Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning. My name is Enis, and I will be your conference operator today.At this time, I'd like to welcome everyone to Héroux-Devtek Fiscal 2022 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 complete forward-looking statements. I would like to remind everyone that this conference call is being recorded today, Wednesday, February 9, 2022, 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, sir.
Thank you very much, Enis, and good morning, everyone. [Foreign Language]On behalf of all of us here in Longueuil, welcome to our third quarter earnings conference call for fiscal 2022. As usual, I invite you to follow along by referring to the financial statements, press release and presentation, which can be found in the Investors section of our website.Let me open my remarks this morning by addressing the latest operational environment dynamics across our production sites. As you are well aware, we have to date been successful in sheltering our throughput from the challenges of supply chain and employee absenteeism that plague manufacturing facilities worldwide. In the final weeks of the third quarter, however, the additional challenges brought about by the Omicron variant, temporarily led to a lower throughput, particularly for aftermarket products and to higher quality-related costs. It results in the financial performance in the low end of the sales range we had targeted for the quarter short of our ambitions.Yes, all of our fundamentals remain very strong. Our OEM deliveries are on schedule. Our order book is unimpacted, and we are confident in our ability to recover the lower throughput in the quarters ahead. In other words, these sales are essentially moved to the right.I will now turn it over to Stéphane for the key highlights of our Q3 financial results.
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 and adjusted EPS. Our non-IFRS measure are defined and reconciled in the MD&A issued earlier today.In Q3, consolidated sales decreased 12.7% year-over-year to $131.1 million, excluding $4.3 million of negative foreign exchange rate fluctuation, sales decreased 9.9%. Defense sales were down 3.9% in the quarter, while civil sales decreased 22.4% compared to the corresponding period last year, excluding foreign exchange fluctuation. In defense, the ramp-up of deliveries under the Sikorsky CH-53K, Boeing F-18, and MQ-25 programs partially mitigated the impact of the lower throughput caused by the Omicron-induced environment mentioned by Martin.As for civil phase, we continue to be curtailed by the lower OEM demand, particularly in twin-aisle aircraft as well as by the repatriation by customer of certain Tier 2 contracts in the large commercial sector. As in prior quarter, this was in part offset by higher deliveries for business jet program, a sector that continue to fare well overall throughout this pandemic.Gross profit as a percentage of sales decreased from 18.7% to 16.3%. Lower throughput and higher quality-related costs explain the year-over-year change. Operating income decreased to $10.5 million or 8% of sales from $13.4 million or 8.9% of sales last year. Adjusted EBITDA, which excludes nonrecurring items, stood at $19.7 million or 15% as a percentage of sales compared to 15.8% a year ago. And finally, earnings per share set at $0.18 this year compared to $0.24 last year, or $0.26, excluding nonrecurring items.Let's now discuss our cash flows and financial position. Cash flow related to operating activity reached $17.5 million in the third quarter, down from $26.7 million last year. Last year, cash flow has been positively impacted by $12.2 million of inventory burn-down as we adjusted to the lower level of civil sales. As at December 31, 2021, the corporation net debt stood at $158.6 million from $157.5 million 9 months prior. Our net debt to adjusted EBITDA ratio remained stable at 1.8x.Before I turn the call back to Martin for his closing remarks, let me provide you with a brief update on our NCIB. As of February 8, we had repurchased for cancellation a cumulative total of nearly 2.3 million common share at an average price of $17.86 per share for a total consideration of $41 million. Based on the turn of the NCIB approved by the TSX, approximately 117,000 shares remained available for repurchase until May 24, 2022.Back to you, Martin.
Well, thank you, Stéphane. In closing, we are confident that our approach and strategy are the right ones, and that we have strong teams and customer relationships that will allow us to overcome the industry's challenges, and deliver on our objectives. Our sales diversification in terms of segmentation, geography, and type of product offering, is a strength which allow us to maneuver in this turbulent environment.Our employees are very engaged and are working hard to deliver according to plan. Even though it is hard to predict the future with the virus variants, we strongly believe the company is in a great position to capitalize on growth opportunities in the near future.Enis, we are ready to answer questions.
[Operator Instructions] Your first question comes from Nauman Satti with Laurentian Bank.
My first question going back to the supply chain issues. I think in your comments, you've mentioned that it sort of came about at the end of the last quarter. I just want to get a sense how many weeks were impacted? Because you've mentioned that Q4 is going to get impacted as well. So just trying to get a sense if that was just like a two-quarter impact that we saw? Is it like a month impact? And how that sort of plays out for the fourth quarter?
Yes. Thank you for the question. It's -- as you know that the Omicron start in December and has continued in some of our operations in January, so these -- this turbulent environment is last 2 months or [ this build ]. So we see good progress lately since the last week. As an example, we had, let's say, 200 cases that contracted the virus before in November.Now we have 400 people who have contracted the virus. So you can imagine the turbulent environment that we have, and our suppliers are living the same thing. So yes, we will see some disruption in the fourth quarter. However, we have good plans, and the team is engaged to recuperate these late, but not fully, but to recuperate these late in the fourth quarter. We have a solid plan, and people are committed and focused.
Okay. And if I understand this correctly, so the major impact came from Omicron where you had 200 cases, and employees were not there to work on it rather than procuring off any parts or supply chain issues as such?
Both. Both. The suppliers are living the same thing that we do.
Okay. Okay. Now, that's good. And generally, so when this is happening, do you adjust the production schedule? Or is it like some of production is done, it's just that it's not a final product and you can't deliver it. Just trying to get a sense that how -- like once things get fully back, how quickly you can sort of scale at that?
Well, sometimes it takes -- landing gear is made of a multitude parts, and we have thousands of suppliers. It takes only a few to delay deliveries of a complete chipset or a complete landing gear. So that's why we believe that we should see positive results in the Q4.
Okay. That's great. And just for the NCIB program, you've said that you've utilized 95% of it. So any additional color? Is that something that you're going to review it, renew it or if any other color there?
Well, that's part of -- this one will end at almost the end of May. So that's part of the discussion we'll have at the coming Board meeting. So we reevaluate that every year. So depending on the opportunity, so we'll review in due time.
Okay. And maybe just one last one. I don't see backlog in MD&A. Maybe I have missed it. Is that something that you've discontinued giving.
Yes. What we want to do there -- because I just want to make sure that it is pretty clear also, we only include purchase order from our customers so that this reflects only firm order and that long-term agreement we have with various customers. So we will disclose that annually, but it has been stable. When you compare from March to today, it's at about the same level. So -- but we don't disclose because it could give sometimes I have a customer giving us the order for the full year once a year. So it's only a view that is short term.So for us, it was important to reassure the community and the financial community at the beginning of the pandemic, right, giving the full visibility every quarter, but now this has stabilized.
Your next question comes from Konark Gupta with Scotia Capital.
So maybe my first question is about the supply chain issues you talked about. I'm kind of wondering, I know you mentioned the aftermarket products were mostly impacted, which kind of seems obvious, given the supply chain issues or relevant parts that probably supply those aftermarket demand. Where in terms of regions or your factories, where did you see sort of the most impact of beat Omicron or supply chain delays?
We see it in North America that we were mainly impacted, and we prioritize OE deliveries over aftermarket. So that's why we're saying that the aftermarket was reduced compared to our objective because it's important for us that the customers get their product on time to be able to assemble the complete aircraft. So to minimize the disruption or the impact over their operation. So -- but it's mainly in North America that we had most of these challenges.
Okay. And then looking at the margins, obviously, they had some compression. I'm not sure if any of these absenteeism, they had impact on the margin as well, given some of the employees might be absent on pay instead of not on pay. And perhaps, you also faced some tough comparison from the wage subsidy last year. So any thoughts on the margin performance?
Yes. So well, first, I'd like to mention that we had the resource to do more sales than that. So obviously, volume for us is key in the margin. So we were targeting higher throughput by 10%, and obviously, margin would have been up compared to what we have.So yes, we have cost of absentees. Where we lose it is really the production opportunities, right, from a absenteeism and all the impact that has on the production system, as Martin described. So it's not only an employee not being there, it's the impact on the other. So a quick example that we had late in December just before Christmas in our Cleveland facility, we have 4 plants and 4 of them at the COVID. So we have to go outside to do the thing. So that's cost us. Obviously, we have in the business because we needed to outsource to finish and assembly. But that's a good example of the resilience of our people that had went through in order to go through the difficult month of December we have.
Okay. That's good. And on the recovery timeline, so you mentioned the MD&A. I guess it seems like it's going to take a few quarters here. What's -- what do you need to see to see the recovery? I mean I guess in the employees coming back and supply chain coming back, or are you going to have to kind of accelerate success from deliveries to your customers? What's the recovery timeline going to look like? Is it 2 or 3 quarters kind of thing? Or is it 1 or 2 quarters?
Yes, 2 or 3 quarters, that's our internal goal, obviously. And what we need is to stabilize the workforce within our operation also within our supplier base. So when you go for plating or retreating or processing, those are highly skilled employees, and when it's somebody else that's performing the job that as opposed to a very experienced employees, of course, it has an impact. So we need to have these people coming back and have a stability and predictability in our workforce planning to be able to recuperate and to expedite those deliveries.
Like Martin said, I mean we lived through that in December and January. So we know actually the month of January was impacted as well. So that's why we know we cannot recuperate this in this quarter, knowing that the effect is December, January to date, right? And it looks like it's going in the right direction, but there's only 2 months now. So that's why it's going to be over quarters and not only in this quarter.
And last one for me. On the 777X, it seems like there's been a recent order placed by, I think, Qatar, on Boeing 777X cargo variant. Any thoughts on where the production for the 777X from landing gear perspective goes from here for this year and next year?
That's a very good news. That's a very good news for us. You know that we have the capacity to produce more landing gears than that. So it will be the same facilities, the same equipment, the same people that will do 777X than the 777 ER. So we're going to better utilize our capital asset and Boeing announced a rate increase to [ 3 ] in the middle of the year, and so that's all good news for us. And the Qatar announcement and the launch of the 777X cargo is a very good news for us.
Your next question comes from Benoit Poirier with Desjardins Capital Markets.
Specifically for the loss of productivity in the quarter, would you be able to quantify how it impacted revenues in the quarter? And how much it could give the boost we might see in Q4?
Essentially, Benoit, as I said, we had a plan to do 10% more sales than what we did. So this was a solid plan at the beginning of the quarter. Unfortunately, I think what happened in December was too fast. I mean as we described, the number of cases doubled over 2 months from the pandemic of 2 years. So it was too much at the end of the quarter, where we have a significant proportion of our sales that is made every quarter at the end of the quarter. So it was a very difficult production environment. So this explains obviously the shortfall of the sales.
Okay. And could you talk about the measures you put in place to mitigate the impact, and also the measure in place to boost the output and recover the productivity loss in the quarter?
The first is -- so the measure that we have implemented and we have designed our protocol is to ensure the health and safety of our employees, and to minimize the number of absenteeism. As an example of the measures that we took that will never show up in the numbers, in some of the cases where the risk exists, we ask all the employee before coming back to work after the Christmas holidays to take a test. And fortunately, we've done it because there was a few -- a fair portion of the employees that tested positive. So the impact last only 1 week instead of a month or 2. So that's one of the first measure is to monitor the health of our people, the help to minimize the potential propagation of the virus within our workforce. That's something.And now we have planned in -- as of last week and starting last week, we almost have 100% of our workforce back to work now. So that -- with all the people at their workstation, doing things that they're used to do, we should see an improvement in efficiencies.
Okay. Perfect. And Martin, with respect to AAR, you signed a big contract, a 4-year agreement back in May 2018 for aftermarket products on the KC-135, C-130. Could you provide some color related to your ability to renew the contract and maybe expand the scope?
Yes. So that contract is not that material as it used to be in our numbers. It's not material anymore. So we have been able to replace that shortfall with this contract with other contracts. And like I said, so we're still working with other opportunities. I'm sure that we will have other questions like that, but when it's important, when we win a new program, a new product is first to industrialize the OE, and then support the customer with aftermarket services.So you saw the platform that we signed and we delivered, and the new products that we introduced. So those are good example of how do we replace the lack of business or the reduction in the AAR contract.
Okay. That's great color. And for fiscal '23, I understand we are still early, but could you provide maybe some color about what we might expect in fiscal '23, and maybe comment about the potential project or bidding pipeline you're dealing with for 2022?
Yes. Well, thank you for the question. I think because we prefer that question for you. So before the -- our fiscal year-end finish in March 31, right? So our budget and we review all of our sales budget for the next 5 years in November timeframe, and we crystallized those sales in December. So I can tell you that we -- at that time, we were seeing growth, all right? So the orders are there. The opportunities are there, right. Now is the challenging environment that we're working on that came so fast, like Stéphane said, that it will be a -- how do you say that, the challenge to make sure that we have all the resources, and we minimize the impact of potential or other potential virus impact that would have on our production system.So that's the unknown, but -- so we're confident that we have the order. We confident that we have the workforce. It's a total, but the problem that we don't know is what would be the impact of this bizarre environment that we just experienced in the last 2 months.
Okay. Great. And last one for me. Back in Q2, you made a -- you had a more positive tone with respect to M&A. So is it still the case? Could you give us an update on the M&A?
We still have -- we're still active. It takes [ 2 ] to time go again. So we have opportunities, so it's still in our plan. It's still in our growth plan. So we want to do acquisition, Benoit. So I cannot comment more.
Your next question comes from Cameron Doerksen with National Bank Financial.
So just on the -- back to the supply chain, I guess, maybe unrelated to COVID. I'm just wondering if you're seeing any other challenges on that front. I mean we've heard some -- from some other aerospace suppliers out there that maybe there is some limitations on things like forgings and castings.So I just wonder if you could comment on if you're seeing any bottlenecks in the supply chain sort of beyond the short-term impact that you saw in the last couple of months?
Yes, the raw material is a concern. If you -- raw material forging, pricing, inflation, that we're closely monitored, but great question, Cameron. We have different contracts with different -- 4 different programs. Some of them were supplying the forging, the raw material, some of them is under agreement with our customers. So it's somewhat perfect us against shortages and against inflation there. For long-term contracts, we always have inflation or indexation like fund contracts. So that is also something like that. And aftermarket that's -- we will have to make sure that we -- pricing reflects the -- those current economic conditions.So haven't seen shortages in the raw material because these [ PD POs ] were placed long time ago, and we have a good procurement team. But in the future, I don't know, I don't know. Like I said earlier, supply chain remain a challenge, so we need to stay close to our suppliers, and that's what we do. Does that answer your question, Cameron? I know that I give you more.
Yes. So I guess, not an issue now, but something that you're watching closely, is that probably the best way to summarize it?
Okay. Yes, I agree with that.
Okay. So second question, just on, I guess, a new contract opportunity you kind of hinted at this -- in an earlier question, but I know you've been pursuing some of the F-18 repair and overhaul work. I believe that Boeing was awarded a contract on that front. So I'm just wondering where things stand with you on that potential new business opportunity?
Well, Cameron, you know that when I -- like I said, when we win a new program, we'd like to -- I have nothing to announce. I have nothing to announce yet. So when we're trying to satisfy our customer and then give the top services, and when you give top services, you can maximize aftermarket revenue with those platforms. So that's our strategy, and we're working actively to support our customers.
Okay. Fair enough. And maybe just a final question for me. Just on the Boeing actuation contract, can you just comment on where things stand on the industrialization ramp-up on that work?
First, our first shipset is really tested. It's working beautifully. We're just waiting for the approval from the customer to ship. And the second product, the second actuator is a few weeks ago, a few weeks from now to deliver. So it's going according to plan, even ahead of schedule.
Okay. So we should start to see some contribution of that in fiscal 2023?
Absolutely, yes.
Your next question comes from Tim James with TD Securities.
Just wondering -- and forgive me if you mentioned this earlier just in reference to the impact on the quarter from revenue delays or deferrals related to Omicron. Did you indicate or could you give us a bit of a sense for how much of -- you mentioned kind of a 10% higher expectation originally, how much of it was sort of commercial aftermarket versus defense aftermarket or looking at that entire 10%?
Defense aftermarket.
All defense, okay. And then secondly, on the 777 program, you mentioned -- of course, we know that Boeing is planning on taking up production rates this year. When does that like given your production and delivery timing? When does that sort of step up? What quarter does that impact your revenue run rate from that?
Normally, a quarter prior to the [ rate delivery of both]
A quarter prior to their increase in rate or they're delivering the aircraft?
That's right, delivery of the aircraft.
Great. Delivery. Okay. Okay. And then just going back to the margin, by my math, about a 15% EBITDA margin. I think given the situation that you've faced, this was aftermarket revenue 10% lower than you expected. Not something you could plan for, I actually feel like that margin performance in the quarter was quite commendable or good. Was there anything there that sort of helped you out more than you would have anticipated? Or it just would have been obviously a better margin performance, were it not for these events?
Absolutely, 15% was that volume, it was good. So obviously, there's plus and minus. You mentioned aftermarket, but there's other plus and minus. So it's still a good performance at 16%. It's a bit -- if you recall, about 2 years ago, we said, well, we anticipated between 15 and 16, obviously, with a higher volume would be closer to the 16% EBITDA margin. So...
Okay. That's helpful. Yes. No, I just feel like from what you've described, I think that was actually quite an accomplishment.I guess my last question is -- and I'm thinking out longer term here over the next several years. And as you look across the business, are there any areas or programs where you believe cost reductions or learning curve improvements are necessary. And I want to exclude just kind of the normal benefits that you expect as certain programs ramp up their volume, and obviously, your margins will increase. But do you feel there's any sort of meaningful initiatives that you need to undertake in the business to get cost down in any particular areas?
It's a journey. It's a journey, and we started that in now many years. Every year fighting against inflation. We're fighting against to reduce -- we're fighting to reduce our cost base and to be more productive. So those opportunities is always to get a competitive supply chain, performance and competitive supply chain.Every year, we have an approach on every program. We review the supply base or the suppliers of every program. Every year, we attack some of them, the main ones. We have also a journey on automation, trying to automate our process as much as possible, and to have our machinist or operator running more than one machine, like I already said, that helps the [ MRD ] rate. So that's a journey to use the technology to be more automated.And third of all, is the non-quality costs. The non-quality cost, we were second to none. We had a bad performance in Q3 compared to historical levels. It's not a recurring theme, but that's also a cost component of reworks, scrap, MRD are key objectives to reduce and to keep it at the lowest minimum. So we did great improvement over the past years. We have -- I'm proud of the ratios, the historical ratios that we had and the improvement, and we need to continue that. So we did a fall steps in Q3, and we're going to continue to do that.
Your next question comes from Bryan Fast with Raymond James.
Just one question for myself. I know that the business jet market was a source of strength over the last 2 years. Are we seeing a moderation from that end market? Or are you still seeing that level of strength?
Well, for us, it's the business jet market, so the market where we're introducing new products, right? The [indiscernible], we started the ramp-up of delivery this year. As you know, we won 10x. So in 2 years from now, we'll probably start to seeing some production. So for us, it's because we have more programs, right, coming in, in that market. So despite as you're referring, maybe some program might slow down, it's not the case in our case because we are introducing new content, right, that we didn't have before.
And the [indiscernible] remains robust, right. In terms of the business jet. To [solid ] airplane and we're doing good.
There are no further questions at this time. Mr. Brassard, you may proceed.
Thank you. Thank you very much, Enis, and thank you, everyone, for your support, and thank you very much for having joined us this morning, and have a great day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.