Heroux Devtek Inc
TSX:HRX
Earnings Call Analysis
Q3-2024 Analysis
Heroux Devtek Inc
The company witnessed a robust increase in sales, totaling $164 million for the last quarter, which marked a 16.1% rise from the previous year and culminated in a near-return to peak historical performance with trailing 12-month sales soaring above $600 million. Global traffic reaching pre-pandemic levels, coupled with rising new aircraft orders due to robust travel demand and increased OEM production rates, is a potent tailwind for the company's financial growth.
Financial prudence in response to inflationary pressures has yielded a substantial EBITDA margin growth of 500 basis points, reaching 15%. The company’s strategic initiatives, including production system stabilization and pricing reviews, foresee further margin enhancements. Additionally, the heightened geopolitical tension adds to the defense sector's new aircraft program demand in strategic global regions, boosting the company's prospects.
The third-quarter consolidated sales exhibited a 16.1% increment to $163.5 million compared to the previous year. Gross profit also surged to $29.1 million, a 3.7% leap in percentage terms, attributed to higher sales and effective pricing strategies, albeit partially offset by inflation on costs. Adjusted EBITDA and net income saw dramatic rises relative to sales, demonstrating the company's enhanced profitability.
The company's financial agility is reflected in an improved leverage ratio, with net debt to adjusted EBITDA decreasing to 2.8x from 3.1x. Despite outperforming expectations with historical volume levels and profitability, the management acknowledges more work to be done to enhance and sustain these gains.
The management’s outlook for the aerospace industry remains bullish with anticipated trends of increasing sales volume and profitability. Recovery from the pandemic, busy markets in both defense and civil sectors, as well as strategic initiatives, suggest a strong growth trajectory for the company in the coming years.
Despite carrying $50 million more in inventory to stabilize production, the company views this as a temporary measure, expected to normalize over time; it's an investment towards ensuring future sales growth rather than a permanent baseline shift.
The company showed marked strength in civil sales for the quarter. They look forward to upcoming defense contracts in light of increasing geopolitical tensions that indicate a potential swell in demand. While cautious on specific forward guidance, executives are certain that the aerospace sector will stay dynamic and provide significant growth opportunities.
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Good morning, Ladies and gentlemen, and I will be your conference operator today. At this time, I would like to welcome everyone to Héroux-Devtek's Fiscal 2024 Third Quarter Results Conference Call. [Operator Instructions]
Before turning the meeting over to management, please be advised that this 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 the press release 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, Wednesday, February 7, 2024 at 8:30 a.m. Eastern Time. I will now turn the conference over to Mr. Martin Brassard, President and Chief Executive Officer; and to Mr. Stéphane Arsenault, Vice President and Chief Financial Officer of Héroux-Devtek. Mr. Brassard, please go ahead, sir.
Thank you very much, Gwen, and good morning, everyone. Welcome to our third quarter earnings conference call for fiscal year 2024. 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.
We're pleased to announce that our sales for the last quarter totaled $164 million, a 16.1% increase compared to the same quarter last year, and that brings our trailing 12-month sales above $600 million or representing 98% of our record years in fiscal 2020. This strong group is a sign that our focus on stabilizing our production system is beginning to pay off. The increase in volume, along with the effect of our pricing initiatives in response to inflationary pressure, drove our EBITDA margin up to 15%, marking a significant 500 basis point improvement over last year.
These results are rapidly approaching our historical performance in terms of profitability. While we are pleased with our progress, there remains work to be done. Linearity in our deliveries within the quarter remains a challenge, especially given the ongoing pressure in the aerospace supply chain environment. However, we have demonstrated resilience and adaptability, and we are confident in our ability to navigate and make further progress in overcoming these challenges.
Looking beyond this immediate challenge, we see positive long-term dynamics for the aerospace industry. Global traffic is back to pre-pandemic levels, and IATA is forecasting continued growth. The resurgence in travel demand is once again driving new aircraft orders. And this, combined with long-term fleet replacement forecast, is pushing OEMs to increase production rates.
Geopolitical tension have also added urgency to the defense industry's effort to maintain, develop and launch new aircraft programs in the United States, the United Kingdom, Western Europe and the Pacific area. At this point, I would like to turn it to Stéphane for a review of our third quarter financial performance.
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.
Our consolidated sales in Q3 increased by 16.1% to $163.5 million compared to $140.9 million last year. Dividend sales rose 41.4%, reflecting increased deliveries for the Boeing 777 and Embraer Creator Program, while Defense sales remained relatively stable year-over-year. Gross profit increased to $29.1 million or 17.8% of sales from $19.9 million or 14.1% of sales last year, due to higher throughput and pricing initiatives, partly offset by the effect of inflation on costs.
Operating income increased to $15.6 million or 9.5% of sales from $5.1 million or 3.6% of sales last year, reflecting higher gross profit, combined with a 1% year-over-year positive foreign exchange impact. For the same reason, adjusted EBITDA increased to $24.5 million or 15% of sales from $14.1 million or 10% of sales last year.
Reported and adjusted net income for the third quarter stood at $9 million or $0.27 per diluted share compared to $1.8 million or $0.05 per diluted share last year. Cash flow related to operating activity reached $11 million in the third quarter compared to $5.2 million last year. The improvement in cash from operations occurred despite continued investment in inventory to stabilize our production system and sustain future sales growth.
Our leverage ratio at quarter end improved as a result of our increased profitability with net debt to adjusted EBITDA decreasing to 2.8x from 3.1x at September 30, 2023.
Back to you, Martin.
Yes. Thanks, Stéphane. While we are pleased with our performance this quarter as our return to our historical levels of volume and improvement in profitability has arrived sooner than expected, more work needs to be done. Our focus remains on the execution of our priorities to restore the health of our supply chain, automate manufacturing processes wherever feasible to reduce our cost, and continued our pricing initiatives in response to inflationary pressures.
Outside of the immediate headwinds, however, the long-term outlook for our industry is promising with robust forecast and new aircraft program on the horizon for both the civil and defense sectors. This outlook, the new business opportunities and the momentum of our strategic initiatives over the next few years allow us to foresee a continued upward trend in sales volume and profitability beyond the sales and margin we have generated in the past.
In closing, I'd like to thank our team again for their efforts throughout these last few quarters, and I'm confident we can achieve even more in the months and the years ahead.
Gwen, we're now ready for to answer questions.
[Operator Instructions] Your first question comes from Benoit Poirier with Desjardins Capital Markets.
Congrats for the very impressive quarter. Could you maybe provide some comments about the overall supply chain issues? It seems that we've seen an improvement, and whether the strong throughput that was achieved in Q3 is sustainable in Q4, especially as Q4 tends to be the strongest quarter of the year. So I'm just wondering whether there's something not sustainable that went -- that impacted Q3.
Yes. I think the increased level in inventory is helping us to stabilize our internal production systems, where we see better improvement, better efficiencies and more linearity in our throughput month after month. So that issue, having inventory, give us a good feeling over the last 4 quarter -- the last quarter, which is historically our strongest quarter. So it's still fragile environment, Benoit. But the teams are -- has developed the tools and the mechanism and the agility necessary to deliver our product.
Okay. And specifically on the Boeing 777 and 777X program. I was wondering if you could provide an update. If you look at the backlog, it stands at 514 units. Boeing was successful, booking 98 orders, and they also announced that they resumed production on the 777X. So I was wondering if you could provide us an update about what do you foresee on this specific program.
Well, not much more than what you just explained. I think that's a very good program. Entry service is very critical. So we have no news about delays or introduction. So we're still following what Boeing is telling us. And that's true. We have resumed production on the 777-9 or the 777X, yes.
Okay. That's great. And on the business jet side. Could you comment about what do you see these days, especially on the Creator? It looks like there has been a strong ramp-up. But also, if you could provide an update on the 6X and 10X with Dassault.
So the Falcon 6X has entered service last quarter. So they are delivering airplanes as we speak. So as you know, we're supplying landing gear. So we had up there forecast. So it's a strong program, and we continue to deliver. So it's a beautiful airplane. I think Dassault has made -- and we're very proud of the system that we have developed for them. So that will generate the future sales for us in the upcoming years.
Also, the Falcon 10X is -- so we're in the certification campaign. We have delivered our gears to them, or we're qualifying the gears that it's ready. So we have the certification campaign. So as far as the entire program, I cannot tell you much more. But we're there, and we're supporting very well our customer there. And the Creator Embraer, it's very good. Like you said, it's going up in rates. We see it in the numbers, and we should see it in their numbers,too.
Okay. And last one for me, Martin. In the press release, you mentioned that you foresee a continued upward trend in sales and volume and profitability beyond the sales and margins that you've generated in the past. So when looking at the margins, you were quite good about bringing EBITDA margin around 15%, 16%. So just wondering when you say profitability beyond historical levels, what do you intend to achieve from a profitability standpoint?
Volume is magic. Stability is magic. Efficiency is magic. Automation is magic. And the pricing initiative also helps to continue that growth. So we see -- we're very busy. We'll see that the aerospace industry is booming in all of the segments, even more new and aftermarket. So we're in a good position right now on that one.
Next question comes from Konark Gupta with Scotiabank.
My first question is on the margin side. I was a little bit surprised to see 15%, it's so early in. And I understand there's a 1 percentage point contribution from FX, I guess, compared to last year. But even if you strip it out and say it's 14% like-for-like, it's still a pretty good margin number in this environment. And I know you pointed out the volume and pricing they are contributing here. Were there any surprises from either volume or pricing side to you guys? Or was it the inflation that did not materialize as much as you anticipated initially? Like I'm just looking for any surprises from your perspective, which would have contributed to this strong margin.
Yes,Konark. Every business unit realized their plan. So that's the thing. So sometimes, we're in the decentralized environment. So we have -- and every business unit has generated their plan. So no one has dragged this, dragged this, so when you all add up, so that makes a good surprise.
I see. Yes. So it's basically everything added up. There was nothing lagging this time compared to like previous quarters. We saw a few plants had issues with profitability?
Yes. And still having -- and we still foresee some improvement, yes.
Okay. Great. Okay. And then on the Boeing side, I understand you are not highly exposed to the narrow market, either Boeing or Airbus. But the whole issue with Boeing, with FAA and their quality and their suppliers, quality, not including you, obviously, it's going to eventually come down to questions on some of the aircraft types possible. I mean is there any discussion with Boeing where you foresee Boeing probably controlling production rates on all aircraft types, not just the 737, just so that they can show the quality and compliance with that?
Wow. So the first one, the 3 in service is a 777X that will have to go through all the requirements with the FAA. That's one thing. But I can tell you that Boeing is taking the quality assurance and the quality initiative very seriously. We have meeting every month with them where all the industry participate with that. So it's a very good initiative. So they take that very seriously. And our industry will benefit from that. So that's what I can say right now, Konark.
Makes sense. And a last one for me. I'm not...
But I don't want to look on the phone optimistic or put my head on the ground. But it's unfortunate, these events. So that makes us or the entire realize -- makes the industry realize that we do a very important job, and we take that very seriously as an industry. So that's mainly the message I want to take -- I want to pass.
Fair enough. And last one for me. Now you are at a point where perhaps a lot of production stability has happened and maybe the big chunk of the cost inflation issues are behind you perhaps. Is there any point when you think you can start guiding again on sales or margins?
We have not made that decision yet, Konark. So I cannot have an answer, a clear answer for you as this time.
Your next question comes from Tim James with TD Cowen.
Great quarter. Just want to turn to the revenue and the strong revenue performance in the quarter. The increase from the second quarter to the third quarter was historically strong. And in particular, in Civil, where revenues were up, call it, $10 million from the second quarter. Could you talk about sequentially what drove that? What's in that additional $10 million in revenue? I know you called out sort of the freighter and 777, which I think is a reference to year-over-year. But is it -- are those 2 programs also the primary reason for that big sequential jump in revenue?
Well, we have the orders, Tim. We said it in the previous call, the matter -- that the challenge is to execute them and improve the throughput. So as far as the 2 program that were cited, we all know that the OEMs are published, not Embraer, but Boeing has published an increased production rates, and we're following that.
And also Embraer, they signed up last year a very important order. So their backlog, what I can say is their backlog is full. So we're executing per what they tell us to do. So that's why we see an improvement in -- specifically in these 2 programs. So it's not a problem of demand that we have. The challenge is remains to deliver that continued growth. And that's why we have -- and we told you that we need to invest in inventory not only to make our shop more efficient, but also to answer this increased volume.
Okay. That's helpful. Then just turning to margins. And you talked about this earlier, and you've said there's more opportunity for margin expansion from here. You're at 15% in the quarter. Pre-pandemic, you -- the company got into that 15% to 16% range. And it sounds like now there's an opportunity to surpass that in the coming years. Could you just talk about the differences between the pre-pandemic margin of -- when it got into that 15% to 16% range and what allows the company to go beyond that in the future?
Because pre-pandemic, we didn't have the inflation issues, some of inefficiency, supply chain, et cetera. So what's left in the business in terms of propelling margins higher in the future? Is it about mix? Is it further without not as many development programs that are maybe a drag on margin to begin? Just compare pre-pandemic peak margins to kind of the opportunity to go higher than that in the future?
Well, pre-pandemic, we were also foreseeing an improvement in margin, right? So Tim, so we -- but right now, the strategic initiatives is allowing us to see even further improvement, like we said for many quarters now, stabilization of our production system. Once the supply chain environment is much more stable, we will gain more efficiencies in our shop.
Automation also, the pandemic allowed us to review all of our programs and look at ways to do and to absorb any increase in volume. Like we said in previous call, increase in volume. Our challenge, our goal is to absorb all this increase with the same amount of resource. So that's what we've seen in the third quarter, and we intend to continue.
The pricing initiatives to compensate some inflationary pressure is also another one. Now we need to relook at our cost and stabilize this supply chain environment so we could have some cost reduction there, too. And also, we're busy. The outlook in the aerospace is busy, is busy everywhere. Defense. We're not talking a lot about defense, but the geopolitical situation is increasing demand in both new programs and maintaining programs right now. So it's not a secret that all the NATO countries needs to replenish their stock, and we foresee again some volume there.
So we will be very busy. The outlook is pretty good. It's pretty promising that like I said during my opening remarks. So this is how you should think about going further. And volume is magic in our business.
And Tim, if you recall, we had just made 4 acquisition. So it was very recent in 2020. So the teams have worked very, very hard over those years, even though we had a pandemic to improve the business. So we took out some fixed cash as well through the pandemic. So we're in a good position because of the action that were taken also during the pandemic time.
Okay. That's really helpful. Stéphane, maybe just a quick question on the working capital. Obviously, those investments you've been [ peeking ] have paid off, or it certainly looks that way given the quarter you put together and the progress you've made on revenue and the margin. Should we think about the investments you've made in working capital and, I guess, inventory, in particular, as sort of a new baseline? Or does some of that reverse and generate cash in the coming quarters or years? Or do you feel this inventory relative to the level of sales and volumes, just the new baseline, and this is kind of an indefinite investment that you'll need to maintain going forward?
So the comment I made on the previous call was that we were carrying $50 million more inventory to stabilize our production system. So eventually, this will normalize, but it's not in the coming quarters. It's going to take some time before we see this normalizing. But in due time, this will come back, right, to the level that we used to have.
So in terms of inventory turns. So now that combined with the growth that we're having in both of our market is supporting also that growth. So it's not a short-term thing. It's really more after the year here also that we will see those gradual improvement with the environment that we are operating in.
Next question comes from Cameron Doerksen with National Bank Financial.
So just on the, I guess, the repricing of contracts. I mean it certainly, based on the margins you've generated, it looks like you're having some pretty good success there. Just wondering where we are in that process? I guess how much is left to do? I mean, obviously, it's an ongoing process. But on some of the sort of bigger contracts, where are we as far as repricing some of those inflation impacted contracts?
Yes. Thank you for the question. So we will not get into the specific if this initiative, Cameron, at this time, but we have several ongoing discussions that we expect to finalize. So in terms of scope, what we can say is we're taking a very good approach looking at all of our contracts, and customer has established what we believe are reasonable objectives.
So as you know, again, we have 3 type of contracts, life of the program contract with the indexation formula. We do have contract with the duration where adjustment can be made at the end of the specific contract again. So we still have some. And P2P basis that are generally that we can adjust pricing after every PO.
So we're in that cycle, as we speak, Cameron. So that's what I can tell you. But again, demand for our aerospace product is very strong in both segments, right? And a balanced approach, it's always in our discussion with the customer and have always been the foundation of our strong relationship with them. So every situation is looked at with this in mind indifferently so.
Okay. And I guess as far as some of those discussions you're having, does some of that maybe involve an increase in volumes or an expansion of the scope of the work you're doing with some of the customers? I mean are those part of the repricing discussions? I'm just trying to think about your opportunity to win additional volumes given that you're delivering as an aerospace supplier, and maybe some of the OEMs would like to do more business with you?
Yes, all of the above. All of the above. But our strategy is the selling price higher than the cost.
Yes, definitely a good strategy. Maybe a second question for me. Obviously, you spent maybe the last couple of years kind of working through the supply chain issues, the inflation and maybe acquisitions have been on the back burner somewhat. I'm just wondering where -- what your thinking is these days. Things seem to stabilize a lot more for you and for the aerospace industry generally. So how are you thinking about M&A these days?
We have so many opportunities ahead of us. So -- and the multiple of these M&A opportunities. So with laser focus on executing the organic growth and internal opportunity that we have ahead of us so. And we always have that in mind. So it's a disciplined approach, Cameron. And we aim then to do an acquisition just so to do an acquisition, it needs to be accretive for our shareholders.
[Operator Instructions]
Your next question comes from Jonathan Lamers with Laurentian Bank Securities.
Congratulations on the strong quarter. Yes, Martin, Stéphane, it sounds like you're seeing strong demand in excess of your capacity across both the defense and civil markets. So you have a nice problem to have here in terms of ramping production towards that. Can you help us think about the magnitude of the production increase that we could see into next year, fiscal '25? Can you -- do you have any metrics on the number of shipsets that you expect to deliver this year and the number that you might be able to do next year, for example?
Yes, Jonathan. So thanks for the question. We have so many platforms, right, in so many different segments, but the majority of them are increasing. So we see improvement, some of them -- and also some new aircraft entered into service. I'm thinking about the Falcon 6X. I'm thinking about the 777, 777X. I'm thinking about the preheaters selling well. I'm thinking in the defense area also with platform, GSF is still solid. So all of the platform.
And when you look at the peers because we don't provide guidance, and I'm very cautious there. So we have all the matrix, right, in front of us. But what I can tell you is the challenge will not be to get the orders. The challenge will be to deliver them on time and efficiently. Still there. And we see again the supply chain environment and when you loosen to all of my peers and all of my colleagues there, they all say that it's a concern. And we see stabilization improvement, but it's still unstable.
So some are saying 18 months of instability. Some are saying 12. So that's -- and I agree with these statements so. And once we -- all the industry fully recovered from the up and down swing caused by the pandemic and everybody stabilized their production system, yes, that will be even greater. Does that answer your question, Jonathan?
That provides me with a good sense, although I still don't have a good guess as to the magnitude, whether you can increase production 5% or -- before COVID, you talked about -- no, I know. But before COVID, you talked about having production capacity for $650 million to $680 million of sales. Given how strong inflation on your costs and how successful your repricing initiatives have been, I would think that your total capacity has moved beyond that now. Would you have an update for us on where you see...
That's a fair assessment, Jonathan. That's a fair assessment.
So it's a fair assessment that that's moved up, okay. And...
Jonathan, look at the third quarter, right? I don't want to imply times 4. But you see every quarter the growth with that versus the prior year. So we are -- we have done a lot of work in the past few years, especially in the past year. And obviously, this is paying us but it's not the end of it, right? So that's what we're trying to give you, right, what we see in front of us, without providing new guidance. So I think it's -- we're in a bit of a unique position, like both markets are very busy. The business is strong, and we are recovering, right, from a tough year last year so.
And Martin, civil sales were much stronger this quarter. But you've spoken to a lot of indications that the defense programs are adding up to a lot of demand. I know some of that is for much later years. As you look to next year, do you think you'll see stronger production growth to the defense or civil markets?
Yes, yes, yes. And it's going to take, like you are well aware that our production cycles are not 3 months, 6 months, it's even longer. But yes, we'll see some upcoming orders. Now it's going to be to deliver them on time. Yes.
Okay. And just a last question, if I can, on the margin. I understand you're not providing guidance. Do you have any monthly breakdown in front of you showing sort of where gross margin percentage was at the exit of the quarter versus at the beginning? You mentioned that you had seen continued linear improvement in throughput over the months.
But we still have not achieved a linearity on a monthly basis. Some business units are doing that, have achieved that, but some other are not. So when you look at it on a month-by-month basis, you still have fluctuations from the last month versus the previous and second month. But we see the improvement compared to last year when we look at each of the month. That's what we've seen in Q3, the previous quarter. So at the end, Jonathan, this is an opportunity to further improve, right, for us. Because as things are stabilizing and we're able to do more linearity on a month-to-month basis in our sales, this will remove some of the costs we're bearing to expedite deliveries at the end.
It sounds like there's room for further improvement, particularly as you continue on your efforts to automate certain facilities.
That's the plan. The plan is unchanged.
Your next question comes from Tim James with TD Cowen.
I just have a follow-up. It actually ties in a little bit to the previous question. As you look out across your facilities, are there any where you feel like you need to win new work? And thinking about your projections, the growth that you already have planned and in the pipeline, are there any gaps where you say, "Gosh, that facility is going to remain underutilized?" And I guess what I'm wondering is do you really need to win new work? I kind of feel like just given the growth outlook across the board, that you're probably in pretty good shape. Maybe with the exception of the capacity that was created related to the original 777 contract. But outside of that, when you think about your expectations for volume growth based on the work you already had. Is there anywhere that you say it'd be great to win new work and bring new throughput to a particular facility?
Yes. Well, as you pointed out, the facility where we invested on the 777, right, to go up to 100 aircraft per year. We went as low as 24 aircraft, right, recently. Now the last quarter in Q3, we did the equivalent of 10 shipsets. Last year, we did 6. So obviously, the increase rate on the 777 going forward with the entry in service of the X combined with the demand, right? Like Benoit said earlier, the demand on that aircraft is strong, right, with the increased order book.
Now this is investment we've done to be in the large commercial sector. So 777 is an example. But obviously, more in due time, we will be invited, right, eventually when there's a new aircraft coming in the market. So that investment is there and obviously, will pay off. Other than that, I think we have capacity. Some units are more busy, more crowded. But we have capacity to improve the top line.
And there are no further questions at this time. Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.
Thank you.