Covalon Technologies Ltd.

Good morning, ladies and gentlemen, and welcome to Covalent's Fiscal 2021 Second Quarter Financial Results Conference Call. My name is Anas, and I'll be your conference operator today. As a reminder, today's conference is being recruited. All lines have been placed on mute to prevent any background noise. At this time, I would like to join the conference server to Mr. Brian Pedler, Chief Executive Officer, and Mr. Danny Bradigan, Chief Financial Officer. Please go ahead, Mr. Pedler and Mr. Brannigan.

Thank you. My name is Danny Brannigan, and as Kovalon'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 Kovalon's second quarter and six months ended March 31, 2021. 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 Kovalon'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 Kovalon in its public securities filings, actual events may differ materially from current expectations. Kovalon 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, Kovalon 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 meaning 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 quarter ended March 31, 2021, Covalent's total revenue was $6.7 million with a net income of approximately $0.4 million or $0.02 per share. This compares to the prior year's second quarter which saw a total revenue of $5.3 million and a net loss of approximately $4 million or $0.15 per share. The overall gross margin was 54% in this quarter compared to 53% in the prior year's second quarter. Operating expenses decreased by approximately $3.4 million or 52% for the second quarter of fiscal 2021 to $3.1 million compared to $6.5 million for the same period of the prior year. For the six-month period ended March 31st, 2021, Covalent's total revenue was $12.7 million with a net income of approximately $50,000 or zero cents per share. This compares to the prior year's comparable period which saw a total revenue of $13.2 million and a net loss of approximately $5 million or $0.20 per share. The overall gross margin was 57% in this quarter compared to 58% in the prior year's six months ended March. Operating expenses decreased by approximately $5.3 million or 43% for the six months ended March 2021 to $7 million compared to $12.3 million for the same period of the prior year. Consistent with prior periods, the company is supplying more information to provide supplemental context for the gross margin and for the earnings figures to help compare these items to other periods, but these should not be used in place of IFRS measures. The adjusted gross margin for the second quarter of fiscal 2021 was 55% compared to 59% in fiscal 2020. The adjusted gross margin for the six months ended March 31st, 2021 was 58% compared to 63% in the prior period. These changes are largely driven by product and revenue mix in a given period. The adjusted EBITDA for Q2 was a loss of approximately $141,000 compared to a loss of $1.5 million in the same period of the prior year. The adjusted gross margin for the six months ended March 31st, 2021 was with a loss of approximately $276,000 compared to a loss of $1.5 million in the prior year. The adjusted EBITDA removes the impact of government subsidies and other non-cash expenses as outlined in the MD&A. Overall revenue for Q2 of fiscal 2021 increased 28% to $6.7 million compared to $5.3 million due primarily to an increase in collagen sales as well as an increase in shipments to the Middle East. Product revenue increased 38% to $6.4 million compared to $4.6 million in the prior year. Development revenue decreased to $0.3 million compared to $0.6 million in the prior year's second quarter. Overall revenue for the six months ended March 31st, 2021 decreased 4% to $12.7 million compared to $13.2 million in the prior year. Revenue from development work was down approximately half of a million dollars from the prior year and licensing revenue increased approximately $40,000. In the second quarter of fiscal 2021, the company had approximately 77% of revenue in the United States and the remaining revenue was approximately split between Middle East and the rest of the world. Operational expenses decreased in the second quarter to $3.1 million compared to $6.5 million for the prior year's second quarter due to a reduction in headcount and discretionary spending across all departments. Main drivers of the decrease were reductions in compensation, travel, and administrative expenses. The company also recorded $1 million of government subsidies that were netted out against the related expenses. For the six months ended March 31st, 2021, the operating expenses decreased 43% to $7 million in the current year compared to $12.3 million in the prior year. This reduction was also driven by the reduction across all departments in compensation, travel, and administrative expenses. The company also recorded approximately $1.3 million of government subsidies that were netted out against their related expenses. I would now like to turn the call over to Kovalan's CEO, Brian Pedlett.

Thanks, Danny, for the review of our Q2 results for fiscal 2021. Good morning, fellow investors. Thanks for joining Danny and I on this call. Our second quarter of fiscal 2021, which ended on March 31st, demonstrated continued sequential quarter-over-quarter improvement in our operations and our financial performance. And we continue to deal with the effects of COVID-19 on our business. As Danny discussed, our revenue increased this past quarter about 28% compared to last year, and also increased compared to last quarter, which ended December 31st. We were profitable this past quarter, and we continued to diligently manage our operating expenses. Our continued cost management initiatives contributed to a 52% reduction in operating costs compared to the same period last year. We achieved these results while continuing to manage COVID-19 related impacts, such as temporary delays and shipments of some of our calls and products in the United States, and the lower consumption of some of our products by hospitals due to delays in elective procedures. We've talked about this on a number of the past calls as well. COVID-19 is still affecting our customer base and some of our suppliers. But our team at Kovalon continues to work very hard to overcome the challenges facing us, and the improvement we saw this past quarter is really a result of that hard work. Kovalon, at its heart, is an infection prevention company that was founded on the strength of our lab and the team over the years, and we have developed patented technology platforms that we have leveraged to create highly competitive products and services to help protect patients from getting infections and help heal their wounds. Now, we leverage our patented medical technology platforms and expertise in two ways, by developing products that are sold under Covalon's name and by developing and commercializing medical products for other medical companies under development and license contracts. In the United States, Latin America, the Middle East, and Europe, we generate revenue by selling our products through over 30 established medical product distribution networks. Our collagen business in the United States is stronger than it's ever been. Revenue from our collagen products was largely responsible for our growth in product revenue this quarter. Increases in orders placed by our distribution customers in the United States have provided us with strong visibility into forecasted demand over the next 12 months. In the United States, we also have our own sales team that sells our infection prevention products into hospitals. Our AquaGuard product dominates its market category and has become a key brand recognized by clinicians in our hospital customer base throughout the US. In response to the challenges that we faced in engaging with hospitals during COVID-19, we launched three new products. during the second half of fiscal 2020 into our U.S. hospital and clinical customer base. I'm happy to report that our sales team in the U.S. is experiencing strong engagement from the clinicians that are evaluating our products despite the continued lockdown restrictions in hospitals in certain states. That's easing now a little bit, which is positive. And we're leveraging our strong reputation with clinicians for protecting patients and solving clinical problems at the bedside to engage with them on our new products. I'm pleased with the level of sales activity we've generated in such a short time with our new products, particularly in the difficult circumstances where a team has to change their approach from all face-to-face to using virtual and online tools. So I see a strong potential for these products in our US hospital customer base over time, and I anticipate that they will contribute to revenue. Now, we also develop antimicrobial products for other medical companies using our patented medical device coding technology. This quarter, we engaged with approximately 10 medical coding customer development projects of various sizes with three different companies, and we have a strong pipeline of new customer development projects. We are excited about the future potential of these new projects as well as the various projects currently underway with the previously announced major contract with one of the world's largest medical device companies. At the same time, the Covalent team is working very hard to continue to control operating expenses while working closely with our customers in the United States on the new products we launched in 2020 and in supporting the growth of our collagen products and accelerating our pipeline of medical coding projects. Now, as we have previously discussed on calls and announced in press releases, in response to expressions of interest made by medical industry and private equity organizations, Kovalon's board of directors formed a special committee and hired advisors to assist in undertaking a strategic review process to ensure that all available strategic alternatives to enhance value for our shareholders are being evaluated. Over the past several months, the Special Committee has been carefully evaluating a number of interesting expressions of interest and assessing the impact of these potential strategic alternatives on the overall value, future profitability, and growth prospects of Koblon. Each strategic alternative is being evaluated and assessed as to its impact on current and long-term shareholder value. The goals of the strategic process are to help us improve our capital structure and to evaluate where to focus our growth efforts going forward. We have received several expressions of interest for each of our technology platforms, and this process has clearly validated that Kobalon owns a number of valuable medical technologies that are of interest to the medical industry. No matter which path the strategic process takes, we will update our shareholders on the outcome of the process when it's complete. Now, while this process has been underway, our team has continued to remain focused on executing on our growth strategy, promoting our life-saving products to the medical industry and providing meaningful growth opportunities for all of our staff. To that end, Kovalon is in a stronger position operationally and financially today than we were last year at this time. As we look forward, there's definitely light at the end of the tunnel, and I actually feel very good about the position we are in. Not everything is perfect. We are profitable this past quarter, and I fully expect us to continue to be profitable this year. Again, our team is working very hard Unfortunately, we're not able to control every aspect that has an influence on our business, but I believe the growth of our business will continue and will continue with the positive progress that we've made to date. I'm very confident in the fundamental improvements we've made to Kovalon over the past year and the strong progress through these first six months. I would now like to open the line for questions. I ask that you keep to one question at a time, and there will be lots of time to get back into the queue to ask more. Thanks, and over to you, Anas, to commence the Q&A.

Thank you. We will now open the floor for questions. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you'd like to withdraw your question, please press star, then the number two. One moment for your first question. First question comes from Howard Petroak, investor. Howard, please go ahead.

Thank you. It's good to see the turnaround in results and a bit of profit in the company. I just wondered when you expect the strategic review to be completed. Also, could you clarify the statement that the company is significantly undervalued? Is that by 10%, 20%, 100%, 200%? I'd appreciate if you could sort of clarify. Thanks a lot.

Howard, those are good questions, and I appreciate you asking them. The process is hard to predict exactly when it will end. As I talked about, there's a number of expressions of interest, and I think the special committee of the board has done an extremely good job and been very diligent in assessing all of those. It just takes longer than we anticipate. I don't want to attempt to predict when that might be completed. As I said, we will continue to update and certainly update the outcome of that process to investors. It's not the kind of thing that we would simply leave and not provide closure for our investors to understand the outcomes. So stay tuned is all I can say at this point and we'll see how it progresses. It's always a tricky question, Howard, and what's the fair value of a company? Obviously, through this process, we've had a lot of experts looking at Covalon, both advisors that the company has engaged, but also outside organizations that have found interest in the platforms of technology that Covalon has, and we As I mentioned, we've got lots of multiple expressions of interest virtually on each platform. So when you start to take a look at the value of each asset within the company, I think we've made a pretty strong statement in saying that the board and the major shareholders – all believe the company is significantly undervalued from where its shares are trading, and recognizing that our stock is relatively thinly traded. So, again, I don't want to, you know, provide a range of what significant means, but I can tell you, you know, when you compare to other companies, I think you would find that Colon – has a lot of unrecognized value that has yet to be displayed in our share price. I appreciate the questions, Howard.

Thank you. Ladies and gentlemen, as a reminder, should you have any questions, please press star 1. It appears there are no further questions at this time. Mr. Pedler, you may proceed.

Great. Thanks, Anas. Look, I truly believe that we're faced right now with certainly challenges in the market, but also we've made a lot of progress. That lot of progress has been a lot of hard work by the Kovalon team, and I'd like to extend a thank you to all of those, all of our staff in every location around the world where I know they're working very diligently to help make us a better company. I think we've had some strong progress, as I mentioned. I expect that that progress will continue, and we will continue to be profitable through fiscal 2021. And I know the hard work will continue with the staff and the board. And I truly believe that the unrecognized value that that we just spoke about will be realized at some point, and I believe that there is a very strong upside for Kovalon, and I appreciate you attending our call. Thank you, and I look forward to updating you on our next discussion.

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