a chunk of capitalized bidding?

No, they were not -- that wasn't -- the issue on the CF-18 was really to get the benefit of the manufacturing volume and then ultimately the revenue in Military so it would have an impact on overheads a bit. More of the issue impacting the margins in Military were the costs in connection with the 3 programs we talked about that are behind us, the 4 million.

Okay. And last question. Don, you touched on this, and I apologize, but I couldn't keep up. Specific to the NH-90 and the AVTS, the NH-90 you expect to sign in 2004, and I was just curious, I know you talked about it, I didn't catch the numbers, but how much of the NH-90 is equipment, and what would be the timing for that? And how much of the AVTS is equipment and what would be the timing for that assuming the June 2005?

It's not -- it's not -- the NH-90 program, it's not clear yet what the actual nature of the program will be. There are 2 negotiations underway. One is with the NHI consortium, which is the big program which will provide, over time, up to 450 million euros in equipment, and that is separate from a follow-on -- series of contracts that will likely come, it will be even larger for services. It is not our expectation that that kind of a contract will be signed this year. We would think that much smaller contracts for design and development will be signed. At the same time, we have been selected with our partner Thales in a consortium for a possible PFI, Private Finance Initiative, with the German government, and both of these are running at the same time, it's a bit premature for me to either give timing on which one is going to come first.

So if I interpret your comments correctly, the NH-90 would be worth up to potentially 415 million?

Euros over time.

Is that over 10 years?

And equipment.

Like 10, 20 years?

It's difficult to say exactly when it will first begin design and development. It's not -- the program as to when the actual equipment will come in is not clear yet.

Okay.

But it will certainly be in less than 10 years.

Okay. And the AVTS, I know you talked some numbers there.

The AVTS, we will be taking over training, sort of the current training services which are all live with the conclusion of the contract expected for next -- for our next fiscal year, early in our next fiscal year. At the same time, we will commence the building of equipment which will be about 100 million pounds in equipment, and that will be a 3-year program of building that equipment, which we will be doing under subcontract as well.

Is that following the official closure of the deal in June '05?

That would be following the official closing of the deal.

Okay. Thank you very much.

Thank you, Mr. David. The following question from Ben Cherniavsky from Raymond James. Please go ahead.

Good morning. Just to be clear on the -- I just want to clarify from the earlier question on the ITC. Paul, should we then expect some permanent lift in your margins from this? Like have you changed your accounting going forward?

You would expect to see some lift in our margins.

Okay. Great. And you mentioned on your Civil side there was some reorganization charge. How material was that?

That was 1.8 million, Ben, and it related to combining some AV initial [ph] training schools in Europe and that was in the costs, the severance costs, associated with the benefits of eliminating some people when we combined the schools.

So that would be -- that wouldn't recur, obviously?

No, that's done, and that's all been provided for, in fact, the activity is now complete.

Okay. So it sounds like your margins -- I mean, one of the questions I had in mind here with the margins in Civil was that you mentioned utilization rate was up in training, but you didn't see a big lift in the margins, and that, to me, seems like such an inherently -- a business with such inherent operating leverage, that was a bit surprising. You're not increasing your utilization rates by giving away the training time at this point, are you? In other words, are you seeing some price stability on the training side of the business?

Certainly on the training side you're seeing more price stability than you are on the equipment side, but, again, the capacity issue is one thing, but, you know, the other game is yield. We're seeing some improvements, and obviously, as we get wetter we hope to see further improvements in terms of revenue per SIM.

Great. Finally, in, I think it was the last quarter or the one before that, you spoke about getting $40 million of cash from the German receivables.

Yes.

Was that in this quarter?

No, that's a bit of -- we always anticipated it would be negative this quarter, not as negative as we prior were, but the NTF is the one program that slipped, but we are confident that we will receive all of the money in this fiscal year and that's why we remain confident with respect to our expectation for year to be cash-flow positive when it comes to non-cash working capital. A lot of that is coming on the NTF and a couple of other military programs.

I thought a milestone had already been hit there.

We got some money at the end of last year, but realistically, still the bulk of the cash is still there.

Okay. So still expect cash flow from working capital and free cash flow positive overall for the year?

Yep. Yes.

Okay. Thanks very much.

Thank you, Mr. Cherniavsky. The following question is from Jacque Cavesion from Research Capital. Please go ahead.

Hi. Good afternoon, Paul. My question also relates to the utilization rate of 73%. To me that sounds like a big jump in relation to the margin improvement that you experienced. Do you have any better explanation than what you just said?

No, I can't -- no more comment than what we just said.

Okay. But that's -- what -- that looks like a fairly decent utilization rate, and yet margins are still fairly low. Do you think that the utilization rate can go higher than 73%?

Well, I think that's quite an improvement from the utilization. Don't forget it's a seasonal business, and I think our utilization rates this year, certainly in the first quarter compared to last year a lot better and we will see that, you'll still have the seasonal fluctuations as the summer period is always the slowest part, but I think the improvement in the utilization is certainly a good indicator for the market and hopefully a good indicator of our ability to, you know, work -- get better yields at the end of the day. The game is to get better yields and to get wetter so that we can improve the revenue per SIM, per hour.

If I could just add, Jacque, to Paul's comments, I do think it's important to keep in mind the actual increase in margins that he spoke to, which is largely attributable to the contribution coming from training. The utilization did increase significantly over last year. Despite the seasonality we expect to see the yield continue to improve as more -- as we bring more wet training into the operation. But at the same time, you have to understand that the price competition we faced out there is not just on equipment, it's on training, particularly spot training. So we're not unmindful of the fact that with some of the spot training, particularly in Europe, it's highly competitive, and the rates are under pressure, but despite that we're seeing an increase in revenue per SIM, we're seeing an increase in margins, and we think it's roughly equivalent to what we would have anticipated 73% capacity utilization should generate for us in terms of operating margins.

Okay. Thank you. Excluding the investment tax credits, what would the earnings per share would have been in the quarter?

Well, at the end of the day you can calculate it.

I did. I'm just wondering --.

16.1 million pretax, 11.4 million after tax. So take the 11.4 and divide by the 250 million shares you get a pretty good number.

Okay, Paul, I did the calculation, I got the number I was just wondering if your number matched with mine.

Yeah, it does. I think we went to the same math school so it can only be one way, it's pretty exact.

Jacque, thank you very much for your questions. Operator, we'll move on to the next caller, please.

Thank you, Mr. Cavesion. The following question from Cameron Jeffreys from CSFB. Please go ahead.

Hi, guys. Thanks very much. Most of mine have been answered, just had a quick question on the split of your Civil equipment revenue versus training. Is it still kind of ballpark similar splits as prior quarter or is it any notable changes?

Pretty much the same, just like 60/40.

Okay. And can you just -- maybe I missed this, but can you just give me a -- give us a quick kind of rundown as to what you did over in Europe, that restructuring in note 7 kind of caught me by surprise. As I said, maybe I missed it, but that, to me, hasn't been announced before, so can you just run through that?

Yeah, what we did is we had 2 AV initial [ph] training schools, 1 in Portugal and 1 in Masdrik [ph] and we combined the 2 schools and that really -- to get the economies of scale, and obviously reduce the costs, so the economics, you know, putting 2 schools together we eliminated just over 30 positions.

Okay. Thanks.

Thank you, Mr. Jeffreys. The following question from Pierre-Yves Therisse from Desjardins Securities. Please go ahead.

Yes, thank you. Just going back to the CapEx for the year, Paul, you said you expect between 100 to 120 million for the full year?

For the full year, correct.

Okay. All right. And can you break down again the backlog? I missed the number.

The backlog of 3.1 billion is 1.1 billion for Civil, 1.3 billion for Military, and about 650 million for Marine.

Okay. All right. One last question. Derek talked about the spot training. I assume that's what you were previously talking about, dry training.

No, what I mean by spot training is training that is booked almost a week in advance or a day in advance on an hourly basis. Not all dry training is booked that way. We have dry training on long-term contracts, but spot training to me is almost gap filling training when you've got airlines looking for a chunk of hours for a small group of pilots with very little notice, and so what they basically do is almost go on eBay and see what the best rate they can get for it and then that's where they go so. There's no long-term continuity to it, you can't plan on it, but you use to the fill capacity while recognizing that you're not going to get the highest price in the market for that kind of training, and that is particularly true in Europe. Not as much so in our Americas operations or in Asia and certainly not in most of our joint venture operations.

Derek, would you say that spot training is mostly related to commercial aviation training or is it also related to business aviation?

Almost exclusively commercial. Business as you know is almost entirely wet program related and I'm not aware of any spot training at all on the business side.

Okay. All right. Thank you very much.

Thank you, Mr. Therisse. The following question from Marco Pankac from JMP Securities. Please go ahead.

Good afternoon. Just want to clarify that $1.8 million charge. It did flow through the year income statement in the quarter?

Yes.

Okay. On the Astute program where are we right now in terms of your expectations? You say sort of balance of year, but should we expect it in the current quarter? And generally can you give us sort of a frame of reference in terms of its relative revenue magnitude in terms of how much of a dollar impact that was from Marine?

In terms of -- there's 2 contracts, as you know, on Astute. We have the control systems contract, which is probably pretty far along in the 60, 70% in terms of completion so the activity sold a little bit. I think the other big contract coming out of Astute was the change order which is really under fast is the training. So what's really happening there is the training center, as much as the building is built, some of the equipment is done, this thing is not going to be commissioned into training until our fiscal '08, fiscal '09, so there's been a delay there, but the flip side is we are being compensated for the delay, that was all part of the change order that we've got. So in terms of the absolute magnitude, I can't tell you in the quarter but obviously, you know, that activity will be made up as things progress and our goal is, you know, to the extent we're delayed we seek compensation for the delay.

Okay. But, I mean, the compensation -- basically what you're talking about is a push-out to '08-'09.

That's just on the training, and once the training center operates the joint venture we have with Alenia Marconi, so, in other words, we're building the training center but there's no revenue yet coming from that. We won't get any revenue.

Right. But, so if we just -- what I'm just trying to discern here is if I go back and look at your numbers sequentially as opposed to year-over-year, the drop from 39.2 in Q4 to 31.9 this year really's got nothing to do with Astute.

It's a combination of the mix. So I think last year if you were to look at last year the order book was a little bit soft, and so we had delays in orders, and so that had an impact. Until you get the order you don't start doing work. We had a lot of activity going on on Asian programs.

Right. But that's separate and distinct from Astute.

Yeah, but there's some delays on Astute as well. If there were no issues with respect to the submarine we'd be much further ahead on the control part of the contract.

Okay. On the Military side of the business you identified the $4 million in cost overruns related to those programs. I know you that guys have talked about previously how this is much more customized nature of work and I guess my question is, is what gives you specifically the confidence you're going to be able to rebound to your old margin levels because my sort of presumption is, is that this is an inherent part of your business and the risk management thing and why is that it that we won't have whatever other programs that sort of have these issues as they come towards their completion and you guys sort of know exactly where you're coming out on them?

Well, it's quite true that a lot of our programs are leading edge, but these were one of them in particular which was a submarine contract for the British Navy was a particularly innovative program that had some significantly more risk and that program is basically done. Taking a look at the mix of programs that we've got ahead I think that the risk challenge that we've got is such that we are going to return to our normal margins.

Okay. Just lastly on this -- on your training business of 73% versus 67% in Q4, you sort of talked about various things here and it's still not clear to me why the numbers aren't better. Is it, in fact, that you've had a change in mix so you're getting, you know, decent utilization but you've got -- so while pricing on an apples-to-apples basis may be stable, there's a mix issue going on here that you've got some relatively lower margin business that's taking up relatively more utilization?

No, I don't think it's as much of a mix issue as a price issue, Marco. If anything, the mix is getting better because we're getting more wet and we're getting a higher revenue per SIM, but there's no question but that the price pressure is having some effect, but keep in mind the margin improvement that is there, the margin improvement in Civil is coming primarily, if not exclusively, from training.

Right. But I guess most people are looking at your Q4 numbers and your Q1 numbers not year-over-year and they're sort of saying revenues were roughly flat, your utilization popped dramatically over the last 3-month period and yet we're not really getting anywhere on profitability and I think that really is the key question here.

Well, we think we are getting some where on profitability because the margins are moving in the right direction, but we acknowledge that the margins on equipment are not what they ever were. There's still a lot -- there's even more price pressure on equipment sales than there is on Civil -- on training, and so, in effect, training is the one that's contributing to the margin improvement in Civil and it's more than compensating for margin erosion from equipment.

Got it. Okay. Thank you very much.

Thank you, Mr. Pankac. The following question from Egor Daniluk from Merrill Lynch. Please go ahead.

Sure. A lot of the questions have been answered. But, I guess just, Paul, in terms of your cash flow statement so I can get a -- this investment tax credit, you have a noncash item in your cash flow statement.

That's it.

Hello?

That's it.

So that 15.6 is essentially the 16.1.

Yeah. That's right.

Okay. That's one question. Your net debt has gone up essentially $100 million in the quarter. Can we assume the divestitures are behind you now?

Oh, yeah. Oh, yeah. Again, Egor, the big contributor to the debt was the financing put in place on the Iberia joint venture, so these are all simulators on balance sheet and we got some 7-year very attractive financing.

Right. But all your operations are now core?

Yeah, we have not -- we've sold all the discontinued businesses.

Okay. In terms of the breakdown, I know you roughly said 60/40, can you give us those exact percentages in terms of revenue? You used to give them verbally before, at least enough so that we could back --.

Training is 63%.

Okay. Is that exact enough? That's fine. I could always ask about EBIT, but I won't [laughter].

Don't go there.

Well, I'll wait until Bob is there.

Yeah, okay.

Thank you.

Thank you, Mr. Daniluk. The following question from Cameron Doerksen from Dlouhy Merchant. Please go ahead.

Yeah, just to follow up on the debt question. At the end of the fiscal year your current long-term debt was 13.5 million, and at the end of Q1 it was just around 43 million. I'm just wondering if you could explain what's going on there?

Probably one of our finances. I don't know which one offhand, Cameron. I could get back to you. Probably there's a principal payment due in the next 12 months. I believe it would be part of the private placement we did in 1997. I think there were some 8-year money there and that could be now falling into the current category.

Okay.

Because the bulk of our long-term financing is really tied by the revolving facilities we have in North America and in Europe and those are up for renewal in just under 2 years from now.

Okay. And just another quick one. Off balance sheet leases, what was the number at the end of the quarter?

We didn't do any more during the year, and so relative to the obligation stayed the same, 35 SIMs, lease obligation 482 million, annual lease payments of about 45 million.

Okay. That's it for me. Thanks.

Thank you.

Thank you, Mr. Doerksen. The following question from John Devros [ph] from Raymond James. Please go ahead.

Hello. Sorry, hi. It's actually Ben Cherniavsky here again. I just had a follow-up question on your SIM orders. Right now you're at 5 for the year. Your previous -- I think your previous expectation was to be somewhat flat this year, is that still -- do you still see that kind of environment?

Yes.

Okay. And then with respect to your margins, again, getting back to that issue, I know I don't want to belabor this, but if your -- Derek, you said that the margin improvement in training is offsetting some further deterioration in manufacturing, but where are you now in your work flow with respect to, you know, what you're building in relation to your order rate? Because you obviously work with a lag, and at some point I would expect the higher order rate that you achieved last year and that you expect to achieve this year versus fiscal '03, wouldn't that start to see some margin recovery as well?

In theory it should, but the problem with theory is reality sometimes is different and the pricing market that we're in today on simulators is even more aggressive than the pricing market we were in last year. So while it's true we're seeing some productivity enhancement from a slightly larger order book under production at the moment, we're also in a very tough -- very aggressive price market. Very simple reason, Ben, the A380 market, which is the newest market for the newest aircraft, the reason why it's so fiercely competitive is because you've got 2 major suppliers. CAE won the first 3, and there was very tough competition for the next 2. Because with 5 A380 simulators under production, we should be able to see some productivity enhancement come from that, but our competitor also knows that having lost the first 5 A380 orders, they're going to be under the gun to produce as efficiently for any future orders as we are, so that explains to you 1 portion of the aggressive pricing that's going on on the simulator front. I think our margins have improved on equipment, but not nearly to the extent that they were in the robust days of selling 35 simulators, and we don't see those kind of margins returning. I stressed in my remarks to the shareholders that the airlines are not seeing profits, so they're looking for lower cost wherever they can get it. So we know we have to continue to get our costs down because the only way we're going to see any margin enhancement is not from price, it's going to be from cost reduction.

Okay. That makes sense. That's a good answer. But then you still see room to get your costs down?

Yes, absolutely, and I'm going to convey that good wish to my successor.

Finally, getting back to the first question about order rate and you said you're still on track to be flattish with -- to achieve as many orders this year as last. Now, with the -- what looks like from the OEMs an upward revision in their expectation for aircraft deliveries, you think there may be room to actually exceed your forecasts this year or does it just get better visibility into next year?

I'm sorry, I missed the last part of your question.

Sorry. Just with the -- recently after Farenbaur [ph] and just in the industry in general with some of these OEMs, particularly Airbus and Boeing increasing their expectation for deliveries in their build rate, does that -- you know, can we then say that there's an upside potential for SIM orders as well, or does it maybe just spill more into better visibility for next year?

I would not want to encourage you to go that far. Actual deliveries of aircraft in the first half of this year were slightly behind the first half of last year. Keep in mind that last year our order book included a is singular order of 6 simulators from Jet Blue. So we're obviously -- we're obviously encouraged by what we see as the increase in passenger traffic, by the fact that U.S. Airlines have hired more pilots in the first half of this year than in all of last year, so there are signs of improvement, but those are probably more indicative of uptick on training than on equipment. We don't expect to see major airlines purchasing new aircraft until sometime in the next calendar year. So that's why we're being fairly conservative with our outlook. The fact that we captured 5 out of 6sales to date, market share is what we are putting our priority on as opposed to volume in a very tight market.

Right. But, I mean, 3 to 6 months ago when you first had forecast a flat year for this year, the market seems -- almost everyone else in the market seems to believe things could be better than they originally expected.

Hey, nothing would make me happier, but I'm not going to hang myself on my last day.

Okay. Fair enough. Thanks very much.

Thank you, Mr. Cherniavsky. The following question from Ross Turnbull from Odlum Brown. Please go ahead.

Good afternoon. Derek, this is your last call, you must be looking forward to this.

I'm looking forward to lobster season beginning in New Brunswick on Sunday.

I just wanted to follow on the Iberia debt, Paul. This debt that you're taking on, do you think eventually it gets pushed off balance sheet?

No. I mean, it's 7-year money, 2 banks, IND, BBBA [ph] and Spain, all in under 5%, we'll leave it exactly where it's at.

Okay. That's it for me.

Thank you, Mr. Turnbull. The following question from Richard Stoneman from Dundee Securities. Please go ahead.

First question, Paul, the unusuals in the quarter that were negative were 1.8 million in Civil, 4 million Military. Were there any others?

No, you've got it, Richard.

And the second one is for Don. You mentioned 450 equipment with Thales split on NH-90 and the German contract. Is the German contract part of the Thales partnership or is it in addition to the Thales partnership and would it be greater than the 450 million you mentioned on equipment?

No, we expect the 450 million, which as you rightly say is a Thales/CAE split. If the German PFI comes in, it would be included with that number. It would form a portion of that.

And then the training component would be additional?

The training component would be significantly higher. It will be, we're talking somewhere over 700, 800 dread. If it goes -- I mean, it will be a different setup, obviously, if you have a PFI and Germany or if you just have standard procurement.

Don, is that 700, 800 dread euros or Canadian dollars?

Euros.

Thank you.

Thank you, Mr. Stoneman. The following question from Ron Schwartz from CIBC World Markets. Please go ahead.

Thank you. I think at the beginning of -- or at the end of last year, there was some commentary made that you were probably going to add 5 to 10 cents to the overall training network this year, either, you know, brand-new ones or through joint venture. I've counted roughly 5 so far, not in the quarter, but so far this year. Is that about right, with another 5 to go, or is that number going to go up a little bit?

Sounds about right.

Okay. And I don't want to beat a dead horse, just on the training margins, but I guess it begs the question, Derek or Paul, given a lot of the order announcements that you've made over the last couple of months, whether it be Military or Civil, I mean, pricing pressure, competition, seems to have been aggravated even more than last year. I mean, how do you feel about the profitability that's built into your backlog today and do you feel good about it because you think you're going to get the cost cuts or because it was priced in a way that even if you don't get the cost cuts this is just legacy business that's tailing off?

With respect to the backlog, I think we feel pretty good about it and obviously to pick up on Derek's point we now got 5 Airbus 380s. So we now with 5 Airbus 380s we will have the benefit of getting some [inaudible] similar-type simulators through the shop and I think that's going to help us offset the pricing pressure which is far more intense on the equipment side.

I think it's also important to keep in mind that we now have long-term agreements for equipment from Emirates and from Jet Blue and those have -- those give us a lot of confidence on our ability to improve margins. We said at the end of last year that we wanted to double our EBIT and our return on net assets in the next 2 to 3 years and I think that's still a forecast that we would stick to.

Okay. And then just last question, I might be confusing CAE with another company in this case, but was there a comment made or given some of the accounting changes that are coming through that might push some of the other SPE debt that you have off balance sheet, like the MSHAT and potentially the AVTS setup back on your balance sheet, Paul?

No. Certainly under the MSH, we don't anticipate any of that. We've been there, done that. The only issue you always have, Ben, is the county regulators both in Canada and U.S. are not in harmony on this issue. As I understand it, Canada is going to come up with some new pronouncements yet again in November so it just tells us to look, but in our mind I'm not at all concerned about the MSH. The only one we may focus on a little bit is the last September's sale and lease back for 5 SIMs, but we've looked at it at year end under U.S. GAAP and we were fully compliant under U.S. GAAP, so I've got to believe we will be fully complaint under Canadian, but it's something you can't make a final disposition on until you see the final rules that come out of continuing bodies. With respect to AVTS, I think Don's comment, we're not sure yet on the structure as to how that will work. It's too early to tell whether or not we'll put it in an off balance sheet/on balance sheet structure.

Okay, thanks.

Operator, that's all the time we have for questions. Before we conclude this conference call, it is our privilege to welcome Mr. Robert Brown to offer a few words to the financial community. Please bear in mind that Mr. Brown only officially assumes his mandate as CAE CEO tomorrow so understandably, he will not yet be in a position to answer questions that you may have. Bob, welcome.

Thank you, Andrew. And thank you, Derek, for your words of encouragement. Let me respond by expressing my personal belief that CAE is well positioned today, owing largely to Derek's strategic direction over the past 5 years. I am very pleased to have been invited to succeed Derek as President and CEO and I welcome the opportunity to lead this technology-driven, world-leading Company. Given my experience in the aerospace industry, I have the advantage of already being familiar with most financial analysts who follow CAE. I sincerely look forward to renewing my relationship with old acquaintances and to building solid relationships with those I will be meeting for the first time. I officially take the helm of CAE tomorrow and I want to assure you that CAE's Board, management team, Derek and I are all committed to ensuring a smooth transition as I take up my leadership responsibilities.

I have been engaged in a thorough review of CAE's businesses throughout the month of July. I have attended several operations meetings and have met with the executive team. I intend to continue this process in the coming months and to visit CAE's global facilities in order to get a full understanding of our capabilities and a better appreciation for the kind of bench strength underpinning our operations. As part of this process, I would appreciate very much hearing your thoughts about CAE. What you believe we are doing well, and what you think we can do better. I firmly believe that Investor Relations is a 2-way street and that in the best-run organizations investor feedback can in many cases and in many cases does help shape strategy and tactics.

As you can well appreciate, this will be an intense activity that will require several more months of my time. You will all also understand it would be imprudent to prejudge this process by providing more specific views of the Company at this early stage. I look forward to my first opportunity to present to you on a formal basis our second quarter report in November. Thank you.

I'd like to thank all participants and listeners for taking the time to join us in our first quarter conference call. Today's remarks, AGM webcast and additional information about CAE can be found on our website, located at www.cae.com.

Thank you, Mr. Arnovitz. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation, and have a great afternoon.