Covalon Technologies Ltd.

Good morning, ladies and gentlemen, and welcome to Covalent Q2 fiscal 2024 conference call and webcast. My name is Ludi, 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. If you would like to ask a question during this time, simply press the star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star two. Alternatively, you can submit type questions via the webcast. If at any time during this call you require immediate assistance, please press star zero for the operator. And at this time, I would like to turn the conference over to Mr. Brent Ashton, Chief Executive Officer, and Ms. Katie Martinovich, Interim Chief Financial Officer. Please go ahead, Mr. Ashton and Ms. Martinovich.

Hey, thank you so much. And good morning to all of you on the call today. We do sincerely appreciate you connecting in to hear a little bit more about Kovalon and specifically our second quarter performance. Katie Martinovich, our interim chief financial officer, is joining me in this presentation. And Salia Asadzada from Kovalon is also helping in the webcast today and will now provide us with some instructions.

Thank you, Brent. Good morning, everyone. My name is Salia Asadzada, and I am the executive assistant to Kovalan'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 second quarter ended March 31, 2024. There will be an opportunity for you to ask questions at the end of the call. Before we begin the discussion, I would like to remind participants that this call and webcast are covered by Kovalan's Safe Harbour 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... 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 our public securities filings, actual events may differ materially from current expectations. Kovalon disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. In the management's discussion and analysis, press release, and this call, Kovalon has provided non-GAAP financial 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 accounting standard measures and any adjusting items may recur in the future. I will now turn the call back over to Brent Ashton, Kovalan's Chief Executive Officer.

Hey, thanks, Celia. It's great to be here and I hope that everyone's week is off to a very good start. I've now been with Kovalon for coming up on about five months and I've really enjoyed my time here. It's been a whirlwind for sure, but it's been great to meet our Kovalon team members in person and virtually. Great to meet customers and shareholders, key opinion leaders and business partners. I was recently at a scientific meeting in Kansas City for the annual meeting where Covalent was exhibiting, and I had the opportunity to engage with some existing customers as well as a large number of clinicians who we hope to have as customers in the near future. It was really great to talk to them and hear their challenges and ways in which Covalent is and could also help them. So exciting times. So with that as a lead off, I'm going to jump to our first slide here. and we'll get into our Q2 fiscal year 2024 results. I'm really proud of our Q2 financial outcome. We delivered on our key financial metrics and made a lot of solid progress on really important activities. Many of you likely attended our annual general meeting that was held almost three months ago. During that meeting, I shared our focus on delivering positive EBITDA for our full fiscal year 2024. And here in Q2, I'm really pleased and proud to share that we've turned around the profitability of the company and broke free from more than eight quarters, straight quarters of net losses. So here in our most recent Q2, we generated $1.7 million of EBITDA and $2.5 million of adjusted EBITDA. This was the end result of a number of very deliberate actions that we have taken. some just prior to me joining Kovalon in early January, and some during my time here. Some of these actions include significant changes to our U.S. commercial team structure and the overall selling and marketing model, changes to the structure and operating approach of our Kovalon leadership team, as well as impactful focus on and changes to some of the really critical building blocks for MedTech success. Operations, quality, regulatory, clinical affairs, commercial execution, and the like. And when you think about the levers of the P&L that could go into driving a return to profitability, I'm really pleased with the way we achieved this strong outcome. Really three big drivers that combined to deliver the positive EBITDA, started with strong revenue growth. And then we also had very solid margin expansion and combined that with reduced operating expenses. We'll talk more about these in a few slides. But success with all three of these drove the strong bottom line achievement. On the revenue front, solid growth in the mid-teens overall. but more impressive when you look at our primary area of focus, which is the U.S. product segment, our U.S. collagen business plus our U.S. vascular access and post-operative dressings business. This combined segment represented a little more than 75% of our revenue this past quarter, and we grew it by 54% on a year-on-year basis. Strong focus, solid execution, and we'll talk in a few slides about how our customers are increasingly valuing our offerings. And before we turn the page, I do want to provide a little color on the last bullet point here around foundational activities. I've been very fortunate in my career between companies I've worked for as well as companies that we've partnered with, acquired, or looked into acquiring. I've seen a wide range of performance, operating discipline and rigor, of planning and execution, And I'm so grateful to have had the opportunity to see this in my past because I think it's given me a really good lens to be able to come into Kovalon and assess what's working well and what needed to improve. We have an amazing Kovalon team that are really good people doing very important work. There were areas where we were having a lot of success, but there were also a number of areas where we could do and actually needed to do better. We've prioritized a number of these areas of improvement worked hard on them, and I'm really proud to say that a few of them are already yielding some of the benefits that show up on the numbers on this slide. I'm a really big proponent of growth mindset being better today than tomorrow, and I'm definitely seeing that with our team as well. But there's also a fair bit of work still to do, and like any company that believes in continuous improvement, we'll always be doing it. I'm really excited to lay down this super strong foundation that we can continue to build off of now and into the future. So going to the next slide here. When I was in Kansas City, it was another opportunity to hear firsthand the difference that our products make to patients and the amazing clinicians who treat them. Our compassionate care solutions are a differentiator and one that the whole Covalent team is very passionate about. You can see on the slide here, the three primary business platforms that we have here at Covalon. Our advanced room care business, which is led by our Collective Plus and Collective Plus with silver products. And then our vascular access and post-operative dressings business, where we have our IVClear, CovaClear and SurgiClear products. These two businesses combined are really the commercial focus of our company right now. And we are seeing the benefits of that focus. The third business we have, our medical coatings business, is one that we indicated a few quarters ago that we were deprioritizing effort on to shift even more focus on the two other businesses to the left. We've recently started a process to strategically review the medical coatings business and assess the best future actions here. One last slide here to start on a little deeper dive on the key financial metrics. And then I'll turn it over to Katie for a double click. You know, we talked about the growth overall, solid, but I really would like to draw your attention to that product revenue piece. This captures the two businesses on the left-hand side of the last chart, our advanced wound care and our vascular access and postoperative dressings businesses. Together, these are driving such strong growth at almost 40% growth year on year versus Q2 last year. And this climbs to more than 50% if you take the US region only for these businesses. We have balance here because we're seeing strong growth from both the advanced wound care side, as well as the vascular access side. On the gross profit side at 63.1%, it's a 500 plus basis point improvement from last year. Katie will share a little more detail on the next slide, but I think it's also worth noting that this margin expansion versus last year's Q2 was accomplished despite the history we had last year with a fair bit of revenue from our highly profitable medical coatings business. In the quarter, we were able to reduce our operating expenses by 22% compared to the prior year. This was driven by tough strategic decisions we made to reduce resourcing and investment on our commercial team, but really about smarter choices in what we chose to invest in. And I think that it makes our revenue growth all the more powerful and accomplishment. We were able to achieve significantly higher growth with a lot less investment when compared to a year ago. And when you do all of these things right, it shows up on the bottom line. $2 million of year-on-year improvement in net income and nearly a $3 million improvement in adjusted EBITDA. And then to close out this slide, a view into our regional splits. Here you can see the US region accounting for just a little bit shy of 80% of our Q2 revenue. Certainly a big area of focus and will be going forward as well. And now for a double click on our financial performance, I'd like to turn the call over to Katie.

Thank you, Brent. The company's financial performance for the three months ending March 31st, 2024 reflects significant improvements and strategic adjustments compared to the same period in the previous year. The following are the key financial data points from Q2. Revenue has increased 16.1% from $7.2 million in the prior year period to $8.4 million in the current year. Part of the success has been the increase in the product revenue, which has grown 37% from 6.1 million to 8.4 million. This rise is attributed to stronger customer demand for the company's collagen dressing and the expansion of product offerings in the U.S. hospitals. Covalent's gross margin has increased to 63% in Q2 2024 versus 58% in the same period a year ago. This improvement is driven by a favorable product mix and improved cost of goods. Covalent has made successful efforts to streamline operations and optimize cost with a 1.1 million decrease, 21.8% in operating expenses in Q2 versus the prior year period. This is a result of reductions in sales and marketing expenses related to staffing and the associated travel expenses. In general and administrative costs, we have decreased costs due to lower spending on professional services and staff costs as well. Within the operating expenses, we have had better cost absorption due to higher manufacturing activity levels as we continue to grow and improve our manufacturing process. Additionally, this has been the first full quarter of subleasing two-thirds of our U.S. warehouse location, which has also reduced our costs. The increase in EBITDA to $1.7 million from a loss of $0.5 million in the previous year's period is a notable achievement. It highlights the company's effective management of operating expenses and the benefits of growth revenue. The positive net income achieved for the first time since Q4 2021 underscores Covalent's successful turnaround strategy and improved financial performance. Lastly, by focusing on our revenue growth in the U.S. market, cost management, and making strategic financial decisions, Covalent has been able to achieve profitability, therefore improving our earnings per share from a negative 0.3 cents in Q1 to a positive 6 cents in Q2. This improvement not only enhances shareholder value, but also indicates a strong and more effective operational performance this quarter. On the balance sheet and cash side of things, our cash position is stabilizing, which is reflecting a predictable and steady cash flow essential for planning and sustaining long-term operations within the company. We have strong asset position. This balance sheet shows a robust asset based indicating strong financial health and substantial resources available for growth and investments. Evidence in the increase in, Evidence in the increased fixed assets as the company expands its manufacturing operations and information systems. The absence of our debt on the balance sheet highlights that Covalent has financial freedom, providing greater flexibility to allocate resources towards growth and innovation without the burden of debt repayments. Lastly, sustainable growth. Without the pressure of debt repayments, the company can focus on sustainable sustainable growth strategies, reinvesting earnings into our core operations and long-term projects. Covalent maintains a healthy liquidation as evident by a high current ratio of 6.8, ensuring it can meet its short-term obligations comfortably as we continue to grow. And now I will turn the call back over to Brent.

Hey, thanks so much, Katie. To dig a little bit deeper here into some key components of momentum that we're building here at Kovalon, you've heard us talk about the key financial areas that we think are putting us in a good spot. No debt, cash stabilizing, critical to flexibility, and allows us to make the right investments at the right time. Our solid margins combined with resetting our operating expenses to be more in line with what made sense. smarter decisions on commercial investment. These all give us some really good areas to build off of financially moving forward. On the product side in the present day, absolutely no doubt that our product's value propositions are resonating with customers. These are big, tough problems that the clinicians we serve have to deal with every day. It's not an easy job and we applaud the work they do, And we're very proud to give them some tools in their toolkit to help their patients in a caring and compassionate way. Excuse me. We're definitely seeing word of mouth spreading as more and more clinicians have success with our products. They share that within their network and the multiplier effect is definitely kicking in here. And add to that, that we've really taken a different look at how we market both our company and our products. And we're seeing the benefits from that here as well. And then, you know, we constantly look ahead to the future. There are some really strong market trends working in our favor. At the most recent annual general meeting, I talked about several of these, including the increased clinical focus on MARSI or medical adhesive related skin injury. as well as the looming shift in infection surveillance from what's referred to as CLABSI and shifting in the future potentially to HOB. These trends will be working in our favor, some today, some into the future. We're constantly monitoring them and looking at how do we assess our business and make sure that our offerings are in line with favorable trends and riding those waves. And then as I've had the opportunity to work with our team on opportunities, be they sales opportunities in the funnel, business opportunities to go after new products, new ways to look at different business models, and so much more, our hopper of our opportunities is really abundant right now. Definitely a good thing. Incumbent on us as leaders to assess and prioritize to the critical few and then go after them with flawless execution. And of course, that's actually the harder part. Tough decisions on what we choose to do and what we choose not to do. But having the ability to choose is a really good position to be in. And last but not least on this page, as we've had the opportunity to work with the full Kovalon team, I see a team that is really energized with a can-do attitude and an approach of doing things the right way. We're building a new culture here at the company. And we'll showcase this a little more in a future call. We're actually rolling this out in our first wave of our new culture journey tomorrow to our broader team members up at our Mississauga location. But suffice to say, I'm really excited about the company culture we're building and demonstrating each day. And going back to the value that our customers see with our products, you know, just a quick view of some of the amazing healthcare facilities that have adopted our products. both leading children's hospitals as well as notable acute care facilities. Some absolutely amazing care taking place in these hospitals and utilizing our products to help make a difference with the patients that they serve. And then, you know, to wrap up today's presentation so that we can take some questions, you know, really solid quarter. Really pleased to see a great outcome. to what I saw as some outstanding work by the team to get there. We do see continued line of sight to strong growth and profitability for the rest of the fiscal year and then into 2025 and beyond. We expect to see our really strong momentum continuing here. And the hard work that the team is doing every day on the foundational items, it's super critical and we do believe that it will enable significant value for Kovalon today, tomorrow, and well into the future. And now one last point before we open up the question and answer period. We really do appreciate all of you who have invested in us or are considering investing in us. We're really excited about the future and really glad to have you with us. With that, I'll turn it over to the operator for Q&A.

Thank you. And we will now open the floor for questions. As a reminder, if you would like to ask a question at this time, simply press the star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, please press star 2. Alternatively, you can submit type questions via the webcast.

Okay, I can see we've got some good questions that have come in. And the first question is from Jason Sinensky. Good morning, Jason. And the question is, do you have the opportunity to take gross margins up further from Q2 levels? And the answer there is yes. We do think with continued focus, you know, we got benefit this quarter from both product mix as well as from some greater efficiencies and investments in in-house manufacturing. And I think on the latter, as we continue to drive cost out and efficiencies up, I think there's opportunity there. And then certainly as we continue to grow and see greater efficiencies in the products that we sell, see a good opportunity there as well. And so and so, you know, I think that's part of it. Also worth noting, you'll see in our in our financial notes that in the current quarter, there were there were still there was another provision for inventory obsolescence. And, you know, that's part of that foundational cleanup work. You know, some some activities in the past that generated a lot of inventory that has been slow moving. Uh, we've moved beyond that, but, uh, still, uh, uh, still, uh, took, uh, took, uh, uh, an accrual there. And so as, as that situation fully resolves itself, uh, from the past, I think we'll, we'll be continued to be in better shape. On is dependence on us sales a risk if Trump wins the election and increases import duties on everything foreign. Good question. I'm going to for sure stay away from any political commentary. You know, we see a really strong market in the U.S. and the health care side of things. I mean, the reality is lots of it's a huge market in the U.S. and very resilient market. We're always looking at, you know, where we make and source products from and make decisions on where is the best location for that. And so, you know, tough to predict, you know, first of all, which way the election will go. But we're always looking at different contingencies on that front and what would make sense for us moving forward. We have a question from, it's showing up as Matthew Martin. Can you expand on the changes you've made to the U.S. sales team and go-to-market strategy? For sure. So the changes really, you know, there were some significant investments made several years ago to bring on a larger team Part of it connected to an acquisition that we made several years ago and then some changes from there. You know, fundamentally, last calendar year, so in 2023, some tough decisions were made to consolidate down that team. And I'm really proud. So we right-sized the right things and where we can drive the most value. And really, I would see it as being a do more with less approach. As we've made some further changes earlier this year around our commercial leadership and consolidating commercial leadership under Ron Hebert, our Senior VP of Growth, I think we're seeing really good focus. We're certainly, you know, part of growing is defending the existing business you have. And we're really proud that our products are proving to be very sticky with our customers. But also looking at, you know, expanding our business within our existing customers, as well as growing from there. You know, we're seeing a lot of interest from new customers. But I'd say that that'd be the sales and marketing strategy there. And we do see a lot of strength in our U.S. hospital business. You're seeing the growth there. And it's really exciting times for sure.

That was a similar question from Jason. And John Irving asked a related question. I'll maybe just build off a little.

being quite striking. More color there.

I guess just to build off, right, what are the right incremental changes to make?

And I think we've got as we continue to grow and

Jordan Q has a question on the seasonality of the business. Katie, do you want to answer that?

I think the short answer is we're in such a strong growth mode that I don't know that it's easy to see a lot of seasonality. Typically, a lot of our business comes from

particularly bad, you know, seasonality. How about you? Yeah, anything we've been seeing is as we get more and more

So far there hasn't been any seasonal basically with the sales and we've been, it's actually, it looks like it will keep growing and hopefully expanding without fluctuations.

Thanks, Katie. John Irving has another question around cash stabilization. Do we expect cash to build through the end of the year? Yes, we do. With the turnaround of the company and profitability, where as we continue to grow sales and expand margins, we don't expect to see a lot of big like capital, CapEx investment or whatnot. And so with the momentum of the business, That would be our expectation. Of course, things can pop up from time to time. And so we're cognizant of that. And I think building upon the cash gives us good ability and flexibility if something emerges that we either want to take advantage of or need to deal with. Good to have that flexibility, as Katie pointed out. Jason had another question around um, the Middle East business. Can, can you update us on the Middle East business? Yeah. So that's, uh, that's a business. It represents about 10%, a little more than 10% of our geographic revenues. And, uh, it's, it's obviously, uh, an exciting part of the world. Um, we're fortunate. We, we go to market there through strong partnerships and, uh, have a team led by Hector Padilla and really that success with pull through of products.

We do see it as a market that similar to the U.S.

but very does that we look for continued growth in. Irving has a question, a few of them.

He's got the last question for me, which I think has an exclamation point or smiley face. Do you see good traction in the Canadian market? You know, that's an area that as we continue, the short answer is we don't have a super large presence in the Canadian market.

North America region, we see it as a very strong return on investment. Canada is definitely an area as a Canadian. going forward. And I think we're seeing, you know, as we go forward and evaluate, okay, where do we, where do we deploy precious sales and marketing a little bit differently as well.

And then working through the questions here, Jason, Q2 revenue, feel sustainable. I like the way you, so nothing, and I'll, one time, success.

Advancement as well as.

Oh, yeah, you know, Q2 revenue, I'd say definitely sustainable, and we hope to continue to grow at bigger and bigger numbers.

Those. More difficult. Side to continue to momentum.

As we continue to become a more solid and predictable company, we may in the future choose to give specific guidance. At this point, we see a lot of upside, a lot of momentum building. but we're not giving specific guidance on either revenue or other key financial metrics. As I said, we do see a strong growth momentum and do, you know, especially with this strong quarter here in Q2, do see the pathway to full year EBITDA profitability and excited about that. So that ends the online questions. I'd say, hey, appreciate the questions. It shows a strong interest in the business and our company, and we greatly appreciate that. I will turn it back over to the operator.

Thank you. We do have a question from Tony Kamen with Eastwood Partners. Please go ahead.

Two related questions, one of which I think you kind of touched on, but just again with this last quarter, was there anything unusual in terms of inventory of your customers being low, so they were filling the channel a little more aggressively this last quarter, or was this just, did you not see any sort of extraneous issues on this quarter? Was it a normal quarter, I guess?

the question but you know with growth where we saw it I'd say normal not the word I would use I'd say from years we've wave different waves of women this is on drugs on whatnot the short answer is a very small amount of in, I think, and really net neutral.

As we look forward from Q2, you know, we do see slight benefit from that. Tens of thousands of dollars Probably close to net neutral, maybe a little bit of positive benefit.

Do you have any? We're seeing a sense of our customers slowly increasing our orders.

be that it's them catching up with our customers. The POs are coming in every so often, and they're just getting bigger as we go, as they're ordering.

Your kind of sales pipeline of your competitors that's

to make progress in that area.

Just kind of curious and whether can kind of continue. Yeah, I'll you know, is marked by several

large companies and it's a big space but i do think we've carved out a really strong opportunity where our compassionate care message is is resonating um so nothing i would say uh in uh big

uh, you know, the space overall is, is growing both unfortunate things, uh, fortunate wound care. So whether it's diabetes or, you know, surgical wounds, a lot of, uh, a lot of increases there.

And on the vascular access side, uh, you know, I think, uh, a couple of years ago, we saw a big spike on the ICU side, um, uh, with COVID and that's certainly subsided, but, uh, again, uh, good for our business, but, but not as good for society overall, or for those that have loved ones, uh, in the ICU, uh, those, those ICU, excuse me, beds are, are, you know, uh, remaining pretty full in most hospitals and, uh, And so I'd say that characterizes more of the market overall. But, you know, we're always focused on how do we position our products best against our competition. We know our customers have choices to make.

And I'd say we feel good about where we're at. And for the future as we continue to refine our competitive positioning.

Thanks a lot, Tony.

Thank you. Thank you.

And I'm showing no further questions at this time. I would like to turn it back to Mr. Brent Ashton for closing remarks.

I guess we'll skip through that Q&A slide. Hey, thank you so much, everyone. First of all, as I said, some really good questions. I appreciate the interest you have in the company, and hopefully Katie and I gave you the answers that you were looking for.

As we go forward, you know, we've got a lot of momentum that we're building. A few minutes to go. We appreciate your interest in the company. We appreciate your investment. And looking forward.

The quarter we just had a lot of hard work from a lot of people, the entire company, in fact, to seeing people.

And I will also say that we also recognize that one quarter, the three to five year, five year, run starts with a job to do. For sure, myself, our leadership is to build upon this again next quarter and the quarter after that. Exciting journey here. We look forward to a strong future. So thank you very much. a great rest of your week. Thank you, presenters.