Héroux-Devtek Inc. (OTCPK:HERXF) Q1 2023 Earnings Conference Call August 5, 2022 11:30 AM ET
Company Participants
Martin Brassard – President & Chief Executive Officer
Stéphane Arsenault – Vice President & Chief Financial Officer
Conference Call Participants
Konark Gupta – Scotia Capital
Benoit Poirier – Desjardins Bank Capital Markets
Cameron Doerksen – National Bank
Tim James – TD Securities
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 Héroux-Devtek Fiscal 2023 First Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions].
Before turning the meeting over to management, please be advised that this conference call will contain statements that are forward-looking and subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. We refer you to Slide 2 of the accompanying presentation available on the company’s website for the complete forward-looking statements.
I would like to remind you that this conference call is being recorded today Friday August 5, 2022 at 11:00 a.m. Eastern Time. And I would like to turn the conference over to Mr. Martin Brassard, President and Chief Executive Officer; and Mr. Stéphane Arsenault, Vice President and Chief Financial Officer of Héroux-Devtek. Please go ahead.
Martin Brassard
Thank you very much, Sylvie. Good morning, everyone and welcome to our first quarter earnings conference call for fiscal 2023. I invite you to follow along by referring to the financial statements, MD&A and press release, which can be found in the Investors section of our website.
Our financial results for the first quarter fell short of our objectives, as we generated less sales than planned. However, our manufacturing activities create value and demonstrate by the $17 million increase of our inventory level when compared to March 31st. As a matter of fact, our revenue profile is shifting to the right.
Before going into further detail about our results, I’d like to spend a few minutes on the industry macro environment. Passenger traffic is continuing to recover from the pandemic and 2019 levels should be within reach in 2023 or 2024. Growth in China’s traffic and global COVID-19 restrictions remain key drivers of full recovery. Following recently published – their annual commercial market outlook study for new airplanes demand and still predict that more than 41,000 aircraft will be produced over the next 20 years. This represents an average of 2,000 airplanes per year and is mainly driven by the customer demand fleet renewal and the expected long-term increase in passenger traffic. More than 25% of this 20-year demand is already in the order book of Airbus and Boeing.
Demand for business jet aircraft has remained robust throughout the pandemic and all major manufacturers plan to increase their production rates as a result. In addition to optimistic, demand forecast for civil aerospace market segment, the current geopolitical environment continues to drive global defense budget higher.
Most NATO countries reaffirm the commitment to invest at least 2% of their GDP in defense as demonstrated in the recent announcement of Canadian, Finnish and German government to buy F-35 fire jets as well as the announcement of the German government to buy 60 CH-47 helicopters. Closer to us, the US defense budget is expected to increase to $813 billion from the $773 billion announced in March of this year.
As you can see, demand is not an issue for the aerospace industry. The challenge we all face is to produce consistently and steadily, due to the near-term challenge caused by supply chain disruption, inflation and labor constraint. The COVID-19 pandemic continued to contribute to higher absenteeism both in our facility and in our supply chain.
In the first quarter alone compared to the same period last year, we have observed four times more positive cases. The safety of our employees is important to us and the protocols are still in place in our facilities to avoid community transmission. This obviously caused some distraction to our production system.
Workforce constraints were and are an issue for us and our industry. Skilled labor is necessary to produce airplanes and we are facing difficulty filling vacancies in many sectors in the industry. However at Héroux-Devtek, we have had some success mitigating this issue as we have 95% of the required resources in place to execute our plan. Nevertheless, we are experiencing higher turnover than the historical average.
In addition, Russia’s invasion of Ukraine has led to limited availability of certain raw materials, adding more pressure on the industry production system. We expect these challenging conditions to continue in the near-term. And as a result, we expect higher volatility in our delivery from quarter-to-quarter. We are fully committed to improving our throughput and are working relentlessly to combat these challenges.
We are leaving no stone unturned, taking nothing for granted in our efforts to improve our production system and we are closely — and we are working closely with our suppliers, supporting them in their own challenges.
At this time I would like to turn it to Stéphane for a detailed review of our first quarter results.
Stéphane Arsenault
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. Consolidated sales for the quarter decreased 9.6% to $114.1 million, compared to $126.2 million last year. This decrease is the result of the impact of the current operating environment on the corporation ability to generate throughput.
That lower throughput however was partially offset by the ramp-up of delivery for the F-18 program with Boeing, as well as higher delivery for the Embraer Predator. Gross profit decreased to $12.5 million or 11% of sales from [Technical Difficulty] or 17.1% of sales last year. The decrease is attributable to lower throughput and higher production and efficiency, resulting from the production system disruption in the quarter.
Operating income decreased to $2.6 million or 2.3% of sales from $10.8 million or 8.6% of sales last year. Lower operating income reflects the decrease in gross profit as well as a marginal decline in SG&A expenses. Adjusted EBITDA stood at $11.4 million in Q1 or 10% of sales compared with $20 million or 15.9% of sales a year ago.
Net income for the first quarter of fiscal ’23 stood at $1 million or $0.03 per diluted share from $6.7 million or $0.19 per diluted share in the corresponding period last year. Cash flows related to operating activity reached $12 million in the first quarter down from $19.1 million last year with the decrease reflecting lower net income in the quarter. Given the current supply chain environment, we expect to carry a higher level of inventory during the coming quarters which should help stabilize throughput. Our financial position remained strong at the end of Q1 with net debt at $150 million down from $152.1 million at March 31, 2022.
Back to you Martin.
Martin Brassard
Thank you, Stéphane. While our deliveries for the quarter were lower than what we would have liked, our order book, which builds over a long sales cycle is unimpacted and we are encouraged by the growing demand for our products and services. This morning, we announced a significant agreement with Boeing for the repair and overhaul of the F/A-18 Super Hornet landing gear and side braces. The first phase of the contract covers 40 aircraft and is expected to be followed by options for the sustainment of the complete US Navy fee. This new example — this new contract is a good example of how we are maximizing revenues from a recent program award and it testifies to the strength of our business relationship with long-standing partners.
We believe that transparent communication and collaboration are the foundations of such relationships. To that effect, we had many constructive meetings with our customers and industry partners in Farnborough. Finally while our immediate focus is on delivering to our customers our financial position is strong and allow us not only to cope with the current challenges but also to consider growth opportunities including accretive acquisitions.
We believe we are now ready to answer questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question will be from Konark Gupta at Scotia Capital. Please go ahead.
Konark Gupta
Thanks and good morning everyone. I wanted to understand the absenteeism and the supply chain issue a little bit better. So — thanks for sharing some color in terms of how many — how much resource you have right now versus what you need. Can you provide a couple of things? One maybe in terms of your active working headcount during the quarter versus recent times? And then, I mean how much absenteeism you saw in the quarter? And then, what are sort of your mitigation efforts to kind of reduce impact on production because of absenteeism? Because as you said I think absenteeism is not in your control I mean it may or may not happen and the magnitude may change. But what can you do to mitigate that?
Martin Brassard
So let – to mitigate that inventory though into our as we speak – $17 million increase in the inventory. That’s a mitigation to get the top line and to be able to deliver. So we have many assembling that are missing a few components to be able to deliver. So in terms of absenteeism – so it’s – you can imagine that we have – we had 50 cases last year, and we had 200 cases for the same period this year. So when you multiply that number the five to 10 days of absenteeism that represents significant absenteeism. So, and disruption because we have – when you have an employment in the line that gives some halts in the production system also. So and at the end, it’s – you have something to add Stephane?
Stéphane Arsenault
I said earlier. So I think Martin, you did a communication as well is that not only us, we’re going through that, but the supply chain as well. So this is – we’re having some issues getting some key components and where there was some specific also issue a certain facility for the supply chain right I think. So I don’t know if you want to explain a bit on that?
Martin Brassard
Yeah. So mainly, where we did hit the most on line – all the other analysts that are on the line also – as there’s three facilities that are still short by 48% the other is 45%. So Stéphane and I was – we have – we are looking at this very closely. We’re doing the detailed reviews and we leave no rough unturn there and – to improve these hiccups. So basically these three facilities explain most of the shortfall out of the 15 facility – most of the shortfall that we have compared to our objective.
Konark Gupta
That’s good, color. That seems like a pretty high number for sure in terms of how these facilities are contributing and impacting. Is there any particular geography in your facilities where you’re seeing these issues? Like is it more like Europe or US or Canada?
Martin Brassard
Three countries, three countries facilities with different countries.
Konark Gupta
Okay.
Stéphane Arsenault
That’s on environment. And when I was in Farnborough nothing strange that it would have granted but everybody is dealing the same situation throughout the industry. We were at – in Farnborough. Everybody is talking about how difficult it is right now to deliver product and get their production system the way it used to, right? And we’ve said it many times over the last quarters that there is some disruption. But the sales out there mainly posed]to the right, right – the revenue model posed to the right. The challenge here is to execute and to have a steady production system and everybody is sharing the same thing.
Konark Gupta
All right. And my second question before I turn it over. It’s on the Boeing contract. So congratulations on that. It seems like this is something that you were waiting for some time. And it’s a first F-18 MRO contract I believe. So I want to understand the 40 aircraft that you have in the first phase how long do you have further ramp-up of that contract if you have any ramp there? And then how like how long does the contract run for the entire life of the 600 aircraft?
Stéphane Arsenault
First delivery will be in fiscal 2023-2024 right next fiscal year. And we have three years to deliver the 40 aircraft. So right now, we’re in the long lease item provision, right?
Konark Gupta
Okay. And is that a steady sort of run rate for the next five –?
Martin Brassard
Again to add to the uncertainty, it’s going to depend on how many the customer will spend to us, right? So right now we have built a rotable pool. That’s what we understand right? The Navy has built a rotable pool. Now they need to send through Boeing with the that PBL contract that Boeing has is to send these units to us.
Konark Gupta
And would you have to rebid or bid again on the options or they come to you by default?
Martin Brassard
No. Once you have developed all that and once you have all the options and we’re satisfied, we should be renewed should the US renew the contract with Boeing, right?
Konark Gupta
All right. Okay. Perfect. Thanks for the answer. That’s it for me.
Martin Brassard
Thank you, Konark.
Operator
Thank you. Next question will be from Benoit Poirier at Desjardins Bank Capital Markets.
Benoit Poirier
Hi. Good morning, Martin. Good morning. Could you provide maybe more color about your ability to recover in the coming quarter? If you add up $18 million buildup in inventory to revenue would it be fair to say that revenue would be closer to normal expectation under normal circumstances? What about your ability to recover in the back half? How should we be looking at the sales?
Martin Brassard
We haven’t dropped the ball on our objectives Benoit. The team and all the sites are fully committed to meet the objectives. However, second quarter we’re getting — as you know second quarter we’re getting into the holiday period in Europe and here in Canada and — so that’s what it is. So we should see.
We haven’t dropped the ball to our objective. It’s a tough environment to work in. We are — in terms of — you saw the increase in the inventory. So like I said to Konark inventory is a good friend to us right now in this situation in this environment. And to be sitting on inventory — more inventory is a good thing right now because it gives us ability to deliver throughput.
So as a matter of example in one of the sites we had 100 actuators to deliver with a fair pricing. And because we were missing one part we did not deliver one. Now we’re starting — we’re resuming deliveries in July, right? And we should be meeting these targets should we have stabilized that.
And another subject — we have another site. It’s a three-part number that we could do. We could increase from a revenue of $2 million to $5 million. So if we can get the three-part numbers right we can get to the increase by $3 million throughput. The rest of the components are there.
So it’s a tough — I’m not saying three units it’s a three-part number right? Just to be careful and to be more — so I don’t want to minimize and I don’t want to put my pink glasses there but we need to be realistic and we need to understand the challenge of the environment. And we understand the challenge of the environment and we are adjusting resources accordingly to deliver the throughput.
Benoit Poirier
Okay. That’s great color. Thanks. And what about your ability to pass-through inflation cost and raw material? I’m just wondering how it could impact your ability to sustain kind of a EBITDA margin in the range of 15% 16% that you’ve been able to maintain over the last years?
Stephane Arsenault
Yes, Benoit. Good question but our concern right now is to generate the throughput. We believe that once we generate the throughput to the normal level right we’re going to get to — more closer to historical levels.
Now the same answer to the inflation. We have contracts. We have different type of contracts. We’re in the life of the program contracts. We have escalation class. Those plots have been executed. Those plots have been honored by our customers. So we do have other contracts where the inflation on the raw material is passed for one-to-one with a certain percentage. So the inflation of the raw material is covered and the value add is — we’re taking the risk, but those contracts there have an expiry date from two to three, four years, right? So — and then we have the Square business that it’s on a POP basis. Those — it’s easy to adjust everything that we get in sales right?
Benoit Poirier
Okay. That’s perfect. And you just come back from the Farnborough Airshow. We saw Boeing outperforming Airbus with close to $16.3 billion an announcement Embraer has been successful with the E-2. We saw increased activity in defense. So I was just curious to see if you could provide some highlights and anything positive that stood out for you guys?
Martin Brassard
Well, of course, it gives us an opportunity to meet all of our customers, our industry partners. People are very satisfied with our performance. There is no customer that is unhappy with our — level of our services and delivery so which is a very good thing. We’re all in the same situation. We are sharing. That’s why I was saying every time that we were getting in a meeting with procurement people I was telling them how hard it is in this environment. And everybody answered that there’s never seen such a thing, right?
So demand is there. People are optimistic as to the future. It’s the near-term issues that we need to fix altogether to be able to stabilize our respective production system. So if you look — if you deal with big leaders conference call and earnings release there’s micro ships shortages, there are raw materials shortages staffing and some major systems. So in Farnborough very good meeting, very good relationship with customers. Everybody was happy. The mid-term future is pretty optimistic and shared by everybody.
Benoit Poirier
Okay. And last one for me. Just on the 777X. We saw the recent cancellation from Qatar Airways on the A350s. And the CEO also stated that Boeing may beat its 2025 billable target on the 777X. So I was just curious to see — if you see also this as a possibility and any color on the 777X for this year and next year what we might expect in terms of production rate?
Martin Brassard
Nothing new, Benoit. Nothing new. The backlog is there. The increase in service is a critical thing for Boeing to be able to sell more 777X. So like we said and like Boeing said, there’s two to three airplanes a month combined. They switched 777X to cargo airplanes, delivering the cargo market.
Cargo market is pretty good for them. I believe that we have really more than 75% of the market share there. So I believe that’s what I heard from — when on their call, if I’m not mistaken. You can verify that. So for us, it’s — the critical data is, 777X has the higher entry in service.
Benoit Poirier
That was great. Thank you very much for the time.
Martin Brassard
Thank you, Benoit.
Operator
Next question will be from Cameron Doerksen at National Bank. Please, go ahead.
Martin Brassard
Good morning, Cameron
Cameron Doerksen
Yes. Thanks. Good morning.
Stéphane Arsenault
Good morning.
Cameron Doerksen
Just maybe a couple of questions, just on the production and throughput issues. I just sort of want to make sure I understand, if I think of the margin compression in the first quarter, can we really put that mostly down to the lower throughput? Is that by far the big significant contributor to the lower EBITDA margins?
Stéphane Arsenault
Absolutely. When compared to last year, it’s the most important impact. And if you recall last year, we still had $2.5 million. So the inefficiency have not been disappeared. They have just increased, as explained by Martin. So — but most of the impact comes from the lower throughput.
Cameron Doerksen
Okay. And if I think about, I guess, the trends going forward, am I right to assume that there was — this was probably the worst quarter and that things have maybe gotten a little bit better in your fiscal Q2?
Stéphane Arsenault
We’re certainly aiming for that. That was a bad quarter for us. So we won’t — we certainly want to stabilize the production system.
Cameron Doerksen
Okay. And there was just a — I guess, a comment in your MD&A, just with regarding some of your — I guess, your own supply chain and maybe some concerns about the financial health of maybe some of these companies that supply to you. Can you maybe expand on that a little bit? Are you seeing any of your own suppliers that are maybe facing some financial challenges? And if that’s the case, what can you do about that?
Martin Brassard
Yes, absolutely. So, I’ll give two examples. We have a risk matrix of our suppliers. So we knew we know those suppliers. So sometimes what you do, you starting preparing a second source, right? But you got — just to go to somebody else, it takes a while. It takes nine months before you get paid. Six to nine and maybe a year to get to full production ramp up.
So when you make a decision to develop another source, so it’s a lengthy process. You have to do it first in a call. You have to develop the tooling, the method and then they get the material. So we — I estimate nine months. So as matter of fact — so we have that plan in place, but the supplier assured us by two months or one week — by one month, two month, they said, we got the letter and saying that they’re stop operating at the end of August. So those are type of examples that is happening also.
So you cannot pinpoint to one factor in the current environment. So it’s — and we’ve said it all along. Since the nine — the past nine months or six months we’re saying — like Stéphane was saying, when we were doing our tours. I feel that there’s — you have to place appeal before. You put a date and then the supplier was sending PO on that date. And if they were late they were late by one week.
Now you need to follow up. You have to have boots on the ground. You have to go at your supplier and visit the supplier to get those products in. So that’s the environment that we’re operating in. And we have maneuvers, right? We have — well, we have performed well for the past nine months. Now, it’s — we’re disappointed with these results, but we’re fully committed to recover those shortfalls.
Cameron Doerksen
Great. Okay. No, that’s helpful. I’ll pass the line. Thanks, very much.
Martin Brassard
Thank you.
Stéphane Arsenault
Thank you, Cameron.
Operator
[Operator Instructions] And your next question will be from Tim James at TD Securities.
Stéphane Arsenault
Good morning, Tim.
Tim James
Good morning, everyone. Thanks for taking my call. Just a couple of housekeeping questions, I guess, first. I was just wondering if you can give us a bit of a sense for the backlog at the end of the first quarter.
Stéphane Arsenault
Very stable compared to the year-end.
Tim James
Okay. Then you mentioned —
Stéphane Arsenault
Actually, without putting the recent announcement. Right.
Tim James
Right. Okay, okay.
Martin Brassard
As of the end of the first fiscal quarter, we stated —
Tim James
Yes. Okay. You mentioned about absenteeism and you were kind of comparing it year-over-year with first quarter of fiscal 2022 I believe and you mentioned it’s gone up four times. What about relative to Q4 of fiscal 2022? Like sequentially, what sort of trend have you seen?
Martin Brassard
If we compare to Q4, we were mostly — if you recall in the month of November and January, right? That was where we had — we doubled our case from 200 to 400 cases in just two months — 2.5 months. And now we have over 800 case, as we speak. So it’s higher than Q4. And hopefully it will stabilize with the way — I don’t know which way we are in, in the country but it has been some sort of a nightmare.
Stéphane Arsenault
And the customers too, we had inspectors — inspection to inspect from the customer. And we got COVID. We were there in inspection by three weeks it was delaying delivery also.
Tim James
Okay. Forgive me if you already gave an indication of this and I missed it, it’s entirely possible. But can you give us a sense for, how much revenue or the difference in reported revenue in the quarter versus what you had kind of planned? I’m just trying to get a sense for, sort of the shortfall relative to what you expected due to these reasons that you’ve cited in your MD&A.
Martin Brassard
Okay. Normally we don’t give guidance right, Tim but because as you are have it, if you look at the increase in the inventory kind of close to the number.
Tim James
Okay, okay. That’s great. Yeah. I guess my last question — yeah, my last question here. Back in the third quarter of fiscal 2022, I believe, it was, — there was some delays. Again I think some of which were common reasons. I think at the time.
You talked about maybe about a 10% impact on revenue and then sort of making that up over the coming quarters. And have you been able to recover some of those revenues that were delayed sort of in fiscal 2022?
And — but now they’re being more than offset by delays in further revenues or those sort of deliveries that — I mean, have you been — I guess making some inroads on recovering some of those revenues from last year? Just more — there are more delays on top of that?
Stéphane Arsenault
Yeah. Some of it — if you recall in Q4 we had a very strong Q4 right? We recovered partially what we had not delivered in Q3, but we have a lot of work in front of us.
Tim James
Okay. Okay. Those all the questions I had. Thank you very much.
Stéphane Arsenault
Thank you.
Martin Brassard
Thank you.
Operator
Thank you. And at this time Mr. Brassard, we have no further questions. Please proceed.
Martin Brassard
Yeah. Thank you very much everyone for having, joined us at the — our AGM and earnings call this morning. So thank you as well for your interest and ongoing support to us at Héroux-Devtek. And have a great day.
Operator
Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good weekend.
Be the first to comment