Firan Technology Group Corporation

Good morning, everyone. My name is Myra, and I'll be your conferencing operator today. I would like to welcome everyone to the FTG Quarter 3, 2021 analyst call. All lines have been placed on mute. There will be a question and answer session following the call. If you would like to ask a question during this time, simply press star followed by one on your telephone keypad. If you would like to withdraw your question, Simply press the pound key. Please note that this call is being recorded today, October 14, 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 Ferran Technology Group. Mr. Bourne, you may proceed.

Thank you. Good morning. I'm Brad Bourne, President and CEO of Frank 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 and 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 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 a result of new information, future events, or otherwise. Our third quarter showed continued improvement as the impact of the COVID-19 pandemic diminishes for both the overall market demand and our operations. While our sales have not fully recovered to pre-pandemic levels, we are definitely seeing improvement in demand in the commercial aerospace market. We had no direct COVID-related operational impacts in Q3, but we did have some indirect impacts. During the quarter, we had higher than typical absenteeism in our Toronto plants as people utilized the new Ontario paid time off legislation, which allowed for up to three days of paid sick days. Our Fredericksburg plant had some secondary effects, such as people being absent due to their children's schooling issues, etc. 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, our sequential performance will improve. Regarding our vaccination rates, we are over 95% vaccinated in our Toronto plants. We are still collecting data for our U.S. sites. In China, vaccines were mandated, so we are 100% vaccinated. Before we get into the details, let me summarize some key accomplishments from our third quarter. FTG achieved a third sequential quarter of increased bookings as the commercial aerospace industry recovers from the COVID-19 pandemic. Third quarter bookings are up 7% over Q2 2021, then up 28% over Q4 last year. FTG increased net cash on the balance sheet to $17.1 million, an increase of $2.3 million in Q3 2021, again showing the cash generating nature of the business. Over the past 20 months during the pandemic, FTG has generated $13 million in free cash flow after investments in R&D and capital. FTG received forgiveness of 1.3 million U.S. dollars being the residual of the U.S. Paycheck Protection Program funds received by our U.S. operation as a result of FTG maintaining our workforce for the required period of time. FTG was approved for an additional 700,000 Canadian and Canada 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. And we extended the existing $20 million U.S. dollar committed credit facility with our primary lender to July 2026 with improved financial terms. In addition, the Averitech semi-additive circuit board manufacturing investments and our circuits Fredericksburg facility made additional progress in Q3. Activities have been initiated with over 10 customers to 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. Jamie will talk about our financials shortly, but I would like to highlight what we are seeing in the future market demand. To again state the obvious, the COVID-19 pandemic deeply impacted air travel in 2020. This in turn impacted the airlines, which then flowed through to hurt the aerospace industry. But we are seeing a positive trend develop in Q3 US air travel continue to rebound is nearing 80% of pre pandemic levels. And we are seeing the 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 the 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. Our customers are mostly showing a return to sales growth in their latest quarters. Specifically, Collins Aerospace, a business within Raytheon, reported an 8% revenue growth, and Honeywell Aerospace reported a 9% growth. When looking at aircraft deliveries, Airbus reported a 35% drop in deliveries in 2020 and are forecasting a small increase in 2021 and a further increase in 2022. At Boeing, it is more dramatic as they also had the challenge of the 737 MAX to deal with. Their 2020 deliveries were down 80% from pre-pandemic, pre-737 issues. In 2021, their deliveries are projected to be up 100% versus 2020. Both companies have announced production rate increases for 2022. This bodes well for us and with our already increased bookings, we should see revenue growth at least sequentially going forward. I've also looked at results from defense contractors and Lockheed, the largest defense contractor, reported a 5% revenue growth in their most recent quarter, while Northrop Grumman reported a 3% growth. The defense market is government funded and it appears well supported in the near term. 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. 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 a two- to three-year downturn as air travel recovers, and it continued to show 40% of all new aircraft deliveries going to Asia, as has been the case in their recent forecasts. 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. A recent business jet market forecast from Honeywell similarly predicts growth in this market in the coming years. The simulator market mirrors the in-market application. So commercial aerospace simulator activity is down, whereas defense simulator market remains strong. But as we remind everyone about this market, it is lumpy, so year-to-year variations do occur. So as we have said for many years, FDG's goal is to participate in all segments of the aerospace and defense market 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, we have mitigated the impact. Our Circus Toronto site, as well as our sites in China, are most closely tied to commercial aerospace, so they were most impacted. Our U.S. sites are more focused on the defense market. Beyond all of this, let me give you a quick update on our third quarter. Q3 sales were $19.7 million versus $24.4 million in Q3 last year. In Q3 last year, we were ramping down due to COVID, but had not yet hit the bottom of the trough. Also compared to Q3 last year, simulator activity was down almost $3 million this quarter, again due to the lumpiness of this business. And lastly, the Canadian dollar has strengthened 10 cents over the past 12 months, And this hurt our revenue comps by about $1.7 million. In our aerospace business, sales were down 24% or $2 million compared to Q3 last year. Almost all of the decline is in our Aerospace Toronto facility. But the decline is deceiving. Our simulator-related activities, our simulator-related sales were down about $3 million year over year. And this was offset by increases in other more traditional cockpit products. So we are seeing an increase in demand in traditional products, as we would expect. Some of the increase is also in defense products in our Chatsworth site. And our Tianjin site actually had increased sales over Q3 last year of about 6%. As noted previously, the strengthening of the Canadian dollar reduced sales by about 7% from Q3 last year to Q3 this year. With regard to the simulator activity, as we have said 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 about $8 to $10 million compared to the previous few years. It is timing rather than underlying change in overall demand. The majority of FTG simulator activity relates to defense applications. On the circuit side of our business, sales were down 2.6 million or 16% on a year over year basis. Circus Toronto was off the most in absolute dollars, but all four sites had decreased sales. On a sequential basis, circuit sales were up 1%. This is in the face of the 7% headwind resulting from the strengthening of the Canadian dollar. Overall at FTG, our top five customers accounted for 59.3% of the total revenue in the quarter. This percentage compares to 63.9% in Q3 last year. Well, the percentages are similar. The companies have changed. Last year's top five included a large simulator company, and there are no simulator companies in the top five this year. Also interesting to note, of the top ten customers, six 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 2021, 33% of our total revenues came from our aerospace business, compared to 36% in Q3 last year. The drop is due to reduced simulator activity, partially offset by increasing legacy products. I'd like to turn the call over to Jamie, who will summarize our financial results for Q3 2021. And afterwards, I will talk about some key priorities we are working on. Jamie?

Thanks, Brad. Good morning, everyone. All references to dollar amounts within my comments refer to Canadian currency unless noted otherwise. I'd like to provide some additional detail on our financial performance for Q3. On sales of $19.7 million, FTG achieved a gross margin of $3.8 million, or 19.2%, compared to $6.7 million, or 27.6%, on sales of $24.4 million in Q3 2020. The decrease in gross margin dollars and the gross margin rate for the third quarter of 2021 is primarily the result of reduced operating leverage on lower sales volumes. In addition, gross margin for the Toronto sites is negatively impacted by the stronger Canadian dollar relative to the US dollar, as much of the cost structure of those sites is in Canadian dollars. The average exchange rate experienced in Q3 2021 was $1.25, as compared to $1.34 in Q3 2020. FTG continues to manage its operations with efficiency to ensure that we are well positioned to participate in the recovery of the commercial aerospace industry from the impacts of COVID-19. Headcount has been reduced by approximately 13% from 2019 year-end levels, primarily through attrition. Prior to the end of fiscal 2021, we will close our engineering office in the Dallas-Fort Worth area and transition certain staff to a work-from-home model, which offers annual cost savings of $200,000. FTG continues to participate in government programs for which it is eligible, which offer support to the aerospace industry. Although the Canadian Wage Subsidy Program is scheduled to wind down in Q4 2021. Our FGG circuits Chatsworth site has been approved for up to 400,000 US in assistance pursuant to the aviation manufacturing jobs program administered by the US Department of Transportation. The benefit of the AMJP program will be accounted for as a reduction of cost of sales over a six month period ending in March 2022. From a geographical standpoint, 74% of FTG's Q3 2021 sales were derived from customers in the United States, which is down marginally from the prior year. SG&A expense was 3.1 million or 15.9% of sales in Q3 2021, as compared to 2.8 million or 11.6% of sales in the prior period. The increased expense level is due to the resumption of cross-border business travel, increased professional fees, and increased performance compensation costs at certain sites. R&D costs for Q2 2021 were 1.2 million or 6.2% of net sales compared to 1.3 million or 5.3% of sales for Q3 2020. R&D efforts include product and process improvements at the circuit segment and efforts to develop and qualify products for future aerospace programs. The exchange rate at the Q3 2021 close was $1.25 as compared to $1.21 at the Q2 2021 close, which is a weakening of the Canadian dollar. FGG's balance sheet includes assets and liabilities denominated in U.S. currency, with a net asset balance of approximately $7.2 million. The translation of our net U.S. dollar assets and liabilities into Canadian currency at the end of Q3 2021 resulted in foreign exchange gains for the quarter, as opposed to losses incurred in Q3 2020. Realized and unrealized foreign exchange in Q3 2021 amounted to $0.4 million. Although FTG does maintain an active FX hedging program for the sales and purchases in foreign currency, we currently have an unhedged balance sheet position with respect to 5.1 million US cash within FTG's Canadian and Chinese operations. We continue to reduce that US dollar cash position to mitigate FX exposure. In Q3 2021, FTG received notification from the SBA that the remaining Paycheck Protection Program, or PPP, loan of 1.3 million U.S., which had been provided to the FGG Circuits Chatsworth entity to support the continued employment of employees during these uncertain economic conditions caused by COVID-19, had been forgiven in full. As a result, FGG recorded a gain of 1.7 million in the Q3 2021 operating results. Earnings before interest tax depreciation and amortization, EBITDA, was $11.3 million for the trailing 12-month period ended Q3 2021, compared to $12 million for the trailing 12-month period ended Q3 2020. The EBITDA margin for the trailing 12-month sales ended Q3 2021 is 13.2% as compared to 11.6% for the comparable period in 2020. For Q3 2021, FGG recorded earnings before income taxes of 1.5 million as compared to 1.4 million for Q3 2020. The Q3 2021 income tax provision of 0.7 million, or 48% of pre-tax earnings, reflects that the corporation's Canadian operations were profitable and that deferred tax assets on foreign operating losses were not recognized in the court. Our net cash position as of Q3 2021 is $17.1 million as compared to net cash of $8.8 million as of Q3 2020. Free cash flow defined as cash from operations, less cash used in investing activities excluding acquisitions was $0.2 million for Q3 2021 as compared to $2.7 million for Q3 2020. Free cash flow was negatively impacted in Q3 2021 by increased CapEx spending, principally to support operational improvements at the FGG circuits Chatsworth site. CapEx in Q3 was $1 million as compared to $0.2 million in the prior year quarter. At that quarter end, the company's primary sources of liquidity totaled $51.5 million consisting of cash, accounts receivable, contract assets, and inventory. During Q3, FGG was able to extend the committed revolving credit facility with our existing bank to 2026 and with improved economic terms. This facility includes $10 million U.S. in support of working capital requirements, $10 million in support of CapEx investments, and a $10 million U.S. accordion facility in support of future acquisitions. As of September 3, 2021, outstanding bank debt under the credit facility amounted to $2 million U.S. Working capital at Q3 quarter end was $40.3 million as compared to $39.4 million as of the 2020 year end. Accounts receivable days outstanding were $64 as at Q3 quarter end, compared to 62 at the 2020 year end. Inventory returns were 3.4 at Q3 quarter end as compared to 3.8. And accounts payable days outstanding were 74 at both the Q3 quarter end and the 2020 year end. We completed Q3 2021 with a book to bill ratio of 1.06 and a backlog of $36 million. Backlog includes $24 million of orders scheduled for Q4 2021, with the caveat that supply of certain aerospace components remains a constraint that could result in some of that backlog shifting to Q1 2022. We will continue to focus on cash management and the balance sheet, cost control, and operating efficiencies. Our complete set of Q3 filings are now available on CDER.com. With that, I would like to turn things back over to Brad.

Thanks, Jamie. Let me delve into some important items for future performance of FTG. For me, I thought our third quarter sales were better than it appears when looking at the gross amounts. As I have already noted, in Q3 last year, we were still heading into the pandemic crop. If you look at the sales drop from Q3 2020 to Q3 2021, it was $4.6 million. But $1.7 million was due to strengthening the Canadian dollar, and about $3 million was due to simulator-related sales. And when you adjust for these items, sales were flat or up a small amount over the last year. Again, I think it's important, as it shows there is recovery in our business on a normalized basis. On a sequential basis, sales were down about 600,000 or 3%. As I did note earlier, bookings are up each quarter. The sales drop sequentially is primarily due to seasonality as Q3 includes the summer months of June, July, and August where we lose production days due to summer holidays. Typically, we lose about one week of production in Q3 or about 8% of the quarter. Conversely, I was disappointed with our profitability in Q3. We had some production challenges primarily in our Circus Chatsworth and Circus Fredericksburg sites. Luckily for us, the final tranche of our US PPP loans were forgiven in the quarter, and this was more than an offset for these challenges. In our segmented results, you will see an increase in profits in our circuit segment in Q3 compared to the same quarter last year due to this loan forgiveness. So Q3 this year shows improved profitability on significantly lower sales. In our aerospace business, our Toronto facility has done a great job in managing costs down over the last 18 months. 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 new bezel for the U.S. military trainer aircraft just now starting production. And our first parts were successfully shipped to the customer in Q3. Our Chatsworth facility had a small increase in sales in Q3 this year compared to Q3 last year in U.S. dollars, but when converted to Canadian dollars, it shows a reduction. purely due to the strengthening of the Canadian dollar. They have the largest backlog of orders of any FTG site, and they have a long list of new sales opportunities, almost all coming from the defense market. As we announced during the quarter, that site has had success in winning aftermarket defense work from the U.S. Defense Logistics Agency, and they signed a 3.7 million multi-year contract for F-18 assemblies to be delivered over the next five years. In our circuit segment, as noted previously, sales in Toronto were down compared to Q3 last year 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 up compared to all previous quarters and their bookings are even stronger, indicating a recovery is building in the commercial aerospace market. Fredericksburg started Q1 slowly, but they improved their bookings and backlog more recently. During the second quarter, the general manager at the Fredericksburg site had resigned for family reasons. The transition to a new GM has caused a little disruption in operations, but I believe this will be resolved and the site will ramp with the market. Overall, the site has seen relatively flat sales in each of the last three quarters. Circus Catsworth continues to have a solid backlog, but has not yet been able to ramp production to benefit from this demand. To assist in the recovery at Circus Chatsworth, we're investing in some key new pieces of production equipment to insource some processes, which will save costs and improve cycle time. These investments include a VFL machine, an electrical tester, and a laser drill to insource these functions. The benefits of these investments will increase going forward as they are fully integrated into our operations. Both our China sites are exclusively focused on the commercial aerospace market, so both have seen 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 longer term. Our aerospace Tianjin facility has seen sales increase in each quarter this year as the commercial aerospace market recovers. And progress continues on the C919 aircraft development in China. And while we have not quite completed our qualification activities, we have shipped our first production orders this year. At our Circus 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 Q4 and beyond. We continue to manage our balance sheet. Our net cash on the balance sheet increased from $12.6 million at the end of 2020 to $17.1 million at the end of Q3 2021. We are seeing a number of acquisition opportunities arise that could fit with either of our businesses, but we're currently seeing more on the circuit side of our business. Given our increased confidence in our performance at the reduced revenue levels, our very strong cash position, we are evaluating these opportunities. Our criteria for any such transaction would remain what we've always said, 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 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. We are seeing the end of the original covert government support programs, such as the wage subsidy program in Canada, as this program runs through October of this year, and the PPP loans in the U.S. But there are other government support options we are pursuing. As Jamie mentioned, subsidies Subsequent to quarter N, FTG Circus Tract Force was approved for $400,000 from the Aviation Manufacturing Jobs Protection Program, which will be used to offset employee compensation costs for a six-month period ending March 2022. We are also investigating possible additional support from the Canadian government. With a focus on operational excellence, in all parts of FDG are demonstrated financial performance at lower revenue levels. We are confident we have weathered the storm and will 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. Mayra.

Thank you. At this time, we would like to take any questions that we have for us today. And as a reminder, to ask a question, Simply press star followed by 1 on your telephone keypad. If you would like to withdraw your question, you may press the pound key. We'll pause for a moment to compile the Q&A list. This will only take a few moments. We have our first question comes from the line of Nick Corcoran. Your line is open. You may now ask your question.

Good morning. You announced some new contract work awarded for the USDLA and TrainerJet. Can you provide any further details on the revenue per year and the duration of those contracts?

Sure. On the DLA contract, we announced it's a five-year contract with a value of $3.7 million. Essentially, that's spread equally over five years, but the important item to note on that, that is a guaranteed minimum on the contract, and they can acquire additional units and drive that up. For instance, already in year one, we have seen orders of about $900,000, which is above the minimum. So we're hoping that that would continue through the subsequent four years, but we'll have to wait and see. And I'm sorry, Nick, I missed the second one you asked about.

Yeah, the trainer jet you announced as well.

Yeah, that's an important program for us. U.S. is developing a new trainer jet, called the Q7A, and I did say that in the quarter we had shipped our first production units to a customer, which was for a display bezel, which is true. What I did not say, but we also received orders from a different customer in the quarter for some additional cockpit panels that go into that aircraft. We have not shipped those yet. So both of those represent good opportunities for FTG. The bezel goes to our Aero Toronto facility. The panels will go through our Chatsworth facility. But what we really like to do at FTG is get involved in these programs at the beginning. essentially become an annuity to the company. I would expect production of that aircraft to last, could be 20 years. And so if we can get in at the beginning like we have, we believe we can just, you know, ride that annuity for the next couple of decades.

Great. And are there other similar contracts that are in the pipeline that you expect to to start delivering product on or announce in the next couple quarters?

Yeah, I mean, we're, you know, as we've said for the last two years, one of our priorities is to try to do more in the aftermarket. So, you know, it's more back along the lines of what we announced with DLA, but our aerospace Chatsworth facility, still has a number of qualification initiatives underway where we are building first products that would be supporting more additional aftermarket opportunities. The fact that we have orders for qualification units and first deliveries means if we can get it done successfully, there should be additional revenue from those opportunities in the coming quarters and in the coming years. And surprisingly, and it's amazing in some regards, some of these opportunities are still as a result of our acquisition in 2016 of Teledyne PCT. So the defense market doesn't always move fast, but if you can become the supplier of record on some of these components, you then can see an ongoing revenue stream again for many years going forward. I did mention it, but one of the things we have talked about for many, many years is our initiatives and activities in China. So this is more on commercial aerospace, but our content on the C919 is significant. It still remains probably the aircraft where we have the most content per plane. The fact that we have started to ship production units on that is great news for us. And our expectation is still that that could represent a $5 million a year revenue stream as that program ramps into production, into full production. It won't be $5 million next year, but I still do believe the forecast of them going to about 120 planes a year is real. So that is also a really important new program and growth opportunity for FTG.

Great. And then switching gears with the Canadian wage subsidy ending, do you expect to receive any money in Q4?

Yes, we will receive subsidies for at least the month of September and And the month of October is likely also. So it'll be a few hundred K for Q4.

And last question for me. There's a lot of talk of supply chain impacts in various industries. Have there been any direct impacts on brand?

Nothing direct, like you're seeing in the news. Everything in the news is around brands. electronic chips, components like that. We have not seen that. But having said that, we have also talked about for the last number of years that we are seeing extended lead time on some military components. They're a very different class of product. Those lead times remain extended, but nothing worse than what we have seen for the last three or four years.

And I'll add, in certain cases, where we do anticipate a possible risk, since we have the cash, we actually are moving to carrying higher levels of inventory of certain components.

Great. That's all for me. Thank you.

Thanks, Nick.

Once again, I would like to remind everyone, if you wish to ask a question, simply press star, then the number one on your telephone keypad. Presenters, there are no further questions at this time. You may continue.

Okay, thank you. A replay of this call will be available until November 14, 2021. The number is listed on the press release. A replay will also be available on our website in a few days. I thank you all for your interest and participation. Thank you.

That thus concludes our conference for today. Thank you all for participating. You may now disconnect. Have a great day.