Kontrol Technologies Corp

Good afternoon and welcome to the Control Technologies year-end and fourth quarter 2022 earnings conference call. I am joined by the CEO of Control Technologies, Paul Gassi, and CFO, Claudio Del Vasto. Before we begin, please be reminded that certain statements and information included in the management discussion and analysis and financial statements and presentations, including information related to future financial or operating performance, and other statements that express expectations of management or estimates of future performance constitute forward-looking statements. For more information on the company's forward-looking statements and risk factors, please reference the management discussion and analysis in our financial statements. For all public information filings, please visit the www.cdar.com. Thank you. I would now like to turn the conference call over to Mr. Paul Gazi, CEO of Control Technologies. Mr. Gazi, you may begin.

Thank you. Hello, everyone, and welcome to the Control Technologies year-end 2022 earnings conference call. I'm joined on the call today by our CFO, Claudio Del Vasto. 2022 was a challenging and disappointing year for Control with the underperformance of operating subsidiary global HVAC and Automation. While our commercial and industrial service and solutions business performed in line with expectations, the poor performance of Global HVAC led to the non-compliance of a covenant with our secured lender in Q3, which placed the overall company in the short-term position of financial strain. We were faced with a choice of operating Global HVAC with continued losses in the current environment or attempting to limit those losses by discontinuing operations. After careful consideration and in the context of managing our debt and covenants, Global HVAC was assigned to voluntary bankruptcy in February 2023. The impact of the loss of global is taken into consideration in Q4, with the accounting policies requiring a write-down of certain global assets, which include accounts receivable, as well as impairment of goodwill and intangibles. However, since Global did not enter bankruptcy until Q1 2023, there will be a significant gain in Q1 related to certain global liabilities, which remain on the books in Q4 2022. I'll provide an update on our business initiative shortly, but first I will turn the call over to Claudio for a review of the impact of Global on Q4 2022 and Q1 2023. Thanks, Paul.

Due to global discontinued operations and bankruptcy, the company suffered a net loss of 42.1 million for the year ended December 31, 2022. That loss includes the following items. Global credit provisions of 28.8 million related to accounts receivable, unbilled revenue, and deferred revenue. Global impairment of goodwill and intangibles of 5.5 million. Global provision for loss on contracts of $727,000. As the company had not filed for voluntary bankruptcy as of December 31, 2022, the company has not deconsolidated global, and therefore the liabilities of the subsidiary remain on the consolidated statement of financial position. As such, the company is expected to record a significant gain in earnings in Q1 2023 on liabilities that will be credited to income as part of discontinued accounting treatment. The company will remove $24.6 million of Global's liability in the first quarter of 2023. Subsequent to the year end, the company completed an equity private placement for gross proceeds of $5 million as we seek to grow our higher margin revenues and scale into new growth markets following the discontinuance of Global. The company generated positive adjusted EBITDA in 2022 when excluding global HVAC and automation. The company is projecting positive EBITDA for the 2023 fiscal year. In terms of our corporate financial outlook, we believe the worst of the global disappointment is behind us, and we are focused on driving a profitable 2023. Our commercial and industrial service solutions performed in line with expectations and the company will focus its operations on higher gross margin service and technology solutions. Eliminating loss-making operations directly benefits the gross margins and earnings. We have been able to reduce debt levels by approximately $3.5 million in the first quarter of 2023 while building up our cash position. We remain current on debt obligations with our secured lender as the company continues to deleverage the business. I will now turn the call over to Paul to discuss further company updates and the outlook for the 2023 year. Paul?

Thank you, Claudio. As we operate in 2023 and put the disappointment of global behind us, we will focus on profitability and building cash flows. We have worked diligently to reduce discretionary expenses and are running as lean as possible while targeting organic growth opportunities with scale potential. We also continue to target numerous potentially accretive acquisition targets. There are no global operating losses in Q1 2023, and we are operating on an EBITDA positive basis. I'd like to take you through a slide deck. We are having some technical difficulties with the presentation, and if you give us a couple minutes, we'll sort that out. Thank you. Okay, I'm back. You might hear some noise in the background. We had some trouble with the technology. So if you're on the web, you should be able to see slide four of the company presentation. There's also a live chat on the presentation for any of those who are interested.

All right, so on slide four.

We're looking at Q1 2023. The company is not providing any forward guidance at this time. However, for Q1 2023, there will be an addition of approximately $24.6 million to income due to the elimination of global HVAC liabilities. This addition to income reflects the ceasing of global operations in Q1 2023 and the elimination of various liabilities. As we discussed, the company is currently operating on an EBITDA positive basis in Q1. Our business and focus strategy for 2023 is multifaceted, but first and foremost, it's focused at operating EBITDA positive beginning in Q1 and for the balance of the year. To focus on growing our cash balances as we continue to pay down secure debt obligations and deleverage. Continue to manage discretionary spending and operate as a lean organization with a particular focus on scalable growth opportunities. Operate with higher margins beginning in Q1, historically in the range of 40% to 50% without global HVAC. Continue to innovate, grow patent portfolio and intellectual property. And at this time, there is no requirement for the company to raise capital.

We're now on slide

Slide six, yes. So I wanted to share a few examples of success we're having in the market. The first is net zero emission leadership. I think shareholders should be pleased to note that Control has won the highest number of net zero emission RFPs for municipalities in Ontario, out-competing some of the largest engineering companies globally. We've certainly developed a niche here. How we've done this is by focusing in on the problems of municipalities and helping them solve those problems, which includes feasibility, design, moving to installation, verification, and carbon credit monetization. I would say municipalities are leading the net zero emission push. Private industry will follow, but this year it's all about municipalities. We've got a great foothold and I would say an ongoing commitment to grow this market. There may be continued problems with the web, so I'm just going to continue moving forward.

Okay, next slide.

This is a press release we had a few weeks ago on ethylene oxide emissions, which is really a new regulatory environment. requirement for many industrial companies, something new to control that was delivered through our operating subsidiary, CEM Specialties. We're working with a U.S. customer to help them integrate their technology into a robust ethylene oxide analyzer in real time, and we have strong aspirations for this market because it is a regulated market and growing. In this capacity, we're acting as the integrator applying software and hardware solution for an integrated product for the customer, and the customer does have scale potential. We're not going to put a number on that, but multiple orders have been received, and this could be a strong growth market for control driven by regulation. The next opportunity we want to discuss is the joint venture with the European Instrumentation Manufacturer. And what's exciting about this opportunity is this is a well-established company with a 30-year history looking to expand into North America. And we're working on a partnership with them to build out their technology solutions as a prime distributor across North America. And again, this is a regulated market. It's in the emission business and has great scale potential for control. We also recently announced that we were selected by a Fortune 100 customer. And that customer selected us primarily because they had a challenge. They're an ESCO company, and what they have to do is run performance contracts where things have to be monitored very precisely. And if performance is low, there may be a penalty. So we were selected because of our ability to integrate very complex systems, which includes building automation, on-site HVAC, utilities, integrating all that information together. and coming up with a solution that can be managed in real time. It's not every day you get selected by a Fortune 100 customer, so we're very pleased with that. This is one very large mission-critical facility, and the goal here, of course, is to do great work together and scale that work into other buildings. When we look at mergers and acquisitions, We are very much looking at a number of accretive opportunities. And typically what we're looking at right now is service companies with recurring revenue in the $3 to $6 million range annually, high gross margin. I would say there is a bit of a paradox right now in the market that interest rates have climbed dramatically, but valuations haven't changed much for private operators. So that's something we're paying close attention to in terms of valuations. We're also spending quite a bit of time on analyzing the acquisition opportunities relative to organic growth opportunities with scale potential, which can ultimately generate a better return potentially. That's something that we're monitoring closely. There is a robust market for acquisitions in what I would call the $3 to $6 million private sector. enterprise vendor exiting through retirement market. And so we're actively looking and working on a few deals. In terms of patents and intellectual property, the company continues to develop its patent and IP portfolio with the advancing of the control bio solutions. The company intends to seek further funding for new pandemic preparedness initiatives at the federal level. That is a new term that's being used as we have discussions with various levels of government pandemic preparedness. The word COVID doesn't show up too much in conversation. The new term is pandemic preparedness, and there is funding available for technology that we're seeking. The company anticipates that its patent filings related to Control BioCloud will become issued patents in 2023, following a typical multi-year and multi-stage process. Most recently, the company has received funding to support new technology innovation for the cement industry for a dry kiln probe, which is actually quite a significant problem for many of our customers. And we've brought on one of the largest cement operators in the world as a pilot partner. So we're excited about that. So before we go to Q&A, and we'll be taking Q&A over the web and phone, before we go to Q&A, in conclusion, as we put 2022 behind us and focus on 2023, The elimination of Global will create a loss in Q4 and a gain to income in Q1. The company is operating on an EBITDA-positive basis beginning in Q1 2023. We will seek to grow our cash balances and continue to pay down secured debt obligations. We're going to focus on scalable organic growth opportunities with high margins. We're going to target accretive service and recurring revenue-based companies for potential acquisition. We will continue to innovate, grow our patent portfolio and intellectual property. So we will now move to the Q&A portion.

Thank you, ladies and gentlemen. We will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touch-tone phone. You will hear a three-tone prompt acknowledging your request. Questions will be taken in the order received. Should you wish to cancel your request, please press the star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question.

Hold on. We have a number of web questions that I'm going to take. Let me start with those.

I cannot see the conference line. All right, so we'll start with the web-based questions.

So the question is, how do you get to profitability in 2023? So what we've done in the removal of global, we've removed the loss-making operation, and the remaining subsidiaries collectively are profitable, EBITDA positive. historically have operated at strong gross margins. So the focus for control is immediately beginning at Q1 to be EBITDA positive and to grow that over the course of the year. A question from Jeff, is there any going concerns? Is there a going concern? Concern, I think, is the question. So in terms of the audit, everything is going to be filed today. We would have preferred to file yesterday. Unfortunately, with the issues surrounding global and this audit, the audit's taken a little longer and all financial statements and MD&A will be filed today. And so, yes, there is an issue of the going concern. It relates primarily to global and it relates to 2022. So our view on that is that's a standard part of the audit whenever you have a material disruption. And we think that's historical going forward, being EBITDA positive, growing our cash flows. We're not concerned about that for 2023. Please describe the ethylene oxide opportunity in greater detail if you can. So this is an opportunity that we're not going to disclose the customer at this time due to confidentiality reasons. but also because we have an important opportunity here to execute on. And from that perspective, really what we're focused on is solving the customer's problem, which is creating an analyzer that can be sold in what I would call a turnkey fashion globally. And the first number of orders received are for markets outside of Canada. So we're very pleased with that. And we think this could scale in terms of a new opportunity, as well as further regulation in the market, is really driving this opportunity forward.

And we're part of that admission opportunity.

So just letting the operator know that your over-the-phone screen is not working and the web platform is fine. So you may have to reactivate that, okay, if the operator is there.

Yes. Hi, sir.

As of the moment, no one has pressed door one.

Okay.

So I can't see that on my screen. I'm just letting you know that the system is down. That's all. Unfortunately. Okay. We'll continue with the web-based questions. What's happening with the secured lender? So as we... Press released with the secured lender. We're working closely with them. The debt has been reduced significantly. We're in pretty good shape there. And we have the forbearance agreement, which we're meeting and compliance with up to date on our interest in principle and driving our cash flows forward. So we're comfortable that we're working closely with our lender. And, you know, as that debt comes down and that balance sheet leverage improves, the financial statements will look better. But key importance is to continue to drive EBITDA growth and cash flow growth. Okay, so before we open the phone lines, maybe a couple more web questions and hopefully your system can come back online. Right now it's showing a blank. Can you further explain the loss in Q4 and the large gain in Q1. Okay, so this is a technical accounting issue where the event of global happens over two quarters. So part of that event gets recorded in Q4, which is a negative to the financials because of the write-down of accounts receivables. Now, some of those receivables may actually be collectible. We don't know yet. And if they are collectible, they will reduce the debt. But from a conservative accounting and audit principle perspective, those get written off. The payables stay on the books, which seems a bit odd, but the technical reply to that is they stay on the books until they're removed in Q1 when they become a gain in the financials because the voluntary assignment into bankruptcy happened in February. So really you have a multi-quarter view of global, but our view on that is from a Fundamental perspective, what's going to drive the business forward is generating earnings and cash flows. And from a global accounting perspective, the loss in Q4 turns into a gain in Q1 on the payable. So a little confusing, but the accounting will cover two quarters. Okay, so one last web question before we move to Q&A on the phone. How do you value control as a company? So I'm not an analyst. I'm not going to give a value on the business. Every micro cap, in a sense, is its own story. But fundamentally, we can generate EBITDA, which we are in Q1, and we anticipate for the rest of the year. That will have a certain value to the market, and the market can value that. and price the future of that. In addition, we've got innovation and technology, and the market will come to its own conclusion on what that value is. I would say in this market, because I do spend a lot of time looking at various companies and talking to other CEOs, I think the primary focus is be a self-sustaining company, generate your earnings, build your business, And really, that's the most important, I would say, operating criteria in what I would call a challenging microcap environment and also a very high interest rate environment. So the market will assess what we're worth as we continue to execute and deliver into 2023.

So we can take some phone questions, even though I can't see anything on that screen.

Yes, once again, please press door one should you wish to ask a question. The first question is from Adam Marutak. Please ask your question.

Thanks, Paul. Do you have any updates on Health Canada and BioCloud?

Yes, everyone's favorite technology, mine too. So look, let's be honest about where we are in the market. You know, the pandemic's over. You know, governments are not investing in PPE. The vaccines won the race. And the way we look at the technology is, you know, BioWater is an extension. We think the opportunity for BioWater, in a sense, is stronger because it's an overall pandemic preparedness technology. It's not specific to COVID. And so I think, unfortunately, COVID's gone away. Unfortunately, the government never made a big investment. Vaccines won the race, and we're focused on the controlled bio water as the next stage of development. We will be receiving our patents shortly, and so I think we've created value in the technology, and we'll see where we can take bio water as a future pandemic preparedness technology. Thank you.

Thank you. The next question is from HD. Please ask your question.

Hey, Paul. So a question regarding the global. Can global be brought back into the product mix, let's say, one, two, three, or four years down the line when the conditions are favorable?

So thank you for the question. So Global, by being assigned to bankruptcy, is no longer technically owned by Control. And as we discussed, the choice there was to fund operating losses in a very difficult environment. I mean, if you look around at other companies in Canada, they're in the microcap space. Some of them that are funding significant losses have raised $50, $60, $70, $80 million, and they're funding their losses. Others have less. But the choice for us was fairly simple. Continue to fund losses and raise equity to fund losses or end the losses and focus on the most profitable aspects of the business. And so once something is assigned into bankruptcy, it's no longer owned by the company, which creates that funny accounting treatment from Q4 to Q1. I would say our service business is very profitable and we're focused on growing our service revenues. And in our service business, we could pass on inflation almost to the point of 100% to the customer. And we've had some interesting growth in the service business, and we really want to focus on that. So while the revenues will be lower, the margins will be higher. And to my earlier point, the most important thing any operator can do in this environment is be self-sustaining, generate your earnings, and it's not growth at any price in this market. So hopefully that addresses your question.

Sounds good. Thanks for that. Thank you.

Thank you.

Thank you.

Once again, that is star one, should you wish to ask a question. And the next one is from Jeff LeFleur from Highwood Capital. Please ask your question.

Hi, Paul. Quick question. Can you maybe talk about just the landscape for acquisitions relative to possibly funding and fueling internal innovation and growth?

Thanks for the question. It's a really good question, especially in this market. I would say we always have two or three acquisitions on the go in various stages of, let's say, due diligence or readiness. What's interesting is there's really been no change in vendor expectations relative to what's happening in the market. I'm going to use a bad analogy. In the real estate market, what I'm hearing is the market's a little frozen between sellers and buyers. So sellers still want last year's price and buyers want a different price. So I would say in the context of any acquisition, we are scrubbing for valuation in a slightly different way and looking at it from a cost of capital and spread. And what I mean by that is if your cost of capital is from $2 to $8 or $10, and you're trying to generate 15 to 20, well, your spread has been diminished substantially, and where should that show up in the acquisition price? So that's one aspect. The other aspect is we've got some very interesting organic growth opportunities with some substantial companies. Is a dollar of capital better invested in those opportunities to drive organic growth versus an acquisition? And I think we're looking at that choice very carefully, very closely. So there's numerous opportunities out there for us, and we want to be careful about that choice. We are excited about the organic growth, and organic growth is always the best kind of growth that you can deliver as a business. So we are keenly focused on that in this environment. So hopefully that addresses your question. Thank you.

Once again, please press Store 1 should you wish to ask a question.

So I do have a question on the web. I think I answered this, but the question came in anyway. When will financial statements in MD&AB be filed? So again, there's no special day about Friday, except this is the last day of the month and the last day of the audit. Typically, we would like to be 24 hours in advance of the last day. So in a perfect world, we would have been completed yesterday. This audit took a little longer, certainly because of the global issues. And so everything will be filed tonight, hopefully in the next hour or so. And again, it's the last day of the month, the last day of the audit. We wish we could have been completed yesterday, but it took a little longer. So everything will be filed very shortly. Thank you for the question. So I think we've addressed all the questions. I wonder if there's no other questions, we should move to a closing remarks operator.

No further questions on the phone line, sir.

All right, so thank you, everyone, for joining the call. We appreciate you spending time with us, and we look forward to continuing to build the business of control as we move past 2022 and focus on a profitable 2023 with organic growth initiatives, development of technology, and putting the business on the right track for a successful year. So thank you very much. If you'd like to connect with the company, info at controlcorp.com is our corporate email. Thank you again and have a good weekend.

That does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.