Firan Technology Group Corp
TSX:FTG
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Firan Technology Group Corp
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Ladies and gentlemen, thank you for standing by and welcome to the Firan Technology Group Second Quarter 2020 Analyst call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker for today, Brad Bourne, President and CEO. Please go ahead, sir.
Thank you. Good morning. I'm Brad Bourne, President and CEO of Firan Technology Group Corporation, or FTG. Also on the call today is Jamie Crichton, our Chief Financial Officer. Before we go any further, I must caution you that this call may contain forward-looking statements. Such statements are based on current expectations of management of the company and inherently involve numerous risks and uncertainties, known and unknown, including economic factors and the company's industry generally. The preceding list is not exhaustive of all possible factors. Such forward-looking statements are not guarantees of future performance, and actual events and results could differ materially from those except or implied by forward-looking statements made by the company. The listener is cautioned to consider these and other factors carefully when making decisions with respect to the company and not place undue reliance on forward-looking statements. The company does not undertake and has no specific intention to update any forward-looking statements, written or oral, that may be made from time to time by or on its behalf, whether as a result of new information, future events or otherwise. Well, our second quarter was a much improved quarter operationally and financially. In fact, with all the challenges we faced, I'm extremely pleased with how everyone at FTG responded and with the result we achieved. Let me start with the external situation as we see it now. But keep in mind, things are evolving fast. So comments today might be different from comments tomorrow or next week. It's all about COVID-19. The virus is -- the virus in the short-term is impacting operations, and in the longer term, I think, will impact market demand. Let me start with the short term. Every FTG site is in a geographic region that has had or has some sort of shutdown or stay-at-home order. In February, all of China shut down and FTG's plants in China were shut down. But they are now back up and operating, following many rules. But the good news is the shutdown in China is over and things are getting back on track. Although, there are certainly lots of new rules in place regarding how an operation runs now. These rules provided us with many valuable lessons for things we should do in our North American facilities to keep everyone safe. Next up was California with the stay-at-home order in March. But California designated defense as an essential industry, so we stayed open. But our operations are being impacted in many secondary ways, such as longer lead times from suppliers, some suppliers and service providers have closed and absenteeism has increased for many reasons, including needing employees to self-isolate. As mentioned, we have implemented a number of rules and practices to do everything possible to keep our employees safe while at work. These measures include: Increased plant cleaning and sanitizing, mandatory temperature checks for all employees and any visitors entering our facility, severely restricting all travel and incoming visitors, to name a few. Using our absenteeism rate as a proxy for productivity, we're running at about 85% typically right now with a few dips as specific events happen. In our second quarter, we had 2 cases of COVID-19 with our employees in our Circuits-Chatsworth operation. And since quarter end, we have had 2 more in Aerospace-Chatsworth. In each case, the employee stays home until they recover, and with others who work in the area, test and stay at home is necessary. We have not seen any spread of the virus within FTG, so we believe our rules are keeping people as safe as possible. Recently, California has seen a resurgence of COVID-19, and are scaling back their reopening plans. But there has been no further impact to our operations to this point in time. Virginia was subject to a stay-at-home order during our second quarter as well. And again, FTG Circuits Fredericksburg remained open due to defense being deemed an essential industry. So far, the impact there on productivity has been minimal. We did have a fire in appliance in June but more on this later in my talk. Ontario also had a sale order in our second quarter. But again, FTG remained open as manufacturing was designated an essential business. Again, we are seeing increased absenteeism in our Canadian plants during this period. And again, there are increased measures to try to keep everyone safe. Like California, using absenteeism as a proxy for productivity, Toronto sites are running at about 85%. We had 2 cases of COVID-19 in our Toronto facilities right at quarter end. Again, sent many others to test and found no spread of the virus within FTG. So overall, in short term, there is some disruption and a lot of uncertainty. And at any time, if there were a significant event at any site, it could get shut us down indefinitely for the safety of our employees. But I believe we can and will manage through our short-term COVID-19 related challenges. I believe the longer-term implications from the coronavirus are much more complicated with larger risks and much uncertainty. So here is my assessment of the market implications as a result of the virus. Air travel is down dramatically across the globe. There are government-posed restrictions on most international travel, and people are concerned and not traveling for almost any reason. As a result, airlines are in survival mode. While some travel restrictions are beginning to be lifted, it looks like it will be a long, slow process over a few years to get back to where we were. Airlines will, and have to, defer aircraft deliveries they can't afford, particularly when they have more than 50% of their existing fleet parked. This has to ripple back through the aerospace industry from the OEMs of Boeing and Airbus down through their supply chain. We have been tracking what is happening to others in the industry and what actions they are taking. Some examples are: Boeing raised $25 billion in new debt, and they are working to reduce their workforce by 10% or 12,000 people through a combination of voluntary and involuntary actions. They also announced plans to reduce 787 production by about 50% over the next few years. And they are still working to get their 737 research live. But in the near term, while they have restarted production, it is at a very low rate. They have over 400 planes already finished that have not been delivered to customers until the recertification is complete. Airbus has announced plans to reduce production 30% to 40% and also announced plans to reduce their workforce. Honeywell raised $6 billion of new debt and reported an 11% decline in OEM deliveries in their first quarter, which ended in March. They reduced staff recently. In Canada, Magellan reported an 11% decline in their revenues in their most recent quarter also ended in March. In their latest quarter, Lockheed Martin reported an 8% revenue growth over the previous year. Lockheed's business is primarily focused on the defense market. We continue to see mixed signals in the business and regional jet market segment. And in areas we participate in the whole aftermarket, we have seen increased orders in 2020 compared to 2019. As we went through the quarter, we did start to see push-outs of orders from various customers and reduce in orders in the commercial aerospace market. Having said this, our orders in Q2 this year were within 10% of orders in Q2 2019, and our backlog remains at over $50 million at the end of the second quarter. For FTG, roughly half our revenue was defense. Going forward, about 10% is simulator work and the remaining 40% is all types of commercial aerospace. We believe the most significant risk to future revenues is from commercial aerospace, with the other segments being solid. We still need to be mindful of the future and the likelihood of a downturn. We have taken actions to stay ahead of the curve. For example, we have a hiring freeze across the company as well as the pay freeze. Where the pay freeze relates to our represented employees, we are in discussions with them as to what we can and will do. We have cut back our CapEx plans for 2020. We have pursued government support wherever it is available. As noted in our second quarter press release, during the quarter, we received approximately $800,000 in emergency wage subsidies from the Canadian government, and we received USD 2.3 million as a loan under the U.S. Paycheck Protection Program. These loans can become forgivable in future quarters if certain conditions are met. There have been other opportunities to defer or delay tax payments in various jurisdictions that we operate. Beyond this, let me give you a quick update on our Q2 results. We achieved sales of $26.8 million in Q2, 2020 compared to $32.2 million in Q2 last year. There are a number of moving parts within these numbers. First, as previously discussed, our simulator-related sales are much more volatile than our traditional work and can vary significantly from quarter-to-quarter. In Q2 last year, simulator-related sales were over $5 million, and in Q2 this year, they were only $2 million. This reduction in simulator work impacted all 3 of our aerospace sites. Other than this item, we did see revenue decreases across all but one site, offset by the addition of our Circuits Fredericksburg site in this year's results. By far, our biggest impact was across our Aerospace segment, where again, reduction in simulator related sales impacted us significantly. In the quarter, sales were down 44%, of which 23% was due to the variability in simulator related. Looking forward, our simulator-related activity will pick up in Q3 and should stop being a drag on our top line. On the circuit side of our business, sales were up 2% on a year-over-year basis in Q2. Decreases at the 2 North American sites were offset by the addition of our Fredericksburg site. Beyond our revenues, let me summarize some key positive metrics for the quarter. We achieved a book-to-bill ratio in Q2 of 0.97 to 1. We ended Q2 2020 with over $50 million in total backlog. Of this, $28 million is due in Q3 2020. But I can see some of this $28 million that will not shift in Q3 due to component related shortages. We generated $3 million in cash from Q2 and ended the quarter with $6.4 million in net cash on the balance sheet. We achieved our highest ever gross margin percentage of 32.3%. We achieved net income of $2 million in the quarter or 7.6% of sales. We achieved EBITDA of $5.2 million and trailing 12-month EBITDA of $12.9 million. Overall at FTG, our top 5 customers accounted for 54.1% of total revenue in the quarter compared to 51.1% last year. The percentage is up slightly due to the ongoing consolidation, such as the combination of Raytheon with United Technologies that was completed in the quarter. Also interesting to note, of the top 10 customers, 5 are customers shared between Circuits and Aerospace. We like to see the shared customers as it means we are maximizing our penetration of these customers by selling both cockpit products and circuit boards. In Q2 this year, 27% of our total revenues came from our aerospace business compared to 40% last year. The drop is attributable to our drop in simulator related work as well as our acquisition of the Circuits Fredericksburg business, which consolidates into our Circuits business segment. I'd like to turn the call over to Jamie, who will summarize our financial results for Q2 2020. And afterwards, I will pop with some site-specific items and other key priorities we are working on. Jamie?
Thanks, Brad. Good morning, everyone. All references to dollar amounts in my comments refer to Canadian currency and NOLs. I would like to provide some additional detail on our financial performance for Q2. On sales of $26.8 million, FTG achieved a gross margin of $8.7 million or 32.3% compared to $9.7 million or 31 -- 30.1% on sales of $32.2 million in Q2 2019. The negative impact on gross margin resulting from lower sales volume was mitigated by strong cost controls, the Canada emergency reach subsidy, the weaker Canadian dollar and high manufacturing throughput. All of the sites were able to maintain operations during the quarter, albeit with varying degrees of challenges as previously described by Brad. From a geographical standpoint, 79% of FTG's Q2 sales were derived from customers in the United States, which is up from 73% in the prior year. This shift is attributable to continued strong demand from the U.S. defense market and the acquisition of FTG Circuits Fredericksburg. The Fredericksburg site, which contributed $2.6 million to Q2 2020 sales, currently sells primarily into the U.S. Northeast region and primarily to defense market customers. SG&A expense was $4.1 million or 15.1% of sales in Q2 2020 as compared to $4.1 million or 12.8% of sales in Q2 2019. The incremental operating expenses of the acquisition of the Fredericksburg site were offset by lower professional fees, lower employee termination costs and reduced travel costs within the quarter. R&D costs for Q2 2020 were $1.6 million or 5.9% of net sales compared to $1.2 million or 3.6% of sales for Q2 2019. The R&D efforts include development and integration of robotic manufacturing equipment at the Circuits Toronto site and efforts to develop and qualify products for future aerospace programs. FTG adopted IFRS 16 effective December 1, 2019, start of the fiscal year, with the result being a recognition of right-of-use assets of $13.8 million and lease liabilities of a similar NIM. In FTG's case, all of our facility [ in the ] Middle East and the widely recognized, include both the present value of obligated lease payments and the present value of these payments for lease extension options, which we anticipate will be exercised. Q2 2020 operating results include depreciation of right-of-use assets of $401,000 accretion on lease liabilities of $141,000 as new cost elements within our P&L. Absent this accounting change, Q2 2020 P&L would have included rent expense of $466,000. The net IFRS 16 impact for Q2 2020 is a reduction of earnings before income tax of $76,000. During Q2 2020, the weakening of the Canadian dollar as compared to the U.S. dollar by approximately $0.04, resulting in foreign exchange gains of 500 -- $0.5 million as compared to foreign exchange losses of $100,000 in Q2 2019. These gains are incremental to the favorable impact on revenue. Earnings report and EBITDA was $13.0 million for trailing 12 months period ended Q2 2020 as compared to $15.9 million for the trailing 12 months ended Q2 2019. The EBITDA margin for the trailing 12 months Q2 2020 is 12.2% as compared to 12.5% for the comparable period ended Q2 2019. For Q2 2020, FTG recorded earnings before income taxes of $3.3 million as compared to EBIT for Q2 2019 of $3.8 million. The Q2 2020 income tax provision of $1.3 million or 39% of pretax earnings, reflects that the -- the corporation's Canadian operations were profitable and that deferred tax assets on foreign operating losses were not recognized in the quarter. Our net cash position as of Q2 2020 was $6.4 million as compared to net debt of $2.2 million as of Q2 2019. Free cash flow defined as cash from operations less cash used in investing activities, excluding acquisitions, was $3 million for Q2 2020 as compared to $2.3 million for Q2 2019. During Q2 2020, drivers of free cash flow were the strong operating results, prudent management of working capital and the Canadian wage subsidy of $0.8 million. As at quarter end, the corporation's primary sources of liquidity totaled $57.2 million, consisting of cash, accounts receivable, contract assets and inventory. During Q2 2020, FTG's U.S. operations received Paycheck Protection Program or PPP loans of USD 2.4 million or [ CAD 3.3 million ]. These loans may be forgiven in whole or in part to the extent permitted under the program. Subsequent to the end of the quarter, FTG concluded a 2-year committed revolving credit facility with our bank of USD 20 million on terms which are similar to the previous agreement. This facility includes USD 10 million in support of working capital requirements and USD 10 million in support of capital -- CapEx investment. As of May 29, 2020, outstanding term loans with the bank commented to USD 3.3 million or CAD 4.6 million, leaving over USD 16 million of unused credit availability. Working capital at May 29, 2020, was $30 million as compared to $28.6 million as of the 2019 year-end. Accounts receivable days were outstanding were 66 as at Q2 2020 compared to 70 as at the 2019 year-end. Inventory turns were 2.9 as at May 29, 2020, as compared to 3.7 at the 2019 year-end. And accounts payable days outstanding 98 as at Q2 2020 as compared to 81 for the 2019 year-end. The increased level of inventory is in part the result of working process inventory in support of simulator revenues scheduled for the second half of 2020. Investment in plant and equipment for Q2 2020 was $1.4 million. Current capital -- current quarter capital expenditures included [ deburring ] line additions, a planarizer and information technology infrastructure of approximately $250,000. Although we enter Q2 -- Q3 2020 with a strong backlog of $50 million, we are operating with considerable uncertainty with the global economy as a whole, and in particular, within the commercial aerospace market. To mitigate the risk, we will be focused on cash management, cost control and operating efficiency. In addition, governments in Canada, the United States and China, each continue to assist in -- offer assistance in various ways. We will record additional Canada wage subsidies of $800,000 for Q3, and China just announced a reduction of corporate income tax rates for calendar 2020. Our complete set of Q2 2020 filings are now available on sedar.com. With that, I would like to turn things back over to Brad.
Thanks, Jamie. Let me delve into some details at the corporate level and then at some of the sites. First, we clearly had a surprisingly high gross margin in Q2 relative to our revenue. As I have said many times, for FTG, top line drives bottom line. But in this quarter, our margin and bottom line was better than you would expect. Let me provide some insight as to why that is. There are 4 main reasons. First, we did receive $800,000 Canadian wage subsidies in the quarter. And of this, about $700,000 was credited to cost of sales. This increased our margins by about 2.6%. In the quarter, we also benefited from dramatic devaluation of the Canadian dollar that peaked in March and then slowly recovered a bit in April and May. Any devaluation of the Canadian dollar increases our profitability in our Canadian plants as almost all revenues are in U.S. dollars and costs are partially in Canadian dollars. Next, while our revenue was $26.8 million, our throughput was $2.8 million higher, as we built work in process and finished goods, primarily for upcoming simulator program deliveries and throughput also drives profit. And lastly, the management team and everyone at FTG did a great job this quarter managing costs and performing exceptionally well during these very challenging times. Looking at our various sites, Circuits Toronto had a very solid quarter, with sales down only 4% to 5% compared to Q2 last year. But as the site is more heavily focused on commercial aerospace, we are seeing some more weakness in the coming months. Aerospace Toronto sales were down almost 40%, which was almost all due to the timing of simulator program deliveries. They were one of the sites that built work in process in advance of higher simulator sales in Q3 and 4. While they do some commercial aerospace work, they have a reasonable percentage of military revenue. And that, combined with the already noted simulator related revenue suggests they should be less impacted in the coming months. In Aerospace Tianjin, sales were down to 10% on a year-over-year basis, again, due to the drop in simulator related work there. Looking forward, their outlook is a bit challenging as they are almost exclusively focused on commercial aerospace market. In the circuits joint venture in China, activity was actually up slightly on a year-over-year basis, but still on a very small base. They are also exclusively focused on the commercial aerospace market. So we do expect some challenges. At Circuits-Chatsworth, revenue was down about 30% year-over-year. This was not due to any market weakness, but more due to operational challenges for COVID-19 at FTG and with some suppliers. This site has had the most impact from COVID-19. They have, however, had strong bookings this year, and their focus primarily on the defense market bodes well for them in the future. At Aerospace-Chatsworth, activity was also down about 30% due to the temporary drop in simulator work, and there was an additional drop due to timing of other defense programs. But they, too, are very focused on the defense market, and their backlog of work for the future looks strong. Subsequent to quarter end, we have already booked over $3 million of new simulator and defense contracts, as an example. Circuits Fredericksburg is our newest site, and they contributed about $2.6 million in Q2 in revenue, and May was one of their highest sales months in the history of the company. While their focus is defense oriented, they do have a component of commercial aerospace work that could see reduced demand in the coming months. Also, as noted in our press release, they did have a fire at a plant in June. The fire damaged one piece of equipment, and there was collateral damage through larger areas of the plant from smoke and water. But production was down for just 2 days and a workaround plan for the damaged piece of equipment is in place. The wide plant remediation is underway and progressing well. Almost all FTG sites have scheduled a summer shutdown this year, typically for 1 week in our third quarter. This will help us manage costs during the slowdown in the industry in the summer months. We continue to manage our balance sheet, particularly during these uncertain times. Our pursuit of government assistance in all jurisdictions in which we operate as well as the tax deferral or delayed payment opportunities have also helped. In the quarter, performance share units, or PSUs, vested in Q1 were paid up to certain executives, and for the first time at FTG, the required shares were purchased in the market. And while a cash cost to FTG, this eliminated any dilution in our share base. This made sense to us given our strong cash position, combined with the relative weakness in the FTG share price. With a focus on operational excellence in all parts of FTG, our short-term focus on maintaining a strong balance sheet, we expect to weather the storm and return to long-term growth and improving financial metrics when we get past the short-term challenges. This concludes our presentation. I do thank you for your attention. I would now like to open the phones for any questions. Carol?
[Operator Instructions] Our first question this morning comes from Nick Corcoran from Acumen Capital.
I think in your MD&A and your prepared remarks, you said that you have the Canadian wage protection, the U.S. payroll protection and then the tax cuts in China. Have there been any government programs that might benefit you either in the quarter or going forward?
The ones you mentioned definitely benefited us in the quarter. And the one that really impacted our P&L in Q2 was the Canadian wage subsidy, that $800,000 was a cash grant. And so it was credited into costs, $700,000 of it in cost of sales, $100,000 of it into SG&A. The U.S. payroll protection funding in Q2 provide USD 2.3 million of cash, but offsetting that was $2.3 million of debt. So it did not hit our P&L and really was -- an in and an out on the balance sheet. As I think both Jamie and I said, in the future, that program does have provisions where that loan can be forgiven. It's primarily tied to ongoing employment and wages. And if we achieve that, then that could benefit our quarter -- or our P&L in future quarters. The other thing, Jamie did mention during his talk, subsequent to the end of Q2, coming back to Canada, we have qualified for one more round of Canadian wage subsidy for a further approximately CAD 800,000. So that will benefit Q3. After that, the amounts get a lot smaller. There are tax deferrals or delayed payments we're seeing in Canada. There's been some reduced employee benefit costs in China, but they're minimal or not terribly material compared to the other numbers.
Great. And then you made some comments about just longer lead times on components might impact your ability to get through the $28 million of backlog in Q3. Can you give any indication what percentage of the $28 million might be affected in the quarter?
Yes. And I guess, I can elaborate a little bit. So $28 million is what is due to new customers in the quarter. But then there are component delays and one of our ongoing challenges, and this seems to always be our big challenge in Aerospace Chatsworth is, an assembly might have 100 component in it. If one of them is missing, then you can't ship. So we kind of work through this on a day-to-day, week-to-week basis. And when we try to chase that final component to try to get it in. I guess, specifically to answer your question, I don't have an exact number, but I do know that some components that we're hoping to get look like they're not coming in, in Q3 right now. But beyond that, Q3 is always a bit of a slower quarter for us. Just -- and I mentioned we're doing shutdowns, but whether we do shutdowns or don't do shutdowns, there's a lot of vacations that people take during Q3. And so essentially, one way or another, I look at it always about a weaker production across the company due to vacations. And so that's going to impact my Q3 numbers, again, somewhat independent of what the backlog looks like. So I said those are the big items. But for me, say, I don't expect to ship all $28 million of what we see in backlog.
Okay, great. And then just a final question for me. How long do you expect to see the full impact of COVID on the supply chain for commercial aircraft?
That's a really tough question. The -- just given -- and what we do is we try to see what the big guys are saying or even what the airlines are saying. But now realistically, this industry downturn is -- it's not a few months. It's going to be a few years. And as people adjust production rates, that take a little while for it to kick in, that's what we're seeing now. And then, I would expect it to stabilize at the lower production rates. And then, as I say, over the couple of year period, it would start to climb back up to where we were before COVID-19.
[Operator Instructions] Your next question comes from Gabriel Leung from Beacon Securities.
I guess just 2 things, Brad. You mentioned -- you had provided your view on how things sort of -- you think things are going to play out on the supply chain side due to COVID. I'm just kind of curious, so the bookings or the pace of bookings that you're seeing now, do you think they're reflective of these lower production rates on commercial aircraft? Or do you anticipate that there's still another leg down to go in terms of how bookings will sort of play out for you guys as the market adjusts to the new reality?
Yes. I'd say our bookings are reflective of slower production rates in commercial aerospace. And then we are seeing a little bit of an offset. We have had -- and I mentioned one example. But particularly in our Chatsworth plants, the defense activity has been strong and remains strong. And so even subsequent to the end of our quarter, we're early in Q3, but Aerospace Chatsworth has booked a couple of significant defense contracts. And I think -- truly believe the defense market is going to stay robust for the foreseeable future. And that's really helpful to us.And I guess one other thing I would mention, and we've done small amounts of it so far, but we have moved a little bit of work from our Circuits Chatsworth plant, either into Circuits Toronto or Fredericksburg to try to balance the load between plants because, again, Chatsworth has seen good order, good backlog, good bookings, and it's in our interest to try to spread the good news into our other sites.
Got you. And just last question for me. In terms of the fire over at Fredericksburg, you mentioned that the potential impact from a revenue perspective is, I guess, 2 days' worth of production, is that what the expectation is? Or just given some ongoing stuff, it might be additional delays in production rates or utilization in the quarter?
No. That is my expectation. And the reason I say that is we are back in production. So we were down. We did lose 2 days’ production, but we are back in production. And the workaround is a little bit more complicated than just the normal production process, but it is certainly manageable. And I don't think it's going to impact their throughput any further in the quarter or beyond.
And perhaps just to add to that point, the fire was modest. The cost of equipment and downtime are being pursued through our insurance. So we expect to be maintained relatively whole.
And we have no one else in queue at this time. I'll turn the call back for some closing remarks.
Okay. Thank you. An instant replay of this call is available until August [ 10 ], 2020, at (416) 621-4642 or 1 (800) 585-8367, ID 1275227. The replay will also be available on our website in a few days. I thank you all for your interest and participation. Thank you.
Ladies and gentlemen, this does conclude today's conference call. Thank you once more for participating. You may now disconnect.