Héroux-Devtek Inc.

Thank you very much, Sylvie. And good morning, everyone.

And welcome to our second quarter earnings conference call for fiscal 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 on our website.

We are happy to report that we delivered $141 million of sales this past quarter, continuing our positive momentum and bringing our trailing 12 months sales to just under CAD 580 million. We delivered 14% more sales than during the first half of last year.

And we expect to continue our improvements during the seasonally stronger second half of the fiscal year. This performance is a remarkable accomplishment given the seasonal shutdowns and vacations that occurred during the second quarter, and it attests to the hard work and dedication of our teams.

Our adherence to the plan we put in place also drove stronger profitability compared to last year. We took another step towards restoring our margin to historical levels, but there remains work to be done.

Linearity remains a challenge as our industry continues to operate in a difficult supply chain environment, while working hard to adapt to it as our customers and suppliers, but we expect the conditions to remain for some time still. Outside of the immediate headwinds, however, the future for our industry has rarely looked this bright.

I'll develop on that later, but first, I would like to turn it to Stéphane for a detailed review of our second quarter performance.

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 measure are defined and reconciled in the MD&A issued earlier today.

Our consolidated sales in Q2 increased by 6.6% to CAD 141.5 million compared to CAD 132.7 million last year, reflecting a 29.8% growth in the civil market segment, as well as a 4.1% positive impact of foreign exchange. Gross profit increased to CAD 22.5 million or 15.9% of sales from CAD 18.4 million or 13.8% of sales last year due to higher throughput and pricing initiatives, partly offset by the effect of inflation on labor and general production supplies, as well as a less favorable product mix.

Operating income increased to CAD 9.1 million or 6.4% of sales from CAD 8.6 million or 6.5% of sales last year, reflecting higher gross profit, partly offset by higher employee-related costs. For the same reason, adjusted EBITDA increased to CAD 18.2 million or 12.9% of sales from CAD 16.2 million or 12.2% of sales.

Net income for the second quarter of fiscal 2024 stood at CAD 4.6 million or CAD 0.14 per diluted share compared to CAD 4.8 million or CAD 0.14 per diluted share last year and up from CAD 3.6 million or CAD 0.10 per share on an adjusted basis. Cash flow related to operating activity represented a usage of CAD 15.6 million in the second quarter compared to CAD 8.3 million generated last year.

The use of cash reflects continued investment in inventory, stabilize our production system and sustained future sales world. Our improved profitability partly offset the effect of these investment on our net debt to adjusted EBITDA ratio, which stood at 3.1 compared to 2.7 at March 31, 2023.

Back to you, Martin.

Thank you, Stéphane. We are quite pleased with our performance.

And we can already see the positive outcomes of our efforts to return to historical levels of volume and profitability. Aerospace demand continued to increase.

Passenger traffic levels are very nearly back to the pre-pandemic levels globally. And domestic travel is in fact 9% higher.

The return of travel demand is once again driving new aircraft orders and this, combined with long term fleet replacement forecasts, is pushing OEMs to increase production rates. Geopolitical tensions have also added urgency to the defense industry's effort to maintain, develop and launch new aircraft programs, both in the United States and Western Europe.

The expertise of our engineers and the excellence of our manufacturing teams are attracting very strong demand for our services. As a result, we are well positioned to participate in many programs across the world that should drive our revenue for years to come.

The contract we announced last week with ITP Aero is a great example of this. We will be partnering with them to develop a nozzle actuator technological demonstrator for the next generation fighter engine to kick off our participation in the FCAS program.

We're entering the seasonally stronger second half of our fiscal year with great momentum and we are having many positive discussion with our clients and partners. In closing, I'd like to thank our team again for their efforts throughout the summer months.

And I'm confident that the best is yet to come. Sylvie, we are now ready to answer questions.

This is Eli [ph] filling in for Konark. Congrats on the good results and margin progression.

Two questions on my behalf. So the 12.9% margin is the highest you've achieved in the last six quarters.

How does it compare to your expectations in August? And what does the EBITDA bridge look like from Q1's 11.6%?

It's a very good remark. Obviously, this is the trail and the effort we have put in the last few quarters, reestablishing our throughput.

And obviously, the volume and pricing is contributing to the margin. So we're on the path to bring back the margin to historical level.

I think Martin has been pretty clear on that in the past few quarters. So this is, again, a step in the right direction.

And in the bridge, compared to Q1 last year, is reflective of what I just said, like volume/pricing, partly offset by the inflation that we have versus last year on our supplies and utilities and freight. But it's getting better compared to Q1.

And my last question is, what are your top capital allocation priorities at this time, given the ongoing improvements in margin?

The number one priority has been to invest in our working capital to reestablish our throughput. But also, you see, as Martin said, our trailing 12-month sales has increased again this quarter to CAD 580 million.

So this is going in the right direction on our goal to exceed CAD 600 million of revenue. That's the goal.

That's the priority that we have done since the past three quarters. And we have bought back shares through the NCIB program announced in August.

So that's remained the same priority as the previous quarter.

I want to follow up on your just commentary around the working capital. Obviously, another significant investment in the second quarter here, another CAD 16 million in inventory.

I guess, maybe two questions from this. How much more do you have to invest in to get comfort around the throughput?

And how much do you think is excess inventory at this point? I'm just trying to think about when this unwinds, what kind of cash generation that might produce.

We're more at the end than at the beginning to answer your question. So we are in a very good place to have a very strong second half of this fiscal year.

So that's what we've done to put that in place. We don't have excess inventory, but we have inventory to support the issue we have within the production system.

So if you go back to fiscal 2020, pre-pandemic, when the pandemic hit, we were at about CAD 240 million. And we were trending to sales at the time that are similar to what we foresee in the next couple of quarters.

So, probably have anywhere between CAD 40 million, CAD 50 million of inventory additional to manage through the production environment, but this will be an opportunity. Not in the short term, but will be an opportunity eventually when things stabilize.

Maybe you can just update us on where things are on discussions you're having with customers around repricing. I know it's a long game to do this.

But how is the tone of those conversations you're having with some of your customers to try to get pricing up to offset inflation?

Yeah, very good tone, Cameron. So we work transparently with our customer.

We are ready to share information and the initiatives that we took last year is very improved. It's in line with our expectation.

And we have very constructive discussion and positive discussion. And we haven't been able to readjust the pricing or to structure better the pricing to reflect the condition/environment.

So there's still work to be done. We still have contracts that will be expiring in few years to come.

That will give us another opportunity to review our pricing there. But all in all, it's going well.

We're starting to see the effect of that, like Stéphane said, in our margin, but we should see greater impact towards the end of the fiscal year.

Just a follow-up on that last point. Could you share with us a little more color about the portion of revenue that's subject to repricing?

And maybe what portion you've already completed the negotiations on and what portion will be expiring over the coming year?

That's a very touchy question. It's a difficult question to answer.

What I can tell you is the contract that we were allowed to do and that we had an opportunity, they're done. So a portion of it to clearly evaluate based on our percentage of our sales.

It's very difficult to answer at this point, Jonathan?

I'm wondering if you could talk about if there are any new opportunities in terms of aftermarket revenue or aftermarket business development over the next couple of years that you see. You kind of touched on new platform opportunities.

It's a little tougher to see from the outside, but are you seeing any opportunities to build and take market share effectively in the aftermarket business?

Our order book for aftermarket sales or aftermarket orders is very, very strong. Well, I would say, closely to the strongest that it's ever been.

We're busy with the product that we developed, our IP products and people wants to fly their assets. So, it's a healthy situation that we have in the aftermarket, as we speak.

And with the geopolitical tension, there's going to be some demands also with aftermarket of the US and Western countries to replace and to maintain aircraft and other systems or the different systems, given the situation that we have. So that's what we see in the aftermarket today.

Maybe following on that question, if I think forward to a couple of years, two to three years out when, hopefully, a lot of the supply chain and logistics challenges are behind you and more of the inflation has been passed on through contracts, could you talk about how your product mix and your service mix might be different than it was pre-pandemic? And I'm thinking about the actuation business, sort of its contribution aftermarket versus new platform, just anything from a product mix perspective that we should think about when comparing kind of longer term margins to historical margins?

Well, I would say that, because of the defense, demand is going up and 777 will take some time to get to historical level or pre-pandemic level at 66 airplanes or 70 airplanes a year. Aside of that, the percentage should remain approximately the same because we're booking business, as we speak, in OE and aftermarket.

Like I said, we're solicitated with many projects on the different sides in the US, in the UK, in Europe, and even in South Korea. So we're going to be busy.

So, we're in a good position today. So to give you a straight percentage, you can use approximately the same percentage than what we're living today.

But the nominal – the value will increase, the total will increase, but in percentage, should be as we are today. Right, Stéphane?

And contributing to that, Tim, we have product that we have developed in the past few years, like the creator and other program. These eventually will see aftermarket.

That's one of the factors I'm trying to consider. I'm thinking back to pre-pandemic.

You did have some products in development, which would have biased margins lower and been a bit of a headwind, and those should be in more of a production or a higher margin phase going out a couple of years. So, I would think that would actually help the comparison slightly.

But that's helpful. My last question just on capital expenditures.

Correct me if I'm wrong, but there's nothing in your pipeline of deliveries over the next couple of years that should require any significant growth CapEx. Like, your CapEx should be reasonable.

And if there is a need for additional or a step up in CapEx, it would probably come hand in hand with a new business opportunity? Is that a good way of thinking about your CapEx over the next two or three years?

Absolutely. That's a fair statement.

Of course, if we have the big opportunities, really big opportunities, CapEx will have to be revised. But today, it's a normal trend.

Again, for the free cash flow, between 3% to 5% of sales should be a good number.

I just wanted to also ask about the opportunity going forward on single aisle. At what point do you believe that you'll have opportunities to increase your content on those?

How do you see – how is the bidding pipeline looking over the next year?

The line is not very good, Jonathan. So I believe I understood the question and the question was to – if we see any opportunities on the single aisle market and how far can we see it.

So, the single aisle markets or Airbus is looking for new airplanes that are still to be launched with the new propulsion strategy or greener airplane. Before they launch new airplanes in the single aisle, we cannot touch that market because the IP belongs to Safran.

As opposed to the 737 MAX, which is the other platform, the other single aisle, this one is a built to print contract, but the contract expires in 2030. So when are we going to have the chance is depending of the customer needs, and the opportunity will come with the launch of a new platform by Boeing and by Airbus.

And I expect, and when I read between the line there, communication is towards the end of the decade. So probably in the timeframe between 2027 to 2030.

But, obviously, we will be called slightly before that to be invited to propose our solution for these programs. Does that answer your question?

Did I understand well?

Yeah, that's interesting. Thank you.

Okay. Thank you very much, everyone.

And I thank you for your confidence and looking forward to have other discussions with you and update you on our business. Thank you very much.

And have a great day.