Héroux-Devtek Q4 2023 Earnings Call Transcript

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May 18, 2023

There are 8 speakers on the call.

Operator

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Herudevtech's Fiscal 2023 4th Quarter and Fiscal Year Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Today's conference call. 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. Today's conference call. 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 am Eastern Time.

Operator

Mr. Martin Brassard, President and Chief Executive Officer and Mr. Stephane Arsenault, Vice President and Chief Financial Officer of Heroux DevTech. Mr. Brassard, please go ahead.

Speaker 1

Thank you very much, Sylvie, Good morning, everyone. On behalf of all of us here in Longueuil, welcome to our 4th quarter the fiscal 2023 earnings conference call. As usual, I invite you to follow along by referring to the financial statements, MD and A press release and presentation, which can be found in the Investors section of our website. During the Q4, we continued to improve our financial performance, and I am proud to say that we We generated $156,000,000 of sales last quarter, Bringing our second half total to $297,000,000 We continue to operate in a challenging the company's financial results and dynamic environment. The situation is improving, but we are still facing headwinds.

Speaker 1

Labor availability remains a constraint for us and for our supply chain, 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, OEM's 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 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.

Speaker 1

I would like now to turn it to Stephane to discuss our Q4 results.

Speaker 2

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 and A issued earlier today. In Q4, sales for the quarter rose 5.8% year on year to $156,000,000 Compared to $147,500,000 last year and $140,900,000 in Q3 of this year. Sales were up 28.9%, mainly driven by increased delivery for the Boeing 777, Embraer Creator and Dassault Falcon 6X program, while defense sales were relatively stable at 107,100,000 Foreign exchange had a positive impact of $6,000,000 on sales compared to last fiscal year.

Speaker 2

Gross profit decreased to 14.6 percent 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 $9,900,000 or 6.2 percent of sales, down from $11,500,000 at this time last year, Reflecting the lower gross margin and higher selling and administrative costs. Similarly, adjusted EBITDA reached $19,600,000 up from $14,100,000 in Q3, but lower compared to $22,100,000 in Q4 of last year. Net income So that's $6,300,000 or $0.18 per share compared to $11,500,000 or $0.33 per share last year. Cash flow related to operating activity reached $4,500,000 in the quarter, reflecting lower profitability and an investment in inventory to stabilize our production system and mitigate the effect of supply chain delays.

Speaker 3

At the end

Speaker 2

of Q4, our financial position was solid with net debt at 165,000,000 Thank you.

Speaker 1

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 constraint remain and the Kill Aerospace labor market is exceptionally tight. However, we are pleased with our backlog, 1st, 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 suppliers operation to better track manage quality and delivery. 2nd, we are reexamining our production processes to identify efficiency gains, whether through streamlining processes or by optimizing automation in our machining centers of excellence.

Speaker 1

These measures can all be implemented with limited additional capital requirements. 3rd, We are reviewing our pricing structure with customers and suppliers to offset the effect of inflation and conversation with stakeholders have been constructive a successful company. Our strong balance sheet allows us to take steps to facilitate production such as investing inventory the company's Q and A. Looking ahead, we have a record backlog, a strong team and opportunities for margin improvements. As a trusted supplier 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 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.

Speaker 1

Another step towards stabilizing our production system the call. The renewal of our Longue 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 1800 employee worldwide, who have put in countless effort and hard work an effort for the benefit of our customers.

Speaker 1

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 months. Sylvie, we are now ready to answer questions.

Operator

Thank you, sir. To. And your first question will be from Konark Gupta at Scotiabank. Please go ahead.

Speaker 4

Thanks, operator. Good morning, Mac and Stephane. How are you?

Speaker 1

Good morning. Thank you. Yes, Will.

Speaker 4

Great. Congrats on a good quarter, given the challenging environment. 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, etcetera. But when we look at your margin performance over the last four quarters, so you have 10% margins in 2 quarters and 12% plus in 2 quarters.

Speaker 4

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 That's kind of driving the quarterly variation.

Speaker 2

Well, first, there's a volume. Obviously, in the year, We had volume in the Q1 at $114,000,000 right. So this was very low. In the back in the last 6 months, we have experimented more the inflation, right, on our costs. So Over at cost, utilities, supplies and maintenance, we are seeing that and that's why We're focusing on reducing those costs, but Also looking at with our customer on some adjustment on the pricing.

Speaker 4

Okay. Makes sense. Thank you. 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 your plan to do with customers?

Speaker 2

Well, right now, I think we're 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 It's really to stabilize a month by month. So like we don't have the wave that we Currently have at the end of the quarter, the end of the last month and the last week. So that's the focus now.

Speaker 4

Okay, perfect. Thanks. 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?

Speaker 1

So we are very confident. We have the orders deliver a strong throughput. Obviously, our manufacturing plan is higher Then we're delivering on a quarterly basis. So we're very confident with these orders to improve and maintain our production system to deliver our already spoken to. So we have the orders.

Speaker 1

And then with these orders and a stable flow, like Stephane said, coming from the supply chain and From our manufacturing plan, machining plan, margin should improve.

Speaker 4

Okay. That makes sense. Thanks a lot for the questions. Thank you.

Speaker 1

Thank you.

Operator

Next question will be from Tim James at TD Securities. Please go ahead.

Speaker 5

Thank you. Good morning, everyone. 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?

Speaker 5

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 when things normalize, you can bring that down again.

Speaker 1

Absolutely. I can give you few examples, but it's mainly in many programs, right. So like We have industrialized that orders, so we are industrializing it. That one is This inventory is higher than what we should be, because we have 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.

Speaker 1

We also have some development Program that we're working on at our engineering, namely classified defense program That 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 the systems, 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 demands for Seville business jet like the Embraer 1.

Speaker 1

We performed well on this, right? And that's a good one also, but it's contributing and growth Right, Stefan, did I forget? Do I There are

Speaker 2

mixed tax entrants into service, right, and 777 rate is, as As you know, has increased, it's increasing. So I think it's really reflective of the growth we're seeing in our Both Seville program and the new program that Martin described on the defense side.

Speaker 5

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 I mean, is it a balance of both? If we weren't in this supply chain sort of challenged market, would inventory investments have been less?

Speaker 5

I guess is where I'm going. It's a combination of both of those things driving inventory higher. Is that correct?

Speaker 1

Yes, that's correct. That's correct. Okay. Inventory turns should be between 3 to 4 turns, right?

Speaker 5

Greg. Okay. My next just a quick question on the F-eighteen. You've called that out as one of the drivers growth there in the defense business for the top line for revenue. Through what period does that revenue continue to grow on a year over year basis?

Speaker 5

So 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?

Speaker 6

Which program? Sorry.

Speaker 2

The F-eighteen. The F-eighteen. Okay.

Speaker 1

The F-eighteen, I think, So we have delivered many products in the aftermarket and also the OE business. Now we are entering into the phase 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 had 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 repair.

Speaker 7

Okay, great.

Speaker 1

And then

Speaker 5

just my last question turning to Sessa. 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?

Speaker 1

I cannot talk about it now. But there's some growth opportunity. There's 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.

Speaker 1

So Stefan, do you have anything to complement there?

Speaker 2

No, no. We have a strong demand on our product, right, Spares Aftermarket Existing Business. I mean, it's the demand is there, etcetera. And you have the ramp up of the Boeing actuators, right, that we have announced 2 years ago. So we're going to complete the ramp up

Speaker 1

Thank you, okay.

Operator

Thank you. And your next question will be from Cameron Doerksen at National Bank Financial. Please go ahead.

Speaker 1

Yes, thanks. Good morning. Good morning. Good morning.

Speaker 7

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?

Speaker 2

Good point. Well, it's receivable when Martijn described the amber and men earlier in the call. I mean, we're still heavy loaded at the end of the quarter. So the receivable are reflecting this. It's really the timing of our sales.

Speaker 2

So it's heavy loaded at the end of the quarter and that's why receivable IRR.

Speaker 7

Okay. And as 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 You can actually start to unwind some of this by the end of the year.

Speaker 2

As the production system stabilizes, right, That we are more comfortable at some point. You need less inventory than what we need today. And this will also reflect a more balanced sales in the quarter and No receivable at a level that is more as what we've seen directly.

Speaker 7

Okay. And maybe to that point on the supply chain and the throughput, I mean, you've talked about You're kind of hitting that $150,000,000 per quarter run rates and kind of stabilizing that for this year. Are you still I mean, obviously, there's going to be Quarter to quarter variability here. We understand that. But are you fairly comfortable that you're kind of at that roughly $150,000,000 per quarter kind of run rate Where you feel comfortable around stability of the supply chain?

Speaker 1

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.

Speaker 1

And that's what we our manufacturing Our production plan, that's what we're targeting. And that's what it supports.

Speaker 7

Okay. Okay. That's helpful. Maybe just a final thought here on M and A. Is that something you're still looking at?

Speaker 7

Obviously, supply chain is a distraction here.

Speaker 1

Sorry, Cameron. I just want to To remind you that the second quarter is also 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. All right.

Speaker 7

Right, right. Yes, no, understood. Yes, there's obviously going to be seasonality quarter to quarter. So maybe just some thoughts around M and A. Is that something that's still Kind of on the table for you or do we more focused on the supply chain for this year and M and A is kind of put On the back burner for now.

Speaker 1

Well, it's not our focus, M and 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 and M and A, however, Depending on the size, depending on the strategic nature of the M and A, of course, we need to look at it, right? Of course, we need to look at it, Because we believe that we have a solid business.

Speaker 1

We financially are 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?

Speaker 7

Okay. Absolutely. So I appreciate the thought. Thanks very

Speaker 2

much. Yes. Thank you. Thank you.

Operator

Your next question will be from Benoit Poirier Ed Desjardins Capital Markets. Please go ahead.

Speaker 6

Yes. Good morning, Martin. Good morning, Stephane, and congratulations for

Speaker 1

Thank you very much, Benoit. Good morning. Yes.

Speaker 6

Last quarter, you talked about some key actions to improve margins, which include, obviously, qualifying new sources, increased automation and 3rd, 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 2024.

Speaker 1

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 are 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 at the machining in our manufacturing site everywhere.

Speaker 1

So machining site is Springfield, Kitchener, Cambridge and Nottingham, very good results there. So we're seeing some improvement 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 with best practices and implemented in each of the machining sites.

Speaker 1

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 to discuss because we're not there to arm their business.

Speaker 1

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 this takes time. So but there's some improvement being made.

Speaker 6

Okay. And just in terms of hiring efforts, where are you in terms of having the right amount of people to deliver the 150,000,000 throughput, Martin?

Speaker 1

We do have the right amount of people. Maybe, let's say 3%, 5% here and there because it's the balance. It's the nature of the turnover Benoit. Sometimes we do have when we leave, we replace We have a very good team here in the human resource team. We are able to replace.

Speaker 1

We stabilized it somewhat in the last quarter. And that's also but I'm prudent, right? I'm prudent optimistically, because you never know. 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 departures and turnover.

Speaker 6

Okay. And with respect to the big order we saw with NetJets and Embraer on the Creator 500, If you look at Embraer's comment on the last conference call, there is a steep increase in production rate that is For the foreseeable future on the Creator, 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?

Speaker 1

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.

Speaker 6

Okay. That's great color. And how should we be thinking about, Martin, on the impact on the backlog? Is it something that should be added to your backlog At the end of Q1.

Speaker 1

Sorry, could you repeat?

Speaker 2

Is this going to translate to firm beyond the 250 order.

Speaker 1

Oh, 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?

Speaker 6

Yes. Yes. Okay, perfect. And just in terms of backlogs, stable last quarter still very strong. How would you qualify your bidding the pipeline right now.

Speaker 6

And maybe if you could talk about the opportunities you see for actuation system now that you're

Speaker 1

Yes, it's fine. But We have delivered we have designed, developed 2 critical system for our contracts 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.

Speaker 1

And also, don't forget UF, the passenger to freighter conversion program that we're still developing for Those are also opportunities that we're working, but we need to digest those. We need to deliver on the customer expectations And then ramp up production.

Speaker 6

Okay. And maybe last one for me. The MQ25 initial operational Catedotia has been delayed somewhat by another 10 months by the U. S. Navy.

Speaker 6

Any short term impact for you?

Speaker 1

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 or Whatever you can say that the qualification customer is very happy. We're waiting for the production now.

Speaker 6

Okay. Okay. Thank you very much for the time.

Speaker 1

Thank you, Benoit. Thank you.

Operator

And your next question will be from Jonathan Lammers at Laurentian Bank Securities. Please go ahead.

Speaker 3

Thank you.

Speaker 1

Good morning. Good morning.

Speaker 3

Good morning. There was a very strong step up in the Civil sales in particular sequentially from the Q3, they were up by about $15,000,000 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?

Speaker 1

There's volume improvement maybe.

Speaker 3

So based on the contract discussions you're having, do you have visibility to any improvement in pricing flowing through later this year?

Speaker 1

Yes. So indexation formula will kick in, right, Namely for Civil Products. So it should improve our sales pricing. Yes.

Speaker 3

Okay. Thanks. Stephane, I believe in some prior quarters you provided EBITDA Margin Bridge. Do you have any of those figures in front of you?

Speaker 2

Well, we're going to publish something, but if you have specific questions, it's not a problem you can ask.

Speaker 3

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. The margin improvement that we saw all from the higher volumes, it sounds like there was no benefit of inflation. And then just I'd just like to know if the production or the product mix were worse versus the prior quarter, that's all?

Speaker 2

Yes. Volume is the key driver when you look at Q4 versus Q3.

Speaker 1

Right.

Speaker 2

And on the cost side, what we We saw the same team in Q4. So it's Inflation in the specific cost is not going away for supply, maintenance and utilities, but yes, we see some, Let's say improvement on that side on the utility costs in Europe, but in Spain, but in UK, we had a fixed contract. So we see a higher cost on that front. So all in all is still higher like Q3

Speaker 3

to Okay, thanks. And the Change in the U. K. Energy subsidy and pricing that just took effect, How are you expecting that to impact margins in the upcoming quarters?

Speaker 2

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 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 that at this stage and this is built up in our fiscal 'twenty four budget.

Speaker 2

So and the pricing with the customer, that's why It's reflective as well. So we're passing that inflation in the UK because it's exceptional. So So net net is still going to be higher than what we experimented this year because of this grant, special grant in the UK,

Speaker 3

Thanks. And we noticed that there were some activity on the NCIB over the past quarter. How are you thinking about using the program for the next fiscal year?

Speaker 2

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'll look at the quarter to quarter, let's say, situation. So but

Speaker 3

Okay. Thanks for your comments.

Speaker 2

Thank you. Thank you, Jonathan.

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