Héroux-Devtek Inc. (OTCPK:HERXF) Q2 2023 Earnings Conference Call November 11, 2022 8:30 AM ET
Company Participants
Martin Brassard – President & Chief Executive Officer
Stéphane Arsenault – Vice President & Chief Financial Officer
Conference Call Participants
Konark Gupta – Scotia Bank
Benoit Poirier – Desjardins Bank
Cameron Doerksen – National Bank Financial
Tim James – TD Securities
Jonathan Lamers – Laurentian Bank Securities
Bryan Fast – Raymond James
Operator
Good morning. My name is Julie and I will be your conference operator today. At this time I would like to welcome everyone to Héroux-Devtek Fiscal 2023 Second 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 November 11, 2022 at 08:30 a.m. Eastern Time. I would now 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. Mr. Brassard, please go ahead sir.
Martin Brassard
Thank you very much Julie and good morning everyone. Welcome to our second quarter earnings conference call for fiscal 2023. I invite you to follow along by referring to the financial statements and the press release which can be found in the investor sections of our website.
We are encouraged by the improvement in our delivery compared to the first quarter, even though as usual annual sub balance summer vacation affected our production capacity. Our profitability improved as well despite the on-going strength in the production environment. We have also stayed in close contact with our customers and continued to build on our reputation as a trusted partner. As such, our backlog has been growing bolstered by upcoming deliveries of landing news [ph] for business jets order as well as spare parts and aftermarket services.
To this effect, we also announced this morning that we were selected by Embraer for a life cycle contract to supply a cargo door actuation system for the E190 and E195 Freighter conversion program. This contract is the first for our Spanish operation with Embraer and we look forward to bringing more top tier customers to their portfolio.
At this time, I would like to turn it over to Stéphane for a rundown of the second quarter results. Stéphane?
Stéphane Arsenault
Thank you Martin and good morning everyone. As usual, please be aware that we will be referring to certain non-IFRS measure 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.
Consolidated sales for the quarter rose 1.1% to $132.7 million, compared to $131.3 million last year, a strong rebound from $114.1 million in that first quarter. Civil sales were up 10.7% to $41.3 million as increased deliveries for the Embraer Praetor and Boeing 777 program more than offset production system disruptions.
Defense sales were $91.4 million, at 2.8% decline, partly offset by the ramp up of delivery for the F-18 program of Boeing. Gross profit decreased to 13.8% of sales compared to 16.9% last year. The decrease is attributable to product mix and production system disruption, while last year the impact of COVID-19 was compensated for by the Canadian emergency wage subsidies representing an impact of 1.8% of sales.
As a result, operating income was $8.6 million from just under $12 million at this time last year, but up from $2.6 million in the first quarter of this fiscal year. Excluding non-recurring item, adjusted EBITDA decreased to $16.2 million compared to $21.2 million last year, while up from $11.4 million in the first quarter.
Net income stood at $4.8 million or $0.14 per share, compared to $7.5 million or $0.21 per share last year. Excluding non-recurring items, adjusted EPS stood at $0.10 per share compared to $0.21 last year.
Cash flow related to operating activities reach $8.3 million in the quarter, a decrease from $17.5 million reported at the same time last year, due mainly to an increase in inventory levels made to stabilize our production system and prepare for the sales ramp up of the second half of the fiscal year. Our financial position remains strong at the end of Q2 with net debt at $164.5 million stable with March 31, 2022.
Back to you Martin?
Martin Brassard
Well, thank you Stéphane. Our management teams have worked hard and diligently to better align our resources to face the challenges of the current production environment. As a result, we believe we are in a better position to improve our throughput in the back half of the fiscal year. The current increases in financial costs could result in new growth opportunity, and the strength of our financial position gives us the flexibility to seize them whether they are organic, or acquisitional.
Along with the discipline approach it also enables us to navigate the current turbulence. Our focus continues to be on managing our business tightly to deliver quality products to our customer on time. Julie, we’re now ready to take to answer questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question comes from Konark Gupta from Scotia Bank. Please go ahead.
Konark Gupta
Thanks operator and good morning Martin and Stéphane. And my first question is on the inventory, I think that’s mentioned in the MD&A that the inventories increased by $13 million sequentially here, which I think you alluded to previously to stabilize production and other ramp ups are going on. How much more inventory do you need to build increase here to continue to do that and so production and support and ramp up?
Martin Brassard
I think our view on this point we have a strong last six months to do right with, typically the last semester is always stronger than the first semester. It’s particularly true in this case as well. So we believe we have reached the level that we want, that we want it to be to achieve the last semester and then to prepare ourselves for the next fiscal year. So we [Indiscernible] decrease from now to the end of the fiscal year.
Konark Gupta
That’s all, thanks. And then you also mentioned about the challenges sort of continue over the coming quarters. What challenges are you facing at this point here? I mean, supply chain still seems to be an issue in the industry, I guess. But any particular pockets where you would point and say like, these are the challenges, which you don’t really have a clue when they will end.
Martin Brassard
Konark, it’s to get the production the parts on time to make our assemblies, right. That’s the main challenge. So our team are working very diligently to make sure that we receive all the parts needed to make an assembly. That’s the main challenges.
Konark Gupta
Okay, that’s helpful. Thanks for the time.
Martin Brassard
Okay, thank you.
Operator
Your next question comes from Benoit Poirier from Desjardins Bank. Please go ahead.
Benoit Poirier
Good morning, Stéphane. Good morning, Martin.
Martin Brassard
Good morning, Benoit.
Benoit Poirier
Martin, could you maybe provide an update on the three facilities where you were experiencing some issues with throughput last quarter, and how is Q3 and Q4 shaping up so far?
Martin Brassard
So one of these facilities have rebounded over our expectation, and it’s, it’s going well, in the U.K., namely, in the U.K. we’re very satisfied with that operation. We see a bright future ahead for that facility. So yes, it turned the corner faster than what we expected. In Michigan lots of improvement for throughput, now we need to work on profitability. It’s not at the expected level, but the throughput is there. So that’s a good first sign, and in our Longueuil operations, so we see some encouraging sign of in September and October. It looks like they’re going to have a good quote, good Q2 and get ready for strong Q4.
Benoit Poirier
Okay, that’s great color. And at the recent Boeing investor day, they’ve announced that the 777X production will jump to four planes a month in 2026. I’m just wondering whether it’s — the build-up is later than you had originally expected. Or basically, you need to build up some parts in advance of the ramp up if you could comment about the expected production rates on the 777X that would be great.
Martin Brassard
And so at four months and 2026, it’s maybe a bit pushed to the right, but not that much. And we don’t need the extra capacity there to meet the production. The products we announced production right…
Benoit Poirier
Okay…
Martin Brassard
The thing is that again, it’s more the risk will be more on the on raw material, with Russia and Ukraine, right to get our material on time. And that’s what Boeing announced. That’s why they pushed out the bid compared to our expectation.
Benoit Poirier
Okay, and with respect to the recent award with Embraer for actuation system, I was wondering if you could provide some color about the timing and the potential sights and we’re just wondering also out the bidding pipeline for actuation system as evolved now that you’ve secure some key contracts with Boeing and Embraer.
Martin Brassard
Yes, so the cross selling is working, is showing and showing results and it’s compensating from the reduction in sales of the military program that we have with Airbus Defense. So, so glad that we are securing orders with Embraer and Boeing and, and we have orders with others too. Right. So the so for the timing I cannot disclose all this information Benoit in terms of value and timing, but I can tell you that that’s, that’s a good opening door to, to for other products with Embraer and to show them the capacity or the capability that we have in Spain. Stéphane?
Stéphane Arsenault
No I, it’s a it’s a design, it’s a development, so it takes some ways two, three years and in the in the acceleration to get ready for production after that.
Benoit Poirier
Okay. And last one for me. The U.S. Navy recently stated that the MQ-25 will be the trailblazer for the uncrewed transition. So it seems that they love the program. So do you see further momentum on the MQ-25 and any impact so far?
Martin Brassard
Yes it is great news, Benoit wow, we love that news. So the MQ-25, we always believe in that the capacity capability and the technical. So now it’s, we’re ahead of the schedule of the for our part, right. So we performed well. Our system, our qualification testing is, is ahead of the customer schedule. Now it’s we need to have that airplane certified and deliveries to the end customers. So it’s a great program, we’re ready to ramp up to face production ramp up. We look forward to get into [Indiscernible] phases.
Benoit Poirier
Thanks for the time.
Martin Brassard
Thank you Benoit.
Operator
Thank you. Your next question comes from Cameron Doerksen from National Bank Financial. Please go ahead.
Cameron Doerksen
Yes, thanks. Good morning.
Martin Brassard
Good morning, Cameron.
Cameron Doerksen
So I just wanted to ask a question on a comment you made, just with regards to and correct me if I’m wrong, but I think you sort of suggested that your higher interest rate environment, maybe putting some stress on the financials of certain smaller companies, and that potentially could be an opportunity for you guys, for some organic growth. And I just wanted to maybe clarify what you’re sort of trying to say there. I guess, are you seeing some opportunities here for some business to come your way that maybe the OEMs are moving out of smaller suppliers to more financially secure suppliers like yourselves?
Martin Brassard
Yes.
Cameron Doerksen
Okay, and can you can you expand on that? I mean, or is or is this also your, I guess, an M&A opportunity for you as well.
Martin Brassard
But there’s some opportunity, Cameron, but we need to put the puck in the net. We’re not alone, in these competitions, but yes, we see some, some opportunities there. Yes.
Cameron Doerksen
Okay. And maybe you can provide an update on in this sort of related question, but just on M&A? I mean, does the higher interest rate environment still change your appetite for M&A? Or is maybe the preferred path to just try to win some new business organically?
Martin Brassard
We’re going to be working on both Cameron. So if the right opportunity present and it’s accretive to shareholders. Yes, we will do it. There are some that are moving. But we’ll see. We’ll see if we can conclude an agreement. But we were looking at both. We’re looking at both. So I don’t know which one will come first, Cameron.
Cameron Doerksen
Okay, that’s fair enough. And maybe just lastly, for me. I just wonder if you can give us an update on I guess that the labor situation I mean, I guess there’s an on-going issue with COVID absenteeism. I mean, I don’t know if that’s going maybe ever going to improve and but I just where do you where do you stand on labor? I mean, are you you’re going to have to maybe ultimately hire more people than then you would have had previously just because there’s an expectation that people are going to be off sick more often.
Martin Brassard
Not often sick more often. It’s more to turnover. Right. So we have 99% of our resource for the plan to execute our plan, right. Our forecast and budget. What we’re seeing yes, you’re right, the COVID related absenteeism is higher. So we have improved a bit in Q2. But my wondering is the turnover in the support department. And that’s we’re not alone. We’re all living the same thing. In support thing, the shop floor people, the shop floor employees is okay. But it’s the supporting document department that has turnovers. Our human resource department are doing very well there in that regards. But again, so when you have an employee that work for you for three, four years, and then he’s up to speed and then they have to restart. That’s, that’s the chat. That’s another challenge to the, to the question of corners that we do have but so far, we’ve been able to, to fulfill the open position, but it’s a constant battle, Cameron.
Cameron Doerksen
Okay. That’s great. Thanks very much for the questions.
Martin Brassard
Thank you.
Operator
Your next question comes from Tim James from TD Securities. Please go ahead.
Tim James
Thank you. Good morning, everyone. I’m wondering if you can talk a little bit further you kind of touched on the material risk that you’re dealing with on 777 relate to the Russia Ukraine situation. I’m just wondering if you could maybe give us a bit more of a broad look at what and that obviously comes into play here. But what are your primary concerns or risks that you’re looking at in terms of supplies material, as you look out over the next, 12 to 18 months what are your kind of watch points where you feel you need to do some extra work or secure alternative sources of supply to minimize risk.
Martin Brassard
That’s right, we’re working with our customer right now for to compensate or to mitigate the risk of supply chain disruption on all the titanium provided from Ukraine. So we’re working very, we have we have to resource it. Right now the plan is tight, but we have a plan to continue delivering on the production rate. So there so we’re, we’re working very closely with our customers. And we have success. We’ve been able to reduce and mitigate the potential. So we’re working on this since February or since March with our customer and we have a detailed part by part listing and requalification of all the of the forging and the communication is extremely good.
The other one is to secure the raw material in long term. We have asked our customer to give us more visibility more firm contract more firm orders. So that way, we can go ahead and place PO [ph] with all of our supplier. Then our be your place, it’s a matter of following the execution and be in contact with our supplier making sure that they’re going to be delivering on time. [Indiscernible] titanium, those are the watch item.
Tim James
Okay, and so that’s helpful. And so when you say you’re looking to your customers to give you longer-term contracts, so that you can go out and procure the necessary materials. Are there particular sort of pain points there, certain metals that you are, obviously titanium is coming into play in that but are there other metals as well or other supplies that you feel you’d like to be able to kind of go out further into the future and enter contracts to purchase them in order to reduce the risk because you feel, the risk to that particular supply is higher than you’d like it to be?
Martin Brassard
While all the nickel alloys, material, and aramid [Ph] that’s, that’s on top of titanium. And we have the orders and from the customer because the purchase order that it’s important for us to have that secured because we do not procuring on forecasts and take the risk of having overstock, right. So we need the legal contractual document, right? Because, typically, customer were giving us a firm, firm order from six to one year, six months to one year. Now we are asking two years to make sure that they’ll take the material if something happens to the demand. So that’s what I meant. So we’re acting very cautiously right? To not expose the company to greater risks than necessary.
Tim James
Okay, okay. That’s, that’s really helpful. My next question on capital deployment. You’ve been buying back stock. How are you currently thinking about your capital deployment priorities, deleveraging further, versus share buybacks and CapEx, so how do you how do you look at that and then in terms of prioritizing at this point?
Martin Brassard
Again, again, we want to reinvest in our company in business acquisition, right. But again, with the right opportunity, if we need CapEx, we modernize our equipment. We definitely do it and share buyback program. So in terms of uncertainties, we have divergent opinions within the board, right. So there’s some people that were more conservative, and some people are more, in the capital deployment, so the NCIB is there, it’s a good tool. And to see the stock at that price, it’s, it’s a shame. So we want to boost up the stock. So, right.
Tim James
Okay, that’s helpful. And then my last question, just turning to the 777, as you see here today, I mean, obviously, the 777 rates aren’t what was anticipated, when years ago, when you when you got into this contract. You’ve created a very efficient manufacturing process there for that aircraft. And I know you have capability to go much higher. So as you look at that today, and earnings or the margins that are coming from your 777 content, is there a significant amount of upside? As rates increase over and I’m thinking very long-term over a kind of a three to five year period? Or have you have you managed to kind of downsize the some of the costs in a way that you can still earn decent margins today on it, even though rates are much lower than originally anticipated?
Martin Brassard
Yes, yes. Right. Listen, Tim right now we’re getting ready for that, that ramp up. That has been in less than 3, 4, 5, a month. What we’re doing is we’re putting a lot of effort to make our machining program much more robust. And at the end of the day, so we want to absorb these production rate increase without adding any variable costs. We look at this as a as a fixed costs. Our shops, you saw you saw our shops in Ontario, and in the in Springfield, and in Cleveland that are dedicated or not dedicated, but are working on the 777 program. These are the staff that are working mostly on the 777 program. They’re all into initiatives of getting ready for that ramp up, and that the margin will go up.
So we will what we want is we will absorb all these increases with the same amount of result, results resource, right? Do you want to add something? Does that answer your question Tim?
Tim James
No, that’s perfect. That’s, that’s very helpful. Thank you.
Martin Brassard
And it’s to compensate all the inflation that’s the business is so we will have no, no, I truly believe in that initiatives, Tim.
Tim James
Okay. I’d like to squeeze in one more question, if I could, very quickly, returning maybe to a comment you made about the Michigan facility. Your Michigan operations, the throughput is very good. You said but you need there needs to be a little work on the on the profitability on the margin there. What is it that is holding back the profitability, even though throughput is strong?
Martin Brassard
Stabilizing the production environment, and once you’re stabilizing, so imagine so and it’s not only in that facility, so imagine, so when you start an assembly and your assembler are lacking work at the beginning of the month, and all the parts are coming in at the end of the month, so you’re asking all your people to work overnight. So that’s a reason why efficiency are or profitability is not there. Working on our revenues on our pricing is also another initiatives, working on automation also is the other initiative. So we’re working on three fronts over there. And we’ll get back and I believe within the next 12 months, so historical profitability there.
Tim James
Okay, thanks very much for your time. Very helpful.
Operator
[Operator Instructions] Your next question comes from Jonathan Lamers from Laurentian Bank Securities. Please go ahead.
Jonathan Lamers
Good morning Thanks for taking my questions. Nice step up in the civil and commercial sales this quarter, although I’m sure they’re still not where you would like them to be if you didn’t have the supply constraints? Could you just provide a little more commentary on what’s allowed you to increase the civil and commercial sales as much as you have? Has it been more driven by the demand side from Boeing and Embraer? Or is it been some release of the supply constraints?
Martin Brassard
So Jonathan, our cycles, when we get an order or cycles is more like a year to deliver a year, year and a half, 18 months. So the orders are there, the backlog is healthy, we have the orders for commercial and military program. And it’s very robust, and it’s all backed up IPO firm purchase order. So the challenge that we all face here is execution, is really to get all the products on time, and all the parts needed to assemble our product.
So I used to say I said a lot to all of my team, because Stéphane and I we’re traveling a lot during the Q2. And the motto is, how many parts we need to assemble an airplane. We need all of them. So if we’re missing one part, we cannot deliver our product. So, the challenge here is operational, and make sure that we have a steady flow of our parts.
So, yes, you have the raw material, you have labor constraint. And you do have some financial stability coming from supply chain. So we need in that environment to be a child. So the main, the main focus here is because when you resource products, so we have some few suppliers that that when that we’re financially not sound that we have to resource in. And that’s what we were ready to take these decisions, encourage decision in an expedited minor manner. So challenges is operational.
Jonathan Lamers
Okay, I’ll leave it there. Thank you.
Martin Brassard
Thank you, Jonathan.
Operator
Your next question comes from Bryan Fast from Raymond James. Please go ahead.
Bryan Fast
Hey, good morning.
Martin Brassard
Good morning, Bryan.
Bryan Fast
Just one question from myself here. Marginally didn’t answer. But could you talk a bit about the financial stability of some of your suppliers right now? I mean, as the economic backdrop shifts, and rates rise, are you seeing any increase in risks from outside?
Martin Brassard
Well, yes, some of them. Yes. And that’s why we need to look for it and be ready to have Plan B’s on those. And our team is, is working relentlessly to identify those and get ready to resource because resourcing process, it takes nine months, nine to 12 months. So we have done it. That’s why we have been able to, to increase our throughput. And that’s why we’re saying that, yes. If things all being equal, we can we can have a strong six months ahead of us.
Bryan Fast
Okay, that’s good color. Thanks.
Martin Brassard
Thank you, Bryan.
Operator
And there are no further questions at this time.
Thank you very much, Julie. Thank you very much. Thank you very much everyone for having joined us for our second quarter earnings call this morning. Thank you as well for your interest and on-going support towards Héroux-Devtek. Have a good day. Have a great day.
Operator
Thank you ladies and gentlemen. This concludes today’s conference call. You may now disconnect.
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