Earnings Call: Q1 2022

Jul 14, 2021

Earnings release

Greetings, and welcome to the Valon, Inc. Q1 Financial Results. Presentation participants will be in a listen only mode. After this, we'll conduct a question and answer session. If anytime the conference, you could reach the operator, you may press the star or a better 0. As a reminder, this call is being recorded Wednesday, 07/14/2021. I would now like to turn the conference over to Yves Lejuez, CEO. Please go ahead. Welcome to our first quarter fiscal twenty twenty two conference call. I'm joined today by Benoit Alain, our new CFO and John Ballo, 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. 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 three percentage points above last year, thanks in large part to our V20 program, whose primary aim was precisely to drive our North American operations margins up. We were disappointed by the several nonoperational factors that increased our administration costs 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 $5,100,000 or $0.24 per share compared to $1,900,000 or $0.90 per share last year. EBITDA amounted to a negative $900,000 or $900,000 or $04 per share compared to a positive 2,600,000 or $0.12 per share last year. The movement toward 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 V-twenty. We're also benefiting from a $1,200,000 reduction of restructuring and transformation costs in the current quarter, also reflecting the progress made last year in the deployment of our V-twenty program. These improvements could only partially offset the negative impact of the delay in shipments in our Italian operations and an increase in administration costs of $6,100,000 or 34.6%. The increase in administration costs is primarily attributable to an increase of 2,100,000 in the cost recognized in connection with ongoing liability litigation, the decrease of $1,100,000 in Canada emergency wage subsidy 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, as best discussed, for the quarter is due to the timing of settlements in these two periods rather than the changes in long term trends. Our gross profit percentage increased from 24% to 26.8% for the quarter. That's two eighty basis points. The increase in gross profit percentage was such that it could more than offset the impact of $1,300,000 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 spending from the margin improvement activities implemented over the course of the past fiscal years in the scope of our V-twenty restructuring and transformation plan. I'll talk now about sales, order bookings and backlog. Sales amounted to 74,500,000.0 a decrease of $2,100,000 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, the shipment of some large orders by our Italian operations, who are currently very efficiently 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, it's important to note, our nonproject sales for the quarter were negatively affected by the persistent unfavorable market conditions triggered by the COVID-nineteen 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 $39,600,000 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 $607,200,000 That's an increase of 44,700,000.0 or 7.9% since the beginning of the current fiscal year. The increase in the backlog for the quarter is primarily attributable or resulting 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 $71,200,000 at the end of the quarter, an increase of $8,300,000 or 13.2% since the beginning of the fiscal year. The net cash per share was USD 3.3 or CAD 3.98. Our equity at the end of the quarter settled at USD 296,600,000.0 or USD 13.74 per share. In Canadian dollars, our equity was USD 16.58 at 05/31/2021 compared to our TSX share price at the close of business on that day of CAD 9.85 indicating once more that our share price is notably undervalued. We had our Annual General Meeting for our shareholders yesterday, I encourage you to have a look at my presentation, which we will post on our website at the beginning of next week. You'll get more details and comments about the quarter as well as the most interesting highlights of fiscal year twenty twenty one, 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 an essential industry in the last year has been a reality in the way we operate our business. Customers call or refuse to call or delay shipments, delay release for shipments, that's part of the problem when I refer 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 Quebec, which I'll be talking about in a couple of minutes. The pandemic has had a significant impact on the material costs as well. The commodity costing and pricing has gone up, we had to compose with that as well. And I mentioned the liability costs a little earlier. So these are call them external factors. They, 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 I have? What do we have going for us? Let's start with business health. You often 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, the 20 program for which most of the infrastructural elements and investment elements are behind us, they were carried out for the most part, during, fiscal year twenty twenty one is driving substantial and sustainable margin improvements. We're benefiting this year largely for the full year of the reduction significant reduction of structural costs, almost $15,000,000 that dragged 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 B-twenty. Another direct consequence of our B-twenty portfolio decisions is that we set strategic businesses. We now talk about the land in terms of our five reorganized strategic businesses, two of which were already in existence out of Europe. And they contributed to turning around our financial performance in our North American ops 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 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 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 twenty twenty one was remarkable. And it had a lot to do with the fact that the line 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 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 $600,000,000 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 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 were purchasing pre machine cascades that come out of Asia. And obviously, that continues to play a factor given the accumulated delays in global logistics. But we have a procurement team that's well aware of this and doing great work to offset those hurdles. And our bookings keep repeating where the month 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 rate 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 have 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 the new Agulated BED product line. We now have 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 HPOW high pressure acid leach acid feed 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 up with a design that significantly simplifies the infield controls and maintenance, thereby adding end user benefits. It's what we're about. We're an engineering company, and we see 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 be ready for it because they require high integrity casts and forgings, 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, 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 Valen China plant to produce API 6D valves, the 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. And that fits well and it explains why UTAN 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, the people showing up in the plant, our leaders, our managers, composed with a very difficult situation last year. Want I 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 assigned to India for a digester capping valve to produce ethanol from bamboo. Normally, that metal ceded valve valves or soft ceded valve valves 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 capacity is increasingly leveraged 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 q one, 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 twenty eighteen. It had a lot to do with the very, very poor margins of our North American operations. And 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 a global company. I like to use the analogy of one plus one plus one should equal three when we bring all our forces together, and this is increasingly a distinction and a characteristic of the brand. So I want to finish by just summarizing what I see as the investment highlights from talking to investors. Really five things and you can see it in the annual report that was published recently, five 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 seventy 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 D20 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 V-twenty, now 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 five strategic business very dynamic action plans that leverage our own assets and capabilities. And last but not least, a portfolio of diversified businesses that truly constitutes 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. And then, 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 recent past to address 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 questions. Thank you. Thank you very much. And if you'd like to register any question, please press the one by the floor on your telephone. You'll hear a three tone prompt, technology request. If your question has been answered, like to withdraw your registration, please press the 1 followed by the 3. Once again on the phone, it is the one followed by the 4 to register any questions or comments. One moment, please, for our first question. Robert Rutel, the Oak West Corporation. Our next first question is from the line of Robert Rutel with Oak West. Please go ahead. Congratulations on your improvement in margins, your maintenance of revenues in a tough period. So operationally, are certainly looking better. My question this morning sorry. I cut you off. No. No. Thank you. I I just I cut you off, so it's okay. Go ahead. Okay. My question this morning was well, my first question this morning is really on on your cost. And with respect to the asbestos, the $2,100,000 increase in asbestos litigation expenses, you 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? Yes. I've said that because it's very difficult to read to see into what those increased costs are changing trends. The reality is that in the last five, six 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 got bankrupt. So the attorneys are looking for companies that were present and did have asbestos in their product in the eighties. And even if the causal relationship is very thin or nonexistent, then we'll if we if we check that profile, we'll be we'll be sued, and that's what's happening right now. So does that mean that we're going to see the cost continue to go up. We're trying to see clearly through it. It's 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, and we believe that might help us in terms of the efficiency of the legal costs. But it's a problem, and that's always been there. The only thing I can tell you is that we're managing it tightly with the highest possible level of oversight. He's pointed out 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. I mean if I understand from the notes in the annual report, you've been experiencing about $10,000,000 or on average $10,000,000 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 I I my second part is is that is there no way to provide I mean, you make provisions for warranty work and other things. You know, the question is is a $2,000,000 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 see the improvement, if you will, with these kind of very loud noises in the background. So perhaps that's They're very loud? Question. It's it's a good suggestion, and I I've been I I've actually been spending more oversight on the whole matter in the last year, personally. And then you're right. It is a lot of noise. So the only thing I can tell you is that there there's complete awareness and understanding of the details of the issue, and we're gonna continue finding ways to mitigate those that exposure. And it is unfairly driving you know, driving down our results, unfairly because unfairly said the great work of our operational team in North America, obviously, followed 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. Okay. My second question touches a little bit on this, and that is, 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? Well, let's recognize that our performance, has been very disappointing, you know, at least from fiscal eighteen to fiscal twenty when we started implementing V20. So is it surprising that our share price went down during that period? No. I think I think it's I I think we need to deliver, I'll be quite candid with you, a string of profitable quarters before we get moving 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. If you take a look at our company and you see our North American operations, the improvement there and the performance of our European operation and all of that. And so in the end, we agree it's undervalued and we do it 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. And the other observation is we're about twice what we were last year. We were trading between $5.5.5 dollars and now we're close to $10 $10.5 we're moving in the right direction, but we're not there. I agree with everything you just said. I guess where I'm really at is the company trades a little bit by appointment. It's not terribly liquid. 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 you know, when things start firing the way they should, I just just hope that, you know, that that that your target is more than simply meeting book value, I guess, is what I'm saying. So Right. Totally. We have to get there first to surpass it. So let's let's get back on the road to recovery. So sorry. Message message received and agreed to. Okay. Thank you again, and and best of luck as things come back. Okay. Thanks, Robert. Appreciate it. Thank you very much. We'll get to our next question on the line from Dean Trotty, Private Investor. Please go right ahead. Good morning, guys. 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 we should expect to see increased revenue kind of going forward. Should we see inventory sort of move in line with that and same with receivables and payables as well? Well, it's a good question. We watch working capital very, very closely. And if you look at what's happened at the February, you'll see our inventories went from $2.00 $4,000,000 to $236,000,000 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 is something that's got a very high importance in our week to week objective. Okay. Yeah. That was that was kind of what I was alluding to with the with the inventory levels. Look, when I look back to, you know, kind of previous, when we've seen higher top line from the company, and this is before, obviously, the d 20 plan. I was just trying to get a sense of what we should expect going forward. But it it sounds like the the investment is made up front. And then but if you continue to see strong bookings and a book to bill ratio above one, we should continue to see inventory levels kind of creep up in step with that. One other factor but one other factor, Eve alluded to some of the contracts where 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. When you look at that increase since the February of $32,000,000 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, Azid 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 an increase of inventory. Okay. And you can add it to your system one. That's true. Our inventory is going up, but I just want to point out that since our backlog here, part of it is financed by the customer deposit. So you can see our customer deposit increased by more than $10,000,000 in the quarter. So at least it's partially offset by that. Our customers are paying for part of our inventory. Yeah. And I understand there's a fair bit of moving pieces in the supply chain, and then you're there on the added complexity of stated reopens with different countries at different places in their vaccine rollout. So I don't envy you guys with a global supply chain. Thanks for the question. Any other? No, thank you. Thank you for taking the time. Appreciate it. Thank you very much. And our next question comes from the line of Jean Larocque, private investor. Please go ahead. And by the way, I I will shortly translate once I'm finished with the answer to to to those who who don't understand French. So the question is why is what explains the drop of the decline of sales since 2013? And the the main driver of that was the significant drop of our Western Canada sales. It was up to 80,000,000 and a drop as low as below $10,000,000 in just a few years. Just that was a major factor that hurt the company very, very hardly. They were profitable sales on top of it. And then 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 reorganization around more focused strategic businesses, that helped get bookings back up. And I would say the industry has 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 its lion's share going forward. Thank you. Lezuk, we have no more questions on the line. I'll turn it back to you. 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. Thank you. And that does conclude the conference call for today. We thank you for your participation and if we disconnect your