CAE Inc (CAE) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the CAE third quarter conference call. Please be advised that this call is being recorded.

I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now proceed, Mr. Arnoviitz.

Thank you, and good afternoon, everyone. Thank you for joining us today.

Before we begin I need to read the following. Certain statements made during this conference including but not limited to statements that are not historical facts are forward-looking and are subject to important risks, uncertainties and assumptions. These results or events predicted in these forward-looking statements may differ materially from actual results or events. These statements do not reflect the potential impact of non-recurring or other special items or events that are announced or completed after the date of this conference including mergers, acquisitions or other business combinations and divestitures. You'll find more information about the risks and uncertainties associated with our business in the MD&A section of our Annual Report and annual information form for the year-ended March 31, 2009. These documents have been filed with the Canadian Securities Commissions and are available on our website and on SEDAR. They've also been filed with the US Securities & Exchange Commission under form 40-F and are available on EDGAR. Forward-looking statements in this conference represent our expectations as of today, February 10, 2010. And accordingly are subject to change after this date. We do not update or revise forward-looking information even if new information becomes available unless legislation requires us to do so. You should not place undue reliance on forward-looking statements.

On the call with me this afternoon are Marc Parent, CAE's President and Chief Executive Officer, and Alain Raquepas, our Chief Financial Officer. After comments from Marc and Alain, we will take questions from financial analysts and institutional investors. Following the conclusion of that Q&A period we'll open the call to members of the media. For your convenience this conference call we be archived on CAE's website. Let me turn the call over to Marc.

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss a few highlights of the quarter and then Alain will take you through the financials. After that I'll provide you with our outlook for the remainder of the fiscal year.

Our performance in the third quarter was good in the current civil aerospace context. Military delivered more growth and our civil segments have held up reasonably well thanks to our diversification between markets and regions and to the cost saving measures that we've been putting in place since the start of the fiscal year to adapt our business. We're positioning CAE for an eventual gradual market recovery and long term sustainable growth. We generated $383 million of revenue on a consolidated basis and $65 million of operating income for a total segment operating margin of 17%. Net debt at the end of the quarter was up by $14 million to $272 million, and our net debt-to-capital remains at a reasonable 27%.

In Training and Services/Civil, we booked orders with an expected value of $86 million. The average annualized number of RSEUs in our network in the third quarter was 129 and utilization was about 65%. This compares to a low of 60% last quarter and reflects some of the seasonal pick up that we normally see. In Simulation Products/Civil, we signed contracts for six full flight simulators with customers in China, Malaysia, and New Zealand, which brings our year-to-date orders announced to 14. During the quarter we also received a cancellation of a similar order from a prior year. The current level of market activity in deals we have in progress over the remaining two months of the fiscal year continue to support our order target of 20 simulators.

CAE is today a different kind of company. Our civil business is less cyclical as the result of our increased presence in services. And while products are integral to our total solutions, it's noteworthy that so far this year, our Simulation Products/Civil segment accounted for about 19% of CAE's total business. On a combined basis, our two civil segments generated an operating margin of over 16%.

In the combined and military segments, we received orders of $167 million during the quarter, including a long term training services agreement with the Royal Netherlands Air Force and a maintenance and support services contract with the German Ministry of Defense. In addition, we won major upgrade work for Chinook Helicopter and Tornado jet fighter simulators used to train these two national Air Forces.

We've been restructuring the size of our business according to current and expected demand so that we can continue to be profitable through the downturn. At the same time, we've made it a priority to maintain our technology leadership and to continue to position CAE for long term sustainable growth. To do this, we've maintained a scale of our R&D investments and we've also continued to pursue diversification to leverage CAE's core capabilities into new markets including healthcare. We've already made some incremental progress to establish a position in what we believe will one day become a material part of CAE. We acquired two small companies, ICCU and Vinidex to continue to build up our market offering and add a cadre of experts in the medical field to the CAE healthcare team.

With that I'll now ask Alain to provide a more detailed look at our financials.

Thanks, Marc, and good afternoon, everyone. From a P&L standpoint, in our combined military segments, revenue was up 13% over last year and we've achieved an operating margin of 17.2%. Our military segments had good execution on programs and backlog and the growth in our order book over the past few years is contributing to the continued growth of this business overall. CAE is doing business with over 50 national defense forces including all branches of the US services. As such, the sources of revenue we derive are well diversified globally.

In Training and Services/Civil, compared to last year, we had 11 more RSEU in the network in the third quarter and revenue was down 15%. In addition to market softness in North America and Europe, the strong appreciation of the Canadian collar explains half of this decrease. Revenue and income generated by our foreign subsidiaries is mostly self-hedge but we are exposed to currency translation for Canadian dollar reporting purposes.

Revenue was stable in Q3 compared to the second quarter even though we had seasonally higher utilization in our training centers. This is mainly explained by additional FX pressure and delayed revenue in our Ab-Initio Flight Schools mostly caused by the extreme weather conditions in Europe which limited the number of available flying hours in the quarter. Revenue in Simulation Products/Civil was $72 million in the third quarter. We had a simulator cancellation which lowered revenue and we achieved acceptance on the sales type lease which more than offset the cancellation impact. Without these two items revenue would have been somewhat lower. We finished Q3 with an operating margin of 15.7% which is beginning to reflect the market downturn condition and pricing pressures that we've highlighted in previous quarters.

On the balance sheet standpoint, we've continued to protect the strength of our balance sheet, and since the beginning of the year, we've been making selective investments to help realize future growth. As a result, goodwill and other assets have increased from acquisitions like Seaweed which is now an integral part of [Pristigious] and the defense system business unit we acquired from Bell Aliant. We made additional investments in our military training business in the UK. And in support of our move into healthcare simulation, we've invested in a partnership with Toronto Michener Institute and we just bought ICCU Imaging, Inc.

From a cash flow standpoint, during the quarter we've invested around $40 million in working capital accounts, mainly inventory related to long lead items such as aircraft data and equipment packages. Commensurate with our growth in defense services, we have also seen an increase in contract in progress in military. As a result of these changes, free cash flow this quarter was minimal at $300,000 but still $64 million for the year-to-date. Capital expenditure totaled $24 million with around $15 million of that for growth expenditures. Year-to-date we've invested $82 million and we expect total CapEx this year to reach approximately $140 million. During the quarter we've incurred a restructuring charge of $3.9 million and we estimate total restructuring costs to be around $34 million with the remaining $2 million to be expensed by year-end.

On that, thanks for your attention and back to you, Marc.

Thanks, Alain. We're encouraged to see some indications that the civil aerospace market is bottoming, although we're not yet it the clear. IATA reported that in 2009, passenger traffic worldwide had its largest ever decline. The current forecast is for global passenger traffic to return to growth this year but the industry's clawing its way back from a very old base. Nonetheless, we're optimistic that both passenger and cargo markets will continue to show signs of progress.

Looking specifically at the airlines, it still is a bit of a mixed bag. North American and European carriers continue to rationalize capacity. While the Middle East and Asia Pacific continue to experience growth especially in China, we think CAE is particularly well positioned for long term growth in either of the world's most rapidly developing regions. While there are some bright spots, the prevailing view is that airlines globally will lose money in 2010 and may only become profitable in the 2011 to 2012 time frame. Yields are still off significantly year-over-year and they've been recovering slowly in North America and more notably internationally.

In business aviation, much depends on the pace of global economic recovery and more specifically, the sustainability of corporate growth in the US as the economy is weaned off of economic stimulus. The inventory of used business aircraft has decreased modestly over the last few months and pricing appears to have stabilized. Another positive indicator is that business jet flying activity is up, especially in the large cabin segment, but again this is from a very low level. We think recovery will be gradual. In terms of opportunities for full flight simulator sales, we'll be watching closely to see what develops in terms of aircraft production rates and the level of airline activity more generally. The large aircraft OEMs have not indicated there will be major cuts in 2010 but some aerospace suppliers have taken a more guarded view.

Notwithstanding the market downturn and the intense competitive environment, we've maintained our industry leading market share with over 70% of the competed market and we've continued to be profitable. We believe this is testament to our ability to support our customers through tough times as well as in good ones. We continue to expect our combined civil segments to generate an operating margin in the mid teens. As recovery slowly takes hold the margin in our Civil Training and Service segment should help to offset some of the ongoing pressure in the Simulation Products/Civil segment. The outlook for our combined military segments remains up beat. We continue to anticipate more than 10% combined revenue growth and 15% operating margins. CAE offers world class simulation technologies and capabilities and there remains a continued emphasis by governments and defense courses to increase the use of simulation to lower cost and increase the quality of training.

The timing of government contract awards can be elusive, but we have good visibility into our order pipeline and we're encouraged by what we see. We expect to conclude this year with another good level of orders to support our growth and profit outlook. Governments and industry will have to contend with budgetary constraints in the years ahead as well as increasing demands on national security. This will require some difficult tradeoffs and creative solutions to do things more efficiently. At present, the US has seen that the military and national security will remain a top priority. The President's proposed budget includes a more than 6% boost for the Special Operations Command. The proposed budget appears to be more favorable in those areas related to the use of simulation. Included in the proposal is a 30% increase for aircraft modernization which involves platforms highly relevant for CAE's business including a C130 transport aircraft and A60 and CH47 helicopters.

For CAE overall, our outlook hasn't changed much since last quarter. We are, however, encouraged by some of the positive market indicators we've seen more recently. Our performance through the civil aerospace downturn benefited from the actions we took early on to size our business. Indications are that civil aerospace may finally be stabilizing. And while this gives us more confidence, we feel patience will be required as the market works its way back from very low levels. We benefit from good diversification between civil aerospace and defense markets and we have a good position in some of the fastest growing markets like Asia. The fundamentals of our business remain strong and we'll continue to make investments in areas vital to our future.

Thank you for your attention and we're now ready to take your questions. Andrew?

Operator, we would now be pleased to take questions from analysts and institutional investors. Before you open the lines let me first ask in the interest of fairness that you please limit yourselves to a single question. If you have additional questions after that if time permits please do reenter the queue.

(Operator Instructions) Our first question is from Cameron Doerksen from Versant Partners, please go ahead.

Good afternoon. A question on the civil training business. You provided some commentary around what's going on in the end markets there. I'm just wondering if CAE specifically has seen any kind of pickup in the training business in either airline sub segment or business aircraft. Have you seen anything in the last few months that would indicate that perhaps we've seen the bottom for the training market?

I think if we look at the large cabin airplanes, large business jets, I think that has not dropped as much, so there's a bit of a pickup there. I think if you look Middle East it was still flying pretty well there. I think you can really look at the utilization. We were at 60% which was pretty much of a historical low for us, 60% utilization through our network last quarter. Now that was also the weak seasonal quarter. This quarter we see 65%. We normally see about that level of pickup seasonally so it's hard for us to figure out whether there was anymore pilots there but it doesn't appear to be when you look at that metric. And if you look at the macroeconomic factor that we see, like utilization, it's hard to imagine that you would see a big pickup. So we'll watch things in the next few months to see what happens but I think this quarter what we saw is probably just normal seasonal variances.

Okay, thank you.

Thank you. The next question is from Claude Proulx from BMO Capital Markets.

Thank you, good afternoon. You talked about the impact or your view on the US military budget. Can you talk a little bit about other countries and the UK in particular, what do you see in terms of budgeting and the impact on your business?

Yes, if I look at the UK, definitely there's a lot of pressure in the UK and we expect things to happen there, we're closely linked to that market. If you look at this year in the short-term for us in the UK, even though there's significant budgetary pressure and likely elections on that, for us the platforms that we're exposed to in the UK where we have the training center in Benson that trains all of the Royal Air Force medium helicopter crews, and this year because of the war in Afghanistan and Iraq, we saw a lot of order activity on the CH47 that we had out there related to modernization. We saw, as an ancillary benefit, the Dutch taking the CH47 training in Benson as well, so business there. We expect, if you look at programs that they've recently announced, they've announced that they are going to pick up, extend the PUMA helicopter. That's a platform that we have, so that means that we'll be seeing more activity there because we have PUMA civil air. So overall I think we'll continue to do well there. And I think we'll see the same pressures that we see everywhere else is that as budgets are under pressure, simulators lower cost, because simulators, as you well know, it's 10% of the cost to train in a simulator relative to flying a real aircraft. And with the technology that we're the world leader at, you can do training that's just as effective and, in fact, sometimes better because you control aspects such as the environment, of the weather and the tactical environment. So with all of those trends I think it bodes well.

If I look at the military budget in the US, you saw a proposed budget (because it isn't approved yet) but even if you put that and you take the quadrennial defense review, the budget's going up. The base budget in the US is proposed to go up 3.4% but it could dig deeper. And you look at the line items of budget which CAE is exposed to, and that's the operations and maintenance budget, as well as the procurement budget, both of those elements are going up by 8%. And as well the platforms that, again we've talked in the past, the platforms that are used very much in what's called the war on terror, aircrafts like C130J, CH47, Blackhawk helicopter, Seahawk for Navy, all of those are seeing a pickup in the budget. And we're not exposed to any of the programs that are seeing a cut. So if I look overall, it bodes as a positive for us in the US and I think in the rest of the world we'll continue to do well.

Okay, thank you.

Thank you. The next question is from Ben Cherniavsky from Raymond James. Please go ahead.

Hi, guys. I just have a question, a point of clarification around your financials. That restructuring charge in the quarter, how should we think of it as we look at your segment and margins? I'm just trying to get a sense of what some kind of a normalized profitability rate would be for your GO4 divisions. Did it land predominantly in any one of those groups that we can adjust for?

As you might have noticed, Ben, the charge is not pushed into the segment operating income. We left it separate on the P&L. And obviously if you would like to put it back in the margin it has mainly affected the manufacturing facility here in Montreal, the major portion of the layoff were in Montreal in the beginning, but right now it's not included in the SOI and the margin you've seen.

And that's the way you've presented it in the past? That's consistent with the past?

Yes, exactly so it's below the SOI.

Okay, right. Sorry about that. Thanks a lot.

Thank you. The next question is from Ron Epstein from Bank of America. Please go ahead.

Good morning guys. Just quickly, does your outlook still contemplate a narrow body rate cut in calendar 2010? And if that doesn't happen what do you think could happen to the narrow body rates?

I'm not even going to begin to think about what -- sorry, I've got an echo on the line. I'm not going to begin to think about what (inaudible), I can only simulate open Airbus, Boeing, in terms of the narrow body pressure rates. For us, what we've seen in a downturn environment is that you got to look at Russian aircraft and you also got to look at the level of activity. Our aircraft is more airplanes (inaudible) or is this what it was or basically saying (inaudible) from an earlier model, and there's less initial training and more recurrent. So to me, we haven't baked in, we have an outlook of the number of simulators next year and delivery rates predominant catalyst. As we get into the quarter we'll be more precise and hopefully by then, we'll see the communication (inaudible).

Great, thank you.

Thank you, the next question is from Benoit Poirier from Desjardins Securities. Please go ahead.

Hi, gentlemen, good afternoon. Just one question. When we look at the US defense budget more specifically are you exposed to the C17 or replacement for the EP3 intelligence aircraft?

No, we're not.

Okay, thank you.

Thank you, the next question is from Tim James from TD Newcrest. Please go ahead.

Thank you, good afternoon. I'm just wondering if you could talk a little bit about the regulatory environment globally. Safety has been an increasing concern arguably here over the last 12 to 24 months. I assume that creates a potential opportunity. So I'm wondering if you could talk about that and if you're seeing any influences on your business and maybe at the same time if you could touch on MPL and progress on that.

Yes, maybe just to start with the last question in terms of the MPL. We've started our first, we had announced just a short time ago that we've started our first MPL beta course and that's begun at the Moncton Flight College, so that's well underway.

In terms of the more general question, because we're an industry leader in training, we participate and in fact we lead sometimes a lot of the industry working groups, working with the regulators to draft new regulations that will come out, out of any accidents or regulatory changes or changes in the environment. So we'll participate in that. For example,, as a result of the very unfortunate crash in Buffalo, the FAA administrators has come out to industry asking for inputs so of course we'll participate in that. In terms of future opportunities, I'm not banking on any future opportunities. I'm just banking that training will remain a very key priority, a key emphasis of airlines and the general aviation environment going forward.

Do you have any sense for, at this point, whether these increasing safety concerns that have come to light shift demand in terms of your products towards full flight simulators or your flight training devices or any particular product? Or is it difficult to say that at this point?

I don't see any wholesale changes to any product line one way or another at this time.

Thank you.

Thank you. Our next question is from David Tyerman from Genuity Capital Markets.

Yes, good afternoon. A question on your military. On the guidance you provided, which I guess is a reiteration of what you've said before, the more than 10% growth and the 15% operating margins, for the growth, how far out would you be comfortable thinking about that kind of number? And then on the operating margins, you being above that 15% for seven quarters in a row, is there something that would take you down to the 15%?

The first part of your question, I think I'd go pretty much, in terms of that outlook I'd pretty much go to what I've got in the backlog and in products mainly, so you're probably talking about a couple years there in terms of that's typically what you see. Beyond that, and even within two years, you've got to assume you're going to win contracts to start to replenish the backlog. But I feel confident in that for the reasons I've talked about before in terms of the trends of the market, so that's what I would say. And the second part of your question, sorry?

On the 15% operating margin, you being above it for seven quarters in a row, what would take you down to the 15%?

Again, the way we work, the way we do our accounting is percentage of completion of accounting which means that we book revenue as we book costs. So clearly you've got to make sure that when you sell a product, sell a military program, I know what margin we sold it at. Now we've got to execute at that margin or else, with that kind of accounting system, you're faced with a significant write-off which would happen all of a sudden, so you don't want to be exposed to that. So really what you're seeing there in terms of higher margin is we've been executing the program at a higher margin than we've won on average, and that's really what we're seeing. And there's a bit of a mix. If I look going forward in terms of buyback log, not all programs are the same level of profitability. There's some of that there, so I think what you're seeing is we've been executing better than we've been winning the projects at. Cost cutting has played a factor and going forward there's a mix of programs that has different profitability that plays into that.

Okay, fair enough. And then on the CapEx, you're doing very well this year, quite low CapEx at $82 million. Is this significantly below what would be a steady state? Any thoughts in terms of what would be a more normal run rate for a business of your size right now?

Yes, I think we'll update it when we get to the first quarter. I think a general statement I could make is that we have brought it down and some of that is a consequence of, as we've said at the beginning of the year, a consequence of the times we're in. We're maintaining. We have a fleet of assets out there and a fleet in our network that clearly we have to continue to do maintenance, what we call maintenance CapEx. So probably you're talking about maybe $30 million, $40 million a year on that, and after that it's growth and that depends on the market opportunities out there.

Okay, but to maintain the Company at the current size, could you actually maintain $30 million, $40 million?

In terms of the run rate of maintenance CapEx I would say around $50 million is the right number, yes.

Okay, great. Thank you.

Thank you. Our next question is from Scott Rattee from CI Capital Markets.

Great, thank you. Marc, just a question, that it sounds like you reiterated your guidance of 20 stimulators for the year. I was wondering a little bit more along the lines of hearing, are you seeing the pace of discussion improve a little bit and/or the volume of it? What gives you the confidence that you can make that through the balance of the year? Thanks.

I think the pace of activity is there. I wouldn't say I've seen a wholesale major increase. I think we have more discussion. I think that's fair enough, more discussions out there. And you'd expect that because the delivery rates are still relatively high out there. So there is a little bit more activity. In terms of finishing the year at 20, I think this is going to be kind of a race to the finish. The deals that we see out there, the deals that we're currently working with customers, as I said before it's taking a lot longer both in terms of the marketing activity and closing of deals because most deals now involve financing. There's very significant capital constraints at airlines so everything has to be elevated to quite senior levels in the company. So for all of those reasons, I think as I said last quarter, when we achieve our target of 20 this year, I'll consider that a great success. But having said that, we expect that we can get there.

Thank you. Our next question is from Marko Pencak from GMP Securities.

I've just got a couple of financial questions for Alain. In your MD&A you talk about a couple of items that affected your number but you didn't provide disclosure on the amount so that's what I'm trying to get here. The first is in the military training segment, you talk about a contract amendment. Can you quantify the impact in revenue and/or segment profit during the quarter?

Yes, Marko. It was close to $1 million, so just south of $1 million.

In profit?

Yes.

Okay, you also talk about a change in accounting for pre-operating costs in the same segment. That's the first time this quarter I believe, is that correct?

No, we had that in the past and I do not have the amount close by, Marko, on that point.

Okay, maybe we can follow-up because you also said you restated last year's third quarter so I'm just not clear.

Yes, that's the change that we've put in, economics three quarter. It's not a new item for the quarter.

Okay, so that's ongoing. And then can you just tell me what was the actual amount of the sales type capital lease? Because you gave us a net amount versus cancellation but I was just curious what the actual impact of that is.

I think what we said, we're willing to go as far as saying that it was a positive contributor to the same product top line this quarter and you could assume $4 million or $5 million of positive contribution when you take the net of the two.

Net of the two, okay.

Yes, because it was a positive impact of the sales type lease was offsetting more.

Right, but you're not going to give us the split?

I don't have the exact number, but I can give you it's $4 million or $5 million of additional contribution is the right number to use.

And then, finally, can you just help me understand your interest expense a little bit? In Q1 this year it was about $6.6 million, it increased to $7.4 million in Q2 and then it's dropped to $6.5 million in Q3, yet your net debt is higher. So it's not clear to me what's affecting such significant quarter to quarter swings given that your debt balances are not moving around that much.

Yes, there's a couple of things, Marko, that you could consider. You know we bought more of that--

In Q1.

Yes, when we raised the private placement and that was driving close to 7.5% interest. So the mix has changed which can be one of the explanations. And the other thing is because we have less capital expenditure going into the network, under accounting rules you can capitalize a portion of your interest expense when you have growth CapEx and because we have less this year, obviously a smaller portion of the interest expense went to the capitalization of the assets we've deployed. So these are the two items probably you could consider to normalize the interest line.

Okay, so basically, as we look forward, so just so I'm clear on this, if your growth CapEx goes down, then you're going to be capitalizing less interest and so your interest expense goes up?

Yes, absolutely. Effectively there's less asset to be deployed in the network, the interest portion that we attach to that during the build phase cannot be capitalized and have hit the bottom line so you're absolutely right. That's under the accounting principle. And just as a clarification, Marko, when I said $4 million to $5 million, it's on the top line obviously.

Yes, understood.

My colleagues here are telling me.

Okay, thank you.

Thank you. The next question is from Richard Stoneman from Dundee Securities. Please go ahead.

Good afternoon. I notice that the sales in Canada are up 64% to date this year. Would that be the C130J project? And when would you expect the Chinook contract to be signed?

I didn't look in detail but that would have to be it for sure. It would be the C130J contract. And on the CH47, as you know, the government's acquired the helicopters and we were identified early on as part of the OTSB contract as the partner to look at training on the CH47. So we're currently negotiating with the government. As I said in my remarks, sometimes the pace of those can be somewhat elusive, but having said that, I feel confident that we'll be able to do that in a relatively short time.

Thank you very much.

Thank you. Our next question is from Benoit Poirier from Desjardins Securities.

With respect to civil product equipment, you were talking about a longer term to sign the deal but would you say, Marc, that the pipeline right now is about the same or unchanged versus the previous quarter?

Yes, it's similar. It's similar I think than last quarter. I think it would be better than we saw earlier in the year and we weren't sure as the market downturn really hit but comparing what I saw last quarter it's probably similar in terms of level activity. And of course when we get the beginning of next year we'll update what we think it looks like in terms of orders.

And maybe one housekeeping question. Alain, could you maybe talk about how much was the dividend from the UK investment for military?

Again, if my memory serves me well, Benoit, it's again just south of $1 million, but we can confirm that to you. It's always in the same ballpark every quarter that we have the dividend class on.

On the operating income, right?

Yes, this is on the bottom line, yes.

Perfect, thanks.

Thank you. Our next question is from Michael Harbour from Picton Mahoney.

Hi, guys. Just wondering if you have any kind of timeline for any level of materiality from the healthcare business and if you can offer more details on how you are progressing there?

Yes, I think what I would tell you is it's still very early days. It's too early for us to be able to put a number of that. We're still enthusiastic in this market and that's why we're investing it. We're putting the essential elements of the business in position right now and you saw these two small acquisitions. That's really for us to get subject matter expertise for medical practitioners. I think that really what I would like to see is positive contributor over the next few years and material long term. And if I look at long term, I think the new core markets which we talked about before, ie, healthcare, energy, and mining, if we're going to get into them, to me it's going to have to be that we have an expectation that at some point it will be at least as important as any of our existing four segments. But it's early days right now. What we see of the healthcare training market today, it's a pretty fragmented market. It's about $700 million to $800 million in terms of revenue today. We expect that over the next four or five years to grow to probably double and we want to be part of that, but again we're very small at the moment and I think we'll have to be patient on that one. I think at this point what I would tell investors is it has option value at this point.

All right, thanks.

Our next question is from Tim James from TD Newcrest. Please go ahead.

Thank you. I just wanted to explore the free cash flow in the quarter a little bit further. Alain, you mentioned about the inventory influences, it sounds like it was the primary reason for the cash use for working capital. Can you just talk a little bit about the specific differences in the contracts or whatever color you can provide on why it required so much additional cash this year relative to the same quarter last year?

Yes, sure. First of all, we said that roughly speaking we invested $40 million in working cap this quarter . If you look at Note 8 there's a good breakdown of where the $40 million is coming from, essentially three key areas. $15 million in contract in progress. So that's the account on the balance sheet that comes when you do your PUC and you cannot bill your customer because you have not achieved the milestone, you have an asset. So it has increased by $15 million and because our military business is increasing it makes a lot of sense that the contract can progress, or what we call the UBS, unbilled sales, is augmenting. So nothing to worry there, it's with military, they all have very good credit so it's not something that worries us in terms of the collectability of these increases.

Inventory, we've got a cancellation during the quarter, so that simulator went back into inventory which explains a bit of the $12 million or $13 million increase in the inventory accounts as well as some long-lead items that we bought for future program from an OEM. And the other leg explaining, the third leg explaining the increase is at one point in time you had to pay your payable and a good portion came out for that amount. People should be reminded that here today, though the cash flow is at $64 million, the free cash flow is at $64 million versus $104 million of net earnings so in terms of quality of earning, that's not a bad ratio. I would like it to be a bit higher but it's still quite good. And overall, when you looked at the balance sheet at CAE, when you look at our short-term assets versus our short-term liability, we only have, for a company of our size, $13 million invested in short-term assets over my short-term liabilities. So the boys are doing quite a good job in managing all of the short-term assets and short-term liabilities despite the investment that we show sporadically in working cap.

Okay, thank you very much. That's very helpful.

Operator, we only have about ten minutes left on this call and so I think we'll open the lines now to members of the media. If there are any other additional questions from investors and analysts I, of course, will be available in my office after this call. So Operator, if you would please open the lines now to the media.

Our first question is from Nic Suave from Merger Market.

Hi, good afternoon, gentlemen. Just from a CAE growth standpoint, can you tell me about plans, if any, to add any new divisions to the business or to acquire other businesses and partnerships for your existing divisions?

I think our plan is what we laid out. We have our four segments, we have two in the military, two in civil, and that's the bulk of our business, it's our core business. What we've talked about is we've started to lay the ground for leveraging our competencies into other markets such as healthcare and mining and energy and assuming that becomes material as like our plan over the next few years, then at that point, we would report it separately. In terms of acquisitions, our focus has been on relatively small acquisitions, mainly to get subject matter expertise in areas that we don't have or gain distribution channels, but nothing what I would consider major and that's not within the kind of things that we're really envisioning right now.

Okay, thank you very much.

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