CAE Inc (CAE) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the CAE second quarter conference call. Please be advised this call is being recorded. I would now like to turn the meeting over to Mr. Andrew Arnovitz. You may now proceed, Mr. Arnovitz.

Thank you. Good afternoon, everyone, and 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. The 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 any nonrecurring 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 divestiture's. 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, 2011.

These documents have been filed with the Canadian Securities Commission and are available on our website and on SEDAR. They've also been filed with the US Securities and Exchange Commission under form 40F and are available on EDGAR. Forward-looking statements in this conference represent our expectations as of today, November 10, 2011 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 Stephane Lefebvre, our Chief Financial Officer. After comments from Marc and Stephane, we will take questions from financial analysts and institutional investors. Following the conclusion of that Q&A period, we will open the call to members of the media. Let me now turn the call over to Marc.

Thank you, Andrew, and good afternoon to everyone joining us on the call. I'll first discuss some highlights from the quarter and then Stephane will provide a bit more detail about our segmented results. I'll come back at the end to talk about the way forward.

We had good performance in the second quarter with strong demand in all regions for our civil products and services and we signed a number of important US and European defense contracts. Overall, we concluded the quarter with a healthy CAD3.6 billion backlog, which includes a number of long-term recurring services agreements. We also saw our operating margin improve with the combined civil segments reaching 20% and military at 15%.

The quarter also marked a turning point for new core markets with our acquisition of METI Healthcare, which gives the business segment greater visibility and materiality. Looking specifically at civil, we continued to experience a high level of activity for full-flight simulator sales and upgrades to existing simulators. We sold another 8 full-flights bringing us to 19 at the half year mark. And in civil training, we signed new agreements expected to generate CAD246 million in future trending revenue.

In business aviation, we continued to see much of the same situation as in past quarters with demand for small jet training continuing to lag the mid-size and the more robust, large cabin aircraft training segments. All told, our combined civil book-to-sales reached 1.6 times in the quarter.

We currently have 165 simulators deployed in 29 training locations on four continents. And from a market acceptance standpoint, our solutions-based approach is working well. To date, we have approximately 20 strategic relationships with airlines and OEMs involving joint ventures, long-term service agreements, and other forms of cooperation that are testaments to the value that CAE brings as a trained solutions partner.

Looking now at defense, we received orders for seven simulators for the United States military and a customer in the Middle East, two simulators for the US Navy, and a contract to perform upgrades to the Air Force's KC-135 tanker simulators. We also received a contract to perform upgrades for the German Army's Tornado simulators. Taken together, these contracts demonstrate the validity of the kinds of platforms that CAE is best known for and also show the types of downstream opportunities that arise from the existing training infrastructure.

Our total military orders in the quarter were CAD206 million for a book-to-sales ratio of 1.02 times, which adds to our solid military backlog of CAD2.2 billion. Turning now to new core market segment, in CAE Healthcare, we acquired METI, which brings us a step closer to fulfilling our vision to drive acceptance of simulation as the way to improve how doctors, nurses, and other health care professionals are trained.

We also acquired products and technology from Haptica to enhance our capabilities and broaden our surgical solutions portfolio. From a market standpoint, we continue to have good traction as we integrate our new businesses. We sold products in our range of surgical, patient, and imaging solutions to customers like the Madigan and Ft. Bragg Womack Army Medical Centers in the US, New York University, and Western Carolina University.

In CAE Mining, I continue to be impressed with our progress to leverage our core competencies and develop new solutions to address our customers' needs for safety and efficiency. Specifically, in the quarter we sold our geological modeling and mine planning systems and professional services to major customers in Mexico, Russia, and Brazil. With that, I'll now ask Stephane to take you through the financials.

Thank you, Marc, and good afternoon, everyone. Revenue for the quarter was up 12% year over year at CAD433.5 million and net income attributed to equity holders of the Company was CAD38.4 million or CAD0.15 per share. Excluding the special items associated with the acquisition and integration of METI, net income was CAD41.1 million or CAD0.16 per share, which is up 5%.

Operating profit in the quarter was CAD63.9 million and excluding the special items, it was CAD72.3 million for a net operating margin of 16.7%. Orders were strong during the quarter with CAD563 million booked for a consolidated backlog of CAD3.6 billion. Bookings came in at 1.3 times revenue.

We had strong cash flow performance with free cash flow of CAD109.3 million in the quarter. We said last quarter that we normally see unfavorable movement in our non-cash working capital accounts at the start of the fiscal year and we did in Q1. We also said that we expect a portion of this to reverse as the year progresses and we signed the second quarter a CAD67.3 million favorable change in our non-cash working capital.

Net debt was CAD618.8 million as at September 30, compared with CAD520.5 million at the end of last quarter. The increase of CAD98.3 million was mainly due to the issuance of two private placements during the quarter, mostly in support of our METI acquisition. We raised CAD150 million at an average rate of approximately 4.5% and an average term of 11.7 years. We believe this was a cost-effective approach to raise capital and it reflects the quality of CAE's financial position.

Income taxes were at CAD10.3 million, presenting an effective tax rate of 21%. The rate is lower than usual because we recognized this quarter previously unrecognized tax assets resulting from net operating losses in the US. This was triggered by our acquisition of METI and excluding that element, income taxes would have been at CAD13.5 million for an effective tax rate of 28%, which is in line with our outlook.

Capital expenditures totaled CAD46.7 million this quarter, including CAD35.8 million in support of our growth initiatives and the balance for maintenance. Now looking at our segmented financial performance. In our combined civil segments, second quarter revenue increased 22% year over year, reaching CAD211.7 million. For the year-to-date, revenue grew by 21%.

Our combined civil operating income for the quarter was up 34% to CAD42.3 million, which gave us an operating margin of 20%. In simulation products civil, segment operating income increased 86% to CAD14.7 million for an operating margin of 15.9%. We're seeing the benefit of higher volume and a favorable program mix. In training and services civil, we had a good level of activity in all regions.

The second quarter is seasonally slower for training because few flight crews are normally flying during the summer, the busy summer travel months. Nonetheless, we saw utilization of 70% compared to 67% last year and trailing 12-month revenue per simulator was CAD3.5 million compared to CAD3.3 million last year. Our operating profit in training and services was up 17% to CAD27.6 million, for a margin of 23.2%.

In our combined military segments, second quarter revenue was 3% lower year over year at CAD201.5 million. On a year-to-date basis our military revenue was up 5%. We generated 15% combined military segment operating margin in the second quarter, which is back in the range of our outlook for the year.

In new core markets, second quarter revenue increased from CAD8.1 million to CAD20.3 million, reflecting the inclusion of METI in our quarterly results for five weeks. We had an operating loss of CAD8.6 million in the quarter, which includes the CAD8.4 million pretax charges related to the acquisition and integration of METI. Excluding these special items, our performance compares well to the loss of CAD1.3 million last year. With that I'll turn the call back over to you, Marc.

Thanks, Stephane. We had a good quarter and based on the market indicators specific to our business, we maintain our optimism about the way forward. Our outlook for civil remains positive, as we see continued strong demand for our products and services across all regions. Our combined civil order backlog has increased nearly 50% from last year to its current CAD1.5 billion. Key indicators in our civil business show a robust market and the long-term civil aerospace picture remains attractive. Air travel grew again in September, with airline revenue passenger kilometers up 5.7%. Commercial aircraft order backlogs have reached nearly 9,000 aircraft or about seven years at the current delivery rates. And aircraft production is slated to go even higher. We believe passenger growth, particularly in the emerging markets, and the [reef] leading opportunity in the mature markets will remain important drivers.

We reached 20% operating margins in our combined civil segments and we expect this strength to be sustained. In simulation products, the first half was highly active and assuming market conditions continue to be robust, we expect to conclude simulator sales in the mid-30%s for this fiscal year. The recent first quarter reflected the bottom for operating margins in our civil simulation product segment and we now expect to maintain a combined civil margin around the current 20% level. In defense, we're pleased to have won some key contracts during the second quarter in a challenging environment. We recognize that the uncertainty caused by the US budget process and forced structure adjustments in the US and Europe has not gone away. But that being said, we still see a good number of programs in the order pipeline.

There are three important factors that gives us confidence in our business. One of it which is our global diversification. In fact, 1/3 of our military revenue is generated in the US, 1/3 in Europe, and 1/3 in the rest of the world, including high-growth markets like India, southeast Asia, and the Middle East. The largest western defense markets have already experienced significant cuts to defense spending and are still rationalizing their budgets. The reverse is true, however, for the emerging markets, which are expected to see significant increase in defense spending to 2015 and beyond. The growth in these regions is driven by the desire to modernize forces and is supported by strong GDP growth.

A second reason why we're confident is that we've got a good position on platforms that have held up well in terms of forced rationalization. And we believe they'll continue to have long legs. I'm referring to platforms like transport aircraft and helicopters, which serve defense operations and also humanitarian and nation-building roles. A third and fundamental reason why we feel confident about CAE's defense business is because we're on the right side of the equation. We see an explicit desire by defense forces and governments to maintain mission readiness at a lower cost by moving more training hours from aircraft to simulators as a means of achieving recurring savings. We've seen some of this already by way of systems upgrades, and additional procurements. And I'm convinced we'll see more of that over long term. Taken together, I believe all of these three factors helped to distinguish CAE's defense business.

In summary, we're in a good position in context of the macro environment and I'm pleased with our performance overall. We grew military revenue in the first half and we remain confident that we'll grow in defense for the year as a whole. As in the past, orders tend to skew toward the fourth quarter, but we have a solid order pipeline and expect another good year of order bookings. In new core markets, we're making good progress and we've moved from what I've described in the past as option value to something more tangible. We firmly believe that new core markets will become as material in size to CAE as any one of our other segments. And we expect over CAD120 million of revenue next fiscal year, which is already becoming more material. Also importantly, we expect new core markets to generate a profit next year.

To conclude, CAE is a unique Company, which remains well positioned with its global diversification and balance between markets, products, and services. We continue to be confident about the way forward. Thank you for your attention and we're now ready to take your questions. Andrew?

Operator, we'd now be pleased to take questions from analysts and institutional investors. Before we open the line, let me first ask in the interest of fairness that you please limit yourself to a single one-part question. If you have additional questions after that, if time permits, please feel free to reenter the queue.

(Operator Instructions) Hamzah Mazari with Credit Suisse.

The first question is or my only question I guess is on the civil training business. I realize that summer is a slow period, but maybe if you could tell us what you saw in that business in September and October and maybe talk about the mix you're seeing in that business in terms of initial certification-type work relative to recurring training.

I think it's strong in the quarter. I mean, if you look at the numbers, the utilization, you see we had I think 70% in the quarter. And if you look year-over-year that compares to 67% last year at the equivalent time. So both in the summer months where people, airlines usually are flying the line. And it is normal that we saw the drop from Q1, probably less than we saw last year. I tell you the mix -- I mean, again, very, very strong both in initials and recurring, particularly on the airline side in emerging markets. On the business aircraft side, it's again strong on the businesses side in the large segments like Dassaults, Global Expresses, Gulf Stream, that level is strong, but less in terms of your entry Learjet series, Cessna's, that kind of product line. That hasn't really changed from the last quarter. I think that when we talk about our 20% EBIT expectations for the next period in consolidate civil, that's the assumptions we're making here.

Got it. Thank you very much.

You're welcome.

David Newman with Cormark Securities.

Just on the production delta in civil sim, I know you don't disclose this, but just a quarter over -- year-over-year in the quarter, how many more sims might you have produced?

Boy, do we have that number, Andrew?

Yes, in terms of deliveries, David, we delivered 6 in Q2.

Okay. Versus--

The deliveries don't quite capture, I think, what you're looking for because it measures where the simulators are at a point in time. The actual volume moving through the plant would be more -- would be greater than what that number tells.

Okay, got it.

And the revenue volume, I think, gives you a good indication of that year-over-year comparison.

And for the year, what are you sort of anticipating on production versus, let's say, last year, which I think you were 20, I think, last year?

Yes, it will be significantly higher.

And it sounds like you've cleared out that lower margin backlog on the low priced through the recession. Is that pretty much effectively gone now?

Yes, in the large -- yes, we always have a mix of programs, but yes, what we referred to as the low margin backlog, which you're saying, yes, that's pretty much cleared through now.

And just -- you said you're still expecting, I think, growth for the year on the top line in the military side. Marc, did you mention a margin that you're still anticipating for the year? Is it still going to be like 15 combined military overall? Is that your expectation or how do you think this plays out?

Yes. That's what I expect. I mean, I haven't -- I'm a broken record on this, but I continue to expect that we'll be able to do 15-plus margins in the military and that's what we expect to see as for the year going forward.

And I know it's early dave, but if you look out to the next year, you have any sense on how organic growth might come back on the military side? Where are you, I guess, in the traction that you're getting in convincing the military that simulation is the way to go and like how does that all play out as we go into next year?

As I said, talk about right remarks, we clearly see evidence that they're using more simulation to save cost. We seen that because we've seen some programs that where people are upgrading simulators so they can do more training, more effective training on it. We've seen contracts like that. We've seen uptick in some other areas. But you know, some of it is counterbalanced by the fact that they're cutting in the overall fore structure.

Now longer term, I think that's definitely a positive, it goes more positive. That's one factor. The other ones, as I mentioned, the platforms that we're on, helicopters, C-130s, P-8s, that's still going -- that's growing, that's strong. And finally again, the global diversification, always -- obviously, we're focused on the big news in the US and Europe. But if you look at some of our order in-take you'll see it's coming from areas of world which are growing. It's too early for me to tell with any certainty what the growth rate will be next year. I mean, we'll have to update because, I mean, things are -- it all depends on some of the decisions that are being made. But what I see today, though, if I look at our order pipeline, and we always look at this, I see as many potential orders in there as I've ever seen.

Okay.

That for me has not changed. I haven't seen a drop in the numbers of opportunities. Make clearly we have to win them. There's competition. But do I feel optimistic about the future? Yes, I'm optimistic about the outlook in military.

And last one from me. Just on the tax rate, obviously 21% in the quarter. How long do you think you might be able to utilize those tax loss carry-forwards and the effective tax rate for the year? And, I guess, how long it might take to absorb them?

Well, you see, the benefit in the quarter was around CAD3 million. So the last carried forward itself was in the range of CAD8 million to CAD9 million.

So a couple more quarters to go?

Yes. As we said, there's going to be -- by the time that we actually ramp up the business and get to a steady state, I think I'll -- we said last quarter that in that business we expect getting to a profitable situation for the whole new core market next year. So it will definitely be starting next year.

So a couple quarters of maybe lower tax rates for the back half of the year kind of thing.

No, sorry. We expect that the tax losses will be used starting next year. But the benefit has been accounted for in this quarter. So that's why we're at 21%. Going forward for the rest of the year, I expect being in the 28% tax rate range.

Very good, thank you.

Cameron Doerksen with National Bank.

Yes, question on the military business and specifically in Germany. We've gotten a little more recently, anyway, an indication of specifically what the German military is going to do as far as cutting some of their programs. And then there's a number of programs in which you're involved there. I'm just wondering if you can discuss what the impact you think will be to your business in Germany, specifically. And you've also got a joint venture there on the NH-90 training and I'm just wondering how the cuts that have been announced are going to affect the value of that investment for you.

Well, I don't think it changes, just specifically the last part of the question, I don't think it changes the value of our investment. We've looked at that very close, as you can imagine, because of what you say, our business there. We're quite integrated with the German army, we're on their base. We did a lot of their training. So clearly there's been -- what we've seen is they've announced a number of base closings, reductions on term platforms. They still have some making -- decisions to make, by the way. But I mean, so far what we've seen is that there's some modest negatives to our existing business on the services side, but there's also potential to mitigate it. The complete shoe hasn't dropped.

It's kind of in the, what I talked about again this quarter as in last quarter, is that the first thing you do is cut, but then they figure out though, okay, we still got to maintain readiness. And as they look about how did do they maintain readiness, then you look at, well, how can we basically do things that and train people at lower cost. And that's what we do, obviously. So for us in the short term it's a modest negative. But we're looking for, based on what we've seen for -- so far, I think in Germany specifically, I think we have a flat situation in terms of revenue for the foreseeable future. And -- but that's reflected in our overall thinking about the military business.

And maybe if I could just follow up on the same theme. I mean, you've started a, or set up, I guess, a joint venture with a Company in India, obviously, to pursue some military opportunities there. I'm just wondering if there's anything you can specifically say about what opportunities that you think are available in India on the military side that might offset some of the weakness we might be seeing in other countries.

I don't have the detail here. I mean, there's a number of opportunities that we could probably give you some later on by specific programs that Andrew could provide. But there's a number -- I mean, basically the Indian military is undergoing a very significant modernization of their defense forces. And that -- not only in India, but specifically your question is for India. And that's supported by the growth that they have in that country.

So I think we have a very good position if you look at the joint venture we have there. The joint venture is with HAL and that's Hindustan. And Hindustan is the largest defense contractor in India. Most of the airplanes and helicopters that are produced in India are produced there, either indigenously or through an agreement with the OEMs to produce them there. I think we're well positioned. We'll get back to you with the specific platforms that they're buying.

Great. Thank you very much.

You're welcome.

Ben Cherniavsky with Raymond James.

Just one question I have from the commentary you made in the MD&A and we haven't heard a whole lot about this recently on the CAE Global Academy, that the revenue -- there was a revenue drag there.

Yes.

What -- can you give us an update on what's happening with that initiative and the end markets that would explain that.

Yes. I think what you're seeing is we've refocused that business from going where the markets for new pilots really is, from the legacy markets to emerging markets. So I think that explains a large part of it. That's really what you see it going. We continue to be very optimistic about that business. Not only from the point of view of being able to train people to become pilots, but it's a great compliment to our total solutions offering. Like for example, we sold simulators to Vietnam Airlines, but they needed pilots. And we could differentiate ourselves by being able to train pilots and if you were to go, for example, to our CAE Global Academy location in Phoenix, you would find quite a number of cadets from Vietnam in Phoenix. But I think back to your question, I think it's mainly a focus on legacy to emerging markets.

And on the end markets, just looking at some of the plans for capacity from major carriers in Europe and the US predominantly, I appreciate the emerging markets are still very robust. But do you see any potential pressure on training revenues, commercial training opportunities as airlines start to consider scaling back capacity this fall and being more disciplined about ASM growth next year?

Well, I guess, we'll see if that happens. I can tell you what we see now is it's strong across the board, including Europe. We're doing very well. It's sometimes something you wonder if it's counterintuitive because of what you read and what you see about what's happening from an overall macroeconomic situation, but it's really not reflected in what we see in terms of activity in the airlines, again, not only in emerging markets across the world. So we'll see what happens in a few quarters, but that's the situation today.

But hasn't there traditionally been a relationship between capacity plans and demand for training?

Yes, you're right. I mean, yes, and it's pretty directly related. If they cut capacity, they take airplanes out, then clearly they're going to -- pilot training demand is pretty proportional to the amount of airplanes flying. I mean, it doesn't go down that much, clearly because it's a regulated market. They have to train. But I think in the end, if it comes back -- it should -- I'm of a mind that we're growing here and that we'll continue to see what we're seeing in the market today. And, yes, should it go the other way, I think we've proven the ability to adapt and be resilient in a down market, as we proved when coming out of 2008, 2009 crisis. So if it goes the other way, we'll adapt.

Can I squeeze one more quick one in there? Just on the new core markets, you mentioned you expected to be profitable next year. Would you be willing to give us any indication of what the margin potential for that business is at a normalized rate, just trying to get a better understanding of the economics of that business versus aerospace simulation. What would a -- what are you sort of aiming for long term for profitability of that business?

Long term we're expecting the same kind of profitability as the rest of our business.

So it would be comparable margins?

Yes, comfortable margins. I don't say we're going to get there next year, because our focus is still attaining the revenue that we're targeting, which is as big as any other of our segments. But as I said in the past, it's not going to be dilutive to the margins the rest of our business. So that's what I mean by it. We're targeting the same kind of margins as the rest of our business.

Right. Okay, thank you very much.

You're welcome.

(Operator Instructions) David Tyerman with Canaccord Genuity.

Just following up on the training question and I guess the question I have, and it's not just training, it's also the civil equipment business. Can you kind of remind us in 2008, 2009, when you really started to see something happening. I guess, it feels a little bit like September 2008, right now. And I'm wondering whether you just haven't seen it yet and you probably didn't back in September 2008, because it was too soon for people to know what was going on, but the tea leaves were there from the broader geopolitical situation and macroeconomic situation. So I'm just wondering how long was it before you saw something back then in terms of order flow or order activity from the customers both on the training side and the -- on the equipment side for civil?

I think what we saw first at the time was we saw airlines starting to be capital constrained. They're shutting down capital and that reflects itself in what our after market is, like upgrades, maintenance to their simulators. That's where they start cutting first. Then of course, it follows on by -- because of a CapEx crunch, then basically shutting down any kind of acquisition of any unused kind of or not absolutely essential kind of equipment including simulators. I could tell you we're not seeing it. It didn't happen overnight. And if you remember at the time, we restructured our business and we did a pretty good restructuring in advance of everything happening. And that allowed us to continue to be profitable throughout the whole downturn. That's why I continue to say that should a storm happen, we're -- CAE's a pretty good port in the storm. So I think -- I don't know about being the same place as were in 2008. I mean, there is a different situation.

If you remember at the time, people were talking about whether or not we were going to go in global depression. I mean, that's how bad it was. And nobody knew what was going on. There was not -- no access to capital. People were worried about whether or not they could get any liquidity. So this is not the situation we have today.

Having said that, we keep monitoring very closely, very, very closely. I mean, we look at leading indicators. We have seen a drop in freight indicators over the last few quarters. That's something we look at, because that typically usually reflects itself in down shipments. Then is that signaling a slowdown. That we're watching. But usually, it -- passenger traffic comes in pretty close after, but that's not what we're seeing. We're seeing it very strong across all segments of our industry.

So just to follow up -- sorry, just to follow up, Marc. So the maintenance, et cetera, that you talked about as the leading edge of what you do see, when did you actually start seeing that? Was it the fall of 2008 or was it really by the time you were getting into the start of 2009 or the spring of 2009?

I don't really remember, to be very honest about it. Do you remember?

David, it's Andrew. I think one of the big factors in the last downturn was the sudden, the very abrupt interruption of capital, as Marc was saying. So part of it clearly is a function of decreased demand for air travel. But the absence of or the perceived absence of credit for many of our customers saw them clamp down on their CapEx plans pretty abruptly. To this point I don't think we've seen that. The other factor is -- to consider is where were the airlines in the 2008 period relative to where they are today in terms of the capacity they're flying and the kinds of yields that they're generating. So as a question to how much they would need to take out relative to what they took out in 2008, 2009.

Okay. Thank you.

Benoit Poirier with Desjardins Capital Markets.

This is [Ed LaDesjaron] for Benoit this afternoon. First question, on the civil simulation sites, was just wondering whether you were seeing somewhat lesser competitive pressures as you used to in the past quarters.

In what segment, sorry?

In SPC.

SPC, okay. No, I think the composition -- competitive environment hasn't really changed. Same number of competitors, same players that you see, not necessarily in all markets, but I haven't seen a huge difference in the competitive environment.

And would you say that the second quarter level for margins is a good number to look at going forward?

Yes. I mean, there will be some variation to the level that we can predict it, of course. I think it will be probably around what you see. I think what I tend to look at more is the combined number and that's -- as I said, at least for what we see going forward here, I expect it around be around 20% combined.

Next question on military side, maybe if I remember correctly, I think you said on a previous call that you still needed to secure around 30% of your fiscal '12 revenues on the defense side. So I was just wondering if you could give us an update on that.

Well, you saw the orders that we had in the quarter. I think we were pretty satisfied with the orders. And that lessened the risk that we were looking at in terms of us being able to grow this year. The exact number right now, I think we're north of 80% for sure. I don't have the exact number for you. But I think they're trying to dig it out for me. I think we have the exact number. It's around 86% for the whole year. So, I think there's -- we still have to win some, but I think the risk has been minimized of what we need to win. And I think what continues to be the risk for us is not specifically of whether we'll win is when we'll win and timing.

But having said that, I -- with what we need to win, I'm pretty confident that we'll grow overall for the whole year. Which means that -- which means, of course, we'll have a strong second half in the military business.

Right. Right. And these recent orders, would you say that you've gotten them on time or were they somewhat delayed compared to your expectations?

If you remember what we said, we said that things tended to be just moved from like one quarter to the next or one half to the next. That's pretty much what's happened. Some of them that we expected to win a couple quarters ago we've won. And it's kind of a mix of that.

Okay. Thank you very much.

Marko Pencak of GMP Security.

In your MD&A for the civil equipment segment you talk about more revenue being recorded for simulators already manufactured for which you signed contracts during the quarter. Can you explain to me how that's possible. In other words, why is it that you guys had the availability of those, I guess, pre-built simulators?

Actually, it's not something that happened this quarter. It happens quite -- we always have that happening to a certain extent in a quarter. And sometimes it gets a little bit more -- it becomes more than a previous quarter. That's why we pointed out. But what it is, is that its simulator -- as we build the simulators, we don't necessarily -- usually we have a customer, but not always.

In some cases, we want to have some that are partially built in order that we can react quickly to a customer having a short lead time requirement, specifically on A-320s, on Boeing 737s, we tend to want to do that. So depending on when we sell it, if it's -- let's say the simulator is half built when we sell it. Well, clearly, because of the way we account for revenue on a percentage of completion, basically we will -- we recognize half of the revenue immediately when we sign the contract. And of course, if it's 90% dealt by the time we sell it, then of course we recognize 90%. That's one factor.

Another factor is sometimes we'll batch simulators, meaning that let's say we've sold two 737 simulators and we may, even though the timing may be such that one delivers, let's say, now, and another one delivers in six months, it's more cost efficient for us to bill them at the same time. So it's those kind of factors that you see. But it's mainly the first one. And that is --.

So as you go through your budget process, what portion -- and let's say you just, and I'm pulling a number out of the air just for discussion purposes, let's say you're planning to build 40 simulators next year. How many of those would be based on orders and how much would be sort of "built to forecast"?

Typically, we build most of them on the orders we expect to win, i.e., we typically build based on getting an order. But we'll have a certain proportion that we're not, we don't disclose for competitive reasons, that we build in order to have a shorter lead time. But we don't disclose how much, because of it's commercially sensitive.

And so none of these were related to order cancellations from prior orders you got from other customers?

No, no. And as I said, I mean, this is if you go back and look at MD&As for the last three or four years, you will find it is not something new, it's something that is pretty regular in our business. And SPC specifically.

Okay, I actually thought it was kind of new, which is why I'm asking.

Sorry, sorry, but it isn't. It isn't.

Okay.

It's sometimes just more in one quarter than it is another. Just because of the -- if everything was linear, then of course you wouldn't see it. But then sometimes we'll deliver two in a quarter, then one in the next. But we -- that's kind of reflected in our thinking when we talk about the margins for the whole year.

And I'm sure you saw the acquisition of Sim Industries by Lockheed Martin. So just curious how you see the competitive dynamic evolving over the next two years.

No, we saw it, of course. I mean, our industry is pretty small, all things considered. And Lockheed we know well, of course, because we work with them. And they're a partner. They are a competitor, as well. Depends which segment we're looking at. They haven't been a competitor in training.

So now that they own Sim Industries, I think they'll be a competitor there. Having said that, I think what they've said is they're going to, I think, -- who knows what they're going do. But I think to me what it says is that Sim Industries, we've seen them in the market. They tend to place two to four simulators into the market every year. I expect that to continue. I expect that they'll continue to be a competitor. I think we'll see how that changes. I'm sure Lockheed has their strategy for it.

For us, I think we still continue to play our game. I think we have -- we're the only pure play in the business. We have a strong brand and we have very deep relationships with the majority of the world's airlines. So I think we're going to continue to focus on our business, on our strategy, but at the same time we don't rest on our laurels. We take everyone, any competitor in the market, we take very seriously. And even though this is not a new competitor, Sim Industry is owned by someone else and that someone else is Lockheed Martin, we're -- we don't take it for granted. And I'll point out that -- I mean, it's not new that we're competing with high tech, relatively, if you like I should say, rich competitors, for example Rockwell Collins is in the business.

They've been in the business for quite a few numbers and they got into it by acquiring a small Company called NLX at the time. We compete with FSI in the market. So I think we're used to competing with highly -- high-tech companies that are well capitalized. Now Sim Industries is that way, so I think in the end I think it's not a new competitor, but it's one we'll be watching. But we'll be playing our game.

Okay. Thank you.

Ron Epstein with Bank of America.

Hi, it's actually Elizabeth in for Ron. The 86% that you're now booked on the defense leg, where are you typically at this point in the year? Is that 86 -- how does that sort of fall into the average?

It's about average.

That's about in line. And then when you talk about the new core markets being profitable by next year, is that mean it will end the year profitable or it will be profitable for the entire year.

It will be profitable for the whole year.

Okay, great. Thank you.

You're welcome.

Operator, I'd like to now conclude the Q&A session for analysts and investors and now open the lines to members of the media. I would thank members of the investment community for their participation and note that I will be available for calls after this conference.

(Operator Instructions) Ross Marowitz with the Canadian Press.

I'm wondering if you could say what the top emerging military markets that you're seeking. You mentioned, obviously, India, but can you sort of enumerate which ones they are and what you're seeking from them.

I think I'd point out India for sure. Asia, countries in Asia, countries in the Middle East, such as the UAE, as an example. Those are the ones that come to mind. And they're looking at modernizing their fleets, what will be defense forces across the whole gamut of their defense forces. I think includes South America in that, as well. And I think that's -- they're all supported by strong GDP growth, that it gives them the money to be able to modernize their forces. So we expect and we're actually seeing order opportunities that are coming out of those markets and we expect more in the future.

Are there countries that are you unable to go into, like China or others?

Yes. Specifically that would be the one that we can't go into, China.

And how much would the additional revenue from these countries offset decreases in the US and Germany and elsewhere?

It's a bit too early to tell. It will depends of the timing of when they actually ramp up their procurements specifically to ours. So it's a little early to tell to what extent it will compensate. Today, we do about 1/3 of our military business in those countries. I would tend to expect that will continue. But again, it's a bit early to tell because it's so dependent on the timing of when they put orders through or put RFP's through.

So if there's dramatic decreases in military budgets in the west, it's not going to have a large, offsetting impact?

It depends what large is. We already seen large cuts in -- if I talked about, for example, in Germany. What they talked about base closings, but we are still able to grow in that environment. I think we're talking hypothetically. Yes, of course, it depends of the magnitude of cuts, who knows that will happen. But I think that in the end I'm pretty confident of the fact that when you train on the simulator, you can do it at 10% of the cost of a real aircraft. Simulation will become a strong enabler to being able to run things more cost efficiently. So I'm not -- I'm convinced that our -- the impact on our business will not be proportional to any cuts that are made, certainly not a longer term basis.

Thank you.

You're welcome.

Peter Hadekel with The Gazette.

I'm just wondering if you could talk a little bit about the new core markets initiative. You were saying you hoped to achieve CAD120 million revenue next year. And would that put you then on equal footing with the civil and the military simulation business?

No, I think we'd be about halfway to our lowest, our smallest segment, which is training and services military, which is in the just north of CAD250 million.

Okay, so the timeframe for achieving parity with the other two segments would be what?

We haven't really given one. And some of it we'll see how we're able to execute. We're convinced that we're able to get there, but we haven't really given a timeframe on it ourselves.

The initiative was announced I think back in '09. How would you describe the process since then? The take-up is faster or slower than you expected?

Well, I'm pretty happy with the progress that we've made. If you look, as we said, in 2009 we had zero. And next year we'll be making CAD120 million in this business and we'll be profitable. So I think I'm pretty happy with the progress we've made. Of course we've made acquisitions partly to be able to achieve that. If you look at both segments, healthcare and mining are both segments that are attractive. Mining, as I said in my remarks, I'm very happy about the progress that we're making there. And we're -- so, overall, I think that we're making the progress that we'd anticipated and we're on track.

Obviously, there's technological similarities between the different industries. But if you look at healthcare and mining, they are obviously also different from aerospace. So I'm just wondering from a management perspective, what challenges does that pose to you in terms of culture shift at your organization.

It's interesting. First of all I think -- even though they're very different, you're absolutely right, they share some common traits with our businesses. And one of the ones that I would point out is in both cases they're mission critical. Mission critical is the same as a factor is in aviation. Also the need for safety and efficiency is there as well. So at the high level, those are the things that cut across. From a culture standpoint, it's not as -- it's interesting, it's not as different as you might imagine as it relates to the kind of work that we do. Because what we do is take our expertise in simulation-based model, simulation-based training and what we really have to learn is the actual subject matter expertise. Of course, the human body is very different than an airplane, except that they have in common kind systems, like the blood system, circulatory system interestingly has some similarities to a hydraulic system in an aircraft.

But having said that, they're clearly very different. But our being able to adapt, say for example, our engineers being able to adapt, what they really need is to get the subject matter expertise. And we get that from the people that we either acquire or we partner with, and that gives us -- that's what I think, from a culture shift it's not as significant as you might expect.

Thank you.

Operator, that's all the time we have this afternoon for questions from members of the media. I would like to thank the members of the media for participating on this call, as well as the investors earlier. And I would remind everyone that a transcript of the call can be found on CAE's website at cae.com. Thank you very much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.