Covalon Technologies Ltd.

Good morning, ladies and gentlemen, and welcome to Covalent's Q4 and year-end FY 2022 conference call and webcast. My name is Lara, and I will be your conference 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 one on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Alternatively, you can submit type questions via the webcast. At this time, I would like to turn the conference over to Mr. Brian Pedler, President and Chief Executive Officer, and Mr. Jason Goral, Interim Chief Financial Officer. Please go ahead, Mr. Pedler and Mr. Goral.

Thanks, Laura. Good morning, fellow investors, and thank you for joining us on this call. Salia Asadzada from Kovalon is helping to coordinate the conference call and webcast today and will now provide us with some instructions.

Thank you, Brian. Good morning, everyone. My name is Salia Asadzada and I am the Executive Assistant to Kovalon'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 fourth quarter and year-ended September 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. 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 related to 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 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 Brian Pedlar, Covalent's President and Chief Executive Officer.

Thanks, Shalia. So I will provide some context to our strategic plans that we implemented in 2022 and provide some context to the year-end financial results, as well as talk about some of our growth objectives underway in 2023 and beyond. And then both Jason and I will take your questions either through the phone line or via the message function in the webcast. So fiscal 2022, was a year of strengthening and transforming our company. We are a much more valuable company today than we were a year ago. A year from now, we will be significantly more valuable than we are today. We were excited to start 2022 following the divestiture of our AquaGuard product line with a clean balance sheet, no debt and significant cash reserves. Covalon is blessed with an incredible portfolio of assets including our infection prevention products and technologies that help prevent patients from getting an infection while in hospital, our amazing advanced wound care portfolio products that help close complex wounds, and our deep portfolio of patents and know-how that allow us to innovate new products for our own sales efforts and in support of some of the largest medical companies in the world that turned to us for new product development help. At the start of 2022, through consultation with our board and others, we set a very achievable goal of putting in place the foundation required to transform Kovalon and unlock value. We set a new vision and mission for our company. With our strong product and technology portfolio, Kovalon is focused on becoming the leading provider of compassionate care solutions that help patients heal faster and live better. Our mission is to provide innovative, cost-effective healthcare solutions that reduce pain, prevent infection, and promote healing. Why is this important? How relevant is Covalon? Uninsured hospital-acquired infections have increased as much as 63% in intensive care units in the United States since the onset of COVID in 2020. Current standard of care products used to combat vascular access and surgical site infections in hospitals in the United States are ineffective. It's a very true statement and we hear this all the time in our interactions with hospitals and clinicians and doctors. Clinicians and patients are demanding better and safer products. What they're really looking for is a better standard of care. We at Kovalon are becoming that new standard of care in the areas that we compete in. But we needed to make some changes to allow us to succeed in our mission. In fiscal 2020, our team began executing on our plan. We made deliberate and well-planned strategic decisions to reposition Covalon so we can unlock value from our lifesaving patented products and technology by focusing on three major items, investing in our people, expanding our sales and marketing capabilities, and improving our infrastructure and supply chains. We are on track to grow Covalon into the company we know it can be, and we have already made strong progress in our fiscal 2023 towards reaching our goals. As part of our transformation strategy in fiscal 2022, I hired highly experienced leaders to transform our marketing and sales teams to focus on the largest medical products in the world. Sorry, the medical products market in the world, the United States. Ronnie Baer, and Mark Doolittle, who joined us in 2022, have made a strong down payment on transforming our marketing and sales efforts in the United States and internationally. We have attracted top talent in sales and marketing roles at the leadership level as well as at the field level, and they have a strong track record in creating value in medical companies. I am actually very excited about what we've been able to accomplish this past year. Throughout 2022, we established our key products in more than 70 major United States hospitals, including a dominant position in six of the top 10 children's hospitals in the United States. We anticipate strong revenue growth going forward as the company works to improve its margins and further align its operating expenses to growth prospects. Strategic priorities for this fiscal year, 2023, include a focus on strengthening core business areas with respect to people and processes. Our United States distributor partners that focus on the home health care and long-term care markets are anticipating growth in 2023 through sales of our collagen products. Covalon intends to increase its United States hospital customer base through our direct sales team and increase product usage in many significant hospitals where our infection prevention products have become standard of care. Going forward, we will focus on key markets where our products will capture significant and meaningful market share. Our portfolio of patented infection prevention products is, as I mentioned, becoming the standard of care in intensive care units and surgical departments of our hospital customers. This is actually a major accomplishment for such a small company. Many of the major teaching hospitals that set what I would consider the gold standard in healthcare worldwide for managing patients in intensive care units and during surgical procedures, are selecting our products to help their patients of all ages stay free from infection and help them heal. They have recognized that using innovative, gentler, and more compassionate solutions like our IvyClear, ValGuard, Colloctiv+, and surgical products support better clinical outcomes. We also expanded our digital marketing efforts, which have helped us grow our brand presence both in the United States and internationally with physicians and clinicians that are focused on reducing infections and improving patient outcomes in both hospitals and community care settings. Over the course of the next year, our team is laser focused on building brand awareness of Covalon in major hospitals that can benefit from our unique life-saving medical technologies. We invested heavily in 2022 in strengthening our sales teams with staff and capabilities to engage our customers, whether digitally, virtually, or in person. Today, we engage with our customers and sales leaders in a much more efficient and cost-effective way than we did before. which allows us to grow more rapidly with less investment. We ended 2022 with $18.1 million in sales. The investments we made in sales and marketing capabilities will only begin to show up in our top line revenue growth in 2023. Going forward, our company will focus on the key markets where our products will capture significant and meaningful market share for us. As a result, we rationalized several markets in 2022 and we are focusing on selling our key products going forward. Internationally, we eliminated our sales efforts in the United Kingdom and several other markets which do not offer us the opportunity to create a meaningful market presence. We also incurred inventory provisions in 2022 that negatively impacted our product margins during the year. Our gross Profit margin for the year ended gross product margin for the year ended September 30th, 2022 was 6.2 million or 41%, but that includes about $2.3 million of inventory provisions that were incurred during the year. After adjusting these provisions, we achieved an adjusted gross margin of 55% for the year, which is more reflective of our go forward business. And we intend to improve our margins further. As part of the company's customer-focused initiatives, we improved supply chain operations and invested in upgrading both business systems and infrastructure to allow the company to better serve customers and drive growth in key markets going forward. Additional investments included expanding Covalent's in-house manufacturing and medical coding services capabilities. As a result of our investment in our people, our data systems, and our supply chain infrastructure, our operating costs increased to $16.6 million. Several of our investments in our supply chain and infrastructure will help us improve our margins in 2023 and beyond, and we have already identified several cost-saving initiatives that we will execute on in this year to align our operating costs to our growth revenue. We are in a much stronger position in our key markets compared to last year, and we look forward to seeing the results of these investments that we've made positively impacting us in 2023 and beyond. In 2022, our investments in leadership, sales, marketing, and operations, along with our focused approach to our key revenue markets, have strengthened Covalon. Every department in the company embraced significant change in 2022. to processes, resources, and people. And I am proud of our team's resilience. To be sure, some uncertainty will continue to affect global supply chains in the economy. But the momentum we have and the certainty of purpose we have in our products and our mission will allow our company to succeed. We are excited about our progress in transforming Kovalon into a patient-driven medical device company. that's built on the relentless pursuit to help the most vulnerable patients have a better chance of healing. As we previously announced, 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 905,000 shares for cancellation, which strengthens the value of each existing shareholders shares. I would now like to open the line for questions. I ask that you keep to one to two questions at a time. There will be lots of time to get back into the queue to ask more. Thank you. I'll turn it over to you, Lara, to start the questions.

Thank you, sir. We will now open the floor for questions. As a reminder, if you would like to ask a question at this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Alternatively, you can submit typed questions via the webcast.

Your first question comes from the line of Arnold Schell.

Your line is now open.

Yes, thanks. So every year, basically, the story is the same. And the story is, this is why last year was terrible, and this is why next year will be terrific. And you're proud of everybody. What reason is there to believe that this year is going to be any different than last year and the year before and the year before and the year before when the story has always been exactly the same?

Well, Arnold, thank you for your question. I tried to walk through some of the key things that we've done this year, including some new leadership. We have a significant groundswell of hospitals and clinicians that absolutely love our products. And in a medical space, things do take time. We've spent a lot of time and effort this past year in repositioning ourselves focusing on markets and products that have strong potential for strong margins. And I think we're on a strong roll. All I can say to you is continue to watch our progress in 2023. And I think you'll see results show up relatively quickly. I really appreciate your question.

Well, as I say, every year it's the same story. Last year you told us about last year's repositioning, and the year before was the year before's repositioning. How much cash do we have, and what's your burn rate?

So we ended the year at about $14.1 million in cash. Currently we have about $13.9 million of cash. So we're relatively stable at this particular point in time from that perspective. Thanks, I really appreciate it.

Yeah, I appreciate your questions.

Thank you. Your next question comes from the line of Sol de Turizan.

Please go ahead.

Hey, good morning, Brian, and good morning, Jason.

Hi, Sal.

Hey, I had a couple of questions. One you touched on already on the cash position. I know that we are a clean balance sheet, no debt and significant reserves, which you just mentioned were 14.1 at the end of the quarter and 13.9. I guess based on the run rate, you know, at this time next year, do we have a concern of being out of cash where we require us to go back to the equity market or go back into debt again?

Absolutely not. I'm really confident. We made really specific decisions in 2022 to invest in things that will position us to manage and benefit from the growth that we see, and we were very careful in those decisions. I don't see a situation where we have to go back to the markets for cash at all.

Right, because it kind of wouldn't make sense after we're just doing a buyback.

Absolutely. I mean, we see that that's a good use of some of our excess cash is to reduce the outstanding shares.

Okay. One other question I did have, a couple of questions. In your press release, we said we're on track to grow power on and to the company know it can be, and we have already made strong progress in 23 toward our goals. Since we're already into the fourth month of 2023, can you expand on that a bit and tell us specifically, you know, what strong progress are we making? Is it in revenue? Where is it? I mean, you obviously have seen it.

Yes. So it's in a couple – it's in probably three strong areas, and one is revenue. We did a lot of work last year to position ourselves to grow and we're seeing that pay off in our top line. We also see a lot of engagement with customers and our focus market as I talked about Sal is the United States and we've got a lot of focus on hospitals. Unfortunately, right now, there is a crisis in hospitals around unwanted infections, and our products are being very well received. We have a lot of champion key opinion leaders and hospitals that are adopting our products. It seems like the children's hospitals are moving very fast. I think they just tend to make decisions quicker, and so we have a good head start there. And we see a lot of progress on that front. I also see some strong growth in our wound care, in our long-term care and home health care channel in the US, as well as our international channel. So we're seeing our growth prospects in most of our revenue initiatives. I'm also really impressed with the infrastructure we've put in place around our supply chains. Over the past several years, supply chains have been in complete disarray in almost every company. We've done a lot of work to try to reduce our product costs and improve our product efficiency in bringing product to our customers. It's not perfect yet, but we're getting better and better, and so I'm really pleased with our progress on that front. And then I think we have a really strong team we've put together, and we're seeing the payoff for us in that investment in some of the challenges we're able to tackle and overcome very, very quickly. So I'm really... Really excited about where we are and I appreciate your question.

Thank you. One more point. Another quote from the press release says management anticipates strong revenue growth going forward. Can you give us your definition of strong revenue growth and let's say gauge it by let's say 23 revenue over 22 or 24 over 23? What kind of strong growth are we looking for?

Yeah, Sal, I've got to be careful there because we are not giving guidance, so I have to step carefully. But, you know, we put a lot of effort into building up our sales and marketing initiatives, and, you know, we're going to see the beginnings of that payoff in 2023. So, you know, I think we will – you know, and the other thing I would say is that we've – We've also been keeping our eye on our operating costs. We know we invested. We have some what I would consider non-recurring costs going through 2022. And so we have the ability to align our cost structure and we will to our growth prospects, which I think are quite strong on the top line. So I think 2023, from what I can see right now, is going to be a really solid year for us. I really appreciate the question.

Okay. Thank you very much, Brian.

Thanks, Sal.

Thank you. As a reminder, if you want to ask a question, you can press star 1 on your telephone keypad. We have a follow-up question coming from the line of Arnold Schell. Please go ahead.

Is Shanghai still an important part of our supply chain?

We do have one product line, our complimentary CovaWound product line that is used with our patented collagen product that comes through our Chinese supply chain. We've opened a second warehouse to avoid some of the issues that we had with Shanghai. It's in a different city. And so far, so good. It's been very efficient. So I think, Arnold, we've tackled that. And, you know, China opening up from its COVID zero policy is also helping. So I don't foresee we're going to be in that situation that we were previously in. around China being a challenge.

What percentage of our sales are represented by that product?

Roughly, I'd say about 15%.

Okay, thank you. Thanks, Arnold.

Thank you. Your next question comes from the line of Trevor Halsinger from Aspen Wealth Management. Please go ahead.

Good morning, Brian.

Hi, Trevor.

Hey, over the last few years, you've talked a lot about the Middle East opportunities and the coding opportunities. And in your call, you haven't mentioned them once. Can you elaborate on where those two areas stand?

Yeah, so I did talk a little bit about international. We changed our partner in the Middle East. which is a very positive move for us and de-risked that market. We continue to have good, solid business there, and we see some good growth coming out of the Middle East. So I think that's still a market. But, you know, again, it's a tender-driven market, and we go through distributors where we don't necessarily have a relationship with the clinicians the same way we do in our hospital channel in the United States. So Still a good market for us, but I think a real strong growth area is the United States market. You know, Trevor, from living in the U.S., it's a big healthcare market. The medical coatings is a really strong part of our business, but it's still a small part. If you look at our financial statements and you see our revenue line items, that talk about our services and licenses. That's effectively our medical coatings business. We've got some great contracts and great partners that we work with there. It is an area where I do see a lot of opportunity. But those are projects that take time, and over the course of time, things are going well. And as we get more developments there, we'll be happy to talk about those. So they're good, solid parts of our business, but we really see some strong growth in our U.S. product distribution channels, and that's what I've focused on over the past year and getting that to the point where I think we can enjoy some strong growth as a company. And quite honestly, that's where there's a strong need for the products that we have.

Thank you. Thanks, Trevor.

So now I'll switch over to some of the questions coming from the webcast. One of the questions that came through is, can you explain the inventory provisions of $2.3 million and where that came from? So as I look at that, I would say about $1.3 million of that roughly came from either products that we discontinued and are not our focus products going forward, partly because the demand was not there, but also because we need to focus on higher margin products and a combination of that and markets that we stepped out of, like the UK, which had specifically packaged product that was CE marked for the European market. And so that's roughly $1.3 million of the inventory provisions. The other million dollars, is products that have aged, and there is a risk that we will not realize value. We obviously are going to try our best to sell all of those, but I think we've been prudent in taking reserves against those products in case we are not able to realize all the value that we have in inventory. Another question that came through how much G&A one-time costs were incurred in Q4. If you sort of look at that, there's probably about half a million or so of costs that I would say are non-standard costs that we booked in addition to the inventory provision that we booked into cost of goods sold. As we look at Q4, there are costs in our operating expenses that I would consider non-recurring or non-standard costs. Another question is, can you outline the path and timing to expected break even? I think over the course of the next couple quarters as we start to report our results, I think we're going to see very clearly what our pathway is to profitability. It will take us still a couple quarters, but I think we're well on our way. I see us achieving that in the next 12 months. That obviously can adjust a quarter or two, but we're definitely on our way. I appreciate those questions. There's one question asking whether we are continuing to sell our Covigard product, which was a very impressive product. We are not. That was a product that we launched during the COVID crisis. At the time, the Health Canada and FDA rules allowed organizations that normally did not manufacture those kinds of products to manufacture and distribute those. I think they're wonderful products. Those who use them like them very much. But the regulations that allowed us to continue to sell those products changed because they were special circumstances for the COVID situation. And we did not continue those products. We just were not getting the kind of return out of them that we initially expected. expected, but still great technology and that's a technology that we have looked at building upon for other medical companies that are interested in those kinds of products. Thank you very much. I think that's the end of the questions. Really appreciate your participation. I'm confident in the changes that we've made to Kovalon over the past year and in the progress that we've made to date in 2023. And I think that we will be able to demonstrate through our financial results the value that I believe currently exists in our company. The hard work continues. And as I said earlier, we are a much more valuable company today than we were a year ago. And a year from now, we are going to be significantly more valuable than we are today. I look forward to discussing our progress in the next call. Thank you, and have a good day.

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.