| **Table of  Contents**

** **             | ** **                                                                                                                                                                  |
|------------------------------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Management’s Discussion and Analysis** | ** **                                                                                                                                                                  |
| 1.                                             | HIGHLIGHTS                                                                                                                                                                  | 1 |
| 2.                                             | INTRODUCTION                                                                                                                                                                | 2 |
| 3.                                             | ABOUT CAE

3.1    Who we are

3.2    Our vision                                                                                                                             | 4

4

4 |
|                                           | 3.3    Our strategy and value proposition

3.4    Our operations

3.5    Foreign exchange

3.6    Non-GAAP and other financial measures                                     | 4

6

12

14 |
| 4.                                             | CONSOLIDATED RESULTS

4.1    Results of our operations – fourth quarter  of fiscal 2014

4.2    Results of our operations – fiscal 2014                         | 16

16

18 |
|                                           | 4.3    Consolidated orders and backlog                                                                                                                                      | 20 |
| 5.                                             | RESULTS BY SEGMENT

5.1    Civil segments

5.2    Military segments

5.3    New Core Markets                                                                                | 21

22

26

30 |
| 6.                                             | CONSOLIDATED CASH MOVEMENTS AND LIQUIDITY

6.1    Consolidated cash movements

6.2    Sources of liquidity

6.3    Government assistance

6.4    Contractual obligations    | 32

32

33

34

34 |
| 7.                                             | CONSOLIDATED FINANCIAL POSITION

7.1    Consolidated capital employed

7.2    Off balance sheet arrangements

7.3    Financial instruments                                  | 35

35

36

37 |
| 8.                                             | BUSINESS COMBINATIONS                                                                                                                                                       | 40 |
| 9.                                             | BUSINESS RISK AND UNCERTAINTY

9.1    Risks relating to the industry

9.2    Risks relating to the Company

9.3    Risks relating to the market                             | 40

40

42

44 |
| 10.                                            | RELATED PARTY TRANSACTIONS                                                                                                                                                  | 45 |
| 11.                                            | CHANGES IN ACCOUNTING POLICIES

11.1  New and amended standard adopted

11.2  New and amended standards not yet adopted

11.3  Use of judgements, estimates and assumptions | 46

46

49

49 |
| 12.                                            | CONTROLS AND PROCEDURES

12.1  Evaluation of disclosure controls  and procedures

12.2  Internal control over financial reporting                                           | 51

51

51 |
| 13.                                            | OVERSIGHT ROLE OF AUDIT COMMITTEE AND  BOARD OF DIRECTORS                                                                                                                   | 51 |
| 14.                                            | ADDITIONAL INFORMATION                                                                                                                                                      | 51 |
| 15.                                            | SELECTED FINANCIAL INFORMATION                                                                                                                                              | 52 |

 

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Management’s Discussionand Analysis

*forthe fourth quarter and year ended March 31, 2014*

 

**1.****    ****HIGHLIGHTS **

**RESTATEMENT OF COMPARATIVES**

EffectiveApril 1, 2013, we implemented the new IFRS 11, *Joint Arrangements* andthe amended IAS 19, *Employee Benefits*. Certain comparative figuresprovided for each quarter of the year ended March 31, 2013 have been restatedto reflect the adoption of these accounting standards. The adjustments to ourconsolidated statements of financial position, net income, comprehensive incomeand cash flows as a result of the changes are discussed further in *Changesin accounting policies*. 

**FINANCIAL**

FOURTHQUARTER OF FISCAL 2014

### **Higher revenueover last quarter and higher revenue over the fourth quarter of fiscal 2013**

-   Consolidated revenue was $583.4 million thisquarter, $69.8 million or 14% higher than last quarter and $17.8 million or 3%higher than the fourth quarterof fiscal 2013.

 

**Higher net incomeattributable to equity holders of the Company compared to last quarter and comparedto the fourthquarterof fiscal 2013**

-   Net income attributable to equity holders of theCompany was $60.0 million (or $0.23 per share) this quarter, compared to $46.1 million (or $0.18 per share) last quarter, representing an increase of$13.9 million or 30%, and compared to $43.1 million (or $0.17 per share) in thefourth quarter of last year,representing an increase of $16.9 million or 39%; 

-   For the fourth quarter of fiscal 2013, restructuring,integration and acquisition costs recorded were $13.8 million ($10.2 millionafter tax). Net income before restructuring, integration and acquisition costs1was $53.3 million (or $0.20 per share) in the fourth quarter of fiscal 2013.

 

### **Positive free cashflow[1] at $105.1million this quarter**

-   Net cash provided by operations was $124.3million this quarter, compared to $17.0 million last quarter and $113.7 millionin the fourth quarter of lastyear;

-   Maintenance capital expenditures1 andother asset expenditures were $20.4 million this quarter, $20.0 last quarterand $9.8 million in the fourth quarter of last year;

-   Proceeds from the disposal of property, plantand equipment were $8.5 million this quarter, $0.5 million last quarter and $1.1 million in the fourth quarterof last year;

-   Cash dividends were $9.9 million this quarter,$10.6 million last quarter and $10.2 million in the fourthquarter of last year.

 

FISCAL 2014

### **Higher revenue overfiscal 2013**

-   Consolidated revenue was $2,114.9 million, $79.7million or 4% higher than last year.

 

**Higher net incomeattributable to equity holders of the Company**

-   Net income attributable to equity holders of theCompany was $190.0 million (or $0.73 per share) compared to $137.7 million (or$0.53 per share) last year, representing a $52.3 million or 38% increase;

-   For fiscal 2013, restructuring, integration andacquisition costs recorded were $68.7 million ($51.2 million after tax). Netincome before restructuring, integration and acquisition costs1 was $188.9million (or $0.73 per share) in fiscal 2013.

 

### **Positive free cashflow at $200.6 million**

-   Net cash provided by operations was $276.0million this year, compared to $154.5 million last year;

-   Maintenance capital expenditures and other assetexpenditures were $69.9 million this year, compared to $53.6 million last year;

-   Proceeds from the disposal of property, plantand equipment were $15.4 million this year, compared to $9.2 million last year;

-   Cash dividends were $40.1 million this year,compared to $37.1 million last year.

 

**Capitalemployed1 ending at $2,338.4 million**

-   Capital employed increased by $378.6 million or19% this year;

-   Return on capital employed1 (ROCE)was 11.4% this year compared to 10.2% last year;

-   Non-cash working capital1 decreasedby $87.2 million in fiscal 2014, ending at $124.6 million; 

-   Property, plant and equipment increased by$198.4 million;

-   Other long-term assets and other long-termliabilities increased by $303.8 million and $36.4 million respectively;

-   Net debt1 increased by $42.8 millionthis year, ending at $856.2 million.

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[1]Non-GAAP and other financial measures (see Section 3.6).

CAE Annual Report 2014 | 1

 

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Management’s Discussion and Analysis

 

**ORDERS2****[2]**

-   The book-to-sales ratio2 for thequarter was 0.97 x (combined civil was 1.08x, combined military was 0.82x andNew Core Markets was 1.0x). The ratio for the last 12 months was 1.13x(combined civil was 1.28x, combined military was 0.92x and New Core Markets was1.0x);

-    Total order intake this year was $2,380.3 million, up $240.6million over last year;

-   Total backlog2 was $4,205.6 millionat March 31, 2014, $487.8million higher than last year.

** **

**Civilsegments**

-    Training & Services/Civil signed contracts with an expectedvalue of $898.9 million;

-   Simulation Products/Civil won $608.4 million oforders, including contracts for 48 full-flight simulators (FFSs).

** **

** Military segments**

-    Simulation Products/Military won $484.7 million of orders for newtraining systems and upgrades;

-   Training & Services/Military won contractsvalued at $272.1 million.

** **

**NewCore Markets segment**

-   New Core Markets order intake was valued at$116.2 million.

** **

**2.****     **** INTRODUCTION **

In this report, *we*, *us*,*our*, *CAE * and *Company * refer to CAE Inc. and itssubsidiaries. Unless we have indicated otherwise:

-   *This year* and *2014 *mean the fiscal year ending March 31, 2014;

-    *Last year, prior year* and *a year ago*meanthe fiscal year ended March 31, 2013;

-   Dollar amounts are in Canadian dollars.

 

This report was prepared as of May 15, 2014, and includesour management’s discussion and analysis (MD&A) for the year and thethree-month period ended March 31, 2014 and the consolidatedfinancial statements and notes for the year ended March 31, 2014. Wehave prepared it to help you understand our business, performance and financialcondition for fiscal 2014. Except as otherwise indicated, all financialinformation has been reported in accordance with International Financial ReportingStandards (IFRS). All quarterly information disclosed in the MD&A is basedon unaudited figures.

 

For additional information,please refer to our annual consolidated financial statements for this fiscalyear, which you will find in the annual report for the year endedMarch 31, 2014. The MD&A provides you with a view of CAE as seenthrough the eyes of management and helps you understand the company from avariety of perspectives:

-    Our vision;

-    Our strategy and value proposition;

-    Our operations;

-    Foreign exchange;

-    Non-GAAP and other financial measures;

-    Consolidated results;

-    Results by segment;

-    Consolidated cash movements and liquidity;

-    Consolidated financial position;

-    Business combinations;

-    Business risk and uncertainty;

-    Related party transactions;

-    Changes in accounting policies;

-    Controls and procedures;

-   Oversight role of the Audit Committee and Boardof Directors.

 

You will find our most recent annual report and annualinformation form (AIF) on our website at www.cae.com, on SEDAR at www.sedar.comor on EDGAR at www.sec.gov.

 

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2 Non-GAAP and otherfinancial measures (see Section 3.6).

2 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**ABOUT MATERIAL INFORMATION**

This report includes theinformation we believe is material to investors after considering allcircumstances, including potential market sensitivity. We consider something tobe material if:

-    It results in, or would reasonably be expected to result in, asignificant change in the market price or value of our shares, or;

-    It is quite likely that a reasonable investor would consider theinformation to be important in making an investment decision.

 

**CAUTIONREGARDING FORWARD-LOOKING STATEMENTS**

This report includesforward-looking statements about our activities, events and developments thatwe expect to or anticipate may occur in the future including, for example,statements about our vision, strategies, market trends and outlook, futurerevenues, capital spending, expansions and new initiatives, financialobligations and expected sales. Forward-looking statements normally containwords like *believe*, *expect*, *anticipate*, *plan, *  *intend*,*continue*, *estimate*, *may*, *will*, *should, strategy,future* and similar expressions. By their nature, forward-looking statementsrequire us to make assumptions and are subject to inherent risks anduncertainties associated with our business which may cause actual results infuture periods to differ materially from results indicated in forward-looking statements. While these statements are based on management’sexpectations and assumptions regarding historical trends, current conditionsand expected future developments, as well as other factors that we believe arereasonable and appropriate in the circumstances, readers are cautioned not toplace undue reliance on these forward-looking statements as there is a riskthat they may not be accurate.

 

Important risks that could causesuch differences include, but are not limited to, risks relating to theindustry such as competition, level and timing of defence spending,government-funded military programs, constraints within the civil aviationindustry, regulatory rules and compliance and conflict mineral rules, risksrelating to CAE such as product evolution, R&D activities, fixed-price andlong-term supply contracts, procurement and original equipment manufacturer (OEM)leverage, warranty or other product-related claims, product integration,protection of intellectual property, key personnel, environmental liabilitiesand claims arising from casualty losses, integration of acquired businesses,our ability to penetrate new markets, length of sales cycle and our reliance ontechnology, and risks relating to the market such as foreign exchange,availability of capital pension plan funding, doing business in foreigncountries and income tax laws. Additionally, differences could arise because ofevents that are announced or completed after the date of this report, includingmergers, acquisitions, other business combinations and divestitures. You willfind more information in the *Business risk and uncertainty* section ofthe MD&A. We caution readers that the risks described above are notnecessarily the only ones we face; additional risks and uncertainties that arepresently unknown to us or that we may currently deem immaterial may adverselyaffect our business.

 

Except as required by law, wedisclaim any intention or obligation to update or revise any forward-lookingstatements whether as a result of new information, future events or otherwise.The forward-looking information and statements contained in this report areexpressly qualified by this cautionary statement.

CAE Annual Report 2014 | 3

 

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Management’s Discussion and Analysis

**3.****    ****ABOUT CAE**

**3.1****       ****Who we****are**

 

CAE provides theindustry’s most comprehensive training solutions based on world-leading simulationtechnology and integrated training services. Our vision is to be our customers’Partner of Choice and we take a long term approach to customer relationships. Weoffer our civil aviation, defence and security and healthcare and miningcustomers a complete range of highly innovative product, service and trainingcentre solutions designed to help them meet their mission critical needs forsafety, efficiency and readiness. We have the broadest global presence in ourindustry, enabling us to respond to our customers locally, with 8,000 people atmore than 160 sites andtraining locations in 35 countries, including our jointventure operations. In fiscal 2014, we had annualrevenue exceeding $2.1 billion, approximately 90% of which came from worldwide exports andinternational activities. We have the largest installed base of civil andmilitary flight simulators, supported by arange of after-sales services. We have the broadest training services network in the world and offer civilaviation and military training services in 67 locations worldwide where we train morethan 120,000civil and military crewmembers annually. 

 

Approximately halfof our revenue comes from the sale of simulators and related products,and the balance from services including training, maintenance, ab initio (cadet)pilot training and aircraft crew sourcing services. 

 

Founded in 1947and headquartered in Montreal, Canada, CAE has built an excellent reputationand long-standing customer relationships based on nearly 70 years of experience, strong technical capabilities, a highly trainedworkforce and global reach.

 

CAE’s commonshares are listed on the Toronto and New York stock exchanges under the symbolCAE.

**3.2****     ****Our vision**

 

We intend to be the partner ofchoice for customers operating in complex mission-critical environments byproviding the most innovative modeling and simulation-basedsolutions to enhance safety and improveefficiency. 

 

**3.3****     ****Our strategy and value proposition**

**Our strategy**

We are a world-leading provider ofmodeling and simulation-based training solutions. We have a long history ofserving the needs of customers in the civil aerospace and defence and securitymarkets, and the CAE brand has become  synonymous with safety,quality and reliability the world over.

 

Our focus involves supporting airlines,aircraft operators and defence and security forces with theirongoing, long-term training needs. In defence and security, this means helpingforces to ensure mission readiness,  and in civilaviation, the necessity for training solutions is driven by the need for uncompromised safety in globallyregulated markets. Our unique ability to provide comprehensive solutions, ourtechnology leadership, proven customer support, and a vastglobal presence differentiates us  in our end markets.We are invested in both mature and emerging markets and this enables us to capitalize on current demand and future growth opportunities. Approximately one third of ourrevenue comes from the U.S., one third from Europe and one third from the restof the world including the higher growing, emerging markets. 

 

**Value proposition**

The value weprovide customers is the ability to enhance the safety of their operations,improve their mission readiness for potentially dangerous situations and lowertheir costs by helping them become more operationally efficient. We offer arange of products and services solutions to enhance our customers’ planning anddecision-making abilities.  We also offer a broad global reach, and asa result, we are able to provide solutions in proximity to our customers, whichis an important cost-benefit consideration for them.

 

#### Our core competencies andcompetitive advantages include:

-    World-leading modeling and simulation technology;

-   Comprehensive knowledge of training and learningmethodologies;

-    Total array of training products and services solutions;

-    Broad-reaching customer intimacy;

-    High brand equity;

-    Proven systems engineering and program management processes;

-    Best-in-class customer support;

-    Well established in emerging markets.

4 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

*World-leading modeling and simulation technology*

We pride ourselves on ourtechnological leadership. Pilots around the world view our simulation as theclosest thing to the true experience of flight. We have consistently led theevolution of flight training and simulation systems technology with a number ofindustry firsts. We have simulated the entire range of large civil aircraft in use today, alarge number of the leading regional and business aircraft and a number ofcivil helicopters. We are an industry leader in providing simulation andtraining solutions for fixed-wingtankerand transportaircraft, maritime patrol aircraft, trainer aircraft andhelicopter platforms for the military. We also have extensive knowledge,experience and credibility in designing and developing simulators forfirst-to-market aircraft of major aircraft manufacturers. We now use ourexpertise in modeling and simulation beyond training into other mission‐criticalareas,such as emergency response services, where these technologies are usedto support superior decision‐making capabilities. As well, we haveextendedthese capabilities to the  healthcare andminingmarkets. 

 

*Comprehensiveknowledge of training and learning methodologies*

With nearly 70 years ofexperience in simulation, we are an industry expert in aviation training andare the industry’s training solution one-stop shop. We are constantlyintroducing and implementing ways to improve safety and training efficiency, fromab initio to professional pilot training. For instance, data from simulationtraining sessions is captured, analyzed and displayed to provide instructorsand trainees with real-time feedback on training performance, allowing focus onpriority development areas to increase training efficiency. We are also playinga leadership role in supporting airlines toward the adoption of the Multi-CrewPilot Licence (MPL) program, the most recent pilot licence introduced by theInternational Civil Aviation Organization (ICAO), which embeds the latestadvances in learning leveraging simulation. Another example is our industryleadership towards implementing Upset Prevention and Recovery Training,specifically geared toward preparing pilots to address adverse and extremeflying conditions. In the defence and security market, we are increasinglyleveraging our unique training and systems integration capabilities to offercustomers comprehensive training solutions that can include training centres,training services and simulation products. We are using ourexperience gained in the development of training and learning methodologies inaerospace to bring and enhance modeling and simulation technologies to ourtraining solutions in the healthcare and mining domains. Inhealthcare, we offer both training expertise and the widest breadth ofsimulation training products in the industry, with surgical, patient, andultrasound simulators and trainers for more than 20 medical specialties. Oursimulation centre management system, LearningSpace, effectively captures every aspect of a livesimulation, allowing the delivery of instant, multimedia debriefing sessionsand ongoing training improvement. In mining, we have borrowed from aviation standardsto introduce new solutions to train mining vehicle operators.

 

*Totalarray of training products and services solutions*

Weoffer a wide array of training products, from desktop trainers to FFSs,addressing both our civil and defence and security customers’training needs. With a large network of training centres, we are also a globalleader in aviation training providing the complete solution to meet ourcustomers’ training and pilot sourcing needs. Our pilot training programsspan over 100 different civilianaircraftmodels including commercial airliners, business aircraft and helicopters. In the defenceand security market, our programs involve training for transportaircraft, helicopters, trainer aircraft, aerial refuelers, maritime patrolaircraftand remotely piloted systems. Our range of training services includesthe provision of curricula for pilot type training, cabin crew and maintenancetraining. Our civil pilot sourcingsolutionadds value and moves our customers’ businesses forward by identifying,screening, selecting, training and ultimately placing pilots at their airlines.In addition, we deliver civil ab initio pilot training through CAE OxfordAviation Academy.

* *

*Broad-reachingcustomer intimacy*

The realizationof our mission to be our customers’ partner of choice is evident in therelationships that we have with most of the world’s airlines,aircraft operators, governments and original equipment manufacturers (OEMs).Our broad geographic coverage allows us to respond quickly and cost effectivelyto customer needs and new business opportunities while having a deepunderstanding of the regulations and customs of the local market. We operate afleet of over 259  full-flight and full-mission simulators in 67 civil aviation and military training locations worldwide tomeet the wide range of operational requirements of our customers. Among ourthousands of customers, we have long-term training services agreements andjoint ventures with more than 30 major airlines and aircraft operators aroundthe world and relationships with approximately 50 defence operators inapproximately 35 countries.

 

*Highbrand equity*

We areunique in the simulation industry as the only truly global company focused onmodeling, simulation, and training. We continually reinforce our focus,experience and technology leadership as we position the Company with customersaround the world. We invest in building and maintaining our brand andreputation as a company committed to innovation that will help its customersenhance safety, improve efficiency, enhance decision-making and achieve missionreadiness. We are focused on offering the aviation industry’s mostcomprehensive portfolio of simulation products, training services, and crewsourcing with the ability to tailor a flexible training solution to theindividual requirements of each of our customers. Our simulation products arerated among the highest in the industry for reliability and availability. Thisis a key benefit because simulators normally operate in high-duty cycles of upto 20 hours a day, seven days a week. We design our products so customers canupgrade them, giving them more flexibility and opportunity as products changeor new air worthiness regulations are introduced. The CAE brand is synonymouswith industry-leading simulation technology as well as superior training and customersupport and we strive to be our customers’ partner of choice for any simulationand training related requirement. 

####  

#### ** **

CAE Annual Report 2014 | 5

 

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Management’s Discussion and Analysis

#### *Proven systems engineering andprogram management processes*

We continue toevolve our technology platform to meet the changing market needs, and todevelop solutions and deliver technically complex programs to help ensure thatthere are trained and mission-ready aircrew and combat troops around the world.We have a proven track record on delivering complex civil and military first-to-marketsimulators. Our defence and security business unit has several of itsorganizations around the world certified to Level 3 or above of the CapabilityMaturity Model Integration (CMMI), which is an internationally recognized modelof industry best practices in organizational process improvement, projectmanagement, systems and software development. Our experience,coupled with our continued investment in research and development, strengthensour technological leadership as well as our management expertise to provideprograms featuring sensor simulation for maritime operations, synthetictactical environments for naval and fighter operations as well as visualizationand common database technologies that deliver rich, immersive syntheticenvironments for the most effective training and mission rehearsal possible.

#### * *

#### *Best-in-class customer support*

We maintain a strong focus onafter-sales support, which is often critical in winning additional salescontracts, as well as important update and maintenance services business. Ourcustomer support practices, including a web-based customer portal, performancedashboard, and automated report cards, have resulted in enhanced customersupport according to customer comments and feedback.

 

#### *Well established in emerging markets*

We pride ourselves in our localpresence in each of our global markets, while simultaneously maintaining theefficiencies and advantages of being an international organization. Thisapproach has enabled us to lead in high-growth markets like China, EasternEurope, the Indian sub-continent, the Middle East, South America and SoutheastAsia, where we have been active for several decades.

 

**3.4****       ****Our operations**

 

We are a globalleader with an extensive range of capabilities to help our customers achievegreater levels of safety, operational efficiency, decision-making capabilitiesand mission readiness. We offer integrated solutions, which often involvemulti-year agreements with our customers to provide a full complement of bothproducts and services.

 

Weprimarily serve four markets globally:

-    Thecivil market includes aircraft manufacturers, major commercial airlines,regional airlines, business aircraft operators, civil helicopter operators,third-party training centres, flight training organizations (FTOs), maintenancerepair and overhaul (MRO) organizations and aircraft finance leasing companies;

-    Thedefence and security market includes OEMs, government agencies, public safetyorganizations and defence forces worldwide;

-    Thehealthcare market includes hospital and university simulation centres, medicaland nursing schools, paramedic organizations, defence forces, medical societiesand OEMs;

-   Themining market includes global mining corporations, exploration companies,mining contractors and the world’s premier mining consultancies.

** **

**CIVILMARKET**

** **

**Training &Services/Civil (TS/C)**

*Providescommercial, business and helicopter aviation training for flight, cabin,maintenance and ground personnel and ab initio pilot training and crew sourcingservices*

 

We are the largestprovider of commercial andhelicopter aviationtraining services in the world and the second largest provider of businessaviation training services. We lead the market in growth regions of China,India, the Middle East, South America and Southeast Asia. Through our broadglobal network of training centres, we serve all sectors of civil aviationincluding airlinesand other commercial operators, helicopter operators and businessaviation. We currently operate 239  FFSs, including FFSs operating in ourjoint ventures, and provide aviation training and services, includingsimulation-based crew training, crew sourcing, ab initio pilot training andtraining centre operations in approximately 30 countries around the world. Among our thousandsof customers, we havelong-termtrainingcentre operation and training services agreements and jointventures with approximately30major airlines and aircraft operators around the world. We offer acomprehensive range of training solutions and services, including curriculumdevelopment, training centre operations, pilot training, cabin crew training,aircraft maintenance technician training, courseware solutions and consultingservices. We are a leader in flight sciences, using flight data analysis to improveairline safety, maintenance, flight operations and training. CAE OxfordAviation Academy is the largest ab initio network in the world with 10academies,a fleet of over 220 aircraft and the resources and expertise to train more than2,000cadets annually. CAE Parc Aviation is the global market leader in the provision offlight crew and technical personnel to airlines, aircraft leasing companies,manufacturers and MRO companies worldwide. 

** **

6 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**SimulationProducts/Civil (SP/C)**

*Designs,manufactures and supplies civil flight simulation training devices and visualsystems*

 

We are the worldleader in the provision of civil flight simulation equipment, including FFSsand a comprehensive suite of integrated procedures trainers, flight trainingdevices and computer-based tools, using the same high-fidelity Level D software as the FFSs. We havedesigned and manufactured more civil FFSs for major and regional commercialairlines, third-party training centres and OEMs than any other company. We havedeveloped a wealth of experience in developing first-to-market simulators formore than 35 new types of aircraft models including recent years’ developmentof simulators for the Airbus A350 XWB, AVIC Medium-Sized Transport, Mitsubishi Regional Jet (MRJ), ATR42-600 and ATR72-600,Bombardier CSeries, Global 5000/6000, Global 7000/8000 andLearjet 85,Dassault Falcon 5X and the Commercial Aircraft Corporation of China,Ltd (COMAC) ARJ21 and C919. Leveraging our extensive worldwide network of spareparts and service teams, we also offer a full range of support services. Thisincludes emergency support, simulator updates and upgrades, maintenanceservices and simulator relocations.

** **

**Market trends andoutlook**

In commercialaviation, aircraft capacity and passenger traffic growth are primarily drivenby gross domestic product (GDP). Over the past 20 years, air travelhas grown at an average rate of 4.8% and the aerospaceindustry’s widely held expectation is that long-term average growth for airtravel will be approximately 5% annually over the next two decades. The InternationalAir Transport Association (IATA) forecasts that by 2017 total passenger demandis expected to increase by 31%, representing 930 million more passengerscompared to 2012. Growth rates are higher in the emerging markets thanin large and established markets like Europe and the U.S. Continued growthin air travel and re-fleeting requirements have led to record commercial aircraft backlogs and OEM production rates.

 

In the business and helicopter aviationsector, demand for air travel is primarily driven by corporate profitabilityand general economic conditions. According to the U.S. Federal AviationAdministration (FAA), the number of business jet flights has increased by 3.4%in the past 12 months. The industry remains optimistic of further recovery andlong-term growth in business aircraft travel, and consistent with this view,major business aircraft OEMs have announced new aircraft programs.

 

Consolidation of the industry continuesas companies position themselves to capitalize on this robust commercialaerospace market. 

 

Thefollowing secular trends continue to form the basis of our civil marketinvestment hypothesis:

-   Expectedlong-term growth in air travel;

-   Demandin emerging markets arising from secular growth and a need for infrastructureto support air travel;

-   Aircraftbacklogs and delivery rates;

-   Moreefficient and technologically advanced aircraft platforms;

-   Long-termdemand and shortage of trained aviation professionals (pilots, maintenance,cabin crew).

 

***Expectedlong-term growth in air travel***

In calendar 2013, global passengertraffic increased by 5.2% compared to calendar 2012. For the first three monthsof calendar 2014, passenger traffic increased by 5.6% compared to the firstthree months of calendar 2013. Emerging markets outperformed with passengertraffic in the Middle East, Latin America, Asia/Pacific and Europe growing at 13.3%,7.1%, 7.0% and 5.2% respectively, while North America remained stable. Theglobal commercial aircraft fleet increased by 4.0% from March 2013 to March2014, growing in Asia/Pacific, the Middle East and Latin America by 8.4%, 7.8%and 5.7% respectively, increasing slightly in Europe and remaining stable in NorthAmerica. Possible impediments to steady growth progression in air travelinclude major disruptions such as regional political instability, acts ofterrorism, pandemics, natural disasters, sharp and sustained increases in fuelcosts, major prolonged economic recessions or other major world events. 

*** ***

***Demandin emerging markets arising from secular growth and a need for infrastructureto support air travel***

Emerging marketssuch as China, Eastern Europe, the Indian sub-continent, the Middle East, SouthAmerica and Southeast Asia are expected to continue experiencing higher airtraffic growth over the long term versus mature marketssuch as North America and Western Europe. 

 

***Aircraftbacklogs and delivery rates***

Commercialaircraft OEMs continue to work through record backlog levels of over 12,000 aircraft. Our civil business relies mainly on the already in-servicefleet to drive demand as approximately two thirdsof our revenue is generated from training and services in support of the globalfleet. Our product sales are driven mainly by aircraft deliveries coming from  OEMs’production lines. Recentaircraft order intake remains strong, with North American airlines such as AirCanada and American Airlines and airlines in the emerging markets such asEtihad Airways, Lion Air, VietJet Air and Air Costa leading the intake. Weexpect the continued high rate of aircraft deliveries to translate intocontinued high demand for training products and incremental demand for services. 

 

CAE Annual Report 2014 | 7

 

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Management’s Discussion and Analysis

***Moreefficient and technologically advanced aircraft platforms***

More efficient and technologicallyadvanced aircraft platforms will drive the demand for new types of simulatorsand training programs. One of our strategic priorities is to partner withmanufacturers to take an early position on these future programs. In recentyears, we have signed contracts with Bombardier for the CSeries aircraft andthe Global 7000/8000 aircraft, ATR for the ATR42/72-600 aircraft, MitsubishiAircraft Corporation for the MRJ aircraft, Airbus for the A350 XWB aircraft, Dassaultfor the Falcon 5X, AVIC for the Medium-Sized Transport aircraft and COMAC forthe C919 aircraft. These contracts allow us to leverage our modeling,simulation and training expertise to deliver training solutions, including CAE7000 Series FFS and the recently launched CAE 7000XR Series FFS, CAE SimfinityTMprocedures trainers, comprehensive training programs and expansion of ournetwork to meet airlines’ training needs. The demand for new andmore efficient platforms is driven by better operational flexibility, reducedmaintenance costs, reduced fuel costs and improved emissions and environmentalfootprints. Airlines are actively seeking ways to reduce fuel costs and theoperational risk against further fuel cost fluctuations, as well as ways toobtain benefits offered by new generation aircraft and propulsion technologies. 

* *

Businessjet operatorsalsodemand high performance aircraft. Business aircraft OEMs haveannounced plans to introduce, or have already introduced, a variety of newaircraft models incorporating the latest technologies to enhance performanceand operator benefits such as range, speed, comfort and the accessibility ofbusiness air travel. Some examples include Bombardier’s Learjet 70, 75 and 85, Challenger 350 and Global 7000/8000, Embraer’s LegacySeries and Lineage 1000, Gulfstream’s G650, Cessna’s Citation M2 and Dassault’sFalcon 5X.

 

Deliveries of new-model aircraftare subject to program delays, which in turn affect the timing of FFS ordersand deliveries.

 

***Long-termdemand and shortage of trained aviation professionals (pilots, maintenance,cabin crew)***

*Worldwidedemand is expected to increase over the long term*

Growth in thecivil aviation market has driven the demand for pilots, maintenance techniciansand cabin crew worldwide, resulting in a shortage of qualified professionals inseveral markets, notably the faster growing emerging markets. Pilot supplyconstraints include aging crew demographics and fewer militarypilots transferring to civil airlines. 

 

*Newpilot certification processes require more simulation-based training*

Simulation-basedpilot certification training is taking  on a  greater roleinternationally with the MPL, with stall and upset prevention and recoverytrainingand with new Airline Transport Pilot (ATP) requirements in the U.S. Indeed, the ICAOand various national and regional aviation regulatory agencies have publishednew regulatory requirements, standards and guidance on these specifictopics. 

 

MPL is analternative training and licensing methodology which places more emphasis onsimulation-based training to develop ab initio students into First Officers ofairliners in a specific airline environment. On average, current MPL programs inthe industry consist of one third of the training in actual aircraft and two thirdsof the training in flight simulation training devices, versus traditionaltraining for other licences that average 80% to 90% in actual aircraft. Today,there are approximately 50 nations that have MPL regulations in place and over15 of these nations already use these regulations with training providers andairlines. CAE has MPL programs in Asia and in Europe with variousairlines.Froma global industry perspective, MPL is producing promising results and over 800 MPLgraduates are alreadyflyingsuccessfully with their airline. As the MPL methodology continues to gainmomentum, it will result in increased use of simulation-based training.

 

Finally, the FAA in the U.S.enacted its final set of rules on July 15th, 2013 on new pilotcertification and qualification requirements for air carrier operations,requiring pilots to obtain an ATP and Type Rating. As of August 2014, pilotsapplying for an ATP certificate will be required to complete practicalrequirements which call for more simulation-based training that includesadverse weather conditions, low energy states, stalls, upset prevention andrecovery, and high altitude operations. We believe these new requirements willlead to an increase in demand for training in simulators.

** **

**DEFENCE AND SECURITY****MARKET **

** **

We believe that in thesimulation-based training market, we are uniquely positioned to bepart of the solution for governments and defence forces toreduce  thecost of military readiness. Threeimportant factors help distinguish our defence business and underlie the large pipeline of opportunities for ourmodeling and simulation-based solutions. First, we have a unique globalposition that provides balance and diversity across the world’s defence andsecurity markets. Second, we have a strong, experienced position onenduring aircraft platforms serving both defence and securitymarkets that are expected to have long program lives. Third, and mostfundamentally, simulation-based training provides considerable value as defenceforces operate in a constrained budget environment yet still need to train andmaintain a high state of readiness. 

 

**SimulationProducts/Military (SP/M)**

*Designs,manufactures and supplies advanced training equipment and software tools forair forces, armies, navies and public safety organizations*

 

We are a worldleader in the design and production of military flight simulation equipment. Weoffer solutions to help maintain and enhance our customers’ safety, efficiency,mission readiness and decision-making capabilities.* *Wedevelop simulation equipment, training systems and software tools for a varietyof military aircraft, including fighters, helicopters, trainer aircraft,maritime patrol and tanker/transport aircraft and remotely piloted systems. Wealso offer simulation-based solutions for land and naval forces, including arange of driver and gunnery trainers for tanks and armoured fighting vehicles(AFVs) as well as hands-on and virtual maintenance trainers. We have deliveredsimulation products and training systems to more than 50defence operators in approximately 35countries. 

 

8 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**Training& Services/Military (TS/M)**

*Suppliesturnkey training services, simulation-based integrated enterprise solutions andmaintenance and in-service support solutions*

 

We are aworld-class training systems integrator with the capability toprovide comprehensive,turnkeytraining solutions  toglobal defenceand securityforces. We provide a range of training support services such as contractorlogistics support, maintenance services, classroom instruction and simulatortraining at  over80 sites around the world,including our joint venture operations. Increasingly, we are offering ourtraining systems integration expertise across air, land, sea and public safetyto help our customers create an integrated, immersive training enterprise. We alsooffer avariety of modeling and simulation-based integrated enterprise solutions,and a range of in-service support solutions such as systems engineering andlifecycle management. 

 

**Market trends andoutlook**

While the U.S. Bipartisan BudgetAct for fiscal year 2014 has helped reduce the near-term impact ofsequestration cuts and provided the U.S. Department of Defense with greaterbudget certainty over the current government fiscal year, the timing ofcontract awards will continue to be difficult to predict as the U.S. militaryservices work to achieve the right balance in military capacity, capabilitiesand readiness. This may impact our ability to grow revenueand income in the short term; however, our view is that theimpediment to growth is not the size of the market, but rather the timing ofprocurements.  InEurope, force structure reductions and reduced future investment plans havenarrowed the pipeline of new opportunities; however, we maintain a portfolio ofrecurring business for which we have sized our operations. While the UnitedStates and Europe still present modest challenges, weare seeing increased opportunities originating from regions with growingdefence budgets, like Asia and the Middle East where we have an established andgrowing presence. We also continue to bid on a solid pipelineof global opportunities. In addition, thereare encouraging signs for our market specialization and we are confident thatthe use of simulation-based training will continue to increase in the future. 

 

Thefollowing trends continue to drive the use of our training centres, servicesand products in defence:

-   Explicitdesire of governments and defence forces to increase the use of modeling andsimulation to mitigate budget pressures;

-   Attractivenessof outsourcing of training and maintenance services;

-   Needfor synthetic training to conduct mission rehearsal, including joint andcoalition forces training;

-   Relationshipswith OEMs as their partner of choice for simulation and training;

-   Useof modeling and simulation for analysis and decision support.

 

***Explicitdesire of governments and defence forces to increase the use of modeling andsimulation to mitigate budget pressures***

More defence forces andgovernments are adopting simulation in training programs because it improvestraining effectiveness, reduces operational demands on aircraft, lowers riskcompared to operating actual weapon system platforms and significantly lowerscosts. For example, the U.S. Air Force (USAF) is making more extensive use ofsimulation for KC-135 tanker boom operator training, which costs approximately$20,000 for a three-hour training mission in the actual aircraft, but only$1,000 for that same three-hour training mission in simulators. The higher costof live training and the desire to save aircraft for operational use are twofactors prompting a greater adoption of simulation-based training. Unlike civilaviation, where the use of simulators for training is common practice, thereare no regulatory requirements to train in simulators in the military and thenature of mission-focused training demands at least some live training;however, the balance of live and synthetic training is shifting more tosimulation. 

  

We have begun tosee militaries plan for the increased use of simulation as part of the overalltraining curriculum. For example, the U.S. Navy reports the share ofsimulation-based training on some specific U.S. Navy aircraft platformscould rise close to 50% by 2020. Because of the cost associated withconducting live training exercises, most militaries expect to rebalance the mixof live, virtual and constructive (computer-based) training and shift more ofthe training curriculum to home station virtual and constructive simulation.For example, the U.S. Army is planning to reduce the use of live trainingranges and transfer some of this training to virtual and constructivesimulation to reduce costs. This will ultimately create opportunities for simulation-based trainingcentres, services and products. We view CAE as being part of the solutionto achieving lower training costs while maintaining or improving readiness.

 

***Attractiveness ofoutsourcing of training and maintenance services***

Defence forces andgovernments continue to scrutinize expenditures to find ways to reduce costsand allow active-duty personnel to focus on operational requirements, which hasan impact on defence budgets and resources. There has been a growing trendamong defence forces to consider outsourcing a variety of training services andwe expect this trend to continue. For example, during fiscal year2014 we opened a new military training centre in Australia where the AustralianDefence Forces will train their King Air 350 aircrews. This represents the first simulator services contractthat the Australian Defence Forces have signed as part of acontractor-owned/contractor-operated service delivery program. We believe governmentswillincreasingly lookto industry for the delivery of training services because they often can bedelivered faster and more cost effectively.

*** ***

***Need for synthetictraining to conduct mission rehearsal, including joint and coalition forcestraining***

There is a growingtrend among defence forces to use synthetic training to meet more of their missiontrainingrequirements. Simulation technology solutions enable defence customers to plansophisticated missions and carry out full-mission rehearsals in a syntheticenvironment as a complement to traditional live training or missionpreparation.Synthetic trainingoffers militaries acost-effectiveway to provide realistic training for a wide variety of scenarios whileensuring they maintain a high state of readiness. Allies are cooperating andcreating joint and coalition forces, which are driving the demand for networkedtraining and operations. Training devices that can be networked to traindifferent crews and allow for networked training across a range of platformsare increasingly important as the desire to conduct mission rehearsal exercisesin a synthetic environment increases. We are activelypromoting open, standard simulation architectures, such as the Common Database(CDB),aswell as new capabilities such as the CAE Dynamic Synthetic Environment (DSE), tobetter enable mission rehearsal and joint, networked training. 

* *

CAE Annual Report 2014 | 9

 

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Management’s Discussion and Analysis

***Relationships with OEMs as their partner of choicefor simulation and training***

Wepartner with manufacturers in the defence and security market to strengthenrelationships and position for future opportunities. OEMs have introduced newplatforms and continue to upgrade and extend the life of existing platforms,which drives worldwide demand for simulators and training. For example, Boeinghas developed the new P-8A maritime patrol aircraft, Airbus Military has soldand continues to market boththeA330 MRTT andC295 globally,Lockheed Martin is successfully marketing variants of the C-130J Hercules transport aircraft and F-35 fighter, Alenia Aermacchi and BAESystems are selling the M-346 and Hawk lead-in fighter trainers, andAgustaWestland is continuing to develop a range of helicopters such as theAW139, AW169 and AW189. We have established relationships with each of the OEMson these platforms. We also signed a memorandum of understanding to pursueworking with General Atomics Aeronautical Systems, the world’s leading manufacturerof unmanned aircraft systems, on offering training solutions for GA-ASI’sPredator family of remotely piloted aircraft, and during fiscal year 2014 solda Predator unmanned aerial system (UAS) mission trainer to the Italian AirForce.

* *

***Use of modelingand simulation for analysis and decision support***

Traditionally, modeling andsimulation have been used to support training, but is now increasingly appliedacross the program lifecycle, including support for analysis anddecision-making operations. We see governments and defence forces looking touse simulation-based synthetic environments to support research and developmentprograms, system design and testing, intelligence analysis, integration andexploitation, and to provide the decision support tools necessary to supportmission planning in operations. As an example, we were recently contracted toestablish a training centre and conduct emergency management training for theBrunei Ministry of Home Affairs and see further opportunities to developintegrated modeling and simulation centres.

** **

**NEW CORE MARKETS(NCM)**

** **

**Healthcare market**

Simulation-basedtraining is one of the most effective ways to prepare healthcare practitioners tocare for patients and respond to critical situations while reducing the overallrisk to patients. Through acquisitions and partnerships with experts inhealthcare, we are leveraging our experience and best practices insimulation-based aviation training to deliver innovative solutions to improvethe safety and efficiency of this industry. The healthcare simulation market isgrowing rapidly, with simulation centres becoming the standard in nursing andmedical schools, while proprietary education is now using technology andsimulation to compete with public institutions. 

 

We are a leader insimulation-based technology for healthcare with more than 8,000deliveries of patient, imaging and surgical simulators in medical schools,nursing schools, hospitals, defence forces and other entities. We  have offices located in Canada, the U.S., Hungary and Germany and a network of approximately 50distributors in morethan 50 countries. 

 

We generaterevenue in five main areas: patient simulators, surgical simulators, ultrasoundsimulatorsand task trainers, learning applications/courseware and centremanagement systems. Our patient simulators offer a high level of believabilityand life-like responses and teach students and practitioners to intervene withappropriate clinical measures. Our surgical simulators incorporate haptictechnology that allows students and practitioners to acquire skills andpractice in performing minimally invasive procedures, including bronchoscopies,endoscopies and cardiac valve replacements. Our ultrasound solutions utilizee-learning, ultrasound training models, mannequins and 3D animated display thatallow students and practitioners to become familiar with diagnostic bedsideultrasound and ultrasound-guided procedures. Our simulation learningapplications can be embedded within hospital work environments or largeteaching institutions, allowing remote delivery of content for self‐guidedlearning and assessment. Our medical simulation centre solutions simplify theoperations behind managing complex simulation, assessment, recording anddebriefing.

** **

**Market trends andoutlook**

The Healthcaresimulation-based market is focused mainly on education, and is estimatedupwards of $850 million. Of that, the largest share of the market isrepresented by the human patient simulation market, which is expected to growin the double-digit range over the next five years. Our vision is for CAEHealthcare to lead in the broad adoption of simulation-based training solutionsfor healthcare practitioners to improve patient safety, reduce overall trainingcost and ultimately save more lives. 

 

Medical simulatorscan help to reduce medicalerrorsby fundamentally changing the competency assessment and training of healthcarepractitioners, just as flight simulators revolutionized pilot certification andtraining decades ago. In addition to the 850,000active physicians and 67,000 medical students, there are approximately 3million nurses and 250,000 nursing students in the U.S. and 8.8 millionphysicians and 14.5 million nurses worldwide.

 

The demand for our products and servicesis driven by the:

-   Use ofpatient simulators to improve training and patient safety;

-   Increasedadoption of minimally invasive surgery;

-   Advancesin imaging technology applications in healthcare;

-   Increasinghealthcare costs;

-   Serviceprovider shortages.

 

***Use ofpatient simulators to improve training and patient safety***

Patientsimulators are the most commonly used simulators in the healthcare educationand training markets. Human patient simulation provides an opportunity toreduce medical errors by providing opportunities to train for high-risk,low-frequency events. 

 

10 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

***Increased adoption of minimally invasive surgery***

Minimally-invasive surgery (MIS) isaccomplished through small surgical incisions, specialized surgicalinstruments, and endoscopic or alternative surgical imaging. Due to theadvantages of MIS, such as reduced patient trauma and shorter hospitalizationperiods, it has seen increased adoption in place of previously invasivesurgical procedures. Continuing advances in surgical technology and MIStechniques have established surgery as a leading driver for simulationtechnology training.

** **

***Advancesin imaging technology applications in healthcare***

Regulatoryreform, the development of affordable technology-driven products and growingindustry awareness have advanced the integration of imaging technology intohealthcare. Increasing patient awareness of alternative technologies andprocedures has helped to pressure insurers and providers to implement advancedimaging technologies. Bedside ultrasonography has become an invaluable tool inthe management of critically ill patients. The hand-carried ultrasound (HCU)can immediately provide diagnostic information that is not accessible by aphysical examination alone, provided that healthcare practitioners performingthe examinations have adequate training.

 

***Increasein healthcare costs***

Thegrowth and increasing cost of medical care is correlated to population growthand healthcare coverage expansion. Longer life expectancy and the baby boomergeneration have generated significant demand for healthcare services.Widespread adoption of advanced medical technologies and services couldtranslate into higher demand for training. Experts have demonstrated thatmedical simulation improves patient outcomes and reduces errors, which can helpto mitigate the rate of increase in healthcare costs.

* *

***Serviceprovider shortages***

The World Health Organization hasreported that there were 57 countries with critical shortages equivalent to aglobal deficit of 2.4 million doctors, nurses and midwives worldwide. As students graduate andmove into clinical practice, there is a growing need among hospitals for on‐boardingprograms that transition the new students to competent practitioner effectivelyand efficiently. Simulation is now moving from the academic setting intoclinical practice to provide a safe environment for clinical training.

** **

**Miningmarket**

We have customers in over 90countries that are currently supported by our offices in Australia, Brazil,Canada, Chile, India, Kazakhstan, Mexico, Peru, South Africa, the U.S. and theU.K. We provide products and services for open pit and underground operationsto mining organizations, from large diversified miners to junior miners andconsultancies.

 

We generate revenue by deliveringproducts and services across the mining value chain. Our software products areused for managing exploration and geological data, mine strategy, optimization,detailed design and scheduling for all mining methods and commodities. Our technicalconsulting team includes experienced geologists and mining engineers, servicingclient needs such as managing exploration drilling programs, mining studies,resource evaluation, on-site technical services and business improvementprojects. Our CAE Terra mining equipment simulators leverage our experience insimulation to provide an unrivalled level of realism. Our simulators areintegrated with a comprehensive student management system, lesson planningtools and interactive touch panel instructor station. Our training services includeworkforce development planning, training needs analysis, professionaldevelopment in technical disciplines and the design and implementation ofoperator training curriculum. Our operator training courseware is designed formultiple delivery modes including self-paced e-learning, instructor-ledclassroom training, procedural training and scenarios delivered in our highfidelity simulators.

 

**Markettrends and outlook**

Our technology and services areused by customers to increase productivity and improve safety. The factorsdriving demand for our technology and services are:

-   Healthand safety priority;

-   Declininggrades and higher energy consumption resulting in increased cost of extraction;

-   Cyclicalityof commodity prices;

-   Operationsmanagement and control.

* *

***Healthand safety priority***

Health and safety standardscontinue to be an area of focus for improvement through the use oftechnological advances and increased skills training to create a more highlyskilled and better-educated work force. Mining companies are focusing onautomated equipment, remote control of operations and simulation-based trainingof the workforce as means to improve overall safety.

 

CAE Annual Report 2014 | 11

 

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Management’s Discussion and Analysis

***Declining grades and higher energy consumptionresulting in increased cost of extraction***

In the last 30 years, the averagegrade of ore bodies has halved, while the waste removed to access the mineralshas more than doubled, resulting in higher energy use and cost of extraction.Given the volatility of mineral prices and energy costs, different approaches areneeded. These will include the increased use of optimization tools, simulationand scenario analysis within the industry to maximize value and maintain theviability of current operations, while helping mining companies focus onmaximizing metal recovery instead of simply maximizing throughput. We areactively involved in finding technology-based solutions for recovering metalusing less energy. Our existing tools for optimization and scenario analysishelp mining organizations respond to changing prices and input costs in orderto maximize the potential of their existing operations.

 

***Cyclicalityof commodity prices***

Demand for commodities is highlycorrelated to economic cycles. This means that in addition to the increasedcost of extraction, mining companies will usually experience pricing pressureduring economic contractions. This tends to result in a reduction in capitalspending by mining companies and delays in procurements, which negativelyaffect the business prospects of the mining industry supply chain. However,this factor serves as another driver toward increased use of optimizationtools, simulation and scenario analysis within the industry to maximize theefficiency of operations.

 

***Operationsmanagement and control***

With increasing scale and complexityof operations, mining companies are seeking solutions for the real timeoversight, coordination, decision-making and remote control of fixed and mobileassets. We are collaborating in global markets and providing mine operatorswith an opportunity to integrate our widely used mining systems with otheroperational management technologies. 

 

**3.5****       ****Foreign exchange**

 

We report all dollar amounts in Canadiandollars. We value assets, liabilities and transactions that are measured inforeign currencies using various exchange rates as required by IFRS.

 

The tables below show the variations of theclosing and average exchange rates for our three main operating currencies. 

 

We used the closing foreign exchange ratesbelow to value our assets, liabilities and backlog in Canadian dollars at theend of each of the following periods:

 

|                           | **2014 ** | 2013  | Increase |
|--------------------------------|----------------|------------|----------|
| U.S. dollar (US$ or  USD)      | **1.11 ** | 1.02  | *9%*     |
| Euro (€ or EUR)          | **1.52 ** | 1.30  | *17%*    |
| British pound (£ or  GBP) | **1.84 ** | 1.54  | *19%*    |

 

| We used the average  foreign exchange rates below to value our revenues and expenses: |           |       |
|---------------------------------------------------------------------------------------|----------------|------------|
|                                                                                  |           |       |   |   |   |
|                                                                                  | **2014 ** | 2013  | Increase |
| U.S. dollar (US$ or  USD)                                                             | **1.05 ** | 1.00  | *5%* |
| Euro (€ or EUR)                                                                 | **1.41 ** | 1.29  | *9%* |
| British pound (£ or  GBP)                                                        | **1.68 ** | 1.58  | *6%* |
|                                                                                  |           |       |   |   |   |

 

For fiscal 2014,the effect of translating the results of our foreign operations into Canadiandollars resulted in an increase in revenue of $72.9 million and an increase innet income of $6.1 million, when compared to fiscal 2013. We calculated  this bytranslatingthe current year’s foreign currency revenue and net income using theaverage monthly exchange rates from the previous year and comparing theseadjusted amounts to our current year reported results.

 

Three areas of ourbusiness are affected by changes in foreign exchange rates: 

 

-   **Ournetwork of foreign training and services operations**

Mostof our foreign training and services revenue and costs are denominated inlocal currency.Changes in the value of local currencies relative to the Canadian dollartherefore have an impact on these operations’ net profitability and netinvestment. Gains or losses in the net investment in a foreign operation thatresult from changes in foreign exchange rates are deferred in the foreigncurrency translation account (accumulated other comprehensive income), which ispart of the equity section of the consolidated statement of financial position.Any effect of the fluctuation between currencies on the net profitability hasan immediate translation impact on the consolidated income statement and animpact on year-to-year and quarter-to-quarter comparisons.

 

12 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

-    **Our simulation products operations outside of Canada (Australia, Germany, India, Singapore, U.K. and U.S.)**

Most of the revenue and costs in these operations from foreign operations are generated in their local currency except for some data and equipment bought in different currencies from time to time, as well as any work performed by our Canadian manufacturing operations. Changes in the value of the local currency relative to the Canadian dollar have a translation impact on the operation’s net profitability and net investment when expressed in Canadian dollars, as described above.

 

-    **Our simulation products operations in Canada**

Although the net assets of our Canadian operations are not exposed to changes in the value of foreign currencies (except for receivables and payables in foreign currencies), a significant portion of our annual revenue generated in Canada is in foreign currencies (mostly U.S. dollar and Euro), while a significant portion of our expenses are in Canadian dollars.

 

We generally hedge the milestone payments of sales contracts denominated in foreign currencies to mitigate  some of the foreign exchange exposure. Since less than 100% of our revenue is hedged, it is not possible to completely offset the effects of changing foreign currency values, which leaves some residual exposure that can affect the consolidated income statement.

 

We continue to hold a portfolio of currency hedging positions intended to mitigate the risk to a portion of future revenues presented by the volatility of the Canadian dollar versus foreign currencies. The hedges are intended to cover a portion of the revenue in order to allow the unhedged portion to match the foreign cost component of the contract. With respect to the remaining expected future revenues, our manufacturing operations in Canada remain exposed to changes in the value of the Canadian dollar.

 

In order to reduce the variability of specific U.S. dollar and Euro-denominated manufacturing costs, we also hedge some of the foreign currency costs incurred in our manufacturing process.

 

**Sensitivity analysis**

We conducted a sensitivity analysis to determine the current impact of variations in the value of foreign currencies. For the purposes of this sensitivity analysis, we evaluated the sources of foreign currency revenues and expenses and determined that our consolidated exposure to foreign currency mainly occurs in two areas:

-    Foreign currency revenues and expenses in Canada for the manufacturing business – we hedge a portion of these exposures;

-    Translation of foreign currency of operations in foreign countries. Our exposure is mainly in our operating profit.

 

First we calculated the revenue and expenses per currency from our Canadian operations to determine the operating profit in each currency. Then we deducted the amount of hedged revenues to determine a net exposure by currency. Next we added the net exposure from foreign operations to determine the consolidated foreign exchange exposure in different currencies.

 

Finally, we conducted a sensitivity analysis to determine the impact of a weakening of one cent in the Canadian dollar against each of the other three currencies. The table below shows the typical impact of this change, after taxes, on our yearly revenue and operating profit, as well as our net exposure:

 

|                                                                                        |                    |       |    |      |   | Operating |   |      |    |   |   | Net      |   |
|---------------------------------------------------------------------------------------------|-------------------------|------------|---------|-----------|--------|-----------|--------|-----------|---------|--------|--------|----------|--------|
| Exposure                                                                                    | *(amounts in millions)* |       | Revenue |      |   | Profit    |   |      | Hedging |   |   | Exposure |   |
| U.S. dollar (US$ or USD)                                                                    | $                       | 12.6  | $       | 4.0  | $      | (3.4)     | $      | 0.6  |
| Euro (€ or EUR)                                                                       |                    | 3.2   |    | 0.6  |   | (0.3)     |   | 0.3  |
| British pound (£ or GBP)                                                               |                    | 0.9   |    | 0.1  |   | (0.1)     |   | 0.0       |
|                                                                                        |                    |       |    |      |   |      |   |      |    |   |   |     |   |
| A possible strengthening of one cent in the Canadian dollar would have the opposite impact. |                    |       |    |      |   |      |   |

CAE Annual Report 2014 | 13

 

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Management’s Discussion and Analysis

 

**3.6****       ****Non-GAAP and otherfinancial measures**

 

This MD&A includes non-GAAP andother financial measures. Non-GAAP measures are useful supplemental informationbut may not have a standardized meaning according to GAAP. You should notconfuse this information with, or use it as an alternative for, performancemeasures calculated according to GAAP. You should also not use them to comparewith similar measures from other companies.

**Backlog**

Backlogis a non-GAAP measure that represents the expected value of orders we have receivedbut have not yet executed. 

-   Forthe SP/C, SP/M and TS/M segments, we consider an item part of our backlog whenwe have a legally binding commercial agreement with a client that includesenough detail about each party’s obligations to form the basis for a contractor an order;

-   Militarycontracts are usually executed over a long-term period and some of them must berenewed each year. For the SP/M and TS/M segments, we only include a contractitem in backlog when the customer has authorized the contract item and hasreceived funding for it;

-   Forthe TS/C segment, we include revenues from customers with both long-term andshort-term contracts when these customers commit to pay us training fees, orwhen we reasonably expect the revenue to be generated.

 

The book-to-salesratio is the total orders divided by total revenue in a givenperiod.

**Capital employed**

Capitalemployed is a non-GAAP measure we use to evaluate and monitor how much we areinvesting in our business. We measure it from two perspectives:

Capitalused:

-   Forthe company as a whole, we take total assets (not including cash and cashequivalents), and subtract total liabilities (not including long-term debt andthe current portion of long-term debt);

-    Foreach segment, we take the total assets (not including cash and cashequivalents, tax accounts and other non-operating assets), and subtract totalliabilities (not including tax accounts, long-term debt and the current portionof long-term debt, royalty obligations, employee benefits obligations and othernon-operating liabilities).

 

Sourceof capital:

-    Inorder to understand our source of capital, we add net debt to total equity.

**Capital expenditures (maintenance andgrowth) from property, plant and equipment**

Maintenancecapital expenditure is a non-GAAP measure we use to calculate the investmentneeded to sustain the current level of economic activity.

 

Growthcapital expenditure is a non-GAAP measure we use to calculate the investmentneeded to increase the current level of economic activity.

**Free cash flow**

Freecash flow is a non-GAAP measure that shows us how much cash we have availableto investin growth opportunities, repay debt and meet ongoing financialobligations. We use it as an indicator of our financial strength and liquidity.We calculate it by taking the net cash generated by our continuing operatingactivities, subtracting maintenance capital expenditures, investment in otherassets not related to growth and dividends paid and adding proceeds from thedisposal of property, plant and equipment, dividends received from equityaccounted investees and proceeds, net of payments, from equity accountedinvestees. 

** **

**Grossprofit**

Grossprofit is a non-GAAP measure equivalent to the operating profit excludingresearch and development expenses, selling, general and administrativeexpenses, other (gains) losses – net, after tax share in profit of equityaccounted investees and restructuring, integration and acquisitioncosts.

**Joint venture backlog**

Jointventure backlog is a non-GAAP measure that represents the expectedvalue of ourshare of ordersthatour joint ventureshave receivedbut have not yet executed. 

**Net debt**

Net debt is anon-GAAP measure we use to monitor how much debt we have after taking intoaccount liquid assets such as cash and cash equivalents. We use it as anindicator of our overall financial position, and calculate it by taking ourtotal long-term debt, including the current portion of long-term debt, andsubtracting cash and cash equivalents.

**Net income before restructuring, integrationand acquisition costs**

Net income before restructuring,integration and acquisition costs is a non-GAAP measure we use as an alternate viewof ouroperating results. We calculate it by taking our net income attributable toequity holders of the Company and adding back restructuring, integration andacquisition costs, net of tax. We track it because we believe it provides abetter indication of our operating performance and makes it easier to compareacross reporting periods.

14 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**Non-cashworking capital**

Non-cash workingcapital is a non-GAAP measure we use to monitor how much money we havecommitted in the day-to-day operation of our business. We calculate it bytaking current assets (not including cash and cash equivalents or the currentportion of assets held-for-sale) and subtracting current liabilities (notincluding the current portion of long-term debt or the current portion ofliabilities related to assets held-for-sale).

**Operating profit**

Operatingprofit is a non-GAAP measure that shows us how we have performed before theeffects of certain financing decisions and tax structures. We track operatingprofit because we believe it makes it easier to compare our performance withprevious periods, and with companies and industries that do not have the same capitalstructure or tax laws.

**Research and development expenses**

Research anddevelopment expenses are a financial measure we use to measure the amount ofexpenditures directly attributable to research and development activities thatwe have expensed during the period, net of investment tax credits andgovernment contributions.

**Return on capital employed**

Return on capitalemployed (ROCE) is a non-GAAP measure we use to evaluate the profitability ofour invested capital. We calculate this ratio over a rolling four-quarterperiod by taking earnings from continuing operations attributable to equityholders of the Company excluding interest expense, after tax, divided by theaverage capital employed. 

**Segment operating income (loss)**

Segment operatingincome or loss (SOI) is a non-GAAP measure and our key indicator of eachsegment’s financial performance. This measure gives us a good indication of theprofitability of each segment because it does not include the impact of anyitems not specifically related to the segment’s performance. We calculate it byusing segment operating profit, including the after tax share in profit of equityaccounted investees and excluding  net financeexpense, income taxes, restructuring,integration and acquisition costs and other items not specificallyrelated to the segment’s performance.

**Simulator equivalent unit**

Simulator equivalent unit(SEU) is anoperatingmeasure we use to show the total average number of FFSs available to generate earnings during the period. For example, in the case of a 50/50 flight training jointventure, we will report only 50% of the FFSs deployed under this joint ventureas a SEU. If a FFS is being powered down and relocated, it will not be includedas a SEU until the FFS is re-installed and available to generate earnings. 

**Unfunded backlog**

Unfunded backlogis a non-GAAP measure that represents firm military orders we have received buthave not yet executed for which funding authorization has not yet beenobtained. We include unexercised negotiated options with ahigh probability that they will be exercised, but excludeindefinite-delivery/indefinite-quantity (IDIQ) contracts.

CAE Annual Report 2014 | 15

 

----

Management’s Discussion and Analysis

**4.****    ****CONSOLIDATED RESULTS****[3] **

**4.1****   ****Results of ouroperations – fourth quarter of fiscal 2014**

 

| *(amounts  in millions, except per share amounts)*       |                                                        | **Q4-2014**     |             | Q3-2014      |         | Q2-2014      |         | Q1-2014 |   | Q4-2013 |   |
|----------------------------------------------------------|-------------------------------------------------------------|-----------------|------------------|--------------|--------------|--------------|--------------|---------|--------|---------|--------|
| Revenue                                                  | $                                                           | **583.4 ** | 513.6       | 487.5   | 530.4   | 565.6   |
| Cost  of sales                                           | $                                                           | **416.9 ** | 364.8       | 353.4   | 382.9   | 406.6   |
| Gross  profit3                                      | $                                                           | **166.5 ** | 148.8       | 134.1   | 147.5   | 159.0   |
|                                                     | *As a  % of revenue*                                        | *%*             | ***28.5 *** | *29.0 * | *27.5 * | *27.8 * | *28.1 * |
| Research  and development expenses3                 | $                                                           | **19.9 **  | 16.1        | 14.9    | 17.5    | 18.0    |
| Selling,  general and administrative expenses            | $                                                           | **76.6 **  | 68.6        | 66.6    | 75.3    | 65.5    |
| Other  gains – net                                 | $                                                           | **(8.1)**       | (2.0)            | (5.1)        | (5.2)        | (2.9)        |
| After  tax share in profit of equity accounted investees | $                                                           | **(8.1)**       | (11.5)           | (7.5)        | (2.9)        | (2.3)        |
| Restructuring,  integration and acquisition costs        | $                                                           | **- **     | -           | -       | -       | 13.8    |
| Operating  profit3                                  | $                                                           | **86.2 **  | 77.6        | 65.2    | 62.8    | 66.9    |
|                                                     | *As a  % of revenue*                                        | *%*             | ***14.8 *** | *15.1 * | *13.4 * | *11.8 * | *11.8 * |
| Finance  income                                          | $                                                           | **(2.4)**       | (2.3)            | (2.3)        | (2.8)        | (2.0)        |
| Finance  expense                                         | $                                                           | **18.7 **  | 21.0        | 20.9    | 19.9    | 19.3    |
| Finance  expense – net                             | $                                                           | **16.3 **  | 18.7        | 18.6    | 17.1    | 17.3    |
| Earnings  before income taxes                            | $                                                           | **69.9 **  | 58.9        | 46.6    | 45.7    | 49.6    |
| Income  tax expense                                      | $                                                           | **10.0 **  | 11.3        | 8.4     | 0.3     | 3.9     |
|                                                     | *As a  % of earnings before income taxes (income tax rate)* | *%*             | ***14 ***   | *19 *   | *18 *   | *1 *    | *8 *    |
| Net  income                                              | $                                                           | **59.9 **  | 47.6        | 38.2    | 45.4    | 45.7    |
| Attributable  to:                                        |                                                        |            |             |         |         |         |
| Equity  holders of the Company                           | $                                                           | **60.0 **  | 46.1        | 38.3    | 45.6    | 43.1    |
| Non-controlling  interests                               | $                                                           | **(0.1)**       | 1.5         | (0.1)        | (0.2)        | 2.6     |
|                                                     | $                                                           | **59.9 **  | 47.6        | 38.2    | 45.4    | 45.7    |
| Earnings  per share (EPS) attributable to equity holders |                                                        |            |             |         |         |         |         |    |   |
| of  the Company                                          |                                                        |            |             |         |         |         |         |    |   |    |   |
| Basic  and diluted                                       | $                                                           | **0.23 **  | 0.18        | 0.15    | 0.18    | 0.17    |

 

**Revenue was 14% higher than last quarterand 3% higher compared to the fourth quarter of fiscal 2013**

Revenue was $69.8 million higherthan last quarter mainly because:

-   TS/C’s revenue increased by $26.2 million, or 15%,mainly due to higher revenue generated in North Americaand Europe as a result of higher simulator utilization rates and a favourableforeign exchange impact on the conversion of foreignoperations into Canadian dollars;

-   TS/M’s revenue increased by $15.5 million, or21%, mainly due to higher revenue from North American programs, afavourable foreign exchange impact on the translation of foreign operations andhigher activity from our IES services business;

-   SP/C’s revenue increased by $15.2 million or14%, mainly due to higher production levels resulting from an increasein order intake; 

-   SP/M’s revenue increased by $13.0 million, or 10%,mainly due to higher revenue from North American andAustralian programs and a favourable foreign exchange impact on the translationof foreign operations. The increase was partially offsetby lower revenue from Asian programs;

-   NCM’s revenue remained stable, decreasing by$0.1 million. Lower revenue from CAE Mining was offsetby higher revenue from CAE Healthcare. In CAE Mining, revenue was lower due toa decrease in software licence and consulting services revenue. In CAEHealthcare, higher revenue from surgical simulators and from centre managementsystems, including the impact from a stronger U.S. dollar against the Canadiandollar, was partially offset by lower patient simulator revenue. 

----

3  Non-GAAPand other financial measures (see Section 3.6).

16 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

Revenue was $17.8 million higherthan the same period last year largely because:

-   TS/M’s revenue increased by $25.8 million, or40%, mainly due to higher revenue from North American programs,a favourable foreign exchange impact on the translation of foreign operations,higher activity from our IES services business and higher revenue from ourAustralian programs;

-   TS/C’s revenue increased by $22.3 million, or 13%,mainly due to a favourable foreign exchange impact onthe conversion of foreign operations into Canadiandollars and higher revenue generated in Europe andNorth America as a result of higher simulator utilization rates. The increasewas partially offset by lower revenue from our crew sourcing business;

-   NCM’s revenue increased by $0.6 million or 2%,mainly due to higher revenue from CAE Healthcare, partially offset by lowerrevenue from CAE Mining. In CAE Healthcare, revenue was higher due to anincrease in surgical and patient simulator revenue, including the impact of astronger U.S. dollar against the Canadian dollar. In CAE Mining, revenue waslower due to a decrease in software licence and consulting services revenue;

-   SP/C’s revenue decreased by $18.3 million, or 13%,mainly due to lower revenue attributed to partiallymanufactured simulators;

-   SP/M’s revenue decreased by $12.6 million, or 8%,mainly due to lower revenue from Asian and Australianprograms. The decrease was partially offset by a favourable foreign exchange impacton the translation of foreign operations.

 

You will find more details in *Resultsby segment*. 

**Operating profit was $8.6 million higherthan last quarter and $19.3 million higher compared to the fourth quarterof fiscal 2013**

Operating profit this quarter was$86.2 million or 14.8% of revenue, compared to $77.6 million or 15.1% ofrevenue last quarter and $66.9 million or 11.8% of revenue in the fourthquarter of fiscal 2013. The increase over the fourth quarter of fiscal 2013 wasmainly due to restructuring, integration and acquisition costs of $13.8 millionrecorded during that quarter. Segment operating income for the fourth quarterof fiscal 2013 was $80.7 million, or 14.3% of revenue.

  

Segment operating income4increased by $8.6 million, or 11% compared to last quarter. Increases insegment operating income of $14.4 million for TS/C and $1.0 million forTS/M, were partially offset by decreases in segment operating income of $4.0million, $1.6 million and $1.2 million in SP/M, SP/C and NCM respectively. [4] 

 

Segment operating income increasedby $5.5 million, or 7% compared to the fourth quarter of fiscal 2013. Theincrease in segment operating income of $12.0 million from TS/C was partiallyoffset by decreases in segment operating income of $4.7 million, $1.6 million, $0.1 million and $0.1 million from SP/C, NCM, SP/M and TS/Mrespectively.

 

You will find more details in *Resultsby segment*. 

 

**Net financeexpense was $2.4 million lower than last quarter and $1.0 million lowercompared to the fourth quarter of fiscal 2013**

The decrease from last quarter was mainlydue to lower finance expense on royalty obligations. 

 

The decrease from the fourthquarter of fiscal 2013 was mainly due to lower finance expense on royaltyobligations, partially offset by an increase in R&D obligations.

 

**Effective income tax rate was 14% thisquarter**

Income taxes this quarter were$10.0 million, representing an effective tax rate of 14%, compared to 19% lastquarter and 8% for the fourth quarter of fiscal 2013. 

 

The decrease in the effective tax ratefrom the last quarter was mainly due to a change in the substantively enactedtax rates of Germany, United Kingdom and Norway, the settlement of tax auditsin the quarter, as well as the change in the mix of income from various jurisdictions.Excluding the effect of the change in the tax rates and the settlement of taxaudits, the income tax rate for the quarter would have been 21%.

 

The increase in the effective tax ratefrom the fourth quarter of fiscal year 2013 was mainly due to the settlement oftax audits in the fourth quarter of fiscal year 2013, in addition to the changein the mix of income from various jurisdictions.

----

4 Non-GAAP and other financial measures (seeSection 3.6).

CAE Annual Report 2014 | 17

 

----

Management’s Discussion and Analysis

 

**4.2****       ****Results of our operations – fiscal 2014**

 

| *(amounts in millions, except per share amounts)*       |                                                | **FY2014**        |             |          | FY2013       |   |
|---------------------------------------------------------|-----------------------------------------------------|-------------------|------------------|---------------|--------------|--------|
| Revenue                                                 | **$**                                               | **2,114.9 ** |             | 2,035.2  |
| Cost of sales                                           | **$**                                               | **1,518.0 ** |             | 1,450.4  |
| Gross profit                                            | **$**                                               | **596.9 **   |             | 584.8    |
|                                                    | *As a % of revenue*                                 | ***%***           | ***28.2 *** |          | *28.7 * |
| Research and development expenses                       | **$**                                               | **68.4 **    |             | 60.1     |
| Selling, general and administrative expenses            | **$**                                               | **287.1 **   |             | 264.5    |
| Other gains – net                                 | **$**                                               | **(20.4)**        |             | (22.4)        |
| After tax share in profit of equity accounted investees | **$**                                               | **(30.0)**        |             | (20.1)        |
| Restructuring, integration and acquisition costs        | **$**                                               | **- **       |             | 68.7     |
| Operating profit                                        | **$**                                               | **291.8 **   |             | 234.0    |
|                                                    | *As a % of revenue*                                 | ***%***           | ***13.8 *** |          | *11.5 * |
| Finance income                                          | **$**                                               | **(9.8)**         |             | (9.4)         |
| Finance expense                                         | **$**                                               | **80.5 **    |             | 74.5     |
| Finance expense – net                             | **$**                                               | **70.7 **    |             | 65.1     |
| Earnings before income taxes                            | **$**                                               | **221.1 **   |             | 168.9    |
| Income tax expense                                      | **$**                                               | **30.0 **    |             | 28.2     |
|                                                    | *As a % of earnings before income taxes (tax rate)* | ***%***           | ***14 ***   |          | *17 *   |
| Net income                                              | **$**                                               | **191.1 **   |             | 140.7    |
| Attributable to:                                        |                                                |              |             |          |
| Equity holders of the Company                           | **$**                                               | **190.0 **   |             | 137.7    |
| Non-controlling interests                               | **$**                                               | **1.1 **     |             | 3.0      |
|                                                    | **$**                                               | **191.1 **   |             | 140.7    |
| EPS attributable to equity holders of the Company       |                                                |              |             |          |
| Basic and diluted                                       | **$**                                               | **0.73 **    |             | 0.53     |

 

**Revenue was 4% or $79.7 million higher than last year**

Revenue was higher than last year mainly because:

-    TS/C’s revenue increased by $55.5 million, or 8%, due to the integration into our results of Oxford Aviation Academy Luxembourg S.à r.l. (OAA) acquired in May 2012, a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars and higher revenue generated in North America and Asia as a result of higher simulator utilization rates. The increase was partially offset by lower revenue from our crew sourcing business and our training business in South America and Europe;

-    TS/M’s revenue increased by $48.7 million, or 20%, mainly due to new contracts signed in the current year in North America and Australia combined with programs where the construction phase was completed and are now in the in-service support phase for the same regions. The increase was also due to a favourable foreign exchange impact on the translation of foreign operations, increased activity in our IES services business and higher revenue from European programs. The increase was partially offset by the creation of a joint venture in late fiscal 2013 now accounted for as an equity investee, whereas it was previously accounted for as a joint operation and proportionally consolidated;

-    SP/C’s revenue remained stable, increasing by $4.6 million. The increase related to higher production levels resulting from an increase in order intake and backlog was offset by lower revenue attributed to partially manufactured simulators;

-    NCM’s revenue increased by $4.1 million, or 4%, mainly due to higher revenue from CAE Healthcare, partially offset by lower revenue from CAE Mining. In CAE Healthcare, higher ultrasound task trainer and surgical simulator revenue and higher centre management system revenue, including the impact from a stronger U.S. dollar against the Canadian dollar and an expanded installation base, was partially offset by lower patient simulator revenue. In CAE Mining, revenue was lower due to the cyclical downturn in the mining industry, with lower software licence and consulting services revenue partially offset by an increase in software maintenance revenue;

-    SP/M’s revenue decreased by $33.2 million, or 6%, mainly due to lower revenue from certain Australian and North American programs for which the construction phase was completed and we are now in the in-service support phase. The decrease was also due to lower activity in our IES products business and lower revenue from European and Asian programs. The decrease was partially offset by a favourable foreign exchange impact on the translation of foreign operations.

 

You will find more details in *Results by segment.*

18 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

**Gross profit was $12.1 million higher than last year**

The gross profit was $596.9 million this year, or 28.2% of revenue compared to $584.8 million or 28.7% of revenue last year. As a percentage of revenue, gross profit was stable when compared to last year.

 

**Operating profit was $57.8 million higher than last year**

Operating profit this year was $291.8 million, or 13.8% of revenue, compared to $234.0 million, or 11.5% of revenue last year. The increase from last year was mainly due to restructuring, integration and acquisition costs of $68.7 million recorded last year. Segment operating income was $302.7 million, or 14.9% of revenue last year. 

 

Segment operating income decreased $10.9 million, or 4% compared to last year. Decreases in segment operating income of $4.7 million, $4.4 million, $2.6 million and $2.2 million from SP/C, TS/C, SP/M and NCM respectively, were partially offset by an increase in segment operating income of $3.0 million from TS/M. 

 

You will find more details in *Results by segment.*

 

**Net finance expense was $5.6 million higher than last year**

|                                              |                                                                                 |           | **FY2013 to** |   |
|---------------------------------------------------|--------------------------------------------------------------------------------------|----------------|---------------|--------|
| *(amounts in millions)*                           |                                                                                 | **FY2014**     |          |
| Finance expense, prior period                     | **$**                                                                                | **74.5 ** |
|                                              | Increase in finance expense on long-term debt (other than finance lease obligations) |           | **7.5 ** |
|                                              | Decrease in finance expense on finance lease obligations                             |           | **(0.2)**     |
|                                              | Decrease in finance expense on royalty obligations                                   |           | **(2.1)**     |
|                                              | Increase in other finance expense                                                    |           | **1.7 ** |
|                                              | Decrease in borrowing costs capitalized                                              |           | **(0.9)**     |
| Increase in finance expense from the prior period | **$**                                                                                | **6.0 **  |
| Finance income, prior period                      | **$**                                                                                | **(9.4)**      |
|                                              | Decrease in interest income on loans and receivables                                 |           | **0.4 ** |
|                                              | Increase in other interest income                                                    |           | **(0.8)**     |
| Increase in finance income from the prior period  | **$**                                                                                | **(0.4)**      |
| **Net finance expense, current period**           | **$**                                                                                | **70.7 ** |

 

Net finance expense was $70.7 million this year, $5.6 million or 9% higher than last year. The increase was mainly due to higher interest expense resulting from the private placement of senior notes issued in December 2012 and an increase in R&D obligations, partially offset by lower interest expense due to a reduced use of credit facilities and lower finance expense on royalty obligations.  

 

**Effective income tax rate is 14%**

This fiscal year, income taxes were $30.0 million, representing an effective tax rate of 14%, compared to 17% for the same period last year. 

 

The decrease in the effective tax rate compared to fiscal year 2013 is mainly due to the change in the mix of income from various jurisdictions. Significant elements impacting the 2014 effective tax rate include a favourable decision by the Federal Court of Appeal of Canada, rendered April 17, 2013, with respect to the tax treatment of the depreciation and sale of simulators in Canada, a change in the substantively enacted tax rates of Germany, United Kingdom and Norway as well as the settlement of tax audits during the year. Other than the mix of income, significant elements impacting the fiscal year 2013 tax rate included the settlement of tax audits.

CAE Annual Report 2014 | 19

 

----

Management’s Discussion and Analysis

**4.3****       ****Consolidated orders and backlog**

 

Our consolidated backlog was $4,205.6 million at the end of fiscal 2014, which is 13% higher than last year. New orders of $2,380.3 million increased the backlog this year, while $2,114.9 million in revenue was generated from the backlog.

 

| **Backlog up by 13% over last year** |   |              |   |          |   |   |
|--------------------------------------|--------|-------------------|--------|---------------|--------|--------|
|                                 |   |              |   |          |   |   |
| *(amounts in millions)*              |   | **FY2014**        |   |          | FY2013 |   |
| Backlog, beginning of period         | **$**  | **3,717.8 ** | $      | 3,379.0  |
| + orders                             |   | **2,380.3 ** |   | 2,139.7  |
| - revenue                            |   | **(2,114.9)**     |   | (2,035.2)     |
| + / - adjustments                    |   | **222.4 **   |   | 234.3    |
| Backlog, end of period               | **$**  | **4,205.6 ** | $      | 3,717.8  |

 

In fiscal 2014, adjustments included $222.4 million related to a positive foreign exchange impact.

 

In fiscal 2013, adjustments included $234.3 million worth of backlog added as a result of the acquisition of OAA and a reduction of an existing order of Level B simulators originating in 2006.

 

The book-to-sales ratio for the quarter was 0.97x. The ratio for the last 12 months was1.13x.

 

Following the implementation of the new IFRS 11, *Joint Arrangements*, discussed in *Changes in accounting policies*: 

-    The expected value of orders contracted by our joint ventures in which we have an ownership interest are excluded from CAE’s backlog;

-    The full value of orders between us and our joint ventures is included in CAE’s backlog.

 

Our consolidated backlog as at March 31, 2013 was restated accordingly.

 

Our combined military unfunded backlog5 was $406.7 million at March 31, 2014. In addition, our joint venture backlog5, which represents the expected value of our share of orders that our joint ventures have received but have not yet executed, was $392.5 million[5]at March 31, 2014. These are not included in the consolidated backlog presented in the table above.

 

You will find more details in *Results by segment*. 

----

5  Non-GAAP and other financial measures (see Section 5).

20 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

**5.****    ****RESULTS BY SEGMENT**

We manage ourbusiness and report our results in five segments:

 

Civil segments:

-    Training & Services/Civil (TS/C);

-    Simulation Products/Civil (SP/C).

 

Military segments:

-    Simulation Products/Military (SP/M);

-    Training & Services/Military (TS/M).

 

New Core Markets (NCM) segment.

 

Transactions between operatingsegments are mainly simulator transfers from the SP/C segment to the TS/Csegment and are recorded at cost.

 

The method used for the allocationof assets jointly used by the operating segments and costs and liabilitiesjointly incurred (mostly corporate costs) between operating segments is basedon the level of utilization when determinable and measurable, otherwise theallocation is based on a proportion of each segment’s cost of sales.

 

Unlessotherwise indicated, elements within our segment revenue and segment operatingincome analysis are presented in order of magnitude.

 

| **KEY  PERFORMANCE INDICATORS**                   |       |             |         |   |             |         |         |         |         |    |   |    |   |    |   |   |
|---------------------------------------------------|------------|------------------|--------------|--------|------------------|--------------|--------------|--------------|--------------|---------|--------|---------|--------|---------|--------|--------|
|                                              |       |             |         |   |             |         |         |         |         |    |   |    |   |    |   |   |
| **Segment  operating income**                     |       |             |         |   |             |         |         |         |         |    |   |    |   |    |   |   |
| *(amounts in millions, except operating margins)* | **FY2014** |             | FY2013       |   |             | **Q4-2014**  |         | Q3-2014      |         | Q2-2014 |   | Q1-2014 |   | Q4-2013 |   |
| *Civil  segments*                                 |       |             |         |   |             |         |         |         |         |
| Training  & Services/Civil                    | $          | **96.3 **   | 100.7   |   | **36.9 **   | 22.5    | 19.4    | 17.5    | 24.9    |
|                                              | *%*        | ***13.5 *** | *15.3 * |   | ***18.6 *** | *13.1 * | *11.7 * | *9.8 *  | *14.1 * |
| Simulation  Products/Civil                        | $          | **83.5 **   | 88.2    |   | **21.1 **   | 22.7    | 19.6    | 20.1    | 25.8    |
|                                              | *%*        | ***18.1 *** | *19.3 * |   | ***16.9 *** | *20.7 * | *19.0 * | *16.3 * | *18.0 * |
| *Military  segments*                              |       |             |         |   |             |         |         |         |         |
| Simulation  Products/Military                     | $          | **77.4 **   | 80.0    |   | **19.3 **   | 23.3    | 18.3    | 16.5    | 19.4    |
|                                              | *%*        | ***14.6 *** | *14.2 * |   | ***13.7 *** | *18.3 * | *14.8 * | *12.0 * | *12.7 * |
| Training  & Services/Military                 | $          | **30.4 **   | 27.4    |   | **8.7 **    | 7.7     | 6.9     | 7.1     | 8.8     |
|                                              | *%*        | ***10.4 *** | *11.2 * |   | ***9.7 ***  | *10.4 * | *10.2 * | *11.6 * | *13.8 * |
| New  Core Markets                                 | $          | **4.2 **    | 6.4     |   | **0.2 **    | 1.4     | 1.0     | 1.6     | 1.8     |
|                                              | *%*        | ***3.6 ***  | *5.7 *  |   | ***0.7 ***  | *4.7 *  | *3.7 *  | *5.4 *  | 6.2     |
| Total  segment operating income (SOI)             | $          | **291.8 **  | 302.7   |   | **86.2 **   | 77.6    | 65.2    | 62.8    | 80.7    |
| Restructuring,  integration and acquisition costs | $          | **- **      | (68.7)       |   | **- **      | -       | -       | -       | (13.8)       |
| Operating  profit                                 | $          | **291.8 **  | 234.0   |   | **86.2 **   | 77.6    | 65.2    | 62.8    | 66.9    |

CAE Annual Report 2014 | 21

 

----

Management’s Discussion and Analysis

 

**Capitalemployed6**

 

|                              |   | **March  31**     |          | December  31  |          | September  30 |   | June  30 |   | March  31 |   |
|-----------------------------------|--------|-------------------|---------------|---------------|---------------|---------------|--------|----------|--------|-----------|--------|
| *(amounts in millions)*           |   | **2014 **    | 2013     | 2013     | 2013     | 2013     |
| *Civil segments*                  |   |              |          |          |          |          |   |     |   |      |   |
| Training &  Services/Civil    | $      | **1,703.1 ** | 1,612.7  | 1,515.1  | 1,520.9  | 1,464.7  |
| Simulation  Products/Civil        | $      | **73.2 **    | 52.5     | 52.5     | 104.4    | 56.4     |
| *Military segments*               |   |              |          |          |          |          |
| Simulation  Products/Military     | $      | **354.9 **   | 382.1    | 340.9    | 344.1    | 326.1    |
| Training &  Services/Military | $      | **212.4 **   | 194.6    | 177.0    | 174.1    | 152.0    |
| New Core Markets                  | $      | **222.4 **   | 217.8    | 205.7    | 207.6    | 199.2    |
|                              | $      | **2,566.0 ** | 2,459.7  | 2,291.2  | 2,351.1  | 2,198.4  |

 

**5.1     Civilsegments**

**FISCAL 2014 EXPANSIONS AND NEW INITIATIVES****[6] **

**Expansions**

-    Ourjoint venture Emirates-CAE Flight Training (ECFT) inaugurated its second pilottraining facility in Dubai, UAE;

-    Weannounced the introduction of 35 new Piper airplanes to our CAE Oxford AviationAcademy fleet;

-    ECFTannounced that its dual configuration FFS for Bombardier Challenger 604 andChallenger 605 business jets has received certification from various countriesand also announced that it will deploy a Bombardier Global 5000/6000 businessjets FFS equipped with the Bombardier Vision flight deck, which is expected toenter into service at the end of 2014;

-    Weannounced, with Bombardier, the expansion of the Authorised Training Partner(ATP) agreement in Europe with the addition of a Bombardier Challenger 605aircraft FFS and the deployment of a new Bombardier Global 5000/6000 businessjets FFS equipped with the Bombardier Vision flight deck in our Amsterdamtraining centre;

-    Weannounced, with Aviation Performance Solutions (APS), an extension of ourpartnership to provide Upset Prevention and Recovery Training (UPRT) forbusiness aircraft pilots in Europe. The program uses proven e-Learningweb-based academics, in-aircraft practical skill development and FFS exercises and scenarios;

-    Welaunched a new MPL training program with Tigerair. In support of this program,we announced that we will open an ab initio ground school training centre inSingapore;

-    Wecommenced training at the CAE Simulation Training P.L. centre in Delhi, India.The training centre is a joint venture between CAE and Interglobe, parentcompany of IndiGo;

-    Weannounced an agreement with Airbus Helicopters (formerly Eurocopter Group) tocreate an approved EC225 helicopter training centre in Norway featuring a LevelD flight and mission simulator;

-    Weannounced the addition of a fourth Dassault Falcon 7X FFS to our globaltraining network. The simulator is expected to be ready for training in 2015;

-    Wedeployed a Boeing 737 NG FFS to the Air France training centre located in Orly,France;

-    Weannounced, with Dassault, an agreement naming CAE as the exclusiveDassault-Approved Training Provider for the newly-launched Dassault Falcon 5X long-range business jet.

 

**New programs and products**

-    Weintroduced CAE TroposTM-6000XR, the latest generation of our market-leadingvisual image generator for civil aviation training. The software provides amore immersive environment and an enhanced pilot training experience;

-    Weannounced maintenance training on the new Dassault Falcon 2000 LXS and 2000Saircraft platforms, including EASy II and launched CAE RealCase Troubleshootingfor the Dassault Falcon 7X, Falcon 900EX EASy, and Falcon 2000EX EASy models;

-    Weannounced the introduction of the CAE 7000XR Series FFS, leveraging the latestadvancements in technology and training capabilities and setting a new standardin level D FFSs. Thislatest evolution of CAE’s industry benchmark FFS is designed tooptimize life-cycle costs for our customers and to address new and futuretraining requirements.

 

----

6 Non-GAAP andother financial measures (see section 3.6).

22 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

| **COMBINED FINANCIAL RESULTS**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |              |          |   |              |          |          |          |          |    |   |    |   |    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|---------------|--------|-------------------|---------------|---------------|---------------|---------------|---------|--------|---------|--------|---------|
| *(amounts  in millions, except operating margins)*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             | **FY2014** |              | FY2013        |   |              | **Q4-2014**   |          | Q3-2014       |          | Q2-2014 |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | $          | **1,176.7 ** | 1,116.6  |   | **323.5 **   | 282.1    | 269.3    | 301.8    | 319.5    |
| Segment  operating income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      | $          | **179.8 **   | 188.9    |   | **58.0 **    | 45.2     | 39.0     | 37.6     | 50.7     |
| *Operating  margins*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | *%*        | ***15.3 ***  | *16.9 *  |   | ***17.9 ***  | *16.0 *  | *14.5 *  | *12.5 *  | *15.9 *  |
| Backlog                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | $          | **2,161.7 ** | 1,722.6  |   | **2,161.7 ** | 2,081.9  | 1,997.0  | 1,754.4  | 1,722.6  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |              |          |   |              |          |          |          |          |    |   |    |   |    |   |   |
| For the fourth quarter of fiscal 2014, combined civil revenue  was $323.5 million, up 15% over last quarter. Both civil segments contributed  to the increase mainly resulting from an increase in training revenue due to  a higher utilization rate on the FFSs in our network, most notably in North  America and Europe, as well as an increase in product revenue due to higher  FFS production levels driven by an increase in order intake. Combined civil  segment operating margin was 17.9%, up from 16.0% last quarter. The higher  margin is the reflection of the increased training revenue following a higher  utilization rate on FFS in our training network. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |              |          |
| For fiscal 2014, combined civil revenue was $1,176.7 million, up  5% over last year mainly as a result of the integration into our results of  OAA. Combined civil segment operating margin was 15.3%, down from 16.9% last  year. The lower margin was mainly the result of lower utilization on FFS in  our training network as well as higher costs associated with the  operationalization of new training centres in Asia, relocation of simulators  and severance expenses.                                                                                                                                                                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |              |          |
| The  combined civil book-to-sales ratio was 1.08x  for the quarter and 1.28x on a  trailing 12-month basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |       |              |          |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |              |          |
| The  joint venture backlog was $263.1 million at March 31, 2014.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |              |          |

 

**TRAINING &SERVICES/CIVIL****[7] **

TS/C obtained contracts this quarter expected togenerate future revenues of $247.5  million, including:

-   A long-term contract with Turkish Airlines forpilot training services;

-   A long-term contractrenewal with Aerovias del Continente Americano S.A. for maintenance of theirflight training devices and pilot training services;

-   A long-term contractrenewal with Robert Bosch GmbH for pilot training services;

-   A long-term contract with WorldWide Jet CharterLLC for pilot training services.

 

| **Financial results**                                                     |                |              |            |       |              |           |          |          |          |      |   |    |   |    |   |   |
|---------------------------------------------------------------------------|---------------------|-------------------|-----------------|------------|-------------------|----------------|---------------|---------------|---------------|-----------|--------|---------|--------|---------|--------|--------|
| *(amounts in millions,  except operating margins, SEU and FFSs deployed)* | **FY2014**          |              | FY2013          |       |              | **Q4-2014**    |          | Q3-2014       |          | Q2-2014   |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                                                   | $                   | **715.3 **   | 659.8      |       | **198.4 **   | 172.2     | 166.4    | 178.3    | 176.1    |
| Segment operating  income                                                 | $                   | **96.3 **    | 100.7      |       | **36.9 **    | 22.5      | 19.4     | 17.5     | 24.9     |
| *Operating margins*                                                       | *%*                 | ***13.5 ***  | *15.3 *    |       | ***18.6 ***  | *13.1 *   | *11.7 *  | *9.8 *   | *14.1 *  |
| Depreciation and  amortization                                            | $                   | **98.3 **    | 92.5       |       | **25.8 **    | 23.3      | 23.9     | 25.3     | 23.6     |
| Property, plant and  equipment                                            |                |              |            |       |              |           |          |          |          |
|                                                                      | expenditures        | $                 | **120.5 ** | 71.4  |              | **52.9 ** | 30.3     | 16.8     | 20.5     | 5.8  |
| Intangible assets and  other                                              |                |              |            |       |              |           |          |          |          |
|                                                                      | assets expenditures | $                 | **17.0 **  | 19.8  |              | **4.0 **  | 3.0      | 2.6      | 7.4      | 2.7  |
| Capital employed                                                          | $                   | **1,703.1 ** | 1,464.7    |       | **1,703.1 ** | 1,612.7   | 1,515.1  | 1,520.9  | 1,464.7  |
| Backlog                                                                   | $                   | **1,597.7 ** | 1,311.6    |       | **1,597.7 ** | 1,502.1   | 1,445.4  | 1,300.0  | 1,311.6  |
| SEU7                                                                 |                | **191 **     | 181        |       | **194 **     | 190       | 188      | 190      | 187      |
| FFSs deployed                                                             |                | **239 **     | 227        |       | **239 **     | 238       | 233      | 230      | 227      |

----

7  Non-GAAPand other financial measures (see Section 3.6).

CAE Annual Report 2014 | 23

 

----

Management’s Discussion and Analysis

 

**Revenue up 15% over last quarter and up 13% over the fourth quarter of fiscal 2013**

The increase over last quarter was mainly due to higher revenue generated in North America and Europe as a result of higher simulator utilization rates and a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars.

 

The increase over the fourth quarter of fiscal 2013 was mainly due to a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars and higher revenue generated in Europe and North America as a result of higher simulator utilization rates. The increase was partially offset by lower revenue from our crew sourcing business.

 

**Revenue was $715.3 million this year, 8% or $55.5 million higher than last year**

The increase was mainly due to the integration into our results of OAA acquired in May 2012, a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars and higher revenue generated in North America and Asia as a result of higher simulator utilization rates. The increase was partially offset by lower revenue from our crew sourcing business and our training business in South America and Europe.

**Segment operating income up 64% over last quarter and up 48% over the fourth quarter of fiscal 2013**

Segment operating income was $36.9 million (18.6% of revenue) this quarter, compared to $22.5 million (13.1% of revenue) last quarter and $24.9 million (14.1% of revenue) in the fourth quarter of fiscal 2013.

 

Segment operating income increased by $14.4 million, or 64%, over last quarter. The increase was mainly due to higher revenue in North America and Europe, gains on disposal of two FFSs and a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars. 

  

Segment operating income increased by $12.0 million, or 48%, over the fourth quarter of fiscal 2013. The increase was mainly due to higher profit from equity accounted investees (joint ventures), higher revenue in Europe, a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars and gains on disposal of two FFSs.

**Segment operating income was $96.3 million, 4% or $4.4 million lower than last year**

Segment operating income was $96.3 million (13.5% of revenue) this year, compared to $100.7 million (15.3% of revenue) last year. 

 

The decrease was mainly due to lower revenue in South America and higher costs associated with the operationalization of new training centres in Asia, relocation of FFSs and severance expenses. The decrease was partially offset by higher profit from equity accounted investees (joint ventures), gains on the reversal of an OAA acquisition‐related provision and on disposal of FFSs and the integration into our results of OAA acquired in May 2012. The increase was also explained by a favourable foreign exchange impact on the conversion of foreign operations into Canadian dollars, which was partially offset by an unfavourable foreign exchange impact from the revaluation of our non-cash working capital accounts.

**Property, plant and equipment expenditures at $52.9 million this quarter and $120.5 million for the year**

Maintenance capital expenditures were $7.8 million for the quarter and $28.3 million for the year. Growth capital expenditures were $45.1 million for the quarter and $92.2 million for the year. 

 

**Capital employed increased by $90.4 million over last quarter and by $238.4 million over last year**

The increase in capital employed over the last quarter and over last year was mainly due to higher property, plant and equipment and intangible assets resulting mainly from movements in foreign exchange rates and an increase in the value of our investments in equity accounted investees due to movements in foreign exchange rates and increased profitability.

 

|                                                                                                                |       |              |   |          |   |   |
|---------------------------------------------------------------------------------------------------------------------|------------|-------------------|--------|---------------|--------|--------|
| **Backlog was at $1,597.7 million at the end of the year**                                                          |       |              |   |          |   |   |
|                                                                                                                |       |              |   |          |
| *(amounts in millions)*                                                                                             | **FY2014** |              | FY2013 |          |
| Backlog, beginning of period                                                                                        | **$**      | **1,311.6 ** | $      | 937.4    |
| + orders                                                                                                            |       | **898.9 **   |   | 778.4    |
| - revenue                                                                                                           |       | **(715.3)**       |   | (659.8)       |
| + / - adjustments                                                                                                   |       | **102.5 **   |   | 255.6    |
| Backlog, end of period                                                                                              | **$**      | **1,597.7 ** | $      | 1,311.6  |
|                                                                                                                |       |              |   |          |   |   |
| Fiscal 2014 adjustments are mainly due to foreign exchange movements. Adjustments in fiscal 2013 were mainly due to |
| $254.0 million worth of backlog added as a result of the acquisition of OAA.                                        |
|                                                                                                                |       |              |   |          |   |   |
| This quarter's book-to-sales ratio was 1.25x. The ratio for the last 12 months was 1.26x.                           |       |
|                                                                                                                |       |              |   |          |   |   |
| The joint venture backlog was $263.1 million at March 31, 2014.                                                     |       |              |   |          |   |   |

24 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

 

** **

**SIMULATIONPRODUCTS/CIVIL**

SP/C was awarded contracts for the following 8  FFSs this quarter:

-   One Boeing 737-800W FFS to Southwest Airlines;

-   One Airbus A320 FFS to Lufthansa Flight Training;

-   One Airbus A320 FFS to CAE Flight Training(India) Private Limited, a joint venture between CAE and InterGlobe;

-   Five FFSs, three Airbus A320s, one Boeing 737NG andone Boeing 777 to undisclosed customers;

 

This brings SP/C’s order intake for the year to 48  FFSs.

 

| **Financial results**                              |                |             |           |       |             |          |         |         |         |      |   |    |   |    |   |   |
|----------------------------------------------------|---------------------|------------------|----------------|------------|------------------|---------------|--------------|--------------|--------------|-----------|--------|---------|--------|---------|--------|--------|
| *(amounts in millions,  except operating margins)* | **FY2014**          |             | FY2013         |       |             | **Q4-2014**   |         | Q3-2014      |         | Q2-2014   |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                            | $                   | **461.4 **  | 456.8     |       | **125.1 **  | 109.9    | 102.9   | 123.5   | 143.4   |
| Segment operating  income                          | $                   | **83.5 **   | 88.2      |       | **21.1 **   | 22.7     | 19.6    | 20.1    | 25.8    |
| *Operating margins*                                | *%*                 | ***18.1 *** | *19.3 *   |       | ***16.9 *** | *20.7 *  | *19.0 * | *16.3 * | *18.0 * |
| Depreciation and  amortization                     | $                   | **12.2 **   | 8.6       |       | **3.5 **    | 3.3      | 2.5     | 2.9     | 3.0     |
| Property, plant and  equipment                     |                |             |           |       |             |          |         |         |         |
|                                               | expenditures        | $                | **7.8 **  | 4.9   |             | **4.1 ** | 1.7     | 0.8     | 1.2     | 0.6  |
| Intangible assets and  other                       |                |             |           |       |             |          |         |         |         |
|                                               | assets expenditures | $                | **23.4 ** | 20.4  |             | **8.0 ** | 5.4     | 4.5     | 5.5     | 5.5  |
| Capital employed                                   | $                   | **73.2 **   | 56.4      |       | **73.2 **   | 52.5     | 52.5    | 104.4   | 56.4    |
| Backlog                                            | $                   | **564.0 **  | 411.0     |       | **564.0 **  | 579.8    | 551.6   | 454.4   | 411.0   |

 

**Revenue up 14%over last quarter and down 13% from the fourth quarter of fiscal 2013**

The increase over last quarter wasmainly due to higher production levels resulting from an increase in orderintake.

 

The decrease from the fourthquarter of fiscal 2013 was mainly due to lower revenue attributed to partiallymanufactured simulators. 

 

**Revenue was $461.4million for the year, stable compared to last year**

The increase relatedto higher production levels resulting from anincrease in order intake and backlog was offset by lower revenue attributed topartially manufactured simulators.

 

**Segment operatingincome down 7% from last quarter and down 18% from the fourth quarter of fiscal2013**

Segment operating income was $21.1million (16.9% of revenue) this quarter, compared to $22.7 million (20.7% ofrevenue) last quarter and $25.8 million (18.0% of revenue) in the fourthquarter of fiscal 2013.

 

The decrease from last quarter wasmainly due lower project margins resulting from a less favourable program mixand higher selling, general and administrative expenses in support of increasedsales activity, partially offset by higher revenue, as mentioned above.

 

The decrease from the fourthquarter of fiscal 2013 was mainly due to lower revenue, as mentioned above, andan unfavourable foreign exchange impact. The decrease was partially offset bylower research and development expenses net of government funding.

** **

**Segment operatingincome was $83.5 million for the year, 5% or $4.7 million lower thanlast year**

Segment operating income was $83.5  million (18.1% of revenue) this year, compared to $88.2  million (19.3% of revenue) lastyear.

 

The decrease  was mainly due to an unfavourable foreign exchange impact and higherselling, general and administrative expenses, partially offset by a favourableprogram mix.

 

**Capital employedincreased by $20.7 million over last quarter and by $16.8 million over lastyear**

Capital employed was higher than last quarter mainly due to higher contracts in progressassets, partially offset by a decrease in accounts receivable. 

 

Capital employed was higher than last year mainly due to an increase in inventories, intangible assets resultingfrom investments in development costs and accounts receivable, partially offsetby increase in contractsin progress liabilities.

 

CAE Annual Report 2014 | 25

 

----

Management’s Discussion and Analysis

|                                                                                                                                                                                            |       |            |   |        |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|--------|-------------|--------|--------|
| **Backlog up 37% compared to last year**                                                                                                                                                        |       |            |   |        |   |   |
|                                                                                                                                                                                            |       |            |   |        |
| *(amounts in millions)*                                                                                                                                                                         | **FY2014** |            | FY2013 |        |
| Backlog, beginning of period                                                                                                                                                                    | **$**      | **411.0 ** | $      | 385.5  |
| + orders                                                                                                                                                                                        |       | **608.4 ** |   | 494.7  |
| - revenue                                                                                                                                                                                       |       | **(461.4)**     |   | (456.8)     |
| + / - adjustments                                                                                                                                                                               |       | **6.0 **   |   | (12.4)      |
| Backlog, end of period                                                                                                                                                                          | **$**      | **564.0 ** | $      | 411.0  |
|                                                                                                                                                                                            |       |            |   |        |   |   |
| Fiscal 2014 adjustments are mainly due to foreign exchange movements. Adjustments in fiscal 2013 were mainly due to a reduction of an existing order of Level B simulators originating in 2006. |       |
|                                                                                                                                                                                            |       |            |   |        |   |   |
| This quarter's book-to-sales ratio was 0.82x. The ratio for the last 12 months was 1.32x.                                                                                                       |       |
|                                                                                                                                                                                            |       |
| There was no joint venture backlog at March 31, 2014.                                                                                                                                           |       |

 

**5.2****       ****Military segments**

**FISCAL 2014 EXPANSIONS AND NEW INITIATIVES**

**Expansions**

-    We commenced construction of the new CAE Brunei Multi-Purpose Training Centre (MPTC) in Rimba, Brunei Darussalam which is now at the completion phase. The centre is expected to be operational by the end of spring 2014.  We also announced jointly with the Government of Brunei that MPTC will establish an Emergency and Crisis Management Centre of Excellence to support disaster preparedness; 

-    We are providing on-site training support services at the Army Aviation Training Centre in Queensland, Australia, following the acceptance into service of the world’s first Level D certified NH90 full-flight and mission simulator;

-    We installed a CAE 5000 Series King Air 350 simulator at a new training facility in Sale, Australia and will now provide simulator services to the Royal Australian Air Force and Royal Australian Navy through 2018 under a contractor-owned, contractor-operated training program; 

-    We announced that our Rotorsim training centre in Sesto Calende, Italy, which is a joint venture with AgustaWestland, will expand with the addition of a CAE 3000 Series AW169 helicopter simulator;

-    We announced that the world’s first CAE 3000 Series AW189 FFS was certified to Level D and is now ready for training at the Rotorsim training centre in Sesto Calende, Italy;

-    We announced that Rotorsim will add a second CAE 3000 Series AW189 helicopter simulator to a new training location in Aberdeen, Scotland to support Bristow helicopters and other North Sea operators.

**New programs and products**

-    We signed a memorandum of understanding with Lockheed Martin as its preferred provider of Canadian F-35 training support, training systems integration, operations and maintenance should Canada select the F-35;

-    We signed a memorandum of understanding with General Atomics Aeronautical Systems to pursue international opportunities for CAE to offer its simulation and training systems for the Predator family of remotely piloted aircraft;

-    We delivered the latest generation CAE GESI command and staff training system, now operational at the German Army Combat Simulation Center located in Wildflecken, Germany;

-    We assisted Ambulance Victoria in Brisbane, Australia with the launch of the Virtual Paramedic, a simulation-based training solution, to help prepare for mass casualty incidents;

-    We signed a cooperation agreement to combine CAE’s GESI command and staff training system with Rolands & Associates Joint Theatre-Level Simulation into a new, federated constructive simulation solution called GlobalSim;

-    We provided an Emergency Management Information System to the City of Ottawa that will improve multi-agency collaboration and enhance effective decision-making during emergency incidents;

-    We are designing and manufacturing a UH-60L/M Black Hawk full-mission simulator to be used by the Mexican Federal Police.

 

26 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

| **COMBINED FINANCIAL RESULTS**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |              |          |   |              |          |          |          |          |    |   |    |   |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|---------------|--------|-------------------|---------------|---------------|---------------|---------------|---------|--------|---------|--------|---------|
| *(amounts  in millions, except operating margins)*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          | **FY2014** |              | FY2013        |   |              | **Q4-2014**   |          | Q3-2014       |          | Q2-2014 |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | $          | **822.0 **   | 806.5    |   | **230.3 **   | 201.8    | 191.1    | 198.8    | 217.1    |
| Segment  operating income                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   | $          | **107.8 **   | 107.4    |   | **28.0 **    | 31.0     | 25.2     | 23.6     | 28.2     |
| *Operating  margins*                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | *%*        | ***13.1 ***  | *13.3 *  |   | ***12.2 ***  | *15.4 *  | *13.2 *  | *11.9 *  | *13.0 *  |
| Backlog                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | $          | **2,043.9 ** | 1,995.2  |   | **2,043.9 ** | 2,024.3  | 1,942.4  | 1,960.1  | 1,995.2  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |              |          |   |              |          |          |          |          |    |   |    |   |    |   |   |
| For the fourth quarter of fiscal 2014, combined military revenue  was $230.3 million, up 14% over last quarter. The increase was mainly due to  higher contribution from new contracts signed this quarter and a favourable  foreign exchange impact on the translation of foreign operations. Combined  military segment operating margin was 12.2%, down from 15.4% last quarter.  The lower margin is due to a more favourable program mix in the previous  quarter and higher research and development expenses net of government  funding this quarter.                                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |              |          |
| For fiscal 2014, combined military revenue was $822.0 million,  up 2% over last year mainly as a result of a favourable foreign exchange  impact on the translation of foreign operations. Combined military segment operating  margin was 13.1%, stable compared to last year. The decrease in margin due to  a reversal of a contingent consideration provision which occurred last year,  higher selling, general and administrative expenses and higher research and  development expenses net of government funding was offset by the margin  improvement resulting from our European and North American programs and the  increased profitability in our equity accounted investees (joint ventures). |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |              |          |
| The  combined military book-to-sales ratio was 0.82x for the quarter and 0.92x on  a trailing 12-month basis.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |              |          |

 

The combined military unfunded backlog was $406.7million and the joint venture backlog was $129.4 million at March 31,2014.

** **

**SIMULATION PRODUCTS/MILITARY**

SP/M was awarded $133.1 million in orders thisquarter, including contracts from:

-   Beechcraft Corporation to develop acomprehensive T-6C ground-based training system for the Royal New Zealand AirForce;

-   The Polish Air Force to provide an SW-4helicopter full-flight simulator to support training at the Polish Air ForceSchool in Deblin, Poland;

-   Boeing to manufacture four additional P-8Aoperational flight trainers for the U.S. Navy.

 

| **Financial results**                              |                |             |           |       |             |          |         |         |         |      |   |    |   |    |   |   |
|----------------------------------------------------|---------------------|------------------|----------------|------------|------------------|---------------|--------------|--------------|--------------|-----------|--------|---------|--------|---------|--------|--------|
| *(amounts in millions,  except operating margins)* | **FY2014**          |             | FY2013         |       |             | **Q4-2014**   |         | Q3-2014      |         | Q2-2014   |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                            | $                   | **529.3 **  | 562.5     |       | **140.5 **  | 127.5    | 123.5   | 137.8   | 153.1   |
| Segment operating  income                          | $                   | **77.4 **   | 80.0      |       | **19.3 **   | 23.3     | 18.3    | 16.5    | 19.4    |
| *Operating margins*                                | *%*                 | ***14.6 *** | *14.2 *   |       | ***13.7 *** | *18.3 *  | *14.8 * | *12.0 * | *12.7 * |
| Depreciation and  amortization                     | $                   | **17.2 **   | 15.3      |       | **4.7 **    | 4.5      | 4.1     | 3.9     | 4.2     |
| Property, plant and  equipment                     |                |             |           |       |             |          |         |         |         |
|                                               | expenditures        | $                | **7.0 **  | 5.2   |             | **2.3 ** | 2.0     | 1.2     | 1.5     | (0.6)     |
| Intangible assets and  other                       |                |             |           |       |             |          |         |         |         |
|                                               | assets expenditures | $                | **15.3 ** | 26.1  |             | **5.6 ** | 3.5     | 2.4     | 3.8     | 6.8  |
| Capital employed                                   | $                   | **354.9 **  | 326.1     |       | **354.9 **  | 382.1    | 340.9   | 344.1   | 326.1   |
| Backlog                                            | $                   | **682.5 **  | 688.7     |       | **682.5 **  | 669.9    | 635.4   | 673.4   | 688.7   |

 

**Revenue up 10%over last quarter and down 8% from the fourth quarter of fiscal2013**

The increase over last quarter wasmainly due to higher revenue from North American and Australian programs and afavourable foreign exchange impact on the translation of foreign operations.The increase was partially offset by lower revenue from Asian programs.

 

The decrease from the fourthquarter of fiscal 2013 was mainly due to lower revenue from Asian andAustralian programs. The decrease was partially offset by a favourable foreignexchange impact on the translation of foreign operations.

  

**Revenue was $529.3 millionthis year, 6% or $33.2 million lower than last year**

The decrease in revenue from last year was mainly due tolower revenue from certain Australian and North American programs for which theconstruction phase was completed and we are now in the in-service supportphase. The decrease was also due to lower activity in our IES products businessand lower revenue from European and Asian programs. The decrease was partiallyoffset by a favourable foreign exchange impact on thetranslation of foreign operations.

** **

CAE Annual Report 2014 | 27

 

----

Management’s Discussion and Analysis

**Segment operating income down 17% compared to last quarter and stable compared to the fourth quarter of fiscal 2013**

Segment operating income was $19.3 million (13.7% of revenue) this quarter, compared to $23.3 million (18.3% of revenue) last quarter and $19.4 million (12.7% of revenue) in the fourth quarter of fiscal 2013.

 

The decrease from last quarter was mainly due to lower volume on Asian programs, higher research and development expenses net of government funding and lower margins on European programs, partially offset by higher volume on North American programs.

 

Segment operating income was stable when compared to the fourth quarter of fiscal 2013. The decrease resulting from lower volume on Asian programs and higher research and development expenses net of government funding was offset by higher margins on North American and European programs. 

 

**Segment operating income was $77.4 million this year, 3% or $2.6 million lower than last year**

Segment operating income was $77.4 million (14.6% of revenue) this year, compared to $80.0 million (14.2% of revenue) last year.

 

The decrease in segment operating income from last year was mainly due to the reversal of a contingent consideration provision which occurred in the second quarter of fiscal 2013, higher research and development expenses net of government funding and lower volume on Asian programs. The decrease was partially offset by higher margins on European and North American programs.

 

**Capital employed decreased by $27.2 million from last quarter and increased by $28.8 million over last year**

The decrease from last quarter was mainly due to an increase in accounts payable and accrued liabilities, higher contracts in progress liabilities and lower contracts in progress assets, partially offset by an increase in accounts receivable and foreign exchange movements resulting from the depreciation of the Canadian dollar.

  

The increase over last year was mainly due to a higher investment in other long-term assets and an increase in intangible assets resulting primarily from movements in foreign exchange rates. 

 

|                                                                                                                                                                                                  |       |            |   |        |   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|--------|-------------|--------|--------|
| **Backlog stable compared to last year**                                                                                                                                                              |       |            |   |        |   |   |
|                                                                                                                                                                                                  |       |            |   |        |
| *(amounts in millions)*                                                                                                                                                                               | **FY2014** |            | FY2013 |        |
| Backlog, beginning of period                                                                                                                                                                          | **$**      | **688.7 ** | $      | 787.2  |
| + orders                                                                                                                                                                                              |       | **484.7 ** |   | 397.0  |
| - revenue                                                                                                                                                                                             |       | **(529.3)**     |   | (562.5)     |
| + / - adjustments                                                                                                                                                                                     |       | **38.4 **  |   | 67.0   |
| Backlog, end of period                                                                                                                                                                                | **$**      | **682.5 ** | $      | 688.7  |
|                                                                                                                                                                                                  |       |            |   |        |   |   |
| Fiscal 2014 adjustments are mainly due to foreign exchange movements. Adjustments in fiscal 2013 were mainly due to the reclassification of equipment procurement from a long-term services contract. |
|                                                                                                                                                                                                  |       |            |   |        |   |   |
| This quarter's book-to-sales ratio was 0.95x. The ratio for the last 12 months was 0.92x.                                                                                                             |       |
|                                                                                                                                                                                                  |       |
| Unfunded backlog was $38.0 million and there was no joint venture backlog at March 31, 2014.                                                                                                          |       |

28 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

 

**TRAINING &SERVICES/MILITARY**

TS/M was awarded $55.9 million in ordersthis quarter, including contracts from:

-   Germany's Federal Office ofBundeswehr Equipment, Information Technology and In-Service Support to providea range of on-site training support services for flight simulation equipment,including Tornado, C-160 Transall, P-3C Orion, Mk-41 Sea King and the GermanForces' pilot selection system;

-   PWN Excellence Sdn Bhd, based in Subang,Malaysia, to provide comprehensive lifecycle support and maintenance services on an AW139 simulator over the next ten years.

 

| **Financial results**                              |                |              |           |       |              |          |          |          |          |      |   |    |   |    |   |   |
|----------------------------------------------------|---------------------|-------------------|----------------|------------|-------------------|---------------|---------------|---------------|---------------|-----------|--------|---------|--------|---------|--------|--------|
| *(amounts in millions,  except operating margins)* | **FY2014**          |              | FY2013         |       |              | **Q4-2014**   |          | Q3-2014       |          | Q2-2014   |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                            | $                   | **292.7 **   | 244.0     |       | **89.8 **    | 74.3     | 67.6     | 61.0     | 64.0     |
| Segment operating  income                          | $                   | **30.4 **    | 27.4      |       | **8.7 **     | 7.7      | 6.9      | 7.1      | 8.8      |
| *Operating margins*                                | *%*                 | ***10.4 ***  | *11.2 *   |       | ***9.7 ***   | *10.4 *  | *10.2 *  | *11.6 *  | *13.8 *  |
| Depreciation and  amortization                     | $                   | **25.2 **    | 14.6      |       | **7.5 **     | 6.9      | 6.7      | 4.1      | 4.8      |
| Property, plant and  equipment                     |                |              |           |       |              |          |          |          |          |
|                                               | expenditures        | $                 | **19.0 ** | 12.1  |              | **5.7 ** | 2.6      | 5.1      | 5.6      | 7.2  |
| Intangible assets and  other                       |                |              |           |       |              |          |          |          |          |
|                                               | assets expenditures | $                 | **1.0 **  | 2.4   |              | **0.4 ** | 0.2      | 0.1      | 0.3      | 0.3  |
| Capital employed                                   | $                   | **212.4 **   | 152.0     |       | **212.4 **   | 194.6    | 177.0    | 174.1    | 152.0    |
| Backlog                                            | $                   | **1,361.4 ** | 1,306.5   |       | **1,361.4 ** | 1,354.4  | 1,307.0  | 1,286.7  | 1,306.5  |

 

**Revenue up 21%over last quarter and up 40% over the fourth quarter offiscal 2013**

The increase over lastquarter was mainly due to higher revenue fromNorth American programs, afavourable foreign exchange impact on the translation of foreign operations and higher activity from our IES services business.

  

The increase over the fourth quarter offiscal 2013 was mainly due to higher revenue from North American programs, afavourable foreign exchange impact on the translation of foreign operations,higher activity from our IES services business and higher revenue from ourAustralian programs.

 

**Revenue was $292.7million this year, 20% or $48.7 million higher than last year**

The increase was mainly due to newcontracts signed in the current year in North America and Australia combinedwith programs where the construction phase was completed and are now in thein-service support phase for the same regions. The increase was also due to afavourable foreign exchange impact on the translation of foreign operations,increased activity in our IES services business and higher revenue fromEuropean programs. The increase was partially offset by the creation of a jointventure in late fiscal 2013 now accounted for as an equity investee, whereas itwas previously accounted for as a joint operation and proportionallyconsolidated.

 

**Segmentoperating income up 13% over last quarter and stable compared to the fourth quarter of fiscal 2013**

Segment operating income was$8.7 million (9.7% of revenue) this quarter, compared to $7.7 million (10.4% ofrevenue) last quarter and $8.8 million (13.8% of revenue) in the fourth quarterof fiscal 2013.

 

The increase over lastquarter was mainly due to higher volume on North American programs and highermargins on European programs, partially offset by lower profit from equityaccounted investees (joint ventures).

  

Segment operating income wasstable when compared to the fourthquarter of fiscal 2013. The decreaseresulting from higher selling, general andadministrative expenses was offset byhigher margins on European programs, higher volume on Australian programs andhigher profit from equity accountedinvestees (joint ventures).

**Segment operating income was $30.4 million this year,11% or $3.0 million higher than last year**

Segmentoperating income was $30.4  million (10.4%of revenue) this year, compared to $27.4 million (11.2% of revenue) last year.

 

The increase over last year was mainlydue to higher profit from equity accounted investees (joint ventures) andhigher volume on North American and European programs. The increase waspartially offset by higher selling, general and administrative expenses includingcosts incurred for start-up activities in certain Asian programs.

**Capital employed increased by $17.8 million over lastquarter and by $60.4 million over last year**

The increase over last quarter was mainlydue to higher property, plantand equipment, higher other long-term assets resulting primarily from foreignexchange rates, an increase in non-cash working capital and a higher investmentin equity accounted investees as a result of increased profitability.

 

The increaseover last year was mainly due to higherother long-term assets resulting primarily from movements in foreign exchangerates, an increase in non-cash working capital, a higher investment in equityaccounted investees as a result of increased profitability and higher property,plant and equipment resulting from capital expenditures and movements inforeign exchange rates.

 

CAE Annual Report 2014 | 29

 

----

Management’s Discussion and Analysis

|                                                                                                                                                                                                      |       |              |   |          |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|--------|---------------|--------|--------|
| **Backlog up 4% over last year**                                                                                                                                                                          |       |              |   |          |   |   |
|                                                                                                                                                                                                      |       |              |   |          |
| *(amounts in millions)*                                                                                                                                                                                   | **FY2014** |              | FY2013 |          |
| Backlog, beginning of period                                                                                                                                                                              | **$**      | **1,306.5 ** | $      | 1,268.9  |
| + orders                                                                                                                                                                                                  |       | **272.1 **   |   | 357.5    |
| - revenue                                                                                                                                                                                                 |       | **(292.7)**       |   | (244.0)       |
| + / - adjustments                                                                                                                                                                                         |       | **75.5 **    |   | (75.9)        |
| Backlog, end of period                                                                                                                                                                                    | **$**      | **1,361.4 ** | $      | 1,306.5  |
|                                                                                                                                                                                                      |       |              |   |          |   |   |
| Fiscal 2014 adjustments are mainly related to foreign exchange movements. Adjustments in fiscal 2013 were mainly due to the reclassification of equipment procurement from a long-term services contract. |       |
|                                                                                                                                                                                                      |       |              |   |          |   |   |
| This quarter's book-to-sales ratio was 0.62x. The ratio for the last 12 months was 0.93x.                                                                                                                 |       |
|                                                                                                                                                                                                      |       |              |   |          |   |   |
| Unfunded backlog was $368.7 million and the joint venture backlog was $129.4 million at March 31, 2014.                                                                                                   |       |

 

**5.3****       ****New Core Markets**

**FISCAL 2014 EXPANSIONS AND NEW INITIATIVES**

 

CAE Healthcare expansions and new initiatives included the following:

**Expansions**

-    We signed agreements with new distributors in Bangladesh, Chile, Costa Rica, Germany, India, Malaysia, Malta, Peru, Singapore, Netherlands and United Arab Emirates;

-    We opened a new training facility with a hospital group in Brazil and began operations;

-    We partnered with Community Hospital in Long Beach, U.S. to utilize their facilities in order to expand our training centre locations across the West Coast.

**New programs and products**

-    We released an update of our LearningSpace audiovisual and performance management system with a new Resource Manager feature that tracks simulation centre assets;

-    We released an updated version of our VIMEDIX ultrasound simulator operating system with additional user features and pathologies for the VIMEDIX cardiac simulator and VIMEDIX Ob/Gyn;

-    We released a first trimester endovaginal ultrasound training module for VIMEDIX Ob/Gyn;

-    We unveiled the CAE Fidelis Maternal Fetal Simulator at the International Meeting for Simulation in Healthcare (IMSH) in San Francisco, U.S.  

 

CAE Mining expansions and new initiatives included the following:

**Expansions**

-    We expanded our customer support and sales capability in Columbia;

-    We entered into a distribution agreement with Simsmart Technologies Inc. to offer their SmartEXEC automated underground ventilation technology to the global market;

-    We announced a collaboration agreement with Geovariances granting CAE Mining exclusive access to their mining sector geostatistical libraries. Commercial release within the CAE Mining product suite is expected to be launched in the first quarter of fiscal 2015.

**New programs and products**

-    We delivered and commissioned our first underground mining simulator models to the Fresnillo PLC training centre in Mexico;

-    We launched a cloud-based service for open pit mine optimization that is significantly faster than current methods;

-    We released major updates to our geological data management system, Sirovision 3D photogrammetry, mapping system and our flagship resource modeling solution including performance improvements and new functionality for condition simulation;

-    We released an innovative new drill and blast design system featuring automated design and electronic transfer of data to drill rigs;

-    We released a major update to our stratigraphic modeling system, with improvements in model calibration, fault modeling and contouring.

 

**ORDERS**

CAE Healthcare sales this quarter included:

-    Ten ultrasound simulators and five surgical simulators to five National Health Service (NHS) hospitals through the Local Education and Training Board committees of Health Education England;

-    Three patient simulators, one ultrasound simulator, two ultrasound task trainers, a centre management system and multi-year warranty to a public research university in the U.S.;

-    Five patient simulators, two ultrasound simulators, two ultrasound task trainers and a multi-year warranty to a private university in the U.S.;

-    A centre management system to a public university in Saudi Arabia.

 

30 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

CAE Mining sales this quarter included:

-    Resourcemodeling, stratigraphic modeling and mine planning systems to Kazakhmys PLC inKazakhstan;

-    A mineventilation automation project for Fresnillo PLC’s San Julian mine in Mexico;

-    Openpit resource modeling and mine planning systems to Swakop Uranium (Pty) Ltd inNamibia.

 

| **Financial  results**                             |                 |            |           |      |            |          |        |        |        |      |   |    |   |    |   |   |
|----------------------------------------------------|----------------------|-----------------|----------------|-----------|-----------------|---------------|-------------|-------------|-------------|-----------|--------|---------|--------|---------|--------|--------|
| *(amounts  in millions, except operating margins)* | **FY2014**           |            | FY2013         |      |            | **Q4-2014**   |        | Q3-2014     |        | Q2-2014   |   | Q1-2014 |   | Q4-2013 |   |
| Revenue                                            | $                    | **116.2 ** | 112.1     |      | **29.6 **  | 29.7     | 27.1   | 29.8   | 29.0   |
| Segment  operating income                          | $                    | **4.2 **   | 6.4       |      | **0.2 **   | 1.4      | 1.0    | 1.6    | 1.8    |
| *Operating  margins*                               | *%*                  | ***3.6 *** | 5.7       |      | ***0.7 *** | *4.7 *   | *3.7 * | *5.4 * | *6.2 * |
| Depreciation  and amortization                     | $                    | **14.2 **  | 11.7      |      | **3.9 **   | 3.5      | 3.3    | 3.5    | 4.0    |
| Property,  plant and equipment                     |                 |            |           |      |            |          |        |        |        |
|                                               | expenditures         | $               | **3.1 **  | 3.1  |            | **0.7 ** | 0.6    | 0.7    | 1.1    | 0.7  |
| Intangible  assets and other                       |                 |            |           |      |            |          |        |        |        |
|                                               | assets  expenditures | $               | **13.4 ** | 9.5  |            | **3.8 ** | 4.1    | 2.8    | 2.7    | 2.5  |
| Capital  employed                                  | $                    | **222.4 ** | 199.2     |      | **222.4 ** | 217.8    | 205.7  | 207.6  | 199.2  |

 

**Revenue stablecompared to last quarter and up 2% over the fourth quarter of fiscal 2013**

Revenue was stablecompared to last quarter. Lower revenue from CAE Mining was offset by higherrevenue from CAE Healthcare. In CAE Mining, revenue was lower due to a decreasein software licence and consulting services revenue. In CAE Healthcare, higherrevenue from surgical simulators and from centre management systems, includingthe impact from a stronger U.S. dollar against the Canadian dollar, waspartially offset by lower patient simulator revenue. 

 

The increase overthe fourth quarter of fiscal 2013 was mainly due to higher revenue from CAEHealthcare, partially offset by lower revenue from CAE Mining. In CAEHealthcare, revenue was higher due to an increase in surgical and patientsimulator revenue, including the impact of a stronger U.S. dollar against theCanadian dollar. In CAE Mining, revenue was lower due to a decrease in softwarelicence and consulting services revenue.

**Revenue was $116.2 million this year, 4% or$4.1 million higher than last year**

The increase wasmainly due to higher revenue from CAE Healthcare, partially offset by lowerrevenue from CAE Mining. In CAE Healthcare, higher ultrasound task trainer andsurgical simulator revenue and higher centre management system revenue,including the impact from a stronger U.S. dollar against the Canadian dollarand an expanded installation base, was partially offset by lower patientsimulator revenue. In CAE Mining, revenue was lower due to the cyclicaldownturn in the mining industry, with lower software licence and consultingservices revenue partially offset by an increase in software maintenancerevenue.

**Segment operatingincome down 86% compared to last quarter and 89% compared to thefourth quarter of fiscal 2013**

Segment operating income was $0.2million this quarter (0.7% of revenue), compared to segment operating income of$1.4 million (4.7% of revenue) last quarter and a segment operating income of$1.8 million (6.2% of revenue) in the fourth quarter of fiscal 2013. 

 

The decrease in segment operatingincome from the last quarter was mainly due to lower revenue from CAE Mining,as mentioned above.

 

The decrease from the fourthquarter of fiscal 2013 was mainly due to lower segment operating income fromCAE Mining as a result of lower revenue, partially offset by lower selling,general and administrative expenses.

**Segment operating income was $4.2 million this year,34% or $2.2 million lower than last year**

Segmentoperating income  was $4.2  million (3.6% of revenue) this year, compared to a segment operating income of $6.4  million (5.7%of revenue) last year.

 

The decrease from last year wasmainly due to lower segment operating income from CAE Mining as a result oflower revenue, partially offset by lower selling, general and administrativeexpenses.

**Capital employed increased by $4.6 million over lastquarter and by $23.2 million over last year**

The increase over last quarter was mainly dueto higher intangible assets mainly as a result of movements inforeign exchange rates, partially offset by an increase in accounts payable andaccrued liabilities. 

 

The increaseover last year was mainly due to higher intangible assets mainly as a result ofmovements in foreign exchange rates.

CAE Annual Report 2014 | 31

 

----

Management’s Discussion and Analysis

**6.****    ****CONSOLIDATED CASH MOVEMENTS AND LIQUIDITY**

 

We manage liquidity and regularly monitor the factors that could affect it, including:

-    Cash generated from operations, including timing of milestone payments and management of working capital;

-    Capital expenditure requirements;

-    Scheduled repayments of long-term debt obligations, our credit capacity and expected future debt market conditions.[

 

 

**6.1     Consolidated cash movements**

 

| *(amounts in millions)***                               |                                     | **FY2014**      |           |        | FY2013    |   |            |           | **Q4-2014** |      |   | Q3-2014     |       |   |   | Q4-2013 |   |
|---------------------------------------------------------|------------------------------------------|-----------------|----------------|-------------|-----------|--------|-----------------|----------------|-------------|-----------|--------|-------------|------------|--------|--------|---------|--------|
| Cash provided by operating activities*                  | **$**                                    | **304.8 ** | $              | 239.1  |      | **$**  | **96.4 **  | $              | 56.2   |      | $      | 80.6   |
| Changes in non-cash working capital                     |                                     | **(28.8)**      |           | (84.6)      |      |   | **27.9 **  |           | (39.2)      |      |   | 33.1   |
| Net cash provided by operating activities               | **$**                                    | **276.0 ** | $              | 154.5  |      | **$**  | **124.3 ** | $              | 17.0   |      | $      | 113.7  |
| Maintenance capital expenditures8                  |                                     | **(46.1)**      |           | (31.8)      |      |   | **(15.1)**      |           | (14.4)      |      |   | (2.7)       |
| Other assets                                            |                                     | **(23.8)**      |           | (21.8)      |      |   | **(5.3)**       |           | (5.6)       |      |   | (7.1)       |
| Proceeds from the disposal of property, plant           |                                     |            |           |        |      |   |            |           |        |      |   |        |
|                                                    | and equipment                            |            | **15.4 ** |        | 9.2  |   |            | **8.5 **  |        | 0.5  |   |        | 1.1   |
| Net proceeds (payments) from equity accounted investees |                                     | **4.2 **   |           | (1.4)       |      |   | **1.8 **   |           | 0.4    |      |   | 1.4    |
| Dividends received from equity accounted investees      |                                     | **15.0 **  |           | 11.9   |      |   | **0.8 **   |           | -      |      |   | 9.0    |
| Dividends paid                                          |                                     | **(40.1)**      |           | (37.1)      |      |   | **(9.9)**       |           | (10.6)      |      |   | (10.2)      |
| Free cash flow 8                                   | **$**                                    | **200.6 ** | $              | 83.5   |      | **$**  | **105.1 ** | $              | (12.7)      |      | $      | 105.2  |
| Growth capital expenditures 8                      |                                     | **(111.3)**     |           | (64.9)      |      |   | **(50.6)**      |           | (22.8)      |      |   | (11.0)      |
| Capitalized development costs                           |                                     | **(48.1)**      |           | (49.6)      |      |   | **(14.1)**      |           | (11.7)      |      |   | (12.6)      |
| Other cash movements, net                               |                                     | **3.6 **   |           | 3.5    |      |   | **14.0 **  |           | 1.0    |      |   | 1.5    |
| Business combinations, net of cash and cash             |                                     |            |           |        |      |   |            |           |        |      |   |        |
|                                                    | equivalents acquired                     |            | **(3.8)**      |        | (285.3)   |   |            | **(0.4)**      |        | (2.9)     |   |        | (0.7)      |
| Effect of foreign exchange rate changes on              |                                     |            |           |        |      |   |            |           |        |      |   |        |
|                                                    | cash and cash equivalents                |            | **23.4 ** |        | -    |   |            | **9.5 **  |        | 9.3  |   |        | -     |
| Net increase (decrease) in cash before                  |                                     |            |           |        |      |   |            |           |        |      |   |        |
|                                                    | proceeds and repayment of long-term debt | **$**           | **64.4 ** | $           | (312.8)   |   | **$**           | **63.5 ** | $           | (39.8)    |   | $           | 82.4  |
| * before changes in non-cash working capital            |                                     |            |           |        |      |   |            |           |        |      |   |        |       |   |   |    |   |

 

**Free cash flow was $105.1 million for the quarter**

Free cash flow was $117.8  million higher than last quarter and $0.1  million lower compared to the fourth quarter of fiscal 2013.   

 

Free cash flow was higher compared to last quarter mainly due to an increase in cash provided by operating activities and favourable changes in non-cash working capital.

 

Free cash flow remained stable compared to the fourth quarter of fiscal 2013. The decrease related to unfavourable changes in non-cash working capital and higher maintenance capital expenditures was offset by an increase in cash provided by operating activities. 

**Free cash flow was $200.6 million this year**

Free cash flow increased $117.1 million, or 140%, compared to last year. 

 

Free cash flow was higher compared to last year mainly due to an increase in cash provided by operating activities and favourable changes in non-cash working capital.

**Capital expenditures were $65.7 million this quarter and $157.4 million for the year**

Growth capital expenditures were $50.6 million this quarter and $111.3 million for the year. Our growth capital allocation decisions are market-driven in nature and are intended to keep pace with the demands of our existing and new customers. Maintenance capital expenditures were $15.1 million this quarter and $46.1 million for the year.

----

8 Non-GAAP and other financial measures (see Section 3.6).

32 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

 

**6.2****     ****Sources of****liquidity**

 

We have committed lines of credit at floating rates, eachprovided by a syndicate of lenders. We and some of our subsidiaries can borrowfunds directly from these credit facilities to cover operating and generalcorporate expenses and to issue letters of credit and bank guarantees.

 

The total amount available through these committed banklines at March 31, 2014 was US$550.0 million (2013 – US$550.0 million) with anoption, subject to lender’s consent, to increase to a total amount of US$850.0million. There was an equivalent of US$49.1 million drawn under the facilities as at March 31, 2014 (2013 – US$66.5million) and US$120.4 million was used for letters of credit (2013 – US$121.6million). The applicable interest rate on this revolving term credit facilityis at our option, based on the bank’s prime rate, bankers’ acceptance rates orLIBOR plus a spread which depends on the credit rating assigned by Standard& Poor’s Rating Services. Effective October 1, 2013, we amended ourrevolving unsecured term credit facilities to extend the maturity date fromApril 2017 to October 2018.

 

We have an unsecured Export Development Canada (EDC)Performance Security Guarantee (PSG) account for US$150.0 million. This is anuncommitted revolving facility for performance bonds, advance paymentguarantees or similar instruments. As at March 31, 2014, the total outstanding for all these instruments translated intoCanadian dollars, was $48.8 million (2013 – $62.6 million).

 

We have a facility of €10.0 million with a European bankfor the issuance of bank guarantees and letters of credit. The amount usedprincipally in support of our European military operations, translated intoCanadian dollars, was approximately $9.5 million (2013 – $9.6 million).

 

We manage a program in which we sell undivided interests incertain of our accounts receivable and contracts in progress assets (currentfinancial assets program) to third parties for cash consideration for amountsup to $150.0 million without recourse to CAE. As at March 31, 2014, we sold $79.5million of accounts receivable (2013 – $88.6 million) and $4.2 million ofcontracts in progress (2013 – $3.1 million).

 

In September 2013 and October 2013, we entered into variousfinance leases for the leasing of simulators located in the U.S. Thesetransactions represent a total finance lease obligation of $34.2 million as atMarch 31, 2014.

 

In February 2014 we entered into an interest-bearinglong-term obligation with the Government of Canada relative to ProjectInnovate, an R&D program extending over five and a half years, for a maximumamount of $250.0 million. The discounted value of the debt recognized amountedto $1.3 million as at March 31, 2014.

 

We have certain debt agreements which require that wemaintain a certain level of capital. As at March 31, 2014, we are compliant withall our financial covenants.

 

We believe that our cash and cash equivalents, access tocredit facilities and expected free cash flow will provide sufficientflexibility for our business, the payment of dividends and will enable us tomeet all other expected financial requirements in the near term.

 

| The following table  summarizes the long-term debt: |                |              |            |          |   |   |
|-----------------------------------------------------|---------------------|-------------------|-----------------|---------------|--------|--------|
|                                                | **As  at March 31** |              | As  at March 31 |          |
| *(amounts in millions)*                             | **2014 **      | 2013         |
| Total long-term debt                                | **$**               | **1,168.5 ** | $               | 1,073.4  |
| Less:                                               |                |              |            |          |
| Current portion of  long-term debt                  |                | **23.8 **    |            | 43.7     |
| Current portion of  finance leases                  |                | **26.8 **    |            | 26.9     |
| Long-term portion of  long-term debt                | **$**               | **1,117.9 ** | $               | 1,002.8  |

CAE Annual Report 2014 | 33

 

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Management’s Discussion and Analysis

 

 

**6.3****     ****Government assistance**

We have signed agreements with various governments whereby the latter share in the cost, based on expenditures incurred by CAE, of certain R&D programs for modeling, simulation and training services expertise.

 

During fiscal 2009, we announced Project Falcon, an R&D program that extended over five years. The goal of Project Falcon was to expand our modeling and simulation technologies, develop new ones and increase our capabilities beyond training into other areas of the aerospace and defence market, such as analysis and operations. Concurrently, the Government of Canada agreed to participate in Project Falcon through a repayable investment of up to $250 million made through the Strategic Aerospace and Defence Initiative (SADI), which supports strategic industrial research and pre-competitive development projects in the aerospace, defence, space and security industries. As at March 31, 2014, Project Falcon was completed.

 

During fiscal 2010, we announced Project New Core Markets, an R&D program extending over seven years. The aim is to leverage our modeling, simulation and training services expertise into the healthcare and mining markets. The Québec government, through Investissement Québec, agreed to participate up to $100 million in contributions related to costs incurred before the end of fiscal 2016.

 

During fiscal 2014, we announced Project Innovate, an R&D program extending over five and a half years. The goal of Project Innovate is to expand our modeling and simulation technologies, develop new ones and continue to differentiate our service offering. Concurrently, the Government of Canada agreed to participate in Project Innovate through a repayable investment of up to $250 million made through the SADI.

 

You will find more details in Note 1 and Note 13 of our consolidated financial statements.

___

**6.4****     ****Contractual obligations**

We enter into contractual obligations and commercial commitments in the normal course of our business. These include debentures, notes and others. The table below shows when they mature.

 

| **Contractual obligations**                  |   |            |   |   |            |   |   |            |   |   |           |   |   |            |   |           |            |   |          |              |   |
|----------------------------------------------|--------|-----------------|--------|--------|-----------------|--------|--------|-----------------|--------|--------|----------------|--------|--------|-----------------|--------|----------------|-----------------|--------|---------------|-------------------|--------|
| *As at March 31, 2014 (amounts in millions)* |   | **2015 **  |   |   | **2016 **  |   |   | **2017 **  |   |   | **2018 ** |   |   | **2019 **  |   | **Thereafter** |            |   | **Total**     |              |
| Long-term debt (excluding interest)          | $      | 24.5       |   | $      | 31.9       |   | $      | 98.2       |   | $      | 34.4      |   | $      | 75.9       |   | $              | 749.1      | $      | 1,014.0  |
| Finance leases (excluding interest)          |   | 26.8       |   |   | 20.1       |   |   | 13.7       |   |   | 13.7      |   |   | 11.5       |   |           | 73.4       |   | 159.2    |
| Operating leases                             |   | 53.4       |   |   | 43.1       |   |   | 36.3       |   |   | 29.4      |   |   | 22.1       |   |           | 77.5       |   | 261.8    |
| Purchase obligations                         |   | 12.2       |   |   | 5.3        |   |   | 5.3        |   |   | -         |   |   | -          |   |           | -          |   | 22.8     |
|                                         | **$**  | **116.9 ** |   | **$**  | **100.4 ** |   | **$**  | **153.5 ** |   | **$**  | **77.5 ** |   | **$**  | **109.5 ** |   | **$**          | **900.0 ** |   | **$**         | **1,457.8 ** |

 

We also had total availability under the committed credit facilities of US$380.5 million as at March 31, 2014 compared to US$361.9 million at March 31, 2013. 

 

We have purchase obligations related to agreements that are enforceable and legally binding. Most are agreements with subcontractors to provide services for long-term contracts that we have with our clients. The terms of the agreements are significant because they set out obligations to buy goods or services in fixed or minimum amounts, at fixed, minimum or variable prices and at various points in time.

 

As at March 31, 2014, we had other long-term liabilities that are not included in the table above. These include some accrued pension liabilities, deferred revenue, deferred gains on assets and various other long-term liabilities. CAE’s cash obligation in respect of the accrued employee pension liability depends on various elements including market returns, actuarial gains and losses and interest rates.

 

We did not include deferred 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.

34 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**7.****    ****CONSOLIDATED FINANCIAL POSITION**

 

**7.1   Consolidated capital employed**

 

|                                                 |           | **As at March 31** |   |          | As at March 31 |   |
|------------------------------------------------------|----------------|--------------------|--------|---------------|----------------|--------|
| *(amounts in millions)***                            | **2014 ** | 2013          |
| **Use of capital:**                                  |           |               |   |          |
| Current assets****                                   | **$**          | **1,350.8 **  | $      | 1,307.6  |
| Less: cash and cash equivalents****                  |           | **(312.3)**        |   | (260.0)       |
| Current liabilities****                              |           | **(964.5)**        |   | (906.4)       |
| Less: current portion of long-term debt              |           | **50.6 **     |   | 70.6     |
| Non-cash working capital9                       | **$**          | **124.6 **    | $      | 211.8    |
| Property, plant and equipment                        |           | **1,341.2 **  |   | 1,142.8  |
| Other long-term assets                               |           | **1,544.7 **  |   | 1,240.9  |
| Other long-term liabilities                          |           | **(672.1)**        |   | (635.7)       |
| Total capital employed                               | **$**          | **2,338.4 **  | $      | 1,959.8  |
| **Source of capital:**                               |           |               |   |          |
| Current portion of long-term debt****                | **$**          | **50.6 **     | $      | 70.6     |
| Long-term debt****                                   |           | **1,117.9 **  |   | 1,002.8  |
| Less: cash and cash equivalents****                  |           | **(312.3)**        |   | (260.0)       |
| Net debt9                                       | **$**          | **856.2 **    | $      | 813.4    |
| Equity attributable to equity holders of the Company |           | **1,441.6 **  |   | 1,114.6  |
| Non-controlling interests                            |           | **40.6 **     |   | 31.8     |
| Source of capital****                                | **$**          | **2,338.4 **  | $      | 1,959.8  |

 

**Capital employed increased $378.6 million, or 19%, over last year**

The increase over last year was mainly due to higher and property, plant and equipment and higher other long-term assets.

 

Our return on capital employed9 (ROCE) was 11.4% this year compared to 10.2% last year. 

**Non-cash working capitaldecreased by $87.2 million****[9] **

The decrease was mainly due to lower income taxes recoverable as a result of a reclassification of certain investment tax credits (ITCs) from short-term to long-term, an increase in contracts in progress liabilities and higher accounts payable and accrued liabilities. The decrease was partially offset by an increase in accounts receivable, inventories and prepayments. 

**Net property, plant and equipment up $198.4 million**

The increase was mainly due to $157.4 million of capital expenditures and $118.0 million of movements in foreign exchange rates, partially offset by depreciation of $99.5 million.

**Other long-term assets up $303.8 million**

The increase was mainly due to higher other assets as a result of a reclassification of certain ITCs from short-term to long-term and an increase in intangible assets, investment in equity accounted investees and other assets resulting primarily from movements in foreign exchange rates.

**Net debt higher than last year**

The increase was largely caused by the effect of foreign exchange rate changes on long-term debt and new finance leases signed during the year, partially offset by an increase in cash and cash equivalents.

 

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9 Non-GAAP and other financial measures (see Section 3.6).

CAE Annual Report 2014 | 35

 

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Management’s Discussion and Analysis

| **Change in net debt**                                    |                                                   |            |       |        |        |   |
|-----------------------------------------------------------|--------------------------------------------------------|-----------------|------------|-------------|-------------|--------|
|                                                      |                                                   |            |       |        |        |
| *(amounts in millions)*                                   | **FY2014**                                             |            | FY2013     |        |
| Net debt, beginning of period                             | **$**                                                  | **813.4 ** | $          | 453.0  |
| Impact of cash movements on net debt                      |                                                   |            |       |        |        |   |
|                                                      | (see table in the consolidated cash movements section) |            | **(64.4)** |        | 312.8  |
| Effect of foreign exchange rate changes on long-term debt |                                                   | **64.6 **  |       | 12.9   |
| Net finance lease additions                               |                                                   | **31.4 **  |       | -      |
| Other                                                     |                                                   | **11.2 **  |       | 34.7   |
| Increase in net debt during the period                    | **$**                                                  | **42.8 **  | $          | 360.4  |
| Net debt, end of period                                   | **$**                                                  | **856.2 ** | $          | 813.4  |

 

**Total equity increased by $335.8 million this year**

The increase in equity was mainly due to net income of $191.1 million and a favourable foreign currency translation of $159.5 million.

 

*Outstanding share data*

Our articles of incorporation authorize the issue of an unlimited number of common shares and an unlimited number of preferred shares issued in series. We had a total of 263,771,443 common shares issued and outstanding as at March 31, 2014 with total share capital of $517.5 million.

 

As at April 30, 2014, we had a total of 263,808,466 common shares issued and outstanding.

 

*Dividends*

We paid a dividend of $0.05 per share in the first and second quarter and $0.06 per share in the third and fourth quarter of fiscal 2014. These dividends were eligible under the Income Tax Act *(Canada) * and its provincial equivalents.

 

Our Board of Directors has the discretion to set the amount and timing of any dividend. The Board reviews the dividend policy once a year based on the cash requirements of our operating activities, liquidity requirements and projected financial position. We expect to declare dividends of approximately $63.3 million in fiscal 2015 based on our current dividend policy and the number of common shares outstanding as at March 31, 2014.

 

**Guarantees**

As at March 31, 2014, we have a total of $191.4 million outstanding letters of credit and performance guarantees which are not recognized in the consolidated statement of financial position, compared to $198.7 million last fiscal year. 

 

**Pension obligations**

We maintain defined benefit and defined contribution pension plans. We expect to contribute approximately $3.8 million more than the annual required contribution for current services to satisfy a portion of the underfunded liability of the defined benefit pension plan. In fiscal 2015, contributions necessary to fund our pension obligations are expected to decrease mainly as a result of improved long-term bond returns and stock market performance.

 

**7.2****     ****Off balance sheet arrangements**

Although most of our sale and leaseback transactions entered into as part of our TS/C operations are classified as finance leases and their obligations are included in the consolidated statement of financial position, certain sale and leaseback transactions are classified as operating leases and are off balance sheet obligations. 

 

Most of our current off balance sheet obligations are from obligations related to operating leases from:

-    The operation of a training centre for the MSH project with the U.K. Ministry of Defence to provide simulation training services. The operating lease commitments are between the operating company, which has the service agreement with the U.K. Ministry of Defence, and the asset company, which owns the assets. These leases are non-recourse to us;

-    Certain buildings that are leased throughout our training network and production facilities in the normal course of business;

-    Certain FFSs that are leased throughout our training network in the normal course of business.

 

You can find more details about operating lease commitments in Note 27 of our consolidated financial statements.

 

In the normal course of business, we manage a program in which we sell undivided interests in certain of our accounts receivable and contracts in progress assets (current financial assets program) to third parties for cash consideration for an amount up to $150.0 million without recourse to CAE. We continue to act as a collection agent. These transactions are accounted for when we have considered to have surrendered control over the transferred accounts receivable and contracts in progress assets. As at March 31, 2014, $79.5 million (2013 – $88.6 million) and $4.2 million (2013 – $3.1 million) of specific accounts receivable and contracts in progress assets respectively were sold to financial institutions pursuant to these agreements.

36 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

 

**7.3****     ****Financial instruments**

We are exposed to various financial risksin the normal course of business. We enter into forward and swap contracts tomanage our exposure to fluctuations in foreign exchange rates, interest ratesand changes in share price which have an effect on our share-based paymentscosts. We also continually assess whether the derivatives we use in hedgingtransactions are effective in offsetting changes infair values or cash flows of hedged items. We enterinto these transactions to reduce our exposure to risk and volatility, and notfor speculative reasons. We only deal with highly rated counterparties.

 

**Classification of financial instruments**

We have made the following classificationsfor our financial instruments:

-   Cash and cash equivalents, restricted cash andall derivative instruments, except for derivatives designated as effectivehedging instruments, are classified as fair value through profit and loss(FVTPL);

-   Accounts receivable, contracts in progress,non-current receivables and advances are classified as loans and receivables,except for those that we intend to sell immediately or in the near term, whichare classified as FVTPL;

-   Portfolio investments are classified asavailable-for-sale;

-   Accounts payable and accrued liabilities andlong-term debt, including interest payable, as well as finance leaseobligations and royalty obligations are classified as other financialliabilities, all of which are measured at amortized cost using the effectiveinterest rate method.

** **

**Fair value of financial instruments**

Thefair value of a financial instrument is determined by reference to theavailable market information at the reporting date. When no active marketexists for a financial instrument, we determine thefair value of that instrument based on valuation methodologies as discussedbelow. In determining assumptions required under a valuation model, weprimarily useexternal, readily observable market data inputs. Assumptions or inputs that arenot based on observable market data incorporate our bestestimates of market participant assumptions, and are used when external data isnot available. Counterparty credit risk and the fair values of our owncredit risk are takeninto account in estimating the fair value of all financial assets and financialliabilities, including derivatives.

 

Thefollowing assumptions and valuation methodologies have been used tomeasure fair value of financial instruments:

-   The fair value of accounts receivable, contractsin progress, accounts payable and accrued liabilities approximate theircarrying values due to their short-term maturities;

-   The fair value of derivative instruments,including forward contracts, swap agreements and embedded derivatives witheconomic characteristics and risks that are not clearly and closely related to thoseof the host contract, are determined using valuation techniques and arecalculated as the present value of the estimated future cash flows using anappropriate interest rate yield curve and foreign exchange rate. Assumptionsare based on market conditions prevailing at each reporting date. Derivativeinstruments reflect the estimated amounts that we would receive or pay tosettle the contracts at the reporting date;

-   The fair value of the available-for-saleinvestment which does not have a readily available market value, is estimatedusing a discounted cash flow model, which includes some assumptions that arenot supportable by observable market prices or rates;

-   The fair value of non-current receivables areestimated based on discounted cash flows using current interest rates forinstruments with similar terms and remaining maturities;

-   The fair value of provisions, long-term debt andnon-current liabilities, including finance lease obligations and royaltyobligations, are estimated based on discounted cash flows using currentinterest rates for instruments with similar terms and remaining maturities.

 

Adescription of the fair value hierarchy is discussed in Note 29 of ourconsolidated financial statements.

 

**Financial risk management**

Due to the nature of the activities thatwe carry out and as a result of holding financial instruments, we are exposedto credit risk, liquidity risk and market risk, including foreign currency riskand interest rate risk. Our exposure to credit risk, liquidity risk and marketrisk is managed within risk management parameters approved by the board ofdirectors. These risk management parameters remain unchanged since the previousperiod, unless otherwise indicated.

 

Embedded derivatives are recorded at fair value separately from thehost contract when their economic characteristics and risks are not clearly andclosely related to those of the host contract. We may enter into freestandingderivative instruments which are not eligible for hedge accounting, to offsetthe foreign exchange exposure of embedded foreign currency derivatives. In suchcircumstances, both derivatives are carried at fair value at each statement offinancial position date with the change in fair value recorded in consolidatednet income.

 

Our policy is not to utilize anyderivative financial instruments for trading or speculative purposes. We maychoose to designate derivative instruments, either freestanding or embedded, ashedging items. This process consists of matching derivative hedging instrumentsto specific assets and liabilities or to specific firm commitments orforecasted transactions. To some extent, we use non‐derivative financialliabilities to hedge foreign currency exchange rate risk exposures.

CAE Annual Report 2014 | 37

 

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Management’s Discussion and Analysis

***Credit risk***

Credit risk is defined as our exposure toa financial loss if a debtor fails to meet its obligations in accordance withthe terms and conditions of its arrangements with CAE. We are exposed to creditrisk on our accounts receivable and certain other assets through our normalcommercial activities. We are also exposed to credit risk through our normaltreasury activities on our cash and cash equivalents and derivative financialassets.

 

Credit risks arising from our normalcommercial activities are managed in regards to customer credit risk. An allowancefor doubtful accounts is established when there is a reasonable expectationthat we will not be able to collect all amounts due according to the originalterms of the receivables (See Note 4 of the consolidated financial statements).When a trade receivable is uncollectible, it is written-off against theallowance for doubtful accounts. Subsequent recoveries of amounts previouslywritten-off are recognized in income.

 

Our customers are mainly establishedcompanies with publicly available credit ratings and government agencies, whichfacilitates risk monitoring. In addition, we typically receive substantialnon-refundable advance payments for construction contracts. We closely monitorour exposure to major airlines in order to mitigate our risk to the extentpossible. Furthermore, our trade receivables are not concentrated with specificcustomers but are held with a wide range of commercial and governmentorganizations. As well, our credit exposure is further reduced by the sale ofcertain of our accounts receivable and contracts in progress assets tothird-party financial institutions for cash consideration on a non-recoursebasis (current financial assets program). We do not hold any collateral assecurity. The credit risk on cash and cash equivalents is mitigated by the factthat they are in place with a diverse group of major North American andEuropean financial institutions.

 

We are exposed to credit risk in the eventof non-performance by counterparties to our derivative financial instruments. Weuse several measures to minimize this exposure. First, we enter into contractswith counterparties that are of high credit quality. We signed *InternationalSwaps & Derivatives Association, Inc*. *(ISDA) * Master Agreementswith the majority of counterparties with whom we trade derivative financialinstruments. These agreements make it possible to offset when a contractingparty defaults on the agreement, for each of the transactions covered by theagreement and in force at the time of default. Also, collateral or othersecurity to support derivative financial instruments subject to credit risk canbe requested by CAE or our counterparties (or both parties, if need be) whenthe net balance of gains and losses on each transaction exceeds a thresholddefined in the ISDA Master Agreement. Finally, we monitor the credit standingof counterparties on a regular basis to help minimize credit risk exposure.

 

The carrying amounts presented in Note 4and Note 29 of the consolidated financial statements represent the maximumexposure to credit risk for each respective financial asset as at the relevantdates.

***Liquidity risk***

Liquidity risk is defined as the potentialthat we cannot meet our cash obligations as they become due.

 

We manage this risk by establishing cashforecasts, as well as long-term operating and strategic plans. The managementof consolidated liquidity requires a regular monitoring of expected cashinflows and outflows which is achieved through a forecast of our consolidatedliquidity position, for efficient use of cash resources. Liquidity adequacy isassessed in view of seasonal needs, growth requirements and capitalexpenditures, and the maturity profile of indebtedness, including off balancesheet obligations. We manage our liquidity risk to maintain sufficient liquidfinancial resources to fund our operations and meet our commitments andobligations. In managing our liquidity risk, we have access to a revolvingunsecured credit facility of US$550.0 million, with an option, subject tothe lender’s consent, to increase to a total amount of up to US$850.0 million.As well, we have agreements to sell certain of our accounts receivable andcontracts in progress assets for an amount of up to $150.0 million (currentfinancial assets program). We also regularly monitor any financingopportunities to optimize our capital structure and maintain appropriatefinancial flexibility.

***Market risk***

Market risk is defined as our exposure toa gain or a loss in the value of our financial instruments as a result ofchanges in market prices, whether those changes are caused by factors specificto the individual financial instruments or its issuer, or factors affecting allsimilar financial instruments traded in the market. We are mainly exposed toforeign currency risk and interest rate risk.

 

Weuse derivative instruments to manage market risk against the volatility inforeign exchange rates, interest rates and share-based payments in order tominimize their impact on our results and financial position. Our policy is notto utilize any derivative financial instruments for trading or speculativepurposes.

*Foreigncurrency risk*

Foreign currency risk is defined as ourexposure to a gain or a loss in the value of our financial instruments as aresult of fluctuations in foreign exchange rates. We are exposed to foreignexchange rate variability primarily in relation to certain sale commitments,expected purchase transactions and debt denominated in a foreign currency, aswell as on our net investment from our foreign operations which have functionalcurrencies other than the Canadian dollar (in particular the U.S. dollar, euroand British pound). In addition, these operations have exposure to foreignexchange rates primarily through cash and cash equivalents and other workingcapital accounts denominated in currencies other than their functionalcurrencies.

 

We also mitigate foreign currency risks byhaving our foreign operations transact in their functional currency formaterial procurement, sale contracts and financing activities.

 

38 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

We use forwardforeign currency contracts and foreign currency swap agreements to manage ourexposure from transactions in foreign currencies and to synthetically modifythe currency of exposure of certain financial position items. Thesetransactions include forecasted transactions and firm commitments denominatedin foreign currencies. Our foreign currency hedging programs are typicallyunaffected by changes in market conditions, as related derivative financialinstruments are generally held until their maturity, consistent with theobjective to fix currency rates on the hedged item.

* *

*Foreign currency risk sensitivityanalysis*

Foreign currency risk arises on financialinstruments that are denominated in a foreign currency. Assuming a reasonablypossible strengthening of 5% in the U.S. dollar, euro and British poundcurrency against the Canadian dollar as at March 31, 2013, and assuming allother variables remained constant, the pre-tax effects on net income would havebeen a negative net adjustment of $3.1 million (2013 – no significant effect) and a negative net adjustment of $21.5million (2013 – negative net adjustment of $25.0 million) on other comprehensive income (OCI). Areasonably possible weakening of 5% in the relevant foreign currency againstthe Canadian dollar would have an opposite impact on pre-tax income and OCI.

 

*Interestrate risk*

Interest rate risk is defined as ourexposure to a gain or a loss to the value of our financial instruments as aresult of fluctuations in interest rates. We bear some interest ratefluctuation risk on our floating rate long-term debt and some fair value riskon our fixed interest long-term debt. We mainly manage interest rate risk byfixing project-specific floating rate debt in order to reduce cash flowvariability. We have a floating rate debt through our revolving unsecuredcredit facility and other asset-specific floating rate debts. A mix of fixedand floating interest rate debt is sought to reduce the net impact offluctuating interest rates. Derivative financial instruments used tosynthetically convert interest rate exposures are mainly interest rate swapagreements. 

  

We use financial instruments to manage ourexposure to changing interest rates and to adjust our mix of fixed and floatinginterest rate debt on long-term debt. The mix was 84% fixed-rate and 16%floating-rate at the end of this year (2013 – 83% fixed rate and 17% floating rate).

 

Our interest rate hedging programs aretypically unaffected by changes in market conditions, as related derivative financialinstruments are generally held until their maturity to establish asset andliability management matching, consistent with the objective to reduce risksarising from interest rate movements. As a result, the changes in variableinterest rates do not have a significant impact on net income and OCI.

 

*Interestrate risk sensitivity analysis*

In fiscal 2014 and fiscal 2013, a 1%increase/decrease in interest rates would not have a significant impact on ournet income and OCI assuming all other variables remained constant.

 

*Hedgeof share-based payments cost*

We have entered into equity swapagreements with two major Canadian financial institutions to reduce our incomeexposure to fluctuations in our share price relating to the Deferred Share Unit(DSU) and Long-Term Incentive Deferred Share Unit (LTI-DSU) programs. Pursuantto the agreement, we receive the economic benefit of dividends and share priceappreciation while providing payments to the financial institutions for theinstitution’s cost of funds and any share price depreciation. The net effect ofthe equity swaps partly offset movements in our share price impacting the costof the DSU and LTI-DSU programs and is reset quarterly. As atMarch 31, 2014, the equity swap agreements covered 2,400,000 of ourcommon shares (2013 – 2,706,816).

 

*Hedge of net investments in foreignoperations*

As at March 31, 2014, we have designated aportion of our senior notes totalling US$417.8 million (2013 – US$417.8 million) and a portion of the sale lease back obligation totalling US$16.1million (2013 – US$17.9million) as a hedge of net investments in foreign operations. Gains or losses on the translation of the designated portion of oursenior notes are recognized in OCI to offset any foreign exchange gains orlosses on translation of the financial statements of foreign operations.

 

We have determined that there is noconcentration of risks arising from financial instruments and estimated thatthe information disclosed above is representative of our exposure to risk duringthe period.

 

Refer to the Consolidated Statements ofComprehensive Income for the total amount of the change in fair value offinancial instruments designated as cash flow hedges recognized in income forthe period and total amount of gains and losses recognized in OCI and to Note29 of the consolidated financial statements for the classification of financialinstruments.

CAE Annual Report 2014 | 39

 

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Management’s Discussion and Analysis

**8.****    ****Businesscombinations**

 

**Fiscal 2014 acquisitions**

During the year, we paid $3.8 million for business combinationtransactions of which $0.8 million was for the payment of contingentconsideration of previous acquisitions, $2.9 million (€2.1 million) was for thebalance of the purchase price for the May 2012 acquisition of OAA and $0.1million was to acquire the assets of RW Consulting and Training ServicesLTD (RWCTS), a provider of mining training and consulting services. The totalconsideration transferred for the RWCTS acquisition is $0.4 million,including $0.3 million of contingent consideration. 

 

**9.****    ****BUSINESS RISK AND UNCERTAINTY**

 

We operate in several industry segmentsthat have various risks and uncertainties. Management and the Board discussquarterly the principal risks facing our business, as well as annually duringthe strategic planning and budgeting processes. The risks and uncertaintiesdescribed below are risks that could materially affect our business, financialcondition and results of operation. These risks are categorized asindustry-related risks, risks specific to CAE and risks related to the currentmarket environment. These are not necessarily the only risks we face;additional risks and uncertainties that are presently unknown to us or that wemay currently deem immaterial may adversely affect our business.

 

In order to mitigate the risks thatmay impact our future performance, management has established an enterpriserisk management process to identify, assess and prioritize these risks.Management develops and deploys risk mitigation strategies that align with ourstrategic objectives and business processes. Management reviews the evolutionof the principal risks facing our business on a quarterly basis and the Boardoversees the risk management process and validates it through proceduresperformed by our internal auditors when it deems necessary. 

**9.1****     ****Risks relating to the industry**

**Competition**

We sellour simulation equipment and training services in highly competitive markets.New participants have emerged in recent years and the competitive environmenthas intensified as aerospace and defence companies position themselves to tryto take greater market share by consolidating existing civil simulationcompanies and by developing their own internal capabilities. Most recently, Textron,Lockheed Martin and L-3 Communications have acquired commercial aircraftsimulator competitors. Most of our competitors in the simulation and trainingmarkets are also involved in other major segments of the aerospace and defencecomplex beyond simulation and training. As such, they are larger than we are,and may have greater financial, technical, marketing, manufacturing anddistribution resources. In addition, our main competitors are either aircraftmanufacturers, or have well-established relationships with, or are importantsuppliers to, aircraft manufacturers, airlines and governments, which may givethem an advantage when competing for projects for these organizations. Inparticular, we face competition from Boeing, which has pricing and othercompetitive advantages over us. Boeing has a licencing model for Boeing civilaircraft simulators which includes a requirement for simulator manufacturersand service training operators to pay Boeing a royalty to manufacture, updateor upgrade a simulator, and to provide training services on Boeing simulators.

 

Airbushas decided to deepen its services offered to customers for training services.OEMs like Airbus and Boeing have certain advantages in competing withindependent training service providers. An OEM controls the pricing for thedata, parts and equipment packages that are often required to manufacture asimulator specific to that OEM’s aircraft, which in turn is a critical capitalcost for any simulation-based training service provider. OEMs may be in aposition to demand licence royalties to permit the manufacturing of simulatorsbased on the OEM’s aircraft, and/or to permit any training on such simulators.CAE also has some advantages, including being a simulator manufacturer, havingthe ability to replicate certain aircraft without data, parts and equipmentpackages from an OEM, and owning a diversified training network that includesjoint ventures with large airline operators which are aircraft customers forOEMs. We work with some OEMs on business opportunities related to equipment andtraining services. 

 

Weobtain most of our contracts through competitive bidding processes that subjectus to the risk of spending a substantial amount of time and effort on proposalsfor contracts that may not be awarded to us. A significant portion of ourrevenue is dependent on obtaining new orders and continuously replenishing ourbacklog. We cannot be certain that we will continue to win contracts throughcompetitive bidding processes at the same rate as we have in the past. Thepresence of new market participants as noted above, and their efforts to gain marketshare, creates heightened competition in bidding which may negatively impactpricing and margins.

 

Economicgrowth underlies the demand for all of our products and services. Periods ofeconomic recession, constrained credit, and or government austerity generallylead to heightened competition for each available order. This in turn typicallyleads to a reduction in profit on sales won during such a period. Should suchconditions occur, we could experience price and margin erosion. 

**Level and timing of defence spending**

Asignificant portion of our revenue comes from sales to defence and securitycustomers around the world. We are either the primary contractor or asubcontractor for various programs by Canadian, U.S., European, and otherforeign governments. If funding for a government program is cut, we could losefuture revenue, which could have a negative effect on our operations. Whencountries we have contracts with significantly lower their military spending,there could be a material negative effect on our sales and earnings. InEurope, force structure reductions and reduced future investment plans havenarrowed the pipeline of new opportunities. We arealso experiencing longer and delayed procurement processes in mature markets,such as the U.S. and Canada, which impacts the timing of contract awards andresults in delayed recognition of revenue.

40 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**Government-fundedmilitary programs**

Likemost companies that supply products and services to governments, we can beaudited and reviewed from time to time. Any adjustments that result fromgovernment audits and reviews may have a negative effect on our results ofoperations. Some costs may not be reimbursed or allowed in negotiations offixed-price contracts. As a result, we may also be subject to a higher risk oflegal actions and liabilities than companies that cater only to the privatesector, which could have a materially negative effect on our operations.

**Civil aviation industry**

Asignificant portion of our revenue comes from supplying equipment and trainingservices to the commercial and business airline industry.

 

If jetfuel prices attain high levels for a sustained period, there could be a greaterimpetus for airlines to replace older, less fuel-efficient aircraft. However, higher fuel costs could also limit theairlines’ available financial resources, and could potentially cause deliveriesof new aircraft to be delayed or cancelled. Airlines may slow capacity growthor cut capacity should sustained high fuel costs make the availability of suchcapacity not economically viable. Such a reaction would negatively affect thedemand for our training equipment and services. 

 

Constraintsin the credit market may reduce the ability of airlines and others to purchasenew aircraft, negatively affecting the demand for our training equipment andservices, and the purchase of our products. 

 

We arealso exposed to credit risk on accounts receivable from our customers. We haveadopted policies to ensure we are not significantly exposed to any individual customer.Our policies include analyzing the financial position of certain customers andregularly reviewing their credit quality. We also subscribe from time to timeto credit insurance and, in some instances, require a bank letter of credit tosecure our customers’ payments to us.

**Regulatory rules imposed by aviationauthorities**

We arerequired to comply with regulations imposed by aviation authorities. Theseregulations may change without notice, which could disrupt our sales andoperations. Any changes imposed by a regulatory agency, including changes tosafety standards imposed by aviation authorities such as the U.S. FAA, couldmean that we have to make unplanned modifications to our products and services,causing delays or resulting in cancelled sales. We cannot predict the impactthat changing laws or regulations might have on our operations. Any changescould present opportunities or, to the contrary, have a materially negativeeffect on our results of operations or financial condition.

**Sales or licences of certain CAE productsrequire regulatory approvals and compliance**

Thesale or licence of many of our products is subject to regulatory controls.These can prevent us from selling to certain countries, or to certain entitiesor people in a country, and require us to obtain from one or more governmentsan export licence or other approvals to sell certain technology such asmilitary related simulators or other training equipment, including militarydata or parts. These regulations change often and we cannot be certain that wewill be permitted to sell or licence certain products to customers, which couldcause a potential loss of revenue for us. 

 

If wefail to comply with government laws and regulations related to export controlsand national security requirements, we could be fined and/or suspended orbarred from government contracts or subcontracts for a period of time, whichwould negatively affect our revenue from operations and profitability, andcould have a negative effect on our reputation and ability to procure othergovernment contracts in the future.

**Conflict minerals**

We are subject to rules of theSecurities Exchange Commission (SEC) issued pursuant to the Dodd-Frank WallStreet Reform and Consumer Protection Act that require public companies toconduct due diligence on and disclose whether certain materials including gold,tantalum, tin and tungsten that originate from mines in the Democratic Republicof the Congo or certain adjoining countries, known as conflict minerals, areused in products that we manufacture. The first report is due by May 31, 2014for the 2013 calendar year and we have implemented appropriate measures tocomply with such requirements, including verifying with our suppliers thesources of their minerals. The implementation of these rules could adverselyaffect the sourcing, supply, and pricing of materials used in our products,although this has not proved to be the case to date. If we determine thatcertain of our products contain minerals not determined to be conflict free orif we are unable to sufficiently verify the origins for all conflict mineralsused in our products, it could have a negative effect on our reputation. 

 

CAE Annual Report 2014 | 41

 

----

Management’s Discussion and Analysis

**9.2****     ****Risks relating to the Company**

**Product evolution**

The civil aviation and defence andsecurity markets in which we operate are characterized by changes in customerrequirements, new aircraft models and evolving industry standards. If we do notaccurately predict the needs of our existing and prospective customers ordevelop product enhancements that address evolving standards and technologies,we may lose current customers and be unable to attract new customers. This could reduce our revenue. Theevolution of the technology could also have a negative impact on the value ofour fleet of FFSs.

**Research anddevelopment activities**

Wecarry out some of our R&D initiatives with the financial support ofgovernments, including the Government of Québec through Investissement Québec(IQ) and the Government of Canada through its Strategic Aerospace and DefenceInitiative (SADI). In February 2014, CAE and the Government of Canada enteredinto a new SADI funding program for a five and a half year period. The level ofgovernment financial support reflects government policy, fiscal policy andother political and economic factors. We may not, in the future, be able toreplace these existing programs with other government funding and/orrisk-sharing programs of comparable benefit to us, which could have a negativeimpact on our financial performance and research and development activities.

 

Wereceive investment tax credits on eligible R&D activities that we undertakein Canada from the federal government and investment tax credits on eligibleR&D activities that we undertake in Québec from the provincial government.The credits we receive are based on federal and provincial legislationcurrently enacted. The investment tax credits available to us can be reduced bychanges to the respective governments’ legislation which could have a negativeimpact on our financial performance and research and development activities. 

 

**Fixed-price andlong-term supply contracts**

Weprovide our products and services mainly through fixed-price contracts thatrequire us to absorb cost overruns, even though it can be difficult to estimateall of the costs associated with these contracts or to accurately project thelevel of sales we may ultimately achieve. In addition, a number of contracts tosupply equipment and services to commercial airlines and defence organizationsare long-term agreements that run up to 20 years. While some of these contractscan be adjusted for increases in inflation and costs, the adjustments may notfully offset the increases, which could negatively affect the results of ouroperations.

** **

**Procurement andOEM leverage**

Wesecure data, parts, equipment and many other inputs from a wide variety ofOEMs, sub-contractors and other sources. We are not always able to find two ormore sources for inputs that we require and in the case of specific aircraftsimulators and other training equipment, significant inputs can only be solesourced. We may therefore be vulnerable to delivery schedule delays, thefinancial condition of the sole-source suppliers and their willingness to dealwith us. Within their corporate groups, some sole-source suppliers includebusinesses that compete with parts of our business. This could lead to onerouslicencing terms, high licence fees or even refusal to licence to us the data,parts and equipment packages that are often required to manufacture and operatefor training, a simulator based on an OEM’s aircraft. 

**Warranty orother product-related claims**

Wemanufacture simulators that are highly complex and sophisticated. These maycontain defects that are difficult to detect and correct. If our products failto operate correctly or have errors, there could be warranty claims or we couldlose customers. Correcting these defects could require significant capitalinvestment. If a defective product is integrated into our customer’s equipment,we could face product liability claims based on damages to the customer’sequipment. Any claims, errors or failures could have a negative effect on ouroperating results and business. We cannot be certain that our insurancecoverage will be sufficient to cover one or more substantial claims.

 

**Product integration and programmanagement risk**

Ourbusiness could be negatively affected if our products do not successfullyintegrate or operate with other sophisticated software, hardware, computing andcommunications systems that are also continually evolving. If we experiencedifficulties on a project or do not meet project milestones, we may have todevote more engineering and other resources than originally anticipated. Whilewe believe we have recorded adequate provisions for risks of losses on fixed-pricecontracts, it is possible that fixed-price and long-term supply contracts couldsubject us to additional losses that exceed obligations under the terms of thecontracts.

** **

**Protection of intellectual property**

We relyin part on trade secrets and contractual restrictions, such as confidentialityagreements, patents and licences, to establish and protect our proprietaryrights. These may not be effective in preventing a misuse of our technology orin deterring others from developing similar technologies. We may be limited inour ability to acquire or enforce our intellectual property rights in somecountries. Litigationrelated to our intellectual property rights could be lengthy and costly andcould negatively affect our operations or financial results, whether or not weare successful in defending a claim.

**Intellectualproperty**

Ourproducts contain sophisticated software and computer systems that are suppliedto us by third parties. These may not always be available to us. Our productionof simulators often depends on receiving confidential or proprietary data onthe functions, design and performance of a product or system that oursimulators are intended to simulate. We may not be able to obtain this data onreasonable terms, or at all.

 

Infringementclaims could be brought against us or against our customers. We may not besuccessful in defending these claims and we may not be able to developprocesses that do not infringe on the rights of third parties, or obtainlicences on terms that are commercially acceptable, if at all.

42 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

 

Certain markets in which we operate,including without limitation the healthcare market, are subject to extensivepatenting by third parties. Our ability to modify existing products or todevelop new products may be constrained by third party patents such that weincur incremental costs to licence the use of the patent or design around theclaims made therein.

**Key personnel**

Ourcontinued success will depend in part on our ability to retain and attract keypersonnel with the relevant skills, expertise and experience. Our compensationpolicy is designed to mitigate this risk.

 

**Environmentalliabilities**

We use,generate, store, handle and dispose of hazardous materials at our operations,and used to at some of our discontinued or sold operations. Past operators atsome of our sites also carried out these activities.

 

Newlaws and regulations, stricter enforcement of existing laws and regulations,the discovery of previously unknown contamination, new clean-up requirements orclaims on environmental indemnities we have given may result in us having toincur substantial costs. This could have a materially negative effect on ourfinancial condition and results of operations.

 

Inaddition, our discontinued operations are largely uninsured against suchclaims, so an unexpectedly large environmental claim against a discontinuedoperation could reduce our profitability in the future.

 

**Liability claimsarising from casualty losses**

Because of thenature of our business, we may be subject to liability claims, including claimsfor serious personal injury or death, arising from:

-   Accidents or disasters involving trainingequipment that we have sold or aircraft for which we have provided trainingequipment or services;

-   Our pilot provisioning;

-   Our live flight training operations.

 

We mayalso be subject to product liability claims relating to equipment and servicesthat our discontinued operations sold in the past. We cannot be certain thatour insurance coverage will be sufficient to cover one or more substantialclaims.

**Integration of acquired businesses**

Thesuccess of our acquisitions depends on our ability to crystallize synergiesboth in terms of successfully marketing our broadened product offering as wellas efficiently consolidating the operations of the acquired businesses into ourexisting operations.

**Our ability to penetrate new markets**

We are leveragingour knowledge, experience and best practices in simulation-based aviationtraining and optimization to penetrate the simulation-based training markets inhealthcare and mining.

 

As we operatein these markets, unforeseen difficulties and expenditures could arise, whichmay have an adverse effect on our operations, profitability and reputation.Penetrating new markets is inherently more difficult than managing within ouralready established core markets.

**Enterprise resource planning (ERP)**

Followingthe successful implementation of the Canadian manufacturing portion of the ERPsystem in fiscal 2013, we continue to invest time and money in the next phases.If the system does not operate as expected or when expected, we may not be ableto realize the expected value of the system and this may have a negative effecton our operations, reporting capabilities, profitability and reputation. Agovernance process has been designed to mitigate this risk.

**Length of sales cycle**

Thesales cycle for our products and services is long and unpredictable, rangingfrom 6 to 18 months for civil aviation applications and from 6 to 24 months orlonger for military applications. During the time when customers are evaluatingour products and services, we may incur expenses and management time. Makingthese expenditures in a period that has no corresponding revenue will affectour operating results and could increase the volatility of our share price. Wemay pre-build certain products in anticipation of orders to come and tofacilitate a faster delivery schedule to gain competitive advantage; if ordersfor those products do not materialize when expected, we have to carry the pre-builtproduct in inventory for a period of time until a sale is realized.

**Security and information technology**

We depend on information technologynetworks and systems to process, transmit and store electronic data andfinancial information, to manage business operations and to comply withregulatory, legal, national security, contractual and tax requirements. Inaddition, our business requires the appropriate and secure utilization ofsensitive and confidential information belonging to third parties such asaircraft OEMs and national defence forces. An information technology systemfailure, cyber-attack or breach of systems security could disrupt ouroperations, cause the loss of, or unauthorized access to, business information,compromise confidential information, expose us to regulatory investigation andlitigation, require significant management attention and resources and couldmaterially and adversely affect our operations, reputation and financialperformance. We have implemented security controls, policy enforcementmechanisms and monitoring systems in order to prevent, detect and addresspotential threats. 

  

CAE Annual Report 2014 | 43

 

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Management’s Discussion and Analysis

**9.3****     ****Risks relating to the market**

**Foreign exchange**

Ouroperations are global with approximately 90% of our revenue generated fromworldwide exports and international activities generally denominated in foreigncurrencies, mainly the U.S. dollar, the Euro and the British pound. Our revenueis generated approximately one-third in each of the U.S, Europe and the rest ofthe world.

 

Asignificant portion of the revenue generated in Canada is in foreigncurrencies, while a large portion of our operating costs in Canadian dollars.When the Canadian dollar increases in value, it negatively affects our foreigncurrency-denominated revenue and hence our financial results. Wecontinue to hold a portfolio of currency hedging positions intended to mitigatethe risk to a portion of future revenues presented by the volatility of theCanadian dollar versus foreign currencies. The hedges are intended to cover aportion of the revenue in order to allow the unhedged portion to match theforeign cost component of the contract. It is not possible to completely offsetthe effects of changing foreign currency values, which leaves some residualexposure that may impact our financial results. When the Canadiandollar decreases in value, it negatively affects our foreigncurrency-denominated costs and our competitive position compared to otherequipment manufacturers in jurisdictions where operating costs are lower. Inorder to reduce the variability of specific U.S. dollar and Euro-denominatedmanufacturing costs, we also hedge some of theforeign currency costs incurred in our manufacturing process. 

 

Businessconducted through our foreign operations are substantially based in localcurrencies. A natural hedge exists by virtue of revenues and operating expensesbeing in like currencies. However, changes in the value of foreign currenciesrelative to the Canadian dollar creates unhedged currency translation exposuresince results are consolidated in Canadian dollars for financial reportingpurposes. Devaluation of foreign currencies against the Canadian dollar wouldhave a negative translation impact and an appreciation of foreign currenciesagainst the Canadian dollar would have the opposite effect.

**Availability of capital**

Our main credit facility, which was extendedin October 2013, is scheduled for renewal in October 2018. We cannot determineat this time whether the credit facility will be renewed at the same cost, forthe same duration and on similar terms as were previously available. 

 

We also have various debt facilities withmaturities until October 2036. We cannot determine at this time whether thesefacilities will be refinanced at the same cost, for the same durations and onsimilar terms as were previously available.

**Pension plans**

Pensionfunding is based on actuarial estimates and is subject to limitations underapplicable income tax and other regulations. Actuarial estimates preparedduring the year were based on assumptions related to projected employeecompensation levels at the time of retirement and the anticipated long-termrate of return on pension plan assets. The actuarial funding valuation reportsdetermine the amount of cash contributions that we are required to contributeinto the registered retirement plans. Our latest pension funding reports showthe pension plans to be in a solvency deficit position. Therefore, we arerequired to make cash funding contributions. If this reduced level of pensionfund assets persists to the date of the next funding valuations, we will berequired to increase our cash funding contributions, reducing the availabilityof funds for other corporate purposes. 

** **

**Doing business inforeign countries**

We haveoperations in 35 countries and sell our products and services to customersaround the world. Sales to customers outside North America made upapproximately 60% of revenue in fiscal 2014. We expect sales outside NorthAmerica to continue to represent a significant portion of revenue in theforeseeable future. As a result, we are subject to the risks of doing businessinternationally, including geopolitical instability.

 

These are the main risks we are facing:

-    Change in laws and regulations;

-    Tariffs, embargoes, controls and other restrictions;

-    General changes in economic and geopolitical conditions;

-    Complexity and corruption risks of using foreign representatives andconsultants.

 

**Income tax laws**

A substantial portion of our business is conducted inforeign countries and is thereby subject to numerous countries’ tax laws andfiscal policies. A change in applicable tax laws, treaties or regulations ortheir interpretation could result in a higher effective tax rate on ourearnings which could be significant to our financial results.

44 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

**10.**** ****RELATED PARTY TRANSACTIONS**

 

A list of principal investments which significantly impact our results or assets is presented in Note 32 of our consolidated financial statements.

 

The following table presents our outstanding balances with joint ventures:

 

| *(amounts in millions)*                  |   |   |   | **2014 ** |   |   | 2013  |
|------------------------------------------|--------|--------|--------|----------------|--------|--------|------------|
| Accounts receivable                      |   |   | **$**  | **30.1 ** |   | $      | 49.9  |
| Contracts in progress: assets            |   |   |   | **13.5 ** |   |   | 41.3  |
| Other assets                             |   |   |   | **30.6 ** |   |   | 34.3  |
| Accounts payable and accrued liabilities |   |   |   | **16.3 ** |   |   | 25.3  |
| Contracts in progress: liabilities       |   |   |   | **6.3 **  |   |   | 9.3   |

 

Other assets include a finance lease receivable of $16.9 million (March 31, 2013 - $19.0 million) maturing in October 2022 and carrying an interest rate of 5.14% per annum, loans receivable of $8.4 million (March 31, 2013 - $10.4 million) maturing in September 2016 and December 2017 and carrying respectively an interest rate of LIBOR 6 month plus 1% and 11% per annum and a long-term receivable of $5.3 million (March 31, 2013 – $4.9 million) with no repayment term. As at March 31, 2014 and 2013, there are no provisions held against any of the receivables from related parties.

 

The following table presents our transactions with joint ventures:

 

| *(amounts in millions)*                       |   |   |   | **2014 **  |   |   | 2013   |
|-----------------------------------------------|--------|--------|--------|-----------------|--------|--------|-------------|
| Revenue from products and services            |   |   | **$**  | **101.0 ** |   | $      | 131.5  |
| Purchases of products and services, and other |   |   |   | **11.3 **  |   |   | 12.3   |
| Other income transactions                     |   |   |   | **2.9 **   |   |   | 2.8    |

 

In addition, during fiscal 2014, transactions amounting to $2.7 million (2013 –  $4.3 million) were made, at normal market prices, with organizations whose partners or officers included one of our directors.

 

**Compensation of key management personnel**

Key management personnel have the ability and responsibility to make major operational, financial and strategic decisions for the Company and include certain executive officers. The compensation of key management for employee services is shown below:

 

| *(amounts in millions)*                         |   |   |   | **2014 ** |   |   | 2013  |
|-------------------------------------------------|--------|--------|--------|----------------|--------|--------|------------|
| Salaries and other short-term employee benefits |   |   | **$**  | **3.8 **  |   | $      | 4.0   |
| Post-employment benefits                        |   |   |   | **1.6 **  |   |   | 2.0   |
| Termination benefits                            |   |   |   | **2.4 **  |   |   | -     |
| Share-based payments                            |   |   |   | **6.4 **  |   |   | 2.4   |
|                                            |   |   | **$**  | **14.2 ** |   | $      | 8.4   |
|                                            |   |   |   |           |   |   |       |   |   |
|                                            |   |   |   |           |   |   |       |   |   |

CAE Annual Report 2014 | 45

 

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Management’s Discussion and Analysis

**11.**** ****changes in accounting POLICIES**

 

**11.1****    ****New and amended standards adopted**

 

***Joint arrangements***

In May 2011, theIASB released IFRS 11, *Joint Arrangements*, which supersedes IAS 31, *Interestsin Joint Ventures*, and SIC-13, *Jointly Controlled Entities –Non-monetary Contributions by Venturers*. IFRS 11 focuses on the rights andobligations of a joint arrangement, rather than its legal form as waspreviously the case under IAS 31. The standard addresses inconsistencies in thereporting for joint arrangements by requiring the equity method to account forinterests in jointly controlled entities. We previously accounted for ourinterests in joint ventures using the proportionate consolidation method andnow account for our interests  in joint ventures using the equity method.IFRS 11 was adopted retrospectively effective April 1st, 2013 in accordancewith the transition rules of IFRS 11. 

 

Under the equitymethod, our share of net assets, net income and other comprehensive income(OCI) of joint ventures will be presented as one-line items on the statement offinancial position, the statement of income and the statement of comprehensiveincome, respectively. In addition, the consolidated statement of cash flowsincludes the cash flows between us  and our  joint ventures, and not our proportionate share of the joint ventures’ cash flows. We assessed that theclassification of our joint arrangements remained the same upon adoption ofIFRS 11. When making this assessment,  we considered the structure of thearrangements, the legal form of any separate vehicles, the contractual terms ofthe arrangements and other facts and circumstances. 

 

***Employee benefits***

In June 2011, theIASB amended IAS 19, *Employee Benefits*. IAS 19 was amended to requirethe calculation of a net interest that iscalculated by applying the discount rate to the net defined benefit liability or asset and  to expand the disclosure requirements.  As a result, we determined  a net interest expense on the net definedbenefit liability which is presented as part of the finance expense. The net interest on the defined benefit obligationliability or asset replaces the interest cost on the defined benefit obligationand the expected return on plan assets.  Theamended IAS 19 was adopted retrospectively effective April 1st, 2013in accordance with the transition rules of the amended IAS 19 and additionaldisclosure is provided in Note 14 of our annual consolidated financialstatements.  

 

***Consolidation***

In May 2011, theIASB released IFRS 10, *Consolidated Financial Statements*, which replacesSIC-12, *Consolidation – Special Purpose Entities*, and parts of IAS 27, *Consolidatedand Separate Financial Statements*. The new standard builds on existingprinciples by identifying the concept of control as the determining factor inwhether an entity should be included in a company’s consolidated financialstatements. IFRS 10 was adopted retrospectivelyeffective April 1st,2013 in accordance with the transitionrules of IFRS 10. We assessedthat the adoption of IFRS 10 does  not result in any change in theconsolidation status of our subsidiaries. 

 

***Disclosure of interests in other entities***

In May 2011, theIASB released IFRS 12, *Disclosure of Interests in Other Entities*. IFRS12 requires disclosure for all forms of interests in otherentities, including joint arrangements, associates and unconsolidatedstructured entities. The standard requires an entity to disclose informationregarding the nature and risks associated with its interests in other entitiesand the effects of those interests in its financial position, financialperformance and cash flows. IFRS 12 was adopted effective April 1st,2013 in accordance with the transitionrules of IFRS 12. The newdisclosure pursuant to IFRS 12 is  included in our  annual consolidatedfinancial statements.

*** ***

***Fair value measurement***

In May 2011, theIASB released IFRS 13, *Fair Value Measurement*. IFRS 13 defines fairvalue, sets out in a single IFRS a framework for measuring fair value andrequires disclosure about fair value measurements. IFRS 13 applies when otherIFRS standards require or permit fair value measurements. It does not extend the use of fair valueaccounting but provides guidance on how it should be applied when its use isalready required or permitted by other standards within IFRS. IFRS 13 was adoptedprospectively effective April 1st, 2013 in accordance with the transitionalrules of IFRS 13. Other than additional disclosure which is included in Note 29, the adoption of IFRS 13 has no significant impact onour consolidated financial statements. 

 

***Financial statement presentation***

In June 2011, theIASB amended IAS 1, *Financial Statement Presentation,*to change thedisclosure of items presented in OCI, including a requirement to separate itemspresented in OCI into two groups based on whether or not they may be recycledto net income in the future. The amendments were adoptedeffective April 1st, 2013 inaccordance with the transition rules of IAS 1. The new OCI requirements are presented in ourconsolidated statement of comprehensive income.

*** ***

***Financial instrument disclosures***

In December 2011,the IASB amended IFRS 7, *Financial Instrument: Disclosures*, on asset andliability offsetting. The amendment requires additional disclosuresillustrating the effect or potential effect of netting arrangements associatedwith our  recognized financial assets and financial liabilities.The amendments were adopted retrospectively effective April 1st, 2013 inaccordance with the transition rules of IFRS 7 and the additional disclosure is included in Note 29 of our annualconsolidated financial statements . 

*** ***

46 | CAE Annual Report 2014

 

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Management’s Discussion and Analysis

***Property, plant and equipment***

In the 2011 Annual Improvements, the IASB amended IAS 16, *Property, Plant and Equipment,*to clarify when certain assets are property, plant and equipment or inventory. This amendment clarifies that major spare parts and servicing equipment that meet the definition of property, plant and equipment are not inventory. The 2011 annual improvement amendment removes the requirement for spare parts and servicing equipment used only in connection with an item of property, plant and equipment to be classified as property, plant and equipment. This annual improvement was adopted retrospectively effective April 1st, 2013 in accordance with the transition rules of IAS 16. The amendment of IAS 16 has  no impact on our consolidated financial statements.

 

***Impairment of non-financial assets***

In May 2013, the IASB amended IAS 36, *Impairment of assets* regarding disclosures for non-financial assets. This amendment removed certain disclosures related to the recoverable amount of CGUs which had been included in IAS 36 with  the issue of IFRS 13. The amendment is not mandatory until January 1st, 2014, however; we  have  decided to adopt the amendment as of April 1st, 2013. 

 

The following tables summarize the adjustments to our consolidated statement of financial position as at April 1, 2012 and March 31, 2013, and our consolidated statements of income, comprehensive income and cash flows for the year ended March 31, 2013 as a result of those changes in accounting policies: 

 

| **Summary reconciliation of financial position** |                     |
|--------------------------------------------------|--------------------------|
|                                             |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             |                     |   |   |   |   | IFRS 11 |   |   | IAS 19 |   | **March 31, 2013** |   |   |   | IFRS 11 |   |   | IAS 19 |   | **April 1, 2012** |   |
| *(amounts in millions)*                          | March 31, 2013           |   | Adjustment |   | Adjustment |   | **Restated** |   | April 1, 2012 |   | Adjustment |   | Adjustment |   | **Restated** |   |
| **Assets**                                       |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                        |                     | $ | 293.2  | $ | (33.2) | $ | -  | **$** | **260.0 ** | $ | 287.3  | $ | (32.6) | $ | -  | **$** | **254.7 ** |
| Total current assets, excluding                  |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             | cash and cash equivalent |   | 1,040.6  |   | 7.0  |   | -  |   | **1,047.6 ** |   | 860.8  |   | 0.1  |   | -  |   | **860.9 ** |
| Property, plant and equipment                    |                     | 1,498.6  |   | (355.8) |   | -  |   | **1,142.8 ** |   | 1,293.7  |   | (300.5) |   | -  |   | **993.2 ** |
| Investment in equity                             |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             | accounted investees      |   |   | -  |   | 196.9  |   | -  |   | **196.9 ** |   | -  |   | 172.9  |   | -  |   | **172.9 ** |
| Other non-current assets                         |                     |   | 1,046.3  |   | (2.3) |   | -  |   | **1,044.0 ** |   | 741.9  |   | 5.3  |   | -  |   | **747.2 ** |
| **Total assets**                                 |                     | $ | 3,878.7  | $ | (187.4) | $ | -  | **$** | **3,691.3 ** | $ | 3,183.7  | $ | (154.8) | $ | -  | **$** | **3,028.9 ** |
| **Liabilities and equity**                       |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total current liabilities                        |                     | $ | 1,002.8  | $ | (96.4) | $ | -  | **$** | **906.4 ** | $ | 883.4  | $ | (57.6) | $ | -  | **$** | **825.8 ** |
| Provisions                                       |                     |   | 8.3  |   | (0.4) |   | -  |   | **7.9 ** |   | 6.0  |   | (0.5) |   | -  |   | **5.5 ** |
| Long-term debt                                   |                     |   | 1,097.0  |   | (94.2) |   | -  |   | **1,002.8 ** |   | 685.6  |   | (97.2) |   | -  |   | **588.4 ** |
| Royalty obligations                              |                     |   | 160.6  |   | -  |   | -  |   | **160.6 ** |   | 161.6  |   | -  |   | -  |   | **161.6 ** |
| Employee benefits obligations                    |                     |   | 136.1  |   | -  |   | -  |   | **136.1 ** |   | 114.2  |   | -  |   | 0.1  |   | **114.3 ** |
| Other non-current liabilities                    |                     |   | 339.4  |   | (8.3) |   | -  |   | **331.1 ** |   | 290.7  |   | (8.8) |   | -  |   | **281.9 ** |
| **Total liabilities**                            |                     | $ | 2,744.2  | $ | (199.3) | $ | -  | **$** | **2,544.9 ** | $ | 2,141.5  | $ | (164.1) | $ | 0.1  | **$** | **1,977.5 ** |
| **Equity**                                       |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Share capital                                    |                     | $ | 471.7  | $ | -  | $ | -  | **$** | **471.7 ** | $ | 454.5  | $ | -  | $ | -  | **$** | **454.5 ** |
| Contributed surplus                              |                     |   | 21.9  |   | -  |   | -  |   | **21.9 ** |   | 19.2  |   | -  |   | -  |   | **19.2 ** |
| Accumulated other                                |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             | comprehensive loss       |   |   | (16.6) |   | 4.6  |   | -  |   | **(12.0)** |   | (9.8) |   | 3.8  |   | -  |   | **(6.0)** |
| Retained earnings                                |                     |   | 625.7  |   | 7.3  |   | -  |   | **633.0 ** |   | 558.0  |   | 5.5  |   | (0.1) |   | **563.4 ** |
| Equity attributable to equity                    |                     |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                             | holders of the Company   |   | $ | 1,102.7  | $ | 11.9  | $ | -  | **$** | **1,114.6 ** | $ | 1,021.9  | $ | 9.3  | $ | (0.1) | **$** | **1,031.1 ** |
| Non-controlling interests                        |                     |   | 31.8  |   | -  |   | -  |   | **31.8 ** |   | 20.3  |   | -  |   | -  |   | **20.3 ** |
| **Total equity**                                 |                     | $ | 1,134.5  | $ | 11.9  | $ | -  | **$** | **1,146.4 ** | $ | 1,042.2  | $ | 9.3  | $ | (0.1) | **$** | **1,051.4 ** |
| **Total liabilities and equity**                 |                     | $ | 3,878.7  | $ | (187.4) | $ | -  | **$** | **3,691.3 ** | $ | 3,183.7  | $ | (154.8) | $ | -  | **$** | **3,028.9 ** |

 

CAE Annual Report 2014 | 47

 

----

Management’s Discussion and Analysis

| **Reconciliation of net income**                        |
|---------------------------------------------------------|
|                                                    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Year ended March 31, 2013*                             |   | As previously |   |   |   | IFRS 11 |   |   |   | IAS 19 |   |   |   |   |   |
| *(amounts in millions, except per share amounts)*       |   |   | reported |   |   | Adjustment |   |   | Adjustment |   |   | **Restated** |   |
| Revenue                                                 |   |   | $ | 2,104.5  |   | $ | (69.3) |   | $ | -  |   | **$** | **2,035.2 ** |
| Cost of sales                                           |   |   |   | 1,482.8  |   |   | (31.8) |   |   | (0.6) |   |   | **1,450.4 ** |
| **Gross profit**                                        |   |   | $ | 621.7  |   | $ | (37.5) |   | $ | 0.6  |   | **$** | **584.8 ** |
| Research and development expenses                       |   |   |   | 60.6  |   |   | (0.5) |   |   | -  |   |   | **60.1 ** |
| Selling, general and administrative expenses            |   |   |   | 269.9  |   |   | (5.6) |   |   | 0.2  |   |   | **264.5 ** |
| Other gains – net                                 |   |   |   | (23.4) |   |   | 1.0  |   |   | -  |   |   | **(22.4)** |
| After tax share in profit of equity accounted investees |   |   |   | -  |   |   | (20.1) |   |   | -  |   |   | **(20.1)** |
| Restructuring, integration and acquisition costs        |   |   |   | 68.9  |   |   | (0.2) |   |   | -  |   |   | **68.7 ** |
| **Operating profit**                                    |   |   | $ | 245.7  |   | $ | (12.1) |   | $ | 0.4  |   | **$** | **234.0 ** |
| Finance income                                          |   |   |   | (7.3) |   |   | (2.1) |   |   | -  |   |   | **(9.4)** |
| Finance expense                                         |   |   |   | 75.5  |   |   | (6.1) |   |   | 5.1  |   |   | **74.5 ** |
| Finance expense – net                             |   |   | $ | 68.2  |   | $ | (8.2) |   | $ | 5.1  |   | **$** | **65.1 ** |
| **Earnings before income taxes**                        |   |   | $ | 177.5  |   | $ | (3.9) |   | $ | (4.7) |   | **$** | **168.9 ** |
| Income tax expense                                      |   |   |   | 35.1  |   |   | (5.7) |   |   | (1.2) |   |   | **28.2 ** |
| **Net income**                                          |   |   | $ | 142.4  |   | $ | 1.8  |   | $ | (3.5) |   | **$** | **140.7 ** |
| Attributable to:                                        |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity holders of the Company                           |   |   | $ | 139.4  |   | $ | 1.8  |   | $ | (3.5) |   | **$** | **137.7 ** |
| Non-controlling interests                               |   |   |   | 3.0  |   |   | -  |   |   | -  |   |   | **3.0 ** |
| **Earnings per share from continuing operations**       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **attributable to equity holders of the Company**       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                       |   |   | $ | 0.54  |   | $ | -  |   | $ | (0.01) |   | **$** | **0.53 ** |
| Weighted average number of                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| shares outstanding (basic)                              |   |   |   | 259.0  |   |   | -  |   |   | -  |   |   | **259.0 ** |
| Weighted average number of                              |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| shares outstanding (diluted)                            |   |   |   | 259.4  |   |   | -  |   |   | -  |   |   | **259.4 ** |

 

| **Summary reconciliation of comprehensive income** |   |
|----------------------------------------------------|--------|
|                                               |   |   |   |   |   |   |   |   |   |
| *Year ended March 31, 2013*                        |   | As previously |   | IFRS 11 |   |   | IAS 19 |   |   |   |   |   |
| *(amounts in millions)*                            |   |   | reported |   | Adjustment |   | Adjustment |   |   | **Restated** |   |
| **Net income**                                     |   |   | $ | 142.4  | $ | 1.8  | $ | (3.5) |   | **$** | **140.7 ** |
| Foreign currency translation                       |   |   | $ | 2.5  | $ | -  | $ | -  |   | **$** | **2.5 ** |
| Net changes in cash flow hedge                     |   |   |   | (9.2) |   | 0.8  |   | -  |   |   | **(8.4)** |
| Defined benefit plan actuarial losses              |   |   |   | (22.5) |   | -  |   | 3.6  |   |   | **(18.9)** |
| Other comprehensive loss                           |   | $ | (29.2) | $ | 0.8  | $ | 3.6  |   | **$** | **(24.8)** |
| **Total comprehensive income**                     |   | $ | 113.2  | $ | 2.6  | $ | 0.1  |   | **$** | **115.9 ** |
| Attributable to:                                   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Equity holders of the Company                      |   |   | $ | 110.1  | $ | 2.6  | $ | 0.1  |   | **$** | **112.8 ** |
| Non-controlling interests                          |   |   |   | 3.1  |   | -  |   | -  |   |   | **3.1 ** |
|                                               |   | $ | 113.2  | $ | 2.6  | $ | 0.1  |   | **$** | **115.9 ** |

 

| **Summary reconciliation of statement of cash flows** |   |
|-------------------------------------------------------|--------|
|                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Year ended March 31, 2013*                           |   |   | As previously |   |   | IFRS 11 |   |   | IAS 19 |   |   |   |   |
| *(amounts in millions)*                               |   |   |   |   | reported |   | Adjustment |   | Adjustment |   | **Restated** |   |
| Cash provided by operating activities                 |   |   |   | $ | 204.1  | $ | (49.6) | $ | -  | **$** | **154.5 ** |
| Cash used in investing activities                     |   |   |   |   | (504.9) |   | 71.2  |   | -  |   | **(433.7)** |
| Cash provided by financing activities                 |   |   |   |   | 306.7  |   | (22.2) |   | -  |   | **284.5 ** |
|                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

48 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

 

**11.2****    ****New and amended standards not yetadopted**

**Financial Instruments**

In October 2010, theIASB released  IFRS 9, *FinancialInstruments*.  IFRS 9, which is the first part of a three-partproject to replace IAS 39, *Financial Instruments: recognition andmeasurement.* This first part addresses the classification and measurementof financial assets and financial liabilities. The IASB is considering makinglimited modifications to this part, which would include the introduction of afair value through OCI category for debt instruments that would be based on acompany’s business model. In November 2013, the IASB released the hedgeaccounting part, introducing a new hedge accounting model, together withassociated disclosures about risk management activity. Impairment of financialassets, the third part of the project, is still under development. 

* *

Replacing the multiple rules in IAS 39, thefirst part of IFRS 9 uses a new approach to determine whether a financial assetis measured at amortized cost or fair value and is based on how a company managesits financial instruments and the contractual cash flow characteristics of thefinancial assets. The majority of the requirements in IAS 39 for classificationand measurement of financial liabilities were carried forward in IFRS 9; however,the portion of the changes in fair value related to the company’s own creditrisk, in measuring a financial liability at FVTPL, will be presented in OCIrather than in the income statement. The new hedge accounting model representsa substantial overhaul of hedge accounting that will enable companies to betterreflect their risk management activities in their financial statements.

 

The initial mandatory effective date ofIFRS 9, set for annual periods beginning on or after January 1, 2015, has beenremoved by the IASB, and a new date will be determined closer to projectcompletion, however, early application is permitted. We are currentlyevaluating the impact of the standard on our consolidated financial statements.

 

In June 2013, the IASB amended IAS 39 toprovide relief from discontinuing hedge accounting when novation of aderivative designated as a hedging instrument meets certain criteria. This amendmentwill be effective for our fiscal year beginning on April 1, 2014. Similar relief will be included in IFRS 9.

**Employee benefits**

In November 2013, the IASB amended IAS19, Employee benefits. The amendment simplifies the accounting forcontributions to defined benefit plans that are independent of the number ofyears of employee service, for example, employee contributions that arecalculated according to a fixed percentage of salary. The amendment iseffective for annual periods beginning on or after January 1, 2015,with earlier application permitted. We are currently evaluating the impact ofthe amendment on our consolidated financial statements. 

** **

**11.3****    ****Use of judgements, estimates and assumptions**

 

Thepreparation of the consolidated financial statements requires our management tomake judgements, estimates and assumptions that affect the application ofaccounting policies, the reported amounts of assets and liabilities and disclosuresat the date of the consolidated financial statements, as well as the reportedamounts of revenues and expenses for the period reported. We also requiremanagement to exercise its judgement in applying our accounting policies. Theareas involving a high degree of judgement or complexity, or areas whereassumptions and estimates are significant to the consolidated financialstatements are disclosed below. Actual results could differ from thoseestimates. Changes will be reported in the period in which they are identified.

**Business combinations**

Businesscombinations are accounted for in accordance with the acquisition method; thus,on the date that control is obtained. The consideration transferred and the acquiree’sidentifiable assets, liabilities and contingent liabilities are measured attheir fair value. Depending on the complexity of determining these valuations,we either consult with independent experts or develop the fair value internallyby using appropriate valuation techniques which are generally based on aforecast of the total expected future net discounted cash flows. Theseevaluations are linked closely to the assumptions made by management regardingthe future performance of the related assets and the discount rate. Contingent considerationis measured at fair value using a discounted cash flow model based on expectedrevenues.

**Development costs**

Developmentcosts are recognized as intangible assets and are amortized over their usefullives when they meet the criteria for capitalization. Forecasted revenue andprofitability for the relevant projects are used to assess compliance with thecapitalization criteria and to assess the recoverable amount of the assets.

 

CAE Annual Report 2014 | 49

 

----

Management’s Discussion and Analysis

**Impairment of non-financial assets***   *

Ourimpairment test for goodwill is based on internal estimates (level 3) of fairvalue less costs of disposal calculations and uses valuation models such as thediscounted cash flows model. The cash flows are derived from the projections approvedby management for the next five years. Cash flow projections take into accountpast experience and represent management’s best estimate about futuredevelopments and form part of our strategic plan approved annually by our Boardof Directors. Cash flows after the five-year period are extrapolated usingestimated growth rates. Key assumptions which management has based itsdetermination of fair value less costs of disposal include estimated growthrates, post-tax discount rates and tax rates. The post-tax discount rates werederived from the respective cash generating units’ representative weightedaverage cost of capital which range from 7.5% to 14.0%. These estimates,including the methodology used, can have a material impact on the respectivevalues and ultimately the amount of any goodwill impairment. 

 

Likewise,whenever property, plant and equipment and intangible assets are tested forimpairment, the determination of the assets’ recoverable amount involves theuse of estimates by management and can have a material impact on the respectivevalues and ultimately the amount of any impairment.

** **

**Revenuerecognition**

Thepercentage-of-completion method requires us to estimate the work performed todate as a proportion of the total work to be performed. Management conductsmonthly reviews of its estimated costs to complete, percentage-of-completionestimates and revenues and margins recognized, on a contract-by-contract basis.The impact of any revisions in cost and earnings estimates is reflected in theperiod in which the need for a revision becomes known. 

** **

**Definedbenefit pension plans**

Thecost of defined benefit pension plans and the present value of the employeebenefits obligations are determined using actuarial valuations. Actuarialvaluations involve making assumptions about discount rates, future salaryincreases, mortality rates and future pension increases. All assumptions arereviewed at each reporting date. Any changes in these assumptions will impactthe carrying amount of the employee benefits obligations and the cost of thedefined benefit pension plans. In determining the appropriated discount rate,management considers the interest rates of high quality corporate bonds thatare denominated in the currency in which the benefits will be paid, and thathave terms to maturity approximating the terms of the related pensionliability. The mortality rate is based on publicly available mortality tablesfor the specific country. Future salary increases and pension increases arebased on expected future inflation rates for the specific country.

 

Otherkey assumptions for pension obligations are based, in part, on current marketconditions. See Note 14 of our consolidated financial statements for furtherdetails regarding assumptions used.

** **

**Governmentassistance repayments**

Indetermining the amount of repayable government assistance, assumptions andestimates are made in relation to discount rates, expected revenues and theexpected timing of revenues. Revenue projections take into account pastexperience and represent management’s best estimate about the future. Revenuesafter a five-year period are extrapolated using estimated growth rates, rangingfrom 5% to 9%, over the period of repayments. The estimated repayments arediscounted using average rates ranging from 6% to 8.5% based on terms of similar financial instruments. Theseestimates, along with the methodology used to derive the estimates, can have amaterial impact on the respective values and ultimately any repayableobligation in relation to government assistance. A 1% increase to the growthrates would increase the royalty obligation at March 31, 2014 by approximately$9.4 million (2013 − $10.2 million).

 

**Share-basedpayments**

Wemeasure the cost of cash and equity-settled transactions with employees byreference to the fair value of the related instruments at the date at whichthey are granted. Estimating fair value for share-based payments requiresdetermining the most appropriate valuation model for a grant, which isdependent on the terms and conditions of the grant. This also requires makingassumptions and determining the most appropriate inputs to the valuation modelincluding the expected life of the option, volatility and dividend yield.

 

**Incometaxes**

Weare subject to income tax laws in numerous jurisdictions. Judgement is requiredin determining the worldwide provision for income taxes. The determination oftax liabilities and assets involve certain uncertainties in the interpretationof complex tax regulations. We provide for potential tax liabilities based onthe weighted average probability of the possible outcomes. Differences betweenactual results and those estimates could have an effect on the income taxliabilities and deferred tax liabilities in the period in which suchdeterminations are made. 

 

Deferredtax assets are recognized to the extent that it is probable that taxable profitwill be available against the losses that can be utilised. Significantmanagement judgement is required to determine the amount of deferred tax assetsthat can be recognized, based upon the likely timing and the level of futuretaxable profits together with future tax planning strategies. The recordedamount of total deferred tax assets could be altered if estimates of projectedfuture taxable income and benefits from available tax strategies are lowered,or if changes in current tax regulations are enacted that impose restrictionson the timing or extent of our ability to utilise future tax benefits.

50 | CAE Annual Report 2014

 

----

Management’s Discussion and Analysis

**12.**** ****CONTROLS AND PROCEDURES**

The internal auditor reports regularly to management on any weaknesses it finds in our internal controls and these reports are reviewed by the Audit Committee.

 

In accordance with National Instrument 52-109 issued by the Canadian Securities Administrators (CSA), certificates signed by the President and Chief Executive Officer (CEO) and the Chief Financial Officer (CFO) have been filed. These filings certify the appropriateness of our disclosure controls and procedures and the design and effectiveness of the internal controls over financial reporting.

 

**12.1****    ****Evaluation of disclosure controls and procedures**

Our disclosure controls and procedures are designed to provide reasonable assurance that information is accumulated and communicated to our President and CEO and CFO and other members of management, so we can make timely decisions about required disclosure.

 

Under the supervision of the President and CEO and the CFO, management evaluated the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) and 15d-15(e) under *U.S. Securities Exchange Act of 1934*, as of March 31, 2014. The President and CEO and the CFO concluded from the evaluation that the design and operation of our disclosure controls and procedures were effective as at March 31, 2014, and ensure that information is recorded, processed, summarized and reported within the time periods specified under Canadian and U.S. securities laws.

**12.2****  ****Internal control over financial reporting**

Management is responsible for establishing and maintaining adequate internal controls over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the *U.S. Securities Exchange Act of 1934*. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting, and the preparation of consolidated financial statements for external purposes in accordance with IFRS. Management evaluated the design and operation of our internal controls over financial reporting as of March 31, 2014, based on the framework and criteria established in *Internal Control – Integrated Framework*(1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and has concluded that our internal control over financial reporting is effective. Management did not identify any material weaknesses.

 

There were no changes in our internal controls over financial reporting that occurred during fiscal year 2014 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

**13.**** ****OVERSIGHT ROLE OF AUDIT COMMITTEE AND BOARD OF DIRECTORS**

The Audit Committee reviews our annual MD&A and related consolidated financial statements with management and the external auditor and recommends them to the Board of Directors for their approval. Management and our internal auditor also provide the Audit Committee with regular reports assessing our internal controls and procedures for financial reporting. The external auditor reports regularly to management on any weaknesses it finds in our internal control, and these reports are reviewed by the Audit Committee.

 

**14.**** ****ADDITIONAL INFORMATION**

You will find additional information about CAE, including our most recent AIF, on our website at www.cae.com, or on SEDAR at www.sedar.com or on EDGAR at www.sec.gov.

CAE Annual Report 2014 | 51

 

----

Management's Discussion and Analysis

**15.**** ****SELECTED FINANCIAL INFORMATION**

The following table provides selected quarterly financial information for the years 2012 through to 2014.

 

| *(amounts in millions, except per share amounts and exchange rates)*                                                                           | Q1     |            |   | Q2              |   |            | Q3     |            |   | Q4                |   |   | Total  |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|-----------------|--------|-------------------|--------|--------|--------|--------|
| **Fiscal 2014**                                                                                                                                |   |            |   |            |   |            |   |            |   |              |
| Revenue                                                                                                                                        | **$**  | **530.4 ** |   | **487.5 ** |   | **513.6 ** |   | **583.4 ** |   | **2,114.9 ** |
| Net income                                                                                                                                     | **$**  | **45.4 **  |   | **38.2 **  |   | **47.6 **  |   | **59.9 **  |   | **191.1 **   |
| Equity holders of the Company                                                                                                                  | **$**  | **45.6 **  |   | **38.3 **  |   | **46.1 **  |   | **60.0 **  |   | **190.0 **   |
| Non-controlling interests                                                                                                                      | **$**  | **(0.2)**       |   | **(0.1)**       |   | **1.5 **   |   | **(0.1)**       |   | **1.1 **     |
| Basic EPS attributable to equity holders of the Company                                                                                        | **$**  | **0.18 **  |   | **0.15 **  |   | **0.18 **  |   | **0.23 **  |   | **0.73 **    |
| Diluted EPS attributable to equity holders of the Company                                                                                      | **$**  | **0.18 **  |   | **0.15 **  |   | **0.18 **  |   | **0.23 **  |   | **0.73 **    |
| Average number of shares outstanding (basic)                                                                                                   |   | **260.2 ** |   | **261.0 ** |   | **261.5 ** |   | **262.7 ** |   | **261.3 **   |
| Average number of shares outstanding (diluted)                                                                                                 |   | **260.2 ** |   | **261.5 ** |   | **262.3 ** |   | **264.0 ** |   | **261.9 **   |
| Average exchange rate, U.S. dollar to Canadian dollar                                                                                          |   | **1.02 **  |   | **1.04 **  |   | **1.05 **  |   | **1.10 **  |   | **1.05 **    |
| Average exchange rate, Euro to Canadian dollar                                                                                                 |   | **1.34 **  |   | **1.38 **  |   | **1.43 **  |   | **1.51 **  |   | **1.41 **    |
| Average exchange rate, British pound to Canadian dollar                                                                                        |   | **1.57 **  |   | **1.61 **  |   | **1.70 **  |   | **1.83 **  |   | **1.68 **    |
| **Fiscal 2013**                                                                                                                                |   |            |   |            |   |            |   |            |   | Total             |   |
| Revenue                                                                                                                                        | $      | 462.2      |   | 506.5      |   | 500.9      |   | 565.6      |   | 2,035.2      |
| Net income                                                                                                                                     | $      | 21.9       |   | 35.9       |   | 37.2       |   | 45.7       |   | 140.7        |
| Equity holders of the Company                                                                                                                  | $      | 21.5       |   | 35.6       |   | 37.5       |   | 43.1       |   | 137.7        |
| Non-controlling interests                                                                                                                      | $      | 0.4        |   | 0.3        |   | (0.3)           |   | 2.6        |   | 3.0          |
| Basic EPS attributable to equity holders of the Company                                                                                        | $      | 0.08       |   | 0.14       |   | 0.14       |   | 0.17       |   | 0.53         |
| Diluted EPS attributable to equity holders of the Company                                                                                      | $      | 0.08       |   | 0.14       |   | 0.14       |   | 0.17       |   | 0.53         |
| Average number of shares outstanding (basic)                                                                                                   |   | 258.4      |   | 258.7      |   | 259.2      |   | 259.7      |   | 259.0        |
| Average number of shares outstanding (diluted)                                                                                                 |   | 258.6      |   | 259.0      |   | 259.5      |   | 260.2      |   | 259.4        |
| Average exchange rate, U.S. dollar to Canadian dollar                                                                                          |   | 1.01       |   | 1.00       |   | 0.99       |   | 1.01       |   | 1.00         |
| Average exchange rate, Euro to Canadian dollar                                                                                                 |   | 1.30       |   | 1.25       |   | 1.29       |   | 1.33       |   | 1.29         |
| Average exchange rate, British pound to Canadian dollar                                                                                        |   | 1.60       |   | 1.57       |   | 1.59       |   | 1.57       |   | 1.58         |
| **Fiscal 2012**1                                                                                                                          |   |            |   |            |   |            |   |            |   | Total             |   |
| Revenue                                                                                                                                        | $      | 427.9      |   | 433.5      |   | 453.1      |   | 506.7      |   | 1,821.2      |
| Net income                                                                                                                                     | $      | 43.5       |   | 38.7       |   | 46.1       |   | 53.7       |   | 182.0        |
| Equity holders of the Company                                                                                                                  | $      | 43.1       |   | 38.4       |   | 45.6       |   | 53.2       |   | 180.3        |
| Non-controlling interests                                                                                                                      | $      | 0.4        |   | 0.3        |   | 0.5        |   | 0.5        |   | 1.7          |
| Basic EPS attributable to equity holders of the Company                                                                                        | $      | 0.17       |   | 0.15       |   | 0.18       |   | 0.21       |   | 0.70         |
| Diluted EPS attributable to equity holders of the Company                                                                                      | $      | 0.17       |   | 0.15       |   | 0.18       |   | 0.21       |   | 0.70         |
| Average number of shares outstanding (basic)                                                                                                   |   | 257.0      |   | 257.3      |   | 257.6      |   | 257.9      |   | 257.5        |
| Average number of shares outstanding (diluted)                                                                                                 |   | 258.0      |   | 258.0      |   | 258.0      |   | 258.6      |   | 258.2        |
| Average exchange rate, U.S. dollar to Canadian dollar                                                                                          |   | 0.97       |   | 0.98       |   | 1.02       |   | 1.00       |   | 0.99         |
| Average exchange rate, Euro to Canadian dollar                                                                                                 |   | 1.39       |   | 1.38       |   | 1.38       |   | 1.31       |   | 1.37         |
| Average exchange rate, British pound to Canadian dollar                                                                                        |   | 1.58       |   | 1.58       |   | 1.61       |   | 1.57       |   | 1.58         |
|                                                                                                                                           |   |            |   |            |   |            |   |            |   |              |   |   |   |   |   |   |
| (1) Figures have not been restated to reflect the adoption of IFRS 11 and IAS 19. Refer to Changes in accounting policies for further details. |
|                                                                                                                                           |   |            |   |            |   |            |   |            |   |              |   |   |   |   |   |   |

52 | CAE Annual Report 2014

 

----

Management's Discussion and Analysis

 

| **Selected segment information**                                                                                                               |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *(amounts in millions, except operating margins)*                                                                                              |   |   | **Q4-2014** |   |   | Q4-2013 |   |   |   | **FY2014** |   |   | FY2013 |   |   | FY20121  |
| **Civil segments**                                                                                                                             |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Simulation Products/Civil**                                                                                                                  |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **125.1 ** | $ | 143.4  |   | **$** | **461.4 ** | $ | 456.8  | $ | 342.5  |   |
| Segment operating income                                                                                                                       |   | **21.1 ** |   | 25.8  |   |   | **83.5 ** |   | 88.2  |   | 51.6  |   |
| *Operating margins (%)*                                                                                                                        |   | ***16.9 *** |   | *18.0 * |   |   | ***18.1 *** |   | *19.3 * |   | *15.1 * |   |
| **Training & Services/Civil**                                                                                                              |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        |   | **198.4 ** |   | 176.1  |   |   | **715.3 ** |   | 659.8  |   | 498.4  |   |
| Segment operating income                                                                                                                       |   | **36.9 ** |   | 24.9  |   |   | **96.3 ** |   | 100.7  |   | 122.2  |   |
| *Operating margins (%)*                                                                                                                        |   | ***18.6 *** |   | *14.1 * |   |   | ***13.5 *** |   | *15.3 * |   | *24.5 * |   |
| **Total Civil segments**                                                                                                                       |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **323.5 ** | $ | 319.5  |   | **$** | **1,176.7 ** | $ | 1,116.6  | $ | 840.9  |   |
| Segment operating income                                                                                                                       |   | **58.0 ** |   | 50.7  |   |   | **179.8 ** |   | 188.9  |   | 173.8  |   |
| *Operating margins (%)*                                                                                                                        |   | ***17.9 *** |   | *15.9 * |   |   | ***15.3 *** |   | *16.9 * |   | *20.7 * |   |
| **Military segments**                                                                                                                          |   |   |   |   |   |   |   |   |   |   |   |   |
| **Simulation Products/Military**                                                                                                               |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **140.5 ** | $ | 153.1  |   | **$** | **529.3 ** | $ | 562.5  | $ | 619.2  |   |
| Segment operating income                                                                                                                       |   | **19.3 ** |   | 19.4  |   |   | **77.4 ** |   | 80.0  |   | 101.2  |   |
| *Operating margins (%)*                                                                                                                        |   | ***13.7 *** |   | *12.7 * |   |   | ***14.6 *** |   | *14.2 * |   | *16.3 * |   |
| **Training & Services/Military**                                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        |   | **89.8 ** |   | 64.0  |   |   | **292.7 ** |   | 244.0  |   | 278.1  |   |
| Segment operating income                                                                                                                       |   | **8.7 ** |   | 8.8  |   |   | **30.4 ** |   | 27.4  |   | 40.9  |   |
| *Operating margins (%)*                                                                                                                        |   | ***9.7 *** |   | *13.8 * |   |   | ***10.4 *** |   | *11.2 * |   | *14.7 * |   |
| **Total Military segments**                                                                                                                    |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **230.3 ** | $ | 217.1  |   | **$** | **822.0 ** | $ | 806.5  | $ | 897.3  |   |
| Segment operating income                                                                                                                       |   | **28.0 ** |   | 28.2  |   |   | **107.8 ** |   | 107.4  |   | 142.1  |   |
| *Operating margins (%)*                                                                                                                        |   | ***12.2 *** |   | *13.0 * |   |   | ***13.1 *** |   | *13.3 * |   | *15.8 * |   |
| **New Core Markets segment**                                                                                                                   |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **29.6 ** | $ | 29.0  |   | **$** | **116.2 ** | $ | 112.1  | $ | 83.0  |   |
| Segment operating income (loss)                                                                                                                |   | **0.2 ** |   | 1.8  |   |   | **4.2 ** |   | 6.4  |   | (13.8) |   |
| *Operating margins (%)*                                                                                                                        |   | ***0.7 *** |   | *6.2 * |   |   | ***3.6 *** |   | *5.7 * |   | -  |   |
| **Total**                                                                                                                                      |   |   |   |   |   |   |   |   |   |   |   |   |
| Revenue                                                                                                                                        | **$**  | **583.4 ** | $ | 565.6  |   | **$** | **2,114.9 ** | $ | 2,035.2  | $ | 1,821.2  |   |
| Segment operating income                                                                                                                       |   | **86.2 ** |   | 80.7  |   |   | **291.8 ** |   | 302.7  |   | 302.1  |   |
| *Operating margins (%)*                                                                                                                        |   | ***14.8 *** |   | *14.3 * |   |   | ***13.8 *** |   | *14.9 * |   | *16.6 * |   |
| **Other**                                                                                                                                      |   | **$** | **- ** | $ | (13.8) |   |   | **$** | **- ** | $ | (68.7) | $ | -  |   |
| **Operating profit**                                                                                                                           |   | **$** | **86.2 ** | $ | 66.9  |   | **$** | **291.8 ** | $ | 234.0  | $ | 302.1  |
|                                                                                                                                           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| (1) Figures have not been restated to reflect the adoption of IFRS 11 and IAS 19. Refer to Changes in accounting policies for further details. |   |

CAE Annual Report 2014 | 53

 

----

Management's Discussion and Analysis

 

| **Selected annual information for the past five years**                                                                                        |   |           |           |                    |       |          |              |          |              |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------|----------------|-------------------------|------------|---------------|-------------------|---------------|-------------------|
|                                                                                                                                           |   |           |           |                    |       |          |              |          |              |   |
| *(amounts in millions, except per share amounts)*                                                                                              |   |           | **2014 ** |                    | 2013  |          | 2012 1  |          | 2011 1  |
| **IFRS**                                                                                                                                       |   |           |           |                    |       |          |              |          |              |   |
| Revenue                                                                                                                                        |   |           | **$**          | **2,114.9 **       | $          | 2,035.2  | $                 | 1,821.2  | $                 | 1,630.8  |
| Net income                                                                                                                                     |   |           |           | **191.1 **         |       | 140.7    |              | 182.0    |              | 160.9  |
| Equity holders of the Company                                                                                                                  |   |           |           | **190.0 **         |       | 137.7    |              | 180.3    |              | 160.3  |
| Non-controlling interests                                                                                                                      |   |           |           | **1.1 **           |       | 3.0      |              | 1.7      |              | 0.6  |
| Average exchange rate, U.S. dollar to Canadian dollar                                                                                          |   |           |           | **1.05 **          |       | 1.00     |              | 0.99     |              | 1.02  |
| Average exchange rate, Euro to Canadian dollar                                                                                                 |   |           |           | **1.41 **          |       | 1.29     |              | 1.37     |              | 1.34  |
| Average exchange rate, British pound to Canadian dollar                                                                                        |   |           |           | **1.68 **          |       | 1.58     |              | 1.58 **  |              | 1.58  |
| Financial position:                                                                                                                            |   |           |           |                    |       |          |              |          |              |   |
| Total assets                                                                                                                                   |   |           | **$**          | **4,236.7 **       | $          | 3,691.3  | $                 | 3,183.7  | $                 | 2,817.3  |
| Total non-current financial liabilities2                                                                                                  |   |           |           | **1,340.2  ** |       | 1,209.3  |              | 869.0    |              | 757.5  |
| Total net debt                                                                                                                                 |   |           |           | **856.2 **         |       | 813.4    |              | 534.3    |              | 383.8  |
| Per share:                                                                                                                                     |   |           |           |                    |       |          |              |          |              |   |
| Basic EPS attributable to equity holders of the Company                                                                                        |   |           | **$**          | **0.73 **          | $          | 0.53     | $                 | 0.70     | $                 | 0.62  |
| Diluted EPS attributable to equity holders of the Company                                                                                      |   | **0.73 ** |           | 0.53               |       | 0.70     |              | 0.62     |
| Dividends                                                                                                                                      |   |           |           | **0.22 **          |       | 0.19     |              | 0.16     |              | 0.15  |
| Total equity                                                                                                                                   |   |           |           | **5.67 **          |       | 4.43     |              | 4.05     |              | 3.63  |
|                                                                                                                                           |   |           |           |                    |       |          |              |          |              |   |
|                                                                                                                                           |   |           |           |                    |       |          |              |          |              |   |
| *(amounts in millions, except per share amounts)*                                                                                              |   |           |           |                    |       |          |              |          | 2010         |
| **Previous Canadian GAAP**                                                                                                                     |   |           |           |                    |       |          |              |          |              |   |
| Revenue                                                                                                                                        |   |           |           |                    |       |          |              |          | $                 | 1,526.3  |
| Earnings from continuing operations                                                                                                            |   |           |           |                    |       |          |              |          |              | 144.5  |
| Net earnings                                                                                                                                   |   |           |           |                    |       |          |              |          |              | 144.5  |
| Average exchange rate, U.S. dollar to Canadian dollar                                                                                          |   |           |           |                    |       |          |              |          |              | 1.09  |
| Average exchange rate, Euro to Canadian dollar                                                                                                 |   |           |           |                    |       |          |              |          |              | 1.54  |
| Average exchange rate, British pound to Canadian dollar                                                                                        |   |           |           |                    |       |          |              |          |              | 1.74  |
| Financial position:                                                                                                                            |   |           |           |                    |       |          |              |          |              |   |
| Total assets                                                                                                                                   |   |           |           |                    |       |          |              |          | $                 | 2,621.9  |
| Total non-current financial liabilities2                                                                                                  |   |           |           |                    |       |          |              |          |              | 457.0  |
| Total net debt                                                                                                                                 |   |           |           |                    |       |          |              |          |              | 179.8  |
| Per share:                                                                                                                                     |   |           |           |                    |       |          |              |          |              |   |
| Basic earnings from continuing operations                                                                                                      |   |           |           |                    |       |          |              |          | $                 | 0.56  |
| Diluted earnings from continuing operations                                                                                                    |   |           |           |                    |       |          |              |          |              | 0.56  |
| Basic net earnings                                                                                                                             |   |           |           |                    |       |          |              |          |              | 0.56  |
| Diluted net earnings                                                                                                                           |   |           |           |                    |       |          |              |          |              | 0.56  |
| Basic dividends                                                                                                                                |   |           |           |                    |       |          |              |          |              | 0.12  |
| Shareholders' equity                                                                                                                           |   |           |           |                    |       |          |              |          |              | 4.52  |
|                                                                                                                                           |   |           |           |                    |       |          |              |          |              |   |
| (1) Figures have not been restated to reflect the adoption of IFRS 11 and IAS 19. Refer to *Changes in accounting policies* for more details.  |
| (2) Includes long-term debt, long-term derivative liabilities and other long-term liabilities meeting the definition of a financial liability. |

 

54 | CAE Annual Report 2014