Covalon Technologies Ltd

XTSX:COV

Earnings Call Transcript 2019-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to Covalon's Fiscal 2019 Year-end Financial Results Conference Call. As a reminder, today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brian Pedlar, President and Chief Executive Officer; and Mr. Danny Brannagan, Chief Financial Officer. Please go ahead, Mr. Pedlar and Mr. Brannagan.

[Danny Brannagan, Chief Financial Officer]

Thank you, Melissa. My name is Danny Brannagan. And as 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 fiscal 2019 year-end. 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. For the fourth quarter ended September 30, 2019, Covalon's total revenue was $6.6 million with a net loss of approximately $3.5 million or $0.16 per share. This compares to the prior year's fourth quarter, which saw a total revenue of approximately $6.6 million and a net loss of approximately $600,000 or $0.03 per share. Operating expenses increased for the fourth quarter to $7.3 million compared to $5 million for the same period of the prior year. The overall gross margin for this quarter was 60% compared to 64% in the fourth quarter of the prior year. The increase in expenses during the quarter mainly related to the AquaGuard acquisition and costs associated with running that business, which were not included in the comparative period. For the year ended September 30, 2019, Covalon's total revenue was $34 million with a net loss of approximately $9 million or $0.41 per share. This compares to the prior year's comparative period which saw a total revenue of $26.7 million and a net income of $1.6 million or $0.07 per share on a diluted basis. Operating expenses increased to $30 million compared to $18 million in 2018. The overall gross margin for the year decreased to 64% compared to 74% in fiscal 2018. In 2018, Covalon received an upfront licensing payment of approximately $4.5 million from a major medical device company, and this led to an increase in the prior year's percentage. I would now like to turn the call over to Covalon's CEO, Brian Pedlar.

[Brian E. Pedlar, President, CEO & Director]

Thanks, Danny, for the review of our annual results for fiscal 2019, and good morning, fellow investors. Thank you for joining Danny and I on this call. Fiscal 2019 saw Covalon undergo, what I think, are significant changes as an organization, many of which have actually strengthened our business and provided us with a very strong platform for future growth. At the same time, we also did not meet our growth objectives in fiscal 2019, in particular, in the Middle East, and our share price has, I think, reflected this fact. I am confident that the fundamental improvements that we have made to Covalon over the past year, which I intend to try to discuss some of those during this call, they will, over time, demonstrate the significant unrealized value for Covalon shareholders that I believe currently exists in our company. We started fiscal 2019 by adding almost 2,000 new hospital and medical institution customers in the United States.Along with that, we added a very talented and experienced sales force to call on those customers. The acquisition of U.S.-based AquaGuard gives Covalon a presence in the market and a certain amount of scale in our U.S. business that over time will allow our company to begin selling our own patented infection prevention products directly into hospitals alongside our AquaGuard product line. This is a valuable new asset for Covalon, and it's valuable because we now control the clinical relationships with customers who use our products in the United States. I believe, over time, investors will see how this strategic move will benefit the value of Covalon over the long term. Another area that I'm particularly -- think that we have made some strides forward in, is an area of the business we call our OEM or development and consulting services revenue business, which has grown about 83% year-over-year. Now some of this growth is a result of the signing of the previously announced major OEM contract and the development work under that contract that we announced previously and was -- is with one of the world's largest medical device companies. And they have licensed Covalon's proprietary coating technology, and we're applying that coating technology to their product lines. These development agreements have long sales cycles. And they start with small projects that can lead [ indiscernible ] larger license deals. This is an example of one that started with a small project and led to a larger license deal. And our coating technology, I believe, is world-class, and a number of big medical companies are interested in the possibilities of combining our technology with their existing products to protect their patients from getting infections. Now we also completed the registration of a number of our flagship products in most of the Latin American countries, excluding Brazil. So we've completed the product registration, which means that we're now allowed to sell our products into the markets, in markets like Mexico, Argentina and Chile, among a number of others in Central and South America. This means that we can begin now competing for business in these markets in fiscal 2020 and beyond with our full product portfolio. It will take us another year or 2 to complete the registration of our full product line in Brazil. And we are just at the beginning of our growth as a result of these key changes to Covalon. And I think over 2020 and 2021, I expect us to generate meaningful growth in these key markets. As I mentioned, not all of our business initiatives met our expectations in 2019. Our Middle East business declined in fiscal 2019 compared to 2018, as a result of significant delays in shipments under the contracts we secured in Saudi Arabia, and we talked about this in our third quarter conference call. It is very difficult to predict the volume and timing of business in Saudi Arabia, particularly in light of the current regional uncertainty. And also our business in the -- the business -- our business in the region has continued, and we are working to grow it further, but it's just not predictable. In fact, right now in the Middle East, we're pursuing additional business for 2020 and beyond. And my job is to try to maximize the business I can get from all markets. And the Covalon team that's here with me is working hard here in the Middle East to identify new leads and diversify our presence in a number of other countries beyond just Saudi Arabia. One thing I have to point out, though, is that we were successful in beating out multinational companies, and we were -- and we had been awarded some very strong contracts in Saudi Arabia, which has given us significant credibility in our markets, not only here, but around the world. However, Saudi Arabia is a closed society, and we are a western company, and the truth is that we have very little visibility into how the system works on the ground. Not just Covalon, all international companies that I talked to -- that I've talked to this week as well as in the past, had the same issue. We need to rely on a local agent to navigate the closed system that exists here. And despite that fact, we are pushing for more business, but the culture and the inner workings of the business environment is closed to outsiders. Our fiscal 2019 numbers did not have the performance from the Middle East that I expected, and I am disappointed with the results we posted for the year and for our business in the Middle East, as I believe most other investors are. But I will say this, and it's important that we are a much stronger company today as a result of our ability to beat out the competition to secure the contracts we won, even if they didn't result in meeting our expectations. The credibility we gained has helped us in many other markets to advance our business. Both clinicians and patients continue to tell me how much they love our products in this market and virtually every other market that we're in. As I said, going forward, we will continue to push for more business in the Middle East and recognize revenue as it occurs. And I believe we're no longer, as a company, dependent on our Saudi business as we once were. We've also made some really positive changes to our operations during the second half of fiscal 2019 and the first quarter of 2020, that I will believe -- that I believe will see Covalon reduce its operating expenses by up to $7 million in fiscal 2020 compared to fiscal 2019.And I believe that these cost reduction initiatives will still leave us well positioned for growth in the United States, Latin America and Europe. And I'm optimistic about our potential for significant growth, both this year and beyond. Our share price has declined this past year due to the uncertainty in the Middle East. Many shareholders who saw the challenges that we experienced in the Middle East as temporary headwinds, took the opportunity to invest more in Covalon, either in the public markets or by participating in the private placement we closed in September 2019. I am confident that they will be rewarded when our underlying value gets reflected in our share price. Now some of the reasons for my confidence I think are laid out in the press release, so I want to talk about them again here. And they relate to what I believe are fundamental improvements in Covalon over the past 2 years and significantly in the past year in fiscal 2019. I think we're a stronger, more diverse company. We added approximately 35 people to our sales and marketing teams, which means we now have more people selling our products in the market. We now have nearly 2,000 new hospital, clinic, group purchasing organizations, integrated delivery network customers in the United States, and that provides us a new customer base for our existing products. We've also begun to distribute very recently our products in about 16 new countries. And that over time, I think this will begin to materially contribute to revenue going forward. We have 4 product families that each now account for 20% or more of our annual revenue individually. And I think that provides more stability and diversification for our business as we step into new markets. We have at least 4 new products that we have yet really to launch in our key markets, particularly in the United States, which again, over time, will provide additional growth opportunities. As I look at our new product pipeline, we have several products that I believe we're going to launch this year that will have strong revenue opportunities for us. And one of those, as I mentioned in the press release, is an improved version of one of our flagship products, IV Clear. On our customer development project side, we worked on over 60 customer development projects of various sizes this past year. And that's approximately 22 medical product companies or divisions of medical product companies. And that's under the umbrella that we call our OEM business. This includes various projects underway associated, as I've mentioned, with the large contract that we previously announced as well as with a number of other new organizations that are interested in our coating technology. I'm extremely confident in Covalon's present commercialization position and our upside potential. We do have a suite of lifesaving products, and we have a very dedicated and driven staff, and that's always what's really set us apart from our competition. And we continue to leverage those strengths going forward and as we grow our business. Now I'd like to open the line up for questions, and I'd ask that you please try to keep yourself to one or two questions at a time, and please get back into the queue if you have another question to ask. Melissa, over to you to open up the question line.

[Operator]

[Operator Instructions] Your first question comes from the line of [ Howard Petroc, ] private investor.

[Unknown Attendee]

I just wondered how much cash you have in hand at the moment? And will there be any need to raise more money in the foreseeable future? Or is it now self-sustaining? I realized that the need for the private placement was due to having inventory in hand that wasn't shipped to Saudi Arabia. The other thing is -- second question is, is there any indication from the Saudis about the offtake schedule that they planned? And what is the balance of that initial Saudi order that's yet to be shipped? That's the end of the questions.

[Brian E. Pedlar, President, CEO & Director]

Howard, thanks for those questions. I think we had significant cash at year-end. I think we're around a little over $4 million in cash in hand now. That fluctuates over time as we invest in working capital and then collect our receivables, et cetera. So cash can move up and down with Covalon. I don't -- I think we -- the changes that we've made, I think, puts this company on a much better footing to generate cash. And I think operationally, I think we can fund our operations with the cash that we have. So -- and as far as the Saudi business, as I said, [ Howard, ] it's really -- it's a difficult environment to understand what's going on for outsiders. We -- the rules can change quickly, and you have to be a Saudi citizen in order to really understand and be plugged into how things operate, and that's why we rely on our local partners. We're going to be recognizing our revenue as we ship and not make attempts to predict the future. I think we've positioned ourselves in a way where we are not reliant on the business the way we were in the past, in Saudi. That said, I still intend to try to maximize as much of the business we can from our current contracts and from new ones that we're pursuing. So I really appreciate the questions.

[Unknown Attendee]

What is the balance of the current contracts of -- with the Saudis still to be shipped?

[Brian E. Pedlar, President, CEO & Director]

Yes. So we're not providing guidance. [indiscernible] So we -- as I said, we're just -- as we ship, we'll recognize that revenue. And we'll continue to chase new contracts and chase orders under the current ones.

[Unknown Attendee]

Okay. There was one other question I had to ask is, have you looked at the Far East markets? Or have you been approached by anybody in the Far East like Singapore, Malaysia, Taiwan, which are pretty substantial markets and...

[Brian E. Pedlar, President, CEO & Director]

Yes. We have a team focused on that -- on those markets, and we've recently made some inroads into several countries there. Almost every country we go into, there is a product registration process that's underway. And we are beginning in some countries and well down the road in others in Asia in the Far East. So again, I think there is a lot of growth opportunities for us in those markets that we intend to enter and to compete for business over time.

[Operator]

Your next question comes from the line of Trevor Holsinger from Aspen Wealth Management.

[Unknown]

Can you shed some light on what your Saudi local partners are saying about -- did they build up inventory, and they're working through it? Are they using the product? Are they switching to other products? Are they -- just some insight into what they're saying and what they're doing. And not [indiscernible] you know what I mean?

[Brian E. Pedlar, President, CEO & Director]

Yes. Look, it's -- this is, as I said, this is a part of the world where if you're not plugged into the decision-making processes that occur within Ministry of Health, it's very hard to understand how -- how the -- the business is unfolding. Because we use partners, we don't get that sort of visibility like we now do in the United States, where we have our own sales team, that's in there monitoring product usage within the hospitals on a daily basis. We just don't get that visibility. Everywhere we go, including all the meetings I've had this week here with clinicians as well as with decision-makers in various departments of health across the Middle East, all the feedback is they love our products and both patients and clinicians. It's -- and so I believe there is still very strong opportunities for us in the market, but it's really hard for me to know all of the ins and outs of what are going on. And I hesitate to speculate because I -- again, that's not -- I don't think that's healthy. We're just focusing on gaining the business we can. We're recognizing the revenue as it's appropriate and trying to grow the region as much as we possibly can.

[Unknown]

Okay. So second question in the U.S. sales. The U.S. sales was fairly flat, excluding AquaGuard's addition. And with the expansion of the sales force, can you elaborate on why the U.S. sales aren't ramping up for the non-AquaGuard products?

[Brian E. Pedlar, President, CEO & Director]

I think, actually, they are. And there -- I think what you have to do, I believe, the large license fee that we received was a U.S.-based license fee and would be included in U.S. revenue in 2018. So when you're doing year-to-year comparison, you kind of have to back that out. So our U.S. business is up on the other product lines, and I think we're -- the U.S. is going according to plan. I'm really excited about our opportunities there. So I know when you sort of crunch the numbers on the financials that it doesn't always show up because there's other line items included there. But I think when you look at a license fee that we recognized in 2018, and that would be I think included in U.S. business.

[Operator]

[Operator Instructions] Your next question comes from the line of [ Paul Luca, ] private investor.

[Unknown Attendee]

I see we've built inventories up to $8.5 million in the quarter. And I was wondering if you could comment on the types of products those are. And if you think those -- that inventory is going to move? Or if we're going to have to take another write-down on that inventory? Just seems -- that's the highest I've seen it.

[Brian E. Pedlar, President, CEO & Director]

Yes. I think -- I don't foresee write-downs, those are our -- the majority of our inventory are our flagship products, they have long shelf lives. So I don't foresee us having a problem with that. Again, the more we're moving of inventory, the better for the business, and I think we're drawing down on those inventories. So I think we'll be in good shape there. So I'm not anticipating any financial hits from inventory.

[Unknown Attendee]

Great. And also the other question is regarding the OEM business. That's -- I appreciate seeing the additional detail about 60 development contracts with approximately 22 medical device companies. I'm invested in another medical device coating company that breaks their contracts down into a, what they call, preliminary standstill agreements that allow the customers to experiment with their coatings and test the coatings. And then if those are successful, they go on to formal licensing agreements to allow for commercialization of products. That being said, can you give me a breakdown of how many of those 22 medical device companies represent new relationships in the year? How many would -- of those 22 agreements -- I'm sorry, yes, how many would be preliminary agreements? And how many are more formal agreements for commercialization? So I guess that's a 3-part question.

[Brian E. Pedlar, President, CEO & Director]

Yes. Look, I don't intend to go into that detail around these. The reason that I talked about the different projects and pointed out and -- much like the company you're talking about, a lot of these projects start very small, pilot projects to see if our technology works with the various companies' products. And these are long sales cycles. They can extend over a number of years. And some can go very quickly. We've had relationships with a number of companies and worked with them for several years. And every year, including this past year, we attract a number of new companies that want to explore our technology. Not every project ends up in a license deal. And I think we tend to do fairly well with those, but they just take time. And so I think that by providing that level of information, I think what I was trying to demonstrate is the fact that it's a very healthy side of our business that isn't just one contract, it's a number of relationships that over time will grow into more license agreements and larger business as more and more companies -- and there's thousands out there that we can potentially work with. More and more companies will become aware of and work with us to examine our technology and whether that can help them be more competitive in their market spaces.

[Unknown Attendee]

All right. I respect the need for keeping trade secrets, but a -- yes it's just -- it's always been the [ fueling ] aspect of Covalon to me, been trying to chase down the next Angiotech for the past 2 decades. So I'll just wait for more -- more developments.

[Brian E. Pedlar, President, CEO & Director]

Yes. You're welcome, Paul. It's an area that I'm very excited about as well. So we share that.

[Operator]

Your next question comes from the line of Lyle Atkins from Independent Financial.

[Unknown]

Brian, are there any patent issues coming up in the next year or 2 that we should be aware of?

[Brian E. Pedlar, President, CEO & Director]

Well, I don't believe we have patent issues. I think it's actually the other way around. We've got a lot of exciting things in the works that we expect to receive patents on. And so I think it's [ indiscernible ] what we've been doing with our portfolios of technology as we treat them like a portfolio. So we're continuously innovating on the platform technologies that we have. And so we're -- we filed for a number of new patent applications, that helped extend the life of the underlying platform. So I think we're in really good shape there. And I think some of the things we have going on in the lab are quite exciting. And once we're able to publicly talk about them, I think it'll -- I think investors will find them exciting as well. But I really appreciate that question.

[Operator]

Your next question comes from the line of Mathieu Martin of Espace MicroCaps.

[Mathieu Martin, Analyst]

I have 2 questions. First, you mentioned that the cash is now about $4 million, which is down from $9.5 million at year-end. So was wondering if it's only due to working capital movements. Or if you have paid down some of the HSBC debt?

[Brian E. Pedlar, President, CEO & Director]

There might have been a little bit paid down, and I think we do pay some of that over time. But most of it is just the flowing back in and out of working capital. So we're putting that cash to work in the business.

[Mathieu Martin, Analyst]

Okay. All right. And second question is, can you provide more details on the cost reduction initiatives?

[Brian E. Pedlar, President, CEO & Director]

Sure. So I would say, it falls into 3 buckets. One bucket is head count, another bucket are agency fees and the third bucket are -- is discretionary spending. And we've tightened the belt in a number of areas, and we've undergone some head count reductions. I did mention off the top that we -- we've been investing in sales and marketing, and most of those head count reductions have come in other support areas that are not affecting our ability to generate business going forward. So I think we've taken a very prudent approach to reducing expenses, and I expect that we'll be able to meet our -- the number of $7 million that I talked about.

[Operator]

There are no further questions at this time. Mr. Pedlar and Mr. Brannagan, I turn the call back over to you.

[Brian E. Pedlar, President, CEO & Director]

So I'd like to end and close by really repeating what I've said, which is that I think we have a very -- this past year, although, there have been challenges, and there's been aspects of our Middle East business that has not gone to plan. I think we are a stronger company. I think we are a better company. We have a lot of building blocks in place that I think are going to add value to Covalon over time. And one of the ways that -- the easy gauges that I look at is the clinicians and the customers that use our products love them. And we're able to compete and win business with large -- against large companies. And I don't -- I truly do not believe that the market has fairly reflected the advances that we've made in the business and the opportunities that are in front of us, but I am very confident that over time, that will show up. I appreciate everyone attending the call, and I look forward to updating you at the end of our first quarter in a very short period of time. Thank you.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.