Velan Inc

TSX:VLN

Earnings Call Transcript 2022-Q1

[Operator]

Greetings, and welcome to the Velan Inc. Q1 Financial Results. [Foreign Language] [Operator Instructions] [Foreign Language] [Operator Instructions] [Foreign Language] As a reminder, this conference is being recorded Wednesday, July 14, 2021. [Foreign Language]. I would now like to turn the call over to Yves Leduc, CEO. [Foreign Language]. Please go ahead. [Foreign Language].

[Yves Jacques Leduc, President, CEO & Director]

[Foreign Language] Welcome to our first quarter fiscal 2022 conference call, joined today by Benoit Alain, our new CFO; and John Ball, who has recently served as Interim CFO and has transitioned back to Executive Vice President. I will start with a brief summary of our results, followed by a more detailed discussion of our outlook. Thereafter, John, Benoit, and I will open the line to your questions. [Foreign Language]. Our first quarter results were mixed. Sales were flat for the quarter caused primarily by temporary shipment delays and lower distribution channel orders in previous quarters. That being said, we're extremely encouraged by our gross margin surging near 27%, almost 3 percentage points above last year, thanks in large part to our V20 program, whose primary aim was precisely to drive of our North American operations' margins up. We were disappointed by the several non-operational factors that increased our administration cost to a notably higher level than last year. In summary, if I consider all of this, the improving business health and margins of our global operations were not sufficient to cover for the increased administration costs and the impact of those delayed shipments that I will be talking about in a minute. Speaking of business health, we project our sales to grow, thanks to another strong quarter in terms of bookings as reflected by our 1.56 book-to-bill ratio, driving up our backlog to the highest level since August 2012. I will expand on that later on in my presentation. Now let's have a look at our results. Net loss amounted to $5.1 million or $0.24 per share compared to $1.9 million or $0.09 per share last year. EBITDA amounted to a negative $900,000 or $0.9 million or $0.04 per share compared to a positive $2.6 million or $0.12 per share last year. The movement towards a net loss and EBITDA is, on the one side, disappointing, but the improved profitability and margins of our global operations is highly encouraging. Despite sales being flat compared to last year, our gross profit percentage increased, reflecting the notably improved product mix and margins resulting from our targeted efforts under V20. We're also benefiting from a $1.2 million reduction of restructuring and transformation costs in the current quarter, also reflecting the progress made last year in the deployment of our V20 program. These improvements could only partially offset the negative impact of the delay in shipments in our Italian operations and an increase in administration cost of $6.1 million or 34.6%. The increase in administration costs was primarily attributable to an increase of $2.1 million in the cost recognized in connection with ongoing liability litigation, the decrease of $1.1 million in Canada Emergency Wage Subsidies received compared to last year's first quarter, and a general increase in administration expenses that have been significantly lowered when the global pandemic broke out last year. The fluctuation in asbestos costs for the quarter is due to the timing of settlements in these two periods rather than to changes in long-term trends. Our gross profit percentage increased from 24.0% to 26.8% for the quarter. That's 280 basis points. The increase in gross profit percentage was such that it could more than offset the impact of $1.3 million lower amount of Canadian Emergency Wage Subsidies compared to last year. The subsidies were allocated between cost of sales and administration costs. Improvement in gross profit percentage was mainly attributable, as I said earlier, to a product mix with a greater proportion of higher margin product sales as well as the improved margin stemming from the margin improvement activities implemented over the course of the past fiscal years in the scope of our V20 restructuring and transformation plan. I talk now about sales, [ bookings ] and backlog. Sales amounted to $74.5 million, a decrease of $2.1 million or 2.8% from the prior year. Sales were impacted by temporary shipment delays in our Italian operations due to various customer-related and also global logistics factors as a result of the shipment of some large orders by our Italian operations who are currently very efficient in executing a record backlog is expected to shift into the second quarter of the current fiscal year. The shift had a negative impact on comparative sales given last year's very high first quarter sales by our Italian operations. Now on the other hand, the increase in shipments from our French operations partially offset the negative impact of the sales shift in Italy. Additionally, that's important to note, our non-project sales for the quarter were negatively affected by the persistent unfavorable market conditions triggered by the COVID-19 global pandemic which had significantly affected our distribution channels bookings in the previous fiscal year. As you heard me say before, the MRO and aftermarket business is the strategic business but was by far the most hit by the prices provoked by the pandemic. The lower distribution channels bookings in the latter part of the prior year translated in lower shipments of such orders in the current quarter. Bookings increased by $39.6 million or 51.7% for the quarter. This increase is primarily attributable to large project orders recorded by our North American and Italian operations notably in the marine, mining and downstream oil and gas markets. We ended the period with a backlog of $607.2 million. That's an increase of $44.7 million or 7.9% since the beginning of the current fiscal year. The increase in the backlog for the quarter is primarily attributable -- or results in a strong book-to-bill ratio of 1.56. Financial position. We continue to have a healthy balance sheet, highlighted by a net cash balance of $71.2 million at the end of the quarter, an increase of $8.3 million or 13.2% since the beginning of the fiscal year. The net cash per share was USD [ 3.30 ] or CAD [ 3.98 ]. Our equity at the end of the quarter settled at $296.6 million or USD 13.74 per share. In Canadian dollars, our equity was CAD 16.58 at May 31, 2021, compared to our TSX share price at the close of business on that day of [ 9.85 ] indicating once more that our share price is notably undervalued. We had our Annual General Meeting for our shareholders yesterday, and I encourage you to have a look at my presentation, which we will post on our website at the beginning of next week. You will get more details and comments about the quarter as well as the most interesting highlights of fiscal year 2021, which I reported about last night. So let's move now to our business situation. What I'd like to do is assess our vantage point. What's the vantage point that we're seeing going forward? Well, first of all, I want to say that we're very conscious of the challenges. We can't understate the fact that the pandemic is still raging in most areas of the world. that's making a lot of project owners or project managers very nervous, slowing down their decisions and very often delaying shipments. That's been a reality that despite the constant flow of operations maintained by the fact that we were in a central industry in the last year, has been a reality in the way we operate our business. Customers call, or refused to call, or delay shipments -- delay release for shipments. That's part of the problem when I referred to global logistics. Speaking of which, global logistics right now, if you read the news, are in havoc. We have delays at ports. The time to ship parts has been significantly increased. And given that our supply chain is largely resting in Southeast Asia and India, obviously, that adds to the operational challenges we're seeing in particular, in Québec, which I'll be talking about in a couple of minutes. The pandemic has had a significant impact on the material cost as well. The commodity costing and pricing has gone up, and we have to compose with that as well. And I mentioned the liability cost a little earlier. So these are, call them, external factors. They fuel the challenges we're facing, and we're very conscious of them. Now, on the other hand, we're, in many ways, in a very good position, much better than one year ago, even if our results are slightly lower. What do we have going for us? So let's start with business health here. Often, you hear me talk about business health. But a few key drivers of business health are going in the right direction right now. First of all, V20 program for which most of the infrastructural elements and the investment elements are behind us. They were carried out for the most part during fiscal year '21, is driving substantial and sustainable margin improvements. We're seeing -- we're benefiting this year largely for the full year of the reduction -- significant reduction of structural costs, almost $15 million that drag down our operational performance in North America. And we're seeing a dramatic improvement in the profitability of our MRO and aftermarket business thanks to the transfer to India of our low-cost valves that we were still producing in our Montreal plant. As a result, we're seeing our Indian plant thrive right now with higher volume and margins and overall, the MRO business has increased in profitability, all of that as a direct result of V20. Another direct consequence of our V20 portfolio of decisions is that we set strategic businesses. We now talk about the land in terms of our 5 reorganized strategic businesses, 2 of which were already in existence out of Europe and they contributed to turning around our financial performance in our North American operations because of that extra focus. And we're seeing, for example, in severe service, a dramatic increase in our backlog, more than fivefold since we created the strategic business two years ago. We're seeing great success with project manufacturing. We call it Margin IQ, but that consciousness when we price of winning orders that drive profitability and the project business has also reinvented our business model of how to serve the power market in North America, and we've seen significant success in obtaining orders. When we talk about our North American operations, I think what we need to state here unequivocally is the world-class performance of our European operations. They're strong and growing, very profitable. Italy is executing a very -- very efficiently, as I said earlier, a record backlog with a temporary hurdle that caused some of the shipments of large orders in Q1 to be shifted to later on this year, mostly in Q2. The other thing is, I mentioned that many times in the last few quarters, but our booking performance and success in fiscal '21 was remarkable, and it had a lot to do with the fact that the land is well positioned in Southeast Asia and China. And most of the growth in orders and bookings came from those regions when you compare it to a lot of North American valve companies, that had significant issues last year in performance and sales had to do largely with the fact that most of their market was North America, and that's the geographic area last year that was the most affected by the pandemic. So it's a good thing that from a business health point of view, our portfolio is so geographically well balanced. And as a result of that success in those areas of the globe, it turns out that our plants in China and India are also thriving and achieving very high level of production, not seen before. Another factor that makes me state that we're in a very good position compared to last year is obviously our outstanding backlog where we have over $600 million right now to execute. And the momentum of last year is still going, given the excellent bookings performance in the first quarter of this year. With this outstanding backlog, getting our sales up this year is really largely about execution. Most of our subs and operations are working extremely well. And in North America, as I said before, we're still in the process of mastering the new manufacturing model that came about through the V20 plan, and we have accumulated delays. The curve is slower than anticipated, but we're seeing progress that is steady and promising and the team is strong and committed. So the execution of the backlog is still a challenge here in North America, but we're wrapping our arms around a new manufacturing model. And as I mentioned global logistics before, we're far less reliant on internal machining we're purchasing pre-machine casting that come out of Asia and obviously, that continues to play a factor given the accumulated delays in global logistics. And -- but we have a procurement team that's well aware of this and doing great work to offset those hurdles. MRO bookings keep repeating, were the most hit last year, but we're seeing signs of recovery in North America and I hope that this will translate into higher sales in the course of the current fiscal year. But we're encouraged by what we're seeing in North America. I think the vaccination rates in the U.S. is actually creating a positive trend. And hopefully, the refineries will revive their turnaround and maintenance programs that should be able to fuel orders for our channel distributors. Another factor that makes me say we're in a good position in terms of assessing our vantage point, a few key strategic breakthroughs achieved in the last year. As I said, our severe service backlog is up 5x since we created the strategic business two years ago. We've had the new applications, new designs. And in fact, a lot of orders in the course of the last year for specialized applications have actually provided opportunities for us to accelerate innovation. I was talking about that yesterday at our AGM. And I gave the example of a new [dilated] bed product line, we now have at 33 new designs available, covering 80% of the market, a new market for us that we successfully penetrated. We see the mining business coming back, mainly in Southeast Asia. And one of our successful design introduction is the HPAL, high-pressure acid leach -- acid seed valve. This is one of the most severe valve applications out there. And based on an order we were targeting and finally obtained, we came out with a design that significantly simplifies the in-field controls and maintenance, thereby adding end user benefits. This is what we're about. We're an engineering company, and we seize those opportunities. In the area of what we call big science, when we talk about nuclear fusion, hydrogen, cryogenics and so on, our French operations, tired of being called strictly nuclear, they like to recall or remind everybody that they're actually diversifying in those fields of big science. We were able to get orders for hydrogen applications. Hydrogen powered plants in the future are going to be a big thing. We're already seeing developments in Germany, for example. And we're going to be ready for it because they require high integrity cast and forgings and that's exactly what made the reputation of the company. France was also able to get a significant order in -- for control valves, thereby getting the award away from -- taking the award away from the leading control valve manufacturer in the world. So -- and we're seeing strategic breakthroughs in France as well. And in Italy, the FPSO expansion is working well and we've had significant breakthrough orders in the Middle East for Aramco thanks to our strong positioning there. And also to the fact that we've increased the capacity of our North American -- of our Italian -- and by converting the Velan China plant to produce API 6D valves, a lower-margin-lower-cost valves for Italy, which allows our Italian operations to dedicate and focus on the higher-margin-higher-value API 6A valves. That fits well and it explains why the Italian operations are able to execute a record backlog with the capacity that we have in Italy. Last but not least, in terms of assessing our vantage point, mentioned before, how proud I was of how our entire organization, people showing up in the plant, our leaders, our managers composed with a very difficult situation last year. I want to talk about the dynamism of our management team and the employees and the confidence that our performance last year in the face of a terrible crisis has given us, we see increased global cooperation to win orders. Global manufacturing capacity is now treated as an asset. I think Bruno and his team are doing a great job of winning orders by leveraging the existing capacity to produce similar valves in one plant to another. One example of that is a titanium valve order, a ball valve order that we signed to India or a digester capping valve to produce ethanol from bamboo. Normally, that metal seeder ball valve or soft seeder ball valve should have been assigned to Montreal. But we wouldn't have won the order because of lead times if India hadn't been able to take it. So that's a very good example. And manufacturing capacities increasingly leverage as a distinctive competitive asset for us. And our management teams and the workers understand that and are living up to that vision. And so in summary, we're still not happy with the results, but there are a lot of encouraging factors in Q1, and we're focused on the process of rebuilding from the bad situation that triggered all those major changes just three years ago with the poor results of fiscal '18. It had a lot to do with the very, very poor margins of our North American operations. As I said now, we have healthy margins across the board, and we're seeing a sense of a global company coming together and acting like a global company. I'd like to use the analogy of 1 plus 1 should equal 3 when we bring all our forces together and this is increasing a distinction and a characteristic of the land. So I want to finish by just summarizing what I see as the investment highlights, if I'm talking to investors, there are really 5 things and you can see it in the annual report that was published recently. 5 key traits of the company that make us a distinctive player in this highly fragmented global flow control industry. Our brand reputation is stellar at 70 years of track record, outstanding product quality, thanks to the great work of my predecessors. We have, secondly, the broadest and deepest base of end users that you can imagine with installed valves all over the world, in particular, in Southeast Asia, China and India, where we've had so much success last year in our bookings. The V20 program is basically behind us in terms of all the investment that was required to transform our North American operations and our Indian operations, and it triggered a new approach to manufacturing strategy globally. And let's not forget that in addition to [indiscernible], what we're doing is we're joining force in terms of having a high-margin business with the already existing outstanding European operations that we had and that continues driving. Fourthly, the growth is fueled by improved margins, but also the highest backlog since 2012. And we have for every one of our 5 strategic business, very dynamic action plans that leverage their own assets and capabilities. And last but not least, a portfolio of diversified businesses that truly constitute a platform to drive strategic diversification through generic growth and maybe even acquisitions. So that's why I keep saying it's now time to turn our attention to growth. It's -- we have a dynamic strategy to get there. Hopefully, as the year moves ahead, we're going to build on the momentum of our recent achievements. So again, in summary, we're not out of the woods yet. We have a lot of challenges. But overall, we're better positioned than we've ever been in the recent past, addressed those challenges. I want to thank you for your attention. And again, maybe in the spirit of yesterday's presentation at the AGM, I want to thank all of our investors for your loyal support over the year and for your attention this morning. I can now turn to the questions. [Foreign Language]

[Operator]

[Operator Instructions] [Foreign Language] [Operator Instructions] [Foreign Language] Our first question from the line of Robert Beutel of Oakwest.

[Robert Beutel]

And congratulations on your improvement in margins, your maintenance of revenues and in a tough period. So operationally, things are certainly looking better. My question this morning -- sorry, I cut you off.

[Yves Jacques Leduc, President, CEO & Director]

No, no, thank you. I just -- I cut you off so it's okay. Go ahead.

[Robert Beutel]

Okay. My question this morning was -- my first question this morning is really on your admin costs. And with respect to the asbestos, the $2.1 million increase in asbestos litigation expenses. You used the expression that it's a timing matter and that there was no change in the long-term trend. Do I have that correct?

[Yves Jacques Leduc, President, CEO & Director]

Yes, I said that because it's very difficult to read -- to see into what those increased costs, a change in trends. The reality is that in the last 5, 6 years, we've seen ups and downs. This is the higher up that I've seen. Situation is the same. There's a number of claimants out there that look for what I like to refer to as the last man standing, given that the original manufacturer of asbestos product that truly created the issues, most of them actually going bankrupt. So the attorneys are looking for companies that were present and did have asbestos in their product in the '80s. And even if the causal relationship is very thin or nonexistent, and we'll -- if we shift that profile, we'll be sued, and that's what's happening right now. So that mean that we're going to see the costs continue to go up. We're trying to see clearly through it. Not a situation we like at all, but we're managing it very tightly. So for example, we changed our approach and hired new lawyers in the U.S. We believe that might help us in terms of the efficiency of the legal costs. But it's a problem, and it's always been there. The only -- I can tell you is that we're managing it tightly with the highest possible level of oversight.

[Unknown Executive]

And it's quite about the timing related to the change of law firms. So we had an overlap of law firms, and that was probably the biggest part of the increase that we had in Q1.

[Robert Beutel]

I mean if I understand from the notes in the annual report, you've been experiencing about $10 million or -- on average, $10 million a year in the last couple of years. And since, as you say, it's been a legacy problem, certainly, I don't envy you. As a shareholder, that's obvious, but nobody envies you. The question I -- my second part is this that is there no way to provide -- I mean, you make provisions for warranty work and other things. The question is a $2 million increase, it's a substantial portion of your annual administration expense that is really not tied to ongoing operations. And certainly, as an analyst type, it's hard to know -- it's hard to see the improvement, if you will, with these kind of very loud noises in the background. So perhaps that's the question.

[Yves Jacques Leduc, President, CEO & Director]

It's a good suggestion. And I've been -- I've actually been spending more oversight on the whole matter in the last year personally. And you're right, it is a lot of noise. So the only thing I can tell you is that there's complete awareness and understanding of the details of the issue. And we're going to continue finding ways to mitigate those -- that exposure [indiscernible] it is unfairly driving -- sure, it is driving down our results unfairly. [ U.S. ] and Paris had a great work of our operational team in North America. [indiscernible] by what is a factor that has nothing to do that we have no control -- that they have no control over. And that's disappointing, but it's our job to figure out ways to mitigate it. So thank you for your comment.

[Robert Beutel]

Okay. My second question touches a little bit on this, and that is I think in the last number of conference calls, you do make reference to the fact of what the share price is and what the book value is, and you use the term undervalued. And again, I certainly agree with you. My question is, if you feel it's undervalued today, when will it be fairly valued in your opinion?

[Yves Jacques Leduc, President, CEO & Director]

By what [indiscernible]? Well, Let's recognize that our performance has been very disappointing and at least for fiscal '18 to fiscal '20 when we started implementing V20. So is it surprising that our -- the share price went down during that period? No. I think it's -- I think we need to deliver, I'm going to be quite candid with you, a string of profitable quarters before we get movement in the direction that we want, and we're going to get there. So we don't give guidance, as you know, during the conference calls. I won't set any timing issues, but we're all eager to build on the margin momentum that you referred to earlier and get our performance up. In terms of being undervalued, it's obviously undervalued. It's -- if you take a look at our company and you see our North American operations, the improvement there and the performance of our European operations and all of that, and some -- In the end, we agree it's undervalued, and we do what we need to do to bring the value back up is to get our performance back in the black. And that's what -- that's where we're heading towards.

[Unknown Executive]

And the other observation is for about twice what we were last year. We were trading between CAD 5-5.50 and now we're close to CAD 10-10.50. So we're moving in the right direction but we're not there.

[Robert Beutel]

I agree with everything you just said. I guess where I'm really at it is the company trades a little bit by appointment. It's not terribly liquid. I think the -- by comparison to other perhaps bigger and diverse valve companies, book value isn't necessarily the aspiration -- the only aspiration, and so I think the company -- I hope when the company reaches book value, it still has a long way to go. And that is when things start firing the way they should, I just hope that your target is more than simply meeting book value, I guess, is what I'm saying. So we have to get there first to surpass it. So let's get back on the road to recovery. So -- Sorry.

[Yves Jacques Leduc, President, CEO & Director]

Message received and agreed to.

[Operator]

We'll get to our next question on the line from Dean Trottier, Private Investor. [Foreign Language]

[Dean Trottier]

Looking for a little bit -- sorry, just looking for a little bit more, maybe as an investor, what should we expect from working capital levels moving forward as it sounds like the -- we should expect to see increased revenue kind of going forward? Should we see inventory sort of move in line with that and see with receivables and payables as well?

[Unknown Executive]

Well, it's a good question. We watch working capital very, very closely. And if you look at what's happened at the end of February, you'll see our inventories went from $204 million to $236 million, and that's a reflection of the growing backlog. So unfortunately, our working capital we invest in the inventory before we make the sales. And with the backlog now up at a record high level or at least the highest since 2012, you see that. But we have been focusing quite a bit of effort on the accounts receivable, both here and overseas. Some of the accounts receivable have very long payment terms because that's the nature of Chinese nuclear contracts. But in other locations, we've been consciously working on bringing down that investment in working capital. But it's something that's got a very high importance in our week-to-week objective.

[Dean Trottier]

Okay. Yes, that was kind of what I was alluding to with the inventory levels. Look -- when I look back to kind of previous -- when we've seen higher top line from the company, and this is before obviously, the V20 plan, I was just trying to get a sense of what we should expect going forward. But it sounds like the investment is made upfront. And then -- but if you continue to see strong bookings and a book-to-bill ratio above what we should continue to see inventory levels kind of creep up in step with that?

[Unknown Executive]

And one other factor -- Yes. But one other factor -- Yves alluded to some of the contracts where the customers had delayed taking possession or ownership. That's the other factor for the increase in the inventory. So we've got a couple of sizable projects where we're trying to make sure that we get them out the door. So when you look at that increase since the end of February of $32 million. It is a portion of it that's related to future backlog, a portion of it related to these delayed contracts. And our supply chain, the more we work on projects where we're sourcing from the far East, as Yves mentioned, there's major disruption these days with container ships. We're getting reports of containers going up 3x in cost since a year ago and just not being available. So that, too, the length of our supply chains also results in increase of inventory.

[Dean Trottier]

Okay. And maybe [indiscernible]?

[Unknown Executive]

[indiscernible].

[Dean Trottier]

Sorry, go ahead.

[Unknown Executive]

That's true our inventory is going up, but I just want to point out that since our backlog, part of it is financed by the customer deposit. So you can see the -- our customer deposit increased by more than $10 million in the quarter. So at least it's partially offset by that -- our customers are paying for part of our inventory.

[Dean Trottier]

Yes. And I understand there's a fair bit of moving pieces in the supply chain. And then you layer on the added complexity of stated reopens in different countries at different places in there or vaccine rollout. So I don't envy you guys with a global supply chain.

[Operator]

[Operator Instructions] [Foreign Language]And our next question comes from the line of [indiscernible], private investor.[Foreign Language].

[Unknown Attendee]

[Foreign Language]

[Unknown Executive]

[Foreign Language]

[Unknown Attendee]

[Foreign Language]

[Unknown Executive]

[Foreign Language] And by the way, I will shortly translate once I'm finished with the answer to those who don't understand French. [Foreign Language]

[Unknown Attendee]

[Foreign Language].

[Unknown Executive]

So the question is why is -- what explains the drop of the decline of sales since 2013? And the main driver of that was the significant drop of our Western Canada sales was up to $80 million and a drop as low as below $10 million in just a few years. Just that was a major factor that hurt the company very, very hardly. There were profitable sales on top of it. And then it was the oil recession itself brought a recession in the industry that had projects -- big CapEx projects delayed on almost every continent for a couple of years. So that didn't help, obviously, our project manufacturing business. Obviously, now with the restructured -- or organization around more focused strategic businesses that helped get bookings back up, and I would say the industry is basically adapted to an oil price at $55 to $65 a barrel. So we're seeing good signs and still a very vital industry. And as I said, the company is better positioned to capture it's lion's share, going forward. [Foreign Language]

[Unknown Attendee]

[Foreign Language]

[Unknown Executive]

[Foreign Language]

[Unknown Attendee]

Okay, perfect. [Foreign Language].

[Unknown Executive]

[Foreign Language]. Yes. [Foreign Language].

[Unknown Attendee]

Okay, perfect. [Foreign Language].

[Unknown Executive]

[Foreign Language].

[Operator]

[Foreign Language] Mr. Leduc, we have no more questions on the line, I'll turn it back to you.

[Yves Jacques Leduc, President, CEO & Director]

I just want to thank everybody for listening, for your attention this morning. And I wish you a very restful, and above all, healthy summer. [Foreign Language].

[Operator]

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