CAE Inc (CAE) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the CAE third-quarter conference call. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now precede, Mr. Arnovitz.

Thank you and good morning, everyone. Before we begin I need to read the following. Statements in this conference call and question-and-answer session 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, assessments 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 guarantee 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 are those described in CAE's filings with the Securities and Exchange Commission.

Participating in the conference call are Bob Brown, President and Chief Executive Officer, and Alain Raquepas, our new Chief Financial Officer. The format will be as follows. Mr. Brown will present CAE's restructuring plan, some highlights from the fiscal third quarter and outlook. Following his presentation we will invite questions from financial analysts and institutional investors.

In the interest of fairness and to ensure that we address as many people's questions as possible in the time we have got allotted, please keep to a limit of two questions per participant. If you wish to ask more questions you're welcome to re-enter the queue or to contact me for follow-up after the call. Once we have concluded our question-and-answer period with analysts and institutional investors, we will invite questions for members of the media. For your convenience, this conference call will be archived on CAE's website. Let me now turn the call over to Bob.

Thank you, Andrew. Good morning. By now you will all have read our press release and you can see that we have some pretty important challenges ahead of us and a lot to discuss today. To summarize, here is what I would like to address on this call. First the restructuring and rightsizing of operations, related costs implications including upfront charges, as well as some of the identifiable cost benefits going forward.

Second, our new divisional structure with full accountability and P&L responsibility to business unit leaders and with full transparency of financial results. Third, the restructuring of our balance sheet including the marine sales and the impairment charge we have taken in Q3 as well as our plans to rebuild the balance sheet going forward. Fourth, our third-quarter results and what we look for in our fourth quarter as well as the outlook for fiscal '06.

I can sum up our actions into one underlying theme, doing the right thing to restore shareholder value. Often decisions in business are hard to make, but I sincerely believe we are doing the right thing for CAE and all of its stakeholders including the long-term stability of the Company.

When I joined the Company, the management team and I undertook a serious review of our stakeholders including customers, shareholders, employees, and our competition. We concluded that CAE has many positives including world leading technology, a well diversified product portfolio, a talented workforce, and a well thought out diversification strategy. But there were also clearly some disappointments. The strategy was not creating shareholder value. The top line looked great, but that was at the expense of earnings supported by cash flow and a proper return on capital.

And there was a level of frustration among members of the investment community at their inability to analyze our progress in training. It was not the strategy that was wrong, it was the execution. It clearly needed fixing and it needed fixing right away. We made a promise to the street to reveal our new plan and the findings of our strategic review before the end of March; however, we felt that it was important to share with you what has already become apparent as quickly as possible. Having said this, you will appreciate that certain elements of our plan are still being developed and we will share them with you as they become more definitive.

As we analyzed the situation it became clear that we had focused on the transformation of our business from equipment only to a balance between equipment and training. But while we did a good job of balancing the Company's revenues, we failed to recognize some fundamental changes that were taking place in the market and the bottom line suffered. To make matters worse, those changes were creating serious conflicts within the organization. Our simulator people were continuing to design and manufacture highly customized equipment with relatively high costs. Our trading group was then challenged to make an acceptable return when they were deploying our high-cost equipment to our own training centers. And finally, the high-cost of our equipment also watered down our training proposition as we asked airlines to consider us over their own in-house training.

Both of our two different business units, civil and military, were building simulators, but there was little sharing of information, functions, and technologies between the two groups. As an example, important procurement functions were decentralized such as aircraft parts, data, and instrumentation. Once the problem became clear, so did the solution. And instead of two, we will have three reporting business units starting in the first quarter of fiscal '06. So we are removing the silos by creating a totally new divisional structure that brings simulation products back to its roots and clearly clarifies responsibilities.

We will have a civil training group, a military group, and a simulation products group. The people in the civil training group will have one overriding focus, delivering the most cost-effective and competitive training service in the marketplace. The military group will also have one overriding focus, servicing our military customers with technological excellence in simulation and modeling solutions. We believe there is a huge potential opportunity in military training and we must organize ourselves to increase our share in this market.

The simulation products group will stand on its own and take full accountability for its actions. In my books, that means learning how to compete and generate a decent return on investment. The leaders of these three business units will have full strategic and P&L responsibility. They will also be expected to set meaningful, quantifiable objectives and to be fully accountable for the results that follow.

We will provide full segmented disclosure of these three units so you will be able to properly monitor the progress of our training and equipment businesses. And we have three excellent leaders for these business units. Many of you know Don Campbell, who remains as President of the Military and Jeff Roberts, President of Civil Training. The new Simulation Products group would be headed up by Marc Parent, who joined us last week. Let me tell you a bit about him.

Marc is a mechanical engineer and he has spent the last 20 years working in aerospace at Bombardier. Before joining CAE, he was Vice President and General Manager for the Challenger programs and the Doorbell Plant. A graduate of Harvard's Advanced Management Program, he was honored in 1999 as one of Canada's top 40 under 40. We welcome his arrival to the Company.

We also recognized our procurement services which use to be carried out under each business units. We now have a global strategic sourcing group reporting to Marc Parent. We expect to have substantial savings in this area. Remember close to half of the cost of a simulator is procured from outside.

So these moves address our structural issues but doing the right thing as I said earlier, also has a lot to do with making tough decisions. And the Board and executive team have come to the inevitable conclusion that a number of tough decisions need to be made to put CAE on a healthy footing for the longer term.

First, we had to fortify our balance sheet. We have done that by selling Marine, which will reduce our debt by some $300 million and will increase our equity by about 110 million. That sale will be recorded on our balance sheet at the end of this fiscal year. And we have addressed the quality of the balance sheet by the asset impairment write-down. The complete description of this is covered in our MD&A but let me summarize the process.

In our normal December 31 annual testing for impairment of goodwill, we found that the carrying value of the goodwill in our civil training assets was not supported by the anticipated operating cash flows. This was mainly due to the new reality of our market including the higher Canadian dollar, the profitless recovery of the airline industry, and the collapse of the 30- to 50-seat regional jet market. In light of these findings, we assessed the impairment of other assets and were also required to take a write-down in the value of intangible and tangible assets including nonperforming simulators. The impairment charge totals $443 million on a pre-tax basis and $355 million after-tax. Our balance sheet will now more accurately reflect reality, and that means the assets you see are all good quality.

As you saw in the press release, the annual reduction in non-cash amortization of intangible assets will be $14 million, equal to 5 cents per share. Restructuring the balance sheet is one thing, but in order to make our divisional organization work and prosper we needed to radically address our business processes and our cost structure. Unfortunately that meant losing approximately 450 employees as we reorganized and recalibrate all departments including corporate, engineering, and program management. The layoffs will be done rapidly.

I would like to thank all of the employees for all their efforts and commitment to CAE. I sincerely regret the disruption that this will cause to the men and women who will be leaving us and to their families and to the communities in which we operate.

As part of our restructuring plan, we will consolidate some locations in our global training network and we will redeploy some of our simulators in order to become more efficient. We expect to take a restructuring charge for severance and other costs in the range of 55 to $65 million. Roughly 30 million of this will be for severance and related charges and will be incurred in the fourth quarter of this year. The rest of the charge or approximately 25 to 35 million will be taken next year as further cost-saving opportunities are identified and implemented.

The annual savings from the restructuring is anticipated to be $14 million in '06, increasing to approximately $30 million by fiscal 2008. The range around both the size and timing of the restructuring charge is deliberate since we need to give Marc Parent some time to finalize his strategy and planning needs for the Simulation Products division. And this may well take us through our Q4 reporting period. Our goal is not to give you any more surprises.

Looking forward we also needed more financial flexibility. Clearly we are in a capital intensive business and CAE's Board approved a reduction in our dividend from 12 cents a year to 4 cents. We believe this is a more conservative level that better reflects our funding requirements and will enable us to retain approximately $20 million annually. We will also take a more disciplined approach to CapEx decision-making, particularly for growth in the civil training business. And we are examining ways to reduce our cost of capital and to alleviate our employment of capital in our businesses. These moves are all designed to generate free cash flow and to demonstrate that the training strategy works.

I would like to spend a few minutes now talking to you about the quarter just ended, the one we are in the middle of and the outlook for next year. First the third quarter. We reported EPS from continuing operations before the impairment charge of 4 cents, compared to 5 cents last year. The results included an initial restructuring charge of 3.8 million which would have added a penny to the EPS from continuing operations. Both civil and military reported lower operating earnings from a year ago. Civil's revenues increased by 14 percent with higher sales in all sectors.

Looking at earnings before interest and taxes, the training business held steady but equipment earnings were lower. Military had a 9 percent drop in revenue and EBIT against a very strong quarter last year where the German NTF helicopter program made a major contribution. Of course foreign exchange negatively impacted all of our businesses with the Canadian dollar strengthening by 8.2 percent year-over-year and impacting EBIT by $2.5 million or just under 1 cent per share.

Looking ahead into the quarter we are in, we announced a contract for the German NH90, a program that will see revenues of 30 million euros over the next three years. We sold two simulators to Editad (ph), a new airline in the Emirates and a new CAE customer. We sold another simulator to West Jet. We have also secured two new orders from Airbus for the A330. This brings our total simulator sales this year to 16 and negotiations are going well for other contracts on both the civil and military sides of the business. So Q4 will show pretty good order of bookings and bring about benefits over the next several years.

Looking ahead to fiscal '06, I will start out by saying that it's going to be challenging. We project stable full-flight simulator demand following moderately higher aircraft deliveries but as you know, it takes 18 months to build a civil simulator and we are currently working off a civil backlog that reflects considerable price pressure from the trough in the market. We expect that we will make some additional progress in civil training but we see no reason to believe that civil's overall margin will improve significantly on its own. Military should see some topline growth, and we anticipate another year of solid order bookings with progress on our ABTS (ph) and NH-990 (ph) opportunities.

This pretty much sums up the base case for next year. We have got a lot of work to do in our restructuring and that is going to take time. I have already indicated that we won't see the full savings from restructuring next year because of the long cycle on programs. Having said that, we expect approximately 14 million of cost savings from restructuring in fiscal '06 and a $14 million reduction in our amortization expense.

The management team and I have four priorities for the upcoming year. First we need to ensure that the new plan is executed fully without putting the Company at risk. By that I mean we absolutely intend to protect our technology leadership. Second we will implement sound business processes throughout the organization.

Third, we will ensure that the process of rebuilding our balance sheet through free cash flow generation begins next fiscal year. And that is not going to be easy because of our prior CapEx commitments. Finally, our intention is to end the year with a restructured and solid earnings base, one that can serve as a springboard to meaningful earnings growth and return on investment in fiscal '07 and fiscal '08.

We don't provide specific earnings guidance in this organization. That is not new. We are however prepared to share some of our operating objectives for the next 12 months. We intend to reduce substantially our simulator manufacturing costs. We plan to sustain double-digit margins in our military business unit. We plan to increase our revenue per simulator in our training centers around the world, and we will maintain tight control on working capital and additional investment in the civil training business.

This discussion all boils down to three words, restore shareholder value. That's what we intend to do. And this means building a structure that will maximize the value of our strategy. It means putting together a tough, hard-nosed management team with P&L responsibility and full accountability. It means rebuilding our balance sheet to its former health. It means generating recurring and growing free cash flow. It means protecting and enhancing our technology leadership, and it also means commuting more openly and frequently with our investors. In short, we have but begun the process of changing the way we do business.

We also announced today the appointment of Alain Raquepas as CFO. After doing a thorough outside search and interviewing many candidates, I realized the person most qualified for the job was in the office just a few doors down. Not only does he know CAE inside out, his knowledge of the industry and his dedication to CAE are exceptional. As you know, Alain, who has a law degree as well as being a CA was VP of Finance of our military business and has been acting CFO for the past four months. He has done an excellent job and has guided us skillfully through this entire restructuring process.

We now have a well-balanced executive committee with three new people, namely Marc Parent; Nathalie Bourque, who is our new VP Communications and myself; and five experienced CAE employees, Don Campbell, Jeff Roberts, Alain Raquepas, and VP HR, Michel Lucie (ph); and our Corporate secretary, Hartland Paterson. With this team in place I am positive we are doing the right thing for CAE, its employees, its clients, and its shareholders. I strongly feel we are positioning ourselves to deliver quality and growing earnings for our shareholders.

Thank you for you your attention. We are now pleased to take your questions.

(OPERATOR INSTRUCTIONS) Marko Pencak from GNP Securities.

Good morning. My first question, Bob, you talked about double-digit margins in military. They were quite weak in this quarter. Were there some specific contracts that happened here and why do you have confidence that the double-digit margins are sustainable?

Yes, I think, Marko, the low double-digit margins, I think this is a lumpy business and things vary in the military business quarter-to-quarter. You have seen some quarters where we have been up 13, 14 percent. You've seen some down at 8, 9. When you look at it on an annualized basis I feel quite confident that we are going to be able to do that in the low double-digits. There is no specific reason other than the flow of work.

Okay, my second question has to do with your civil training. You talked about EBIT staying constant. Can you talk about what has been happening trend wise with respect to pricing in the market both on the business jet side and on the commercial side?

I would say overall that the pricing has rested, stayed fairly stable, we haven't really seen any major changes. There has clearly been a pick up on the business side. I think the business side you've seen the activity in sales is looking quite good.

You're talking from volume standpoint is picking up?

It was picking up from a volume point and I would say that the pricing has remained stable.

Okay, thanks.

Richard Stoneman from Dundee Securities.

Yes, Bob, two questions. First one is utilization rate in the civil side. Could you tell us what that was in the quarter?

Yes, the utilization rate now is trending up to 70 percent, so it is increasing and so again I think that is a positive sign.

Is that in the quarter or the year, Bob?

I would say that it's on the year overall but clearly some of that -- most of that increase has occurred in the last two quarters.

Second question relates to the margins in the civil side. Could you give us an idea of what the percentage loss would have been in commercial equipment in the quarter?

The way I would put it, Richard, is that you saw in the quarter that the overall margin was around 4.5 percent and I would say that the aviation training is doing quite well and -- while I can't tell you specifically what I would say is that it is very close to break even on the civil equipment.

Thank you.

Fred Larkin from Orion Securities.

First question, Bob, just with respect to the accounts receivable, at the end of December, the $285 million I am assuming that you have no meaningful exposure to financially challenge its customers. Would that be correct?

That is correct. I think overall we have -- no customer has more than 5 percent of our activity. And I think you know with customers where we may be exposed, I think we have that under control and there is really no more exposure than a sort of a month of any payments that we would be getting.

Okay, great, my second question for now would be, of the 450 people that are going to be released, can you give us some color with respect to their skill levels? How many of them are engineers? Are they primarily based in the Montreal area?

As you look at it, there are no hourly employees in this number. There's about 300 that are direct labor; 75, overhead; 75 in administration. And of the 450, around 350 are here in Montreal and as well a lot of them -- -- what we have done is we have recreated the old CAE. We have put all of the engineering back together from military and civil. We put all the program management back together. We have put all of the global sourcing back together. We are treating finance a different way.

So we were going in different directions in terms of developing technologies and approaches to the market. We weren't transferring some of the great technologies we have been getting in our military business to the civil side. So just by doing that and operating more efficiently, I think that it is not only going to have a saving in terms of cost, it's going to actually allow us to improve our approach to technology and have a much more focused approach. So that's where the people are coming from.

Just a follow-up on that, are you comfortable that there is a level of spirit of cooperation between the civil and the military people that this is going to work smoothly?

I believe that very strongly. I have been meeting with the employees and am going to meet with the executives again this morning, the management of the Company. I think we have to realize that in the market conditions we are in we have to find a way to make money to have a return for shareholders. There has to be a sense of urgency in terms of what we need to do and I am convinced the people in the Company are buying into this and are going to really get behind all of this initiative and make a success of it.

Thanks a lot.

Ben Cherniavsky from Raymond James.

My question is with respect to your contract with Airbus. I'm just wondering if that can be -- the ten-year agreement that you got -- I'm wondering if there are, if that is retractable in any way. I'm just thinking about the talk in the industry that Airbus would be interested in acquiring Tallis (ph) and what kind of implications that would have for your business with them?

I think we have the ten-year agreement. I'm not aware of -- I think it is a general agreement. I don't think that it's one that has firm lines to it. I would have to look at this and get back to you. I'm not sure. But you know, I think the most important thing here is that we, regardless of what would happen with Tallis, I think the most important thing for us is to be able to provide a high-quality product with a low cost. And I think that we are very, very well positioned to do that going into the future. I think that that will be the most important differentiator and determinant of who is going to win in this particular segment.

Right, so the best way to preserve that contract is to reduce your costs?

Yes, and it is to perform.

Right and when you were looking at -- when you put the pieces back together as you said between military and commercial, did you also evaluate the option of breaking them up and piecing them off, selling the military and the commercial assets to potentially two separate buyers?

I think that we looked at all of the possibilities and you will notice that we have kept -- the thing that I have not wanted to interrupt is the interface with the customer. The customer on the military side is very different from the customer on the civil side and even on the civil side the difference between what I will call the commercial airlines and the business aircraft customers is extremely different as well. So I want to make sure that we are very sensitive to customer requirements so we've kept that in the way that we have organized.

But you know, I think in Canada we kid ourselves a little bit. It is very hard to have an aerospace business that is not diversified and does not have some implication in the defense or military area. If you look at what has happened to companies like Aerospatiale, Dassault, Boeing, they all recovered after 9-11 and to a large part that is because I think of the balance that they had in their organization. And I think it is also clear that a way of acquiring technology is clearly through the military side. There are longer cycles. There is funded R&D. And for a business like ours, a high-technology business like ours, I think that it makes a lot of sense to keep the two of them together. If you only had the civil side of the business it would be a lot more cyclical and I think that you would be a lot more vulnerable.

Thanks, those are good answers.

Cameron Doerksen from Diouhy Merchant.

Just two quick things for me. Just on the CapEx, you mentioned that you are committed with your CapEx plans for fiscal '06. Can you just outline what that might be? And I guess following on that, what is a more steady-state kind of maintenance CapEx for CAE going forward beyond fiscal 2006?

I think that this year we are coming in around 120 which is a little higher than I would have liked. And next year because of the commitments we have made that were made in the past, things like the Northeast Training Center, the deal was Dassault, the joint venture with Iberia, we are likely to be up around 135, something of that nature.

On a more steady-state going forward, I want to go back to the theme that I've talked about before and that is that we should have a -- we should be much more matched with the depreciation. And so I would like us to be below $100 million on a steady-state going forward and that includes anything that we would put into the QTEs.

Okay and secondly you talked a bit about reorganization of your training network. I'm just wondering if that envisions any actual closures of any of your simulator centers?

Yes, it does. In North America, you'll see that in Dallas we have two facilities, the one site will be closing there. We are going, also going to look at what we can do in our facility here in Montreal. We have in Montreal about six simulators where we are actually doing training for customers and this seems to be an ongoing theme and I think it is a good utilization of our assets here. So we are going to be organizing ourselves to be able to present a fully professional training operation here and there may be simulators moving in and out of it but we are going to have an operation here. And then we are going to be looking at other areas. In Europe we're going to be consulting with the governments and the employees in terms of ways that we can improve our profitability there.

The other things that we are closing down; we have a number of manufacturing sites here in Montreal. I don't know if you know the Monte Dellaise (ph) Street. We have four or five buildings over there and some we own, some we lease. We are going to concentrate everything back into our facility and become a lot more efficient.

The other thing that we are doing is that we have some simulators I think I've mentioned it to some of you in the past that really we have some that have been built and are not being used. We have the parts for some that have not yet been built. We have a number of simulators that have very low utilization and we are dealing with them. We also have some simulators that are not in the best place as it relates to attracting customers into our facilities. We're going to redeploy a number of those simulators to maximize the quality and the access of service for our customers.

So those are a whole series of things that are also included in these initiatives and these are ones that you can't just do immediately. That is why some of the restructuring flows into or falls into next year.

Okay, thank you.

Ron Schwartz from CIBC World Markets.

Thank you. Bob, can you just give us what the training revenues were in the quarter in the civil segment?

Do you have that, Alain? What I can tell you is that generally the split in the business --

You have disclosed it before.

Yes we have. I know -- it's 40 percent I think -- 40 percent for simulator and 60 percent for the training. (multiple speakers) I just wanted to make sure I gave you the right number, Ron.

Okay and then second question is once we kind of get through '06 into '07 and the restructuring is complete, what should we be thinking about given capital intensive business, is this a mid teens kind of return on capital business for both the training business or let's say even the military business? Or should the training business be north of 20 percent?

I think the way that I would look at it is our goal as we get out into '07, we have to get -- we have to at least get a return on our weighted average cost of capital, which is say 11, 12 percent, something of that nature. We have to get to that and their goal is to do that by '07 and we are putting all of the actions in place in the current fiscal year and next year to be able to deliver that.

And as just a follow up to that, would bringing back some of the sims that are off-balance sheet finance be potentially part of that strategy?

I have looked at all the QTEs to see what we can do. Unraveling them would be difficult. I think we still think from a general capital structure point of view, it still makes sense to have about a third of all of the simulators that we have deployed be done through QTEs. We obviously would prefer to have as many as we can financed ourselves so that we have a gain in our operating earnings, but the cost to us -- the cost implication of the lower interest rate which you see below the operating earnings by putting them in the QTEs is very, very beneficial as well. So it is going to have to be a continued, to be a mix I think between the two.

Thank you.

Steve Arthur from RBC Capital Markets.

Thank you, just quickly following up on one of the comments you made about stable full-flight simulator demand this year, can you just expand a little bit on your pipeline and is it fair to say that a higher proportion of those sims are larger ones which presumably carry higher price points and margins with them as well?

Yes, I think that is true. We are at 116 now. I think we have a chance for another one or two this year. We have got some military orders that are coming as well. So I think that generally the sims are bigger, like the 380 and I would see that what we are planning on is that we would stay at about the same level in terms of order intake for next year. I know that the trend is people are saying the market is coming back but I think in our terms of our planning, we are going to be conservative.

In terms of the 380, I believe I saw Tallis win one of those late last year. Can you talk about that situation a little bit? Was there a competitive pricing issue there or what led to that deal?

Well, on that one that was with Singapore Airlines I believe. That was just after I arrived. I looked at the pricing and I felt that it did not make sense in terms of what was out there and we had won most of the orders of the five orders up-to-date on that. And the actions that we are taking now and what we have seen in the marketplace I think are going to help us considerably in terms of how we bid and bid successfully and bid with a profit in the future.

So presumably that means a lower price point but sustaining the margins?

Improving the margins.

Thank you.

Marco Pencak for GMP Securities.

Thanks, in the press release you talked about that you had secured some changes in terms of your debt covenants from your lenders. Is that just a temporary thing or is there new terms and could you could share those with us?

What we did, I wanted to make sure that by this one-time act, basically the covenants that we have are obligations are on a rolling 4 quarter average and so you can trigger them by a one-time event but also they can stay with you on a rolling basis. And so we went back to the banks and as well to the noteholders and we got an agreement from them that it would not trigger it on a one-time event basis and also it would not be included in the average going forward quarter by quarter. So that gives us, because of what we have done with marine and because of the other actions that we are taking, we considerably lower our EBITDA to total debt covenant that we have and we continue to meet our equity requirements. So we are well within those on a going forward basis as we restructure and strengthen the balance sheet.

So that ratio is still 4 to 1?

The ratio is still 4 to 1 but I think on that we go with this event we go down close to 2. (multiple speakers)

I'm sorry, say that again?

We go close to 2.

Thank you.

Peter Rozenberg from UBS.

Good morning. Taking into account the current industry excess capacity in simulators and the changing structure of the market, what do you think your peak simulator deliveries will be in this cycle and in what year?

Peter, very hard to say. I wish I could give you more insight into where the market is going in the next period. We are back basically to pre-9-11 loads in the airlines. But the yields are not coming back as quickly. We have seen a lot of hirings that have been taking place. I think there are 4500, 5000 but there's still about 9000 pilots that have been furloughed. So I think we will have to wait and see what is going to happen.

Our focus right now is to make money assuming that we are staying at the rate we are at. I don't know when the market is going to turn. I feel it's going to come and I feel its coming but we want to make sure that we structure the business so that we can make money and get a decent return even at the current levels. If we then get a break in the market, I think we will be very well situated.

Thank you.

James David from Scotia Capital.

Good morning. A couple questions. I think this has sort of been addressed a bit but I just wanted to maybe go more specifically at it. You talk about the military margin potential in the low double-digits and presumably your cost-saving efforts are going to allow you to sustain that. I guess what I'm looking at is what is a reasonable starting point for civil margins right now, because they have been very volatile? I'm just curious what is a reasonable starting point? And as you look at your cost-savings program, what is -- very simplistically, I'm not trying to split between training and equipment but what is a reasonable end point for those margins or target for those margins?

You probably are trying to split between the two. I think that I have said right now you can assume that training is doing well and I think it's going to improve. And it is all going to depend on a more efficient network, a more efficient deployment of the simulators and what drives all of our business right now, we have to get the cost of our simulators down. That is going to determine the margin in our training business because we will be able to put in simulators where we can get a return. It's going to relate to how successful we are in military because there we will be able to improve our margins if we can get the cost of the simulator down. And as well, in third-party sales, it is key for us to maintain the market leadership that we have.

So right now, I think I basically told you that we are making money basically at breakeven in the simulator business and in the equipment business. And that is one where we have traditionally made our money. We have got to find a way to get that margin back up. So if we can do something there that we could get that to double digits, we could get our training business to improve. And I think you know just by divining what I have -- from what I have told you, if you look at the total civil business and you assume what's happening with the equipment business and you know what we reported for fourth quarter, you would be able to from that determine what the margin generally is for training.

I'm sorry, James, that I'm not being as direct as you want here, but until we get the segmentation, that is basically what I have to do.

That is fair enough, Bob. The second question was, right now you have a global duopoly, if you will, in civil equipment, and yet there's no pricing power. Rockwell Collins about three weeks ago mentioned that they are bidding very aggressively on the Dreamliner 7E7, which I think is coming out pretty soon. What are the implications to -- and the way they speak in their conference call talking about how important this is to them and so on sort of suggests that they are more interested in strategy than in profit right now. It is important for them from a headline perspective. What are the implications of Rockwell Collins coming into the market, in terms of being able to get some pricing parity? Are we going to see pricing protraction soon, or is this going to actually extend the problem?

I don't know. We have to take them very seriously; obviously, a competent group. But no one customer is going to determine the future success of the company. And again, I guess we have to go back to basics. We have to get a return for the shareholders and we have to make money, and we have to deal with what we control ourselves. So we are going to very, very aggressively go after a cost, and at the same time maintain the quality. You know, reputation in terms of what we've done in the past, our ability to deliver during development programs for the OEMs is extremely important, and that is a risk I don't think that they want to take. So we have advantages in addition to cost, but when it all comes down at the end of the day, you have to be cost competitive. We have not been.

The only other comment I would make is that we have to be more disciplined in terms of the way we bid, and we are not going to take on loss-making business.

Just as a follow-on question to that, Bob, presumably they can do all the avionics simulation. I'm curious, would they have access to global airport databases? Is there a third party that they can do that, or do they have to develop that all themselves?

It would probably be a mix, but I assume they are at least as smart as we are, and I think that is the assumption we should have.

Okay, thank you.

Pierre-Yves Therisse from Desjardins Securities.

Good morning, everyone. First of all, in terms of cost-saving you mention in your press release 14 million in '06, 30 million in '08. Is it fair to assume that for '07, it's going to be in the range of 20 to 25 million?

I would not disagree with that.

Now, Bob, when do you forecast to start to be free cash flow positive? Is it possible to see that by fiscal '06, or are we going to have to wait for fiscal '07?

I'm trying very, very hard even for this year with the restructuring to be cash flow neutral/slightly neutral, something of that kind. It is very, very tough. So it is going to be hard for this year. Next year with the level of capital expenditure, it's going to be very, very tough as well. So I think that probably what you've said is right. We should really be looking at '07 as the first year we'll have a real shot at it. Because we're still going to have restructuring costs for this year and for next year as well. Clearly, the way that we have organized this is that '06 is a transition year for us where get organized to do all of the hard things that have to be done; get organized, get the people mobilized, engaged, and really start delivering in '07.

Okay, thank you. And in terms of cost-saving on the equipment side, obviously you mentioned that you used to be making money in this activity. In your business review, have you looked into maybe outsourcing the assembly of the simulator? Would that make any sense in your new business model? I know that you used to outsource a portion of the cabling assembly. So looking at the new business model would make sense that ultimately that specific activity would be outsourced.

Marc Parent, as part of his exercise, is looking at all possibilities in terms of what we can do, and he is going to be consulting with all of the employees, with the customers, to see what can be done here so that we can explain the situation to everyone and we can come up with a plan that works for everyone. But everything is on the table.

Okay and in terms of the recently awarded contract for on the equipment side the one you announced this week and last week, is it fair to assume that again you're going to be breaking even on those contracts?

No, it is not a fair assumption. What I said is the quality of the backlog that we had and the work in process was not very good in terms from a margin point of view. The contracts that we have had that we have taken, there are margins on them and when we blow through, the next 18 months with what we've got in our backlog that is also going to situate us well when we get out into '07. We are going to have contracts there that have margins on them.

Can you provide us some insight to what portion of the backlog is at depressed prices? Is it like one-third of the backlog? Is it possible to have some sense on that?

I would say that you can assume that the military contracts are all pretty good and that --.

Of course I am referring to (multiple speakers).

The civil side. But I look at the whole -- I don't want to give you a number because I don't -- I can't give it to you that precisely but a fair portion I would say.

A fair portion. Okay. One last question. In your press release you talk about the fact that outsourcing is low on the airline priority list. The feedback that we have got also with talking with airlines is similar but the feedback also that we got is that outsourcing could accelerate if cost savings by outsourcing were greater than what is currently demonstrated by companies such as CAE. Again looking at your new business model, is that something that you could be reviewing in the sense that maybe would be better to price a little bit lower but get much more volume?

I think that the first thing I want to do is lower expectations that our growth is going to be based outsourcing from airlines. That's point number one. The second thing is that I have some experience with airlines and I've learned a fair bi. And one of the things I've learned is that the airlines have considerably taken down their costs from a couple of years ago. And so coming up with a proposition that gives them the level of savings that they require is more difficult and the other thing would be that a lot of people are interested in transferring their assets and also getting an operational gain. That makes it very, very difficult as well.

So we have to look at a new way of approaching it. I think there are a number of ways of approaching it. I wonder if airlines are all going to be able to maintain their own training facilities? Is there going to be in the future a different way that training is approached in general by the industry? If you look at the low-cost carriers, basically they have not done it in-house. They have gone to establishing centers that are shared with other people. So we have to take a different approach here.

Okay, well thank you very much. Good luck on your restructuring plan and congratulations to Alain for his promotion.

Ross Turnbull from Odlum Brown.

Good morning. I just wanted to talk a little more about the cost of simulators. When you say they are too expensive do you mean they are over-engineered for what your clients need or they are just too expensive to build?

Both. I would say here that in the past technology has been a prime differentiator and it still is to a certain extent but it is less so and I think that as airlines have been in a situation where they are being squeezed and they have to get a return as well, they have been looking at everything that is possible. So it is what you build and it is also how you bid. Sometimes in the past we have bid a lot more than what the customer wants to have. And I think that we have got to look more sharply at making sure that we meet the requirements of the customer but we don't overdo it.

The second thing is we have not been efficient in terms of the way that we build simulators and when I say build, I include everything from the way it is specified, interpreting the specification of the customer, influencing the customer on the specifications of what they require, how you design it, how you build in repeatability and commonality between the simulators for different models, the mix in terms of what you make yourself and what is outsourced, and then just how you build the flow. I'm still amazed that it takes 18 months to build and deliver a simulator. I'm sure that Marc Parent is going to come up with some solutions here that is going to make all of this more efficient. So you should be able to lower your cost and also reduce your work in process because it will be here for less time.

And Bob, how much of the past manufacturing inefficiencies do you think were hidden by the weak Canadian dollar?

A huge amount. This is not a problem just for CAE. It is a problem for the Canadian manufacturing industry. I think that the low Canadian dollar did not require companies to put in place the productivity measures that were necessary to be competitive. And the rapid change in the exchange rate over the last couple of years has just exacerbated this problem and really not given companies a chance to adjust.

If this was happening over four or five year period you could do something but the rapid changes made it more difficult, and that is why we are starting to take the measures, the drastic measures that we're taking today. We have to react. We have to control what we control or influence what the control.

Thank you.

Steve Laciak from National Bank Financial.

Can you tell us what -- I guess the write-offs probably all went to training, but what the NAV is left in that business after the write-offs?

Sorry -- oh, net asset value?

600 million.

First of all, your assumption is right, Steve. It is basically all in the training business, and I think basically it is reduced from 900 and something down to around --.

The net function was 355, so from a 950 minus -- we're at 600.

At 600, okay. And as you do your goodwill test and measure it against your -- I guess it is probably return on average capital; does that imply if it is 11, 12 percent, I guess you brought it down because you can only see civil after you fix it and everything else only getting to 70 million EBIT?

Well, I think that you're doing the calculations the right way, Steve. What you basically do is you take your earnings, your projected earnings from your strategic plan over a period of time, and out beyond that you establish a terminal value for the business. You discount all of those cash flows and bring them back, and you measure that against the carrying value of the business. And if there's a difference, you are impaired. So, essentially, you're using the assumptions that you had in doing that particular exercise.

The way I look at it simply would be a model of how you did it?

Yes.

Okay, second thing, I know you had this investment tax credit in Q1, but it keeps showing back up on the cash flows in Q2 and Q3. Could you explain that?

Yes, Steve, it is Alain. What is coming back on the cash flow is the portion of the ITC that we utilized to offset the tax payable. So that is what is showing up in the cash flow. So it is what we are reducing our ITC balance with. Instead of paying the taxes or the installment in the quarter, we're drawing down the ITC. So that is probably what you see in the --.

So it is not anything on the income line anymore?

No.

Unfortunately, it was a onetime item before that we're going to have to carry for the rest of this year. The ITC is built-in as part of the business, especially a business of our kind, and it is going to be there, but it won't be lumpy; it won't be big onetimers. It is just a constant start of the business.

No, I understood the Q1 adjustment. It just keeps seeing them come back. So these things by the end of this year will unwind, and it won't be a material item on the cash flows next year.

I don't think so.

That's it, thank you.

Ihor Danyliuk from Merrill Lynch.

Two questions. First of all, with regards to your low margin contracts that you have outstanding, Bob, was that due to the marketplace itself, or was that in part also a strategy from the previous senior management of pursuing market share?

I really don't know. All I can tell you is that is what was there, and I can tell you going forward that is not the approach we're taking.

But you plan on improving margins. You said that pricing is going to be an issue, so the margin will have to be improved through costs as opposed to top line. Is that correct?

I think that is the right assumption, yes. We are not assuming any increases in price.

The second question with regards to training margins, when CAE first got into pilot training, the goal was to have margins similar to that of flight safety, and that indeed was the case, just as recently as two years ago. Your margins, I know you combined them, but the margins that you had were somewhere in the mid to high 20 percent level, and now we're talking, just sort of back of the envelope math from what you've disclosed today, let's assume training margins are somewhere 10 percent. Why the decline? I mean, flight safety is still somewhere up in the mid-20s. Can you get back there?

First of all, I think if you go back a couple of years, even after 9/11 there was quite a big order backlog in the simulator equipment business that had good margins. So a lot of those margins were coming from the equipment business for starters.

I agree with that, but I --.

Don't assume that the training margins were at that level, okay? Because you were just looking at the civil margins.

Correct, but they were, let's say, 27, 28 percent. The civil margins -- the training margins would've been somewhere in the midteens and the other guys would've been --.

At that time, the equipment margins were very, very good. So don't make the assumption that the training margins were at that high level. When you look at FSI, first of all, they have a great formula. They have done and are doing a great job. The first thing is that they have got about -- I think about 240 simulators that are deployed in their training centers. They have had them there for a long period of time. They have come through the initial period of heavy depreciation, so that is an advantage for them.

The second thing is they have been very, very good at building what the customer needs and not a lot more. And as a result -- so the cost of their simulators has been lower than ours. They have done a good job on that. The other thing is that they have a good scheme for financing. They have a low cost to capital with Mr. Buffett. So when you take all those things into account, that is what gives them the high margin. And so what we have to do in looking at them and comparing ourselves, the first thing we have to do is get the cost of a simulator down. We have to come up with a program for financing our simulators that we can get our costs down there. And we have to continue to be more efficient in terms of the way that we operate the simulators in the centers. If we do all of that, I think that we're going to start to get to some decent margins.

Okay, so that $131 million charge that is part of the 443 million, you say 131 million is the reduction of nonperforming simulators and other assets. Those nonperforming simulators, those are the simulators that are on your books. They were there for the 453 million at the end of fiscal year '04. Is that where that 131 is coming from?

Yes, it is coming out of the plant and equipment on the balance sheet, Ihor. And essentially, they were for Dornier simulators and old simulators and MD10s and all these type of aircraft that are not flying a lot these days. So that is what effectively we have impaired, as well as one or two ERJ and CRJ simulators. So they were really the nonperforming assets in the fleet that has been impaired.

Okay, so that is where your 14 million amortization savings are coming from; is that --?

There is a portion there, Ihor, and the other one is some of the intangible. The goodwill is not depreciable anymore under the new rules, but the trade names and the customer relationship were. And that is what composed effectively your 14 million annual --.

So you're going to get an extra 4 cents a year out of those reduced -- out of that charge?

That is my estimation at this stage, you're right.

Thank you.

Horst Hueniken from Westwind Partners.

Good morning. I have two questions. You have slated 25 to 35 million of restructuring charges in fiscal '06 for unspecified actions. I'm wondering whether you could give us little more color on what is potentially being restructured there and how confident you are that this amount will be incurred. In other words, what is the likelihood that the number turns out to be higher or lower?

Well, what we're trying to do here, a lot of it is tagged for things that are going to happen. They are, as I mentioned, the redeployment of the assets or of some of the simulators, the closing of some of the facilities, both in the manufacturing and in our training centers, all of those things. So most of it has been determined. The part that we are not sure of yet is we want to get Marc Parent a chance to do his full exercise of his whole operation. And we are hopeful that we're going to be able to provide some more insight to that when we get into May and we start talking about what happened in the fourth or in that particular quarter. So that is why I am not sure exactly what it is going to be, but I feel that it is going to be -- I feel pretty good we're going to be in the range of what we have talked about.

All right, I'll look forward to that. Second question, you had mentioned that it is an objective to rebuild the balance sheet through free cash flow, but that it may not be easy. If hypothetically should the expected benefits of your restructuring plans be realized at a slower pace than you hope, I'm kind of wondering how you might manage this. Might you consider eliminating the dividend altogether in that circumstance or perhaps envision another way to fortify the balance sheet?

No, I feel pretty good or comfortable with the plan that we have got right now. I think it is important to have a dividend. I don't foresee that for now. I think that in addition to that, the way that -- there is a lot more innovative ways that we can deal with the balance sheet. So I don't think that we are really looking at anything that is major in terms of things that we would do to fortify the balance sheet.

That's it for me. Thank you very much.

Operator, that is all the time we have for questions from the financial community. We will now open the lines for questions from members of the media.

Thank you. We're now opening the question period for the media only. (OPERATOR INSTRUCTIONS) Doug Alexander from Bloomberg News.

Bob, you mentioned about double-digit growth for the military. Can you actually clarify what we're talking about for double-digit? I mean, that could be 10 or 99. I think you said low.

What actually I talked about is a low double-digit return, not growth.

Sorry. So what are we talking about for low double-digit then? Any numbers that can go with that?

Just over 10.

That's fine. Thank you.

Robert Melnbardis from Reuters.

Good morning, Mr. Brown. I wonder if you could provide some details on where you expect the job cuts to happen, and if you can elaborate on that comment regarding the 18-month backlog on simulators. If I understand you correctly, part of the problem there is that because of that, you're locked into prices for simulators that were actually fairly low because of competitive pricing and the state of the market at the time.

Yes, it takes about 18 months to build a simulator, so you basically cannot change those contracts, and we will not be able to make all of the efficiencies or changes in efficiencies in the organization in order to be able to reduce the costs from those contracts. So we basically have to perform on them, get them out, and then replace them with contracts that have margins and also effect the changes in our engineering manufacturing organization to be able to produce a margin. As it relates to the employment, essentially, I think as I mentioned before, there are no hourly rate or people that are being cut with this, and that -- essentially, we've said it's around 300 people, our direct labor; 75 from overhead, 75 from administration, and that of the total number, about 350 are here in Montreal.

Okay, can you comment a little bit about how the market looks right now in terms of a rebound in the civil or part of the business? There has been much chatter about airlines and aerospace companies bracing for a rebound in both civil and business aircraft. We have (indiscernible) probably announcing the launch of their new jet in a few weeks.

The way I would look at it is, first of all, we have seen increased activity in the business aircraft segment, and that has been reflected in the activity in our centers. As it relates to the commercial airlines, we have also seen that the loads are up. There have been some pilot hirings, but I think we're going to have to take this quarter-by-quarter over the next period. The signs are positive, but I think we have to wait and see whether the recovery is really going to come.

All right, thanks very much.

Sean Silcoff from National Post.

I'm wondering what you foresee with regards to merger and acquisition activity for the company, and also the company attempted a couple of financings in the last years that didn't go well. I wonder if you see anything on the horizon in terms of going back to the street for any financing.

On the merger acquisition, no, I think that we have done our divestment of marine, that we still have some things to do, but essentially we feel it's well on the way to being done. So I think that activity is finished. We do not really -- what we are focusing on right now, we are not really in a position to give any serious consideration to merger and acquisition activity. We have to get our house in order first, and so that is the priority of what we're doing. The second thing as it relates to financing, I don't believe that we will be going out. We are going to get the house in order. We're going to generate free cash that will help us. And also with the change in the dividend, that basically frees up $20 million a year as well that gives us some flexibility.

Okay, thank you.

Brent Jang from Globe and Mail.

I just wanted you to try to break down on the number of employees total overall in Montreal, in Canada and in total.

We have about 5500 employees around the world, and in Montreal we have about 3500 in total.

And how many in Canada?

Well, we have about 1000 in the USA, so most of our people are right here in Montreal. We have a number -- we have a training facility that is in Toronto if you're looking in Canada, but essentially, the people are here in Montreal.

So there aren't that many in the Toronto area?

No, there is not that many. We have a training facility there. I would say we probably have 20, 30, something like that. But they're in a training facility. They are not in the manufacturing or operations.

Of the civil aviation training, you said only Dallas would face closures, or would some of the other centers face closure as well?

No, there are others that we're not in a position right now to announce specifically, because there are consultation processes that we have to through in terms of determining the best way to approach this whole issue.

You've got about 20 or so, so as proportionate, would it be a quarter, do you think?

Of the training facilities?

Right, that might face closure --

No, no.

-- of the aviation training?

No, nothing that high. It would be a handful, would be a way to do it. That would be a best description, yes.

Thanks.

Francois Shalom from The Gazette.

Actually, it was the same question I had about the -- it wasn't clear to me exactly aside from Dallas what else was going to close. Are you saying that the next closures will be in Europe, though, and you have to do consultations first?

That's right, Francois. We have to go through a full consultation process with governments and the employees, and not have a predetermined position in terms of doing that.

And how many employees would that affect, do you think?

We basically -- we can't give the exact number of employees either, because of the way that I've approached that question, but you can assume that they are included in the 450.

Great, thank you.

Bernau Shabdulan (ph) from (indiscernible) Canada.

(Questions asked in French)

(Answers given in French)

Operator, that's all the time we have for the conference call. I'd like to thank all participants for joining us this morning. The transcript of today's conference call can be found on CAE's website. Thank you very much.

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