Covalon Technologies Ltd.

Good morning, ladies and gentlemen, and welcome to Kovalon's Q3 Fiscal 2022 Conference Call and Webcast. My name is Michelle, and I will be your operator today. As a reminder, today's conference is being recorded. All 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 the number 1 on your telephone keypad. If you would like to withdraw your question, please press star then the number 2. Alternatively, you can submit typed questions via the webcast. At this time, I would like to turn the conference over to Mr. Brian Pedlar, President and Chief Executive Officer, and Mr. Jason Gorel, Interim Chief Financial Officer, Please go ahead, gentlemen.

Thanks, Michelle. Good morning, fellow investors. Thanks for joining us on the call. Salia Asadzada from Covalon is helping to coordinate the conference call and webcast today and will now provide us with some further instructions. Go ahead, Salia.

Thank you, Brian. Good morning, everyone. My name is Salia Asadzada, and I am the Executive Assistant to Covalon's Chief Executive 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 Kovalan's third quarter ended June 30, 2022. 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 and webcast are covered by Kovalan'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 our 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 call. Due to risks and uncertainties, including those identified by Kovalon in our 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'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 back over to you, Brian.

Thanks, Alia. 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 or via the message function on the webcast. Looking at our revenue results for Q3, it was certainly an improvement on Q2 this year, and on a year-to-date basis, we are trending similar to last year on our top line overall. Revenue from continuing operations for the nine months ended June 30, 2022, was $12.8 million, which is just about 2% lower than the same period last year. This year, the United States remains our strongest market, and we continue to see strong future growth opportunities for our key products in the U.S., for both our collagen and our infection prevention products. A significant portion of our sales in the United States today goes through distributors, and the timing of those orders are not always in our control. As we saw last year in Q3 and Q4 of 2021, the majority of our United States collagen sales were weighted to the last half of the year. This year, our collagen sales have been more evenly spaced throughout the year so far. Like most companies, we continue to see expanding lead times on our supply chains, and we have spent considerable time and effort to manage our contract manufacturers. our raw material suppliers and our customer orders to try to mitigate as many delays and disruptions as possible. Last quarter, we were affected by the Chinese government imposed COVID restrictions on Shanghai businesses that resulted in significant restrictions on the ability for companies to manufacture and ship products out of Shanghai. We are largely free of these restrictions and their impacts today. We are in the fortunate position of being able to withstand temporary supply chain disruptions and the need to deploy cash to secure uninterrupted production. We have a very strong balance sheet with significant cash and no debt. Our customer base is very loyal and our customers simply love our products. Even when we experience shipment delays, our customers continue to be vocal champions for Covalon.

We have not lost any significant customers during these challenging supply chain periods.

As I mentioned, revenue to date this year was $12.8 million with the United States accounting for about two-thirds of our revenue. Our gross profit margin for the nine months ended June 30th, 2022 of $6.2 million or 48% includes about $1 million of inventory provisions mostly from past quarters. After adjusting for these provisions, we achieved an adjusted gross margin of 58% for the first nine months, which is more reflective of our go-forward business. We continue to invest in sales and marketing resources and improving our operations.

As a result, expenses are up for the year and we incurred losses to date. Revenue for Q3 was $4.5 million and gross profit was $2.1 million.

Operating expenses for the quarter were $3.7 million and the increase primarily relates to investments we are making in adding sales staff, launching marketing initiatives and building out our capabilities to manufacture certain of our products in our facility in Mississauga to help significantly improve future margins.

Our net loss for the quarter was $1.6 million and our adjusted EBITDA loss was $1.1 million.

Product revenue was $4.1 million for the quarter and development and consulting services combined revenue was $0.3 million. The dip in revenue in Q3 2022 compared to last year's Q3 is related to the timing of customer orders around our United States college and business. We are still seeing very strong demand for products both in the United States and in our international markets. The investments we are making in our sales team and our marketing initiatives have not yet shown up in our top line revenue. I'm very encouraged with the current activity we are seeing in our hospital customer base and in our college and distribution channels and our international markets. Year-to-date, United States revenue is up about 7% overall, with the product revenue portion of that being up 10%. The United States continues to be our dominant market. Our sales and clinical teams are highly focused on converting our sales funnel of major hospitals that have recognized that our IvyClear, ValGuard, and SurgiClear products can solve real clinical problems associated with unwanted infections in intensive care and intensive care units and surgical patients. We are also seeing growth opportunities around our collagen powder that we launched in 2021. We have invested in improvements to our supply chain and our own manufacturing capabilities in order to efficiently meet the demand for our products we are seeing. In our commercialization facility in Mississauga, we manufacture our recently launched collagen powder and collagen dressings. By being able to manufacture certain products in-house, we are able to gain better margins on those products than with using contract manufacturers. Our investments to help improve margins are paying off, and we are beginning to see some impact from our efforts on these products, which have a significantly higher gross margin than our overall adjusted margin of 58%.

Our operating expenses are up year over year.

As we have previously talked about on other calls, we are investing in building our sales and marketing resources so we can accelerate our growth opportunities in the United States market, where we have a solid base of hospital and college and customers. We also redeployed some very strong team members to support our growing U.S. operations that were previously focused on our divested Aquaguard business. We intend to continue to invest in accelerating our revenue growth in the United States. and we'll do so by making sure that we can recover our investments in resources and personnel in the shortest time possible. I'm highly confident that we will achieve our objectives. We have a much stronger leadership team today than in the past. We have attracted top talent in sales and marketing roles, both at the leadership level and at the field level, that have strong track records in creating value in medical companies. Over the course of the next year, our team is laser-focused on building Kovalon into the powerhouse it deserves and is destined to be, given our unique life-saving medical technologies. Now I'm going to talk a little bit about some of the growth drivers in Kovalon. This is one of the reasons that I'm very encouraged by where we are today with our company. We have world-class products that are sought after by clinicians and by patients. We have the world's only dual antimicrobial surgical site dressing, the world's only dual antimicrobial silicone IV dressing, and the world's only vascular access line-to-line connection barrier. We are the only company in the market with a collagen wound filler with antimicrobial silver. Now, these products are supported by a portfolio of intellectual property patents and know-how that give Kobalon a serious advantage with our product portfolio over other companies. Our products are better and safer than our competitors. We see strong growth opportunities with our product solutions in the markets we address and have a clear path to substantial revenue over the next several years. Our advanced wound care portfolio, of which our collagen products are the flagship, have a long history of helping patients to heal when other products have been unable to help. The demand for our collagen in the United States continues to be strong, and our recently launched collagen powder allows us to open up new revenue opportunities in chronic and surgical wound healing. We have strong partnerships in the United States targeted at long-term care and home health care patients, which is where most of the United States wound care patients are treated. We also have a growing footprint in direct sales into U.S. hospitals. We see strong opportunities to cross-sell our IvyClear, ValGuard, and SurgiClear products through our existing U.S. customer base. We have a solid base of reference hospitals in the United States that have demonstrated SurgiClear's ability to help reduce surgical site infections. As we launch SurgiClear into additional hospitals, we anticipate meaningful revenue growth from our products in U.S.

hospitals.

We are making real and significant progress in transforming our sales, marketing and operations teams to position us to achieve growth over the next few years. There is a significant need for cost-effective solutions for infection prevention and wound healing right now in the market. In a post-COVID world, both patients and clinicians are demanding better, safer products that protect them while they heal. Covalon is one of the select few companies that have products ready to be used today by clinicians to help solve these serious infection issues. Given the adoption of our products such as ValGuard, IvyClear, and SurgiClear, and four of the top five pediatric hospitals, and over 50 major teaching hospitals in the United States today, we are positioned to become standard of care in helping doctors and clinicians prevent bloodstream and surgical site infections in these hospitals. We are in the fortunate position to have some of the largest and best hospitals in the United States adopt our products as standard of care for their most vulnerable patients. We see a clear path to growing our presence in the United States hospital market by building on the solid clinical results that clinicians have achieved with our products and doing so with both acute care and pediatric patients.

We are a much stronger company today than a year ago.

We strengthened our balance sheet and improved our operations since last year at this time. We also have a stronger, more talented leadership team. We have decided to use our strong cash position to further strengthen the company by buying back up to 5% of Covalent shares for cancellation. To date, we have purchased about 575,000 shares for cancellation, which strengthens the value of each existing shareholders' shares. 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 your business and continue the progress we have made to date. I'm looking forward to seeing the impact of the building blocks we have put in place on our financial performance through into 2023 and 2024. I would now like to open the line for questions. I ask that you try to keep to one question and one follow-up at a time. and there will be lots of time to get back into the queue to ask more. Thank you, and I'll turn it back over to you, Michelle.

Thank you, sir. Ladies and gentlemen, we will now begin the audio portion of the question and answer session. If you are dialed into the phone lines and you would like to ask a question, please press star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, please press star followed by the number 2 And alternatively, you can submit typed questions via the webcast. Please stand by for your first question. Your first question will come from Saper Monachery of 8 Capital. Please go ahead.

Thanks, and good morning. Congrats on the quarter. I wanted to understand when you talk about some of the sales teams' wins that are, I guess, ahead of us, some of the recent hires and you said the impact has not really hit the top line yet. Can you give us visibility as to what you think that would look like? Would that be in terms of new jurisdictions that your team's looking to help you enter or is it just individual hospital wins or potential partnerships? Just wanted to understand that a little bit.

Yes, good question and thanks for asking it. Our team is really focused on the United States market. We have a strong distribution internationally. We have strong distribution through our major distribution partners for collagen in the U.S. But where we see some real significant growth is within hospitals. And hospitals tend to go through a process before adopting our products. We've been pretty successful over the past... eight to twelve months in attracting some very key hospitals and we have a small but strong footprint. They tend to buy on a frequent basis so it's you know monthly as opposed to the rest of our business which tends to be in large shipments and so it takes a little bit of time for those accounts to start showing up in revenue and we've been We've been building our sales and marketing team over the past several months, and I'm really excited about the opportunities and the talent of the folks that we've been able to attract, both from a leadership perspective and those on the ground calling on hospitals. So a lot of that team is going to be focused growing our hospital business within the United States.

Understood. And I guess the bulkier orders that you touch on, is that with regards to the international distributors or also in terms of kind of the long-term care market as well?

Sorry, Sepp.

You said there's like a larger orders typically kind of bulkier orders. Is that from the distributor side that you're referring to?

Yeah. So typically, and whether it's us selling to international distributors, they tend to be by the container, the shipping container, or to our distributors within the United States for quality. We tend to do runs of product that go in large shipments. And so those shipments don't happen every month, or in the case of some distributors, they don't buy every quarter. And so it tends to create a little bit of a lumpy top line, whereas the hospital business is very steady. They buy in smaller volumes and more frequently, so it's a lot more predictable. So, you know, that's a very positive outcome of our, you know, growth opportunities within hospitals.

Understood. So that makes sense on the hires and the spend that's going there. We should see the top line growth come from those hospitals and kind of help with the consistent buildup. So that's good insight. Appreciate it.

Next up.

Your next question comes from Sal Dedeteris, a private investor.

Please go ahead. Hey, good morning, Brian. This is Sal Dedeteris. And just a quick question on the cash balance. What is the cash balance at the end of the third quarter? And can you just explain, Delta, where we've been from the second quarter of $22 million?

Yeah, it's a good question, Sal. I'd say about half of the cash that we went through went to more one-time items like paying down some trailing costs on the divestiture of Aquaguard that were accrued. We spent about $1.2 million on share buyback. And we had some, I'd say, one-time costs, some recruiting costs, et cetera, that we incurred to the tune of about $600,000. And those are all sort of one-time. The other half is sort of split between operating losses, and then we've deployed cash on a couple other fronts. There's a couple... opportunities where we needed to secure some production with our contract manufacturers, so we had to prepay for certain orders and raw materials to secure supply. In these crazy times where supply chains are fluctuating quite frequently, we were in the fortunate position to be able to do that and got ahead of others so we could keep our production lines going. And then we've invested a little bit into some capital equipment and some internal software and systems to improve our production so we can make some of our products in-house and drive better margins.

So where do we stand today at the end of the third quarter? Is it $18 million? Is it $17 million? Is it $20 million?

We're about $17 million in cash.

$17 million. Okay. Thank you very much.

Thanks, Al.

Ladies and gentlemen, once again, if you are dialed into the audio portion and would like to ask a question, please press star 1 now. There are no further questions from the phone lines.

I will turn the conference back to Mr. Pedler for the web questions. Please go ahead, sir.

Thanks, Michelle. So we have a question that is...

What is the average price per share that we have paid for shares that we have bought back? I believe that's, I don't have the exact number, but it's around $2.60 roughly. But that we can see on our filings, so we can update that number. The next question is, would you consider upsizing the 5% NCIB, and when will these development projects convert into products and product revenues? So the first part of that question, so we're limited to a 5% by the rules of a normal course issuer bid, so we can't actually go beyond that. We'll have to stick with that 5%. The development projects and our products. Development projects for our medical coding business, we do anticipate that turning products into the market within the next 12 to 18 months. Any of the products that we are launching through hospitals, we intend to see those continue to contribute to revenue and grow over the course of the next year.

That's what our main focus of our sales and marketing teams are. Sorry, I just got a note. I think the average price is about $2 and

And that looks like it for the questions online. Appreciate all your questions. I'm confident in the fundamental changes we've made to Kovalon and the progress that we're making. And I am very confident that over time that is going to translate into significant value for us as shareholders. The hard work continues. I can tell you that the team is working extremely hard to get our U.S.-focused business to the point where it deserves to be. We've got a good, solid starting point, and we've got some good opportunities to grow in both the U.S. market and internationally, and I look forward over the next several calls and reporting on our progress on that front. Thank you for joining us today and hope you have a wonderful day.

Ladies and gentlemen, this concludes your conference call for this morning. We would like to thank you all for your participation and ask you to please disconnect your lines.