Speech - guest speaker: Mr. Derek H. Burney, president and CEO, CAE Challenges and opportunities facing the Canadian aerospace and defence industry

Speech given by Mr. Derek H. Burney
President and CEO, CAE

March 18, 2003

Challenges and opportunities facing the Canadian aerospace and defence industry

I know the Board of Trade would prefer that speakers not use these events simply to promote their own company. I warn you up front that I will bend that rule a bit but, since I do not expect what I have to say will trigger a sale, I hope you will see it as more than a commercial. I will also offer a few remarks which go beyond the parameters of my current job, but may be topical nonetheless. (And no, they will not be about the Quebec election!)

I learned early on that Montrealers generally recognize the name “CAE”, even though they are less certain about what it is we actually do. “Something involving flight simulators” is what people usually say, but often in a manner that is more quizzical than confident.
Flight simulation is at the heart of much of what CAE does. The flight simulators we make are the apex of virtual reality. They can take you anywhere you want to go, in any kind of weather without ever leaving the ground (or losing any luggage!). Sounds like fun? It is. But, because simulators cost about $15 million each (and are a bit large for your family room), you can understand why I don't expect to make a sale here today!

While we are best known as the leading global manufacturer of flight simulators, and proud of that heritage, that represents only about 25% of CAE's current business.

What we have become most recently is a provider of fully integrated training solutions – a complete package of equipment and services for Civil or Commercial as well as Military customers. Providing what we call “The Essential Edge” in terms of greater safety, readiness and efficiency.

This fundamental strategic shift at CAE is giving us a platform for more stable and more balanced growth going forward. The strategy is working, despite some strong market headwinds.

The new look of our largest division – Civil – reflects our transformation most dramatically. We have moved beyond the one-time sale of flight simulators and now offer full training packages for pilots using more than 80 simulators in 18 different centres spanning four continents.

As a result, CAE today is not only the world's #1 supplier of civil aircraft simulators, we have become, in three short years, the second largest independent provider of aviation training services for regional, business and wide-bodied or large jet aircraft.

We invested heavily in the technology and in establishing a global network of training facilities, primarily because the training market is many times larger than our traditional equipment market. We are financing our expansion prudently with efficient long term saleleaseback financing and by calibrating all future growth carefully to market demand and to the cash generated by this business segment. And, as our training business grows, our debt will decline in both absolute and relative terms.

Our goal is to set the standard for training by revolutionizing the way pilots are trained. Our leading edge technology is a key differentiator for CAE in the market and reinforces a comprehensive menu of training services, extending from the classroom through complementary PC and web-based programmes to time spent on state of the art full flight simulators.

By providing what we call “The Essential Edge” in training, our goal is to ensure greater safety for all who fly.

The performance of our other two units – Military and Marine – have made CAE also the largest Canadian-based defence contractor – another source of balanced growth.
Our Military unit provides more than 30 defence forces around the world with the “essential edge” in readiness. Our forte is flight training, both fixed wing aircraft and helicopters, but we also simulate a growing range of land-based activities for ground forces.
While Marine has a growing business in the commercial market, it too serves primarily Military customers, providing automated control systems for ships in 16 national navies. These are real systems controlling real ships at sea. And both divisions are also moving into the training domain, providing simulated training for pilots and submarine crews at CAE facilities in the U.K., the U.S.A. and Canada.

Simulated training is becoming more important in all the modern militaries of the world. It's cost-effective and safer. In some cases, it creates a virtual environment that is impossible to create in reality. It allows the simultaneous participation of armed forces in remote locations and can be used efficiently to rehearse difficult missions in a virtually real environment. It even allows forces to practice with new systems and equipment before they are delivered. The more real the simulation becomes, the more efficient the training will be.

Digital simulation technologies are also finding new applications beyond training. By modeling, testing and integrating new systems as they are being designed and developed, simulation-based acquisition can lower the cost and raise the quality of new Military programs.
We expect Boeing will use our simulation software and capabilities to design and test ballistic missile defence systems that could one day deflect incoming missiles away from North American cities.
Canada is using our software as a test bed for unmanned aerial vehicles, notably for coastal surveillance. Our software is also being used to design and test future interoperable systems; systems with the ability to collect data from a variety of sensors and satellites, translate that information into knowledge of the battle space and then issue commands to ensure a timely and targeted response on the front line.
Rapid advances in graphics technology are revolutionizing both the fidelity and the cost of visual systems which are at the core of simulation. We can now use satellite photography to replicate, in a three dimensional manner, images of locations and landscapes all around the globe. The growing availability of digital imagery and mapping data enable us to depict a level of realism that is unprecedented.

The most important drivers for our business are innovation, productivity and people.
I have already mentioned several examples but innovative technology is what really helps differentiate CAE in the market. What is important to this audience is that Montreal is the site of most of our R&D effort. Annual expenditures equal about 10% of our global revenues, or 100% of our sales in Canada.
Innovation is not just about products. It's about better processes. Through dramatically reducing both our manufacturing cycle time and the number of snags in our products, we have been able to sustain solid margins and profitability despite the market downturn and fierce pricing pressures. (And) by manufacturing a range of products for the global market, we have been able to create a platform of competitive scale right here in Canada.
Of course, innovation and productivity both depend ultimately on people. And we are fortunate to employ a critical mass of highly committed people here in Montreal where 4,000 employees or 2/3 of our global work force reside. They not only have the right skills, but also the right attitude. (Which is also why several are at today's lunch!)

To build that critical mass, we have relied heavily on a flow of well-trained recruits from the excellent universities here, as well as from a steady flow of skilled and creative new Canadians.
More than 60 nationalities are represented at CAE in Montreal – people who can communicate with customers from more than 100 countries in their own language. It is a source of pride - and part of our essential edge. Our unity in such diversity is a genuinely Canadian asset and a Montreal advantage - all the more remarkable in light of the ethnic and religious intolerance found elsewhere in the world. It is something we must all treasure, protect and never take for granted.

I am often asked why the global leader in simulation technology is based in Montreal. A good question. The short answer is people. More than 50 years ago, about a dozen World War II veterans gathered in an abandoned hangar in Saint Hubert and decided to make a difference. They were the pioneers who initiated what CAE is today, beginning with radar systems for Canada's North. Thousands of talented people have followed in their footsteps to help make Montreal the center of excellence for aerospace in Canada today. People do make a difference.
Montreal is a center of excellence for Canadian aerospace. That's why it makes sense for Montreal to be hosting, this May, the annual meeting of “WATS” – the World Airline Training conference and trade show. WATS 2003 will be an opportunity for some 600 leading air-training professionals from airlines, companies and aviation organizations to come together. It's a first for Canada – and CAE is pleased to be acting as host sponsor.

Montreal is important to CAE; and vice-versa. But we are just one piece of a large complex of companies here in the city that together form more than half of the Canadian aerospace and defence industry.

It is an industry of great economic importance to the country as a whole, employing nearly 90,000 Canadians in challenging, well-paid jobs. The annual value of industry production exceeds $20 billion; 80% is exported (in the case of CAE, make that 90%), generating export income and a sizeable annual trade surplus for our national balance of payments.

That is why I make no apology whatsoever for the financial support that flows to aerospace companies from governments. It is minimal compared to the support showered upon our competitors in Europe and the United States. It is miniscule compared to the revenue flowing to governments as a result of our existence. It offsets corporate tax rates that are higher than south of the border. And in the case of the federal government's technology partnership program, it is a true partnership in innovation. Companies spend $10 on approved R&D programs in order to get about one quarter of that back and the government receives a royalty based on future success.

Aerospace is a sector of global excellence for Canada. We should find more ways to celebrate, not denigrate that basic fact and to support, not undermine industry efforts, especially at times of severe market stress.

These are challenging days for all in our industry. (To describe the prospects as “uncertain” is an understatement worthy of the most prudent Canadian observer.)

Aerospace companies today face a double whammy. Depressed markets and the ominous overhang of war. Both reinforce the prevailing uncertainty in the global economy.

Some companies are affected more severely than others. Aircraft manufacturers are recalibrating production capacity to declining short run demand.

Airlines, and especially major North American airlines, are bearing the brunt of what has been called the “worst year in aviation history”. They are having to consider fundamental change in their business model, changes that, in the long run, should benefit manufacturers of regional jets, like Bombardier.

Airlines are also hampered these days by passenger apprehension and avoidance. They deserve some relief from the taxes, surcharges, airport improvement fees and other burdens to operational efficiency beyond their control. Along with all who travel by air, they would also welcome a better balance between the need for heightened security and the desire for less hassle at airports.
Obviously, the best tonic for all would be the prospect of a solid recovery in the aerospace market.

Having diversified into training, and with more than half of our revenues coming from the defence sector, CAE is less vulnerable than many others in our industry. Market uncertainty is the over-riding challenge for our Civil business. And, in the build up to war, Military training needs become secondary to operational requirements.
Being Canadian presents a challenge of a different order for our Military business. We are a global supplier. We have to be – Canadian defence firms could not survive on domestic demand alone. But politics is never too far removed from defence contracts, so even being the best is sometimes not good enough.

CAE may be in the business of virtual reality but we are under no illusions about the challenges that lie ahead. The risks are real but so are the opportunities. That's why the watchwords at CAE today are focus, perseverance and commitment. We have a strategy for growth that we believe is credible and a team dedicated to a successful future. We are confident that we will flourish when the storm clouds lift. And they will.
But our challenges pale in comparison with the grave decisions confronting many world leaders. That leads me to the final and purely personal part of my remarks reflecting, essentially, my previous career in government.

We are in a new and very precarious world.
Events relating to Iraq are being played out almost hourly and in living colour on television. Old alliances and international institutions are under severe stress and, if war ensues, as now seems likely, they may well be among the casualties.

As the only hyper-power, the U.S.A. is all powerful. But it is also somewhat lonely, increasingly frustrated and very determined.

Since September 11, it has seen itself very much at war against terrorists poised to strike again at random and tyrants who have weapons of mass destruction and are ready to use them. We may have doubts about the American approach on Iraq, but we should not doubt their resolve.

There is an aversion to war that is palpable in all countries. The preference for Military action sanctioned by a “united” United Nations is also obvious. After all, pre-emptive Military action is fraught with uncertainty and the battle itself may in fact be less difficult than the consequences flowing from it for the region and the world.

What should Canada do? Well, a posture of studied ambivalence or a stealth policy has not made much of a contribution. More troubling are juvenile outbursts of anti-Americanism which serve no purpose whatsoever other than momentary publicity (of the wrong kind).
In my view, Canada's relationship with the United States is too important for vacillation and too vital for detachment. I believe the true Canadian spirit was evident in the welcome and the hospitality extended on both coasts to Americans whose travel plans were diverted to Canada immediately after September 11. And from the hundred thousand who stood respectfully on the lawn of Parliament to mourn the victims of September 11.

This is a time when the Americans could benefit from advice and support from friends and neighbours they trust. We have had that position of trust and influence in the past.

I would have preferred, frankly, to see Canada among the “coalition of the willing” standing with the U.S., the U.K. and Australia. That would have been consistent with our traditions, and our interests, including our interest in having the U.N. perform more than a declaratory role in responding to global crises. We quietly accept U.S. security without being prepared to pay much of a price ourselves.

If we genuinely expect to exercise any influence on the U.S. at times like this, we need to be more concerned about what is right than what seems popular at the moment. We need either to support our convictions with tangible commitments or offer alternatives that are credible.
We have tried valiantly in recent weeks to find a middle ground and the basis for consensus at the U.N. but the gap proved unbridgeable. We have chosen to refrain from combat (it being too late frankly for us to do otherwise). We should now concentrate on the best role Canada can play in obtaining some semblance of stability in the aftermath of war.
I believe we also need to intensify efforts to thwart indiscriminate terrorist attacks against North America. We may not see ourselves as a target but surely we have an obligation to help the neighbour we know is the target. In my opinion, it is not only the right thing for us to do, it is also the best way to preserve vital Canadian interests.


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