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 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, February 7, 2019, at 10 a.m. 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 third 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 statement, MD&A on our website at www.hérouxdevtek.com. Please note that we also posted a PowerPoint presentation on our website in the Events section that summarize the key point of this conference call.Before I begin, please be aware that we will refer to certain indicators that are non-IFRS financial measures such as EBITDA and free cash flow. These may not be comparable to similar measures presented by other issuers and are defined and reconciled to the most comparable IFRS measures in our MD&A.First, let me start by discussing a new -- a few financial highlights from the quarter, which are presented on Page 3 of the presentation. We are pleased with our third quarter financial and operational performance. All our major business units performed well, generating 8.2% organic growth in sales. Our margins improved significantly due to higher throughput, which led to better absorption of manufacturing costs. More precisely, we achieved sales of $144.5 million, up 49% from last year with defense sales surpassing commercial sales for the quarter. We reported operating income of $11.9 million or 8.2% of sales and adjusted EBITDA of $22.9 million or 15.8% of sales, which allow us to generate solid cash flow from operating activities totaling $12.7 million for the quarter.This being the first quarter in which we account for the result of both Beaver and CESA, I would like to highlight the fact that their contribution exceeded our expectations. CESA, in particular, delivered good throughput combined with a favorable product mix when compared to their previous 6 months.Stéphane will provide additional details on our results and financial position in a moment.Please turn to Page 4 for some operational highlights. First, I am pleased to report that we received customer approval for the final surface treatment process for the Boeing 777 and 777X contract. We are on track to insource substantially all the related processing, which will enable us to gradually realize our full margin potential. In the quarter, we also delivered 14 shipsets for the Boeing 777 and 777X programs, a record high, bringing the year-to-date total to 36. In fact, this month, we will deliver the 100th shipset for the 777 program, which represent a great accomplishment that we are very proud at Héroux-Devtek.Next, I wanted to give you a quick update on the U.S. Air Force and AAR contracts. Final work under the U.S. Air Force contract was completing -- completed during this quarter while AAR was gradually ramping up. We expect the AAR contract to contribute at full rate during the fourth quarter. With the CESA and Beaver acquisitions, our funded backlog grew to $629 million. On a stand-alone basis, excluding CESA and Beaver, our backlog grew 11% to $515 million compared to $466 million as at March 31, 2018.As a reminder, the backlog only includes business for which we have received a firm purchase order.Stéphane will now review Q3 result and financial position.
Thank you, Gilles. Let's start with our financial results on Page 5 of the presentation.Third quarter consolidated sales reached $144.5 million versus $97 million last year. This 49% increase mainly reflects the $39.6 million contribution from acquisition and organic sales growth of 8.2% from robust performance across the organization. Commercial sales improved 25.7% to $65.5 million compared with $52.1 million last year. The increase was mainly driven by the addition of Beaver and CESA sales, higher delivery to Boeing for the 777 and 777X program and higher business jet sales mainly related to the increased delivery from the Embraer 450/500 program. Defense sales increased 76% to $79 million from $44.9 million. This variation is essentially due to the addition of Beaver and CESA sales, higher spares requirements from the U.S. government and higher manufacturing sales to certain civil customers. These factors were partially offset by the ramp-down of the U.S. Air Force contract.Turning to Page 6. Gross profit increased to $24.9 million or 17.2% of sales versus $15.8 million or 16.3% of sales last year. The increase was mainly driven by the impact of the Beaver and CESA acquisition and higher absorption of manufacturing costs. Operating income increased to $11.9 million or 8.2% of sales compared with $6.6 million or 6.8% of sales last year, reflecting the year-over-year improvement in gross profit partially offset by higher acquisition-related costs. Adjusted EBITDA, which exclude nonrecurring items, was $22.9 million or 15.8% of sales compared with $13.6 million or 14.0% of sales a year ago.Turning to Page 7. Net income was $7.4 million or $0.20 per diluted share compared with $0.6 million or $0.02 per diluted share a year ago. Excluding nonrecurring item net of taxes, adjusted net income reached $9.4 million or $0.26 per share versus $5.7 million or $0.16 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 $12.7 million versus $19.3 million last year. This variation mainly reflects a net unfavorable variation in noncash working capital items. As a result, free cash flow reached $11.9 million, down from $17.1 million last year. Turning to our financial position on Page 9. As at December 31, 2018, long-term debt, including the current portion but excluding net deferred financing costs, increased to $285.9 million, and cash and cash equivalents amounted to $28.6 million. As a result, the net debt position was $257.3 million, up from $38.8 million as at March 31, 2018, reflecting essentially the CESA and Beaver acquisitions. Over the coming quarter, as we continue to generate strong cash flow, one of our main objectives will be to reduce our debt.I will now turn the call back to Gilles.
Thank you, Stéphane. For fiscal 2019, we are reiterating our annual guidance as provided on October 1, 2018, with the closing of the CESA acquisition. We expect sales to be in the range of $460 million to $470 million and capital expenditure of approximately $20 million. 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 2018.This morning, we issued a press release concerning the appointment of Beverly Wyse as a Director of the corporation. Mrs. Wyse is a seasoned executive in the aerospace industry. She worked for over 30 years at Boeing in several high-level positions. She is a great addition to our board, and we look forward to her contribution to Héroux-Devtek.In conclusion, we are entering the last quarter of fiscal 2019 with a strong pipeline of potential business and a very solid backlog. We are continuing to dedicate significant resources to ensure the successful integration of Beaver and CESA, both of which are advancing well, and we are clearly embarking on our next expansion phase. And we remain dedicated to improving shareholder value by focusing on creating cross-selling opportunity, extracting operational leverage, maintaining a strong cash flow and reducing debt.Before answering your question, I would like to take the opportunity to thank all our team at Héroux-Devtek from U.K., from Spain, from U.S.A. and Canada for an excellent performance in Q3.Now we'll take your questions.
[Operator Instructions] Your first question comes from the line of Derek Spronck with RBC.
Just -- Boeing released some details around the anticipated 777 and 777X production rates. It's looking like 3.5 per month for 2019 or about 14 units per quarter and then slightly higher was the commentary, I believe, for 2020. Is that in line with your expectations and in line with your longer-term revenue guidance?
Well, I mean, yes, it's in line, but you have to take into account also that the X also will be taken into account. So I mean, there's a mix of both 777 and 777X. And of course, the 777X program will require to sort of build up of airplane. So the plane is selling well. I mean, the backlog is building, so if we look at it from, let's say, a short-term and medium-term type thing, like over 3 years, we know that the program will ramp up, so we're quite objective -- positive on this program.
Okay. And just in terms of a mix perspective, I mean, the legacy 777 seems to be holding up quite well from a demand perspective, including the cargo option. Is there any difference for you from a margin or production or operational level whether you're delivering a 777 or a 777X landing gear system?
It's quite similar because there's not a change in term of design on the X. They are not that important in term of sales and margin. So they should be quite similar to the 777.
Okay, great. And just one more for myself in terms of the margin profile in the fourth quarter. I mean, 14 units for the 777 program was a record, as you indicated in your press release. It looks like that's going to be the run rate for the rest of 2020 calendar year -- calendar year 2019. How much of that is helping the margin profile from a leverage -- operating leverage perspective? Should we continue to expect EBITDA margins somewhere in the range of what you delivered in the third quarter over the next several quarters?
Certainly. I mean, we had a very good quarter in Q3. As you know, we had a favorable product mix in Spain. But we also, if you take out the Spain and the Beaver, you'll see that -- if you look at our EBITDA margin on the existing business or the legacy business, call it, we have improved our margin, right? So we believe we can at least maintain that in Q4 certainly. So I mean, the legacy, call it the legacy business, is also growing as we speak, so it's going to the right direction.
And we should see a little bit more incremental margin lift as well as that -- you get the full run rate benefit of the internalization of the surface treatment?
Yes, of course. Over time, this will take some time, but this will happen, of course. I mean, we will reduce our costs in term of surface treatment due to the approval now.
Your next question comes from the line of Cameron Doerksen with National Bank Financial.
Just wanted to follow up on the surface treatment approval. I guess, so was there any positive impact in Q3 from getting that done? It doesn't sound like it, but I just wanted to clarify that. And if -- assuming that it was still a drag in Q3 on the margin, is there any way you can kind of quantify the lack of that approval's impact on the margin in Q3?
Essentially, what you have to understand is that we have been approved for various process before that last one, right, so we have been able to internalize already some process so we see a benefit in the margin of 0.3% this quarter in our Q2 results. So -- and as Gilles indicated, as we fully internalize now the process with the last approval, we still see a benefit in the cost improvement in line with what we have disclosed in the past, so another 0.7%. So forward, as we complete completely this insourcing, we'll reduce the cost associated with the processing.
Okay, so if I understand, all things being equal, once you've got fully for the latest approval in all internalized, it potentially could be another 0.7% positive impact on margins?
Correct, yes, yes. It was a drag of 1%, right, in that process. Now we see already the benefit now of 0.3% in the quarter.
Okay, got it. And just going back to the CESA performance. I mean, it does sound like it was -- beat your expectations in the third quarter and then certainly it looks like the margin performance was much better than what they had produced in the prior couple quarters. I mean, what gives you the confidence you can kind of maintain that? I mean, it sounded like maybe product mix had a role to play there. I'm just wondering just how repeatable this is going to be going forward.
Well, that's an excellent performance. But as we said, the product mix was very good. So we may not see this at every quarter depending on the product mix. So I guess, that answered your question.
Okay. And now that you've had the business under your control for a few months here, I mean, I guess, are you more confident now in your ability to kind of integrate the business and drive synergies? Just any thoughts on kind of your initial first few months of ownership.
Things are going as planned in term of integration. Our team and the CESA team are working well together. We have already 3 persons from the Héroux-Devtek in Spain, as we speak, working with our Spanish team. And things are moving in the right direction in every aspect on the sales and marketing, on the operation. And we have a good team in Spain, I mean, very professional people, also quite engaged and they want to -- they do a great job in servicing the customer in term of delivery, on time, and they're very good. Most of the customer are -- their service level is very high. And so things are going in the right direction, so we're pleased with the results in Q3 and we'll work with them to continue the same path in Q4 and all next year.
Okay, great. And just last one for me, just on the -- I guess, the reiteration of the revenue guidance for the full year. I mean, normally, your Q4 would be the biggest quarter of the year for you and sort of at the high end of your revenue range, kind of implies sequentially kind of flat or maybe even a decline in revenue. Is that how we should read that? Or is this you being kind of conservative here? Or is there anything in the fourth quarter that is a drag on the revenue?
Stéphane?
Essentially, as we given the guidance at $460 million to $470 million guide you to similar in Q3, right, on the high range. So this is still much higher than last year, right? So you can see that we provided the conservative guidance and we reiterate the guidance that we had in the previous quarter.
Okay, so I should read this as just more conservatism? Because, normally, sequentially Q3 to Q4 in your -- the sort of existing business, ex the acquisitions, it would be sequentially higher from Q3 to Q4.
That's what happened. Normally, Q4 is always very strong, right?
Yes.
But we stick with the guidance.
Your next question comes from the line of Mona Nazir with Laurentian Bank.
So I just want to go a little bit deeper into the previous line of questioning, just on the 10% kind of revenue beat this quarter versus the Street because when I'm just adding up the addition of CESA for Q4 and then adding in Beaver, I'm getting to higher than the lower end of the Q4 range. So I just want to make sure, was there any pull factor for Q3 or timing of certain orders that positively impacted the quarter?
I mean, we just discussed this. I mean, we have a guidance, it's, what, between $460 million to $470 million, right?
That's correct. At $470 million, that brings you to a similar quarter in Q3, right? And as Gilles indicated, we didn't change our guidance and we want to have this quarter being a strong quarter.
Look, we'll work to -- let's say, we should be at least in the higher end of the guidance. We'll try to beat it, but at this point we'll stick with our guidance.
Okay. And then just turning to the margin profile, and Stéphane, we've spoken previously about your desire to increase the margin profile of acquisitions and ultimately reduce the purchase price multiples in time. I understand that there were a number of variables that played into the margin profile this quarter just from your prior comments. There was product mix, the surface treatment internalization had a 30 basis point impact, better outperformance from the acquisitions versus a few months ago and higher production for the 777 program. But is there any margin guidance targets that you could provide for either 2020 or even further out? I'm just trying to get a sense of adding up all of the different parts, what it could equate to.
As you know, we don't provide guidance on the margin, right? So we stick to what we disclose this quarter.
Well, you are very smart people, I'm sure you can figure this out.
Okay. So then just on -- in the MD&A, the numbers for CESA and Beaver. If we were to kind of annualize that, would that be fair for the next year?
Well, we disclosed the information as this quarter was a strong quarter. And we don't disclose again the margin, right, on the total that we'd expect. So you're asking differently the same question, but as Gilles indicated, we had a good quarter. We're happy with the performance, both on the organic side and from the acquisition of Beaver and CESA, both of them. And we know that we had a good product mix at CESA, so this impacted positively the margin.
You have to look at also -- you have to look at the margin without CESA and without Beaver, I mean, it's possible -- I think it's -- you can look at the MD&A probably, figure this out. So you'll see that our margin in our legacy business is better also.
No, 100%. Okay. And then just looking at your cash flow generation and kind of the pro forma leverage, so I know you don't provide guidance, but it would be fair that -- you said that you want to focus on debt reduction going forward. So it's very feasible that this figure could came in under the 3-turn range for next year.
Look at the free cash flow we generated year-to-date, right, we're around the 8% in terms of a percentage of sales, right? A bit higher than 8%. So that gives you an idea on how we can generate free cash flow. And our priority is to reimburse the debt as we indicated in our release in this morning. So that gives you a good idea on where you can see the debt level, right?
And also I think when we did the -- I mean, Stéphane, I mean, we indicate also that the target we had in term of debt level -- EBITDA ratio to debt 12 month after.
Yes. Essentially, when we acquire, as you know, CESA, right, we disclosed that total net debt within 12 months should reduce to 3x. And net from the debt when we exclude the loan we have with the government authorities should be below 2x, net from the debt, we call it. So we're consistent with that.
Your next question comes from the line of Tim James with TD Securities.
I'm just wondering if you can update us on what you view now as the most significant opportunities for an earnings contribution coming from CESA over the next couple years, and I'm thinking kind of specific revenue opportunities or cost savings opportunities.
Well, I mean, we said when we acquired the company is really cross-selling was the most important synergy. In this business, I mean, we are introducing CESA to many of our customer in North America. But as you know, I mean, we will not win a contract overnight, and until it will turn into revenues, will take some time. But certainly, there is campaign, as we speak, to introduce CESA and we're bidding on new opportunity also that they had no chance really to bid on. Since we are the owner today, we -- they are not part of Airbus any more, they are part of us, so certain door are opening at other customers. So this will take some time to go there in term top line. But certainly, on the cost synergies, we have already identified many opportunity and they will turn into additional profit and margin.
Okay, that's helpful. My second question, just wondering as we look out over the next couple years, obviously there's lots of programs that are growing at various rates. I'm wondering if there's anything material that will be declining in its revenue contribution over the next 2 or 3 years.
Well, at this point, I think, all the bad news we had, I mean, as you know, we lost the Air Force contract some 18 month ago, and so this one we have been replacing, not totally, but with the contract we have with AAR. And when I look at the program we are on, I mean, I don't see really any major decline. On the contrary, we see some new program that will help us to build upon the top line. One of them is, for example, the F-18 and also the ramp-up of the 777. And then the 53K is going to the right direction also, so it's going to enter the production and the 53K will be a very good program. And eventually, once the 6X is finished with Dassault, that's another one that we create additional revenue. The Gripen is still in the early stage. So we have a good pipeline of program that will generate additional revenues and we have other that we're working on, new opportunity that eventually will turn into additional top line and additional free cash flow.
Your next question comes from the line of Ben Cherniavsky with Raymond James.
All my questions have been asked already. Thank you.
Your next question comes from the line of Jean-Francois Lavoie with Desjardins.
So I just wanted to come back on the product mix at CESA that you experienced during the quarter. Just wanted to know if you could provide additional details about the progress you made on the A400M program, please.
Essentially, this program, as you know, is -- there is official rate of production disclosed on this program, so that's one of the program we have there. But we have other program, as you know, on the Eurofighter, we are on the Airbus A350 and also on certain program, the C program we call it. So there's a decline on the A400M, which we were expecting, and the contribution from the other one such as the Airbus 350 is ramping up, right? So all in all, that's where we stand with CESA.
Okay, okay. Good. And when you talk about the cross-selling opportunities, I was wondering if there was any additional details to provide about the actuator market and maybe ball screw with Beaver, please?
Well, I mean, Beaver backlog is growing as we speak, so they won some new business over the last 6 months. So things are going in the right direction. I think the fact that Beaver has been, call it, the owner before us. The financial stability was not perfect, so since we are the owner of this business now, we see the customer coming back to us. I think the fact that we are there and we have been -- the customer are more confidence with Beaver and so we -- the backlog has increased quite a bit in 6 months, so we're benefiting from that. And we are also bidding new opportunity for them. So things are going good at Beaver as we speak.
Your next question comes from the line of Turan Quettawala with Scotiabank.
I guess, maybe I just have a couple of quick clarifications here. First of all, on the Boeing business and the internalization. The 0.7%, Stéphane, is it fair to assume that sort of over the next 6 months or so, you get pretty much all of that in?
Essentially, as we are internalizing that, at the same time, we optimize it, right, so this will happen. By the end of next summer, we should have internalized it. So plus or minus what you said, it's about the next 6 to 9 months, right, in terms of timing.
Perfect. And I guess, just one more also on the margin. Just on the AAR contract, as you're going to be fully ramped up, I guess, you said this quarter now on that business, from a margin standpoint, I guess, that should also be a net positive as you get better fixed cost leverage?
Well, there's two thing. One, we end up the USAF right, now completed the delivery in Q3. And we have a strong workload for the Q4. So during Q4, we'll be at the full rate of the AAR contract during the quarter. So this is very positive as we basically exiting this transition, right? Now we will be on this contract and the other one is completed.
And we have more activity and more volume in our repair and overhaul facility. I mean, it's -- volume is always magic on a margin.
[Operator Instructions] Your next question comes from the line of Mona Nazir with Laurentian Bank.
Just had a quick follow-up. Looking at the contribution of both Beaver and CESA, it's about 40% M&A growth. I'm just wondering if you could touch on the corporate culture of the 2 acquisitions versus your legacy business and just how it sits now. I understand that both Beaver and CESA saw some revenue decline post purchase. And did that have anything to do with an uptick in turnover perhaps? Or just looking for some clarity on the integration and the culture.
Well, I mean, we have deployed our -- what we call our 4R in term of culture, I mean, which is for resilience and responsibility and respect. So we have deployed this. And so far, I mean, the people are reacting very good. When we take the keys, we meet with -- I personally meet with all the employee; Martin Brassard, the same; Stéphane. And so the whole management team is taking time to meet with the employee. And then after, we implement step-by-step our culture and so far, I mean, Michigan is -- things are going better. I think employee are -- they see that we are willing to invest in their factory and changing things to improve their factory. And in Spain, I mean, that's the same thing. I mean, we -- I think we had great -- on October 1, we were there and October 2 we meet with them and they already changed the name of all the building. They changed all the name of CESA for Héroux-Devtek. They're wearing Héroux-Devtek shirt and so it's going to the right direction. And they know that we are working hard to go and get some additional business for them. So that's positive. I think it's going -- really going to the right direction. And we'll make it -- we'll make this business very strong in the future.
Mr. Labbé, there are no further questions at this time. Please continue.
Thank you all who listening to us this morning. We had a very good Q3. We are pleased with the result. And I want to thank again my -- all the HDI team across all our location in Spain, Canada, U.S. and also U.K. We're going to work hard to continue to deliver good result in Q4 and also next year. So I think we have a solid, sustainable business, but we're going to continue to work to increase value for our shareholders. So thank you so much for taking time this morning to listening to our call, and we'll see you -- we'll talk to you in May, I believe, Q4. So have a good day. Merci. Thank you.
Ladies and gentlemen, that concludes our conference call. Please note that a replay of this call can be accessed as of 3:00 Eastern Time today at telephone number 1 (800) 585-8367 and entering passcode 1498853. This replay will be available until midnight on February 14, 2019. Thank you. You may now disconnect your lines.