Velan Inc

TSX:VLN

Earnings Call Transcript 2019-Q1

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Velan Incorporated Q1 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, July 12, 2018.I would now like to turn the conference over to Yves Leduc, President and CEO. Please go ahead, sir.

[Yves Jacques Leduc, President, CEO & Director]

Thank you. Welcome to our first quarter fiscal year 2019 conference call. I'm today joined by John Ball, our CFO. I'll start with a brief summary of our results, followed by a more detailed discussion of our outlook. We'll then open the line to your questions.After a difficult fiscal year '18, we see encouraging signs of recovery on the sales side, but are still very concerned about project manufacturing bookings, where the global market is still struggling and about the margins in our North American operations. The complexity of our project manufacturing business keeps increasing at a pace faster than our improvements. This, combined with sharply contracting margins in project valves, contributed to a weak margin, again, mostly in our North American operations, which dragged down the overall margin improvement observed at the consolidated level.Let's have a closer look at our results. Net earnings or loss. Net loss for the quarter amounted to $3.7 million or $0.17 per share compared to a net loss of $4.3 million or $0.20 per share last year, so a mild improvement. EBITDA amounted to negative balance of $1.5 million or $0.07 per share compared to a negative balance of $2.5 million or $0.12 per share last year. Improvement in our results is primarily attributable to a higher sales volume and improved margins. Our gross profit percentage increased from 19% to 22.7% for the quarter. The increase in the gross profit percentage is primarily attributable to the higher sales volume and shipping, a product mix with a greater proportion of projects with higher margins, particularly spare parts and cost items. However, the continued pressure on pricing continues to cause an erosion of our margins, again, particularly in our North American operations.Let's talk about sales, order bookings and backlog. Sales amounted to $77.9 million, an increase of $6.8 million or 9.6% from the prior year. Despite the higher sales volume for the quarter, delays in shipments of certain large project orders caused by various customer-related supply chain and an internal operational issues continue to be an issue. Fierce competition continues to have a negative impact in most of the company's markets, which increased the importance for the company to target discrete market segments, whereas engineering know-how and agile design capabilities can be a leverage for future growth. I'll be coming back to that later when I talk a little more at length of our new sales structure. Bookings amounted to $86.2 million, an increase of $14 million or 19.5% for the quarter. This increase in bookings is due primarily to higher orders booked by the company's North American and Italian subsidiaries, particularly in the oil and gas sector. The company also noted an increase in non-project valve orders in the current quarter, and I'll be giving a few more -- a bit more detail on that particular subject. Despite the fact that we had a positive book-to-bill ratio of 1.11, our backlog settled at $460 million, a decrease of $4.6 million or 1% since the beginning of the current quarter. This decrease in backlog was substantially due to the negative impact of the weakening of the euro spot rate against the U.S. dollar over the course of the quarter, which went from EUR 1.22 to EUR 1.17.Financial position. We continue to have a strong balance sheet. Net cash settled at $48 million at the end of the quarter, a decrease of $13.1 million or 21.5% since the beginning of the quarter. The net cash per share was USD 2.22 or CAD 2.87. Our equity at the end of the quarter settled at $311.1 million or USD 14.39 per share. In Canadian dollars, our equity per share was CAD 18.63 at May 31, 2018, compared to our TSX share price at the close of business day on that day of CAD 14.75, indicating that our share price continues to be undervalued.Now I'm going to talk about the outlook, and I'll start by once again referring to our strategic plan, Velocity 2020, which we launched last fiscal year. It rests on a few key building blocks. It aims at transforming our company into a high-performing business model through greater focus on fewer markets and customers, and supported by a realigned global supply chain and continuously improving core processes. We're far from the goal of becoming a high-performing company obviously, but our business results overshadowed the fact that we're making progress on many fronts in transforming our company. What are those key building blocks? And what progress have we made against them? The first building block is that we need to leverage our strengths, which are unique. The combination of our strengths is unique. We are talking about a unparalleled product reputation, very deep design and agile design, know-how capabilities. We have a global footprint, a global chain of customers and agents, even customers who never purchase valves from Velan, know who we are and what we stand for and, obviously, a very strong balance sheet. So this is something we have to continue leveraging, but the 4 other building blocks really have to do with what are the pillars of our transformation. We need to become much more focused on growth markets. So becoming RFQ-driven -- going from being RFQ-driven to customer needs-driven and our ability to serve them very fast, offering our quick design capabilities. We need to get closer to the end user. And I'll give you a stellar example of something we've achieved recently that supports that pillar. We need to improve processes and systems and we need a faster, more efficient global supply chain. So what's happening at our -- let's talk about having a faster, more efficient global supply chain. At our Q4 conference call, I mentioned that we're on track to deliver the 3-year commitment that I made last year to reduce our cost base by a cumulative $20 million over 3 years. To date, we've identified $5.2 million of cost savings under this initiative. We achieved these material savings through our new corporate materials management, which started about 18 months ago, and focusing on global synergies and commodity buying. We're leveraging a low-cost sourcing and footprint that we -- like we never did before. For example, we've just completed the industrialization for pressure steel valves of our Velan Indian sub, which gives us a lot more flexibility and also access to low-cost manufacturing for that flagship product line. And we're automating and streamlining our footprint. Currently, the phase of deployment of our material cost strategy is about spanning efforts across all of our subs to capture savings through combining our buying power. A strategic buyer from corporate office has, in fact, been transferred to Europe this month to work with our European subs. And I'm pleased with the cooperation of all involved to further deliver material savings. There's a lot more going on, but maybe on the subject of faster, more efficient global supply chain, I just want to point out that we went from 4 DCs and now only 1 distribution center. The one remaining is VelTEX, which we invested in to expand the floor space. But we successfully completed the closure of the fourth one earlier this year.Let's now talk about improving our processes and systems. I'm not going to go at length. I did allude to the fact that we invested last year in the new ERP system. That went well, although it did create turbulence that compounded our operational issues. I mentioned that at the Q4. But the point I want to make here, this is a massive cross-company effort. And it is a significant investment in our effort to modernize our business and achieve that vision I was talking about of becoming much more agile in serving, in a very tailored way, our customers. We are also building our project management capabilities of the new ERP and developing a whole set of new systems, like project scheduling, project visibility, lean capacity planning, which is going to become a new function to help maximize our capacity across our global plants. And I'm saying that accompanying that is also a change of culture because we're building process awareness, process know-how, and delegating the task of continuously improving those newly system-supported processes, with continuing innovation. So no more on the subject, but the point is that -- I'm going to come back to that later, this is foundational and we're having a good success on that front.Focus on growth markets. Let's talk about the MRO business. Remember I mentioned that we restructured our sales force in 4 vertical markets: process industries; the power market; upstream, midstream; MRO. And we're seeing results already. Let's talk about the MRO maintenance repair operations. That's the replacement valve business, which is largely distributor-driven for us. It's a North American business. And as I said in earlier conference calls, we've seen our sales fall off a cliff to a certain degree in the last 4, 5 years, largely because refineries or end users were turning to cheaper valve suppliers out of China, and were willing to upgrade them to Tier 1, which was our status. And as a result, we've seen a change in the business environment and a significant decline in orders. So what's happening? First 6 months of fiscal '18, we had reached, I guess, the bottom of that cycle because in the last 9 consecutive months, we've seen our average bookings per month go up by 20%. What's accounting for that? Yes, distributors are replenishing their stocks after a few years depleting inventories, but we also are changing our channel configuration. We appointed a new master distributor and we revised our pricing strategy, incentivizing distributors on volume-driven discounts. In the end, it actually helps our margin, and it has for certain fueled part of that growth that I just alluded to. So basically, the MRO sector is slowly recovering, but it's also the result of our greater focus on optimizing our channel, which we wouldn't have been so successful doing with the previous sales structure, which was mainly geographic-driven. Now we have a team of folks who are concentrating on how to drive demand, both at the end-user level and through our distributors. And those are -- there's a true channel strategy that's emerging out of that. And so I'm not thinking that the MRO business will come back to the levels we had 4, 5 years ago, but I'm saying, we should expect slow recovery of it this year, thanks to the factor I just alluded to.Let's talk about upstream, midstream. You rarely hear me talk about our Italian division, other than to say that we turned it around last year. And suddenly things look much brighter. We just obtained a $15.4 million order from MODEC. That is an EPC specialized in offshore and gas exploration. And they're working for Petrobras, the oil company of Brazil. And the ABV concentrates -- that's our Italian sub, concentrates on developing a very specific niche market. It's called floating production storage and offloading. We call that FPSO. We have specialized products for that. They're API 6D non-slam check, class 150 up to 24 inch. And that $15.4 million order to us is a breakthrough after 2 or 3 years of almost nothing happening in that special market. So that's great news, and we're going to issue a press release next year to announce -- next week to announce it.Let's talk about that pillar that's kind of intriguing. Getting closer to the end user, what does that mean? Well, it means that we've long -- for a long time, sold our valves through either EPCs or distributors, and not much directly to end-user customers. Certainly in North America distributors have basically buffered us out of the end-user relationship. That was not bad, but there are ways to develop -- to fuel sales of valves by getting closer to the end user. And we don't want to circumvent distributors, but we want to stimulate those sales. And there are ways to do that, and one of them is actually the object of a breakthrough pilot project that we've now launched and successfully completed. What did it consist of? We've been hired by Calpine. That's a company operating power plants, either wind mills or coal or gas, combined cycle-activated power plants. And they've hired us to go and refurbish their fleets of valves at 1 plant located in California. That's a model that we actually successfully deployed in France, namely the valve manufacturer is the selected service firm to go and do the work, where typically a lot of end users use local shops to do that. The reason why they chose us is because of our know-how obviously. And we've done it well by integrating with local shops, but they want the contract with us. That project is -- the learnings that we got out of it is something we want to expand and continue focusing on developing of service business. It's not only about the fees we get, but the opportunity of interacting with operators, understanding their needs and finding ways to sell not only services and spares but also valves. So it's the beginning of something quite promising in terms of changing our business model.We believe, to conclude, our strategic direction is right. And we've been laying the foundation for the future in the midst of a shifting business environment. But as I said in May, if we don't make adjustments, we believe the return to acceptable performance levels will not be fast enough. Important changes are required and are coming. Specifically speaking, although we're encouraged by the fact that global sales are slowly recovering this year, and if you haven't noticed, it's a first time in 5 years that we've observed a slight recovery of our sales. We've seen a sales decline now for 4 consecutive years. Margins are not acceptable, even if we see a slight recovery in sales, and that's true namely in our North American operations. Much of what is already done or in progress will address this problem, namely our investments in modernizing systems and business processes, the encouraging results of our new corporate materials management department and the new sales force, focusing on segments with higher growth and margins. But in addition, our plan has to be bolstered by accelerating our cost reduction initiatives as well as by putting a much greater focus on reducing business complexity where it hinders our ability to drive improvements and create value for our customers.Can we be -- what are the reasons why we should be confident despite the tough challenges we're going through? While many factors play in our favor, we need to continue focusing on our strengths, namely the -- one of the best names in the industry, our global presence, the know-how and the passion of our employees. We have a foundation that didn't exist 2 years ago, the new ERP, the project manufacturing systems and tools. We've hired a lot of new talent, not only in the sales force in the last couple of years. And we're accelerating because we can now. We've developed an appropriate method. It's building up. We can accelerate breakthrough improvement initiatives in the manufacturing environment. And we have a global corporate materials department that's seeking, and successfully so, to achieve synergies and materials management. Winning attitude and self-confidence. I talk to employees and I'm touched and moved by their commitment to turning the company's performance. They're not accepting the results. That, I find, is very motivating. We can build on that passion. If you're talking about confidence, what does the CEO see in the company? I told Tom when -- not too long ago that I have more confidence in our potential than I have that -- when I even started. And those who note what I'm saying, I would ask to remind the market that I made a significant investment in the stock in the last month. And that should be seen as a proxy of my confidence in our ability to turn things around.Last but not least, I said last week -- last year that we're in a strong financial position, so we're careful not to rush things. And I -- at Q4, I told you, well, we're a little less patient. It's not about rushing, but there is a sense of urgency. And -- but we're carefully thinking about the adjustments I referred to earlier. And the adjustments consist in accelerating our cost initiatives but also finding ways to reduce the complexity that hinders our ability to drive value for our customers or to drive the improvements that we started initiating. So to conclude and my last words, we're not losing sight of the long-term potential of Velan, but there is a sense of urgency that requires great attention to our short-term results. I will keep you updated as we progress. Thank you.I can now turn it over to our moderator, and open and ready to answer questions if there are any.

[Operator]

[Operator Instructions] And I'm showing no questions on the phone lines at this time.

[Yves Jacques Leduc, President, CEO & Director]

So if there aren't any questions, I thank you for your attention. Wish us luck. Luck is always good. We're on to turning things around. And as I said, we'll keep you updated. Thank you for your attention.

[Operator]

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.