Velan Inc

TSX:VLN

Earnings Call Transcript 2019-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Velan Inc. Q2 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Friday, October 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]

Welcome to our second quarter fiscal year 2019 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 your questions.After a difficult first quarter showing light signs of recovery on the sales side, we're happy with the improved performance on several fronts in this quarter. But the need to transform remains strong and were slowed down by our complexity, and we need to realign our business and global supply chain to markets where we can drive faster and more profitable growth and achieve greater pricing power through our engineering and design capabilities. I'll be saying a few words about this when I address our outlook, but first, let's look at our results.Net earnings or loss. Although this quarter showed some positive signs, we still recognized a quarterly net loss of $2.4 million or $0.11 per share, but it was lower than the $5.6 million net loss or $0.26 per share that we announced last year. The improvement is primarily due to the higher volume of shipments that occurred in the quarter compared to last year despite a higher sales volume and improved margins, fierce competition and weakness in the company's North American operating markets continue to apply pressure on the company's overall results. Gross profit percentage increased by 60 basis points from 20.5% to 21.1%. This increase in the gross profit percentage is mainly attributable to the higher sales volume, which helped to cover the company's fixed production overhead as well as a product mix with a higher proportion of higher-margin product sales. However, the continued pressure on pricing, as I said, continues to affect our margins, namely with respect to our project business in North America.EBITDA amounted to $1.4 million or $0.06 per share compared to a negative $4.2 million or $0.19 last quarter. The increase is due primarily to a higher sales volume and a higher gross profit percentage.On the sales order bookings and backlog side, I'll start by saying sales increased by $14.9 million or 19.5% for the quarter. Sales were positively impacted by an increase in improved MRO business and shipments of large project orders that were ordered in the prior fiscal year for the company's North American operations. This increase was partially offset by decreased shipments from the company's Italian operations, which was caused by the lower order bookings by that subsidiary in the prior year.Bookings increased by $11 million or 11.9% for the quarter. This increase is due primarily to new orders booked by the company's Italian operations, once again, which was partially offset by a decrease in orders booked in the company's North American operations, which we were comparing to the recorded significant large project orders in the prior year.The increase in bookings and the improved sales performance was achieved thanks to the recovery observed in the oil and gas markets, benefiting mainly MRO and upstream valve bookings and also in part by the realignment in the prior year of the global sales force along vertical market lines rather than geographic lines. I've explained that in previous quarter reports.Meanwhile, in markets other than oil and gas, like power, the pricing pressure on margins remains extremely challenging. The company's book-to-bill ratio for the current quarter was a positive 1.13. As a result of bookings outpacing sales in the period, the company ended this year with a backlog of $469 million, an increase of $4.5 million or 1% since the beginning of the current fiscal year. The positive book-to-bill ratio was in part negatively impacted by the weakening of the euro spot rate against the U.S. dollar at quarter end, dropping from EUR 1.17 to EUR 1.165.While our financial performance for this fiscal year remains difficult, we continue to have a strong balance sheet. Net cash remained flat for the quarter by settling at $51.3 million, a decrease of $0.3 million or 0.01%. The net cash per share was USD 2.37, or CAD 3.10.Our equity at the end of the quarter settled at $306.7 million or USD 14.18 per share. In Canadian dollars, our equity per share was CAD 18.52 at August 31, 2018, compared to our TSX share price at the close of business on that day of CAD 12.14, indicating that our share price continues to be undervalued.Now talking about our outlook. Our strategic plan, Velocity 2020, launched last fiscal year, rests on a few key building blocks, including: one, a greater focus on growth markets; two, leveraging the installed base to increase our aftermarket and service revenues; three, a faster and more efficient global supply chain and footprint; and four, a massive upgrade of our systems and processes. Although we're still far from our financial performance goals, our positive achievements beyond those regarding most key financial metrics commented on earlier that I'd like to talk about.First, a few words on the goal to reduce our overall cost structure by $20 million over 3 years that I set last year. In recent months, we've seen commodity pricing and freight costs go up, which is slowing down our material savings plan, but we're still successful in achieving cost reductions through shifting sourcing to low-cost countries and tightening up our procurement practices, an effort that is now including all of our subs, not just our North American operations.But more importantly, our efforts to improve our cost base is not -- are not solely focusing on materials. As I stated in the last quarterly report, we see many opportunities to improve our competitiveness, mainly in the project booking business, and to reduce our fixed cost structure as well. What I'm going to say today is that we're actively looking at a range of options, but have not reached conclusions that we're ready to make public yet.As we move ahead, accelerating the transformation under our V20 plan, we're -- here are some factors that will fuel or help our efforts, starting with the positive development of the service business platform. Our greater focus on the installed base is paying off as spare parts billings and percentage of sales continues to stay very strong. After a successful pilot performing a service contract with one of our power customers, Calpine in Western U.S., we're now working on expanding this business model, basically imitating our French operations' proven track record of building up a business leveraging its installed base of nuclear valves.One of the most important recent developments mentioned earlier is the revival of the oil and gas market, our nonproject valves' average monthly bookings that we refer to as our MRO business, for the first 2 quarters, are over 20% higher than last year to date. Several factors explain these positive developments other than industry dynamics. First, we have opened new distributors in Western Canada for both our North American and Italian operations. Also, several end-users have increased their demand for top-tier valve suppliers, and Velan is one of the few top-tier valve suppliers. Of course, the tariffs imposed by the American administration on Chinese imports are also playing to our advantage as most of our commodity valves are produced in Korea, not China.After having reduced our distributor centers from 4 to 1, and relocated our Houston, D.C. into a larger facility, we have improved our productivity helping us handle the surge in nonproject valves' bookings. And finally, we have increased our strategic focus on managing the distributor channel as a direct consequence of organizing along 4 vertical markets last year, the MRO market being 1 of the 4.Meanwhile, I announced an order last quarter exceeding EUR 15 million from MODEC, a Singapore-based ETC working on behalf of Petrobras, the Brazilian state-owned company, and we're expecting important add-on orders. These are for our Italian operation that specializes in exploration valves for floating production storage and offshore FPSO. We've recently received an order from our American customer mandated to build ships for the American Navy, and expected an increase -- and are expecting an increase in navy orders in the course of the next 2 years.But as I said in July, our margins remain under significant pressure, mainly in our project business that heavily relies on the power market, a market that is far from recovering and where we face many competitors ready to cut pricing to earn business in a sharply contracted market. We can blame the industry environment for our decreasing margins, but the fact is that if we don't make adjustments to return to acceptable performance levels, we'll not be fast enough. Important changes are required. One of the things that will help is the significant progress in upgrading our capacity planning and project tracking systems, building on the successful upgrade of our ERP system last year. Our investment in systems is foundational and an integral part of transformation linking directly to our goal of improving delivery and directly benefiting our project manufacturing business.Also, an important milestone is the completion of the industrialization of our Indian operation for a flagship pressure seal valve line that we intend to leverage in the future, serving Southeast Asia and Middle East customers. We're completing, at this moment, a significant GE India order for these valves and believe we'll be in a great position in the future as a result of this.To conclude, we're benefiting from tailwinds in the progress and we're -- sorry. To conclude, we're benefiting from tailwinds and the progress achieved in key business areas, but are not at all satisfied with our results. The whole company is mobilized by a sense of urgency to improve our results and I look forward to keeping you posted on the progress we make. We'll then talk again, of course, in January.And on this note, I will hand it back to our moderator, and John and I are ready for questions. Thank you.

[Operator]

[Operator Instructions] And our first question comes from the line of Robert Beutel from Oakwest Corp.

[Robert Beutel]

My -- it was a very good presentation and very informative. I don't know if you're prepared to talk. You do write, and you did touch on, the question of elevating gross margins and how you come about it. Could you give us -- or could you give me an idea what you think the gross margin should be at the end of your process? And to what degree changing your mix might accelerate the increase in gross margin?

[John D. Ball, Chief Financial Officer]

Yes. So we don't make forward-looking projections of either sales, margin or net income, of course. So you understand I won't be able to give you sort of like a precise number of where we'd like to be. But part of this is got to do with increasing our volume into certain locations. Part of it is reducing our fixed cost manufacturing footprint. So take out a certain level of fixed cost, thereto, to improve the margin. And part of it is the mix. When we look at our -- the profitability of our business, we see wide variances, particularly in the project business, where in some contracts we're barely breaking even. So to a certain extent, we need to prune back the unprofitable business, unprofitable project business with complicated and expensive engineering changes and so on, or the very small contracts where the cost of handling just isn't that justified. And at the same time, just scale back the size of our manufacturing footprint so as to be able to more profitably handle these. So between the 2 of them, without giving you a precise number, we expect to get back up to higher gross margin numbers like we used to enjoy.

[Yves Jacques Leduc, President, CEO & Director]

That was John Ball, by the way, speaking, our CFO. And let me add just one point to the answer. You heard me talk about being highly dependent on the power market and also allude to the need to increase our pricing power in some of our markets. I think it's going to be very difficult to do that in the power market. And one the key pillars of our growth strategy that I alluded to in the past is our greater focus on growth markets, that's why we've organized along vertical markets. Now doing that takes time. It's planting the seeds, for example, in process-related industries. We need license or approvals, and we need more focus to get there. So the idea here is to develop a much better positioning in markets where we can exercise pricing power, namely by being able to ask for an acceptable price premium for our unique and outstanding design capabilities. So that's something that takes a little bit more time, but that's also part of the plan to improve our gross margin.

[Robert Beutel]

Okay. Just a follow-on, I mean, your book-to-bill is good, your backlog is good. How much of what you report as backlog is in the project area where margins are so skinny?

[John D. Ball, Chief Financial Officer]

Well, the -- well, it's not all projects where the margins are skinny. It's some projects that are in there. Most of the backlog tends to be project related just because projects take a longer time to unwind from the original loop, request for quotes to submitting a purchase order, signing contracts, doing the design and so on. The MRO business tends to be more book and bill. So in and out, relatively quickly. But at any point in time, when you take a snapshot of the backlog, there's going to be a component of MRO and a component of projects that -- projects, because it has a longer lifespan for each project, will tend to make up the larger part of it.

[Yves Jacques Leduc, President, CEO & Director]

Maybe adding to this again, the mix of the backlog includes what I allude to as more severe service business areas, namely, for example, nuclear, where you have traditionally very strong margins. And in the process industry, when you talk about coker valves or valves requiring specific design capabilities, you tend to have good margins there too. So when I talk about the project business, I'm talking about the straightforward, highly competitive project manufacturing business in sectors like power, for example, where we see a lot of competitors competing in a contracting market.

[John D. Ball, Chief Financial Officer]

The other trend we were faced with over the last couple of years was in the upstream, midstream oil and gas where our Italian operations that competed. With the drop of the price of oil and a lot of spending, CapEx spending was cut back, so the players in that industry tended to be very competitive to pick up orders just to cover overheads. So anyone in that business suffered the sales and margin level. As the price of oil has gradually rebounded and the business has picked up, we're hoping to see sort of a relief on -- from the pressure on the margins and the prices in that sector.

[Robert Beutel]

Okay, very good. Good luck on that. Just one that comes to mind, you mentioned in your prepared remarks, business for the U.S. Navy. If I recall correctly, historically, there had been issues with asbestos and valves in military applications. Is that, what shall I say? I assume that going forward, that's not an issue. Is anything going forward suggest that you can clean up the old issue?

[John D. Ball, Chief Financial Officer]

Well, it's a good question. The Navy business was the source of most of our asbestos lawsuits, but it went back to their practices back in the 1970s and '80s of using asbestos packing. And as we've discussed on past calls, you can't sue the U.S. Navy. So what happened over the last 30 years, 40 years, most of the companies that manufactured the asbestos have been sued into oblivion, and then the attention shifted probably about 20 years ago to the companies whose valves were protected by the asbestos. It -- the trend so far this year is favorable, but we have up years and down years. And it's -- there's no rhyme or reason to it that we can see. Maybe it's not tailed off, but it's eased up a little bit this year. The new business for the Navy has none of the asbestos because I think they've learned the lesson, so asbestos is not an issue going forward on Navy contracts, but the current asbestos lawsuits are a result of contracts 40 years ago.

[Robert Beutel]

And in no way does the new business enable you to contain, control or mitigate anything that happened 40 years ago? I mean...

[John D. Ball, Chief Financial Officer]

No, unfortunately. Until we have tort reform -- I mean, we have some pretty strong feelings about some of these law firms in the States. Until we have tort reform to clean up the legal environment of the States, I think we're -- it's safe to say, we're still going to be sued even if it's completely without justification. It's almost like legal blackmail.

[Robert Beutel]

And the valves for the U.S. Navy are going to be made where? In which of your systems?

[John D. Ball, Chief Financial Officer]

They will be made in our Williston plant. We have an operation in Williston, Vermont, and it's a good base. And I think we continue to use that plant, especially in Trump's America where they're building up barriers. So that's going to continue.

[Operator]

[Operator Instructions] And our next question comes from the line of [ Stephane Debelle ] from [ Debelle Capital & Company ].

[Unknown Analyst]

On a different subject, what are the benefits of Velan staying public?

[John D. Ball, Chief Financial Officer]

I mean, we have been public. Our share price is relatively low right now. We think it's below -- about -- it's definitely below our net book value. You can argue that it's not very useful to us as a financing tool for making acquisitions, and see, you're probably wondering about the possibility of going private. It's something that has been debated continuously by both you shareholders, bankers, investment bankers that would like take us private. But at this point, we have no fixed plans to change the capital structure.

[Unknown Analyst]

Because, the company was not -- over the last 2 years, I mean, it's just -- yes, the market was difficult. But I mean, there was no creation of shareholder value over the last 10 years. I mean, it's just none. So it's -- it actually -- it looks like you're trying to run like a family company, and there's not even a corporate presentation on the website. No analyst is following it. You don't need money that much, and I just don't see any reason why you guys should stay public. I mean, why -- you might as well run the company as a family office?

[Yves Jacques Leduc, President, CEO & Director]

This is a question that keeps coming back. And it obviously depends on the decisions that the majority shareholders need to make and...

[Unknown Analyst]

The only decision that the Board made is just last year's dividend. I mean -- and that just drove away all the patient investors. I mean, it's just a disastrous situation.

[Yves Jacques Leduc, President, CEO & Director]

No one accepts the situation right now. And as I said, we're looking at a range of options to accelerate our business...

[Unknown Analyst]

Yes, I know. That was the same talk a couple of years ago. And just -- there's just no -- there's -- it will probably be helpful for the whole company to save a couple of millions a year just to stay public. I mean, there's just no benefit.

[Yves Jacques Leduc, President, CEO & Director]

Well, thanks for your input. That's all I can say today.

[Unknown Analyst]

I mean, I think the Board should be aware of that. I'm sure they are aware, but just maybe listen to your bankers. All right. So...

[John D. Ball, Chief Financial Officer]

We understand, Stephane.

[Unknown Analyst]

Yes?

[John D. Ball, Chief Financial Officer]

We understand. Thank you.

[Unknown Analyst]

Yes. All right. And -- because this -- whatever decision you guys made, I'm not talking about today, but over the last 5 or 6 years, there's just no value. There's just no value construction. And nobody's following your company. I mean, there's just no analyst and no corporate presentation. There's not even on the website the Board membership. I mean, I think you guys should be better off just to run the whole thing privately.

[Yves Jacques Leduc, President, CEO & Director]

Thanks for your input. But there's...

[Operator]

And there appears to be no questions at this time.

[Yves Jacques Leduc, President, CEO & Director]

Okay, very well. Thank you very much, everybody. I look forward to our next quarterly call. Have a good weekend.

[Operator]

Thank you. Ladies and gentlemen, that does conclude the call for today. We thank you for your participation and ask that you please disconnect your lines. Have a great day.