Covalon Technologies Ltd. (COV) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to Covalon's Fiscal 2020 Fourth Quarter and Year-end Financial Results Conference Call. My name is Andes, and I'll be your conference operator today. As a reminder, today's conference is being recorded. [Operator Instructions] At this time, I would now -- I would like to turn the conference over to Mr. Brian Pedlar, Chief Executive Officer; and Mr. Danny Brannagan, Chief Financial Officer. Please go ahead, Mr. Pedlar and Mr. Brannagan.

Thank you, Andes. My name is Danny Brannagan. And I'm Covalon's Chief Financial Officer, I would like to thank everyone for taking the time this morning to attend our conference call. We will be discussing the financial statements, MD&A and press release related to Covalon's fourth quarter and year-end September 30, 2020. There will be an opportunity for you to ask questions at the end of our call. Before we begin the discussion, I would like to remind participants that this call is covered by Covalon's safe harbor statement. Certain statements included on this conference call may be considered forward-looking. Such statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from those implied by our statements. And therefore, these statements should not be taken as guarantees of future performance or results. All forward-looking statements are based on management's current beliefs, assumptions and information currently available to us and related to anticipated financial performance, business prospects, partnership opportunities, strategies, regulatory developments, market acceptance and future commitments, among other things. Participants on this conference call are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this conference call. Due to risks and uncertainties, including those identified by Covalon in its public securities filings, actual events may differ materially from current expectations. Covalon disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In the management discussion and analysis, press release and this call, Covalon has provided non-IFRS measures that are meant to provide further understanding of our results by helping to highlight trends and to assist in comparing different periods. The adjusted gross margin and adjusted EBITDA are terms that do not have any standardized meanings and may not be comparable to other companies. These measures are not meant to replace the similar IFRS measures and any adjusting items may recur in the future. For the fourth quarter ended September 30, 2020, Covalon's total revenue with $5.9 million with a net loss of approximately $2.2 million or $0.08 per share. This compares to the prior year's fourth quarter, which saw a total revenue of $6.6 million and a net loss of approximately $3.5 million or $0.16 per share. Operating expenses decreased for the fourth quarter to $3.8 million compared to $7.2 million for the same period of the prior year. The overall gross margin for the fourth quarter was 31% compared to 60% in the fourth quarter of the prior year. For the year ended September 30, 2020, Covalon's total revenue was approximately $25.8 million with a net loss of $7 million or $0.27 per share. This compares to the prior year's comparative period, which saw a total revenue of $34 million and a net loss of $9.1 million or $0.41 per share. Operating expenses decreased to $18.6 million compared to $30.1 million in 2019. The overall gross margin for the year decreased to 48% compared to 64% in 2019. During the year, the company received various government subsidies in the United States, Canada and United Kingdom for a total of about $2.1 million. The company also recorded a total inventory provision of approximately $2 million, of which $1.4 million was recorded in Q4 and an accounts receivable write-off of $1.4 million in the quarter ended June. With these items, the company has provided more information to provide supplemental context for the gross margin and for the earnings figures to help compare these figures to other periods, but these should not be used in place of IFRS measures. The adjusted gross margin for the fourth quarter of 2020 was 55% compared to 62% in 2019. And the adjusted gross margin for the year was 58% compared to 66% for the prior year. The gross margin was impacted by the previously mentioned inventory provision, costs incurred to rework existing products, low-margin sale of personal protective equipment and increased shipping costs as impacted by COVID-19. Generally, tender business won by Covalon will have minimum shelf life requirements for products that must be satisfied by the company. Inventory provision was taken in the fourth quarter to reflect that the delay in shipments seen during the year meant that we would not be able to sell some of the existing inventory. Covalon also incurred cost to rework the existing products so that they could be sold to other customers, which allowed us to sell product but at a reduced margin. Covalon will continue to assess the inventory on hand but note that with disruptions in supply chain, there's always a risk for future write-offs related to bulk orders. Covalon continues to push for reduced inventory levels in order to reduce the risk of future write-offs, which are not currently anticipated to be of a similar magnitude going forward. The adjusted EBITDA for Q4 was a loss of $700,000 compared to a loss of $2.6 million in the same period of the prior year. The adjusted EBITDA for the year ended September 30, 2020, was a loss of $2.6 million compared to a loss of $5.8 million in 2019. This adjusted EBITDA removes the impact of government subsidies in the accounts receivable bulk provision, which was expensed during the year. As a reminder, the accounts receivable provision was taken as a result of changing our partners in the Middle East. Covalon has strengthened our presence in the Middle East through a new partner that is the subsidiary of a multinational company with the resources to support Covalon's product portfolio to decrease the risk of receivables becoming uncollectible. The company continues to assess subsidies and grants that are made available to companies that have been impacted by COVID-19 and has been able to obtain additional subsidies in the first quarter of fiscal 2021. We will continue to provide updates related to subsidies as we report our future results. For the year ended September 30, 2020, revenue in United States was down by $2.9 million, due primarily to COVID-19 impacts and the postponement of elective surgeries. The slowdown is anticipated to continue until hospitals and health care facilities return to normal levels of activity. Middle East revenue was down $6.4 million compared to the year ended September 30, 2019. The decrease was driven by delayed contracts and the transition to a new partner in the region. Covalon now believes that we have a stronger partner in the region who is better suited to sell and distribute Covalon products going forward. Covalon ended fiscal 2020 with a strengthened and more diversified revenue base with 82% of revenue being derived from the United States and 9% from the Middle East compared to fiscal 2019, which had 71% of revenue in the United States and 26% in the Middle East. Subsequent to year-end, the company has received a waiver for all breaches related to our banking facilities with HSBC that occurred as of September 30, 2020. At year-end, the company was offside on financial covenants, which resulted in the full amount of outstanding debt to be classified as a current liability. Covalon has a strong relationship with HSBC in the history of obtaining wires for covenant breaches, which has been the approach taken as it relates to COVID-19 impacts. We believe that we will be able to obtain waivers in the future, but recognize that there are no guarantees. As previously discussed, Covalon continues to have access to an additional $1 million lending facility through HSBC and Business Development Bank of Canada's program called the Business Credit Availability Program. The acquisition note payable on the company's balance sheet is an item that I would like to take a moment to discuss. This amount relates to a vendor takeback note from the acquisition of AquaGuard. The full amount is listed as a current liability. However, the noteholder entered into a subordination agreement with HSBC that unconditionally and irrevocably deferred, postponed and subordinated in all respects, this note to the HSBC debt. The noteholder does not currently have recourse under defined subordination agreement. Covalon has taken steps to reduce the operating expenses in fiscal 2020 by $11.5 million or 38% compared to fiscal 2019. As I have previously mentioned, there were some items disclosed to help compare period-to-period performance. Backing out the government subsidies and the accounts receivable provision, the company reduced operating expenses by $10.8 million from the prior fiscal year. While operating expenses will fluctuate based on growth and other initiatives, we believe that the reductions have put Covalon in a strong position for fiscal 2021. I would now like to turn the call over to Covalon's CEO, Brian Pedlar.

Thanks, Danny, for a review of our Q4 and our year-end results for fiscal 2020. Good morning, fellow investors, and thanks for joining Danny and I on this call. 2020 was a strategically important year for Covalon, but it was also one that included significant challenges related to COVID-19. And it has certainly had an impact on our operations and our financial results that we reported this morning. We started fiscal 2020 with reasonable double-digit revenue growth in our key market in United States in the first quarter. We end -- and we ended the year with overall revenue down 24%. I can say with fiscal 2020 in the rearview mirror, I firmly believe that the steps that we have taken over this past year to mitigate the impacts of COVID-19 have positioned Covalon to overcome the pandemic's impact on our company, and that we are positioned to grow our top line and return to profitability. We are now almost 4 months into our new fiscal year, and I am truly pleased with our progress to date. Covalon at its heart is an infection prevention company that was founded on the strength of our lab. And over the years, we have developed patented technology platforms that we have leveraged to create highly competitive products and services that help protect patients from getting infections and help heal wounds. We generate revenue by selling our products through over 30 established medical product distribution networks with a major focus on the United States, and we also sell products in Latin America, Middle East and Europe. In the United States, we have our own sales team that calls on over 2,000 hospitals and clinics. And our AquaGuard product dominates its market category in the U.S. and has become a key brand recognized by clinicians in our hospital customer base. The restrictions imposed by governments and a significant deferral of elective procedures by hospitals in the U.S. and internationally, negatively impacted our product sales and our ability to sell to new customers during the majority of fiscal 2020. Our team has assessed our customer status account by account, and I am happy to report that the decline of business that we experienced is temporary. We have not lost any major customers. In response to the challenges in engaging with hospitals, we launched 3 products during fiscal 2020 into our U.S. hospital clinic customer base. And we actually experienced strong engagement from clinicians in evaluating these new products despite the lockdown restrictions. We are leveraging our strong reputation with clinicians for protecting patients and solving clinical problems at the bedside to engage with them on these new products. During 2020, key antimicrobial patents were granted to the company by the United States Patent and Trademark Office, the Canadian Intellectual Property Office and the European Patent office. And these are integral to our IV Clear, MediClear Pre-Op and SurgiClear products. These products are unique, and they help clinicians solve real clinical problems. I see strong potential for these products in our U.S. hospital customer base, and we are only at the beginning of unlocking the significant value of having 2,000 hospitals and clinics as customers of ours in the U.S. We also developed antimicrobial products for other big medical companies using our patented medical device coding technology. In 2020, we engaged in 39 customer development projects of various sizes with approximately 10 medical product companies. These products ranged in size, and they can lead to large multiyear license and development agreements, similar to our previously announced major licensing agreement with one of the world's largest medical device companies. Much like we have experienced in the United States, the government restrictions and social distancing measures implemented in our international markets as a result of COVID-19 have made it very difficult for our sales team and our distribution partner sales teams to engage with hospitals and clinicians in the way we used to, in the Middle East and elsewhere, in order to sell our products. As Danny mentioned, to reduce the risk and position our product brands for growth in the Middle East, we transferred distribution rights in the region to a European multinational medical device company, and a new local agent. And both of those parties have strong sales forces and distribution capabilities throughout major markets in that region. I believe this will enable Covalon to maintain our market position and grow our business in the Middle East. Our suppliers and contract manufacturers were also affected by COVID-19, which has resulted in delays in us being able to ship some products to our customers, particularly for sales of our collagen products. We are actively working on strengthening our supply chain and catching up on the backlog of collagen orders in the U.S. and internationally. Our collagen platform generates significant cash flow for our business and has historically experienced predictable and strong growth year-over-year. The Covalon team has worked night and day over the past year to assess the impact of COVID-19, adjust our business practices and make changes in order to position us as best we could entering into 2021. I want to thank each and every Covalon team member for their very, very hard work over the past year. As a result of our team's efforts, we were able to minimize some of the negative impacts of COVID-19 by reducing operating expenses by $11 million or 38% for fiscal 2020 compared to 2019. And I know Danny and I are actively pursuing further operating cost optimization and investigating additional government subsidies. I'm proud of our team's efforts in mitigating as much of the negative COVID-19 impact on Covalon as possible, and I firmly believe that we are positioned for growth in 2021. Now as we previously announced, in response to expressions of interest in Covalon made by medical industry and private equity organizations, Covalon's Board of Directors formed a special committee and hired outside advisers to assist in undertaking a strategic review process to ensure that all available strategic alternatives to enhance value for our shareholders are being evaluated. The process has been running since our announcement and has been successful in attracting several additional very interesting expressions of interest that are currently being evaluated and discussed. The process has clearly validated that Covalon owns a number of very valuable medical technologies that have interest in the medical industry, including our collagen platform, our medical coating platform and our antimicrobial silicone technology. These platforms are all capable of generating significant revenue and growth with the right focus and investment. We are a small company. And given our current capital structure, we are not able to fully exploit all of these growth opportunities on our own. It is evident, based on the interest that has been generated, that larger medical companies see the opportunity to leverage their larger reach into the market, their stronger worldwide distribution channels and their access to more resources to generate significant value from several of our platforms. I see this as further validation of the view that is held by our entire Board of Directors, including our company's major shareholders, that Covalon is significantly undervalued, given our compelling combination of patented intellectual properties, our technology platforms and our commercialized medical product portfolio that goes through our global sales channels. Through the special committee and outside advisers, we will carefully deliberate on what actions, if any, are in the best interest of the company's shareholders. While this process is underway, I could assure you that the Covalon team continues to remain focused on executing on our growth strategy, promoting our established and new lifesaving products to our customers and providing meaningful growth opportunities to our dedicated staff. So far in 2021, we are seeing signs of improvement in product usage by our customer base in the United States and internationally even though COVID-19 restrictions have not eased in many of the geographies in which we operate, and we are overcoming the shipping and supply chain delays I talked about. I expect our gross margins to return to pre-COVID-19 levels in 2021, and I anticipate our reduced operating expenses in 2021 to be consistent with fiscal 2020 and may be reduced by additional government subsidies related to COVID-19 relief programs and further cost savings. The changes made to our operations have placed the company in a position to return to growth and profitability in 2021. With cash on hand and amounts available under our HSBC facilities, we believe we have sufficient future cash flow to support our operating needs going forward. I'd now like to open the line for questions. I ask that you please try to keep to one question at a time, and there will be lots of time to get back into the queue to ask more. Thank you. Over to you, Andes.

[Operator Instructions] First question is from John Biddle with Polymer Science.

Brian or Danny, is there concern with future supply chain issues of the antimicrobial products due to Covalon management lack of response to significantly large past due amounts being held at raw material vendors, some more than 12 months, which is not being adequately addressed by Covalon?

John, I know you're one of our suppliers, and I appreciate the question. No, I don't think we do have concerns there. And I think we have continuity of supply around our antimicrobial silicone. And I don't think we have issues from that respect.

[Operator Instructions] Your next question is from [ Arnold Shell ], private investor.

Given the significant reduction in -- of expenses, and I assume, staff, how would you characterize the morale among the staff at the company?

It's a good question, [ Arnold ]. We have optimized our staff. We've also found lots of other ways to cut costs and overheads out of the business. I think in general, our staff are actually adapting quite well to working from home, for the most part, working remotely. And I think they're actually quite excited about what we've been able to achieve in adapting our processes in order to continue with our business in our key channels. We've got still lots of really strong development of new technologies underway. So I think, in general, our team is -- no question, we've all suffered in our personal lives with COVID-19 and our -- and had to make a lot of changes in adaptation. But in general, I think the staff is pretty keen and energized. So I'm really proud of what they've been able to accomplish over the past year.

There are no further questions at this time. You may proceed.

Great. Thanks very much. I'm confident that the fundamental improvements we've made to Covalon over the past year will, over time, demonstrate the significant unrealized value for our shareholders that I believe currently exists in our company. And the hard work continues. I look forward to discussing our progress on the next call. Thank you very much, and have a great day.

Ladies and gentlemen, this concludes your conference call for today. Thank you for participating, and I ask that you please disconnect your lines.