Canada Markets closed

Edited Transcript of EIL.V earnings conference call or presentation 2-May-19 2:00pm GMT

Full Year 2018 Empire Industries Ltd Earnings Call

WINNIPEG May 20, 2019 (Thomson StreetEvents) -- Edited Transcript of Empire Industries Ltd earnings conference call or presentation Thursday, May 2, 2019 at 2:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Allan Francis

Empire Industries Ltd. - VP of Corporate Affairs & Administration and Corporate Secretary

* Hao Wang

Empire Industries Ltd. - President & COO of Dynamic Attractions

* Kenneth Guy Nelson

Empire Industries Ltd. - Executive Chairman, CEO, President & Director

* Michael Martin

Empire Industries Ltd. - CFO

================================================================================

Conference Call Participants

================================================================================

* Elmer Friesen

E. B. Friesen Associates, Ltd. - Executive

* Hugh Cooper

Royal Bank of Canada - Analyst - RBC Dominion Securities

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Thank you for standing by. This is the conference operator. Welcome to the Empire Industries Fourth Quarter and Full Year 2018 Results Conference Call. (Operator Instructions) and the conference is being recorded. (Operator Instructions)

I will now hand the call over to Mr. Allan Francis, Vice President of Corporate Affairs and Administration for Empire Industries. Please go ahead.

--------------------------------------------------------------------------------

Allan Francis, Empire Industries Ltd. - VP of Corporate Affairs & Administration and Corporate Secretary [2]

--------------------------------------------------------------------------------

Hello, and welcome again to the Empire Industries fourth quarter investors conference call. Today, we will hear from Guy Nelson, Executive Chairman and CEO of Empire Industries; Hao Wang, Chief Operating Officer; and Michael Martin, Chief Financial Officer. In addition, Nonexecutive Chair, Ian Macdonald, will be available with our presenters to answer questions that you may have. On the first part of the call, we will provide insights into the company's performance in 2018 and the outlook for 2019 and beyond. After that, we will be available to answer your questions.

First, a couple of housekeeping notices. If you'd like more information about Empire or to receive our update bulletins, please let me know. You can find my e-mail address on any of our press releases. It is afrancis@empind.com. Today's call is being recorded. The recording will be available on our website tomorrow.

We remind you that our remarks will include forward-looking statements that are subject to important risks and uncertainties. For more information on these risks and uncertainties, please see our Reader Advisory at the bottom of our results news release as well as in our MD&A. You can find these on our website and on SEDAR. The company's actual performance could differ materially from these statements.

Empire is in the theme entertainment industry, which is experiencing significant growth globally, especially in the U.S. and Asia. Our specialty is designing and building cutting-edge rides for major theme parks. If you've been to a major theme park, you have probably ridden or seen several of our rides. We are the secret name behind some of the most popular attractions in the world. In addition to Florida and California, our rides are centerpiece attractions in theme park resorts in China, Japan, Korea, Macau, Dubai, Abu Dhabi, France and many other locations. We've also been working towards entering the co-venture market through our Dynamic Entertainment Group. Co-ventures are partnerships where we partner with tourist venues to co-own and operate our attractions with a corresponding recurring revenue stream.

Let's begin our call with a review of the numbers, so I will hand the call over to Michael Martin, Empire's CFO.

--------------------------------------------------------------------------------

Michael Martin, Empire Industries Ltd. - CFO [3]

--------------------------------------------------------------------------------

Thanks, Allan. Revenues in 2018 increased to $140.9 million or 7% from the $131.8 million in 2017. Contract backlog at the end of 2018 was $252 million, which is up $4 million from the $248 million at the end of the company's third quarter of 2018. 90% of that backlog has been from non-first-generation contracts.

The net loss is $50.5 million in 2018 versus $8.8 million in 2017. The inclusion of a going-concern basis of presentation note in the financial statements required a number of accounting provisions to be included in the net loss for 2018. $18.4 million was the valuation allowance of its deferred tax assets. These tax assets remain available to be used by the company to shield up to $65 million of taxable income in the future. The value of these assets may also be recognized again in future periods. Notwithstanding this, these tax losses and investment tax credits continue to represent a valuable asset that could be used going forward.

An impairment of the group's intangible assets of $6.3 million, of which was noncash impairment, similar to the deferred tax assets, the intangible assets may also be written back up again when the company determines it's appropriate to do so. The impairment decision on the group's intangible assets also resulted in not recognizing approximately $6.7 million of additional development costs relating to the group's intellectual property. The consolidated statement of cash flows eliminates most of the above noncash items presented in the income statement. Therefore the cash used in operating activities in 2018 was $4.4 million compared to cash generated in operating activities of $3.3 million. We will shelter our future profits from income taxes to utilize the loss carryforwards and the investment tax credits which arose because of our historical capital investments that qualified as scientific research and experimental development.

Also, as outlined in the Subsequent Events section of our filings, on April 29, we successfully closed a $38.5 million debt financing from a Fortune 500 company. We paid out our former senior lender in full and provided net new funding of $19.5 million, which has improved our working capital position significantly.

As far as this new financing, $5.5 million of term debt formally due within 1 year is now rescheduled to be paid out within 18 to 24 months from closing. In addition, the group announced last week that it is undertaking an $8.5 million convertible preferred share issue which is due to close in Q2 2019. Strengthening the group's liquidity will allow it to effectively and efficiently execute our backlog of $252 million.

I'll be on the line to answer your questions at the end of the call. But first, I'll hand the call back to Guy.

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [4]

--------------------------------------------------------------------------------

Thank you, Mike. Hello, everyone. 2018's financial results were obviously disappointing with such a significant loss. Notwithstanding this, I'm going to explain why management has never been more bullish about its business, its outlook and the company's preeminent positioning in the market.

As Mike mentioned, our journey forward starts with the liquidity to make it happen. We've secured appropriate working capital and are implementing, with rigor, production efficiencies and cost reductions and process in our record profitable backlog. Before anyone asks me who the lender is, let me say that they don't wish to be identified, and we're going to honor that wish. I won't be responding to questions on speculations on that.

I'm going to talk about 3 topics today: hidden assets, co-ventures and the outlook. With the various write-offs and impairment charges we took at the end of last year, I want to summarize where Empire's asset value is now hidden.

First, the record backlog is only 10% first-generation rides with no margin, whereas 90% are second-generation rides that carry our more traditional job margins of anywhere between 30% and 40%.

Proprietary intellectual property and patents. The company had total capital investments over the past 5 years of $45 million to build its world-class product. Our intangible assets are now valued at only $4 million. I will let the future sales and profit speak for why management is of the view that this is a huge undervalued asset. For example, our world-class Flying Theater is not valued at all, and we have now sold 12 theaters, and our patented Flying Theater is the backbone of our co-venture expansion.

Our co-venture business is gathering momentum by leveraging our unique and patented Flying Theater IP. The pipeline of opportunities we're pursuing is superb, and we can hardly wait to show you exactly how Empire shareholders are going to benefit from Dynamic Entertainment with future announcements.

Our tax losses and investment tax credits from our development efforts can shelter $65 million of future taxable income. Our plan is to use these tax losses starting this year and take advantage of them quickly. The company owns -- also owns 30 million Tornado shares. The current market value of Tornado is twice our book value, and we expect this to become even more of a hidden gem because Tornado is gathering momentum and expected to increase in profitability.

The third topic I wanted to talk about is co-ventures. The MOU announced November 29, 2018, with our local partner in Tennessee, Smoky Mountains, has made good progress. However, the working capital issues have led to modest slippage in our projected opening time line. The party is now expected to have the land lease signed soon with a co-venture attraction opening to guests in late 2020 or early 2021. This is the first of several co-venture opportunities that Dynamic Entertainment has been negotiating in North America and China. We see co-ventures as a natural extension of our business for manufacture of iconic ride systems for major theme parks to be a co-owner of our world-class -- our own world-class attractions in prime tourist locations. Empire's co-venture strategy is designed to generate a recurring, predictable revenue stream to our business model. As mentioned earlier, one of the very valuable IPs owned by Empire is its patented Flying Theater, and the group's 74% owned subsidiary, Dynamic Entertainment Group, is leveraging the use of this Flying Theater IP on several prospects in this pipeline of opportunities.

I want to be very clear here, the challenges faced in Empire in 2018 related to our illiquidity and the complexity of the ride systems that we're bringing to market for the first time. Our problem was not our technical capability or the robustness of our product line. Our rides and unique skills have never been more popular in the marketplace as witnessed by our growing backlog. There are 4 main reasons why our financial results are expected to improve commencing in Q2 2019 and subsequent quarters. First, having come through a design-intensive phase of its growth, building its award-winning product line, the group is streamlining and improving its efficiencies by reducing its cost structure in all areas. The group is undertaking an organization-wide cost-reduction initiative that Hao Wang will provide more details on speaking after this.

Secondly, the revenue in the last 3 quarters of 2019 is expected to exceed $40 million per quarter with the working capital constraint fixed. This contrasts to an average of only $25 million per quarter in Q4 2018 and Q1 2019 due to working capital constraints. Contract backlog is expected to be replenished at this higher level by future contract awards currently in the group's sales pipeline.

Third, job margins have been reduced in the past 4 years because of the losses incurred on the 3 first-generation jobs, the losses of which have been provided for in the historical results. Excluding these first-generation jobs, our job margins have averaged approximately 34% in the last 4 years. Going forward, there is approximately $25 million of revenue left to be earned on these first-generation jobs for which no margin is left to be recognized. These contracts will suppress the overall job margin percentage until these jobs are finished. Two of the 3 jobs are scheduled to be so substantially complete later this year and the third one in 2020. IFRS requires the losses on these 3 jobs to be recognized immediately when known to be -- and so that the $18 million cumulative loss on these 3 projects has already been recognized in our results from 2016 to 2018.

The fourth reason is that the group's free cash flow is expected to increase in future quarters because it is scaling back on its R&D and product development expenditures to a more sustainable pace. In the past 5 years, the group has invested heavily in R&D and product development and is now more focused on leveraging this investment for the bottom line.

I will be the first to acknowledge that the new financing just arranged is expensive, but not in the context of what it is allowing the group to generate in terms of operating income and what it avoids in terms of highly dilutive equity raise at this juncture. Management plans to refinance this debt with lower-cost traditional debt, which we have the right to do, realizing on some of the hidden assets and future equity raises as appropriate.

I'll be available for questions at the end of the presentation. But first, I'll hand the call over to Hao Wang, our Chief Operating Officer, to talk about operations, particularly our cost-reduction plans.

--------------------------------------------------------------------------------

Hao Wang, Empire Industries Ltd. - President & COO of Dynamic Attractions [5]

--------------------------------------------------------------------------------

Thanks, Guy. Hello, everyone. There are 3 areas I want to touch on today. First is ride openings, backlog and pipeline; second is focus on innovation, quality and safety; and of course, production and overhead cost-reduction initiatives.

We recently opened our newest robotic ride in Warner Brothers theme park in Abu Dhabi to critical acclaim, and we're scheduled to open a Special Effects Coaster in Abu Dhabi and a Dual Power Coaster later this year in Malaysia. We have invested heavily to make these 2 award-winning first-generation rides as our 2018 and 2017 financials attested. However, when they both open later this year, jaws will drop for both the guests and the industry experts. Upon commissioning these 2 first-generation rides, our backlog will almost entirely be made up by second-generation mature products carrying a much more predictable profit margin. The design of these 2 attractions won the award for Best New Ride Concept in 2018 and 2015 by the industry's global organization known as the IAAPA, the International Association of Amusement Parks and Attractions. Having all 3 of these proprietary ride systems open to the public will set the groundwork for adding to an already robust pipeline and prospects.

In addition to its existing backlog, the group continues its business development efforts to identify and establish future projects. The group expects its sales pipeline of opportunities to continue to be strong as the theme park industry continues to expand, particularly throughout Asia and upgrades to their attractions in the West. The group expects manufacturing capacity to remain tight in the industry which will enable us to maximize returns.

We're significantly better positioned today than we have ever been to accomplish what we're here to do, which is to provide the best guest experience to the end customer. And we do this by engineering, developing and commissioning the most advanced, never-been-done-before ride systems in the world, which we have proven is not an easy task to achieve. However, our unwavering focus on delivering on our promise in 3 contracts with a financial loss is the foundation on which we stand and what our customers value in a relationship with Dynamic Attractions. This tenacity and commitment to innovation is starting to bear fruit.

Just last week, we were able to complete auto cycling of a ride vehicle completely around the track in Abu Dhabi at our Special Effects Coaster. This is a significant milestone on the road to opening this attraction in 2019. We are progressing step by step and have a clear path to completion.

One of the other first-generation rides is well underway to achieving a power up in the mountains of Malaysia outside of Kuala Lumpur. All of the ride vehicles are either on-site or en route, and we're confident that the first vehicle will be running around the track by the end of this summer with a target opening by the end of the year.

This level of confidence in our outlook is the result of the significant investments that we have made in the development of this exciting technology and in the organization that is bringing this to market. We have realigned and rightsized our engineering and production operations to optimize how we develop and bring products like this to market faster and at an acceptable margin.

We have started to transition our engineering group to realize a 15% net cost reduction in headcount to date while strengthening our expertise and capabilities and controls in integration. This is a strategic move to increase our value add and control the IP that we embed into our products.

Our production group under the leadership of Steve Turner is now capable of pumping out a ride vehicle every 2 days, previously one a week, which has more than doubled our revenue-generating capacity and enabled us to take on the next production order without adding significant capital or overhead. We have made significant improvements in our operational efficiency and cost-control initiatives. We are not close to being done.

Every executive and manager has a clear understanding of what we need to do as a team and also as individuals with a specific action plan to improve our efficiency, drive to our deliverable and control costs through reduction, prevention and avoidance. We have set ourselves an aggressive target of 20% reduction and have defined a plan to achieve it, which includes consolidation of facilities, replacement of our manufacturing systems, implementing a global sourcing strategy and long-term relation supplier agreements and alignment of our product portfolio to lead the market. And that is our focus for 2019.

I can answer any questions after the call. But now I hand it back to Guy.

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [6]

--------------------------------------------------------------------------------

Thanks, Hao, for describing that. And in addition to making the world's best rides, we're focused on production efficiencies and cost reductions to improve our bottom line. Combined with our stronger working capital position, we anticipate excellent financial results this year and improving even more in the years to come as co-ventures start to add to our bottom line and then greatly improve our margin. While the going-concern note is disappointing, ironically, it comes at a time when our liquidity was substantially improved because of the financing that closed earlier this week. The group has a current market capitalization of $40 million, of which management and the Board believes does not reflect its intrinsic value based upon the existing backlog of profitable contracts, estimated future profitability, the company's hidden assets outlined above. The officers, directors and insiders own approximately 40% of the company, so their goals are completely aligned with all the shareholders.

We have another participant on today['s call], Ian Macdonald. Ian is the Nonexecutive Chair and also the Chair of Empire's Audit Committee. I want to give a special thank you to Ian as we worked tirelessly, using his considerable experience in the mezzanine debt world and in scouring the market -- the financial market to find an alternative lender interested in financing our progress billings and working capital and future cash flow, not our past. Thankfully, we found what we were looking for.

Ian is here, along with Hao Wang, Mike Martin, Allan Francis and I, to answer any questions you may have. Operator, would you please facilitate the question-and-answer part of this call?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) The first question comes from Hugh Cooper of RBC.

--------------------------------------------------------------------------------

Hugh Cooper, Royal Bank of Canada - Analyst - RBC Dominion Securities [2]

--------------------------------------------------------------------------------

Can you talk about the Mario Kart orders and where you stand on those? And when do you expect to complete for each of the parks that you've got the orders for? And secondly, just on the co-ventures. How likely do you think you might have a deal signed this year?

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [3]

--------------------------------------------------------------------------------

Thanks, Hugh. Maybe, Hao, you could talk about the vehicle production. I'm not sure we've announced anything about specific names there. But do you want to talk about the production there on that, Hao? And then I'll talk about the co-venture.

--------------------------------------------------------------------------------

Hao Wang, Empire Industries Ltd. - President & COO of Dynamic Attractions [4]

--------------------------------------------------------------------------------

Well, like I said, I think the vehicle production is going extremely well. We are not in a position to divulge -- discuss specific delivery timing. Like I said, our production efficiency has more than doubled. We are now well positioned to achieve all of the milestones for delivery and really working through the basic start-up issues that all vehicle manufacturers experience. But they've been overcome. We have a very clear, defined process to ensure that each vehicle leaves the assembly facility 100% quality checked and will meet all of the -- and exceed all the requirements that will make this a successful attraction.

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [5]

--------------------------------------------------------------------------------

On the co-ventures, I think I've mentioned in my messaging that we've advanced on a number of fronts. And on the Tennessee one, which we actually announced previously, that we're -- we've slipped a little time-wise because of the -- our working capital constraints, but we do expect that to have an announcement in the near term on the starting of that. There is a lag between announcing the final contract and the opening -- grand opening at the site in the Smoky Mountains. So that's the first one that we are hopeful to move into, give some more specifics on that.

I think the other element of that is really understanding what the impact of those co-ventures are on our bottom line and our investment profile. The -- it's important to note that the co-ventures, as we have them financed going forward, will be largely self-financed, so we will not be using any of the current financing to do any of that, any of the co-ventures. But the recurring profit does have a big impact. But it does lag between the time of announcement and the time of opening. Does that help, Hugh, answer that?

--------------------------------------------------------------------------------

Hugh Cooper, Royal Bank of Canada - Analyst - RBC Dominion Securities [6]

--------------------------------------------------------------------------------

Yes. No. That's great.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

(Operator Instructions) This concludes the question-and-answer session. I would like to turn the conference -- we have one more. The next question is from Bill Colby, private investor.

--------------------------------------------------------------------------------

Unidentified Participant [8]

--------------------------------------------------------------------------------

Yes. I'm curious, a, as to what the interest rate is being paid on the new $30 million credit facility. And #2, and a separate question, I'm not sure I heard it right, but there are 2, if not 3, contracts that are being completed on a no-profit basis because of costs that were previously incurred and are to be -- are they to be included in the next few months? And has appropriation been made for that situation?

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [9]

--------------------------------------------------------------------------------

Yes. I can answer that. Thanks, Bill, for that. So the first one is -- it's buried in the notes there, the 50 pages of notes which you probably didn't get through overnight. It's prime plus 9.5%. The 2 to 3, it's actually 3 first-generation contracts that are still in backlog. There's about $25 million of revenue and $25 million of cost left to be recognized. Two of those will be substantially completed this year, and then the third one will be impacting revenue and cost this year and next year when the completion is scheduled for the end of next year on the third one. So they will have a dilutive effect on the overall margin because they're coming in at 0% of margin. The actual losses -- IFRS 15 is a new standard that was implemented January 1, 2018, that requires us, as a company, to recognize the loss on the job as soon as it's known in full, including the cost to complete, and any overage. So by definition, there's 0% margin left to be taken on that. So those losses have impacted '17 and '18 results.

--------------------------------------------------------------------------------

Michael Martin, Empire Industries Ltd. - CFO [10]

--------------------------------------------------------------------------------

Guy, if I could jump in for a second to just clarify. It's Michael here. I think your question was have we provided for at this point what we think the future sort of shortfall is, right? Doing, like, projects in a loss position. And we're not done, so there's going to be revenue and expenses moving forward, but the expenses exceed the revenues. So are we providing for that as of this -- the date of these statements? And the answer to that is yes. The new -- like that would have been the case under the old standard. So -- but to answer your question, yes, whatever we project our net or future liability is, is reflected in these financial statements.

--------------------------------------------------------------------------------

Operator [11]

--------------------------------------------------------------------------------

The next question is from Elmer Friesen with E. B. Friesen Associates.

--------------------------------------------------------------------------------

Elmer Friesen, E. B. Friesen Associates, Ltd. - Executive [12]

--------------------------------------------------------------------------------

Yes. I'm just wondering are you getting any takeover interest from competitors? That's a lot of backload in -- backlog in work and a fairly unique type part of the market.

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [13]

--------------------------------------------------------------------------------

I'll take that question on. Thanks, Elmer. No, we haven't gotten any direct calls yet on that, and I guess partly the control -- as I say, management, the officers and directors and insiders own more than 40% of the company today, so it would be -- short of being a friendly deal, it would be an unlikely scenario to proceed with, particularly an unfriendly approach. I think the -- whenever the intrinsic value, as we have stated in here, in our view exceeds the market value, you could be susceptible to those sorts of initiatives but nowhere near the pricing we're talking about today.

--------------------------------------------------------------------------------

Operator [14]

--------------------------------------------------------------------------------

This concludes the question-and-answer session. I'd like to turn the conference back over to Mr. Guy Nelson for any closing remarks.

--------------------------------------------------------------------------------

Kenneth Guy Nelson, Empire Industries Ltd. - Executive Chairman, CEO, President & Director [15]

--------------------------------------------------------------------------------

Thank you. On behalf of all of us, I want to thank you for your interest in Empire. As Allan mentioned earlier, you can reach us by e-mailing him. Allan's e-mail address is on the website, which is afrancis@empind.com. And tomorrow, you'll find a recording of the conference call on our website as well. Thank you for participating. Goodbye.

--------------------------------------------------------------------------------

Operator [16]

--------------------------------------------------------------------------------

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.