Velan Inc

TSX:VLN

Earnings Call Transcript 2021-Q1

[Operator]

Greetings, and welcome to the Velan Inc. Q1 Financial Results Conference Call. [Foreign Language] [Operator Instructions] Afterwards, we will conduct a question and answer session. [Operator Instructions] [Foreign Language] [Operator Instructions] [Foreign Language] As a reminder, this conference is being recorded, Friday, July 10, 2020. [Foreign Language]I would now like to turn the conference over to Yves Leduc, CEO. [Foreign Language] Please go ahead. [Foreign Language]

[Yves Jacques Leduc, CEO & Director]

[Foreign Language] Welcome to our first quarter fiscal year 2021 conference call. I'm joined today by Rejean Ostiguy, our new CFO, but it will be John Ball who will stand by to answer questions as he's presiding over his last quarterly results conference call, as he is now the exiting CFO. And I want to congratulate him for the great years spent with the company since 2005. I think we announced the change to Rejean Ostiguy on the 15th anniversary of his tenure with us. We're very, very grateful that he's continuing as Executive Vice President, Global Finance, and that we'll be able to benefit from his great capabilities. And Rejean has already earned his spot very well. He's been with us since last summer and has achieved a lot already, and I welcomed him on the team more than once. I want to congratulate him as well. I think we're going to make a great team, a great trio, the 3 of us. So good luck to both and let's start this conference. 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. But first off, let me start with 2 significant items. Earlier this week, we have agreed to the sale, which will be effective on October 31, 2020, of our McArthur plant in Montreal, the plant known as plant 2/7, within the land. The closing of the plant was planned as part of the V20 reconfiguration of our North American manufacturing footprint, which I've talked about many times in the past. Since we're ahead of time, basically closing operations and getting the plant ready for sale 5 to 6 months earlier than the original plan, we're going to be able to get the benefits of the sale this year rather than what was originally planned to be next fiscal year. So the gross proceeds will be USD 12.6 million and are conditional upon the submission of a clean Bill 72 environmental report to the Quebec authorities. I'm also proud to announce, and that's a very significant milestone, that we've recently secured new financing in the form of $22.5 million mortgage loan as well as a $65 million revolving credit facility. The new financing will replace our old financing structure. It will be used to support our operations, complete our restructuring and transformation plan, provide the necessary capital to pursue future growth initiatives. But equally important, strengthening also our balance sheet as the world economy enters a period of great uncertainty.One of the benefits of V20 is that we started discussing the new borrowing facility last summer because we knew we would need it as we were investing in V20. First off, as I told you before, we're going to end up spending less to make V20 happen, so that's good news. And it's a good thing that we started the negotiations and the discussions with our banks much earlier, and we were ready basically in the last phase of the closing efforts when the crisis hit back in March. So a good outcome, and I'm very, very happy with this very important milestone that brings increased resiliency to our balance sheet.Speaking of uncertainty. The COVID 19 pandemic definitely had negative impact on our results, but we're able to, due to the fact that most governments recognize our company as a critical supplier of essential industry, to be spared of the harshest consequences of the global recession that struck early in the quarter. In fact, it struck at the end of the fourth quarter of fiscal 2020, if you remember. We responded extremely swiftly in protecting our employees and ensuring the continuity of our global supply chain while delivering much improved results, and I will provide more details on this matter further along during the call, but let's have a closer look at our results.Net loss amounted to $1.9 million or $0.09 per share compared to $5.8 million loss last year or $0.27 per share. The decrease in the net loss or the improvement is primarily attributable to our improved gross profit as well as lowered administration costs, which was partially offset by an increase in restructuring and transformation costs combined with an unfavorable movement in income taxes.Operating profit before restructuring and transformation costs amounted to $0.7 million compared to an operating loss before restructuring and transformation costs of $6.8 million last year. Adjusted EBITDA amounted to $3.8 million or $0.18 per share compared to a negative $3.8 million or negative $0.18 per share last year. The improvement in operating profit before restructuring and transformation costs and adjusted EBITDA is primarily attributable to a stronger gross profit, driven by a range of V20 initiatives and a better product mix as well as lowered administration costs.Our gross profit percentage increased from 19.2% to 24% for the quarter. The increase in the gross profit percentage is mainly attributable to a favorable product mix as well as the labor and overhead savings stemming from our restructuring and transformation initiatives, which started in the prior year. The increase is also attributable to our qualification for $1.9 million of wage subsidies. The subsidies were put in place by government authorities to prevent further job loss in the context of the COVID 19 pandemic. By offering wages relief, the company is negatively impacted by the market distress caused by the virus, and that's one of the reasons we were able to preserve our workforce and our talent as we're aiming on rebounding as strong as possible once the crisis is behind us. So that was welcome as we avoided layoffs that might have been forced by the current situation. This increase was partially offset, I mean, the increase in gross margin. The increase was partially offset by a lower gross profit percentage in our French operations due to lower shipments of large project orders for the quarter.Let's talk about sales, order bookings and backlog. Sales amounted to $76.7 million, a decrease of $7.1 million or 8.5% from the prior year. Sales were negatively impacted by a decrease in shipments from our North American and French operations, which was partially offset by increase in shipments from our Italian operations. The decreased sales volume for the quarter is attributable to a lower shippable backlog in our North American operations, combined with the negative impact that the COVID 19 pandemic had on the global economy. For example, we had to manage many disruptions related to our supply chain, which caused significant delays on certain customer orders. And due to travel restrictions, we experienced difficulties in getting inspection clearance to deliver certain large project orders.Finally, as I mentioned before, we were able during the quarter to obtain recognition by most governments of our status as supplier of critical equipment to essential industries. And as a result, we were able to maintain our operations while managing through the pandemic. However, we did nevertheless face government mandated temporary shutdowns in reaction to the spread of the virus in certain regions of the world, in particular in India and for a shorter period of time, in Italy. Our Italian operations, though faced with these challenges, were able to deliver a strong quarter in terms of large project order shipments.Bookings increased by $12.5 million or 19.5% for the quarter. This increase is due primarily to large project orders booked by North American, German, French and Italian operations, notably in the liquefied natural gas and nuclear markets. This increase was partially offset by a decrease in nonproject orders booked by the North American operations due to the unfavorable market conditions caused by the COVID 19 pandemic. I'll say a few words about that when I talk about the outlook. We were encouraged nonetheless to record a 19.5% increase in bookings in the current context when compared to last year.We ended the period with a backlog of $410.3 million, an increase of $3.5 million or 0.9% since the beginning of the current fiscal year. Our book to bill ratio for the quarter being an even 1.00. The increase in backlog is primarily attributable to the strengthening of the euro spot rate against the U.S. dollar over the course of the current quarter.Financial position, summarize all of this. The new financing and the improved results for the quarter reiterate the fact that we have a strong balance sheet. Net cash settled at $44.6 million at the end of the quarter. That's an increase of $13.6 million or 43.9% since the beginning of the quarter. The increase for the quarter is first and foremost attributable to strong noncash working capital movements. The net cash per share was USD 2.07 or CAD 2.85. Our equity at the end of the quarter settled at $283.9 million or USD 13.15 per share. In Canadian dollars, our equity per share was $18.13 at May 31, 2020, compared to our TSX share price at the close of business on that day, which was CAD 5.02, indicating once again that our share price continues to be undervalued.So that's the end of the financial portion of today's summary. I'm going to go now into the outlook, and I'll start by mentioning once again that we're celebrating a 70th anniversary this year. If some of you had the opportunity yesterday to attend our Virtual Annual General Meeting, that was a first. I thought it went fairly smoothly except for that 5 second interruption, I think. We didn't get questions, so I hope maybe that we might get feedback today. Well, I did mention the 70th anniversary and talked about to the great history of the company and what my predecessors had accomplished. But I would encourage you to read that Valve World magazine article that made the cover of the industry's leading magazine. Tom and myself are quoted, but we also talk about many of our leaders and the dynamic transformation that's going on. So the other thing I mentioned yesterday is that we're strengthening our balance sheet. As I said, it's not only about the new credit facility, but the combination of our cash action plan and the V20 initiative, the improvement in margins, et cetera.Maybe say a few words about the COVID situation. As I say to our employees, with whom I communicate every week through a weekly video that I look to record in the next hour, we're not out of the woods yet. The Indian government has locked down last week the entire Chennai area. The outbreak continues strongly in India, now the third highest country in terms of reported cases. And we have a supply chain to manage over there, but our supply chain team is doing really good work in finding alternative sources. And as I said, the company is doing a great job mitigating the impact of the crisis on the overall global supply chain that we're managing. We're very proud of the team's overall response of all of our operations so far. The reaction to the crisis, including support from external stakeholders, like the new bank syndicate and so on, was exceptionally fast. And as a result, the company is showing remarkable resilience in the circumstances.In terms of our Q1 preliminary results, I want to mention that, not affecting our Q1 preliminary results, but we made a decision just a few weeks ago that can have an impact for the rest of the year of cutting our salaries of all employees in North America, starting from the top with the Board members and myself taking a significant salary reduction, and then accordingly, down to the levels in the company. Everybody is contributing. The reaction of our employees is that they understand that we're in the depths of a recession. We don't know where we're going to be in the fall. You're seeing the virus surge again in many areas of the world. So we have the prudence and I would say, the maturity of an organization to do whatever it takes to reinforce our base, and that's what's happening right now. The company is doing great, though, in terms of managing cash, I think in the context, as you see our cash action plan and all of the other actions I mentioned are going to help us build strength as we go through a very, very difficult and unpredictable period.I want to say a few words about V20. Those of you who attended the presentation yesterday have seen me mention our progress against the 5 key levers of V20, namely increasing the focus on our customers through the SBU, the new strategic business units that we created. Each of them have delivered very interesting improvements last year. We're seeing our bookings go up in severe service and project, for example, nuclear still a dominant player in the valve industry.Secondly, we're reorganizing our manufacturing footprint. We're ahead of time on this with the eventual closure and sale of plant 2/7 ahead of time. We're reorganizing our North American production model, making it leaner and faster with a reduced dependency on in house machining and leveraging an existing base of suppliers with whom we're contracting pre machining work, and that's also going on, on track. We're transferring all of the very low cost, small forged valves to India. That's also following the schedule. By doing that, we'll be able to "stop the bleeding" on manufacturing valves that basically sell in the low $100 or even lower than that. In India, we have a state of the art facility, and they're already producing some of those valves, and we're going to end the transfer at the end of the year.And finally, the modernization of our systems and processes, that's the fifth lever, with notable progress made, for example, with on time delivery with a new BPM system. We have configured price quote in CPQ being used and allows for much faster quoting. We're increasing the visibility of our cost tracking and basically modernizing our systems. And there's a very strong overall theme in everything we're doing. Everything about V20, I keep repeating, revolves around improving the end user experience.So overall, progress is being made on V20. And I would say that the COVID crisis although it did slow down some aspects of the work when we were operating under status of essential industry. We could not greet the constructor company making the changes inside the plants. But overall, COVID had a very mild impact on our team's ability to execute the plan. And talent is stepping up and there are elements of culture change, building on teamwork and cross collaboration across the subs. Our margin awareness is going up. And I feel a lot of our leaders are stepping up. So that concludes the summary of where we stand on V20.If I talk about business and operations. In many areas of our portfolio, the business remains generally dynamic, but with the most negative impact observed in the MRO and aftermarket part of the business and also upstream where the center of gravity is Italy. As I mentioned, we saw an increase in bookings quarter to quarter this year, but were dragged down by a decline in bookings in the MRO and spares market because our distributors, who are the main customers of the MRO spares business, are stocking down. They're basically not stocking up. They're waiting for the crisis to pass, and they're willing to buy from master distributors at higher price to protect their cash. So that affects directly our bookings. We hope that's temporary, but it explains why we're seeing a decline in bookings in the last 3, 4 months. That's largely driven by the MRO business. We're also expecting the midstream business with the lower oil price to be experiencing some difficulties this year. And as I said, we're in a recession and we're navigating through the fog as best as we can. The good news is we have a resilient, balanced portfolio because in the project side of the business and the severe service and in nuclear, we're seeing still very active bookings. And there, the impact of COVID really takes the shape of maybe affecting the continuity and fluidity of our supply chain, where we're also taking lots of measures to offset those negative impacts.A few key things I want to mention on the product side. We're going to step up product introduction. We've received recently good orders from the Navy and the Navy surge, the rebuild of the shipyard. So Navy is still a very strong customer for us. And they're relying on our capacity to handle new designs and that translate into very interesting bookings recently. As mentioned earlier, in severe service, we're working on licensure approvals. And we've had recently 2 very important orders for severe service applications based on recently obtained licensure approval. So severe service, which is a growth area for us, is showing good signs of going in that direction. And finally, in operations, I would say that despite the turbulence caused by COVID 19, we're seeing a true culture of continuous improvement building up across the board.So in conclusion, Q1 results were better than expected, especially if the crisis had started striking even before Q1 started in March. The company is capturing the benefits of the V20 plan, our modernized operation, the systems and our much more focused approach to market and end user customers. And I would say in many ways, we're already deeply transformed, and there's a lot more coming on top of it. The combination of our actions, including our swift response to the COVID crisis makes the company lighter, more agile and resilient to great shocks. We continue to improve the work environment, learning how to run manufacturing operations in the midst of a pandemic, but we're not out of the woods yet, as I said. We took every possible action to build that resiliency as we don't know what's around the corner and as we see the virus still spreading at a fast pace in many areas of the world. On the other hand, with a strong balance sheet and improving margins, we intend on capturing opportunities that will emerge from an industry that will inevitably be reshaped by the crisis. So there will be disruption ahead, but our employees have already proven a capacity to handle significant change. I thank them for their resolve and the sacrifice and the confidence they're showing as I do in the future.And on that note, I will hand it over to our moderator and answer questions along with John Ball, if there would be any. Thanks for your attention.

[Operator]

[Operator Instructions] [Foreign Language] There appear to be no questions at this time.

[Yves Jacques Leduc, CEO & Director]

Okay. We can wait another 5 seconds otherwise, so no questions?

[Operator]

We have a question at this time. As we said we didn't, one came up. We have a question from [ Dean Trottier ], which is a private investor.

[Unknown Attendee]

Congratulations on all the progress on the V20 plan. My question relates to kind of the, yes, the question relates to the backlog. I noticed over the years, you hover around 35% of the backlog being beyond the next 12 months from a delivery standpoint. As an outside investor looking at this business, is there an internal target that you guys have? Is there a right amount of backlog that's deliverable beyond the next 12 months?

[Yves Jacques Leduc, CEO & Director]

So the answer follows the lines of having a, as I said, a very diverse and balanced business portfolio, so. And each of these strategic businesses have different cycles. So if you look at the nuclear backlog, typically, orders get shipped far beyond 1 year. So it could be even 18 months. It will depend on the nature of the project or the customer. And the nuclear business requires a lot of what we call the inspection points through the whole process. You do a machining operation and you stop, you wait for the inspector to come in and approve for the next step and so on. So you'll have naturally much longer cycles from order to delivery in the nuclear business, which is a strong part of our overall portfolio.On the other extreme, you see MRO and spares. And typically there, if we have the parts already at our distribution center in Texas, can literally be shipped in a few days, whereas we operate on a cycle of about 26 weeks for parts that are not available at our distribution center and are going to be shipped directly from our plants. It goes from 10 days to half a year cycles for the MRO business.And then when you look at the other parts of our business, whether it's severe service, the more severe the application, typically, the longer the cycle. In the power world, you're looking at 35 to 40 weeks, sometimes lower, depending on whether you have stock in place.So that's my long answer to your question. So what you see is, when you say 35% of our backlog goes beyond 1 year, it's because a large part of our business is in difficult applications or highly technical applications like nuclear and severe service where you have longer cycles or you're in the replacement valve business where you have much shorter cycles. And so over time, if you're worried and say, maybe we should reduce the delivery time for a cycle. That's going to happen nominally over time as we maybe address different sectors or that we gradually make progress in reducing our cycle time through VPM, for example, Velan Project Management. But what you see today, the profile of that backlog is very much a reflection of our diverse business portfolio. I hope I answered your question.

[Unknown Attendee]

Yes, that was quite thorough. I just have one more very quick question. If you could give a brief update on where are all the plants up and running? Like how close would you say you are to 100% or maybe benchmarking it to before COVID hit just to see where you're at?

[Yves Jacques Leduc, CEO & Director]

The current capacity? The current capacity utilization of our overall global so it depends what you want to compare to. So if we're operating on 3 shifts a day, which we're not today, then you have a lot of available capacity. If you operate on 1 shift a day, then you're probably close to using the normal capacity you'd be using. So my point is that we've reduced our capacity globally where we see bookings go down. We adjust it. But we have a lot of room to wiggle in if we see our bookings go up without having to invest in additional manufacturing capacity. And we think that the V20 plan was the right thing to do. We reduced our North American capacity where we clearly had excess capacity and costs, and we're leveraging our Indian facility, which was ready to handle a lot more volume. So we're in a business where it's really all about adding direct labor and additional shifts to capture the extra capacity. I would say that we have in terms of footprint right now a normal capacity that is underutilized because of the current context. Not very much underutilized if you say 1 shift, for example, per day. But we have potential to grow quite fast without having to invest in new facilities.

[Operator]

Our next question comes from the line of Robert Beutel, Oakwest Corporation.

[Robert Beutel]

My compliments on your progress on V20. Notwithstanding the general environment, I'm pleased to see the speed at which you're moving. My question revolves around in the short term, it's really about the asbestos effects. I was wondering, we didn't talk about it in this quarter, but I was wondering whether lower asbestos expenses in the quarter are reflected in your lower SG&A. And then going forward, if you could give us any insight or color into what your expectations are for this very long tail problem?

[Yves Jacques Leduc, CEO & Director]

Let me take the second part of the question, and I'll hand over the first part of your question to John Ball, okay? So on the second part of the question, unfortunately, it's one of our costs in doing business. We're not seeing signs of the asbestos litigation go down. It's been fairly stable over the last 3, 4 years, and you have spikes here and there. But we're dealing with it. So don't expect that to go down. That's all I'll say at this stage, and it's something we're managing very tightly. John?

[John D. Ball, Executive Vice President of Global Finance]

Yes. And you'll see more information on the MD&A, which we filed on SEDAR. There's a section on contingencies. We talk about both the dollars and the number of cases and the location of those cases in the United States. So this is a purely American issue. We don't have a problem with asbestos anywhere else but the United States. It's a significant amount per year. Quarter on quarter, Q1 on Q1, it's pretty much flat by coincidence. It was $2.046 million versus $2.028 million last year. The number of outstanding claims is pretty much flat. We had 1,583 claims outstanding at the end of Q1 versus 1,561.It dates back to the 1970s and 1980s, principally in respect of work, valves that we supply to the U.S. Navy. The U.S. Navy specified asbestos packing to protect against fires on ships. And at that time, I don't think people were fully aware of all the risks of asbestos. So it was a U.S. Navy requirement. The people who supplied the asbestos have all been sued into bankruptcy years and years ago, so they're coming after companies like Velan that supplied the valves that had the asbestos packing on there.You would think this problem would decrease over time. However, the lawyers out there seem to find new and ingenious arguments for continuing to sue. So there's the concept of secondary exposures. So even if many of the people who worked on these shipyards back in the 1970s have passed on, the next generations, their kids and grandkids who might have bounced on their grandfather's knee after he came home from work, they're continuing to sue for us. We have not actually gone to court and settled. We haven't had judgments rendered against us. It's a little bit like an extortion where you try to place your arguments and then you negotiate the best possible settlement given the cost of going all the way to court with additional legal fees and the possibility of a judgment that goes against you. So in short, there is some…

[Yves Jacques Leduc, CEO & Director]

John, just to summarize, as I said, it's a fairly stable cost that we're learning to live with. But in answer to your first question, sir, the reduction in administrative cost is not the result of a reduction in asbestos. It's the consequence of actions we took and also focus on SG&A. And as I said earlier, the wage subsidy has helped in the first quarter as well mild down the impact on overall structural costs.

[Robert Beutel]

Well, no, in a certain sense, I'm pleased by that answer because it wasn't a onetime or short term effect. Nevertheless, this issue, of course, stands and it remains. I was just wondering if, given all the things that have been shut down, whether lawyers and all this stuff, the mechanics of filing were delayed because people couldn't go see their counsel. But it sounds like whatever it is, the pipeline is full, and it will continue to be full for a while.

[Yves Jacques Leduc, CEO & Director]

It's interesting that…

[John D. Ball, Executive Vice President of Global Finance]

Normally, you have that.

[Robert Beutel]

Again, all the best as you continue to make progress. And of course, disposing of the real estate in this market also sounds like a good thing because if you didn't need it, you didn't need it. So good luck.

[Yves Jacques Leduc, CEO & Director]

Thank you very much. Any other questions?

[Operator]

There are no questions at this time, sir.

[Yves Jacques Leduc, CEO & Director]

Okay. So thank you, everybody, for your attention and have a good summer, a restful one. And as I tell every one of our employees, stay healthy and take care of your friends and family as best you can as we go through a very difficult and uncertain period. Thank you very much.

[Operator]

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