«Management Discussion and Analysis of Financial Position and Operating Results The purpose of this management discussion and analysis (“MD&A”) is ...»
The main raw materials purchased by the Company are aluminium, steel and titanium. Supply and cost of these materials is somewhat outside the Company’s control. Difficulty in procuring raw materials in sufficient quantities and in a timely fashion, along with cost increase for these materials, could also have a material adverse effect on the Company’s operations and financial condition.
In the past two years, as this situation has escalated with the improvement of the global economy and the explosive growth of the Chinese economy in particular, the Company has begun to take steps to mitigate this risk. It now includes clauses in its contracts to share the risk of raw materials availability and cost with its customers. It also negotiates long-term supply agreements with its suppliers of raw materials, and has increased its monitoring of the supply chain to ensure timely deliveries.
The activities conducted by the Company are subject to operational risks including competition from other businesses, performance of key suppliers, product performance warranties, regulatory risks, successful integration of new acquisitions, dependence on key personnel and reliance on information systems, all of which could affect the Company’s ability to meet its obligations.
23General Economic Conditions
Unfavourable economic conditions may adversely affect the Company’s business. For example, the large civil aerospace industry has experienced considerable uncertainty in prior years, especially the market for planes with more than 100 seats. In fiscal 2006, the regional jet market was negatively impacted by lower demand. Furthermore, the industrial power generation market, which collapsed in 2002, is now recovering slowly. This could adversely affect the Company’s financial condition and results of operation. Although long-term growth will likely eventually resume, the timing of that resumption is uncertain, and these sectors will remain cyclical. In addition, curtailment of production activities due to unfavourable economic conditions could result in the Company incurring significant costs associated with temporary layoffs or termination of employees.
Military Spending Although significant increases in military budgets, particularly in the United States, were announced in recent years, these expenses are approved by government on a yearly basis and are subject to the political climate and changing priorities.
Foreign Currency Fluctuations The Company is exposed to risks resulting from foreign currency fluctuations arising either from carrying on business in Canada in foreign currencies or through operations in the United States.
In an effort to mitigate those risks, the Company makes use of derivative contracts to hedge this exposure.
Liquidity and Access to Capital Resources
The Company requires continued access to capital markets to support its activities. To satisfy its financing needs, the Company relies on long-term and short-term debt and cash flow generated from operations. Any impediments to the Company’s ability to access capital markets, including significant changes in market interest rates, general economic conditions or the perception in the capital markets of the Company’s financial condition or prospects, could have a material adverse effect on the Company’s financial condition and results of operation.
Restrictive Debt Covenants
The indentures governing certain of the Company’s indebtedness and, in particular, syndicated
credit facilities contain covenants that, among other things, restrict the Company’s ability to:
- sell all or substantially all its assets;
- incur secured indebtedness;
- engage in mergers or consolidations;
- invest in capital expenditures over a certain amount per year; and
- engage in transactions with affiliates.
These restrictions could impair the Company’s ability to finance its future operations or its capital needs, or to engage in other business activities that may be in its interest.
The Company’s profitability may be directly affected by the level of and fluctuations in interest rates. The Company uses derivatives as an integral part of its asset/liability management program to mitigate or reduce its overall financial risk.
External Business Environment The Company faces a number of external risk factors, more specifically, general economic conditions, government policies and changing priorities or possible spending cuts by governments.
Warranty Casualty Claim Losses The products manufactured by the Company are complex and sophisticated and may contain defects that are difficult to detect and correct. Errors may be found in the Company’s products after they are delivered to the customers. If so, the Company may not be able to correct such errors. The occurrence of errors and failures in the Company’s products could result in warranty claims or the loss of customers. Any claims, errors or failures could have an adverse effect on the Company’s operating results and business. In addition, due to the nature of the Company’s business, the Company may be subject to liability claims involving its products or products for which it provides services. The Company cannot be certain that its insurance coverage will be sufficient to cover one or more substantial claims. Furthermore, there can be no assurance that the Company will be able to obtain insurance coverage at acceptable levels and cost in the future.
The Company’s activities are subject to environmental laws and regulations associated with risks to human health and the environment. Changes to these laws and regulations could have a significant adverse effect on the Company’s operations and financial situation. The Company monitors these risks through environmental management systems and policies.
Collective Bargaining Agreements
The Company is party to some collective bargaining agreements, which are subject to expiration at various times in the future. If the Company is unable to renew these agreements or others as they become subject to renegotiation from time to time, it could result in work stoppages and other labour disturbances, which could have a material adverse effect on the Company’s business.
The Company currently has collective agreements in place with all its unionized employees for the next two years.
Skilled Labour Héroux-Devtek’s ability to meet its future goals and objectives depends, in part, on its ability to attract and retain the necessary skilled labour. The skilled labour market in the aerospace industry is expected to be highly competitive in the future. The Company’s inability to attract and retain skilled labour, particularly engineers, machinists and programmers, could adversely affect its financial condition and results of operations.
25 Héroux-Devtek does not anticipate a substantial increase in its manpower requirements over the next few years. The Company is therefore addressing this risk by developing its human resource strengths internally and by working to retain the skilled employees that it currently has and attract the best talent by fostering a strong sense of corporate culture. In 2006, management filled a senior position that includes responsibility for the Company’s human resources.
SELECTED QUARTERLY FINANCIAL INFORMATION
After a slow start in the first half of the year, sales picked up in the last two quarters of fiscal
2006. The improved results of the Landing Gear Division helped generate positive figures in the last two quarters.
Traditionally a strong period, the fourth quarter of fiscal 2006 was yet again strong for the Company, with both Landing Gear and Aerostructure showing improved net earnings over last year’s fourth quarter due to increased sales and performance.
The adjustment of $(0.2) million in the fourth quarter to the net income from discontinued operations represents the final adjustment at year-end to the provision for income taxes estimated at time of sale related to the gain on sale of Diemaco.
OUTLOOK The military aerospace market is expected to remain solid for the next three years. The Joint Strike Fighter (JSF) program, considered to be the largest on-going military program over the next 20 years, is still in the development phase, with the first aircraft set for an inaugural flight later this year. Through our Aerostructure Division, the Company is particularly well positioned to grow with the JSF program, scheduled to ramp-up over a seven-year period beginning in calendar 2008.
Aircraft engine component sales have been impacted by delivery and quality issues at the Gas Turbine Components Division, and while improvements have been made, these sales are expected to decline further in the current fiscal year.
With the exception of regional jets, there is good demand for all civil aircraft, particularly 100+ seaters. Repair and maintenance business for both civil and military aircraft is expected to increase.
The Gas Turbine Components Division has experienced low business volume which negatively impact on its overall results. However, modest sales growth is expected in industrial gas turbines while wind power represents a fast-growing sector where the Company is well positioned to benefit from in the coming years.
The Company continues to work on managing the negative impact of the low US/Canada exchange rate and high raw materials prices. Based on the actual backlog, the Company’s management is expecting an internal sales growth of approximately 10% per year over the next 3 years and an increase in the Company’s overall performance with a return to profit in the current fiscal year.
Additional Information and Continuous Disclosure This MD&A was approved by the Audit Committee on May 30, 2006 and by the Board of Directors on May 31, 2006. Updated information on the Company can be found on the SEDAR web site at www.sedar.com.