engq4fy18fullreport24052018-.htm - Generated by SEC Publisher for SEC Filing

Message from the Chair of the Board

Stronger than ever

In fiscal 2018, CAE’s management once again strengthened the company’s financial and operational performance. This included new records in order intake and backlog, as well as solid growth in our return on capital employed. We also raised our shareholder dividend for the seventh consecutive year. The evidence is unequivocal—we have a strong management team implementing the right strategy.

A winning strategy

Our strategic focus on delivering innovative end-to-end training servicesonaglobalscalegeneratedsignificantresultsinfiscal2018. WiththesupportofCAE’smorethan8,500professionalsworldwide, we won contracts with an increasing number of customers. Our end markets are benefiting from secular growth tailwinds and we foresee sustainable, profitable growth and an expanded market reach in training across all CAE segments.

As a pure-play training company, we heightened our ability to spearhead industry innovation and our customers’ ability to deliver on their mission, safely and efficiently. Our next-generation pilot training solution CAE Rise™ represents an exciting step change in the way operators train their pilots and in how we help them keep the world’s skies safe. Our reputation as a leading training systems integrator for defence forces is growing as is global interest in our healthcare simulation solutions.

Strengthening governance

In fiscal 2018, we continued to reinforce our governance practices and take steps to ensure excellence in ethics and compliance. These steps included making our

Code of Business Conduct more accessible and user friendly. Also, we have made substantial progress in evolving our culture and corporate social responsibility.

We also enhanced our enterprise risk management policy and framework to help mitigate risks related to privacy, aviation safety, and cyber security, a major threat for companies today. To keep pace with our increasingly agile culture, we also improved our talent management review and succession processes.

Diversity and Board renewal

Today two of eleven CAE directors are women. As a Board, our target is to reach at least 30% by 2022. This is a key element of the renewal process underway.

As part of this process, I would like to thank outgoing corporate director General Peter J. Schoomaker, who is retiring consistent with our director age limit requirements, for his invaluable contributions over the past years. I am also pleased to welcome Michael E. Roach, former CEO of CGI Group, who joined the Board in November 2017. Michael brings deep business expertise to the Board.

Looking back as I step down

During my 23 years on CAE’s Board, I have seen this remarkable company evolve and mature beyond many people’s expectations. As testament to this success, our share price and market capitalization more than doubled in the last five years alone and our workforce grew by approximately 1,000 employees to more than 8,500. We secured major training partnerships with world-renowned airlines such as Japan Airlines and AirAsia. Also, we signed on to deliver comprehensive defence training programs around the globe.

It has been an honour to lead a Board of this calibre and I am extremely proud of what we have accomplished together. For the last time as Chair, I would like to thank our shareholders for their trust in CAE’s ability to generate meaningful economic, social and environmental benefits for stakeholders. I feel confident that, with your ongoing support, an even brighter future awaits this great company.

Table of Contents
Management’s Discussion and Analysis
1.	HIGHLIGHTS		1
2.	INTRODUCTION		3
3.	ABOUT CAE		5
	3.1	Who we are	5
	3.2	Our mission	5
	3.3	Our vision	5
	3.4	Our strategy	5
	3.5	Our operations	6
	3.6	Foreign exchange	12
	3.7	Non-GAAP and other financial measures	13
4.	CONSOLIDATED RESULTS		15
	4.1	Results from operations – fourth quarter of fiscal 2018	15
	4.2	Results from operations – fiscal 2018	17
	4.3	Consolidated orders and total backlog	18
5.	RESULTS BY SEGMENT		19
	5.1	Civil Aviation Training Solutions	20
	5.2	Defence and Security	23
	5.3	Healthcare	25
6.	CONSOLIDATED CASH MOVEMENTS AND LIQUIDITY		27
	6.1	Consolidated cash movements	27
	6.2	Sources of liquidity	28
	6.3	Government participation	29
	6.4	Contractual obligations	29
7.	CONSOLIDATED FINANCIAL POSITION		30
	7.1	Consolidated capital employed	30
	7.2	Off balance sheet arrangements	32
	7.3	Financial instruments	32
8.	BUSINESS COMBINATIONS		35
9.	BUSINESS RISK AND UNCERTAINTY		35
	9.1	Risks relating to the industry	35
	9.2	Risks relating to the Company	37
	9.3	Risks relating to the market	40
10.	RELATED PARTY TRANSACTIONS		42
11.	CHANGES IN ACCOUNTING POLICIES		43
	11.1	New and amended standards not yet adopted	43
	11.2	Use of judgements, estimates and assumptions	44
12.	CONTROLS AND PROCEDURES		46
	12.1	Evaluation of disclosure controls and procedures	46
	12.2	Internal control over financial reporting	46
13.	OVERSIGHT ROLE OF AUDIT COMMITTEE AND BOARD OF DIRECTORS		46
14.	ADDITIONAL INFORMATION		46
15.	SELECTED FINANCIAL INFORMATION		47
Consolidated Financial Statements			49

Management’s Discussion and Analysis

for the fourth quarter and year ended March 31, 2018

1. HIGHLIGHTS

FINANCIAL

FOURTH QUARTER OF FISCAL 2018

Revenue from continuing operations higher compared to last quarter and the fourth quarter of fiscal 2017

– Consolidated revenue from continuing operations was $780.7 million this quarter, $76.3 million or 11% higher than last quarter and $46.0 million or 6% higher than the fourth quarter of fiscal 2017.

Total segment operating income¹ higher compared to last quarter and the fourth quarter of fiscal 2017

– Total segment operating income was $141.1 million this quarter, $28.3 million or 25% higher than last quarter and $20.2 million or 17% higher than the fourth quarter of fiscal 2017.

Net income attributable to equity holders of the Company from continuing operations lower compared to last quarter and higher compared to the fourth quarter of fiscal 2017

– Net income attributable to equity holders of the Company from continuing operations was $100.1 million (or $0.37 per share) this quarter compared to $117.9 million (or $0.44 per share) last quarter, representing a decrease of $17.8 million or 15% and compared to $67.4 million (or $0.25 per share) in the fourth quarter of last year, representing an increase of $32.7 million or 49%;

– As there were no restructuring, integration and acquisition costs or one-time tax items this quarter or last quarter, net income before specific items¹ was equal to net income attributable to equity holders of the Company from continuing operations, compared to net income before specific items of $82.4 million (or $0.31 per share) in the fourth quarter of fiscal 2017;

– Last quarter's results include impacts of the income tax recovery resulting from the enactment of a lower U.S. federal income tax rate and the gain on the remeasurement of the previously held Asian Aviation Centre of Excellence Sdn. Bhd. (AACE) investment net of reorganizational costs. Excluding these elements, earnings per share would have been $0.28.

Positive free cash flow¹ from continuing operations at $117.3 million this quarter

– Net cash provided by continuing operating activities was $137.8 million this quarter, compared to $187.6 million last quarter and $197.5 million in the fourth quarter of last year;

– Maintenance capital expenditures¹ and other asset expenditures were $22.8 million this quarter, $17.7 million last quarter and $26.8 million in the fourth quarter of last year;

– Cash dividends were $22.5 million this quarter, $23.2 million last quarter and $20.5 million in the fourth quarter of last year.

FISCAL 2018

Higher revenue from continuing operations compared to fiscal 2017

– Consolidated revenue from continuing operations was $2,830.0 million, $125.5 million or 5% higher than last year.

Total segment operating income higher compared to fiscal 2017

– Total segment operating income was $461.0 million, $60.8 million or 15% 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 $347.0 million (or $1.29 per share) compared to $252.0 million (or $0.93 per share) last year, representing a $95.0 million or 38% increase;

– As there were no restructuring, integration and acquisition costs or one-time tax items in fiscal 2018, net income before specific items was equal to net income attributable to equity holders of the Company from continuing operations, compared to net income before specific items of $278.4 million (or $1.03 per share) last year;

– Fiscal 2018 results include impacts of the income tax recovery resulting from the enactment of a lower U.S. federal income tax rate, the gain on the remeasurement of the previously held AACE investment net of reorganizational costs and the gain realized from the disposal of our equity interest in the joint venture Zhuhai Xiang Yi Aviation Technology Company Limited (ZFTC). Excluding these elements, earnings per share would have been $1.11.

Positive free cash flow from continuing operations at $288.9 million

– Net cash provided by continuing operating activities was $403.3 million this year, compared to $464.3 million last year;

– Maintenance capital expenditures and other asset expenditures were $77.6 million this year, compared to $68.3 million last year;

– Cash dividends were $89.9 million this year, compared to $80.6 million last year.

CAE Financial Report 2018 I 1

¹ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

Capital employed² increased by $184.3 million or 7% this year, ending at $3,016.0 million

– Return on capital employed² (ROCE) was 14.4% this year compared to 11.2% last year. Excluding the impacts of the income tax recovery resulting from the enactment of a lower U.S. federal income tax rate, the gain on the remeasurement of the previously held AACE investment net of reorganizational costs and the gain realized from the disposal of our equity interest in the joint venture ZFTC, our ROCE would have been 12.3% this year;

– Non-cash working capital² decreased by $12.1 million in fiscal 2018, ending at $180.9 million;

– Property, plant and equipment increased by $221.3 million;

– Other long-term liabilities increased by $26.9 million;

– Net debt²decreased by $101.3 million this year, ending at $649.4 million.

ORDERS²

– The book-to-sales ratio² for the quarter was 1.30x (Civil Aviation Training Solutions was 1.20x, Defence and Security was 1.50x and Healthcare was 1.00x). The ratio for the last 12 months was 1.36x (Civil Aviation Training Solutions was 1.44x, Defence and Security was 1.29x and Healthcare was 1.00x);

– Total order intake this year was $3,855.0 million, up $661.6 million over last year;

– Total backlog², including obligated, joint venture and unfunded backlog was $7,849.1 million at March 31, 2018, $318.9 million higher than last year.

Civil Aviation Training Solutions

– Civil Aviation Training Solutions obtained contracts with an expected value of $2,339.5 million, including contracts for 50 full-flight simulators (FFSs).

Defence and Security

– Defence and Security won contracts valued at $1,400.3 million.

Healthcare

– Healthcare order intake was valued at $115.2 million.

BUSINESS COMBINATIONS

– During the second quarter, we acquired a portfolio of training assets in North America and Europe from a full-flight simulator leasing business for cash consideration of $24.7 million. With this transaction, we obtained fully operational full-flight simulators and various customer contracts;

– During the third quarter, we completed the acquisition of the remaining 50% equity interest in AACE from AirAsia, for a cash consideration of $114.8 million [US$90 million] and long-term contingent cash consideration payable of up to US$10 million if certain criteria are met.

OTHER

– During the second quarter, we signed a Memorandum of Understanding with Singapore Airlines, to establish a joint venture for pilot training in Singapore. The joint venture will initially focus on primarily providing simulator training for Boeing aircraft types, supporting Singapore Airlines, its subsidiaries and other operators' pilot training needs in the region. The closing of the transaction is subject to customary closing conditions;

– During the second quarter, we concluded a sale to China Southern Airlines of our 49% equity interest in the joint venture ZFTC for US$96 million, excluding post-closing adjustments. As part of the transaction, both companies reached an agreement on the outsourcing to CAE of third-party airline training conducted at China Southern Airlines’ ZFTC facility;

– During the third quarter, we purchased a 45% interest in Pelesys, forming a joint venture with a global leader in the provision of aviation training solutions and courseware;

– On February 9, 2018, we announced the renewal of our normal course issuer bid (NCIB) to purchase, for cancellation, up to 5,349,804 of our issued and outstanding common shares over a one year period ending February 22, 2019.

2 I CAE Financial Report 2018

² Non-GAAP and other financial measures (see Section 3.7).

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 matters, claims arising from casualty losses, integration of acquired businesses, our ability to penetrate new markets, U.S. foreign ownership, control or influence mitigation measures, length of sales cycle, seasonality, continued returns to shareholders, information technology systems including cybersecurity risk, data privacy risk and our reliance on technology and third-party providers, and risks relating to the market such as foreign exchange, availability of capital, pension plan funding, doing business in foreign countries including corruption risk, political instability 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.

4 I CAE Financial Report 2018

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 record of more than 70 years 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 mission

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 vision

Our vision is to be the recognized global training partner of choice to enhance safety, efficiency and readiness.

3.4 Our strategy

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

We are a unique, pure-play training company with a proven record, of more than 70 years, of commitment to our customers’ long-term training needs.

We offer the most innovative and broadest range of comprehensive training solutions across a global network by incorporating a combination of live training on actual platforms, virtual training in simulators and extended reality applications, and constructive training using computer-generated simulations. Our strategic imperatives focus on the protection of our leadership position and growing at a superior rate than the underlying markets.

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. As well, we have good visibility owing to a large order backlog and high success rate of renewing existing customer contracts.

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 segments. We focus on providing an excellent end-to-end customer experience and 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 3.7% annually over the next decade. In defence and security, we see renewed defence investment as a positive catalyst and an increased focus on training for mission readiness. 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. Each of our three core markets is characterized by a scarcity of critical personnel for which we are in a prime position to help customers meet their needs for highly trained professionals.

CAE Financial Report 2018 I 5

Management’s Discussion and Analysis

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. Backed by more than 70 years 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 design and deliver the industry's most sophisticated training systems, employing the latest in simulation, extended reality and digital, including data-enabled technologies. As well, we have a demonstrated flexibility by engaging customers under a variety of partnership models.

3.5 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 have the unique capability to address 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 experience and thought leadership, large 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 more than 30 countries and through our broad global network of more than 50 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 255 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 our next generation training systems, including CAE Real‑time Insights and Standardized Evaluations (CAE Rise^TM), which will improve training quality, objectivity 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. 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, reliability and innovation 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. Our global reach enables us to provide best-in-class support services such as real-time, remote monitoring and also enables us to leverage 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.

CAE Financial Report 2018 I

Management’s Discussion and Analysis

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 the U.S.

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), with the Airline Transport Pilot (ATP) certification requirements in the U.S. and with Upset Prevention and Recovery Training (UPRT) requirements mandated by both EASA and the FAA.

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 to achieve satisfactory 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.

Our newest innovation in pilot training systems, CAE Rise™, is well positioned to elevate the pilot training experience. Backed by industry‑leading technology, this system enables instructors to deliver training in accordance with airlines’ Standard Operating Procedures and enables instructors to objectively assess pilot competencies using live data during training sessions. Furthermore, CAE Rise™ augments instructors’ capability to identify pilot proficiency gaps and evolve airline training programs to the most advanced aviation safety standards, including Advanced Qualification Program and Evidence Based Training methodologies.

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 3.7% annually over the next decade. For calendar 2017, passenger traffic increased by 7.6% compared to calendar 2016. For the first three months of calendar 2018, passenger traffic increased by 7.2% compared to the first three months of calendar 2017. Passenger traffic in Asia and Europe grew by 9.0% and 7.7% respectively, while Latin America, North America and the Middle East increased by 7.3%, 5.3% and 5.2% 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 with 3.2% 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 improved by 4.8%.

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.

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, oil price volatility 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 3.1% annually over the past 20 years and is widely expected to continue to grow at an approximate average rate of 3.5% annually over the next two decades because of increasing emerging markets, low-cost carrier demand and fleet replacement in established markets. From March 2017 to March 2018, the global commercial aircraft fleet increased by 6.6%, growing by 9.3% in Asia Pacific, 6.3% in Europe, the Middle East and Africa (EMEA) and 4.6% 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 6X and Gulfstream’s 500/600.

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 in the civil aviation market, 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, CAE 400XR, 500XR, 550XR and 600XR Series Flight Training Devices (FTD) and CAE Simfinity™ ground school solutions, in delivering training equipment solutions that address the growing training needs of airlines, business jet operators, and helicopter operators.

8 I CAE Financial Report 2018

Management’s Discussion and Analysis

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.

Our Airline Pilot Demand Outlook, released in June 2017, identifies a global requirement for 255,000 new pilots over the next 10 years to sustain and grow the commercial air transport industry. Rapid fleet expansion and high pilot retirement rates create a further need to develop 180,000 first officers into new airline captains. These numbers mean that over 50% of the pilots who will fly the world’s commercial aircraft in 10 years have not yet started to train. To support this growth in demand, the aviation industry will require innovative solutions to match the learning requirements of a new generation of trained aviation professionals, leading to an increase in demand for simulation‑based training services and products.

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 (iLVC) 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 iLVC 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 program to provide the United Arab Emirates (UAE) Navy with a comprehensive Naval Training Centre. We 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 also 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 live, virtual and constructive 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 iLVC 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 outsourced 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;

– Attractiveness of outsourcing training and maintenance services;

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

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

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

– Installed base of enduring defence platforms and new customers;

– Relationships with OEMs for simulation and training.

CAE Financial Report 2018 I 7

Management’s Discussion and Analysis

Growing defence budgets

In March 2018, the U.S. Congress finalized the U.S. federal budget for fiscal year 2018, which included the authorization of a defence budget for approximately USD $700 billion. In addition, the majority of the 29 members of NATO have expressed plans to increase defence spending in the coming years, and this includes Canada, which plans to grow annual defence spending from approximately $19 billion to $33 billion by 2027. 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.

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 and increase readiness, while allowing 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 our 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 for training support required to meet the demand for producing aircrews and achieve desired readiness levels. For example, we are delivering fixed-wing flight training to the U.S. Army at the CAE Dothan Training Center in Dothan, Alabama. At this training centre, we offer comprehensive classroom, simulator and live-flying training and we believe this type of training service delivery program will become increasingly attractive to defence forces globally.

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. As a training systems integrator, CAE can address the overall iLVC domain to deliver comprehensive training, from undergraduate individual training all the way through to operational, multi-service and joint mission training.

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 U.S., U.K., Australia, Canada and others all have plans and strategies to leverage iLVC domains within a networked common synthetic environment. According to the U.K. Ministry of Defence, they will be establishing and acquiring a simulation architecture designed to better enable networked training while shifting more training from the live to the synthetic environment. We are actively teaming with other industry partners, as evidenced by our November 2017 announcement of a collaborative agreement to develop iLVC training solutions. We are also promoting open, standard simulation architectures, such as the Open Geospatial Consortium Common Database (OGC CDB), to better enable integrated and networked mission training.

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, the desire to save aircraft for operational use, and the advanced simulation technologies delivering more realism are several 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. An example of this shift is the U.S. Navy P-8A program, which is replacing the P-3C Orion. CAE has been contracted to design and manufacture a total of 18 P-8A operational flight trainers for the Navy. The training curriculum for the P-3C was made up of approximately 30 percent synthetic training, while the P-8A training program leverages synthetic training for approximately 70 percent of the training curriculum. This level of rebalancing of live and virtual training is representative of the desire of governments and defence forces around the world to increase the use of synthetic training.

10 I CAE Financial Report 2018

Management’s Discussion and Analysis

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-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-8, C295, MH-60R and MQ-9 in global defence markets, thus creating opportunities to provide new training systems and services for platforms where CAE has significant experience.

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-8 maritime patrol aircraft and has subcontracted CAE to design and develop P-8 operational flight trainers for the U.S. Navy and other international customers. Boeing 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.

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 medical practitioners 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 medical errors. We are leveraging our experience and best practices in simulation‑based aviation training to deliver innovative solutions to improve the safety and efficiency in the delivery of patient care. 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 as well as courseware for simulation-based healthcare education and training. We have sold simulators to customers in approximately 90 countries that are currently supported by our global network. We are a leader in high-fidelity patient simulators that are uniquely powered by advanced models of human physiology to realistically mimic human responses to clinical interventions. For example, our high-fidelity childbirth simulator, Lucina, was designed to offer exceptional realism for simulated scenarios of both normal deliveries and rare maternal emergencies. In June 2017, we introduced CAE Juno, the first contemporary clinical skills manikin that meets requirements for fundamental nurse training, currently the largest segment of the healthcare education market. Juno allows nursing programs to adapt to new realities of more complex conditions of hospital patients, liability concerns in healthcare, and thus, decreased access to live patients for learners.

Through our Healthcare Academy, we deliver peer-to-peer training at customer sites as well as 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 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 UAE.

We offer turnkey solutions, project management and professional services for healthcare simulation programs. We also collaborate with medical device companies and scientific societies to develop innovative and custom training solutions. In September 2017, in collaboration with the American Society of Anesthesiologists (ASA), we released Anesthesia SimSTAT, a virtual healthcare training environment for practicing physicians. This new platform provides continuing medical education for Maintenance of Certification in Anesthesiology (MOCA) and has allowed us to expand access to simulation-based clinical training among the anesthesia community. 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. In January 2018, we announced that in collaboration with the American Heart Association (AHA), we will establish a network of International Training Sites to deliver lifesaving AHA courses in countries that are currently underserved. The first authorized site operated by CAE Healthcare has opened within the CAE Brunei Multi-Purpose Training Centre in Brunei Darussalam.

CAE Financial Report 2018 I 9

Management’s Discussion and Analysis

Market drivers

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

– Limited access to live patients during training;

– Medical technology revolution;

– Broader adoption of simulation, with a demand for innovative and custom training approaches;

– Growing emphasis on patient safety and outcomes.

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 ground-breaking 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. In the U.K., the Nursing and Midwifery Council announced in April 2018 that it has lifted the cap on the number of hours nursing students can spend in simulation-based training in place of clinical hours.

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 22 NATO countries prohibiting the use of live animals in military medical training. CAE Healthcare simulators provide a low-risk alternative for practicing life-saving procedures, interprofessional team training and major disaster response.

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 the introduction of new interventional procedures. We were the first to bring a commercial Microsoft HoloLens mixed reality application to the medical simulation market with the release of the CAE VimedixAR ultrasound simulator. In January 2018, we launched a new mixed reality application, LucinaAR, the world's first childbirth simulator that integrates modeled physiology and augmented reality.

Broader adoption of simulation, with a demand for innovative and custom training approaches

The majority of product and service sales in healthcare simulation involve healthcare education. We estimate 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 virtual, augmented and mixed reality simulators, 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. There is a growing body of evidence demonstrating that medical simulation improves clinical competency, 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 are the third-leading cause of death in U.S. hospitals. Training using simulation can help clinicians gain confidence, knowledge and expertise for improving patient safety in a risk-free environment. As the Medicare and Medicaid reimbursement structure in U.S. hospitals shifts from being based solely on quantity of services to the quality of services, including safety and patient outcomes, CAE expects more hospitals to implement simulation-based training to improve performance and reduce the risk of medical errors.

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.

Management’s Discussion and Analysis

3.6 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 /
	2018	2017	(decrease)
U.S. dollar (US$ or USD)	1.29	1.33	(3	%)
Euro (€ or EUR)	1.59	1.42	12	%
British pound (£ or GBP)	1.81	1.67	8	%

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

			Increase /
	2018	2017	(decrease)
U.S. dollar (US$ or USD)	1.28	1.31	(2	%)
Euro (€ or EUR)	1.50	1.44	4	%
British pound (£ or GBP)	1.70	1.71	(1	%)

For fiscal 2018, the effect of translating the results of our foreign operations into Canadian dollars resulted in a decrease in revenue of $3.8 million and a decrease in net income of $0.5 million, when compared to fiscal 2017. 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.

You will find more details about our foreign exchange exposure and hedging strategies in Business Risks and Uncertainties.

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)		$	16.2	$	4.2	$	(3.5	)	$	0.7
Euro (€ or EUR)		4.5		0.3		(0.2		)	0.1
British pound (£ or GBP)		1.3		0.1		(0.1		)	—

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

12 I CAE Financial Report 2018

Management’s Discussion and Analysis

3.7 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.

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.

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).

CAE Financial Report 2018 I 13

Management’s Discussion and Analysis

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.

Order intake and Backlog

Order intake

Order intake is a non-GAAP measure that represents the expected value of orders we have received:

– For the Civil Aviation Training Solutions segment, we consider an item part of our order intake 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 order intake 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 order intake 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.

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

Backlog

Obligated backlog is a non-GAAP measure that represents the value of our order intake not yet executed and is calculated by adding the order intake of the current period to the balance of the obligated backlog at the end of the previous fiscal year, subtracting the revenue recognized in the current period and adding or subtracting backlog adjustments. If the amount of an order already recognized in a previous fiscal year is modified, the backlog is revised through adjustments.

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. When an option is exercised, it is removed from the unfunded backlog and is considered order intake in the period that it is exercised.

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

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 one of the operating measures we use to assess the performance of our Civil simulator training network. While utilization rate does not directly correlate to revenue recognized, we track it, together with other measures, because we believe it is an indicator of our operating performance. 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 I CAE Financial Report 2018

Management’s Discussion and Analysis

4. CONSOLIDATED RESULTS

4.1 Results from operations – fourth quarter of fiscal 2018³

(amounts in millions, except per share amounts)		Q4-2018		Q3-2018		Q2-2018		Q1-2018		Q4-2017
Revenue	$	780.7		704.4		646.0		698.9		734.7
Cost of sales	$	520.2		488.7		458.0		486.2		499.7
Gross profit³	$	260.5		215.7		188.0		212.7		235.0
As a % of revenue	%	*33.4*		30.6		29.1		30.4		32.0
Research and development expenses³	$	22.8		29.8		30.0		32.3		31.3
Selling, general and administrative expenses	$	112.3		98.6		75.1		94.8		109.5
Other (gains) losses – net	$	(4.3	)	(15.1	)	(18.3	)	0.3		(12.3	)
After tax share in profit of equity accounted investees	$	(11.4	)	(10.4	)	(8.1	)	(12.5	)	(14.4	)
Restructuring, integration and acquisition costs	$	—		—		—		—		20.0
Operating profit³	$	141.1		112.8		109.3		97.8		100.9
As a % of revenue	%	*18.1*		16.0		16.9		14.0		13.7
Finance expense – net	$	24.0		16.9		17.5		17.8		16.3
Earnings before income taxes and discontinued operations	$	117.1		95.9		91.8		80.0		84.6
Income tax expense (recovery)	$	13.7		(24.0	)	24.8		14.6		14.8
As a % of earnings before income taxes and
discontinued operations (income tax rate)	%	12		(25	)	27		18		17
Earnings from continuing operations	$	103.4		119.9		67.0		65.4		69.8
Loss from discontinued operations	$	—		—		—		—		(0.7	)
Net income	$	103.4		119.9		67.0		65.4		69.1
Attributable to:
Equity holders of the Company
Continuing operations	$	100.1		117.9		65.2		63.8		67.4
Discontinued operations	$	—		—		—		—		(0.7	)
	$	100.1		117.9		65.2		63.8		66.7
Non-controlling interests	$	3.3		2.0		1.8		1.6		2.4
	$	103.4		119.9		67.0		65.4		69.1
EPS attributable to equity holders of the Company
Basic and diluted	$	0.37		0.44		0.24		0.24		0.25

CAE Financial Report 2018 I 15

³ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

Revenue from continuing operations was 11% higher than last quarter and 6% higher compared to the fourth quarter of fiscal 2017

Revenue from continuing operations was $76.3 million higher than last quarter. Increases in revenue were $41.5 million, $27.6 million and $7.2 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

Revenue from continuing operations was $46.0 million higher than the same period last year. Increases in revenue were $37.4 million, $7.7 million and $0.9 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

You will find more details in Results by segment.

Total segment operating income⁴ was $28.3 million higher than last quarter and $20.2 million higher compared to the fourth quarter of fiscal 2017

Operating profit this quarter was $141.1 million or 18.1% of revenue, compared to $112.8 million or 16.0% of revenue last quarter and $100.9 million or 13.7% of revenue in the fourth quarter of fiscal 2017. There were no restructuring, integration and acquisition costs recorded this quarter or last quarter compared to $20.0 million in the fourth quarter of last year. Total segment operating income was $141.1 million this quarter compared to $112.8 million last quarter and $120.9 million in the fourth quarter of fiscal 2017.

Total segment operating income was $28.3 million or 25% higher compared to last quarter. Increases in segment operating income were $17.1 million, $6.0 million and $5.2 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

Total segment operating income increased by $20.2 million or 17% over the fourth quarter of fiscal 2017. Increases in segment operating income were $11.9 million, $5.7 million and $2.6 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

You will find more details in Results by segment.

Net finance expense was $7.1 million higher than last quarter and $7.7 million higher than the fourth quarter of fiscal 2017

Net finance expense was higher this quarter compared to last quarter. The increase was mainly due to higher other finance expense resulting from a change in presentation of the classification of certain cumulative finance costs previously accounted within income taxes, following clarification issued by the IFRS interpretation committee during fiscal 2018, as well as higher interest on long-term provisions. The increase was also due to higher finance expense on royalty obligations and higher interest on long-term debt.

Net finance expense this quarter was higher compared to the fourth quarter of fiscal 2017. The increase was mainly due to higher other finance expense, as mentioned above, lower finance income and higher finance expense on royalty obligations.

Income tax rate was 12% this quarter

Income taxes this quarter were $13.7 million, representing an effective tax rate of 12%, compared to a negative effective tax rate of 25% last quarter and an effective tax rate of 17% for the fourth quarter of fiscal 2017.

The increase in the tax rate over last quarter was mainly due to the third quarter's adjustment resulting from the enactment of a lower U.S. federal corporate income tax rate and the non-taxable portion of the net gain on the remeasurement of the previously held AACE investment. The increase was partially offset by a change in the mix of income from various jurisdictions mainly from the recognition, this quarter, of deferred tax assets not previously recognized in Europe. Excluding the effect of these deferred tax assets, the income tax rate would have been 23% this quarter.

The decrease in the tax rate from the fourth quarter of fiscal year 2017 was mainly due to a change in the mix of income from various jurisdictions from the recognition, this quarter, of deferred tax assets not previously recognized in Europe, partially offset by an audit settlement in Canada last year.

CAE Financial Report 2018 I

⁴ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

4.2 Results from operations – fiscal 2018

(amounts in millions, except per share amounts)		FY2018		FY2017
Revenue	$	2,830.0		2,704.5
Cost of sales	$	1,953.1		1,893.3
Gross profit	$	876.9		811.2
As a % of revenue	%	*31.0*		30.0
Research and development expenses	$	114.9		111.0
Selling, general and administrative expenses	$	380.8		364.4
Other gains – net	$	(37.4	)	(12.7	)
After tax share in profit of equity accounted investees	$	(42.4	)	(51.7	)
Restructuring, integration and acquisition costs	$	—		35.5
Operating profit	$	461.0		364.7
As a % of revenue	%	*16.3*		13.5
Finance expense – net	$	76.2		72.4
Earnings before income taxes and discontinued operations	$	384.8		292.3
Income tax expense		29.1		35.2
As a % of earnings before income taxes and
discontinued operations (income tax rate)	%	8		12
Earnings from continuing operations	$	355.7		257.1
Loss from discontinued operations	$	—		(0.5	)
Net income	$	355.7		256.6
Attributable to:
Equity holders of the Company
Continuing operations	$	347.0		252.0
Discontinued operations	$	—		(0.5	)
	$	347.0		251.5
Non-controlling interests	$	8.7		5.1
	$	355.7		256.6
EPS attributable to equity holders of the Company
Basic - continuing and discontinued operations	$	1.29		0.94
Diluted - continuing and discontinued operations	$	1.29		0.93

Revenue from continuing operations was $125.5 million or 5% higher than last year

Revenue from continuing operations was higher than last year. Increases in revenue were $72.8 million, $48.2 million and $4.5 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

You will find more details in Results by segment.

Gross profit was $65.7 million higher than last year

Gross profit was $876.9 million this year, or 31.0% of revenue compared to $811.2 million, or 30.0% of revenue last year. As a percentage of revenue, gross profit was higher when compared to last year.

Total segment operating income was $60.8 million higher than last year

Operating profit for the year was $461.0 million or 16.3% of revenue, compared to $364.7 million or 13.5% of revenue last year. Restructuring, integration and acquisition costs of nil were recorded this year compared to $35.5 million last year and total segment operating income was $461.0 million this year compared to $400.2 million last year.

Total segment operating income was $60.8 million or 15% higher compared to last year. Increases in segment operating income were $51.3 million, $7.3 million and $2.2 million for Civil Aviation Training Solutions, Defence and Security and Healthcare respectively.

You will find more details in Results by segment.

CAE Financial Report 2018 I 17

Management’s Discussion and Analysis

Net finance expense was $3.8 million higher than last year

	FY2017 to
(amounts in millions)	FY2018
Net finance expense, prior period	$	72.4
Change in finance expense from the prior period:
Decrease in finance expense on long-term debt (other than finance leases)	$	(0.2	)
Increase in finance expense on royalty obligations	1.3
Decrease in finance expense on amortization of deferred financing costs	(0.1		)
Increase in finance expense on accretion of provisions	0.4
Increase in other finance expense	5.0
Increase in borrowing costs capitalized	(0.5		)
Increase in finance expense from the prior period	$	5.9
Change in finance income from the prior period:
Increase in interest income on loans and finance lease contracts	$	(1.7	)
Increase in other finance income	(0.4		)
Increase in finance income from the prior period	$	(2.1	)
Net finance expense, current period	$	76.2

Net finance expense was $76.2 million this year, $3.8 million or 5% higher than last year. The increase was mainly due to higher other finance expense resulting from higher interest on long-term provisions and higher interest from a change in presentation of the classification of certain cumulative finance costs previously accounted within income taxes, following clarification issued by the IFRS interpretation committee during fiscal 2018. The increase was also due to higher finance expense on royalty obligations, partially offset by higher finance income.

Income tax rate was 8% this year

This fiscal year, income taxes were $29.1 million, representing an effective tax rate of 8%, compared to 12% for the same period last year.

The decrease in the tax rate compared to last year was mainly due to an adjustment resulting from the enactment of a lower U.S. federal corporate income tax rate, the non-taxable portion of the net gain on the remeasurement of the previously held AACE investment and a change in the mix of income from various jurisdictions mainly from the recognition of previously unrecognized deferred tax assets in Europe. The decrease was partially offset by the impact of audits in Canada, last year's recognition of deferred tax assets in Brazil and the sale of our equity interest in the joint venture ZFTC during the year.

Excluding the effect of the adjustment resulting from the enactment of a lower U.S. federal corporate income tax rate, the recognition of deferred tax assets this year, the remeasurement of our previously held AACE investment and the sale of our interest in ZFTC, the income tax rate would have been 21% this year.

4.3 Consolidated orders and total backlog

Total backlog up 4% over last year

(amounts in millions)	FY2018			FY2017
Obligated backlog, beginning of period	$	5,530.0		$	5,064.9
+ orders	3,855.0			3,193.4
- revenue	(2,830.0		)	(2,704.5		)
+ / - adjustments	67.2			(23.8		)
Obligated backlog, end of period	$	6,622.2		$	5,530.0
Joint venture backlog (all obligated)	366.7			543.7
Unfunded backlog	860.2			1,456.5
Total backlog	$	7,849.1		$	7,530.2

The book-to-sales ratio for the quarter was 1.30x. The ratio for the last 12 months was 1.36x.

You will find more details in Results by segment.

18 I CAE Financial Report 2018

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.

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)		FY2018	FY2017		Q4-2018	Q3-2018	Q2-2018	Q1-2018		Q4-2017

Civil Aviation Training Solutions	$	324.5	273.2		95.7	78.6	77.1	73.1		83.8
	%	*19.9*	17.5		*21.0*	19.0	22.1	17.8		20.1

Defence and Security	$	127.7	120.4		38.7	32.7	30.0	26.3		33.0
	%	*11.8*	11.6		*13.3*	12.4	11.2	10.0		11.7

Healthcare	$	8.8	6.6		6.7	1.5	2.2	(1.6	)	4.1
	%	*7.6*	6.0		*19.1*	5.4	7.8	—		12.0
Total segment operating income (SOI)	$	461.0	400.2		141.1	112.8	109.3	97.8		120.9
Restructuring, integration and acquisition costs	$	—	(35.5	)	—	—	—	—		(20.0	)
Operating profit	$	461.0	364.7		141.1	112.8	109.3	97.8		100.9

Capital employed⁵

		March 31	December 31	September 30	June 30	March 31
(amounts in millions)		2018	2017	2017	2017	2017
Civil Aviation Training Solutions	$	2,096.4	1,998.9	1,850.6	2,073.4	1,985.3
Defence and Security	$	982.4	955.5	965.5	924.6	881.2
Healthcare	$	211.5	205.0	206.4	213.4	224.3
	$	3,290.3	3,159.4	3,022.5	3,211.4	3,090.8

⁵ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

5.1 Civil Aviation Training Solutions

FISCAL 2018 EXPANSIONS AND NEW INITIATIVES

Acquisitions and Divestitures

– We concluded a sale to China Southern Airlines of our 49% equity interest in the joint venture ZFTC. As part of the transaction, both companies reached an agreement on the outsourcing to CAE of third-party airline training conducted at China Southern Airlines’ ZFTC facility;

– We acquired a portfolio of training assets in North America and Europe from a full-flight simulator leasing business for cash consideration of $24.7 million, where we obtained fully operational FFSs and various customer contracts;

– We completed the acquisition of the remaining 50% equity interest in AACE from AirAsia, for a cash consideration of $114.8 million [US$90 million] and long-term contingent cash consideration payable of up to US$10 million if certain criteria are met;

– We purchased a 45% interest in Pelesys, forming a joint venture with a global leader in the provision of aviation training solutions and courseware.

Expansions

– We signed a Memorandum of Understanding with Singapore Airlines, to establish a joint venture for pilot training in Singapore. The joint venture will initially focus on primarily providing simulator training for Boeing aircraft types, supporting Singapore Airlines, its subsidiaries and other operators’ pilot training needs in the region. The closing of the transaction is subject to customary closing conditions;

– We announced the extension of our North American training footprint in Minneapolis-Saint Paul, U.S. Through this centre, we have extended our ability to support regional airline customers and have the capacity to train more than 20,000 pilots every year;

– We, together with Korea Airports Corporation, inaugurated a new training facility at Gimpo Airport, Seoul, Korea, to support the growing pilot training needs of Korean carriers;

– We announced the expansion of our North American pilot training capacity with the addition of a new CAE-built Bombardier CRJ900 FFS and an Embraer ERJ-145 in Phoenix, U.S., and the deployment of one Airbus A320 FFS in Montreal, one Airbus A320 FFS in Mexico and one Bombardier Q400 FFS in Vancouver to be delivered throughout the year;

– We inaugurated an ATR 72-600 FFS at our training centre in Madrid, Spain;

– We announced, together with Abu Dhabi Aviation Training Center (ADA), a new Embraer ERJ-145 pilot training program with Falcon Aviation. Training will be delivered to Falcon Aviation's pilots and other regional operators at ADA's brand-new training facility in Abu Dhabi, UAE.

New programs and products

– We achieved Level D qualification for the world’s first CAE-built Bombardier C Series FFS, located at the Bombardier Training Centre in Montreal, Canada and Interim Level C qualification for the world’s first airline operated Boeing 737MAX FFS, located at Air Canada’s training centre in Toronto, Canada;

– We launched the CAE Master Pilot Training Program, a badge of honor dedicated to further elevate the experience of business aviation pilots throughout their career, raising pilot levels of platform knowledge, safety awareness and situational response capabilities;

– We launched our newest pilot training innovation, the CAE Rise^TM training system, with longstanding partner AirAsia;

– We launched the CAE 600XR Series FTD, the latest addition to CAE's innovative XR Series training equipment suite.

FISCAL 2018 ORDERS

Civil Aviation Training Solutions obtained contracts this quarter expected to generate future revenues of $544.5 million, including contracts for 5 FFSs sold to customers in all regions. This brings the total civil order intake to $2,339.5 million and 50 FFSs for the year.

Notable contract awards for fiscal 2018 included:

– An exclusive 10-year long-term training contract with Virgin Atlantic Airways;

– An exclusive long-term training contract extension to 2036 with AirAsia;

– An exclusive 12-year long-term training contract with Air Transat;

– An exclusive 8-year long-term training contract extension with Jazz Aviation LP;

– An exclusive long-term pilot training contract extension with Flexjet;

– An exclusive long-term contract renewal with Elit'Avia for business aviation pilot training to include UPRT.

22 I CAE Financial Report 2018

Management’s Discussion and Analysis

FINANCIAL RESULTS⁶

(amounts in millions, except operating margins, SEU, FFSs deployed and utilization rate)		FY2018	FY2017	Q4-2018	Q3-2018	Q2-2018	Q1-2018	Q4-2017
Revenue	$	1,629.7	1,556.9	455.2	413.7	349.0	411.8	417.8
Segment operating income	$	324.5	273.2	95.7	78.6	77.1	73.1	83.8
Operating margins	%	*19.9*	17.5	*21.0*	19.0	22.1	17.8	20.1
Depreciation and amortization	$	136.6	140.2	33.7	35.9	31.8	35.2	33.3
Property, plant and equipment
expenditures	$	143.7	124.8	50.2	38.9	21.9	32.7	52.5
Intangible assets and other
assets expenditures	$	18.3	20.5	4.1	6.3	1.9	6.0	5.4
Capital employed	$	2,096.4	1,985.3	2,096.4	1,998.9	1,850.6	2,073.4	1,985.3
Total backlog	$	3,975.9	3,288.9	3,975.9	3,822.3	3,106.6	3,225.0	3,288.9
SEU⁶		206	210	212	205	199	209	210
FFSs deployed		255	269	255	252	249	269	269
Utilization rate⁶	%	76	76	82	75	70	78	77

Revenue up 10% over last quarter and up 9% over the fourth quarter of fiscal 2017

The increase over last quarter was mainly due to higher FFS utilization in the Americas and Europe, higher revenue from our manufacturing facility due to the timing of production milestones and the integration into our results of the revenues from AACE following the acquisition last quarter of the remaining 50% equity interest. The increase was also due to a favourable foreign exchange impact on the translation of foreign operations.

The increase over the fourth quarter of fiscal 2017 was due to higher FFS utilization in the Americas and the contribution of newly deployed simulators in our network in Europe and in the Americas, the integration into our results of the revenues from AACE, as mentioned above, a favourable foreign exchange impact on the translation of foreign operations and higher revenue recognized from simulator sales due to higher deliveries.

Revenue was $1,629.7 million this year, 5% or $72.8 million higher than last year

The increase over last year was mainly due to higher FFS utilization in the Americas and the contribution of newly deployed simulators in our network in Europe and in the Americas, the integration into our results of the revenues from AACE, as mentioned above, a favourable foreign exchange impact on the translation of foreign operations and an increase in demand for our crew sourcing business. The increase was also due to higher revenue recognized from simulator sales due to higher level of deliveries.

Segment operating income up 22% over last quarter and up 14% over the fourth quarter of fiscal 2017

Segment operating income was $95.7 million (21.0% of revenue) this quarter, compared to $78.6 million (19.0% of revenue) last quarter and $83.8 million (20.1% of revenue) in the fourth quarter of fiscal 2017.

Segment operating income increased by $17.1 million, or 22%, over last quarter. The increase was mainly due to higher FFS utilization mainly in the Americas and in Europe, higher revenue from our manufacturing facility, as mentioned above, and gains on the sale of existing simulators from our network to our customers. The increase was partially offset by higher selling, general and administrative expenses and a gain, recorded in the previous quarter, on the remeasurement of the previously held AACE investment net of reorganizational costs.

Segment operating income increased by $11.9 million, or 14%, over the fourth quarter of fiscal 2017. The increase was mainly due to higher FFS utilization and newly deployed simulators, as mentioned above, and higher revenue from our manufacturing facility. The increase was partially offset by higher selling, general and administrative expenses and an unfavourable foreign exchange impact from the revaluation of non-cash working capital accounts.

Segment operating income was $324.5 million, 19% or $51.3 million higher than last year

Segment operating income was $324.5 million (19.9% of revenue) this year, compared to $273.2 million (17.5% of revenue) last year.

The increase was mainly due to higher FFS utilization and newly deployed simulators, as mentioned above, gains realized in the second quarter from the disposal of our equity interest in the joint venture ZFTC, a favourable foreign exchange impact from operations and the net gain on the remeasurement of the previously held AACE investment following the acquisition in the third quarter. The increase was partially offset by higher selling, general and administrative expenses.

CAE Financial Report 2018 I 21

⁶ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

Property, plant and equipment expenditures at $50.2 million this quarter and $143.7 million for the year

Maintenance capital expenditures were $20.9 million for the quarter and $54.7 million for the year. Growth capital expenditures were $29.3 million for the quarter and $89.0 million for the year.

Capital employed increased $97.5 million over last quarter and $111.1 million over last year

The increase in capital employed over last quarter was mainly due to higher property, plant and equipment and intangible assets mainly as a result of movements in foreign exchange rates, a higher investment in equity accounted investees and higher non-cash working capital.

The increase in capital employed over last year was mainly due to higher property, plant and equipment and intangible assets and a lower investment in equity accounted investees resulting from the acquisition of AACE. This increase was partially offset by a lower investment in non-cash working capital, mainly due to higher deferred revenue and lower inventory, partially offset by higher accounts receivable.

Total backlog was at $3,975.9 million at the end of the year

(amounts in millions)	FY2018			FY2017
Obligated backlog, beginning of period	$	2,823.9		$	2,623.3
+ orders	2,339.5			1,698.8
- revenue	(1,629.7		)	(1,556.9		)
+ / - adjustments	148.2			58.7
Obligated backlog, end of period	$	3,681.9		$	2,823.9
Joint venture backlog (all obligated)	294.0			465.0
Total backlog	$	3,975.9		$	3,288.9

Fiscal 2018 adjustments includes $224.1 million added as a result of the acquisition of AACE, positive foreign exchange movements and the revaluation of prior year contracts. An adjustment was made to the joint venture backlog to reflect the removal of the AACE contracts that were transferred to obligated backlog.

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

This quarter's book-to-sales ratio was 1.20x. The ratio for the last 12 months was 1.44x.

22 I CAE Financial Report 2018

Management’s Discussion and Analysis

5.2 Defence and Security

FISCAL 2018 EXPANSIONS AND NEW INITIATIVES

Expansions

– During the year, we began offering the new Initial Entry Fixed-Wing course at CAE's Dothan Training Center. A total of 56 U.S. Army students have since graduated from the program to become Army fixed-wing aviators.

New programs and products

– We upgraded the C-130 Aeromedical Evacuation Training System for the USAF at Dobbins Air Reserve Base with a motion platform, a first-of-its-kind in the world for an aeromedical fuselage trainer;

– We supported the Royal Australian Air Force’s (RAAF) participation in the Diamond Thunder distributed mission training exercise, which saw the RAAF network various simulation assets across the country as part of its inaugural Air Warfare Instructor Course;

– Our CAE 7000 Series C295 FFS and CAE 3000 Series SW-4 FFS were accepted into service by the Polish Air Force at the 8th Air Base Krakow-Balice and 41st Air Base School in Deblin, Poland respectively, where they will play a key role in the training of Polish Air Force aircrews and cadets;

– Our Predator Mission Trainer was accepted into service by the Italian Air Force at Amendola Air Force Base in Italy.

FISCAL 2018 ORDERS

Defence and Security was awarded $434.5 million in orders this quarter and $1,400.3 million in total for fiscal 2018, including notable contract awards from:

– Leonardo Helicopters to provide the Qatar Emiri Air Force with a comprehensive NH90 helicopter training solution that includes simulators, training devices and long-term training services;

– The U.S. Navy under a U.S. foreign military sale program to provide the Brazilian Navy with a comprehensive S-70B Seahawk helicopter training system;

– The Royal Australian Air Force to continue providing King Air 350 simulator services through 2024;

– The U.S. Navy exercising contract options as part of the MH-60R/S Tech Refresh and Procurement of Simulators program;

– The U.K. Ministry of Defence to continue providing aircrew training services at CAE's Medium Support Helicopter Aircrew Training Facility (MSHATF);

– The General Headquarters of the UAE to provide the UAE Air Force with a comprehensive training solution for the RQ-1E Predator remotely piloted aircraft.

FINANCIAL RESULTS

(amounts in millions, except operating margins)		FY2018	FY2017	Q4-2018	Q3-2018	Q2-2018	Q1-2018	Q4-2017
Revenue	$	1,085.1	1,036.9	290.4	262.8	268.7	263.2	282.7
Segment operating income	$	127.7	120.4	38.7	32.7	30.0	26.3	33.0
Operating margins	%	*11.8*	11.6	*13.3*	12.4	11.2	10.0	11.7
Depreciation and amortization	$	49.9	57.8	10.8	10.3	14.0	14.8	14.3
Property, plant and equipment
expenditures	$	27.6	95.8	6.8	3.4	2.3	15.1	19.7
Intangible assets and other
assets expenditures	$	21.6	26.9	9.2	3.6	5.2	3.6	12.6
Capital employed	$	982.4	881.2	982.4	955.5	965.5	924.6	881.2
Total backlog	$	3,873.2	4,241.3	3,873.2	3,546.0	3,607.0	4,101.2	4,241.3

Revenue up 11% over last quarter and up 3% over the fourth quarter of fiscal 2017

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

The increase over the fourth quarter of fiscal 2017 was mainly due to higher revenue from North American programs partially offset by lower revenue from European, Australian and Asian programs resulting from a higher level of activity in the prior year and an unfavourable foreign exchange impact on the translation of foreign operations.

Revenue was $1,085.1 million this year, 5% or $48.2 million higher than last year

The increase was mainly due to higher revenue from North American and Middle Eastern programs partially offset by lower revenue from European and Australian programs and an unfavourable foreign exchange impact on the translation of foreign operations.

CAE Financial Report 2018 I 23

Management’s Discussion and Analysis

Segment operating income up 18% over last quarter and up 17% over the fourth quarter of fiscal 2017

Segment operating income was $38.7 million (13.3% of revenue) this quarter, compared to $32.7 million (12.4% of revenue) last quarter and $33.0 million (11.7% of revenue) in the fourth quarter of fiscal 2017.

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

The increase over the fourth quarter of fiscal 2017 was mainly due to higher margins on European programs and lower net research and development expenses, partially offset by lower margins on Asian programs.

Segment operating income was $127.7 million this year, 6% or $7.3 million higher than last year

Segment operating income was $127.7 million (11.8% of revenue) this year, compared to $120.4 million (11.6% of revenue) last year.

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

Capital employed increased $26.9 million over last quarter and increased $101.2 million over last year

The increase over last quarter was mainly due to movements in foreign exchange rates and a higher profitability in our joint ventures, partially offset by a lower investment in non-cash working capital.

The increase over last year was mainly due to a higher investment in non-cash working capital as a result of higher contracts in progress assets and lower accounts payable and accrued liabilities, partially offset by a decrease in prepayments. The increase was also due to a higher profitability in our joint ventures.

Total backlog down 9% compared to last year

(amounts in millions)	FY2018			FY2017
Obligated backlog, beginning of period	$	2,706.1		$	2,441.6
+ orders	1,400.3			1,383.9
- revenue	(1,085.1		)	(1,036.9		)
+ / - adjustments	(81.0		)	(82.5		)
Obligated backlog, end of period	$	2,940.3		$	2,706.1
Joint venture backlog (all obligated)	72.7			78.7
Unfunded backlog	860.2			1,456.5
Total backlog	$	3,873.2		$	4,241.3

Fiscal 2018 adjustments include the removal of the Initial Entry Rotary-Wing Instructor Support Services contract following a protest which resulted in the client's decision to award the contract to the incumbent and the revaluation of prior year contracts.

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 Bombardier's Military Aviation Training, acquired in fiscal 2016.

This quarter's book-to-sales ratio was 1.50x. The ratio for the last 12 months was 1.29x.

In fiscal 2018, $283.3 million of unfunded backlog was transferred to obligated backlog and $262.1 million was added to the unfunded backlog. An adjustment was made to the unfunded backlog to reflect the removal of the Initial Entry Rotary-Wing Instructor Support Services contract.

24 I CAE Financial Report 2018

Management’s Discussion and Analysis

5.3 Healthcare

FISCAL 2018 EXPANSIONS AND NEW INITIATIVES

Expansions

– We hosted our first expanded Human Patient Simulation Network (HPSN) U.K. conference, expanding our potential customer base and simulation market to include specialties outside of nursing;

– We formed a partnership with the AHA to establish a network of International Training Sites to deliver lifesaving AHA courses in countries that are currently underserved. We began delivering courses in the fourth quarter for clinicians at our first training site, the CAE Brunei Multi-Purpose Training Centre.

New programs and products

– We launched CAE Juno, a new clinical skills manikin for nursing programs designed to help bridge the gap between classroom and hospital settings, in the first quarter of fiscal 2018 at the INACSL annual conference;

– We, together with ASA, launched the Anesthesia SimSTAT - Trauma, the first in a series of interactive screen-based anesthesia simulation modules, which has been approved by the American Board of Anesthesiology for MOCA credits;

– We delivered a Microsoft Hololens augmented reality training solution for the Abiomed Impella, a heart pump system;

– We developed a physics-driven simulator for the Medtronic Micra^TM Transcatheter Pacing System, that offers an augmented reality training solution for up to 12 simultaneous learners;

– We developed the LucinaAR, the world's first augmented reality childbirth simulator, which was launched at the International Meeting on Simulation in Healthcare. This high-fidelity patient manikin allows clinical teams and learners to practice emergency labour and delivery manoeuvers while guided by 3D holograms;

– We signed a distributor contract with WorldPoint to sell CAE Juno manikins to simulation centres in the U.S., which will give us access to WorldPoint's unique network of customers.

Innovation Awards

– Evidencing our thought leadership in healthcare simulation, Anesthesia SimSTAT earned the .orgCommunity Innovation 2017 Award;

– We received the Unity Impact Award for our CAE VimedixAR ultrasound simulator, which integrates real-time interactive holograms of the human anatomy.

FISCAL 2018 ORDERS

CAE Healthcare sales this year included large orders for patient and ultrasound simulators and centre management solutions sold to customers in North America directly and internationally, through distributors, as well as patient and interventional simulators sold to military customers.

FINANCIAL RESULTS

(amounts in millions, except operating margins)		FY2018	FY2017	Q4-2018	Q3-2018	Q2-2018	Q1-2018		Q4-2017
Revenue	$	115.2	110.7	35.1	27.9	28.3	23.9		34.2
Segment operating income	$	8.8	6.6	6.7	1.5	2.2	(1.6	)	4.1
Operating margins	%	*7.6*	6.0	*19.1*	5.4	7.8	—		12.0
Depreciation and amortization	$	13.1	13.9	3.2	3.2	3.1	3.6		3.8
Property, plant and equipment	$	2.6	2.3	0.4	0.7	0.2	1.3		1.4
expenditures
Intangible assets and other	$	7.4	3.7	2.1	1.5	2.3	1.5		—
assets expenditures
Capital employed	$	211.5	224.3	211.5	205.0	206.4	213.4		224.3

Revenue up 26% over last quarter and up 3% over the fourth quarter of fiscal 2017

The increase over last quarter and the fourth quarter of fiscal 2017 was mainly due to higher revenue from centre management solutions and patient simulators, primarily driven by higher sales to North American and military customers. The increase was partially offset by lower revenue from interventional simulators.

Revenue was $115.2 million this year, 4% or $4.5 million higher than last year

The increase was due to higher revenue from centre management solutions as a result of higher sales to North American customers and higher revenue from interventional simulators sold to military customers. The increase was partially offset by lower revenue from key partnerships with OEMs.

CAE Financial Report 2018 I 25

Management’s Discussion and Analysis

6. CONSOLIDATED CASH MOVEMENTS AND LIQUIDITY

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

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

– Capital expenditure requirements;

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

6.1 Consolidated cash movements⁷

(amounts in millions)	FY2018			FY2017			Q4-2018			Q3-2018			Q4-2017
Cash provided by continuing operating activities*	$	446.4		$	435.2		$	130.8		$	117.4		$	116.9
Changes in non-cash working capital	(43.1		)	29.1			7.0			70.2			80.6
Net cash provided by continuing operating activities	$	403.3		$	464.3		$	137.8		$	187.6		$	197.5
Maintenance capital expenditures⁷	(68.5		)	(62.8		)	(25.9		)	(13.9		)	(24.5		)
Other assets	(9.1		)	(5.5		)	3.1			(3.8		)	(2.3		)
Proceeds from the disposal of property, plant and equipment	27.0			6.6			10.6			0.5			4.1
Net (payments to) proceeds from equity accounted investees	(11.5		)	(10.6		)	0.2			(7.7		)	(1.2		)
Dividends received from equity accounted investees	37.6			16.5			14.0			6.5			7.3
Dividends paid	(89.9		)	(80.6		)	(22.5		)	(23.2		)	(20.5		)
Free cash flow from continuing operations⁷	$	288.9		$	327.9		$	117.3		$	146.0		$	160.4
Growth capital expenditures⁷	(105.4		)	(160.1		)	(31.5		)	(29.1		)	(49.1		)
Capitalized development costs	(32.5		)	(37.8		)	(13.5		)	(6.9		)	(14.0		)
Common shares repurchased	(44.8		)	(41.7		)	(0.4		)	(21.8		)	(3.0		)
Other cash movements, net	12.8			13.4			1.9			1.4			2.3
Business combinations, net of cash and cash
equivalents acquired	(124.4		)	(5.5		)	—			(99.7		)	—
Net proceeds from disposal of interest in investment	117.8			—			—			3.8			—
Effect of foreign exchange rate changes on cash
and cash equivalents	15.0			(4.9		)	15.4			4.0			(0.1		)
Net increase (decrease) in cash before proceeds and
repayment of long-term debt	$	127.4		$	91.3		$	89.2		$	(2.3	)	$	96.5
* before changes in non-cash working capital

Free cash flow from continuing operations was $117.3 million for the quarter

Free cash flow was $28.7 million lower than last quarter and $43.1 million lower compared to the fourth quarter of fiscal 2017.

Free cash flow was lower compared to last quarter and the fourth quarter of fiscal 2017 mainly due to a higher investment in non-cash working capital, partially offset by an increase in cash provided by continuing operating activities, higher proceeds from the disposal of property, plant and equipment and higher dividends received from equity accounted investees.

Free cash flow from continuing operations was $288.9 million this year

Free cash flow decreased by $39.0 million, or 12%, compared to last year.

Free cash flow was lower compared to last year mainly due to a higher investment in non-cash working capital, partially offset by higher dividends received from equity accounted investees and higher proceeds from the disposal of property, plant and equipment.

Capital expenditures were $57.4 million this quarter and $173.9 million for the year

Growth capital expenditures were $31.5 million this quarter and $105.4 million for the year including strategic purchases of existing FFSs in the market. Our growth capital allocation decisions are market-driven in nature and are intended to keep pace with the demand of our existing and new customers. Maintenance capital expenditures were $25.9 million this quarter and $68.5 million for the year.

CAE Financial Report 2018 I 27

⁷ Non-GAAP and other financial measures (see Section 3.7).

Management’s Discussion and Analysis

6.2 Sources of liquidity

We have a committed line of credit at floating rates, provided by a syndicate of lenders. We and some of our subsidiaries can borrow funds directly from this credit facility to cover operating and general corporate expenses and to issue letters of credit and bank guarantees.

The total amount available through this committed bank line at March 31, 2018 was US$550.0 million (2017 – US$550.0 million) with the option, subject to lender’s consent, to increase to a total amount of US$850.0 million. There was no amount drawn under the facility as at March 31, 2018 (2017 – nil) and US$46.4 million was used for letters of credit (2017 – US$92.0 million). The applicable interest rate on this revolving credit facility is variable, based on the bank’s prime rate, bankers’ acceptance rates or LIBOR plus a spread which depends on the credit rating assigned by Standard & Poor’s Rating Services. During the year, the maturity date of our revolving unsecured term credit facility was extended to September 30, 2022.

We have an unsecured Export Development Canada (EDC) Performance Security Guarantee (PSG) account for US$225.0 million (2017 – US$125.0 million). This is an uncommitted revolving facility for performance bonds, advance payment guarantees or similar instruments. As at March 31, 2018 the total outstanding for these instruments was $163.6 million (2017 – $115.9 million).

We manage a program in which we sell interests in certain of our accounts receivable (current financial assets program) to a third party for cash consideration for amounts up to US$300.0 million (2017 – US$150.0 million) with limited recourse to CAE. As at March 31, 2018, the Canadian dollar equivalent of $168.3 million (2017 – $141.6 million) of specific accounts receivable were sold to a third party.

As at March 31, 2018, we are compliant with all our financial covenants.

We believe that our cash and cash equivalents, access to credit facilities and expected free cash flow will provide sufficient flexibility for our business, repurchase of common shares and payment of dividends and will enable us to meet all other expected financial requirements in the near term.

The following table summarizes the long-term debt:

	As at March 31		As at March 31
(amounts in millions)	2018		2017
Total long-term debt	$	1,260.9	$	1,255.4
Less:
Current portion of long-term debt	35.2		31.2
Current portion of finance leases	17.0		20.7
Long-term portion of long-term debt	$	1,208.7	$	1,203.5

As part of our acquisition, in fiscal 2018, of a portfolio of training assets from a full-flight simulator leasing business, we acquired a term loan for the financing of a simulator. This represents a loan obligation of $5.3 million as at March 31, 2018.

As part of the acquisition of the remaining 50% equity interest in AACE, we acquired loans in the amount of $28.9 million as at March 31, 2018.

CAE Financial Report 2018 I

Management’s Discussion and Analysis

6.3 Government participation

We have agreements with various governments whereby the latter contribute a portion of the cost, based on expenditures incurred by CAE, of certain R&D programs for modeling, simulation and training services technology.

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

During fiscal 2016, we amended and extended our Project New Core Markets, an R&D program, for an additional four years. The aim is to leverage our modeling, simulation and training services expertise in healthcare. The Quebec government, through Investissement Québec, agreed to participate up to $70 million in contributions related to costs incurred before the end of fiscal 2020.

During fiscal 2017, we announced our participation in Project SimÉco 4.0, an R&D project under the SA²GE program. The aim of this project is the development of new products or processes which will further contribute to greenhouse gas emissions reductions. The government of Quebec, through the Ministry of Economy, Science and Innovation, and SA²GE have committed to contribute amounts up to 50% of eligible costs incurred by CAE to fiscal 2020.

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

6.4 Contractual obligations

We enter into contractual obligations and commercial commitments in the normal course of our business. The table below represents our contractual obligations and commitments for the next five years and thereafter:

Contractual obligations

(amounts in millions)	2019		2020		2021		2022		2023		Thereafter		Total
Long-term debt (excluding interest)	$	35.6	$	195.9	$	34.1	$	176.7	$	43.5	$	631.7	$	1,117.5
Finance leases (excluding interest)	17.0		30.7		27.4		11.0		11.9		47.4		145.4
Non-cancellable operating leases	44.4		37.9		32.5		26.1		22.4		76.7		240.0
Purchase commitments	132.0		70.5		19.5		0.2		0.5		0.5		223.2
	$	229.0	$	335.0	$	113.5	$	214.0	$	78.3	$	756.3	$	1,726.1

We also had total availability under the committed credit facility of US$503.6 million as at March 31, 2018 compared to US$458.0 million at March 31, 2017.

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

As at March 31, 2018, we had other long-term liabilities that are not included in the table above. These include some accrued pension liabilities, deferred revenue, deferred gains on assets and various other long-term liabilities. CAE’s cash obligation in respect of the accrued employee pension liability depends on various elements including market returns, actuarial gains and losses and interest rates. We did not include deferred tax liabilities since future payments of income taxes depend on the amount of taxable earnings and on whether there are tax loss carry-forwards available.

CAE Financial Report 2018 I 29

Management’s Discussion and Analysis

7. CONSOLIDATED FINANCIAL POSITION

7.1 Consolidated capital employed

	As at March 31			As at March 31
(amounts in millions)	2018			2017
Use of capital:
Current assets	$	2,060.8		$	1,919.7
Less: cash and cash equivalents	(611.5		)	(504.7		)
Current liabilities	(1,320.6		)	(1,273.9		)
Less: current portion of long-term debt	52.2			51.9
Non-cash working capital⁸	$	180.9		$	193.0
Property, plant and equipment	1,803.9			1,582.6
Other long-term assets	1,854.5			1,852.5
Other long-term liabilities	(823.3		)	(796.4		)
Total capital employed	$	3,016.0		$	2,831.7
Source of capital:
Current portion of long-term debt	$	52.2		$	51.9
Long-term debt	1,208.7			1,203.5
Less: cash and cash equivalents	(611.5		)	(504.7		)
Net debt⁸	$	649.4		$	750.7
Equity attributable to equity holders of the Company	2,298.2			2,020.8
Non-controlling interests	68.4			60.2
Source of capital	$	3,016.0		$	2,831.7

Capital employed increased $184.3 million, or 7%, over last year

The increase over last year was mainly due to higher property, plant and equipment, partially offset by an increase in other long-term liabilities and lower non-cash working capital.

Our return on capital employed⁸ (ROCE) was 14.4% this year compared to 11.2% last year. Our ROCE this year was impacted by the income tax recovery resulting from the enactment of a lower U.S. federal income tax rate, the gain on the remeasurement of the previously held AACE investment net of reorganizational costs and the gain realized from the disposal of our equity interest in the joint venture ZFTC. Excluding these impacts, our ROCE would have been 12.3% this year.

Non-cash working capital decreased by $12.1 million

The decrease was mainly due to higher deferred revenue and lower inventories, partially offset by higher contracts in progress assets, lower contract in progress liabilities and accounts payable and accrued liabilities.

Net property, plant and equipment up $221.3 million

The increase was mainly due to capital expenditures and the integration into our operations of the fixed assets acquired from AACE, partially offset by depreciation.

Other long-term liabilities up $26.9 million

The increase was mainly due to higher employee benefit obligations resulting primarily from a decrease in the discount rate used to determine our defined benefit pension plan obligations and higher deferred gains and other non-current liabilities, partially offset by lower deferred tax liabilities.

Net debt lower than last year

The decrease was mainly due to the impact of cash movements during the year, partially offset by the addition of loans obtained as part of the acquisition of AACE.

CAE Financial Report 2018 I

⁸ Non-GAAP and other financial measures (see Section 3.7).