Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to Héroux-Devtek Second Quarter of Fiscal 2020 Results Conference Call. [Operator Instructions] Before turning the meeting over to management, please be advised that this 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 complete forward-looking statements. I would like to remind everyone that this conference call is being recorded today, Friday, November 8, 2019, at 8:30 a.m. Eastern Time. I would now like to 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. Brassard, please go ahead, sir.
Thank you very much, Jessa, and [Foreign Language]. On behalf of our team here in Longueuil, welcome to our second quarter earnings release conference call for fiscal 2020. I invite you to refer to the Q2 financial statements, MD&A, press release and presentation during this call. These documents can be found in the Investors section of our new website. We are happy with our Q2 results. I am proud of the robust 14% organic sales growth recorded this quarter and by the performance of our newly acquired company. In fact, CESA, Alta and Tekalia generated revenue of $36 million this quarter. I am also happy to report that all our programs are progressing according to plan. A few examples: we delivered a record number of 777, 777X shipsets to Boeing in Q2, and new orders for production and spares are in line with our internal forecast. Boeing successfully completed the first flight for the MQ-25 in September, which is an important milestone in the development of this unique aircraft. We are also seeing increased demand for the Lockheed F-35 and the Boeing CH-47 program, and the same holds true for the Sikorsky CH-53K, which is seeing production ramp up at this time. Industrialization of Boeing F-18 program is also moving forward as planned, with our first delivery still on track for September 2020. Our Q2 performance illustrates, once again, that our past efforts are yielding positive results for Héroux-Devtek. We are now well on track to achieve our revenue and profitability targets for the year. As we turn to the quarters ahead, our team focus will be on delivering our record order book with the same quality and on-time performance that our customers have been accounted -- have become accustomed to. We will also continue to actively pursue new bids opportunity and maximize cross-selling in the future, mainly in the actuation market. In that period, and before turning the call to Stéphane, I want to thank our employees for -- from every single one of our sites for their invaluable contribution and commitment to our success. Stéphane?
Thank you, Martin, and good morning, everyone. As usual, please be aware that we will be referring to certain non-IFRS measures during this portion of the call, including adjusted EBITDA, adjusted net income, adjusted EPS and free cash flow. All non-IFRS measures are defined and reconciled in the MD&A issued earlier today. Our consolidated sales grew 52.1% to $145.5 million in Q2, up from $95.7 million last year, including a 14.3% organic growth and a solid performance by our recent acquisitions, which contributed $36 million, as pointed out by Martin. As a reminder, Beaver is now recorded as part of our organic growth, while CESA, Alta and Tekalia have yet to complete the full 12-month cycle in our fold. Commercial sales grew 38.1% in the second quarter from $47 million to $64.9 million, mainly driven by increased delivery for the Boeing 777, 777X program. CESA sales were up 65.7% last quarter from $48.6 million to $80.6 million, driven by a number of factors including increased aftermarket demand for the C-130 and KC-135 program with AAR as well as by the Leonardo C27J and Sikorsky H-60 program. Gross profit as a percentage of sales decreased during the second quarter from 6.2% to 15.3%. This is mainly due to a 0.6% negative net impact of exchange rate fluctuation and to higher manufacturing costs at the Longueuil facility. As pointed out in the press release, these negative factors were partially offset by the positive impact of the CESA acquisition. Operating income increased to $10.5 million or 7.2% of sales, up from $5.3 million or 5.5% of sales last year. Adjusted EBITDA stood at $21.5 million in the second quarter or 14.8% of sales compared to $13.2 million or 13.8% of sales 1 year ago, a 100 basis point year-over-year increase. Net income reached $6.3 million in Q2, grew $91.5 million over last year, while adjusted net income, which excludes onetime item recorded last year, was up 43.2%. For the same period, EPS doubled from $0.09 last year to $0.18 this quarter, while adjusted EPS grew 50% from $0.12 last year to $0.18 this year. Let's now turn to our cash flow and financial position. Cash flow from operations increased 81.8% from $10.4 million to $18.8 million this quarter. Cash flows related to operating activity reached $12.5 million, up from $11.7 million last year. Finally, at the end of Q2, our net debt stood at $264.7 million, up from $243 million as at April 1, 2019. The increase in net debt during the 6-month period is mainly explained by the financing of the Alta acquisition in Q1, partially offset by USD 12 million or CAD 16 million repayment made over the course of Q2. Back to you, Martin.
Thank you, Stéphane. Let me conclude our opening remarks this morning by highlighting that our funded backlog has reached, once again, record levels in Q2. And it stood at $769 million, up 23% since the beginning of the fiscal year. The bottom line is in -- is that in accordance with what we have said at our last AGM, the focus of the entire team is on delivering excellence in execution. Jessa, we are now ready to answer questions.
[Operator Instructions] And your first question comes from the line of Konark Gupta from Scotiabank.
So just first one, maybe on the 777 program. You guys said the commercial sales were up, and the 777 has record shipsets in Q2. So can you help us understand how does the delay in the 777X impact the mix between the 777s, the freighters and the 777X, as far as your shipsets are concerned?
Well, right now, we are -- it's -- when we compare the increase in the commercial sales, it's always comparing to last year. So we are now in full production mode, and we delivered the -- over the shipsets that we delivered in the first quarter. As far as -- and we're delivering today also 777X. So Boeing is manufacturing the airplane. So we have a number of ship that already delivered on the line, and they're getting ready so to make delivery once the entry in service of that aircraft is done and is expected in 2021. So as Mr. Muilenburg said 2 weeks ago, the rate -- the combined rate is still at 5 per month. And while the delivery rate is expected to be approximately 3 per month for the ER for the current 777 version in 2020, and they will mitigate the impact of the slide in 777 time line by producing more 777 current generation market. So we are working with our customer right now with our forecast -- and it still as per our internal forecast, the numbers that we received.
Okay. That's great. And the backlog seems to be increasing quite nicely here. And this is despite, obviously, no new acquisitions in the quarter. Any sense on -- have you seen any conversion or any realization of any cross-selling synergies between the recent acquisitions, especially Beaver and CESA, with HDI?
Well, Beaver is -- it's fulfilling its backlog, that's for sure. Cross-selling is helping there. But CESA, we haven't seen any -- we haven't materialized any cross-selling yet. So we're seeing, again, a lot of opportunity -- of bidding opportunity. We're working hard to understand that market. Like I said before, it's a journey. It won't happen in a few months. But right now, what I can say is there's a -- there's some interest from a North American customer base to our newly acquired company in Spain.
Okay. That's great. And lastly for me on the actuation side of things. Can you help us understand how the actuation business combined for all the acquisitions and Héroux-Devtek is trending right now? And where do you see growth opportunities coming from for that market?
Essentially, your question, is this in regards to the current volume of sales for actuation or?
Yes. So how the actuation business is trending for you guys? So I mean like what kind of growth rates are you seeing in that market? And is there any market share increase opportunity?
Our market share will be with what Martin just described in terms of cross-selling, which will take some time. As Martin explained, we have a nice growth at Beaver, which, as you know, they do ball screws and some actuator there. So significant growth at Beaver, stable at CESA, as expected, no surprise on that side. And the growth will come from new opportunities with cross-selling.
Your next question comes from the line of Cameron Doerksen from National Bank.
So just a couple of questions on the revenue because it was very strong in the quarter in what is normally a seasonally weaker quarter for you. I'm just wondering if there was anything from a timing perspective that maybe you were expecting to deliver later in the year that got pulled forward into Q2. So just any comments on why we saw, I guess, seasonally stronger Q2 than what we normally see.
Yes, you're right. Well, normally, it's like the holiday season. That's why historically that Q2 is historically lower. And that's why we are quite happy with the performance of the -- of our manufacturing plants. So we have been able to deliver what we had to deliver the Q2. No pull in from Q3 nor Q4. Does that answer your question, Cameron?
Yes. No, that -- there's nothing that was unusual, as you mentioned, pulled forward from future quarters. Maybe just on the aftermarket, defense, because that was -- you cited that as being something that was quite strong. Are you fully ramped with the AAR contract at this point?
I would say so that we see the demand. That's why we having our [ causes ] inside of the plant. Now it's just to get all the spare parts necessary to deliver this. So we're busy, we're very busy in Longueuil.
Okay. And just maybe -- and just on the margins. Can you just maybe update us on where the surface treatment for 777 is, are we -- are all -- the revenue you're generating from that program now, is that now all reflecting the internalization of the surface treatment?
The answer is no, it's not yet out there. The in-sourcing is progressing well. What we can say is that we're still on target completed by the end of this fiscal year. And we essentially have about 55% repatriated so of the processes that we now perform in-house. So there's still improvement in the margin to come, which represents about 0.5% of sales. So good progress compared to last year on a comparative basis, we improved by 0.2%. So good progress on that front, and we are well aligned to complete the process by the end of this fiscal year.
Okay. No, that's great. And just finally for me, one of the things you said in your presentation here as a revenue growth driver in the quarter was the H-60 helicopter program. I'm just wondering, what are you guys doing for that program? Wasn't one that I've heard you talk about in the past.
Well, it's dampers. So we do a return overall of dampers on the H-60 at the Laval site.
Okay. Okay, so it's all aftermarket.
Your next question comes from the line of Benoit Poirier from Desjardins Capital.
Martin, Stéphane, and congrats for the good quarter. Just to come back on the seasonality. Obviously, you posted a strong first half. It seems that there's nothing unusual in the first half. So would it be fair to expect a stronger second half, like you've been doing in the past?
Yes, absolutely. The seasonality of the first semester compared to the second one, we still see that for this year.
Okay. Okay, perfect. And could you maybe provide an update on the integration of recent acquisition? When I look at your margins, you deliver a strong performance. And I was wondering if the timing around the integration is faster than initial expectation?
Well, we -- you're talking mainly with Alta?
Alta and Tekalia, yes.
So we're happy with the first quarter performance of Alta, or HDI, Montreal right now. Throughput has increased. Obviously, it's not finalized yet, but we're pretty happy with the progress we've made in only 3 months. So we're still seeing some better results in Q3 and Q4 as the increased productivity in there significantly increased the throughput. So we know what we have to do. There's a lot of work to be done. And right now, it's progressing according to plan. At Tekalia, it's a surface treatment. It's a tougher operation. As you know, we had a lot of employee turnover. Now the employee turnover is stabilizing, we're training our employees, and we're focusing on increasing the throughput. So it takes a bit longer than anticipated, but we're confident that we're going to reach the level point that we want to soon, by the end of fiscal year.
Okay. And then you've seen a boost on the backlog with respect to those 2 acquisitions following the acquisition.
No. No. No. Like HDI Montreal has a good program. Namely the A-220, and then the Embraer E2 Jet. So these are very good programs and sustainability and production rate, and we are doing some axles on the A350. So these are winning -- winners, right? So as time as new contracts, new contract in the backlog? No. So it's to deliver what we have under the contract.
Okay. And with respect to Boeing, their stocks related to the NMA, there are some people talking about the fact that Boeing could be looking to launch a new version of the Boeing 767 to accelerate the development of the 737 MAX replacement. So I was just curious to have maybe, Martin, to have some of your thoughts about the -- whether you have already exposure to the 767? And whether this could became an opportunity, let's say, the NMA doesn't move forward?
Well, we're not on the 767. This landing gear is made by the American, by the incumbents. So we're not -- we have no content on the 767.
Okay. Okay. Okay, let's give it a...
That answers your question, but the rest would be speculation. There's so many views and I don't want to speculate on Boeing.
Yes. Perfect. And with respect to the recent election, the federal election. Does it change the mindset with respect to the future fighter program in Canada? Or this should follow as expected here, Martin?
Well, there was -- they're on their bid right now. The country is on the bid, and the platform that Canada is looking, I believe it's still the 3 same platform, right, you have 35, you have the 18 and the Gripen.
We have content on the 3 program.
And we have content on the 3 program.
[indiscernible], we win.
Okay. Okay, that's what I thought. Okay, perfect. And lastly, on the MQ-25, the first slide that happened in September, have you started to recognize some revenues on the R&D side? Or is it more to come? Or...
No, we...
Just before it, isn't it exciting to see our product on that type of airplane. It's a total unmanned aircraft. I don't know if you went to the website on YouTube, but it's quite exciting, and they're done the retraction also and extension. So this is an important milestone, and we're pretty proud to be on that program. So go ahead, Stéphane.
Yes. So the revenue to the development side is recognized over the quarter. And still will be the same until we complete the development phase for this program.
Your next question comes from the line of Kyle Brock from RBC Capital Markets.
This is Kyle on behalf of Derek. Just with respect to the higher manufacturing costs cited in the quarter at your Longueuil facility. Was that a onetime cost? Or is it something we can expect to see going forward?
No, we need to do better throughput over there, and we need to perform a bit more. And we're right there. So we're confident that Q2 -- Q3 and Q4, we will see much better results from that facility.
We haven't highlighted specifically, but we had -- like Martin described is more to throughput, right? But we had also an impact that we did not highlight in the $700,000 since we renegotiated the collective agreement. So that's part of the -- your question, there's $700,000 of onetime costs this quarter associated to this renewal of the collective agreement.
Okay. And could you provide a bit of color on what drove the 14% organic growth in the quarter?
Well, essentially, when you look at our MD&A, you had the growth on the commercial side, which we essentially highlighted the Boeing 777 program. And the rest of it came on the military side, and it came from various programs, including aftermarket on C-130, KC-135 with AAR. And also the aftermarket on C27J and H-60 program that Cameron asked the question earlier. So nice growth coming from this program.
Okay. And last one for me. How would you -- how would a longer delay with the 777X program impacts your ability to meet guidance? And do you feel you have enough in the way of other programs to make up any potential shortfall there?
We are in a good position. You see the backlog is increasing, right? So we're not only on 777 program. There's various program that we see an increasing demand. And that includes the F-15 program, which would only start next year. So we have no revenue yet on this program. As Martin said, we are on track to deliver the first shipsets next fiscal year in September 2020. And this is a plus for us because today, we don't have any sales right on the main landing gear shipsets that will start delivering at that time. And in addition to that, you have all the other programs, such as the CH-53K that is ramping up the demand on the legacy program, the Gripen. So there's various program that is driving the growth that we see in our guidance, so we're confident in this guidance for both fiscal '20 and 2022.
Your next question comes from the line of Tim James from TD Securities.
Just one question from me, really. Just wondering if you can talk in general or update us on kind of key margin drivers that we should be considering either higher or lower between now and fiscal 2022, putting aside that, it sounds like you're pretty close to kind of getting the benefits from the in-sourcing of the surface treatments. But outside of that, I'm thinking about mix impacts or volume impacts, anything you can comment on just in terms of key...
I think the biggest impact, Tim, is really associated, like you said, the surface treatment with the volume, right, as we increase the volume of our total business since we are in a fixed cost environment. So this contributes directly to improving margin going forward. We have started aftermarket business with good program. So we still see that to be as strong going forward. We have a strong backlog. So these are going to be the main 2 factors.
Okay. Will there be any drag at all from like your aftermarket? It sounds like it's very strong now. I mean do you expect any drop-off in that potentially, which I know was higher margin or any of these newer programs like the F-18 when they sort of a drag on -- and I'm not suggesting margins would decline, but I'm just suggesting a bit of a headwind to margins from any of these developments?
Well, right now, it's according to plan and in percentage, yes, it could have an impact. But the EBITDA, the EBITDA will continue to be at the -- between the 15% and 16%, right, 14.9% to 15.5% to 16%, right? Does that answer your question, Tim?
Yes. Yes, I'm just trying to sort of get a sense for how much margin expansion potential there is really, and I'm just kind of thinking through, obviously, those factors that will be a benefit like volume, like the benefit from the rest of the in-sourcing of the surface treatment, and I just want to make sure I'm kind of aware of if there's anything also that drags on margin expansions. So that's helpful.
No.
Your next question comes from the line of Ben Cherniavsky from Raymond James.
Most of my questions have been asked. If I -- but if I could just ask you to maybe clarify some of the comments on the 777. So the current build rate is 5 a month in that, is that equivalent to what your shipsets are per month into the Boeing facility on the 777 program?
Yes.
So -- and then as that transitions -- but are you saying that as that transitions to the X -- the bill rate isn't scheduled to increase? Is it?
Sorry. So how do you say that, Ben?
Well, you're not shipping for the 777X program yet, are you?
Yes. We are.
So I don't know if you agree...
But how many shipset -- I cannot share with you how many shipset we delivered, but we delivered some 777X shipset.
Okay. So that's a combination of both then.
Yes, exactly.
And the total bill rate between the programs is -- those ship -- is 5 a month. That's what you're shipping for?
Yes.
And you know Boeing has said, right, they are at delivery on 777 at 3.5 a month, right, until the end of 2019. And it is going to 3 a month after that. So the difference is really how many 777X we're building.
Exactly. You read carefully the comment of Muilenburg, he says, "a combined 777 and 777X production rate is at 5 per month."
And as they transition fully to the X, that's not scheduled to change at this point. It just becomes a change in the mix, not an increase in the production rate?
That's what we read.
Right. So if -- and in the current environment because I believe they've recently adjusted their 787 production rate. There's no concern that like -- or the view right now is 5 a month is sufficient for their current backlog. I'm just trying to get an idea of what might increase that production rate or perhaps at one point potentially decrease it. But I think the initial plan was to be much higher than 5 per month.
Yes, the initial plan was to be higher than 5 per month. But right now, the backlog is 344 777X, right? And we only have shipped some and 87 of 777 ER as of September 30. So we'll watch the situation closely. So we're looking forward to have this entry in service because we believe that once this will be in service, they will probably announce some new orders.
And then we are -- in our guidance forward, we are prudent in fiscal 2022. I mean, expect 100 shipsets, it's really more around plus and minus in the 60 shipsets so it's really associated to the entry into service of the X, which when it's in service. I mean, they have a backlog, as you know, of around 340 aircrafts. So that's really the driver.
But for the production rate to increase to what the initial plan was not to speak for Boeing, but effectively, you need to see more orders?
"Mhmm."
And then, does that affect how you guys have -- like the kind of capacity that you assumed when you started the program, do you feel like at 5 a month, you're getting -- I mean, I assume you've got room to increase if and when they decide to build more 777s, but this is still sufficiently profitable for you. It's not like you've got a drag on your profitability from 5 a month, is that fair to say?
Of course, if we do more than 5.
Yes. Exactly.
I mean, we'll absorb more of the cash. So we have a drag associated to the number of shipsets, right? The current production volume at 60 a year. But for now, that's what it is, right? It's -- of course, as the production rate increases, eventually with the X, then we'll provide a better absorption of cash and better margin.
Yes, imagine, we built the plant, the plating plant in Cleveland that could do [ 100 ] shipsets, same thing with the assemblies and same thing with our Cambridge facility.
Right. Okay. Well, we'll watch that closely. Hope for the best. On cash flow, Stéphane, it looks like a decent quarter of free cash in this most recent period. But I know your working capital can swing around quite a bit. What should we assume for the next 6 months on that -- in that line?
Essentially, we're investing basically in inventory for the current organic growth. That's what we've done in the past 6 months. And this growth will continue. As highlighted, the second semester will be stronger than the one. So we should be seeing some inventory variation from now to the end of the year because we foresee, obviously, next year, fiscal '21 going to fiscal '22 guidance. So we're still going to have some working cap, but we are working hard to minimize the impact over the fiscal year.
[Operator Instructions] Your next question comes from the line of Konark Gupta from Scotiabank.
Just a follow-up to that free cash flow question. On the CapEx side. So I think in the first half, you have about $8 million to -- $8 million of CapEx. Should we expect this rate to sustain in the second half as well?
Yes, the second half is always stronger than the first one. So that's one. And we don't provide guidance on the CapEx but it will be in the $20 million. That's basically the number, it's going to be around that number.
There are no further questions at this time. I turn the call back over to management for closing remarks.
Thank you. So we look forward to our next call and to meet our guidance. So we're -- well, we have a good plan. We have a good team. We have everything we need to meet the guidance for fiscal 2020. Thank you very much for listening.
Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.