Héroux-Devtek Inc.

Gilles Labbe - President and CEO Stephane Arsenault - CFO

Benoit Poirier - Desjardins Capital Cameron Doerksen - National Bank Financial

Good morning, and welcome to Heroux-Devtek conference call for the fiscal 2017 second quarter ended September 30, 2016. With me is Stephane Arsenault, our Chief Financial Officer.

Our press release was issued earlier this morning. It can be found along with the financial statement and the MD&A on our website at www.herouxdevtek.com.

Second quarter sales reflect lower Tier 1 customer requirements for manufacture components partly offset by an important pickup in defense repair and overall activity. This improvement confirms Heroux-Devtek leading position in this market niche.

Still, we conclude the period with a stabilized adjusted EBITDA margin compared to last year and adjusted EPS of $0.16. Stephane will provide additional details in a moment.

During the second quarter we delivered a first-complete production landing gear success for the Boeing 777 program. At this stage we are continuing to ramp up in order to meet Boeing requirements with more delivery to take place prior to the end of the fiscal year.

We have made more progress on customer qualification and approval process of our surface treatment equipment at Strongsville, Ohio subassembly center. We expect this process to be completed before the end of the fiscal year.

In the meantime, we are relying on our supply chain for the surface treatment process in order to properly manage and mentor meeting delivery schedules. This recalls to subcontractors is currently having a negative impact on our margin for the first production units.

We expect cost to normalize upon completion of the qualification and approval phase. Also during the quarter we signed a long-term contract with Hanwha Corporation of South Korea for the design and development phase of the new KF-X fighter aircraft.

This contract follows the signature by the MOU in February 2016. Heroux-Devtek is very pleased to expand its global reach in Asia and to participate in a new program that is expected to stretch out for many years.

Stephane will now review our Q2 results and financial position.

Thank you, Gilles. Fiscal 2017 second question consolidated sales reached $91.6 million versus $94.5 million last year.

This decrease reflects lower sales to both commercial and defense markets. Year-over-year fluctuation and the value of the Canadian dollar versus foreign currencies had marginally positive impact of $0.2 million.

Commercial sales totaled $48.7 million versus $50 million last year. This decline is mainly due to lower Tier 1 customer requirement on certain business jets and large commercial aircraft programs.

This factor was partially offset by the delivery of the first Boeing 777 production chipset and engineering sales. Defense sales were $42.9 million versus $44.6 million last year.

The decrease reflects lower spare parts requirements with the U.S. government and lower engineering sales following the completion of the development phase for certain programs.

These factors were partially offset by greater return on overall sales to the European customers and the U.S. government resulting from a higher throughput in our MRO facilities.

Gross profit reached $16 million or 17.5% of sales versus $17.5 million, or 18.5% of sales, last year. The decrease is due to a less favorable sales mix and a higher under-absorption of costs, which include the excess external processing costs that Gilles mentioned earlier.

These factors were partially offset by favorable currency fluctuation equivalent to 1.5% of sales. Adjusted EBITDA was $14.1 million, or 15.4% of sales, compared with $14.6 million, or 15.5% of sales a year ago.

The stability as a percentage of sales reflects a lower year-over-year gross profit margin partially offset by the lower selling and administrative expense due to favorable year-over-year variation in the translation of net monetary item denominated in foreign currencies. Adjusted net income amounted to $5.7 million or $0.16 per share versus 6 million or $0.17 per share last year.

This year adjusted net income excluded an after-tax amount of $3.8 million related to the favorable settlement of litigation net of legal and other professional fees. On a pretax basis that amount was $3.7 million.

As a result Heroux-Devtek concluded the second quarter of fiscal 2017 with net income of $9.5 million or $0.26 per diluted share. Turning over to our financial position, we concluded the second quarter with cash and cash equivalent of $15.8 million and total long-term debt of $146.3 million.

This total include an amount of $71.1 million drawn from our authorized credit facility of $200 million. Our net debt position stood at $130.4 million as of September 30, 2016 while the net-debt-to-equity ratio was 0.39:1, slightly down from 0.40:1 three months earlier.

Finally our funded backlog was $437 million at the end of the second quarter, a value that remains stable compared with the previous quarter. I will turn the call back to Gilles.

Looking at the second half of our fiscal year as historically being stronger and this year should not be an exception. Considering first half results as well as the effect of the British pound depreciation on our U.K.

operations, we expect to conclude fiscal 2017 with low single-digit sales growth. However we no longer anticipate sales to reach $420 million.

Over the mid-term we remain on pace to achieve annual sales of approximately $500 million at fiscal 2019 based on existing contracts and planned production rates including those for the Boeing 777 and 777X program. In this regard we also announced earlier this morning the award of supplemental work by Embraer to provide landing gear components and assembly for the KC-390.

This contract broadens the scope of an existing agreement that will generate revenue for an extended period of time as it's done over the life of the program. We are pleased to further expand our reach on the KC-390 program and our relationship with Embraer.

Production will take place at our facility in Canada, U.S. and the UK which clearly shows that our wide manufacturing footprint gave us the flexibility to react quickly and supplying competitive high-quality solutions to the world leading aerospace OEM.

Now looking at our main market, major trend remain mostly favorable. In the commercial sector passenger traffic is expected to grow around 6% for calendar 2016 and 2017.

According to industry forecast made by IATA these figures are above the historical average of 5%. In regards to large commercial aircraft although new order has been lower than last year backlog remains very solid with Boeing and Airbus adding respective backlog representing 8 and 10 years of production at current rate.

They are also adjusting production rates in preparation for the transition to certain more fuel efficient aircraft variants in the next few years. This includes the transition from the Boeing 777 to the 777X.

As for the defense market, we believe it has bottomed out and we expect a modest recovery. This is supported by increased proposed funding in the U.S.

our largest defense market though the end of their 2017 fiscal year. We have a good diversification in the defense market both geographically and through our content on many leading programs.

Our portfolio is also nicely balanced between design and development, new components manufacturing and as well as aftermarket products and services. For the remainder of fiscal '17 our priorities is the execution of the Boeing 777 contract.

We’re focused on finalizing a customer qualification and approval process of the Springfield facility so that we can optimize efficiency and profitability. As it would affect continuous progress on executing the largest landing gear contract in history, we are demonstrating our ability to carry out large-scale mandates for our OEMs.

With fully integrated capabilities, a variety of expertise as well as our world-class team and operation, engineering and management, it would affect in a solid position to further enhance this reach in the global landing gear market and create lasting value of our shareholder. We are now ready to answer your questions.

Hi, good morning, Stephane. Good morning, Gilles.

Yes, obviously if we look at the last few weeks, we’ve seen a lot of new flow around the 777 obviously a key contract for you. I was wondering if you could provide more color on what you see in terms of production rate going forward.

Well, as you know Benoit, we listen to the Boeing press conference and we look at different data at this point. So look we know that the rate is still at 84 and Boeing is working hard to keep it at that level.

As you know they won a big order in Qatar for 10, 777. They are also campaigning another in the Middle East with other customer and also all around the world.

So right now we are still aligned with Boeing with this production rate and look we cannot say more than this. I mean we have to basically meet the customer requirement and this customer’s requirement changed and of course this will impact our topline whether in upside or downside, so we whatever they say we make.

So we have to wait until what Boeing decides.

Okay. Okay, so good color.

And just for the customer qualification and approval process as defined. Would you be able to quantify what was the impact in the quarter and what we could expect in the second half?

Sure. Well for the second quarter, it had an impact of 2% on our gross profit.

So as we mentioned and as we’ve stated on the call it’s significant obviously. But as far as the transition, obviously we’re having on – putting all of this together ready for the customer and essentially this will go down as we are approved for processing the part and gradually obviously doing those part with our facility.

Right now I mean if you look at this specific issue everything is there, the plant is there, the equipment is there, people is there. But we’re not pretty using it at this point to produce any part, so and then we’re using a supplier to do the work.

So we have the cost wise, you can appreciate that so we the cost wise. So we record that as a P&L impact.

Okay.

So I think what’s very important that you understand that we want to do things right. So we’re taking measure to make sure that we do things right in [indiscernible] and at the same time we manage the supply chain to meet the customer requirements.

But we believe that as we get this qualification done there would be a transition between and then we will optimize the cost, reduce the cost and attain the profitability that we’re looking for.

Okay. So in the meantime just bottom line 2% impact on the gross margin, it should be resolved by the end of this fiscal year?

Yes.

Okay, perfect. And just on the currency, Stephane you mentioned obviously some negative impact, but could you walk us through the impact on the cost and also the revenue when you look at the pound sterling out, what is the net impact on that both?

Yes, essentially if you look at the topline, the sales line, so we have the positive impact obviously from – we have some coverage in place for exchange contract. So you have a plus there from the U.S.

dollars 10 point. And for their British Pound it has a negative impact obviously with the Brexit impact at the end of June.

So for the quarter, it has a negative impact, so both almost in assets like I mentioned on the call and in the document 0.2 million for the quarter. Now in terms of cost, we have as much cost in that British Pound and we have revenue.

So we’ve net U.S. position in our UK operation that is favorable.

So that’s why there is an impact on the gross profits. So it’s really all coming from this stronger U.S.

dollar.

Okay, perfect. And just in terms of free cash flow, I mean if we look for the first two quarters I mean you’re up 1 million, you mentioned earlier in the year kind of the $15 million, $20 million for the year in your slides.

Just wondering with what’s happening right now in terms of the working cap in terms of impact or if it’s still something that you might achieve in terms of free cash flow for the year?

Well, essentially after six months as you’ve seen the delivery we have a big second part of the year to do. So we have built up inventory regarding the second half of the year.

We have an increase in inventory of 10 million after at year-to-date. So obviously this is impacting the working capital situation and the associated free cash flow.

So we feel confident. We want to maintain the $20 million CapEx guidance and we still want to generate positive free cash flow like we said in the guidance for this fiscal year.

So we remain confident that we’ll generate positive free cash flow with the level of deliveries that we have to do in the second half of the year.

Okay, so just from an inventory standpoint, how should we be thinking about the second half Stephane?

Well, it’s going to reduce essentially. We have each level on the 777 that as Gilles said, there is an impact of all these processing.

So it’s taking a bit more time, obviously then when we’re going to do it internally. The lead time will be much shorter as we have proved for the qualification.

So we have reached a maximum level of 777 and as we achieve the sales level for the last semester will get those inventory.

Okay perfect. And last question for me, when we look at M&A obviously, Rockwell and B/E Aerospace have done at 12.6 time consensus earnings for 2017.

So what can you say about the potential targets that you’re looking at whether they are trading at those multiple and what do you see out there?

Well, Benoit it’s multiple of our expenses in our business, especially for target that are profitable and you know what we’re looking for. I mean, we’re looking for companies of IP, company that makes our design products that’s similar to us.

So of course when you find a quality company these days, you have a pay these type of multiple or less, but in that range. So I think the thing that’s important is when you move into this transaction, this is to figure the synergies and the fit and all this.

So yes, you pay a high multiple, but you manage to close into the two companies together and make this quite accretive for the shareholder. As we have done with APPH, remember what we’ve done with APPH over the last three years and I think we have proven to the community that we could start this business and make it very accretive for our shareholders.

Okay. And just a quick one with respect to the certification, the customer qualification, the 2% impact, is it something that could be compensated by Boeing just down the road?

Not at this point.

Okay. Thank you very much for the time.

Thanks. Good morning.

I just want to make sure I got the math right here just on the bottom line impact from the surface treatment that you’re outsourcing right now. If I’d done the quick math right, it’s looks to me it’s about $1.7 million, $1.8 million extra cost in the quarter, is that right?

Yes, that’s fine. Yes.

Okay. So if I look at EBITDA margin you reported 15.4% and if you were to back out this deal, this impact it would be sort of north of 17% EBITDA margin, correct?

Correct.

Okay. Just on the KC-390, obviously a nice contract expansion for you there.

I know you’ve been producing some parts on KC-390 already. When does that program really kind of ramp up?

Yes, essentially this is as you know a new program. So we’ll eventually go up to 12% aircraft per year.

So it could represent anywhere between 2% and 3% of our sales. So essentially double the content on this program, but as you know since that we have done this here on the KC-390.

So this will be at last for us.

Eventually this program is going to ramp up and we can produce or create a point in time at one a month, 10 to 12 per year I think maybe more. So we have an exclusive relationship now with Embraer life of the program, so.

Okay. So that’s definitely a nice win.

Can you maybe just on that, can you maybe just talk about other bidding opportunities out there. I mean what are you seeing?

Are you still pretty confident that there’s some more new contracts be it build to printer or full design contracts out there to win?

Yes, we have a couple of opportunity we’re working on. We cannot disclose them at this point.

But we certainly are working diligently to win additional business. We have open capacity at this point, and we want to take advantage of this open capacity.

We don’t have to invest in CapEx to use that capacity, which is importance. So we are actively trying to get additional business like we’ve done with Embraer.

We are talking with other customers such as for example Boeing is one of them and another customer in Europe, so.

Okay.

The good news we have capacity to sell. We don’t have to invest in CapEx to do this, so that’s good.

Okay, good. And maybe just a final quick question for Stephane.

The tax rate look low in Q2. Do you have sort of expectations of what we might see for the rest of the year?

It’s a bit special this quarter because we have the settlement gain, right.

Yes.

So there was almost no taxes associated to this. So that’s why the tax rate is much lower this quarter.

So nothing new to report on this to the exception of this settlement gain.

Okay, great. That was all I had.

Thanks very much.

Thank you, Cameron.

Yes, just coming back on the nice win with Embraer on the KC-390. Do you see a change overall in their strategy when it regards to the landing gear business?

No, I think their strategy at this point is really to design the product, designing it themselves, and then on major components that are difficult to make and to outsource this to product like us that know how to make these product. I think that’s their strategy at this point.

That may change in the future but that’s what it is today.

Okay. And obviously there are some nice opportunities out there.

Could you talk specifically about the next-gen trainer aircraft in the U.S. It seems a big opportunity out there.

So just wondering how do you tackle that opportunity?

Certainly, as you know there is four contenders for that business. So we’re watching this carefully sector probably and talking with the OEM that are competing for that business at this point.

So it’s something that of course we are quite interested to work with the winner on this one. But right now there is no winner at this point.

Okay and for the business jet, I mean you made some comment in your MD&A, I was wondering if you could remind what is your exposure right now and what do you foresee for next year in terms of business jet?

Essentially our sales content on the business jet is 6% of our total consolidated sales. So we see it’s not a big amount in terms of percentage or in terms of the market.

On the Embraer side it’s a new program for us. So we’re about at 30 aircraft per year.

So we foresee that will be probably stable. And we still have growth on the long-term side for the F 5X program, which is a new program.

We have no sales this year as this program is fixing the engine issue. So I think the business jet market will probably stay stable for next year.

That’s pretty much a market information.

It will start to ramp up as the 5X gets into production.

Okay, perfect. Thanks for the color.

Thank you all for listening. We are looking forward to update you on our progress during our next call in February.

So have a good day and thank you very much for listening to us today.