Brian Gaynor: VTL far from a cash machine

Last month's profit warning from VTL Group (formerly known as Vending Technologies) was another major blow to shareholders.

VTL started well and exceeded its IPO prospectus forecasts, but its performance since then has been extremely disappointing.

Its finance company is achieving satisfactory results but the underlying earnings of the vending operations have plummeted over the past three years.

VTL was listed in 2000 following the sale of 5.5 million new shares and 2 million existing shares to the public at $1.00 each. The vendors were John Hotchin and Mervyn Doolan with a million each.

After the issue VTL had 29.5 million shares with Hotchin and Doolan owning 33.2 per cent each and Gary Stevens and Roger Moses 4.1 per cent each. The public held the remaining 25.4 per cent.

The directors were Richard Janes (chairman), Doolan, Hotchin and Elizabeth Coutts. Hotchin was executive director operations and Doolan chief financial officer.

According to the prospectus, "VTL was established to acquire, manufacture and sell vending machines for convenience foods and to manage and service those machines. Over time the intention is to retain ownership of an increasing proportion of the machines."

Chairman Janes believed that "the proprietary computer software in each machine has been the critical element in the company's rapid rise in the vending machine market".

VTL had net earnings of $4 million for the March 2001 year compared with the prospectus forecast of $3.1 million.

Operating earnings were below forecast but the bottom line benefited from a tax provision of only $100,000 compared with a prospectus forecast of $1.5 million. The low tax impost was due to the utilisation of $3 million of tax losses from NZ Vending Investments, which was 19.9 per cent owned by VTL.

Warren Larsen, former chief executive of the New Zealand Dairy Board, became a director and at the 2001 annual meeting shareholders approved the issue of 200,000 options to him at an exercise price of $2 each (VTL shares were trading in excess of $3 at the time).

Net earnings for the March 2002 year were $5.4 million compared with the prospectus of $4.1 million. But once again operating earnings were below forecast and the bottom line was heavily impacted by a tax credit of $0.4 million compared with a forecast payment of $1.6 million.

Janes made no comment in the annual report on the tax situation but a note to the accounts said the company had changed its tax accounting policy.

VTL changed its balance date from March to June and reported net earning of $3.3 million for the 15 months to June 2003.

During the year VTL had begun to convert itself from an owner and operator of vending machines in Australasia to a franchisor, mainly in Australia and the United States.

Although the 2003 result was well down on the previous year Janes remained upbeat. He wrote that an operational review "resulted in the adverse short-term financial results but significantly it has also seen the company successfully established as a franchisor in both the Australian and US markets".

By this stage Coutts and Larsen had resigned. Paul Smart has also come and gone after less than 12 months as a director. In mid-2003 the board consisted of Janes, Hotchin, Doolan and Gary Stevens.

Doolan and Hotchin sold more than one million shares each during the 2003 year.

At a special meeting in July 2003 shareholders approved the purchase of NZ Vending Investments Ltd (NZVIL) - the company with the $3 million of tax losses in 2001 - for $2.3 million. The principal vendors were Hotchin and Doolan.

The appraisal report, which was prepared by John Cregten of Corporate Finance, contained little substantive information.

NZVIL operated at a loss in 2001 and 2002 and further losses were anticipated in 2003 and 2004. Two of its main assets were tax loss reimbursements and the future value of tax losses.

Cregten wrote that NZVIL's return "has been adversely affected by lower sales attributable to sites upon which the equipment was placed" and "additional local competition from the two major corporate competitors in New Zealand slowed down NZVIL's ability to secure top-performing sites".

Oliver Saint of the Shareholders Association made a valiant effort to convince shareholders to vote against the resolution but it was overwhelmingly approved.

Shortly after the NZVIL acquisition Janes resigned. The board now comprises Stevens (chairman), Doolan, Hotchin and Roger Moses, the four original pre-float shareholders.

VTL had net earnings of $1.98 million for the June 2004 year compared with $1.2 million for the 15 months to June 2003. The 2003 year earnings were restated from $3.3 million to $1.2 million without explanation.

It is not clear whether the restatement had anything to do with the NZVIL purchase.

The 2004 year result was adversely affected by a number of items mainly connected with its expansion into North America and, more recently, Europe.

In the six months to December 31, 2005 VTL had net earnings of $2.4 million but this included a one-off profit of $9.2 million from the sale of a US subsidiary to All Seasons Services. Excluding the one-off gain the company had a loss of $6.8 million. The performance of the vending division continued to deteriorate and it reported an operating loss of $7.5 million.

On June 29 VTL told the stock exchange that one-off costs associated with its vending franchise operations in the United States would impact negatively on its results for the June 2005 year. It now expects to report a net loss of $8 million to $10 million for this period. The following week the company announced that it had begun a buy- back of up to 5 per cent of its shares.

The VTL story is extraordinary for a number of reasons.

It moved into North America and Europe before it had established strong and profitable operations in Australia.

It started profitably in the United States, as it did in Australia, but the bigger it gets, the less profitable it becomes.

The result for the six months to December 2004 included a $9.2 million capital gain from the sale of a subsidiary to All Seasons yet VTL is putting money into All Seasons rather than taking it out.

In addition VTL has initiated a share buy-back programme when one of its main priorities is to raise more capital.

Nathans Finance, the group's New Zealand finance company operation, is doing well but there are major concerns about the long-term viability of its vending activities.

VTL now owns 18.9 per cent of All Seasons, which is mainly management and employee owed. There is no financial information available on All Seasons although the US company stated that its involvement with VTL "would dramatically strengthen its balance sheet and position itself for future growth opportunities".

John Hotchin replaced James O'Connor, a turnaround consultant, as chief executive officer of the US company on July 1.

The future of VTL seems to be heavily dependent on the performance of All Seasons.

Based on its total inability to achieve earnings forecasts at the operational level, and the shortage of information on All Seasons Services, it would take a brave person to bet on a VTL turnaround.

* Brian Gaynor is an executive director of Milford Asset Management.