Covalon Technologies Ltd.

Good morning, ladies and gentlemen, and welcome to the Kovalon's Q1 fiscal 2022 conference call and webcast. My name is Kelsey, and I will be your conference operator today. As a reminder, today's conference call is being recorded. All lines have been placed on mute to prevent any background noise. And after the speaker's remarks, there will be a question and answer session. If you'd like to ask a question during this time, simply press start, then the number one on your telephone keypad. If you'd like to withdraw your question, please press the star followed by the two. Alternately, you can submit type questions via the webcast. At this time, I would like to turn the conference call over to Mr. Brian Pedler, President and Chief Executive Officer, and Mr. Jason Gorel, Interim Chief Financial Officer. Please go ahead, Mr. Pedler and Mr. Gorel.

Thank you. Thank you, Kelsey.

Oh, sorry.

Emily?

Yes, sorry. Good morning, everyone. My name is Emily Hill. I'm the Executive Assistant to Kovalan's Chief Executive Officer. I'd like to thank everyone for taking the time this morning to attend our conference call. We will be discussing our financial statements, MD&A, and press release related to Kovalan's first quarter ended December 31st, 2021. There will be an opportunity for you to ask questions at the end of our call. So before we begin the discussion, I'd like to remind participants that this call is covered by COPLON's Safe Harbor Statement. Certain statements included on this call may be considered forward-looking. Such statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results 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 call. Due to risks and uncertainties, including those identified by Kovalon in our public securities filing, 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's 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. I will now turn the call over to Brian Pedler, Covalent's President and Chief Executive Officer.

Thanks, Emily. Good morning, fellow investors. Thank you for joining Jason, Emily, and me on this call. I'll walk through the quarterly numbers and provide some context, as well as talk about some of our growth objectives underway in 2022 and beyond. Then both Jason and I will take your questions. either through the phone line, if that's how you're listening in, or via the message function on the webcast. So there's three key metrics that I want to draw your attention to this quarter. I'm very pleased to report that revenue for the first quarter of fiscal 2022 increased 90% to $4.9 million. The second metric is that we achieved positive operating cash flow of about $540,000 for the quarter. And finally, we finished the quarter with $25 million of cash on our balance sheet. Now, these three metrics indicate we are a much stronger and improved company today, both financially and operationally, than we were last year at this time. During the quarter, we successfully completed the transaction of our discontinued Aquaguard business, which was sold on July 28, 2021. and required us to transition operations and customers to the purchaser. This transition was completed during the quarter, and as a result, our operating costs and profitability were affected by the transition. Operating costs from continued operations were $3.4 million for the quarter, ended December 31, 2021, and as we anticipated, included additional costs associated with the transition. Due to this being a transition quarter, we reported a loss of $1.5 million or $0.06 per share, which includes the discontinued operations related to the Aquaguard product line. Our adjusted EBITDA from continuing operations improved about $600,000 to a loss of $200,000 compared to last year's first quarter. Adjusted EBITDA removes government funding from the previous year and removes inventory provisions of approximately $700,000 from Q1 in 2022. Revenue in the quarter was, as I said, $4.9 million compared to revenue of $2.6 million in the prior year. Our 90% increase in revenue for the three months ended December 31, 2021 increased about $2.3 million. And this was really driven by our product sales in the United States. Product revenue itself increased about 125% in the quarter to $4.5 million compared to the $2 million in the previous year. Now, this increase in product revenue occurred in the United States, where we sell our collagen wound dressings through a distributor network and also our infection prevention products to hospitals and other facilities. Product revenue in the U.S. was up about $2.6 million, in part due to increased orders from our wound care distributors during the quarter and due to recovery from the prior year in our supply chain, which was negatively affected by delays in shipments of our collagen products. The delay in shipments in collagen really were driven by mostly COVID-19 related issues at a contract manufacturer, and that temporarily delayed production and shipments. Our international revenue was relatively flat compared to the prior year, but I can say that I'm confident that we will see improved revenue internationally over the coming quarters. Looking at gross profit, which was $2.3 million, and that compares to the prior period of $1.3 million. As a percentage, gross margin was 46% for Q1 compared to 51% in the prior year. Included in those costs of sales in the current quarter are inventory provisions totaling, as I mentioned, about $700,000. The gross margin is significantly influenced by source of revenue and by the relative mix of products sold in any given financial period. We provide an adjusted gross margin figure, which excludes inventory provisions and depreciation. And if we look at that in this particular quarter, Q1 of 2022, our adjusted gross margin was about 62%. And that compares to about 55% for the prior year. Again, that is driven... largely by product mix or increased sales into the U.S. Turning to operating expenses, operating expenses for the quarter were $3.4 million compared to $2.3 million in the prior year's period. When we exclude the impact of government subsidies, which were about $300,000 on the prior period, operating expenses for continuing operations increased about $800,000. As we sort of break that down, approximately 500,000 of that relates to sales, marketing, operations, and administrative staff that previously were solely dedicated to the discontinued Aquaguard business that we redeployed to continuing operations. This was in line with our commitment to invest in sales and marketing resources to help drive our future growth. The remaining increase of about $300,000 was due to increased facility and other expenses. Net loss for continuing operations was $1.1 million or $0.04 per share compared to a net loss of $1 million or $0.03 per share in Q1 fiscal 2021. When we look at our adjusted EBITDA, I think we were within $200,000 of a break-even during this transition quarter. So when we look at our platforms, and in particular at our collagen and wound care platforms, I'd say we're positioned extremely well to further accelerate our growth of our biological collagen that has been contributing to revenue this past fiscal year in fiscal 2021. Our core business of collagen dressings continues to experience growth in the United States and internationally. The United States has been a strong market for us. The growth path is not always linear, and it can fluctuate from quarter to quarter, but I foresee this continuing as a growth driver going forward. Internationally, we have won additional competitive contracts, and we are seeing increases in orders placed by our distribution partners, which gives us more visibility into forecasted orders over the next 12 months. We also launched a collagen powder product that is seeing some strong acceptance by clinicians in the U.S. and we are anticipating our collagen powder to contribute to revenue this year. Our second platform technology is our antimicrobial silicone adhesive technology, in that we have leveraged to create a family of vascular access and surgical dressings that protect patients from infection. Following the divestiture of our AquaGuard product line, we have refocused our US sales efforts on aside from collagen, on IVClear and their new ValGuard product that protects vascular access lines from external contamination. Both IVClear and ValGuard are used in acute care facilities and also for outpatients as well. We have established a very loyal base of customers in the United States, in United States hospitals and alternative care clinics and are seeing rapidly growing interest in our products. The timing couldn't be better for us to have two strong products to help reduce the risk of bloodstream infections in ICUs. Recent data has been referenced by the CDC that reports the instances of bloodstream infections have risen a shocking 67% while patients are in a hospital ICU undergoing various treatments. Both ValGuard and IVClear solve serious problems that the market-leading products, which are used in most ICUs, cannot. As clinicians recognize the benefits of our products over what they are currently using, we are growing our customer base even in facilities that are contracted with competitors of ours, such as 3M. We now have a customer base of facilities buying IvyClear or Valgard, and our sales leads continue to grow in the U.S. as awareness of our products and their clinical benefits spreads. Our SurgiClear product has been successful. strong success in helping cardiac surgeons reduce infections in pediatric and adult patients recovering from cardiac surgeries. We see this as a growth opportunity for us in 2022, but more so 2023 as we penetrate more hospitals in the U.S. Growth in the Middle East in our fiscal 2021 was driven largely by increased IV clear sales And we have secured additional competitive contracts for deliveries in 2022 and 2023, which will begin to ship later this year. And our final platform technology is our medical coding platform. We have a very strong reputation within the medical device industry as leaders in antimicrobial technology. As a result, many large medical device companies work with us on various size projects to help them develop develop versions of their existing products that can kill bacteria, and they do that by hiring us to apply our patented medical coding to their medical device. We are about 24 months away from seeing royalties and other revenue streams from the large development contract we announced in 2018. To unlock these growth opportunities, we will continue to invest in sales and marketing resources to drive our revenue growth, expand our current distribution partners, partnerships with our key distribution partners that can help us penetrate and grow meaningful markets. And we'll opportunistically look at ways to further accelerate our growth through acquisition. I'm very proud of our team's efforts over the past 18 months to really steer us clear of COVID-19 challenges. and the contributions that our team has made to our successful turnaround, including the sale of our AquaGuard product line. I would like to thank every member of the Covalent team for their dedication and hard work this past year. 2021 was a successful year because our team adapted, worked unbelievable hours, and accomplished an incredible amount over the year. This energy and work ethic has carried over into Q1, where we saw strong revenue growth, and will continue to help us meet upcoming challenges head on as we continue to grow our business. The result of that hard work is that Kovalon is truly a different company today than we were just a few short months ago. We are a much stronger company, both financially and operationally, and we have many more levers at our disposal to fuel further growth. I still don't believe that the value of our highly advanced technology platforms and their relative growth opportunities have been fully reflected in the value of Covalon. I believe that each of these platforms has more value individually than our non-core Aquaguard product line that we sold for $38 million. By combining the value of our $25 million of cash, our clean balance sheet, and the potential of our three highly sought-after product and technology platforms, It's clear to me that Kovalon will generate significantly more value for our shareholders over the coming quarters and years. While we will no doubt face challenges in the future and not everything is in our control, I can say for certain that our team at Kovalon is working harder than ever to grow our business and continue the positive progress we have made to date. I would now like to open the line for questions. I ask that if you're using the slides the call-in number. Please keep your questions to one question at a time, and there'll be lots of time to get back into the queue to ask more. I'll turn it over to you, Kelsey, to start the... I think first we're going to go through and do the questions that come in on the phone, and then we will turn to questions that come in on the webcast. Over to you, Kelsey.

Thank you so much. We will now open the floor to questions. And as a reminder, if you would like to ask a question at this time, simply press the star, then the number one on your telephone keypad. If you would like to withdraw your question, please press the star followed by the two. Alternately, you can submit type questions via the webcast. There are no questions. Oh, just one moment please for your first question. And your first question does come from from A Capital. Please go ahead.

Hi, Brian, and congrats on the continued operational excellence after the Aquaguard divestiture. You mentioned some moving parts during the quarter with regards to some costs that may have still been flowing through related to that divestiture. Can you further characterize that?

Sure. Thanks, Seth, for the question. This was really a transition quarter. I mean, when we sold AquaGuard, we sold the product line. It was really an asset sale. And so we retained all staff and operations. And during the quarter, we transitioned those operations over to the purchaser. And so we were left with staff. And, you know, we've We've had some departures that were planned. We've also redeployed some of the people. So during the quarter, we were still handing over the business. As a result, we had some additional costs that weren't all captured in discontinued operations that I think of as more transition-related. And then we redeployed, as I mentioned, we redeployed some people that were focused on the AquaGuard product line, a few of our sales team, to sell IvyClear and ValGuard into the U.S., some marketing folks, as well as some administrative. So I would really classify it as a transition quarter from that perspective.

Understood. And with regards to kind of the redeployment or maybe the timing of some of those efforts, Would you characterize them as having kind of happened at the front end of the quarter? I'm trying to kind of understand the cadence of maybe the sales and marketing spend moving forward as well as the GNA. Are these run rate numbers you look at this quarter, or do you think based on the timing they're still upwards or downwards? You did mention some departures, so there could be a downward shift there too.

Yeah, so I would say the people that we were redeploying, certainly from sales and marketing, were there fully for the quarter. Some of the operations were not. And so I'd hesitate to sort of look at this quarter as a window into future quarters operating expenses, you know, As it is a bit of a transition, there are some overlaps of costs. I think we'll continue, as we have over the past two years, continue to be very diligent in monitoring operating costs. That said, I do see where we have opportunities to focus some talent on our growth projects. going forward. So we will invest in things like sales and marketing team and initiatives. But I wouldn't necessarily characterize this quarter as the quarter to model out for the future.

Got it. Yeah, based on kind of the OPEX or the proportion of sales, this is higher than your historical. So I understand, like you're saying, some one-time expenses. So would that be, I gather, more on the G&A side rather than sales and marketing, since those folks that you've onboarded are here to stay, essentially, right?

Yes, I would say. But, you know, obviously there's some transition in, I would say, all but the R&D bucket in operations, in sales and marketing, and G&A. But likely, you know, I think your observation is probably fairly directionally okay to to think about.

Awesome. Well, thanks for the added insight, and I'll hop back in the queue.

Thanks, Seth.

Thank you. And your next question comes from Arnold Schell. Please go ahead.

Yeah, thanks. What has to happen for you to have consistent profitability from quarter to quarter, and when do you expect that to be the case?

Thanks for the question, Arnold. As I mentioned, this is a bit of a transition quarter. We have not provided specific guidance going forward on top line, bottom line. We are continuing to manage our operating expenses, but we do have to keep in mind that we transitioned out the Aquaguard business, which was a big part of the company previously. And so, you know, we also see some opportunities for growth on our current product line. So we're trying to balance both profitability, growth, and, you know, and making sure that we can streamline our effectiveness as an organization. So, you know, the I think that's part of the reason that we're trying to provide, in addition to our IFRS financials, to provide both adjusted gross margin and adjusted EBITDA, to give you some sense of some of the moving items. A lot of companies struggle with this. Arnold, when you look at things like the government subsidies that existed, and so we've tried to pull all of that out, so there's a bit more apples to apples comparison. And I think, as I stated, we were pretty close to break even this quarter on our adjusted EBITDA, and I see we can make strides in the right direction going forward, but it'll likely be a quarter or two before we are fully aligned as to having all of our transition expenses managed through.

Thank you. Thanks, Arnold.

I appreciate your question.

Thank you. Ladies and gentlemen, as a reminder, should you have a question, please press the star followed by the one. And there are no further questions at this time. You may please proceed with the webcast.

Okay. Our first question from the webcast is from a representative of Swego Capital. The question is, could you elaborate on the sales and marketing investments made during the quarter? What kind of period sales and marketing costs were up around $600,000? Good question.

Our Aquaguard business was highly focused selling directly into hospitals in the United States, and the team associated with that were, in last year's numbers, included in our discontinued operations disclosures. We transitioned a small subset of that team to focus on selling Valgard and IV clearance. as well as engaging in upgrading our ability in our programs around digital marketing. With lack of access into hospitals, that has created the need for all medical device companies to focus on alternative ways to engage clinicians just because of lack of ability to get into facilities. And so it's really sales people, a bit of an investment in some marketing personnel focused mostly on US hospitals where we see a lot of growth opportunity and a little bit of investment into some tools to help us engage from a digital perspective much better with the clinicians that use our products.

We have two questions on a similar subject. One is from Anthony Marchese from ITF who asks, would you consider a small stock repurchase program? And similarly from Mark Haas, given how depressed valuation is and how much cash is on the balance sheet, what is holding you back from conducting a buyback?

Yeah, certainly this is a good question. Certainly something we've talked about at the board level, uh, And when we come to a decision on that, we'll certainly – and if we do launch a program, we'll absolutely be announcing that. I agree that the stock price is not reflective of the value of the company, and I see a lot of upside there. So that's certainly – something that we've talked about internally.

The next question is from Mark Haas again. There is no longer any analyst coverage. Are you looking to get coverage with any of the brokers that used to provide coverage or perhaps engage an IR firm to increase visibility for investors?

I talk to analysts quite frequently and Talk to a lot of investors on a daily basis. So I think there's a lot of interest in Kovalon. You know, I think it was difficult for people to get a handle on the business as we were going through the divestiture of Aquaguard. But I think now that we've gone through that transition, you know, our core business is a lot more readily identifiable. I think it's easier for outside analysts to track and monitor the company. So that's an area where I'm definitely focused on engaging with the street more and engaging with investors as much as I can. So I do believe there's some interest, and stay tuned. We'll see whether coverage increases on Covalent

Our next question is from Robert Tattersall, private investor, who asks, the press release contains a lot of information on the revenue account, but the only balance sheet item is $25 million in cash. Could you please include a basic balance sheet in future press releases?

Yeah, it's a great suggestion, Robert. I will talk about doing that. I think there's been a lot of focus on operations. Our balance sheet is something we're really proud of. It's very clean, no debt. Certainly, it's available in our public filings, but it's a good suggestion. We'll talk about doing that going forward.

And the last question from the webcast is from John Presley, who says, there are 12 job postings on Covalent's website. Is the company looking to ramp up staff for future growth?

Yeah, John, we're always looking for good people. We have a really solid core team. In this day and age, and I don't know if it's due to people that have been adversely affected by COVID or what it might be, but there seems to be movement of staff in a lot of companies, and so we're continuously looking to build our portfolio of contacts with really talented staff. We do have open positions and some, you know, some positions we continuously look for good people, whether the positions are open or not. And so we're looking to increase the strength of our team and and in particular in areas of sales and marketing where we can see an immediate impact on our revenue and the opportunities for growth. But, again, we do have a few open positions. And, you know, we've been trying to operate very lean over the past few years, and we'll continue to do that. but in a smart way. So I appreciate the question and I appreciate you, certainly if you're interested and have the ability to add value, we'd love to be able to engage with anybody who could fill some of those open spots. Thanks so much. Here's where we've gone through all the questions. I'm really confident that the fundamental improvements we've made this past quarter and through last year, and the strong progress into calendar 2022, I think over time is going to demonstrate significant unrealized value for our shareholders that I believe exist today. The hard work continues. I know the team is working hard, and I look forward to discussing our progress on our next call. Thanks very much.

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