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. Fourth 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, Thursday, May 24, 2018, at 8:30 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, sir.
Good morning, and welcome to Héroux-Devtek conference call for the fourth quarter and fiscal year ended March 31, 2018. 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 statements and MD&A on our website at www.herouxdevtek.com. Please note that we also post a 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 and the year, which are presented on Page 3 of the presentation. Result for the year were relatively in line with our expectations. Sales reached $387 million, down 4.9% from $407 million last year, and our adjusted EBITDA margin was 14.7% as compared with 15.1% last year. We generated a very strong free cash flow for the year, which enabled us to reduce our net debt position significantly since the beginning of the fiscal year. On Page 4, you can observe that we generated $56 million cash flow related to operating activities and a record high $51 million in free cash flow as compared to $56 million and $33 million last year. Given this free cash flow generation, Héroux-Devtek already healthy financial position improved further as of year-end with a net debt position of $39 million from $92 million as of 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 $466 million as of March 2018, up 15% from $405 million at the end of March 2017. As a reminder, the backlog only include business for which we have received a firm purchase order. Stéphane will provide additional detail on our results and financial position in a moment.Please turn now to Page 5. In terms of our different program, I would like to highlight a few things. First, we have strong delivery related to the Boeing's 777 program, shipping 13 landing gear in the fourth quarter alone, or 42 for fiscal 2018, for a total of 63 since the beginning of the program. Furthermore, we expect to receive the approval from Boeing for the final main surface treatment process in the coming weeks. The in-sourcing of the related processing from our third-party suppliers will start gradually in the second quarter of fiscal 2019 and should be completed by the end of fiscal 2019. As a result, we anticipate the effect of margin enhancement to be fully realized in fiscal 2020.Finally, I am happy to report that we have signed an amendment contract with Dassault for the design and manufacture of the Falcon 6X landing gear with an entry into service expected in 2022. We will work on the redesign of the current configuration over the coming year.In the fourth quarter, we also announced workforce adjustment of about 60 employee at our Longueuil facility following the nonrenewal of the U.S. Air Force contract announced last year. However, on May 16, we announced a 4-year contract with AAR Corporation, which helped us to mitigate the loss of the previous U.S. Air Force contract at our Longueuil facility. Under the terms of the agreement, Héroux-Devtek would perform the remanufacturing of landing gear assemblies of the KC-135 aircraft, the manufacturing on spare part for the C-130 and KC-135 aircraft and the manufacturing of other landing gear component. The contract total value could exceed $65 million over its 4-year term. We are thrilled to add AAR as a customer. Our decades of experience with the U.S. government will be put forward into this important contract with the same quality, on-time delivery and customer service as before.Finally, I want to give you a quick update on the closing date of our 2 pending acquisition, CESA and Beaver. The CESA regulatory approval process has provided -- is proving longer than we had previously anticipated. We now expect the transaction to close during the second quarter of fiscal 2019. The closing of the Beaver acquisition is expected during this quarter, subject to customary closing assessment and certain regulatory approvals.Stéphane will now review our Q4 result and financial position.
Thank you, Gilles. Before I begin, please be aware that we will refer to certain indicators that are non-IFRS measure, 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 result on Page 6 of the presentation. Fourth quarter consolidated sales reached $113 million versus $120.9 million last year. The 6.5% variation reflects lower sales in both the commercial and defense aerospace market and a negative foreign exchange impact of $1.4 million. Commercial sales decreased 5.4% to $57.5 million versus $60.8 million last year. The decrease was mainly driven by lower large commercial program sales, including the scheduled ending of a Tier 2 contract and lower aftermarket customer requirement for regional aircraft. These negative factor were partly offset by increased Boeing 777 deliveries. Defense sales decreased 7.7% to 5 -- $55.5 million versus $60.1 million last year. This variation is essentially due to lower spare parts requirement from the U.S. government.Turning to Page 7. Fourth quarter gross profit was 12 -- $19 million or 16.8% of sales versus $20.8 million or 17.2% of sales last year. The decrease was largely attributable to an unfavorable product mix mainly related to lower sales of spare and aftermarket's requirement for regional aircraft. Operating income was $6.7 million or 5.9% of sales versus $8.7 million or 7.2% of sales last year. Adjusted operating income was $12.1 million as compared to $12.3 million last year. This quarter, adjusted operating income excluded $5.4 million of restructuring charge and acquisition-related costs. Adjusted operating income from the fourth quarter last year excluded a $3.6 million restructuring charge. Adjusted EBITDA, which exclude nonrecurring item, was essentially in line with last year at $19.4 million or 17.1% of sales compared with $19.2 million or 15.9% of sales a year ago.Turning to Page 8. Net income was $5.9 million or $0.16 a share compared to $8.9 million or $0.25 per share a year ago. This decrease was mainly driven by higher restructuring charge. Excluding nonrecurring item net of taxes, adjusted net income reached $10.4 million or $0.29 per share versus $9.1 million or $0.25 per share last year.Now let's turn to our cash flow and financial position on Page 9. We generated cash flow related to operating activity of $18.5 million versus $29.1 million last year. This variation mainly reflects a less favorable variation in noncash working capital item. Free cash flow reached $20 million as compared to $22.8 million last year. For the year, as Gilles mentioned, we generated a record high $50.8 million free cash flow, up significantly from the $33 million generated last year, primarily as a result of lower net cash flow utilized in investing activities. Given this free cash flow, our already healthy financial position improved further during the quarter with cash and cash equivalents of $93.2 million as of March 31, 2018, and total long-term debt of $132 million, as can be seen on Page 10. This total include an amount of $54.2 million drawn from our authorized credit facility of $200 million. Remember 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 lenders. Our net debt position stood at $38.8 million as of March 31, 2018, representing a net debt to equity ratio of 0.10:1.I will now turn to call back to Gilles.
Thank you, Stéphane. Please turn to Page 11 of the presentation. For fiscal 2019, excluding the acquisition of CESA and Beaver, we expect sales to be stable as compared to fiscal 2018 due to the ramp down of the U.S. Air Force contract, which will be offset by higher defense volume from other customers and increased delivery related to the Boeing 777 and 777X programs. In addition, we expect to spend approximately $15 million in CapEx for the year. Long-term sales growth guidance is not being provided at this time, as it will be materially impacted by the acquisition of CESA and Beaver. We will provide new long-term sales guidance after the closing of these 2 transactions. We look to the new year with enthusiasts as we expect to leverage many opportunity for future growth, including the closing of the CESA and Beaver acquisition as well as the positive long-term outlook on commercial aerospace and increased defense spending commitment worldwide. In addition, we are well positioned to obtain a number of contract on several aircraft programs given our fully-integrated offering, leading-edge equipment and international network.We are now ready to answer your questions.
[Operator Instructions] Your first question comes from the line of Cameron Doerksen from National Bank Financial.
Just maybe a couple of quick ones for me. Just on the CapEx guidance for $15 million, presumably, that excludes the -- any CapEx with the acquisitions. I'm just wondering if you can -- maybe not give an exact number, but is there any meaningful CapEx that might be required? I know CESA has got pretty modern facilities, but what about Beaver? Would that take the CapEx somewhere potentially higher than $15 million in the -- in this current fiscal year?
Yes. It would be higher than $15 million. And Beaver will require more CapEx than CESA because CESA, as you know, they have a very modern facility and equipment.
Okay. Maybe just secondly, on the -- I guess, on the AAR deal. Nice to see that you've, I guess, mitigated the loss of that contract with that to some contract. Is there any way you can maybe quantify how much of the, I guess, mitigation there is? I mean, it looks like the rough numbers, so it looks like you've mitigated about 50% of the loss of the previous repair and overhaul contract with the Air Force.
Well, I think, as you know, the existing contract when I was at [ Aéro Montréal ], this was representing about $25 million a year. For this one, depending on the volume, it will range between, let's say, $12 million to $15 million. So we should start to -- this workload in the coming weeks. So yes, that's good news for our people because it was painful to do that adjustment that we've done recently. For now, it's done. It's finished, so there would be no more adjustment due to this workload now that's coming in from AAR. So that's a good thing. So we're pleased to work with them, and we hope that we perform correctly, like we do normally. We may get some more. But at this point, that's what it is. It's anywhere between $12 million to $15 million.
Okay. Perfect. Maybe just lastly for me. Just on the business jet market, we're seeing some positive trends there. Maybe still a little bit early to talk about production rate increase on some of your programs. But are you seeing any positive signs on any of your business jet programs, I guess, particularly, with the Embraer? Is there any, I guess, talk of a -- the increased rates on those programs?
Yes. Things are looking better on BJ. The rate production on the Legacy is ramping up somewhat, so it's going to the right direction. So we see that improving slightly. And as you know, the 6X now, it's -- we announced this morning that we have signed an agreement to continue this program. So our engineer are working on it, as we speak. And we need to finish the design and then start production to be ready for an entry into service in 2022. So that means that from a manufacturing standpoint, we will start in 2019 calendar to build and provide the ship at year-end calendar 2019, some shipset, right?
Your next question comes from the line of Derek Spronck from RBC Capital Markets.
Without CESA and Beaver acquisition closing, would you still be on track to reaching the previous guidance of -- I believe, it was $480 million to $520 million in revenue, as it currently stands?
We're still tracking to this, but we're more at the lower end than the upper end at this point. But I think it's more prudent also to -- when we had CESA and Beaver close at -- then we will update the investors, so this will be more clear to them what the plan we can achieve in 2021. So that's where we are, so...
Yes. Are you still pretty comfortable that the CESA acquisition will close? Like, there hasn't been anything materially different, just more of a procedural and...
Well, we -- I think we're confident to close the transaction by, let's say, second quarter of our fiscal year, which is in July, August time frame. So that's what we're looking at to finalize, hopefully. Maybe hopefully, we -- if the government can come back to us soon, we're in discussion with them, so we may be able to finalize this by June. But I think it will be more like July, August at this point. And the Beaver, we're quite confident we'll close this by the end of this month.
Okay. And sorry, I don't know if there -- any update around the surface treatment process?
Well, yes. I said it this morning. We expect to immediately to get the final approval in the coming weeks, not month, weeks, and start basically to integrate everything in July-August time frame. And by year-end, we should totally producing this part enough. And then it means that calendar -- or fiscal year 2020, we will have all the -- I will discuss out of our P&L. So we're getting there. So we made some progress, so we're going there, basically.
And do you still see 100 to 200 basis point margin lift in, say, fiscal year 2020 from the surface treatment internalization?
Yes. The answer is yes. It's -- we see that. We -- obviously, these are direct costs. We -- it's also a painful process now, I mean, to do it the way we're doing it. So yes, we will meet the realized 100 point basis in, like, 2020. Like Gilles said, we'll fully benefit from this.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Market.
First, just to come back on the previous question. The lift we should see on the margin next year coming directly from the internalization, is 100 bps or kind of 100 to 200? Is it closer to 100 bps, Stéphane?
We know it's over 100 bps, so it's -- we -- as you know, we're always prudent, right? So we like to stay like that, but we know that we are incurring over 100 bps currently by doing it the way we have to do it now.
Okay. And could you quantify how much was the impact in Q4 and maybe also for the full year in terms of EBITDA margin?
We'll then -- so the same answer. I mean, now that we're ramping up, you understand that we'll deliver more shipset, which is excellent. But we're also paying the subcontractor, I mean, to do it instead of absorbing more from this facility. So essentially, you take the 100 bps on almost $400 million sales, right? That’s what it is.
Okay. So about 1% in Q4 kind of stabilize versus Q3, I guess.
Yes.
Okay, okay. Perfect. Okay. That's great. And also now, if we look in terms of your guidance for fiscal '19, could you provide some color about the free cash flow expectation? Obviously, you gave some details, but I just want to get a good understanding on the movement in terms of working capital.
Yes. Well, it's a good question, Benoit. Free cash, I think -- of course, last year, we had a fantastic year, I mean, with $50 million-plus free cash flow. This year, basically, with the CapEx down to $15 million, I think we should be in the range of anywhere between 8% to 10%. So we expect to generate, again, a good free cash flow this year.
Okay. And 8%, 10% in percentage of what, Gilles?
Top line. 8% to 10% top line.
Okay, okay, okay. That's pretty good. And could you maybe talk a little bit about your margin? You ended the year close to 14.7% in terms of EBITDA margin. So kind of give some color on the direction you would expect margins to trend in fiscal '19.
Well, Benoit, I think you guys are normally very good at calculating all these margins. So you start with the 14.7% and, I guess, we'll try to reach that level. And then we're planning to improve on the surface treatment and all that. So I will let you and your colleague to determine exactly where our margin would be the next year, as you guys are pretty good at doing this.
Okay. Yes. And would you say that surface treatment is kind of the key lever on the margin? I mean, if you would exclude the surface treatment, would it be fair to say that margins would be kind of stable versus fiscal '18, excluding the surface treatment impact?
Well, this should be better. It should be better. And also -- well, the other key factor is volume. We've got additional volume. The volume is magic in our business. As you know, we have a lot of fixed cost. So if we get more volume, then margin will be better.
But on your side, you are looking for stabilized sale in fiscal '19.
Yes.
But the key, Benoit, is that the lead time to produce the parts is -- it's many months. So as we grow the top line the year after, we'll benefit next year from the better volume as well.
Yes, that's right. Stéphane is right. I mean, there is a top line, but there's also getting ready for the year after where, basically, we see top line going up after that. So -- and we need to build up inventory. So that means with the activity in the factory, it would be higher than -- and this year, we just made the cut in our cost recently. So reducing this fixed cost by doing what we did recently, so...
Okay.
Things are looking better...
Okay. That's pretty good...
There's more activity in the factory now.
Okay. That's very good color, Gilles. And could you talk a little bit about the ramp-up. You deliver 42 landing gear on the 777 last year or so. Any thoughts on -- or expectation for fiscal '19 on how many shipsets you could deliver and the breakdown maybe between the 777 and the 777X?
So essentially, in fiscal -- this fiscal year, right, fiscal '19, we anticipate to increase couple of shipset, right. At the 777X, we're going to start delivery, right, the prototypes gear. So as we are starting to deliver some unit for the X, it will represent a couple of shipset, right, for the year. And then after, we'll see gradually how this will continue to improve our -- the way we see it is that there should be a further ramp-up in the following year.
Yes.
Okay. That's very good. And AAR, could you talk about the -- whether you see opportunity? Obviously, it's been a nice win, a new customer. So I assume that you were referring to the potential to increase your content on the -- for the USAF. But are there some other opportunities interesting that could happen with AAR inside their business right now when you look at their overall service offering?
Well, I think, at this point, this will be limited to the work we've performed at the Air Force. So right now, it's mainly on KC-135 from -- in terms of return overall. But we could see some C-130 that -- it will depend on their side, how much they want to do themselves for and how much they want to put outside. So look, if they want to put some C-130 our way, I mean, we can do it. We've done it for years and years, so it's not difficult for us to do that. But at this point, it's really concentrating on the KC-135.
Okay. And for Beaver and CESA, are there any integration cost to be taken in fiscal '19 with respect to both acquisition?
Sure. Yes, there'll be some integration cost, of course.
Yes.
And we'll disclose them as we do, right?
Yes.
Okay. Perfect. And last one for me. Could you maybe talk a little bit about your overall utilization rate and kind of the potential to improve it? My understanding is that you made some significant investment on the 777 and there is really a nice opportunity for you to ramp up the utilization rate. And also maybe talk a little bit about the potential opportunities with Boeing with respect to the T-X, the MQ-25 and also the Dammam, whether -- any color on those 3?
I think I'll comment on the capacity, a better year. We expect our factory to be busy -- a bit more busy this year than last year. In terms of Dammam, I mean, I cannot say more than what we read in Aviation Week. So we have no info that is to be discussed today. On the T-X, look, we're still in discussion with the customer. And on the MQ, same thing. So look, this decision will be made this year. I mean, from what we understand, the decision of both the MQ and T-X would happen during calendar 2018. So we have made some offer to customer and we are waiting to -- for them to decide. And this customer has to win also the business with the U.S. government. So this is where we are, Benoit. I cannot tell you more than that.
Your next question comes from the line of Tim James from TD Securities.
Just want to return quickly to the new AAR contract. Stéphane, am I correct in interpreting some of your earlier comments as meaning the net impact now of the new AAR contract and the lost USAF business, the net impact on a year-over-year basis is no longer negative going forward?
No. I didn't say that. It's negative because this used to be $25 million. And I was, like, talking about anywhere between $12 million to $15 million. So net-net, it's around $10 million.
Yes.
Okay, okay. So that's really is my next question. The AAR contract is more or less will be sort of running at full rate for most of fiscal '19. Is that correct?
Yes.
Okay. Great.
Yes. But it's a combination also at the term of this plus -- We still have work to complete for the Air Force directly, so...
Okay, okay. Okay. So that is still slowing down. Okay. My next question, just sort of a high-level kind of question. I'm curious to hear some discussion or comments from you on the different requirements and opportunities related to the CESA acquisition as compared to the APPH acquisition, which, I think, has obviously been a big success for you guys.
Well, when you look at the portfolio of CESA of product and services, yes, there is some landing gear business in there. But landing gear represent 25% to 30% of their business. But if you look at all the other product, I mean, the -- there's actuation in there. There is some flight control in there. There's some hydraulic reservoir in there. So a very wide, diverse -- not diverse, but wide product that they build and design that are quite supplementary to what we do. And as I said before, I mean, the market that they address with this other product are 2x bigger than our landing gear business. So we see -- we believe that with CESA and also Beaver, because Beaver is quite supplementary to CESA, we can build this business, penetrate this market and, at the same time, using -- some of these product are used in landing gear system. So for us, it's quite strategic. And we see also -- when we will do a complete landing gear system, of course, we will use CESA for some actuation and, I guess, some ball screws in there. Of course, we will use Beaver product on all this. So it's -- we are penetrate -- we are, on one side, from a landing gear standpoint, I mean, we will become now more complete in term of what we can build. And on the other hand, we're also penetrating a new market that we will [ re-enter ] in too now. Now it's -- so it's both impact. And don't forget, also, CESA not much business in North America due to the fact that they were a subsidiary of Airbus. Now we certainly will open doors for them at Boeing largely than many other North American customers. So I think that's -- and then they will help us to penetrate Airbus. So that's what we -- that is where we are.
So just a follow-on to that then. I'm thinking about, as you mentioned, the North American market. Are there many examples or parts that Héroux, currently, and I mean, Héroux and APPH currently purchase from outside suppliers that, going forward, could be obviously manufactured in-house now or purchased from CESA?
Yes. I mean, when I -- when we look at all the retraction system and we look at even the steering system, and so these are product that we did -- we have bought from other suppliers. So in the new landing gear systems and, of course, CESA could get that -- a portion of that business instead of using a supplier.
[Operator Instructions] Your next question comes from the line of Ben Cherniavsky from Raymond James.
A lot of questions have already been asked. And just, I guess, mine would be more housekeeping in nature for the financial statements. On the income tax, the rate always moves around a lot. What should we assume for the coming year?
Well, I mean, the sales will be stable, so the tax rate will also be relatively stable, okay? As you know, the -- there is a decrease in the U.S. tax rate, but we are in a situation where we have -- we're still at loss in the U.S. But it will be relatively stable when compared to the adjusted tax rate, right, taking into consideration. There was $4.9 million adjustment, right, following the U.S. tax reform. So excluding that, the tax rate will be relatively stable.
Okay. So a blended effective tax rate in fiscal 2019 would be a good number or range to assume.
Well, I mean, we had an adjusted tax rate of about 11%, so in that range.
For this fiscal year, you're saying.
Yes.
And that would be about the same for next year.
Yes.
Okay. And again, maybe, could you just walk through the interest expense? I know you got some of that -- you got some explanations in the MD&A. But just the nature of this -- of the government loan and the interest income that it produces. That's -- obviously, it's a noncash interest income. Is that correct?
That's correct. That's a noncash impact.
And so how does that work? How do you get interest income from a government loan like that?
I think you have to take this into combination, right, with the interest accretion expense, right? You have to take it globally. So as the company -- essentially, the loan that we have is associated to the growth, right, so -- of certain sector of the business. So we adjust that according to the current actual, right, the result. And this is a noncash impact, as we get them.
Right. But what is it exactly that you adjust? Are you saying your assumptions around the growth of the project, if they get extended, then the interest expenses related to that get extended?
If the project takes more time, for example -- as an example, takes more time, well then, you'll repay over a longer period of time. So that means that you discount these payments and that creates a lower debt value on the balance sheet and it creates adjustment in the interest expense.
Your next question comes from the line of Benoit Poirier from Desjardins Capital Markets.
Yes. I just have a question on the fighter program in Canada. I've seen a good article. One of your customer is turning pretty positive about the prospects for selling his plane. So could you give an update on where we are in terms of a potential discussion on where we might see kind of RFP for the 80 planes that the Canadian government is looking for?
Which number you're talking about, Benoit?
Saab Gripen.
Saab.
Yes.
Well, there's -- we know there's 5 customer chasing this business. So -- and soon, once we close CESA, we'll do business with all of them. So we are very good. The fighter business, it would affect. We'll get some business. How much, I cannot tell you, but I'm positive that this -- whoever or whatever the choice of the Canada decides, it would affect with our business on that side. I guarantee that. How much, I cannot tell you today. We work for Saab. As you know, we have the landing gear on the new Gripen. And we work with Lockheed Martin on F-35. We work with Boeing on the F-18. And we will -- we have product on Eurofighter with CESA. And we do a landing gear for Dassault. So...
But no color, Gilles, about the time line though, right?
Well, color, this time line has been changed so many times by the previous government and this government. So this is a political affair more than building airplanes. So it's tough to say. I mean, it's announced that they will make a decision on the jet fighter, if my memory is good, in 2 years from now, I think. So they should make a selection in 2021, I believe, right, 2021 or 2020. And that's where -- that's what we know. I mean, we know -- we don't know more than what the government has published, so far.
Mr. Labbé, there are no further questions at this time. Please continue.
Thank you, operator. Thank you all for listening to us today. I think we had good result for Q4, especially our free cash flow was very strong last year. And we expect to close CESA and Beaver in the coming month. So as we close these businesses, we will update you on our perspective in the short and long term. So thank you for listening to us. And don't forget, we have an annual meeting of shareholder on August 10 at the Omni Mont-Royal Hotel. So we hope to see you there. So have a good day, and thank you for your time today. [Foreign Language]
Ladies and gentlemen, that concludes our conference call. Please note that a replay of this call can be accessed as of 1:00 Eastern time today at telephone number 1 (800) 585-8367 and entering passcode 3186266. This replay will be available until midnight on May 31, 2018. Thank you. You may now disconnect your lines.