Covalon Technologies Ltd

XTSX:COV

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Covalon's Q2 fiscal 2024 Conference Call and Webcast. My name is Ludi, and I will be your conference operator. As a reminder, today's conference is being recorded. [Operator Instructions] 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.

[Brent Ashton, executive]

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 Covalon and specifically our second quarter performance. Katie Martinovich, our Interim Chief Financial Officer, is joining me in this presentation and Saleha Assadzada from Covalon is also helping to coordinate the conference call and the webcast today and will now provide us with some instructions.

[Saleha Assadzada, executive]

Thank you, Brent. Good morning, everyone. My name is Saleha Assadzada, and I am the executive assistant to Covalon's Chief Executive Officer. I would like to thank everyone for taking the time this morning to attend our conference call. We will be discussing the financial statements, MD&A and press release related to Covalon'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 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-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 mentored, place 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, Covalon's Chief Executive Officer.

[Brent Ashton, executive]

Thanks, Saleha. 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 Covalon for coming up on about 5 months, and I've really enjoyed my time here. It's been a whirlwind for sure, but it's been great to meet our Covalon 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 Infusion Nurses Society Annual Meeting, where Covalon 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 Covalon 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 3 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 8 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 Covalon 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 Covalon 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 am really pleased with the way we achieved this strong outcome. Really 3 big drivers that combine to deliver the positive EBITDA started with strong revenue growth. And then we also had very solid margin expansion and combine that with reduced operating expenses. We'll talk more about these in a few slides, but success with all 3 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 postoperative dressings business. This combined segment represented a little more than 75% of our revenue this past quarter, and we grew up 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. 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 in to Covalon and assess what's working well and what needed to improve. We have an amazing Covalon 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've 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.

I'm really excited to lay down the 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 1 that the whole Covalon team is very passionate about.

You can see on the slide here, the 3 primary business platforms that we have here at Covalon, our advanced wound care business, which is led by our ColActive Plus and ColActive Plus with silver products. And then our vascular access and postoperative dressings business where we have our IV Clear, CovaClear and SurgiClear products. These 2 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 1 that we indicated a few quarters ago that we were deprioritizing effort on to shift even more focus on the 2 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.

We talked about the growth overall, solid, but I really would like to draw your attention to that product revenue piece. This captures the 2 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 U.S. 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 in 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 U.S. 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 double-click on our financial performance, I'd like to turn the call over to Katie.

[Katie Martinovich, executive]

Thank you, Brent. The company's financial performance for the 3 months ending March 31, 2024, reflects significant improvements in 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.

Covalon'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. Covalon 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 relating to staffing and the associated travel expenses. In general and administrative costs, we have decreased cost 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 is a -- this has been the first full quarter of subleasing 2/3 of our U.S. warehouse location, which has also reduced our cost. 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 gross revenue. The positive net income achieved for the first time since Q4 2021 underscores Covalon'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, Covalon has been able to achieve profitability, therefore, improving our earnings per share from a negative $0.003 in Q1 to a positive $0.06 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 base, indicating strong financial health and substantial resources available for growth investments.

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 Covalon 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 growth strategies, reinvesting earnings into our core operations and long-term projects.

Healthy liquidation. Covalon 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.

[Brent Ashton, executive]

Thank you so much, Katie. To dig a little bit deeper here into some key components of momentum that we're building here at Covalon. 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 products' 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 are very proud to give them some tools in their toolkit to help their patients in a caring and compassionate way. 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 to 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 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 MARCSI 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 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 Covalon 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. And our first wave of our new culture journey tomorrow to our broader team members up in 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, just a quick view of some of the amazing health care 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 wrap up -- to wrap up today's presentation so that we can take some questions. 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 Covalon 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.

[Operator]

And we will now open the floor for questions. [Operator Instructions]

[Brent Ashton, executive]

Okay. I can see we've got some good questions that have come in. And the first question is from Jason Senensky 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, 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 I think that's part of it. Also worth noting, you'll see in our financial notes that in the current quarter, there were still -- there was another provision for inventory obsolescence. And that's part of that foundational cleanup work, some activities in the past that generated a lot of inventory that has been slow moving. We've moved beyond that, but still took an accrual there. And so as that situation fully resolves itself from the past, I think, we'll be -- continue to be in better shape.

We have a question from Arnold Shell on its dependence on U.S. 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. 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 a very resilient market. We're always looking at where we make and source products from and make decisions on where is the best location for that. And so tough to predict, 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 change is really -- there were 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. Fundamentally, last calendar year, so in 2023, some tough decisions were made to consolidate down that team. And I'm really proud. So we rightsized the selling team to focus on 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 Eber, our Senior VP of Growth, I think we're seeing really good focus. We're certainly -- 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 expanding our business within our existing customers as well as growing from there.

We're seeing a lot of interest from new customers. But I'd say that would be the sales and marketing strategy. 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.

There was a similar question from Jason. And John Irving asked a related question, I'll maybe just build off a little bit. around the decrease in operating expense being quite striking and did provide a little bit more color there.

I guess just to build off of that, we're looking at, okay, now as we go forward, right? What are what are the right incremental changes to make? And going from there, Ron, working with his team. I think we've got some exciting plans as we continue to grow and grow the team as well. So we'll go from there.

Jordan Q has a question on the seasonality of the business. Katie, do you want to answer that? I think the short answer is I don't 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 the ICU. And sometimes you see peaks if flu season is particularly bad. Hopefully, we don't get into another COVID wave situation. But I don't think we see a lot of seasonality. Katie, would you like to [indiscernible] us?

[Katie Martinovich, executive]

Sure. Okay. Yes, we don't really see seasonality. If anything, we've been seeing a lot of growth. It's as we get more products out there more into all the different hospitals and expanding, but 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.

[Brent Ashton, executive]

Thank you, Katie. John Irving has another question around cash stabilization. Do we expect cash to build through the end of the year?

Yes, we do. We -- 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 of something emerges that we either want to take advantage of or need to take -- need to deal with. Good to have that flexibility, as Katie pointed out.

Jason had another question around the Middle East business. Can you update us on the Middle East business. Yes. So that's a business that it represents about 10%, a little more than 10% of our geographic revenues. And it's obviously an exciting part of the world. We're fortunate. We go to market there through strong partnerships and have a team led by Hector Padilla. And really that partnership driving success with tenders and the clinical pull-through of products. We do see it as a market that similar to the U.S. but very different market, similar in the sense that the value proposition of our products does resonate and certainly an area that we look for continued growth in.

Last -- sorry, John Irving has a question. A few of them. He's got the last question for me, which I think has a exclamation point or smiley face. Do you see good traction in the Canadian market?

That's an area that as we continue -- the short answer is we don't have a super large presence in the Canadian market at this time. Our priority within the North America region, our strong priority has been on the U.S. We see it as very strong return on investment that we're making. But it's -- Canada is definitely an area, as a Canadian headquartered company, it's an area that we do see a focus on going forward.

And I think we're seeing interest from some notable pediatric and acute care facilities and as we go forward and evaluate, okay, where do we deploy precious sales and marketing effort. It's an area that I think with the way we're doing things a little bit differently, we can have some impact in it as well.

And then working through the questions here. Jason had another question. Was there anything onetime or unusual in Q2 revenue Asked differently, does the Q2 revenue level feel sustainable?

I like the way you -- so nothing -- and I'll defer to Katie. I don't think anything materially from a onetime or unusual Q2 revenue, just some really solid success in both the advanced wound care led by the collagen product as well as the vascular access space. And so yes, Q2 revenue I'd say, definitely sustainable, and we hope to continue to grow it significantly. As you get to bigger and bigger numbers, those high growth percentages become more difficult. But we do have line of sight to continued momentum and continue the strong growth.

And that's a good segue to the last question we have here that talks about, can you describe your line of sight on growth for the rest of the year?

We're -- 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, 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, that's -- I 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.

[Operator]

We do have a question from Tony Kamin with Eastwood Partners.

[Anthony Kamin, analyst]

Two related questions, 1 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 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?

[Brent Ashton, executive]

Thanks very much for the question, Tony. Normal -- with growth where we saw, I'd say, normal not the word I would use, I'd say, strong quarter, but I get where you're coming from. And I would say it's a good question on inventory. Over the past couple of years we've seen through the kind of COVID wave, different waves of inventory shortages on medical devices, on drugs, and whatnot. The short answer as it relates to Covalon is, we did see a very small amount of kind of back order recovery.

And I think that might have caught the very tail end and really net neutral. As we look forward from Q2, we do see a slight benefit from that. But it's really tens of thousands of dollars, not anything major. So I'd say after Q2, probably close to net neutral, maybe a little bit of positive benefit, low $10,000, $15,000. Katie, do you have any specifics there?

[Katie Martinovich, executive]

What I can add to it is that as we -- we're seeing a steady increase of our customers solely increasing our orders. So it is definitely -- it doesn't appear to be that it's then catching up. that they're definitely -- we're definitely growing within our customers. The POs are coming in as every so often, and they're just getting bigger as we go -- as they're ordering.

[Anthony Kamin, analyst]

That's great. And then my final question. In terms of your kind of sales pipeline, is there something going on in terms of the competitor -- your competitors and your positioning vis-a-vis your competitors that's allowing you to make progress in that area. Just kind of curious how you're seeing the competitive position and whether you believe you can kind of continue to seemingly gain share here?

[Brent Ashton, executive]

Yes, I'll take that. Two good questions, Tony. So thank you. The competitive space 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 resonating. So nothing I would say in the Q2 quarter, where we've seen any specific big competitive moves. I think the space overall is growing, both wound care -- it's one of those unfortunate things. fortunate for us as a company, unfortunate for us as society, wound care, so whether it's diabetes or venous insufficiency, surgical wounds, a lot of increases there.

And on the vascular access side, I think a couple of years ago, we saw a big spike on the ICU side with COVID, and that's certainly subsided. But again, good for our business, but not as good for society overall or for those that have loved ones in the ICU. Those ICU beds are remaining pretty full in most hospitals. And so I'd say that characterizes more of the market overall. But 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 strong opportunities for the future as we continue to refine our competitive positioning. Thanks a lot, Tony.

[Operator]

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

[Brent Ashton, executive]

I guess, we'll skip through that Q&A slide. 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, we've got a lot of momentum that we're building, and I'll close with comments I made a few minutes ago.

We appreciate your interest in the company. We appreciate your investment in the company and looking forward to continuing the momentum going forward. on my way up to our Toronto offices here as I end this call and looking forward to thanking them in person. The quarter we just delivered doesn't happen without a lot of hard work. from a lot of people, the entire company, in fact.

And so looking forward to, we have a town hall tomorrow, looking forward to seeing people and congratulating them on a job well done. I will also say that we also recognize that 1 quarter doesn't make the 3- to 5-year run here. But every good 3- to 5-year run starts with 1 good quarter. And so our job to do, for sure, myself, our leadership team, our entire Covalon team is to build upon the success we had this quarter deliver again next quarter and the quarter after that, and the -- hit and the year after that. And we're on an exciting journey here, and we look forward to a strong future. So thank you very much. Everyone, have a great day and a great rest of your week. All the best.

[Operator]

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.