«Management Discussion and Analysis of Financial Position and Operating Results The purpose of this management discussion and analysis (“MD&A”) is ...»
Management Discussion and Analysis
of Financial Position and Operating Results
The purpose of this management discussion and analysis (“MD&A”) is to provide the reader with
an overview of how the financial position of Héroux-Devtek Inc. (“Héroux-Devtek” or “the
Company”) changed between March 31, 2005 and March 31, 2006. It also compares the
operating results and cash flows for the year ended March 31, 2006 to those for the previous year.
This analysis should be read in conjunction with the consolidated financial statements dated March 31, 2006. Héroux-Devtek’s consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”). The Company reports its results in Canadian dollars. All amounts in this MD&A are in Canadian dollars unless otherwise indicated.
Forward-Looking Statements In the interest of providing shareholders and potential investors with information regarding Héroux-Devtek, including management’s assessment of future plans and operations, certain statements in this MD&A are forward-looking statements subject to risks, uncertainties and other important factors that could cause the Company’s actual performance to differ materially from those expressed in or implied by such statements.
Such factors include, but are not limited to: the impact of general economic conditions in Canada and the United States; industry conditions including changes in laws and regulations; increased competition; the lack of availability of qualified personnel or management; availability of commodities and fluctuations in commodity prices; foreign exchange or interest rates; stock market volatility; and the impact of accounting policies issued by Canadian and U.S. standard setters. Some of these factors are further discussed under Risks and Uncertainties in this MD&A.
Although the Company believes that the expectations conveyed by the forward-looking statements are based on information available to it on the date such statements were made, there can be no assurance that such expectations will prove to be correct. All subsequent forward- looking statements, whether written or orally attributable to the Company or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements.
Overview Héroux-Devtek Inc. and its subsidiaries (the «Company») specialize in the design, development, manufacture, repair and overhaul of systems and components used principally in the aerospace and industrial sectors. As such, a significant portion of the Company’s sales are made to a limited number of customers mainly located in the United States.
The Company was founded in 1942 as Héroux Machine Parts Limited, and later changed its name to Héroux Inc. The Company became public in 1986. In 2000, it acquired Devtek Corporation and the two entities were merged to form Héroux-Devtek Inc., one of thelargest second-tier manufacturers in the Canadian aerospace industry.
Héroux-Devtek serves two main segments: Aerospace and Industrial. The former Aerospace & Defence segment became the Aerospace segment as of March 31, 2005, following the sale of Diemaco, which formed the Company’s Logistics and Defence Division. This Division is shown as discontinued operation. The Company supplies both the commercial and military sectors of the Aerospace market with landing gear (including spare parts and repair and overhaul services), airframe structural components including kits, and aircraft engine components. In the commercial sector, the Company is active in the business jet, regional jet and large commercial jet markets.
On the military side, the Company provides parts and services for all major military aircraft mainly in the United States.
Héroux-Devtek’s main product for the Industrial segment is large components for electricitygenerating gas turbines, with its largest customer being The General Electric Company (GE). It also sells precision components for other industrial applications including products for the wind energy market.
The Company’s sales by segment are as follows:
Héroux-Devtek sells mainly to original equipment manufacturers (OEMs) such as GE, Lockheed Martin, Bombardier and Boeing, and into the aftermarket, where its main customers are the U.S.
Air Force (USAF) and U.S. Navy. In fiscal 2006, sales to these customers represented approximately 64% of total sales.
Héroux-Devtek is structured around two segments: Aerospace and Industrial. The Aerospace segment is comprised of the Landing Gear and Aerostructure Divisions and of the Aircraft Engine Components of the Gas Turbine Components Division. The Industrial segment is comprised of the large components for the power generation and other industrial products. The Landing Gear Division designs, manufactures, repairs and overhauls landing gears and has built a strong, well-recognized design engineering team. The Aerostructure Division manufactures airframe components ranging in size from small to very large, for the commercial and military aerospace markets. The Gas Turbine Components Division manufactures aircraft engine components and large components for the power generation and other industrial markets.
Each division is assigned responsibility for its own market development and operating results in order to foster entrepreneurship and employee involvement. The Company’s corporate head office provides support to the divisions and retains responsibility for such areas as global strategic development, financing, legal counsel, human resources, public relations and the Company’s public financial reporting and disclosure requirements.
Héroux-Devtek’s business strategy is to position itself as a key supplier for its customers in the three pillars of its business: landing gear, aerostructure and gas turbines. For the Company, being a key supplier means providing not only manufactured components but also other services such as design, assembly and program management in order to become a complete service provider and allow customers to focus on their core business. In order to achieve this, the Company aims to develop management and technical expertise so as to add value to products at competitive costs. It also seeks to grow to attain a critical mass in each of its market segments, while maintaining a solid financial position.
In practice, this translates into:
- A focused factory approach, with each plant specializing in a specific type of component;
- Standard, compatible information systems across the Company;
- Migration of technical and managerial know-how between divisions;
- A lean manufacturing approach in all its plants;
- Revenue stability through long-term agreements with its customers;
- Maintain a balanced sales mix between civil and military aerospace markets and, industrial sales; and
- Maintain and build on a culture of entrepreneurship through the participation, dedication and commitment of its employees.
Héroux-Devtek seeks growth externally through acquisitions that can be easily integrated into its existing operations or that bring complementary technology, leading to greater added value.
Internally, the Company aims to:
- Develop valued-added, proprietary products through design engineering;
- Establish or enhance its presence in certain product markets, such as the after-market repair and overhaul of commercial and military landing gear, design and manufacturing of small landing gear, and large structural assemblies for commercial and military aircraft OEMs; and
- Diversify the customer base for its existing product lines, which generally means finding new OEM customers for its landing gear, airframe structural components and industrial products.
Key Performance Indicators
Héroux-Devtek measures its performance on a company-wide basis through key financial indicators that include sales, gross profit, EBITDA, operating income, working capital, longterm-debt-to-equity ratio, and earnings per share. These items are discussed in the appropriate sections below.
Management also tracks the performance through certain indicators related to operations. These include Return On Net utilized Assets (“RONA”), backlog, value-added as a percentage of sales, percentage of on-time deliveries, non-quality costs, attainment of cost reduction targets, and capacity utilization.
In the aerospace industry, there is a broad trend toward OEMs outsourcing manufacturing activities. OEMs are buying more components from increasingly fewer suppliers. They are tending to buy kits for assembly and large sub-assemblies, and to reduce their manufacturing activities in order to concentrate on design and marketing. OEMs are also sourcing components for their products on the global market, in order to benefit from the best cost-quality-delivery parameters, wherever they can. This is expected to be an ongoing trend.
The commercial aerospace market, which started a turnaround last year, showed a steady growth this year with, Boeing1 and Airbus2 deliveries increasing by 10%.
As indicated last year, the regional jet market is shrinking, with reduced demand for 50-seaters3.
However, the outlook for 70- to 90-seaters looks promising for the next three years should the financial situation of the airlines improve4.
Deliveries of business jets are up 20%, with 754 units5 delivered in calendar 2005 compared to 591 units in 2004. The outlook for the next four to five years is positive.
The military market remains solid again this year. This market is adapting to unconventional war with helicopters and small weapons. This opens new possibilities in this market. Furthermore, there is continued interest in unmanned aircraft vehicles (“UAV”).
After a major decline in the last couple of years, the power generation market has stabilized somewhat and is expected to experience slight growth in fiscal 20076.
In fiscal 2006, the Company made inroads into the new and promising wind energy market. This source of “green” energy is very promising, with growth expected for the next 10 years7.
Finally, the continued strength of the Canadian dollar has had a significant negative impact on Héroux-Devtek in the past few years, given that a substantial portion of the Company’s sales is in U.S. dollars while it reports in Canadian currency.
Major Achievements of Fiscal 2006
- Closing of the sale of the Logistics and Defence Division, Diemaco The Company entered into an agreement with Colt Defence LLC, a U.S. company, for the sale of its Logistics and Defence Division, Diemaco, in February 2005. The sale transaction closed on May 20, 2005 (see Note 4 to the consolidated financial statements).
1 Source : Boeing press releases 2 Source : Airbus press releases 3 Source : Forecast International 4 Source : Forecast International 5 Source : GAMA (General Aviation Manufacturer Association) 6 Source : GEPS (General Electric Power System) 7 Source : EWEA (European Wind Energy Association)
- Extension of credit facilities The Company’s credit facilities, allowing it to borrow up to $80 million, were extended to March 21, 2007.
- Financial turnaround The Company posted profits in the last two quarters of fiscal 2006.
- Major contracts awarded or renewed in fiscal 2006 $125 million contract with Goodrich to supply landing gear components for the Boeings’ B-777 aircraft over the next 10 years;
$62.6 million contracts for the provision of the following:
- Major structural machined components and assemblies for the F-35 Joint Strike Fighter (JSF) Short-Take-Off / Vertical Landing (STOVL) aircraft currently in the development phase. Deliveries will run through fiscal 2008;
- Major components for the B-777 aircraft to Boeing. The work will be performed over 3 years and commenced in fiscal 2006;
- Landing Gear components and complete assemblies for the F-15 and F-16 fighter aircraft, and B-1B aircraft to be delivered over 3 years and commenced in fiscal 2006;
Additional contracts for over $20 million with the USAF and the U.S. Navy for the production of landing gear components for the KC135R, C-130, B1B aircraft and the P-3, to be delivered over the next four years;
$12 million in new contracts with Lockheed Martin for work on the Conventional TakeOff and Landing (CTOL) versions of the F-35 Joint Strike Fighter (JSF), currently in the development phase.
- Kitchener plant expansion Work began on expanding the Kitchener landing gear plant by 27,000 square feet to accommodate new work on the B-777. The $12 million expansion should be completed by December 2006.
- Progressive plant expansion The Company announced a 12,500 square feet extension to its main plant in Arlington, Texas, to support work on the JSF and other aircraft programs.
Due mainly to the acquisition of Progressive in April 2004, sales and EBITDA rose in fiscal
2005. Progressive’s good performance was partially offset by further reductions in sales and profitability at the Landing Gear Division in fiscal 2005 arising from reduced business activity and an unfavourable sales mix. The Company’s fiscal 2005 results were also negatively affected by continued marginal capacity utilization at its plants, mainly attributable to sluggish business activity in its key markets. The sustained strength of the Canadian dollar, sharp raw materials 1 Due to the change in accounting policy on asset retirement obligations – see Note 2 to the consolidated financial statements.
The Company’s results improved in fiscal 2006 due to an improved performance by the Landing Gear Division. Sales and EBITDA continued to increase, and the net loss from continuing operations was significantly reduced. These improved results were somewhat tempered by a low production volume at the Gas Turbine Components Division and the even stronger Canadian dollar.
RESULTS OF OPERATIONS