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 Q3 2020 Analyst Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I'd now like to hand the conference over to your speaker today, Brad Bourne. Please go ahead.
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 the current expectations of 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. Well, our third quarter was an excellent quarter operationally and financially. With all the challenges we faced, I'm extremely pleased with how everyone at FTG responded and with the results we achieved. I will explain more later in my talk. But first, let me start with the external situation as we see it now. To state the obvious, COVID-19 has deeply impacted air travel in 2020. This, in turn, has impacted the airlines, which then followed through to hurt the aerospace industry. I have been watching results from various aerospace companies and in the latest quarter being reported, revenues have been down from the high 20% to high 30%. Similarly, Airbus and Boeing have reported production rate cuts in the 30% to 40% range. And we are seeing similar drops in our commercial aerospace activities. Estimates are air travel and commercial aerospace activity will take 2 to 3 years to recover to 2019 levels. So this will be a tough market, and at least through 2021. Yesterday, Boeing put out their updated 20-year forecast. And while it is 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 new aircraft delivery is going to Asia, as has been the case in their recent forecast. But I also looked at results from defense contractors and Lockheed, the largest defense contractor, reported a 12% revenue growth in their most recent quarter. Other defense contractors reported mid-single-digit growth rates. The defense market is government-funded, and it appears well supported in the near term as part of efforts to stabilize the economy. The helicopter market has rebounded in 2020 with increasing production rates compared to previous years. It's not clear what is driving this, but there have been new models introduced by many of the OEMs, and this would be a positive factor. 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 no longer available. There will be a dip in business jet deliveries in 2020, but it appears this market will recover faster. The simulator market mirrors the end market application. So commercial aerospace, similar activity is down, whereas defense simulator market remains strong. As we have said for many years, FTG's goal is to participate in all segments of the aerospace and defense markets as each moves 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 plans. Now the commercial aerospace market is in a downturn, but as it represents about 40% of FTG's overall activity, it significantly mitigated the impact. In fact, in Q3, our sales were down only 12.8%. Our Circuits Toronto site is most closely tied to commercial aerospace, so they are the most impacted. Our U.S. sites are more focused on the defense market. And when looking at Q3 compared to Q2, our Aerospace-Chatsworth site showed growth of over 20%. FTG's activity in the simulator market is almost exclusively for defense applications. So this bodes well for us for the near term. In Q3, simulator-related activity was backed up above 10% of our total sales. Operationally, COVID-19 is impacting us, but at a secondary when compared to the market impact. We continue to have stringent health checks for all people entering FTG facilities. We continue to do enhanced cleaning at all sites, and we have taken many steps to ensure physical distancing in our workplace. To mitigate against the reduced demand, we have taken actions to stay ahead of the curve. For example, we have a hiring freeze across the company. We have reduced overtime at sites most impacted by the commercial aerospace market. For both our Toronto sites, overtime has gone from about 20% to virtually 0 through the quarter. Both these sites also shut down for 1 week in Q3. We have also had some attrition in staffing, and our total headcount was down 3% to 4%. Lastly, we have cut back our CapEx plans for 2020. We have pursued government support wherever it is available. In Q2, we received $800,000 in Emergency Wage Subsidy from the Canadian government, and we received USD 2.3 million as a loan under the U.S. Paycheck Protection Program. These loans can be forgiven if certain conditions are met. In Q3, we received another $800,000 in wage subsidies in Canada. We have received more in Q4 already, and we'll continue to pursue these subsidies. It is hope we can have the PPP loans forgiven in Q4, but no loans have yet been forgiven for anyone. There have been other opportunities to defer or delay tax payments in the various jurisdictions that we operate.Beyond all of this, let me give you a quick update on our Q3 results. We achieved sales of $24.4 million in Q3 compared to $28 million in Q3 last year. As we acquired FTG Circuits Fredericksburg in Q3 last year, it is now being included in both sides of this comp. Our simulator sales were up $1 million compared to Q2 this year, but down from Q3 last year. As previously discussed, our simulator related sales are much more volatile than our traditional work and can vary a lot from quarter-to-quarter.In our aerospace business, sales were down 10% or $900,000. The decrease is due to the drop in simulator activity year-over-year. But this will turn around next quarter as we have a large backlog of simulator-related orders due in Q4, and Q4 last year was relatively light. Again, this market will see significant variability from quarter-to-quarter. On the Circuit side of our business, sales were down $2.6 million or 14% on a year-over-year basis in Q3. Beyond our revenues, let me summarize some other key positive metrics from the quarter. We ended Q3 with over $47 million in total backlog. This is down about $3 million from the previous quarter. The backlog from site-to-site did see some significant changes with Circuits Toronto down and Aerospace-Chatsworth up. But overall, the almost $0.07 drop in the exchange rate was the biggest factor in the lower backlog. Of this backlog, $26 million is due in Q4 2020, but I can see some of this that will not shift in Q4 due to component-related shortages. We generated $3.2 million in cash in Q3, of which $800,000 was from the Canadian wage subsidy and ended the quarter with $8.8 million in net cash on the balance sheet. We achieved earnings before interest, taxes, depreciation and amortization, or EBITDA, of $3.3 million in Q3 and have a trailing 12-month EBITDA of $12 million. Overall at FTG, our top 5 customers accounted for 55.6% of the total revenue in the quarter. The percentage is up slightly from last year due to the ongoing industry consolidation, such as the combination of Raytheon with United Technologies that was completed in Q2. 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 Q3 this year, 36% of total revenues came from our aerospace business compared to 34% last year. The increase is due to the increased activity at Aerospace-Chatsworth arising from the defense market. I would like to turn the call over to Jamie, who will summarize our financial results for Q3 2020. And afterwards, I will talk about some key priorities we are working on. Jamie?
Thanks, Brad. Good morning, everyone. All references to dollar amounts in my comments are Canadian currency, unless indicated. I'd like to provide some additional detail on our financial performance for Q3. On sales of $24.4 million, FTG achieved a gross margin of $6.7 million or 27.6% compared to $7.9 million or 28.3% on sales of $28 million in Q3 2019. Strong cost controls, the CEWS program and productivity improvements provided offsets to the negative volume impact, thus maintaining the gross margin rate close to 28%. Actions taken included reduced overtime and 1-week shutdowns at the sites most impacted by reduced demand in the commercial aerospace sector. In addition, FTG's headcount has been reduced by approximately 4% from 2019 year-end levels, primarily through attrition. During Q3, FTG received $0.8 million in wage subsidies from the Canadian government to partially offset the impact of COVID-19. Productivity improvements included improved production yields and reduced outsourcing requirements. From a geographical standpoint, 75% of FTG's Q3 sales were derived from customers in the United States, which is down marginally from 77% in the prior year. Sales into Asia were 15% in Q3 2020 as compared to 11% in the prior year, which is driven by increased activity in support of the C919 program in China. SG&A expense was $2.8 million or 11.6% of sales in Q3 2020 as compared to $3.4 million or 12.0% of sales in the prior period. The reduced expense level is due to lower performance compensation, fewer employees, reduced professional fees and reduced travel costs.R&D costs for Q3 2020 were $1.3 million or 5.3% of net sales compared to $1.2 million or 4.4% of sales for Q3 2019. R&D efforts include product and process improvements at the Circuits segment and efforts to develop and qualify products for future aerospace programs.FTG adopted IFRS 16 effective December 1, 2019, with the result being recognition of right-to-use (sic) [ right-of-use ] assets of $13.8 million and lease liabilities of a similar amount. In FTG's case, all of our facilities are leased, and the liability recognized includes both the present value of obligated lease payments and the present value of lease payments for lease extension options, which we anticipate will be exercised. Q3 2020 operating results include depreciation of right-of-use assets of $400,000 and accretion on lease liabilities of $139,000 as new cost elements within our P&L. Absent this change, Q3 2020 P&L would have had included rent expense of approximately $466,000. The IFRS 16 impact for Q3 2020 is a reduction of earnings before income tax of $76,000. The average exchange rate experienced in Q3 2020 was $1.34 as compared to $1.32 in Q3 2019. However, during Q3 2020, the Canadian dollar appreciated from USD 0.725 at the end of Q2 2020 to USD 0.764 by the close of Q3 2020. This is an increase of 5.4%. FTG's balance sheet includes assets and liabilities denominated in U.S. currency, with a net balance of approximately USD 9.2 million. The translation of our U.S. dollar assets and liabilities into Canadian currency at the end of Q3 2020 resulted in an unrealized foreign exchange loss of approximately $700,000 for the quarter. Realized and unrealized foreign exchange losses in Q3 amounted to $1 million, including that $700,000 as compared to $0.2 million in the prior year quarter. Although FTG does have an active FX hedging program for sales and purchases in foreign currency, we currently have an unhedged balance sheet position as we are holding cash in U.S. dollars. Earnings before EBITDA was $12 million for the trailing 12-month period ended Q3 2020 compared to $15.3 million for the trailing 12 months ended Q3 2019. The EBITDA margin for the trailing 12-month period is 11.6% as compared to 13.5% for the comparable period in 2019. I would note that the EBITDA margin for Q3 was 13.4%. For Q3 2020, FTG recorded EBIT of $1.4 million as compared to $2.8 million of EBIT in Q3 2019. The Q3 2020 income tax provision of $0.8 million or 56% of pretax earnings reflects that the corporation's Canadian operations were profitable, and net deferred tax assets on foreign operating losses were not recognized in the quarter. Our net cash position as of Q3 2020 is $8.8 million as compared to net debt of $2.4 million as of Q3 2019. Free cash flow, defined as cash from operations, less cash used in investing activities, excluding acquisitions, was $3.1 million for Q3 2020 as compared to $6 million for Q3 2019. During Q3 2020, drivers of free cash flow were strong operating results, prudent management of working capital, and the Canadian wage subsidy. As at quarter end, the corporation's primary sources of liquidity totaled $55.3 million, consisting of cash, accounts receivable, contract assets and inventory. Subsequent to the end of the -- during Q3, FTG concluded a 2-year committed revolving credit facility with our existing bank of USD 20 million on terms which are similar to the previous agreement. This facility includes $10 million in support of working capital requirements and USD 10 million in support of CapEx investment. As at August 28, 2020, loans pursuant to this agreement amounted to USD 2.9 million or $3.9 million, leaving over USD 17 million of credit availability. During Q2 2020, FTG's U.S. operations received Paycheck Protection Program, or PPP, loans of USD 2.4 million or $3.1 million. These loans may be forgiven in whole or in part under the -- except committed under the program, and we have applied for forgiveness. Working capital as at August 28, 2020 was $37.1 million as compared to $28.6 million as of the 2019 year-end. Accounts receivable days outstanding were 59 as at August 28, 2020 compared to 70 as of the 2019 year-end. Inventory turns were 2.8 as at August 28, 2020 as compared to 3.7 at the 2019 year-end. And accounts payable days were 72 at the Q3 quarter-end as compared to 81 for the 2019 year-end. The increased level of inventory is, in part, the result of work-in-process inventory in support of simulator revenues scheduled for the near term. Investment in plant and equipment for Q3 2020 was $0.2 million. Capital expenditures in the quarter were limited to upgrades of existing facilities and equipment. We entered Q4 2020 with a strong backlog of $47 million, which is weighted more heavily to the military and simulator business with reduced backlog in the commercial aerospace sector. We will continue our focus on cash management and the balance sheet, cost control and operating efficiency. In addition, governments in jurisdictions where we operate continue to assist in various ways. We will record additional Canada wage subsidies of $1 million or more for Q4. Our complete set of filings are now available on sedar.com. With that, I will turn things back over to Brad.
Thanks, Jamie. Let me delve into some important items for the future performance of FTG. First, as Jamie outlined, I was extremely pleased with our Q3 financial performance. At $24 million in sales, we have shown we can be solidly profitable with continued strong cash flow. I see the quarter as pretty clean and that there were not significant onetime items. The wage subsidy of $800,000 was more than offset by the foreign exchange loss of $1 million. This FX loss comes from the change in exchange rates rather than the absolute rate, and the change in Q3 was an appreciation of almost $0.07 in the Canadian dollar. The throughput in the plants was very close to the $24 million in sales, so there's no impact from building or depleting inventories. I also see Q3 as an incredible improvement from our first quarter where we had comparable sales. In Q3, the margin was 11.5% higher at 27.6%. In absolute dollars, the margin is up $2.8 million. As mentioned, Q3 had throughput in line with sales, whereas Q1 had $1.3 million lower throughput. Q3 should be repeatable. Q3 benefited from the various labor cost savings of reduced overtime, brief shutdowns and the headcount attrition. Q3 had the $800,000 in wage subsidies and Q3 also had about $0.5 million lower in inventory provisions, primarily in Chatsworth. At the net income level, Q3 was $3.5 million better than Q1. Q1 had the $1.1 million intangible asset write-down, but Q3 had the $1 million FX loss. So these cancel each other out. The gross margin improvement above was augmented by over $0.5 million in SG&A savings from the slightly lower headcount, reduced travel and other discretionary expenses. As I stated, Q3 is a great quarter for FTG, and I believe it is representative of what we could achieve going forward. When factoring in any future government support or loan forgiveness, our results could be further augmented. In our segmented results, you will see a dramatic improvement in profits in our aerospace segment. Our Toronto facility has done a great job in managing costs down this year while improving our performance to customers. And to support future sales, they've made some good inroads increasing activity in the defense market. They have won some exciting new programs in the defense market, including a bezel for the new U.S. military trainer aircraft now just starting production. But equally impressive is the performance in our Aerospace-Chatsworth facility. They have ramped up sales from Q2 to Q3 this year by over 20%. They now have the largest backlog of orders for any FTG site, with Aerospace-Toronto being second highest. And they have a long list of new sales opportunities, almost all coming from the defense market. In our Circuits segment, as noted previously, sales in Toronto were down due to the reliance on the commercial aerospace market. But even at reduced revenues, they have managed costs and remain very profitable. But like our other Toronto facility, we are working to pivot our focus to defense opportunities for this site with some initial success. We've also moved work from our Chatsworth facility to Toronto to help manage the load at both sites. Fredericksburg was impacted somewhat in the quarter due to the fire in their facility at the start of the quarter, but remediation is complete and activity is back to normal. Circuits-Chatsworth continues to see strong demand but has yet been able to ramp production to benefit from this demand. So again, offloading some to Toronto and also some to Fredericksburg enables FTG overall to benefit from the demand they are seeing. 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 activity. So we believe these sites will be valuable in the long term. As progress continues on the C919 aircraft development in -- progress continues on the C919 aircraft development in China, and we now have our first production orders for our cockpit assemblies for this aircraft. We continue to manage our balance sheet. Year-to-date, our net cash on the balance sheet increased from $2.2 million at year-end to $8.8 million at the end of Q3. This would increase to near $12 million if the PPP loans are forgiven. We see a number of acquisition opportunities arising that could fit with either of our businesses. Given our increased confidence in our performance at these reduced revenue levels and our very strong cash position, 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: They would need to be aligned with our current market and profit focus, they need to expand our technology offering or expand our geographic coverage to Europe for commercial aerospace or defense markets, accelerate FTG's penetration of the aftermarket segment, drive up plant utilization and financially have an attractive price multiple and be accretive to FTG's earnings. So with a focus on operational excellence across all parts of FTG, our demonstrated financial performance that lower revenue levels, we are confident we will weather the storm and return to long-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 your questions. James?
[Operator Instructions] Our first question comes from the line of Nick Corcoran with Acumen Capital.
Just a couple of questions for me. The first is on the backlog. What's your confidence level in being able to get through close to that $26 million you mentioned in your press release and MD&A?
Sure. Yes. As I said, what we have that's deliverable is $26 million. And I guess there's 2 factors. I do believe we'll book a little bit more into our Circuits-Toronto facility because they have relatively short lead times to add to that number. But then for sure, I can see some orders, again, primarily out of Chatsworth, where I'm not getting components, specifically, in this case, some machine housings, they're not going to come in, in the quarter. So that will push it out. I would say our history is running kind of in the high 80% to 90% range of the backlog is shippable in the quarter. So I would say somewhere around that number.
Okay. Great. And then maybe just switching gears. What needs to occur for the U.S. PPP to be forgiven? And what do you expect the timing of that to be?
The timing is uncertain. The process, as we understand it, is to submit documentation through our bank, HSBC is the agent of the U.S. government. So we have submitted all documentation that has been requested thus far, and we are awaiting further information from the bank and any other authorities that have to be involved.
Great. And then the last question for me is how are the supply chains reacting to lower commercial air travel, and by connection, just lower demand for aircraft? And what would the time line for those to ramp up be?
Are you asking about our suppliers, our supply chain?
No, just the supply chain in general.
Okay. This -- the aerospace industry tends to, I can say, move gradually. So nothing changes in weeks. It's over a period of quarters when you ramp down and a period of quarters when you ramp up. But it's that order of magnitude. I would say if demand picked up or if production rates ramped up, you would see a 6-month, maybe 6- to 9-month time lag to get to the new production rates.
And where do you think we are in that 6- to 9-month time lag right now?
I guess, right now, I don't think we're seeing any intention to ramp production. I do think we have seen production ramp down, and I am anticipating, given what we're seeing in terms of backlog and orders and that, that we're tracking at the bottom or at the normalized run rate for this current production rates. And then when it starts to ramp up is to be determined. In the Boeing forecast they put out yesterday, they said they expect reduced demands for 2 to 3 years. If you assume 2020 is year 1, 2021 will be 2 years. And I would think it will be later in 2021 when we might see something start to happen. But there's lots of factors involved in that, obviously. I think if there was a vaccine, that would be good news for the whole travel and tourism and aerospace industries. And conversely, if there's a big second wave, that could delay things. So we'll have to wait and see.
And you mentioned we were tracking near the bottom. Do you see any potential downside risk from the activity levels we're at now?
No. Again, the industry doesn't move fast. So I would say that we're tracking at the bottom if travel doesn't come back or something bad happens again, could there be another step down. I guess, theoretically, there could. But I would not think that's a high probability at this point. I'd say, given just what you see and what I see in terms of news, I think the probability of at some point next year, there being a vaccine and see travel and tourism and the aerospace industry start to ramp up is more likely.
[Operator Instructions] Our next question comes from the line of Andrey Omelchak with LionGuard.
Great results during the quarter. Very impressive free cash flow generation. So congratulations to the whole team during these challenging times. I wanted to ask what portion of the business that comes from defense? And maybe you can give some more comments on the growth in the defense business overall. I think you commented a 12% growth roughly year-over-year. But if you could give us more color, that would be appreciated.
Yes. These are approximate numbers because some of what we do is actually dual-use. So it could be going into commercial aerospace or defense. But approximately, the way we split out our business these days, about 40% commercial aerospace, about 40% defense and the balance being simulator -- that might be a little bit high. Simulator is really running around 15%. But having said that, my simulator business is based on history. It's almost exclusively defense oriented. And so that's good news right now. So that means more than half of my business is coming out of the defense market. We are seeing good demand just for existing programs in the defense market. But I actually do believe at this point that the acquisitions we did a few years ago, in 2016, they were definitely challenging ones for us in terms of integrating the business and getting it ramped, have moved us to a different level of opportunity in the defense market. And so we're through that transition, obviously, but we are seeing new opportunities at a higher level assembly in Chatsworth, primarily, that we have not seen historically at FTG. So there are growth opportunities or opportunities to change our market share in the defense market that we have not seen historically. And some of these then take some time to get through. You'll get an opportunity. You might have to build some qualification product. And again, in that, we are at the point where we've seen some work we've been working on over the last year or 2 come to fruition where we are now through the qual activities, and seeing revenue streams from these qual efforts start to materialize in 2020.
Okay. Great. And my second question is given that you're having around the bottom of the cycle, are you starting to see some potential acquisitions? I mean you alluded to that, but anything is getting to be on a depressed valuation level? Can you grab some assets at potentially very attractive prices at this point? Or is there still kind of a pushback on the valuation front?
I guess, first, to specifically answer that, we're definitely seeing opportunities. There's been a significant number of opportunities materialized. I have not yet seen any that are because of financial distress, interestingly enough. I have seen a couple where an acquirer backed away, and therefore, because someone was in deciding to go down or go through the process, they're now looking for alternatives because their initial acquirer has vanished. But nothing on a depressed basis. And then specifically around valuation, nothing has got to the point where we're at a price decision or an offer. And therefore, I honestly cannot comment on whether valuations are still high or trending down. Hopefully, we'll see something along those line in the coming months.
And given the very strong free cash flow generation and the sizable, of course, net cash position on the balance sheet, is it fair to say, though, that any acquisition that you're contemplating, you would still want to keep some net cash on the balance sheet post the transaction? Or given the strong free cash flow generation, you would be comfortable to get into the kind of a 0 net cash or negative net cash position?
Yes. Obviously, the first criteria, the first decision point on that is based on the specific acquisition and what the size is and what the price would be. And for sure, things we have come across, there's a range of size, from small to significant. And so it's hard to say whether we would have to go into a net debt position on some of these acquisitions. But I am feeling pretty confident these days. We have consistently been cash flow positive every quarter. And so for the right deal, I would be willing to see us end up in a net debt position, not crazy levels, but some amount of debt.
Our next question comes from the line of John Sartz with Viking Capital.
Actually, one of the complaints I hear from manufacturers is absenteeism. And I'm wondering if you can comment on the level of -- number one, the level of absenteeism; and number two, the trend of it, if you will.
Okay. Yes, that's good questions. And I would say for the Q2 and much of Q3, our absenteeism was around, if someone tested positive or someone had close contact and had to go test, we were running -- depending on the site, kind of 5, maybe in Chatsworth a little bit higher of 5% to 10% absenteeism. Touch wood, but we've had very little issues around anyone testing positive recently or having close contact. But our new challenge is actually around parents with kids and schooling. And in some areas, schooling is virtual and so kids have to stay home and then the schooling is complicating things. And I'd say right now, that is what's driving our absenteeism across just about all the North American sites. But having said that, I'd say it's running in the -- somewhere around the 3% to 5% range across the company.
And there are no further questions in queue at this time. I'd like to turn the call back over to our presenters.
Okay. Thank you. A replay of the call will be available until November 7 at the numbers posted 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, this concludes today's conference call. Thank you for your participation. You may now disconnect.