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. Second 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, November 12, 2018, at 10:00 a.m. Eastern time. I would now like to 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.
Good morning, and welcome to Héroux-Devtek conference call for the second 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.hérouxdevtek.com. Please note that we also posted a PowerPoint presentation on our website that summarizes the key points of this conference call.Before I begin, please be aware that we will refer to certain indicators that are non-IFRS measures such as EBITDA and free cash flow. These measures are defined and reconciled to the most comparable IFRS measures 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. We are pleased with our second quarter sales and profitability, which increased year-over-year, mainly due to the Beaver acquisition. These results were partially offset by the ramp-down of return overhaul activities for the Air Force as we are progressively transitioning to the AAR contract.In the quarter, we generated $11.7 million of cash flow related to the operating activities and have a free cash flow of $8.2 million. Our financial position remained strong with a net debt position of $55 million or net debt to adjusted EBITDA ratio of 0.9 as the CESA acquisition has not been reflected in our balance sheet. Later in this presentation, we will present the pro forma impact of CESA on our leverage. Stéphane will provide additional details on our results and financial position in a moment.Please turn now to Page 4 for some operational highlights. We have been very active in recent months, completing acquisitions, signing important long-term contracts and making timely deliveries. First, we closed 2 transformational acquisitions. We are very pleased to have completed the CESA acquisition, which is the largest in our history and an important stepping-stone in our international expansion. It will allow us to increase our market presence in Europe, gain important content on several key aircraft programs and levers customer relationships with Airbus and other customers.This transaction, along with the complementary addition of Beaver expertise and ball screw, will allow us to expand our product offering in the broad actuation market by adding new technology to our portfolio such as electromechanical actuation. Our focus now will be on integrating these acquisitions.The Beaver integration is on track and progressing well. It generated $7 million of revenues in the second quarter. Our objective is to improve margins by focusing on sales growth and production efficiencies. We also have begun the integration process of CESA by sending 3 full-time employees to join the Madrid team.Meanwhile, our long-standing commercial partners, Boeing and Lockheed Martin, awarded us with important long-term contracts on the F-18 and C-130 programs. These contract awards, along with our delivery of the third 777X landing gear to Boeing in September marked a great quarter of account management for our operations.Our funded backlog stood at $479 million as at September 2018, up 5% from $454 million at the end of June 2018. As a reminder, the backlog only includes business for which we have received a firm purchase order.Finally, I want to give you a quick update on the final approval of our surface treatment process in Strongsville, Ohio. We remain on track with our time line to insource substantially all surface treatments by the end of fiscal 2019. As such, we anticipate to see significant benefit of this on our margin during fiscal 2020. So now let's turn to Stéphane.
Thank you, Gilles. Let's start with our financial result in Page 5 of the presentation.Second quarter consolidated sales reached $95.7 million versus $89.7 million last year. This 6.7% variation reflects higher sales in both the defense and commercial aerospace market and a positive foreign exchange impact of $1.7 million.Commercial sales improved by 11.5% to $47 million compared with $42.2 million last year. The increase was mainly driven by the higher deliveries to Boeing for the 777 and the 777X program, the addition of Beaver sales and higher business jet sales mainly related to increased deliveries from the Embraer 450/500 program.Defense sales increased 2.4% to $48.6 million from $47.5 million. This variation is essentially due to the addition of Beaver sales and higher sales requirements from the U.S. government. These factors were largely offset by the timing of manufacturing sales to certain civil customers and the ramp-down of repair and overhaul activity for the U.S. Air Force.Turning to Page 6. Gross profit increased to $15.5 million or 16.2% of sales versus $13.6 million or 15.1% of sales last year. The increase was mainly driven by the impact of the Beaver acquisition, higher absorption of costs related to the Boeing 777 program and improved production efficiencies.Operating income increased to $5.3 million or 5.5% of sales compared with $4.6 million or 5.2% of sales last year, reflecting the year-over-year improvement in gross profit. Adjusted EBITDA, which exclude nonrecurring items, was $13.2 million or 13.8% of sales compared with $12 million or 13.4% of sales a year ago.Turning to Page 7. Net income was $3.3 million or $0.09 per diluted share compared with $3.2 million or $0.09 per diluted share a year ago. Excluding nonrecurring items net of taxes, adjusted net income reached $4.4 million or $0.12 per share versus $4.1 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 activities of $11.7 million versus $15.7 million last year. This variation mainly reflects a net unfavorable variation in noncash working capital items. As a result, this quarter's free cash flow reached $8.2 million compared to $13.3 million last year while it amounted to $14.5 million for the first 6-month period ended September 30, up from $13.7 million last year.Turning to our financial position on Page 9. At the end of the quarter, we completed the financing necessary for the closing of the CESA acquisition. Therefore, on September 30, our balance sheet reflected both an increase in cash and debt.Cash and cash equivalents amounted to $196.7 million while total long-term debt was $251.7 million, including the current portion but excluding net deferred financing costs. As a result, the net debt position was $55 million, up from $38.8 million as at March 31, 2018, reflecting essentially the Beaver acquisition and free cash flow generated in the quarter.The net debt to adjusted EBITDA ratio stood at 0.9 versus 0.7 6 months earlier. On a pro forma basis as at October 1, 2018, following the acquisition of CESA, we had $25.8 million of cash and cash equivalents while total long-term debt was $286.2 million, including the current portion but excluding net deferred financing costs. Detail of this pro forma calculation can be found in our second quarter MD&A.I will now turn the call back to Gilles.
Thank you, Stéphane. Now turn to Page 10 for -- of the presentation, please. For fiscal 2019, we are reiterating our annual guidance as provided on October 1, 2018, for the closing of the CESA acquisition. We expect sales to be in the range of $460 million to $470 million with capital expenditures of approximately $20 million for the year that will end in fiscal 2019. Our long-term sales for fiscal 2022 are expected to be in the range of $620 million to $650 million, which represent approximately 60% growth over fiscal 2019.This quarter's developments have positioned us as leading supplier in an industry with strong fundamentals and positive long-term growth outlook. With strong financial flexibility, we have all the elements in place to enter our next expansion phase with renewed enthusiasm.We are now ready to answer your questions.
[Operator Instructions] Your first question comes from the line of Mona Nazir from Laurentian Bank.
So my first question was, I was just wondering if you could quantify -- so the first quarter of Beaver's contribution, what was the revenue in EBITDA?
The -- well, the information is disclosed in our financial statements, so the sales was $7.4 million and net income is also disclosed at $750,000, so slightly higher than 10%.
But we had a good performance in terms of profitability. As you can see, net income is around 10% on the sales, so we were pleased with the profitability of Beaver. And in terms of top line though, what we see going forward is we've seen improvement since -- as you may know, this company was for sale for more than a year. And even though we tried to keep this as confidential as we can, I mean, there's always rumor in the industry that impacts the booking of the orders. So now the booking is getting much better since we announced the transaction. And so booking is going to the right direction. So I think it's going to be a good acquisition for us.
Okay, perfect. And I understand the margin was not disclosed even when you purchased the acquisition, but I believe it was a lower margin profile than your legacy business. Reading through the MD&A, it stated that some of the gross margin increase was attributable to Beaver. So were you -- were the margins better than expected? Or is it still lower than your legacy performance?
Yes. The answer is yes, Mona. Yes, the 10% net income on sales, I mean, obviously, EBITDA and gross profit is better also.
And there wasn't much seasonality attached to that, for the Q2 period for Beaver, was there?
Yes. The sales are lower, right, in Q2 throughout the facility we have because there's shutdown period and there's vacation period. So typically, the second quarter is always lower for all of our facilities, including Beaver's.
Okay, perfect. And then just looking at 2019 guidance and your 2022 outlook, I understand that some of the variance when you put out your outlook last month was due to softer-than-expected contribution from Beaver and CESA, and you explained some of the variance for Beaver. But I'm just wondering, if we look at the expected contribution when the acquisitions were first announced, it was EUR 94 million from CESA and USD 30 million contribution from Beaver. I'm just wondering, where do those 2 numbers sit now if we're looking at kind of the first 12 months performance?
Well, I think -- well, things are -- both businesses were for sale, right, for a long time, CESA and Beaver. So I think that -- of this number we gave you back then were real numbers of the facts. So it's not like something that they have not achieved. So -- but the fact that they work for sale for some time then, of course, this impacts somewhat the booking of the orders. So that's why we see a little less sales as we see it today. So when we did the review of our guidance for the long term, so we took all of this into account, that's why today, we're saying, okay, for fiscal '19, it's very clear, We should be anywhere between $460 million to $470 million. And for 2022, look, we believe it should be between $620 million to $650 million. So I think it's -- these are our best estimates at this point, given what we know.
Okay, perfect. And then just lastly for me, any update on the T-X Boeing contract win? I know it's early days.
Well, we cannot talk about this at this point. We're waiting for a decision from the customer, which is Boeing.
Your next question comes from the line of Cameron Doerksen from National Bank Financial.
I guess, just a question to sort of follow up on sort of the expectations on CESA. I'm particularly interested in the margin profile. We know that the Airbus A400M production rate is coming down, or has come down. I'm just wondering what that -- you know -- and maybe the revenue's lower in that business than a year ago when you announced the deal. But just wondering what the margin profile looks like because I believe that the A400M program was in the relatively early stages and maybe had a lower margin associated with it.
Any program, maybe talking more generally, Cameron, any program at some point [ about ] specific program when it starts, right? It bears typically lower margin and there's no aftermarket, right? So typically, that's the way it works in the business, aftermarket will bear a little bit better margin. So this program, as you said, is in the early stage, right, of -- in production. So over time, it will contribute more positively to the margin. I think -- well, I mean, I don't have the number in front of me, Cameron, but if you look at EBITDA margin that we announced during -- we did the...
11.7%.
On what, on $90 million?
Yes, $94 million.
$94 million. So that must be around 11% to 12%, right?
Yes.
So at this point, I mean, this is what -- it is what has been achieved in the past. So we'll be working with them to improve that. So that's the only thing we think we can do at this point. We want to take it, of course, higher and -- compared to what we achieved at EU, but it will not happen overnight.
Okay, fair enough. Just maybe a question on -- I guess, some other industry-wide issues, I guess, there have been some production rate, I guess, holdups at both Airbus and Boeing with some new programs. I'm just wondering if any of those kind of issues, which I know are fully unrelated to what you're doing for these companies, but if any of these production hiccups at Airbus and Boeing on some of their programs have had any impact on your revenue in the last quarter or so.
The answer is no. I mean, on A320, as you know, we have a good relationship with Messier-Dowty Safran, where we produce major components on the A320 and there's no issue there at all. 87, we have no problem on this program either. We have very little business on the 777, so the hiccups, I mean, are not impacting us. And the 777, it is what it is. I mean, it's a -- we shipped more during the last quarter, right? So things are moving to the right direction. We delivered our first 777X, which is very good, so things are moving well. I mean, that's good. Yes, we don't see -- we're not impacted by the delivery issue that we read about Airbus and the Boeing and the 777.
Okay, very good. Maybe just last one for me, just on, I guess, on the balance sheet. Now that you've got these 2 acquisitions closed, I mean, you're generating pretty good free cash flow here. I'm just wondering what your thoughts are around how quickly you can sort of delever the balance sheet or pay down some of the debt. It seems like it could be fairly rapid.
Well, it's a good question. I mean, the balance sheet is very evident. I think Stéphane has given color. As we speak, we have net debt of $260 million, right? After deduction?
Yes.
First 6 months of this year, dollar-wise, we generated $14.5 million of free cash flow after 6 months, which represents 8% of our top line, okay? If you do the math between what we advertise as the guidance for 2019, we are $460 million to $472 million -- $470 million, that means we have to do anywhere between $280 million to $290 million during the last 6 months. If you do the mathematics and let's say you use the 8% free cash flow that we just achieved in the first 6 months, I mean, this will -- so we would generate very good free cash flow in the last 6 months. That's what we expect. So we want to continue to drive the Airbus to generate free cash flow. And if we do that, we will delever the business rapidly. We believe that within basically 2 years, we'll be at a ratio, very good ratio of debt to EBITDA. So that's the goal we have, Cameron.
Your next question comes from the line of Derek Spronck from RBC.
Just around the margin profile, the internalization of the surface treatment, should we expect any sort of margin benefit in the back half of fiscal year 2019? Or is this a fiscal 2020 opportunity?
Typically, obviously, we have started to insource a part, right, so it's not switching on, off. So this quarter is about 0.7%, so improvement from the 1%, right, that we had in the past for the processing. So gradually, this will continue, right? And we are in the last steps of approval with Boeing, so we're confident with the guidance that we have provided in our workout. So substantially, our -- the parts will be insourced so that we get the benefit in fiscal 2020.
Okay. In 2020, will that be a run rate off of 2019 of around 50 basis points or...
Typically, it could be better than that, right, but it's a conservative estimate.
Yes. But we need to make that calculation only on the sales of the existing business, excluding CESA and excluding Beaver, right?
Yes. And so for that matter then, in 2020, how should we be thinking about the margin profile in the combined business then? I mean, like should we just do the simple math essentially of the margin profile prior to the acquisitions and just -- presumably, there's going to be some margin pressure in the combined company, offset a little bit by the internalization. Is that the right way to be thinking about the EBITDA margin in 2020?
Well, look, we don't disclose the guidance on margin. But certainly, there will be a positive impact coming from the internalization of the processing, right? And look, we're looking at also -- there's no volume in our existing business, that should help too. So all in all, I mean, that -- so -- but I mean, we'll let you decide this. I mean, we gave you quite a bit of guidance on the top line. Now we'd like the expert that's -- to guide you on -- to decide what's this year's margin.
Just on a directional basis over '19, would you consider -- do you anticipate it to be -- the margin flat, up a little bit or down a little bit?
You know what, you should take a hard look at our results between now and year-end in the next 6 months, and this will give you good guidance from there. From there, you can probably figure out what will be 2020 and 2021. That will be [indiscernible].
Okay, okay, okay. And the CESA acquisition, that will start contributing presumably next quarter or the current?
Yes, the acquisition is closed October 1, so we have the result now.
And we'll have a full 6 months then during this fiscal year.
Okay, great. And just one last one for myself before I turn it over. The new Embraer business jet that they announced, any opportunity there and/or any concerns that might cannibalize a little bit of the 450/500 legacy?
Well, that's flying with a Héroux-Devtek landing gear as far as I know. So we've been able to -- basically, the gear we have on the 450/500 is also installed in the new one, the new Praetor, so we have locked -- this business is locked in for us, whether they sell more Praetor or less Legacy, nothing negative for us here.
Okay, that's great. So your carryover landing gear system for the Praetor, from the Legacy? That's great.
Okay. Like a short -- I mean, if the gear we have on the 450/500, we've done the study and we can do the job for the Praetor without any change.
[Operator Instructions] Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets.
Could you provide some color about the ramp-down of the repair and overhaul contract with the USAF but also to talk about the timing on the ramp-up with AAR?
Yes. Well, essentially, the ramp-down is pretty much completed with the U.S. Air Force, so we have substantially completed the contract. So -- and we have started the -- it was very minimal in the second quarter in terms of contribution from the AAR contract, so we are progressively entering into the AAR contract, so we have a lot of work now. It's secure, we have landing gears to repair in the shop and gradually, we'll go to a full ramp-up of this program during the third quarter.
Yes. Well, third quarter, we'll have some impact, but more in Q4.
Okay. So Q4 will be kind of the full run rate?
With the AAR contract, should be pretty much the full run rate.
Okay, okay. And now if we look at Q3 and Q4, obviously, we have kind of a good idea of the revenue generated in the second half. But could you talk little bit about the seasonality from a modeling standpoint between Q3 and Q4, what we should expect? Is it similar to what you achieved in the past or...
The answer is yes. I mean, of course, Q4 is always very strong. So in Q3, we'll have a good look forward because we have full impact from CESA, full impact from Beaver and our own business also -- I mean, existing business without this is also -- should do better because Q2 is lower, so -- Q3 existing business gets better plus the 2 acquisitions. And then when we move to Q4, so there's top line again. So I mean, that's where we're driving the bus forward.
Okay. And you mentioned -- obviously, there was a question asked about the TX, but you -- could you talk overall about your bidding pipeline and also whether you could talk about the MQ-25?
Well, we cannot talk really about contracts we have not been awarded. The pipeline is busy. We have a -- as you know, I mean, of course, T-X is one and MQ-25 is one, but we are -- we have other programs on which we are working as we speak, new programs. But one thing is happening also, remember we had a lot of business in the -- what we call the aftermarket military sales in the U.S. with the Navy and also with the U.S. Air Force, and this part is really picking up now. I mean, we see the backlog is much higher than what it was a year ago, and we see also additional order being placed to us. So that part is going good. I mean, so that's good news.
Okay. And in terms of free cash flow, Gilles or Stéphane, is kind of the 8% sustainable through the long term? I mean, when we look at your revenue guidance in fiscal '22, is it kind of $50 million plus in terms of free cash flow generation?
I think we have proven what we can done -- what we can do and you just heard Gilles giving you some information earlier this call, right, that 8%, so we...
It's certainly a number that -- we like to be around that number. But here in our business, what happens is sometimes if we are too successful, sometimes you win a big program, and we may have to invest in that program. So I think that probably, this 6% to 8% is something that we really -- what's driving the bus, except if we have major program and that will require more major investments, then we will tell you that. So you will have to modify your forecast based on that.
Okay. And from a modeling standpoint, in terms of tax rate, Stéphane, what should we assume going forward?
Well, essentially, if you look at historical Q4, right, we had the full impacts on the tax reform last year Q4. So it's really based on the volume we do, right? So we cannot take just a quarter base -- on a quarter basis. So you need to look at the overall of the year. And when the revenues are stronger like in Q4, tax rate tends to be higher.
Okay. Overall, are you still comfortable with kind of 22% effective tax rate? Is it kind of the number we should be looking at?
If you look at our disclosures, I think it gives you a good idea when you go back to Q4, right, the tax rate that we have.
Okay. And last one for me, any change in terms of military or defense spending following the U.S. midterms? Is there anything we should expect or anything you saw since?
No, we -- I don't. We have not read anything that are -- or know anything that changed that core direction in the U.S.
There are no further questions at this time. M. Labbé, please continue.
Okay. Thank you for joining us today. We will definitely work diligently to deliver you with results in the next 6 months, and we'll be talking to you soon. [Foreign Language] Have a good day.
Ladies and gentlemen, that concludes our conference call. Please note that a replay of this call can be accessed as of 11:30 Eastern time today at telephone number 1 (800) 585-8367 and entering passcode 3390868. This replay will be available until midnight on November 19, 2018. Thank you. You may now disconnect your lines.