Velan Inc

TSX:VLN

Earnings Call Transcript 2018-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to the Velan Inc. third quarter financial results conference call. [Operator Instructions] As a reminder, this conference is being recorded, Thursday, January 11, 2018.I will now turn the conference over to Yves Leduc, President and CEO of Velan Inc. Please go ahead, sir.

[Yves Jacques Leduc, President, CEO & Director]

Good afternoon, and thank you very much. Welcome to our third quarter fiscal year 2018 conference call. I'm joined today by John Ball, our Chief Financial Officer. 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.Net earnings. After 2 consecutive quarters of losses, we're pleased to have returned to a profitable position in the current quarter as we realized net quarterly earnings of $300,000 or $0.3 million, or $0.02 or $0.02 per share, compared to $1.5 million or $0.07 per share last year. Profitability improved at both our French and Italian subsidiaries, which offset continued weakness in our North American operations. The current quarter's improved performance was not enough to offset our disappointing results of the first 2 quarters of the current fiscal year as we continued to feel the effects of weak market conditions, which are causing an erosion of the non-project commodity valve business as well as reduced pricing in the highly competitive project valve business. We're continuing to implement operational improvements initiated under our Velocity 2020 strategic plan. Our goal is to improve the company's competitiveness and simplify its global supply chain while aggressively pursuing market share growth in high-margin segments where our severe service product and innovation capabilities can be fully exploited. I'll be saying a few more words on this subject during my outlook.Gross profit percentage amounted to 25.9% compared to 27% last year. Despite the fact that the gross profit percentage decreased by 110 basis points when compared to the prior year quarter, it represents a significant improvement when compared to the percentage of the first and second quarters of the current fiscal year, namely an increase of 690 basis points when compared to the first quarter and 620 basis points improvement when compared to the second quarter.While product mix and material cost savings positively impact our margins, the improved gross profit percentage in the current quarter when compared to the immediately preceding 2 quarters was also due to the effect of the higher sales volume covering fixed costs, overhead costs. The proportionally high fixed production overhead costs and its effect on our margins highlight the need to implement our global cost reduction and efficiency initiative, which was announced in the first quarter of the current fiscal year. The goal of this initiative is to reduce annual supply chain production and overhead costs by approximately $20 million by the end of the 2020 fiscal year. As for our Velocity 2020 strategic plan, we began a detailed assessment of our global manufacturing footprint, supply chain and cost structure in the second quarter, and we're accelerating the improvement initiatives undertaken in our North American operations to transform and modernize our processes in an effort to increase our competitiveness in project manufacturing.Sales, order bookings and backlog. Sales amounted to $87.7 million, an increase of $7.3 million or 9.1% from the prior year. Sales were positively impacted by an increase in shipments from our French and Italian subsidiaries, resulting from the large project orders that were booked in the prior fiscal year. This increase was partially offset by decreased shipments from our North American operations where delays in shipments of certain large project orders caused by various customer-related supply chain and internal operational issues and lower shipments of non-project commodity valves negatively impacted its operations.Bookings amounted to $83.3 million, a decrease of $51.6 million or 38.3% compared to the last year, but this decrease is due primarily to lower project orders booked by our French and German subsidiaries, both of which had recorded significantly large project orders in the prior-year quarter.This decrease was partially offset by improved bookings in our North American operations. Our decision to restructure our global sales force along vertical market lines is beginning to have a positive impact. More on this during my outlook section.As a result of bookings outpacing sales in the 9-month period, the company ended the quarter with a backlog of USD 485.2 million, an increase of USD 47 million or 10.7% since the beginning of the current fiscal. And in addition to the positive book-to-bill ratio, the backlog was positively impacted by the strengthening of the euro against the U.S. dollar over the course of the 9-month period, rising from $1.06 to $1.18.Financial position and to conclude this section. While the company's financial performance for this fiscal year has been difficult, we continued to have a strong balance sheet. Net cash settled at $73.3 million at the end of the quarter, an increase of $5.1 million or 7.5% since the beginning of the quarter. The net cash per share was $3.39 or $4.37. Our equity at the end of the quarter settled at $328.9 million or USD 15.21 per share. In Canadian dollars, our equity per share was $19.60 at November 30, 2017, compared to our TSX share price at the close of business on that day of $17.65, indicating that our share price continues to be undervalued.Now coming into the outlook. The question is what are we doing about the current business situation. The answer to that question remains very much the same as the last quarter. So what I'll do is give you a progress update, but before I address the specific elements of our action plan to go -- to return to acceptable performance, it's worthwhile to go back to the business environment and how it's changing. On the markets side, I already alluded to it, stagnant oil price is still dampening the investments, and it's still having a very strong effect on the pricing behavior of the competition. In a sharply contracting market, we're seeing huge pressure in our margin, very difficult to price at a level that we used to consider acceptable to get the orders we're after right now, and that's the nature of the market we're in.You have segments and applications or micro markets where there are still positive trends like nuclear. India, in particular, we're investing a lot in growth in India, Southeast Asia, and we're projecting long-term growth in the Middle East.What's important is to remember the key customer trends that we're watching and that we're driving -- deriving insights from. First of all, very important, I keep alluding to it, but that is a significant shift in our market environment. Commodity valves from low-cost countries have been increasingly accepted as Tier 1 suppliers. So when a maintenance operator wanted a Tier 1 valve, not too long ago, it was typically going to be a Velan or one of our Japanese competitors. But now, you have a lot of those low-cost country competitors who have been accepted as Tier 1, essentially as a consequence of refineries wanting to reduce their costs. That shift is important, it is affecting directly what used to be an easy business for us, call it a cushion, and that has put a lot of pressure on the project manufacturing business, which tends to be -- become much more demanding and where pressure on price is what I described it to be a bit earlier.An increasing concern on the side of end-user customers is asset life cycle cost, and this is where the need to pound our value proposition as a product quality company pointing to much lower total cost of ownership is going to be needed for us. And remember that when I talk about the change in our sales structure. But there is an increasing concern for asset life cycle cost, and when you can sell a flow control equipment like valves, which require less maintenance, which leaks less, which have better quality, there's an opportunity for us to capture a customer opportunity, and that's one of the reasons why we changed our sales force structure.So all of these market forces and, obviously, our disappointing sales point to the need to accelerate the transformation initiated under our strategic plan. And if you remember, if you have been privy to previous presentations from me, it rests on a few key pillars. And in a nutshell, it's about putting a lot more focus on fewer markets and customers supported by a realigned global supply chain and continuously improving core processes. What are the pillars focused on growth markets? We want to become a company that's much more customer solution driven, targeting severe service markets, where we can stand out and win. To do that requires that we change our approach to market and that we put a lot more emphasis on commercializing our product innovations. As I said earlier in a previous presentation, it shocked me how unaware the market was of the many designs that we've introduced in the market in the last few years simply because we have not been systematically marketing them.Second pillar, getting closer to the end-user customer. We are, more or less, buffered out by our distribution network that has served us extremely well in the past years. But now, we realize that we need to find ways to get closer to the decision-makers when the time comes to spec out a new refinery or a new power plant, and that's one of the reasons why we're now devoting resources to global business development. More on that in a minute when I talk about our sales force.We're also about -- getting closer to the end-user customer relates directly to the aftermarket, and we've put increased emphasis on spare sales in the last couple of years, and we're on to another very good year. Last year, if you remember, was a record year in terms of selling spares and percentage of total sales, and we've had a pretty good year also this year, so we'll continue on that focus. And the best way to achieve success with spares is to increase our focus on the field and therefore, on the end-user.Third pillar is improving our processes and systems. This is where our investment in project manufacturing, capacity planning. We've implemented a new ERP system this year with the usual turbulence when that happens, but it was a very successful deployment, and we're going to be investing as we see our new ERP system as good foundation for further improvements in our manufacturing environment.And last but not least, we have a global supply chain that is not efficient. It's complex. It's misaligned to markets. And so as I said earlier, we started a few months ago analyzing our manufacturing footprint and have already started making changes there. So continued focus on streamlining our supply chain will be a significant component to our 3-year cost reduction plan that I've alluded to.So as you remember, in July, we announced a global cost reduction and efficiency initiative with the goal of reducing annual supply chain. So this is ongoing. The company is also accelerating the improvement initiatives that I just alluded to. That's also ongoing. And we intend to meet the $20 million goal within the next 3 years.The other priority was to speed up our growth by increasing our market focus. And here's where I want to talk about, again, the sales force restructuring. This is a major move and very happy with the way things are going. This milestone was achieved in September when we restructured our global sales force along vertical market lines rather than geographic lines in order to focus resources on higher-margin segments and end-user customers where fewer competitors can match our product capabilities. This is a new approach to market, which will also involve greater focus on front-loaded business development and a disciplined commercialization of our innovations.Since September, we have recruited exceptional talent from the valve industry, yet another indication of the strength of our brand and Velan's power of attraction. We're already seeing the positive impact of our increased focus and teamwork as the project pipeline by vertical market has been made much more visible, and dedicated resources to sales engineering and upfront business development are fostering a much more effective approach to issuing competitive quotes on big projects. We're also, as I pointed out before, acting on recently acquired licensor approvals in relation to specific industrial processes, the result of our increased focus on business development and needs for licensing of specific industry processes for which our product line shows significant potential.This fiscal year, to conclude will be difficult for the reasons I explicited earlier, but we're confident that the recent surge in our backlog, combined with our strategic efforts, will improve our overall position. Our success in the next fiscal will depend on 3 factors, which we will double down on: first, improving project manufacturing and successfully address the key bottlenecks that have hampered our production this year; secondly, pursue our rollout of our investment in sales and marketing, aiming to build on a healthier backlog than we had last year. Let's all be clear on the fact that the largest driver of our underperformance in North America had to do with the reduced market demand in our American operations, and that has had a tremendous effect on our overall margin.Thirdly, pursue our aggressive approach to commercializing our product innovation. Last year, if you remember, we'd introduced 2 new innovations, one of which was our new cast R-series, a series for metal-seated ball valves, and we've initiated, as a result, several opportunities, opened doors with engineering firms and stimulated demand for our product. We want to do that on a regular basis and acquire the reputation for the most innovative company, which I believe we already are, it's just that the market doesn't know. And in my background, previous work in my previous company, it was key. It was a key contributor to stimulating sales that we had to introduce new products. The good news is we have a lot to talk about, and we've made it part of our processes now.Final word. Meanwhile, the shortest term goal is to end the year on a strong note, as we need to ensure last quarter shipments confirm the trends observed during the third quarter.This concludes my remarks. I thank you for your attention, and we'd leave the line open now for questions you may have to me or to John Ball, our CFO.

[Operator]

[Operator Instructions] There are no questions at this time.

[Yves Jacques Leduc, President, CEO & Director]

Okay. Well, thank you very much for your attention, and we'll be in contact at the next quarter. Thank you very much.

[Operator]

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