engq4fy17fullreport29052017.htm - Generated by SEC Publisher for SEC Filing

Table of Contents
Management’s Discussion and Analysis
1.	HIGHLIGHTS	1
2.	INTRODUCTION	3
3.	ABOUT CAE 3.1 Who we are 3.2 Our vision	5 5 5
	3.3 Our strategy 3.4 Our operations 3.5 Foreign exchange 3.6 Non-GAAP and other financial measures	5 6 11 13
4.	CONSOLIDATED RESULTS 4.1 Results from operations – fourth quarter of fiscal 2017 4.2 Results from operations – fiscal 2017	15 15 17
	4.3 Restructuring, integration and acquisition costs	19
	4.4 Consolidated orders and total backlog	19
5.	RESULTS BY SEGMENT 5.1 Civil Aviation Training Solutions 5.2 Defence and Security 5.3 Healthcare	20 21 24 26
6.	CONSOLIDATED CASH MOVEMENTS AND LIQUIDITY 6.1 Consolidated cash movements 6.2 Sources of liquidity 6.3 Government participation 6.4 Contractual obligations	28 28 29 30 30
7.	CONSOLIDATED FINANCIAL POSITION 7.1 Consolidated capital employed 7.2 Off balance sheet arrangements 7.3 Financial instruments	31 31 33 33
8.	BUSINESS COMBINATIONS	36
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	37 37 39 42
10.	RELATED PARTY TRANSACTIONS	43
11.	CHANGES IN ACCOUNTING POLICIES 11.1 New and amended standards adopted 11.2 New and amended standards not yet adopted 11.3 Use of judgements, estimates and assumptions	44 44 44 45
12.	CONTROLS AND PROCEDURES 12.1 Evaluation of disclosure controls and procedures 12.2 Internal control over financial reporting	47 47 47
13.	OVERSIGHT ROLE OF AUDIT COMMITTEE AND BOARD OF DIRECTORS	47
14.	ADDITIONAL INFORMATION	47
15.	SELECTED FINANCIAL INFORMATION	48
	Consolidated Financial Statements	50

Management’s Discussion and Analysis

for the fourth quarter and year ended March 31, 2017

1. HIGHLIGHTS

FINANCIAL

FOURTH QUARTER OF FISCAL 2017

Revenue from continuing operations higher compared to last quarter and the fourth quarter of fiscal 2016

- Consolidated revenue from continuing operations was $734.7 million this quarter, $52.0 million or 8% higher than last quarter and $12.2 million or 2% higher than the fourth quarter of fiscal 2016.

Net income attributable to equity holders of the Company from continuing operations stable compared to last quarter and higher compared to the fourth quarter of fiscal 2016

- Net income attributable to equity holders of the Company from continuing operations was $67.4 million (or $0.25 per share) this quarter compared to $67.6 million (or $0.25 per share) last quarter and compared to $61.2 million (or $0.23 per share) in the fourth quarter of last year, representing an increase of $6.2 million or 10%;

- Specific items included in net income attributable to equity holders of the Company from continuing operations this quarter were restructuring, integration and acquisition costs of $20.0 million ($15.0 million after tax or $0.06 per share) mainly related to the acquisition of Lockheed Martin Commercial Flight Training (LMCFT). This restructuring, integration and acquisition program was completed during the fourth quarter. Net income before specific items¹ was $82.4 million and earnings per share before specific items¹ was $0.31 for the quarter, compared to $69.6 million (or $0.26 per share) last quarter and $72.8 million (or $0.27 per share) in the fourth quarter of fiscal 2016;

- Net income attributable to equity holders of the Company included a loss from discontinued operations this quarter of $0.7 million (or nil per share) compared to earnings of $0.2 million (or nil per share) last quarter and a loss of $2.4 million (or $0.01 per share) in the fourth quarter of fiscal 2016.

Positive free cash flow¹ from continuing operations at $160.4 million this quarter

- Net cash provided by continuing operating activities was $197.5 million this quarter, compared to $156.1 million last quarter and $51.0 million in the fourth quarter of last year;

- Maintenance capital expenditures¹ and other asset expenditures were $26.8 million this quarter, $16.6 million last quarter and $18.8 million in the fourth quarter of last year;

- Cash dividends were $20.5 million this quarter, $20.8 million last quarter and $19.3 million in the fourth quarter of last year.

FISCAL 2017

Higher revenue from continuing operations compared to fiscal 2016

- Consolidated revenue from continuing operations was $2,704.5 million, $191.9 million or 8% higher than last year.

Higher net income attributable to equity holders of the Company and diluted earnings per share from continuing operations

- Net income attributable to equity holders of the Company from continuing operations was $252.0 million (or $0.93 per share) compared to $239.3 million (or $0.89 per share) last year, representing a $12.7 million or 5% increase;

- Specific items included in net income attributable to equity holders of the Company from continuing operations this year were restructuring, integration and acquisition costs of $35.5 million ($26.4 million after tax or $0.10 per share). Net income before specific items was $278.4 million and earnings per share before specific items was $1.03 this year, compared to $230.5 million (or $0.86 per share) last year;

- Net income attributable to equity holders of the Company included a loss from discontinued operations of $0.5 million (or nil per share) compared to a loss from discontinued operations of $9.6 million (or $0.04 per share) last year.

Positive free cash flow from continuing operations at $327.9 million

- Net cash provided by continuing operating activities was $464.3 million this year, compared to $345.8 million last year;

- Maintenance capital expenditures and other asset expenditures were $68.3 million this year, compared to $65.1 million last year;

- Cash dividends were $80.6 million this year, compared to $56.7 million last year.

Capital employed¹ increased by $104.1 million or 4% this year, ending at $2,831.7 million

- Return on capital employed¹(ROCE) was 11.2% this year compared to 10.6% last year;

- Non-cash working capital¹ increased by $4.1 million in fiscal 2017, ending at $193.0 million;

- Property, plant and equipment increased by $109.5 million;

- Other long-term assets and other long-term liabilities increased by $78.5 million and $86.5 million respectively;

- Net debt¹decreased by $36.6 million this year, ending at $750.7 million.

CAE Annual Report 2017 | 1

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

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

Management’s Discussion and Analysis

2. INTRODUCTION

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

- This year and 2017 mean the fiscal year ending March 31, 2017;

- Last year, prior year and a year ago mean the fiscal year ended March 31, 2016;

- Dollar amounts are in Canadian dollars.

This report was prepared as of May 31, 2017, and includes our management’s discussion and analysis (MD&A) for the year and the three-month period ended March 31, 2017 and the consolidated financial statements and notes for the year ended March 31, 2017. We have prepared it to help you understand our business, performance and financial condition for fiscal 2017. Except as otherwise indicated, all financial information has been reported in accordance with International Financial Reporting Standards (IFRS). All quarterly information disclosed in the MD&A is based on unaudited figures.

For additional information, please refer to our annual consolidated financial statements for this fiscal year, which you will find in the annual report for the year ended March 31, 2017. The MD&A provides you with a view of CAE as seen through the eyes of management and helps you understand the company from a variety of perspectives:

- Our vision;

- Our strategy;

- 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 Board of Directors.

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

CAE Annual Report 2017 | 3

Management’s Discussion and Analysis

ABOUT MATERIAL INFORMATION

This report includes the information we believe is material to investors after considering all circumstances, including potential market sensitivity. We consider something to be material if:

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

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

CAUTION REGARDING FORWARD-LOOKING STATEMENTS

This report includes forward-looking statements about our activities, events and developments that we expect to or anticipate may occur in the future including, for example, statements about our vision, strategies, market trends and outlook, future revenues, capital spending, expansions and new initiatives, financial obligations and expected sales. Forward-looking statements normally contain words like believe, expect, anticipate, plan, intend, continue, estimate, may, will, should, strategy, future and similar expressions. By their nature, forward-looking statements require us to make assumptions and are subject to inherent risks and uncertainties associated with our business which may cause actual results in future periods to differ materially from results indicated in
forward-looking statements. While these statements are based on management’s expectations and assumptions regarding historical trends, current conditions and expected future developments, as well as other factors that we believe are reasonable and appropriate in the circumstances, readers are cautioned not to place undue reliance on these forward-looking statements as there is a risk that they may not be accurate.

Important risks that could cause such differences include, but are not limited to, risks relating to the industry such as competition, level and timing of defence spending, government-funded defence and security programs, constraints within the civil aviation industry, regulatory rules and compliance, risks relating to CAE such as product evolution, research and development (R&D) activities,
fixed-price and long-term supply contracts, strategic partnerships and long-term contracts, procurement and original equipment manufacturer (OEM) leverage, warranty or other product-related claims, product integration and program management, protection of our intellectual property, third-party intellectual property, loss of key personnel, labour relations, environmental liabilities, claims arising from casualty losses, integration of acquired businesses, our ability to penetrate new markets, information technology systems including cybersecurity risk, length of sales cycle, continued returns to shareholders and our reliance on technology and third-party providers, and risks relating to the market such as foreign exchange, political instability, availability of capital, pension plan funding, doing business in foreign countries including corruption risk and income tax laws. Additionally, differences could arise because of events announced or completed after the date of this report. You will find more information in the Business risk and uncertainty section of the MD&A. We caution readers that the risks described above are not necessarily the only ones we face; additional risks and uncertainties that are presently unknown to us or that we may currently deem immaterial may adversely affect our business.

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

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Management’s Discussion and Analysis

3. ABOUT CAE

3.1 Who we are

CAE is a global leader in training for the civil aviation, defence and security, and healthcare markets. Backed by a 70-year record of industry firsts, we continue to help define global training standards with our innovative virtual-to-live training solutions to make flying safer, maintain defence force readiness and enhance patient safety. We have the broadest global presence in the industry, with over 8,500 employees, 160 sites and training locations in over 35 countries. Each year, we train more than 120,000 civil and defence crewmembers and thousands of healthcare professionals worldwide.

CAE’s common shares are listed on the Toronto and New York stock exchanges under the symbol CAE.

3.2 Our vision

Our vision is to be the recognized global training partner of choice to enhance safety, efficiency and readiness. Through the training we provide, our mission is to make air travel safer, defence forces mission ready and medical personnel better able to save lives.

3.3 Our strategy

We address the imperatives of safety, efficiency and readiness for customers in three core markets: civil aviation, defence and security, and healthcare.

Our capital and other resource allocation decisions are guided by three overarching strategic imperatives: grow by providing the most comprehensive solutions worldwide to enable us to be the recognized global training partner of choice; protect our leadership position by ensuring the highest levels of customer satisfaction and operational excellence; and innovate by driving new technology and offerings which advance training for our customers.

We are a unique, pure-play simulation and training company with a proven record of commitment to our customers’ long-term training needs.

Six pillars of strength

We believe there are six fundamental strengths that underpin our strategy and position us well for sustainable long-term growth:

- High degree of recurring business;

- Strong competitive moat;

- Headroom in large markets;

- Underlying secular tailwinds;

- Potential for superior returns;

- Culture of innovation.

High degree of recurring business

Nearly 60% of our business is derived from the provision of services and largely involves long-term contracts and training demand from customers operating under regulations that require them to train on a recurrent basis.

Strong competitive moat

We pride ourselves in building strong customer and partner relationships, which in many cases span several decades, and we are a market leader across all of our market segments. We offer our customers unique comprehensive solutions with market-leading global reach and scale.

Headroom in large markets

We provide innovative training solutions to customers in large addressable markets in civil aviation, defence and security and healthcare with substantial headroom to grow our market share over the long term.

Underlying secular tailwinds

Industry experts expect long-term commercial passenger traffic to grow at a rate of 4.2% annually over the next decade. In defence and security, we see renewed defence investment as a positive catalyst and an increasing use of simulation-based training. We also see an increased propensity for customers in both civil aviation and defence and security to outsource their training enterprises. In the emerging healthcare market, we also see a rising adoption of simulation for education and training of healthcare students and professionals.

Potential for superior returns

Our rising proportion of revenue from training services provides potential for lower amplitude cyclicality as training is largely driven by the training requirements of the installed fleet. As well, we have potential to grow at a superior rate to that of our underlying markets by growing market share.

Culture of innovation

We derive significant competitive advantage as an innovative leader in simulation products and training solutions. As well, we have a demonstrated flexibility by engaging customers under a variety of partnership models.

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Management’s Discussion and Analysis

3.4 Our operations

We provide integrated training solutions to three markets globally:

- The civil aviation market includes major commercial airlines, regional airlines, business aircraft operators, civil helicopter operators, aircraft manufacturers, third-party training centres, flight training organizations (FTOs), maintenance repair and overhaul organizations (MROs) and aircraft finance leasing companies;

- The defence and security market includes defence forces, OEMs, government agencies and public safety organizations worldwide;

- The healthcare market includes hospital and university simulation centres, medical and nursing schools, paramedic organizations, defence forces, medical societies and OEMs.

CIVIL AVIATION MARKET

We provide comprehensive training solutions for flight, cabin, maintenance and ground personnel in commercial, business and helicopter aviation, a complete range of flight simulation training devices, as well as ab initio pilot training and crew sourcing services.

We are uniquely capable of addressing the total lifecycle needs of the professional pilot, from cadet to captain, with our comprehensive aviation training solutions. We are the world’s largest provider of commercial aviation training services and the second largest in business aviation training services. Our deep industry expertise and credibility, installed base, strong relationships and reputation as a trusted partner, enable us to access a broader share of the market than any other company in our industry. We provide aviation training services in 30 countries and through our broad global network of training centres, we serve all sectors of civil aviation including airlines and other commercial, business and helicopter aviation operators.

Among our thousands of customers, we have long-term training centre operations and training services agreements and joint ventures with approximately 40 major airlines and aircraft operators around the world. Our range of training solutions includes products and services offerings for pilot, cabin crew and aircraft maintenance technician training, training centre operations, curriculum development, courseware solutions and consulting services. We currently operate 269 FFSs, including those operating in our joint ventures. We offer industry-leading technology, and we are shaping the future of training through innovations such as the Next Generation Training System, which will improve training quality and efficiency through the integration of untapped flight and simulator data-driven insights into training. As the industry leader in training, we continue our strategy to recruit, develop and retain the best instructors, who represent our second largest employee group after engineers. In the formation of new pilots, CAE operates the largest ab initio flight training network in the world with seven academies and a fleet of over 165 aircraft. In the area of resource management, CAE is the global market leader in the provision of flight crew and technical personnel to airlines, aircraft leasing companies, manufacturers and MRO companies worldwide.

Quality, fidelity and reliability are hallmarks of the CAE brand in flight simulation and we are the world leader in the development of civil flight simulators. We continuously innovate our processes and lead the market in the design, manufacture and integration of civil FFSs for major and regional commercial airlines, third-party training centres and OEMs. We have established a wealth of experience in developing first-to-market simulators for more than 35 types of aircraft models. Our flight simulation equipment, including FFSs, are designed to meet the rigorous demands of their long and active service lives, often spanning a number of decades of continuous use. We also provide best-in-class support with a full range of services and by leveraging our extensive worldwide network of spare parts and service teams.

Market drivers

Demand for training solutions in the civil aviation market is driven by the following:

- Pilot training and certification regulations;

- Safety and efficiency imperatives of commercial airline and business aircraft operators;

- Expected long-term global growth in air travel;

- Growing active fleet of commercial and business aircraft;

- Demand for trained aviation professionals.

Pilot training and certification regulations

Civil aviation training is a largely recurring business driven by a highly-regulated environment through global and national standards for pilot licensing and certification, amongst other regulatory requirements. These mandatory and recurring training requirements are regulated by national and international aviation regulatory authorities such as the International Civil Aviation Organization (ICAO), European Aviation Safety Agency (EASA), and Federal Aviation Administration (FAA).

In recent years, pilot certification processes and regulatory requirements have become increasingly stringent. Simulation-based pilot certification training is taking on a greater role internationally with the Multi-crew Pilot License (MPL), Upset Prevention and Recovery Training (UPRT) and the Airline Transport Pilot (ATP) requirements in the U.S.

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Management’s Discussion and Analysis

Safety and efficiency imperatives of commercial airline and business aircraft operators

The commercial airline industry is competitive, requiring operators to continuously pursue operational excellence and efficiency initiatives in order to achieve adequate returns while continuing to maintain the highest safety standards and the confidence of air travelers. Airlines are finding it increasingly more effective to seek expertise in training from trusted partners such as CAE to address growing efficiency gaps, pilot capability gaps, evolving regulatory and training environments, and on-going aircraft programs. Partnering with a training provider like CAE gives airlines immediate access to a world-wide fleet of simulators, courses, programs and instruction capabilities, and allows them flexibility in pursuing aircraft fleet options that suit their business.

Expected long-term global growth in air travel

The secular growth in air travel is resulting in higher demand for flight, cabin, maintenance and ground personnel, which in turn drives demand for training solutions.

In commercial aviation, the aerospace industry’s widely held expectation is that long-term average growth for air travel will continue at 4.2% annually over the next decade. For calendar 2016, global passenger traffic increased by 6.3% compared to calendar 2015. For the first three months of calendar 2017, passenger traffic increased by 7.0% compared to the first three months of calendar 2016. Certain markets continued to outperform with passenger traffic in Asia and the Middle East growing at 10.0% and 9.1% respectively, while Europe, Latin America and North America increased 6.9%, 5.1% and 2.3% respectively.

In business aviation, training demand is closely aligned to business jet travel. According to the FAA, the total number of business jet flights, which includes all domestic and international flights, was up modestly with 1.4% growth over the past 12 months. Similarly, according to Eurocontrol, the European Organisation for the Safety of Air Navigation, the total number of business aviation flights in Europe has modestly improved by 1.4%.

In helicopter aviation, demand is driven mainly by the level of offshore activity in the oil and gas sector, as helicopter operators catering to this sector make up the majority of a relatively small training segment. The current protracted downturn in petroleum prices has negatively impacted offshore exploration activity for helicopter operators.

Potential impediments to steady growth in air travel include major disruptions such as regional political instability, acts of terrorism, pandemics, natural disasters, prolonged economic recessions or other major world events.

Growing active fleet of commercial and business aircraft

As an integrated training solutions provider, our long-term growth is closely tied to the active commercial and business aircraft fleet.

The global active commercial aircraft fleet has grown by an average of 3.2% annually over the past 20 years and is widely expected to continue to grow at an approximate average rate of 3.6% annually over the next two decades as a result of increasing emerging market and low-cost carrier demand and fleet replacement in established markets. From March 2016 to March 2017, the global commercial aircraft fleet increased by 4.2%, growing by 7.0% in Asia Pacific, 5.0% in Europe, the Middle East and Africa (EMEA), and increasing modestly by 1.6% in the Americas.

Major business jet OEMs are continuing with plans to introduce a variety of new aircraft models in the upcoming years. Examples include Bombardier’s Global 7000/8000, Cessna’s Citation Longitude and Hemisphere, Dassault’s Falcon 5X, Gulfstream’s 500/600, Cirrus’ SF50 and Pilatus’ PC-24.

Our business aviation training network, comprehensive suite of training programs, key long-term OEM partnerships and ongoing network investments, position us well to effectively address the training demand arising from the entry-into-service of these new aircraft programs.

Our strong competitive moat, as defined by our extensive global training network, best-in-class instructors, comprehensive training programs and strength in training partnerships with airlines and business aircraft operators, allows us to effectively address training needs that arise from a growing active fleet of aircraft.

We are well positioned to leverage our technology leadership and expertise, including CAE 7000XR Series FFSs and CAE Simfinity^TM procedures trainers, in delivering training equipment solutions that address the growing training needs of airlines that continue to operate their own training centers.

Demand for trained aviation professionals

We have large headroom in the training services market driven by a sustained secular demand for trained aviation professionals. Demand for trained aviation professionals is driven by air traffic growth, pilot retirements and by the number of aircraft deliveries. The expansion of global economies and airline fleets have resulted in a shortage of qualified personnel needed to fulfill this growing capacity. Pilot supply constraints include aging crew demographics and fewer military pilots transferring to civil airlines. According to a forthcoming CAE internal market study, expected to be released in the first half of fiscal 2017, approximately 255,000 new airline pilots will be needed over the next ten years to sustain the growth of the commercial air transport industry and support retirements. In support of this growth, the aviation industry will require innovative solutions to match the learning requirements of a new generation, leading to an increase in demand for simulation-based training services and products.

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Management’s Discussion and Analysis

DEFENCE AND SECURITY MARKET

We are a training systems integrator for defence forces across the air, land and naval domains, and for government organizations responsible for public safety.

We are a global leader in the development and delivery of integrated live, virtual and constructive (LVC) training solutions for defence forces. Most militaries leverage a combination of live training on actual platforms, virtual training in simulators, and constructive training using computer-generated simulations. CAE is skilled and experienced as a training systems integrator capable of helping defence forces achieve an optimal balance of LVC training to achieve mission readiness. Our expertise in training spans a broad variety of aircraft, including fighters, helicopters, trainer aircraft, maritime patrol, tanker/transport aircraft and remotely piloted aircraft, also called unmanned aerial systems. Increasingly, we are leveraging our training systems integration capabilities in the naval domain to provide naval training solutions, as evidenced by the contract to provide the United Arab Emirates (U.A.E) Navy with a comprehensive Naval Training Centre and the delivery of a naval warfare training system to the Swedish Navy. We also offer training solutions for land forces, including a range of driver, gunnery and maintenance trainers for tanks and armoured fighting vehicles as well as constructive simulation for command and staff training. We offer training solutions to government organizations for emergency and disaster management.

Defence forces seek to increasingly leverage virtual training and balance their training approach between live, virtual and constructive domains to achieve maximum readiness and efficiency. As such, we have been increasingly pursuing programs requiring the integration of LVC training and these tend to be larger in size than programs involving only a single component of such a solution. We are a first-tier training systems integrator and uniquely positioned to offer our customers a comprehensive range of innovative LVC solutions, ranging from academic, virtual and live training to immersive, networked mission rehearsal in a synthetic environment. Our solutions typically include a combination of training services, products and software tools designed to cost-effectively maintain and enhance safety, efficiency, mission readiness and decision-making capabilities. We have a wealth of experience delivering and operating training solutions across different business models, including government-owned government-operated; government-owned contractor-operated; or contractor-owned contractor-operated facilities. Our offerings include training needs analysis; instructional systems design; learning management information systems; purpose-built facilities; state-of-the-art synthetic training equipment; curriculum and courseware development; classroom, simulator, and live flying instruction; maintenance and logistics support; lifecycle support and technology insertion; and financing alternatives.

We have delivered simulation products and training systems to approximately 50 defence forces in over 35 countries. We provide training support services such as contractor logistics support, maintenance services, classroom instruction and simulator training at over 80 sites around the world, including our joint venture operations. We continue to increase our support for live flying training, such as the live training delivered as part of the NATO Flying Training in Canada and the U.S. Army Fixed-Wing Flight Training programs, as we help our customers achieve an optimal balance across their training enterprise.

Market drivers

Demand for training solutions in the defence and security markets is driven by the following:

- Growing defence budgets;

- Installed base of enduring defence platforms and new customers;

- Explicit desire of governments and defence forces to increase the use of synthetic training;

- Desire to integrate training systems to achieve efficiencies and enhanced preparedness;

- Attractiveness of outsourcing training and maintenance services;

- Need for synthetic training to conduct integrated, networked mission training, including joint and coalition forces training;

- Relationships with OEMs for simulation and training.

Growing defence budgets

The U.S. Administration has proposed plans to increase annual defence spending by over USD $54 billion while also calling on members of the North Atlantic Treaty Organization (NATO) to increase their own defence investment. The majority of the 28 members of NATO have also expressed plans to increase defence spending in the coming years. NATO and allied nations continue to confront the immediate challenges posed by the war on terrorism and have been increasingly renewing and augmenting their strategic defences in view of emerging and resurgent geopolitical threats. Growing defence budgets in the U.S and much of NATO, as well as other regions such as Asia and the Middle East, will create increased opportunities throughout the defence establishment. Training is fundamental for defence forces to achieve and maintain mission readiness and growth in defence spending is expected to result in corresponding opportunities for training systems and solutions.

Installed base of enduring defence platforms and new customers

CAE generates a high degree of recurring business from its strong position on enduring platforms, including long-term services contracts. Most defence forces in mature markets such as the U.S. have slowed down production of new platforms and delayed new acquisition programs, which has required military forces to maximize use of their existing platforms. Upgrades, updates, and life extension programs allow defence forces to leverage existing assets while creating a range of opportunities for simulator upgrades and training support services. Enduring platforms, such as the C-130 Hercules transport aircraft that is operated by more than 60 nations, provide a solid installed base from which to generate business. Because of our extensive installed base of simulators worldwide, our prime contractor position on programs such as the U.S. Air Force (USAF) KC-135 Aircrew Training System and MQ-1 Predator/MQ-9 Reaper aircrew training, and our experience on key enduring platforms, CAE is well-positioned for recurring product upgrades/updates as well as maintenance and support services. In addition, there is strong demand for enduring platforms such as the C-130, P-8A, C295, MH-60R and MQ-1/MQ-9 in global defence markets, thus providing opportunities to provide new training systems and services for platforms where CAE has significant experience.

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Management’s Discussion and Analysis

Explicit desire of governments and defence forces to increase the use of synthetic training

One of the underlying drivers for CAE’s expertise and capabilities is the increasing use of synthetic training throughout the defence community. More defence forces and governments are increasingly adopting synthetic training for a greater percentage of their overall approach because it improves training effectiveness, reduces operational demands on aircraft, lowers risk compared to operating actual weapon system platforms and significantly lowers costs. Synthetic training offers defence forces a cost-effective way to provide realistic training for a wide variety of scenarios while ensuring they maintain a high state of readiness. The higher cost of live training and the desire to save aircraft for operational use are two factors prompting a greater adoption of synthetic training. The nature of mission-focused training demands at least some live training; however, the shift to more synthetic training is advancing. The U.S. Navy reports the share of simulation-based training on some of their existing aircraft platforms could increase to nearly 50% by 2020, and for new aircraft such as the P-8A, the training program has been designed for approximately 70% synthetic training. Because of the high cost associated with conducting live training exercises, most defence forces are beginning to rebalance the mix of LVC training and shift more of the training curriculum to virtual and constructive simulation. An example are the contracts that CAE won under the USAF KC-135 program to support the Mobility Air Force Distributed Mission Operations initiative of the USAF. CAE has upgraded a range of KC-135 aircrew training devices that are now authorized to be used on the USAF’s Distributed Training Center Network, thus providing the USAF the ability to conduct distributed, virtual tanker training.

Desire to integrate training systems to achieve efficiencies and enhanced preparedness

Increased operational tempo combined with limited personnel and budget pressures have prompted defence forces around the world to seek reliable partners who can help develop, manage and deliver the training systems required to support today’s complex platforms and operations. Increasingly, defence forces are considering a more integrated and holistic approach to training. To help manage the complexities and challenges, many training programs are calling for an industry partner to help design and manage the total training system. CAE refers to this approach as training systems integration and has positioned the Company globally as a platform-independent training systems integrator. The overall intent for defence forces is to maximize commonality for increased efficiencies, cost savings, and most importantly, enhanced capability for mission preparedness. A training systems integrator can address the overall LVC domain to deliver comprehensive training, from undergraduate individual training all the way through to operational, multi-service and joint mission training.

Attractiveness of outsourcing training and maintenance services

Another driver for CAE’s expertise and capabilities is the efficiency gained by our customers from outsourcing training and support services. Defence forces and governments continue to find ways to reduce costs while not impacting readiness and allow active-duty personnel to focus on operational requirements. There has been a growing trend among defence forces to consider outsourcing a variety of training services and we expect this trend to continue, which aligns directly with CAE’s strategy to grow long-term, recurring services business. We believe governments will increasingly look to industry for training solutions to achieve faster delivery, lower capital investment requirements, and training support required to achieve desired readiness levels. For example, we inaugurated our new Dothan Training Center in Dothan, Alabama and have begun providing fixed-wing flight training. This new training centre supports the U.S. Army Fixed‑Wing Flight Training program and CAE offers comprehensive classroom, simulator and live-flying training to the U.S. Army, USAF and other customers. We believe this type of training service delivery program will become increasingly attractive to defence forces globally.

Need for synthetic training to conduct integrated, networked mission training, including joint and coalition forces training

There is a growing trend among defence forces to use synthetic training to meet more of their mission training requirements, and to integrate and network various training systems so military forces can train in a virtual world. Simulation-based technology solutions enable defence customers to plan sophisticated missions and carry out full-mission rehearsals in a synthetic environment as a complement to traditional live training for mission preparation. Allies are cooperating and creating joint and coalition forces, which are driving the demand for networked training and operations. Training devices that can be networked to train different crews and allow for networked training across a range of platforms are increasingly important as the desire to conduct mission rehearsal exercises in a synthetic environment increases. For example, the Royal Canadian Air Force (RCAF) has released its Simulation Strategy 2025, which specifically calls for leveraging LVC domains within a networked common synthetic environment. The RCAF is transforming its training approach from one that relies on aircraft to one that exploits new technologies to train aircrews in a simulation-focused system that creates a virtual battlespace. The U.S., U.K. and Australian defence forces have published similar strategies. We are actively promoting open, standard simulation architectures, such as the Common Database, to better enable integrated and networked mission training.

Relationships with OEMs for simulation and training

We are an important partner to OEMs because of our experience, global presence, and innovative technologies. We partner with manufacturers in the defence and security market to strengthen relationships and position for future opportunities. OEMs have introduced new platforms and continue to upgrade and extend the life of existing platforms, which drives worldwide demand for training systems. For example, Boeing has developed the P-8A maritime patrol aircraft and has subcontracted CAE to design and develop P-8A operational flight trainers for the U.S. Navy and Royal Australian Air Force and continues to market the P-8 internationally, which will create further opportunities for CAE. Other examples of CAE’s relationships with OEMs on specific platforms creating opportunities for training systems include Airbus Defence & Space on the C295, which was selected by Canada for the Fixed-Wing Search and Rescue program; Leonardo on the M-346 lead-in fighter trainer; Lockheed Martin on the C‑130J Super Hercules transport aircraft, which is being acquired by several branches of the USAF as well international militaries; and General Atomics on the Predator family of remotely piloted aircraft. We are also part of Team Seahawk in partnership with the U.S. Navy and companies such as Lockheed Martin/Sikorsky which is offering the MH-60R helicopter under the foreign military sales program to international customers.

CAE Annual Report 2017 | 9

Management’s Discussion and Analysis

HEALTHCARE MARKET

We design and manufacture simulators, audiovisual and simulation centre management solutions, develop courseware and offer services for training of medical, nursing and allied healthcare students as well as clinicians in educational institutions, hospitals and defence organizations worldwide.

Simulation-based training is one of the most effective approaches to prepare healthcare practitioners to care for patients and respond to critical situations while reducing the overall risk to patients. We are leveraging our experience and best practices in simulation‑based aviation training to deliver innovative solutions to improve the safety and efficiency of this industry. The healthcare simulation market is expanding, with simulation centres becoming increasingly more prevalent in nursing and medical schools.

We offer the broadest range of medical simulation products and services in the market today, including patient, ultrasound and interventional (surgical) simulators, audiovisual and simulation centre management solutions and courseware for simulation‑based healthcare education and training. We have sold simulators to customers in approximately 90 countries that are currently supported by our network in Australia, Brazil, Canada, Germany, Hungary, India, Singapore, the U.K. and the U.S. We are a leader in high‑fidelity patient simulators that are uniquely powered by complex models of human physiology to mimic human responses to clinical interventions. For example, our Lucina childbirth simulator for both normal deliveries and rare maternal emergencies was designed to offer exceptional reliability and realism in the high-fidelity patient simulation market.

Through our Healthcare Academy, we deliver peer-to-peer training at customer sites and in our training centres in the U.S., U.K., Germany and Canada. Our Healthcare Academy includes more than 50 adjunct faculty consisting of nurses, physicians, paramedics and sonographers who, in collaboration with leading healthcare institutions, have developed more than 500 Simulated Clinical Experience (SCE) courseware packages for our customers. Our Academy partnered with the International Nursing Association for Clinical Simulation and Learning (INACSL) to develop a fellowship program based on international best practices in healthcare simulation with cohorts in the U.S., U.K and U.A.E.

We offer turnkey solutions, project management and professional services for healthcare simulation programs, and collaborate with medical device companies and professional associations to develop innovative and custom training solutions. For example, we partnered with the American Society of Anesthesiologists to develop screen-based simulation training for practicing physicians. This new platform will deliver Maintenance of Certification in Anesthesiology (MOCA) education and allow us to expand access to simulation-based clinical training. Furthermore, through an industry partnership with a medical device company, we developed a specialized interventional simulator to train physicians to implant a new generation of pacemakers.

Market drivers

Demand for our simulation products and services in the healthcare market is driven by the following:

- Increasing use of simulation in healthcare education;

- Growing emphasis on patient safety and outcomes;

- Limited access to live patients during training;

- Medical technology revolution.

Increasing use of simulation in healthcare education

The majority of product and service sales in healthcare simulation involve healthcare education. Market research firm Markets and Markets estimates the total healthcare simulation market at approximately USD $1.1 billion. North America is the largest market for healthcare simulation, followed by Europe and Asia. Together with our more than 55 distributors worldwide, we are reaching new and emerging markets and addressing the international demand potential for simulation-based training. CAE segments the healthcare simulation market by high-fidelity patient simulators, interventional simulators, mid/low fidelity task trainers, ultrasound simulators, audiovisual and simulation centre management solutions, simulated clinical environments and training services. In the U.S., significant demand for healthcare services is driven by, among other factors, longer life expectancy and the baby boomer generation, resulting in higher healthcare spending. The U.S. Centers for Medicare and Medicaid Services projects that annual national health spending will grow at an average rate of 5.8% annually over the next decade. Increasingly, hospitals are given incentives to become safer and more efficient which will drive higher demand for training. There is a growing body of evidence demonstrating that medical simulation improves patient outcomes and reduces medical errors, which can help mitigate the rate of increase in healthcare costs.

Growing emphasis on patient safety and outcomes

CAE expects increased adoption of simulation-based training and certification of healthcare professionals as a means to improve patient safety and outcomes. We believe this would result in a significantly larger addressable market than the current market which is primarily education-based. According to a study by patient-safety researchers published in the British Medical Journal in May 2016, medical errors in hospitals and other healthcare facilities are the third-leading cause of death in the U.S. Training through the use of simulation can help clinicians gain confidence, knowledge and expertise for improving patient safety in a risk-free environment. Simulation is a required or recommended element in a growing movement towards High Stakes Assessment and Certification. Examples in the U.S. include MOCA, Fundamentals of Laparoscopic Surgery and Advanced Trauma Life Support. Moreover, the Accreditation Council for Graduate Medical Education is evolving towards outcome-based assessment with specific benchmarks to measure and compare performance which favours the adoption of simulation products and training.

10 | CAE Annual Report 2017

Management’s Discussion and Analysis

Limited access to live patients during training

Traditionally, medical education has been an apprenticeship model in which the student cares for patients under the supervision of more experienced staff. In this model, students have a limited role and access to high-risk procedures, rare complications and critical decision-making skills. The use of simulation in professional training programs complements traditional learning and allows students to hone their clinical and critical thinking skills for high risk, low frequency events. In 2014, the U.S. National Council of State Boards of Nursing (NCSBN) released a groundbreaking study on the effectiveness of simulation training in pre-licensure nursing programs. Among the findings, nursing students who spent up to 50 percent of clinical hours in high-quality simulation were as well-prepared for professional practice as those whose experiences were drawn from traditional clinical practice.

Simulation provides consistent, repeatable training and exposure to a broader range of patients and scenarios than one may experience in normal clinical practice. As an example, our Vimedix ultrasound simulator offers more than 200 patient pathologies for cardiac, emergency and obstetrics and gynaecology medicine. The training and education model is evolving, as evidenced by military branches around the world and most recently the U.S. Pentagon, prohibiting the use of live tissue testing in most medical training. CAE Healthcare simulators provide a low-risk alternative for practicing life-saving procedures, interprofessional team training, major disaster response and anaesthesia administration.

Medical technology revolution

Advancements in medical technology are driving the use of simulation. New medical devices and advanced procedures, such as intra‑cardiac echocardiography, cardiac assist devices, and mechanical ventilation enhancements, require advanced training solutions, such as simulation, for internal product development and customer training. Regulatory and certification agencies are increasingly stringent in requesting that clinicians be trained before adopting new disruptive technologies, an undertaking for which simulation is well suited. As a training partner of choice with leading OEMs, we continue to collaborate to deliver innovative and custom training for new technologies. CAE Healthcare announced the release of CAE VimedixAR, an ultrasound training simulator integrated with the Microsoft HoloLens, the world’s first self-contained holographic computer. We are the first to bring a commercial Microsoft HoloLens mixed reality application to the medical simulation market.

3.5 Foreign exchange

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

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

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

			Increase /
	2017	2016	(decrease)
U.S. dollar (US$ or USD)	1.33	1.30	2%
Euro (€ or EUR)	1.42	1.48	(4%)
British pound (£ or GBP)	1.67	1.87	(11%)

We used the average foreign exchange rates below to value our revenues and expenses:

	2017	2016	(Decrease)
U.S. dollar (US$ or USD)	1.31	1.31	-
Euro (€ or EUR)	1.44	1.45	(1%)
British pound (£ or GBP)	1.71	1.98	(14%)

For fiscal 2017, the effect of translating the results of our foreign operations into Canadian dollars resulted in a decrease in revenue of $35.9 million and a decrease in net income of $5.3 million, when compared to fiscal 2016. We calculated this by translating the current year’s foreign currency revenue and net income using the average monthly exchange rates from the previous year and comparing these adjusted amounts to our current year reported results.

CAE Annual Report 2017 | 11

Management’s Discussion and Analysis

There are three areas of our business that are exposed to the fluctuations of foreign exchange rates:

- Our network of foreign training and services operations

Most of our foreign training and services revenue and costs are denominated in local currency. Changes in the value of local currencies relative to the Canadian dollar therefore have an impact on these operations’ net profitability and net investment. Gains or losses in the net investment in a foreign operation that result from changes in foreign exchange rates are deferred in the foreign currency translation account (accumulated other comprehensive income), which is part of the equity section of the consolidated statement of financial position. Any effect of the fluctuation between currencies on the net profitability has an immediate translation impact on the consolidated income statement and an impact on year-to-year and quarter-to-quarter comparisons. We apply net investment hedge accounting to hedge our net investments in our U.S. entities. We have designated a portion of the principal amount of our U.S. dollar private placements as the hedging item of those investments.

- Our production operations outside of Canada (Australia, Germany, India, U.K. and U.S.)

Most of the revenue and costs in these 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 operations’ net profitability and net investment when expressed in Canadian dollars, as described above.

- Our production operations in Canada

Although the net assets of our Canadian operations are not exposed to changes in the value of foreign currencies (except for cash balances, 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.

To this effect, 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 currency cost component of the contract. Since not all 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. This residual exposure may be higher when foreign currencies experience significant short term volatility.

In order to minimize the impact foreign exchange market fluctuations may have, we also hedge some of the other 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 our manufacturing activities – 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 expected impact of this change on our annual revenue and operating profit, after taxes, as well as our net exposure:

					Operating				Net
Exposure	(amounts in millions)		Revenue		Profit		Hedging		Exposure
U.S. dollar (US$ or USD)		$	13.7	$	3.6	$	(3.1)	$	0.5
Euro (€ or EUR)			3.6		0.1		(0.1)		-
British pound (£ or GBP)			1.5		0.1		-		0.1

A possible strengthening of one cent in the Canadian dollar would have the opposite impact.

12 | CAE Annual Report 2017

Management’s Discussion and Analysis

3.6 Non-GAAP and other financial measures

This MD&A includes non-GAAP and other financial measures. Non-GAAP measures are useful supplemental information but may not have a standardized meaning according to GAAP. These measures should not be confused with, or used as an alternative for, performance measures calculated according to GAAP. Furthermore, these non-GAAP measures should not be compared with similarly titled measures provided or used by other companies.

Backlog

Obligated backlog is a non-GAAP measure that represents the expected value of orders we have received but have not yet executed.

- For the Civil Aviation Training Solutions segment, we consider an item part of our obligated backlog when we have a legally binding commercial agreement with a client that includes enough detail about each party’s obligations to form the basis for a contract and includes the value of expected future revenues. Expected future revenues from customers under short-term and
long-term training contracts are included when these customers commit to pay us training fees, or when we reasonably expect the revenue to be generated;

- For the Defence and Security segment, we consider an item part of our obligated backlog when we have a legally binding commercial agreement with a client that includes enough detail about each party’s obligations to form the basis for a contract. Defence and Security contracts are usually executed over a long-term period but some of them must be renewed each year. For this segment, we only include a contract item in obligated backlog when the customer has authorized the contract item and has received funding for it;

- For the Healthcare segment, order intake is typically converted into revenue within one year, therefore we assume that order intake is equal to revenue and consequently, backlog is nil.

Joint venture backlog is obligated backlog that represents the expected value of our share of orders that our joint ventures have received but have not yet executed. Joint venture backlog is determined on the same basis as obligated backlog described above.

Unfunded backlog is a non-GAAP measure that represents firm Defence and Security orders we have received but have not yet executed and for which funding authorization has not yet been obtained. We include unexercised negotiated options which we view as having a high probability of being exercised, but exclude indefinite-delivery/indefinite-quantity (IDIQ) contracts.

Total backlog includes obligated backlog, joint venture backlog and unfunded backlog.

The book-to-sales ratio is the total orders divided by total revenue in a given period.

Capital employed

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

Capital used:

- For the Company as a whole, we take total assets (not including cash and cash equivalents), and subtract total liabilities (not including long-term debt and the current portion of long-term debt);

- For each segment, we take the total assets (not including cash and cash equivalents, tax accounts and other non-operating assets), and subtract total liabilities (not including tax accounts, long-term debt and the current portion of long-term debt, royalty obligations, employee benefit obligations and other non-operating liabilities).

Source of capital:

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

Capital expenditures (maintenance and growth) from property, plant and equipment

Maintenance capital expenditure is a non-GAAP measure we use to calculate the investment needed to sustain the current level of economic activity.

Growth capital expenditure is a non-GAAP measure we use to calculate the investment needed to increase the current level of economic activity.

Earnings per share (EPS) before specific items

Earnings per share before specific items is a non-GAAP measure calculated by excluding the effect of restructuring, integration and acquisition costs and one-time tax items from the diluted earnings per share from continuing operations attributable to equity holders of the Company. The effect per share is obtained by dividing the restructuring, integration and acquisition costs, net of tax, and one‑time tax items by the average number of diluted shares. We track it because we believe it provides a better indication of our operating performance on a per share basis and makes it easier to compare across reporting periods.

Free cash flow

Free cash flow is a non-GAAP measure that shows us how much cash we have available to invest in growth opportunities, repay debt and meet ongoing financial obligations. We use it as an indicator of our financial strength and liquidity. We calculate it by taking the net cash generated by our continuing operating activities, subtracting maintenance capital expenditures, investment in other assets not related to growth and dividends paid and adding proceeds from the disposal of property, plant and equipment, dividends received from equity accounted investees and proceeds, net of payments, from equity accounted investees.

CAE Annual Report 2017 | 13

Management’s Discussion and Analysis

Gross profit

Gross profit is a non-GAAP measure equivalent to the operating profit excluding research and development expenses, selling, general and administrative expenses, other (gains) losses – net, after tax share in profit of equity accounted investees and restructuring, integration and acquisition costs. We believe it is useful to management and investors in evaluating our ongoing operational performance.

Net debt

Net debt is a non-GAAP measure we use to monitor how much debt we have after taking into account liquid assets such as cash and cash equivalents. We use it as an indicator of our overall financial position, and calculate it by taking our total long-term debt, including the current portion of long-term debt, and subtracting cash and cash equivalents.

Net debt-to-capital is calculated as net debt divided by the sum of total equity plus net debt.

Net income before specific items

Net income before specific items is a non-GAAP measure we use as an alternate view of our operating results. We calculate it by taking our net income attributable to equity holders of the Company from continuing operations and adding back restructuring, integration and acquisition costs, net of tax, and one-time tax items. We track it because we believe it provides a better indication of our operating performance and makes it easier to compare across reporting periods.

Non-cash working capital

Non-cash working capital is a non-GAAP measure we use to monitor how much money we have committed in the day-to-day operation of our business. We calculate it by taking current assets (not including cash and cash equivalents and assets held for sale) and subtracting current liabilities (not including the current portion of long-term debt and liabilities held for sale).

Operating profit

Operating profit is an additional GAAP measure that shows us how we have performed before the effects of certain financing decisions, tax structures and discontinued operations. We track it because we believe it makes it easier to compare our performance with previous periods, and with companies and industries that do not have the same capital structure or tax laws.

Research and development expenses

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

Return on capital employed

Return on capital employed (ROCE) is a non-GAAP measure we use to evaluate the profitability of our invested capital. We calculate this ratio over a rolling four-quarter period by taking net income attributable to equity holders of the Company excluding net finance expense, after tax, divided by the average capital employed.

Simulator equivalent unit

Simulator equivalent unit (SEU) is an operating measure 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 joint venture, we will report only 50% of the FFSs deployed under this joint venture as a SEU. If a FFS is being powered down and relocated, it will not be included as a SEU until the FFS is re-installed and available to generate earnings.

Total segment operating income

Total segment operating income is a non-GAAP measure and is the sum of our key indicator of each segment’s financial performance. Segment operating income gives us an indication of the profitability of each segment because it does not include the impact of any items not specifically related to the segment’s performance. We calculate total segment operating income by taking the operating profit and excluding the impact of restructuring, integration and acquisition costs.

Utilization rate

Utilization rate is an operating measure we use to assess the performance of our Civil simulator training network. We calculate it by taking the number of training hours sold on our simulators during the period divided by the practical training capacity available for the same period.

14 | CAE Annual Report 2017

Management’s Discussion and Analysis

4. CONSOLIDATED RESULTS³

4.1 Results from operations – fourth quarter of fiscal 2017

(amounts in millions, except per share amounts)			Q4-2017	Q3-2017	Q2-2017	Q1-2017	Q4-2016
Revenue		$	734.7	682.7	635.5	651.6	722.5
Cost of sales		$	499.7	483.4	448.6	461.6	511.9
Gross profit³		$	235.0	199.3	186.9	190.0	210.6
	As a % of revenue	%	*32.0*	29.2	29.4	29.2	29.1
Research and development expenses³		$	31.3	28.8	25.9	25.0	26.5
Selling, general and administrative expenses		$	109.5	90.0	84.3	80.6	88.9
Other (gains) losses – net		$	(12.3)	(6.8)	3.7	2.7	(10.8)
After tax share in profit of equity accounted investees		$	(14.4)	(14.1)	(12.8)	(10.4)	(10.6)
Restructuring, integration and acquisition costs		$	20.0	2.8	9.6	3.1	16.8
Operating profit ³		$	100.9	98.6	76.2	89.0	99.8
	As a % of revenue	%	*13.7*	14.4	12.0	13.7	13.8
Finance income		$	(4.3)	(2.2)	(2.8)	(2.3)	(2.8)
Finance expense		$	20.6	20.7	20.7	22.0	21.2
Finance expense – net		$	16.3	18.5	17.9	19.7	18.4
Earnings before income taxes and discontinued operations		$	84.6	80.1	58.3	69.3	81.4
Income tax expense (recovery)		$	14.8	11.0	9.5	(0.1)	19.3
	As a % of earnings before income taxes and
	discontinued operations (income tax rate)	%	17	14	16	-	24
Earnings from continuing operations		$	69.8	69.1	48.8	69.4	62.1
(Loss) earnings from discontinued operations		$	(0.7)	0.2	0.1	(0.1)	(2.4)
Net income		$	69.1	69.3	48.9	69.3	59.7
Attributable to:
Equity holders of the Company
	Continuing operations	$	67.4	67.6	48.3	68.7	61.2
	Discontinued operations	$	(0.7)	0.2	0.1	(0.1)	(2.4)
		$	66.7	67.8	48.4	68.6	58.8
Non-controlling interests		$	2.4	1.5	0.5	0.7	0.9
		$	69.1	69.3	48.9	69.3	59.7
EPS attributable to equity holders of the Company
Basic and diluted - continuing operations		$	0.25	0.25	0.18	0.25	0.23
Basic and diluted - discontinued operations		$	-	-	-	-	(0.01)
		$	0.25	0.25	0.18	0.25	0.22

CAE Annual Report 2017 | 15

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

Management’s Discussion and Analysis

Revenue from continuing operations was 8% higher than last quarter and 2% higher compared to the fourth quarter of fiscal 2016

Revenue from continuing operations was $52.0 million higher than last quarter mainly because:

- Defence and Security revenue increased by $39.0 million, or 16%, mainly due to higher revenue from North American and Middle Eastern programs partially offset by lower revenue from European programs;

- Healthcare revenue increased by $8.0 million, or 31%, mainly due to higher revenue from centre management solutions and ultrasound simulators, primarily driven by higher sales to U.S. customers;

- Civil Aviation Training Solutions revenue increased by $5.0 million, or 1%, mainly due to higher FFS utilization in the Americas and Europe, partially offset by lower revenue from LMCFT acquired in the first quarter of fiscal 2017 and an unfavourable foreign exchange impact on the translation of foreign operations.

Revenue from continuing operations was $12.2 million higher than the same period last year largely because:

- Civil Aviation Training Solutions revenue increased by $24.8 million, or 6%, mainly due to higher revenue from our manufacturing facility due to the timing of production milestones, the integration into our results of the revenues of LMCFT and higher FFS utilization in the Americas and Europe. The increase was partially offset by the deferral of revenue recognition, to upon completion, from construction contracts for standardized simulators as a result of our process improvement program and an unfavourable foreign exchange impact on the translation of foreign operations;

- Defence and Security revenue decreased by $11.0 million, or 4%, mainly due to lower revenue from North American programs and an unfavourable foreign exchange impact on the translation of foreign operations partially offset by higher revenue from Middle Eastern programs;

- Healthcare revenue decreased by $1.6 million, or 4%, mainly due to lower patient simulator revenue due, in part, to lower volume from our international and military customers, partially offset by an increase in centre management solution and ultrasound simulator revenue in the U.S.

You will find more details in Results by segment.

Total segment operating income⁴ was $19.5 million higher than last quarter and $4.3 million higher compared to the fourth quarter of fiscal 2016

Operating profit this quarter was $100.9 million or 13.7% of revenue, compared to $98.6 million or 14.4% of revenue last quarter and $99.8 million or 13.8% of revenue in the fourth quarter of fiscal 2016. Restructuring, integration and acquisition costs of $20.0 million were recorded this quarter compared to $2.8 million last quarter and $16.8 million in the fourth quarter of last year. Total segment operating income was $120.9 million this quarter compared to $101.4 million last quarter and $116.6 million in the fourth quarter of fiscal 2016.

Total segment operating income was $19.5 million or 19% higher compared to last quarter. Increases in segment operating income were $12.4 million, $4.1 million and $3.0 million for Civil Aviation Training Solutions, Healthcare and Defence and Security respectively.⁴

Total segment operating income increased by $4.3 million or 4% over the fourth quarter of fiscal 2016. Increases in segment operating income of $8.8 million for Civil Aviation Training Solutions and $0.6 million for Healthcare were partially offset by a decrease of $5.1 million for Defence and Security.

You will find more details in Restructuring costs and Results by segment.

Net finance expense was $2.2 million lower than last quarter and $2.1 million lower than the fourth quarter of fiscal 2016

Net finance expense was lower this quarter compared to last quarter. The decrease was mainly due to higher finance income.

Net finance expense this quarter was lower compared to the fourth quarter of fiscal 2016. The decrease was mainly due to higher finance income, lower interest expense on long-term debt as a result of a repayment, in June 2016, of senior notes issued by way of a private placement and a decrease in other finance expense. The decrease was partially offset by higher finance expense on royalty obligations and R&D obligations.

Income tax rate was 17% this quarter

Income taxes this quarter were $14.8 million, representing an effective tax rate of 17%, compared to 14% last quarter and 24% for the fourth quarter of fiscal 2016.

The increase in the tax rate over last quarter was mainly due to a change in the mix of income from various jurisdictions, partially offset by an additional audit settlement in Canada this quarter. Excluding the effect of the audit settlement in Canada, the income tax rate would have been 22% this quarter.

The decrease in the tax rate from the fourth quarter of fiscal year 2016 was mainly due to an audit settlement in Canada and a change in the mix of income from various jurisdictions.

16 | CAE Annual Report 2017

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

Management’s Discussion and Analysis

4.2 Results from operations – fiscal 2017

(amounts in millions, except per share amounts)			FY2017	FY2016
Revenue		$	2,704.5	2,512.6
Cost of sales		$	1,893.3	1,816.7
Gross profit		$	811.2	695.9
	As a % of revenue	%	*30.0*	27.7
Research and development expenses		$	111.0	87.6
Selling, general and administrative expenses		$	364.4	311.5
Other gains – net		$	(12.7)	(24.2)
After tax share in profit of equity accounted investees		$	(51.7)	(43.4)
Restructuring, integration and acquisition costs		$	35.5	28.9
Operating profit		$	364.7	335.5
	As a % of revenue	%	*13.5*	13.4
Finance income		$	(11.6)	(9.5)
Finance expense		$	84.0	84.7
Finance expense – net		$	72.4	75.2
Earnings before income taxes and discontinued operations		$	292.3	260.3
Income tax expense		$	35.2	20.4
	As a % of earnings before income taxes and
	discontinued operations (income tax rate)	%	12	8
Earnings from continuing operations		$	257.1	239.9
Loss from discontinued operations		$	(0.5)	(9.6)
Net income		$	256.6	230.3
Attributable to:
Equity holders of the Company
	Continuing operations	$	252.0	239.3
	Discontinued operations	$	(0.5)	(9.6)
		$	251.5	229.7
Non-controlling interests		$	5.1	0.6
		$	256.6	230.3
EPS attributable to equity holders of the Company
Basic - continuing operations		$	0.94	0.89
Basic - discontinued operations		$	-	(0.04)
		$	0.94	0.85

Diluted - continuing operations		$	0.93	0.89
Diluted - discontinued operations		$	-	(0.04)
		$	0.93	0.85

CAE Annual Report 2017 | 17

Management’s Discussion and Analysis

Revenue from continuing operations was $191.9 million or 8% higher than last year

Revenue from continuing operations was higher than last year mainly because:

- Civil Aviation Training Solutions revenue increased by $127.8 million, or 9%, mainly due to higher revenue from our manufacturing facility, the integration into our results of the revenues of LMCFT and higher FFS utilization in Europe and the Americas. The increase was partially offset by the deferral of revenue recognition, to upon completion, from construction contracts for standardized simulators as a result of our process improvement program;

- Defence and Security revenue increased by $66.8 million, or 7%, mainly due to the integration into our results of the revenues from BMAT acquired in the second quarter of last year and higher revenue from European and Middle Eastern programs. The increase was partially offset by lower revenue from North American programs and an unfavourable foreign exchange impact on the translation of foreign operations;

- Healthcare revenue decreased by $2.7 million, or 2%, mainly due to lower patient simulator revenue due, in part, to lower volume from our international and military customers, partially offset by increased revenue from key partnerships with OEMs.

You will find more details in Results by segment.

Gross profit was $115.3 million higher than last year

Gross profit was $811.2 million this year, or 30.0% of revenue compared to $695.9 million, or 27.7% of revenue last year. As a percentage of revenue, gross profit was higher when compared to last year.

Total segment operating income was $35.8 million higher than last year

Operating profit for the year was $364.7 million or 13.5% of revenue, compared to $335.5 million or 13.4% of revenue last year. Restructuring, integration and acquisition costs of $35.5 million were recorded this year compared to $28.9 million last year and total segment operating income was $400.2 million this year compared to $364.4 million last year.

Total segment operating income was $35.8 million or 10% higher compared to last year. Increases in segment operating income were $35.8 million for Civil Aviation Training Solutions and $0.6 million for Defence and Security respectively, were partially offset by a decrease of $0.6 million for Healthcare.

You will find more details in Restructuring costs and Results by segment.

Net finance expense was $2.8 million lower than last year

			FY2016 to
(amounts in millions)			FY2017
Net finance expense, prior period		$	75.2
Change in finance expense from the prior period:
	Decrease in finance expense on long-term debt (other than finance leases)	$	(2.1)
	Increase in finance expense on royalty obligations		2.6
	Increase in finance expense on amortization of deferred financing costs		0.1
	Decrease in finance expense on accretion of provisions		(0.8)
	Decrease in other finance expense		(1.0)
	Decrease in borrowing costs capitalized		0.5
Decrease in finance expense from the prior period		$	(0.7)
Change in finance income from the prior period:
	Increase in interest income on loans and finance lease contracts	$	(0.3)
	Increase in other finance income		(1.8)
Increase in finance income from the prior period		$	(2.1)
Net finance expense, current period		$	72.4

Net finance expense was $72.4 million this year, $2.8 million or 4% lower than last year. The decrease was mainly due to lower interest expense on long-term debt as a result of a repayment, in June 2016, of senior notes issued by way of a private placement, higher finance income and lower interest on other debt, partially offset by higher finance expense on R&D obligations and royalty obligations.

18 | CAE Annual Report 2017

Management’s Discussion and Analysis

Income tax rate was 12% this year

This fiscal year, income taxes were $35.2 million, representing an effective tax rate of 12%, compared to 8% for the same period last year.

The increase in the tax rate compared to last year was mainly due to the net impact last year of the favourable settlement of tax oppositions in Canada with respect to the tax treatment of the sale of certain simulators, the negative impact of certain tax audits and the U.S. tax incentives applicable to domestic manufacturers, partially offset by this year’s recognition of deferred tax assets in Brazil, the favourable impact of the audit settlements in Canada and a change in mix of income from various jurisdictions. Excluding the effect of the recognition of deferred tax assets in Brazil and this year’s favourable impact of the audit settlements in Canada, the income tax rate would have been 18% this year.

4.3 Restructuring, integration and acquisition costs

During the first quarter of fiscal year 2016, we implemented a process improvement program to realize the benefits from the transformation of our production processes and product offering to further strengthen our competitive position, which resulted in a reduction of our workforce. The restructuring program was completed during the second quarter of fiscal 2017. Restructuring costs consisting mainly of severances and other related costs related to this process improvement program of $4.3 million after-tax were included in net income in fiscal 2017.

In the first quarter of fiscal 2017, we acquired 100% of the shares of LMCFT, a provider of aviation simulation training equipment and services. For the three months and twelve months ended March 31, 2017, costs for restructuring, integration and acquisition activities of $15.6 million after-tax and $22.1 million after-tax were included in net income, respectively, in relation to this acquisition. Restructuring costs consist mainly of severances, costs to exit leases and other related costs. Integration costs represent incremental costs directly related to the integration of LMCFT within our ongoing activities. This primarily includes expenditures related to regulatory and process standardization, systems integration and other activities. Acquisition costs include expenses, fees, commissions and other costs associated with the collection of information, negotiation of contracts, risk assessments, and the services of lawyers, advisors and specialists. The restructuring program related to the acquisition of LMCFT was completed during the fourth quarter of fiscal 2017.

You will find more details in Note 11 and Note 22 of our consolidated financial statements.

4.4 Consolidated orders and total backlog

Our total consolidated backlog was $7,530.2 million at the end of fiscal 2017, which is 18% higher than last year. New orders of $3,193.4 million were added this year, partially offset by $2,704.5 million in revenue generated from our obligated backlog. The adjustment of $23.8 million was mainly due to the cancellation of orders and the revaluation of prior year contracts, partially offset by a contract amendment related to the acquisition of Bombardier’s Military Aviation Training (BMAT) business, acquired last year, and an adjustment of $117.8 million added as a result of the acquisition of LMCFT. Our joint venture backlog⁵was $543.7 million and our unfunded backlog was $1,456.5 million.

Total backlog up 18% over last year

(amounts in millions)		FY2017		FY2016
Obligated backlog, beginning of period	$	5,064.9	$	4,354.1
+ orders		3,193.4		2,782.0
- revenue		(2,704.5)		(2,512.6)
+ / - adjustments		(23.8)		441.4
Obligated backlog, end of period	$	5,530.0	$	5,064.9
Joint venture backlog (all obligated)		543.7		551.3
Unfunded backlog		1,456.5		756.4
Total backlog	$	7,530.2	$	6,372.6

In fiscal 2016, adjustments were mainly related to the acquisition of BMAT, as well as the revaluation of certain contracts and the cancellation of two orders from previous years within the Civil Aviation Training Solutions segment and foreign exchange movements.

The book-to-sales ratio for the quarter was 1.03x. The ratio for the last 12 months was 1.18x.⁵

You will find more details in Results by segment.

CAE Annual Report 2017 | 19

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

Management’s Discussion and Analysis

5. RESULTS BY SEGMENT

We manage our business and report our results in three segments:

- Civil Aviation Training Solutions;

- Defence and Security;

- Healthcare.⁶

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

Unless otherwise indicated, elements within our segment revenue and segment operating income analysis are presented in order of magnitude.

KEY PERFORMANCE INDICATORS

Segment operating income
(amounts in millions, except operating margins)		FY2017	FY2016	Q4-2017	Q3-2017	Q2-2017	Q1-2017	Q4-2016

Civil Aviation Training Solutions	$	273.2	237.4	83.8	71.4	54.2	63.8	75.0
	%	*17.5*	16.6	*20.1*	17.3	15.3	17.2	19.1

Defence and Security	$	120.4	119.8	33.0	30.0	29.0	28.4	38.1
	%	*11.6*	12.3	*11.7*	12.3	11.5	11.0	13.0

Healthcare	$	6.6	7.2	4.1	-	2.6	(0.1)	3.5
	%	*6.0*	6.3	*12.0*	-	9.4	-	9.8
Total segment operating income (SOI)	$	400.2	364.4	120.9	101.4	85.8	92.1	116.6
Restructuring, integration and acquisition costs	$	(35.5)	(28.9)	(20.0)	(2.8)	(9.6)	(3.1)	(16.8)
Operating profit	$	364.7	335.5	100.9	98.6	76.2	89.0	99.8

Capital employed⁶

		March 31	December 31	September 30	June 30	March 31
(amounts in millions)		2017	2016	2016	2016	2016

Civil Aviation Training Solutions	$	1,985.3	2,016.5	2,052.4	2,027.4	2,017.1


Defence and Security	$	881.2	875.3	862.6	823.6	720.3


Healthcare	$	224.3	222.8	214.1	210.4	206.0

	$	3,090.8	3,114.6	3,129.1	3,061.4	2,943.4

20 | CAE Annual Report 2017

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

Management’s Discussion and Analysis

5.1 Civil Aviation Training Solutions

FISCAL 2017 EXPANSIONS AND NEW INITIATIVES

Acquisition

- We completed the acquisition of LMCFT, a provider of aviation simulation training equipment and services on May 2, 2016.

Expansions

- We integrated six FFSs into our training network following the completion of our acquisition of LMCFT. The FFSs are located in South Korea, Brazil and Turkey;

- Our joint venture Embraer-CAE Training Services announced an expansion of its training programs for Embraer Phenom 100 and Phenom 300 pilots and maintenance technicians at our location in Amsterdam. The program is expected to be ready for training in the first quarter of calendar 2018;

- We inaugurated, together with the Hibernia Management and Development Company Ltd. and the Research & Development Corporation, a new helicopter training and R&D centre in Newfoundland and Labrador featuring the first civilian Level D helicopter simulator with night vision in Canada;

- CAE Simulation Training Private Limited (CSTPL), a joint venture between CAE and InterGlobe Enterprises, announced the inauguration of its fourth A320 FFS;

- We commenced training on the Gulfstream G650 FFS, located at the Emirates-CAE Flight Training centre in Dubai, UAE;

- We announced the expansion of our commercial, business and helicopter aviation training agreement with Abu Dhabi Aviation (ADA) through which CAE and ADA will be delivering training to regional operators at ADA’s brand new training facility in Abu Dhabi, UAE;

- CAE-Lider, a joint venture between CAE and Lider Aviação, announced its designation by Leonardo Helicopter as the Recognized Flight Simulation Centre for the delivery of AW139 flight simulator hours supporting training in South America.

New programs and products

- We announced that our business aviation Upset Prevention and Recovery Training (UPRT) program is ready for training and has received endorsement by Dassault Aviation, reaffirming our leadership position in helping prevent Loss of Control In-Flight;

- We initiated the Next Generation Training System and launched the validation phase with AirAsia, focusing on the validation and refinement of the system’s new training capabilities for pilot critical skill performance;

- Our joint venture Flight Training Alliance unveiled its first C Series aircraft FFS during an inauguration held in Frankfurt, Germany and began pilot training at the Lufthansa Flight Training Center Frankfurt;

- Our new CAE Terminal online portal aims to enrich the customer experience by providing line pilots and flight department leaders instant access to appropriate documentation, training records and reservation details.

ORDERS

Civil Aviation Training Solutions obtained contracts this quarter expected to generate future revenues of $481.3 million, including contracts for 17 FFSs.

FFS contracts awarded for the quarter:

- Five FFSs, including two Boeing 737MAX, one Boeing 787, one Airbus A350 and one Airbus A320neo to Shanghai Eastern Flight Training Co., the training centre subsidiary of China Eastern Airlines;

- One Boeing 737NG FFS to Donghai Airlines;

- One C Series CS300 FFS to Korean Air;

- One Airbus A320 FFS to Avenger Flight Group;

- One Airbus A350 FFS to Ethiopian Airlines;

- One Airbus A320 FFS to Airbus;

- One Boeing 737NG FFS to ChongQing Yu Xiang Aviation;

- Six FFSs, including two Airbus A320s, two Airbus A330s, one Airbus A350 and one Boeing 767 to undisclosed customers in Asia and North America.

This brings the civil FFS order intake for the year to 50 FFSs.

Other notable contract awards for the quarter included:

- A new long-term ab-initio pilot training program for an undisclosed customer in the Middle East;

- An exclusive contract renewal with Scandinavian Airlines for pilot training and cabin crew recruitment and training services;

- An exclusive pilot training contract with an undisclosed customer in Europe.

CAE Annual Report 2017 | 21

Management’s Discussion and Analysis

Financial results
(amounts in millions, except operating margins, SEU, FFSs deployed and utilization rate)			FY2017	FY2016	Q4-2017	Q3-2017	Q2-2017	Q1-2017	Q4-2016
Revenue		$	1,556.9	1,429.1	417.8	412.8	354.7	371.6	393.0
Segment operating income		$	273.2	237.4	83.8	71.4	54.2	63.8	75.0
Operating margins		%	*17.5*	16.6	*20.1*	17.3	15.3	17.2	19.1
Depreciation and amortization		$	140.2	133.8	33.3	37.3	34.0	35.6	34.8
Property, plant and equipment
	expenditures	$	124.8	92.9	52.5	16.6	25.1	30.6	29.6
Intangible assets and other
	assets expenditures	$	20.5	33.7	5.4	4.7	5.3	5.1	8.3
Capital employed		$	1,985.3	2,017.1	1,985.3	2,016.5	2,052.4	2,027.4	2,017.1
Total backlog		$	3,288.9	3,078.6	3,288.9	3,253.5	3,337.6	3,221.6	3,078.6
SEU⁷			210	204	210	209	210	209	205
FFSs deployed			269	261	269	269	269	269	261
Utilization rate⁷		%	76	71	77	76	70	79	76

Revenue up 1% over last quarter and up 6% over the fourth quarter of fiscal 2016⁷

The increase over last quarter was mainly due to higher FFS utilization in the Americas and Europe, partially offset by lower revenue from LMCFT acquired in the first quarter of fiscal 2017 and an unfavourable foreign exchange impact on the translation of foreign operations.

The increase over the fourth quarter of fiscal 2016 was mainly due to higher revenue from our manufacturing facility due to the timing of production milestones, the integration into our results of the revenues of LMCFT and higher FFS utilization in the Americas and Europe. The increase was partially offset by the deferral of revenue recognition, to upon completion, from construction contracts for standardized simulators as a result of our process improvement program and an unfavourable foreign exchange impact on the translation of foreign operations.

Revenue was $1,556.9 million this year, 9% or $127.8 million higher than last year

The increase over last year was mainly due to higher revenue from our manufacturing facility, the integration into our results of the revenues of LMCFT and higher FFS utilization in Europe and the Americas. The increase was partially offset by the deferral of revenue recognition, to upon completion, from construction contracts for standardized simulators as a result of our process improvement program.

Segment operating income up 17% over last quarter and up 12% over the fourth quarter of fiscal 2016

Segment operating income was $83.8 million (20.1% of revenue) this quarter, compared to $71.4 million (17.3% of revenue) last quarter and $75.0 million (19.1% of revenue) in the fourth quarter of fiscal 2016.

Segment operating income increased by $12.4 million, or 17%, over last quarter. The increase was mainly due to higher FFS utilization in Europe and the Americas and gains on the sale of simulators from our network, partially offset by higher selling, general and administrative expenses and lower income from LMCFT.

Segment operating income increased by $8.8 million, or 12%, over the fourth quarter of fiscal 2016. The increase was mainly due to a favourable program mix from our manufacturing facility, gains on the sale of simulators from our network and higher FFS utilization in Europe and in the Americas. The increase was partially offset by higher selling, general and administrative expenses, non-recurring reorganization expenses in our FTOs following the consolidation of our operations in Europe and the impact on segment operating income of the deferral of revenue recognition for standardized simulators.

Segment operating income was $273.2 million, 15% or $35.8 million higher than last year

Segment operating income was $273.2 million (17.5% of revenue) this year, compared to $237.4 million (16.6% of revenue) last year.

The increase was mainly attributable to a favourable program mix from our manufacturing facility, higher income generated in Europe as a result of higher FFS utilization and a net favourable foreign exchange impact from operations. The increase was partially offset by higher selling, general and administrative expenses, non-recurring reorganization expenses in our FTOs following the consolidation of our operations in Europe and the impact on segment operating income of the deferral of revenue recognition for standardized simulators.

Property, plant and equipment expenditures at $52.5 million this quarter and $124.8 million for the year

Maintenance capital expenditures were $17.9 million for the quarter and $46.8 million for the year. Growth capital expenditures were $34.6 million for the quarter and $78.0 million for the year.

22 | CAE Annual Report 2017

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

Management’s Discussion and Analysis

Capital employed decreased $31.2 million from last quarter and decreased $31.8 million from last year

The decrease in capital employed from last quarter was mainly due to a lower investment in non-cash working capital mainly as a result of higher accounts payable and accrued liabilities and deferred revenue, partially offset by higher accounts receivable. The decrease was also due to higher long-term provisions and was partially offset by an increase in property, plant and equipment resulting from investment in capital expenditures.

The decrease in capital employed from last year was mainly due to higher deferred gains and other non-current liabilities, higher long‑term provisions and a lower investment in non-cash working capital. The lower investment in non-cash working capital was mainly due to higher deferred revenue and accounts payable and accrued liabilities, lower contracts in progress assets and higher provisions, partially offset by an increase in inventory and higher accounts receivable. The decrease in capital employed was partially offset by an increase in property, plant and equipment and a higher investment in equity accounted investees as a result of increased profitability within our joint ventures.


Total backlog was at $3,288.9 million at the end of the year

(amounts in millions)	FY2017		FY2016
Obligated backlog, beginning of period	$	2,623.3	$	2,397.7
+ orders		1,698.8		1,683.0
- revenue		(1,556.9)		(1,429.1)
+ / - adjustments		58.7		(28.3)
Obligated backlog, end of period	$	2,823.9	$	2,623.3
Joint venture backlog (all obligated)		465.0		455.3
Total backlog	$	3,288.9	$	3,078.6

Fiscal 2017 adjustments includes $117.8 million added as a result of the acquisition of LMCFT, the revaluation of prior year contracts and the cancellation of an order from a previous year.

Fiscal 2016 adjustments were mainly due to the revaluation of certain contracts during the year, the cancellation of two orders from previous years and foreign exchange movements.

This quarter's book-to-sales ratio was 1.15x. The ratio for the last 12 months was 1.09x.

CAE Annual Report 2017 | 23

Management’s Discussion and Analysis

5.2 Defence and Security

FISCAL 2017 EXPANSIONS AND NEW INITIATIVES

Expansions

- We delivered the Naval Warfare Training System to the Swedish Navy and commenced the provision of training support services during the third quarter;

- We continue to expand our naval capabilities and expertise, and have begun the design and build of the Naval Training Centre for the United Arab Emirates Navy;

- We constructed and inaugurated the CAE Dothan Training Center in Dothan, U.S., where we began offering training for the U.S. Army Fixed-Wing Flight Training program in March 2017;

- We received an Authorization to Operate KC-135 aircrew training devices on the U.S. Air Force’s Distributed Training Center Network.

New programs and products

- We signed a Memorandum of Understanding with Draken International to pursue global opportunities related to the provision of advanced adversary and aggressor air training services;

- We supported both the Royal Canadian Air Force and Royal Australian Air Force as they participated in Coalition Virtual Flag 16, one of the world's largest virtual air combat exercises;

- We launched our next-generation CAE Medallion-6000XR image generator to support the creation of highly immersive and realistic synthetic environments;

- The Open Geospatial Consortium (OGC), an international consortium developing geospatial standards and interoperable solutions, formally approved the CAE-developed Common Database (CDB) as an international OGC standard.

ORDERS

Defence and Security was awarded $238.8 million in orders this quarter, including notable contract awards from:

- Airbus Defence and Space for a comprehensive C295W aircrew and maintenance training solution to support the Royal Canadian Air Force’s (RCAF) Fixed-Wing Search and Rescue program;

- The NATO Support and Procurement Agency to provide comprehensive training services, including instructors, for the NATO E-3A Airborne Warning and Control System aircrew training program;

- Lockheed Martin to continue providing a range of training support services for the U.S. Air Force C-130J Maintenance and Aircrew Training System program.

Financial results
(amounts in millions, except operating margins)			FY2017	FY2016	Q4-2017	Q3-2017	Q2-2017	Q1-2017	Q4-2016
Revenue		$	1,036.9	970.1	282.7	243.7	253.2	257.3	293.7
Segment operating income		$	120.4	119.8	33.0	30.0	29.0	28.4	38.1
Operating margins		%	*11.6*	12.3	*11.7*	12.3	11.5	11.0	13.0
Depreciation and amortization		$	57.8	69.8	14.3	14.5	11.1	17.9	20.7
Property, plant and equipment
	expenditures	$	95.8	22.9	19.7	19.0	33.5	23.6	9.4
Intangible assets and other
	assets expenditures	$	26.9	17.6	12.6	6.7	2.9	4.7	8.1
Capital employed		$	881.2	720.3	881.2	875.3	862.6	823.6	720.3
Total backlog		$	4,241.3	3,294.0	4,241.3	4,139.6	3,197.4	3,306.0	3,294.0

Revenue up 16% over last quarter and down 4% from the fourth quarter of fiscal 2016

The increase over last quarter was mainly due to higher revenue from North American and Middle Eastern programs partially offset by lower revenue from European programs.

The decrease from the fourth quarter of fiscal 2016 was mainly due to lower revenue from North American programs and an unfavourable foreign exchange impact on the translation of foreign operations partially offset by higher revenue from Middle Eastern programs.

Revenue was $1,036.9 million this year, 7% or $66.8 million higher than last year

The increase was mainly due to the integration into our results of the revenues from BMAT acquired in the second quarter of last year and higher revenue from European and Middle Eastern programs. The increase was partially offset by lower revenue from North American programs and an unfavourable foreign exchange impact on the translation of foreign operations.

24 | CAE Annual Report 2017

Management’s Discussion and Analysis

Segment operating income up 10% over last quarter and down 13% from the fourth quarter of fiscal 2016

Segment operating income was $33.0 million (11.7% of revenue) this quarter, compared to $30.0 million (12.3% of revenue) last quarter and was $38.1 million (13.0% of revenue) in the fourth quarter of fiscal 2016.

The increase over last quarter was mainly due to higher volume on North American programs and higher margins on Asian programs, partially offset by higher selling, general and administrative expenses and lower volume on European programs.

The decrease from the fourth quarter of fiscal 2016 was mainly due to a benefit recognized last year related to the renegotiation of long-term royalty obligations partially offset by an unfavourable tax assessment in one of our joint ventures and a loss on disposal of assets related to our process improvement plan. The decrease was partially offset by higher margins on North American and Asian programs and higher profitability in our joint ventures, offset, in part, by higher selling, general and administrative expenses.

Segment operating income was $120.4 million this year, 1% or $0.6 million higher than last year

Segment operating income was $120.4 million (11.6% of revenue) this year, compared to $119.8 million (12.3% of revenue) last year.

The increase over last year was mainly due to higher margins on North American programs, the integration into our results of BMAT, higher margins on Asian programs, higher profitability in our joint ventures and higher volume on European and Middle Eastern programs, partially offset by higher selling, general and administrative expenses and higher net research and development expenses. The increase in segment operating income was partially offset by a benefit recognized last year related to the renegotiation of long‑term royalty obligations and higher investment tax credits claimed last year partially offset by an unfavourable tax assessment in one of our joint ventures, and a loss on disposal of assets related to our process improvement plan.

Capital employed increased $5.9 million over last quarter and increased $160.9 million over last year

The increase over last quarter was mainly due to higher intangible assets, higher property, plant and equipment and lower deferred gains and other non-current liabilities, partially offset by a lower investment in non-cash working capital as a result of higher accounts payable and accrued liabilities, partially offset by an increase in accounts receivables.

The increase over last year was mainly due to an increase in property, plant and equipment as a result of capital expenditures related to the U.S. Army Fixed-Wing Flight Training program, lower deferred gains and other non-current liabilities, higher other assets, an increase in intangible assets and a higher investment in non-cash working capital. The higher investment in non-cash working capital was mainly due lower accounts payable and accrued liabilities and an increase in accounts receivables, partially offset by a decrease in prepayments.


Total backlog up 29% compared to last year

(amounts in millions)	FY2017		FY2016
Obligated backlog, beginning of period	$	2,441.6	$	1,956.4
+ orders		1,383.9		985.6
- revenue		(1,036.9)		(970.1)
+ / - adjustments		(82.5)		469.7
Obligated backlog, end of period	$	2,706.1	$	2,441.6
Joint venture backlog (all obligated)		78.7		96.0
Unfunded backlog		1,456.5		756.4
Total backlog	$	4,241.3	$	3,294.0

Fiscal 2017 adjustments include the cancellation of two orders and the revaluation of prior year contracts, partially offset by a contract amendment related to the acquisition of BMAT, acquired in the second quarter of fiscal 2016.

Fiscal 2016 adjustments are mainly due to backlog added as a result of the acquisition of BMAT and foreign exchange movements.

This quarter's book-to-sales ratio was 0.84x. The ratio for the last 12 months was 1.33x.

In fiscal 2017, $146.7 million of unfunded backlog was transferred to obligated backlog and $939.2 million was added to the unfunded backlog.

CAE Annual Report 2017 | 25

Management’s Discussion and Analysis

5.3 Healthcare

FISCAL 2017 EXPANSIONS AND NEW INITIATIVES

Expansions

- Our Vimedix ultrasound simulator was used to deliver the European Diploma in Echocardiography exam for the first time during the European Society for Intensive Care Medicine Congress in Milan, Italy, demonstrating its use not only for training, but also for certification;

- We commenced collaboration under a co-marketing agreement with a medical device manufacturer promoting point-of-care ultrasound training and its expanded use for patient assessment and diagnosis;

- We released a new version of the Respiratory Education Simulation Program (RESP 1 and RESP 2) Learning Module for Apollo, iStan, METIman and the Human Patient Simulator;

- Our Essentials of Simulation course, which is offered in partnership with the University of Rotterdam, was accredited by the Dutch National Office of Continuous Medical Education;

- We hosted our 20^th Human Patient Simulation Network (HPSN) World conference for attendees from 21 countries in the fourth quarter, and hosted our first HPSN conferences in China and India, expanding our potential customer bases and simulation markets.

New programs and products

- We launched the VimedixAR ultrasound simulator with Microsoft Hololens, the first ultrasound simulator with real-time interactive holograms of human anatomy;

- We launched the Blue Phantom Gen II PICC with IV and arterial access ultrasound model at the National League for Nursing conference in Orlando, U.S. This model is used to train clinicians in the skills associated with ultrasound guided peripheral venous and arterial access procedures;

- We added a Spectral Doppler capability as well as a new Emergency Care pathology package to our Vimedix offerings.

ORDERS

CAE Healthcare sales this quarter included:

- 13 patient simulators and five centre management systems for major contracts to customers in the U.S. and the Middle East;

- Five VimedixAR ultrasound simulators with Microsoft Hololens to customers in the U.S. and a custom Vimedix solution to an OEM.

Financial results
(amounts in millions, except operating margins)			FY2017	FY2016	Q4-2017	Q3-2017	Q2-2017	Q1-2017	Q4-2016
Revenue		$	110.7	113.4	34.2	26.2	27.6	22.7	35.8
Segment operating income		$	6.6	7.2	4.1	-	2.6	(0.1)	3.5
Operating margins		%	*6.0*	6.3	*12.0*	-	9.4	-	9.8
Depreciation and amortization		$	13.9	14.2	3.8	3.5	3.3	3.3	3.6
Property, plant and equipment
	expenditures	$	2.3	2.0	1.4	0.2	0.2	0.5	0.8
Intangible assets and other
	assets expenditures	$	3.7	2.6	-	1.6	1.0	1.1	0.4
Capital employed		$	224.3	206.0	224.3	222.8	214.1	210.4	206.0

Revenue up 31% over last quarter and down 4% from the fourth quarter of fiscal 2016

The increase over last quarter was mainly due to higher revenue from centre management solutions and ultrasound simulators, primarily driven by higher sales to U.S. customers.

The decrease from the fourth quarter of fiscal 2016 was mainly due to lower patient simulator revenue due, in part, to lower volume from our international and military customers, partially offset by an increase in centre management solution and ultrasound simulator revenue in the U.S.

26 | CAE Annual Report 2017

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.⁸

6.1 Consolidated cash movements

(amounts in millions)			FY2017		FY2016		Q4-2017		Q3-2017		Q4-2016
Cash provided by continuing operating activities*		$	435.2	$	348.9	$	116.9	$	124.4	$	100.3
Changes in non-cash working capital			29.1		(3.1)		80.6		31.7		(49.3)
Net cash provided by continuing operating activities		$	464.3	$	345.8	$	197.5	$	156.1	$	51.0
Maintenance capital expenditures⁸			(62.8)		(45.4)		(24.5)		(13.9)		(12.7)
Other assets			(5.5)		(19.7)		(2.3)		(2.7)		(6.1)
Proceeds from the disposal of property, plant
	and equipment		6.6		1.8		4.1		0.2		0.3
Net (payments to) proceeds from equity accounted investees			(10.6)		3.4		(1.2)		(0.6)		(1.3)
Dividends received from equity accounted investees			16.5		18.5		7.3		6.4		0.9
Dividends paid			(80.6)		(56.7)		(20.5)		(20.8)		(19.3)

Revenue from continuing operations higher compared to last quarter and the fourth quarter of fiscal 2016

Positive free cash flow1 from continuing operations at $160.4 million this quarter

Higher revenue from continuing operations compared to fiscal 2016

Positive free cash flow from continuing operations at $327.9 million

Positive free cash flow¹ from continuing operations at $160.4 million this quarter