Velan Inc

TSX:VLN

Earnings Call Transcript 2021-Q4

[Operator]

Greetings and welcome to the Velan Inc. Q4 Financial Results Conference Call. [Foreign Language] [Operator Instructions] [Foreign Language] [Operator Instructions] [Foreign Language] As a reminder, this conference is being recorded. Thursday, May 20, 2021. [Foreign Language] I would now like to turn the conference over to [Foreign Language] Yves Leduc, CEO. Please go ahead. [Foreign Language]

[Yves Jacques Leduc, CEO & Director]

[Foreign Language] Good morning and welcome to our fourth and last quarter conference call for fiscal year 2021. I'm joined today by John Ball, our current CFO. I say current, because as you probably know, John will be succeeded on June 1 by Benoit Andre, our new CFO. Benoit has an outstanding category that was fully outlined in our recent press release, so I won't expand on it. He has been with us almost 3 weeks now, learning our business incredibly fast and getting ready for his new role. Meanwhile, John, who agreed to step back up in his old CFO role on an interim basis when our previous CFO announced he would leave earlier this year, did an outstanding job closing the year with the team. It's almost as if you'd never ceased to be our CFO. John, a sincere expression of my gratitude and the board's for stepping in this year and doing such a great job helping the company close the year and assisting in the recruiting process that led to Benoit joining the company. As of June 1, you will continue your course as EVP Global Finance. And while Benoit steps in, and Benoit all the best, I look forward to the future with you leading our finance operation. It's going to be a very exciting ride. So let's get started. We have a lot to talk about. Fiscal year 2021 will be remembered as a watershed year for Velan. Although our sales were severely impacted by the global pandemic, the company made great progress on many fronts, while demonstrating its commitment to protecting its employees and customers, ensuring the integrity of our global supply chain as well as to responsibly supporting each of the many local communities we are present. And we begin with our quarterly results. Net earnings amounted to $0.3 million or $0.02 per share compared to a net loss of $11.1 million or $0.51 per share last year. The improvement in net earnings for the quarter was primarily due to the recording in the prior fiscal year of $8.2 million noncash tax adjustment to derecognize a portion of unused tax losses as well as a reduction of restructuring and transformation costs, combined with an improved gross profit percentage in the current quarter. This increase in net earnings was partially offset by the lower sales volume and an increase in administration costs. The negative impact on our net earnings of the reduced sales volume for the quarter was offset by the reporting of $2.4 million of nonrecurring pandemic wage subsidies, namely the Canada Emergency Wage Subsidy. Our gross profit percentage for the quarter increased from 24.6% to 27.0%, an improvement of 240 basis points compared to the prior year. The increase in the gross profit percentage for the quarter was attributable to the margin improvements resulting primarily from the production overhead savings brought by our restructuring and transformation initiatives. The increase is also attributable to the recording of $1.3 million of nonrecurring pandemic wage subsidies. On the sales side, billings amounted to $85.5 million, a decrease of $28.1 million or 24.7% from the prior year. The disappointing sales performance for the quarter were caused mainly by 2 factors: the reduction of non-project orders recorded by North American operations as our MRO strategic business was by far the most affected by the global pandemic as the impact of the oil -- the drop in the price of oil and CapEx and maintenance spending in the oil and gas industry caused a significant decrease in our distribution channel stocking orders. And also the second factor affecting sales was the continued supply chain and production disruption caused by both the COVID-19 pandemic and significant difficulties experienced in reconfiguring the manufacturing layout in our Canadian plants under the V20 program, causing delays and disruption in our production flow, more on this later. Now let's move on to our year-to-date results. Net earnings amounted to $2.9 million or $0.13 per share compared to a net loss of $16.4 million or $0.76 per share last year while EBITDA jumped from $6.5 million to $15.6 million. Many factors contributed to EBITDA near tripling, and our net earnings for the year re-enter the positive zone this year despite significantly reduced sales. First, our gross profit percentage increased by 290 basis points from 23.7% to 26.6%. This increase in our gross profit percentage was attributable to: a, the delivery of our product mix with greater proportion of higher-margin product sales; b, margin improvements resulting from the production overhead savings brought by our restructuring and transformation initiatives; c, from a more selective screening and improved pricing discipline initiated over the last 2 years as part of the V20 plan in North American quotation activities that led to substantially improved margins in our project business; d, favorable movements in warranty and in late delivery penalties provisions due to effective management of these matters, leading to an improved outlook in these areas; e, our gross margin benefited also from the recording of nonrecurring pandemic wage subsidies, which offset the impact of the lower sales volume for the fiscal year. And also gross profits were improved by a reduction of administration costs as well as restructuring and transformation costs, including a $1.4 million severance provision reversal. These improvements were partially offset by a lower sales volume and $1.5 million in unrealized foreign exchange losses incurred over the course of the fiscal year. The second factor that helped our net earnings were helped -- were the $7.2 million after-tax gain recognized on the disposal of one of our Montréal plants, a vital part of our North American manufacturing footprint optimization efforts. It should be noted that the closure and sale of the plant, which was an integral part of the V20 program was originally planned to occur in FY '22. However, faced with the uncertainty caused by the global economic crisis, we made the very important decision to pull forward the closure in sale. Financially speaking, this was a very good decision as we were able to get a good price on the property, and it helped our results. On the other hand, it created additional turbulence that added to the challenge of transforming our manufacturing operations during the fall where, as I said, we experienced significant production delays. The disposed plant's production has been transferred within our remaining North American plants and our Indian operations. Third factor, as mentioned earlier, the improvement in net earnings was also explained by the $8.2 million noncash tax adjustment to derecognize a portion of unused tax losses in the prior fiscal year. These improvements were partially offset by a lower sales volume and $1.5 million of unrealized foreign exchange losses incurred over the course of the fiscal year. And last but not least, a special mention has to be made about the superb performance of our European operations, French, Italian and Portuguese, which once again delivered fantastic results despite the hurdles brought about by the pandemic. Let's talk about order bookings, backlog and sales. Bookings amounted to $426.6 million, an increase of $86.2 million or 25.3% compared to last year, representing a strong book-to-bill ratio of 1.41 compared to 0.92 the previous year. We owe this increase to the great success of our French, Italian and North American operations, who are able to win large project orders, notably in the nuclear, downstream oil and gas and process markets. The impressive bookings growth was partially offset by a decrease in non-project orders booked in our North American operations. We ended the period with a backlog of $562.5 million. That's an increase of $155.7 million or 38.3% since the beginning of the fiscal year. Our backlog was positively impacted by the strengthening of the euro stock rate against the U.S. dollar over the course of the fiscal year. It increased for the period due to temporary factors such as delays in shipments created by the COVID-19 pandemic and inefficiencies experienced in the reconfiguration of the manufacturing layout of our Canadian plants under the V20 program. Sales amounted to $302 million, a decrease of $69.5 million or 18.7% compared to last year. As I said, they were significantly impacted by the reduction of non-project orders recorded by North American operations due to the unfavorable market conditions that were triggered by the COVID-19 global pandemic as well as the impact of the drop in the oil price on CapEx and maintenance spending in the oil and gas industry. And obviously, the sales were also negatively impacted by the temporary factors mentioned previously. I go now to our financial position. We continue to have a very healthy balance sheet, highlighted by a net cash balance of $63 million at the end of the quarter. This $32 million or 103.2% increase since the beginning of the fiscal year, is attributable in part to the net proceeds of paying through the sale of our plant in Montreal, 6 months earlier than originally scheduled, along with the new financing we finalized over the course of the fiscal year. The net cash per share at the end of the quarter was USD 2.92 or CAD 3.70. Our equity in dollars -- our equity at the end of the quarter settled at $298.4 million or USD 13.82 per share. In Canadian dollars, our equity per share was CAD 17.65 as at February 28, 2021, compared to our TSX share price at the close of business on that day, which was CAD 7.80, indicating once again that our share price continues to be undervalued. So in summary, we closed the year with notably improved results, delivering net profits for the first time in 4 years and increased our backlog by near 40%, thanks to an outstanding bookings performance, equally important succeeded in deploying our V20 transformation strategy faster than originally planned, thereby laying the base for North American operations financial health to return. This is evidenced by the sharp reduction in our production overhead costs in North America. Now the dive of our sales was mitigated by Canadian federal subsidies amounting to $13 million, profits from the sale of our Montréal plant and important temporary cost reduction measures taken in North America. It's important to note that combined, these avoided the company layoffs, which would have weakened us going into this fiscal year. Instead, we expect to build on our bookings momentum, substantially improve our sales and fully realize the benefits of our V20 plan, a major milestone that clears the path now for directing more energy and focus to our growth strategies. Now speaking of growth. Let me now delve into other important aspects of the company's performance last year that carry important implications and insights for our future. First, Velan led by example in health and safety. The day after the pandemic was declared, we held our first crisis committee, attended by the CEO and maintained every week since and established a still active COVID-19 response team. We stayed in touch with our customers and suppliers and with all our stakeholders, and I'm proud of how our employees in every site and plant have risen to the occasion, immediately adjusting work practices remotely or in our plants, quickly deploying the protocols and measures to maximize the safety and health of our employees. We concluded the year with one of our best health and safety records ever. Second, we achieved 1 of the highest backlogs in our history during the worst economic crisis since the great depression. As I reported many times last year, we're a supplier of critical equipment to essential industries, authorized to continue operations even during lockdowns, but the shock on our sales and operations was nonetheless insidious and dramatic. For example, customer-delayed shipment release and the lockdown of our Indian supply chain greatly affected our plants during the fall. We estimate that at least 2/3 of the drop in sales in fiscal year 2021 were caused by the global economic crisis. Our employees' response was fantastic and the spirit of teamwork and solidarity, never more evident between Velan employees across the world. For example, forces were joined across divisions to create new designs to win orders and alternate routes were found when breaks in global logistics interrupted the flow of material. And orders were won, thanks to the wide range of options provided by an agile and diverse global manufacturing capacity, a competitive advantage we have leveraged more than ever before. The global pandemic has hit our MRO business the hardest, deeply affecting our non-project orders as the North American market suffered greatly from the oil price depression during the spring. But our 4 other strategic businesses grew our backlog to its highest level in over 8 years, thanks to our strong market position in the Middle East, India, Southeast Asia and China, in the nuclear, petrochemical and oil production sectors as well as to new product designs that are true market or innovation breakthroughs. Third, transforming the company in North America, that was a major step forward. A gradual erosion of our business competitiveness, if you remember, mainly in our North American operations, is what led our Board of Directors to unanimously approve the V20 plan in January 2019, a transformation strategy that aims to better leverage our assets and strengths and to unlock significant recurring bottom line improvements. In March 2020, when the pandemic broke out, we had barely undertaken the investment intensive portion of the plan. After briefly considering delaying the project, the decision was made to instead accelerate the deployment of our V20 agenda, taking measures to reduce expenses and resources at the same time. In these challenging circumstances, we effectively carried out the transformation plan last year, ahead of schedule. And as a result, the company has entered fiscal year 2022 with significantly reduced structural costs in our North American operations. Also now that 1 of our 2 Montreal plants has been sold, all remaining plants, including our plant in India, have been reconfigured in line with our less vertically integrated manufacturing model based on production [ sales ]. On the other hand, the task of transforming our manufacturing model into a leaner and more agile operation in North America is not over yet. The combination of new processes, adaptive capabilities along with COVID-driven disruptions, the move of machinery, the accelerated plant closure created turbulence causing significant production delays in our North American plants. I'm disappointed, but the effort is there to get back on track as soon as possible, and this is going to be a key area of focus in the months to come. Fourthly, talk about growth prospects are strong, and our people, very strong. What I'd like to say here, there were many other achievements to report during this remarkable year. There are only just a few of them. These are only just a few of them, each constituting a building block for our growth ambitions. Let me mention, for example, that following the collapse of the oil price in April, we saw a spectacular rebound of Velan ABV, our Italian operation, fueled in part by a breakthrough in its Middle East business. Also, the certification of our plant in Suzhou, China, to produce API 6D valves for our Italian operations, which thanks to freed up capacity now in Lucca, Italy are now able to meet the surge in demand for its high-end products. The many breakthroughs of our French operations in the cryogenic and big science fields and with control technology, proving once again that our French friends are not just about nuclear. The successful transformation of our Indian facility into a versatile hub for our MRO products as well as for specialized multi-turn products serving our end-user of customers in India and Southeast Asia. I can go on, but let me conclude by saying it's been a year like no whether. We had to learn how to make our global manufacturing operations work while coping with a devastating global health crisis and pursuing a complex transformation. As you can imagine, no book had ever been written on how to do this. It's quite a way to celebrate Velan's 70th anniversary. On a more personal note, the pandemic brought about a deep sense of loneliness that each of us must have had to grapple with so often in the last 15 months. Yet remarkable things were achieved by our employees uniting to overcome extraordinary challenges, both personal and professional. I want to express my deepest gratitude to all our employees and their families for their courage and perseverance and resilience. Our progress this year would not have been possible without the work and commitment of our experienced Board of Directors who remain dedicated to Velan's success throughout the most difficult moments. I want to thank our new Chairman, Jim Mannebach, for his great support and the wealth of business experience and wise counseling that he provided both the Board and me personally. On behalf of the Board and the management team, we also want to thank you, our shareholders, for your continued support and trust. We remain committed to creating long-term value for you every day as we work towards pursuing Velan's 70 years' track record as one of the strongest brands in the industry. In March 2020, in my weekly video, the first of many initiated to inform our employees across the world of our navigation course through unchartered waters, I predicted that Velan would come out of the storm stronger than when it hit us. Clearly, we are stronger, although still faced with many challenges ahead of us. As we are now turning a lot more attention to our growth strategy, the uncertainty of a world in flux continues to cloud the way, but we like our odds and look forward to the journey. I thank you for your attention. I will now turn the conference to questions.

[Operator]

[Operator Instructions] [Foreign Language] [Operator Instructions] And our first comes from Michael [indiscernible] private investor.

[Unknown Attendee]

I'm really relatively new to the story. So I hopefully don't get sort of redundant here on questions that have been asked before. But you mentioned supply chain issues as a reason for the lower sales in the quarter. I mean, are you largely through that at this point? Or has that gotten better? Or will it take several months to get through that?

[Yves Jacques Leduc, CEO & Director]

I wish I could tell you we're through this, and that's going to lead me to talk about what's happening in India. If you read the news there, the pandemic is going through a terrible third wave. But the main impact to our third and fourth quarter sales originated in the spring where the Indian government declared a complete lockdown of every industry company in India. And a large portion of our supply chain depends on supply of forgings and cast components. And as a result, these came in late and we had to reroute some orders in other areas of Asia. So the other thing I would add is that the new manufacturing model under V20 calls for a lot more pre-machined components as opposed to a lot greater reliance on in-house machining activities that we had before. So as a result of all that, some components that we had to reroute came not pre-machined. And it's not something we were planning for as we'd already reduced our machining capacity at the time. So that was a lot of turbulence. And this is the main reason why we were hit by those supply chain disruptions. All related to the pandemic, in other words. I hope I answered your question. Going forward, are we out of the woods? Well, right now, what we've heard this week is the Indian government has actually ordered a lockdown of a few days starting right now, I think, today or tomorrow. I don't know whether it's only going to be a few days. But we're prepared for that. We already had established alternate routes in the past. I'm expecting that we're still going to be hit by pandemic-related disruption this year, whether in our supply chain or at the customer side -- on the customer side of things.

[Unknown Attendee]

Okay. And without providing [ specific guidance ] should we expect -- yes, that's perfect. And without some guidance, would -- I mean, should we expect a similar sales level? Because, I guess, on the one hand, we've got a record backlog, and if you use historical comparisons, you can get a sense that revenue can run at a much higher rate. But it doesn't feel like we're there yet. Maybe it's a quarter or maybe it's 2. Hopefully, it's not 3 or 4, I think for all of us here in terms of how we're hoping for a recovery. But just to get a sense for an inflection, if there is one that we should expect?

[Yves Jacques Leduc, CEO & Director]

Yes. So without providing specific guidance, we're a backlog driven company, and our backlog has reached a near record level, but you should expect sales to go up this year. It's a very strong backlog.

[Unknown Attendee]

Yes. And then just to get a better sense of the gross profit margins. I mean, you've talked about V20, and that's obviously been a contributor. I presume operating leverage is another factor here, too. So just to try to get a sense for where the gross margins could shake out again, understanding that supply chain issues could persist for a quarter or 2 and potentially, hopefully, sales come back. But just to get a sense for, again, the gross profit margin profile of this business post restructuring?

[Yves Jacques Leduc, CEO & Director]

So subject to what could -- the disruption that might come with the pandemic this year, just as you just said, the reason why we launched the V20 program was largely to improve our gross margin. And what's going to drive the gross margin in the right direction is 3 things. First of all, as I explained in the past, one of the 5 things we did with V20 was reorganize our strategic businesses to be a lot more focused on their markets and a lot more disciplined in choosing where to quote and that pricing discipline and that discipline allowed to improve the margin. So we have a better mix now in our backlog. So that's 1 driver. The 2 other ones have to do with our structure. So 1 is by eliminating 1 of the 4 plants we had in North America, we significantly reduced the production overhead that goes into the gross margin. So that reduction in production overhead, obviously, will impact positively the gross margin of our North American operations. And by transferring the lower value small forge valves that were still being produced in Montréal to India, we're obviously improving the margin of that business because of lower cost of manufacturing in India. So the combined effect of these 3 is very positive when it comes to the gross margin of North American operations. Additionally, when you look at what's happening elsewhere, we're seeing the surge in bookings in the North American and Italian operations will help the gross margin there, of course, and we've always had a very healthy gross margin in our nuclear operations in France. You want to add anything there, John?

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

Yes. So the one other comment I would make is the headwind that we're facing with the recent dramatic increases in metal prices. It's been across the board, iron ore, steel, nickel, [ millicom ] and so on. They've all taken a big jump since December onwards. And we lived through this before, 10 years ago, we went through some pretty hefty price increases. And to protect our margins, you have to be able to pass it on as quickly as possible. The other factor that affects our bottom line margins are the cost of shipping. And with the pandemic, a lot of ships were pulled from service. And we've noted in the last few months, a tripling of the cost per container to ship. And we try to pass these on the best way we can, but it's a headwind that's out there. So we've done the best we can internally. We just have to make sure we deal with these economic factors.

[Yves Jacques Leduc, CEO & Director]

Other questions? Michael, does that cover your...

[Unknown Attendee]

Yes, that's a very thorough answer. No, I appreciate it. That's very thorough. And maybe if I could ask 1 last one. I mean, it's pretty [ obviously ] a heavy business, strong working cap. You've highlighted the equity per share value. I'm curious what the thought is of maintaining a net cash balance for this company or any thoughts about where that can be deployed over time.

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

The one thing I'll say is the cash isn't sort of like evenly spread about. Some places like North America, we are in a borrowing position. Other places, particularly some of the European subs, where we have heavy projects, the business with a lot of advanced payments. We do get a lot of cash advances. So when you look at our balance sheet, you also have to look at the advances on the liability side. So it's not as easily spendable as you might think. But we do try to keep a relatively strong balance sheet. And we're aware -- we're keeping our money for when we really need it. We're watching our pennies. We're watching our CapEx expenditures. And there's always a lot of interesting merger and acquisition business going on in this business. We keep our eyes open and try to keep our balance sheet as strong as possible.

[Operator]

[Operator Instructions] The next question comes from Dean Trottier, private investor.

[Dean Trottier]

The first question I had was around the North American production delays and I guess, with the Montreal plant getting sold ahead of time, understanding there were some delays. Is there any sort of timeline on when you expect the majority of that disruption to be finished or completed?

[Yves Jacques Leduc, CEO & Director]

Yes. We're planning to see a gradual recovery in the course of this fiscal year.

[Dean Trottier]

Okay. Okay. So we should still see some impact into Q1 and likely into Q2, fiscal Q1 and Q2 for 2020?

[Yves Jacques Leduc, CEO & Director]

That's exactly right.

[Dean Trottier]

Okay. And then my last question is looking at -- with the lower revenue numbers and looking at inventory, are we expecting inventory to come down a little bit from where it's at right now? Or is this kind of a level we should expect for the remainder of -- or for, I guess, for the next fiscal year for 2022?

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

Well, inventory is probably the key working capital assets that companies have to manage. So we realize we could probably do better on inventory turns. When you have a year, such as last year, with a relatively low sales, cost of sales base, you throw out lower inventory turns. When you have a jumping backlog and a book-to-bill ratio of 1.41 in North America, a 30% increase in backlog, you tend to buy into the future business. So when you're looking at your inventory at a point in time, you're measuring the turns against is a lower history and a higher backlog, which is yet to percolate its way through the cost of sales. So the inventory, I wouldn't call for a drop. But what I'd like to see is an increase in turnover.

[Operator]

And that was our final question. I'll turn the call back over to you.

[Yves Jacques Leduc, CEO & Director]

All right. So thank you for everybody's attention, and I look forward already to our next report in July. Meanwhile, enjoy the nice weather, and have a good weekend. Thank you.

[Operator]

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