Covalon Technologies Ltd.

Good morning ladies and gentlemen and welcome to Covalent's fiscal 2021 Q3 financial results conference call. My name is Sylvie and I will be your conference operator today. As a reminder, today's conference is being recorded. Note that all participant lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then number one on your telephone keypad And if you would like to withdraw your question, you will need to press star followed by two. At this time, I would like to turn the conference over to Brian Pedlar, President and Chief Executive Officer, and Mr. Danny Branigan, Chief Financial Officer. Please go ahead, gentlemen.

Thank you, Sylvie. My name is Danny Branigan, and as Covalent'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 third quarter and nine months ended June 30th, 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 risk, 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. Covalent 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, Covalent has provided non-IFRS measures that are meant to provide further understanding of our results by helping to highlight trends and 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 June 30th, 2021, Covalent's total revenue was $8.8 million with a net income of approximately $1 million or $0.04 per share. This compares to the prior year's third quarter, which saw a total revenue of $6.7 million and a net income of approximately $300,000 or $0.01 per share. The overall gross margin was 58% in this quarter compared to 46% in the prior year's third quarter. For the period ended June 30, 2021, Covalent's total revenue was $21.5 million with a net income of approximately $1.1 million or $0.04 per share. This compares to the prior year's comparable period which saw a total revenue of $19.9 million and a net loss of approximately $4.8 million or $0.18 per share. The overall gross margin was 57% and this compares to 54% in the prior year's nine months ended June 30th. Consistent with the 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 third quarter of 2021 was 60% compared to 50% in 2020. These changes are largely driven by the product mix and revenue mix in a given period. The adjusted gross margin for the nine months ended June 30th, 2021 was 59% and consistent with the prior period. The adjusted EBITDA for Q3 was a profit of approximately $1.4 million compared to a loss of $500,000 in the same period of the prior year. The adjusted EBITDA for the nine months ended June 30th was a profit of approximately $1.3 million compared to a loss of $2 million in the prior year. This adjusted EBITDA removed the impact of transaction costs, government subsidies and other non-cash expenses as outlined in the MD&A. Overall revenue for Q3 in fiscal 2021 increased 32% to $8.8 million compared to $6.7 million in the prior year. Product revenue increased 33% to $8.5 million compared to $6.4 million due primarily to an increase in collagen sales. Development revenue increased to $0.3 million compared to $0.2 million in the prior year's third quarter. Overall revenue for the nine months ended June 30th increased 8% to $21.5 million compared to $19.9 million in the prior year. Revenue from development work was down approximately $400,000 from the prior year and licensing revenue was consistent. In the third quarter of fiscal 2021, the company had approximately 78% of revenue in the United States and the remaining revenue was approximately split between Middle East and the rest of the world. Operational expenses increased in the third quarter to $3.9 million compared to $2.5 million for the prior year's third quarter. The prior year's third quarter had $1.8 million of government subsidies netted out against operating expenses, and the current quarter had approximately $0.6 million. After factoring in subsidies, the year-over-year increase was approximately $200,000. For the nine months ended June 30th, The operating expenses decreased 27%, or $4 million, to $10.9 million in the current year compared to $14.8 in the prior year. This reduction was driven by the reduction across all departments in compensation, travel, and administrative expenses. The company recorded approximately $1.9 million of government subsidies and netted out these subsidies to the related expenses. In the prior year, this amount was $1.8 million. On July 29th, 2021, the company announced the sale of its AquaGuard product line to Tidy, an arm's-length party, for approximately $38 million. The sale represents a gain of approximately $20 million over the purchase price paid by Covalon for the AquaGuard business approximately three years ago. Covalon has paid out the acquisition note and all outstanding bank debt and terminated the facilities with HSBC Bank Canada. $2 million U.S., was placed in escrow for indemnity claims, which is set to be released with 50% in 12 months and the remaining amount after 14 months. The acquisition note was settled with a cash payment of $4 million and 200,000 warrants with an exercise price of $4 in a period of five years. The sale was completed via a share purchase agreement that included certain trademarks, intellectual property, related customer contracts, and manufacturing assets to support the AquaGuard business. I would now like to turn the call over to Kovalon CEO, Brian Pedler.

Thanks, Danny, for the review of our Q3 results for fiscal 2021. Good morning, fellow investors. Thank you for joining Danny and I this morning on this call. I am truly delighted to report that our third quarter ended June 30th was a strong quarter. with 32% year-over-year revenue growth and over $1 million in net income, which I think signals a very successful turnaround. With the recently completed sale of our AquaGuard product line, we are now debt-free. We have over $24 million of cash on our balance sheet. And I think it's important to realize that our cash balance represents approximately $0.93 per share. We are positioned extremely well to further accelerate the growth of our biological collagen and our antimicrobial products that have been contributing to our revenue growth this fiscal year. Our core business of collagen and antimicrobial silicone adhesive dressings continues to experience growth in the United States and internationally. We are seeing increases in orders placed by our distribution partners, and we have more visibility into forecasted orders over the next 12 months than we have in any point in our history. Now, I just want to remind investors that Kovalon, 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, which we have leveraged to create highly competitive products and services that help protect patients from getting infections and help heal wounds. We leverage those patented medical technology platforms and our expertise in two ways. We develop products that are sold under our name, and we develop and commercialize 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. We also develop antimicrobial products, as I mentioned, for other medical companies using our patented medical device coding technology. We continue to engage in medical coding customer development projects of various sizes with a growing customer base of medical product companies. We have a strong pipeline of new customer development projects. I'm very excited about the future revenue 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. Covalon, I believe, is truly a different company today than we were a few short months ago. We have a significantly improved balance sheet. We have posted strong earnings year-to-date, and we have many more levers at our disposal to fuel our further growth. We sold Aquaguard. It was a non-core product line supported by very little intellectual property, and we sold it for about $38 million. We still have our three platform technologies, our biological collagen, our antimicrobial silicone technology, and our medical coatings, which are supported by very strong patents and intellectual property. And these platforms address issues in massive markets such as chronic wounds related to diabetes, such as protecting patients from infection when they have an IV or other catheter, and helping them to heal from surgical procedures. These technology platforms and the products that we have developed from them are recognized by major medical companies as being very valuable technologies and products. We have secured strong distribution relationships in the United States, some of the largest wound care and medical products companies, and we've established a growing presence in international markets such as Latin America and the Middle East. Our distribution networks have engaged with Covalon because our products are good, and their customers, those are clinicians and patients alike, benefit from using our products over the competition. Our products truly work. Now, I want to make it clear that the value of these highly advanced technology platforms have yet, in my opinion, to be fully reflected in the value of Kovalon. I believe that each of these platforms has much more value individually than our non-core Aquaguard product line that we sold for $38 million. By combining the value of our $24 million of cash, our clean balance sheet, and the potential of our three highly sought-after product and technology platforms. It is clear to me that Covalon will generate significantly more value for our shareholders over the coming quarters. While we no doubt will face challenges in the future, and not everything is in our control, I can say for certainty that our team at Covalon is working harder than ever to grow our business and continue the positive progress we have made to date. To that end, I'm very proud of our team's efforts over the past 18 months to steer us clear of COVID-19 challenges that we've faced, and I'm very proud of the team's contributions to our successful turnaround. The Kovalon team continues to work very hard to control our operating expenses while working closely with our customers on the new products we've launched and new products we've yet to launch. Also working very hard to support the growth of our products, both in the United States and internationally. And finally, also working very, very hard to accelerate our pipeline of medical coding projects. 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. I'll turn it over to you, Sylvie.

Thank you, sir. Ladies and gentlemen, if you do have a question, please press star followed by one on your touchtone phone. You will then hear a three-tone prompt acknowledging your request. And if you would like to withdraw your question, simply press star followed by two. And if you're using a speakerphone, we do ask that you please lift the handset before pressing any keys. Please go ahead and press star one now if you have any questions. And your first question will be from Arnold Chell, private investor. Please go ahead.

Yeah, thanks. Is the strategic committee on the board still intact and active, and are there other potential deals under consideration?

Thanks, Arnold. The committee decided, I think, to deal with most of the further expressions of interest that we have at the board level, so those discussions are are continuing. There was a lot of interest in our business and a lot of interest in each one of our platforms of technology. The board, in considering all the various options, really felt that the AquaGuard transaction was the one that positioned us the best, a divestiture of a non-core product line with very little IP to support it. and retaining our deep intellectual property and patented platforms. So those discussions continue, but I suspect going forward they will be largely dealt with at the board level and not necessarily through a separate strategic committee.

Okay, thank you.

Thanks, Earl.

Thank you. Next question will be from Sal Duterte. Please go ahead, Sal.

Hey, good morning. I just had the same exact question that you had prior to this one. So I thank you for the answer, and I also find the third quarter a very encouraging quarter. Thanks a lot, guys.

Thanks, Sal. You know, obviously Danny and I both share that sentiment that it's very encouraging. I think we've made great progress. Still a lot of work to do, so we're not slowing down. But thanks very much, Sal.

Okay, thank you. Thank you. Next question will be from Dave Kegler. Please go ahead, Dave.

Good morning, Brian. Just a follow-up question. Just wondering if you could comment on the expressions of interest you had on all the other product lines. And if you could add all those up, just wondering what you'd end up selling the company for, I guess, in terms of either a Marvel cap or a per share basis, because I know that you said you had multiple expressions of interest. So I just wanted to be able to share something like that.

Yeah, thanks for the question, Dave. Look, there was an awful – I know shareholders were being very patient with the process, and we really took our time to evaluate each one of the expressions of interest that were made. There was an awful lot of interest in Kovalon, I can tell you that, from the – all different kinds of medical companies and private equity. And so when we take a look at all of those expressions of interest, it took a long time to go through to evaluate the impact on Covalon and where those would position us. But going through that process, there's no question, and I think I made that comment in my remarks, that when you sort of take a look at the value of obviously the AquaGuard product line that, as I said, was a non-core, low IP product line that we sold for $38 million. And I made the comment that I believe each one of our platforms is significantly more valuable by itself than that. So you start to add that up, you add up the fact that we have some seriously strong distribution channels, and we have $24 million of cash, and you could easily see the value of Covalon massively exceeding where we are today. When you add all those up, look, you know, valuing companies is difficult. When you look at some companies out there that are called peer companies of us, Many of them have no revenue and they're hundreds of millions of dollars in valuation before you start to look at their balance sheet and their cash positions. You look at Kovalon and I think we're on the other end of that spectrum right now. So I easily see us multiplying the value we got from the AquaGuard transaction by our remaining platforms. or more, and adding our cash together, and you're into hundreds of millions of dollars of value of potential in Kovalon. So when you look at what we are capable of, the technology that we have, and I obviously can't speak to each individual expression of interest that we had, but I can tell you that The special committee had its work cut out for us in evaluating the options for us as a company. But there's no question in my mind, and I don't want to speak for the rest of the board, but I know that those who really have taken a good hard look at Covalent see the same thing. Tremendous upside value with us as a company. Dave, I hope I answered your question correctly.

In a roundabout way, thank you.

Yeah, thanks, Dave.

Thank you. Next question will be from Paul Lucif. Please go ahead, Paul.

Hi, Brian. I was curious what the Covalon sales force looks like after the asset sale, what the U.S. sales force looks like. I know that was a major reason for acquiring AquaGarden. I wonder what we have now.

Yeah, good question, Paul. So just to be clear, the Aquaguard sale was the sale of the product line. And so we retained all the operations that we took on as part of the original transaction and the sales force. And obviously, we're looking at ways to continue continue to build and market and sell our products into the United States, and we'll continue to do that. So the sales team from what was historically the AquaGuard acquisition stayed with Kobalon. Obviously, we've changed and adjusted and altered that team over time in the three years. But, you know, that group, the operations retained, you know, stayed with Kobalon as part of that transaction. So, you know, going forward, I see lots of opportunity for us to be really smart and in how we deploy our resources to help grow our business. We still have a strong presence in the United States. We still have strong revenue streams and strong distribution relationships that we'll continue to grow and foster over time. So I think we ended up with the best of both worlds out of that transaction.

Great. And do you think last quarter will be representative of the margin profile? And I know sales are always lumpy, but do you think we can continue profitability?

Yeah, I think absolutely. I mean, you look at there's a transition associated with the Aquaguard transaction. You know, we sold the product and, you know, we have to hand the baton off to Tidy and in an orderly manner to make sure that things continue. And so that's going on as we speak and going quite well. And so following our obligations with that transition, our focus is solely on our go-forward business and our three platforms of technology and our huge portfolio of products. So that is underway and going quite well. Thank you.

Thank you. Next question will be from Howard Petrick. Please go ahead, Howard.

Yes, good morning. I just want to ask if anybody else is... If any analysts are looking at the company now that it's turned into a profit situation and with a strong balance sheet, are you making efforts to get analysts to write a report on this company? Because despite the optimism... Unfortunately, the market doesn't seem to recognize the value that Covalon has. And the other sort of question is, have you done any projections for the forthcoming one or two years? And if so, are you able to give an estimate of where sales and profitability will be?

Howard, thanks for the questions. Look, I think... We have turned a lot of heads, not only within our industry, but also in the markets, in the capital markets, with where we are today. There are very few, if any, companies I can point to with the depth of technology, the product portfolio, the markets that we are in and we address. and the distribution relationships and presence that we have in the market, along with a clean balance sheet and the cash that we now have on that balance sheet. So I think a lot of people are beginning to take notice. It takes time, so none of these things happen overnight, but I think since Since the transaction, I consider it a truly good turnaround in both our operations and our balance sheet. As I look at where we are, I know there's lots of interest. I expect over time that we'll be able to foster and grow that interest with the the analyst community. I think there's a lot here to follow. So I do expect that we will gain that. As far as forecasts, we are not in a position today, unfortunately, Howard, to provide guidance going forward. That's always a difficult thing and requires a lot of thought and consideration by a board. But, you know, we have done a lot of planning we have a really solid plan going forward and I'm really excited about it so I see the opportunity for us you know as time unfolds to to talk a little bit more about where we're going the you know from revenue projections but today we're not in a position to do that so thanks for the question thank you as a reminder ladies and gentlemen if you would like to ask a question

please press star followed by one on your touchtone phone. Next is a question from Arnold Schell. Please go ahead.

Yeah, on the deal that you have with the major deal with the medical device company, what is the schedule of future payments to come in?

Good question, Arnold. So we announced that in 2018, right? they paid $3.5 million U.S. up front in a license fee, and then there were a further $5 million in milestones as we approached getting their product through the FDA and in the market as first commercial sale. So that That will unfold, and we've been working on the development with that partner, so they've been paying us development fees. Those milestones will be paid to us upon completion of those events, and our royalties will continue for each and every product manufactured and sold into the market. So very, very lucrative upside for Kolon under that contract. And it's a multi-product arrangement. So there are seven different products that were part of that original license. And I can tell you our team has not sat still with that particular customer nor others in engaging with other opportunities. because we do have a large portfolio of technology that is very suited to helping companies like that particular extremely large medical device company to round out their portfolio of antimicrobial products and make them much more competitive in their markets, leaning on our technology. So a really strong opportunity, and that's only one of many. So I'm really excited about that, and I think we're approaching some of those critical points where I think that part of our business will start to contribute heavily to our operating results in a positive way. Thanks for that question, Arnold.

Thank you. And at this time, gentlemen, we have no further questions. Please proceed.

Okay. Thanks, Sylvie. Again, I just want to reiterate that I'm really proud of our team and their ability to pull us through the challenges that we have faced during the last 18 months or so with COVID. I'm really confident that the fundamental improvements that we have made to our company over this past year and the progress that we have to date will continue. And I am truly excited about the the position we find ourselves in today. I think there's an extremely significant unrealized value for Covalent shareholders, and I believe that we have a really solid plan in place to unlock that over time. I want to assure you that the hard work continues. We are not slowing down in any way, shape, or form. And Danny and I both look forward to discussing progress on our next call with you. Thank you very much for joining us this morning.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.