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Heroux Devtek Inc
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Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Heroux-Devtek's Fiscal 2020 Fourth Quarter and Year-end 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 statement. I would like to remind everyone that this conference call is being recorded today, Thursday, May 21, 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. Stephane Arsenault, Vice President and Chief Financial Officer of Heroux-Devtek. Mr. Brassard, please go ahead, sir.
Thank you very much, Sharon, and good morning, everyone. [Foreign Language]On behalf of all of us here in Longueuil, welcome to our fourth quarter and year-end earnings conference call for fiscal 2020. I invite you to follow along by referring to the financial statements, MD&A, press release and presentation, which can be found in the Investors section of our website. Before discussing the impact of the COVID-19 pandemic on our activities and sharing our vision for the quarters ahead, I would like to spend some time talking about our strong Q4 and year-end results. Q4 and fiscal 2020 were the best quarter and fiscal year ever in our history. We exceeded our sales target and generated a very strong operating margins, and we could have delivered an even stronger performance had it not been for the pandemic, which caught up to us in the last month of the fiscal year. However, paradoxically, the fourth quarter was also one for record loss. We recorded noncash impairment charges totaling $85.8 million during the quarter, which drove our results for Q4 and fiscal 2020 to the biggest loss the company has ever recorded. These write-downs reflect the new expected demand dynamics in the commercial aviation market. Stephane will discuss the impairment charges in greater detail in a moment. Now on to COVID 19. Given the virus' East-West trajectory, our operations in Spain were exposed ahead of other -- were exposed ahead of our other facilities and their successful effort at mitigating the spread of the virus, serves as a good example for our other locations. The first steps we took were geared at ensuring the health of our people while working at our facilities. Knowing that governments and public health authorities would recognize our sector as essential, we quickly developed and rolled out our COVID-19 protocol aimed at keeping our working environments safe. Now well over 2 months into this new reality, I am pleased to report that to this date, we have maintained normal operation at each of our 18 sites. We have recorded the physical attendance of approximately 85% of our employees on average. And we have been able to keep our employees safe as there has not been a single case of virus transmission at any of our plants. We are also fortunate to count on an experienced and disciplined management team -- the same team which has led us to the record quarter and year that we discussed a moment ago, had also displayed strong proactivity and resilience when facing challenges. Accordingly, we act quickly and decisively to adjust our workforce and manufacturing capacity to the new demand reality of the commercial aviation market as well as to realign our resources towards the defense segment. Earlier this month, we announced our restructuring plan to address the new market dynamics by reducing our workforce by approximately 10%, the equivalent of 225 employees, over the next 10 months. As part of this plan, we also announced the closing of the Alta Precision site. These actions will have the crucial effect of reducing both fixed and variable costs, allowing us to maintain a competitive cost base and to remain profitable as we weather the storm. I will expand further on our strategy going forward in my closing remarks, but before turning the call over to Stephane, I wish to express my gratitude to our employees. They are a key part of our robust performances in fiscal 2020 and have worked extremely hard these past weeks. I am very proud of their resilience and commitment. Stephane?
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, adjusted net income and adjusted EPS. All non-IFRS measure are defined and reconciled in the MD&A issued earlier today. In Q4, consolidated sales grew 5.6% to $166.8 million, up from $157.9 million last year mainly due to an $8.1 million contribution from our acquisition. Specifically, commercial sales grew -- were down by 7.8% in Q4 from $78 million to $72 million, while defense sales were up 18.7% from $79.9 million to $94.8 million. For the full year, consolidated sales grew 26.7% to $613 million, up from $483.9 million last year. Commercial sales were up 20.1% from $236.3 million last year to $283.7 million this year. Defense sales were up 33% in fiscal '20 from $247.6 to $329.3 million, fueled by acquisition and a 12.2% organic growth. In Q4, gross profit decreased from 18.8% to 17.9% and was down 16.8% from 17.2% for the year. The decline was mainly driven by inefficiency and delayed delivery brought on by the impact of COVID-19 as well as higher manufacturing costs at our Longueuil facility in the first 6 months of the year. As pointed out earlier by Martin, we recorded an $85.8 million noncash impairment charge as a direct result of the impact of COVID-19 on our commercial aerospace forecast. More specifically, our cash flow projection now reflects production rate cuts for the large commercial program, such as the 777 and 777X as well as delays in cross-selling opportunity related to the strategic acquisition of CESA. As a result, we recorded a $79.7 million nonrecurring impairment charge of goodwill. The downward revision of industry forecasts also resulted in the write-down of investment tax credit receivable and deferred income tax asset in the amount of $2.3 million and $3.8 million, respectively. These noncash charge drove us to an operating loss of $64.4 million for the fourth quarter and of $30.1 million for fiscal 2020. Excluding nonrecurring items, operating income would have been $17.6 million in Q4, representing 10.5% of sales, an increase of 0.2% when compared to the same period the year before. On an annualized basis, also excluding nonrecurring items, the operating income as a percentage of sales remained stable this past year at 8.6%. Adjusted EBITDA which exclude nonrecurring items, stood at $28.6 million in Q4 or 17.2% of sales compared to $25.9 million or 16.4% of sales a year ago. For the full year, adjusted EBITDA stood at $96.2 million or 15.7% of sales compared with $74.2 million or 15.3% of sales last year. The noncash impairment charge recorded in Q4 of $2.36 per share resulted in a loss per share of $1.98 for the quarter. Excluding these onetime charge, the adjusted EPS reached $0.38, an increase of 5.6% compared to last year's $0.36. For fiscal 2020, the loss per share amounted to $1.38, mainly due to the noncash impairment charge. The adjusted EPS stood at $1, up 19% from $0.84 recorded last year. Now let's turn to our cash flow and financial position. Cash flow related to operating activity reached $26.7 million in the fourth quarter compared to $37.2 million last year. For the 12-month period, cash flow related to operating activity amounted to $52.6 million, down from $70 million in the prior year. The decrease in both periods result from investment in inventory related to the organic growth in our defense sector. As at March 31, 2020, we our net debt position at -- stood at $246.9 million, up from $243 million a year prior. The increase in net debt is mainly related to the Alta acquisition, partially offset by cash flow generation over the fiscal year. At year-end, we had $193.6 million in available liquidity. As a precaution for potential cash requirement related to COVID-19, we drew $60 million on our credit facilities on April 1. Today, as we haven't used these funds, we are at around the same level of available liquidity compared to year-end. We remain very comfortable in our ability to continue to meet our debt covenant for the entire year since we expect positive cash flow generation to offset the lower level of commercial business. As a reminder, and before turning the call over back to Martin, I would also like to point out that in Q3, we reached an agreement with our banking syndicate to extend the term of our revolving facility from May 2022 to December 2024. This, along with the length of our term loan facility, means that we have no major capital repayment obligation under our credit facility until fiscal 2025. Back to you, Martin.
Well, thank you, Stephane. And before opening up the call to questions, let me conclude our remarks this morning by a comment regarding the future. As you have seen, we have recently withdrawn our sales guidance for fiscal 2022 and haven't issued guidance for fiscal 2021. Both of these decisions stem from the unprecedented volatility brought to the commercial aerospace market by the pandemic. Since its onset, we have been in regular communication with our customers and suppliers. Airbus and Boeing recently announced production rate cuts totaling approximately 40% of their commercial aircraft volume. And industry analysts do not expect rates to return to pre COVID-19 levels before the next 2 to 3 years. In spite of the significant downturn COVID-19 has brought to the commercial aerospace market, we remain optimistic about our growth prospects in the defense side of our business. Defense sales accounted for 54% of our sales in fiscal 2020, a proportion set to increase. Additionally, our funded backlog, which sat at $810 million as at March 31, is up 30% year-over-year and comprised of -- and defense orders are in the proportion of 2/3. We now turn to the future with relative confidence. We are entering this downturn on the heels of a record year with a strong funded backlog we are acting quickly and decisively to protect our profitability and cash flows. We are well diversified geographically and by market segment. We have a solid reputation and strong customer relationships. And the least -- the last but not the least, we have a very strong and experienced leadership team at all levels of Heroux-Devtek that will continue to manage our company proactively. Sharon, we are now ready to answer questions.
[Operator Instructions] Your first question comes from Konark Gupta.
So the first, I would like to ask you, from your margin perspective, the restructuring initiatives you have taken recently and perhaps you have some ability to redeploy available capacity for defense contracts. How much protection can you get from these 2 things in your margins? And to what level do you feel comfortable with your margins?
Well, essentially, we know that next year, the volume is -- well, this year, fiscal '21, the volume will be lower than last year. As you know, we let go 10% of our workforce, which is a good indication of the expected demand from our customer. As we have some fixed costs and with the Alta closure that Martin described, we are addressing both variable and also fixed costs during the year. So we are expecting a lower margin than this year, fiscal '20, due to the reduced volume of sales expected in fiscal '21.
Okay. And then on the free cash flow, so you mentioned that you expect free cash flow to remain positive. Any thoughts on CapEx and working capital? Would there be any initial benefits on working capital side as you have already prebuilt inventory that you are delivering at this point and you don't need to build more inventory? And how much CapEx can be reduced?
Well, CapEx will be reduced in line with the reduction we see in the demand compared to this year. As far as working capital, as you have indicated and as disclosed in the number, we've made significant investment on the defense sector for the program that are kicking in this year. There will be some noise, I believe, over the quarters this year with the noise created by the pandemic. But we certainly don't see such an increase that we have in the last fiscal year for inventory.
Okay. And then last one for me. Given obviously this pandemic and the demand weakness that's happening in the large commercial aerospace market, do you see any opportunities to improve your competitive positioning with respect to any particular OEMs or Tier 1 suppliers?
Well, that's the goal. That's why we are -- relook at our manufacturing capacity and our cost structure. And I believe that the plan that we put together is on the way right now, and that will allow us to utilize our capacity and to relook at our park of machinery and equipment. So therefore, at the end of this pandemic, we should be in a good position to win other businesses. And we'll see what will be the situation in aerospace. So it's going to be a challenging time for the OEMs and we will have to be proactive and rapid to identify the opportunities that they may have, either in terms of resourcing or if you have other acquisitions. So we'll look at it. But right now, I think it's turbulent. The environment is pretty much turbulent. So we're managing prudently and we keep on our toes to make sure that we benefit from every opportunity that may present to us.
And we have -- as disclosed, a strong defense backlog in total, which account for 2/3 like Martin said, right? So to the point earlier, we are allocating the work between the facility and the chances -- we're very lucky to be in that sector at this point, that mitigate the commercial impact that we have discussed.
Absolutely.
Next question comes from Cameron Doerksen.
Just on the margins, I mean -- so maybe the scenarios in the company is quite a bit different than going back to kind of the early 2000s. But if we go back to that time frame when Boeing especially was cutting production rates pretty significantly. We saw your sort of EBITDA margin get for at least a few years, a couple -- below 10% and it was a couple of years there, it was lower than that. And again, I know the company was quite a bit different then, but I'm just wondering if you could see any kind of scenario in the current circumstances where you would see your EBITDA margin be hit to that kind of degree? Or do you think that you've got a much better balance here of military work and proprietary work and been pretty aggressive on reducing costs early enough that you can avoid that kind of scenario?
Good question, Cameron. You know that we're not giving guidance on the margin, but let me give you some color on this. We are a totally different company than we were in 2000. I was there at that time. Stephane was there. And this one is -- we're getting into this situation with new contracts such as F-15 -- F-18. We're going to start the industrialization of the F-15. Both airplanes are in demand, and I don't see any pushouts for deliveries. We're having the CH-53K, that is also a good platform, good helicopter that will have some demand, they need it. We have the Gripen E, Gripen that -- in Sweden. They are at -- still 100, and it's total full ship sets. And I can name a few, again, but it's not only parts that we're doing anymore. We're providing value-added services. And those -- no, it won't be at the low level at the early 2000. And we have also Beaver in Detroit, that it's in the defense segment that is winning the part of this -- of the market right there. We're very happy with them. And on top of it is we have now -- we have 40% of our business in the intellectual product IP products. So we're in much better situation than we were in early 2000. Even in 2008, you could look at the 2008, how we managed through this. And that's why we're saying, we were not that -- we were not relatively confident those years, let me say. But -- and we have a strong balance sheet. So I don't want to be too overoptimistic, but I think we're doing the right thing, and we act rapidly to protect the margin, Cameron. You can appreciate that. We could have stayed and wait and see and things like that. But we believe that this situation on the commercial aviation market will last at least 2 years, right? So we took the measure rapidly early in the -- we analyze that, and we did not have our year-end finish. We start in April. That's why I said that the team was so great. And we came up with 3, 4 iteration of budget, we look at workload, and we had to make the decision. And when Boeing and Airbus announced their production rate, it confirmed our model. So we were ready to adjust and to deploy our plan to protect profitability and free cash flow.
Okay. No, that's really good. No, that was my thinking as well, but just wanted to get your view on it as well. Just maybe secondly for me, I'm just thinking about M&A. I mean, obviously, this is probably off the table for a little while here until things stabilize. But I have to believe there's going to be some maybe some distressed suppliers out there who are more heavily involved in commercial work that are going to struggle and perhaps valuations for companies will get a lot cheaper. So I'm just thinking maybe over the next couple of years, do you think there's any opportunities for you to add some -- maybe some tuck-ins? Maybe in the actuation space to accelerate that? And would you consider doing that in the environment that we're in? Is that something you would be willing to make an acquisition in a maybe challenging environment if the right opportunity came along?
Yes, exactly. You just said it, if the right opportunity came along, and we're still generating free cash flow like we expect and nothing else happened, yes, as you know, Cameron, we have made a -- an analysis, especially in the actuation business. We identified targets. We're contacting them. We're looking if they have -- if they're very strategic and complement our offer to accelerate our actuation strategy, we will seriously look at it. And we will look at their product, we will look at their portfolio and what do they bring to the offer. We will not duplicate, maybe not to duplicate the capacity but if there's something that bonify our offer, we seriously look at it, right Stéphane?
Yes.
Next question comes from Benoit Poirier with --.
When we look at defense side, you'll be ramping up a few key programs in fiscal '21. Do you still expect robust demand for aftermarket businesses?
Yes. We're still some fuel in the aftermarket, especially you're talking about the U.S. government and the U.S. Navy. We see it also in the, in Europe. Yes, we could see still a regular demand. We're strong right now in the backlog. We have win a few programs into that, reflecting that activity. So -- but I don't know how sustainable it will be, Benoit; it's very difficult to judge. But yes, I'm expecting to have some demand and the U.S. government might want to also to support the aerospace industry through the defense activity, right, Stéphane?
And with the new program like F-18, right, that we're starting, F-15. So those are aircraft that there is a lot of aftermarket demand, right, because aircraft are flying. So most of our aftermarket is defense. So we have -- we don't have a lot of volume on the commercial side of aftermarket.
Okay. That's great color. And looking at the 787, could you talk maybe about the reason why you did not renew the contract on the 787? And are there any other contracts that might expire in the more short term?
Yes. This was -- you're referring, I believe, to -- you did your own work, right? You're referring to align the 787 torque tube that we manufactured in Laval. That was set to terminate in December, we tried to renew. But obviously, it's a torque tube, it's not landing gear. It has not been renewed with Boeing. So under that, no, but obviously, we have Safran landing system or in-sourcing. So we have Tier 1 that are -- we have contract with them. They have capacity, but we will make sure that we honor our contract and everybody, we all need to be together in that business with our customer, with our end suppliers. So no, we don't see any termination right now of contract.
Boeing have in-sourced that part, Benoit. So we didn't lose it to a competitor. They in-sourced it.
Okay. And do you know how material it was on the backlog? Was it the main explanation about the slight backlog decline?
No. Maybe -- essentially we get the order from Boeing once a year on 777s. So typically, we receive the order in Q3 or Q4 of our fiscal year. So over the year, so you have a decline because you deliver your 777 and then they issue a PO for a full year -- a full calendar year. For example, let's say, in fall they will issue a calendar year 2021 PO for 777. So that's the main reason. So nothing to do with the program itself, it's just that they issue a PO once a year. And that's what we have in our bag.
Okay. Perfect. And now when we look at the -- your available capacity, we also saw some comments from Honeywell about trying to put pressure on pricing on suppliers. So would you -- have you hosted some discussion with the customers where they are trying to pressure the -- the pricing? And could you maybe provide some granularity around that? And do you see opportunities to leverage your current available capacity right now?
No. But as you know, that we have long-term contract in aerospace. There's not much inflation for many years. When we bid a contract, we have a firm fixed pricing and we haven't seen -- we have long-term contracts. We have IPs, right? There's -- and inflation does not exist in aerospace. So we'll keep honoring our contract like our customer and like with our suppliers, right? So does that answer your question?
Yes. Yes, sure. Great color. And could you talk maybe, last one for me, about the capital allocation priorities, Stéphane?
Well, the priority will be to reimburse debt this year. So as we said, we are expecting positive free cash flow, and we'll reimburse that. For now, we have keep some more security on the cash position, but we'll apply the -- we'll reimburse that over the year.
Next question comes from Tim James.
I just want to dig in a little further on the working capital question, if you don't mind, Stéphane. The -- it was, as you mentioned, a usage of about $30 million in fiscal '20 and more than 100% of that was inventory. As you mentioned inventories in fiscal '21 will not use as much cash. Will it come down enough or could it even turn positive just given the dynamics? And if so, when we think about working capital overall, I mean, could it be sort of neutral to positive in fiscal '21? Or should it -- should we still think of it as being a bit of a draw on the operating cash?
It could certainly be positive because we have a reduction of volume. So we will have less to carry in terms of receivable and net of the payable portion. So it could be positive, and we're managing very tightly with the schedule we have with our different customers. So we're following that very closely. But there could be some noise over the quarters. From quarter-to-quarter.
Okay. And then I guess the only other question I had is just around the backlog and more specifically that 1/3 that is commercial. How do you view the risk in that portion of the backlog, if any? Or is it more related just to the timing of delivering on the backlog?
Well, we have set, I think we have set our capacity in line with the customer demand and in line with the view we have on the production rate. So it's not only if we have a firm PO, we have also looked at what we think should come as adjustment from customer. And that's why we've made the workforce adjustment of 10%. So that's not only the deceleration from customers. As Martin said, we were already expecting the production rate cut of Boeing and Airbus, and it confirms what we had in our numbers. So we're being proactive, if that can answer your question.
Yes. Yes, that's helpful. I mean, just roughly like that 1/3 of the backlog, what is the time for delivery on average of that component of the backlog, how far out does it stretch?
Between 1-year -- 12 to 18 months, because what we're disclosing is funded backlog, it's POs that we receive from customer. And Boeing issued, let's say, the largest part of that backlog, obviously, the 777 and Boeing issued a 1-year PO at every year. So before reducing their rate, they announced, if you -- 5-per month -- delivery of 5-per month till March of next year, right? And 5-per month until March of next year is before going down to 3 for 4 quarters, approximately, and then go back up, right? So that's what they have announced. And that means us, we're going to see that probably 2 to 3 months, our rate reduction, we'll see that maybe 2 to 3 months prior to their rate.
Next question comes from Mona Nazir.
So my first one is just in regard to your projections for cash flow for 2021 and also the protection of margins. You spoke of a reduction in workforce, closure of Precision Alta and reining in Capex. I'm just wondering, have you pulled all the planned levers? Or is there more to come? And if there is, can you discuss them?
Could you repeat that we did not pulled what?
The Capex. So I mean, you talked about different levers that you have in order to just kind of protect the margin profile and also try to deliver the positive free cash for 2021. So just going through your commentary, you talked about the reduction in work force and your reining in of Capex. And I'm just wondering, have you pulled all your planned levers? Or is there more to come potentially?
Yes, yes. Well, absolutely. That's what Martin described. We made several iteration of budget. We had a beautiful budget before COVID-19. And it's a piece of history. So we did a couple of version after that, including reviewing significantly the capital expenditure of the company. So yes, we have realigned all our facility early in April to address the situation in terms of capital expenditure. But also in terms of inventories with the expected deceleration from our customer in the commercial sector. So our people are very agile right now to make sure that we get the right inventory in terms of defense work and that we adjust commercial inventory incoming, considering the new rate expected. And again, Mona, it's -- so it's based on what we know today. When we restart to do the budget, we had the V-shaped recovery, the U shaped recovery, and we have been very conservative, very prudent. But we don't know what we don't know what's going to happen. But based on the situation that we know today and our anticipation, and we're reading the expectations and this is there. We -- our plan is to pull all the trigger.
Yes. Okay. So do you just say you pulled all the triggers? Or I'm just wondering if there could be more to come.
Not that we know today.
Okay. So that's exactly.
We have been proactive with what we know, and we believe we acted with a prudent approach with the current situation. So we'll adjust if there's anything happening that is not expected, we'll be proactive again and will adjust.
Absolutely.
Okay. Perfect. That's exactly what I was looking for. And I'm just turning to the defense sector. I'm just wondering if you could give a little bit of detail on how discussions are going with your customers in that -- in that end market. Is there any risk to work there? Or on the contrary, could we bring -- could you bring forward some orders and capitalize on some of the space freed up on the commercial side?
So based on the defense side, all the spare activity, they need it, right? So we can deliver prior to POs, if you're referring to that. So yes, we are accelerating, and we're looking -- that's what we have done. We're looking at our manufacturing capacity, looking at our bottlenecks, and that's what we're doing. That's why we've been able to realign and to minimize the impact. So -- but there's an impact, but that's what we have done to protect again profitability and cash flow generation. Right, Stéphane?
Yes. And some order, we can ship early. I mean, definitely spare orders.
But the one that goes on the line, yes, we cannot -- the spares that go with the aftermarket, yes, we can ship.
That was part of the rebudgeting -- making sure that these opportunity, we can accelerate the work with the material and use the available capacity that was freed up with the commercial reduction and benefit from accelerating defense order.
Okay. And how fast can that pivot occur? Will it be a few weeks or a few months or a couple of quarters?
A few months.
Okay. That's very helpful. And just lastly...
We want to realign, but like you know, our cycle times, our manufacturing cycle times are taking 6 to 12 months, right, depending on the parts, depending on the complexity of the work.
And we have new work starting this year. As Martin said, the F-18, the F-15. So these are order that we don't do today, right? We didn't do before. So it's new sales that will add to our defense work. And we are ramping up on the 53K and Gripen. So -- and the defense activity under the ball screws in Beaver, it's pretty good.
Okay. Perfect. And just lastly for me. I mean you touched on it in your opening remarks -- across the board, we've been reading that projections of the recovery taking 2 to 3 to even potentially up to 5 years. You provided color on 2021, and I know you don't give guidance, but I'm just wondering if we could expect similar levels of commercial declines next year, the year after and then also the same positive free cash flow.
It's very difficult to predict with the pandemic, but we certainly don't see an increase in commercial next year, right?
No.
I think we said that we see it 2 to 3 years, right, the impact on the commercial side. So we will stay agile to work on the defense and accelerate user capacity available.
Perfect; thank you for me, and congrats on the good quarter.
[Operator Instructions] We have a question from Ben Cherniavsky.
It's a different world from when we spoke last. So you guys have done a good question, answering all the questions that I already had. So I won't belabor anything.
Okay. Well, Ben, keep safe and your province is doing good.
We are doing well. Yes, we're -- I hope you guys get out of this quickly, too.
Thank you.
Thank you.
[Operator Instructions] And we do not have any telephone questions at this time. I will turn the call over to presenters.
Thank you very much, everyone, to be on the call and to have a listen to us, and we appreciate your confidence towards our company and your interest towards on company, and believe me, and we're doing everything we can to -- to navigate through this turbulence. And again, like I said before, as I'm very proud of the team, and we're very -- we're well equipped to weather this storm ahead of us. So thank you very much for attending the call, and stay safe. Goodbye.
Thank you. Ladies and gentlemen, this concludes today's conference call. You may now disconnect.