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 2020 Third 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 company's forward-looking statements. I would like to remind everyone that this conference call is being recorded today, Thursday, February 6, 2020, at 8:30 a.m. Eastern time. I will now 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.
Well, thank you very much, operator, and good morning, everyone. [Foreign Language] Welcome to our third quarter earnings conference call for fiscal 2020. In discussing our Q3 results during this call, I invite you to refer to financial statements, MD&A press release and presentation, which can be found in the Investors section of our website. We are pleased with our Q3 results and by the commercial and defense sales growth recorded in the third quarter. Given namely the increased demand for our defense products under long-term contracts, I am glad to report that our funded backlog has increased to a new record high of $839 million during the quarter. This $70 million increase over the quarter is the largest ever recorded by Héroux-Devtek that was not driven by acquisition. This is a testament to the growing relationship we are building with our customers. In that same spirit, I wish to extend our sincere congratulations to the Boeing team for the first flight of their new 777X. We are proud to have contributed to its success and as a reminder, Héroux-Devtek supplies main and nose landing gear systems for the Boeing 777 and 777X. Before turning the call over to Stéphane, I wish to express our gratitude to all of our employees. We continue to entertain major ambitions for Héroux-Devtek, and we are proud to have you by our side. 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 and adjusted EPS. Our non-IFRS measure are defined and reconciled in the MD&A issued earlier today. Our consolidated sales grew 8.8% to $157.3 million in Q3, up from 145 -- $144.5 million last year, including a 1.4% organic growth. As a reminder, Beaver and CESA are now recorded as part of our organic growth while Tekalia and Alta have yet to complete the full 12-month cycle in our books. Commercial sales grew 11.8% in the third quarter from $65.5 million to $73.2 million. Growth in Q3 was mainly driven by recent acquisitions, partially offset by lower aftermarket requirements. Defense sales were up 6.3% in the third quarter from $79 million to $84.1 million. This growth was driven by our acquisition and by a number of organic factors including increased aftermarket demand for the C-130, KC-135 and Sikorsky H-60 programs; increased production rate on the Lockheed Martin F-35 program and higher spare demand for the Northrop Grumman RQ-4D program. These factors were partially offset by lower spares delivery to the U.S. government. Strong performance by Beaver and CESA offset by the temporarily dilutive effect of the margin of more recently acquired businesses led to relatively stable gross profit as a percentage of sales for the third quarter as compared to the corresponding period last year. Operating income increased to $13.5 million or 8.6% of sales, up from $11.9 million or 8.2% of sales last year. Adjusted EBITDA, which excludes nonrecurring items, stood at $24.6 million in the quarter or 15.6% of sales compared to $22.9 million or 15.8% of sales a year ago. Foreign exchange rate fluctuation had an unfavorable impact of $1.1 million year-over-year or 0.7% of sales. Net income reached $8.7 million in Q3, up 17.8% over last year. EPS grew from $0.20 last year to $0.24 as last year's EPS included nonrecurring acquisition costs of $2 million net of tax or $0.06 a share. Adjusted EPS decreased from $0.26 to $0.24, mainly due to the foreign exchange fluctuation, representing $0.02 per share. Let's now turn to our cash flow and financial position. I especially invite you to refer to Slide 7 of our accompanying deck for explanation on the quarter-over-quarter change to all 3 metrics. Cash flow from operations increased 19.7% from $17.4 million to $20.8 million in Q3 while cash flow related to operating activity decreased from $12.7 million last year to $9.7 million this year. Cash flow related to operating activity were negatively impacted by an increase in inventory in preparation for upcoming growth. Finally, at the end of Q3, net debt stood at $256.8 million, down from $264.7 million as at September 30, 2019. In conclusion, I would like to point out that over the course of Q3, we extended the term of our existing revolving facility with our syndicated bank by approximately 30 months from May 2022 to December 2024. Most of the other terms remains unchanged. Back to you, Martin.
Thank you, Stéphane. Before opening up the call to questions, let me conclude with a word on the road ahead. As you have seen in our press release earlier this morning and in accordance with the stronger-than-expected growth since the beginning of the year, we announced an increase in our fiscal 2020 sales guidance. It now stands at $600 million to $610 million. Our focus remains on the execution of our backlog, with the same quality and on-time performance that our customers worldwide have come to expect. Operator, we are now ready to answer your questions.
[Operator Instructions] Your first question comes from the line of Mona Nazir with Laurentian Bank.
The first question is, in the MD&A, and you just mentioned on the call that recent acquisitions have had a slightly negative impact on margins. I didn't see any material onetime items, selling and admin expenses were up 22%, while sales were up 8.9%. So I'm just wondering, do you expect margins to improve in the coming quarters? And I just wanted to get a sense of what's causing it, the margin's slight decline, and talk about the sustainability of your margin performance?
Yes. I'll answer in 2 parts, your question. First, regarding the dilutive effect of the 2 recently acquired businesses. So essentially, these businesses, we bought them, and we knew that there was some trouble to reduce some costs, and we are in process of doing that. We have been doing some good improvement over there. And those 2 businesses have lower margins than Héroux-Devtek, so that's why the effect is the negative on the overall margin of Héroux-Devtek. And we expect this, like other business we acquired over time, that we will extract all the synergy that we foresee with those acquisitions. The second part, maybe to your question, is in regard to the G&A. So the IR G&A came essentially when we look at it as a percentage of sales, there was a loss this quarter of $0.6 million compared to a gain of $0.8 million last year. So essentially, year-over-year impact on operating income, when we take into consideration the overall exchange effect of $1.1 million. So this explains mainly the variation in the SG&A as a percentage of sales.
Okay. That's very helpful. And just when you -- just as a follow-up, when you extract those synergies from those acquisitions, you expect margins to flat line versus legacy margin or improve? Or just trying to get a sense of where it could sit.
Well, we're working to improve...
We're working to improve. As you know, when we bought these companies, there were in financial difficulties, and there's a reason why they were -- the cost structure was not optimum. So since we acquired these 2 businesses, namely Tekalia and Alta, we have put a cost-reduction program, and we're pretty happy and increase of the throughput. Today, we're on plan with what we were expecting. We're pretty satisfied with the performance and the progress that we made with these 2 businesses' units. But when you compare it against our legacy margin, it's the -- then it's lower, right?
Yes.
So we have a plan. So we have a plan to improve their margin to the legacy level. We don't have any -- I don't want to communicate any time frame, but so far, the plans have synergized or making the synergies are per plan. But I think it was good for the reader of the financial statements to understand that they had a dilutive impact on the -- that's why we said it. Does that answer your question?
Yes, very helpful. And just my second question before getting back in queue. You had mentioned in the last call that cross-selling opportunities had not yet materialized meaningfully for CESA. I'm just wondering if there was any change on that front and any plan in place currently to start capitalizing on some of those prior acquisitions in a more meaningful way?
Yes. So we have not announced any material contract into -- with this. So we have small success. We're working on good opportunities as we speak. We're in aerospace business, so it goes sometimes longer than what we expect. But we have a better grasp on this actuation market. And we believe that we have some opportunities that we're working on that could, I said, really could materialize. We never know until the puck is in the net.
Your next question comes from the line of Cameron Doerksen with National Bank Financial.
So a question on the 777 program, obviously, first flights recently saw a good milestone there. I'm just wondering if you can talk about whether there's been any change in your expectations for landing gear production versus a few months ago. I mean, is Boeing still kind of planning to build 777Xs at kind of the same schedule as they were looking back in the fall?
Yes. It's the same as in the fall. There haven't been any communication, positive or negative, towards this forecasted quantity or what we believe or what was announced by the president of Boeing at that time. So -- but it's an important milestone though. We were there in January. It's a very important milestone. People are very happy with the success of the first flight. And hopefully, this will enter into service next year. So that's what it is, and we're following our plan, Cameron. We're following -- no change.
Okay, perfect. And just on the 777 as well, just on the surface treatment. I wonder if you can just provide a bit of an update on where things stand there, the progress there.
So as we speak, and I'll let Stéphane comment on the impact there. As we speak, we -- all the parts that were in December that were produced outside of our facility are repatriate. We expect to -- so our repatriate, we're tooled up for. There's 3 main components that are plated in our facility that we need to transfer into our shop and to maximize the asset that we have developed. So we should expect that to be finished in Q4.
So essentially our margin to complete, Martin, did show improvement compared to last year, about 0.2%. So there's still some to get as we fully internalize the last part and optimize this process, we'll be able to achieve our targeted numbers for the 777 processing.
Okay, perfect. And just finally for me, just on the backlog growth, I mean, pretty impressive in Q3. I'm wondering if you could maybe just go into a little bit more detail on what's actually driving that backlog growth. I mean, you sort of cited some defense programs. I wonder if you can be any more specific on where all that growth is coming from.
We're seeing -- so you know that we signed long-term contract with Boeing, and we -- it was no secret that we say that those products are working very hard, and we saw an increased demand in the spare business of those contracts. So you have the OE, we're sole-sourced in the future. And as promised, so we see some activity related to this program. And on top of it, as USAF or it's been a while that the defense budget or the spare market for the U.S. Air Force, different platform. We saw low demand for many years. Now we see some -- we told you that we could see some activities. And we had very nice orders there in the U.S. Air Force spare market for new parts. Does that answer your question, Cameron?
Yes. No, that's helpful.
Your next question comes from the line of Benoit Poirier with Desjardins.
Congratulations for the quarter. Just thinking back on -- yes. With respect to organic growth on commercial, could you provide more color on the fact that the organic growth was down almost 4% in the quarter and maybe what we should be looking for in terms of organic growth for commercial in the coming quarters?
I think for the first 6 months, right, the organic growth for the commercial side was mainly driven by 777. So this quarter, pretty stable compared to last year. So this is why you don't see an additional growth on the commercial side. And so for the rest of the program, the decrease is really associated to a lower aftermarket demand that varies from quarter-to-quarter, so comparing this year to last year. So the timing's a bit different. So that's what explain the actual results.
Okay, perfect. Perfect. Okay. And with respect to the investment in working capital, Stéphane, what should we expect for the full year? I mean, there's typically a strong working capital improvement in Q4, a big recovery. So far, the working capital has been negative about $31 million for the year. So year-to-date, just want to have some color about what we should expect in terms of working capital elements for Q4 and for the full year, maybe?
Well, we expect that Q4, with the volume of sales, we have a reduction in inventory for the last quarter. The main investment in the working capital is associated to a program that sales will start next year. The F-18 being one of the program and Q-25 also and finally the Gripen. So 3 key programs in our growth that will only generate revenue next year. And as we prepare -- as we are in Q4 and at the end of Q3, we had to prepare for Q4. So we had to invest additional for meeting our Q4 sales. Overall, we see many opportunity on improving over time the inventory level. But we'll focus on our fourth quarter to finalize the year.
Yes, that's an area that we could -- yes, that's an area that we want to improve there.
Okay, perfect. Okay. And would you be comfortable to expect a similar performance in terms of working capital change versus what you've done in Q4 a year ago? You were able to improve working cap by almost $18 million. Is it kind of a similar number we could expect this Q4?
Yes, we don't provide the guidance on cash flow. So essentially, I cannot comment additional to what I just described.
Okay. Okay. And in terms of CapEx for the year, Stéphane. Any update on the expectation in terms of CapEx?
No. I think it's going to remain to the level that I mentioned in previous call, anywhere between $20 million and $23 million. That's going to be the range for this year.
Perfect. And with respect to the guidance increase in terms of revenue, could you maybe comment on what is the key driver behind that? Is it more driven by defense, commercial? And also how does it impact the guidance for fiscal '22?
So thank you, Benoit. Thank you for your comments and your questions. So yes, we have a very strong performance for the first Q3. As you explained in our documentation, defense segment or defense sales are explaining this good growth. There's good performance. And it's only 2 months in the fiscal year. So I think -- I think the new guidance reflects much more what we're going to do this year. In terms of FY 2022, we're still confident. It's an environment, as you know, that it's -- there's a lot of things happening today, right, in this -- right now in this quarter, but we remain confident to meet the FY 2022 guidance. That's why we haven't changed.
Your next question comes from the line of Konark Gupta with Scotiabank.
Congrats on a great backlog increase here, which is obviously a great work. So just wanted to start with maybe the acquisition contribution this year in this quarter. So I saw the acquisitions on the commercial side was about $10 million revenue increase on growth contribution. If I can go back to the time when you acquired Alta Precision, I think you raised guidance in August by $20 million. So I just wanted to make sure I understand, the acquisition contribution of $10 million coming from Alta only, and is it performing as expected or maybe better than your expectations?
Maybe just to correct a little bit, it's both Alta and Tekalia. Tekalia was acquired in January. So we have no results from Alta and Tekalia in the last year third quarter. And the comment on how it's going with those 2 acquisitions, it's like Martin described previously and myself. So essentially, things are progressing well. As expected, we had a starting point and where we are now, we're progressing according to our plan. We still see that we will continue improving the cost and the related margin for these 2 businesses.
And the throughput, right? And the throughput increase compared to historical data, like Stephane said, it meets our objective in terms of throughput and cost. It's good. It's going on plan, and we believe that we're going to continue on that growth with these 2 acquisitions. So we're pretty happy with the performance of -- or the restructuring or the [ other estimate, ] if you want, of these 2 business units.
So like, is it fair to assume that the contribution we saw in Q3 is a good run rate from quarterly standpoint? Or is there a big seasonality in Q4?
Yes. No, it's not a big seasonality. It should be -- while we consider this amount compared to the biggest -- to the global picture, it's not that material. Maybe increased, but when you isolate it to that specific business, it's pretty significant, right? It's what we should see. We should see, let's say, slightly over, like you said.
Okay. No, that's great. And then secondly on Boeing. So obviously, there's a management change there. There's a MAX grounding that's still going on and some issues obviously there. I understand you don't have a material exposure to Boeing 737 MAX. But on the 787 program, I think they are looking to reduce production here slightly before rebounding again maybe in the future. What kind of impact do you anticipate from Boeing 787?
Well, the Boeing 787, we have limited content on the Boeing 7 as we supply components to Safran. So it should not impact any of our guidance in the future. So it has a little impact. So they're talking about 12 to down to 10, if you're referring that, right? So we don't see that with -- materially affect or impact our result. So.
Okay. That's great. Any programs, Martin or Stéphane, you think of in commercial, like beat Airbus or Boeing, where you think the programs are ramping up faster than you anticipate? Or they are weaker than your anticipation on the commercial side?
On the commercial side or...
Sorry, the line cuts. We're here, we're in the U.K. So the line cuts, could you retain a bit the first part of the question, please?
Yes. No, I was wondering on the commercial side, which OEM programs that you have exposure toward ramping up faster than you think or do you have sort of stronger growth profile here and then some programs are weaker, right? So can you identify some of the programs, which are growing faster and weaker than you think?
So what we see on the large commercial, we could see that it's going to go -- remain flat, the commercial program that we are on, right? As you know, we have some components like you just said, the 787 and 320 to Tier 1 players. We expect that these sales remain flat. But in the future or in the near future, commercial sales should increase, namely in the business jet, where we have the entry in service of the Dassault Falcon 6X that we should start to see soon. So -- and in terms of the regional jet, this new acquisition is with Embraer on the E2 jet, and we -- it will remain flat again. But the grow will come from an operational improvement, where we generate more sales throughput and get on time with the customer.
The growth is really more on the defense side than commercial.
Yes. And then that makes sense, obviously. And then lastly for me, last few quarters, we saw some manufacturing cost increase but this time in Q3 did not call out the cost increases at Longueuil. I just want to understand, like, where is the manufacturing cost performing now versus your expectations? And is there room for further improvement?
Yes, good question. We highlighted that we had some challenges over the longer plan for the first 2 quarters. We are -- improvement had been made in Q3, but there's still some improvement to be done in Q4. So that's why we haven't talked about it, because improvement were made and it was somewhat positive. But we're still working on improving the efficiency and the throughput of that plan. So -- and it did not have a material impact over quarter-to-quarter over last year. So that's why it was not explained in the way we explained it in the first Q2 -- the first 2 quarters. But we, on the other hand, see, we correct the direction of that plan, and things should improve in the Q4.
Your next question comes from the line of Tim James with TD Securities.
It sounds like it's due generally to the defense side of the business. I was wondering if you can comment specifically on any programs. Or is it really just this increased aftermarket demand for C-130, KC-35, et cetera? Is that what's been stronger than expected? Or can you provide any kind of program-specific commentary?
Yes, good morning Tim, we just understood the last part of your question. So I'm sorry to make you -- to ask you to repeat it. So could you repeat it again, please?
Okay. Yes, I just wanted to follow-up on the question regarding the higher revenue guidance for the current fiscal year. It sounds like it's on the defense side of the business. I'm just wondering if you could comment on any sort of specific programs that are driving that. Is it this higher aftermarket demand that you're seeing in C-130 and KC-135, et cetera?
Yes. The increase in aftermarket on the KCR and the Sikorsky H-60, it's aftermarket products and repair and overall products that we do services, right, with this platform. And again, performance have long been improved and all about plans of improving throughput was better, and that helps to reach the sales to make it, right? And then on the defense side, the F-35, like Stéphane said during the conference call, so production ramp-up and the rate increase explain why we're better than expected, and we're going to continue in the fourth quarter.
Okay, great. And then just looking at your overall commercial revenue in the third quarter. It was up about $8 million sequentially from the second quarter. With all the acquisitions in recent years, I'm just trying to understand, is that a normal kind of seasonal uptick that you would expect in the third quarter? Or what commercial programs caused that $8 million increase in revenue relative to the second quarter?
More specifically, comparing Q2 -- Q2 to Q3, I would have to really look at it. I can look at it more specifically compared to last year to well explain. But we have Alta acquisition, right, that provided for growth this quarter. It was also there in Q2, but with lower sales volume. And Tekalia did very well as well. So these 2 businesses in terms of top line, we had some additional revenues. But again, in terms of profitability, that's what we're working on.
Okay. And then just my last question. The commentary earlier regarding the inventory investments that have been taking place this year on F-18, MQ-25, the Gripen, and the expected revenues to come from those next year. Does that mean that working capital or cash from working capital next year should be stronger than what we'll see for fiscal '20 because those programs start generating revenue and you're delivering those programs?
Well, it certainly helped, right, yes? Well certainly helped because the investment that we do this year, we won't have to add it up next year. So we'll have to reach the production rate at some point, and it will not be all done at this fiscal year-end. There's still going to be an increase next year to achieve the production rate, but certainly it will help to -- for the next requirement for working capital.
And again, we booked -- and again, well, like Stéphane said, we should see for these 2 programs or at least the F-18 some -- a bit more increase with the increased demand that we've got from the aftermarket orders.
[Operator Instructions] Your next question comes from the line of Ben Cherniavsky with Raymond James.
Most of my questions have always been covered. I just -- on a housekeeping item. Stephane, can you just comment on what we should assume for the tax rate? I mean, I know you've added a few different tax jurisdictions now to the whole operation. So what should we expect going forward?
Essentially, last quarter was about -- well, it was 17.6%. As the profitability grow, the tax rate will grow more in the tune of 20%, 21% over time. So in that -- so it's really depending on the level of profitability in different business units and also the total profitability that we have. So you can note that when we have an increased profitability quarter-to-quarter, the rate will expect to be higher in terms of income tax rate.
And there are no further questions at this time. Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.
Thank you.
Thank you.