Covalon Technologies Ltd

XTSX:COV

Earnings Call Transcript 2022-Q2

[Brian Pedlar, executive]

[Audio Gap] was $8.2 million, which is up -- which is a 19% growth over the same period last year. This year-to-date growth is predominantly driven by increased product sales into our core market, which is the United States.

We continue to see strong growth opportunities for our key products in the U.S. for both our collagen and our infection prevention products. As we are all aware, during the quarter ended March 31, 2022, the Chinese government imposed severe restrictions on Shanghai businesses that resulted in significant restrictions on the ability for companies to manufacture and ship products out of Shanghai.

We were negatively affected by these restrictions as were most worldwide supply chains. This resulted in delays in product shipments from our warehouse in Shanghai, and our second quarter revenue was $3.3 million as a result. We are in the fortunate position of being able to withstand this temporary supply chain disruption. We have a very strong balance sheet with $22 million of cash as of March 31, 2022, and no debt.

Our customer base is very loyal, and our customers simply love our products. With every shipment -- even with our shipment delays, they continue to be vocal champions for Covalon. In addition -- in addition to being ahead of last year's revenue by 19%, despite the shipping restrictions in Q2, our gross profit margin, once adjusted for revenue provisions was 60% for the first 6 months.

Our efforts to improve our operations are having a positive impact on our gross margin. Because of the delays in shipments in Q2, our gross margin for the -- gross profit margin for the quarter was $1.7 million compared to $2 million in Q2 fiscal 2021.

On an adjusted basis, our margin was 56%, which is up from last year's 54%. Margin is heavily influenced by product mix and any inventory provisions booked in a quarter.

Turning to our Q2 revenue for the reasons we discussed around delays in shipping product revenue came in at $3 million compared to $4 million in the same period in the prior year. We are still seeing very strong demand for our products in both the United States and in our international markets. I'm very encouraged with the current activity we are seeing in our hospital customer base and our collagen distribution channels and our international markets.

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 IV Clear, VALGuard and SurgiClear products can solve real clinical problems associated with unwanted infections for Intensive Care Units and surgical patients.

We are also seeing growth opportunities around our collagen products, including our collagen powder that we launched in 2021. We have invested in improvements to our supply chain and our manufacturing capabilities in order to efficiently meet the increasing demand for our products that we're seeing. In our commercialization facility in Mississauga, we manufacture our recently launched collagen powder and collagen dressings to meet increased market demand.

By being able to manufacture in-house certain products, 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 as our gross margins on an adjusted basis are up over last year.

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, where we have a solid base of hospital and collagen customers.

We also redeployed some very strong team members that were previously focused on our divested AquaGuard business to support our growing U.S. operations. 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 and resources and personnel in the shortest time possible.

I am highly confident that we will achieve our growth objectives. As we previously announced, 2 experienced industry veterans joined Covalon, Ron Hebert as Senior Vice President of Marketing; and Mark Doolittle as Senior Vice President of Commercial Sales. Both Mark and Ron are very talented and experienced executives that have a strong -- that have individually strong track records in creating value in medical companies.

Ron, Mark and I, along with the rest of the management team are laser-focused on building Covalon into the powerhouse it deserves to be, given our unique life-saving medical technologies.

So I'm going to talk now a little bit about some growth drivers. And this is one of the reasons that I believe Ron and Mark joined Covalon. We have world-class products that are sought after by clinicians and 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 also the only company in the market currently with a collagen wound filler with antimicrobial silver.

These products, as I mentioned, are supported by a portfolio of intellectual property, patents and know-how that give Covalon 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 that have a clear path to substantial revenue over the next several years.

We see strong opportunities to cross-sell our IV Clear and VALGuard products through our existing U.S. customer base. We are already seeing additional contract opportunities internationally for Vascular Access Technologies. 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 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 hospital and ambulatory surgical center channels, we also anticipate meaningful revenue growth from our perioperative care products. Even though our revenue for Q2 was below expectations due to circumstances beyond our control, I'm very encouraged with the growth prospects we are seeing in the second half of fiscal 2022.

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.

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 intending to buyback up to 5% of Covalon's shares for cancellation.

To this end, as previously announced, the company has filed its intention to make a Normal-Course Issuer Bid or NCIB for its common shares with the TSX Venture Exchange, which is subject to regulatory approval. 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 Covalon is working harder than ever to grow our business and continue the positive progress we have made to date.

These improvements are already positively impacting our growth prospects, and Covalon is well positioned to take advantage of growth opportunities in 2022 and 2023. I would now like to open the line for questions. I ask that you try to keep to 1 or 2 questions at a time, if you're calling in, and there will be lots of time to get back in the queue to ask more. Please also feel free to use the chat function in the webcast. I'll turn it back over to you, Michelle.

[Operator]

[Operator Instructions] Your first question comes from Sepehr Manochehry of Eight Capital.

[Sepehr Manochehry, analyst]

Congrats on some of the recent impressive hires. Just a question on the timing of the delays with the shipments. Is that something that you've gained visibility on? Is that basically orders that are going to be pushed forward to the next quarter? Or you see ongoing delays? And are things getting kind of pushed over or are those lost orders? And what visibility do you have on Q2, I guess?

[Brian Pedlar, executive]

Yes. Thanks,. I appreciate the question. We -- the orders -- what happened in Shanghai specifically was basically all the facilities, manufacturers as well as warehouses were shut. People were not allowed to go to work. So shipments that we had sitting waiting to go in March could not be shipped out. . And so that -- those restrictions have stayed in place and have recently been lifted. So those shipments are now going. So I don't consider it lost. It's delayed.

[Sepehr Manochehry, analyst]

Understood. So do you expect, I guess, relative to the quarter prior to this, do you expect to see this backlog, let's call it, to cause quarter-over-quarter growth above your -- what was previously a $20 million run rate?

[Brian Pedlar, executive]

Well, what happens up is -- these are consumed products. So there's order patterns in our distribution chain, including at hospitals and the products need to get consumed and reordered. And so we -- there will be some impact that gets pushed forward into quarters going beyond the quarter that we're in right now. But that's -- in general, I would say it's not lost business. .

[Sepehr Manochehry, analyst]

Understood. That's great. And just on the recent hires, is the focus to really have them lead the scaling in the U.S.? Or is the focus right now some of these international markets specifically, I guess, some of the legacy ones like Saudi Arabia, some of the other regions that you've talked about?

[Brian Pedlar, executive]

Yes. So we have good strong distribution channels into our international markets. And so although our team is looking at Ron and Mark specifically in our marketing and sales teams are looking at the world in total. . The real focus is growing our U.S. presence where we see a lot of opportunity. And we have a really strong base of both hospital customers and collagen distribution partners that we see opportunities to grow. So their main focus of the entire company is going to be growing in the United States. But obviously, we have solid distribution channels internationally as well.

[Sepehr Manochehry, analyst]

And have you guys kind of internally come up with a number or goal in terms of hospitals you're in now versus ones you want to get into -- and is that something you can kind of ballpark?

[Brian Pedlar, executive]

Yes. I think there's -- we're in a small fraction of the hospitals right now. I'd say we have probably 60 hospitals that are buying products from us. There's a -- and that's 60 out of 6,000 that exist. So there's a huge growth opportunity for us.

We have a good solid platform. We're in some of the top children's hospitals that are world-class facilities. And when we're dealing with solving serious clinical problems with some of the most vulnerable patients, that position where we're able to do that in those facilities translates very well for our ability to solve those same issues in adult populations. And so I think leveraging our current position will help us accelerate that growth. So we're adding hospitals on a continuous basis as customers.

And we're trying to try to maximize our ability to solve the clinical infection problems in each facility. And that happens over time as well. So our business within our installed base grows as well as us adding additional facilities.

[Operator]

Your next question comes from Arnold Shell.

[Arnold Shell]

Just a follow-up from that question. One when you bought AquaGuard, I thought you said it gave you entree into 1,500 hospitals. And just now you said you have 60 hospitals that buy products from. Can you -- what's the difference between the 1,500 and the 60?

[Brian Pedlar, executive]

Yes, Arnold, good question. When we sold the AquaGuard product those hospitals that were buying AquaGuard we went with the transaction. We have contacts and relationships, but not all of the AquaGuard hospitals were also buying other Covalon products like IV Clear, VALGuard or SurgiClear.

We have a good solid base, and we're trying to maximize our opportunity in those hospitals. And we have relationships and entry points into the historic AquaGuard installed base. But we can't call those our customers if they're not buying our current Covalon products from us.

[Operator]

Your next question comes from [ Sal Ditheres ]

[Unknown Analyst]

I got my question, and it was very, very similar to the first question you answered, but I want to just be clear on 1 or 2 points. So I'd appreciate if you could just give me a little additional info. I was questioning again $3.3 million, and the reason for that was major delays in the product shipments from the warehouse in Shanghai. And you also mentioned that you're able to withstand this temporary supply chain disruption.

The question I have, and I think you answered part of it already, is what is the current status of these disruptions and delays and can we expect to see some of this flow through that didn't come through in the second quarter in quarter 3 and 4? I think you said some or most of these restrictions have been lifted. Is that correct?

[Brian Pedlar, executive]

Yes. We're -- Sal, it's a good clarification point. So yes, the restrictions are lifting. You can imagine there's a bit of a backlog in Shanghai, not only with us, but all the other organizations that have warehouse facilities and factories there.

So our shipments are moving now, and they will -- the products that are there will begin to move out. Again, I reiterate that some of these are consumable products. So they go to facilities, they need to get consumed and then they reorder. So some of the business gets shifted beyond this current quarter into the following quarter. But in general, I don't view this as lost business at all.

[Unknown Analyst]

So okay. Then should we expect to see improved revenues in Q3 and Q4?

[Brian Pedlar, executive]

Well, it's our intention. Again, you've been following Covalon for quite some time. And we're not -- I got to be careful we're not providing guidance, but based on what we see right now in our book of orders that we have and our shipments that are going out, I do see improvements going forward in our Q3 and Q4. .

[Operator]

[Operator Instructions] Your next question comes from Jason Senensky of Chapter Twelve.

[Unknown Analyst]

Sorry to belabor the Shanghai issues, but just wanted to go back there. I guess I wasn't aware that the company had any operations in Shanghai. Could you just provide a little more color on whether that's on the collagen side of the business, the antimicrobial side? And is it fair to assume that, that operation is mainly or exclusively shipping into the Middle East?

[Brian Pedlar, executive]

Jason, it's mostly our wound care products. Our infection prevention products generally come out of the U.S. And so it's mostly our non-collagen based wound care products that come out of the Middle East -- or sorry, out of Shanghai, and they go all over. They go into all of our international and as well some into our North American channels.

[Operator]

Your next question comes from Arnold Shell.

[Arnold Shell]

Yes. Also about Shanghai. Why do we have a warehouse in Shanghai and how long have we had it?

[Brian Pedlar, executive]

Arnold, we've had a warehouse there for 7, 8 years. And it's because some of our products are manufactured in Shanghai or outside of Shanghai and are shipped from there to various parts of the world. So it's a -- we have contract manufacturers in the United States as well as in China.

It happened that we got caught up in the government closures that happened there. Normally, we have a pretty strong supply chain and plan ahead. This was just out of our control.

[Operator]

[Operator Instructions] Your next question comes from Joseph [ Sheer ].

[Unknown Analyst]

I'm confused. You speak about missed shipments as being often consumed, which I assumed you meant that a hospital would say, "Well, we use so much of a certain material over a week, a month or whatever it is. So we order that. Of course, if you don't receive it, so many patients who had operations during which they might use some of this, have had their operation, have left and they're not returning.

So it's not something that will add to that will be recovered in sales later on. The hospital had certain budget or forecast for the use of this. So it's consumed. It's like a restaurant. You can't say, well, you miss some -- you had to close for a blizzard, and therefore, you will recover those the meals that will be, they're lost, they're gone. I thought that's what you meant by consume, but yet you keep saying that no, you'll recover these sales. Could you -- am I -- I'm confused, I guess.

[Brian Pedlar, executive]

Okay. Joseph, sorry, I -- what I said was confusing. So you have to think of this as a supply chain. So we ship to our distribution partners that tend to warehouse and then ship to hospitals that also tend to warehouse. So the reason that it's a delay, and I don't view it as a loss is that our products are not just in time consumed the day that they arrive at a facility. They're consumed over periods of time. . And so the inventory that's in the distribution channel will drop below normal levels, but it doesn't mean that facilities run out of our product. The product will make its way to the facilities. There may be some that -- where the product levels within the hospitals and our distributor warehouses fall extremely low.

But in general, I think with the delay that we've had over a couple of months on these shipments. Unfortunately, it fell out of our revenue, but they -- we will pick them up again and they'll impact our revenue going forward in a positive way. So there is a supply chain that has a product in it. And that's why it's not really like meals in a restaurant. It is more like products sitting on shelves and in the back warehouse of Walmart. So hopefully, that helps explain it.

[Operator]

There are no further questions from the phone lines. At this time, I would like to turn the conference back to Emily Hill. Please go ahead.

[Emily Hill, executive]

I'll read our first questions from the webcast. The first question comes from Jason Senensky, Chapter Twelve Capital, who asks to please discuss priorities for Ron and Mark in their first year with the company.

[Brian Pedlar, executive]

Yes. Thanks, Jason, for the question. Ron and Mark and the entire team are focused on a few key areas. One is immediately helping to grow our top line revenue.

We're also implementing much stronger digital engagement with our clinicians. So we can educate and support and train them in a manner that's as efficient as possible as well as to use their experience in order to look at further opportunities for us to penetrate the market with our current products and sales up for growth going forward as we look at additional opportunities to leverage our products into treatment areas that we're currently not focused on. I appreciate the question.

[Emily Hill, executive]

Our next question comes from Dave Kegler, who asks, you mentioned that the decrease in revenue was a result of government restrictions in Shanghai relating to COVID-19, which adversely reduced the company's ability to ship products to customers.

My question is, if there were no restriction or supply chain issues, what do you estimate your revenue would have been? And do you see this continuing into the next quarter?

[Brian Pedlar, executive]

Yes. Thanks, Dave. Really appreciate the question. I don't foresee the supply chain issue specifically that we faced in Shanghai continuing into this quarter that we're currently in. And I think we'll just stay tuned and see what our numbers are that we release as of our June quarter. I'm not going to speculate on where we would have been. I don't think that's fair. But I certainly appreciate the question.

And I think we'll see going forward that we're more -- our quarters are more in line with where we all anticipated they would be. Thanks, Dave. I appreciate that question.

[Emily Hill, executive]

We have 3 questions from Howard Patrick, private investor. He asks, why is there almost a total lack of interest in the stock. What efforts are being made to market it to a wider audience? And why is there an absence of analyst coverage from major houses?

[Brian Pedlar, executive]

Howard, thanks for the questions. I don't believe there's a lot -- a total lack of interest in the stock. We are a thinly traded stock, but I got a lot of interest from shareholders. I talk to shareholders every day, both current and potential shareholders. So we are attending a lot of shows. I've attended several of them and have several more coming up where we are their investor shows.

And as far as analysts, I think you've heard on the phone, there's been several that are asking questions on these calls and are beginning to follow the company. So I think we're making progress on that front. But I certainly appreciate the questions.

[Emily Hill, executive]

We have a question from Arnold Shell, who ask for the Normal-Course Issuer Bid, does the stock price have to fall further before you start the purchases.

[Brian Pedlar, executive]

Arnold, no, we're simply just waiting for the approval from the TSX Venture Exchange. And as soon as we receive that, there's a short waiting period of a couple of days, and then we will begin the process. And I think we all feel that the value of Covalon is not aligned with its stock price.

And so a good use of our capital currently is to reduce the number of outstanding shares. So we'll be moving forward with the -- aggressively on the NCIB as soon as we are able to do so.

[Emily Hill, executive]

We had a series of questions from a private investor. Who asks, have sales/supply normalized debt given the COVID restrictions in China. Did Covalon lose customers as clients sought other suppliers or have sales normalized. Why don't we start with those 2, and then we'll get to second half of the question after.

[Brian Pedlar, executive]

Yes. So I think we've talked a lot about Shanghai and the issues there. So I'd like to readdress that. I don't think we've lost any customers. I think, in fact, we've -- we're beginning to gain and are gaining customers. Just there -- we are in a lumpy business where our shipments internationally tend to be lumpy as we ship large containers full of product.

In the United States, as we look at our hospital business, that's a little bit more steady. But right now, our quarterly revenue can swing based on when shipments leave. And we saw that we had planned a significant number of shipments going out that didn't make it into our Q3.

So I think increased prospects -- the world has changed as far as how medical products companies engage with hospitals. Before COVID, 70% of the sales done in our industry were face-to-face. Now that's reversed and a lot of engagement is happening virtually and digitally, but we're also obviously still able to get into facilities and engage one-on-one, but our preference is to engage clinicians and facilities in the most efficient way possible. And so that's really where I see the opportunity for our growth going forward.

And that's one of the reasons that Ron has joined the organization. He's got a strong background in engaging with clinicians digitally and through multichannel in the U.S. market.

[Emily Hill, executive]

This investor also asks how much of an increase in collagen production capacity has been as a result of investments?

[Brian Pedlar, executive]

I think there's been a significant. We have a patented process of making our product that allows us to expand production without major investments in capital equipment. And so I think we have a good, strong capacity right now. And we will continue to grow that as we see the business growth prospects continue over the next 12 months.

We have a pretty good visibility into that marketplace. And I'm really encouraged with our ability to manufacture cost effectively and our capacity within that part of our supply chain.

[Emily Hill, executive]

Our next question comes from Arnold Shell, who asks if Covalon is looking to alternatives to China to mitigate risk going forward.

[Brian Pedlar, executive]

Again, I think this is a temporary issue, Arnold. Changing suppliers and contract manufacturers of medical devices requires regulatory processes that take a certain period of time. . I think we are comfortable that this situation we face was temporary, and I think we're largely through it. So I don't -- we are always on the lookout for better, safer products for our patients. But right now, I think we have a pretty good relationship with our partners there, and I don't foresee that we're going to have the same issues going forward.

[Emily Hill, executive]

Our next question comes from John private investor, who asks, over the years, you've had a few big deals like the ones with [ America ] and then your Saudi Arabia deal. Unfortunately, both have not produced the initial results expected, do you expect any large contracts with these to occur in the future?

[Brian Pedlar, executive]

We're always engaging with large medical partners that are interested in our products. And we have the option with some of our technologies to license them where we don't think we have the opportunity or it's not the best use of our resources to exploit them directly in the market.

So we're continuously talking to large companies about opportunities whether that's distribution or otherwise with our platform technologies. So one of the benefits at Covalon that we have such a depth of products and intellectual property that there's lots of opportunities for us in order to unlock that value in different ways. So that's that is still part of our business model, and we see opportunities and are engaging with organizations. Those tend to take a long period of time to come to fruition.

And we don't -- it's not our main focus at this point, but it can certainly move our needle rather quickly when we do enter into one of these lucrative opportunities.

[Emily Hill, executive]

Our next question comes from Trevor Holsinger at Aspen Wealth. Who asks, Mark Doolittle has experience with U.S. health care group purchasing organizations and integrated delivery networks, CPOs and IDNs, respectively. Can you discuss these networks and how this can expand sales?

[Brian Pedlar, executive]

Sure, Trevor. Great question. Really appreciate it. There's sort of 2 tracks that we have to follow in order to be successful with U.S. hospitals. And one of those is engaging clinically with the physicians, nurses and other clinicians that are going to use our products on patients. And the other is working with the C-suite, the group purchasing organizations as you've identified in IDNs that are contracting products from medical companies. And so we have to hit on both of those in order to be successful. . And Mark certainly brings a lot of experience in engaging at that level. And I see this as a way for us when we do get clinical -- clinicians to really champion our products. We now have the opportunity to attack these revenue sources from both the clinical and the business side, which I think is necessary for us to accelerate our growth. So certainly, Mark has experience there as does Ron, and I'm really looking forward to the opportunity to engage with these organizations differently than just strictly through a clinical means. So a great observation and a great question, Trevor. I really appreciate it.

Looks like we're out of questions. I really appreciate everyone's participation in today's call. I'm confident that the fundamental improvements that we've made to Covalon and our progress to date are going to demonstrate the significant unrealized value for our shareholders that I believe currently exists in Covalon. And I can assure you that we are working very hard and are laser-focused on building value in the company, and I look forward to discussing our progress on our next call. Thank you for attending today's call.

[Operator]

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