##### 



EXHIBIT 3 > CAE ANNUAL REPORT 2005 
 MANAGEMENTS DISCUSSIONAND ANALYSIS For the year ended March 31, 2005 as of May 10, 2005 For purposes of this discussion, CAE or the Company refers to CAE Inc. and its
subsidiaries. This Managements Discussion and Analysis (MD&A) for the year ended March 31, 2005,

current as of May 10, 2005, focuses on the core businesses of CAE: Military Simulation and
Training (Military) and Civil Simulation and Training (Civil). HIGHLIGHTS OF FISCAL 2005 ORGANIZATION  
    Robert E. Brown became CAEs new CEO on August 12, 2004 and on February 11, 2005, outlined a
comprehensive restructuring plan aimed at restoring the Companys profitability, cash flow and return on investment.
    The restructuring plan is progressing in accordance with the initial timetable and within the estimated costs.
    As of April 1, 2005, CAE is organized in three business groups; Civil Training & Services,
Military Simulation & Training and Simulation Products, and will start reporting results under this format at the end of the first quarter of fiscal 2006. OPERATIONS  
    Revenue from continuing Military and Civil businesses increased by 5% over last year, notwithstanding an appreciation of the Canadian
dollar versus its U.S. counterpart.
    Earnings from continued operations for fiscal 2005 reached $0.19 per share net of impairment,
restructuring and other non-recurring items.
    Net cash flow provided by continuing operating activities reached $186 million for the year.
    During the third quarter, CAE recorded a non-cash charge of $443 million ($354 million after
taxes) as a result of the impairment of goodwill, intangible and tangible assets for the Civil business.
    As of March 31, 2005, the Company incurred
$25 million in restructuring charges, tracking in line with the global $55 to $65 million restructuring plan.
    CAE completed the divestiture of substantially the entire Marine Controls segment to L-3 Communications (L-3) during the fourth
quarter in a transaction valued at $239 million, resulting in an after-tax gain of approximately $104 million. In accordance with the purchase
agreement, L-3 will also acquire two other components of the Marine Controls segment, including
the assumption of the CAEs guarantee of
£23 million of project-finance related debt for the U.K. Astute Class submarine training program. FINANCING  
    Net proceeds of the Marine Controls divestiture were used to reduce debt.
    Two sale and leaseback transactions for three full-flight simulators were completed, raising
$44 million. The transactions also triggered the
recognition of $4 million of tax benefits related to prior years net operating losses for tax purposes in the United States.
    CAEs Board of Directors took the decision to reduce the quarterly dividend to $0.01 per share,
conserving $20 million of cash annually. ORDERS / INVESTMENT  
    With an order intake of $681 million, Military reached a new record. More than 40% of fiscal
2005 equipment orders came from U.S.-based customers.
    Military secured approximately 152 million of backlog from a contract awarded by the German
Armed Forces on the new NH90 platform.  -
    The 488 million program, structured as a Private Financing Initiative, will be executed
through Helicopter Flight Training Services GmbH (HFTS), an industrial consortium consisting of CAE, Eurocopter, Rheinmetall Defence
Electronics and Thales, each owning a 25 percent share.-
    The Consortium concluded the non-recourse financing of this project on April 29, 2005.  
    CAE-led Landmark Training Ltd. was selected as intended preferred bidder for the £1 billion British Armys Armoured Vehicle Training
Services program.
    CAE and Dassault partnered for the Dassault Falcon 7X training program.
    CAE continued deployment of its training network:  -
    in Latin America: CAE signed a $40 million 10-year deal with LAN Chile S.A. airlines and acquired its training centre;-
    in Europe: CAE became easyJets training provider;-
    in North America: CAE expanded its footprint in the U.S. with the announcement of a new training centre in Morris County, NJ; and-
    in the Middle East: Emirates-CAE Flight Training continued its expansion.  
    For fiscal 2005, CAE was awarded 17 of 22 competed civil full-flight simulator orders (77% market share). > 18




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 INTRODUCTION Founded in 1947 and headquartered in Montreal, Canada, CAE is a leading provider of simulation
and modelling technologies and integrated training services for civil aviation and defence
customers worldwide. CAE employs more than 5,000 people in manufacturing operations and training
facilities in 17 countries on five continents. More than 90% of CAEs annual revenues are derived
from worldwide exports and international activities. Prior to the sale of its Marine Controls division (Marine) in the fourth quarter of fiscal
2005 the Company also provided simulators and training services for sea-based activities and

supplied marine automation systems for military and civil applications. For a further description of the Companys core businesses please refer to Business Profile and
Strategyof this MD&A. The MD&A, which includes a review of the operations of each business segment and the
financial condition of CAE, is intended to assist in the understanding and assessment of
significant trends, risks and uncertainties related to the results of operations for each business
segment and should be read in conjunction with the audited consolidated financial statements and
accompanying notes contained on pages 44 to 86. This MD&A contains statements from CAE management (Management) regarding CAEs strategy,
operating results and financial condition. Management is responsible for its accuracy, integrity
and objectivity, and has developed, maintains and supports the necessary systems and controls to
provide reasonable assurance as to the validity and completeness of the disclosures contained
herein. CAEs common shares are listed on the Toronto and New York stock exchanges under the symbols CAE
and CGT respectively. CAEs fiscal year end is March 31, and unless otherwise indicated, all references to the
current year or 2005 are for the year ended March 31, 2005, and all references to last year, prior
year, or a year ago are for the year ended March 31, 2004. Except as otherwise indicated, all financial information related herein is determined in
accordance with Canadian generally accepted accounting principles (GAAP) and all dollar amounts
referred to herein are in Canadian dollars. CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION This MD&A contains forward-looking statements with respect to CAE and the operations of each
business segment based on assumptions that CAE considered reasonable at the time they were prepared
and may include information concerning the Companys future financial performance, business
strategy, plans, goals and objectives. These forward-looking statements, by their nature,
necessarily involve risks and uncertainties that could cause actual results to differ materially
from those contemplated by the forward-looking statements. Statements preceded by the word
believe, expect, anticipate, intend, continue, estimate, may, will, should and
similar expressions are forward-looking statements. CAE cautions the reader that the assumptions
regarding future events, many of which are beyond the control of CAE, may affect the extent to
which a particular projection materializes and/or could ultimately prove to be incorrect. Factors
that could cause actual results or events to differ materially from current expectations are
discussed herein. (Refer to Business Risks and Uncertaintiesof this MD&A for additional
information.) The Company disclaims any intention or obligation to update or revise any
forward-looking statements, whether as a result of new information, future events, or otherwise. In
particular, forward-looking statements do not reflect the potential impact of any merger,
acquisition or other business combinations or divestitures that may be announced or completed after
such statements are made. NON-GAAP FINANCIAL MEASURES This MD&A provides comments on non-GAAP financial measures. Readers should be cautioned that
this information should not be confused with or used as an alternative for performance measures
determined in accordance with GAAP. CAE believes that these measures provide useful supplemental
information to GAAP financial measures. However, these non-GAAP financial measures have no
standardized meaning prescribed by GAAP and therefore are unlikely to be comparable to similar
measures presented by other companies. EBIT EBIT is a financial term used to report a companys earnings as they would be without specific
deductions including non-operating expenses (such as interest, taxes and other non-core expenses). CAE considers EBIT to be useful supplemental information since by eliminating the effects of
some financing and accounting decisions, performance can be analyzed between different periods,
different companies and different industries with dissimilar capital structure. FOREIGN EXCHANGE The Companys reporting currency is the Canadian dollar and assets, liabilities and
transactions measured in foreign currencies need to be translated to Canadian dollars at various
exchange rates as required by GAAP. For the purposes of this MD&A, foreign exchange (current
financial information restated at the rates in use for the same period a year ago) is presented on
a consistent basis from period to period. CAE considers foreign exchange exclusion to be useful
supplemental information as it provides an indication of performance comparable to a year ago
excluding the impact of currency fluctuation, which can significantly affect the Companys
operations and financial results. 19 >




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 The year-end exchange rates used to translate assets and liabilities were as follows as at March 31: 2005
    
    
    
    2004
    
    
    (decrease)U.S. dollar (USD or US$)
    
    
    1.2096
    
    
    
    
    1.3105
    
    
    
    (8
    %)Euro ()
    
    
    1.5689
    
    
    
    
    1.6109
    
    
    
    (3
    %)British pound (£ or GBP)
    
    
    2.2848
    
    
    
    
    2.4116
    
    
    
    (5
    %)
 The average exchange rates used to translate revenues and expenses were as follows for the
fiscal years ended March 31: increase/2005
    
    
    
    2004
    
    
    (decrease)U.S. dollar (USD or US$)
    
    
    1.2789
    
    
    
    
    1.3539
    
    
    
    (6
    %)Euro ()
    
    
    1.6064
    
    
    
    
    1.5893
    
    
    
    1
    %British pound (£ or GBP)
    
    
    2.3573
    
    
    
    
    2.2903
    
    
    
    3
    %
 FREE CASH FLOW Free cash flow is defined by Management as net cash flows provided by continuing operating
activities less capital expenditures and dividends paid, plus proceeds from sales and leaseback of
simulators. CAE considers free cash flow to be an indicator of the financial strength and
liquidity of its business as it shows how much cash is available to repay debt and to meet its
ongoing obligations. NET DEBT Net debt (total debt including amounts due within one year less cash and cash equivalents) is
presented on a consistent basis from period to period. CAE considers net debt to be an indicator
of the Companys overall financial position. NON-RECURRING ITEMS Non-recurring items are items identified by their nature as outside of the normal course of
business because they are infrequent and/or unusual. Management considers that highlighting
non-recurring items and providing operating results excluding these items is useful supplemental
information that allows for analysis of CAEs underlying operating performance. BUSINESS PROFILE AND STRATEGY CAE provides a wide range of simulation and training products and services including
full-flight simulators (FFS), full-mission simulators, visual systems, training devices and
systems, flight training centres, and support services. The Company operates in two core markets:
Civil and Military. CAEs Civil business is the world leader in the design and manufacture of civil flight
simulators and visual systems used to train airline and business jet pilots. In addition, CAE is
the second largest independent civil aviation training provider, with a global network of 22
training centres equipped with 105 FFS. CAEs Military business is also a global leader in the design of advanced military training
systems for air, land and sea applications, having supplied the defence forces of more than 30
nations with military training systems and services. In addition to its comprehensive training
services, the Company offers a range of simulation equipment and modelling and simulation
software. CAE has designed one of the widest ranges of military helicopter simulators in the world
and more training systems for the C-130 Hercules than any other company. Over the past five years, the Company transformed itself, evolving from a supplier of
equipment to a provider of integrated training solutions. CAEs strategy going forward revolves
around taking the necessary steps to restore shareholder value. Following Robert E. Browns arrival as Chief Executive Officer in August 2004, an in-depth
strategic review of CAEs markets, customers and other stakeholders as well as the Companys
internal resources and capabilities was conducted. As a result of this review, the Company has
reconfirmed its strategic direction. It adopted a plan intended to protect its technological
leadership while at the same time fostering synergies between its various operating units, and
implementing sound business practices. The plan maintains the existing Civil and Military Groups,
and adds a third: Simulation Products. The reorganization, which became effective April 1, 2005,
is expected to result in significant savings to the Company and to position it well to face new
market realities. The major priorities of the newly formed Civil Training & Services (CT&S) Group are to
increase revenue per simulator in the Companys global network of training centres, and to deliver
the most cost-effective and competitive training service in the marketplace. To this end, the CT&S
Group is expected to consolidate training centres where duplication exists, and to reallocate a
number of simulators to maximize yield. The Military Simulation & Training (MS&T) Groups main goals are to service the defence
market with technological excellence in modelling and simulation; to increase the Companys market
share of the military training market, and to explore opportunities in non-traditional areas of
the defence market, including such areas as analysis and planning. > 20




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 The newly formed Simulation Products Group consolidates all manufacturing activities and
includes engineering, program management, global procurement, and the marketing and sales of Civil
equipment. Its immediate focus is to substantially reduce the costs associated with manufacturing
simulation equipment intended both for sale to third parties as well as for installation in the
Companys own global network of training centres. Fiscal year 2006 will be a transitional year for CAE while the Company addresses its business
processes and cost structure, with the goal of ending the year with a restructured and solid
earnings base. CAEs strategy is to leverage its extensive experience in modelling and simulation to expand
both vertically into other products and services within the aerospace and defence industry, as
well as horizontally to pursue opportunities presented by emerging markets such as homeland
defence and urban simulation. In order to be able to respond to growth opportunities, CAE must
continue to invest in new and innovative technologies. CONSOLIDATED RESULTSSTATEMENT OF EARNINGSSUMMARY OF CONSOLIDATED RESULTS (amounts in millions, except per share amounts)
    
    2005
    
    
    
    2004
    
    
    2003Revenue
    
    $
    986.2
    
    
    
    $
    938.4
    
    
    $
    976.8EBIT
    
    
    (373.0
    )
    
    
    
    81.3
    
    
    
    194.4Interest
    
    
    32.1
    
    
    
    
    22.4
    
    
    
    28.1Income taxes
    
    
    (100.4
    )
    
    
    
    11.5
    
    
    
    52.4Earnings (loss)Continuing operations
    
    
    (304.7
    )
    
    
    
    47.4
    
    
    
    113.9Discontinuing operations
    
    
    104.8
    
    
    
    
    16.6
    
    
    
    3.3Net (loss) earnings
    
    
    (199.9
    )
    
    
    
    64.0
    
    
    
    117.2EPS from continued operations
    
    
    (1.23
    )
    
    
    
    0.20
    
    
    
    0.52Basic EPS
    
    
    (0.81
    )
    
    
    
    0.27
    
    
    
    0.53
 CONSOLIDATED REVENUE FROM CONTINUING OPERATIONS For the twelve-month period ended March 31, 2005, consolidated revenue from continuing
operations reached $986.2 million, representing an increase of $47.8 million, or 5% over the
$938.4 million reported for the previous year. This net increase in consolidated revenue is due to
a $58.4 million, or 13% increase in Civil revenues, partially offset by a $10.6 million, or 2%
decreased contribution from Military. Consolidated revenue from continuing operations, excluding the impact of foreign currency
fluctuations (mainly the decrease of the USD), would have been slightly over $1 billion, an
increase of 8% over last year. Further analysis on each segment is provided in Segmented Results. CONSOLIDATED EBIT FROM CONTINUING OPERATIONS Consolidated EBIT amounted to a loss of $373.0 million, compared to earnings of $81.3 million
last year. The loss is mainly due to non-recurring items, such as impairment and restructuring
charges together with other unusual items that are further discussed in a separate section
hereunder. Excluding the impact of these non-recurring items, consolidated EBIT would have
amounted to $88.3 million, compared to $90.6 million a year ago on the same basis. On a segmented
basis, Civils EBIT would have been $41.2 million, a marginal increase of $2.2 million from the
previous year, and Militarys EBIT would have declined by 9% to $47.1 million, from $51.6 million
a year ago. Further analysis of non-recurring items is provided in Reconciliation of Non-Recurring Items.
Further analysis on each segment is provided in Segmented Results. INTEREST Interest expense amounted to $32.1 million compared to $22.4 million a year ago, an increase
of $9.7 million. The increase results mainly from one-time costs arising from repayments of
various debts with the proceeds generated from the sale of Marine. The main increase in interest
expense is due to the early settlement of a long-term debt facility with a Brazilian financial
institution, which resulted in the write-off of $4.7 million (non-cash) of financing costs that
were deferred in the balance sheet and amortized over the term of the facility (53 months were
remaining). In addition, CAE incurred a $2.5 million charge in the form of an early repayment
premium which also contributed to the non-recurring increase. Both amounts are included in the
interest expense line in the statement of earnings. In addition, there was a total of $2.0 million
of costs associated with the unwind of one interest rate swap ($0.9 million) which converted the
floating rate debt under the revolving credit facility to fixed rate debt, and the restructuring
of another interest rate swap ($1.1 million) converting a floating rate debt to fixed rate debt,
related to the non-recourse project financing for the MSH project. Excluding the impact of these
early settlements and interest rate swaps, interest expense would have been $22.9 million for the
current fiscal year, slightly above last year as a result of higher interest rates prevailing
during fiscal 2005 and a lower level of interest capitalized. (Refer to Non-recourse Project
Financing). 21 >




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 INCOME TAXES Income taxes amounted to a net recovery of $100.4 million for the year compared to $11.5
million tax expense last year. This years tax recovery results from the various elements including
non-recurring charges taken during fiscal 2005, together with the recognition of $23.5 million of
tax assets. Of the $23.5 million, $12.2 million is related to the reduction in the valuation
allowance on CAEs net operating losses in the United States. The remaining amount relates to the
materialization of the net capital losses in the United States as a result of the sale of Marine.
The later recognition of the net capital losses was not included in the gain on disposition of
Marine. Excluding the non-recurring items, the income tax expense would have been $18.5 million,
representing a tax rate of 28% for the year, which is in line with the prior year. As at March 31, 2005, the Company had approximately US$101.3 million of accumulated
non-capital tax losses carried forward that can be used to offset tax payable on future earnings
from U.S. operations. CAE also had accumulated non-capital tax losses carried forward relating to
its operations in other countries of approximately $66.8 million. RESULTS FROM DISCONTINUED OPERATIONS On February 3, 2005, CAE completed the divestiture of substantially all of its Marine business
to L-3 Communications Corporation (L-3). The results of Marine have been reported as
discontinued operations since the second quarter, in line with applicable GAAP requirements, and
previously reported statements have been reclassified accordingly. The net earnings of these
discontinued operations for the year amounted to $104.8 million and includes the recognition of a
gain of $103.9 million (net of taxes of $25.1 million) on the sale of Marine. This gain includes
$7.0 million of release of cumulative translation adjustments associated with the Companys
foreign investments in Marine. Excluding this gain, earnings from discontinued operations would
have amounted to $0.9 million compared to $16.6 million last year. In addition, a $4.4 million
charge was recorded during the current year in relation to CAEs former Cleaning Technologies. For a complete discussion on the sale of the Marine segment refer to Acquisitions, Business
Combinations and Divestitures. NET (LOSS) EARNINGS CAE reported a consolidated net loss for the year of $199.9 million compared to earnings of
$64.0 million a year ago. The loss resulted mainly from an impairment, the restructuring measures
announced in February 2005, and other non-recurring charges incurred during the third and the
fourth quarter. These elements are partially offset by the one-time investment tax credits (ITC)
recognition in the first quarter, the gain on the sale of Marine, and the various tax recoveries
in the fourth quarter previously discussed. Excluding the impact of these non-recurring items, net
earnings would have amounted to $46.9 million for the year. EPS Basic EPS amounted to a loss of $1.23, compared to earnings of $0.20 last year. Net of
non-recurring items, basic EPS would have amounted to $0.19 and $0.21, respectively. RECONCILIATION OF NON-RECURRING ITEMS The table below shows how certain non-recurring items have affected the Companys results in
the respective reporting periods. The Company believes that this supplemental information is
useful as it provides an indication of the Companys underlying performance excluding these
non-recurring items. Readers should be cautioned, however, that this information should not be
confused with or used as an alternative for net earnings (loss) determined in accordance with GAAP
as an indicator of performance. RECONCILIATION OF NON-RECURRING ITEMS 2005
    
    
    
    2004amount
    
    
    amount
    
    
    per
    
    
    
    amount
    
    
    amount
    
    
    per(amounts in millions, except per share amounts)
    
    pre-tax
    
    
    after tax
    
    
    share
    
    
    
    pre-tax
    
    
    after tax
    
    
    shareEarnings (loss) from continuing operations
    
    $
    (405.1
    )
    
    $
    (304.7
    )
    
    $
    (1.23
    )
    
    
    $
    58.9
    
    
    $
    47.4
    
    
    $
    0.20Impairment of goodwill,
intangible and tangible assets
    
    
    443.3
    
    
    
    354.2
    
    
    
    1.43
    
    
    
    
    
    
    
    
    
    
    
    
    Restructuring charges
    
    
    24.5
    
    
    
    16.7
    
    
    
    0.07
    
    
    
    
    9.3
    
    
    
    6.4
    
    
    
    0.03Additional
ITC recognition (FY00FY04)
    
    
    (14.2
    )
    
    
    (10.1
    )
    
    
    (0.04
    )
    
    
    
    
    
    
    
    
    
    
    
    Costs associated with the early settlement
of long-term debts
    
    
    9.2
    
    
    
    8.6
    
    
    
    0.03
    
    
    
    
    
    
    
    
    
    
    
    
    Tax recoveries
    
    
    
    
    
    
    (23.5
    )
    
    
    (0.09
    )
    
    
    
    
    
    
    
    (4.4
    )
    
    
    (0.02
    )Other non-recurring items
    
    
    7.7
    
    
    
    5.7
    
    
    
    0.02
    
    
    
    
    
    
    
    
    
    
    
    
    Earnings (loss) from continued operations, excluding
non-recurring items (not in accordance with GAAP)
    
    $
    65.4
    
    
    $
    46.9
    
    
    $
    0.19
    
    
    
    $
    68.2
    
    
    $
    49.4
    
    
    $
    0.21
 Each specific item highlighted in the above table is further discussed below. > 22




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 IMPAIRMENT OF GOODWILL, INTANGIBLE AND TANGIBLE ASSETS The Company performs the annual testing for impairment of its long-lived assets as at December
31 of each year using the two-step method prescribed under GAAP. Based on the test performed as at
December 31, 2004, CAE concluded that an impairment charge was required. As part of the first step, the total fair value of each reporting unit (Military and Civil)
was compared with its respective carrying amount (net book value), including goodwill, in order to
identify a potential impairment. The fair values of the reporting units were estimated using
generally accepted valuation techniques including discounted cash flow and comparable analysis. The
process of determining fair values requires Management to exercise judgment in making assumptions
about future results, including revenue and cash flow projections and discount rates. If the fair value of a reporting unit is lower than its carrying amount, the goodwill of this
reporting unit may be impaired and the reporting unit must proceed with a second step in order to
quantify the amount of impairment, if any. Under a second step, the fair value of goodwill is
determined in the same manner as the value of goodwill would be determined in a business
combination context. If, after performing the second step, it is determined that the goodwill
recorded is higher than the implied fair value of goodwill, an impairment charge is recorded in
the period. During the third quarter of fiscal 2005, CAEs Management initiated a comprehensive review of
current performance and the strategic orientation of its Civil and Military business units. This
strategic review revealed that several factors have emerged and/or worsened over the course of the
past year that severely affect the Civil business, including:  
    the enduring adverse economic and financial environment of the airline industry creating a
new market reality, including a decreased level of interest in pilot training outsourcing;
    the appreciation of the Canadian dollar;
    the erosion of the less than 50-seat regional jet market; and
    the escalating cost of acquiring data, parts and avionics for the manufacturing of full-flight simulators. Most of these elements are outside the direct control of the Company and currently show only
modest signs of abatement. These elements caused Management to recalibrate some key assumptions in
Civils strategic planning. New Market Reality The enduring adverse economic environment of the airline industry, first initiated in 2001
with the 9/11 terrorist attacks, and was further impacted by the SARS outbreak in Asia and by the
Iraq war, was, in 2004, exacerbated by soaring fuel costs and declining yields. These factors
continue to offset the extensive cost-cutting initiatives the airlines have undertaken to such a
point that U.S. airlines lost an estimated US$5 billion in 2004 when less than a year ago,
analysts were forecasting a break-even year. This fourth consecutive year of important losses for
U.S. airlines shows that there are no immediate solutions underway. In addition, the four years of
lost growth will not easily be made up as only in mid-2004 did traffic volume return to pre-9/11
levels. CAE is now in a new market reality where cost management is at the centre of all
decisions. In addition, interest in training outsourcing, which could contribute to improving
cost-effectiveness, is low on the airline industrys priority list, where the focus is mainly on
reducing labour and fleet costs. This new reality has translated into continued price pressures on
Civils equipment and training businesses. Appreciation of the Canadian Dollar The vast majority of Civil equipment revenues are based in U.S. dollars while Civils
manufacturing costs are primarily in Canadian dollars. Therefore, the appreciation of the Canadian
dollar to over US$0.83 (or C$1.20) in calendar 2004 had a material adverse impact on the
profitability of Civils business. Erosion of the Less Than 50-Seat Regional Jet Market The latter part of calendar year 2004 saw a major shift in demand for regional jets from the
sub 50-seat segment to newer, larger platforms (70-to-100+ seat range). The value proposition for
smaller regional jets has been severely impacted by the new low-yield market environment. In
addition, legacy airlines are relaxing scope clauses, which previously restricted their use of
70-seat jets. Bombardier and Embraer have both reduced their 20-year market forecast in the less
than 50-seat range and Bombardier has severely reduced its planned production for CRJ200s as
evidenced by significant workforce reductions in 2004. These factors also make it less likely that
production of the Dornier 328JET, for which CAE was the exclusive entitlement training provider,
will be restored. 23 >




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 Escalating Cost of Acquiring Data, Parts and Avionics for the Manufacturing of
Full-Flight Simulators In 2002, CAE launched its next generation FFS design, which was intended to reduce
manufacturing and life cycle costs. However, as the Company experienced reduced throughput in its
manufacturing facilities, the anticipated savings have not materialized, which has prompted
Management to make this issue a key priority to address. Furthermore, CAE has also incurred increased costs for acquiring data, parts and avionics in
the past few years, with these costs representing a major component in its manufacturing of FFS. Therefore, based on the preceding factors and the results of the strategic review previously
mentioned, CAE concluded its annual testing for impairment of its long-lived assets, including
goodwill, intangibles and property, plant and equipment as well as certain other assets and
deferred costs. The Company concluded that the carrying value of some of Civils tangible and
intangible assets (including goodwill) were impaired and, on this basis, recorded in the third
quarter of fiscal 2005 a $443.3 million impairment charge detailed as follows: DETAILED IMPAIRMENT CHARGE (amounts in millions)
    
    impairment amountGoodwill
    
    $
    205.2Customer relations
    
    
    86.7Trade names and other intangible assets
    
    
    20.4Other assets
    
    
    19.3Property, plant and equipment (simulators)
    
    
    78.4Inventories
    
    
    33.3Total before taxes
    
    $
    443.3Tax recovery
    
    
    89.1Total impairment charge, net of tax
    
    $
    354.2
 The 20% tax recovery rate associated with the impairment charge was a result of the
non-deductibility, for tax purposes, of some of the goodwill and intangibles assets impairment
charge. As indicated in the table above, the after-tax effect of this non-cash charge on CAEs
consolidated net earnings in the third quarter of 2005 was $354.2 million or $1.43 per share. RESTRUCTURING CHARGES On February 10, 2005, CAE announced a comprehensive restructuring plan (the Plan), that will
materially change the manner in which CAE conducts its business, and is aimed at restoring the
Companys profitability, cash flow and return on investment. This Plan, to be executed over the
next 18 months, results from the extensive strategic review of CAEs markets, customers and other
external stakeholders as well as its internal resources and capabilities undertaken by the
Management under the leadership of the new CEO. The Plan, geared towards the elimination of duplication and the achievement of a more competitive
cost structure, includes actions such as:  
    the rationalization of its Civil training centres footprint including the consolidation of
training centres where duplication exists and relocation of a number of FFS to maximize yield and streamlining of the management structure; and
    the consolidation, into the new Simulation Products division as of April 1, 2005, of all manufacturing activities including engineering,
program management and global procurement. These functions had previously existed in various business units and regionally, resulting
in duplication. The Company is reducing headcount; as of May 10, 2005, 400 of the 450 employees have already left
the Company since the announcement of the Plan. In addition, as part of the Plan, the Company will be implementing an enterprise resource
planning system (ERP), a business management system that integrates all aspects of the business,
including planning, manufacturing, and sales and marketing, in order to improve transparency,
accountability and information flow. Finally, CAEs compensation structure has been reoriented,
with a specific emphasis on building shareholder value through focus on delivery of free cash
flows and adequate return on capital invested. > 24




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 The Company accounts for the restructuring charges in accordance with GIGA EIC-134
Accounting for Severance and Termination Benefits and EIC-135 Accounting for Costs Associated with
Exit and Disposal Activities (Including Costs Incurred in a Restructuring)as described in Note 24
of the consolidated financial statements. These CICA abstracts provide guidance on the timing of
recognition and measurement of liabilities as well as disclosures for the various types of costs
associated with an exit or disposal activity, including restructuring. Under EIC-135, a liability
for a cost associated with a restructuring can only be recorded when that liability is incurred
and can be measured at fair value. A liability is incurred when an event obligates the Company to
transfer or use assets, or more explicitly, when an event leaves the Company little or no
discretion to avoid transferring or using the assets in the future. Under these rules, commitment
to an exit plan or a plan of disposal expresses only Managements intended future actions and,
therefore, does not meet the requirement for recognizing a liability and the related expense. The Company intends to report as restructuring costs, all costs associated with the closure
of business activities, the relocation of business activities from one location to another, the
changes in management structure, and all other costs related to the restructuring as it affects
the nature and focus of the operations. In order to comply with accounting requirements, all restructuring costs incurred by the
Company prior to establishment of its formal restructuring plan were not included in the
restructuring charge line of the financial statements and were expensed as part of the normal
operations. Please refer to Other non-recurring itemsfor further information. During fiscal 2005, the Company has recorded a $24.5 million restructuring charge for
workforce reduction and related expenses. In line with the Plan previously announced, an
additional restructuring cost in the range of $30 to $40 million should be incurred by the Company
in fiscal 2006. RECOGNITION OF
ADDITIONAL ITC FOR FY00 TO FY04 While investment tax credits (ITC) are a normal, recurring part of CAEs business, fiscal
2005 results from continuing operations were positively affected by the recognition, in the first
quarter, of additional ITC totalling $14.2 million ($10.1 million, net of tax) for continuing
operations. During the year tax authorities completed their audit of R&D expenses thereby enabling
CAE to release provisions for tax expenses. Hence CAE reviewed its methodology to provide for tax
expenses for fiscal 2004 and 2005. The additional ITC included in the fiscal 2005 EBIT of Civil and Military were, respectively,
$9.8 million and $4.4 million. EARLY SETTLEMENT OF LONG-TERM DEBT At the end of the fourth quarter, as part of the restructuring of its balance sheet and the
reduction of its debt level, CAE fully repaid the term loan related to the project financing for
its training centre in São Paulo, Brazil. The one-time cost associated with these elements is
further described in Interest.In addition the Company settled two swaps. TAX RECOVERIES Non-recurring items include the recognition of a $23.5 million tax asset from a reduction in
the valuation allowance for net operating losses and for capital losses for income tax purposes in
the United States. During fiscal 2004 the Company had recognized a $4.4 million tax benefit related
to prior years tax losses in Australia. 
     Refer to Income Taxesfor further details. OTHER NON-RECURRING ITEMS The amount includes a variety of items that were not classified under restructuring charges in
the statement of earnings or that are not part of the day-to-day operations of the Company,
including:  
    the costs related to employees and executives who were terminated prior to the adoption of a
formal restructuring plan (as defined by GAAP);
    the costs related to the closing of the Toronto head office; and
    the incremental costs associated with the recent strategic review. BALANCE SHEET The Companys shareholders equity excluding currency translation adjustment (CTA) at the end
of fiscal 2005 amounted to $717.9 million, a decrease of $213.0 million compared to $930.9 million
at the end of fiscal 2004. The decrease reflects the net loss of $304.7 million from continued
operations, distribution of $24.7 million in dividends offset by the $104.8 million contribution
from discontinued operations (including a gain of $103.9 million net of tax), a $3.3 million
adjustment resulting in the adoption of a new accounting standard and an increase of $6.3 million
and $2.0 million in capital stock and contributed surplus, respectively. The following table
describes the significant variances in the consolidated balance sheet from March 31, 2004 to March
31, 2005. 25 >




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##### 



>CAE ANNUAL REPORT 2005 MANAGEMENTS DISCUSSION AND ANALYSIS SIGNIFICANT BALANCE SHEET VARIANCES (amounts in millions, unless otherwise noted)
    
    increase /(decrease)
    
    
    explanationAccounts receivable
    
    $
    (60.8
    )
    
    
    During the course of the fiscal year the Company received funds on a number of large
outstanding Military receivables. In addition CAE entered into a program under which it sells
accounts receivable to a third party without recourse. The total amount sold as at March 31, 2005
was $16.5 million.Inventories
    
    
    (46.7
    )
    
    
    The decrease is mainly due to a write-down of $33.3 million mainly of obsolete FFS parts for
less than 50-seat aircraft.Intangible assets
    
    
    (109.0
    )
    
    
    The decrease is mainly due to an impairment charge of $107.1 million of customer
relationship and trade names-type intangible assets.Goodwill
    
    
    (208.6
    )
    
    
    The decrease is due to an impairment charge of $205.2 million for Civil. The remaining
amount of $3.4 million is due to the net effect of foreign exchange fluctuations and business
acquisitions and combinations.Assets
held for sale 
(current and long-term)
    
    
    (166.4
    )
    
    
    The decrease is as a result of the sale of Marine in the fourth quarter of the fiscal year.
The remaining assets held for sale includes mainly assets of two Marine businesses to be sold to
L-3 in fiscal 2006.Liabilities
held for sale 
(current and
long-term)
    
    
    (53.5
    )
    
    
    The decrease is as a result of the sale of Marine in the fourth quarter of the year.Long-term
debt 
(including current portion)
    
    
    (241.4
    )
    
    
    Proceeds received from the sale of Marine ($238.6 million) in the fourth quarter were used
to reduce long-term debt levels. The reduction was slightly offset by the inclusion in the
financial statements of a variable interest entity which increased long-term debt by $38.8
million.Currency translation adjustment
    
    
    (54.2
    )
    
    
    The decrease is due mainly to the
effect of changes in exchange rates during the year on net
investment in self-sustaining subsidiaries, and the release of $7.0 million as a result of the
sale of Marine.
 VARIABLE INTEREST ENTITIES On January 1, 2005, the Company adopted Accounting Guideline Consolidation of Variable
Interest Entities (AcG-15) on a retroactive basis without restatement of prior periods. AcG-15
provides a framework for identifying variable interest entities (VIEs) and determining when an
entity should include the assets, liabilities and results of operations of a VIE in its
consolidated financial statements. In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any
other legal structure used to conduct activities or hold assets that either (1) has an
insufficient amount of equity to carry out its principal activities without additional
subordinated financial support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity owners that do not have
the obligation to absorb losses or the right to receive returns generated by its operations. AcG-15 requires a VIE to be consolidated if a party with an ownership, contractual or other
financial interest in the VIE (a variable interest holder) is exposed to a majority of the risk of
loss from the VIEs activities, is entitled to receive a majority of the VIEs residual returns (if
no party is exposed to a majority of the VIEs losses), or both (the primary beneficiary). Upon
consolidation, the primary beneficiary generally must initially record all of the VIEs assets,
liabilities and non-controlling interests at fair value at the date the enterprise became the
primary beneficiary. However, for variable interest entities created prior to the initial adoption
of AcG-15, the assets, liabilities and non-controlling interest of these entities must be
initially consolidated as if the entities were always consolidated. AcG-15 also requires
disclosures about VIEs in which the variable interest holder is not required to consolidate, but it
has a significant variable interest. A key element of CAEs finance strategy to support the investment in its Civil training
business is the sale and leaseback of certain FFS installed in the Companys global network of
training centres. This provides CAE with a cost-effective long-term source of fixed-cost
financing. A sale and leaseback transaction can only be executed after the FFS has achieved
certification by regulatory authorities (i.e. the simulator is installed and is available to
customers for training). The sale and leaseback structures are typically structured as leveraged
leases with an owner participant. Typically, the Company has the option to purchase the equipment at a specific period during
the lease terms at a specific purchase price. Some leases include renewal options at the end of
the term. In some cases, the Company has provided guarantees for the residual value of the
equipment at the expiry date of the leases or at the date the Company exercises its purchase
option. These Special Purpose Entities (SPEs) are financed by secured long-term debt and
third-party equity investors who, in certain cases, benefit from tax incentives. The equipment
serves as collateral for the SPEs long-term debt. The Companys variable interests in these SPEs
are solely through residual value guarantees and fixed purchase price purchase options. These
leases expire in different periods up to 2023. > 26




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 The following table summarizes total assets and total liabilities of the SPEs that the
Company has identified as VIEs as at March 31, 2005: CIVIL SIMULATION AND TRAINING sale and leaseback structures(amounts in millions)
    
    assets
    
    
    liabilitiesAir Canada Training Centre -Fiscal 2000
    
    $
    15.4
    
    
    $
    15.4Toronto Training Centre -Fiscal 2002
    
    
    26.6
    
    
    
    26.6Denver / Dallas Training Centre -Fiscal 2003
    
    
    58.7
    
    
    
    58.7SimuFlite- Fiscal 2004
    
    
    83.1
    
    
    
    83.1Amsterdam Training Centre -Fiscal 2002
    
    
    44.1
    
    
    
    40.8227.9
    
    
    
    224.6Less assets and liabilities:Newly consolidated under AcG-15
    
    
    44.1
    
    
    
    40.8Assets and liabilities of non-consolidated VIEs subject to disclosure
    
    $
    183.8
    
    
    $
    183.8
 The Company is the primary beneficiary for only one of the above VIEs. The Companys
participation in this VIE results from the acquisition of Schreiner Aviation Training B.V. in
August 2001. As part of this acquisition, CAE assumed a sale leaseback transaction, for simulators
in the Companys Amsterdam Training Centre, arranged by Fortis Bank. The deal was structured
through a SPE with MeesPierson XXX as owner trustee and owner participant. Pursuant to the adoption of AcG-15 on January 1, 2005, the consolidation of the SPE, resulted
in an increase in total assets, total liability, and shareholders equity of $46.4 million, $43.2
million, and $3.2 million. Detailed impact by balance sheet element is as follows as of January 1, 2005: (amounts in millions)
    
    newly consolidatedAssetsPrepaid expenses
    
    $
    (0.5
    )Property, plant and equipment
    
    
    46.9$
    46.4LiabilitiesAccounts Payable and Accrued Liabilities
    
    $
    0.1Long-term debt (including portion due within one year)
    
    
    41.3Future Tax Liabilities
    
    
    1.8$
    43.2Shareholders EquityRetained Earnings
    
    $
    3.3Currency Translation Adjustment
    
    
    (0.1
    )$
    3.2$
    46.4
 The liabilities recognized as a result of consolidating this VIE do not represent additional
claims on the Companys general assets; rather, they represent claims against the specific assets
of the consolidated VIE. Conversely, assets recognized as a result of consolidating this VIE do not
represent additional assets that could be used to satisfy claims against the Companys general
assets. Additionally, the consolidation of this VIE did not result in any change in the underlying
tax, legal or credit exposure of the Company. For all of the other SPEs that are VIEs, the Company is not the primary beneficiary and
consolidation is not appropriate under AcG-15. For additional information on the Companys VIEs,
see Note 25 of the consolidated financial statements. STATEMENT OF CASH FLOW The Companys cash and cash equivalents at the end of fiscal 2005 amounted to $57.1 million,
an increase of $2.4 million compared to $54.7 million at the end of fiscal 2004. In 2005, CAE
generated $186.0 million of cash from continuing operating activities and $137.4 million of cash
from investing activities of continuing operations, while it used $340.5 million of cash for
financing activities of continuing operations. The major cash contribution during 2005 came from
the divestiture of Marine. 27 >




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##### 



> CAE ANNUAL REPORT 2005
  MANAGEMENTS DISCUSSION AND ANALYSIS
 The following table summarizes the major elements of the statements of cash flow for the
fiscal year ending March 31, 2005, with prior year comparatives: STATEMENTS OF CASH FLOW (amounts in millions unless otherwise noted)
    
    2005
    
    
    2004
    
    

explanationCash and cash equivalents, beginning of the
year
    
    $
    61.9
    
    
    
    $
    17.1Provided by (used in):Operating activities
    
    
    207.6
    
    
    
    
    5.7
    
    
    
    The majority of
cash generated from
operating activities
is from positive
non-cash working
capital and cash
generated from
operating results. The
impairment charge is
non-cash and therefore
has no impact on cash
flow from operating activities.Investing activities
    
    
    131.6
    
    
    
    
    24.5
    
    
    
    Cash generated
from investing
activities is mainly a
result of proceeds
from disposal of
discontinued
operations for $239.4
million ($238.6
million relates to the
sale of Marine) and
proceeds from sale and
leaseback of assets
for $43.8 million
offset by capital
expenditures of $
118.0 million and deferred costs.Financing activities
    
    
    (337.3
    )
    
    
    
    17.8
    
    
    
    Cash used by
repayments of
long-term debt of
$588.5 million
(financed in part by
proceeds from disposal
of discontinued
operations) and
dividends paid of
$24.0 million offset
mainly by proceeds
from long-term debt.Total cash provided in the year
    
    $
    1.9
    
    
    
    $
    48.0Effect of foreign exchange rate changes on cash
and cash equivalents
    
    
    (2.3
    )
    
    
    
    (3.2
    )Cash and cash equivalents, end of year
    
    $
    61.5
    
    
    
    $
    61.9
 CONTINUING OPERATING ACTIVITIES Cash generated from continuing operating activities totalled $186.0 million in 2005, compared
to $1.5 million in 2004. The increase in cash generated by operating activities was mainly due to
an increase in operating results from continuing activities, excluding the non-cash items,
together with cash generated of $85.6 million in non-cash operating working capital in 2005. The positive non-cash operating working capital in fiscal 2005 is mainly due to a $60.8
million decrease in accounts receivable, following large collections on several Military projects
and a receivables factoring program together with a $46.7 million reduction of inventories mainly
as a result of impairment write-off. The current level of working capital is low and some reversal
should be expected for the first quarter of fiscal 2006. Accounts receivable in the previous year were enhanced by progress towards the achievement of
milestones on two major programs: the German Night-Time Low-Level Flight (NTF) helicopter program
and the Chinook helicopter simulator program for the Government of Singapore. FINANCING ACTIVITIES OF CONTINUING OPERATIONS Cash used in financing activities of continuing operations totalled $340.5 million in fiscal
2005, compared to a cash generation of $7.4 million in 2004. The decrease of cash generated was
mainly due to lower proceeds of long-term debt in the current year and the fact that there was a
common stock issuance in the prior year for $176.4 million. Long-term debt, including the current portion, amounted to $342.9 million as at March 31,
2005 compared to $584.3 million last year. The decrease in long-term debt was mainly due to the
repayment of long-term debt with cash generated by the sale of Marine as well as the impact of the
strengthening of the Canadian dollar on U.S. dollar denominated debt. INVESTING ACTIVITIES OF CONTINUING OPERATIONS The Company generated $137.4 million of cash for investing activities of continuing operations
in fiscal 2005, compared to $36.5 million in 2004. In fiscal 2005, the Company generated $238.6
million from the sale of Marine but used $118.0 million for capital expenditures (compared to
$86.8 million in fiscal 2004). Major elements included in growth are related to the expansion of
the Civil training network, including deployment of FFS to CAEs centres in China, Chile, Middle
East and in the U.K. together with the progression of our investment in the Dassault Falcon 7X and
Airbus A380 programs. FREE CASH FLOW Free cash flow from continuing operations for the year improved by $78.0 million, to reach
$87.8 million. The improvement results from positive variances in non-cash working capital offset
marginally by an increase in capital expenditures. > 28




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##### 



> CAE ANNUAL REPORT 2005
  MANAGEMENTS DISCUSSION AND ANALYSIS
 BACKLOG CAEs consolidated continuing operations backlog as at March 31, 2005 stood at $2.5 billion,
$212.3 million higher than a year ago. These figures exclude any amounts for CAEs contract with
Dassault Aviation to provide entitlement training on its new Falcon 7X business jet. SEGMENTED RESULTS CIVIL REVIEW OF OPERATIONS Equipment Orders CAE won a total of 17 FFS orders out of a possible total of 22 competed orders, maintaining a
77% market share. For the first order of fiscal 2005, CAE and Qantas signed a contract with a value of
approximately $25 million for a suite of Airbus A380 integrated training solutions, including a
FFS and a CAE Simfinity training device. This was CAEs third A380 FFS order, further evidence of
CAEs success in developing A380 integrated training solutions. During the Farnborough air show in early July 2004, CAE secured a competed order from Dubais
Emirates airline for three FFStwo Airbus A380-800s and one Airbus
A340-600 for a value of
approximately $65 million. These were the fourth and fifth A380 FFS orders for CAE. Under the
terms of the agreement, CAE became Emirates exclusive provider of FFS for 10 years. Emirates-CAE Flight Training (ECFT) expanded its aviation training facility with the
addition of three CAE FFS. As part of this expansion, Emirates bought two new FFS from CAE: a
Boeing 777 and an Airbus A320, worth approximately $31 million. The third FFS, an Airbus
A330/A340, is an existing device to be relocated from within CAEs global network. In a number of contracts from airlines in the Asia-Pacific region with a total list-price
value of $88 million, longstanding CAE customer Japan Airlines International purchased a CAE
Boeing 777-200ER FFS; China Airlines International ordered an A330-200 FFS equipped with a
new-generation CAE Tropos visual system; and China Eastern Airlines ordered an Airbus
A330-200/A340-600 convertible FFS, also featuring the CAE Tropos visual system. As part of the
latter contract, CAE undertook to provide a range of CAE Simfinity classroom training products and
a second CAE Tropos visual system to upgrade an existing simulator owned by China Eastern. CAE
agreed to provide an Airbus A320 FFS and an A320 CAE Simfinity Integrated Procedure Trainer
(IPT) as well as a Boeing 737NG IPT to Zhuhai Flight Training Centre, a joint venture between
CAE and China Southern Airlines. CAE was selected by Singapore Flying College, a subsidiary of
Singapore Airlines, to deliver a Learjet 45 FFS and an IPT to its branch in Maroochydore,
Australia. CAE won a contract to supply two Airbus A330/A340 FFS with the CAE Tropos visual systems to
Etihad Airways, a new airline based in the United Arab Emirates, and a first-time customer to CAE.
In addition, WestJet purchased a Boeing 737-700 FFS, also equipped with CAE Tropos. These
contracts were valued at approximately $48.0 million. CAE was awarded a contract with a value of approximately $31.0 million, at list price, to
provide Airbus with two new Airbus A330/A340 FFS scheduled for installation at Airbus training
centre in Toulouse, France. As part of its last civil equipment simulator contract of fiscal 2005, CAE sold an Embraer
170 FFS featuring the CAE Tropos visual system to a third-party customer. Training Contracts CAE signed a 10-year services agreement with LAN Chile S.A. (LAN) to provide training on
Boeing 737-200 and Airbus A320 FFS beginning in 2004 and on the Boeing 767-300ER FFS commencing in
the last quarter of 2005. The total value of the contract, together with third-party revenues, is
expected to be $40 million. Training takes place in Santiago, Chile, at LANs training centre,
which CAE acquired for $0.9 million on April 22, 2004. CAE ratified a contract to train pilots of European low-fare carrier easyJet on the Airbus
A320 family of aircraft for a minimum of seven years. The value of the agreement is expected to be
in the range of $40 to $60 million. At the Farnborough air show CAE and Dassault Aviation signed a contract making CAE the
exclusive provider of entitlement trainingthe initial training provided by the aircraft
manufacturer with the purchase of an aircraftfor the all-new Falcon 7X, the first fly-by-wire
business jet. Also included in this agreement was entitlement training for pilots, maintenance
personnel and cabin crew. This was the first contract of this kind to be awarded to CAE by a
business jet manufacturer. CAE signed a number of multi-year aviation training agreements for centres in North America
and Europe. Sun Country Airlines and Skyway, a wholly owned subsidiary of Midwest Airlines, signed
agreements for training at CAEs North American centres. Baron Air, Italy First and TUI Airlines
Belgium are among 13 airlines, many of them new customers, who signed agreements to train at CAEs
European centres. These agreements are cumulatively valued at about $15 million, based on expected
training volume. ECFT is slated to become a Bell Associated Training Facility for Middle East-based operators
of the Bell 412 helicopter, with Doha-based Gulf Helicopters, who signed a five-year exclusive
agreement, as its first customer. 29 >




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 CAE Training Centres Following a number of new training contracts, CAE plans to open a civil aviation training
centre in the area of London, U.K. Intended to be operational by fall 2006, the proposed centre
will serve both airlines and business aircraft operators, beginning
with anchor customers easyJet
and Dassault. CAE is also in the process of building a new business aviation training centre in
Morris County, New Jersey. The new centre is expected to be operational by summer 2006, when
entitlement training will begin for the Falcon 7X business aircraft. Once the centre is
operational, CAEs global network will include four major business aviation training centres
strategically located around the world: Morris County and Dallas, U.S., Dubai, U.A.E., and London,
U.K. FINANCIAL RESULTS (amounts in millions, except operating margins in %)
    
    2005
    
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Revenue
    
    $
    520.2
    
    
    
    
    461.8
    
    
    
    517.2
    
    
    
    545.2
    

    
    
    481.5EBIT
    
    $
    47.6
    
    
    
    
    39.0
    
    
    
    115.6
    
    
    
    157.3
    
    
    
    114.4Operating margins
    
    
    % 9.2
    
    
    
    
    8.4
    
    
    
    22.4
    
    
    
    28.9
    
    
    
    23.8Backlog
    
    $
    1,103.1
    
    
    
    
    1,021.3
    
    
    
    877.1
    
    
    
    805.6
    
    
    
    656.9Capital expenditures
    
    $
    111.5
    
    
    
    
    81.7
    
    
    
    212.1
    
    
    
    216.7
    
    
    
    72.9
 Civils revenue amounted to $520.2 million for the year, up 13% over the prior year. Training
revenue increased as result of the addition of the new CAEIberia training centre in Madrid, Spain
(which contributed an additional 6.6% to Civils training revenue) and additional simulators in
the Dubai training facility. Equipment and services revenue benefited from the higher order intake
in the current year. Offsetting these gains is a $19.8 million negative foreign exchange impact.
Excluding foreign exchange, revenue would have amounted to $540.0 million, $78.2 million above
last year. Civil achieved EBIT growth of 22% compared to last year, to reach $47.6 million. This
includes $9.8 million from additional ITC recognized in the first quarter, related to expenditures
of prior years. Civil also absorbed approximately $3.4 million of non-recurring costs in the third
and fourth quarter of fiscal 2005. Excluding the additional ITC benefit and other non-recurring
items, Civils EBIT would have been $41.2 million, 6% higher than last year. Fiscal 2005 was
marked with continued competitive pressure in the equipment market, further compounded by the
stronger Canadian dollar which directly impacts on pricing. In training, EBIT growth significantly
outpaced revenues despite the higher operating lease expenses associated with the Companys
ongoing FFS sale and leaseback program, offset by growth in training revenue. Excluding the
impacts of foreign exchange Civils EBIT would have amounted to $55.9 million, $16.9 million above
last year. BACKLOG Backlog for Civil consists of both equipment sales and training services. The training
services portion includes revenue from customers under both long- and short-term contractual
arrangements where training revenues are guaranteed or expected based on current customer
requirements. CAEs ability to complete contracted sales included in its order backlog is
dependent in part on the long-term financial condition of the contracting customers. As at March 31, 2005, Civils backlog stood at $1.1 billion, $81.8 million higher than a year
ago. Order intake amounted to $668.0 million for the year compared to $662.8 million last year. OUTLOOK Notwithstanding the issues discussed earlier in this MD&A under Reconciliation of
non-recurring items,Management saw some signs that the civil aviation market was beginning to
recover commencing late in calendar 2004, as traffic levels surpassed pre-9/11 levels for the
first time and pilot hiring and aircraft deliveries were up over calendar 2003. However, the U.S.
airline industry still lost an estimated US$5 billion in calendar 2004 and is forecast to lose
money again in 2005. In the near term, the Asian and Middle Eastern markets are expected to drive the majority of
equipment demand as these regions continue to expand faster than the more mature North American
and European markets. Airlines in the latter markets, particularly the legacy carriers, are being
affected by high fuel costs and weakening domestic yields, which Management expects will continue
to limit their capital spending. The equipment demand in these markets will mainly be driven by
the introduction of new platform types (e.g., Airbus A380, Embraer 170/190, Boeing 787) into
airline fleets. Civils near-term priorities are to optimize returns on existing training investments while
pacing its entry into developing growth markets. CAEs immediate financial goals are to drive
positive free cash flow and improve return on invested capital. > 30




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 MILITARY REVIEW OF OPERATIONS Equipment Orders CAE was awarded a number of contracts that further solidify its presence in its various markets
around the world. In the U.S., CAE USA was awarded a contract valued at approximately US$26 million by the US
Army Program Executive OfficeSimulation, Training & Instrumentation (PEO STRI) to manufacture an
MH-60 Black Hawk Block 1 combat mission simulator (CMS) for the U.S. Armys 160th
Special Operations Aviation Regiment-(Airborne) (SOAR(A)). In addition, PEO STRI awarded CAE
contracts valued at approximately US$9.5 million to provide its
CAE MedallionS visual system for
two upgrades to combat mission simulators for the SOAR(A). When Lockheed Martin signed a contract to provide three KC-130J Weapon Systems Trainers
(WST) to the US Marine Corps, the design, manufacture, and integration of these KC-130J WSTs was
subcontracted to CAE USA in a contract valued at approximately US$34 million. The United States Navy awarded CAE USA a contract valued at US$60 million to develop three
MH-60S tactical operational flight trainers and four MH-60S weapons tactics trainers. The contract
includes options for more simulators of these types as well as support services that could bring
the total value to more than US$75 million. CAE USA also won a contract, valued at US$12.5 million, to upgrade two P-3C flight simulators
for the United States Navy. This contract includes options to upgrade four more simulators, which
are expected to be exercised in 2006 and 2007 and could bring the total contract value to
approximately US$23 million. CAE USA was also awarded contract options for the C-130J Maintenance and Aircrew Training
System program as well as the C-130 Aircrew Training System program. In Europe, the Royal Netherlands Navy selected CAE to perform a $9 million upgrade of the Lynx
helicopter full-mission flight trainer at Naval Air Station de Kooy in Den Helder, The Netherlands.
CAE will add new radar and communications systems to the simulator, as well as enhance a range of
other helicopter systems. Furthermore, the German Armed Forces awarded CAE a contract of
approximately $33 million for on-site maintenance and support services, as well as various upgrades
and modifications to flight simulation equipment. CAE also signed a subcontract with Lockheed
Martin valued at $13.4 million to perform upgrades on the U.K. Royal Navy Merlin Training System. In line with its strategy to expand its products offering, CAE introduced a suite of CAE
Simfinity integrated training solutions for the C-130 aircraft at the 2004 Airlift/Tanker
Association Convention. Designed for both aircrew and maintenance training programs, CAE Simfinity
integrated training solutions are based on the same high fidelity simulation software found on
CAEs full-mission simulators. Training & Services Eurofighter Simulation Systems GmbH awarded a contract to CAE to provide a range of engineering
and on-site support services for the visual systems on the Eurofighter Aircrew Synthetic Training Aids program. The contract is valued at
approximately $30 million over five years. CAE-led Landmark Training Ltd. was selected as the intended preferred bidder for the British
Armys Armoured Vehicles Training Services (AVTS) program. The program, valued at approximately
£1.0 billion over 30 years, is a private finance initiative (PFI) designed to provide turnkey
driver, gunnery and command information systems training to crews of armoured fighting vehicles.
Landmark Training Ltd. is owned 65% by CAE, 25% by AgustaWestland, the Anglo-Italian helicopter
company owned by Italys Finmeccanica, and 10% by Interserve Plc. In another PFI, the German government awarded a contract to Helicopter Flight Training
Services GmbH (HFTS) to provide NH90 helicopter training to the German Armed Forces. HFTS was
founded by an industrial consortium consisting of CAE, Eurocopter, Rheinmetall Defence Electronics
and Thales, each owning a 25% share. HFTS will design, build, and operate three NH90 training
centres in Germany. The total contract signed by HFTS is valued at 488.0 million, of which CAEs
share is 122.0 million. FINANCIAL RESULTS (amounts in millions, except operating margins in %)
    
    2005
    
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001Revenue
    
    $
    466.0
    
    
    
    
    476.6
    
    
    
    459.6
    
    
    
    465.5
    
    
    
    338.8EBIT
    
    $
    47.2
    
    
    
    
    51.6
    
    
    
    78.8
    
    
    
    66.6
    
    
    
    26.4Operating margins
    
    
    % 10.1
    
    
    
    
    10.8
    
    
    
    17.1
    
    
    
    14.3
    
    
    
    7.8Backlog
    
    $
    1,401.6
    
    
    
    
    1,271.1
    
    
    
    1,258.6
    
    
    
    1,393.7
    
    
    
    988.9Capital expenditures
    
    $
    6.5
    
    
    
    
    5.1
    
    
    
    12.1
    
    
    
    14.1
    
    
    
    1.8
 Militarys revenue amounted to $466.0 million, a decrease of $10.6 million from last year. The
majority of the decrease ($8.3 million) is due to a negative foreign exchange impact together with
delays in contractual awards. Excluding this impact revenue would have amounted to $474.3 million. 31 >




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 EBIT amounted to $47.2 million, a decrease of $4.4 million compared to the same period
last year. The shortfall compared to the previous year was mainly attributable to higher costs to
complete certain programs, particularly in the first quarter, together with the absorption of
approximately $4.3 million of non-recurring costs in the third and fourth quarter and the negative
foreign exchange impacts of approximately $1.2 million. This was partially offset by lower selling
and marketing expenses, as well as $4.4 million of additional ITC recognition in the first quarter
of fiscal 2005. Militarys cumulative EBIT, excluding the impact of additional ITC and other
one-time items, would have amounted to $47.1 million, $4.5 million lower than a year ago. BACKLOG As at March 31, 2005, Militarys backlog stood at $1.4 billion, $130.5 million higher than a
year ago. Militarys total order book for the year stands at a record $681.4 million compared to
$506.7 million last year, an increase of 34%. Successes in Europe with the award of the German
NH90 PFI program and in the U.S. market where Military has more than doubled its order intake over
the last two years have contributed strongly to CAEs success and underlined the criticality of
local presence. Militarys backlog is strong and contains a well-balanced mix of near-term
equipment delivery contracts and long-term training service contracts which provide predictable
and growing cash flow. OUTLOOK Military experienced solid order intake ($127 million) in the last quarter of fiscal 2005 with
more than 75% of orders coming from its CAE USA operation, including additional orders from the
U.S. Special Operations Forces. As well, CAE USA achieved significant new business in the past
year with a new customer- the U.S. Navy. CAE is well-positioned as the Navys provider of training
solutions for the MH-60S helicopter, which should also lend credibility to CAEs pursuit of future
U.S. Navy helicopter training opportunities. Looking forward to next fiscal year, Military is expecting continued solid and well-balanced
order intake. The first quarter is expected to bring training support services orders in Canada
and a range of equipment orders in the U.S. Military will also continue to strengthen its position
as a training system integrator to governments and a key lead systems integrator. In this vein,
CAE-led Landmark Training Ltd. is actively engaged in the negotiations to achieve preferred bidder
status for the British Armys AVTS program. Militarys focus is continued growth in its core market and pursuit of growth opportunities
where it can leverage its technology leadership. The recent creation of CAE Professional Services,
a line of business integrated with Military, focused on modelling and simulation and homeland
defence is a concrete example of CAEs adaptation to the changing nature of warfare. These
fast-growing domains, fuelled with new sources of funding, rely heavily on the application of the
same simulation and modelling technology which has been a hallmark for CAE. Military has
experienced successes in these areas this year, with nearly $30 million in orders and intends to
grow its Professional Services capabilities at a rapid pace and in a well-focused manner
throughout the next year. With a keen attention to customers satisfaction, CAE remains focused on program execution
and best-in-class technology which indeed have been the driving force behind Militarys growing
backlog and winning new business. Through well-targeted R&D plans, Military is committed to
technology leadership and helping CAEs customers address their security needs in dealing with
terrorism and conflict situations requiring a new breed of mission rehearsal and training
solutions. BUSINESS SEGMENTS: GOING FORWARD As described in Business Profile and Strategies,starting in fiscal 2006 CAE will provide
results on a newly segmented basis. This will enable stakeholders to properly assess the
operational performance, financial condition and prospects of each of the Companys three business
groups: Civil Training & Services, Military Simulation & Training, and Simulation Products. ACQUISITIONS, BUSINESS COMBINATIONS AND DIVESTITURES The Companys strategy with respect to acquisitions and dispositions is to re-align itself by
divesting its non-core businesses and to focus on its two key market segments: Civil and Military.
Civil training centre acquisitions enable the Company to expand its training facility network.
Military acquisitions have allowed the Company to continue to expand its product offerings in the
area of modelling and simulation. MARINE CONTROLS In the second quarter of fiscal 2005, the Board of Directors approved a plan to divest its
Marine business. The plan was consistent with the Companys strategic process of focusing on its
core competency-the development and use of simulation and modelling technology to provide training
solutions. On February 3, 2005, CAE completed with L-3 the sale of the substantial components of
its Marine Controls segment for cash consideration of $238.6 million. This amount is subject to
completion of a net working capital audit of the Marine Controls segment. CAE does not believe
this provision will result in a material adjustment to the cash consideration received. In
accordance with the purchase agreement, L-3 will also acquire two other components of the Marine
Controls segment, including the assumption of the CAEs guarantee of $53.0 million (£23.0 million)
of project finance related debt for the U.K. Astute Class submarine training program. The sale of
these components is subject to regulatory approvals and expected to be completed during fiscal
2006. The expected proceeds on the sale of these components are nominal. > 32




---



##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 The results of Marine have been reported as discontinued operations and previously
reported statements have been reclassified. Interest expense relating to debt not directly
attributable to the continuing operations and expected to be paid with the proceeds of the sale of
the Marine business has been allocated to the discontinued operations based on their share of net
assets. This transaction resulted in a gain of $103.9 million, net of taxes of $25.1 million. For the 10-month period starting on April 1, 2004 and ending at the closing of the
transaction, Marines revenues amounted to $109.6 million compared to $154.8 million for the
12-month period ended March 31, 2004. Apart from the difference in the number of days between this
year and last year the decline is primarily due to continuing customer delays, which consequently
led to delays in recognition of revenues as well as lower volume from some of Marines larger
programs. Net earnings for the divested Marine business, excluding the gain on sale, amounted to $5.5
million, $14.5 million lower than the same period last year due to the same reasons as mentioned
above. SERVICIOS DE INSTRUCTION DE VUELO, S.L. In February 2004, CAE and Iberia Lineas Aereas de Espana, SA (Iberia) agreed to combine
their aviation training operations in Spain after receiving regulatory clearance from the Spanish
authorities to commence operations, under an agreement entered in October 2003. On May 27, 2004, in connection with the financing of the combined operation, CAE Servicios
Globales de Instruccion de Vuelo (Espana), S.L. (SGIV), a wholly owned subsidiary of CAE, and
Iberia contributed the net assets of their respective training centre facilities to Servicios de
Instruccion de Vuelo, S.L. (SIV), with SGIV obtaining ownership of 80% of SIV. SIV financed the
acquisition of the assets from SGIV and Iberia through an asset-backed financing transaction
(refer to Note 11 of the consolidated financial statements). As part of this transaction, should
the October 2003 agreement be terminated, SGIV and Iberia will be obliged to repurchase the assets
they contributed, in proportion to the fair market value of the assets, for a total amount equal
to the outstanding balance under the financing transaction. GREENLEY & ASSOCIATES INC. On November 30, 2004, the Company acquired all the issued and outstanding shares of Greenley &
Associates Inc. (G&A), now known as CAE Professional Services, which provides services in the
areas of project management, human factors, modelling and simulation. Total consideration for this
acquisition was $4.4 million payable in equivalent common shares issued by CAE in four instalments
as follows: 424,628 shares (representing $2.0 million) at the closing date, $0.8 million on
November 30, 2005, $0.8 million on November 30, 2006 and 169,851 shares (representing $0.8 million)
to be issued on November 30, 2007. The number of shares issued (to be issued) to satisfy the first
and the fourth payments was calculated based on the average closing share price of CAE common
shares on the Toronto Stock Exchange (TSX) for the 20-day period ending two days prior to
November 30, 2004. The number of shares to be issued to satisfy the second and third payments will
be based on the average closing share price of CAE common shares on the TSX for the 20-day period
ending two days before their respective date of issuance. The purchase price is subject to an
adjustment based on performance of the business for the 12-month period following the acquisition.
Any changes in the total consideration will be accounted for as a change in goodwill. FLIGHT TRAINING CENTRE CHILE S.A. On April 22, 2004, the Company acquired from LAN Chile S.A. all the issued and outstanding
shares of Flight Training Centre Chile S.A. (FTC Chile) located in Santiago, Chile, for a total
cash consideration of $0.9 million (US$0.7 million). This acquisition expands the Companys
pilot-training operations into the growing South American market. These acquisitions and business combinations were accounted for using the purchase method and
operating results have been included from their respective acquisition date (Refer to Note 2 of
the consolidated financial statements). LIQUIDITY The Companys financing needs are met through internally generated cash flow, available funds
under credit facilities, and direct access to capital markets for additional long-term capital
resources. CAE considers that its present and expected capital resources and current credit
facilities will enable it to meet all its current and expected financial requirements for the
foreseeable future. The Company plans to generate sufficient cash from operating activities in fiscal 2006 to pay
for capital expenditures and dividends. CAE also expects to be able to repay contractual
obligations maturing in 2006 and future years through cash on hand, cash generated from operations
or by issuing new debt. During the final quarter of fiscal 2005, the Company disposed of its Marine segment for
US$196.8 million. The proceeds of disposal were used to substantially reduce the borrowings under
the revolving credit facilities as well as project financing related to its Brazil Training
Centre. 33 >




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 SOURCES OF LIQUIDITY CAE maintains committed bank lines at floating rates, each provided by a syndicate of lenders.
These credit facilities permit the Company and certain designated subsidiaries to borrow funds
directly for operating and general corporate purposes. The total available amount of committed
bank lines at March 31, 2005, was $580.3 million, of which 5% ($30.4 million) was utilized. As at
March 31, 2004, the total available was $619.8 million, of which 49% ($305.3 million) was
utilized. The decrease of total availability results from the fact
that the committed lines are
denominated in U.S. dollars and Euros and thus the appreciation of the Canadian dollar against
these currencies has created a reduction in availability in Canadian dollar equivalent. The
decrease in total utilization was mainly due to the repayment of debt subsequent to the disposal
of the Marine business. In connection with the impairment charge taken during the third quarter of fiscal 2005, CAE
obtained amendments to certain definitions related to financial covenants from both its banking
syndicate, with respect to the unsecured revolving credit facilities, and its senior note holders.
These amendments resulted in the Company being compliant with the financial covenants associated
with each agreement. As at March 31, 2005 CAE is in full compliance with its financial covenants. CAE also has the ability to borrow under non-committed operating lines in various currencies
for up to $31.0 million, of which $11.2 million was drawn as at March 31, 2005. As at March 31, 2005, CAE had long-term debt totalling $342.9 million. This compared to
long-term debt of $584.3 million as at March 31, 2004. As at March 31, 2005, the short-term portion
of the long-term debt was $35.3 million compared to $8.8 million as at March 31, 2004. The
increase in the short-term portion results mainly from the classification of a June 2005 maturity
of a $20 million senior notes. The decrease of total debt results from repayments of borrowings
under the revolving credit facilities and the Brazil Training Centre debt offset by an increase in
debt assumed for the CAE-Iberia training centre and additional debt due to the consolidation of
previously treated off-balance sheet debt, subsequent to the implementation of AcG-15. Refer to
Variable Interest Entities for further information. Under an agreement dated March 24, 2005, the Company has the possibility to sell third party
receivables on a non-recourse basis to a financial institution for an amount of up to $25.0
million. Under the terms of the agreement, the Company will continue to act as collection agent.
A: at March 31, 2005, $16.5 million of specific accounts receivable were sold to the financial
institution pursuant to this agreement. Net proceeds of the sale were used to repay borrowings
under the Companys committed credit facilities. DIVIDENDS During fiscal 2005, the Board of Directors took the decision to reduce the quarterly dividend
to $0.01, conserving $20 million of cash annually. With the current dividend policy and with the
248.1 million common shares outstanding as at March 31,
2005, CAE expects to pay annual dividends
of approximately $10 million. CONTRACTUAL OBLIGATIONS In the normal course of business, CAE enters into certain contractual obligations and
commercial commitments, such as debentures and notes, letters of credit and others. The table below
provides a summary of the Companys contractual obligations of the various components and
maturities of the Companys long-term debt for the year ended March 31, 2005. CONTRACTUAL OBLIGATIONS (amounts in millions)
    
    2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    

thereafter
    
    

totalLong-term debt
    
    
    32.8
    
    
    
    43.8
    
    
    
    46.5
    
    
    
    21.7
    
    
    
    84.2
    
    
    
    94.6
    
    
    
    323.6Capital lease
    
    
    2.5
    
    
    
    1.9
    
    
    
    1.3
    
    
    
    0.2
    
    
    
    0.1
    
    
    
    13.3
    
    
    
    19.3Operating leases
    
    
    80.8
    
    
    
    84.8
    
    
    
    72.7
    
    
    
    59.4
    
    
    
    55.4
    
    
    
    361.5
    
    
    
    714.6Purchase obligations
    
    
    12.8
    
    
    
    10.0
    
    
    
    11.4
    
    
    
    11.9
    
    
    
    11.3
    
    
    
    67.0
    
    
    
    124.4Other long-term obligations
    
    
    4.3
    
    
    
    3.4
    
    
    
    2.2
    
    
    
    2.2
    
    
    
    2.1
    
    
    
    2.5
    
    
    
    16.7Total
    
    
    133.2
    
    
    
    143.9
    
    
    
    134.1
    
    
    
    95.4
    
    
    
    153.1
    
    
    
    538.9
    
    
    
    1,198.6
 The long-term debt includes $30.4 million drawn under CAEs committed credit facilities
maturing in fiscal 2007. The Company has begun work on the renegotiations of the facilities on a
similar basis, and intends to complete this in the course of fiscal 2006. The total availability of
the committed credit facilities is equal to $580.3 million. Rental expense related to operating leases was $94.0 million in fiscal 2005 compared to $92.5
million in fiscal 2004. The sale and leaseback of certain FFS installed in the Companys global
network of training centres accounted for $42.7 million of the total rental expense. Other purchase obligations are related to agreements to purchase goods or services that are
enforceable and legally binding on CAE and that specify all significant terms, including: fixed or
minimum quantities to be purchased; fixed, minimum or variable price provisions; and the
approximate timing of the transaction. Principally, the purchase obligations are related to
agreements with subcontractors to provide services in the context of long-term contracts with the
Companys clients. > 34




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 Other long-term obligations include a total of $10.3 million of repayments under various
government assistance programs. As at March 31, 2005 CAE had other long-term liabilities that were not included in the table
above. They consisted of some accrued pension liabilities, deferred revenue and gains on assets
and various other long-term liabilities. Cash obligations of accrued employee pension liability
depend on various elements such as market returns, actuarial losses and gains and interest rate. CAE did not include future income tax liabilities since future payments of income taxes
depend on the amount of taxable earnings and on whether there are tax loss carry-forwards
available to reduce income tax liabilities. COMMITMENTS CAEs commitments for capital expenditures include investments to add new facilities to its
training centre network in order to meet customer demand. R&D expenditures are incurred to provide
new products to the marketplace, as alternative ways of training are developed and different types
of training equipment are needed for our clients training needs. OFF-BALANCE SHEET ARRANGEMENTS GUARANTEES In the normal course of business, CAE issued letters of credit and performance guarantees for
a total amount of $73.3 million at March 31, 2005, compared to $168.6 million at March 31, 2004.
The reduction results mainly from the expiry of advance payment guarantees related to the
completion of one major project ($36.9 million) and many smaller projects, as well as the
reduction of guarantees issued in support of the project financing for the Brazil training centre
($37.0 million). SALE AND LEASEBACK TRANSACTIONS A key element of CAEs finance strategy to support the investment in its Civil training
business is the sale and leaseback of certain FFS installed in the Companys global network of
training centres. This provides CAE with a cost-effective long-term source of fixed-cost financing.
A sale and leaseback transaction can only be executed after the FFS has achieved certification by
regulatory authorities (i.e., the FFS is installed and is available to customers for training).
Prior to completing a sale and leaseback transaction, CAE records the cost to manufacture the
simulator as a capital expenditure, which is included as a fixed asset on the Companys balance
sheet. On the execution of a sale and leaseback transaction, CAE records the transaction as a
disposal of a fixed asset. The cash proceeds received on the disposal approximate the fair market
value of the FFS. The difference between the proceeds received and CAEs cost to manufacture
(approximately the margin that CAE would record if it had a completed FFS sale to a third party) is
recorded under deferred gains and other long-term liabilities and is then amortized over the term
of the sale and leaseback transaction as a reduction of rental expense, net of the guaranteed
residual value where appropriate. At the end of the term of the sale and leaseback transaction, the
guaranteed residual value is taken into income should no reduction occur in the value of the
underlying FFS. During fiscal 2005 CAE sold and leased back three FFS for net proceeds of $43.8 million. The
following is a summary as at March 31, 2005 of the existing sale and leaseback transactions for
FFS currently in service in Civils training locations, accounted for as operating leases on
CAEs financial statements. EXISTING FULL-FLIGHT SIMULATORS UNDER SALE AND LEASEBACK number
of
    
    
    
    
    
    
    initial
    
    
    imputed
    
    
    unamortized
    
    
    residualfiscal
    
    
    simulators
    
    
    lease
    
    
    term
    
    
    interest
    
    
    deferred
    
    
    value(amounts in millions, unless otherwise noted)
    
    year
    
    
    (units)
    
    
    obligation
    
    
    (years)
    
    
    rate
    
    
    gain
    
    
    guaranteeSimuFlite
    
    
    2002 to 2005
    
    
    
    14
    
    
    $
    211.4
    
    
    
    10 to 20
    
    
    5.5% to 6.7%
    
    $
    13.1
    
    
    $
    Toronto training centre
    
    
    2002
    
    
    
    2
    
    
    
    42.7
    
    
    
    21
    
    
    
    6.4
    %
    
    
    16.2
    
    
    
    9.2Air Canada training centre
    
    
    2000
    
    
    
    2
    
    
    
    33.1
    
    
    
    20
    
    
    
    7.6
    %
    
    
    14.9
    
    
    
    8.3Denver/Dallas training centres
    
    
    2003
    
    
    
    5
    
    
    
    86.9
    
    
    
    20
    
    
    
    5.0
    %
    
    
    30.9
    
    
    
    China Southern joint venture1
    
    
    2003
    
    
    
    5
    
    
    
    22.7
    
    
    
    15
    
    
    
    3.0
    %
    
    
    
    
    
    
    Others
    
    
    
    
    
    
    7
    
    
    
    26.3
    
    
    
    3 to 10
    
    
    2.9% to 10.1%
    
    
    15.6
    
    
    
    15.635
    
    
    $
    423.1
    
    
    
    
    
    
    
    
    
    
    $
    90.7
    
    
    $
    33.1Annual Lease Payments (upcoming 12 months)
    
    
    
    
    
    
    
    
    
    $
    38.7
   1
    
    Joint venture in which CAE has a 49% interest. Future minimum lease payments for such arrangements, amounting to $423.1 million as at March
31, 2005, are included in Note 20 Operating Lease Commitments to the consolidated financial
statements. 35 >




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##### 



> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 NON-RECOURSE PROJECT FINANCING During 1997, the Company arranged project financing for the Medium Support Helicopter (MSH)
program it entered into with to the U.K. Ministry of Defence. The contract was awarded to a
consortium, CAE Aircrew Training Services Plc (Aircrew). The capital value of the assets supplied
by Aircrew, is in excess of $200 million. The entity that owns the assets operated by the training
centre is CVS Leasing Ltd. (in which CAE has a 14% interest). CAE manufactured and sold the
simulators to CVS Leasing Ltd., and CVS Leasing Ltd. then leased this equipment to Aircrew for the
full term of the MSH contract. As Aircrew is majority-controlled by CAE, its financial statements
are consolidated in the Companys results. Future minimum lease payments associated with the
simulators leased to Aircrew amount to approximately $187 million as at March 31, 2005, and are
included in the amount disclosed in Note 20 Operating Lease Commitments of the consolidated
financial statements as well as in the operating leases presented as contractual obligations in the
liquidity section herein. FINANCIAL INSTRUMENTS The Company enters into forward, swap and option contracts to manage its exposures to
fluctuations in foreign exchange rates, interest rates, and changes in share price. CAE assesses
on an ongoing basis whether the derivatives that are used in hedging transactions are effective in
offsetting changes in fair values or cash flows of hedged items. CAE deals only with sound counter
parties in executing any of its derivative financial instruments. CAE employs foreign exchange forward contracts to manage exposures created when sales are made
in foreign currencies. The amount and timing of the maturity of these forward contracts varies
according to a number of project-related factors, including milestone billings and the use of
foreign materials and/or subcontractors. As at March 31, 2005, CAE had $305.0 million Canadian
equivalent in forward contracts compared to $181.4 million Canadian dollar equivalent in forward
contracts as at March 31, 2004. The increase is mainly due to additional hedging due to hedging of
most of the new contracts signed during the last fiscal year. CAE also uses financial instruments to manage its exposure to changing interest rates and to
adjust its mix of fixed and floating interest rate debt at a desirable level. The mix of fixed rate
versus floating rate debt on its long-term debt was 70% versus 30%, respectively, as at March 31,
2005. The variation in the mix since March 31, 2004, when it stood at 40% versus 60%, respectively,
is due mainly to the decrease in borrowing under the revolving credit facility, which was mostly
all, except for $35.0 million, on a floating rate basis. CAE had interest rate swaps converting
mostly floating rate long-term debt into fixed rate long-term debt totalling $65.8 million, as at
March 31, 2005, compared to $114.6 million as at March 31, 2004. The difference resulted from the
termination of a floating to fixed swap as a result of the reduction in floating rate borrowings
and partly from the lower amount of Canadian equivalent of the foreign denominated swaps due to the
appreciation of the Canadian dollar. As well, CAE reduced its exposure to the fluctuation in its share price, which impacts the
cost of the management compensation deferred share unit
(DSU) programs. As at March 31, 2005, the
hedging contract covered 600,000 shares of the Company, compared to 700,000 shares as at March 31,
2004. During fiscal 2005, the amount had been increased to 800,000 and subsequently reduced to the
year-end position of 600,000 in order to reflect the variation in the amount of DSUs outstanding. BUSINESS RISKS AND UNCERTAINTIES CAE operates in different industry segments that involve various risk factors and
uncertainties, which are carefully considered in the Companys Management policies. The risk
factors and uncertainties stated below may impact the implementation of CAEs strategy. EXECUTION OF THE RESTRUCTURING CAEs future success depends in part on the ability of its current management team to timely
deploy the restructuring plan described in Restructuring Charges. PRODUCT RELIABILITY CAEs success in civil aviation and military markets depends fundamentally on the reliability
of its products, the quality of its services and its ability to adapt, in a timely manner, to
changing customer needs and industry standards. The Company operates in different industry
segments and global markets that involve various risk factors and uncertainties, including
worldwide economic and political trends and developments. CIVIL AVIATION INDUSTRY CAE operates in the civil simulation equipment and training services markets, both of which
are heavily dependent on demand for air transportation and the financial condition of commercial
airlines. The major airline bankruptcies in Europe, the U.S., Canada and other CAE markets pose
risks to CAE as an unsecured vendor and/or service provider to these and other potentially
insolvent customers. Demand for simulation equipment tends to follow the trend established in the
commercial airline industry, particularly the delivery of new aircraft. Any reduced demand may in
turn lead to reduced production levels, which impacts margins negatively. The utilization of CAEs
installed base of simulators in its training network depends on the extent to which simulated
aircraft types match the configuration of in-use aircraft, as well as on the overall level of
commercial air traffic. CAE must comply with rules imposed by regulatory authorities that may change without notice,
resulting in potential disruptions to sales and operations. The sale or licensing of virtually all
of CAEs products is subject to various regulatory controls that change with some frequency. > 36




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 LEVEL OF GOVERNMENT EXPENDITURES CAEs Military business depends heavily on government programs and contracts that ultimately
reflect the level of government expenditures directed towards national defence budgets
(particularly capital equipment programs), the priority of various programs within defence budgets
and in certain instances, the maintenance of government programs supporting R&D. Programs may be
only partially funded pending future appropriations and may contain provisions permitting
termination at the governments convenience, in whole or in part, without prior notice, upon
payment of limited compensation. Government-funded military programs are also heavily regulated,
and the regulation of certain government purchasing agencies limit the range of reimbursable costs
in fixed-price contracts, including most financing costs and the amortization of various
intangible assets. CANADIAN DOLLAR Fluctuations in the value of the Canadian dollar relative to foreign currencies could result
in currency exchange gains and losses. Current hedging activities may not be successful. COMPETITION CAE operates in intensely competitive markets. Some of its competitors, particularly in
military markets, possess substantially greater resources, well-established relationships with
various procuring organizations and a greater in-country presence that may give them an advantage
in winning contracts. Some competitors may benefit more, or suffer less, than CAE from currency
fluctuations. LENGTH OF SALES CYCLE CAEs often lengthy and unpredictable sales cycle could result in volatility in its operating
results. The Company must invest significant amounts of time and resources educating and informing
potential customers about the benefits of products and services (particularly government agencies
with lengthy internal budgeting approval and competitive evaluation processes), with no guarantee
of compensatory revenue. TECHNOLOGY CAEs business could be harmed if its products do not successfully integrate or operate with
other sophisticated and continually evolving software, computing and communications systems. If
CAE experiences difficulties or does not meet project milestones in a timely manner, the Company
could be obligated to devote more engineering and other resources to a particular project than
originally anticipated. While CAE believes it has recorded adequate provisions for losses on
fixed-price contracts, obligations under fixed-price and long-term supply contracts could subject
the Company to contract losses in excess of provisions. FINANCIAL CONDITION OF CUSTOMERS CAEs ability to complete contracted sales included in its order backlog is dependent on the
long-term financial condition of the contracting customers. In addition, approximately 60% of the
backlog is comprised of long-term contracts where revenues are guaranteed or expected, based on
current customer requirements. The contracting customer may terminate these contracts,
unilaterally, if it desires. PROTECTION OF INTELLECTUAL PROPERTY CAEs ability to protect its intellectual property is limited and unauthorized parties may be
able to use CAEs technology or products in ways that weaken CAEs competitive position. Reliance
on the intellectual property of others, including data concerning the functions, design and
performance characteristics of a product or system in the process of being simulated, could prevent
or delay performance. Future litigation related to the defence of CAEs intellectual property
rights or involving infringement claims brought against CAE or a customer could be lengthy and
costly, with no assurance of success. DOING BUSINESS IN FOREIGN COUNTRIES CAE is subject to the risks of doing business in foreign countries, including: changes to laws
and regulations in host countries; the cost and complexity of using foreign representatives and
consultants; the imposition of tariffs, embargoes, controls and other restrictions impeding the
free flow of goods, information and capital; the difficulties of managing and operating an
enterprise and complying with laws in multiple jurisdictions; and general changes in economic and
geopolitical conditions. ENVIRONMENTAL LAWS AND REGULATIONS CAE may be subject to liabilities imposed by new environmental laws and regulations or
contractual indemnities; product liability and warranty claims or liabilities arising out of
accidents or disasters involving aircraft or power plants for which CAE has provided training
products or services. CAE cannot be certain that existing insurance coverage, if applicable to any
such claims, will be sufficient to cover one or more substantial claims. KEY PERSONNEL CAEs continued success will depend in part on the ability to retain and attract key personnel
with the relevant skills, expertise and experience. The Company applies a compensation policy
designed to mitigate this risk. 37 >




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> CAE ANNUAL REPORT 2005MANAGEMENTS DISCUSSION AND ANALYSIS
 FINANCIAL STATEMENTS DISCLOSURE SIGNIFICANT CHANGES IN
ACCOUNTING STANDARDS-FISCAL 2003 TO FISCAL 2005 Canadian Institute of Chartered Accountants (CICA) Handbook Sections, Accounting Guidelines
(AcG) and Emerging Issues Committee Abstracts (EIC) CONSOLIDATION OF
VARIABLE INTEREST ENTITIES On January 1, 2005, the
Company adopted AcG-15 Consolidation of Variable Interest Entitieson
a retroactive basis without restatement of prior periods. AcG-15 provides a framework for
identifying variable interest entities (VIEs) and determining when an entity should include the
assets, liabilities and results of operations of a VIE in its consolidated financial statements. In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any
other legal structure used to conduct activities or hold assets that either (1) has an
insufficient amount of equity to carry out its principal activities without additional
subordinated financial support, (2) has a group of equity owners that are unable to make
significant decisions about its activities, or (3) has a group of equity owners that do not have
the obligation to absorb losses or the right to receive returns generated by its operations. AcG-15 requires a VIE to be consolidated if a party with an ownership, contractual or other
financial interest in the VIE (a variable interest holder) is exposed to a majority of the risk of
loss from the VIEs activities, is entitled to receive a majority of the VIEs residual returns (if
no party is exposed to a majority of the VIEs losses), or both (the primary beneficiary). Upon
consolidation, the primary beneficiary generally must initially record all of the VIEs assets,
liabilities and non-controlling interests at fair value at the date the enterprise became the
primary beneficiary. However, for variable interest entities created prior to the initial adoption
of AcG-15, the assets, liabilities and non-controlling interest of these entities must be initially
consolidated as if the entities were always consolidated based on majority voting interest. AcG-15
also requires disclosures about VIEs that the variable interest holder is not required to
consolidate, but in which it has a significant variable interest. The adoption of AcG-15 on January 1, 2005 resulted in an increase in total assets, total
liability, and retained earnings of $46.4 million, $43.2 million, and $3.3 million, respectively
and a decrease in the currency translation adjustment of $0.1 million. GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES AND FINANCIAL STATEMENT PRESENTATION On April 1, 2004, the Company adopted CICA Handbook Section 1100 Generally Accepted Accounting
Principlesand Section 1400 General Standards of Financial Statement Presentation.Section 1100
describes what constitutes Canadian GAAP and its sources, and provides guidance on sources to
consult when selecting accounting policies and appropriate disclosure when a matter is not dealt
with explicitly in the primary sources of GAAP, thereby recodifying GAAP hierarchy. Section 1400
clarifies what is fair presentation in accordance with GAAP and provides general guidance on
financial presentation. The adoption of these standards did not have any material effect on the
Companys consolidated financial statements. HEDGING
RELATIONSHIPS Effective April 1, 2004, the Company adopted prospectively AcG-13 Hedging Relationshipsand
EIC-128 Accounting for Trading, Speculative or Non-Hedging Derivative Financial Instruments.This
guideline addresses identification, designation, documentation and effectiveness of hedging
relationship for the purpose of applying hedge accounting, and the discontinuance of hedge
accounting. Under this guideline, complete documentation of the information related to hedging
relationships is required and the effectiveness of the hedges must be demonstrated and documented.
The adoption of this guideline did not have a material impact on the Companys financial
statements. EMPLOYEE FUTURE
BENEFITS Effective April 1, 2004, CAE adopted the CICA Handbook Section 3461 Disclosure Requirements
Employee-Future Benefits.The new required disclosures include items such as a narrative
description of each type of plan, the measurement date of the plan asset and liability, the
effective date of the last actuarial evaluation and the detail of the plan asset by major
category. STOCK-BASED
COMPENSATION Effective April 1, 2003, CAE commenced prospectively expensing its stock-based compensation
using the fair value method, as prescribed by CICA Handbook Section 3870 Stock-based Compensation
and Other Stock-based Payments.Since that date, the compensation cost for the Companys stock
options has been recognized in net earnings, with a corresponding credit to contributed surplus
(refer to Note 13 of the consolidated financial statements). IMPAIRMENT OF
LONG-LIVED ASSETS Effective April 1, 2003, the Company adopted CICA Handbook Section 3063 Impairment of
Long-Lived Assetswhich requires the recognition of an impairment loss for a long-lived asset to be
held and used when events or changes in circumstances cause its carrying value to exceed the total
undiscounted cash flows expected from its use and eventual disposition. An impairment loss, if any,
is determined as the excess of the carrying value of the asset over its fair value. It replaces the
impairment provision in Section 3061 Property, Plant and Equipment.In the third quarter of 2005,
the Company proceeded with a write-down of $78.4 million on its Long-Lived Assets (refer to
Impairment of goodwill, intangible and tangible assetsand to Note 4 of the consolidated financial
statements). > 38




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> CAE ANNUAL REPORT
2005  MANAGEMENTS DISCUSSION AND
ANALYSIS
 DISPOSAL OF LONG-LIVED ASSETS AND DISCONTINUED OPERATIONS Effective April 1, 2003, the Company adopted CICA Handbook Section 3475 Disposal of Long-Lived
Assets and Discontinued Operations,which provides guidance on recognizing, measuring, presenting
and disclosing long-lived assets to be disposed of. It replaces the disposal provisions in Section
3061 Property, Plant and Equipment,and supersedes the former Section 3475 Discontinued
operations.Under this section, an asset classified as held for sale is measured at the lower of
its carrying amount or fair value less disposal costs, and is not depreciated while classified as
held for sale. DISCLOSURE OF GUARANTEES Effective March 31, 2003, the Company adopted AcG-14 Disclosure of Guarantees,which requires
disclosure of information concerning certain types of guarantees that may require payments,
contingent on specified types of future events (refer to Note 14 of the consolidated financial
statements). SEVERANCE, TERMINATION BENEFITS AND COSTS ASSOCIATED WITH EXIT AND DISPOSAL ACTIVITIES Effective April 1, 2003, the Company prospectively adopted the new EIC-134 Accounting for
Severance and Termination Benefitsand EIC-135 Accounting for Costs Associated with Exit and
Disposal Activities (Including Costs Incurred in a Restructuring)relating to exit or disposal
activities after March 31, 2003. These abstracts provide guidance on the timing of recognition and
measurement of liabilities as well as disclosures for the various types of severance and
termination benefits related to the termination of employees services prior to normal retirement
and costs associated with an exit or disposal activity. Under this new guidance, liabilities for
these costs are to be recognized in the period when they are incurred and measured at their fair
value. CAE applied these guidelines in EIC-134 for severance and other costs (as described in Note
24 of the consolidated financial statements). REVENUE RECOGNITION In December 2003, the Emerging Issues Committee issued EIC-141 Revenue Recognition,
summarizing the principles set forth in Staff Accounting Bulletin 101 (SAB 101) of the United
States Securities and Exchange Commission and providing general interpretive guidance on the
application of revenue recognition accounting principles. These recommendations were effective for
CAEs fiscal year beginning April 1, 2004. The adoption of this abstract did not have any material
effect on CAEs consolidated financial statements. REVENUE ARRANGEMENTS WITH MULTIPLE DELIVERABLES Also in December 2003, EIC-142 Revenue Arrangements with Multiple Deliverableswas issued.
EIC-142 addresses certain aspects of the accounting by a vendor for arrangements under which
multiple revenue-generating activities will be performed. These recommendations were effective for
CAEs fiscal year beginning April 1,2004. The adoption of this abstract did not have any material
effect on CAEs consolidated financial statements. FUTURE CHANGES IN ACCOUNTING STANDARDS FINANCIAL INSTRUMENTS-RECOGNITION AND MEASUREMENT, HEDGES AND COMPREHENSIVE INCOME In January 2005 the ASB issued three new standards dealing with financial instruments; (i)
Financial Instruments-Recognition and Measurement; (ii) Hedges; and (iii) Comprehensive Income.
The new standards are based on the US FASB Statement 133, Accounting for Derivative Instruments
and Hedging Activities, and on the International Accounting Standards (IAS) Boards new
standard, IAS 39, Financial Instruments-Recognition and Measurement. These requirements will be
applicable for CAE in the first quarter of fiscal 2007. The Company is currently evaluating the
impact of these new Handbook Sections on its financial statements. The Handbook Section 3855 Financial Instruments, Recognition and Measurement prescribeswhen
a financial instrument is to be recognized on the balance sheet and the measurement method used,
fair value or cost-based. It also specifies how financial instrument gains and losses are to be
presented. The new Handbook Section 3865 Hedgesallows optional treatment providing that hedges be
designated as either fair value hedges, cash flow hedges or hedges of a net investment in a
self-sustaining foreign operation. For a fair value hedge, the gain or loss attributable to the
hedged risk is recognized in net income in the period of change together with the offsetting loss
or gain on the hedged item attributable to the hedged risk. The carrying amount of the hedged item
is adjusted for the hedged risk. For a cash flow hedge or for a hedge of a net investment in a
self-sustaining foreign operation, the effective portion of the hedging items gain or loss is
initially reported in other comprehensive income and subsequently reclassified to net income when
the hedged item affects net income. The ASB has issued new Handbook Section 1530 Comprehensive Income,and amended, Section 3250
Surplusto be renamed Section 3251 Equity.These standards require that an enterprise present
comprehensive income and its components, as well as net income in its financial statements; and
that an enterprise present separately changes in equity during the period, as well as components
of equity at the end of the period, including comprehensive income. 39 >




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> CAE ANNUAL REPORT
2005  MANAGEMENTS DISCUSSION AND
ANALYSIS
 CRITICAL ACCOUNTING ESTIMATES The preparation of financial statements in conformity with GAAP requires CAEs Management to
make estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses for the period reported. On an ongoing basis, Management
reviews its estimates, particularly as they relate to accounting for long-term contracts, useful
lives, employee future benefits, income taxes, impairment of long-lived assets and goodwill, based
on Managements best knowledge of current events and actions that the Company may undertake in the
future. Significant changes in estimates and/or assumptions could result in impairment of certain
assets. Actual results could differ from those estimates. CAEs critical accounting policies are those that it believes are the most important in
determining its financial condition and results, and require significant subjective judgment by
Management. See Note 1 of the consolidated financial statements for a description of the Companys
accounting policies. The Company considers an accounting estimate to be critical if the estimate
requires Management to make assumptions about matters that were highly uncertain at the time the
estimate was made, if different estimates could have been reasonably used or if changes in the
estimate that would have a material impact on CAEs financial condition or results of operations
are likely to occur from period to period. A summary of the Companys significant accounting policies, including the critical accounting
policies discussed below, is set out in the notes to the consolidated financial statements. REVENUE RECOGNITION Revenue from long-term contracts for the design, engineering and manufacturing of FFS is
recognized, when recovery is reasonably certain, using the percentage-of-completion method.
Revenue and earnings are recorded as related costs are incurred, on the basis of the percentage of
actual costs incurred to date, relative to the estimated total costs to complete the contract.
Accounts receivable, unbilled receivables and deposit on contract are recorded based on the
payment schedule for such contracts, the terms of long-term contracts provide for progress
billings based on completion of certain phases of work. Warranty provisions are recorded at the
time revenue is recognized, based on past experience. Post-delivery customer support is billed
separately and revenue is generally recognized over the support period. The Company conducts quarterly reviews of its total estimated costs on long-term contracts.
The effect of any revision is accounted for by way of a cumulative catch-up in the period in which
the revision takes place. Losses on contracts, if any, are recognized fully when first
anticipated. For Military, full-flight mission simulators are more complex and the time to design and
manufacture is at least two years. There are fewer repeat orders and the level of non-recurring
cost in each simulator could be significant, making the predictability of total costs more
difficult when compared to a Civil FFS. With the focus of the Civil business on training, the number and amount of long-term
contracts is down considerably from prior years. The cost of a FFS is very predictable
particularly for repeat or common simulator types such as an A320 or B737. No revenue is recorded
for FFS built for CAEs own training centres. The cost is reflected as a capital expenditure.
Revenue derived from training is recorded when the training event occurs. INCOME TAXES The Company uses the tax liability method to account for income taxes. Under this method,
future income tax assets and liabilities are determined according to differences between the
carrying value and the tax bases of assets and liabilities. This method also requires the
recognition of future tax benefits such as net operating loss carry-forwards to the extent that
realization of such benefits is more likely than not. Future tax assets and liabilities are
measured by applying enacted or substantively enacted rates and laws at the date of the financial
statements for the year for which the temporary differences are expected to reverse. CAE does not
provide for income taxes on undistributed earnings of foreign subsidiaries that are not expected
to be repatriated in the foreseeable future. A valuation allowance is recognized to the extent that, in the opinion of Management, it is
more likely than not that the future income tax assets will not be realized (Refer to Note 15 of
the consolidated financial statements). CAE is subject to examination by the taxation authorities in various jurisdictions. The
Company provides for potential tax liabilities based on Managements best estimates. Differences
between these estimates and the ultimate amounts of tax liabilities are recorded in earnings at
the time they can be determined. VALUATION OF GOODWILL AND INTANGIBLE ASSETS Goodwill is no longer amortized, but instead tested for impairment, at least annually or more
frequently if events or changes in circumstances indicate that it might be impaired. The impairment test consists of a comparison of the fair value of the Companys reporting
units with their carrying amount. When the carrying amount of the reporting unit exceeds the fair
value, the Company compares, in a second step, the fair value of goodwill related to the reporting
unit to its carrying value and recognizes an impairment loss equal to the excess. The fair value
of a reporting unit is calculated based on one or more generally accepted valuation techniques. > 40




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> CAE ANNUAL REPORT
2005  MANAGEMENTS DISCUSSION AND
ANALYSIS
 The Company performs the annual review of goodwill as at December 31 of each year, and based
on the impairment test performed as at December 31, 2004, CAE concluded that a goodwill impairment
charge was required (refer to Note 4 of the consolidated financial statements). CAE accounts for its business combinations under the purchase method of accounting, which
requires that the total cost of an acquisition be allocated to the underlying net assets based on
their respective estimated fair values. Part of this allocation process requires that the Company
identify and attribute values and estimated lives to the intangible assets acquired. These
determinations involve considerable judgment, and often involve the use of significant estimates
and assumptions, including those with respect to future cash flows, discount rates and asset
lives. These determinations subsequently affect the amount of amortization expense to be
recognized in future periods, over the intangible assets estimated useful lives. DEFERRED DEVELOPMENT COSTS Where CAE intends to produce or market a product under development that is clearly defined,
has identifiable costs, is technically feasible, and has a clearly defined market or use, and the
Company expects to have the financial resources to complete the project, the costs associated with
the project are deferred (as per CICA Handbook Section 3450 Research and Development Costs)to the
extent their recovery through future sales or use of the product is reasonably assured. This
requires CAE to make judgments about the likelihood of recovery of the costs or assets if
deferred. If the Company determines that recovery of the costs through future sales or use is no
longer likely, deferred costs are charged against earnings in the period in which it becomes
likely that the costs will not be recovered. Once the project is complete, CAE amortizes the
deferred costs by reference to sales or use of the product over a period not to exceed five years
(refer to Note 10 of the consolidated financial statements). PRE-OPERATING COSTS The Company defers costs incurred during the pre-operating period for all new training
centres. Pre-operating costs are incremental in nature and are considered by Management to be
recoverable from the future operations of the new training centre. Capitalization ceases at the
opening of the training centre. Amortization of the deferred pre-operating costs is taken over
five years in respect to civil training operations. DEFERRED FINANCING COSTS Costs incurred relating to the issuance of long-term debt are deferred and amortized on a
straight-line basis over the term of the related debt. Costs related to sale and leaseback
agreements are amortized on a straight-line basis over the term of the lease (refer to Note 10 of
the consolidated financial statements). EMPLOYEE FUTURE BENEFITS The Company maintains defined benefit pension plans that provide benefits based on length of
service and final average earnings. The service costs and the pension obligations are actuarially
determined using the projected benefit method prorated on employee service and Managements best
estimate of expected plan investment performance, salary escalation and retirement ages of
employees. For the purpose of calculating the expected return on plan assets, those assets are
valued at fair value. The excess of the net actuarial gain (loss) over 10% of the greater of the
benefit obligation and the fair value of plan assets is amortized over the remaining service
period of active employees. Past service costs, arising from plan amendments, are deferred and
amortized on a straight-line basis over the average remaining service period of active employees
at the date of amendment. When a curtailment arises, any unamortized past service cost associated with the reduction of
future services is recognized immediately. Also, the increase or decrease in benefit obligation is
recognized as a loss or a gain net of unrecognized actuarial gains or losses. Finally, when the
restructuring of a benefit plan gives rise to both a curtailment and a settlement of obligations,
the curtailment is accounted for prior to settlement (refer to Note 21 of the consolidated
financial statements). DISCLOSURE OF OUTSTANDING SHARE DATA CAEs articles of incorporation authorize the issuance of an unlimited number of common
shares, and an unlimited number of preferred shares, issuable in series. To date, the Company has
not issued any preferred shares. As at March 31, 2005, CAE had 248,070,329 common shares issued
and outstanding. As at the same date, the Company had 8,208,675 options outstanding, of which
3,731,085 were exercisable. SYSTEMS, PROCEDURES AND CONTROLS Management is responsible for establishing appropriate information systems, procedures and
controls to ensure that all financial information disclosed externally, including this MD&A, and
used internally by Management, is complete and reliable. These procedures include a review of the
financial statements and associated information, including this MD&A, by the Audit Committee of
the Board of Directors. The Companys Chief Executive Officer and Chief Financial Officer have a
process to evaluate the applicable systems, procedures and controls and are satisfied they are
adequate for ensuring that complete and reliable financial information is produced. ADDITIONAL INFORMATION Additional information relating to the Company, including its Annual Information Form (AIF),
is available on-line at www.sedar.comas well as on the Companys website at www.cae.com. 41 >