Velan Inc

TSX:VLN

Earnings Call Transcript 2020-Q1

[Operator]

Greetings, and welcome to the Velan Inc. Q1 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Friday, July 12, 2019.I would now like to turn the conference over to Yves Leduc, President and CEO. Please go ahead.

[Yves Jacques Leduc, President, CEO & Director]

Missy, thank you very much. Good morning, everybody. Welcome to our first quarter fiscal year 2020 conference call. I'm joined today by John Ball, our CFO. I will start with a brief summary of our results followed by a more detailed discussion of our outlook, we'll then open the line to our questions.First off, I will state that we're not satisfied with the results for the first quarter of our fiscal year. We've experienced delays in shipping higher margin products in our North American and French operations, from which we expect to recover in the course of the year. The performance of our North American operations should also gradually improve as we replace last year's backlog with new orders reflecting greater rigor in project selection and pricing. I'll say a few words about this further along during the call.Let's have a closer look at our results. Net earnings or loss. Net loss amounted to $5.8 million or $0.27 per share compared to $3.7 million or $0.17 per share last year, also a loss. The increase is net loss -- in net loss is primarily attributable to lower margins despite our higher sales volume. EBITDA amounted to a negative $4.3 million or negative $0.20 per share compared to a negative $1.5 million or a negative $0.07 per share last year. The $2.8 million decrease in EBITDA is primarily attributable to a lower gross profit percentage caused by the shipment of larger lower margin orders combined with an unfavorable product mix, which is what I just referred to, namely the difficulty in shipping products out of our French operations.Our gross profit percentage decreased from 22.7% to 19.2%, that's 350 basis points for the quarter. The decrease in the gross profit percentage is mainly attributable to a combination of temporary or nonrecurring factors as well as to a more structural business-related factors. Temporary or nonrecurring factors include a product mix with a lower proportion of higher margin product sales caused by delays in shipments, such as nuclear valves from our French operations, spare parts and highly engineered severe service valves in our North American operations, all of which are expected to pick up later this fiscal year. The more structural factors causing the decline in gross margin include the shipment of technically complex orders with lower margins entered prior to this fiscal year. Overall, we're still delivering the backlog built since the end of fiscal year 2018, which carries the significantly reduced margins experienced in our North American project manufacturing business, a heavy trend observed and reported in the last 3 years.Carrying over this legacy backlog means that the first quarter margins do not yet reflect the impact of the number of measures launched in the last month's under our V20 transformation plan. These measures include, but they're not limited to, a dedicated business unit with sharper market focus, which I'll be talking about in a few minutes, much greater and rigorous project selection and pricing, we've become a lot more disciplined or careful, I would say, in selecting projects we want to quote with an eye on margin and pricing. And we've expanded our low-cost supplier network in Asia, which we'll continue leveraging increasingly more.The combined effect of these measures is expected to gradually take effect in the course of this fiscal year and next year, but the greater impact, and that's very important part of my message, the greater impact of our transformative V20 initiatives is only expected late in fiscal year 2021, namely calendar year 2020, when the task of reorganizing and reducing our North American footprint will be completed.Sales, order bookings and backlogs. Sales amounted to $83.8 million, an increase of $5.9 million or 7.6% from the prior year. Sales were positively impacted by an increase in shipments from our Korean, Italian and North American operations, which was partially offset by a decrease in shipments from our French operations. The increased sales volume for the quarter is primarily attributable to the higher number of orders booked in the prior fiscal year in the shorter lead time MRO business, which was partially offset by lower sales from our French operations due to the timing of the deliveries of certain of its large project orders, which are scheduled for the later part of the fiscal year.Bookings decreased $22 million or 25.5% for the quarter. This decrease is due primarily to lower orders booked by our North American operations, which had seen, last year, an unusually high surge of nonproject valve restocking orders from our distributors in the first quarter of the prior fiscal year. MRO distributor orders this fiscal year are expected to reflect a more normalized stock replenishment cycle. The decrease in bookings is also due to lower project orders booked by our French operations.We ended the period with a backlog of $423 million, a decrease of $26.4 million since the beginning -- or 5.9% since the beginning of the current fiscal year. The decrease in backlog is primarily attributable to the weak book-to-bill ratio of $0.70 in the quarter and the weakening of the euro spot rate against the U.S. dollar over the course of the current quarter.Financially -- speaking of our financial position, I want to say a few words about this. While our financial performance for this fiscal year has not been satisfactory to date, we continue to have a strong balance sheet. Net cash settled at $39.4 million at the end of the quarter, a decrease of $1.5 million or 3.7% since the beginning of the quarter. The net cash per share was USD 1.82 or CAD 2.46. Our equity at the end of the quarter settled at $299.7 million or $13.86 per share. In Canadian dollars, our equity per share was CAD 18.75 at May 31, 2019, compared to our TSX share price at the close of business on that day of CAD 9.46 indicating that our share price continues to be undervalued.Now I'll talk about our strategy. Again bringing all the pieces together to explain our V20 plan, as I said at the beginning of this conference call, I'm not satisfied with the results. FY '19 as I reported the last quarter conference call shows -- showed a glimpse of recovery, great improvement, notable improvement in the gross profit even facing the headwinds that we're facing, but I'm not going to tell you that I'm satisfied. The company is going through a very challenging period, which mandates a lot of big changes at the same time. As you know, it's not the same market environment as a decade ago. It shifted massively and fast in the last 10 years and the fact is that the company was not ready for it. We had systems and processes that needed to be upgraded, the way our business is structured has to be changed and all of that means that our business model was simply not suited for a new competitive environment. We're still facing external challenges like asbestos, but this is under control. Many of these investments, that I just referred to, started in the last 3 years, they're all necessary to bring the company, mainly and I insist on that North American operations, back to levels where the company could successfully compete. It is a big ship to turn, and yes, it is and was as I said last year slower to change than expected, which is why we decided to go deeper and truly transform the business model, which led to the V20 decisions, which were approved unanimously by the Board and announced back in January. It's about rethinking the North American business structure, not just the footprint, but the business model and our approach to market. It's a big move. It's not just closing a plant, it all amounts to creating winning conditions that are not going to be present unless we change the business model.So the decisions that led -- the factor that led to those decisions, when we talk about the North American situation, is that we have overcapacity in our -- with our 4 North American plants. The plants are not configured optimally to meet the market conditions that we're facing. We have generous plants that combine many, many different products, which makes it for very high variability and product diversity. Overall, my point is that the greater of our focus going forward with V20 is addressing our North American manufacturing operations and the way we go about marketing the products. We have a very solid foundation. I'll conclude my message with this. When you look at the rest of our business globally, the subs are doing well overall. So it really is about addressing the fact that our North American performance has seen declining results in the last 5 or 6 years. A few months since the announcement, the company is fully engaged in a major transformation. We're adapting our business model and building capabilities and assets that the company did not have before North American sales started their decline 6 years ago.Let me summarize the most important cornerstones of our strategy. Modernized operations and technology-enabled processes, more targeted go-to-market strategies and increased end user focus and a global manufacturing strategy designed to support our customer focus and market strategies. The vision is to transform Velan by making it less dependent on the industry cycles and better able to shape its own fate by dictating the pace and better selecting its customers. Our commitment is to grow both sales and profitability. 4 decisions will enable this vision. Let me go through them quickly. And then I will update -- while I update you on the progress.What were those 4 decisions? #1 is we restructured Velan North America into 3 strategic business units, MRO and aftermarket, project manufacturing and severe service. The second decision was to modernize and specialize our VNA plants in addition to connecting them to the new business units. The third decision, which is the one that caught the most attention was the closure of 1 of our 4 North American plants, namely plant 2/7 in Montréal. And the fourth decision was to speed up our investment in upgrading our business processes and systems. They're all integrated together. It really is a whole and it is not only about closing a plant. The 3 business units are now in full fledge. Rob Velan is in-charge of the MRO and aftermarket, which is focusing on leveraging our installed base from 3 different angles, replacement valves, spares and services, with a much greater focus on serving the end user. And Rob will be managing largely an Asian supply chain. Wolfgang Maar is in-charge of the project business unit, mostly power and nuclear, petrochemical project contracts. His job is to make sure that we sharply target attractive applications and improve execution and cycle time and he will be benefiting from a very focused Granby plant where we will specialize and concentrate multiturn project valves.And last but not least is our severe service business unit, which carries what we believe significant growth potential, will consist of quarter-turn products for process industries and also the Navy. And the name of the game there will be proactive sales engineering and license approvals, and Duc Tran, who will -- who is leading the business unit will be benefiting from a specialized Montréal plant where we will invest in upgrading our R&D operations as well as increasing our focus on technology for those valves where we see, as I said, great growth potential.So as I said, these are 4 decisions that come together and the one that drew the most attention is the closure of plant 2/7. Let me give you a bit of progress update on this. Of course, it created a shock with all employees. We are creating more jobs in Granby but that will have an impact on employment in North America and you may have noticed that the negotiations or discussions we're having with the unions have now joined the public space. All I want to tell you is that those discussions are going well. The idea is to do it together with the input from the unionized employees to see how we can minimize the impact of an unemployment. But the fact of the matter is that we are closing a plant, but we are investing in upgrading our 2 other plants in Québec and that is a testimony to our dedication to growth.This vision, that I just described, which is about making Velan less dependent on industry cycles and better able to shape our own fate by -- with a greater market focus, we're harnessing or linking to specific top line and margin improvement goals and we've equipped ourselves with the means to deliver them. We've set up a transformation office, as soon as we receive Board approval. The resources are fully deployed and things are progressing to plan on all fronts.I want to conclude with a summary of where we stand today and refer to what I like to call the step stones to Velan's return to strong operational results. First of all, we have a strong foundation and tailwinds that we can benefit from. What are those foundation -- foundational elements and tailwind factors? We're expecting a heavy surge of Navy orders, which we've already started entering in the course of the last few months. The Navy is building new aircraft carriers and we are on the frontline as a traditional and well-appreciated supplier of valves for the Navy so that will be coming in the course of the next 18 months. And as I said, we've already received good orders from our Navy customer. We have a strong MRO installed base that's global with existing high-performing distributors, along with new distributors, and I believe that the new business unit that's been established, headed by Rob Velan is going to have success in -- with the increased focus leveraging even more. Velan Italy has a record backlog and their very focused strategic plan is an indication of the success we want to have with our dedicated business unit as North America. They're focusing on FPSOs, which are floating production storage operations that are temporary oil exploration platforms in the deep sea and we are a supplier of choice for our core customers there. We have strong and profitable French operations. And recent license approval supporting our severe service business are a good step in the right direction in terms of capturing the growth potential with our severe service business unit as I -- that I just described.Second step stone are the structural and -- cost and margin improvements that we're driving. We're reducing the North American footprint and the production overhead. We're reducing our SG&A that will come with it. As I said, most of that impact will come late next calendar year. We're going to be leveraging our Indian plant with less complex valves, a lot more. We're driving material cost savings through an improved and expanding supplier base in Southeast Asia and our higher margin severe service growth is expected to drive growth in margin as well.So these 2 platforms or step stones have a strong likelihood of happening within next 2 years. And there's a third step stone, which I connect to SBUs in the modernizing of our business. When we invest and continue investing in digitizing and modernizing our systems and processes, the connected and more focused plants supporting our SBUs, which are going to be focused on -- focusing on end users a lot more or introducing new products. We expect that our new approach to project manufacturing, greater selection and pricing discipline, that I referred to, will drive margin growth. These are the key elements of our 5-year growth plan and they're greatly enabled by the V20 change and investments that we're now deep into carrying out since the announcement in January.So to summarize what we're doing is that the plan is a very straightforward plan. It really is about focusing more on end users, aligning our supply chain through our market strategy, leveraging more a low-cost base with India and reducing our production overhead structure by streamlining our production capacity in North America. It involved very difficult decisions. We can't underestimate the signs and importance of all those decisions. And at this stage, we're deep into deploying those actions and managing all stakeholders at the same time.My point is that fiscal year 2019 gave us a glimpse of a promising recovery, but as I said, we're not out of the woods. The execution of the plan requires significant and well-planned investments, and I'm very thankful for the Board's support and unanimous approval of it. Going forward and in the end, management believes it has the mandate and the means to carry out the plan that will bring back Velan to strong and consistent profitability. And I'd like on this to thank you for your attention and get ready for questions if there are any.

[Operator]

[Operator Instructions] And we have no questions at this time.

[Yves Jacques Leduc, President, CEO & Director]

Okay. Well, we have the benefit of getting a lot of questions at yesterday's AGM so I suppose most of them were made already. On that note, I'd like to thank everybody for your attention this morning and I look forward to meeting again on our next quarterly call.

[Operator]

Thank you. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.