Heroux Devtek Inc
TSX:HRX
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Heroux Devtek Inc
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Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Heroux-Devtek's Fiscal 2023 Fourth Quarter and Fiscal Year 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 18, 2023 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.
Thank you very much, Sylvie, and good morning, everyone. [Foreign Language]. On behalf of all of us here in Longueuil, welcome to our fourth quarter and fiscal 2023 earnings conference call. As usual, 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.During the fourth quarter, we continued to improve our financial performance, and I am proud to say that we have mounted a strong recovery from the beginning of the fiscal year. We generated $156 million of sales last quarter, bringing our second half total to $297 million. We continue to operate in a challenging and dynamic environment. The situation is improving, but we are still facing headwinds. The reliability of the supply chain has an effect on our production system and our ability to deliver products steadily to our customers. Labor availability remains a constraint for us and for our supply chain, and inflation continues to negatively impact our cost.Fiscal 2023 was a year of adjustment for the aerospace industry. After a significant 2-year drop in civil aerospace demand, we've seen a rebound in the demand for civil products. As a result, OEMs order books are filled with orders for new aircraft as well as aftermarket parts and services. In fact, OEMs are raising their delivery guidances for calendar 2023 and on. Meeting this demand efficiently in the current global production environment while facing the effect of inflation is challenging. Our last quarter results are a testament to our ability to navigate the current challenges, but there's still work to be done. Specifically, our production is still more heavily loaded towards the end of each quarter than we would like to. This has led to cost inefficiencies that, combined with the raising prices for production supplies are keeping our margin lower than they should be.I would like now to turn it to Stephane to discuss our Q4 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, adjusted net income and adjusted EPS. All non-IFRS measures are defined and reconciled in the MD&A issued earlier today. In Q4, sales for the quarter rose 5.8% year-on-year to USD156 million compared to USD147.5 million last year and USD140.9 million in Q3 of this year. Civil sales were up 28.9%, mainly driven by increased delivery for the Boeing 777, Embraer Praetor and Dassault Falcon 6X program, while defense sales were relatively stable at $107.1 million. Foreign exchange had a positive impact of $6 million on sales compared to last fiscal year.Gross profit decreased to 14.6% of sales compared to 17.6% last year due to production system disruption and the impact of inflation on our cost supplies and utilities. Last year, gross profit was also bolstered by pandemic relief measure representing 0.7% of sales. Operating income totaled $9.9 million or 6.3% of sales, down from $11.5 million at this time last year, reflecting the lower gross margin and higher selling and administrative costs. Similarly, adjusted EBITDA reached $19.6 million, up from $14.1 million in Q3, but lower compared to $22.1 million in Q4 of last year.Net income stood at $6.3 million or $0.18 per share compared to $11.5 million or $0.33 per share last year. Cash flow related to operating activity reached $4.5 million in the quarter, reflecting lower profitability and an investment in inventory to stabilize our production system and mitigate the effect of supply chain delays. At the end of Q4, our financial position was solid with net debt at $165 million compared to $152.1 million at the end of last year.Back to you, Martin.
Thank you. As we close the book on an exceptionally challenging year for the industry in terms of supply constraints, we look ahead with prudent optimism. To be clear, supply chain constraints remain and the skilled aerospace labor market is exceptionally tight. However, we are pleased with our backlog, which is near a record level, and our focus remains on 3 priorities to deliver on it and return to higher level of profitability.First, we will continue to work on restoring health to our supply chain and therefore, stabilizing our production system. We are continuing to qualify new sources of supply and strengthen our presence in our supplies operation to better track and manage quality and delivery. Second. We are reexamining our production processes to identify efficiency gains, whether through streamlining processes or by optimizing automation in our machining centers of excellence. These measures can all be implemented with limited additional capital requirements. Third, we are reviewing our pricing structure with customers and suppliers to offset the effect of inflation and conversation with stakeholders have been constructive and ongoing.To achieve these priorities, we are fortunate to be able to draw on Heroux-Devtek's long-standing history as a successful company. Our strong balance sheet allows us to take steps to facilitate production such as investing in inventory and growth projects. Looking ahead, we have a record backlog, a strong team and opportunities for margin improvements. As the trusted suppliers of systems and components for critical platforms, we are well positioned to capitalize on the attractive growth rate in demand for defense, large civil and business aircraft as demonstrated by the recent Embraer announcement of their NetJets order for up to 250 Embraer Praetor Jets. As a reminder, we have developed a landing gear system for this aircraft, which entered in service in 2014 and now counts more than 250 aircraft in services.Another step towards stabilizing our production system is the renewal of our Longueuil facility collective bargaining agreement, which now extends to April 2026. This agreement covers approximately 200 employees and planned 12% salary increases over the next 3 years. The revised agreement also features amendment, which will improve the flexibility and agility of our operations. I want to express my deep appreciation and gratitude to our 1,800 employees worldwide who have put in countless effort and hard work and effort for the benefit of our customers. With their support and dedication, we are confident in our ability to deliver continued success. Thank you for your support, and I look forward to updating you on our progress in the coming monthsSylvie, we are now ready to answer questions.
[Operator Instructions] And your first question will be from Konark Gupta at Scotia Bank.
Great. Congrats on a good quarter given the challenging environment. My first question is on the margins actually. I know you noted a lot of things with respect to how production systems are still not fully back to normal and labor availability issues, supply chain, et cetera. But when we look at your margin performance over the last 4 quarters, so you have 10% margins in 2 quarters and 12% plus in 2 quarters. I know it's not really a consistent track or path for margins here. So can you explain us what's really happening with the margins here from quarter-to-quarter? What's really driving this fluctuation? Is it the mix? Or is it really the stability of the supply chain and production that's kind of driving the quarterly variation?
Well, first, there is a volume. Obviously, in the year, we had volume in the first quarter at $114 million, right? So this was very low. In the back -- in the last 6 months, we have experimented more the inflation, right, on our [ work cost ]. So overhead cost utilities supplies maintenance. We are seeing that, and that's why we're focusing on reducing those costs, but also, also looking at -- with our customer on some adjustment on the pricing.
Okay. Makes sense. And I know you mentioned on the dependence on the end of the quarter for production. Is there anything you can do to make it more smooth over the quarter or not even at the end of the quarter, but maybe like middle of the quarter or something. Is there anything you are doing right now or you're planning to do with customers?
Well, right now, I think we're focusing on supply chain as Martin has described in previous quarters. So we have people at suppliers place to make sure that we get our parts on the manufacturing production. It's really where we see for the parts we manufacture to have, obviously, the higher delivery at the beginning of the quarter, so we can translate that into sales. So I think that's for now the focus is really to stabilize month by month. So like we don't have the waste that we currently have at the end of the quarter, at the end of the last month and the last week. So that's the focus now.
Okay. Perfect. And last one before I turn it over. The backlog looks pretty solid here, not too far off from what you saw in the previous quarter. How much of this current fiscal year, fiscal 2024 revenue would you say is in the backlog right now? And what's your sense on the margin progression this year?
So we are very confident we have the orders to deliver a strong throughput. Obviously, our manufacturing plan is higher than we're delivering on a quarterly basis. So we're very confident with these orders to improve our -- and maintain our production system to deliver our already spoken to. So we have the orders. And then with these orders and a stable flow, like Stephane said, coming from the supply chain and from our manufacturing plan, machining plant, margin should improve.
Next question will be from Tim James at TD Securities.
Just wondering if you can provide a little bit of additional color on the inventory investments that you took on in the quarter. Are there any particular programs that are notable in there? Is it more defense? Is it more commercial? Just any sort of additional insights? And maybe if you can reflect on, is this sort of current level of inventory, sort of a new run rate that should continue going forward? Or do you anticipate a time, whether it's a couple of quarters or a couple of years from now where you could kind of recover some of that inventory investment and then when things normalize, you can bring that down again.
Absolutely. I can give you few examples, but it's mainly in many programs, right? So like F-15, we have industrialized at orders, so we are industrializing it. That one is inventory is higher than what we should be because we had a few parts that are needed to be more reliable on the production system in terms of quality as soon as we fix that, and we're almost there, we should see better throughput on that program and a reduction there.We also have some development program that we're working on at our engineering, namely, namely classified defense program that's also contributing to increase inventory because we are prototyping the test article as we speak. And then we don't delay the orders. So obviously, we're not aiming for the perfect reception on the supply chain, right? So we get the parts in, so because we need all the parts to make those systems, right?And also the development program, we have the Falcon 10X, that we are currently certifying in the test campaign in qualification test campaign. So that's a commercial program. And obviously, there's a lot of demand for civil business jet like the Embraer one. We performed well on this, right? And that's a good one also that is contributing and growth is seen, right. Stephane, did I forget to...
[ Entrants ] into service, right? And 777 rate is, as you know, has increased, is increasing. So I think it's really reflective of the growth we're seeing in our both civil program and the new program that Martin described on the defense side.
Okay. That's really helpful. Maybe if I could just help me understand, just summarizing it. If I think about the inventory investment in the quarter, is it equally balanced between sort of growth or needs because of growth in programs and sort of dealing with existing supply chain challenges? I mean, is it a balance of both? If we weren't in the supply chain sort of challenged market, would inventory investments have been less, I guess, is where I'm going. It's a combination of both of those things driving inventory higher. Is that correct?
Yes, that's correct. That's correct. Inventory turns should be between 3 to 4x, right?
Okay. My next -- just a quick question on the F-18. I know you've called that out as one of the drivers of growth there in the defense business for the top line for revenue. For what period does that revenue continue to grow on a year-over-year basis? And when does it -- I'm trying to just get a sense for when it sort of reaches what you believe will be sort of a steady rate for you.
For which program, sorry.
The F-18.
The F-18, okay.
The F-18, I think -- so we have delivered many products in the aftermarket and also the OE business. Now we are entering into the phase of MRO, as you know. So those sales, the sales of aftermarket will reduce, but it will be compensated by the MRO activity that we're still expecting from the Navy. We have a few assets to repair, and we're expecting more to come. So the challenge here is to get the asset in the shop to fully. So we're ready. We have the people, but we don't have enough asset yet to prepare.
Okay. Great. And then just my last question, turning to [ spares ]. I'm just wondering if you could give us a bit of an update on that business today. What are the key programs there, key platforms now? And any opportunities you might be looking at for that particular business?
No, I cannot talk about it now. But there is some growth opportunity. There are some projects that we're working on well in advance, but -- so again, the demand is there. We have interesting things on the table, right, in terms in all the segments. So Stephane, do you have anything to complement there?
No, no. We have a strong demand on our product like spares aftermarket existing business. I mean it's -- the demand is there, et cetera, and you have the ramp-up of the Boeing actuators that we have announced 2 years ago. So we're going to complete the ramp up in the coming quarters. But new program has -- I mean there's a lot of new things like also in the equation.
And your next question will be from Cameron Doerksen at National Bank Financial.
So I wanted to follow up on a couple of the questions around inventory, working capital. You explained the inventory investment fairly well, but there was also a pretty big increase in accounts receivable in Q4. So I'm just wondering if you can maybe talk about that. And I guess maybe overall, what your expectation is for kind of working capital investment or maybe cash from working capital in the next fiscal year?
Good point. I'll let, receivable when Martin described the environment earlier in the call, I mean, [ we were still heavy ] loaded at the end of the quarter. So the receivables are reflecting this. It's really the timing of our sales. So it's heavy loaded at the end of the quarter, and that's why receivables are higher.
Okay. And if you look ahead for the next 12 months, I mean, what's your expectation for working capital investment overall? I mean, should we expect another big investment in 2024? Or do you think it's -- you can actually start to unwind some of this by the end of the year?
As the production system stabilizes, right, that we are more comfortable at some point you'll need less inventory than what we need today. And this will also reflect a more balanced sales in the quarter and receivable at the level that is more at what we've seen directly.
Okay. And maybe to that point on the supply chain and the throughput, I mean, you've talked about kind of hitting that $150 million per quarter run rate and kind of stabilizing that for this year. Are you still -- and obviously, there's going to be some quarter-to-quarter variability here, we understand that. But are you fairly comfortable that you're kind of at that roughly $150 million per quarter kind of run rate where you feel comfortable around stability of the supply chain?
Yes, we have our plans. Our plans support this. It will be a question of the reliability of the supply chain. But yes, things are improving. And that's what we -- our manufacturing plan, our production plan, and that's what we're targeting. And that's what it supports.
Okay. Okay. That's helpful. Maybe just a final thought here on M&A. Is that something you're still looking at, obviously, supply chain distraction here.
Sorry, Cameron. I just want to remind you that the second quarter is also in a quarter that historically is lower, right, because of summer shutdowns and things like that, and we see a bit of impact in Q1. So I just want to remind you this, right?
Right. Right. Yes. No, understood. Yes. There's obviously going to be seasonality quarter-to-quarter. So maybe just some thoughts around M&A. Is that something that's still kind of on the table for you? Or is -- or do we more focus on the supply chain for this year and M&A is kind of put on the back burner for now?
Well, it's not our focus, M&A. It's more -- the focus is more on getting back, restoring the production system, get the throughput stabilized, generate the target that you just mentioned, right, improve our margin, right? And the M&A, however, depending on the size, depending on the strategic nature of the M&A, of course, we need to look at it, right? Of course, we need to look at it, because we believe that for the -- we believe we have a solid business, we financially, or you know our conservatism with the balance sheet. We have a strong balance sheet, and we'll look at it. But on the long term, we have a solid business, and we believe that we can build on this, right?
Your next question will be from Benoit Poirier at Desjardins Capital Markets.
Yes, congratulations for the improvement over the last quarter. Yes. Last quarter, you talked about some key actions to improve margins, which include, obviously, qualifying new sources, increased automation; and third, review pricing with customers. So could you talk about the progress made in the quarter on each of those initiatives? And what needs to be done in fiscal year '24.
So basically, on restoring, we're still increasing our presence, our suppliers to get the parts in, making sure that we have the right systems, the right signal. We have not finalized our resourcing or sourcing different projects. So we have a few items here and there. So some progress has been made, but it's not as fast as we would like to, all right?On the automation. So we're seeing some very good progress as we speak. We're increasing the level of unattendance and the machining in our manufacturing site everywhere. So machining site is Springfield, Kitchener, Cambridge and Nottingham very good results there. So we're seeing some improvement in unattended hours, and we need to continue. So programs are being updated, toolings are being changed. So I'm happy with the progress we're making right there. But again, it takes time. So I would like to have it faster. But we have -- the team has a solid plan and they're sharing all information from one side to the other. We have weekly calls or by monthly, let's say, every 2 weeks where everything [ every ideas or share ] with best practices and implemented in each of the machining sites.In terms of the pricing structure, pricing revision, obviously, we're working with our customer. We're being transparent with them. We're showing all of our costs. We're showing the detail of our operation, and then we have a discuss because we're not there to arm their business. We're just there to explain the situation, and we are discussing about ways of how we can do both be better. So we have some constructive discussion with the targeted customers that we target, the first ways that we target. And there's some improvement. But again, the same time. So -- but there's some improvement being made.
Okay. And just in terms of hiring efforts, where are you in terms of adding the right amount of people to deliver the $150 million throughput, Martin?
We do have the right amount of people, maybe it's 3%, 5% here and there because it's the balance. It's the nature. It's the nature of the turnover, Benoit. Sometimes we do have when we leave, we replace quite -- we have a very good team here in the human resource team, we are able to replace. And we stabilize it somewhat in the last quarter. And that's -- it's also -- but I'm prudent, right? I'm [ not ] prudent optimistically because you never know. It's every day is a different day. So I'm remaining prudent, but we have the people, and we have been able to cope and to fulfill those departure and turn over.
Okay. And with respect to the big order we saw with NetJets and Embraer on the Praetor 500. If you look at Embraer's comment on the last conference call, there is a steep increase in production rate that is expected for the foreseeable future on the Praetor. Is it something that you can deliver? And what are the actions you can undertake to make sure that you deliver on Embraer's initiatives?
We have increased significantly our production rate in the last 2 years. It's very difficult for me to comment on their announcement. But we're not impacting the delivery line, let's say.
Okay. That's great color. And how should we thinking about Martin on the impact on the backlog? Is it something that should be added to your backlog at the end of Q1?
Sorry, could you repeat that...
Is this going to translate to far beyond the 250 order...
Eventually. Eventually, it's going to transfer into POs, but now it's an order that will be delivered, I believe, and don't quote me there, right? I believe it's going to be over 10 years, right?
Yes. Yes. Okay. Perfect. And just in terms of backlog, stable last quarter, still very strong. How would you qualify your bidding pipeline right now? And maybe if you could talk about the opportunities you see for actuation system now that you're ramping up a nice contract with Boeing. Just wondering if it could provide you more opportunities on actuation system as you build up your reputation on that front?
[ Actually ], but we have delivered -- we have designed, developed to, to critical system for our contracts and in Spain, replacing supply chain on defense programs. So that's also an opportunity, right? So that's also a significant accomplishment. So we have 2 programs, namely that we had some performance issue that we are developing programs or products, so with the Spain.And also don't forget you have the passenger to freighter conversion program that we're still developing for Embraer. Those are also opportunities that we're working. When we need to digest those, we need to deliver on the customer expectation and then ramp up production.
Okay. And maybe last one for me [ then 225 ] initial operational capability has been delayed somewhat by another 10 months by the U.S. Navy. Any short-term impact for you?
No, no, no, no. We're well advanced into the qualification. We're going to be waiting for LRIP production orders, right? So we have been exceeding or meeting or advancing whatever you can say that the qualification customer is very happy, we're waiting for the production now.
[Operator Instructions] And your next question will be from Jonathan Lamers at Laurentian Bank Securities.
There was a very strong step-up in the civil sales, in particular, sequentially from the Q3. They were up by about $15 million. That's more than we would have expected based on seasonality. Was that all volume improvement? Or was there some pricing improvement from the contract discussions that you talked about, was there any pricing in the sequential step-up we saw?
It's volume improvement mainly.
So based on the contract discussions you're having, do you have visibility to any improvement in pricing flowing through later this year?
Yes. So indexation formula will kick in, right, namely for civil product. So it should improve our sales pricing. Yes.
Okay. Stephane, I believe in some prior quarters, you provided an EBITDA margin bridge. Do you have any of those figures in front of you?
Well, we're going to publish something. But if you have specific questions, it's not a problem you can ask.
Well, clearly, the volume improvement would have been one driver of the margin step-up. It sounds like product -- like I don't know if you want to go through it versus the prior quarter, but that's kind of what I'm the most interested in. Is the margin improvement that we saw all from the higher volumes. It sounds like there is no benefit of inflation. And then I'd just like to know if the production or the product mix were worst versus the prior quarter at all?
Yes. Volume is the key driver when you look at Q4 versus Q3. And on the cost side, what we experimented in Q3, we saw the same thing in Q4. So it's inflation in the specific cost is not going away for supply maintenance and utilities. But yes, we see some some, let's say, improvement on that side on the utility gas in [indiscernible], but in Spain, but in U.K., we had a fixed contract. So we see higher costs on that front. So all in all, it's still higher like Q3 compared to historical level for utility costs for us.
Okay. And the change in the U.K. energy subsidies and pricing that just took effect, how are you expecting that to impact margins in the upcoming quarters?
Yes. Good question. So this is ending at the end of March. At the same time, as I said, when you look at the indices, we see that it's going in the right direction for us. So the cost has reduced from December to today, and we are looking at opportunity maybe to fix that cost. We are looking at, at this stage. And this is built up in our fiscal '24 budget. So -- and the pricing with the customer, that's why it's reflected as well. So we're passing that inflation in the U.K., because it's exceptional. So net-net is still going to be higher than what we experimented this year because of this grant, special grant in the U.K., but the cost is going down. So...
And we noticed that there was some activity on the NCIB over the past quarter. How are you thinking about using the program for the next fiscal year?
Well, this -- the NCIB is expiring, right, in May. So we have not put yet a new one in place. So we'll look at that and we look at the quarter-to-quarter, let's say, situation. So -- but this one is expiring now, and there's not one starting right after.
And there are no further questions at this time. Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect your lines.