Earnings Transcript for FTGFF - Q1 Fiscal Year 2022

Company Representatives: Brad Bourne - President, Chief Executive Officer Jamie Crichton - our Chief Financial Officer

Operator: Good morning, everyone! My name is Rain and I will be your conference operator today. I would like to welcome everyone to the FTG Q1, 2022 Analyst Call. All lines have been placed on mute. There will be a question-and-answer session following the call. . Please note that this call is being recorded. I would now like to turn the call over to Mr. Brad Bourne, President and Chief Executive Officer of Firan Technology Group. Mr. Bourne, you may proceed.

Brad Bourne: 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 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 listeners caution 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 there's no specific intention to update any forward-looking statements, written or oral, that has been made from time-to-time by or on its behalf, whether result of new information, future events or otherwise. Well, finally FTG has returned to growth. The impact of the pandemic is weaning after a tough couple of years. We are not back to pre-pandemic levels, but the booking trend is very positive and sales are increasing. And our sales increase in Q1 is in spite of an amazing list of unusual challenges we experienced in the quarter. I will explain some of these challenges later, but I do want to say again, that I am so very proud of the efforts of everyone at FTG, in doing whatever it takes to overcome these challenges. In the face of such a difficult period for the aerospace industry and so much adversity, everyone buckled down, worked together and did what needed to be done to get us through another quarter in good shape. I'm sure that this team is up to any challenge we may face in the coming years. Before I get into details, let me talk about a very important topic for the future of FTG. It is our mindset, for the past two years we've been playing defense. We played great defense. We took many actions to ensure we got through the pandemic, but defense is only half the game. As of the start of 2022, we are consciously taking actions to play some offense as well. We have a great balance sheet and the market is coming back. We are taking advantage of our balance sheet to increase capital spending to support higher technology, improve our operations and to grow. We will continue to do this, but we can and will do more. Our balance sheet put us in a great position to grow through acquisition or other corporate development activities. We are putting a lot of effort into this area now and we can and are looking at other capital allocation options that can benefit our shareholders. We believe that investing for the future growth of FTG is most important. But in the short term, we believe there are other capital allocation plans we could undertake to the benefit of our shareholders, until we see a stronger valuation for the company and its results. Now, let me summarize some key accomplishments from our first quarter of 2022. FTG achieved a fifth sequential quarter of increased bookings as the aerospace industry recovers from the COVID-19 pandemic and we achieved a 1.27

Jamie Crichton: Thanks Brad. Good morning everyone! I would like to provide some additional detail on our financial performance for Q1, 2022. On the sales of $20.5 million, FTG achieved a gross margin of $4.2 million or 20.7% in Q1, 2022 compared to $3.7 million or 19.3% on sales of $19 million in Q1, ‘21. The increase in gross margin dollars as a result of increased operating leverage on higher sales volume, operational improvements and reduced provisions for obsolete inventory. Government assistance within gross margin in Q1, ’22 included $0.3 million from the Aviation Manufacturing Jobs program AMJP in the U.S., whereas Q1, 2021 included $1 million of wage and rent subsidies in Canada. Excluding the impact of government assistance, gross profit increased in Q1, 2022 by $1.2 million on incremental sales of $1.5 million. From a geographical standpoint, combined sales into Europe, Asia and other Americas increased to $3.1 million, which is up 57% from $2 million in Q1, ‘21. FTG sales into these markets is for commercial aerospace applications, which is recovering as governments reduce travel restrictions. SG&A expense was $3 million or 14.8% of the sales in Q1, 2022 as compared to $2.7 million or $14.2% of the sales in the prior period. The increased expense level is due to increased travel costs as business travel begins to normalize and the inclusion of 100,000 of wage subsidies in Q1, 2021. R&D costs for both Q1, 2022 and prior year were $1.4 million, which was 6.8% of sales in the current quarter as compared to 7.3% in the prior year quarter. R&D efforts include product and process improvements at the circuit segment and efforts to develop and qualify products for future aerospace programs. Continued significant investment in R&D reflects a high level of new initiatives in place at FTG. The average exchange rate experienced in Q1 ’22 was 1.27, which was the same as in Q1, 2021. During Q1, 2022 the Canadian dollar appreciated by approximately 0.3%. FTG's balance sheet includes assets and liabilities denominated in U.S. currency with a net balance of approximately $8 million U.S. at the start of Q1 and $5.4 million at the end of Q1. Realized and unrealized foreign exchange losses in Q1 amounted to $0.2 million as compared to $0.6 million in the prior year quarter. Earnings before interest, tax, depreciation and amortization was $9.1 million for the trailing 12 month period ended Q1, 2021 – 2022 sorry, as compared to $9.6 million for the trailing 12 month period ended Q4, 2021. The EBITDA margin for the trailing 12 month sales ended Q1, 2022 is 11.2% as compared to 12.2% for the comparable period ended Q4, 2021. EBITDA in Q1 ’22 was $1.3 million for an EBITDA margin of 6.5%; however, 5.3% excluding government assistance. By comparison, the trailing 12 months period ended Q4, 2021, the EBITDA margin was approximately 4.5% excluding government assistance. We do expect EBITDA margins to increase as commercial aerospace revenues recover. For Q1, 2022 FTG recorded a net loss before income taxes of $0.4 million as compared to income before income taxes of $0.1 million in 2021. The Q1 ‘22 income tax provision of $0.3 million reflects that the corporation's Canadian operations were profitable and the deferred tax assets on foreign operating losses were not recognized in the quarter. Our net cash position as of Q1, 2022 is $16.2 million as compared to net cash of $17.9 million end of Q4, 2021. Free cash flow defined as cash from operating and investing activities excluding acquisitions, less lease liability payments was a usage of $1.6 million for Q1, which included $2.1 million in CapEx during the quarter. CapEx is expected to be higher in 2022 than the two previous years in support of business growth. Equipment investments are driven by insourcing of certain manufacturing and test processes, productivity improvements and replacements. Further, these investments are skewed towards the circuit segment. As at quarter end, the company's primary sources of liquidity totaled $50.7 million including cash, accounts receivables, contract assets and inventory. In addition, FTG has access to approximately $18 million U.S. in credit lines. Working capital as at quarter end was $38.8 million as compared to $40 million as of the 2021 year end. Accounts receivable days outstanding were 66 at quarter end compared to 72 at the 2021 year end. Inventory turns were up to 3.7 from 3.4 at the 2021 year end, and accounts payable days outstanding were 80 at the end of Q1 as compared to 86 for the 2021 year end. Our lease for the aerospace Chatsworth facility expires on June 30, 2022 and the owner has advised us of their intention to sell the facility. To secure the facility for continued occupancy, we have entered into a purchase and sale agreement to purchase the facility for €6.7 million. Our intention is to secure a new owner for this facility prior to the closing date from whom FTG would lease the facility as we do with all of our production facilities. In the case that agreement has not been assigned to a third party prior to closing, the corporation will complete a purchase of the facility using a combination of cash, credit lines, or other financing. Backlog at the end of Q1 was $45.1 million, which is up $5.3 million from Q4, 2021. With an improved market situation for commercial aerospace and robust defense spending by NATO countries, FTG will focus on both growth and profitable efficient operations in future quarters. Our complete set of filings are now available on Sedar.com. With that, I'll turn things back over to Brad.

Brad Bourne : Thanks Jamie. Let me delve into some important items regarding our future performance across FTG. For me I thought our first quarter had strong operational performance in the face of a myriad of headwinds. If you look at Q1 this year versus Q1 last year and exclude the government assistance received in each of the quarters, the revenues increased $1.5 million and the bottom line increased $1.8 million. While I know we have a high contribution margin, it takes an amazing effort by everyone at FTG to improve profitability by more than the increase in sales. If we had not had all the operational headwinds, we would have had even better sales and bottom line. And as I and many others in the aerospace industry has suggested to many people in the government, support to the aerospace industry was withdrawn before the industry had recovered sufficiently. There is an indication this message is being heard, as there are new programs in Canada and in the U.S. that have been established to help the industry invest for the future and we are actively pursuing these programs. In our aerospace business, our Toronto facility has done a great job in managing through the pandemic, but now the focus is on growth. They have made some good inroads in increasing activity in the defense market. They are involved in some exciting new programs in this area. And as mentioned, they booked a new simulator order for a defense program that will be deliverable in the second half of ‘22. We have had a few supply chain challenges due to the chip shortages this year, but so far we have mitigated the impact down to a manageable level. Our aerospace Chatsworth facility is also impacted by push-puts of suppliers for some military components, but they continue to have a long list of new sales opportunities, almost all coming from the defense market. They continue to see and win U. S. defense aftermarket opportunities. Our aerospace Chatsworth facility operating performance was significantly improved in Q1 this year compared to Q1 last year, with sales up more than 25%. In our circuit segment, bookings in our Toronto facility have been very robust this year as the commercial aerospace industry recovers. We are taking actions to ramp production in line with this increased demand. Circuits Fredericksburg was impacted by a very difficult snowstorm in January. The site has not performed to expectations and subsequent to quarter end we've made some organizational changes to improve things going forward. Circuits Chatsworth had improved operating performance in Q1 this year with sales up more than 15%, which was nice to see. We continue to invest in the business to further improve performance, including additional CapEx, process improvements and strengthening that organization. Both our China sites are exclusively focused on the commercial aerospace market. 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. Our aero Tianjin facility has seen orders increase consistently since the start of 2021 as the commercial aerospace market recovers and they win new work. Subsequent to the end of the quarter, we received a new order for cockpit products for Boeing 737 aircraft, with production to be shared between our Toronto and Tianjin facility, and our total backlog of panels for the 737 aircraft is now approaching $2 million. These orders are showing the results, a return on investment of having these sites approved to supply cockpit panels to Boeing that we completed last year. Tianjin is also seeing strong demand from the business jet customers and in general aviation. We now have a hiring plan in Tianjin that would see us add 40% to 50% more production staff as fast as possible. At their current capacity, they were sold out through September, but of course our goal is add capacity, so they can continue to grow. Progress continues on the C919 aircraft development in China, and while we still have not quite completed our qualification activities, we have shipped our first production orders and are starting to see some new orders for 2022. At our circuits joint venture in China, the uncertainty regarding the owners of our partner is settling down in a positive way. We saw new wins and increased demand at that site in Q1 and in the coming quarters. We continue to manage our balance sheet, but also to leverage its strength. Our net cash on the balance sheet remained above $16 million at the end of Q1 and we did invest in CapEx above our normal rate to improve operations primarily in our circuits business. We are seeing a number of acquisition of corporate development opportunities arise that could fit with either of our businesses, but we are currently seeing more on the circuit side of our business. Given our commitment to playing some offense, our very strong cash position, we are evaluating and pursuing them. Our criteria for any such transaction would remain what we have always said. They would need to meet a number of the following objectives that need to be aligned with our market, the product focus and need work that could expand our technology offering or expand our geographic coverage such as Europe for commercial aerospace or Europe, India or other top 10 western defense countries for defense that accelerate FTG’s penetration of the aftermarket segment. It could drive up our plant utilization and of course it would need to have an attractive price and multiple and be accretive to our earnings. And finally, looking forward into the balance of 2022 and beyond, there is reasons for optimism. As already noted, the industry is recovering 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 playing offense to capture new work. With a focus on operational excellence in all parts of FTG, we are confident we will remain on a growth trajectory in the coming quarters. And lastly, the FTG annual general meeting, this next Wednesday, April 20 at 10

Operator: Thank you. Your first question comes from Nick Corcoran from Acumen Capital. Your line is open.

Nick Corcoran: Good morning! Just a few questions for me. The first has to do with the business disruptions of Q1. Can you quantify the impact in the quarter of all those events?

A - Brad Bourne: Yeah, it's not a precise number, but if all the different things we saw definitely impacted revenue by more than $1 million and I would say you know less than $2 million, so somewhere in that range. And of course as our top line impacts bottom line, there's definitely an impact on both.

Nick Corcoran: And then, was there any impact on gross margins from either higher employee absenteeism or any of the other headwinds that you faced?

A - Brad Bourne: Yeah definitely, and it’s just every one of these things cause us to have – you know to do work arounds, to try to mitigate the impact, but you know for instance you talked about COVID absences. When we had people absent, our first line of defense to mitigate that is to have other people work overtime, but obviously you know overtime costs drive upper costs, so that would be an example. You know I talked about with one piece of equipment down in Circuits Chatsworth, it ended up being the same sort of thing that, you know that is right in the middle of our production process, so we had to run product up to that point and then hold it, and as soon as we got the equipment up and running we did everything we can to get as much through as fast as possible, but that meant again that people working overtime and just a less productive, less efficient manufacturing flow than we would've liked.

Nick Corcoran: And then think about EBITDA margins, they were down sequentially, what do you think the driver of that was?

A - Brad Bourne: Yeah, you really need to look at EBITDA margins and Jamie sort of touched on it in his talk, but EBITDA margins, you got to look at them excluding the government support that we received, and the reason I say that, you know if you go back to 2019 which was pre-pandemic, our EBITDA margin was 13%. If you look at 2020, our EBITDA margin was still 13%, but we had some government support in there. If you take that out, it was actually only 10%. In 2021 it’s even more dramatic. This is for the full year, but our reported EBITDA margin was 12%. Taking off the government support, it was actually more like 4.5%, and then you reported Q1 this year. If you take out the government support we were around 5.1%. So not a great number, but up from full year last year, and I guess the – I think the key on this is our EBITDA margin increases, the percentage increases as the revenue goes up, it's not a linear function. So you know, we are trending up from where we were last year, but the drop-off in the government funding makes it look like sequentially we were down, but on a normalized basis, it is trending in the right direction.

Nick Corcoran: And then for full year ’22, do you have an EBITDA target in line for the year?

A - Brad Bourne: We don't provide guidance as you know, but I guess if you look at the historic numbers, then again assuming we're not getting government support, I would love to see our brand back up towards the 2020 numbers, where 2020 was $100 million in sales and a 10% EBITDA. So I think you know that, we’re aiming for that sort of number, but again you know that’s not guidance.

Nick Corcoran: That's fair. And then another question, just there’s been broad inflationary impacts. Have you been able to take any price from your customers?

Brad Bourne: Yeah, that's a good topic. You know it’s getting a ton of attention at FTG. Obviously our customers are sophisticated organizations. They would love us not to pass on any impact of inflation, and there is definitely some situations where we can’t, but there's also many situations where we can, and for sure the sites and the sales team are looking to adjust pricing to reflect reality, and after you know say some initial pushback from customers, generally they acknowledge, that is through cost increase and therefore prices need to be adjusted and we have definitely had some significant price wins with our customers in the first three months of this year.

Nick Corcoran: Great! And then last question for me, how much do you expect to spend in CapEx in fiscal ’22?

Brad Bourne: Definitely more than we have spent in the past. Our historic target has been about 3% of sales. I think you know this year we are probably targeting something closer to double that, around 6% of sales.

Nick Corcoran: Thank you both. Best of luck!

Brad Bourne: Okay, thanks Nick.

Operator: . There's no further questions this time. I would now like to turn the call over back to Mr. Bourne for the closing remarks.

Brad Bourne : Thank you. Again a reminder, our Annual General Meeting is next Wednesday at 10

Operator: This concludes today's conference call. Thank you all for joining. You may now disconnect.