Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning. My name is Jilly, and I will be your conference operator today. At this time, I would like to welcome everyone to Héroux-Devtek's First Quarter of Fiscal 2020 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. We refer you to Slide 2 of the accompanying presentation available on the company's website for the company's forward-looking statements. I would like to remind everyone that this conference call is being recorded today, Friday, August 9, 2019, at 11:30 a.m. Eastern Time. I will now turn the conference over to Mr. Martin Brassard, President and Chief Executive Officer; and Mr. Stéphane Arsenault, Vice President and Chief Financial Officer of Héroux-Devtek. Mr. Martin Brassard please go ahead.
[Foreign Language] Our press release was issued earlier this morning, and it can be found along with the financial statements and the MD&A on our website at www.herouxdevtek.com. Please note that we also posted a PowerPoint presentation on our website that summarizes the key points of this conference call. Our first quarter results remained strong on all fronts. Sales increased by 67%, reaching $143 million, driven by both our CESA and Beaver acquisitions as well as organic growth from our Héroux-Devtek legacy businesses. Our operating profitability also improved to 7.2% of sales, up from 5.7% last year. And adjusted EBITDA reached 15%, up from 15.3% last year. Now please turn to Page 4. Since the end of fiscal 2019, we recorded a significant increase in the value of our backlog. It now stands at the record of $747 million. This 20% growth, mainly came from the defense sector in North America due to the introduction of new programs and the increased demand for our products. On the commercial front, we conclude 2 new contracts with Boeing. We were awarded the contract to supply the complete landing gear system for the MQ-25 program in April, and in May we expanded the scope of our supply agreement for the Boeing F-18 program to include the advanced F-15 program. On the M&A front, in June, we concluded and announced acquisition of Alta Precision, a Montreal-based manufacturer of landing gear components employing 110 highly-skilled personnels. This acquisition expands our portfolio of commercial products by improving -- by providing access to new and growing program as well as additional content on the existing platform. Before I turn the call over to Stéphane for an overview of our financial results, I would like to provide a quick update on the integration of CESA and Beaver acquisitions. During the first 9 months of operation under Héroux-Devtek, Héroux-Devtek Spain has already generated some synergies and contributed to our bottom line. For example, several Héroux-Devtek customers have presented bidding opportunities. This will allow us to better understand the actuation market and will soon generate additional revenues. We are sharing business processes and practices, which have allowed us to reduce the cost of purchase parts for specific programs by more than 15%, and we decided to use CESA facility to manufacture critical components for our F-18 contract, which allow us to save approximately $2 million in CapEx. Beaver has also delivered on its promise since its acquisition with consistently strong financial results. In order to improve this business we're planning on investing in new technology which will help efficiencies and raise its competitive edge. And since the acquisition, Beaver's backlog has increased significantly. I would like now to turn the call over to Stéphane for a review of our Q1 results and financial position.
Thank you, Martin. Before I begin, please be aware that we will refer to certain indicator that are non-IFRS measures, such as adjusted EBITDA, adjusted net income, adjusted earning per share and free cash flow. These measure are defined and reconciled to the most comparable IFRS measure in our MD&A. Let's start with our financial results on Page 5 of the presentation. Consolidated sales grew 67.2% to $143.4 million, up from $85.8 million in the same period last fiscal year. $44.6 million of this increase was driven by the CESA and Beaver acquisition while the growth of our Héroux-Devtek legacy business contributed 15% or $13.1 million. On the commercial side, sales grew 47.4% to $67.4 million, up from $45.8 million in the same period last year. Organic growth on the commercial side, mainly came from the ramp-up of the Boeing 777, 777X program. Defense sales grew 89.9% to a $76 million, up from $40 million in the same period last fiscal year. Héroux-Devtek legacy defense sales grew mainly from the ramp-up of the F-35 program and higher aftermarket sales. Turning to Page 6. Gross profit increased to $24.2 million or 16.9% of sales, up from $13.1 million or 15.2% of sales last year. The increase is attributable to the impact of the Beaver and CESA acquisition and positive foreign exchange rate fluctuation, partially offset by higher manufacturing costs of our Longueuil facility. Operating income increased to $10.4 million or 7.2% of sales, up from $4.9 million or 5.7% of sales last year. This quarter's operating income including -- included $0.6 million of nonrecurring item, up from $0.4 million in the same period last year. These nonrecurring item are mainly related to acquisition. Adjusted EBITDA, which exclude these nonrecurring items, stood at $21.5 million or 15% of sales compared with $12.2 million or 14.3% of sales one year ago. Turning to page 7. Net income for the first quarter of fiscal 2019 stood at $6.4 million or $0.18 per diluted share, up from $3.6 million or $0.10 per diluted share in the corresponding period of last fiscal year. Excluding nonrecurring item, net of taxes, adjusted net income reached $7 million or $0.19 per share, up from $3.8 million or $0.10 per share last year. Now let's turn to our cash flow and financial position on Page 8. Cash flow related to operating activity amounted to $3.7 million in the first quarter of fiscal 2020, down from $8.5 million in the same period last fiscal year. This variation mainly reflects a negative net change in noncash working capital item, due to an increase in inventory due to upcoming organic growth. As a result, free cash flow decreased to a usage of $1.6 million, down from a positive free cash flow of $6.4 million in the same period last year. And on to Page 9. As at June 30, 2019, net debt stood at $269.6 million, up from $228.1 million at March 31, 2019, mainly due to the recognition of $27 million of additional lease liability as debt following the adoption of IFRS 16 as well as higher utilization of the credit facilities to finance the acquisition of Alta. I will now turn the call back to Martin
Well. Thank you, Stéphane. And let's now turn to Page 10. To discuss the -- our updated guidance for fiscal 2020 and fiscal 2022. For fiscal 2020, we had indicated sales should reach between $560 million to $580 million. Adjusting for the recent acquisition of Alta Precision, we now expect sales to reach between $580 million to $600 million. Long-term growth prospect was also updated. Fiscal 2020 sales guidance stood between $620 million and $650 million at the end of the previous quarter. And we now estimate sales will reach between $650 million to $680 million in fiscal 2022. Our funded backlog that stands at the record of $747 million is a strong foundation for our ability to deliver on this guidance. And we are now ready to answer your questions.
[Operator Instructions] Your first question comes from the line of Konark Gupta with Scotiabank.
So first on the Boeing 777 and 777X. So Boeing recently announced that the 777X's first flight will be delayed, and they are also warning that the first delivery is also at risk. And you still raise the guidance here. So just wanted to understand what are you assuming for 777 and 777X? And how do you assess the risk here?
So Mr. Muilenburg 2 weeks ago said that the 777 and 777X, there are some delay in the program certification of the X. And entry into service shall be in 2020 or early 2021. They will be producing freighter aircraft instead of 777X. So the rate that was announced and communicated to us by Boeing, and it was confirmed on the call was approximately 60 aircraft delivery in 2020, and they should be delivering 3.5 aircraft per month to their customer. So preparing the 777X so we -- our guidance is based on 60 ships set.
Okay. That's helpful. And then on the revenue guidance, again. So fiscal 2022, you raised it by $30 million and for 2020 it's $20 million. So the $10 million GAAP, is that related to Alta only or is there something else in the mix?
It's mainly related to Alta as we see this business growth that was part of the thinking of this acquisition.
Okay. That's great. And then secondly for me, leverage ratio, I think it looks around 3.5 turns when you normalize for IFRS. I know some acquisitions have yet to fully contribute in EBITDA. But what kind of leverage ratio are you most comfortable with before pursuing more big acquisitions?
So let me clarify the leverage based on the trailing 12-months EBITDA, which does not include CESA for 12 months, only 9 months in other acquisitions so we had 3.2, right? And when we exclude the debt we have with the government, we are 2.1. So -- and that's really the ratio that we have with our bank covenant. So we have sufficient space there in terms of leverage with our coverage we have with the bank. So typically, we'd like to be on a net debt basis around 3, right, that's where we want to be. And 2, net funded debt this basically eventually will allow us to look at other opportunities, but our focus is on deleveraging.
Okay. That's helpful. And lastly from me on the working capital, the inventory buildup that you mentioned for the future deliveries, for which programs is that inventory buildup mostly for? And then when do you anticipate the deliveries for those programs?
Well. Essentially, this is really in line with the organic growth we have in the backlog, right? So one of the main programs that we see more demand is related to the aftermarket, C-130, KC-135R. We have also increased demand on the CH-47. So it's buildup of the new program we have, the 53k, as this is now coming with a firm order, with Lockheed. So various program but all of them related to the upcoming group. Yes.
Your next question comes from the line of Cameron Doerksen with National Bank Financial.
I guess maybe just a few questions for me on the F-35 program, and that's one of the ones you cited here as driving some of the growth in the defense side. I think you want some additional content on the F-35, I'm just wondering if the increase that we've seen this last quarter reflects that additional content?
Well, the F-35, there is no additional content, Cameron. You're talking F-35, right? I heard you well?
Yes. Yes.
So as you know we're providing the uplock, and there is a production rate increase that will go up to 150 aircraft. So that's -- the rate are increasing and even also the current climate over Turkey and the -- and the resourcing activity with the geopolitical situation we see also some increased demand for F-35 products.
Okay, that was going to be my -- my second question was related to Turkey being kicked out of the program. So you're seeing some opportunities to potentially get some additional business here. I think you may be a Turkish...
Yes. And building up safety stock also for the program.
Okay. Okay. So do you see some opportunities from some of the work that might be taken away from them? And I think you may have a Turkish partner on some parts there, is there any impact to you on that?
Page breakYes. So we have a Turkish partner so -- but we will repatriate much more of the production, and as I said there is some built buffer stock that Lockheed is requiring us to build also. So -- and we're always on the lookout, Cameron, for new opportunity that can arise, especially for that program.
Okay. Excellent. And maybe just finally, for me just on the Alta Precision, I mean I know it's not a huge acquisition I mean, obviously, some interesting new programs for you with that. I assume that maybe the margins in that business are not at the Héroux-Devtek margins today. I'm just wondering if you could talk about some opportunities to improve that business and additional synergies you might see from the Alta Precision deal.
Yes. Alta Precision, it was a -- I think it is a good acquisition like you said. It just brings 2 very good program, the A-220 and the E2 jets, and we're E2 jets. And -- so solid backlog. Its new program, it's going to ramp-up. There's a lot of opportunity for us. So management will be much more devoted or concentrate on improving the cost, and they are in the due diligence. We saw many opportunity in reducing especially the hours taken or the time taken to manufacture parts. So we have already a plan to make it better. We're going to be able to invest -- they had some constraint -- financial constraint so now they're going to be devoting much more of their time about delivering product to the customer at the cheapest cost. And as you know that we have -- we have identified many opportunities. So -- in terms of sharing, programming, tooling, cutting tools and metallurgy and also reattributing some works between Alenia and Alta Precision. So there's some good stuff that's coming in from that acquisition. Obviously, won't be done overnight so it's going to take 1 year or 2. But I think we're going to have a very strong business in 2 years from now.
Your next question comes from the line of speech Benoit Poirier with Desjardins Capital Markets.
Congratulations for the solid quarter. Just to come back on the Alta, is it fair to assume that the timeline to bring back the margins more comfortable to Héroux-Devtek is about 2 year? Martin, is it kind of the timeline we should be expecting?
Yes. And it will happen gradually so we cannot implement everything at once. So it's going to be in implemented -- so we're going to implement best practices. We're going to focus by program, by part. Once we've done the part, we'll move the second one. So that's how. And -- so gradually we should be going up in margin. Anything to add?
Okay. Perfect. And also in terms of M&A, guys, you completed 4 acquisition over the last 18 months. In Spain, at your Investor Day, there was a lot of discussion around the actuation market, which is much larger, but you are just scratching the surface. So I was wondering, given the integration that you are doing on the last 4, did you take a pause on M&A? Or would you be interested in doing something in the actuation market? And could an acquisition be larger than the last 2 you just announced?
If you have any proposal, we'll be willing to look at it. So now we would continue the strategy to grow and for the acquisition, the right strategic fit we will seriously look at it.
Okay. Okay. That's very good. And in terms of surface treatment, Stéphane , could you maybe provide the impact that we saw in the quarter? I would expect a positive condition this time around.
Compared to last year, we showed a positive consideration of 0.3%. So going the right direction. But we still have 0.6% to get our standard by then repatriation of the surface treatment.
Okay. So 0.3% improvement versus last year still 0.6% to get. And what's the timeline in your view, Stéphane, to get back to the kind of [indiscernible]?
I will answer, I will answer to this one Benoit. It's -- it not goes as fast as anticipated. So we're working hard to repatriate the work done. We're having repeatability problem. But we will overcome these challenge. So we believe, again, that we will by the end of the calendar, if not by the end of the fiscal year we will be -- fully repatriate the production. So we have solid plans. So we're a bit late on these plans to -- for repatriation, but we're committed to -- but it will happen, it will happen for sure.
Okay. Okay. That's great color. And from the financial standpoint, obviously, there was inventory, working capital, investment in Q1 so about $13 million. Stéphane, could you maybe provide kind of color about what type of working cap we might see for the full year? Are you going to be reversing that amount? Or given you're growing we should expect more working capital investment for the full year?
Sure. We need to -- for the first 6 months we have -- as you know -- in other words, saying so we're building some sort of what's happening in the last 6 months. So the growth you see in the inventory more specifically will support the growth for the last 6 month. But in addition to that, in FY '21, we still see, obviously, the top line to grow. So we don't expect this will reverse by year-end. I think we are really in organic growth mode. And we still could have an impact on the working capital by year-end.
Okay. Perfect. And would you say kind of a $20 million working capital investment a year for fiscal '20 and $20 million fiscal '21 kind of a reasonable expectation given the good growth profile that you are facing?
I think the assumption, obviously, you can -- if Gilles would be here, he would tell you, you have -- you are a good analyst, Benoit. So -- but certainly you can make a good assumption. And the focus is really for us to execute the plan, the growth we have in front of us. And as I indicated in backlog I think it's very positive with what is upcoming.
Yes. We're busy, and this is not only to you, Benoit, but we're busy. And if you remember, 2 years ago we had 2 big hits, the loss of the U.S. Air Force contract, we had the Boeing production rate reduction. We reduced our cost base, we took the appropriate measure, and we booked businesses, we booked many contracts, solid contracts. We're going to have new airplanes coming in too. So we're very fortunate to have a resilient team, and we're in much better shape than we were 2 years ago.
Yes. No, definitely agree. And in terms of CapEx, Stéphane, when you bundle all those 4 acquisitions, it seems that you mentioned this morning that there is opportunity also to better exploit some synergies. What should we expect in terms of kind of the run rate, in terms of normalized CapEx, let's say in fiscal '20 and going forward?
When you look at the -- at our investment of this fiscal year we know we need to do some investment at Beaver. So it's important for us because there's a nice growth on the side of Beaver coming from last year. So solid backlog there. There is going to be also some investments to be made in Canada. So we're going to invest more than what you have seen in the past 2 fiscal years, that's for sure. And as we are growing, there's backlog, obviously, we'll have more CapEx than what -- the one we have invested in the last 2 fiscal year. All-in-all, I think, all-in-all, I think you need to look at the overall free cash flow. So the last 6 months will be where we'll be the strongest in terms of free cash flow. And we're still expecting to generate good free cash flow for this fiscal year.
Okay. Is $25 million kind of a good run rate? Would you say Stéphane going forward?
That number that, obviously, you just mentioned, I think it could be an assumption.
Okay. That's perfect. And looking at your fiscal '22 number, what type of run rate would you expect for the overall 777 program? Is kind of a 60 units a year that you are currently assuming for 2022 because we all know that there is more upside in the longer-term, given the strong momentum that the build on the order [ looks ].
Obviously, it's not information that we can disclose, Benoit. And it's up to Boeing. So we have monitored the situation with Boeing very closely. But very confident in Boeing ability to put the 777X in service. And once they have in service, I am sure they will [ literally ] increase their rate. So -- because the backlog of the 777X is there. And they have facilities to build up to 100 aircraft a year, but it's up to them so we'll follow them. Watch them, watch -- we're confident that they will put that aircraft in the air.
Your next question comes from the line of Tim James with TD Securities.
My first question, and forgive me if this is somewhere in the report, but the higher costs that were cited at Longueuil during the quarter, are those costs expected to continue going forward? Or are those sort of short-term costs just the next couple of quarters or this quarter?
I think what we saw in the first quarter still expecting a drag in the second quarter, but this will go back to normal during this fiscal year.
Okay. And then just looking again at your longer-term, your fiscal '22 revenue guidance, can you just talk in general about how much of that revenue lift comes from commercial versus defense opportunities?
Right, it's coming. Investing in Héroux-Devtek, investing in the aerospace market, it's not only one segment. So we're civil, we're defense, and within these segments we still have a lot of content in the -- in every sub market segment. So like I said during the annual meeting in the [indiscernible] so we did a recap of all the by segment of where we see that growth. I would invite you to see the script that would be posted on the website, I guess, it will be posted on the website. But as to the large commercial aircraft, and the key is the 777 and maybe the launch of a new aircraft for that market. As to the helicopter -- military CH-53K will enter into service pretty soon, as to the fighter the Gripen E we haven't seen any sales yet. So they have a backlog of 96 airplane to be delivered between 5 to 10 years. On the business jet market so we don't expect any major decrease on the legacy Predator program from Embraer and the Learjet 45 and the entry into service of the Falcon 6X is expected to be in 2022, I believe, 2021 or 2022. So in all the segment, I would not point out a specific segment, but we're good. And not forget the F-18, we are right now in the industrialization of the F-18 landing gear contract to Boeing. This -- this program looks like it has a second life, and there is a lot of activity with this airplane, and we're going to be delivering our first ship set in August 2020.
Your next question comes from the line of Derek Spronck with RBC.
I apologize if some of this -- some of the questions have already been addressed, but first off, it seems like you're making quite a bit of headway with Boeing, winning new programs and increased scope. How is the activity level with Airbus? Have you been -- since you've had CESA, have you been able to increase any sort of exposure with Airbus? And how do you see that playing out in the future?
Yes. Of course, for our actuation business that helps the -- to help CESA and with the networking that they have with Airbus military and now with Airbus commercial. So yes, we do see some activity over there, mainly in the actuation business. As to the landing gear, it's -- this is all IP stuff, this is all IP work. So it's all market that is captive to mainly Messier or Safran. So we'll see what they going to do. So there's no -- in our numbers there's no expectation with Airbus landing gear. But we believe that we can win some business with actuation.
Okay. And with Bombardier, I don't think you've had a lot of activity levels there, and I know there are not a lot of programs remaining. But any opportunities with some of the, I guess Bombardier or Embraer going forward?
No. Bombardier, we're doing the Lear45. This is a program that is selling. It still continues to sell. There are 700 airplanes in the market so we see some aftermarket revenues as more aircraft are delivered, it's pretty good. So same as the Legacy 450/550 or the Predator program, same landing gear for this airplane. So it's -- the rate is stable for many years now, and we expect, again, aftermarket revenue. And the Falcon 6x is going to enter into service soon. Along with Bombardier I don't see anything.
Okay. And with the increase in the backlog, was that more driven on the commercial aero side or the defense side from an organic perspective?
It was driven on the defense line. It's 53K, F-18. All aftermarket that we do KC-135, C-130. So this is where we had a lot of activity. So essentially defense.
Are you seeing growing demand on the defense side given the global kind of the geopolitical situation and pickups in defense spend?
Yes. But it's also -- the win and the effort -- win of the F-18 and the effort we have put on developing new products. We've mentioned the 53k, but the Gripen like they mentioned earlier. So I think we're well...
The geopolitical solution, yes, we see an increased demand. And there is also the increase about what for Alta.
$38 million.
Yes. $38 million increase, and it's a good program. It's at the early stage of the program the A-220 and the E-2 jets from Embraer in early stage of the program.
Okay. And just one last one for myself. Now that you've had CESA and you've kind of built up in scale, do you feel that your status within the industry is improving and you're now being considered truly a global Tier 1 aerospace and defense company?
It will not happen overnight, it will happen over time, and we're committed to work. So we see many opportunities right now coming from Héroux-Devtek customers because it was not accessible for CESA in the past. So these bidding opportunities some you win, some you lose. So it allow us to better understand that market and refine our proposal and refine our services, and then we'll soon generate some additional revenue for the Corporation. I'm confident that we have the right team, we have the right capability, we're technically sound, but in aerospace nothing happened in the quarter.
But did you have a -- just quickly did you have a good air show this summer?
Of course. Always. It was -- weather was nice. Paris was beautiful. And we had very good meeting -- and very good -- very good meeting and very good event with all of our customers. They're very satisfied with our performance.
There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.
Well, it's me. Thank you, operator. Thank you for -- thank you all for listening to us today. After a strong end to fiscal 2019, I am proud of our 2020 first quarter results. Our growing funded backlog resulting from the strength of our legacy Héroux-Devtek products, aftermarket sales and from the contribution of our 4 recent acquisition is positioning us well for sustained, long-term growth. I would like to thank you all for listening again, and thank all the employees that make Héroux-Devtek a very solid company in the aerospace market. So have a great rest of the summer [Foreign Language].
This concludes today's conference call. You may now disconnect.