Covalon Technologies Ltd

XTSX:COV

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Covalon's Q2 fiscal 2023 Conference Call and Webcast. My name is Joelle, and I will be your conference operator today. As a reminder, today's conference is being recorded. [Operator Instructions] 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, Mr. Pedlar and Mr. Gorel.

[Brian Pedlar, executive]

Thanks, Joelle. Good morning, fellow investors. Thanks for joining us on the call this morning. Saleha Assadzada from Covalon is helping to coordinate the conference call and webcast today, and she's now going to provide us with some instructions.

[Saleha Assadzada, executive]

Thank you, Brian. Good morning, everyone. My name is Saleha Assadzada, and I'm 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 Covalon's second quarter ended March 31, 2023. 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 Covalon'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 conference call.

Due to risks and uncertainties, including those identified by Covalon in our public securities filings, actual events may differ materially from current expectations. Covalon 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, Covalon 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, Covalon's President and Chief Executive Officer.

[Brian Pedlar, executive]

Thanks, Saleha. I'll provide some context to our strategic plans that we are executing on in 2023 and also provide some context to our Q2 2023 financial results. We'll also talk about some of our growth objectives underway this year and beyond this particular fiscal year. Then we'll take your questions as been mentioned either through the phone line or via the message function on the webcast.

So Covalon isn't just another medical device company. Covalon has an incredible portfolio of assets, including our infection prevention products and technologies that truly help prevent patients from getting an infection while in hospitals. We have our amazing advanced wound care portfolio of products that help close complex wounds. We also have a 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 turn to us for new product development help. And we have a very talented team that is focused on our mission and committed to our strategic growth plan.

With our strong portfolio of products, and technology, Covalon is focused on providing our customers and their patients with cost-effective products that reduce pain, help prevent infection and promote healing. Hospitals around the world are struggling with rising infection rates and a failure of their traditional products that they've used for decades to help them prevent hospital-acquired infections. Uninsured hospital-acquired infections in the United States have increased as much as 63% in intensive care units over the past few years, and health care providers are demanding better products, products like ours.

Our strategy is very simple. We believe that innovative, compassionate care products, like ours, when delivered efficiently to the people that need them, will displace the current standards of care in hospitals and in home care settings because those products result in better clinical outcomes and better clinical -- clinician-patient interactions at a lower cost of care. Our products are loved by doctors, nurses and patients, and many of the hospitals in the United States use Covalon. We are very focused on becoming the leading provider of compassionate care solutions that help patients heal faster and live better.

On the last few calls, I focused on things that we had deliberately planned to invest in and change in 2022 to transform Covalon and the progress we have made so far in 2023. We are truly a much more valuable company today than we were a year ago. Whether we are talking about our ability to drive awareness of our brand to clinicians in U.S. hospitals, our significant presence in pediatric facilities or our strong -- our strong distribution into United States home health care markets or our international presence and brand recognition in over 20 countries. Covalon is stronger and better positioned to succeed.

As an investor, it's very easy to focus on the past and miss the signs that highlight just how much we have transformed over the past year. Again, we are a much more valuable company today than we were a year ago. There are some investors that have taken the time to understand what has changed with Covalon and are focused on the future. Taking a look at our revenue growth over the past 5 quarters, I believe, helps to illustrate the progress we are making. None of us can be 100% certain of the future, but there's one thing that I am convinced about as are the rest of the Covalon team, a year from now, we will be a significantly more valuable company than we are today.

We are beginning to see the results of the changes we've made in our company in our Q2 and fiscal year-to-date performance. We are in a much stronger position in our key markets compared to last year, and we are seeing the results of investments we made in 2022 positively impact us in 2023. I am pleased to report that revenue so far this fiscal year for the first 6 months is up 63% to $13.4 million and our Q2 revenue is up 120% to $7.2 million compared to last year.

Gross margin for the quarter has improved to 58% compared to last year's Q2 gross margin of 53%. Our previous investments in added leadership in our sales, talent, marketing and operations, along with our focused approach to key revenue markets have strengthened Covalon. We incurred a loss of $698,000 this past quarter, which compares to last year's Q2 loss of $2.5 million. I anticipate that we will continue to improve our operating results in coming quarters and improve our bottom line as we grow. We are on track with our growth plan, and we have already made strong progress in the first half of 2023 towards reaching our goals. We finished the quarter with $11 million of cash on our balance sheet and no debt. We anticipate being able to maintain a strong cash position as we continue to fund our working capital and operations for the foreseeable future.

Both product revenue and development and services revenue were up this past quarter compared to last year's first quarter. We continue to focus our growth efforts on markets where we feel we can capture significant and meaningful market share for our products, whether that's within the United States hospitals and home health care settings or internationally in the Middle East and Latin America. That also includes focusing on our medical coating development services customers that we can develop into deeper and meaningful partnerships as we help them bring advanced infection products to the market.

The United States accounted for about 74% of our revenue this past quarter. Q2 revenue in the U.S. increased by about 119% to $5.4 million and was driven by increased collagen sales, increased development services, and additional -- adding additional hospital customers. International revenue more than doubled to $1.8 million as a result of deliveries under competitive contracts that have been awarded to Covalon in the Middle East. This year, we are continuing to invest in our sales and marketing efforts to grow our customer base in the United States and strengthen our brand worldwide.

Our sales and marketing team started fiscal 2023 with a focused sales and marketing strategy based on the planning and investments we made in 2022. We have seen positive impacts in our product sales to hospitals and through our distributors in the United States. We've seen increased orders from our international channels and stronger services revenue from our medical coating products -- projects. I think we have proven that our products and that our brand can consistently compete and win in competitive contracts against much larger companies.

Gross margins have improved in the first 6 months of 2023. Gross margin for this past quarter was about 58% compared to 53% for the same period of the prior year. As part of our customer focus initiatives, we improved our supply chain operations and invested in upgrading both business systems and infrastructure. Additional ongoing investments to allow us to better serve customers and drive growth in key markets going forward include expanding our in-house manufacturing and our medical coating services capabilities. The full positive impact on our margins from our supply chain improvement initiatives are expected to be further realized over time. We continue to align our operating costs to our growth prospects as we see the results of our improved sales and marketing initiatives and as we fully realize the benefits of our efforts to transform our supply chain.

Operating costs from continuing operations for this past quarter increased about 17% over the same quarter last year. Our team is executing on deliberate and well-planned strategic activities to reposition Covalon to be able to unlock value from our lifesaving, patented products and technology, and we are investing in our people, our commercial capabilities and our infrastructure.

As I've mentioned several times, we invested heavily in 2022 in strengthening our sales team with staff and capabilities to engage our customers, whether that's digitally, virtually or in person. Today, we engage with customers and sales leads in a much more efficient and cost-effective way than we did before. This allows us to grow more rapidly with less investment going forward.

Strategic priorities for this fiscal year for 2023 include a focus on strengthening our core business areas with respect to people and processes. We are confident that the changes we have made to Covalon will allow us to consistently achieve our objectives. We have been aggressively pursuing key hospitals in the United States, aggressively pursuing growth of our collagen business and competing and winning contracts for our products internationally. We have closed the gap to becoming profitable, and we are continuing to balance our growth prospects and our operating costs, so we can generate greater value for Covalon and achieve our targets.

The momentum we have and the certainty of purpose we have in our products and our mission will allow Covalon to succeed. Some of the best hospitals in the world have selected Covalon to help them reduce infections and give their patients a better chance to heal. Our growing hospital customer base and our results from the first half of our fiscal 2023 demonstrate that we are moving in the right direction with respect to the investments and the strategy we put in place. This includes several key business areas, including our sales and marketing, our operations and our information technology infrastructure. We are excited about our progress in transforming Covalon into a patient-driven medical device company built on the relentless pursuit to help the most vulnerable patients have a better chance at healing.

I would now like to open the line for questions. I ask that you try to keep to one question and a follow-up at a time. There will be lots of opportunity to get back into the queue to ask more. Thank you.

[Operator]

[Operator Instructions] Your first question comes from Jason Senensky with Chapter Twelve Capital.

[Jason Senensky]

Just on the product revenue side, so some good results there. In the news release, you called out the collagen business as well as IV Clear. Can you just provide a little more color within the collagen business and within IV Clear what you're exactly seeing, especially on the IV Clear side? I know that's been a real focus from a sales and marketing perspective.

[Brian Pedlar, executive]

Sure. So we did experience growth across both the collagen or IV Clear and several other product areas, including VALGuard, which is a new product we launched in the last 18 months. We're definitely seeing growth in our U.S. collagen business. That's a business where we go after the home health care and long-term care markets through really good portfolio of distribution partners. And we're seeing a lot of positive signs of growth as well as increased orders on that side.

IV Clear is a product that we sell both internationally and in the United States directly to hospitals. We're seeing some growth in U.S. hospitals. But we're seeing -- and I think a big part of the uptick internationally is driven by IV Clear's positioning in international markets. And so, again, I think we are seeing great signs of our ability to compete and to win against the larger companies internationally, and we're seeing that within the United States market as well. Obviously, the U.S. market is a key focus of ours and is the largest health care market in the world, and our products are very well positioned to compete and win in the hospital space within the U.S. health care system.

[Jason Senensky]

Okay. And maybe just as a follow-up. In the news release, you mentioned that you anticipate continued growth in revenue this year compared to fiscal 2022. I know things can be lumpy, especially on the collagen side, but does that mean that you expect for the full year 2023 revenue will be up over 2022? Or was that a comment particularly in the second half of 2023, you expect to see like continued growth relative to the second half of 2022?

[Brian Pedlar, executive]

Yes. Good question, Jason. If you look at the first half, we're up 63% with 120% increase in our Q2 quarter. That comment is meant for the entire year, including the back half of the year, we do anticipate increased revenue growth over last year. No guarantees that our growth rates are consistent quarter-to-quarter. As you know, we do have a bit of a lumpy business, particularly when it comes to international shipments that tend to go in container-full shipments, and they can go out the door June 25 or July 8, and they fall into a different quarter. But in -- but absolutely, we're seeing very strong signs of continued growth for the back half of this year. And we do anticipate that we'll do better than we did last year in the back half as well.

[Operator]

Your next question comes from Sal [indiscernible] with -- he's a private investor.

[Unknown Attendee]

Thanks very much for your information. And it looks like a pretty decent quarter here. So I continue to enjoy the growth that you guys are showing. I did have a question on the cash. I think I asked this last time I was on the call too that in the Q2 last year, we had $22 million, and we're down to $11 million now. So we used $11 million. And the concern is that are we going to be at 0 next year this time because we did use up $3 million also in the last quarter. So what are your thoughts on our cash? And how are we going to manage that to not have to either go into debt or go into the equity market?

[Brian Pedlar, executive]

Yes, Sal, thanks for the question. And I know you've -- I think you've been following us for a while and...

[Unknown Attendee]

I have been a long time.

[Brian Pedlar, executive]

Yes. And you've got -- you always have great questions. So I'll say this. I think if you take a look at our cash flow statement for the first 6 months of this year, you'll see that there's a line that says cash used in operating activities before change in noncash working capital balances. So before managing working capital, for the first 6 months in operations, we consumed $238,000 of cash. We have probably a little more cash tied up in working capital than we'd like. And we have a pretty strong focus to reduce and optimize our inventory levels and manage our receivables, which are in very great -- very good shape and manage our payables to reduce the investment in working capital to free up more cash going forward.

And then if you look down, we do have our normal course issuer bid that's consumed a little over $1 million of cash this year. And that comes to an end at the end of this month. And so, unless the Board decides to continue with it, that use of cash will disappear. So I think we're in pretty good shape. Last year, we did invest purposefully some of our cash in order to reposition us for growth. We're seeing some of that impact this year as our revenues and our engagement in the market is up. So I'm not -- I'm always concerned and watch cash very carefully, but we're not in a burn position where we're going to continue to burn cash on a go-forward basis anywhere similar to last year. Last year was purposeful investments that we made to reposition us. So I think we have -- as I said in my opening remarks, I think we are -- have enough cash for the foreseeable future, and we're not going to be in a situation where we're forced to go to the markets to raise.

[Operator]

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

[Jason Senensky]

Just on the development and consulting services revenue line, Brian, like it's very strong in Q2. It was also strong in Q1. Can you provide any additional color on what's driving that? Is it mainly related to the large device contract? And can you sustain something sort of in that level going forward?

[Brian Pedlar, executive]

Yes. So I think we -- certainly, we have one large contract that we publicly disclosed back in 2018. We're continuing to work very diligently on that with our partner -- projects going well. We're coming close to the time where -- that the first product will enter the FDA clearance phase. And then once clearance is granted, we'll hit the market. That's on track. There's always things that can make a project speed up or slow down, but that's going well.

We also have several other smaller projects in earlier stages that we work on. I think there is a bit of lumpiness to these projects as we work on our -- our part of the project. We deliver our medical -- the medically coated products to our partners. They go through testing phases. So often, these are sprints of work with a bit of a waiting period while our partner does some analysis and does some things on their side and then we get to the next phase. So -- but in general, I think we've -- we're on the right track in that -- in that part of our business, and we do anticipate stronger revenues. They will be a little lumpy quarter-to-quarter, but we do see stronger opportunities and growth there. COVID really did impact a lot of the projects and a lot of companies put things on hold while they focused on other priorities during the last couple of years. I think a lot of that noise is gone. And so, we're seeing a lot of opportunities that are a little bit more steady than they were probably 2 years ago. So large project going well, other projects at earlier stages do see the opportunity to continue to have better -- higher revenues than we've enjoyed in the past under the development and consulting services part of our business.

[Jason Senensky]

Okay. And maybe just then related to that. So on the gross margin side, on an adjusted basis, I think you were flat year-over-year and you've kind of been talking about the opportunity for that to climb higher. So maybe like the development and consulting services revenue, I mean, what is the margin profile on that business? Is that sort of above the consolidated gross margin? Or how do we think about that mix issue?

[Brian Pedlar, executive]

Yes. It's generally a positive margin business compared to our overall margin. It's more of a people and infrastructure-based services business at this stage until it kicks into the royalty stage, which, as you know, the royalty and license streams are -- generally fall straight to the bottom line. We've been really focusing on supply chain and reducing the cost of many of our key product offerings.

We have talked about bringing in-house a significant portion of our collagen manufacturing. We are also looking at ways to take cost out of other products, both by placing more bulk orders, which allow us to get economies of scale as we work with outside contract manufacturers but also looking at our product set and focusing on those that have stronger margins over those that perhaps have weaker margins. And so, a lot of the work we've done and the plans that we have in place are just beginning to impact our margins. So over time, I do anticipate that we will improve margins. Again, it's not a linear path, but we definitely have in place several strategies to help drive stronger margins for us overall.

Margin is also very impacted by the geography and the product mix. So sales in the United States have a different -- when we're selling directly to hospitals have a different margin profile than selling through international distributors where often those products have to go through a couple of hands. And so just the mix of revenue within a quarter can significantly impact our margins. But I think we've got really good plans in place, and we do see -- some of the investments that we've made are beginning to pay off in better margins, and there's several of those initiatives that are yet to fully impact our margin profile.

[Jason Senensky]

Okay. So maybe just last one for me. I think in the previous question you -- asked you a bit about cash generation. And you mentioned there was a $2 million inventory build year-to-date for the fiscal year. Can you share what product line that's associated with? Is that mainly collagen or antimicrobial?

[Brian Pedlar, executive]

It's -- it probably -- it's sprinkled across our wound care portfolio, our collagen and our antimicrobial silicone products. Some of that was investing in raw materials as we increase our in-house manufacturing and the large part of that investment happened in our first quarter. So I think if you -- we don't disclose this normally in our financials on a quarterly cash flow basis. But I think if you look at it, a large part of that investment was in our first quarter. As we were ramping up and -- ramping up production, we tend to buy raw -- raw materials in bulk. And then also -- it's also about us monitoring our supply chain. And again, the world is still not back to normal 100% in supply chain. And so, we take opportunities where we think there's an opportunity for us to get a better margin by looking at a product where we can forecast out over a longer period of time and be assured that product that we acquire will move in a reasonable period of time, but try to buy it in a little bit more bulk quantity to get a little bit better margin out of it. We do see -- we've done a little bit of that in our first quarter and in this quarter as well. So most of that investment in inventory that's going to move over a short period of time. And as I talked about in working capital and cash, we do see the opportunity to reduce the cash invested in inventory and other working capital areas. And so, we are very focused on trying to bring that down to level.

There is a sort of a stocking that we do need to have to make sure that we don't run out of product as sometimes we're not 100% in control all the time of our contract manufacturers and when they -- when the products are available coming off of their production lines for us because, again, they schedule us into their production. But -- but we've got a good team in place, and we've been working really hard to get better and better at that planning, and I think we're on the right track there.

Now we'll turn to a couple of the questions that have come in. There's several questions that have come in about the normal course issuer bid. And just to refresh, we -- June 2, 2022, we filed for and were approved from normal course issuer bid that goes on for a 12-month period. And so, our current normal course issuer bid will end March 31. And the question that came back is, will the company commence a new normal course issuer bid once the current one is completed?

That -- we have not made a decision on that as a Board and as a management team. I think we -- I think it was a prudent investment to -- for us to use some of our excess cash to invest in our own shares that we believe are at a value that does not reflect the underlying intrinsic value of the company. And so, stay tuned. If we do decide to continue with the new one, we will obviously announce that in the course of those decisions being made.

That looks like it for the questions. Again, thank you very much to -- for participating in today's call. As always, I'm confident that the changes we have made to Covalon over this past year, and quite honestly, our progress up to today is going to, over time, demonstrate the value that I believe exists in Covalon. I can assure you that the team is working very hard. And I want to reiterate again, we are a much more valuable company today than we were a year ago. And I do believe that a year from now, we will look back and realize just how much more valuable a year from now we will be than we are today. Thank you. I look forward to discussing our progress on the next call.

[Operator]

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