Firan Technology Group Corp

TSX:FTG

Earnings Call Transcript 2020-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Firan Technology Group Q4 and Year-end 2020 Analyst call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to turn the call over to your speaker today, Brad Bourne, President and CEO. Please go ahead.

[Bradley C. Bourne, President, CEO & Director]

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 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 fourth quarter was a nice end to a challenging year. With all these challenges we face stemming from the COVID-19 pandemic, I'm extremely pleased with how everyone at FTG responded and with the results -- before we get into details, let me summarize some key accomplishments from our 2020 fiscal year. First, FTG has managed successfully through the COVID pandemic in 2020 as a result of a number of key strategies or initiatives. FTG's long-term market diversification strategy enabled the company to mitigate the dramatic downturn in the commercial aerospace market through its involvement in the stable defense market and other market segments. FTG carefully manage costs across the company, balancing decisions on cost reductions with a goal to retain critical skills to ensure the company is positioned for a faster recovery in the future. Related to this, FTG accessed available government support in both Canada and the U.S. and even a little in China to mitigate the drop in revenue, while retaining our skilled workforce. FTG carefully managed investments in the year and ended 2020 with a stronger balance sheet than before the pandemic. Beyond this, here are some other accomplishments for the year. We achieved over $102 million in annual sales, a 9% decline during a very challenging year for the aerospace industry. We maintained gross margins above 25% for the year. We were seeing $3.2 million in emergency wage subsidies through 2020 to offset the decline in revenues in Canada and to enable us to retain our experienced workforce. We received $3.3 million in U.S. Paycheck Protection program funds in the U.S., which remained classified as loans at year-end. We achieved $13.4 million EBITDA in 2020. We achieved $11.1 million in free cash flow for the year and ended the year with $12.2 million in net cash on the balance sheet. And in Q4 2020, we achieved 98.7% of Q4 2019 sales or $26.7 million. Beyond the financial results, we also accomplished many strategic goals in 2020, such as we purchased and installed an automated, highly secure backup system to protect information technology data across the company. This will protect FTG from possible future cyber attacks. In July, FTG completed a new 2-year committed credit facility with our existing financial institution. We reduced overtime across FTG in the series of 1-week plant shutdowns to reduce wage costs, particularly in sites focused on the commercial aerospace market. We reduced headcount by approximately 7% through the year, primarily through attrition. We completed the integration of FTG Circuits Fredericksburg into FTG, including converting to the FTG standard ERP system, completing AS9100 certification and achieving NADCAP accreditation. And finally, FTG Aerospace Toronto was approved by Transport Canada as an approved maintenance organization, opening up future aftermarket opportunities. Now let me switch to the market, or external situation as we see it now. To state the obvious, the COVID-19 pandemic deeply impacted air travel in 2020. This, in turn, has impacted airlines, which then flowed through to hurt the aerospace industry. I've been watching results from various aerospace companies. And in the latest quarters being reported, revenues have been down 20% to 40%. Similarly, Airbus and Boeing have implemented 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 activities will take 2 to 3 years to recover to 2019 levels. So this will be a tough market, at least through 2021. Looking at the longer term, 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 continued to show 40% of all new aircraft deliveries going to Asia. And as has been the case in all of their recent forecast. I also look the results from defense contractors and Lockheed, the largest defense contractor, reported a 7% revenue growth in the most recent quarter, while Northrop Grumman reported 17% growth. 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 rebounded somewhat 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 was 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 simulator activity is down, while 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 for 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 lines. Now the commercial aerospace market is in a downturn, but as it represents about 40% of FTG's overall activity, we have significantly mitigated the impact. In fact, for the full year 2020, our sales were down only 9%. Our Circuits Toronto site as well as our sites in China are most closely tied to the commercial aerospace so they were most impacted. Our U.S. sites are more focused on the defense market. And well, they showed, while they were both down, the percentage drop is much less. FTG's activity in the simulator market is almost exclusively for defense application. Total simulator-related sales in 2020 were up from 2019, and Q4 2020 was particularly strong at close to 25% of total sales. Operationally, COVID-19 is impacting us, but is 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've taken many steps to ensure physical distancing in our workplace. While we continue to do this, we did have a number of COVID-related events across FTG after our year-end in December and January. In December, our Circuits-Chatsworth site was most negatively impacted and had over 50% of production staff out at its peak, with most -- with people either testing positive or being in close contact with someone who tested positive. After the Christmas break, we had smaller events in both Toronto sites as well as our Fredericksburg site. To mitigate against the reduced demand for our products, 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, over time has gone from about 20% to virtually 0 through the second half of the year. Both those sites also shut down for 1 week in Q3 and 2 weeks at Christmas. We've also had some attrition in staffing, and our total headcount was down about 7% for the full year. We have cut back our CapEx expenditures for 2020. We have pursued government funding support wherever it is available. In 2020, we received $3.2 million 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 be forgivable if certain conditions are met. Jamie will talk more about these loans in his presentation. There have also been other opportunities to defer or delay tax payments in various jurisdictions that we operate. Beyond all of this, let me give you a quick update on our full year and fourth quarter results. For the full year, as mentioned, sales were $102.4 million versus $112.7 million in 2019. The drop relates to lower demand in commercial aerospace, but this was offset by increased simulator sales year-over-year and about a $5 million increase as a result of having the Fredericksburg site for the full year in 2020 versus only 4.5 months in 2019. In our aerospace business, sales were down 11% or $4.6 million for the full year. The decrease is due to the drop in commercial aerospace demand. Offsetting this was a mid- single-digit increase in simulator activity year-over-year. During the year, we had a significant new order from the third simulator company that expanded our revenue base for this activity in this segment, again, related to military aircraft. The simulator market will see significant variability from quarter-to-quarter and even from year-to-year. On the Circuits side of our business, sales were down $5.6 million or 8% on a year-over-year basis. Circuits Toronto was off the most, and this was offset by the increase at Fredericksburg, again as a result of us owning them for the full 12 months in 2020. Overall, at FTG, our top 5 customers accounted for 51.5% of total revenue in the year. The percentage is down slightly from 2019. This is particularly good to see as there is ongoing industry consolidation, such as the combination of Raytheon with the United Technologies that was completed during the year. With Raytheon now consisting of themselves, United Technology, and Rockwell Collins, they are our largest customer. Also interesting to note of the top 10 customers, 8 of our customers shared between our Circuits and Aerospace business. We particularly 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 2020, 35.7% of our total sales came from our Aerospace business compared to 36.6% last year. Generally, our Aerospace business did a bit better than Circuits, but in 2020, again, Circuits benefited from a full year of revenue from the Fredericksburg site that added about $5 million in incremental sales to that business. I'd like to turn the call over to Jamie, who will summarize our financial results for fiscal year 2020. And afterwards, I will talk about some key priorities we are working on. Jamie?

[Jamie Crichton, CFO, VP & Corporate Secretary]

Thanks, Brad. Good morning, everyone. I'd like to provide some additional detail on our financial performance for 2020 and Q4, 2020. On sales of $102.4 million FTG achieved a gross margin of $26.4 million or 25.8% in 2020 compared to $30.3 million or 26.9% on sales of $112.7 million in 2019. The decrease in gross margin dollars is the result of reduced sales volume. Funds received from the CEWS program reduced cost of sales by $2.8 million or 2.7% of sales, which combined with FTG's actions to control costs, largely mitigated the negative volume impact on the gross margin rate. Cost controls in 2020 include reduced overtime, headcount reduction from 2019 levels of approximately 7%, largely through attrition and a series of 1-week shutdowns. In Q4, on sales of $26.7 million, FTG achieved a gross margin of $7.1 million or 26.4% compared to $5.9 million or 21.7% on sales of $27.1 million in Q4 2019. Q4 2020 included $1.4 million from the CEWS program, whereas the gross margin rate in Q4 2019 was negatively impacted by operational inefficiencies during our recovery from the cyberattack, which occurred in '19 -- September 2019. From a geographical standpoint, 77% of FTG's 2020 sales were derived from customers in the United States, which is an increase from 74% from the prior year. The increase in percentage of FTG sales to U.S. located customers is in part due to the incremental sales of approximately $5 million from the Circuits Fredericksburg operation. This operation, which was required -- acquired in July 2019 has predominantly U.S.-based customers. In addition, the corporation was able to mitigate the dramatic downturn in the commercial aerospace market through its U.S.-based military customer base, which has remained stable. SG&A expense was $13.3 million or 13% of sales in 2020 as compared to $13.7 million or 12.2% of sales in the prior period. The reduced level -- reduced expense level is due to lower performance compensation and reduced travel costs. Included in SG&A is $300,000 again, which equates to the difference between insurance proceeds and the book value of assets destroyed in the June 2020 fire at the Circuits Fredericksburg site. Also in SG&A is a cost of $155,000, which was the premium paid on conversion of 100% or 1,775,000 of the corporation's preferred shares into common shares on a one-for-one basis. As a result of this transaction, FTG's outstanding share capital is simplified to 1 class of shares. R&D costs for 2020 were $5.3 million or 5.2% of net sales compared to $4.8 million or 4.4% of sales for 2019. R&D efforts included 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 a recognition of 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. Our 2020 operating results include depreciation of right-of-use assets of $1.6 million, and accretion on lease liabilities of $0.6 million as new cost elements within our P&L. Absent this accounting change, 2020 P&L would have included rent expense of approximately $1.8 million. The IFRS 16 impact for 2020 is a reduction of earnings before income tax of approximately $0.4 million. The average foreign -- average exchange rate experienced in 2020 was $1.34 as compared to $1.33 in 2019. However, during 2020, the Canadian dollar appreciated from $0.753 at the end of 2019 to $0.771 by the close of 2020. This is an increase of 2.5%. FTG's balance sheet includes assets and liabilities denominated in U.S. currency with a net balance of approximately USD 12.5 million. Realized and unrealized foreign exchange losses in 2020 amounted to $1 million as compared to $0.8 million in the prior year. Although FTG does maintain an active foreign exchange hedging program for sales and purchases in foreign currency, we currently have an unhedged balance sheet position as we're holding cash in U.S. dollars. Earnings before interest, tax, depreciation and amortization was $13.4 million for the trailing 12-month period ended Q4 2020 as compared to $14.6 million for the trailing 12-month period Q4 2019. The EBITDA margin for the trailing 12-month sales 2020 is 13.1% as compared to 13.0% for the period ended Q4 2019. For 2020, FTG recorded earnings before income tax of $4.6 million as compared to earnings before income tax for 2019 of $9.7 million. The 2020 income tax provision of $3.4 million or 73% of pretax earnings reflects that the Canadian -- Corporation's Canadian operations were profitable and that U.S. in the deferred tax assets and foreign operating losses were not recognized in the year. Our net cash position as of Q4 2020 is $12.6 million as compared to net cash of $2.2 million as of Q4 2019. Free cash flow, defined as cash from operating and investing activities, excluding acquisitions, less lease liability payments, was $11.1 million for 2020 as compared to $8.8 million for 2019. During 2020, drivers of cash -- free cash flow will reduce levels of working capital, principally inventory and accounts receivable. As at quarter end, the corporation's primary sources of liquidity totaled $56.1 million, consisting of cash, accounts receivable, contract assets and inventory. During 2020, 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 USD 10 million in support of working capital and USD 10 million in support of CapEx investment. As of 2020 year-end, outstanding term loans pursuant to this facility amount to USD 2.6 million, leaving over USD 17 million of credit availability. During Q2 2020, FTG's U.S. subsidiaries received 3 separate payroll protection program or PPP loans, aggregating USD 2.4 million or $3.1 million at year-end exchange rates to support the payment of salaries and wages to our U.S. employees. In accordance with the program, the corporation's U.S. subsidiaries submitted forgiveness applications for each of these loans in Q4 2020. In December 2020, 2 of these loans were forgiven by the SBA in the amount of USD 1 million or CAD 1.35 million. Working capital as of November 30, 2020, was $39.4 million as compared to $28.6 million as of the 2019 year-end. Accounts receivable days outstanding were 62 at the 2020 year-end compared to 70 at the 2019 year-end. Inventory turns were 3.8 as compared to 3.7. And accounts payable days outstanding were 74 at the 2020 year-end compared to 81 for the 2019 year-end. Investment in plant and equipment for 2020 was $3.2 million with $0.5 million of that occurred -- incurred in Q4 2020. We entered Q1 2020 with a backlog of $37 million, with reduced backlog in the commercial aerospace sector and the simulator submarket. We will continue our focus on cash management and the balance sheet, cost control and operating efficiency. In addition, the governments and jurisdictions where we operate continues to assist in various ways. In Q1, we expect to receive additional CEWS subsidies of $0.5 million or more, and PPP forgiveness gains of $1.35 million or more. Our complete set of Q4 filings are now available on sedar.com. With that, I would like to turn things back to Brad.

[Bradley C. Bourne, President, CEO & Director]

Thanks, Jamie. Let me delve into some other important items for the future performance of FTG. First, as Jamie outlined, I was extremely pleased with our 2020 financial performance. Subsequent to Q1, we performed well. For the last 9 months of 2020, we added net income after tax of $4 million or $0.17 per share as compared to $4.8 million or $0.20 per share last year. 2020 does have the benefit of the Canadian wage subsidy. But given our market challenges, we gladly and gratefully accept the support to help us maintain our skilled workforce. In our segmented results, you will see an improvement in profits in our Aerospace segment for the year. 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 and increasing activity in the defense market. They have won some exciting new programs in the defense market, including a new bezel for the new U.S. military trainer aircraft just starting production. What's equally impressive is the performance in our Aerospace Chatsworth facility. They had a great second half of the year, and the team there is doing a stellar job. They have the largest backlog of orders than any FTG site with Aerospace Toronto being second highest. And they have a long list of new sales opportunity, almost all coming from the defense market. In our Circuits segment, as noted previously, sales were down in Toronto due to the reliance on the commercial aerospace market. But even in reduced revenues, they have managed costs and remain profitable. But like our other Toronto facilities, we are working to pivot our focus to defense opportunities for this site with some successes. 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 third quarter due to the fire in the facility at the start of that quarter, but remediation is complete and activity is back to normal. And they had a superb year overall, and November was one of their best months in the history of that site, both during and before FTG acquired them. Circuits Chatsworth continues to see strong demand but has yet been able to ramp production to benefit from this demand. This site did not meet the expectations of customers in 2020, then performed poorly financially. As a result, we have made some organizational changes, including a new General manager and new Director of Operations. They are both new to FTG, but have extensive circuit board industry experience. We fully expect they will ride the shift in the coming months. To assist the recovery at 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. These will arise in the first half of 2021. If you look at our segmented results, you will see the Circuits segment profit for 2020 was down 45% compared to 2019, partly due to the lower sales and partly due to the weak performance in Circuits Chatsworth. Both our China sites are exclusively focused on the commercial aerospace market, so both saw a drop in activity. That is, as noted from the Boeing market forecast, Asia remains a key market for the commercial aerospace activity. So we believe these sites will be valuable in the long term. And progress continues on the C919 aircraft development in China, and while we have not quite completed our qualification activities, we now have our first production orders for our cockpit assemblies for this aircraft.During the fourth quarter, control of our joint venture partner was passed to a new private company in China who acquired the parent company of our partner. They have made significant organizational changes at our partner. This has created some uncertainties regarding the path for our venture, but we have hope for this during 2021. Also, the U.S. government is moving 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 will create increased demand for our North American plants. It is early in this process and any longer-term implications will play out in the coming years. We continue to manage our balance sheet. In 2020, our net cash on the balance sheet increased from $2.1 million at the end of 2019 to $12.6 million at the end of 2020. We are very proud of this as has been done during a very challenging year. We've seen a number of acquisition opportunities that could fit with either of our businesses. Given our increased confidence in our performance and reduced revenues and our very strong cash position, we are evaluating these opportunities. Our criteria for any such transaction would remain what we've always said, it would need to meet a number of the following objectives: be aligned with our current market and product focus, expand our technology offering, expand our geographic coverage to Europe for commercial aerospace or defense market, accelerate FTG's penetration of the aftermarket segment, drive up plant utilization, have an attractive price in multiple and be accretive to earnings. And finally, looking forward into 2021, there is much uncertainty, but some reasons for optimism. We are entering the year with reduced backlog of around $37 million. This is down from last year, partly due to decreased demand in commercial aerospace, primarily due to reduced backlog and our simulator-related activities. The lower simulator backlog will impact Q1. Excluding the simulator segment, which could be down about $5 million compared to Q4 last year, overall activity is expected to be similar to recent quarters. And also remember, our Q1 typically has less working days due to the Christmas holidays, which we expanded this year. So production levels will be lower. Longer term, we are expecting to see a slow ramp-up in demand, hopefully, starting in late 2021, but our sales team has been doing a great job, and we are seeing in winning new programs and adding new customers. These opportunities span all FTG sites and are expected to lead to increase future revenues. As 1 example, through a combined effort between FTG Aerospace Toronto and FTG Aerospace Tianjin, over the past few years, we are completing qualification for a new key customer with opportunities for cockpit products that could be in the millions of dollars annually. And we have already -- we already have initial production orders and are building parts with the goal to start shipping this month. At Circuits Toronto, we are pursuing 2 significant opportunities related to reshoring of product that this site previously supplied. And we are very close on adding some new defense customers that need the technology we can offer. With a 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 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. Amy?

[Operator]

[Operator Instructions] Your first question comes from the line of Nick Corcoran with Acumen Capital.

[Nick Corcoran, Equity Research Analyst]

;You indicated that there were some COVID events and you've said these subsequent to year-end. Can you comment on how those events might have impacted your Q1 revenue?

[Bradley C. Bourne, President, CEO & Director]

Sure. As I said, I'll start with the easy one. So we did have minor events in both Toronto facilities and in Fredericksburg. And when I say minor, [indiscernible] people who might have been exposed really to the virus at some point during our shutdown. But the overall impact of those events is insignificant. In Chatsworth, we had a more significant event. And as I said, and it was in December, but at its peak, more than half of our production staff were off. That does not mean half of them tested positive, but it meant either -- we have people who tested positive and then anyone with close contact had to self isolate for 2 weeks. So that definitely impacted activities in late December and early January in Circuits Chatsworth and that definitely will impact Q1 somewhat at that site specifically. So that really is the only site that has seen an event that would impact results for Q1.

[Nick Corcoran, Equity Research Analyst]

Great. That's good color. And then just some on backlog. Can you provide any color on how much of the backlog do you expect to get to in Q1?

[Bradley C. Bourne, President, CEO & Director]

Yes. So total backlog at year-end was $37 million. Of that, it's a low-20s is deliverable in Q1, if everything went perfect, and I guess there's pluses and minuses on that. So it's unlikely will be perfect. So some of the stuff deliverable in Q1 would probably push out. But at the same time, we always book additional orders in the quarter that some of which will be deliverable within the same quarter, particularly in our Circuits Toronto plant. So maybe those wash. And then as I said, the big swing for us or the biggest swing for us in our backlog is a drop in simulator backlog. And I've said this a million times, but the simulator orders tend to come in, in big lumps and are somewhat harder to predict. We are entering 2021 with the lower simulator backlog. And generally, anything that we could book in that regard is probably 2 to 3 quarters away from deliverable. So the simulator -- the low simulator backlog definitely will impact Q1.

[Nick Corcoran, Equity Research Analyst]

Good. And then just for the remainder of the year, would you expect to have more simulator orders come in as the year progresses?

[Bradley C. Bourne, President, CEO & Director]

Yes. It's -- again, it's tough to predict, given the the lumpiness of the business and the -- it's not a standard ongoing production-type program. We definitely expect -- we are going to book some simulator-related activity this year. The exact timing, I honestly can't predict. But I would say, overall, we do see it's likely simulator activity in 2021 will be a little bit lower than 2020, but that's not surprising because 2020 was a stellar year for us and a record year notwithstanding all the other challenges in our market.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now turn the call back over to Brad Bourne for closing remarks.

[Bradley C. Bourne, President, CEO & Director]

Okay. Thank you. A replay of the call will be available until March 12, 2021, at the numbers and the ID on the press release and replay will also be available on our website in a few days. I thank you all for your interest and participation. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. On behalf of FTG, we thank you for participating. You may now disconnect.