Héroux-Devtek
Annual Report 2019

Plain-text annual report

EXCELLENCE IN EXECUTION “AT HÉR OUX- DE VTE K , WE AR E CO MM ITTE D TO EXCE LLE NCE I N E VERY THI NG WE DO . FR O M I NI TI A L DESI GN , E NGI NEE R ING AND MANUFACTURING , TO DELIVERY AND AFTERMARKET SERVICE .” MARTIN BRASSARD, PRESIDENT & CEO BOEING MQ- 25 Unmanned Aer ial Ref uel in g Pr og r am Select ed in A pr il 2019 to S up p ly th e Co mp le te Landing Gear S yste m s HÉROUX-DEVTEK AT A GLANCE } Héroux-Devtek Inc. (traded on the Toronto Stock Exchange under the symbol “HRX”) is an international company specializing in the design, development, manufacture, repair and overhaul of aircraft landing gear, hydraulic and electromechanical flight control actuators, custom ball screws and fracture-critical components for the global aerospace market. } With headquarters in Quebec, Canada, Héroux-Devtek is the third-largest landing gear company in the world, supplying leading aerospace customers operating in both the commercial and defence sectors. } Founded in 1942, Héroux-Devtek now employs approximately 1,960 dedicated people at its 18 facilities located in Canada, the United States, the United Kingdom and in Spain. } Héroux-Devtek is recognized for its forward thinking, engineering, world class service and above all, its excellence in execution. BOEIN G 777/ 777X Hér o ux- Devtek 2019 [ 3 ] Héroux-Devtek 2019 [ 5 ] FEATURED SUPPLY CONTRACTS supplies Héroux-Devtek the complete landing gear systems and aftermarket parts for The Boeing Company’s 777/777x commercial jet. The contract was awarded in 2013 and first deliveries occurred in 2016. SA AB AB G RIP EN E _ Héroux-Devtek supplies the com- plete landing gear systems for Saab AB’s Gripen E fighter aircraft as part of a design, manu- facturing and life cycle contract. _ Héroux-Devtek supplies the landing gear systems for the Sikorsky CH-53K King Stallion heavy lift helicopter as part of design, manufacturing and life cycle contract _ Héroux-Devtek will supply the landing gear systems for Dassault Aviation’s Falcon 6X as part of a design, manu- facturing and life cycle contract. _ SIKORSK Y C H53-K KING S TAL LIO N DASS AULT AV IATION FALC ON 6X Hér o ux- Devtek 2019 [ 4 ] FINANCIAL HIGHLIGHTS FI SC AL Y EA R S END ED MA R C H 3 1 2019 2018 2017 2016 2015 OPERATING RESULTS Sales Operating income Adjusted operating income (1) Adjusted EBITDA (1) Net income Adjusted net income (1) Cash flows related to operating activities Free cash flow (1) Funded backlog FINANCIAL POSITION Cash and cash equivalents Working capital Total assets Long-term debt (2) Shareholders’ equity PER SHARE DATA EPS – basic and diluted Adjusted EPS (1) (in millions of dollars, except per share data and ratios) 483.9 386.6 406.5 406.8 364.9 37.2 41.6 74.2 26.2 30.4 70.0 58.1 23.4 30.3 56.9 13.7 24.2 56.1 50.8 35.6 35.9 61.4 31.8 26.4 56.1 33.0 624.0 466.0 405.0 37.8 39.3 64.1 26.6 27.7 6.8 6.6 29.4 47.8 3.2 19.4 46.2 (66.3) 460.0 (15.0) 459.0 35.1 177.6 874.7 263.3 402.0 93.2 201.9 632.2 132.0 379.0 42.5 165.1 607.3 134.8 355.9 19.3 150.5 609.4 147.2 331.1 35.1 109.7 575.5 114.2 293.5 0.73 0.84 0.38 0.67 0.88 0.73 0.74 0.77 0.09 0.55 Average number of shares outstanding (diluted, in 000’s) 36,437 36,332 36,284 36,119 35,016 FINANCIAL RATIOS Adjusted EBITDA (1) margin Working capital ratio Net debt-to-equity (2) (3) 15.3% 14.7% 15.1% 15.7% 13.1% 1.95 0.56 2.86 0.10 2.58 0.26 2.34 0.39 1.75 0.27 [1] These are non-IFRS measures. Please refer to the “Non-IFRS financial measures” section of the MD&A under Operating Results for definitions and reconciliations to the most comparable IFRS measures. [2] Including the current portion, but excluding net deferred financing costs. [3] Defined as the total long-term debt, including the current portion, but excluding net deferred financing costs, less cash and cash equivalents over shareholders’ equity. Hér o ux- Devtek 2019 [ 5 ] Hé roux - Devtek 2019 [ 7 ] Hé roux - Devtek 2019 [ 7 ] INVESTMENT HIGHLIGHTS B U I LD I NG LO NG -TE RM VALUE FOR SHARE H O L DE RS HÉ RO UX- DEVTEK H AS DE LIVERED A COMP OUND A NNUA L GROWTH RATE OF 11% FOR OPE RATIN G I NCOME AN D 14% FOR ADJUSTED EBITDA (1) OVER THE LAST 6 YEARS GROWING A DJU STE D PRO FITABILIT Y  Adjusted EBTIDA(1) $M  Adjusted EBTIDA(1) % GROWING OPERATING PROFITABILITY AND PRODUCTIVITY ($M)  Non Recurring items  Total Operating Income  Sales per Employee (‘000s) ) s 0 0 0 ‘ n i ( e e y o p m e l r e p s e a S l FY14 FY15 FY16 FY17 FY18 FY19 FY14 FY15 FY16 FY17 FY18 FY19 MAIN TAIN IN G STRO NG C ASH FLOW AND CO NSIS TENTLY R E IMB URS IN G DEB T (In millions of dollars) 225 175 125 75 25 (25) (75) FY14 FY15 FY16 FY17 FY18 FY19 Cash Flow Related to Operating Activities Free Cash Flow(1) Net Debt(2) [1] These are non-IFRS measures. Please refer to the “Non-IFRS financial measures” section of the MD&A under Operating Results for definitions and reconciliations to the most comparable IFRS measures. [2] Including the current portion, but excluding net deferred financing costs. EMBRAER LEGACY 450/50 0 H é r o ux-D ev tek d esigne d, d eve lo p e d a n d s up p l ie s t he l a n d i n g g ea r s ystem s f o r Em brae r’s L e g ac y 4 5 0/5 0 0 b u s i n ess jets as par t of a li fe -c yc le c o nt ra ct ob ta in ed i n J u ly 20 08 FINANCIAL DELIVERING VALUE TO SHAREHOLDERS • Nurture acquisitions • Grow revenues • Extract operational leverage • Deleverage STRATEGIC PILLARS OP ER ATIO NAL E MPL OYE ES FOCUSED ON EXCELLENCE FOSTER OUR ENTREPRENEURIAL CULTURE • Maintain the best operational track record • Respect • Deliver excellence • Responsibility • Implement best-in- class processes and technology • Leverage position as global supplier • Recognition • Resilience CU STOMERS EXCEED EXPECTATIONS • Reliability • Quality • Commitment • Agility Hér o ux- Devtek 2019 [ 7 ] Hé ro ux- Dev tek 20 19 [ 9 ] STRONG GOVERNANCE AND INDUSTRY FOCUSED BOARD GILLES LABBÉ Executive Chairman of the Board Non-Independent Board Member Since 1985 MARTIN BRASSARD President and Chief Executive Officer Non-Independent Board Member Since 2019 PAULE DORÉ Corporate Director Independent Board Member Since 2010 Chair of the Human Resources and Corporate Governance Committee JAMES J. MORRIS Corporate Director and Consultant Independent Director Since 2013 Member of the Human Resources and Corporate Governance Committee BRIAN A. ROBBINS Executive Chairman, Exco Technologies Limited Lead Director Independent Board Member Since 2000 Member of the Human Resources and Corporate Governance Committee NATHALIE BOURQUE Corporate Director Independent Board Member Since 2015 Member of the Audit Committee LOUIS MORIN President, Busrel Inc. Independent Director Since 2008 Chair of the audit committee ANDREW JOHN STEVENS Corporate Director Independent Director Since 2014 Member of the Audit Committee BEVERLY WYSE Corporate Director Independent Director Since 2019 Member of the audit committee Hér o ux- Devtek 2019 [ 8 ] EXECUTIVE CHAIRMAN’S MESSAGE DEAR SHAREHOLDERS, It is with immense pride that I took on the role of Executive Chairman on June 1, 2019. After more than 30 years at the helm of Héroux-Devtek, I am now ready to dedicate more time to our strategic direction and leave our operations in the highly capable hands of Martin Brassard. Today, Héroux-Devtek is the world’s third-largest manufacturer of landing gears and a growing provider of complementary actuation systems, dedicated to serving the world’s largest aerospace companies. It is our team’s focus on excellence, uncompromising quality and entrepreneurial culture that has brought us to where we are today. Strong Financial and Operational Performance in Fiscal 2019 Over the past year, we laid the foundations of our next phase of growth. We completed four strategic acquisitions that broaden our geographical reach and customer portfolio and bring new capabilities in the growing actuation and hydraulic market. We achieved strong financial results on all fronts from the contribution of the acquisitions of Beaver and CESA in Fiscal 2019 and from the ramp-up of our systems deliveries for Boeing’s 777/777X program, from higher sales in the business jet market and of spare parts. We ended the year with $483.9 million in revenues, up more than 25% from last year and exceeding our revenue guidance. Operating income and adjusted EBITDA(1) margins stood respectively at 7.7% of sales and 15.3% of sales, up from 6.0% of sales and 14.7% of sales last year. Strong Fundamentals and Diversification Our industry continues to benefit from strong tailwinds. Passenger travel demand remains strong and global defence spending is reaching record levels. Deliveries and orders for new aircrafts are reaching all-time highs, driving sustained growth and multi-year manufacturing ramp-ups in the industry. As a key systems manufacturer for most of the world’s leading aircraft OEMs, we are well positioned to benefit from these solid fundamentals. We have an enviable and diversified portfolio of customers within both the commercial and defence industries, a healthy combination G O V E R N A N C E Héroux-Devtek has always believed in strong governance. Our Board is mainly composed of independent directors and veterans of the global aerospace industry. Héroux-Devtek’s success is based on consistent and actionable interactions between our Board of directors and our management team. In this spirit, in fiscal 2019 we welcomed Beverly Wyse to our Board, a long-time Boeing executive with an impeccable track record and deep industry relations. She is also the third woman director to join Héroux-Devtek. I am especially proud of our directors’ combined expertise, diversified backgrounds and complementary mindsets. As Executive Chairman of the Board, I look forward to further contributing to our success and assisting Martin Brassard in his new role as President and CEO. I also wish to thank Brian A. Robbins for his exceptional contribution as Chairman of the Board, a position he recently left to become lead director, as well as Andrew Stevens, who will be retiring from the Board of Directors. [1] These are non-IFRS measures. Please refer to the “Non-IFRS financial measures” section of the MD&A under Operating Results for definitions and reconciliations to the most comparable IFRS measures. Hér o ux- Devtek 2019 [ 9 ] Hé rou x- Dev tek 2019 [ 11 ] of build-to-print business and proprietary designs and increasing revenue from spare parts and aftermarket services. As always, we remain dedicated to value creation for all our stakeholders. We strive to create a passionate work environment for all our employees and are unwaveringly committed to offering excellence in our products, irreproachable execution and world-class service for our customers. Sincerely, GIL LES LABBÉ EXECUTIVE CHAIRMAN OF THE BOARD AIRBUS A400M Héroux-Dev tek (vi a C ESA ) supp lies sy st em s and com ponents for Airbus’s A400M military transportation aircraft . DIV ERSIFIED AND BA LA NCED REVENUE MIX DEFENCE / C OMMERCI AL PRO PRIETA RY / B UILD-TO-P RINT 50/50  Defence  Commercial 43% 57%  Build-to-Print  Proprietary and Life of Program Contracts OE M / A FTERMAR KET 64% 36%  OEM  Aftermarket Large Jets Business Jets Regional Jets Helicopters Other Transport Fighters Helicopters Hér o ux- Devte k 2019 [ 10 ] PRESIDENT & CEO’S MESSAGE DE AR STAKEH OLDE RS, I would like to thank Gilles and our Board members for their confidence and support during my 25 years at Héroux-Devtek. Over time, I have had different roles, responsibilities and experiences that prepared me well to take on the role of President and CEO. We have built a strong company with an enviable reputation in a very competitive aerospace market, an accomplishment of which I am proud. With a well-diversified, record firm order backlog and the competent team of executives I am fortunate to count on, the Company is well positioned for long-term success. I am also proud of the excellent work executed by both our operational and corporate teams last year. Their dedication and hard work allowed us to complete four acquisitions while continuing to deliver on our existing business with the high level of execution our customers have come to expect. Four Acquisitions to Accelerate Growth The companies we have acquired are all well-respected suppliers to the global aerospace industry. They are providing us with additional exposure to both the defence and commercial markets and have grown our customer and supplier base internationally. In October 2018, we completed the acquisition of Compañia Española de Sistemas Aeronáuticos S.A. (“CESA”), a subsidiary of Airbus SE, which added to our customer relationships and marked our entry into the complementary actuation systems market. CESA’s strong technical and engineering expertise as well as their proven commitment to delivering quality products on time to customers are pillars that we are excited to build on. We are working closely with the team in Spain to grow that business segment by introducing their capabilities to our existing North American customers’ base. We are very proud to see this newly acquired organization embrace the Héroux-Devtek entrepreneurial culture and many best practices are being exchanged between our teams in a very collaborative and transparent manner. In July 2018, we completed the acquisition of Beaver Aerospace & Defense Inc. (“Beaver”), a leading supplier of ball screws and actuation systems. Since joining Héroux-Devtek, Beaver has performed very well operationally and financially, as evidenced by their firm order backlog increasing significantly. We have plans to invest in new technology that will add to their competitive edge. We also see Beaver as a key partner partner for CESA in developing electromechanical actuators, a product line that will see increasing demand as new aircraft programs will feature more electrical components and systems than those flying today. In January 2019, we completed the acquisition of a majority equity stake in Tekalia Aeronautik (2010) Inc. (“Tekalia”). This plating operation has very unique capabilities in the North American surface treatment supply chain that are necessary to produce landing gear components. It is a one-stop- shop that has all necessary customer approvals which gives us flexibility in KEEPING AHEAD OF THE CURVE While the aerospace sector continues to be a growing and resilient industry, we remain focused on implementing new technology and hiring the best talent to maintain our leading position in the market. We are continuously looking for ways to further automate our manufacturing processes in order to improve our efficiency. We do this, among other ways, by promoting, sharing and implementing best practices throughout all of our facilities. Looking ahead, the digitalization of our business processes and data analytics will push our technology further, allowing us to manufacture first-class products at a lower cost. Hér o ux- Devte k 2019 [ 11 ] Héroux- Devte k 2 019 [ 1 3 ] our production systems, allows our suppliers to count on a reliable plating facility and will generate additional revenue for the corporation. And finally, in June 2019, we completed the acquisition of Alta Precision Inc., a Québec-based manufacturer of high-precision landing gear components. This acquisition adds two new growing programs in the commercial jet market to our portfolio: the Embraer E-jet E2 family and Airbus A-220. It also expands our scope of work on Boeing’s 787 and Airbus’ A-350 programs. with this important customer to set up the required capabilities and capacity to execute properly on this major program. We believe this approach sets the foundations for mutual trust and a long-lasting beneficial relationship with our customers and supply chain. 13% CAG R G ROWIN G REV ENUE $635 $570 $484 These acquisitions bring strong growth opportunities in terms of products and customers and expand our global operations with an incredible group of highly motivated and talented employees. $272 $407 $407 $387 $365 Positioned for Long-Term Success We are entering Fiscal 2020 with a record firm order backlog that is set to grow further with the entry into service of several programs for which we supply landing gear systems. Leading the organic growth, the Boeing 777 production rate is expected to increase in the coming years as the 777X is scheduled to enter in service in 2020. Currently, Boeing has a backlog of 436 airplanes for the 777 program, including 344 orders for the 777X. We have all capabilities necessary to properly execute this new program as we have already manufactured all landing gears sets necessary for the flight test vehicles in Fiscal 2019. Four other programs for which we designed the complete landing gear system are scheduled to enter into service in the coming years. The design and manufacture of these systems, namely the Sikorsky CH-53K King Stallion, Saab Gripen E, Dassault Falcon 6X and Boeing MQ-25 Stingray provides a clear path to sustained growth and profitability while expanding our portfolio of proprietary products. Transparency and Collaborative Approach We believe that our solid relationships with the world’s largest aerospace companies are a testament to our collaborative approach, transparency and dedication to excellence in everything we do. We are proud to have been selected once more by Boeing to provide the main landing gear system for the F/A-18 E/F program, an agreement that was recently expanded to include the Advanced F-15 program. We are currently working hand-in-hand FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY22 GUIDANCE (Middle Range) Reiterating Long-Term Guidance Our recent performance and strong industry fundamentals in both the commercial and defence sectors are allowing us to reiterate our longer- term growth prospects. We are confident in our ability to reach our revenue guidance of $620 million to $650 million in fiscal 2022. We are starting fiscal 2020 in a strong position, with a funded backlog of firm orders that now stands at a record $624 million, up from $466 million as at March 31, 2018. Our solid financial results and the positive outlook created by our expanded business are the result of the hard work and dedication of a strong team of employees and suppliers combined with the collaboration of our clients. I would like to thank them all for contributing to Héroux-Devtek’s success. With our larger manufacturing footprint, new customers and additional product offerings, we have everything in hand to meet our growth and profitability objectives. We are motivated to continue creating shareholder value, and I want to thank our investors for their continued trust. MART IN BR ASSA RD PRESIDENT AND CHIEF EXECUTIVE OFFICER BO EING F/A-18 E /F SUPE R HO R NE T Hér oux-Devtek wa s se l e c te d i n 2018 a n d 2019 t o su p p ly the main landing gear systems for B oeing’s F/A-18 E/F Super Hornet and EA -18G Gr owl e r a n d f o r Bo e i n g ’ s A d v anced F-15 program. 13 3 4 5 2 1 8 67 9 10 11 12 GLOBAL CENTERS OF EXCELLENCE Héroux-Devtek facilities Héroux-Devtek’s recently acquired facilities 1. St-Hubert, Québec, Canada Design, engineering and product support. Technical expertise and state-of-the-art testing facility 2. Longueuil, Québec, Canada R&O, finishing and assembly 3. Laval, Québec, Canada Manufacturing and assembly of actuators. Manufacturing of small to medium landing gear components 4. Alta Précision, Montreal, Québec, Canada Manufacturer of high precision landing gear components 5. Tekalia Aeronautik, Montreal, Québec, Canada Surface treatment services 6. Kitchener, Ontario, Canada Manufacturing of medium to large complex landing gear components 7. Cambridge, Ontario, Canada Manufacturing of ultra large-scale complex landing gear components 8. Magtron Precision, Toronto, Ontario Precision components and assembly Hé rou x- Dev tek 2019 [ 15 ] 14 15 16 17 18 9. Beaver Aerospace and Defense, 12. Wichita, Kansas, U.S. 16. Bolton, Westhoughton, U.K. Livonia, Michigan, U.S. Design and manufacturing of ball screws and actuation systems 10. Springfield, Ohio, U.S. Manufacturing of medium to large complex landing gear and titanium components 11. Strongsville, (Greater Cleveland) Ohio, U.S. Finishing and assembly of landing gear R&O activities and manufacturing of hydraulic systems and components Design, manufacturing, assembly and testing of fluid filtration applications 13. Everett, Washington, U.S. Final assembly of Boeing 777/777X landing gear systems 14. Runcorn, Cheshire, U.K. R&O activities, finishing and assembly of landing gear, product support, testing and design engineering 15. Nottingham, Nottinghamshire, U.K. Manufacturing of small to medium landing gear components 17. Compañia Española de Siestemas Aeronauticos, S.A. Getafe, Spain Design, engineering, assembly and support for landing gear and actuation systems 18. Compañia Española de Siestemas Aeronáuticos, S.A. Seville, Spain Assembly and installation of aircraft components at customer assembly lines MANAGEMENT TEAM Hér o ux- Devte k 2019 [ 14 ] n i l e m a H y m m J i : s t i d e r c o t o h P  STÉPHANE RAINVILLE, Vice-President, Human Resources • PATRICK GAGNON, Director, Internal Audit and Corporate Governance • STÉPHANE ARSENAULT, Vice-President and Chief Financial Officer MARTIN BRASSARD, President and Chief Executive Officer • JEAN GRAVEL, Vice-President, Sales & Programs ANNIE GOUDREAULT, Vice-President Corporate Controller • GILLES LABBÉ, Executive Chairman of the Board OLIVIER PERRON, Tax Director JEAN-PHILIPPE SANCHE, Director, Legal Affairs • MICHEL PAQUIN, Corporate Director of Human Resources  DOMINIQUE DALLAIRE, Eastern Region Vice-President MIKE MESHAY, General Manager - Beaver GAÉTAN ROY, Managing Director UK JACK CURLEY, Central Region Vice-President DANIEL NORMANDIN, Vice-President Engineering, QA & Environment MARC-OLIVIER GAGNON, Vice-President Product Support MANAGEMENT’S DISCUSSION AND ANALYSIS F O R T H E F I S C A L Y E A R E N D E D M A R C H 3 1 , 2 0 1 9 TABLE OF CONTENTS OVERVIEW ................................................................................................................................................................................................ Forward-looking Statements .................................................................................................................................................................... Highlights of the Year ............................................................................................................................................................................... Overview of the Business ........................................................................................................................................................................ Business Acquisition ................................................................................................................................................................................ Economic Outlook .................................................................................................................................................................................... Guidance ................................................................................................................................................................................................. Foreign Exchange .................................................................................................................................................................................... OPERATING RESULTS ............................................................................................................................................................................. Non-IFRS Financial Measures ................................................................................................................................................................. LIQUIDITY AND CAPITAL RESOURCES ................................................................................................................................................. Credit Facility and Cash and Cash Equivalents ....................................................................................................................................... Government Authorities Loans ................................................................................................................................................................. Variations in Cash and Cash Equivalents ................................................................................................................................................ Free Cash Flow ....................................................................................................................................................................................... Liquidity Requirements ............................................................................................................................................................................ FINANCIAL POSITION .............................................................................................................................................................................. Capital Structure ...................................................................................................................................................................................... Issued Capital .......................................................................................................................................................................................... Consolidated Balance Sheets .................................................................................................................................................................. Pension Plans .......................................................................................................................................................................................... ADDITIONAL INFORMATION ................................................................................................................................................................... Key Performance Indicators ..................................................................................................................................................................... Risk Management .................................................................................................................................................................................... Derivative Financial Instruments .............................................................................................................................................................. Critical Accounting Estimates ................................................................................................................................................................... Internal Controls and Procedures ............................................................................................................................................................ New Accounting Standards ...................................................................................................................................................................... Future Changes in Accounting Policies .................................................................................................................................................... Selected Financial Information ................................................................................................................................................................. Additional Information and Continuous Disclosure ................................................................................................................................... 17 17 18 19 20 22 24 25 26 30 31 31 32 33 35 36 36 36 37 38 38 39 39 40 45 45 47 48 49 50 51 16 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A OVERVIEW 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. and its subsidiaries (‘’Héroux-Devtek’’, the ‘’Corporation’’ or “Management”) evolved between March 31, 2018 and March 31, 2019. It also compares the operating results and cash flows for the quarter and fiscal year ended March 31, 2019 to those of the same periods of the prior fiscal year. This MD&A is based on the audited consolidated financial statements for fiscal year ended March 31, 2019, which are prepared in accordance with International Financial Reporting Standards (“IFRS”), and should be read in conjunction with them. All amounts in this MD&A are in thousands of Canadian dollars, the Corporation’s functional and presentation currency for all periods referred to herein, unless otherwise indicated. Financial data for the quarters ended March 31, 2019 and 2018 has not been audited. IFRS and non-IFRS financial measures This MD&A contains both IFRS and non-IFRS financial measures. Non-IFRS financial measures are defined and reconciled to the most comparable IFRS measures in the Non-IFRS Financial Measures section under Operating Results. Materiality for disclosures Management determines whether information is material based on whether they believe a reasonable investor’s decision to buy, sell or hold securities of the Corporation would likely be influenced or changed should the information be omitted or misstated, and discloses material information accordingly. FORWARD-LOOKING STATEMENTS This MD&A contains forward-looking statements which are mainly about, but may not be limited to, Héroux-Devtek’s future financial performance, expectations, objectives or possible events. These statements are mainly, but may not be exclusively, contained in the Guidance and Economic Outlook sections and are usually identifiable by the use of such terms as: “aim”, “anticipate, “assumption”, “believe”, “continue”, “expect”, “foresee”, “forecast”, “guidance”, “intend”, “may”, “plan”, “predict”, “should” or “will”. The predictive nature of such statements makes them subject to risks, uncertainties and other important factors that could cause the actual performance or events to differ materially from those expressed in or implied by such statements. Such factors include, but are not limited to: the impact of worldwide general economic conditions; 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; financial and operational performance of suppliers and customers; foreign exchange or interest rate fluctuations; and the impact of accounting policies issued by international standard setters. For more details, please see the Risk Management section of this MD&A. Readers are cautioned that the foregoing list of factors that may affect future growth, results and performance is not exhaustive and undue reliance should not be placed on forward-looking statements. Héroux-Devtek provides such forward-looking statements for the purpose of assisting the reader in understanding the Corporation’s financial performance and prospects and to present management’s assessment of future plans and operations. The reader is cautioned that such statements may not be appropriate for other purposes. Although management believes in the expectations conveyed by the forward-looking statements and while they are based on information available on the date such statements were made, there can be no assurance that such expectations will prove to be correct and readers are advised that actual results may differ from expected results. All subsequent forward-looking statements, whether written or orally attributable to the Corporation or persons acting on its behalf, are expressly qualified in their entirety by these cautionary statements. Unless otherwise required by applicable securities laws, the Corporation expressly disclaims any intention, and assumes no obligation to update or revise any forward- looking statements whether as a result of new information, future events or otherwise. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 17 HIGHLIGHTS OF THE YEAR Fiscal year Sales Operating income Adjusted operating income (1) Adjusted EBITDA (1) Net income Adjusted net income (1) Cash flows related to operating activities Free cash flow (1) In dollars per share EPS - basic and diluted Adjusted EPS (1) In millions of dollars, as at Funded backlog (2) $ $ 2019 483,877 37,240 41,563 74,213 26,194 30,352 69,969 58,121 2018 386,564 23,378 30,325 56,904 13,674 24,213 56,122 50,811 $ $ 0.73 0.84 March 31, 2019 624 $ $ 0.38 0.67 March 31, 2018 466 (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for definitions and reconciliations to the most comparable IFRS measures. (2) Represents firm orders. Key Events On October 1, 2018, the Corporation completed the acquisition of Compañia Española de Sistemas Aeronáuticos, S.A. (“CESA”), a subsidiary of Airbus SE (PA: AIR) and on July 2, 2018, the Corporation completed the acquisition of Beaver Aerospace & Defense Inc. and its wholly- owned subsidiary PowerTHRU Inc. (“Beaver”). See Business Acquisitions for further details. The Corporation achieved sales of $483.9 million, operating income of $37.2 million and Adjusted EBITDA of $74.2 million in fiscal 2019 compared to $386.6 million, $23.4 million and $56.9 million in fiscal 2018. See Operating Results for further details. Héroux-Devtek generated cash flows related to operating activities of $70.0 million and record free cash flow of $58.1 million during fiscal 2019, compared to $56.1 million and $50.8 million in fiscal 2018. Backlog increased to $624.0 million, compared to $466.0 million as at March 31, 2018 due to contributions by CESA and Beaver totaling $113.8 million and an organic increase of $44.2 million. In January 2019, the Corporation received the final customer certification required to perform all surface treatment planned to produce the Boeing 777 and 777X major landing gear components at its Strongsville, Ohio facility. On July 17, 2018, Héroux-Devtek announced that it had been selected by The Boeing Company (“Boeing”) to manufacture the main landing gear and side braces for the F/A 18 Super Hornet and EA-18G Growler aircraft. First deliveries are expected in the third quarter of calendar 2020. The contract also includes potential spare parts and aftermarket services. In April 2019, subsequent to the end of the fiscal year, the Corporation announced that it had been selected by Boeing to supply the complete landing gear system for the MQ-25 unmanned aerial refueling program. 18 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A OVERVIEW OF THE BUSINESS Profile Héroux-Devtek Inc. (TSX: HRX) is an international company specializing in the design, development, manufacture and repair and overhaul (R&O) of landing gear, hydraulic and electromechanical flight control actuators, custom ball screws and fracture-critical components. The Corporation has also built a strong, well-recognized design engineering team. Héroux-Devtek is the third largest landing gear company in the world based on sales, supplying both the commercial and defence sectors. In the commercial sector, the Corporation is active in the large commercial and business jet, regional aircraft and helicopter markets. On the defence side, the Corporation provides parts and services for major military aircraft in the United States and Europe. As a result, a significant portion of the Corporation’s sales are made to a limited number of customers located in Canada, the United States and Europe. The Corporation's head office is located in Longueuil, Québec while operating facilities are located in the Greater Montreal area (Longueuil, Laval, St-Hubert and Montreal); Kitchener, Cambridge and Toronto, Ontario; Springfield and Cleveland, Ohio; Wichita, Kansas; Everett, Washington; Livonia, Michigan; Seville and Madrid, Spain; as well as Bolton, Runcorn and Nottingham in the United Kingdom. Héroux-Devtek sells to Original Equipment Manufacturers (“OEMs”) such as Boeing, Airbus, Lockheed Martin, Leonardo, Embraer and BAE Systems; to Tier 1 suppliers such as Safran Landing Systems and AAR; and to end users in the aftermarket where its largest customer is the U.S. Air Force (“USAF”). In fiscal 2019, sales to these nine customers represented approximately 63% of total consolidated sales. More specifically, the Corporation has one customer representing 22% of its consolidated sales. The following charts describe Héroux-Devtek’s revenue segmentation in terms of intellectual property and destination: * BTP: Build to Print ** Based on fiscal 2019 actual annualized sales for Beaver, CESA and Tekalia HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 19 BUSINESS ACQUISITIONS Acquisition of CESA On October 1, 2018, the Corporation completed the acquisition of all the shares of CESA, a subsidiary of Airbus SE, for €130.4 million ($195.8 million). Headquartered in Madrid, Spain, CESA is a leading European provider of fluid mechanical and electromechanical systems for the aerospace industry. This acquisition allows the Corporation to broaden its existing aerospace and product offering into actuation, landing gear, and hydraulic systems. The transaction was treated as a business combination. The acquisition of CESA was financed as follows: A $50.0 million, seven-year unsecured subordinated term loan provided by the Fonds de solidarité FTQ; A US$50.0 million ($65.2 million) drawing on the Corporation’s credit facility, whose limit was increased from $200.0 million to $250.0 million; and, The Corporation’s available cash balance. In addition, the Corporation assumed CESA’s net outstanding debt amounting to approximately €23.7 million ($35.6 million) upon closing. For the period between October 1, 2018 and March 31, 2019, the Corporation's consolidated sales and net income included €42.1 million ($63.5 million) and €2.7 million ($4.0 million), generated by CESA, respectively. Management is satisfied with the first six-month of performance by the newly-acquired company as they delivered high throughput combined with a favourable product mix when compared to the previous six months. If the acquisition had closed on April 1, 2018, the consolidated sales and net income of CESA would have amounted to $117.3 million and $2.8 million, respectively, for the fiscal year ended March 31, 2019. Acquisition of Beaver On July 2, 2018, the Corporation completed the acquisition of all the shares of Beaver Aerospace & Defense Inc. and its wholly-owned subsidiary PowerTHRU Inc. («Beaver») for a purchase price of US$21.6 million ($28.5 million). This price includes a working capital adjustment received in April 2019 of US$0.3 million ($0.4 million) and a US$3.5 million ($4.6 million) balance of sale payable over the next two years which bears interest at 3%. The transaction was financed through the Corporation’s cash and was treated as a business combination. This acquisition allows the Corporation to broaden its existing aerospace and product offering into ball screws and actuation systems as well as expand its footprint in North America. For the period between July 2, 2018 and March 31, 2019, the Corporation's consolidated sales and net income included US$18.9 million ($24.8 million) and US $1.4 million ($1.8 million), generated by Beaver, respectively. If the acquisition had closed on April 1, 2018, the consolidated sales and net income of Beaver would have amounted to $33.2 million and $2.2 million, respectively, for the fiscal year ended March 31, 2019. Acquisition of Tekalia On January 23, 2019, the Corporation completed the acquisition of 60% of the shares of Tekalia Aeronautik (2010) Inc. (“Tekalia”), a supplier of surface treatment services to the aerospace sector with annual sales of approximately $12.0 million, for a purchase price of $6.5 million. The transaction was financed through the Corporation’s cash and was treated as a business combination. The acquisition of Tekalia allows the Corporation to further secure surface treatment capacity to support its North American customers’ growth. Purchase Prices The purchase prices and the purchase price allocations that reflect the fair value of the assets acquired and liabilities assumed with any excess allocated to goodwill were determined using the acquisition method as follows: Cash payment Long-term debt assumed Working capital adjustment receivable Balance of purchase price payable Total purchase price for the Corporation’s interest Non-controlling interests CESA $ 170,930 $ 35,594 (10,708) — $ 195,816 $ — $ 195,816 $ Beaver 23,671 $ 574 (388) 4,609 28,466 $ — 28,466 $ Tekalia Total 3,548 $ 198,149 39,149 2,981 (11,096) — 4,609 — 6,529 $ 230,811 2,365 2,365 8,894 $ 233,176 HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 20 Purchase Price Allocations Accounts receivable Inventories Income tax receivable Other current assets Property, plant and equipment Finite-life intangible assets Deferred income tax assets Other long-term assets - Tax credits receivable Total identifiable assets Accounts payable and accrued liabilities Provisions Customer advances and progress billings Provisions Deferred income tax liabilities Other liabilities - long-term accounts payable Total identifiable liabilities Net identifiable assets and liabilities Goodwill Total purchase price Beaver Tekalia $ CESA 28,293 $ 36,692 505 596 66,086 44,923 40,407 — 7,843 $ 159,259 $ 16,773 11,897 4,188 32,858 6,787 $ 10,165 — 50 17,002 3,635 4,050 2,774 — 27,461 $ 2,588 2,118 450 5,156 2,406 $ 1,105 — 182 3,693 Total 37,486 47,962 505 828 86,781 8,566 176 — — 57,124 44,633 2,774 7,843 12,435 $ 199,155 4,833 — — 4,833 24,194 14,015 4,638 42,847 12,857 3,465 4,365 63,534 4,308 3,465 4,365 44,996 $ 8,549 — — 13,705 $ $ — — — 4,833 $ 114,263 81,553 $ 195,816 $ 13,756 14,710 28,466 $ 135,621 7,602 1,292 97,555 8,894 $ 233,176 The purchase price allocations of CESA and Tekalia are preliminary. The purchase price of CESA is subject to final working capital adjustments. In the case of Tekalia, due to the limited time between the date of acquisition and the date of the financial statements, management is in the process of gathering all the information necessary to finalize it. Accordingly, the final purchase price allocations could result in changes to the fair value of assets acquired and liabilities assumed. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 21 ECONOMIC OUTLOOK(1) Commercial Aerospace Growth Forecasts Remain Positive in Light of Recent Signs of a Slowdown in Global Expansion The commercial market represents approximately/over 75% of the total value of aircraft production in Calendar 2018.(5) Passenger traffic volumes and air cargo volumes, measured in revenue passenger kilometers (RPK) and freight ton kilometers (FTK) respectively are two important metrics used to measure commercial air traffic volumes. International Air Transport Association’s (“IATA”) most recent forecast for 2019 calls for passenger volumes to remain broadly in line with the average annual growth rate of 5.6% recorded in the previous 20-year period. Passenger traffic volumes, expressed in revenue passenger kilometres (“RPK”), eased to a year-over-year growth of 5.3% in February 2019. In April 2019, the International Monetary Fund (“IMF”) issued a downward revision to its global GDP growth forecast to 3.3% in calendar 2019, with a return to 3.6% in 2020. This fourth revision in twelve months results from a slowing trend in business confidence (as indicated by the global composite Purchasing Manager’s Index). Following the IMF’s GDP forecast revision, the IATA reported that if the pace of growth of the global economy continued to slow down in 2019, RPK growth in 2019 would be closer to 5.0%, down from its previous forecast of 6.0%. In spite of these short-term revisions, the long-term outlook for the airline industry remains positive. Air cargo volume, measured in freight ton kilometres (“FTK”), were marginally higher by 0.1% year-over-year in March 2019, resulting from softness in global trade and recent economic indicators. According to the IATA, leading indicators suggest that FTK growth should remain subdued in the coming months. IATA’s last update to its FTK long-term growth forecast was published in March 2019 and forecasts an annual growth of 2.7% for 2019 and of 4.4% per year over the next five years. This positive outlook is supported in part by fast-growing areas such as e-commerce.(3) “Air traffic has proven to be resilient to external shocks and doubles every 15 years(2)”, Airbus 2018-2037 Global Market Forecast. 22 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Customers’ Commercial and Defence Order Backlogs Remain Strong Meanwhile, in the large commercial aircraft sector, Boeing reported record revenue and profitability results in 2018 mainly driven by commercial and defence airplane deliveries. Boeing’s commercial airplanes order backlog reached 5,900 airplanes. Over the next 20 years, Boeing forecasts a need for 43,000 new commercial airplanes, which would double the size of today’s fleet. Airbus also reported robust 2018 profitability resulting from strong operational performance. Their commercial aircraft order backlog reached an industry record of 7,577 aircrafts at year end. Airbus reported strong first quarter 2019 results on robust commercial aircraft deliveries and production ramp-up and continues to see good prospects in its helicopter and defence business. Both Boeing and Airbus are adjusting their production rates as they introduce certain more fuel-efficient aircraft variants on several leading programs. These adjustments are scheduled through calendar 2020. Order backlogs have increased year-over-year and remain strong for both manufacturers driven by a higher combined total of new orders and commitments at the end of 2018.(4) Their combined backlogs represent a total of 13,477 aircraft representing over 8 years of production based on calendar 2018 production rates. Defence Remains a Solid Growth Market with Spending on the Rise The defense market in Calendar 2018 represented about 25% of global aircraft production, according to Teal Group(5). It remains a “solid growth” market, driven by rising global tensions and an aging fleet. Fighter jets are forecasted as the largest share aircraft production at approximately $293 billion over the next ten years. (TEAL) On March 11, 2019, the U.S. administration sent Congress a Proposed Fiscal Year 2020 Budget request to increase funding for the Department of Defense (DOD) to US$718 billion from US$668 billion in 2018 representing 7.5% of year over year growth. In Canada, the new defence policy calls for a rise in spending, from $18.9 billion in the 2017 fiscal year to $32.7 billion in the 2027 fiscal year, an increase of over 70%. Europe is also committing more funds to defence, as evidenced by a 7.2% projected overall spending increase by members of NATO for 2019 (expressed in US dollars, assuming constant prices and exchange rates).(6) New Certifications and Demand in North America Drive Business Jet Deliveries Business jets are forecasted as the third largest segment new aircraft production over the next ten years at approximately US$253 billion. (TEAL) In the business jet market, aircraft shipments increased by 3.8% in calendar 2018, to 703 aircrafts, according to data published by the General Aviation Manufacturers Association (“GAMA”). Looking ahead, the business jet industry is expected to experience growth in the short to medium term, supported by several new airplane models coming to market and an improved used aircraft environment. The North American market took delivery of 65.1% of all business jets delivered in 2018.(7) (1) Refer to Forward-Looking Statements in Overview for further information regarding forward-looking statements and related risks. (2) Source: Airbus Global Market Forecast, 2018-2037 (3) Sources: Air Passenger Market Analysis, IATA, February 2019; Air Freight Market Analysis, IATA, May 2019; IMF Downgrades GDP Forecast, But Growth Still Looks OK, April 2019; World Economic Outlook, International Monetary Fund, April 2019. (4) Sources: Airbus press release February 14, 2019 and April 30, 2019; Boeing press releases January 30, 2019 and April 9, 2019; Speech from Boeing CEO Dennis Muilenberg: 2019 Address to Shareholders, April 29, 2019. Statement from Boeing CEO Dennis Muilenburg: We Own Safety - 737 MAX Software, Production and Process Update, April 5, 2019. (5) Source: World Military and Civil Aircraft Briefing, Teal Group Corporation, March 2019. (6)Sources: DOD press release March 12, 2019; NATO press release, December 19, 2018; The Standing Senate Committee on National Finance Evidence, February 19, 2019. (7) Sources: GAMA press release February 20, 2019, GAMA annual report 2018; Business Aviation Market Forecast, Jetcraft, October 2018. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 23 GUIDANCE See Forward-Looking Statements for cautionary notice regarding Guidance and Risk Management for discussion of certain factors which may cause future results to differ from guidance included in this section. In October 2018, Management provided updated fiscal 2019 sales guidance as well as guidance on Fiscal 2019 additions to PP&E and Long term sales growth in order to reflect the expected contributions of Beaver and CESA to Héroux-Devtek’s financial performance. As such, revised guidance for fiscal 2019 was as follows: Metric Fiscal 2019 sales Fiscal 2019 additions to PP&E Long-term sales growth Initial fiscal 2019 guidance Stable as compared to fiscal 2018 Approximately $15 million Updated Fiscal 2019 guidance Sales of $460 to $470 million Approximately $20 million N/A Fiscal 2022 sales of $620 to $650 million FISCAL 2019 OPERATING RESULTS COMPARED TO REVISED GUIDANCE *Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for definitions and reconciliations to the most comparable IFRS measures. Fiscal 2019 sales were slightly above guidance owing to strong results both from the Corporation’s existing and acquired operations. Additions to property, plant and equipment totaled $12.9 million, compared to guidance of $20 million due mainly to the timing of certain investment initiatives. FISCAL 2020 GUIDANCE Metric Fiscal 2020 sales Long-term sales growth Fiscal 2020 Guidance Fiscal 2020 sales of $560 to $580 million Fiscal 2022 sales of $620 to $650 million The growth in fiscal 2020 sales over fiscal 2019 mainly relates to a full year of contribution from acquired businesses as well as increased deliveries related to the Boeing 777 and 777X programs. Management has prepared the foregoing guidance using the best information available upon preparing this MD&A, and based it on assumptions and sources of information including, but not limited to: • • • • • • • Héroux-Devtek’s backlog, long-term sales contracts and estimated future order intake; Existing OEM backlogs, production rates and disclosed production and delivery expectations; Government defence budget, spending climates, trends and expectations; Ongoing economic conditions; Stability of foreign exchange rates; The Corporation’s ability to deliver on key contract initiatives; and, The successful deployment of integration and cross-selling initiatives. 24 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A FOREIGN EXCHANGE As a Corporation with operations in various countries which deals with customers from across the world, Héroux-Devtek’s financial position and results of operations are partly influenced by movements in foreign exchange (“FX”) rates. More specifically, the Corporation has operations in Canada, the United States, Spain and the United Kingdom, and thus incurs costs denominated in the respective currencies of these four countries, the Canadian dollar (“CAD”), United States dollar (“USD”) Euros (“EUR”) and British pound (“GBP”). In addition to costs denominated in their local currencies, a large portion of materials costs of the Canadian, Spanish and British operations are denominated in USD, as is a large portion of their sales. The Corporation must convert foreign-denominated revenues, expenses, assets and liabilities into CAD for financial reporting purposes. Gains and losses occur as a result of the fluctuations of these foreign currencies against the CAD between balance sheet periods, or between the date of a transaction and the reporting date. Transactions denominated in foreign currencies are initially recorded at the functional currency rate of exchange at the date of the transactions, excluding the impact of forward foreign exchange contracts (“FFEC”), while the statement of income of foreign operations is translated at the average exchange rate for the period. Balance sheet items are translated at the spot rate on the reporting date. The foreign exchange rates used to translate assets and liabilities into Canadian dollars were as follows, as at: USD (Canadian equivalent of US$1.0) EUR (Canadian equivalent of €1.0) GBP (Canadian equivalent of £1.0) March 31, 2019 March 31, 2018 1.3363 1.5002 1.7418 1.2894 N/A 1.8106 The foreign exchange rates used to translate revenues and expenses into Canadian dollars were as follows: USD (Canadian equivalent of US$1.0) EUR (Canadian equivalent of €1.0) GBP (Canadian equivalent of £1.0) Quarters ended March 31, Fiscal years ended March 31, 2019 1.3292 1.5094 1.7315 2018 1.2648 N/A 1.7607 2019 1.3122 1.5192 1.7228 2018 1.2834 N/A 1.7022 Héroux-Devtek is most exposed to the performance of the USD versus CAD, GBP and EUR due to the prevalence of USD in Aerospace market transactions and the geographical location of operations. Fiscal 2019 featured a notable increase in the value of the USD compared to CAD, EUR and GBP, the main impact of which was growth in the value of the Corporation’s U.S. denominated sales and assets. Approximately 70% of the Corporation’s sales are denominated in USD, compared to only a bit less than half of the related costs, which creates significant net inflows of USD, the value of which fluctuate with the USD/CAD, USD/EUR and USD/GBP exchange rate. In order to manage this risk, the Corporation has put in place a foreign currency hedging policy whereby Héroux-Devtek contracts FFEC to sell USD in amounts equivalent to expected net inflows. This policy requires that the Corporation hedge between 50% and 100% of the identified net exposure, mainly over the next two fiscal years. See the Derivative Financial Instruments section under Additional Information for further details. As at March 31, 2019, the Corporation had forward foreign exchange contracts outstanding for a notional amount of $228.4 million denominated in USD, EUR and GBP. This amount includes contracts with nominal value of US$146.9 million convertible into Canadian dollars at an average rate of 1.3060. These contracts mature at various dates between April 2019 and March 2023, with the majority maturing this fiscal year and the next. Consistent with hedge accounting under IFRS, gains and losses on these FFEC are accounted for in other comprehensive income until settlement, at which point they are realized in the consolidated statement of income along with the opposing gain or loss on translation of the related financial instruments. As at March 31, 2019, a 1% strengthening of the CAD versus the USD would result in a 0.4 million decrease in the Corporation’s fiscal 2019 net income. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 25 OPERATING RESULTS Quarters ended March 31, Fiscal years ended March 31, 2019 2018 Variance 2019 2018 Variance Sales Gross profit Selling and administrative expenses Adjusted operating income(1) Non-recurring items Operating income Financial (gains) expenses(2) Income tax expense(2) Net income Adjusted net income(1) As a percentage of sales Gross profit Selling and administrative expenses Operating income Adjusted operating income(1) In dollars per share EPS - basic and diluted Adjusted EPS(1) $ $ $ $ $ 157,914 $ 113,024 $ 29,730 13,522 16,208 1,018 15,190 1,402 1,830 11,958 12,794 18.8% 8.6% 9.6% 10.3% $ $ 18,958 6,869 12,089 5,392 6,697 (389) 1,228 5,858 10,439 16.8% 6.1% 5.9% 10.7% $ $ 44,890 10,772 6,653 4,119 (4,374) 8,493 1,791 602 6,100 2,355 200 bps 250 bps 370 bps -40 bps $ 483,877 $ 386,564 $ 83,196 41,633 41,563 4,323 37,240 6,811 4,235 26,194 30,352 $ $ 61,276 30,951 30,325 6,947 23,378 2,537 7,167 13,674 24,213 $ $ $ $ 17.2% 8.6% 7.7% 8.6% 15.9% 8.0% 6.0% 7.8% 97,313 21,920 10,682 11,238 (2,624) 13,862 4,274 (2,932) 12,520 6,139 130 bps 60 bps 170 bps 80 bps 0.34 0.36 $ $ 0.16 0.29 $ $ 0.18 0.07 $ $ 0.73 0.84 $ $ 0.38 0.67 $ $ 0.35 0.17 (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section for definitions and reconciliations to the most comparable IFRS measures. (2) Refer to the Non-Recurring Items section for more details Sales 26 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Sales can be broken down by sector as follows: Commercial Defence(1) Total Commercial Defence(1) Total 2019 2018 Acquisitions FX impact Net variance Quarters ended March 31, $ 78,004 79,910 $ 157,914 2019 $ 236,283 247,594 $ 483,877 $ $ $ $ 57,509 55,515 113,024 $ $ 19,278 24,172 43,450 $ $ 1,685 1,760 3,445 $ $ (468) (1,537) (2,005) (0.8)% (2.8)% (1.8)% Fiscal years ended March 31, 2018 Acquisitions FX impact Net variance 195,101 191,463 386,564 $ $ 31,474 58,924 90,398 $ $ 2,108 2,208 4,316 $ $ 7,600 (5,001) 2,599 3.9 % (2.6)% 0.7 % (1) Includes defence sales to civil customers and governments. The following analysis excludes the impact of acquisitions and foreign exchange which are itemized in the table above. Commercial The $7.6 million net increase in commercial sales for the fiscal year was mainly driven by: Increased deliveries for the Boeing 777 and 777X programs; Higher sales related to business jets, mainly due to the ramp-up of deliveries for the Embraer 450/500 program. Commercial sales were relatively stable during the fourth quarter this year compared to last as increased deliveries for the Boeing 777 and 777X programs were offset by lower sales on Bell Helicopter programs. Defence The $5.0 million and $1.5 million respective net decreases in defence sales for the fiscal year and fourth quarter were mainly driven by: The net impact of the end of the USAF R&O contract partially offset by the ramp-up of the corresponding contract with AAR signed earlier this fiscal year; and Lower manufacturing sales to Boeing for the CH-47 contract; These factors were partially offset by higher sales of spares, namely to the U.S. Navy and USAF. Gross Profit The respective increases in gross profit from 15.9% to 17.2% this fiscal year and from 16.8% to 18.8% for the quarter compared to the same periods last fiscal year were mainly driven by the impact of the Beaver and CESA acquisitions and higher throughput which led to better absorption of manufacturing costs. Foreign exchange did not have a significant impact on gross profit. Selling and Administrative Expenses When excluding gains on translation of net monetary items, selling and administrative expenses represented 8.8% and 8.5% of sales for the fiscal year and the quarter, respectively, compared to 8.0% and 7.6% for the same periods last fiscal year. The increases compared to the same periods last fiscal year mainly relate to lower stock-based compensation expense last year due to the delay in fiscal 2018 long term incentive plan issuances caused by trading blackouts as well as the impact of acquisitions. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 27 Non-Recurring Items Non-recurring items comprise the following: Non-recurring items in operating income Acquisition-related costs Restructuring charges Non-recurring items in financial expenses Net losses on certain derivative financial instruments Non-recurring items in income tax expense Impact of US Tax Reform Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 $ $ $ $ $ $ 1,018 — 1,018 $ $ — $ — $ — $ — $ 402 4,990 5,392 698 698 $ $ $ $ 4,323 — 4,323 391 391 $ $ $ $ 1,957 4,990 6,947 89 89 — $ — $ — $ — $ 4,912 4,912 Acquisition-related costs These costs mainly pertain to professional fees and expenses related to the acquisitions of CESA, Beaver and Tekalia. Restructuring charges In March 2018, the Corporation announced workforce adjustments of about 60 employees at its Longueuil facility following the non-renewal of the USAF contract. These adjustments along with other costs related to the decrease in volume resulted in restructuring charges totaling $5.0 million accounted for during the fourth quarter of fiscal 2018, including termination benefits of $2.7 million and other costs related to the reduction in volume totaling $2.3 million. The unpaid portion of these restructuring charges amounted to $0.3 million as at March 31, 2019 ($2.5 million as at March 31, 2018). Net losses on certain derivative financial instruments These losses relate to derivative financial instruments acquired in order to mitigate foreign currency and interest rate risks arising from the purchase price and financing related to the acquisition of CESA. Refer to the Derivatives section under Additional Information below for further details. Impact of US Tax Reform This one-time tax expense of $4.9 million recorded during fiscal 2018 is related to the US Tax Reform enacted on December 22, 2017. Refer to the Income Tax section for further details. Operating Income The increases in operating income from 6.0% to 7.7% of sales (increase from 7.8% to 8.6% excluding non-recurring items) for the fiscal year and from 5.9% to 9.6% of sales (decrease from 10.7% to 10.3% excluding non-recurring items) for the quarter compared to the same periods last fiscal year were mainly the result of the factors described above. Year-over-year, foreign exchange had a positive impact of $0.7 million on operating income, while it had a negative impact of $1.0 million during the fourth quarter of fiscal 2019 compared to the same period last fiscal year. 28 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Net financial Expenses Quarters ended March 31, Fiscal years ended March 31, 2019 2018 Variance 2019 2018 Variance Interest on long-term debt $ 1,644 $ 536 $ 1,108 $ 4,914 $ 2,614 $ 2,300 Net interest expense (income) related to government loans Interest income (expense) related to financial instruments Other interest income (expense) (549) (46) 353 (1,189) 441 (177) 640 (487) 530 1,325 (409) 981 466 (491) (52) $ 1,402 $ (389) $ 1,791 $ 6,811 $ 2,537 $ 859 82 1,033 4,274 The $4.3 million and $1.8 million respective increases during the fiscal year and fourth quarter compared to the same periods last fiscal year mainly reflect interest charges on new debt incurred to finance the CESA acquisition and higher interest rates, as well as the negative impact of discount rates on provisions compared to a positive impact last year. In addition, there was a lower gain resulting from revisions of the repayment schedules of governmental authorities’ loans, described in Government Authorities Loans under Liquidity and Capital Resources. Income Tax Expense Quarters ended March 31, Fiscal years ended March 31, 2019 2018 2019 2018 Income before income tax expense $ 13,788 $ 7,086 $ 30,429 $ 20,841 Income tax expense Effective tax rate Effect of US Tax Reform Income tax expense excluding U.S. Tax reform Effective tax rate excluding the US Tax Reform impact Canadian blended statutory income tax rate 1,830 13.3% 1,228 17.3% 4,235 13.9% $ — $ — $ — $ 1,830 13.3% 26.6% 1,228 17.3% 26.6% 4,235 13.9% 26.6% 7,167 34.4% 4,912 2,255 10.8% 26.6% For fiscal 2019, the Corporation’s effective income tax rate is lower than the Canadian blended statutory rate by 12.7% primarily due to the favourable impact of earnings in lower tax rate jurisdictions of $4.8 million ($4.8 million in fiscal 2018), partially offset by non-deductible acquisition- related costs of $0.7 million ($0.5 million in fiscal 2018) and permanent differences of $0.5 million ($0.3 million in 2018). The effective income tax rate for the quarter mainly reflects the $1.7 million favourable impact of earnings in lower tax rate jurisdictions ($0.9 million in fiscal 2018), partially offset by permanent differences totaling $0.1 million ($0.1 million in fiscal 2018). The effective income tax rate was also impacted by non-deductible acquisitions-related costs of $0.2 million incurred in the fourth quarter of fiscal 2018. On December 22, 2017, the United States Government passed into law the Tax Cuts and Jobs Act (the "US Tax Reform"). The US Tax Reform includes a number of changes in tax law impacting businesses including a permanent reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018. This reduction caused a revaluation of the Corporation’s net deferred tax assets, resulting in a one-time income tax expense of $4.9 million during fiscal 2018. Net Income Earnings increased from $13.7 million to $26.2 million (or increased from $24.2 million to $30.4 million excluding non-recurring items net of taxes) this fiscal year compared to last and increased from $5.9 million to $12.0 million (or increased from $10.4 million to $12.8 million excluding non-recurring items net of taxes) during the quarter compared to the same quarter last fiscal year mainly as a result of the factors described above. During the fiscal year, earnings per share increased from $0.38 to $0.73 per share (or increased from $0.67 to $0.84 per share excluding non recurring items net of taxes), while they increased from $0.16 to $0.34 per share (or increased from $0.29 to $0.36 excluding non recurring items net of taxes) during the quarter compared to the same quarter last fiscal year. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 29 NON-IFRS FINANCIAL MEASURES This MD&A is based on earnings in accordance with IFRS and the following non-IFRS financial measures: Adjusted operating income: Operating income excluding non-recurring items. EBITDA: Adjusted EBITDA: Adjusted net income: Adjusted earnings per share: Diluted earnings per share calculated on the basis of adjusted net income. Free cash flow: Earnings before financial expenses, income tax expense and amortization expense. EBITDA as defined above excluding non-recurring items. Net income excluding non-recurring items net of taxes. Cash flows related to operating activities, less additions to property, plant and equipment and net increase or decrease in finite life intangible assets. These Non-IFRS financial measures do not have any standardized meaning prescribed by IFRS and may therefore not be comparable to similar measures presented by other issuers. Management considers these metrics to be information which may assist investors in evaluating the Corporation’s profitability and enable better comparability of the results from one period to another and with peers who may employ similar measures. These measures are not considered by management to be a substitute for IFRS measures, nor to be superior as they often do not fully reflect periodic costs, the long-term costs of investing or financing decisions or the impact of events which are not a result of operations. The following are reconciliations of these items to their most comparable IFRS measures as well as additional information about what they represent, excluding free cash flow. For the reconciliation of free cash flow to cash flows related to operating activities, refer to Liquidity and Capital Resources. The Corporation’s Adjusted operating income is calculated as follows: Operating income Non-recurring items Adjusted operating income Quarters ended March 31, Fiscal years ended March 31, 2019 15,190 1,018 16,208 $ $ 2018 6,697 5,392 12,089 $ $ 2019 37,240 4,323 41,563 $ $ 2018 23,378 6,947 30,325 $ $ Management believes adjusted operating income provides investors with a figure that provides an alternative assessment of the Corporation’s future profitability by excluding from operating income the impact of events which are not in the expected course of future operations, or which are not a result of operations. The Corporation’s EBITDA and Adjusted EBITDA are calculated as follows: Net income Income tax expense Financial income (expenses) Amortization expense EBITDA Non-recurring items Adjusted EBITDA Quarters ended March 31, Fiscal years ended March 31, 2019 11,958 1,830 1,402 9,702 24,892 1,018 25,910 $ $ $ 2018 5,858 1,228 (389) 7,280 13,977 5,392 19,369 $ $ $ 2019 26,194 4,235 6,811 32,650 69,890 4,323 74,213 $ $ $ 2018 13,674 7,167 2,537 26,579 49,957 6,947 56,904 $ $ $ Management believes EBITDA and adjusted EBITDA provide valuable insight into the Corporation’s day-to-day operations as they exclude from earnings factors that are more reflective of long-term financing or investing decisions than of current performance. Adjusted EBITDA, in addition, provides an alternative assessment of future operating results as it excludes the impact of events which are not in the expected course of future operations, or which are not a result of operations. Adjusted EBITDA is also used by management to assess operational performance and is a component of certain performance-based employee remuneration. 30 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A The Corporation’s adjusted net income and adjusted earnings per share are calculated as follows: Net income Non-recurring items net of taxes Adjusted net income In dollars per share Earnings per share - basic and diluted Non-recurring items net of taxes Adjusted earnings per share $ $ $ $ Quarters ended March 31, 2018 5,858 4,581 10,439 $ $ 2019 11,958 836 12,794 0.34 0.02 0.36 $ $ 0.16 0.13 0.29 $ $ $ $ Fiscal years ended March 31, 2018 13,674 10,539 24,213 2019 26,194 4,158 30,352 $ $ 0.73 0.11 0.84 $ $ 0.38 0.29 0.67 Management believes adjusted net income and adjusted earnings per share provide investors with an alternative assessment of the Corporation’s current period results and future earnings prospects as they exclude from earnings the impact of events which are of a non-recurring nature or do not reflect current operations. They are also a component of certain performance-based employee remuneration. LIQUIDITY AND CAPITAL RESOURCES CREDIT FACILITY AND CASH AND CASH EQUIVALENTS Senior Secured Syndicated Revolving Credit Facility (“Revolving Facility”) The Corporation has a Revolving Facility with a syndicate of five Canadian banks and their U.S. affiliates or branches and a Canadian branch of a U.S. bank. This facility allows the Corporation and its subsidiaries to borrow up to $250.0 million, either in Canadian dollars, US dollars, British Pounds, Euro or equivalent currencies and will mature in May 2022. It also includes an accordion feature to increase available credit by an additional $100.0 million during the term of this agreement, subject to the approval of the lenders. The Revolving Facility was amended during the fiscal year ended March 31, 2019, increasing the credit limit from $200.0 million to $250.0 million in connection with the acquisition of CESA. As at March 31, 2019, the Corporation had $94.9 million drawn against the Revolving Facility, compared to $54.2 million as at March 31, 2018. This increase is mainly related to a US$50.0 million ($65.2 million) drawing made in order to finance the CESA acquisition, net of US$21.0 million ($27.9 million) repayments made during the last six months of the fiscal year. Unsecured Subordinated Term Loan Facility (“Term Loan Facility”) On September 24, 2018, the Corporation signed a Term Loan Facility with Fonds de Solidarité FTQ for an amount of up to $75.0 million. The facility consists of a $50.0 million term loan related to the acquisition of CESA and additional financing, available until September 30, 2020, of up to $25.0 million subject to certain conditions. The initial $50.0 million loan, drawn on September 25, 2018, bears interest at 5.7% and is repayable at maturity on September 30, 2025. Starting on September 30, 2021, the Corporation will have the option to make early repayments subject to certain fees. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 31 Net Debt Position The Corporation’s net debt position is calculated as follows, as at: Long-term debt, including current portion(1) Less: Cash and cash equivalents Net debt position March 31, 2019 March 31, 2018 $ $ 263,258 $ 131,964 35,128 228,130 $ 93,209 38,755 (1) Excluding net deferred financing costs of $3.0 million as at March 31, 2019 and $0.9 million as at March 31, 2018. Long-term debt is subject to certain general and financial covenants related to, among others, indebtedness, cash flows and equity of the Corporation and/or certain subsidiaries. The Corporation complied with all covenants during the fiscal year ended March 31, 2019 and expects to continue to comply with these restrictive financial covenants through the current fiscal year. In general terms, the Corporation has a healthy financial situation and is well positioned to face its financial needs. GOVERNMENT AUTHORITIES LOANS Governmental authorities’ loans represent government assistance for the purchase of certain equipment or tooling, for the modernization or additions to the Corporation’s facilities or for development costs capitalized or expensed for aerospace programs. They were granted as incentives under Canadian federal and provincial or Spanish industrial programs to promote industry development. These loans have varying terms governing the timing and amount to be refund. Repayments, when not on a fixed schedule, are either based on sales of specific programs or the growth in sales of all or certain of Héroux-Devtek’s product lines and bear no or below-market interest rate. They are measured at a discounted value using a corresponding market rate of interest each time they are received, and the related discount is accreted to income using the effective interest rate method and included in the consolidated statements of income as financial expense. Assumptions underlying loan repayments are reviewed at least annually. As at March 31, 2019, the Corporation updated the estimated repayment schedule of its government authorities’ loans, taking into account revised assumptions mainly related to sales forecasts. This resulted in a non- cash gain of $1,036 ($1,834 in fiscal 2018), which was included in net financial expenses. As at March 31, 2019, the Corporation had a present value of $89.7 million outstanding under these agreements ($52.5 million as at March 31, 2018), bearing effective interest rates of 0.0% to 6.6% as at March 31, 2019 (2.5% to 7.2% as at March 31, 2018). These loans have repayment terms extending to fiscal 2033 at the latest. 32 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A VARIATIONS IN CASH AND CASH EQUIVALENTS Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 Cash and cash equivalents at beginning of periods $ 28,639 $ 70,642 $ 93,209 $ Cash flows related to operating activities Cash flows related to investing activities Cash flows related to financing activities Effect of changes in exchange rates on cash and cash equivalents 37,181 (7,926) (22,096) (670) 18,521 3,121 20 905 69,969 (208,619) 80,320 249 42,456 56,122 (4,996) (565) 192 Cash and cash equivalents at end of periods $ 35,128 $ 93,209 $ 35,128 $ 93,209 Operating Activities The Corporation generated cash flows from operations and used cash and cash equivalents for its operating activities as follows: Cash flows from operations Net change in non-cash items Cash flows related to operating activities $ $ Quarters ended March 31, 2018 11,961 $ 2019 19,116 18,065 6,560 37,181 $ 18,521 Fiscal years ended March 31, 2018 42,624 2019 60,396 $ 9,573 69,969 $ 13,498 56,122 $ $ The respective $17.8 million and $7.2 million increases in cash flows from operations for the fiscal year and fourth quarter ended March 31, 2019 when compared to the same periods last fiscal year mainly relate to the contribution from the results of CESA and Beaver. The net change in non-cash items can be summarized as follows: Accounts receivable Income tax receivable Inventories Other assets Accounts payable and accrued liabilities and other liabilities Provisions Customer advance and progress billings Income tax payable Effect of changes in exchange rates Net change in non-cash items Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 $ (5,546) $ (40) 74 (3,063) 21,233 (1,204) 7,264 (794) 141 (19,305) $ 48 7,520 417 4,165 209 8,913 1,744 2,849 (5,624) $ (385) (1,746) (2,245) 20,013 (5,377) 4,655 (2,404) 2,686 (2,335) (184) 9,539 (869) 719 (3,335) 7,097 1,916 950 $ 18,065 $ 6,560 $ 9,573 $ 13,498 For the fiscal year ended March 31, 2019, the positive net change in non-cash items mainly reflected: An increase in accounts payable due to the higher level of activity in the fourth quarter and the timing of cash outflows; and, An increase in customer advances following cash receipt, offset by revenue recognition. These positive elements were partially offset by an increase in accounts receivable due to higher deliveries in the fourth quarter and an increase in inventories mainly related to the ramp-up of the Boeing 777 and 777X contract and a decrease in provisions mainly due to utilization of the restructuring and product warranty provisions. For the fiscal year ended March 31, 2018, the positive net change in non-cash items mainly reflected: Lower inventories following the scheduled ending of a Tier-2 contract and lower spare parts volume with the U.S. Government; and, The receipt of customer advances. These positive elements were partially offset by a decrease in certain provisions. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 33 For the quarter ended March 31, 2019, the positive net change in non-cash items mainly reflected: An increase in accounts payable due to timing of cash outflows; and, An increase in customer advances following cash receipt, offset by revenue recognition. These positive elements were partially offset by the timing of receivable collections and by the negative effect of change in exchange rates. For the quarter ended March 31, 2018, the positive net change in non-cash items mainly reflected: The receipt of customer advances; A decrease in inventories following a high level of deliveries during the quarter; and, An increase in accounts payable due to a high level of activity in the fourth quarter. These positive elements were partially offset by an increase in accounts receivable due to the high level of activity in the fourth quarter. Investing Activities The Corporation’s investing activities were as follows: Additions to property, plant and equipment Cash payments for business acquisition Net decrease in finite-life intangible assets Proceeds on disposal of property, plant and equipment Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 $ (4,513) $ (3,548) (3,744) $ — (12,858) $ (198,149) 130 5 6,799 66 2,353 35 (9,930) — 4,761 173 Cash flows related to investing activities $ (7,926) $ 3,121 $ (208,619) $ (4,996) The increase in cash payments related to investing activities for the quarter and compared to the same period last fiscal year mainly relates to the $3.5 million payment made for the acquisition of Tekalia. For the fiscal year ended March 31, 2019, the cash payments related to investing activities also include a $170.9 million payment for the acquisition of CESA and a $23.7 million payment made for the acquisition of Beaver. The net decrease in finite-life intangible assets during the quarter and the fiscal year ended March 31, 2019 is due to the timing of certain customer funding for capitalized development costs received during the current period. Additions to property, plant and equipment shown above can be reconciled as follows: Gross additions to property, plant and equipment Government assistance Additions to property, plant and equipment Variation in unpaid additions included in Accounts payable Additions, as per statements of cash flows Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 5,286 (497) 4,789 (276) 4,513 $ $ $ 5,696 (352) 5,344 (1,600) 3,744 $ $ $ 13,876 (497) 13,379 (521) 12,858 $ $ $ 10,691 (619) 10,072 (142) 9,930 $ $ $ Net decrease in finite-life intangible assets shown above can be reconciled as follows: Decrease (increase) in finite-life intangible assets Variation in unpaid additions included in Accounts payable Net decrease, as per statements of cash flows $ Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 (692) 822 130 6,799 — 1,531 822 $ 6,799 $ 2,353 $ 4,761 — 4,761 34 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Financing Activities The Corporation’s financing activities were as follows: Increase in long-term debt Repayment of long-term debt Issuance of common shares Increase in deferred financing cost Cash flows related to financing activities Quarters ended March 31, 2018 2019 Fiscal years ended March 31, 2018 2019 $ 1,278 $ 1,603 $ 117,883 $ (23,652) 245 33 (1,264) 205 (524) (36,198) 1,169 (2,534) $ (22,096) $ 20 $ 80,320 $ 3,821 (4,634) 772 (524) (565) The increase in long-term debt during the fiscal year ended March 31, 2019 is mainly related to a US$50.0 million ($65.2 million) drawing on the Revolving facility and a $50.0 million drawing on the Term Loan Facility, both in order to finance the CESA acquisition. During the fiscal year ended March 31, 2019, repayments of US$21.0 million or $27.9 million (US$16.0 million or $21.3 million in the last quarter) of the Revolving facility and scheduled repayments of finance leases and governmental loans totaling $8.3 million were made. FREE CASH FLOW(1) Cash flows related to operating activities Additions to property, plant and equipment Net decrease (increase) in finite-life intangible assets Free cash flow(1) Quarters ended March 31, Fiscal years ended March 31, 2019 2018 2019 37,181 $ 18,521 $ 69,969 $ (4,789) (692) (5,344) 6,799 (13,379) 1,531 31,700 $ 19,976 $ 58,121 $ 2018 56,122 (10,072) 4,761 50,811 $ $ (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for the definition of this metric. Management considers free cash flow to be a good indicator of financial strength and profitability because it shows how much cash generated by operations is available for distribution, to repay debt and fund investments. Héroux-Devtek’s Free Cash Flow has increased compared to last fiscal year mainly as a result of the contributions of CESA and Beaver. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 35 LIQUIDITY REQUIREMENTS The summary of the following contractual obligations of the Corporation includes payments due over the next five years and thereafter, as at March 31, 2019: Contractual obligations Governmental authorities’ loans Total 1 year 2-3 years 4-5 years > 5 years $ 110,666 $ 6,780 $ 17,165 $ 21,938 $ 64,783 Payments due by period Finance leases Credit facility Term loan facility Others Purchase obligations Accounts payable Building, machinery and equipment acquisition commitments Operating leases - Buildings and facilities 21,762 108,396 69,225 9,623 319,672 205,451 76,749 6,796 16,823 6,007 4,269 2,850 3,306 23,212 172,500 76,749 6,624 2,517 11,185 8,538 5,700 3,897 46,485 30,855 — 172 4,685 4,570 95,589 5,700 798 — — 54,975 1,622 128,595 121,380 1,825 — — 271 — — 3,637 5,984 Total contractual obligations(1) $ 625,491 $ 281,602 $ 82,197 $ 134,057 $ 127,635 (1) Excluding defined benefit pension plan obligations presented in the Pension Plans section. FINANCIAL POSITION CAPITAL STRUCTURE The general objectives of the Corporation’s management, in terms of capital management, reside in the preservation of the Corporation’s capacity to continue operating, providing benefits to its stakeholders and in providing an adequate return on investment to its shareholders by selling its products and services at a price commensurate with the level of operating risk assumed by the Corporation. The Corporation thus determines the total amount of capital required consistent with risk levels. This capital structure is adjusted on a timely basis depending on changes in the economic environment and risks of the underlying assets. In order to maintain or adjust its capital structure, the Corporation can, for example: • • • • Issue new common shares; Repurchase common shares; Sell certain assets to reduce indebtedness; Return capital to shareholders. The net debt-to-equity ratio, calculated as net debt divided by shareholders’ equity, is the overriding factor in the Corporation’s capital management and monitoring practices. During fiscal year ended March 31, 2019, the Corporation pursued the same capital management strategy as last year, which consists in generally maintaining a sufficient net debt-to-equity ratio to allow access to financing at a reasonable or acceptable cost. 36 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A The Corporation's net debt-to-equity ratio was as follows, as at: Current portion of long-term debt Long-term debt Deferred financing costs, net Less: Cash and cash equivalents Net debt Shareholders’ equity Net debt-to-equity ratio March 31, 2019 March 31, 2018 5,356 $ 15,066 $ 245,240 2,952 35,128 228,130 404,098 0.56:1 $ 125,685 923 93,209 38,755 379,034 0.10:1 $ The increase in net debt this fiscal year is mainly related to the business acquisitions, net of free cash flow generated during the year. ISSUED CAPITAL Capital stock varied as follows: Opening balance Issued for cash on exercise of stock options Issued for cash under the stock purchase and ownership incentive plan Ending balance Quarter ended March 31, 2019 Issued capital Fiscal year ended March 31, 2019 Issued capital Number of shares Number of shares 36,341,054 $ 79,361 36,218,572 $ 17,250 3,906 276 39 107,450 36,188 78,105 1,101 470 36,362,210 $ 79,676 36,362,210 $ 79,676 As at May 22, 2019, the number of common shares outstanding stood at 36,362,210. Stock options varied as follows: Opening balance Granted Exercised Cancelled / forfeited Ending balance Quarter ended March 31, 2019 Weighted- average exercise price Fiscal year ended March 31, 2019 Weighted- average exercise price Number of stock options Number of stock options 1,187,720 $ — (17,250) (3,375) 1,167,095 $ 13.22 — 11.87 14.97 13.23 1,105,295 $ 207,500 (107,450) (38,250) 1,167,095 $ 12.09 16.21 6.50 15.24 13.23 During fiscal 2019, following the approval by the shareholders of the Corporation at the last Annual General Meeting of shareholders, the aggregate number of shares available for future issuance under the stock option plan was replenished due to the limited number of common shares remaining under this plan. As at March 31, 2019, 2,762,507 common shares remained reserved for issuance upon exercise of stock options compared to 1,514,481 at March 31, 2018 and 22,678 common shares remained reserved for issuance under the stock purchase and ownership incentive plan compared to 58,866 at March 31, 2018. As at May 22, 2019, the number of stock options outstanding stood at 1,167,095. For further information regarding the Corporation’s outstanding issued capital and related compensation plans, refer to Note 22, Issued Capital, to the consolidated financial statements. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 37 CONSOLIDATED BALANCE SHEETS The acquisitions of CESA, Beaver and Tekalia contributed assets and liabilities to the Corporation’s balance sheet as at March 31, 2019 as detailed in the Business Acquisitions section under Overview. Working Capital The Corporation’s working capital was as follows, as at: Current assets Current liabilities Net working capital Working capital ratio March 31, 2019 March 31, 2018 Variance $ $ $ $ 364,467 186,840 177,627 1.95 310,649 $ 53,818 108,750 78,090 17.3 % 71.8 % 201,899 $ (24,272) (12.0)% 2.86 The $53.8 million increase in current assets is mainly due to: $86.8 million of current asset as acquired through business acquisitions; and, $58.1 million of free cash flow generated during fiscal 2019. These positive factors were partly offset by $82.9 million of cash used for the business acquisitions. The $78.1 million increase in current liabilities is mainly due to $42.8 million assumed in business acquisitions and an increase of $26.2 million in accounts payable and accrued liabilities as previously explained. Long-term assets, Long-term liabilities and Shareholders’ equity The Corporation’s long-term assets and liabilities and shareholders’ equity were as follows, as at: Long-term assets Long-term liabilities Shareholder’s equity March 31, 2019 March 31, 2018 Variance $ 510,273 $ 321,513 $ 188,760 283,802 404,098 144,378 379,034 139,424 25,064 58.7% 96.6% 6.6% The increase in long-term assets is mainly due to $211.0 million acquired with CESA, Beaver and Tekalia, including $97.6 million of goodwill. The increase in long-term liabilities is mainly due to the financing of the acquisition of CESA. Refer to the Credit Facilities & Net Debt Position section under Liquidity and Capital Resources for further details. PENSION PLANS The Corporation has funded and unfunded defined benefit pension plans as well as defined contribution pension plans that provide pension benefits to its employees. Retirement benefits provided by the defined benefit pension plans are based on either years of service and flat amount, years of service and final average salary, or set out by individual agreements. 38 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A The net defined benefit obligations varied as follows, during fiscal year: Net defined benefit obligations, beginning of year Net gains (losses) from remeasurement Employer contributions Current service cost Interest on net defined benefit obligations Other Net defined benefit obligations, end of year The funding status of the Corporation’s pension plans was as follows, as at: Present value of defined benefit obligations of funded plans Fair value of plan assets Funding ratio 2019 $ (3,958) $ (2,487) 1,335 (1,192) (150) (198) $ (6,650) $ 2018 (3,610) 261 1,489 (1,459) (153) (486) (3,958) March 31, 2019 March 31, 2018 61,216 $ 58,974 65,962 60,710 $ 92.0% 96.3% The Corporation made contributions of $1.3 million and $3.5 million to its defined benefit and defined contribution benefit plans, respectively, during fiscal 2019, and expects to make respective contributions of $1.7 million and $3.6 million during fiscal 2020. ADDITIONAL INFORMATION KEY PERFORMANCE INDICATORS Héroux-Devtek measures its performance on a corporate-wide basis through the following elements: • • • • Profitability Liquidity Growth and competitive positioning Financial position To do so, the Corporation developed key performance indicators (“KPI”). The following is a list of these indicators as well as the elements which they help measure: PERFORMANCE ELEMENT KPI Profitability Liquidity Growth and competitive positioning Financial position Gross profit Adjusted operating income(1) Adjusted net income(1) Adjusted EPS(1) MEASURES Manufacturing performance Operating performance Global profitability Global profitability and shareholder return Return on net assets (“RONA”) Return on investment Adjusted EBITDA(1) Cash flow from operations Free cash flow(1) Sales Funded backlog Working capital Net debt to EBITDA ratio Net debt to equity ratio Overall liquidity generation Operating liquidity generation Net liquidity generation Growth Outstanding firm orders Available liquidity Indebtedness Overall capital structure (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for definitions and reconciliations to the most comparable IFRS measures. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 39 In addition to the above measures, on an internal basis, the Corporation uses such measures as manufacturing capacity utilization, as well as on-time deliveries and non-quality costs to measure customer satisfaction. Héroux-Devtek’s incentive-based pay for management varies partially based on reaching established global or divisional targets of certain of the metrics listed above, including operating income, RONA, adjusted EBITDA and adjusted net income. Incentive pay also relies on individual objectives and, in the case of stock-based compensation, share price performance. RISK MANAGEMENT Héroux-Devtek operates in an industry which exposes it to a variety of risk factors and uncertainties that may have a material adverse effect on the business, financial condition and results. The Corporation is also subject to more general economic or natural risks which could have widespread, cross-industry impacts. Héroux-Devtek’s general philosophy is to avoid unnecessary risk and to limit, to the extent practicable, any risk associated with business activities. Taking any risk unrelated to normal business activities is considered inappropriate. It is ultimately the responsibility of the Board of Directors and its committees to identify material risks to the business and ensure management performs adequate risk management duties. Their role in this regard is largely one of high level decisions, oversight and review. In order to succeed, the Board of Directors entrusts the bulk of risk prevention, detection and mitigation to management. It is Corporate management’s responsibility to ensure that systems and procedures are in place to identify and assess risk exposures and manage them within tolerable limits. In order to do so, management has set out the following objectives: • • • identify and evaluate risk exposures and, when practicable, reduce exposures to a tolerable level; use the most effective and efficient methods to eliminate, reduce or transfer risk exposures; and, consider risks associated with operating decisions and structure transactions in such a fashion as to avoid risks whenever possible. The most significant risk management methods used by management have entity-wide impacts. Such entity-wide efforts include, but are not limited to: • the establishment of a corporate culture which fosters responsible management and integrity by adhering to strict hiring policies and emitting strong tone from the top; the application of a code of ethical conduct and a whistleblower policy in order to assure the quality of the Corporation's corporate governance, and the integrity of the Corporation's functioning; the establishment and ongoing alignment of company-wide quality organizations and systems, including supply chain, quality assurance and continuous improvement; and, the company-wide establishment of a strong internal control environment in order to manage risks associated with financial reporting, fraud, treasury and operations. • • • The tables below include a selection of key risks identified by management as well as the related risk management approach. This list is not, nor is it intended to be, exhaustive. Other risks which may not yet have been identified by management could have an adverse effect on the Corporation’s business, financial condition or results. 40 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Strategic Risks Strategic risks have company-wide impacts and are typically related to the Corporation’s overall direction. RISK DESCRIPTION Boeing 777 and 777X programs Reliance on large customers Acquisitions and integrations The Boeing 777 and 777X programs are integral to the long-term growth of Héroux-Devtek and have engendered approximately $110 million of investments. Solid execution of this contract is crucial in order for the Corporation to, among other objectives: - Recover invested capital - Achieve forecasted sales and profitability growth - Demonstrate the Corporation’s ability to compete as a Tier-1 producer of landing gear for larger commercial aircraft The top 9 of Héroux-Devtek’s customers represent approximately 63% of consolidated sales, including one customer representing 22% of its consolidated sales. The loss of one of these customers would have a material adverse impact on current and forecasted financial results. As a growth strategy, the Corporation at times engages in business acquisitions. Such acquisitions increase the size and scale of the Corporation, and may expose it to new geographical, political, operational and financial risks. Acquisitions furthermore may place significant demand on management or cause subsequent difficulties related to the integration of new operations. The integration of new operations poses risks, which are difficult to forecast, that may adversely affect the Corporation's growth and profitability, and may include the inability to successfully integrate acquired operations. RISK MANAGEMENT APPROACH The Boeing 777 and 777X programs are subject to constant oversight by senior management and represent a company-wide effort. Furthermore: - The Corporation has invested in state-of-the-art equipment and facilities to ensure proper execution; - Execution is subject to rigorous internal and external qualification processes; - Héroux-Devtek works very closely with Boeing in order to ensure requirements are consistently met or exceeded. This risk is partly mitigated by entering into long-term sales agreements with customers as well as by actively seeking out new and diverse customers in order to diversify the sales portfolio. In addition, further diversification is achieved by diversifying sales by subsegment and product or service within sales to individual customers. Héroux-Devtek carefully selects acquisition targets within restrictive criteria and only goes forward when satisfactory fit is identified. Acquisition agreements, further, are thoroughly negotiated with the goal in mind to mitigate key acquisition risks via mutually agreeable conditions, warranties and contingent pricing agreements. The Corporation further manages risks associated with acquisitions and integrations via thorough due diligence work, internal experience and external assistance, as needed. Héroux-Devtek plans integration of acquisitions from the top down and dedicates resources over the long term in order to optimize integration and achieve strategic goals. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 41 Financial Risks Financial risks are related to the financial condition, results and liquidity of the corporation and/or relate to market conditions directly related to the Corporation. RISK Foreign currency fluctuations DESCRIPTION Refer to the Foreign exchange section under Overview for details of Héroux-Devtek’s exposure to foreign exchange rate fluctuations and related risk management practices. RISK MANAGEMENT APPROACH The Corporation requires continued access to capital markets to finance its activities. The long-term nature and up-front cost structure of certain programs can require significant amounts of start-up costs. Inability to access such capital could impede the Corporation’s ability to bid on significant contracts, or negatively impact ongoing operations. Héroux-Devtek has access to such financing from its banking syndicate, unsecured subordinated term loan facility as well as from loans from government authorities and capital lease facilities. These agreements subject the Corporation to the financial covenants as described in the Liquidity and capital resources section. They furthermore restrict the Corporation's ability to sell all or substantially all of its assets, incur secured or certain other indebtedness, engage in mergers or consolidations or engage in transactions with affiliates. These restrictions and covenants could impede access to capital or prevent the Corporation from engaging in business activities that may be in its interest. The Corporation is exposed to fluctuations in interest rates through the floating rate of its credit facility as well as the impact on the cost of future capital requirements. Fluctuations in interest rates may also negatively impact profitability by their impact on rates used by Héroux- Devtek to discount provisions and pension obligations, among other balances. Lower interest rates would result in higher present obligations, with resulting adjustments impacting financial results. In order to maintain proper liquidity, Héroux-Devtek makes cash management a daily priority. Liquidity balances, receivables, cash projections and market rates of foreign exchange and interest are monitored constantly. In order to ensure stability and long-term financial viability, the Corporation also: - Ensures proper bid approval in order to ensure proper forecasting and risk assessment of revenue and costs; - Structures contracts in order to obtain customer advances and progress billings; - Develops long-term agreements with customers and suppliers which go through bid processes for key costs; - Performs long-term cash projections as part of the annual budget and strategic plan process; - Maintains positive relationships with all major creditors. Management also monitors covenants on an ongoing basis in order to ensure they are met and identifies trends which could indicate future risks. Héroux-Devtek’s risk management policies specifically address the management of interest rate risk by allowing the use of derivatives such as interest rate swaps. The goal of this policy is to obtain an overall fixed rate debt ratio between 40% and 70% of overall long-term debt. Outstanding derivatives are detailed in the Derivative Financial Instruments section under Additional Information. Risks associated with pensions are managed through investment policies put in place by the Corporation and pension committees. Liquidity, capital resources and related covenants Changing interest rates 42 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Operational Risks Operational risks are more specific to or result from Héroux-Devtek’s operations than strategic risks. RISK Litigation DESCRIPTION Héroux-Devtek is subject to possible litigation in the ordinary course of its business by, among others, customers, suppliers, competitors, shareholders or government agencies including specific import/export laws and regulations. Such litigation can vary both in terms of financial magnitude and in duration, either of which could remain unknown for substantial periods of time. RISK MANAGEMENT APPROACH The Corporation employs legal professionals who advise senior management on the subject of ongoing legal and regulatory compliance and related risk management. The Corporation also subscribes to several forms of insurance coverage which may, in the event of liability of certain types, partially or entirely compensate for potential losses. Regardless of outcome, litigation could result in substantial costs to the Corporation in addition to potentially material losses, both of which would negatively impact financial results. Litigation, in addition, could divert management’s attention and resources away from day-to-day operations and strategic objectives. The Corporation is party to certain collective bargaining agreements which govern the working relationship with certain employees. Failure to renew such agreements upon mutually agreeable terms could result in work stoppages or other labour disturbances which could have adverse effects on financial results, operational execution and customer satisfaction. The market for skilled labour in the aerospace industry is highly competitive and is expected to remain so in the future. Execution of key programs and customer satisfaction are heavily reliant on employing top talent. The Corporation relies on such labour, particularly engineers, machinists and programmers, for all levels of operations. Information technology systems are essential to most of Héroux-Devtek’s operations. These systems could be vulnerable to cyber-attacks or spying, viruses and any other form of hardware or software failures, intentional or not. The non-availability of these systems would directly and negatively affect the Corporation’s operations. Unauthorized access to first or third-party confidential data in Héroux-Devtek’s possession would also negatively affect the Corporation’s reputation and, consequently, its business and results. The complex and sophisticated nature of the Corporation’s products creates a risk that defects may be found after they have been delivered to customers. Such defects may result in warranty claims or customer losses for which Héroux-Devtek may be liable. Furthermore, the primary use of these products being for air travel may compound the magnitude of such warranty claims or losses. Liability for such losses, or the inability to correct such errors, may have material adverse effect on the Corporation’s business and results. The increasing growth, integration and automation of the Corporation’s business result in increased reliance on, and exposure to, the performance of its supply chain. Reductions in quality, reliability, availability of supply chain performance could result in material adverse effects on the Corporation’s business and results. Collective bargaining agreements Availability of skilled labour Information technology Warranty casualty claim losses Supplier performance In order to minimize this risk, Héroux-Devtek endeavours to maintain cooperative and professional relationships with union leadership and plans the negotiation of renewals to allow reasonable time to achieve positive results. Héroux-Devtek targets top candidates for key roles and carefully evaluates hires for long-term fit and growth. Retention of employees is addressed through solid human resources practices, competitive remuneration and, in the case of key management, incentive-based pay such as bonuses, stock options, performance share units and stock purchase and ownership incentive plans. In order to reduce technology-related risks, Héroux Devtek has implemented a variety of measures, including: - A security program based on the NIST framework, including frequent maturity assessments, audits and penetration tests; - 24/7 monitoring via a security operations center; - Intrusion detection and prevention solutions; - A global security committee, strict governances process and policies regarding information technology; - A cybersecurity awareness program and phishing campaigns; and, - Disaster recovery planning. Héroux-Devtek’s rigorous dedication to quality standards, systems and certifications in all stages of design, production or repair and overhaul partially mitigate the risk of product-related failure which could lead to warranty claims or litigation. The Corporation has in place a product support organization which monitors performance and reliability of products and also subscribes to product liability insurance which may mitigate potential losses. Héroux-Devtek manages supplier-related risks through frequent supplier audits and maintaining high standards, such as requiring AS9100 and Nadcap certification. The Corporation also tracks and monitors supplier performance and mitigates potential losses by ensuring poor quality, if any, is detected through internal quality management. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 43 External Risks External risks are generally outside of management’s control and mostly result from external factors. RISK Competition and innovation DESCRIPTION Héroux-Devtek operates in an industry that has faced ongoing consolidation, resulting in a smaller overall number of larger competitors, as well as constant innovation in technology and products. RISK MANAGEMENT APPROACH Héroux-Devtek manages risk from competition by maximizing customer satisfaction, on-time delivery, bidding competitively and maintaining high quality products. Larger competitors may have increased capabilities to compete for significant contracts, as would competitors who bring new technological innovation to market. Either could result in lost customers or opportunities for the Corporation, hindering growth and future profitability. The Corporation also manages risk associated with innovation by monitoring technological developments and performing in-house research and development in order to remain at the forefront of technology in the industry. Availability and cost of raw materials General economic conditions The main raw materials purchased by the Corporation are steel, aluminum and titanium. Supply and cost of these materials can fluctuate due to factors outside of the Corporation’s control. Difficulty in procuring raw materials in sufficient quantities and in a timely fashion or increases in the costs of these materials could have a material adverse effect on Héroux-Devtek’s operations and financial results. While the aerospace and defence industries have proven over the long-term to be relatively resilient in the face of economic turmoil, they are not immune to short-term downturns when market conditions take their toll on customers. Such market conditions may be caused by any number of factors, including but not limited to political instability, terrorist activity, or natural disasters. Such unfavourable conditions could negatively impact which could lead the Corporation to incur significant costs associated with temporary layoffs and termination. Defence spending Environmental matters Defence spending is approved by governments on a yearly basis and is subject to political climates and changing priorities. Austerity measures or shifts away from defence spending on the part of a government, particularly that of the United States, could lead to a significant downward trend in demand for the Corporation’s defence products. The Corporation’s activities are subject to environmental laws and regulations associated with risks to human health and the environment. These laws and regulations and potential related charges could have a significant adverse effect on the Corporation’s operations and financial condition. The Corporation mitigates this risk with the inclusion of clauses in certain long-term sales contracts which govern the sharing of risks related to the availability and cost of raw materials with customers. Héroux-Devtek also negotiates long-term supply agreements for certain raw materials and monitors the supply chain to ensure timely delivery. While such economic conditions are outside of the direct sphere of control of management, Héroux-Devtek indirectly manages this risk through maintaining a portfolio of customers and programs which is diversified both geographically and by market segment. This could decrease the overall impact of a downturn in any one of these segments on the Corporation as a whole. This risk is further mitigated by continuous effort on the part of Héroux-Devtek to manage costs, capital and profitability in such a fashion as to maintain a healthy financial position, allowing for more resiliency in the event of unexpected downturns. The Corporation’s diversified sales portfolio, including a growing commercial product portfolio, defence programs outside of the United States and balance between manufacturing and aftermarket products and services reduces the impact that a downward trend in defence spending on the part of certain governments could have. Héroux-Devtek manages this risk by putting in place management systems and policies in order to manage and monitor the environmental impact its operations may have. In the event of an environmental incident which could lead to a larger loss, the Corporation also subscribes to insurance policies which may partially mitigate such losses. 44 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A DERIVATIVE FINANCIAL INSTRUMENTS Héroux-Devtek makes use of certain derivative financial instruments as tools for risk management purposes in order to mitigate certain foreign exchange, interest rate or other price risks to which it is exposed. Management uses these derivatives within the guidelines laid out by the Corporation’s risk management policy. See the Risk Management section under Overview for further details of Héroux-Devtek’s risk management practices. As at March 31, 2019, these derivative financial instruments are as follows: Forward foreign exchange contracts See Foreign Exchange under Overview for information about the Corporation’s exposure to foreign exchange risks as well as the derivative financial instruments used to mitigate it. See also note 32 to the Consolidated financial statements. Cross-currency interest rate swaps The acquisition of CESA exposed the Corporation to new foreign currency and interest rate risks related to the investment in Euros. A decrease in value of the Euro compared to the Canadian dollar would decrease the value of the foreign investment, and an increase in the interest rates of the underlying debt would increase related the net financial expenses. As at March 31, 2019, the Corporation had entered into the following cross-currency interest rate swap agreements in order to mitigate foreign exchange and interest rate risks: Notional EURO equivalent Interest rate € 25,000 € 34,110 1.86 % 3.40 % € 15,000 Euribor 1 month + 1.74% September 2018 € 15,000 Euribor 1 month + 1.76% November 2018 Inception October 2017 October 2017 Maturity May 2022 September 2025 May 2022 March 2020 US$ C$ US$ US$ 29,370 50,000 17,523 17,100 Equity swap agreement The Corporation’s net income is exposed to fluctuations of its share price through its DSUs and PSUs (see note 22 to the consolidated financial statements). In order to mitigate this exposure, the Corporation has entered into an equity swap agreement with a financial institution. Pursuant to this agreement, upon settlement, the Corporation receives payment for any share price appreciation while providing payment to the financial institution for any share price depreciation. The net effect of the equity swap partly offsets movements in the Corporation’s share price which impacts the expense resulting from the DSUs and PSUs included in the Corporation’s selling and administrative expenses. As at March 31, 2019, the equity swap agreement covered 245,000 common shares of the Corporation (150,000 at March 31, 2018) at a price of $12.68 ($11.45 at March 31, 2018). This agreement is a derivative that is not part of a designated hedging relationship and matures in June 2020. CRITICAL ACCOUNTING ESTIMATES The preparation of the Corporation’s consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities at the reporting date. Uncertainty about these assumptions and estimates could result in outcomes that require material adjustments to the Corporation’s financial results or the carrying amount of assets or liabilities. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 45 Key estimates and assumptions are as follows: Impairment of non-financial assets Impairment exists when the carrying amount of an asset or cash generating unit (“CGU”) exceeds its recoverable amount, which is the higher of its fair value less costs to sell and its value in use. The fair value less costs to sell calculation is based on available data from binding sales transactions in an arm’s length transaction of similar assets and observable market prices less incremental costs for disposing of the asset. The value in use calculation is based on a discounted cash flow model. The cash flows are derived from the Corporation’s five-year budget and strategic plan and do not include restructuring activities that the Corporation is not yet committed to or significant future investments that may enhance the performance of the CGU being tested. The recoverable amount is most sensitive to the discount rate used in the discounted cash flow model, the expected future cash flows and the perpetual growth rate used for extrapolation. The key assumptions used to determine the recoverable amount of the CGUs, including sensitivity analysis, are further explained in note 17 to the Consolidated financial statements. Deferred income tax assets Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. The Corporation establishes provisions based on reasonable estimates for possible consequences of audits by the tax authorities. The amount of such provisions is based on various factors, such as experience of previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authority. Deferred income tax assets are recognized for unused tax losses and deductible temporary differences to the extent it is probable that taxable income will be available against which the losses and deductible temporary differences can be utilized. Management’s judgment is required to determine the amount of deferred income tax assets that can be recognized, based upon the likely timing and the level of future taxable income together with future tax planning strategies. Pensions and other retirement benefits The cost of defined benefit pension plans is determined using actuarial valuations. The actuarial valuation involves making assumptions about discount rates, future salary increases and mortality rates. In determining appropriate discount rates, management considers the interest rates of high-quality corporate bonds. Due to the long-term nature of these plans, such estimates are subject to significant uncertainty. The significant assumptions used to determine the defined benefit obligations and the pension expense, including a sensitivity analysis, are further explained in note 25 to the Consolidated financial statements. Capitalized development costs Development costs are capitalized in accordance with the accounting policy described in note 3 to the Consolidated financial statements. In determining the amounts to be capitalized, management makes assumptions regarding the expected future cash generation of the assets, discount rates to be applied, the expected period of benefits and contract quantities. For purpose of impairment testing, the Corporation exercises judgment to identify the cash inflows and outflows. The recoverable amount is based on fair value less costs of disposal, generally determined using a discounted cash flow model. Other assumptions used to determine the recoverable amount include the applicable discount rate and the expected future cash flows which include costs to complete the development activities. Provisions The Corporation has recorded provisions to cover cost exposures that could materialize in future periods. In determining the amount of the provisions, assumptions and estimates are made in relation to discount rates and the expected cost to settle such liabilities. Government Authorities Loans The Corporation has outstanding loans with government authorities with variable repayment schedules. Annual repayments of these loans generally vary based on the sales of certain of the Corporation’s programs or segments. In order to account for the present value of these loans under the effective interest method, or for government assistance upon initial recognition, management must estimate the future sales growth of these programs or segments over the expected duration of the loan. These forecasts are used to determine effective interest rates and expected repayment schedules. In determining these amounts, management must rely on market rates of interest and assumptions such as, but not limited to, current and future order intake, industry order backlogs, Original Equipment Manufacturer (“OEM”) production rates, expected economic conditions, the stability of foreign exchange rates and the Corporation’s ability to deliver on key contract initiatives. 46 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A Customer Relationships Customer relationships acquired in business acquisitions are considered intangible assets with finite lives. Their value was estimated upon acquisition using valuation methodologies which rely on many underlying assumptions, including: • • • • • Expected future order intake; Operational execution and cost management; Stability of economical conditions, including foreign exchange rates; Production rates; Government spending. They are recorded at cost less accumulated impairment and amortization and are amortized on a straight-line basis over their useful lives without exceeding 15 years. INTERNAL CONTROLS AND PROCEDURES In compliance with Regulation 52-109 respecting Certification of Disclosure in Issuer’s Annual and Interim Filings (“Regulation 52-109”), the Corporation has filed certifications signed by the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) that, among other things, report on disclosure controls and procedures and the design of internal controls over financial reporting. Disclosure controls and procedures The CEO and the CFO have designed disclosure controls and procedures, or have caused them to be designed under their supervision, to provide reasonable assurance that material information relating to the Corporation has been made known to them and has been properly disclosed in the interim and annual filings. As at March 31, 2019, an evaluation of the design and effectiveness of the Corporation’s disclosure controls and procedures was also carried out under the supervision of the CEO and CFO, as defined in Regulation 52-109. Based on this evaluation, the CEO and CFO concluded that the design and operation of these disclosure controls and procedures were effective. This evaluation took into account the Corporation’s disclosure policy and its disclosure committee. Internal controls over financial reporting The CEO and CFO have also designed internal controls over financial reporting, or have caused them to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. As at March 31, 2019, an evaluation of the design and effectiveness of the Corporation’s internal controls over financial reporting was carried out under the supervision of the CEO and CFO, as defined in Regulation 52-109. Based on this evaluation, the CEO and CFO concluded that the design and effectiveness of these internal controls over financial reporting were effective to provide reasonable assurance that the Corporation’s financial reporting is reliable and that the Corporation’s consolidated financial statements were prepared in accordance with IFRS. However, a control system, no matter how well conceived or operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. As permitted by the Canadian Securities Administrators’ Regulation 52-109, management’s assessment and conclusion on the design of disclosure controls and procedures and internal controls over financial reporting exclude the controls, policies and procedures of Beaver and CESA, which were acquired respectively on July 2, 2018 and October 1, 2018. Those results are included in the March 31, 2019 consolidated annual financial statements of Héroux-Devtek and constituted approximately 34.6% of total assets as at March 31, 2019 and 18.3% of total revenues for the year ended March 31, 2019. Management expects that Beaver and CESA business acquisitions will be included in management's assessment and certification on the design of DCP and effectiveness ICFR by the second and third of fiscal 2020, respectively. Changes in internal controls over financial reporting No changes were made to the Corporation’s internal controls over financial reporting during the fiscal year ended March 31, 2019 that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 47 NEW ACCOUNTING STANDARDS IFRS 9, Financial Instruments In July 2014, the IASB issued a complete and final version of IFRS 9 “Financial Instruments”, replacing the current standard on financial instruments (IAS 39). IFRS 9 introduces a single, principle-based approach for the classification of financial assets, driven by the nature of cash flows and the business model in which an asset is held. IFRS 9 also provides guidance on an entity’s own credit risk relating to financial liabilities and has modified the hedge accounting model to align the economics of risk management with its accounting treatment. The standard results in a single expected loss impairment model rather than an incurred losses model. The Corporation adopted IFRS 9 on April 1, 2018 and this adoption did not have a significant impact on the Corporation’s consolidated financial statements. Initial recognition At initial recognition, financial assets are classified either as financial assets at fair value through profit or loss (“FVTPL”), measured at amortized cost (“AC”) or fair value through other comprehensive income (“FVTOCI”). The classification is based on two criteria: the Corporation’s business model for managing the assets; and whether the instruments’ contractual cash flows represent ‘solely payments of principal and interest’ on the principal amount outstanding (the “SPPI criterion”). The Corporation’s financial assets are held within a business model with the objective to hold the financial assets in order to collect contractual cash flows that meet the SPPI criterion are classified and subsequently measured at amortized cost. They consist of cash and cash equivalents, accounts receivable and certain other current and long-term assets. When financial assets are recognized initially, they are measured at fair value, plus in the case of a financial asset other than FVTPL, the directly attributable transaction costs. Purchases and sales of financial assets are recognized on the transaction date, which is the date that the Corporation commits to purchase or sell the assets. FVTPL FVTPL include certain derivative financial instruments, except those that are designated as Hedges. FVTPL are carried at fair value with gains and losses recognized in the consolidated statements of income. The Corporation assesses whether embedded derivative financial instruments are required to be separated from host contracts when the Corporation first becomes party to the contract. AC AC are non-derivative financial assets with fixed or determinable payments not quoted in an active market. AC are mainly comprised of accounts receivable and certain other current and long-term assets. AC are carried at amortized cost using the effective interest rate method. An allowance for doubtful accounts is recorded when an account receivable become impaired. Also, under the forward-looking expected credit loss (“ECL”) approach, all financial assets, except for those measured at FVTPL, are subject to review for impairment at least at each reporting date. ECLs are based on the difference between the contractual cash flows due in accordance with the contract and all the cash flows that the Corporation expects to receive. The shortfall is then discounted at an approximation to the asset’s original effective interest rate. For accounts receivables, the Corporation has applied the standard’ expected credit losses and the amount was insignificant at March 31, 2019 and 2018. s simplified approach and has calculated ECLs based on lifetime If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed by adjusting the allowance for doubtful accounts. Any subsequent reversal of an impairment loss is recognized in the consolidated statements of income. FVTOCI These include cross-currency interest rate swap agreements that are used to hedge the net investments in certain foreign subsidiaries and forward foreign exchange contracts. They are carried at fair value. The change in the fair value of the effective portion of hedges is recognized in other comprehensive income, while the ineffective portion is recognized in the consolidated statements of income, if any. The Corporation assesses at each reporting date whether any financial asset is impaired. IFRS 15, Revenue from Contracts with Customers In May 2014, the International Accounting Standards Board (“IASB”) and the Financial Accounting Standards Board (“FASB”) jointly issued IFRS 15, a converged standard on the recognition of revenue from contracts with customers. It supersedes the IASB’s current revenue recognition guidance including IAS 18 “Revenue”, IAS 11 “Construction Contracts”, and related interpretations. IFRS 15 provides a single principle based five step model to use when accounting for revenue arising from contracts with customers. On April 1, 2018, the Corporation adopted IFRS 15 using the full retrospective method and this adoption did not have a material impact on the Corporation’s consolidated financial statements. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 48 Revenue is measured at the fair value of the consideration received or receivable, net of estimated discounts, and after eliminating intercompany sales. Revenue from the sale of goods is recognized in a manner that depicts the transfer of promised goods to a customer and at an amount that reflects the consideration expected to be received in exchange for transferring those goods. This is achieved by applying the following five steps: 1. Identify the contract with a customer; 2. Identify the performance obligations in the contract; 3. Determine the transaction price; 4. Allocate the transaction price to the performance obligations in the contract; and 5. Recognize revenue when (or as) the entity satisfies a performance obligation, which is generally achieved upon the delivery of the products. Revenues from the sale of new or overhauled aerospace components are considered a single performance obligation and are recognized at the point in time when the customer has obtained control of the component and the Corporation has satisfied its performance obligation. Generally, these conditions are met upon delivery of the goods. FUTURE CHANGES IN ACCOUNTING POLICIES The standard issued but not yet effective that may apply to the Corporation are the following: IFRS 16 - Leases In January 2016, the IASB released IFRS 16 - Leases. The new standard, which represents a major revision of the way in which companies account for leases, sets out the principles that both parties to a contract, i.e. the customer (“lessee”) and the supplier (“lessor”), apply to provide relevant information about leases in a manner that faithfully represents those transactions. To meet this objective, a lessee is required to recognize assets and liabilities arising from a lease, following a single model where previously leases were classified as either finance leases or operating leases. Most leases will be recognized on the Corporation’s consolidated balance sheet. Certain exemptions will apply for short-term leases and leases of low-value assets. The Corporation anticipates the adoption of the IFRS will have an impact on the balance sheet and statement of income as all operating leases will be capitalized with a corresponding lease liability while the rent expense will be replaced by the amortization expense of the right to use the related assets and interest accretion expense from the liability recorded. The Corporation is required to apply this standard based on the full retrospective or modified retrospective (without restating comparative figures) approaches for its fiscal year beginning April 1, 2019. Many of the Corporation’s leases are already accounted for as finance leases on the Corporation’s consolidated balance sheet. Certain operating leases will be required to be brought on balance sheet while others do not as they are covered by practical expedients. The Corporation has elected to apply the following practical expedients: • • Account for leases for which the remaining lease term ends within 12 months of the effective date as a short term lease; and Recognize short term leases and low value leases on a straight line basis as is the case currently under IAS 17, leases as part of the operating expenses in the consolidated statements of income. Upon the initial application of this standard on April 1, 2019, using the modified retrospective approach, the Corporation expects its opening assets (right-of-use assets) and liabilities (lease liabilities) to increase by an approximate amount of $15.0 million in its consolidated financial statements. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 49 SELECTED FINANCIAL INFORMATION Selected financial information is as follows, for the quarters ended: Fiscal year Sales Operating income Adjusted operating income (1) Adjusted EBITDA (1) Net Income Adjusted Net Income (1) In dollars per share Fourth quarter Fourth quarter Third quarter Second quarter 2019 First quarter 2018 First quarter $157,914 $144,528 $ 95,665 $ 85,770 $113,024 $ 97,006 $ 89,677 $ 86,857 5,408 5,408 11,940 4,027 4,027 6,629 7,238 13,563 626 5,690 15,190 16,208 25,910 11,958 12,794 11,904 13,973 22,883 7,390 9,367 6,697 12,089 19,369 5,858 10,439 5,289 6,165 13,176 3,294 4,405 4,857 5,217 12,244 3,552 3,786 4,644 5,590 12,032 3,163 4,057 Second quarter Third quarter Earnings per share - Basic & Diluted Adjusted Earnings per share (1) In millions of shares Weighted average number of common diluted shares outstanding $ 0.34 $ 0.36 0.20 $ 0.26 0.09 $ 0.12 0.10 $ 0.10 0.16 $ 0.29 0.02 $ 0.16 0.09 $ 0.11 0.11 0.11 36.5 36.4 36.5 36.4 36.4 36.4 36.3 36.3 (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for definitions and reconciliations to the most comparable IFRS measures. Seasonal trends Héroux-Devtek’s first semester is usually slower than the last one due to seasonality such as plant shutdowns and summer vacations. Selected financial information is as follows, for fiscal years: Sales Operating income Adjusted operating income(1) Adjusted EBITDA(1) Net income Adjusted net income(1) Earnings per share ($) - basic and diluted Adjusted earnings per share(1) ($) Cash and cash equivalents Total assets Long-term financial liabilities(2) 2019 2018 $ 483,877 $ 386,564 $ 37,240 41,563 74,213 26,194 30,352 0.73 0.84 35,128 874,740 268,273 23,378 30,325 56,904 13,674 24,213 0.38 0.67 93,209 632,162 137,388 2017 406,536 35,552 35,880 61,448 31,768 26,353 0.88 0.73 42,456 607,286 138,257 (1) Non-IFRS financial measure. Refer to the Non-IFRS financial measures section under Operating Results for definitions and reconciliations to the most comparable IFRS measures. (2) Represents long-term debt including the current portion, long-term derivative financial instruments, and the pension and other retirement benefit liabilities included in other liabilities. 50 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A ADDITIONAL INFORMATION AND CONTINUOUS DISCLOSURE This MD&A was approved by the Audit Committee and by the Board of Directors on May 22, 2019. Additional information about the Corporation, including the Annual Information Form, can be found on SEDAR at www.sedar.com or on the Corporation’s website at www.herouxdevtek.com. HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A – 51 52 – HÉROUX-DEVTEK INC. – Fiscal 2019 MD&A CONSOLIDATED FINANCIAL STATEMENTS F O R T H E F I S C A L Y E A R E N D E D M A R C H 3 1 , 2 0 1 9 TABLE OF CONTENTS Note 8 Note 1 Note 2 Note 4 Note 7 Note 5 Note 3 Note 6 Management’s report ................................................................................................................................................................................. Independent Auditor’s report .................................................................................................................................................................... Consolidated financial statements ........................................................................................................................................................... Notes to the consolidated financial statements ...................................................................................................................................... Nature of activities and corporate information ........................................................................................................................ Basis of preparation ................................................................................................................................................................ Significant accounting policies ................................................................................................................................................ Significant accounting estimates and assumptions ................................................................................................................ Business acquisitions ............................................................................................................................................................. Sales and backlog .................................................................................................................................................................. Government assistance .......................................................................................................................................................... Cost of sales, selling and administrative expenses ................................................................................................................ Note 9 Net financial expenses (income) ............................................................................................................................................. Note 10 Non-recurring items ................................................................................................................................................................ Note 11 Earnings per share ................................................................................................................................................................. Note 12 Inventories .............................................................................................................................................................................. Note 13 Derivative financial instruments .............................................................................................................................................. Note 14 Other assets ........................................................................................................................................................................... Note 15 Property, plant and equipment ................................................................................................................................................ Note 16 Finite-life intangible assets ..................................................................................................................................................... Note 17 Goodwill .................................................................................................................................................................................. Note 18 Accounts payable and accrued liabilities ................................................................................................................................ Note 19 Provisions ............................................................................................................................................................................... Note 20 Long-term debt ....................................................................................................................................................................... Note 21 Other liabilities ........................................................................................................................................................................ Note 22 ......................................................................................................................................................................... Note 23 Accumulated other comprehensive income ............................................................................................................................ Income taxes .......................................................................................................................................................................... Note 24 Note 25 Pension and other retirement benefit plans ............................................................................................................................ Note 26 Commitments ......................................................................................................................................................................... Note 27 Contingencies ......................................................................................................................................................................... Note 28 Net change in non-cash items ................................................................................................................................................ Note 29 Geographic information .......................................................................................................................................................... Note 30 Executive compensation ......................................................................................................................................................... Note 31 Financial instruments .............................................................................................................................................................. Note 32 Financial risk management ..................................................................................................................................................... Note 33 Capital risk management ........................................................................................................................................................ Issued capital 55 56 58 63 63 63 64 73 74 75 76 76 76 77 77 77 78 78 79 80 81 82 82 83 85 85 87 87 89 92 92 93 93 93 94 94 97 54 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements MANAGEMENT’S REPORT The accompanying consolidated financial statements and Management Discussion and Analysis (“MD&A”) of Héroux-Devtek Inc. (the “Corporation”) are the responsibility of management and have been reviewed and approved by its Board of Directors. The accompanying consolidated financial statements have been prepared by management in accordance with International Financial Reporting Standards (“IFRS”). The MD&A has been prepared in accordance with the requirements of Canadian securities regulators. The consolidated financial statements and MD&A include items that are based on best estimates and judgments of the expected effects of current events and transactions. Management has determined such items on a reasonable basis in order to ensure that the consolidated financial statements and MD&A are presented fairly in all material respects. All figures presented in these consolidated financial statements are expressed in thousands of Canadian dollars unless otherwise indicated. Héroux-Devtek Inc.’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) have designed internal controls over financial reporting (“ICFR”) and disclosure controls and procedures (“DC&P”), or have caused them to be designed under their supervision, to provide reasonable assurance regarding the reliability of financial reporting, the preparation of consolidated financial statements for external purposes in accordance with IFRS and that material information related to the Corporation has been made known to them and has been properly disclosed in the accompanying consolidated financial statements and MD&A. Héroux-Devtek Inc.’s CEO and CFO have also evaluated the effectiveness of such ICFR and DC&P as of the end of fiscal year 2019. As of March 31, 2019, management has concluded that the ICFR and DC&P effectively provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with IFRS and that material information related to the Corporation has been disclosed in the consolidated financial statements and MD&A. Also, based on this assessment, the CEO and the CFO determined that there were no material weaknesses in the ICFR and DC&P. However, due to their inherent limitation, certain misstatements may not be prevented or detected by ICFR. Management’s assessment and conclusion on the design of ICFR and DC&P excludes the controls, policies and procedures of Beaver and CESA which were acquired respectively 9 months and 6 months prior to the Corporation’s fiscal year-end. Their results since their respective acquisition dates are included in the March 31, 2019, consolidated financial statements of Héroux-Devtek and constituted approximately 34.6% of total assets as of March 31, 2019, and approximately 18.3% of revenue for the year then ended. See Note 5 to the consolidated financial statements for a description of these acquisitions. Héroux-Devtek Inc.’s CEO and CFO have provided a certification related to Héroux-Devtek Inc.’s annual disclosure documents to the Canadian Securities Administrators in accordance with Regulation 52-109, including the consolidated financial statements and MD&A. The Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and is ultimately responsible for reviewing and approving the consolidated financial statements and MD&A. The Board of Directors carries out this responsibility principally through its Audit Committee. The Audit Committee is appointed by the Board of Directors and consists entirely of independent and financially literate directors. The Audit Committee meets periodically with management, as well as with the external auditors, to review the consolidated financial statements, the external auditors’ report, MD&A, auditing matters and financial reporting issues, to discuss ICFR and DC&P, and to satisfy itself that each party is properly discharging its responsibilities. In addition, the Audit Committee has the duty to review the appropriateness of the accounting policies and significant estimates and judgments underlying the consolidated financial statements as presented by management, and to review and make recommendations to the Board of Directors with respect to the fees of the external auditors. The Audit Committee reports its findings to the Board of Directors for its consideration when it approves the consolidated financial statements and MD&A for issuance to Shareholders. The consolidated financial statements have been audited by Ernst & Young LLP, the external auditors, in accordance with Canadian generally accepted auditing standards on behalf of the Shareholders. The external auditors have full and free access to the Audit Committee to discuss their audit and related matters. Gilles Labbé, FCPA, FCA President and Chief Executive Officer May 22, 2019 Stéphane Arsenault, CPA, CA Chief Financial Officer HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 55 INDEPENDENT AUDITOR’S REPORT TO THE SHAREHOLDERS OF HÉROUX-DEVTEK INC. Opinion We have audited the consolidated financial statements of Héroux-Devtek Inc. and its subsidiaries (the Group), which comprise the consolidated balance sheets as at March 31, 2019 and 2018, and the consolidated statements of income, consolidated statements of comprehensive income, consolidated statements of changes in shareholders’ equity and consolidated statements of cash flows for the years then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies. In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Group as at March 31, 2019 and 2018, and its consolidated financial performance and its consolidated cash flows for the years then ended in accordance with International Financial Reporting Standards (IFRS). Basis for opinion We conducted our audit in accordance with Canadian generally accepted auditing standards. Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Group in accordance with the ethical requirements that are relevant to our audit of the consolidated financial statements in Canada, and we have fulfilled our ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Other information Management is responsible for the other information. The other information comprises: • Management’s Discussion and Analysis • The information, other than the consolidated financial statements and our auditor’s report thereon, in the Annual Report Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information, and in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. We obtained Management’s Discussion & Analysis prior to the date of this auditor’s report. If, based on the work we have performed, we conclude that there is a material misstatement of this other information; we are required to report that fact. We have nothing to report in this regard. The Annual Report is expected to be made available to us after the date of the auditor’s report. If based on the work we will perform on this other information, we conclude there is a material misstatement of other information, we are required to report that fact to those charged with governance. Responsibilities of Management and Those Charged with Governance for the Consolidated Financial Statement Management is responsible for the preparation and fair presentation of the consolidated financial statements in accordance with IFRS, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. In preparing the consolidated financial statements, management is responsible for assessing the Group’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless management either intends to liquidate the Group or to cease operations, or has no realistic alternative but to do so. Those charged with governance are responsible for overseeing the Group’s financial reporting process. 56 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with Canadian generally accepted auditing standards will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements. As part of an audit in accordance with Canadian generally accepted auditing standards, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: • • • • • • Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group’s internal control. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the Group’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the Group to cease to continue as a going concern. Evaluate the overall presentation, structure, and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation. Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the Group to express an opinion on the consolidated financial statements. We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. We also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. The engagement partner on the audit resulting in this independent auditor’s report is Wajih Chemali. Ernst & Young, LLP Montréal, Québec May 22, 2019 _____________________________________________ 1 CPA Auditor, CA, public accountancy permit no. A121006 HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 57 CONSOLIDATED BALANCE SHEETS (In thousands of Canadian dollars) As at Assets Current assets Cash and cash equivalents Accounts receivable Income tax receivable Inventories Derivative financial instruments Other current assets Property, plant and equipment, net Finite-life intangible assets, net Derivative financial instruments Deferred income tax assets Goodwill Other long-term assets Total assets Liabilities and shareholders’ equity Current liabilities Accounts payable and accrued liabilities Provisions Customers advances and progress billings Income tax payable Derivative financial instruments Current portion of long-term debt Long-term debt Provisions Derivative financial instruments Deferred income tax liabilities Other liabilities Shareholders’ equity Issued capital Contributed surplus Accumulated other comprehensive income Retained earnings Total equity attributable to the equity holders of the parent Non-controlling interests Total liability and shareholder’s equity Commitments and Contingencies (notes 26 and 27) The accompanying notes are an integral part of these consolidated financial statements. On behalf of the Board of Directors Notes March 31, 2019 March 31, 2018 20 12 13 14 7, 15 7, 16 13 24 17 14 18 19 13 20 20 19 13 24 21 22 23 $ $ $ $ 35,128 115,431 2,393 184,035 783 26,697 364,467 227,954 69,377 5,816 14,575 185,637 6,914 874,740 117,990 27,820 21,919 1,911 2,134 15,066 186,840 245,240 16,789 1,317 7,479 12,977 470,642 79,676 4,707 10,502 307,101 401,986 2,112 404,098 874,740 $ $ $ $ 93,209 73,469 1,412 134,327 1,776 6,456 310,649 179,503 35,856 3,421 7,388 91,137 4,208 632,162 67,591 16,869 15,522 3,023 389 5,356 108,750 125,685 5,921 2,389 3,767 6,616 253,128 78,105 4,227 14,217 282,485 379,034 — 379,034 632,162 Louis Morin Director Gilles Labbé Director 58 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements CONSOLIDATED STATEMENTS OF INCOME (In thousands of Canadian dollars, except per share data) For the fiscal years ended March 31, Notes 2019 2018 Sales Cost of sales Gross profit Selling and administrative expenses Non-recurring items Operating income Net financial expenses Income before income tax expense Income tax expense Net income Attributable to: Equity holders of the parent Non-controlling interests 5, 6, 29 $ 483,877 $ 7, 8, 12 400,681 7, 8 10 9, 10 10, 24 83,196 41,633 4,323 37,240 6,811 30,429 4,235 26,194 $ 26,447 (253) 26,194 0.73 $ $ $ $ $ 386,564 325,288 61,276 30,951 6,947 23,378 2,537 20,841 7,167 13,674 13,674 — 13,674 0.38 Earnings per share – basic and diluted 11 The accompanying notes are an integral part of these consolidated financial statements. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 59 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands of Canadian dollars) For the fiscal years ended March 31, Notes 2019 2018 Other comprehensive income (loss): Items that may be reclassified to net income Gains (losses) arising from translating the financial statements of foreign operations Cash flow hedges: Net gains (losses) on valuation of derivative financial instruments Net losses (gains) on derivative financial instruments transferred to net income Deferred income taxes Gains (losses) on hedges of net investments in foreign operations Deferred income taxes Items that are never reclassified to net income Defined benefit pension plans: Gains (losses) from remeasurement Deferred income taxes Other comprehensive income (loss) Comprehensive income Net income Other comprehensive income (loss) Comprehensive income Attributable to: Equity holders of the parent Non-controlling interests The accompanying notes are an integral part of these consolidated financial statements. 23 23 23 25 $ (850) $ 5,860 (3,362) 906 660 (1,796) (1,221) 152 (1,069) (2,487) 656 (1,831) 4,450 (3,704) (201) 545 1,701 (187) 1,514 261 (68) 193 $ $ $ $ (5,546) $ 8,112 26,194 (5,546) 20,648 $ $ 20,901 (253) 20,648 $ 13,674 8,112 21,786 21,786 — 21,786 60 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (In thousands of Canadian dollars) Notes 23 22 5 22 Balance as at March 31, 2018 Common shares: Issued under the stock purchase and ownership incentive plan Issued under the stock option plan Business acquisition Stock-based compensation expense Net income (loss) Other comprehensive loss Balance as at March 31, 2019 Issued capital $ 78,105 Contributed surplus 4,227 $ Accumulated other comprehensive income 14,217 $ Retained earnings $ 282,485 Total equity attributable to the equity holders of the parent $ 379,034 Non- Controlling interests Total Shareholders ’ equity — $ 379,034 $ 470 1,101 — — — — (402) — 882 — — — — — — — $ 79,676 $ — 4,707 $ (3,715) 10,502 — — — — 470 699 — 882 26,447 (1,831) 26,447 (5,546) $ 307,101 $ 401,986 $ — — 2,365 — (253) — 2,112 470 699 2,365 882 26,194 (5,546) $ 404,098 Balance as at March 31, 2017 Common shares: Issued under the stock purchase and ownership incentive plan Issued under the stock option plan Stock-based compensation expense Net income Other comprehensive income Balance as at March 31, 2018 Notes 23 22 22 Issued capital Contributed surplus Accumulated other comprehensive income Retained earnings Shareholders’ equity $ 77,217 $ 3,735 $ 6,298 $ 268,618 $ 355,868 590 298 — — — (116) 608 — — — — — — 78,105 $ $ — 4,227 $ 7,919 14,217 $ — — — 590 182 608 13,674 193 282,485 $ 13,674 8,112 379,034 The accompanying notes are an integral part of these consolidated financial statements. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 61 CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands of Canadian dollars) For the fiscal years ended March 31, Notes 2019 2018 Cash and cash equivalents provided by (used for): Operating activities Net income Items not requiring an outlay of cash: Amortization expense Deferred income taxes Loss (gain) on sale of property, plant and equipment and software Write-down of property, plant and equipment Non-cash net financial expenses Stock-based compensation expense Cash flows from operations Net change in non-cash items Cash flows related to operating activities Investing activities Cash payment for business acquisitions Net additions to property, plant and equipment Net decrease in finite-life intangible assets Proceeds on disposal of property, plant and equipment Cash flows related to investing activities Financing activities Increase of long-term debt Repayment of long-term debt Issuance of common shares Increase in deferred financing cost Cash flows related to financing activities Effect of changes in exchange rates on cash and cash equivalents Change in cash and cash equivalents during the year Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year Interest and income taxes reflected in operating activities: Interest paid Interest received Income taxes paid The accompanying notes are an integral part of these consolidated financial statements. 62 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements $ 26,194 $ 13,674 15, 16 24 10, 15 9 22 28 5 15 16 5 20 22 32,650 (2,019) (8) — 2,697 882 60,396 9,573 69,969 (198,149) (12,858) 2,353 35 (208,619) 117,883 (36,198) 1,169 (2,534) 80,320 249 (58,081) 93,209 35,128 4,914 800 5,965 $ $ $ $ $ $ $ $ 26,579 67 52 886 758 608 42,624 13,498 56,122 — (9,930) 4,761 173 (4,996) 3,821 (4,634) 772 (524) (565) 192 50,753 42,456 93,209 2,359 580 5,282 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS For the fiscal years ended March 31, 2019 and 2018 (In thousands of Canadian dollars, except per share data) NOTE 1. NATURE OF ACTIVITIES AND CORPORATE INFORMATION Héroux-Devtek Inc. is incorporated under the laws of Québec. Its head office is domiciled at Complexe St-Charles, 1111 St-Charles Street West, suite 600, West Tower, Longueuil (Québec), Canada. Héroux-Devtek Inc. and its subsidiaries (“Héroux-Devtek” or the “Corporation”) specialize in the design, development, manufacture, repair and overhaul of aircraft landing gear, hydraulic and electromechanical flight control actuators, custom ball screws and fracture-critical components. The Corporation operates as one reporting segment, which is the Aerospace segment. The Corporation's common shares are traded on the Toronto Stock Exchange under the symbol "HRX". NOTE 2. BASIS OF PREPARATION The consolidated financial statements have been prepared on the historical cost basis, except for derivative financial instruments, which are measured at fair value, provisions, which are measured based on the best estimates of the expenditures required to settle the obligation and the pension benefit obligations, which are measured at the present value of the defined benefit obligations and reduced by the fair value of plan assets. Statement of compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”) and were approved for issue by the Board of Directors of the Corporation on May 22, 2019. Reclassification of prior year presentation Certain comparative figures have been reclassified to conform to the March 31, 2019 presentation. These relate to the combination of Customer advances and Progress billings under the same caption on the consolidated balance sheet. Basis of consolidation The consolidated financial statements include the accounts of Héroux-Devtek Inc. and its subsidiaries, all of which are wholly-owned, except for Tekalia Inc. where the Corporation holds a 60% controlling interest. The principal wholly-owned subsidiaries included in these consolidated financial statements are the following: Name Devtek Aerospace Inc. HDI Landing Gear USA Inc. APPH Limited Beaver Aerospace & Defense Inc. Compañia Española de Sistemas Aeronauticos S.A. Location Canada United States United Kingdom United States Spain Subsidiaries are consolidated from the date of acquisition, being the date on which the Corporation obtains control, and continue to be consolidated until the date that such control ceases. Control is achieved when the Corporation has power over the investee; is exposed, or has rights, to variable returns from its involvement with the investee; and ability to use its power to affect its returns. The Corporation reassesses whether or not it controls an investee if facts and circumstances indicate that there are changes to one or more of these three elements of control. Changes in the Corporation’s ownership interest in subsidiaries that do not result in a loss of control are accounted for as equity transactions. The cost of an acquisition is measured as the aggregate of the consideration paid, measured at acquisition date fair value and the amount of any non-controlling interest in the acquiree. For each business combination, the Corporation measures the non-controlling interests in the acquiree either at fair value or at the proportionate share of the acquiree’s net identifiable assets. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 63 The financial statements of the subsidiaries are prepared for the same reporting period as Héroux-Devtek Inc., using consistent accounting policies. All inter-company transactions and account balances are eliminated in full. NOTE 3. SIGNIFICANT ACCOUNTING POLICIES A. Foreign currency The consolidated financial statements are presented in Canadian dollars. Each entity in the Corporation accounts for transactions in its own functional currency and items included in the consolidated financial statements of each entity are measured using that functional currency. The functional currency of Héroux-Devtek and of the Canadian operations is the Canadian dollar. The functional currency of the U.S. operations is the U.S. dollar, the functional currency of the U.K operations is the British pound and the functional currency of Spain operations is the Euro. The functional currency is the currency that is representative of an operation’s primary economic environment. Conversion of transactions and account balances Transactions denominated in foreign currencies are initially recorded at the functional currency rate of exchange at the date of the transactions. Monetary assets and liabilities denominated in foreign currencies are translated at the functional currency rate of exchange at the reporting date. All differences are included in the consolidated statements of income. Non-monetary items denominated in foreign currencies are translated at the exchange rate at the date of the transactions. Translation of financial statements of foreign operations Assets and liabilities of foreign operations are translated into Canadian dollars at the rate of exchange at the reporting date and the statements of income are translated at the average exchange rate for the fiscal year. Exchange differences arising from the translation are recognized in other comprehensive income and remain in accumulated other comprehensive income until the disposal of the related net investment, at which time they are recognized in the consolidated statements of income. B. Cash and cash equivalents Cash and cash equivalents comprise cash. C. Inventories Inventories include raw materials, direct labour and related manufacturing overhead costs. Inventories consist of raw materials, work-in-progress and finished goods which are valued at the lower of cost (unit cost method except for certain raw materials that are valued at the weighted average cost method) and net realizable value. The unit cost method is the cost method under which the actual production costs are charged to each unit produced and recognized in the consolidated statements of income as the unit is delivered. Estimates of net realizable value are based on the most reliable evidence available of the amount for which the inventories are expected to be realized. These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the end of the reporting period to the extent that such events confirm conditions existing at the end of the reporting period. D. Property, plant and equipment Assets acquired Property, plant and equipment are stated at cost less accumulated amortization and accumulated impairment losses, if any (see H). Such cost may include the cost of replacing a major part of the property, plant and equipment and, in this situation, the carrying amount of the replaced part is derecognized. Cost also includes borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset (see F). 64 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Buildings and leasehold improvements - 5 to 50 years, Amortization is calculated on a straight-line basis over the useful life of the asset as follows: • • Machinery and equipment - 3 to 25 years, • Tooling related to specific contracts - based on pre-determined contract quantities, not exceeding the lower of ten years or the useful life. Contract quantities are assessed at the beginning of the production stage considering, among other factors, existing firm orders and options. The Corporation’s management conducts quarterly and annual reviews of the contract quantities, Standard and general tooling - 3 to 5 years, Automotive equipment - 3 to 10 years, Computer and office equipment - 3 to 5 years. • • • An item of property, plant and equipment is derecognized upon disposal or when no future economic benefits are expected from its use or disposal. The gain or loss on derecognition of the asset (calculated as the difference between the net disposal proceeds and the net carrying amount of the asset) is included in the consolidated statements of income in the fiscal year the asset is derecognized. The asset’s residual value, useful life and method of amortization are reviewed and adjusted annually at year-end, or when warranted by specific circumstances. The present value of the expected cost for the decommissioning of the asset after its use is included in the cost of the respective asset if the recognition criteria for a provision are met. Refer to section L of this note and note 4 - Significant accounting estimates and assumptions for further information about provisions for asset retirement obligations. Assets leased The determination of whether an arrangement is, or contains, a lease is based on the substance of the arrangement at inception date, whether the fulfillment of the arrangement is dependent on the use of a specific asset or assets or the arrangement conveys a right to use the asset. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership to the Corporation. A finance lease is capitalized at the inception of the lease at the fair value of the leased property or, if lower, at the present value of the minimum lease payments, computed by using the implicit interest rate of the lease contract. Lease payments are apportioned between interest expense and the reduction of the lease obligation. Interest expense is reflected in the consolidated statements of income. Capitalized leased assets are accounted for in the categories of property, plant and equipment corresponding to their nature. Capitalized leased assets are amortized over the shorter of the estimated useful life of the asset and the lease term, if there is no reasonable certainty that the Corporation will obtain ownership by the end of the lease term. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. Operating lease payments are recognized as an expense on a straight-line basis over the related lease term. E. Finite-life intangible assets Finite-life intangible assets include capitalized development costs, customer relationships and contracts and software. They are measured at cost upon initial recognition. The cost of intangible assets acquired in a business combination is the fair value at the date of acquisition. Following initial recognition, they are carried at cost less accumulated amortization and impairment losses, if any. Finite-life intangible assets are amortized over the useful life and assessed for impairment whenever there is an indication that the intangible asset may be impaired. The amortization period and method for finite-life intangible assets are reviewed at each fiscal year-end or when warranted by specific circumstances. Changes in the expected useful life or the expected pattern of consumption of future economic benefits associated with finite-life intangible assets are accounted for as changes in accounting estimates. The gain or loss arising from derecognition of an intangible asset is measured as the difference between the net disposal proceeds and the net carrying amount of the asset and is recognized in the consolidated statements of income. Development costs Development costs of an individual sales contract are capitalized as an intangible asset when the Corporation can demonstrate: • • • • • • the feasibility of completing the intangible asset so that it will be available for use or sale; its intention to complete the intangible asset and use or sell it; its ability to use or sell the asset; how the asset will generate future economic benefits; the availability of resources to complete the development and to use or sell the intangible asset; and, the ability to measure reliably the expenditure attributable to the intangible asset during its development phase. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 65 Capitalized development costs (design engineering, manufacturing engineering costs and other related costs) related to sales contracts are amortized based on predetermined expected quantities to be sold. They are presented net of related government assistance and amounts contributed by customers. The expected quantities to be sold are established based on management’s assessment at the beginning of the production stage for each contract, taking into consideration, among other factors, existing firm orders and options. The Corporation’s management conducts quarterly reviews as well as a detailed annual review in the fourth quarter of the contract quantities, its capitalized development costs and their recoverability. Following initial recognition of capitalized development costs as an asset, the asset is carried at cost less accumulated amortization and accumulated impairment losses, if any. Amortization begins when development is complete and the asset is available for use. Usually, the development phase represents a period of 4 to 7 years. During the period of development, the asset is tested for impairment annually. Customer relationships and contracts Customer relationships and contracts are amortized on a straight-line basis over the estimated useful life of the related customer relationship and contracts, which represents a period of up to 15 years. Software Software is amortized over 3 to 7 years. F. Borrowing costs Borrowing costs are recognized as an expense when incurred, except when they are capitalized as part of the cost of a qualifying asset. Borrowing costs are capitalized when the Corporation: incurs expenditures for the asset; • incurs borrowing costs; and • undertakes activities that are necessary to prepare the asset for its intended use or sale, to the extent that these activities are performed • over a period exceeding the normal operating cycle of the Corporation (12 months). Conversely, the Corporation ceases capitalizing borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are completed. G. Business combinations and goodwill Business combinations are accounted for using the acquisition method. The cost of a business combination is measured as the fair value of assets given, equity instruments issued and liabilities assumed at the date of acquisition. Identifiable assets acquired, liabilities and contingent liabilities assumed are measured initially at fair value at the date of acquisition. Acquisition-related costs associated with the business combinations are expensed as incurred. After initial recognition, goodwill is measured at cost less any accumulated impairment losses, if any. For the purpose of impairment testing, goodwill acquired in a business combination is, from the acquisition date, allocated to each of the Corporation’s cash generating units (“CGU”) or group of CGUs that are expected to benefit from the synergies of the combination, irrespective of whether other assets or liabilities of the acquiree are assigned to those units. A CGU is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Where goodwill forms part of a CGU and part of the operation within that unit is disposed of, the goodwill associated with the operation disposed of is included in the carrying amount of the operation when determining the gain or loss on disposal of the operation. Goodwill disposed of in this circumstance is measured based on the relative values of the operation disposed of and the portion of the CGU retained. H. Impairment of goodwill and other non-financial assets Goodwill is tested for impairment annually on March 31 or when warranted by specific circumstances. A prior year’s impairment test may be used in the annual impairment test when specific criteria are met. Impairment is determined by assessing the recoverable amount of the CGU to which the goodwill relates. A CGU’s recoverable amount is the higher of a CGU’s fair value less costs of disposal and its value in use. The Corporation uses the discounted cash flow method to estimate value in use, consisting of future cash flows derived from the most recent budget and strategic plan, which cover five years, approved by the Corporation’s management and Board of Directors. These future cash flows consider each CGU’s past performance, market share, economic trends, specific and market industry trends and corporate strategies. A perpetual growth rate is used for cash flows beyond this five-year period. The perpetual growth rate is determined with regard to the specific markets in which the CGU participates. The discount rate used by the Corporation for cash flows is a pre-tax rate based on the weighted-average cost of capital pertaining to each CGU, which reflects the current market assessment of (i) the time value of money, and (ii) the risks specific to the assets. 66 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Where the recoverable amount of the CGU is less than its carrying amount, an impairment loss is recognized. Impairment losses relating to goodwill cannot be reversed in future periods. For non-financial assets other than goodwill, the Corporation assesses at each reporting date whether there is an indication that the carrying amount may be impaired. If any such indication exists, the Corporation estimates the asset’s recoverable amount. An asset’s recoverable amount is the higher of an asset’s fair value less costs of disposal and its value in use and is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. If the asset does not generate cash inflows that are largely independent of those from other assets or group of assets, the recoverable amount is determined by reference to the CGU’s value in use. Where the carrying amount of an asset exceeds its recoverable amount, the asset is considered impaired and is written-down to its recoverable amount. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. In determining fair value less costs to sell, an appropriate valuation model is used. These calculations are corroborated by valuation multiples or other available fair value indicators. For non-financial assets other than goodwill, a previously recognized impairment loss is reversed if there has been a change in the estimated recoverable amount since the last impairment loss was recognized. That increased amount cannot exceed the carrying amount that would have been determined, net of accumulated amortization, had no impairment loss been recognized for the asset in prior years. Such a reversal is recognized in the consolidated statements of income. I. Financial assets In July 2014, the IASB issued a complete and final version of IFRS 9 “Financial Instruments”, replacing the current standard on financial instruments (IAS 39). IFRS 9 introduces a single, principle-based approach for the classification of financial assets, driven by the nature of cash flows and the business model in which an asset is held. IFRS 9 also provides guidance on an entity’s own credit risk relating to financial liabilities and has modified the hedge accounting model to align the economics of risk management with its accounting treatment. The standard results in a single expected loss impairment model rather than an incurred losses model. The Corporation adopted IFRS 9 retrospectively on April 1, 2018 and this adoption did not have a significant impact on the Corporation’s consolidated financial statements and no restatement of comparative figures were made. Initial recognition At initial recognition, financial assets are classified either as financial assets at fair value through profit or loss (“FVTPL”), measured at amortized cost (“AC”) or fair value through other comprehensive income (“FVTOCI”). The classification is based on two criteria: the Corporation’s business model for managing the assets; and whether the instruments’ contractual cash flows represent ‘solely payments of principal and interest’ on the principal amount outstanding (the “SPPI criterion”). The Corporation’s financial assets are held within a business model with the objective to hold the financial assets in order to collect contractual cash flows that meet the SPPI criterion are classified and subsequently measured at amortized cost. They consist of cash and cash equivalents, accounts receivable and certain other current and long-term assets. When financial assets are recognized initially, they are measured at fair value, plus in the case of a financial asset other than FVTPL, the directly attributable transaction costs. Purchases and sales of financial assets are recognized on the transaction date, which is the date that the Corporation commits to purchase or sell the assets. FVTPL FVTPL include certain derivative financial instruments, except those that are designated as Hedges. FVTPL are carried at fair value with gains and losses recognized in the consolidated statements of income. The Corporation assesses whether embedded derivative financial instruments are required to be separated from host contracts when the Corporation first becomes party to the contract. AC AC are non-derivative financial assets with fixed or determinable payments not quoted in an active market. AC are mainly comprised of accounts receivable and certain other current and long-term assets. AC are carried at amortized cost using the effective interest rate method. An allowance for doubtful accounts is recorded when an account receivable become impaired. Also, under the forward-looking expected credit loss (“ECL”) approach, all financial assets, except for those measured at FVTPL, are subject to review for impairment at least at each reporting date. ECLs are based on the difference between the contractual cash flows due in accordance with the contract and all the cash flows that the Corporation expects to receive. The shortfall is then discounted at an approximation to the asset’s original effective interest rate. For accounts receivables, the Corporation has applied the standard’ expected credit losses and the amount was insignificant at March 31, 2019 and 2018. s simplified approach and has calculated ECLs based on lifetime HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 67 If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed by adjusting the allowance for doubtful accounts. Any subsequent reversal of an impairment loss is recognized in the consolidated statements of income. FVTOCI These include cross-currency interest rate swap agreements that are used to hedge the net investments in certain foreign subsidiaries and forward foreign exchange contracts. They are carried at fair value. The change in the fair value of the effective portion of hedges is recognized in other comprehensive income, while the ineffective portion is recognized in the consolidated statements of income, if any. The Corporation assesses at each reporting date whether any financial asset is impaired. J. Financial liabilities Liabilities at fair value Financial liabilities classified at FVTPL are comprised of derivative financial instruments, except those that are designated as FVTOCI. They are carried at fair value with gains and losses recognized in the consolidated statements of income. Gains and losses on FVTOCI are recognized in other comprehensive income. Amortized costs All debts, accounts payable, accrued liabilities, provisions and certain other liabilities are initially recognized at fair value less directly attributable transaction costs when they have not been designated as FVTPL. After initial recognition, they are subsequently measured at amortized cost using the effective interest method. Derecognition of financial liabilities A financial liability is derecognized when the obligation underlying the liability is discharged, cancelled or has expired. K. Derivative financial instruments and hedges Derivative financial instruments The Corporation uses derivative financial instruments such as forward foreign exchange contracts, cross-currency interest rate swap agreements and equity swap agreements to hedge its risks associated with foreign currency, interest rate and other price fluctuations. Such derivative financial instruments are initially recognized at fair value on the date on which a derivative contract is entered into. They are subsequently measured at fair value. Derivative financial instruments are carried as financial assets when the fair value is positive and as financial liabilities when the fair value is negative. Cash flow hedges For the purpose of hedge accounting, all hedges are classified as cash flow hedges except for hedges of net investments in foreign operations (see below). Hedging exposure to variability in cash flows is attributable to a risk associated with a recognized liability or a highly probable forecast transaction in foreign currency. At the inception of a hedge relationship, the Corporation formally designates and documents the hedge relationship to which the Corporation wishes to apply hedge accounting and the risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging instrument’s effectiveness. Such hedges are expected to be highly effective in achieving offsetting changes in cash flows and are assessed quarterly to determine that they actually have been highly effective throughout the designated periods. The change in the fair value of the effective portion of hedges is recognized in other comprehensive income, while the ineffective portion is recognized in the consolidated statements of income. Amounts recognized in other comprehensive income are transferred to the consolidated statements of income when the hedged transaction affects income, such as when the hedged financial income or financial expense is recognized or when a forecast sale occurs. In the event that the forecast transaction or firm commitment is no longer expected to occur, amounts previously recognized in accumulated other comprehensive income are transferred to the consolidated statements of income. Hedges of net investments in foreign operations The Corporation designates certain long-term debt as a hedge of its net investments in foreign operations. The portion of gains or losses from the hedging item that is determined to be an effective hedge is recognized in other comprehensive income, while the ineffective portion is recorded in the consolidated statements of income. The amounts recognized in other comprehensive income are reclassified in the consolidated statements of income upon disposal of the related net investments. 68 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements L. Provisions Provisions are recognized when the Corporation has a present obligation (legal or constructive) 1) as a result of a past event; 2) when it is more probable than not that an outflow of resources embodying economic benefits will be required to settle the obligation; and, 3) when a reliable estimate can be made of the amount of the obligation. The expense relating to any provision is accounted for in the consolidated statements of income, net of any reimbursement. If the known expected settlement date exceeds twelve months from the date of recognition, provisions are discounted using a current pre-tax interest rate that reflects the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognized as a financial expense. Provisions are reviewed periodically and adjusted as appropriate. Onerous contracts These represent anticipated negative margins on sales contracts in progress or in the funded backlog (firm customer purchase orders). Asset retirement obligations The Corporation’s asset retirement obligations mainly consist of environmental rehabilitation costs related to one of the Corporation’s manufacturing sites in Canada. The present value of these obligations is measured in the year in which they are identified and when a reasonable estimate of their present value can be made. The present value of the obligations is determined as the sum of the estimated discounted future cash flows of the costs associated with the legal obligations for future rehabilitation. These asset retirement costs are capitalized as part of the property, plant and equipment and amortized over the relevant assets’ useful lives. The discount fluctuation is expensed as incurred and recognized in the consolidated statements of income as financial expenses. The estimated future costs of decommissioning are reviewed annually and adjusted as appropriate. Changes in the estimated future costs are recognized in the consolidated statements of income as changes occur. Product warranty This provision covers the cost of known or anticipated defects on products under terms of warranties. Litigations and other Due to the nature of its business activities including the purchase or sale of businesses, the Corporation is exposed to the risks of technical and business litigations. On the basis of information at its disposal at the reporting date, the Corporation carried out a review of the financial risks to which the Corporation could be exposed. The recorded provision covers the risks associated with these litigations. Restructuring provisions are recognized when the Corporation has put in place a detailed restructuring plan which has been communicated in sufficient detail to create a constructive obligation. Restructuring provisions include only costs directly related to the restructuring plan, and are measured at the best estimate of the amount required to settle the Corporation’s obligations. M. Progress billings Progress billings represent amounts received from customers for costs incurred on specific contracts. These amounts are reversed to sales at such time as the related units are delivered and billed to customers. N. Deferred financing costs Deferred financing costs related to long-term debt are amortized using the effective interest rate method over the period that represents the duration of the related long-term debt. O. Pensions and other retirement benefits The Corporation has defined contribution pension plans as well as funded and unfunded defined benefit pension plans that provide pension benefits to its employees. The current and past service costs of these pension plans are recorded within the cost of sales and selling and administrative expenses under “Employee costs” in the consolidated statements of income while the administrative costs related to these pension plans are included in selling and administrative expenses. The net interest income or expense on the net surplus or deficit is recorded in financial expenses. The actuarial determination of the defined benefit obligations for pensions uses the projected unit credit method which incorporates management’s best estimate of future salary levels, when applicable, other cost escalations, retirement ages of employees, discount rates and other actuarial factors. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 69 The Pension and other retirement benefit plans liabilities included in Other liabilities in the consolidated balance sheets represent the present value of the defined benefit obligations reduced by the fair value of plan assets. Remeasurements on defined benefit plans include actuarial gains and losses, changes in the effect of the asset ceiling and the return on plan assets, excluding the amount included in net interest on the net defined liability or assets. Remeasurements are charged or credited to other comprehensive income in the period in which they arise. Past service costs arising from the plan amendments are recognized in full immediately in the consolidated statements of income. P. Share-based payments Stock option plan The Corporation has a stock option plan in which options to purchase common shares are issued to officers and key employees. The Corporation uses a binomial valuation model to determine the fair value of stock options when granted. The resulting fair value is amortized to income over their earned period using the graded amortization method. The related compensation expense is included in selling and administrative expenses and its counterpart is accounted for in contributed surplus. Stock purchase and ownership incentive plan The Corporation has a stock purchase and ownership incentive plan allowing key members of management to purchase, by payroll deductions of a maximum of 10% of their annual base salary, to a number of common shares of the Corporation on the TSE. The Corporation matches a portion of such employee contributions in the form of additional common shares acquired on the TSE at market price. The Corporation’s matching award cannot exceed 5.25% of the employee’s annual base salary. Common shares purchased by the Corporation on behalf of the employee are accounted for in selling and administrative expenses. Deferred share unit (“DSU”) plan The Corporation has a DSU plan under which rights are issued to its non-employee directors. The DSU enables the participants to receive compensation at the end of their mandate as a member of the Board of Directors, representing a cash amount equal to one time the quoted price of the Corporation’s common share for each DSU. These DSUs are expensed on an earned basis, their value is equal to that of the underlying shares and is remeasured at each reporting period. Each director can also elect, each fiscal year, to have up to 100% of his director’s annual retainer fees converted into DSUs. These DSUs vest over a one-year period. The related compensation expense is included in selling and administrative expenses and its counterpart is accounted for in accounts payable and accrued liabilities until the DSUs are exercised and paid at the end of each director’s mandate. Performance share unit (“PSU”) plan The Corporation has a PSU plan as part of the incentive plan for management and key employees. PSUs vest over a period of three years. The PSU enables the participants to receive compensation at the expiry or termination date representing a cash amount equal to the quoted price of the Corporation’s common share for each PSU vested, conditional on the achievement of certain financial targets. PSUs are expensed on an earned basis, their value is equal to that of the underlying shares and is remeasured at each reporting period. The related compensation expense is included in selling and administrative expenses and its counterpart is accounted for in accounts payable and accrued liabilities until the PSUs are paid or cancelled at the expiry or termination date. Q. Revenue recognition In May 2014, the International Accounting Standards Board (“IASB”) and the Financial Accounting Standards Board (“FASB”) jointly issued IFRS 15, a converged standard on the recognition of revenue from contracts with customers. It supersedes the IASB’s current revenue recognition guidance including IAS 18 “Revenue”, IAS 11 “Construction Contracts”, and related interpretations. IFRS 15 provides a single principle based five step model to use when accounting for revenue arising from contracts with customers. On April 1, 2018, the Corporation adopted IFRS 15 using the full retrospective method and this adoption did not have a material impact on the Corporation’s consolidated financial statements. 70 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Revenue is measured at the fair value of the consideration received or receivable, net of estimated discounts, and after eliminating intercompany sales. Revenue from the sale of goods is recognized in a manner that depicts the transfer of promised goods to a customer and at an amount that reflects the consideration expected to be received in exchange for transferring those goods. This is achieved by applying the following five steps: 1. Identify the contract with a customer; 2. Identify the performance obligations in the contract; 3. Determine the transaction price; 4. Allocate the transaction price to the performance obligations in the contract; and 5. Recognize revenue when (or as) the entity satisfies a performance obligation, which is generally achieved upon the delivery of the products. Revenues from the sale of new or overhauled aerospace components are considered a single performance obligation and are recognized at the point in time when the customer has obtained control of the component and the Corporation has satisfied its performance obligation. Generally, these conditions are met upon delivery of the goods. R. Government assistance Government assistance, which mainly includes investment and other tax credits, grants and the discount portion of the governmental authorities loans, is recognized when there is reasonable assurance that it will be received and all related conditions will be complied with. When the government assistance relates to an expense item, it is recognized as a reduction of expense over the period necessary to match the government assistance on a systematic basis to the costs that it is intended to subsidize. Where government assistance relates to an asset, it is deducted from the cost of the related asset. Forgivable loans from governmental authorities are accounted for as government assistance when there is reasonable assurance that the entity will meet the terms for forgiveness of the loan. Benefits derived from government authority loans with below-market interest rates are measured at the inception of the loans as the difference between the cash received and the amount at which the loans are initially recognized in the consolidated balance sheet. At initial recognition, the fair value of a loan with a below-market rate of interest is estimated at the present value of all future cash disbursements, discounted using a prevailing market rate of interest for a similar instrument with a similar credit rating. After initial recognition, the loan is accounted for as a financial liability measured at amortized cost using the effective interest method. Repayments are mainly based on the Corporations sales growth, or sales of specific programs. Assumptions underlying expected sales are reviewed at least annually, and are used to derive expected repayment schedules. When expected repayment schedule changes, the Corporation recalculates the carrying value of the loan using the original effective interest rate, with the corresponding gain or loss accounted for in financial expenses. S. Taxes Current income tax Current income tax assets and liabilities are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted by the reporting date. Current income tax relating to items recognized directly in shareholders’ equity is recognized in shareholders’ equity and not in the consolidated statements of income or in the consolidated statements of comprehensive income. Deferred income tax Deferred income tax is provided for using the liability method on temporary differences at the reporting date between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred income tax assets and liabilities are recognized for all deductible and taxable temporary differences, except: • where the deferred income tax asset or liability arises from the initial recognition of goodwill or of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting income or loss nor taxable income or loss; in respect of taxable temporary differences associated with investments in subsidiaries, where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. • HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 71 Deferred income tax assets are recognized for all other deductible temporary differences, carry forward or unused tax credits and unused tax losses to the extent that it is probable that taxable income will be available against which the deductible temporary differences and the carry forward of unused tax credits and unused tax losses can be utilized. The carrying amount of deferred income tax assets is reviewed at each reporting date and reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the deferred income tax assets to be utilized. Unrecognized deferred income tax assets are reassessed at each reporting date. Deferred income tax assets and liabilities are measured at the income tax rates that are expected to apply to the fiscal year when the asset is realized or the liability is settled, based on income tax rates and tax laws that have been enacted or substantively enacted at the reporting date. Deferred income tax relating to items recognized directly in shareholders’ equity is recognized directly in shareholders’ equity and not in the consolidated statements of income or in the consolidated statements of comprehensive income. Deferred income tax assets and liabilities are offset if a legally enforceable right exists to set off current income tax assets against current income tax liabilities and the deferred income taxes relate to the same taxable entity and the same taxation authority. All deferred income tax assets and liabilities are classified as non-current. Sales tax Sales, expenses and assets are recognized net of the amount of sales tax, except where the sales tax incurred on a purchase of assets or services is not recoverable from the taxation authorities, in which case the sales tax is recognized as part of the cost of acquisition of the asset or as part of the expense item as applicable. Receivables and payables are stated with the amount of sales tax included, if applicable. The net amount of sales tax recoverable from, or payable to, the taxation authority is included as part of other current assets or accounts payable and accrued liabilities in the consolidated balance sheet. T. Earnings per share Basic and diluted earnings per share is computed based on net income attributable to equity holders of the Corporation. It is also determined using the weighted-average number of common shares outstanding during the year. The calculation of diluted earnings per share takes into consideration the exercise of all dilutive elements. This method assumes that the proceeds of the Corporation’s in-the-money stock options would be used to purchase common shares at the average market price during the year. U. Future changes in accounting policies IFRS 16 - Leases In January 2016, the IASB released IFRS 16 - Leases. The new standard, which represents a major revision of the way in which companies account for leases, sets out the principles that both parties to a contract, i.e. the customer (“lessee”) and the supplier (“lessor”), apply to provide relevant information about leases in a manner that faithfully represents those transactions. To meet this objective, a lessee is required to recognize assets and liabilities arising from a lease, following a single model where previously leases were classified as either finance leases or operating leases. Most leases will be recognized on the Corporation’s consolidated balance sheet. Certain exemptions will apply for short-term leases and leases of low-value assets. The Corporation anticipates the adoption of the IFRS will have an impact on the balance sheet and statement of income as all operating leases will be capitalized with a corresponding lease liability while the rent expense will be replaced by the amortization expense of the right to use the related assets and interest accretion expense from the liability recorded. The Corporation is required to apply this standard based on the full retrospective or modified retrospective (without restating comparative figures) approaches for its fiscal year beginning April 1, 2019. Many of the Corporation’s leases are already accounted for as finance leases on the Corporation’s consolidated balance sheet. Certain operating leases will be required to be brought on balance sheet while others do not as they are covered by practical expedients. The Corporation has elected to apply the following practical expedients: • • Account for leases for which the remaining lease term ends within 12 months of the effective date as a short term lease; and Recognize short term leases and low value leases on a straight line basis as is the case currently under IAS 17, leases as part of the operating expenses in the consolidated statements of income. Upon the initial application of this standard on April 1, 2019, using the modified retrospective approach, the Corporation expects its opening assets (right-of-use assets) and liabilities (lease liabilities) to increase by an approximate amount of $15.0 million in its consolidated financial statements. 72 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements NOTE 4. SIGNIFICANT ACCOUNTING ESTIMATES AND ASSUMPTIONS The preparation of the Corporation’s consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of revenues, expenses, assets and liabilities, and the disclosure of contingent liabilities at the reporting date. Uncertainty about these assumptions and estimates could result in outcomes that require material adjustments to the Corporation’s financial results or the carrying amount of assets or liabilities. Key estimates and assumptions are as follows: Impairment of non-financial assets A. Impairment exists when the carrying amount of an asset or cash generating unit (“CGU”) exceeds its recoverable amount, which is the higher of its fair value less costs to sell and its value in use. The fair value less costs to sell calculation is based on available data from binding sales transactions in an arm’s length transaction of similar assets and observable market prices less incremental costs for disposing of the asset. The value in use calculation is based on a discounted cash flow model. The cash flows are derived from the Corporation’s five-year budget and strategic plan and do not include restructuring activities that the Corporation is not yet committed to or significant future investments that may enhance the performance of the CGU being tested. The recoverable amount is most sensitive to the discount rate used in the discounted cash flow model, the expected future cash flows and the perpetual growth rate used for extrapolation. The key assumptions used to determine the recoverable amount of the CGUs, including sensitivity analysis, are further explained in note 17. B. Deferred income tax assets Uncertainties exist with respect to the interpretation of complex tax regulations and the amount and timing of future taxable income. The Corporation establishes provisions based on reasonable estimates for possible consequences of audits by the tax authorities. The amount of such provisions is based on various factors, such as experience of previous tax audits and differing interpretations of tax regulations by the taxable entity and the responsible tax authority. Deferred income tax assets are recognized for unused tax losses and deductible temporary differences to the extent it is probable that taxable income will be available against which the losses and deductible temporary differences can be utilized. Management’s judgment is required to determine the amount of deferred income tax assets that can be recognized, based upon the likely timing and the level of future taxable income together with future tax planning strategies. C. Pensions and other retirement benefits The cost of defined benefit pension plans is determined using actuarial valuations. The actuarial valuation involves making assumptions about discount rates, future salary increases and mortality rates. In determining appropriate discount rates, management considers the interest rates of high-quality corporate bonds. Due to the long-term nature of these plans, such estimates are subject to significant uncertainty. The significant assumptions used to determine the defined benefit obligations and the pension expense, including a sensitivity analysis, are further explained in note 25. D. Capitalized development costs Development costs are capitalized in accordance with the accounting policy described in note 3. In determining the amounts to be capitalized, management makes assumptions regarding the expected future cash generation of the assets, discount rates to be applied, the expected period of benefits and contract quantities. For purpose of impairment testing, the Corporation exercises judgment to identify the cash inflows and outflows. The recoverable amount is based on fair value less costs of disposal, generally determined using a discounted cash flow model. Other assumptions used to determine the recoverable amount include the applicable discount rate and the expected future cash flows which include costs to complete the development activities. E. Provisions The Corporation has recorded provisions to cover cost exposures that could materialize in future periods. In determining the amount of the provisions, assumptions and estimates are made in relation to discount rates and the expected cost to settle such liabilities. F. Government authorities loans The Corporation has outstanding loans with government authorities with variable repayment schedules. Annual repayments of these loans generally vary based on the sales of certain of the Corporation’s programs or segments. In order to account for the present value of these loans under the effective interest method, or for government assistance upon initial recognition, management must estimate the future sales growth of these programs or segments over the expected duration of the loan. These forecasts are used to determine effective interest rates and expected repayment schedules. In determining these amounts, management must rely on market rates of interest and assumptions such as, but not limited to, current and future order intake, industry order backlogs, Original Equipment Manufacturer (“OEM”) production rates, expected economic conditions, the stability of foreign exchange rates and the Corporation’s ability to deliver on key contract initiatives. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 73 G. Customer relationships Customer relationships acquired in business acquisitions are considered intangible assets with finite lives. Their value was estimated upon acquisition using valuation methodologies which rely on many underlying assumptions, including: • • • • • Expected future order intake; Operational execution and cost management; Stability of economical conditions, including foreign exchange rates; Production rates; Government spending. They are recorded at cost less accumulated impairment and amortization and are amortized on a straight-line basis over their useful lives without exceeding 15 years. NOTE 5. BUSINESS ACQUISITIONS Acquisition of CESA On October 1, 2018, the Corporation completed the acquisition of all the shares of Compañia Española de Sistemas Aeronauticos S.A. ("CESA"), a subsidiary of Airbus SE, for €130,370 ($195,816). Headquartered in Madrid, Spain, CESA is a leading European provider of fluid mechanical and electromechanical systems for the aerospace industry. This acquisition allows the Corporation to broaden its existing aerospace and product offering into actuation, landing gear, and hydraulic systems. The transaction was treated as a business combination. The acquisition of CESA was financed as follows: A $50,000, seven-year unsecured subordinated term loan provided by the Fonds de solidarité FTQ; A US$50,000 ($65,205) drawing on the Corporation’s credit facility; and, The Corporation’s available cash balance. In addition, the Corporation assumed CESA’s net outstanding debt amounting to approximately €23,697 ($35,594) upon closing. For the period between October 1, 2018 and March 31, 2019, the Corporation’s consolidated sales and net income included €42,086 ($63,519) and €2,674 ($4,047), respectively, generated by CESA. If the acquisition had closed on April 1, 2018, the consolidated sales and net income of CESA would have amounted to $117,277 and $2,806, respectively for the fiscal year ended March 31, 2019. This transaction exposes the Corporation to new foreign exchange and interest rate risks. Refer to note 32 for further information on these risks and how they are being mitigated. Acquisition of Beaver On July 2, 2018, the Corporation completed the acquisition of all the shares of Beaver Aerospace & Defense Inc. and its wholly-owned subsidary PowerTHRU Inc. ("Beaver") from Phillips Service Industries Inc. for a purchase price of US$21,617 ($28,466). This price includes a working capital adjustment received in April 2019 of US$295 ($388) and a US$3,500 ($4,609) balance of sale payable over the next two years which bears interests at 3%. The transaction was financed through the Corporation’s cash and was treated as a business combination. This acquisition allows the Corporation to broaden its existing aerospace and product offering into ball screws and actuation systems as well as expand its footprint in North America. For the period between July 2, 2018 and March 31, 2019, the Corporation's consolidated sales and net income included US$18,871 ($24,839) and US$1,395 ($1,828), generated by Beaver, respectively. If the acquisition had closed on April 1, 2018, the consolidated sales and net income of Beaver would have amounted to $33,223 and $2,243, respectively. Acquisition of Tekalia On January 23, 2019, the Corporation completed the acquisition of 60% of the shares of Tekalia Aeronautik (2010) Inc. (“Tekalia”), a supplier of surface treatment services to the aerospace sector, with annual sales of approximately $12,000, for a purchase price of $6,529. The transaction was financed through the Corporation’s cash and was treated as a business combination. The acquisition of Tekalia allows the Corporation to further secure surface treatment capacity to support its North American customers’ growth. In connection with these acquisitions, the Corporation incurred acquisition-related costs which are presented in note 10. 74 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Purchase Prices The purchase prices and the preliminary purchase price allocations that reflects the fair value of the assets acquired and liabilities assumed with any excess allocated to goodwill were determined using the acquisition method as follows: Cash payment Long-term debt assumed Working capital adjustment receivable Balance of purchase price payable Total purchase price for the Corporation’s interest Non-controlling interests Purchase Price Allocations Accounts receivable Inventories Income tax receivable Other current assets Property, plant and equipment Finite-life intangible assets Deferred income tax assets Other long-term assets - Tax credits receivable Total identifiable assets Accounts payable and accrued liabilities Provisions Customer advances and progress billings Provisions Deferred income tax liabilities Other liabilities - long-term accounts payable Total identifiable liabilities Net identifiable assets and liabilities Goodwill Total purchase price CESA $ 170,930 $ 35,594 (10,708) — $ 195,816 $ — $ 195,816 $ Beaver 23,671 $ 574 (388) 4,609 28,466 $ — 28,466 $ Tekalia Total 3,548 $ 198,149 39,149 2,981 (11,096) — 4,609 — 6,529 $ 230,811 2,365 2,365 8,894 $ 233,176 Beaver Tekalia $ CESA 28,293 $ 36,692 505 596 66,086 44,923 40,407 — 7,843 $ 159,259 $ 16,773 11,897 4,188 32,858 6,787 $ 10,165 — 50 17,002 3,635 4,050 2,774 — 27,461 $ 2,588 2,118 450 5,156 2,406 $ 1,105 — 182 3,693 Total 37,486 47,962 505 828 86,781 8,566 176 — — 57,124 44,633 2,774 7,843 12,435 $ 199,155 4,833 — — 4,833 24,194 14,015 4,638 42,847 12,857 3,465 4,365 63,534 4,308 3,465 4,365 44,996 $ 8,549 — — 13,705 $ $ — — — 4,833 $ 114,263 81,553 $ 195,816 $ 13,756 14,710 28,466 $ 135,621 7,602 1,292 97,555 8,894 $ 233,176 The purchase price allocations of CESA and Tekalia are preliminary. The purchase price of CESA is subject to final working capital adjustments. In the case of Tekalia, due to the limited time between the date of acquisition and the approval date of the consolidated financial statements by the Corporation’s Board of Directors, management is in the process of gathering all the information necessary to finalize it. Accordingly, the final purchase price allocations could result in changes to the fair value of assets acquired and liabilities assumed. NOTE 6. SALES AND BACKLOG The amount of sales recognized in the following sectors was as follow for fiscal year: Commercial Defense Total sales 2019 236,283 247,594 483,877 $ $ 2018 195,101 191,463 386,564 $ $ HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 75 The Corporation’s backlog represents the aggregate amount of the revenues expected to be realized within a period of 24 months, from partially or fully unsatisfied performance obligations as at March 31, 2019 as we perform under contracts at delivery. The amounts in backlog include only the value of firm orders. Such orders may be subject to future modifications that might impact the amount and/or timing of revenue recognition. At March 31, 2019, the Corporation had a backlog of $623,925. NOTE 7. GOVERNMENT ASSISTANCE Government assistance deducted from the cost of the related assets or recognized as a reduction of expenses, was as follows, for fiscal year: Finite-life intangible assets Property, plant and equipment Cost of sales and, selling and administrative expenses Government assistance includes research and development tax credits, other credits and grants. NOTE 8. COST OF SALES, SELLING AND ADMINISTRATIVE EXPENSES The main components of these expenses were as follows, for fiscal year: Raw materials and purchased parts Employee costs Amortization of property, plant and equipment and finite-life intangible assets (notes 15, 16) Others 2019 1,125 $ 497 3,903 2018 332 619 1,929 2019 179,395 $ 154,406 32,650 75,863 2018 140,361 126,292 26,579 63,007 442,314 $ 356,239 $ $ $ Foreign exchange gains or losses resulting from the translation of net monetary items denominated in foreign currencies are included in the Corporation’s selling and administrative expenses. During the fiscal year ended March 31, 2019, the foreign exchange gain amounted to $718 ($148 in 2018). NOTE 9. NET FINANCIAL EXPENSES Net financial expenses comprise the following, for fiscal year: Interest accretion on governmental authorities loans Net losses on certain derivative financial instruments (note 10) Revision of governmental authorities loans repayment estimates (note 20) Interest on net defined benefit obligations (note 25) Amortization of deferred financing costs Other non-cash financial expenses (income) Non-cash net financial expenses Interest expense Net gains on certain derivative financial instruments (note 10) Standby fees Interest income on cash and cash equivalents 2019 2,361 $ 391 (1,036) 150 505 326 2,697 4,461 — 453 (800) 6,811 $ 2018 2,300 344 (1,834) 153 238 (443) 758 2,299 (255) 315 (580) 2,537 $ $ HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 76 NOTE 10. NON-RECURRING ITEMS Non-recurring items comprise the following, for fiscal year: Non-recurring items in operating income Acquisition-related costs Restructuring charges Non-recurring items in net financial expenses (income) Net losses on certain derivative financial instruments Non-recurring items in income tax expense Impact of US Tax Reform 2019 4,323 $ — $ 4,323 391 391 $ $ $ — $ — $ $ $ $ $ $ $ $ 2018 1,957 4,990 6,947 89 89 4,912 4,912 Acquisition-related costs These costs mainly pertain to professional fees and expenses related to the acquisitions of CESA, Beaver and Tekalia. Restructuring charges In March 2018, the Corporation announced workforce adjustments of about 60 employees at its Longueuil facility following the non-renewal of the USAF contract. These adjustments along with other costs related to the decrease in volume resulted in restructuring charges totaling $4,990 accounted for during fiscal 2018 fourth quarter, including termination benefits of $2,729 and other costs related to the reduction in volume totaling $2,261. The unpaid portion of these restructuring charges amounted to $304 as at March 31, 2019 ($2,545 as at March 31, 2018) is included in other liabilities and short-term provisions on the Corporation’s consolidated balance sheet. Refer to note 19, under caption Other. Net losses on certain derivative financial instruments These losses relate to derivative financial instruments acquired in order to mitigate foreign currency and interest rate risks arising from the purchase price and financing related to the acquisition of CESA. Refer to the Derivatives section under Additional Information below for further details. Impact of US Tax Reform This one-time tax expense of $4,912 recorded during fiscal 2018 is related to the US Tax Reform enacted on December 22, 2017. NOTE 11. EARNINGS PER SHARE The following table sets forth the elements used to compute basic and diluted earnings per share, for fiscal year: Weighted-average number of common shares outstanding Effect of dilutive stock options of the Corporation Weighted-average number of common diluted shares outstanding Options excluded from diluted earnings per share calculation(1) (1) Excluded from diluted earnings per share calculation due to anti-dilutive impact. NOTE 12. INVENTORIES As at Raw materials Work-in-progress Finished goods 2019 36,307,708 129,344 36,437,052 526,500 2018 36,154,272 177,342 36,331,614 356,500 March 31, 2019 March 31, 2018 $ 97,976 $ 84,752 1,307 $ 184,035 $ 62,902 69,118 2,307 134,327 HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 77 The amount of inventories recognized as cost of sales for the fiscal year ended March 31, 2019 is $333,917 ($267,753 in 2018). Reserves related to inventories are as follows, for fiscal year: Reserves recognized as cost of sales Reversal of prior-period reserves $ 2019 8,118 $ 9,116 2018 7,312 13,639 For fiscal year 2019, the reversal of prior-period reserves includes charges of $1,705 ($5,568 in 2018) for products delivered or written-off during the year for which a net realizable value reserve was recorded in prior years with no effect on income. It also includes the results from the revaluation, at each reporting date, of the net realizable value of inventories, based on related sales contracts and production costs. The revaluation takes into consideration the variations in selling price and number of units to deliver for contracts signed and also the reduction in production costs resulting from improvements in manufacturing processes. NOTE 13. DERIVATIVE FINANCIAL INSTRUMENTS As at Current Assets Forward foreign exchange contracts Cross-currency interest rate swap agreements Long-term Assets Forward foreign exchange contracts Cross-currency interest rate swap agreements Equity swap agreements Current Liabilities Forward foreign exchange contracts Interest rate swap agreements Long-term Liabilities Forward foreign exchange contracts Cross-currency interest-rate swap agreements NOTE 14. OTHER ASSETS As at Working capital adjustment receivable (note 5) Investment and other tax credits receivable Prepaid expenses Sales tax receivable Others Other current assets Tax credits receivable Others Other long-term assets 78 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements March 31, 2019 March 31, 2018 $ $ $ $ $ $ $ $ 399 384 783 190 1,735 3,891 5,816 2,134 — 2,134 1,317 — 1,317 $ $ $ $ $ $ $ $ 1,776 — 1,776 1,172 — 2,249 3,421 382 7 389 76 2,313 2,389 March 31, 2019 March 31, 2018 — 10,695 $ $ 6,366 5,171 3,415 1,050 26,697 $ 6,914 — 6,914 $ $ $ 523 3,614 1,676 643 6,456 3,165 1,043 4,208 NOTE 15. PROPERTY, PLANT AND EQUIPMENT Buildings and leasehold improvements Machinery, equipment and tooling Land Other Construction in progress Total Cost: As at March 31, 2018 $ 6,500 $ 90,089 $ 235,411 $ 14,574 $ Additions Business acquisitions Government assistance (note 7) Retirements and disposals Effect of changes in exchange rates 124 12,487 — — (82) 1,981 22,622 (23) (10) 1,097 10,845 19,380 (420) (1,157) 4,626 2,127 1,568 (54) (94) 100 2,308 (1,201) 1,067 — 7 (48) $ 348,882 13,876 57,124 (497) (1,254) 5,693 As at March 31, 2019 $ 19,029 $ 115,756 $ 268,685 $ 18,221 $ 2,133 $ 423,824 Accumulated amortization: As at March 31, 2018 Amortization expense Retirements and disposals Effect of changes in exchange rates $ — $ — — — As at March 31, 2019 Net book value as at March 31, 2019 $ — $ $ 19,029 $ 29,432 4,638 (6) 285 34,349 81,407 $ $ $ 130,981 17,636 (1,128) 3,022 150,511 118,174 $ $ $ 8,966 2,079 (93) 58 11,010 7,211 $ $ $ — $ — — — — $ 2,133 $ Buildings and leasehold improvements Machinery, equipment and tooling Land Other Construction in progress Cost: As at March 31, 2017 $ 6,502 $ 90,553 $ 233,182 $ 14,607 $ Additions Government assistance (note 7) Retirements and disposals Effect of changes in exchange rates — — — (2) 1,034 (15) (1,018) (465) 10,984 (557) (7,078) (1,120) 1,299 (47) (1,244) (41) $ 4,915 (2,626) — — 19 169,379 24,353 (1,227) 3,365 195,870 227,954 Total 349,759 10,691 (619) (9,340) (1,609) As at March 31, 2018 $ 6,500 $ 90,089 $ 235,411 $ 14,574 $ 2,308 $ 348,882 Accumulated amortization: As at March 31, 2017 Amortization expense Write-down (note 10) Retirements and disposals Effect of changes in exchange rates $ — $ 26,769 $ 121,797 $ — — — — 3,770 — (1,005) (102) 15,234 886 (6,979) 43 $ 8,346 1,811 — (1,169) (22) — $ — — — — As at March 31, 2018 Net book value as at March 31, 2018 $ — $ $ 6,500 $ 29,432 60,657 $ $ 130,981 104,430 $ $ 8,966 5,608 $ $ — $ 2,308 $ 156,912 20,815 886 (9,153) (81) 169,379 179,503 HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 79 Additions to property, plant and equipment shown above can be reconciled as follows, for fiscal year: Gross additions Government assistance (note 7) Additions to property, plant and equipment Variation in unpaid additions included in Accounts payable and accrued liabilities at year-end Additions, as per statements of cash flows 2019 13,876 $ (497) 13,379 (521) 12,858 $ 2018 10,691 (619) 10,072 (142) 9,930 $ $ As at March 31, 2019, cost of machinery, equipment and tooling includes assets acquired through finance leases amounting to $40,716 ($40,151 as at March 31, 2018) with accumulated amortization of $10,006 ($6,847 as at March 31, 2018). As at March 31, 2019 and 2018, construction in progress included mainly the cost related to machinery and equipment. As at March 31, 2019, the cost of property, plant and equipment still in use and fully depreciated is $91,109 ($87,188 as at March 31, 2018). NOTE 16. FINITE-LIFE INTANGIBLE ASSETS Cost: As at March 31, 2018 Additions Business acquisitions Customers funding Government assistance (note 7) Retirements and disposals Effect of changes in exchange rates As at March 31, 2019 Accumulated amortization: As at March 31, 2018 Amortization expense Retirements and disposals Effect of changes in exchange rates As at March 31, 2019 Net book value as at March 31, 2019 $ $ $ $ $ Capitalized development costs Customer relationships and contracts Software 31,160 $ 18,641 $ 25,404 $ 3,165 — (7,142) (1,046) — 219 26,356 11,493 948 — 25 12,466 13,890 $ $ $ $ 2,749 1,693 — (79) (480) (612) 21,912 14,152 2,226 (480) (120) 15,778 6,134 $ $ $ $ — 42,940 — — — (258) 68,086 13,704 5,124 — (95) 18,733 49,353 $ $ $ $ Total 75,205 5,914 44,633 (7,142) (1,125) (480) (651) 116,354 39,349 8,298 (480) (190) 46,977 69,377 80 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Capitalized development costs Customer relationships and contracts Software 37,073 $ 17,773 $ 23,918 $ 1,053 (7,005) — — 39 31,160 10,907 586 — — 11,493 19,667 $ $ $ $ 1,523 — (332) (520) 197 18,641 12,902 1,683 (482) 49 14,152 4,489 $ $ $ $ — — — — 1,486 25,404 9,488 3,495 — 721 13,704 11,700 $ $ $ $ Total 78,764 2,576 (7,005) (332) (520) 1,722 75,205 33,297 5,764 (482) 770 39,349 35,856 Cost: As at March 31, 2017 Additions Customers funding Government assistance (note 7) Retirements and disposals Effect of changes in exchange rates As at March 31, 2018 Accumulated amortization: As at March 31, 2017 Amortization expense Retirements and disposals Effect of changes in exchange rates As at March 31, 2018 Net book value as at March 31, 2018 $ $ $ $ $ NOTE 17. GOODWILL Goodwill varied as follows, during fiscal year: Balance at beginning of the year Business acquisitions Effect of changes in exchange rates Balance, end of year 2019 91,137 97,555 (3,055) 185,637 $ $ $ $ 2018 86,049 — 5,088 91,137 March 31, 2019 67,561 $ 65,041 53,035 185,637 $ The net carrying amount of goodwill was allocated to the following CGUs, as at: North America U.K. Spain Goodwill The following key assumptions were used to determine recoverable amounts for the impairment tests performed as at March 31, 2019: North America U.K. Spain Pre-tax discount rate Perpetual growth rate 13.1% 13.6% 14.1% 2.8% 2.8% 2.8% HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 81 Sensitivity of recoverable amounts The following table presents, for each CGU, the change in the discount rate or in the perpetual growth rate used in the most recently performed tests that would have been required to recover the carrying amount of the CGU as at March 31, 2019: North America U.K. Spain Incremental increase in pre-tax discount rate 3.1% 6.7% Incremental decrease in perpetual growth rate 4.8% 12.9% 0.8% 2.4% NOTE 18. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES As at Trade payables (1) Accrued liabilities (2) Other Accounts payable and accrued liabilities (1) Trade payables are normally settled on 30 to 60 day terms. (2) Accrued liabilities mainly include employees-related liabilities. NOTE 19. PROVISIONS $ March 31, 2019 March 31, 2018 41,645 $ 23,412 2,534 67,591 76,749 37,403 3,838 117,990 $ $ As at March 31, 2018 Arising during the year Business acquisitions (note 5) Interest accretion expense Utilized Reversed Discount rate adjustment Effect of changes in exchange rates As at March 31, 2019 Less: current portion Long-term portion Onerous contracts 243 $ Asset retirement obligations 5,770 $ Product warranty Other (note 26) $ 7,456 $ 9,321 $ 355 14,088 — (2,300) (2) — 54 12,438 5,644 6,794 $ $ $ $ — — 174 — — 152 — 6,096 — 6,096 $ $ 1,052 6,925 — (1,567) (1,029) — (187) 12,650 9,113 3,537 $ $ 1,869 5,859 — (2,642) (821) — (161) 13,425 13,063 362 $ $ Total 22,790 3,276 26,872 174 (6,509) (1,852) 152 (294) 44,609 27,820 16,789 82 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements NOTE 20. LONG-TERM DEBT As at March 31, 2019 March 31, 2018 Senior Secured Syndicated Revolving Credit Facility $ 94,877 $ Governmental authorities loans Unsecured Subordinated Term Loan Facility Obligations under finance leases Balance of sale related to a business acquisition (note 5) Other (1) Deferred financing costs, net Less: current portion Long-term debt (1) Other relates to secured loans contracted by a subsidiary Senior Secured Syndicated Revolving Credit Facility (“Revolving Facility“) The relevant terms and drawings on the Credit Facility are as follows: As at Limit, in Canadian, US$, Euro or British Pound equivalent (1) US$ Drawings Amount Rate Effective rate 89,701 50,000 20,411 4,677 3,592 (2,952) 260,306 15,066 245,240 $ $ 54,155 52,540 — 25,269 — — (923) 131,041 5,356 125,685 March 31, 2019 March 31, 2018 $ 250,000 $ 200,000 US$ 71,000 US$ 42,000 Libor + 2.0% Libor + 1.125% 4.5% 3.0% (1) Includes an accordion feature to increase the Credit Facility up to $350 million during the term of the credit agreement, subject to lenders’ approval. On September 24, 2018, the Corporation reached an agreement with its syndicate of banks to increase the Revolving Facility's limit from $200,000 to $250,000. Most of the other terms remained unchanged. Financing costs totaling $1,699 were deferred and are amortized over the term of the related loans using the effective interest rate method. The Credit Facility is secured by essentially all assets of the Corporation and its subsidiaries and matures on May 24, 2022. Governmental authorities loans Governmental authorities loans represent government assistance for the purchase of certain equipment or tooling, for the modernization or additions to the Corporation’s facilities or for development costs capitalized or expensed for aerospace programs. They were granted as incentives under Canadian federal and provincial or Spanish industrial programs to promote industry development. These loans have varying terms governing the timing and amount to be refund. Repayments, when not on a fixed schedule, are either based on sales of specific programs or the growth in sales of all or certain of Héroux-Devtek’s product lines and bear no or below-market interest rate. They are measured at a discounted value using a corresponding market rate of interest each time they are received, and the related discount is accreted to income using the effective interest rate method and included in the consolidated statements of income as financial expense. Assumptions underlying loan repayments are reviewed at least annually. As at March 31, 2019, the Corporation updated the estimated repayment schedule of its government authorities loans, taking into account revised assumptions mainly related to sales forecasts. This resulted in a non- cash gain of $1,036 ($1,834 in fiscal 2018), which was included in Net financial expenses (income) (see note 9). The effective interest rates for these loans were in the range of 0.0% to 6.6% as at March 31, 2019 (2.5% to 7.2% as at March 31, 2018). HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 83 Unsecured Subordinated Term Loan Facility (“Term Loan”) On September 24, 2018, the Corporation signed an unsecured subordinated term loan facility with Fonds de Solidarité FTQ for an amount of up to $75,000. The facility consists of a $50,000 term loan related to the acquisition of CESA (see Note 5) and additional financing available until September 30, 2020, of up to $25,000 subject to certain conditions. The initial $50,000 loan was drawn on September 25, 2018, bears interest at 5.7% and is repayable at maturity on September 30, 2025. Starting on September 30, 2021, the Corporation will have the option to make early repayments subject to certain fees. Financing costs totaling $835 were deferred and are amortized over the term of the related loans using the effective interest rate method. Obligations under finance leases (“Finance Leases”) Obligations under finance leases bear fixed interest rates between 2.4% and 5.0% as at March 31, 2019 and March 31, 2018, maturing from July 2019 to December 2023, with amortization periods of approximately seven years, secured by the related property, plant and equipment, net of interest of $1,351 ($1,928 as at March 31, 2018). Covenants Long-term debt is subject to certain general and financial covenants related, among others, indebtedness, cash flows and equity of the Corporation and/or certain subsidiaries. The Corporation complied with all covenants as at March 31, 2019. Minimum repayments Minimum repayments of long-term debt during the next five years are as follows: Fiscal years 2020 2021 2022 2023 2024 Beyond 5 years Sub-Total Less: Interest Debt balance (1) Revolving Facility 4,269 4,269 4,269 95,589 — — 108,396 13,519 94,877 $ $ Governmental authorities loans 6,780 7,820 9,345 11,014 10,924 64,783 110,666 20,965 89,701 $ $ Term Loan 2,850 2,850 2,850 2,850 2,850 54,975 69,225 19,225 50,000 $ $ $ $ Finance Leases 6,007 5,746 5,439 3,350 1,220 — 21,762 1,351 20,411 $ $ Other (2) 3,306 3,203 694 590 208 1,622 9,623 1,354 8,269 $ $ Total 23,212 23,888 22,597 113,393 15,202 121,380 319,672 56,414 263,258 (1) Before net deferred financing costs. (2) Includes the balance of sales related to a business acquisition. The following table presents reconciliation between the opening and closing balances for the Long-term debt. Long-term debt, at beginning of the fiscal year Increase in long-term debt Repayment of long-term debt Debt acquired through business acquisitions (note 5) Amortization of deferred financing costs (note 9) Fees incurred to amend or renew the Credit Facility Interest accretion and adjustments on governmental authorities loans (note 9) Effects of fluctuations in exchange rates March 31, 2019 March 31, 2018 $ 131,041 $ 134,139 117,883 (36,198) 43,758 505 (2,534) 1,325 4,526 3,821 (4,634) — 238 (524) 466 (2,465) 131,041 Long-term debt, at end of the fiscal year $ 260,306 $ 84 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements NOTE 21. OTHER LIABILITIES As at Net defined benefit obligations (note 25) Customer advances Deferred revenue Progress billings Other Other Liabilities NOTE 22. ISSUED CAPITAL $ March 31, 2019 March 31, 2018 3,958 $ — 2,639 19 — 6,616 6,650 2,050 1,468 863 1,946 12,977 $ $ Authorized Voting common shares, without par value First preferred shares, issuable in series, without par value Second preferred shares, issuable in series, without par value No preferred shares are outstanding. Variations in common shares issued and fully paid were as follows, for fiscal year: Unlimited Unlimited Unlimited Balance, beginning of year Issued for cash on exercise of stock options Issued for cash under the stock purchase and ownership incentive plan Balance, end of year Stock-based compensation Number 36,218,572 $ 107,450 36,188 36,362,210 $ 2019 Issued capital 78,105 1,101 470 79,676 Number 36,122,050 $ 48,750 47,772 2018 Issued capital 77,217 298 590 36,218,572 $ 78,105 A. Stock option plan The Corporation grants stock options at a subscription price representing the average closing price of the Corporation’s common shares on the Toronto Stock Exchange for the five trading days preceding the grant date. Options granted under the plan mainly vest over a period of four years. The options are exercisable over a period not exceeding seven years after the grant date. Variations in stock options outstanding and related compensation expense were as follows, for fiscal year: Balance, beginning of year Granted Exercised Cancelled / forfeited Balance, end of year Stock-based compensation expense 2019 Weighted- average exercise price Number of stock options 2018 Weighted- average exercise price Number of stock options 1,105,295 $ 207,500 (107,450) (38,250) 1,167,095 $ $ 12.09 16.21 6.50 15.24 13.23 882 914,295 $ 243,500 (48,750) (3,750) 1,105,295 $ $ 10.88 14.93 3.71 11.71 12.09 608 The weighted-average share price at the date of exercise of stock options in fiscal 2019 was $15.86 ($14.44 in 2018). HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 85 Details of stock options granted were as follows, for fiscal year: Number of stock options granted Weighted average fair value per stock option Total fair value Expected life (years) Expected volatility Expected forfeiture Expected dividend distribution Compounded risk-free interest rate 2019 2018 207,500 243,500 $ $ 4.25 882 $ $ 3.84 935 4.8 years 4.9 years 24% 4.2% None 2.3% 25% 4.5% None 1.6% During fiscal 2019, following the approval by the shareholders of the Corporation at the last Annual General Meeting of shareholders, the aggregate number of shares available for future issuance under the stock option plan was replenished due to the limited number of common shares remaining under this plan. As at March 31, 2019, 2,808,257 common shares are reserved for issuance of stock options, of which 2,762,507 remained to be issued, compared to 1,514,481 as at March 31, 2018. As at March 31, 2019, 1,167,095 stock options were issued and outstanding and can be detailed as follows: Exercisable price $10.71 to $11.71 $14.93 to $16.22 Outstanding options Weighted-average years to maturity 2.26 5.72 3.97 Number 640,595 526,500 1,167,095 Weighted-average exercise price $12.15 15.42 $13.23 Vested options Number 602,845 166,000 768,845 Weighted-average exercise price $11.47 14.95 $12.33 B. Stock purchase and ownership incentive plan Movements in common shares and related expenses related to the stock purchase and ownership incentive plan were as follows, for fiscal year: In number of common shares Issued Attributed to participating employees Expense related to common shares attributed 2019 2018 36,188 24,622 $ 227 $ 47,772 18,800 260 As at March 31, 2019, 340,000 shares are reserved for issuance under the stock purchase and ownership incentive plan, of which 22,678 remained to be issued, compared to 58,866 as at March 31, 2018. C. Deferred Share Unit (“DSU”) and Performance Share Unit (“PSU”) plans Movements in outstanding DSUs and related expense were as follows, for fiscal year: In number of DSUs Balance, beginning of year Issued Settled Cancelled/Forfeited Closing balance of DSUs outstanding DSU expense Fair value of outstanding DSUs, end of year 86 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements 2019 2018 136,170 36,008 (4,512) (1,332) 166,334 $ $ 640 2,534 $ $ 135,815 32,588 (32,233) — 136,170 910 1,962 Movements in outstanding PSUs and related expense were as follows, for fiscal year: In number of PSUs Balance, beginning of year Issued Settled Cancelled/forfeited Closing balance of PSUs outstanding PSU expense Fair value of vested outstanding PSUs, end of year NOTE 23. ACCUMULATED OTHER COMPREHENSIVE INCOME Changes in accumulated other comprehensive income were as follows: 2019 2018 187,948 81,350 (38,392) (18,456) 212,450 $ $ 1,505 1,850 $ $ 114,434 100,650 (23,334) (3,802) 187,948 163 842 Balance as at March 31, 2018 Other comprehensive loss Balance as at March 31, 2019 Balance as at March 31, 2017 Other comprehensive income Balance as at March 31, 2018 NOTE 24. INCOME TAXES Income tax expense is as follows, for fiscal year: Consolidated statements of income Current income tax expense Deferred income tax expense (recovery) Income tax expense reported in the consolidated statements of income Consolidated statements of changes in shareholders’ equity Expense (recovery) related to items charged or credited directly to retained earnings Expense (recovery) related to items charged or credited directly to other comprehensive income Income tax expense reported directly in shareholders’ equity Exchange differences on translation of foreign operations Hedge of net investments in foreign operations Cash flow hedges $ $ 20,116 (850) 19,266 $ $ 24 $ (5,923) $ (1,796) (1,069) (1,772) $ (6,992) $ Exchange differences on translation of foreign operations $ $ 14,256 5,860 20,116 $ $ Hedge of net investments in foreign operations Cash flow hedges (521) $ (7,437) $ 545 1,514 Total 14,217 (3,715) 10,502 Total 6,298 7,919 24 $ (5,923) $ 14,217 2019 6,254 (2,019) 4,235 $ $ (656) $ (557) (1,213) $ $ $ $ $ 2018 7,100 67 7,167 68 826 894 HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 87 The computation of income tax expense is as follows, for fiscal year: Income taxes at combined Federal and Provincial statutory tax rates of 26.6% Income tax rate differential – foreign subsidiaries Permanent differences Impact of US Tax Reform (note 10) Other items Income tax expense 2019 8,124 (4,788) 1,018 — (119) 4,235 $ $ 2018 5,554 (4,251) 827 4,912 125 7,167 $ $ On December 22, 2017, the United States Government passed into law the Tax Cuts and Jobs Act (the "US Tax Reform"). The US Tax Reform includes a number of changes in existing tax law impacting businesses including, among other things, a permanent reduction in the federal corporate income tax rate from 35% to 21% effective January 1, 2018. The reduction in the corporate tax rate required a revaluation of the Corporation net deferred tax assets, resulting in a one-time tax expense of $4,912 during the fiscal year 2018. Significant deferred income tax assets and liabilities arising from the effect of temporary differences are as follows: As at Deferred income tax assets Non-deductible reserves Inventories Receivables Derivative financial instruments Governmental authorities loans Deferred tax benefits from tax losses and deductible expenses carried forward Total deferred income tax assets Deferred income tax liabilities Investment and other tax credits Property, plant and equipment Customer relationships and contracts Governmental authorities loans Derivative financial instruments Total deferred income tax liabilities Net deferred income tax assets March 31, 2019 March 31, 2018 $ $ $ $ 9,850 $ 5,345 20 113 10 22,185 37,523 $ (729) (16,903) (12,795) — — (30,427) $ 7,096 $ 4,126 3,872 10 — — 14,012 22,020 (557) (14,863) (2,891) (64) (24) (18,399) 3,621 The net deferred income tax assets are included under the following captions on the consolidated balance sheets: As at Deferred income tax assets Deferred income tax liabilities Net deferred income tax assets March 31, 2019 March 31, 2018 $ $ 14,575 (7,479) 7,096 $ $ 7,388 (3,767) 3,621 As at March 31, 2019, net deferred income tax assets of $4,540 were recognized ($8,790 as at March 31, 2018) in jurisdictions that incurred losses in current and prior fiscal years. Based upon the level of historical taxable income and projections for future taxable income, the Corporation’s management believes it is probable that the Corporation will realize the full benefits of these deductible temporary differences and non-capital losses carried forward. As at March 31, 2019, operating losses carried forward or other temporary differences for which related deferred income tax assets have not been recognized in the consolidated financial statements amounted to $3,329 (none as at March 31, 2018). The Corporation had the following non-capital losses available for carry-forward: 88 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements As at Canada United States Spain March 31, 2019 March 31, 2018 $ $ 19,520 $ 64,219 18,874 102,613 $ 19,943 53,506 — 73,449 As at March 31, 2019, deferred income tax assets of $12,526 and deferred income tax liabilities of $930 are expected to be recovered or settled in less than one year. Deferred income tax is not recognized on the unremitted earnings of subsidiaries where the Corporation is able to control the timing of the remittance and it is probable that there will be no remittance in the foreseeable future. As at March 31, 2019, the temporary differences associated with investments in subsidiaries for which a deferred income tax liability has not been recognized aggregate to $21,614 ($25,151 in 2018). NOTE 25. PENSION AND OTHER RETIREMENT BENEFIT PLANS Description of benefit plans The Corporation has funded and unfunded defined benefit pension plans as well as defined contribution pension plans that provide pension benefits to its employees. Retirement benefits provided by the defined benefit pension plans are based on either years of service and flat amount, years of service and final average salary, or set out by individual agreements. Benefits provided by the post-retirement benefit plans are set out by individual agreements, which mostly provide for life insurance coverage and health care benefits. Since their amount is not significant, they are not included in the figures below. Total cash payments For fiscal year 2019, total cash payments for employee future benefits, consisting of cash contributed by the Corporation to its funded defined benefit pension plans and cash payments directly to beneficiaries for its unfunded defined benefit pension plans amounted to $1,335 ($1,489 in 2018) while the cash contributed to its defined contribution plans amounted to $3,492 ($3,200 in 2018). Defined benefit plans The Corporation measures the fair value of plan assets for accounting purposes as at March 31 of each year while its defined benefit obligations are valued as at December 31 of each year and projected to March 31 for all plans, except one plan for which the valuation is made as at March 31. The defined benefit plans expose the Corporation to actuarial risks such as: • Life expectancy risk The present value of defined benefit obligations is calculated in part by reference to the estimated life expectancy of plan members. An increase in life expectancy increases the Corporation’s obligations. • Currency risk As a significant portion of plan assets are invested in foreign equities, an increase in the value of the Canadian dollar in comparison to the denomination of these foreign equities would result in an increase in the Corporation’s obligations. • Interest rate risk A decrease in market rates of interest would decrease the discount rate used to calculate the present value of defined benefit obligations, thus increasing it. This would be partially offset by the resulting increase in the value of the plans’ bond holdings. • Investment risk Investment risk is the risk that the return on plan assets is lower than the corporate bond interest rate used to determine the discount rate. Currently, the plans have an investment mix of 61% in equity funds, 31% in debt securities and 8% in other funds. Due to the long-term nature of the plans’ defined benefit obligations, the Corporation considers it appropriate that a reasonable portion of the plans’ assets is invested in equity securities and other funds in order to generate additional long- term return on plan assets. The reconciliation of the present value of the defined benefit obligations and the fair value of plan assets to the amounts recognized in the consolidated balance sheets is as follows: HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 89 As at Present value of defined benefit obligations of funded plans Fair value of plan assets Funded status of the plans – deficit Present value of defined benefit obligations of unfunded plan Amount recognized in other long-term liabilities $ March 31, 2019 March 31, 2018 61,216 $ 58,974 (2,242) (1,716) (3,958) 65,962 60,710 (5,252) $ (1,398) (6,650) $ $ $ Defined benefit pension expense recognized in the consolidated statements of income is as follows, for fiscal year: Current service cost Interest on net defined benefit obligations (note 9) Past service cost Administrative cost Defined benefit pension expense recognized in the consolidated statements of income The total amount recognized in other comprehensive income is as follows, for fiscal year: Remeasurements Losses from changes in demographic assumptions Losses from changes in financial assumptions Experience gains Return on plan assets, excluding interest income on plan assets Other comprehensive income The actual return on the fair value of plan assets is as follows, for fiscal year: Actual return on the fair value of plan assets The variation in present value of the defined benefit obligations were as follows, for fiscal year: Defined benefit obligations, beginning of year Current service cost Interest expense Contributions by plans’ participants Losses from change in demographic assumptions Losses from changes in financial assumptions Experience gains Benefits paid Past service benefits Defined benefit obligations, end of year The fair value of plan assets is as follows: $ $ 2019 1,192 150 — 198 1,540 2019 (326) $ (2,855) 255 439 (2,487) $ 2018 1,459 153 325 161 2,098 2018 (2) (915) 1,257 (79) 261 2019 2,547 $ 2018 2,038 2019 62,932 $ 1,192 2,258 675 326 2,855 (255) (2,623) — 67,360 $ 2018 61,106 1,459 2,270 731 2 915 (1,257) (2,619) 325 62,932 $ $ $ $ $ $ $ 90 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements As at Fair value of plans’ assets, beginning of year Interest income on plans’ assets Return on plans’ assets, excluding interest income on plans’ assets Contributions by the employer Contributions by plans’ participants Benefits paid Administrative costs Fair value of plans’ assets, end of year The plans’ assets consist of: As at Equity securities Debt securities Other Total Significant assumptions The significant weighted-average assumptions used at the reporting date are as follows, for fiscal year: Defined benefit obligations as at March 31: Discount rate Rate of compensation increase Average life expectancies based on a pension at 65 years of age: Male, 45 years of age at reporting date Female, 45 years of age at reporting date Male, 65 years of age at reporting date Female, 65 years of age at reporting date $ March 31, 2019 March 31, 2018 57,496 $ 2,117 (79) 1,489 731 (2,619) (161) 58,974 58,974 2,108 439 1,335 675 (2,623) (198) 60,710 $ $ March 31, 2019 March 31, 2018 63% 29% 8% 100% 61% 31% 8% 100% 2019 3.30% 3.50% 86 89 87 90 2018 3.60% 3.50% 86 89 87 90 The following table summarizes the effects of the changes in these actuarial assumptions on the pension expense and the defined benefit obligations for the fiscal year ended and as at March 31, 2019: Increase (Decrease) Discount rate Increase of 0.5% Decrease of 0.5% Rate of compensation Increase of 0.5% Decrease of 0.5% Average life expectancies Increase of 1 year Decrease of 1 year Pension expense % Defined benefit obligations % (25.1) 24.9 0.1 (0.1) 7.6 (7.7) (7.0) 7.8 — — 2.7 (2.7) HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 91 Corporation’s pension benefits future cash flows The cash contributions expected to be made to these plans in fiscal year 2020 amount to $1,653. The duration of the defined benefit obligations at March 31, 2019 is 14.8 years (14.8 years in 2018). The expected maturity of undiscounted pension benefits for the Unionized Pension Plan is presented as follows: As at Less than a year Between 1-2 years Between 2-5 years Over 5 years Total $ March 31, 2019 March 31, 2018 1,689 $ 1,747 5,753 100,542 109,731 1,783 1,834 6,125 99,741 109,483 $ $ Defined contribution pension plans The defined contribution pension plans’ costs are as follows, for fiscal year: Defined contribution pension plan costs NOTE 26. COMMITMENTS 2019 3,492 $ 2018 3,200 $ The Corporation has commitments under operating leases for buildings and facilities and outstanding purchases orders relating to machinery and equipment which have not been delivered yet to the Corporation’s facilities. The minimum payments over the next five years are as follows: 2020 2021 2022 2023 2024 Thereafter Total 2019 Total 2018 Operating leases - Buildings and facilities(1) $ 2,517 2,424 2,261 2,014 1,623 5,984 $16,823 $ 11,737 Building, machinery and equipment acquisition commitments $ 6,624 126 46 — — — $ 6,796 $ 2,952 (1) Excluding escalation clauses. Guarantees The Corporation executes agreements that provide for indemnification and guarantees to counterparties in transactions such as business disposition and the sale of assets. These indemnification undertakings and guarantees may require the Corporation to compensate the counterparties for costs or losses incurred as a result of various events including breaches of representations and warranties, intellectual property right infringement, loss of or damage to property, environmental liabilities, changes in or in the interpretation of laws and regulations (including tax legislations), valuation differences or as a result of litigations that may be suffered by the counterparties. In the sale of all or a part of a business or assets, in addition to possible indemnification relating to failure to perform covenants and breach of representations and warranties, the Corporation may have to indemnify against claims related to past conduct of the business. The nature of these indemnification agreements prevents the Corporation from estimating the maximum potential liability that could be required under guarantees, since these events have not occurred yet. As at March 31, 2019, the duration of these indemnification agreements could extend up to fiscal year 2024. As at March 31, 2019, an amount of $5,012 ($5,012 in 2018) was provided for in the Corporation’s provisions in respect to these items and is classified as short-term provision (note 19) given the undetermined date of settlement. Letters of credit As at March 31, 2019, the Corporation has outstanding letters of credit amounting to $26,153 ($3,302 in 2018). NOTE 27. CONTINGENCIES The Corporation is involved in litigations and claims in the normal course of business. Management is of the opinion that any resulting settlements would not materially affect the financial position and operating results of the Corporation. 92 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements NOTE 28. NET CHANGE IN NON-CASH ITEMS The net change in non-cash items is detailed as follows, for fiscal year: Accounts receivable Income tax receivable Inventories Other current and long-term assets Accounts payable and accrued liabilities and other liabilities Provisions Customers advances and progress billings Income tax payable Effect of changes in exchange rates(1) 2019 (5,624) $ (385) (1,746) (2,245) 20,013 (5,377) 4,655 (2,404) 2,686 9,573 $ 2018 (2,335) (184) 9,539 (869) 719 (3,335) 7,097 1,916 950 13,498 $ $ (1) Reflects the total impact of changes in exchange rates during the period on non-cash items listed above for the Corporation’s foreign subsidiaries. NOTE 29. GEOGRAPHIC INFORMATION The geographic segmentation of the Corporation’s assets is as follows: As at Canada Property, plant and equipment, net $ 97,210 Finite-life intangible assets, net 14,785 U.S. U.K. March 31, 2019 Total Spain Canada U.S. U.K. Total March 31, 2018 $ 72,872 $ 13,987 $ 43,885 $227,954 $ 95,492 $ 71,183 $ 12,828 $179,503 6,433 9,254 38,905 81,671 69,377 186,352 21,166 13,838 1,973 9,691 12,717 67,608 35,856 91,137 Goodwill 14,344 25,296 65,041 Geographic sales based on the customers’ location are detailed as follows, for fiscal year: United States United Kingdom Spain Rest of Europe Canada Other countries 2019 260,397 53,589 26,036 58,837 39,668 45,350 483,877 $ $ 2018 240,377 43,713 — 39,009 39,244 24,221 386,564 $ $ NOTE 30. EXECUTIVE COMPENSATION Key management includes directors (executive and non executive) and members of the Executive Committee. The executive compensation expense to key management is as follows, for fiscal year: Short-term employee benefits and other benefits Pension and other post-retirement benefits Share-based payments Total compensation to key management personnel 2019 3,622 84 1,421 5,127 $ $ 2018 3,458 156 1,655 5,269 $ $ HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 93 NOTE 31. FINANCIAL INSTRUMENTS Fair value hierarchy Financial assets and financial liabilities measured at fair value in the consolidated balance sheets are grouped into three levels of a fair value hierarchy. The three levels are defined based on the observability of significant inputs to the measurement, as follows: Level 1: quoted prices (unadjusted) in active markets for identical assets or liabilities Level 2: inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, and Level 3: unobservable inputs for the asset or liability. The classifications of financial instruments as well as their carrying amounts and fair values are summarized as follows: As at March 31, 2019 March 31, 2018 Fair value hierarchy Carrying amount Fair Value Fair value hierarchy Carrying amount Fair Value Financial assets Cash and cash equivalents Derivative financial instruments Financial Liabilities Level 1 $ 35,128 $ Level 2 6,599 $ 41,727 $ Derivative financial instruments Level 2 $ 3,451 $ Long-term debt, including current portion Level 2 263,258 $ 266,709 $ 35,128 6,599 41,727 3,451 270,716 274,167 Level 1 Level 2 Level 2 Level 2 $ $ $ $ 93,209 5,197 98,406 2,778 131,964 134,742 $ $ $ $ 93,209 5,197 98,406 2,778 137,493 140,271 Derivative financial instruments - The fair value of derivative financial instruments recognized in the consolidated balance sheets has been determined using the Corporation’s valuation models and compared to the fair value information provided by the financial institutions using exchange rates or interest rates quoted in the active market and adjusted for the credit risk added by the financial institution. These models project future cash flows and discount the future amounts to a present value using the contractual terms of the derivative financial instruments and factors observable in external markets data, such as period-end interest rate swap and foreign exchange rates. Long-term debt – The fair value of long-term debt has been determined by calculating the present value of long-term debt using the rate that would be negotiated under the economic conditions at year-end. NOTE 32. FINANCIAL RISK MANAGEMENT The Corporation is exposed primarily to market risk, credit and credit concentration risks, and liquidity risk as a result of holding financial instruments. Market Risk Market risk is the risk of fluctuations in the fair value or future cash flows of financial instruments following changes in market prices, whether those changes are caused by factors specific to the individual financial instruments or its issuer, or factors affecting all similar financial instruments traded in the market. The Corporation is primarily exposed to the following market risks: Foreign exchange risk The Corporation 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 of America, Spain and the United Kingdom. In an effort to mitigate the foreign currency fluctuation exposures, the Corporation makes use of derivative contracts to hedge this exposure, essentially to the U.S. currency and arising from its Canadian, Spanish and United Kingdom operations. The Corporation’s foreign exchange policy requires the hedging of 50% to 100% of the identified foreign currency exposure, mainly over the next two fiscal years, of the forecasted cash inflows generated by sales in U.S. currency made by its Canadian, Spanish and United Kingdom operations and related to sales contracts, net of the forecasted cash outflows in U.S. currency made by its Canadian, Spanish and United Kingdom operations and related essentially to raw materials and certain other material costs. 94 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements As at March 31, 2019, the Corporation had forward foreign exchange contracts outstanding for a notional amount of $228,374 denominated in USD, EUR and GBP. This amount includes mainly contracts with nominal value of US$146,885 convertible into Canadian dollars at an average rate of 1.3060. These contracts mature at various dates between April 2019 and March 2023, with the majority maturing this fiscal year and the next. As at March 31, 2019, a 1% strengthening of the Canadian dollar over foreign currencies, while all other variables would remain fixed, would have impacted the consolidated net income and the other comprehensive income as follows: Decrease in net income Increase (decrease) in other comprehensive income U.S. dollar impact (428) 508 British pound impact (110) (1,678) Euro impact (42) (734) The foreign exchange rate sensitivity analysis shown above is calculated by aggregation of the net foreign exchange rate exposure of the Corporation’s financial instruments including the forward foreign exchange contracts as at the consolidated balance sheet date. Interest-rate risk The Corporation is exposed to interest rate fluctuations primarily due to its variable interest rate on its long-term debt’s Credit Facility (see note 20). In addition, interest rate fluctuations could also have an impact on the Corporation’s interest income which is derived from its cash and cash equivalents. The Corporation’s interest rate policy requires maintaining an appropriate mix of fixed and variable interest rates debt to mitigate the net impact of fluctuating interest rates. Management as such may use derivatives to maintain a fixed debt ratio of between 40% and 70% of long-term debt, excluding government loans. Cross-currency interest rate swaps The acquisition of CESA (see note 5) exposed the Corporation to new foreign currency and interest rate risks related to the investment in Euros. A decrease in value of the Euro compared to the Canadian dollar would decrease the value of the foreign investment, and an increase in interest rates underlying debt would increase related net financial expenses. In order to mitigate these risks, as at March 31, 2019, the Corporation had entered into the following cross-currency interest rate swap agreements in order to manage foreign exchange and interest rate risks: Notional US$ 29,370 C$ 50,000 US$ 17,523 US$ 17,100 Fixed EUR equivalent € € € € 25,000 34,110 15,000 15,000 Interest rate 1.86 % 3.40 % Inception October 2017 Maturity May 2022 October 2017 September 2025 Euribor 1 month + 1.74% September 2018 Euribor 1 month + 1.76% November 2018 May 2022 March 2020 A 100 basis point variation in interest rates would have affected the Corporation’s financial results for fiscal 2019 as follows: Impact on net income related to floating rate long-term debt Impact on comprehensive income related to cross-currency interest-rate swap agreements 100 bps increase (69) 209 100 bps decrease 69 (209) The interest rate sensitivity analysis shown above is calculated on the floating-rate liability at the end of the fiscal year and assumes all other variables remain fixed. Other price risk The Corporation’s net income is exposed to fluctuations of its share price through its DSUs and PSUs (see note 22). In order to mitigate this exposure, the Corporation has entered into an equity swap agreement with a financial institution. Pursuant to this agreement, upon settlement, the Corporation receives payment for any share price appreciation while providing payment to the financial institution for any share price depreciation. The net effect of the equity swap partly offsets movements in the Corporation’s share price which impacts the expense of the DSUs and PSUs included in the Corporation’s selling and administrative expenses. As at March 31, 2019, the equity swap agreement covered 245,000 common shares of the Corporation at a price of $12.68. This agreement is a derivative instrument that is not part of a designated hedging relationship and matures in June 2020. HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 95 Credit and credit concentration risks The credit and credit concentration risks represent counterparty risks where the parties with which the Corporation enters into agreements or contracts could be unable to fulfill their commitments. Credit risks are primarily related to the potential inability of customers to discharge their obligations with regards to the Corporation’s accounts receivable and of financial institutions with regards to the Corporation’s cash and cash equivalents and derivative financial instruments. Credit concentration risks are related to the fact that approximately 61% of the Corporation’s fiscal 2019 sales are made to only nine customers (60% to six customers in 2018). More specifically, in fiscal 2019, the Corporation had one customer representing 22% of its consolidated sales (two customers representing 26% and 11% in 2018). Accounts receivable The credit and credit concentration risks related to these financial instruments are limited due to the fact that the Corporation deals generally with large corporations and Government agencies, with the exception of sales made to private small businesses which represent together approximately 4.2% in fiscal 2019 (5.3% in 2018) of the Corporation’s consolidated sales. As at March 31, 2019, the Corporation has historically not made any significant write-off of accounts receivable and the number of days in accounts receivable was at acceptable levels in the industry in which the Corporation operates. The credit quality of accounts receivable is monitored on a regular basis. Changes in the allowance for doubtful accounts were as follows for the fiscal year ended March 31, 2019: Balance, beginning of year Arising during the year Balance, end of year The details of the Corporation’s trade receivables are the following: As at Not past due Past due less than 90 days Past due more than 90 days Impaired Allowance for doubtful accounts Balance, end of year 2019 39 153 192 $ $ March 31, 2019 March 31, 2018 $ 105,402 $ 66,613 8,866 1,163 192 115,623 (192) 5,777 1,079 39 73,508 (39) $ 115,431 $ 73,469 Estimated credit losses based on expected loss rates were insignificant as at March 31, 2019 and 2018. Cash and cash equivalents and derivative financial instruments The credit and credit concentration risks related to these financial instruments are limited due to the fact that the Corporation deals mainly with high-grade financial institutions such as Canadian chartered banks and their U.S. subsidiaries or branches or with a Canadian branch of a U.S. bank, based on the Corporation’s investment policy. On that basis, the Corporation does not anticipate any breach of agreements by counterparties. As at March 31, 2019, the maximum exposure to credit and credit concentration risks for financial instruments represented the following (see note 31): Cash and cash equivalents Accounts receivable Derivative financial instruments FVTPL FVTOCI (1) $ — $ — 3,891 — $ — 2,708 A.C. 35,128 115,431 — (1) Represents the fair value of derivative financial instruments designated in a hedging relationship. 96 – HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements Liquidity risk The Corporation is exposed to the risk of being unable to honour its financial commitments by the deadlines set, under the terms of such commitments and at a reasonable price. The Corporation manages its liquidity risk by forecasting cash flows from operations and anticipated investing and financing activities. Senior management is also actively involved in the review and approval of long-term sales contracts and planned capital expenditures. As at March 31, 2019, the maturity analysis of financial liabilities represented the following: Accounts payable and accrued liabilities $ Customer advances Long-term debt, including current portion (note 20) Derivative financial instruments < 1 year 117,990 $ 14,502 23,212 2,134 1 to 3 years 4 to 5 years > 5 years — $ 2,050 46,485 1,171 — $ — — $ — 128,595 146 121,380 — Total 117,990 16,552 319,672 3,451 NOTE 33. CAPITAL RISK MANAGEMENT The general objectives of the Corporation’s management, in terms of capital management, reside in the preservation of the Corporation’s capacity to continue operating, providing benefits to its stakeholders and in providing an adequate return on investment to its shareholders by selling its products and services at a price commensurate with the level of operating risk assumed by the Corporation. The Corporation thus determines the total amount of capital required consistent with risk levels. This capital structure is adjusted on a timely basis depending on changes in the economic environment and risks of the underlying assets. In order to maintain or adjust its capital structure, the Corporation can, for example: • • • • Issue new common shares; Repurchase common shares; Sell certain assets to reduce indebtedness; Return capital to shareholders. The net debt-to-equity ratio, represented by net debt divided by shareholders’ equity, is the overriding factor in the Corporation’s capital management and monitoring practices. During fiscal year ended March 31, 2019, the Corporation pursued the same capital management strategy as last year, which consists in generally maintaining a sufficient net debt-to-equity ratio to allow access to financing at a reasonable or acceptable cost. The Corporation’s net debt-to-equity ratio was as follows: As at Current portion of long-term debt Long-term debt Deferred financing costs, net Less: Cash and cash equivalents Net debt Shareholders’ equity Net debt-to-equity ratio The Corporation is not subject to any regulatory capital requirements. March 31, 2019 March 31, 2018 5,356 $ 15,066 $ 245,240 2,952 35,128 228,130 404,098 0.56:1 $ 125,685 923 93,209 38,755 379,034 0.10:1 $ HÉROUX-DEVTEK INC. – Fiscal 2019 Consolidated Financial Statements – 97 SHAREHOLDER INFORMATION H ér o ux-De vt ek 2019 [ (cid:26) (cid:25) ] ANNU AL ME E T I NG OF S H AR E H OLDE R S August 9, 2019 at 10:00 A.M. Westin Montreal Salon les Fortifications, 9th Floor 270 Saint-Antoine Street West Montreal (Québec) Canada H2Y 0A3 R E GI S T R AR AND T R ANS F E R AGE NT Computershare Trust 1500 University Street, 7th Floor Montreal (Québec) Canada H3A 3S8 514 982-7555 /1 800 564-6253 AUDI TOR S Ernst & Young LLP 900 de Maisonneuve Boulevard West, Suite 2300 Montreal (Québec) H3A 0A8 514 875-6060 S H AR E LI S T I NG Shares are traded on the Toronto Stock Exchange Ticker Symbol: HRX I NV E S TOR R E LAT I ONS 450 679-3330 / ir@herouxdevtek.com Ste-Marie Strategy & Communications Inc. 514 465-6701 / danielle@ste-m.ca POUR OBTENIR LA VERSION FRANÇAISE DE CE RAPPORT, VEUILLEZ CONTACTER LES RELATIONS AVEC LES INVESTISSEURS. 1111 SAINT-CHARLES STREET WEST, SUITE 600 WEST TOWER, SAINT-CHARLES COMPLEXE LONGUEUIL (QUÉBEC) CANADA J4K 5G4 450 679-3330 WWW.HEROUXDEVTEK.COM 

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