Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to Héroux-Devtek's Fiscal 2023 Second Quarter 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 complete forward-looking statements.
I would like to remind everyone that this conference call is being recorded today, Friday, November 11, 2022 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 to Mr. Stephane Arsenault, Vice President and Chief Financial Officer of Héroux-Devtek's. Mr. Brassard, please go ahead, sir.
Thank you very much, Julie, and good morning, everyone. Welcome to our second quarter earnings conference call for fiscal 2023. I invite you to follow along by referring to the financial statements and the annual press release, which can be found in the Investors section of our website. We are encouraged by the improvement in our delivery compared to the first quarter, even though, as usual, annual shutdown and summer vacation affected our production capacity. Our profitability improved as well despite the ongoing strength in the production environment.
We have also stayed in close contact with our customers and continue to build on our reputation as a trusted partner. As such, our backlog has been growing, bolstered by upcoming deliveries of landing gears for business jet orders as well as spare parts and aftermarket services. To this effect, we also announced this morning that we were selected by Embraer for a life cycle contract to supply a cargo door actuation system for the E190 and E195 freighter conversion program. This contract is the first for our Spanish operation with Embraer, and we look forward to bringing more top-tier customers to their portfolio. At this time, I would like to turn it over to Stephane for a rundown of the second quarter results. Stephane?
Thank you, Martin, and good morning, everyone. As usual, please be aware that we will be referring to certain non-IFRS measures during the call, including adjusted EBITDA, adjusted net income and adjusted EPS. Our non-IFRS measure are defined and reconciled in the MD&A issued earlier today.
Consolidated sales for the quarter rose 1.1% to $132.7 million compared to $131.3 million last year, a strong rebound from $114.1 million in the first quarter. Civil sales were up 10.7% to $41.3 million as increased deliveries for the Embraer Praetor and Boeing 777 program more than upset production system disruptions. Defense sales were $91.4 million, a 2.8% decline partly offset by the ramp-up of delivery for the F-18 program of Boeing. Gross profit decreased to 13.8% of sales compared to 16.9% last year. The decrease is attributable to product mix and production system disruption, while last year, the impact of COVID-19 was compensated for by the Canadian Emergency Wage Subsidies, representing an impact of 1.8% of sales. As a result, operating income was $8.6 million from just under $12 million at this time last year, but up from $2.6 million in the first quarter of this fiscal year.
Excluding nonrecurring items, adjusted EBITDA decreased to $16.2 million compared to $21.2 million last year, while up from $11.4 million in the first quarter. Net income stood at $4.8 million or $0.14 per share compared to $7.5 million or $0.21 per share last year. Excluding nonrecurring items, adjusted EPS stood at $0.10 per share compared to $0.21 last year.
Cash flow related to operating activities reached $8.3 million in the quarter, a decrease from $17.5 million reported at the same time last year, due mainly to an increase in inventory levels made to stabilize our production system and prepare for the sales ramp-up of the second half of the fiscal year. Our financial position remained strong at the end of Q2 with net debt at $154.5 million, stable with March 31, 2022. Back to you, Marty.
Well, thank you, Stephane. Our management teams have worked hard and diligently to better align our resources to face the challenges of the current production environment. As a result, we believe we are in a better position to improve our throughput in the back half of the fiscal year. The current increases in financial costs could result in new growth opportunity and the strength of our financial position gives us the flexibility to seize them, whether they are organic or acquisitional Along with the disciplined approach, it is -- it also enabled us to navigate the current turbulence. Our focus continues to be on managing our business tightly to deliver quality products to our customer on time.
Julie, we are now ready to take -- to answer questions.
[Operator Instructions] Your first question comes from Konark Gupta from Scotiabank.
So, my first question is on the inventory. I think you guys mentioned in the MD&A that the inventories increased by $13 million sequentially here, which I think you alluded to previously to stabilize production and other ramp-ups going on. How much more inventory do you need to build or increase here to continue to do that in tester production and support and ramp up?
I think our view on this point, we have a strong last 6 months to do, right? With -- typically, the last semester is always stronger than the first semester. It's particularly true in this case as well. So, we believe we have reached the level that we want -- that we wanted to be to achieve the last semester and then to prepare ourselves for the next fiscal year. So, we foresee inventory to decrease from now to the end of the fiscal year.
That's helpful. And then you also mentioned about the challenges sort of continue over the coming quarters. What challenges are you facing at this point here? I mean the supply chain still seems to be an issue in the industry, I guess. But any putting pockets where you would point and say, like, these are the challenges which you don't really have a clue when they will end?
Konark is to get the production -- the parts on time to make our assemblies, right? That's the main challenge. So, our team are working very diligently to make sure that we receive all the parts needed to make an assembly. That's main challenges.
Your next question comes from Benoit Poirier from Desjardins.
Martin, could you maybe provide an update on the 3 facilities where you were experiencing some issues with throughput last quarter? And how is Q3 and Q4 shaping up so far?
So, one of these facilities have rebounded over our expectation and it's going well in the U.K., namely in the U.K., we're very satisfied with that operation. We see a bright future ahead for that facility. So yes, it turned the corner faster than what we expected. In Michigan, lots of improvement for throughput. Now we need to work on profitability. It's not at the expected level, but the throughput is there. So that's a good first sign. And in our Laval operations, so we see some encouraging sign of in September and October. It looks like they're going to have a good Q2 and get ready for strong Q4.
Okay. That's great color. And at the recent Boeing Investor Day, they've announced that the 777X production will jump to 4 planes a month in 2026. I'm just wondering whether it's the buildup is later than you had originally expected? Or basically, you need to build up some parts in advance of the ramp-up? If you could comment about the expected production rate on the 777, 777X, that would be great.
So, at 4 a month in 2026, it's maybe a bit push to the right, but not that much. And we don't need extra capacity there to meet the production, the product we announced production rate. [indiscernible] problem no. The thing is that again, it's more -- the risk will be more on raw material with Russia and Ukraine, right? To get our material on time. And that's what Boeing announced. That's why they pushed out a bit compared to our expectation.
Okay. And with respect to the recent award with Embraer for actuation system. I was wondering if you could provide some color about the timing and the potential size? And just wondering also how the bidding pipeline for actuation system has evolved now that you've secured some key contracts with Boeing and Embraer.
Yes. So, the cross-selling is working is showing results. And it's compensating from the reduction in sales of the military program that we have with Airbus Defense. So glad that we are securing orders with Embraer and Boeing and we have orders with others too, right? So, for the timing, I cannot disclose all the same formation, Benoit, in terms of value and timing, but I can tell you that that's a good opening door to -- for other products with Embraer and to show them the capacity or the capability that we have in Spain. Does that you want to add Stephane?
No, it's a design. It's a development. So, they always 2, 3 years in the actuation to get ready for production after that.
Okay. And last one for me. The U.S. Navy recently stated that the MQ-25 will be the trailblazer for the uncrewed transition. So, it seems that they love the program. So, do you see further momentum on the MQ-25 and any impact so far?
It is a great news, Benoit. Wow, we love that news. So, the MQ-25, we always believe in the capability and the technical. So now it's -- we're ahead of the schedule of the -- for our part, right? So, we performed well. Our system, our qualification testing is ahead of the customer schedule. Now it's -- we need to have that airplane certified and deliveries to the end customers. So, it's a great program. We're ready to ramp up to face production ramp-up. We look forward to get into [indiscernible] phases.
Your next question comes from Cameron Doerksen from National Bank Financial.
So, I just wanted to ask a question on a comment you made just with regards to -- and correct me if I'm wrong, but I think you sort of suggested that higher interest rate environment, maybe putting some stress on the financials of certain smaller companies and that potentially could be an opportunity for you guys for some organic growth. And I just wanted to maybe clarify what you're sort of trying to say there. And I guess, are you seeing some opportunities here for some business to come your way that maybe the OEMs are moving out of smaller suppliers to more financially secure suppliers like yourselves?
Yes.
Okay. And can you expand on that? I mean -- or is this also, I guess, an M&A opportunity for you as well?
But there's some opportunity Cameron, but we need to put the puck in the net. We're not alone in these competition. But yes, we see some opportunities there.
Okay. And maybe you can provide an update on -- in the sort of related question, but just on M&A, I mean, does the higher interest rate environment change your appetite for M&A? Or is maybe the preferred path to just to try to win some new business organically.
We're going to be working on both, Cameron. So, if the right opportunity present and it's accretive to shareholders, yes, we will do it. There are some that are moving, but we'll see if we can conclude an agreement. But we're looking at both. We're looking at both. So, I don't know which one will come first, so I [indiscernible].
Okay. Fair enough. And maybe just lastly for me. I just wonder if you can give us an update on, I guess, the labor situation. I mean, I guess there's an ongoing issue with COVID absenteeism. I mean I don't know if that's maybe abrogate to improve -- but I just -- where do you stand on labor? I mean are you going to have to maybe ultimately hire more people than you would have had previously just because there's an expectation that people are going to be up sick more often?
Not up sick more often. It's more the turnover, right? So, we have 99% of our resource for the plan to execute our plan, right? Our forecast and budget. What we're seeing, yes, you're right, the COVID related absenteeism is higher. So, we have improved a bit in Q2. But my wondering is the turnover in the support department. And that were not a long. We're all living the same thing in supporting the shop floor people, the shop floor employees is okay, but it's the supporting department that has a turnover. So, our human resource department are doing very well there in that regard. But again, so when you have employees that work for you for 3, 4 years and then he's up to speed and then you have to restart, that's another challenge to the question of [indiscernible] that we do have. But so far, we've been able to fulfill the open position, but it's a constant battle, Cam.
Your next question comes from Tim James from Citi Securities.
I'm wondering if you can talk a little bit further. You kind of touched on the material risk that you're dealing with on 777 related to the Russia-Ukraine situation. I'm just wondering if you could maybe give us a bit more of a broad look at -- and that obviously comes into play here, but what are your primary concerns or risks that you're looking at in terms of supplies material as you look out over the next 12 to 18 months. What are your kind of watch points where you feel you need to do some extra work or secure alternative sources of supply to minimize risk?
That's right. We're working with our customer right now for -- to compensate or to mitigate the risk of supply chain disruption on all the titanium provided from Ukraine. So, we're working very -- we have to resource it. Right now, the plan is tight, but we have a plan to continue delivering on the production rate there. So, we're working very, very, very closely with our customers. And we have success. We've been able to reduce and mitigate the potential. So, we're working on this since February or since March with our customer, and we have a detailed part-by-part listing and requalification of the forging and the communication is extremely good.
The other one is to secure the raw material in the long term. We have asked our customer to give us more visibility, more firm contract, more firm orders, so that way we can go ahead and place PO with all of our suppliers. Then our PO are placed, it's a matter of following the execution and be in contact with our supplier, making sure that they're going to be delivering on time. So [indiscernible] titanium, those are on the watch item.
Okay. And so that's helpful. And so, when you say you're looking to your customers to give you longer-term contracts so that you can go out and procure the necessary materials. Are there particular sort of pin points there, certain metals that you are -- obviously, titanium is coming into play in that. But are there other metals as well or other supplies that you feel you'd like to be able to kind of go out further into the future and enter contracts to purchase them in order to reduce the risk because you feel the risk to that particular supply is higher than you'd like it to be?
Well, all the nickel alloy material and [indiscernible], that's on top of titanium. And we have the orders and from the customer because the purchase order that it's important for us to have that secured because we do not procuring on forecast and take the risk of having overstock, right? So, we need a legal contractual document, right? Because typically, customer were giving us a firm order from 6 to -- 6 months to one year. Now we're asking 2 years to make sure that they'll take the material if something happens to the demand. So that's what I meant. So, we're acting very cautiously, right, to not expose the company to greater risk than necessary.
Okay. That's really helpful. My next question on capital deployment. You've been buying back stock. How are you currently thinking about your capital deployment priorities, deleveraging further versus share buybacks and CapEx. How do you look at that in terms of prioritizing at this point?
Again, we want to reinvest in our company and business acquisition, right? But again, with the right opportunity, if we need CapEx, we modernize our equipment, we definitely do it and share buyback program. So, in terms of uncertainties, we have different opinion within the Board, right? So, there are some people that are more conservative and some people are more in the capital deployment. So, the NCIB is there. It's a good tool. And to see the stock at that price, it's a shame. So, we want to boost up the stock.
Okay. That's helpful. And then my last question, just turning to the 777. As you sit here today, I mean, obviously, the 777 rates aren't what was anticipated when years ago when you got into this contract, you've created a very efficient manufacturing process there for that aircraft. And I know you have capability to go much higher. So, as you look at that today and the earnings or the margins that are coming from your content. Is there a significant amount of upside as rates increase over? And I'm thinking very long term over kind of a 3 to 5-year period. Or have you managed to kind of downsize the -- some of the costs in a way that you can still earn decent margins today on it, even though rates are much lower than originally anticipated.
Yes, yes. You're right. Listen, Tim. Right now, we're getting ready for that ramp up that Benoit said 3, 4, 5 a month. What we're doing is we're putting a lot of effort to make our machining program much more robust. And at the end of the day, so we want to absorb these production rate increase without adding any variable costs. We look at this as a fixed cost. Our shops -- you saw our shops in Ontario and in Springfield and in Cleveland that are dedicated -- or not dedicated, but are working on the 777 program. These are the staff that are working most on the 777 program. They're all into initiatives of getting ready for that ramp up and that the margin will go up. So, we will -- what we want is we will absorb all these increases with the same amount of results -- resource right? Do you want to add something? Does that answer your question, Tim?
No, that's perfect. That's very helpful. Actually, I might...
But that is to compensate all the inflation, that's the best. So, we will have -- no, no. I truly believe in that initiative.
Okay. I might just squeeze in one more question, if I could, very quickly. Returning maybe to a comment, I think, you made about the Michigan facility, your Michigan operations. The throughput is very good, you said, but you need -- there needs to be a little work on the profitability on the margin there. What is it that is holding back the profitability even though throughput is strong?
Stabilizing the production environment. And once you're stabilizing, so imagine so -- and it's not only in that facility. So, I imagine when you start an assembly and your assembler are lacking work at the beginning of the month and all the parts are coming in at the end of the month. So, you're asking all your people to work over time. So that's the reason why efficiency or profitability is not there. Working on our revenues, on our pricing is also another initiative. We working on automation also is the other initiative. So, we're working on 3 fronts over there. And we'll get back, I believe, within the next 12 months to historical profitability there.
[Operator Instructions] Your next question comes from Jonathan Lamers from Laurentian Bank Securities.
Nice step-up in the civil and commercial sales this quarter, although I'm sure they're still not where you would like them to be if you didn't have the supply constraints. Could you just provide a little more commentary on what's allowed you to increase the civil commercial sales as much as you have. Has it been more driven by the demand side from Boeing and Embraer or has it been some release of the supply constraints?
So Jonathan, our cycles, when we get an order in our cycle is more like a year, to deliver 1 year, 1.5 years, 18 months. So, the orders are there. The backlog is healthy. We have the orders for commercial and military program, and it's very robust, and it's all backed up by PEO firm purchase order. So, the challenge that we all face here is execution. It's really to get all the product on time and all the parts needed to assemble our product. So, I used to say I said a lot to all of my team because Stephane and I were traveling a lot during the Q2. And the motto is you know how many parts we need to assemble an airplane? We need all of them. So, if we're missing one part, we cannot deliver our product.
So, the challenge here is operational and make sure that we have a steady flow of our part. So yes, you have the raw material, you have labor constraints. And you do have some financial stability coming from the supply chain. So, we need in that environment to be a trial. So, the main focus here is because when you resource products, so we had some few suppliers that went that we're financially not sound that we have to resource and that's what we're ready to take these decisions, encourage decision in an expedited manner. So, challenges is operational.
Your next question comes from Bryan Fast from Raymond James.
Just one question for myself here, largely didn't answer. But could you talk a bit about the financial stability of some of your suppliers right now? I mean as the economic backdrop shifts and rates rise, are you seeing any increase in risk from that side?
Well, yes, some of them yes. And that's why we need to look for it and be ready to have plan Bs on those. And our team is working relentlessly to identify those and get ready to resource because resourcing process, it takes 9 months, 9 to 12 months. So, we have done it. That's why we have been able to increase our throughput. And that's why we're saying that, yes, if things all being equal, we can have a strong 6 months ahead of us.
And there are no further questions at this time.
Thank you very much, Julie. Thank you, everyone. Thank you very much, everyone, for having joined us for our second quarter earnings call this morning. Thank you as well for your interest and ongoing support towards Héroux-Devtek. Have a good day, have a great day.
Thank you. Ladies and gentlemen, this concludes your conference call. You may now disconnect.