Firan Technology Group Corp
TSX:FTG
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Firan Technology Group Corp
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Good morning, ladies and gentlemen. My name is Jay, and I will be your conferencing operator today. I would like to welcome everyone to the FTG Quarter 2, 2021 Analysts Call. [Operator Instructions]. Please note that today's call is being recorded today, July 15, 2021, at 8:30 a.m. Eastern Time. I would now like to turn the call over to Mr. Brad Bourne, President and Chief Executive Officer of Firan Technology Group. Mr. Bourne, you may proceed.
Thank you. Good morning. I'm Brad Bourne, President and CEO 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 the current expectations of the management of the company and inherently involve numerous risks and uncertainties, known and unknown, including economic factors in 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 expressed 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. Our second quarter showed continued improvement as the impact of the COVID-19 pandemic diminishes. While our sales are not yet fully recovered to pre-pandemic levels, we are definitely seeing an improvement in demand in the commercial aerospace market. We were faced with a few COVID-related operational challenges in the quarter, which we managed as best we could. During the quarter, Toronto Public Health designated our Toronto Circuits plant, a COVID hotspot as we had 6 active cases at 1 time. They worked with us. And while they had the authority to shut us down, they deemed that this was not necessary. But with the 6 people absent and others who had close contact also absent, it did impact our operations over about a 2-week period. Also, during the quarter, we had higher than typical absenteeism in our Toronto plants as people took advantage of the new Ontario paid time off legislation, which allows up to 3 days of paid sick days. Our plants outside of Canada had no significant operational COVID impacts in the quarter. But as we get a higher and higher percentage of our employees vaccinated, we feel confident that we will have fewer and fewer disruptions to our operations. And with the increasing demand, we anticipate our sequential performance will improve. Before we get into the details, let me summarize some key accomplishments from our second quarter. FTG achieved a second sequential quarter of increased bookings as the aerospace industry recovers from the COVID-19 pandemic. Second quarter bookings are up 8% over Q1 2021 and up 20% over Q4 2020. This was in the face of a strengthening Canadian dollar, which has been a headwind over the past year. Gross margins rebounded 7.2 percentage points over Q1 2021 to 26.8%, with increased revenues and stronger operating performance, demonstrating the operating leverage that results from increased sales. FTG increased net cash on the balance sheet of $14.8 million, an increase of $1.4 million in Q2 2021, again, showing the cash-generating nature of the business. Over the past 18 months, during the pandemic, FTG has generated $13 million in free cash flow after investments in R&D and capital equipment. FTG was approved for an additional $1.2 million in Canadian emergency wage subsidy in the quarter, which we used to help maintain our workforce in the face of the revenue reductions due to COVID-19. Jamie will talk about the financials shortly, but I'd like to highlight some very important technology and sales-related accomplishments from the quarter, including FTG received significant new bid and qualification opportunities for both businesses that are expected to benefit FTG revenues and market share in the coming quarters. These included repeat -- repatriation efforts of a key customer to reshore some circuit board sourcing to North America, new aerospace opportunities for circuit board sourcing from low-cost countries, opportunities to participate in the new U.S. trainer aircraft cockpit, increased awards for circuit boards on a contract renewal from a U.S. Tier 1 avionics manufacturer, new qualification opportunities for circuit boards from a major U.S. headquartered EMS provider, new opportunities for space applications for circuit boards, and we shipped our first flight cockpits for manned space vehicle within the quarter. Large new circuit board and assembly opportunities from a major U.S. defense contractor and the number of U.S. military aftermarket assembly opportunities for multiyear procurement. These have already converted into about $2 million in incremental annual sales and the potential could be over $5 million as these efforts come to a conclusion. In addition, the [indiscernible] semi added a circuit board manufacturing in our Circuits Fredericksburg facility was installed and operational in Q2. The activities have been initiated with over 10 customers that develop this process to address future industry demands. This is a longer-term R&D initiative, but one we consider strategic. This manufacturing process is definitely more environmentally friendly, and the end product should have improved signal integrity. Now let me switch over to the market or external situation as we see it now. To state the obvious, the COVID-19 pandemic deeply impacted air travel last year. This in turn impacted the airlines, which then flowed through to hurt the aerospace industry. But we are seeing a positive trend developed now. In June, for the first time since the start of the pandemic, U.S. air travel exceeded 2 million people in a single day. This is nearing 80% of pre-pandemic levels. And we are seeing the easing of travel restrictions and travel -- easing of travel and border restrictions. So barring any unforeseen setbacks like a vaccine resistant variant, we anticipate an improving market going forward. There are many predictions regarding the length of time to recover, but all of them indicate or forecast a strong commercial aerospace market in 2022, even if not quite back to pre-pandemic levels. Have also looked at results from defense contractors and Lockheed, the largest defense contractor, reported a 4% revenue growth in their most recent quarter, while Northrop Grumman reported a 6% growth. The defense market is government-funded, and it appears well supported in the near term as part of efforts to stabilize the economy. At a higher level, President Biden released his defense budget request for 2022 and it had some growth. So this market should remain strong for a while longer. Also looking at the longer term, Boeing's 20-year forecast, well, lower than last year, it does show growth beyond the 2- to 3-year downturn as air travel recovers, and it continue to show 40% of all aircraft deliveries going to Asia as has been the case in their recent forecast. The business jet market has already seen traffic recover. This appears to be due to people believing private jets are safer than commercial air travel, and in some cases, because commercial flights are not available. There was a dip in business jet deliveries in 2020, but it appears this market will recover quickly. The simulator market mirrors the end market application. So commercial aerospace simulator activity is down, whereas defense simulator activity remains strong. But as we always remind everyone, this market is lumpy. So year-to-year variations do occur. So as we've said for many years, FTG's goal is to participate in all segments of the earlies and defense market and each goes through their independent business cycles. This continues to prove effective. In the past number of years, dips in activity in helicopter and business jet markets did not impact FTG's growth line. Now the commercial aerospace market is in the downturn, but it represents about 40% of FTG's overall activity, we have significantly mitigated the impact. Our Circuits Toronto sites or our China sites are most quite -- are most closely tied to commercial aerospace. So they were the most impacted. Our U.S. sites are more focused on the defense market, and we saw increased activity at some sites and decreases at other. Once again, in the quarter, there were some organizational changes in the U.S. that had a short-term negative impact on our results. This included a new General Manager in Fredericksburg as the previous GM departed for family reasons and lesser changes in Circuits traffic. Beyond all this, let me give you a quick update on our second quarter. In Q2, sales were $20.3 million versus $26.8 million in Q2 last year. Q2 last year was the last quarter before the full impact of the COVID pandemic really hit FTG. The drop relates to lower demand in commercial aerospace, the impact of COVID-19 on our operations, the impact of organizational changes already mentioned, and a drop in our simulator-related activity of $1.3 million. And finally, an 11% strengthening of the Canadian dollar over the past year. Surprisingly, in our aerospace business, sales were actually up 2% or $100,000 when comparing Q2 this year to Q2 last year. This business benefited from increased activity from our Chatsworth plant, which does predominantly defense work. This increased activity more than offset the $1.3 million decrease in simulator activity. With regard to the stimulator activity, as we have seen on numerous occasions in the past, this market has more variability from quarter-to-quarter and year-to-year. It appears that through 2021, the total simulator activity will be down compared to the previous few years. It is timing rather than any underlying change in overall market demand. The majority of FTG simulator-related activity relates to defense application. On the Circuit side of our business, sales were down $6.6 million or 35% on a year-over-year basis. Circuits Toronto was off the most in absolute dollars, but all 4 sites had decreased sales. Overall, at FTG, our top 5 customers accounted for 53.7% of the total revenue in the quarter. This percentage is very similar to Q2 last year. While the percentage is similar, the companies have changed. Last year's top 5 included or simulator company, and there are no simulator companies in the top 5 this year. Also, interesting to note, of the top 7 -- the top 10 customers, 7 customers are shared between Circuits and Aerospace. We like to see shared customers as it means we are maximizing our penetration of these customers by selling both cockpit products and Circuit boards. In Q2 2021, 36% of total revenues came from our Aerospace business compared to 27% in Q2 last year. The strong sales in Aerospace-Chatsworth combined with the overall lower Circuit board sales drove this change. I'd like to turn the call over to Jamie, who will summarize our financial results for Q2 2021. And afterwards, I will provide some sight specific updates. Jamie?
Thanks, Brad. Good morning, everyone. All references to dollar amounts in my comments are to Canadian currency, unless noted. I would like to provide some additional detail on our financial performance for Q2. On sales of $20.3 million, FTG achieved a gross margin of $5.5 million or 26.8% compared to $8.7 million or 32.3% on sales of $26.8 million in Q2 2020. The decrease in gross margin dollars and rate is the result of reduced operating leverage on lower sales volumes, partially mitigated by the CWS program. The Canada wage subsidy amounted to $1.2 million in Q2 '21 as compared to $0.8 million in Q2 2020. On a sequential basis, Q1 2021 gross margin dollars are up $1.8 million and 7.5% margin points relative to Q1 2021. Although our operations were impacted by COVID-19, including the declaration of our Circuits Toronto operation as a hotspot by the local health authority. This impact was less than the Q1 2020. A large majority of FTG's customer contracts are denominated in U.S. dollars and recent appreciation of the Canadian dollar relative to the U.S. dollar had a negative impact on reported sales in Q2. The average FX rate experienced in Q2 2021 was 11% lower than in Q2 2020 and the estimated negative impact on sales is $2.5 million. This is partially mitigated by FTG's currency hedging program, which resulted in realized gains on FX forward contracts of $0.5 million added to sales during Q2, whereas in Q2 2020 and realized losses on FX per contracts resulted in $0.5 million deducted from sales. All in, we estimate a negative FX impact on sales of $1.5 million for Q2 2021 relative to the prior year quarter. From a geographical standpoint, 72% of FTG's Q2 sales were derived from customers in the United States, which is down from 79% in the prior year. The decrease is due to reduced sales to the commercial Aerospace market and lower simulator revenue. SG&A expense was $2.7 million or 13.1% of sales in Q2 as compared to $4.1 million or 15.1% of sales in Q2 2020. The cost decrease is due to reduced travel costs, fewer people as a result of attrition, lower performance compensation costs, reduced bad debt reserves and the favorable FX impact on costs incurred in U.S. dollars. R&D costs for Q2 were $1.5 million or 7.5% of net sales compared to $1.6 million or 5.9% of sales for Q2 2020. R&D efforts include process development in the Circuit segment and efforts to develop and qualify products for future aerospace programs. A portion of our R&D expense is customer-funded. From a balance sheet perspective, the Canadian dollar strengthened relative to the U.S. dollar by approximately 4.6% from the end of Q1 to the end of Q2 2021. The $544,000 foreign exchange loss identified in our Q2 operating expenses is primarily related to losses on the translation of the U.S. dollar denominated balance sheet items, including cash. This represents a negative swing of $1 million from Q2 2020, which included $464,000 of foreign exchange gains. EBITDA, as described in the press release, was $11.5 million for the trailing 12-month period ended Q2 compared to $13.0 million for the trailing 12 months ended Q2 2020. The EBITDA margin for the trailing 12-month sales ended Q2 is 12.7%, up from 12.2% for the comparable period ended Q2 2020. For Q2 2021, FTG recorded earnings before income taxes of $0.6 million as compared to Q2 2020 of $3.3 million. The Q2 2021 income tax provision of $0.6 million or approximately 100% of pretax earnings reflects that 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 2021 is $14.8 million as compared to net cash of $6.4 million as of Q2 2020. Subsequent to the end of the quarter, FTG was notified that its remaining PPP loan of USD 1.3 million or approximately CAD 1.6 million had been forgiven in full, which will be recorded as income in Q3 2021. Free cash flow, defined as net cash from operations and investing activities, excluding acquisitions, less lease liability payments was $1.9 million for Q2 as compared to $2.6 million for Q2 2020. Lower earnings in Q2 were partially offset by efficiencies in working capital balances and reduced CapEx spending. As at quarter end, the company's primary sources of liquidity totaled $50.7 million, consisting of cash, receivables, contract assets and inventory. Subsequent to the end of the quarter, FTG reached to agreement with our primary bank to extend the existing credit facility to 2026. This facility includes USD 10 million in operating loans, USD 10 million in support of CapEx and USD 10 million in support of future acquisitions. Working capital at June 4, 2021, was $41.3 million as compared to $39.4 million at the 2020 year-end. Accounts receivable days outstanding were 56 as of the Q2 close compared to 62 as of the 2020 year-end. Inventory turns were 3.0 as of Q2 close as compared to 3.8 at the 2020 year-end. And accounts payable days outstanding were 77 as of Q2 close as compared to 74 for the 2020 year-end. Investment in plant and equipment for Q2 was $0.6 million. We do anticipate a higher level of capital expenditures for the second half of 2021 with commitments of approximately $1.2 million already in place. We are entering the second half of 2021 with a backlog of $34 million and experiencing some momentum in the recovery of the commercial aerospace market. In terms of government assistance, the CEWS program remains available through September 2021. I will -- we will continue to review other similar opportunities. In any event, we will be focused on cash management, cost control and operating efficiency. With that, I will turn things back over to Brad.
Thanks, Jamie. For me, I thought our second quarter was exceptionally good in the face of some very stiff external headwinds. Revenue was up over 7% from Q1 but the foreign exchange rate moved negatively $0.04, which represents about a 3% revenue hit. And our sim -- our lumpy simulator activity was down $1.8 million compared to Q1 or about a 7% revenue hit. So when you adjust for these items, our core activity was actually up approximately 17%. Again, on a sequential basis, I thought our profitability also showed exceptionally strong improvement. As noted, our sales were up $1.8 million, and our reported profitability was up $400,000, which by itself does not sound too impressive. But if you look in our financial filings, we estimate that the impact on earnings for every 1% movement in the exchange rate at $113,000 in the quarter. The rate moved negatively $0.04, so this is a $400,000 headwind. When comparing the 2 quarters, Q2 had $1.1 million lower government support, and this was a huge headwind as well. So again, adjusting for these external factors, the profitability of the business was improved by almost $2 million on a $1.8 million increase in sales. This truly shows the performance improvements across FTG in Q2 compared to Q1. And our segmented results, you will see an increase in sales and in profits in our Aerospace segment in Q2 compared to the same quarter last year. Our Toronto facility has done a great job in managing costs down over the last 12 months, while improving performance to customers. And to support future sales, they have made some good inroads in increasing activity in the defense market. They are involved in some exciting new programs in the defense market, including a bezel for the new U.S. military trainer aircraft, just now starting production. Our Chatsworth facility had increased sales in Q2 compared to Q2 last year, given the strong demand for their defense products. They have the largest backlog of orders of any FTG site. And they have a long list of new sales opportunity, almost all coming from the defense market. I will also mention that a number of their opportunities are for aftermarket parts, again, for military applications. In our Circuits segment, as noted previously, sales in Toronto were down due to their reliance on the commercial aerospace market. But even at reduced revenues, they have managed costs carefully and remain profitable. Their sales are rough, however, compared to both Q4 last year and Q1 this year, again, indicating a recovery is building in the commercial aerospace market. But like our other Toronto facility, we are working to pivot our focus to defense opportunities for this site with some successes. I also see Circuits Toronto winning new market share across our customer base on a number of significant opportunities, some of which I mentioned earlier in my [indiscernible]. Fredericksburg started Q1 slowly, but they have had improved bookings more recently. During the quarter, the General Manager of Fredericksburg at the Fredericksburg site resigned for family reasons. The transition to a new GM caused a little disruption in operations, but I believe this will be short-lived, and the site will ramp with the market. Circuits-Chatsworth continues to see strong demand but has yet been able to ramp production to benefit from this demand. We have further strengthened the management team there, and we believe the changes will improve results going forward. We fully expect they will write that shift in the coming months. To assist in the recovery of Circuits-Chatsworth, we are investing in some key new pieces of production equipment, to in-source some processes, which will save costs and improve cycle time. The first of the equipment arrived at the end of Q1 and the balance is expected in Q3. Both our China sites are exclusively focused on the commercial aerospace market. So both saw a drop in activity. But as noted from the Boeing market forecast, Asia remains a key market for commercial aerospace activities. So we believe these sites will be valuable in the long term. Some of our sales and qualification accomplishments in Q1 and Q2 will greatly benefit our Aerospace Tianjin facility. And progress continues on the C919 aircraft development in China. And while we have not quite completed our qualification activities, we expect to ship production orders in Q3 of this year. At our Circuits joint venture in China, the uncertainty regarding the new owners of our partner are settling down in a positive way. We are seeing new wins and increased demand at that site for the end of Q3 and beyond. But the U.S. government continues to move forward with requirements for reshoring or U.S. sourcing of aerospace and defense electronics over a period of years, and this could impact our plans in China. But with the -- at the same time, create increased demand for our North American plant. It is early in this process that any longer-term implications will play out in the coming years. We continue to manage our balance sheet. Our cash on the balance sheet increased from $12.6 million at the end of 2020 to $14.8 million at the end of Q2 2021. We are seeing a number of acquisition opportunities arise that could fit with either of our businesses. Given our increased confidence in our performance at reduced revenues and our very strong cash position and our new bank facility, we are evaluating these opportunities. Our criteria for any such transaction would remain what we have always said. They would need to meet a number of the following objectives. To be aligned with our current market and product focus, expand our technology offering, expand our geographic coverage to Europe for commercial aerospace or defense markets, accelerates FTG's penetration of the aftermarket segment, drive up plant utilization and, of course, have an attractive price and multiple and be accretive to earnings. And finally, looking forward into the balance of 2021 and beyond, there are reasons for optimism. As already noted, the industry is talking about recovery and ramping production. Our sales team has been doing a stellar job and we are seeing and winning new programs and adding new customers. And finally, we expect to see continued benefit from the wage subsidy program in Canada as this program runs through September of this year. And as Jamie mentioned, we had the remaining USD 1.3 million U.S. dollars to U.S. PPP funds forgiven in early Q3. In the U.S., there's also a new fund for Aerospace manufacturers that we are investigating. These programs together will help us remain financially strong until we see the full recovery take hold. With the focus on operational excellence in all parts of FTG, our demonstrated financial performance at lower revenue levels, we are confident we will weather the storm and return to longer-term growth in the coming years. This concludes our presentation. I thank you for your attention. I would now like to open the phones for any questions. Jay?
[Operator Instructions] And the first question will come from Nick Corcoran with Acumen Capital.
The first question is just to do with the simulator revenue is down year-over-year. Once you expected your expectation for the remainder of the year? And do you expect this to return to historical levels?
Yes. Let me answer the second part first. So yes, we definitely expect to return to historic levels. It's just the nature of this business, particularly on the defense side, which is where we play it tends to come in program lumps, significant awards. Historically, we've seen individual awards between $5 million and $8 million at a time. And just timing this year looks like that's not going to happen. But going forward, the programs we're involved in, I fully expect there will be demand, and we will see that. With regard to 2021, I guess, we've looked at it a few different ways. But over the last few years, on average, our simulator activity has ranged kind of $12 million to $14 million a year. In 2021, I would expect to be half or maybe even a touch lower than half of that, again, it's just the timing of programs.
Great. And then maybe just moving to the announcement that you're closing in the Dallas-Fort Worth office, what would the annual cost savings from that be?
Excellent question. We should have talk about that one. But yes, as we announced in the press release, we are closing at the end of this -- our year, the Dallas-Fort Worth engineering office. Just to put it in context, when we bought PhotoEtch back in 2016, we maintained an office there really just to support an engineering team when we transition manufacturing but we decided it's time and it's appropriate to really consolidate all the activity into Chatsworth. We are doing that. And we're really not changing headcount significantly. So that cost stays. The savings in the end really ends up being the facility and related costs, which maybe is $200,000 to $300,000 a year. And that savings would start next year.
Great. And then just one last question for me. It seems like things in the commercial aerospace have started to improve. Do you think we've seen the bottom? Or do you think there's downside risk going forward?
Yes. Again, borrowing, what I said, some vaccine resistant new strain. I think we have seen the bottom. And we look at it -- the first thing the bottom was our bookings. So last year in Q4, our bookings bottomed out. They ramped up in Q1 and ramped up again in Q2. And then sales was really lagging that by 1 quarter. So our sales bottomed out in Q1 this year have ramped in Q2, and I fully expect that ramp to continue as the industry recovers going forward.
The next question is from Ashvin Moorjani with Edward Jones.
During the previous call, you touched on -- during the previous call, you touched upon what your major clients want in terms of supplier side. Have you had any update on this? That's the question.
Right. Let me just -- I would say no real update. And what we have seen is if you go up the food chain in the aerospace and defense market and industry, we've seen consolidation of the bigger players. And the best example is Raytheon Technologies is now a combination of what was Raytheon plus United Technologies plus Rockwell Collins. But I guess, as we saw our customers get bigger, the size of the suppliers and the ability to support these larger organizations went up. I do believe we are definitely of a scale that we still have the ability to support these larger customers. But I don't see any change in that in maybe the last year or so.
[Operator Instructions] Okay. And at this time, there are no further responses.
Okay. Thank you. A replay of the call will be available until August 15. As the numbers noted on our press release. 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, thank you for participating in today's conference call. You may all disconnect.