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. Third Quarter 2018 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, February 7, 2018 at 8:30 AM Eastern Time.I will now turn the conference over to Mr. Gilles Labbé, President and Chief Executive Officer; and Mr. Stéphane Arsenault, Chief Financial Officer of Héroux-Devtek. Mr. Labbé, please go ahead.
Good morning, and welcome to Héroux-Devtek conference call for the Fiscal 2018 Third Quarter ended December 31, 2017. With me is Ms. Stéphane Arsenault, our Chief Financial Officer. Our press release was issued earlier this morning. It can be found along with the financial statement and the MD&A on our website at www.herouxdevtek.com.Please note that we also post PowerPoint presentation on our website that summarizes the key points of this conference call. First, let me start by discussing a few highlights from the quarter, which are presented on Page 3 of the presentation.The key takeaway from our results is that we continue to generate strong free cash flow, a trend that has enabled us to reduce our net debt position significantly since the beginning of the fiscal year. In fact, on the last 12-month basis, we generated $67 million in cash flow relating to operating activities and $54 million in free cash flow as compared to $28 million and $7 million in the previous 12 months.This has translated into a solid financial position with a net debt position at $61 million from $92 million as at March 31, 2017. In addition, since the beginning of fiscal 2018, we recorded a significant increase in the value of our backlog. Our funded backlog was at $475 million as of December 2017, up from $405 million at the end of March 2017. As a reminder, the backlog only includes business for which we have received a firm purchase order.Stéphane will provide additional details on our results and financial position in a moment.We continue to be on track with the Boeing program. In the third quarter, we delivered 12 complete systems or 29 year-to-date for a total of 50 shipsets since the beginning of the program.Last December, Dassault Aviation announced the cancellation process of the Silvercrest contract leading to the termination of the Falcon 5X business jet program and announced the launch of a new Falcon program with an entry into service expected in 2022. We are presently having discussion with Dassault and expect to supply this new aircraft within the framework of the existing Falcon 5x contract.Finally, I just want to give you a quick update on CESA acquisition. The process is ongoing and we continue to expect it will close around the end of our fiscal year. As a reminder, this is a highly strategic acquisition which will expand our reach to new customers in Europe, broaden our portfolio of proprietary product and position us to gain important contracts on several Airbus key programs.Stéphane will now review our Q3 results and financial position.
Thank you, Gill. Before I begin, please be aware that we will refer to certain indicators that are non-IFRS measures such as adjusted EBITDA 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. Third quarter consolidated sales reached $97 million versus $98.5 million last year. This variation reflects lower sales to the defense aerospace market and a negative foreign exchange impact, partially offset by an increase in the sales in the commercial aerospace market.Commercial sales were $52.1 million versus $50.7 million last year. The increase was mainly driven by the ramp-up of delivery to Boeing for the 777 program and higher engineering sales.These factors were partially offset by the scheduled ending of a Tier 2 contract and lower aftermarket sales and support of the Saab 340 program.Defense sales reached $44.9 million versus $47.7 million last year. This variation is essentially due to the decreased sales to civil customer resulting from lower spare parts sales as well as lower repair and overhaul sales on the P-3 program. These factors were partially offset by higher manufacturing sales from a catch-up in delivery to civil customer and higher repair and overhaul sales to the European customer as a result of a better throughput.Turning to Page 6. Third quarter gross profit was $15.8 million or 16.3% of sales versus $15 million or 15.3% of sales last year. The increase was largely attributable to a favorable foreign exchange impact, partially offset by higher under-absorption of manufacturing costs due to excess capacity and processing and finishing costs related to the Boeing 777 program. As a reminder, these processing and finishing costs are expected to normalize when we receive the certification for our surface treatment process.Operating income was $6.6 million versus $7.7 million last year. Adjusted EBITDA, which excludes nonrecurring items, was essentially in line with last year at $13.6 million or 14% of sales compared with $13.9 million or 14.1% of sales a year ago.Turning to Page 7. Net income was $0.6 million or $0.02 per share compared with $8.2 million or $0.23 per share a year ago. The significant decrease was mainly driven by a one-time noncash tax item of $4.9 million associated to the devaluation of the corporation net deferred tax asset in relation to the U.S. tax reform as well as a $2.9 million noncash gain recorded last year in financial expense following the revision of governmental authority loans repayment schedules.Excluding nonrecurring item, net of taxes, adjusted net income reached $5.7 million or $0.16 per share versus $6 million or $0.17 per share last year.Now let's turn to our cash flow and financial position on Page 8. We generated strong cash flow related to operating activities of $19.3 million versus $15.5 million last year. This increase was primarily driven by improved working capital items such as accounts receivable and inventory.Free cash flow reached $17.1 million, up significantly from $9.7 million a year earlier as a result of increased cash flow from operation and a decrease in CapEx due to lower-than-expected investment related to a customer contract.On a year-to-date basis, we generated $30.8 million of free cash flow as compared to $10.2 million for the same period last year. Given this free cash flow, our financial position remained healthy as of December 31, 2017, with cash and cash equivalent of $70.6 million and a total long-term debt of $131.4 million as can be seen on Page 9.This total include an amount of $52.7 million drawn from our authorized credit facility of $200 million. Recall that our credit facility includes an accordion feature to increase it by an additional $100 million during the term of the agreement subject to the approval of the lenders.Our net debt position stood at $60.8 million as of December 31, 2017, representing a net debt to equity ratio of 17:1, down from 0.21:1 three months ago.I'll now turn the call back to Gill.
Thank you, Stéphane. Please turn to Page 10 of the presentation. Looking ahead, as we enter our strongest quarter of the year, we are maintaining our annual guidance of a low single-digit sales decrease and stable adjusted EBITDA margin as compared to last year.However, we decreased our CapEx guidance from about $20 million to $15 million due to lower expected investment related to a customer contract as indicated before. The outlook in our main markets remains mostly unchanged from last quarter. In the commercial aerospace market, airline profitability and passenger traffic are robust. In fact, IATA most recent forecast call for demand to remain healthy in calendar 2018, in both the passenger and cargo markets.Following a strong 7.5% progression in calendar 2017, passenger traffic should grow by 6% in calendar 2018, fueled by solid global GDP growth that is expected to reach 3.1%. These RPK increase are above the annual average growth of 5.6% recorded in the period of '96 to 2016. Meanwhile, air cargo volume increased 9.3% in calendar 2017 and is expected to further rise by 4.5% in calendar 2018.In the business jet market, aircraft shipments increased slightly in the first 9 months of calendar 2017, according to industry association GAMA. Looking ahead, while the number of new jets entering service is expected to increase at a modest pace, the trend towards larger, long-range business aircraft is expected to continue.In the short-term, our activity in this market will mainly benefit from the ramp-up of the Embraer Legacy 450/500 program, given recent announcement delays in Dassault Falcon program. Our financial position remained healthy this quarter, with cash over $70 million and long-term debt of $130 million.We are excited about our future given the game-changing acquisition of CESA, many new opportunities, the positive long-term growth outlook on commercial aerospace and increased defense spending commitment worldwide.We are now ready to answer your questions.
[Operator Instructions] Your first question comes from the line of Cameron Doerksen from National Bank Financial.
Maybe just a question on the margins. Are you able to, I guess, quantify the impact on costs or margins related to the fact that the processes for the 777 have not been fully approved yet?
Yes. Certainly, Cameron. We still incurring the impact of this process. It represented about 1% for this quarter. I mean, I think we basically are into that process, and we are progressing but we still have an impact of 1% in the actual...
Okay. And is there any update, I guess, on when you think that all the processes will be approved?
Yes, certainly -- essentially, as you know, we have qualified all the processes. One remaining is the chrome Class 3, which essentially, we're working very hard on this qualification which is the last one of the surface process to be qualified, and working very hard to have that done by the fiscal year-end, obviously. But we don't control everything, obviously, in a qualification process like that. So it could take a couple of months more than March 31, but we're working very hard to make this happen with our customer by year-end.
Okay. Good. Maybe just a question on the EBITDA. So 5x program, I mean, it sounds like whatever new aircraft Dassault is going to morph this program into, you're going to be the landing gear supplier for it. I'm just wondering if there is -- if it is your expectation that there's going to be a significant amount of new engineering work? Or is this your expectation that you'll see largely kind of a similar landing gear than what you've already developed?
Well, it's a good question, Cameron. Of course, the new Falcon, basically we will be the supplier for landing gear and we will use mostly the design that's already done for the 5X. So there will be modification and all this, but we are assessing this at this point with Dassault. And we will try to basically minimize the impact on the design. So this is where we are. So the -- it's a good news/bad news, meaning that it's a push out by another 2 years as you know, but at least we know that what we've done will be used on the new airplane.
Okay, perfect. Maybe just final question from me. Just maybe talk about what you're seeing out there as far as, I guess, sort of new order activity or potential for new contracts. I mean, I know you've been working to backfill some of the excess capacity that you have in your plants. Just any comments on what you're seeing out there for potential new contracts?
Yes, thank you for the question. Look, we -- as you know, I mean, we built a factory and then put the equipment in place to produce 100 shipsets a year on 777. Unfortunately, we all know that the market is now more like 50 aircraft a year. So we are working with Boeing and other customers who fill the capacity and I know there's -- we have not announced anything yet, but there are things in the pipeline that hopefully within the next couple of quarters, we'll be able to announce to the financial community. At this point, the pipeline is relatively strong. Now we have to finalize these transactions and make some announcement.
Your next question comes from the line of Derek Spronck from RBC Capital Markets.
On the 777 freighter, is it the same landing gear system as the regular 777?
Yes.
Okay. Okay, that's great. And with CESA, are you able to do some of the preplanning while you're waiting for the approval process or some of the back work around the integration ahead of time?
We cannot do integration, but of course, we are refining our integration plan to day 1 when we finally get the key. We have now a more and more robust integration plan. So that's what we're doing. So we're limited somewhat too. We cannot intervene in the running of the business. It's not ours yet. So now we are in the process of waiting. We have to supply the Spanish government with what they need to do their work and all this. And we are waiting for them to authorize the transaction.
Are you feeling pretty confident or comfortable around the acquisition closing?
Yes.
Okay. And just with the A350 program that CESA is involved in, is that a -- what are they doing on that contract? And is that a major program for the company?
They build a large retraction actuator landing gear for the -- for that airplane for Safran or Messier-Dowty. So it's a similar component that we build for Boeing and 777. So that's what they do. And they have other product, but the main product is the large retract actuator.
Okay. That's helpful. And just a couple more for myself. Just wondering your thoughts and impact either directly or indirectly from an Embraer/Boeing joint venture there?
Well, that's a good question. We both enjoy a good relationship with Boeing, of course, and also Embraer. As you know, we are the supplier on the Legacy 450/500. We make -- we build a lot of major components on the KC390. And of course, we are looking also at maybe eventually some supply major component on the new E-Jet. So the relationship is there with both companies. So we don't see this negatively, because -- no, relationship is good. So we certainly, if this deal is done, we certainly will find our way to work with the new entity that could be created. So we are watching this very closely, as we speak.
Okay, that's great. And just one last one for myself. I'm kind of jumping around here. But any concerns around NAFTA?
Well, that's -- well, look, the most important thing for us is that a product that we build, I know you sell to the U.S. is duty-free basically. Before, even before NAFTA and before free trade, our space product were exchanged between Canada and the U.S. without any duties. So we've been in the free-trade environment for a long, long time in the aerospace and defense business. And don't forget also is that from a defense standpoint, the defense -- Canada is considered a domestic source so however, the defense industrial base is very integrated with United States. So -- I mean, there is no, I don't think there is any benefit for the U.S. to basically start to change the rules of the game on that side. So I think that's our comment at this point.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets.
If we come back on the Dassault 5X, would it be fair to say that you'll be paid for additional work to be done on the modification of the landing gear?
Well, this is -- well, we certainly expect that, yes.
Okay, okay. Perfect.
Yes, we are in discussion with the customer, and yes we -- but that's how our expectation.
Okay. Now if we look at your EBITDA margin 14% last year, you were at 14.1%, but there was 3.5% impact on the 777, 1.1% for the U.K. integration. So I'm just wondering, what caused the drop in the EBITDA margin year-over-year? And what makes you confident to achieve the guidance for the year, given what you've reported in the first 3 quarter?
Essentially, the impact in this quarter, more specifically compared to last year, was really the mix on the aftermarket side, both from the military and on the commercial side. We have indicated one program in our MD&A. So this was the unfavorable impact when we compare to the last year impact that we had from the 777. So essentially, we'll remain with the guidance which is calling for a stable EBITDA compared to last year. And we have a strong Q4 to do obviously. As you can see, we have demonstrated our capability of delivering a strong Q4 in our past fiscal years like last year and the year before. So we are working very hard on our last quarter in order to meet our target.
Okay. So do you feel, Stéphane, that the mix was kind of not typical this quarter and that there should be a reversal going forward to kind of a more normalized mix?
Yes, it should normalize. I mean, from quarter-to-quarter, you will see these type of variation. But it will certainly normalize. But these type of order, as I said, I mean, they come and we don't necessarily see it from a quarter-to-quarter basis but more on a year-to-year basis. So this would stabilize more on a yearly basis.
Okay. And just with respect on the tax side with the U.S. tax reform, what should we be modeling going forward in terms of effective tax rate for overall?
Yes, well, certainly or essentially, one thing is important, right, it's a noncash tax impact, right? It's not the -- it's a deferred tax asset devaluation. So in terms of cash flow, I mean, it will not impact going forward our cash flow. On the long-term basis, the depreciation from 35% to 31 -- 21% of the tax rate in the U.S. will be favorable for the corporation. But on a short-term basis, due to the profitability that we have in the U.S., it's slightly negative on our effective corporation income tax rate of about anywhere between 2% to 3% forward. But as I said, will stabilize going forward as we increase our profitability in the U.S.
Okay. And what will drive the increase in profitability in the U.S., Stéphane, going forward?
Essentially, the 777 program and the ramp-up as we have with the processing, right, that's essentially that.
Okay. So the processing, it's about 1% on the -- in terms of margin, but is the volume can also increase the EBITDA?
Absolutely, yes.
Okay. Could you maybe quantify what the volume could bring in terms of improving the EBITDA margin?
No, we don't disclose at this time.
No, at this point, I mean -- Benoit, I mean, it's not for us to disclose the rate of production of Boeing.
Okay. And you've talked a little bit about the bidding pipeline, hopefully, to announce something in the next few quarters. But could you mention the progress or the timing for the T-X, the MQ-25 and the MUM. Do you think it's kind of a 2018 story or more kind of a 2019 story, gentlemen?
I think both the MQ-25 and T-X decision will be made in 2018. So the MUM is really, I mean, we read paper like you. I mean, it's -- will they be launch this year or next year? That we don't know. So it's -- but I think the, on the defense side, we -- it's pretty much a decision that will happen in 2018. So, and we are working with customers who -- it depends who's going to win also this program. So this is where we are.
And how would you qualify the overall mood right now given the U.S. ITC decision? Do you think it brings some positivism for the supply chain in Canada? Or does it impact Eagle-Devtek? Or could you comment a little bit on that decision?
Well, look, it's -- I think it's neutral at this point. I mean, it's business as usual. I mean, at this point, we don't -- we have not seen our customer changing the way they do business every day. So I think to me, it's neutral. So it's a good -- this was good news for Bombardier and Airbus and life continue now.
Okay, okay. And for Boeing, in their last conference call, they mentioned that they stood up operation at Boeing Sheffield in Portland to begin building actuators on the 777 and the 737. So I'm just wondering, if you could talk a little bit about the strategy, whether they bring in-house more actuation business or it's basically an opportunity down the road for you to bring CESA's expertise to Boeing? I just want to clarify a little bit what's happening at Boeing on the actuation side?
Well, I think it's -- first of all, none of our product are impacted by this decision. That's number one. And I think, it could become an opportunity for us, because this work that they are bringing basically -- they are vertically integrated. This workload is taking away from certain other supplier of Boeing. Certainly, people like us -- we are capable of doing actuator and/or major component of this product. So I think this could be eventually an opportunity for us.
Okay. That's very interesting. And last one, if you look at Boeing, they also mentioned that they have a landing gear exchange agreement with All Nippon Airways on the 787. I know, your exposure to the 787 is not very high, but just wondering what does it mean in terms of -- does it mean that they try to bring in-house? Or do you have more color on that, Gilles?
These are normally -- they have this exchange program not only on 87, they have this on 777 and most of their airplane. I mean, this is a service they offer to their customer. So as you know, Benoit, Boeing owns the IP on the landing gear, right? So they're the one basically. They sell the spares -- complete spares of landing gear in the market and/or component. And they offer an exchange program to their customers. So that's normal business for Boeing. So that doesn't change. We build some -- we build 777 as you know, but we build major component on the 87, and that doesn't change that business at all.
[Operator Instructions] Your next question comes from the line of Ben Cherniavsky from Raymond James.
Most of my questions have been answered, but can I just ask you to clarify the comments on the tax rate? Are you saying that in the short term, your tax rate will actually go up with the cut in the U.S.? I didn't quite follow that.
Yes, the reason behind that -- the answer is yes. The reason behind that is that we are in a tax loss position in the U.S. So with the dimension of what I said earlier associated essentially to the 777. But as this program is ramping up and that we moved the extra cost that we have on the processing side, the profitability will increase and then it will become eventually favorable.
I see. So the lower rate means less of a deductibility is why you're losing money?
That's exactly that. But Ben, I mean, cash taxes will be 0 basically for quite some time. Stéphane?
Yes. We have no impact. Like I said no impact on the cash side. We still have some attribute in the U.S. I mean, this will not have any impact on the tax paid in the U.S.
Because we made major investment in CapEx and all this. So we still have a lot of the taxation that we can deduct. So -- and that's one thing, Ben. I think we -- I'd like to mention this again, this quarter, you see the strong free cash flow that we had for the quarter. We were around $17 million of free cash flow. And if you look at the free cash flow for -- from LTM standpoint the last 12 months, free cash flow was $54 million on top line, $400 million. So this is quite a nice development. And -- so it show that once we have finalized our major investment, we can generate some very strong cash flow. And going forward, this will be important, because we -- with the acquisition of CESA, of course, we will put some more debt on the balance sheet, but we intend to deleverage rapidly using this free cash flow that we generate.
Right. Yes, now I know you guys have talked about that for some time, so it's good to see it hold true. On further clarification around the Dassault Falcon 5X, so how much does this -- this I imagine changes the time line of any revenue from that program, pushes it out by how much?
Well, we don't disclose that. Because if we do -- I do disclose that, I'll tell you the price on my product. So...
No, sorry not the value of the contract, but what's the time line? How far does it push...
The enter into service is in 2 years, right? That's what was announced by Dassault. So it's ours by 2 years.
Okay. I missed that. And then just finally your backlog, just to clarify again that, that just reflects the increased production of the 777 contract. There is a pretty sizable increase in the backlog.
Yes, this and the Gripen also.
And the Gripen, okay.
And also...
This is only for [ Boeing ], it's important.
And also, we're seeing -- finally, we're starting to see on the spare part on the DOD side from the Air Force and the Navy, we'll start to see more activity. So we have grown our backlog over the last 12 months in the aftermarket military with the U.S. spare parts.
And the spare parts goes through backlog as well.
Yes.
Yes.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets.
Just in terms of free cash flow, obviously, your balance sheet is improving a lot. You've been doing $54 million in the trailing 12 months. So going forward, obviously, if you're ramping up the volume on the 777, I would still expect a very decent free cash flow numbers, but would it be fair to say that, that the $54 million could go down a little bit as you're ramping up a little bit the working capital or do you...
Yes, of course, Benoit. But we will continue to generate some decent free cash flow going forward. Of course, $54 million is somewhat of a record. But we are working on this, and this is a very important for us given the recent acquisition.
Yes. And with respect to the M&A opportunities, obviously the focus is on closing CESA, the integration as well. Do you see some M&A opportunities these days given what's happening in the market, Gilles?
Well, we have not closed the M&A department. It's still open. So we still have a list of targets. They are smaller though, and we are still investigating and building the pipeline. And I think, it's -- we still have room on the balance sheet even with the CESA operation.
Mr. Labbé, there are no further questions at this time. Please continue.
Well, thank you for listening. As you -- as I said earlier, I think we -- the quarter highlight is really the fact that we've been able to generate free cash flow of $17 million during the quarter, and on an LTM basis, we've been able to generate $54 million for the last 12 months. So we're looking forward to update you on our progress during our next quarterly call. So have a good day today. And we'll be talking to you soon. Merci.
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 7297916. This replay will be available until midnight on February 14, 2018. Thank you. You may now disconnect your lines.