Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Héroux-Devtek Inc. First Quarter 2019 Results Conference Call. [Operator Instructions]Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated.I would like to remind everyone that this conference call is being recorded today, Friday, August 10, 2018, at 11:30 a.m. Eastern Daylight Time.I will now turn the conference over to Mr. Gilles Labbé, President and Chief Executive Officer; and Mr. Stéphane Arsenault, Chief Financial Officer of Héroux-Devtek. Mr. Labbé, please go ahead, sir.
Good morning, and welcome to Héroux-Devtek conference call for the first quarter of fiscal 2019. With me is Stéphane Arsenault, our Chief Financial Officer.[Foreign Language]Our press release was issued earlier this morning. It can be found, along with the financial statements and MD&A, on our website at www.herouxdevtek.com. Please note that we also post a PowerPoint presentation on our website that summarize the key points of this conference call.Before I begin, please be aware that we will refer to certain indicators that are non-IFRS measure, such as adjusted EBITDA and free cash flow. These measure are defined and reconciled to the most comparable IFRS measure in our MD&A.First, let me start by discussing a few financial highlights from the quarter, which are presented on Page 3 of the presentation. Result for the year, including sales and profit, were stable versus last year, in line with our expectation. Sales reached $85.8 million, down slightly from $86.9 million last year. Our adjusted EBITDA reached $12.2 million or 14.3% of sales, up from $11.9 million or 13.7% of sales last year.We continued to generate strong free cash flow this quarter, which enabled us to reduce our net debt position further. We generated $8.5 million in cash flow related to operating activities and $6.4 million in free cash flow as compared to $2.6 million and $0.5 million, respectively, last year. Given this free cash flow generation, Héroux-Devtek's already healthy financial position improved further with a net debt position of $33 million as at June 30, 2018, down from $39 million as at March 31, 2018. Stéphane will provide additional details on our result and financial position in a moment.Please turn now to Page 4. I would like to highlight a few points. First, we expect to receive the approval from Boeing for the final main surface treatment process in the coming weeks. The in-sourcing of the related processing from our third-party suppliers will start gradually in the second quarter of fiscal 2019 and should be completed by the end of fiscal 2019. As a result, we anticipate the effect on margin enhancement to be fully realized in fiscal 2020.As mentioned on the last call, in the quarter, we signed a 4-year contract with AAR Corporation that could generate sales in excess of $65 million, which will help us recover a portion of the business we previously had with the U.S. Air Force. The contract will start to gradually ramp up in the second quarter and should contribute on a fuller run rate basis in the third quarter.After the end of the quarter, on July 2, we successfully completed the acquisition of Beaver. This transaction will allow us to broaden our existing aerospace and product offering into ball screws and actuation system and will expand our footprint in North America. As a result, we have increased our sales guidance, which I will discuss in a few minutes.Furthermore, at the Farnborough Airshow, we announced 2 major contract. First, we were selected by Boeing to manufacture main landing gear and side braces for the F-18 Super Hornet and the EA-18G Growler. First delivery are expected in the third quarter of calendar 2020. The contract also includes spare part and aftermarket services. We are very pleased to have been selected to build the F-18 main landing gear and side braces. It attests to our growing relationship with Boeing and represent a significant win for our defense activities.Second, we announced that we were awarded a 5-year contract by Lockheed Martin to manufacture landing gear for the C-130J Hercules aircraft. This contract renewal covers the manufacture and assembly of landing gear and provision of spare part and aftermarket services. We are very proud to support Lockheed Martin by further contributing to a program which has the longest, continuous military aircraft production run in history. We have been actively involved in this highly successful program for more than 30 years, which allow us to showcase our solid performance, high-quality products and on-time deliveries. This contract renewal is once again a testament to our leadership in the military landing gear market.Finally, I wanted to give you a quick update on the closing date of CESA. We are currently in the last stage of the regulatory approval process and expect the transaction to close sometime during the second quarter of fiscal 2019.Stéphane will now review our Q1 result and financial position.
Thank you, Gilles.Let's start with our financial result on Page 5 of the presentation. First quarter consolidated sales reached $85.8 million versus $86.9 million last year. This 1.3% variation reflects lower sales in the defense aerospace market and a negative foreign exchange impact of $2.5 million, partially offset by higher sales in the commercial aerospace market.Commercial sales increased 5.6% to $45.8 million versus $43.3 million last year. The increase is mainly attributable to higher large commercial program sales, mainly related to the increased Boeing 777 and 777X deliveries. It is also due to higher business jet sales, primarily related to higher deliveries for the Embraer 450/500 program. These positive factor were partly offset by lower engineering activities.Defense sales declined 8.1% from $43.5 million to $40 million. This variation is essentially due to the ramp-down of the repair and overhaul activities for the U.S. Air Force contract and lower manufacturing requirement for certain civil customer. Note that in the second quarter, the new AAR contract will begin to mitigate a portion of this loss, as Gilles just mentioned. These negative factor were partly offset by higher spare parts requirement for the U.S. government.Turning to Page 6. First quarter gross profit was $13.1 million or 15.2% of sales versus $12.9 million or 14.9% of sales last year. The increase mainly reflects higher absorption of costs related to the Boeing 777 and 777X program and improved production efficiencies.Operating income stood at $4.9 million or 5.7% of sales compared to $5.4 million or 6.2% of sales last year. Adjusted operating income was $5.2 million as compared to $5.4 million last year. This quarter, adjusted operating income excluded $0.4 million of acquisition-related costs. Adjusted EBITDA, which exclude nonrecurring item was slightly higher than last year at $12.2 million or 14.3% of sales compared with $11.9 million or 13.7% of sales a year ago.Turning to Page 7. Net income was $3.6 million or $0.10 per share compared with $4 million or $0.11 per share a year ago. This decrease was mainly driven by acquisition-related costs and a higher effective tax rate. Excluding nonrecurring items net of tax, adjusted net income reached $3.8 million or $0.10 per share versus $4 million or $0.11 per share last year.Now let's turn to our cash flow and financial position on Page 8. We generated cash flow related to operating activity of $8.5 million versus $2.6 million last year. This variation mainly reflects a more favorable variation in noncash working capital item. Free cash flow reached $6.4 million, up significantly from $0.5 million last year for the same reason just mentioned. Given this free cash flow, our already healthy financial position improved further during the quarter with cash and cash equivalent of $99 million as at June 30, 2018, and total long-term debt of $132.4 million, as can be seen on Page 9. This total includes an amount of $55.3 million drawn from our authorized credit facility of $200 million. Our credit facility includes an accordion feature which can increase it by $100 million, subject to the approval of the lenders. Our net debt position stood at $33.4 million as at June 30, 2018, representing a net debt to adjusted EBITDA ratio of 0.6x.I will now turn the call back to Gilles.
Thank you, Stéphane.Please turn to Page 10 of the presentation. We increased our fiscal 2019 sales guidance to reflect the closing of the Beaver acquisition. We now expect sales growth in the mid-single digits versus fiscal 2018, up from stable sales in the previous guidance. Capital expenditure remain unchanged at $15 million for the year. Note that this new guidance exclude the CESA acquisition as it's still pending regulatory approval.In the past few months, we continue to build a sustainable future. We completed the acquisition of Beaver and signed contract with AAR Corporation, The Boeing Company and Lockheed Martin. These accomplishment are a testament to our leadership in the landing gear market. In particular, the contract for the F-18 Super Hornet attests to our growing relationship with Boeing and represent a significant win for our defense activities. Finally, with the CESA acquisition expected to close in the coming weeks, we are well positioned for our next expansion phase.We are now ready to answer your question.
[Operator Instructions] Your first question comes from the line of Tim James from TD Securities.
Just wondering if -- and forgive me if you mentioned this, Gilles. I think you touched on the ramp-down in the USAF, the R&O contract. I'm just wondering what quarter that will be fully down to 0 revenue. And again, putting aside the ramp-up in the sort of offsetting contract.
We're going to start to deliver in Q2, but the full ramp-up should be in Q3.
And sorry, but the USAF, the Air Force repair and overhaul contract which is coming down, is it completely not generating any revenue now? Is it complete?
Still some revenue, but very limited at this point.
Okay. And by the time we get to the second quarter of fiscal '19, will it be done?
Well, pretty much, but it should be pretty much done by Q2, Q3, yes.
Okay. And then my next question, I wonder if you could talk about some of the platforms that are included in the impact, the negative impact on defense revenue, and it's from the decline in requirements from certain civil customers that's referred to in the MD&A.
There's no specific trend. I mean, it's more a question of timing in the deliveries than a specific trend during the year. So these are just a quarterly timing of sales, the thing to highlight there.
And is it 1 or 2 platforms in particular or it's across a broad range?
No, it's not. Really, the impact was more on the U.S. Air Force this quarter, the ramp-down, than the other platform.
Okay. So that reference to a decline in requirements from certain civil customers that's...
No, what I am saying is, the civil customer lower sales was not obviously as significant as the U.S. Air Force ramp-down in repair and overhaul.
Okay. I see. I see. And then my last question, I'm just wondering if you could talk about any particular changes, up or down, in terms of military program revenue from European customers for the APPH business, in particular.
Well, at APPH, I think the platform, the growth platform is the KC-390. So that's one of the platform. We're very strong still on the MRO market on the Hawk, the AgustaWestland repair and overhaul that we're doing over there. We have the ramp-up of the Gripen program, right? This is a program that we have designed. So it will gradually ramp up our business.
And the KF-X.
And we are working on the engineering, like Gilles mentioned, for the KF-X program. So eventually, we'll see more of this and more in the coming years as this is still a development phase program.
And so are there any programs that are actually slowing down and sort of offsetting the strength in things like the Gripen or the KF-X engineering or KC-390? Or are all the other programs relatively stable?
When you look at it on a yearly basis, there's no significant decrease expected on the Gripen side of the APPH.
Your next question comes from the line of Mona Nazir from Laurentian Bank.
I appreciate the sales guidance from mid- to low single digit revenue growth driven by the Beaver closing. I'm just looking back at your prior guidance that called for $480 million to $500 million in revenue or kind of an 8% to 11% annualized growth figure organically. Do you think that, that range is still possible or plausible if we're looking maybe more forward to the 2020 time period, particularly with the synergies from Beaver and CESA?
That's a good question. First, we said that once we close CESA, we'll review that guidance and give you a new guidance. And second, at the last conference call, I said that it's more the lower range of the $480 million to $520 million that now we see.
Okay. And just, I see that you're reiterating your CapEx. And I think from the last call, you said that was related to the legacy business and you expect to invest some in Beaver. Would that investment in Beaver begin immediately? And what would that figure be? And given CESA facility is fairly modern and up to date, I believe from our conversations, is there any related spend there that you anticipate?
We gave guidance this morning including Beaver. So we still believe that with Beaver the CapEx will be $15 million. And we'll update again the guidance for CapEx when we close CESA. But as you said, CESA is mainly very modern in term of building and equipment so we don't expect major CapEx in CESA for this year and next year. So we'll give you a good guidance in due time.
Okay. And then just on the internalization of the surface treatment program related to Boeing. I believe you've been expecting that approval for some time. And on the last call, you stated that it should have been finalized by last month. It was really in the coming weeks and potentially a month at that point. I'm just wondering, could you walk through just what the delays have been at this point.
Well, we said this morning that we should expect this in coming weeks. So look, we're pretty much confident to get this approval. As we get this approval, we will bring back work that is done by third-party supplier, as we speak. And we should have the full benefit of this in-sourcing from a cost standpoint on a full year basis in 2020, which is next year.
[Operator Instructions] Your next question comes from the line of Benoit Poirier from Desjardins.
I don't have a lot of question, obviously. I think you've done a great job at the AGM. I also want to congrats you for the significant milestone you achieved over the last year. And I think it will be interesting to look at Héroux over the next expansion phase. And just related to one question, you mentioned some color at the AGM with respect to the impact of the tariff on aluminum and steel. You mentioned that the potential risk or the cost could be around $500,000 on an annualized basis. So to me, it doesn't seem material, but you also mentioned that you could put some initiatives in place to try to reduce the $500,000. So could you talk a little bit about the initiatives you could put in place?
Thank you for the question. Yes, I said that. Basically, we work with our team to evaluate what would be the impact for us. So the maximum impact that we see today is about $0.5 million, okay? And it's all a matter of -- if you buy -- it's coming really from the tariff imposed by Canada because we buy most of our steel and aluminum -- these are specialized steel and aluminum. So we buy mainly from the U.S., right? So then we're impacted by the Canadian tariff, not the U.S. tariff. And the thing here is really if there's enough transformation of the steel and aluminum, then there's no tariff because you get into a different code than raw material like raw steel or raw aluminum. So if you buy a product that is enough transformed in the U.S., then there's no tariff. So that's where we are. So we're looking at ways of -- can we transfer more, make more operation in the U.S. so we don't have to pay the tariffs. That's what we're looking for.
We're also looking at the possibility of buying in Canada or elsewhere in Europe. So these are all mitigating factors.
[Operator Instructions] Your next question comes from the line of Derek Spronck from RBC Capital Markets.
I apologize if any of these comments have been addressed. But it seemed like your commentary around the CESA acquisition, it seems like you're close to closing it. Do you still remain pretty confident that this will close? And have you kind of worked through most of the contingencies with the Spanish government on that deal?
Yes. We're quite confident, as I said earlier, but it will not happen in August because, I mean, the government is in -- everybody is in vacation in Spain at this point. And we're going on vacation, too, so.
Okay. Great. And any other -- I guess the 2 big deals with Beaver and CESA, do you see like good amount of revenue synergies in the combination of CESA and Beaver together?
Yes. I point out this morning if you -- I think our presentation to the shareholder will be available on the website, right?
That's correct.
So you should take a look at this because we show a 3 circle. A circle where we show all the customer of Héroux-Devtek, a circle of the CESA customer, another circle of the Beaver customer. And you can see that we have a lot more customer than CESA and Beaver. So these 2 companies will be able to sell their product to our existing customer. So when you are an Airbus subsidiary, it's quite difficult to sell to Boeing and many large North American players. So now that CESA will be in our portfolio, then they will have access to these major customer in North America.
Okay. And just one last one for myself. And again, I apologize if it's already been addressed. But the airshow, that went well for you this year, and any sort of color or takeaways from that?
Well, we had a very good airshow. It was pretty hot this year in London though, but I guess it's hot everywhere in the world these days. So we meet most of our major customer. As you know, we announced also a good deal with Boeing on the F-18. We're able to -- F-18 main landing gear now will be produced by Héroux-Devtek. And that's a very large win for us. And then we renewed our contract with Lockheed Martin on the C-130 Hercules for another 5 years. So that's good business because it's a stable business for us. We've been doing this C-130 landing gear for a long time. So that's good. And look, we are working on other opportunities, but at this point, we have nothing to disclose. But I can tell you that a lot of customer are coming to talk to us about new product and so that's a very encouraging sign at this point.
Any concerns with the joint venture with Boeing and Embraer that Embraer could start doing a little bit more on the landing gear side for Boeing?
That's a good question. As you know, we know Embraer very well so the same thing with Boeing. It's true that Embraer, they have a subsidiary called Eleb. You know that we have designed and built a landing gear for the Legacy 450/500 for Embraer. And that program is ramping up as we speak. So Eleb, they have a limited capacity in terms of production. They are limited in terms of production capacity, but also by size. We know them, have been there 2 or 3 times over the last couple of years. And basically, their equipment is sized to do landing gear of the size of the Embraer product. And when they don't have enough capacity, what they do, they outsource work outside. And we have a lot of product on the KC-390. Actually, the major component, the biggest component of the KC-390 are built by us. We also are discussing maybe that if we can get on their new E2. So I mean, the gear of a size of a 737, for example, I mean, would require quite a large investment for Eleb, but I'm not so sure that they want to go there. But certainly, not only that they build landing gear, but they are pretty good also at designing and building actuation. So that could be a product for Eleb.
Okay, no, that's great. Do you think they would ever sell or carve out Eleb like Airbus has or do you think it's pretty entrenched with Embraer?
I cannot really answer, but if they would do it, then we will certainly be interested.
Mr. Labbé, there are no further questions at this time. Please proceed.
Okay. Thank you, operator. And thank you for joining us today and thank you for your interest in Héroux-Devtek. We'll be speaking to you again in the next quarter. Have a good day. Thank you. Good weekend also.
Ladies and gentlemen, that concludes our conference call. Please note that a replay of this call can be accessed as of 2:30 Eastern Daylight Time today at telephone number 1 (800) 585-8367 and entering passcode 3274689. This replay will be available until midnight on August 17, 2018. Thank you. You may now disconnect your lines.