Covalon Technologies Ltd. (CVALF) CEO Brian Pedlar on Q1 2021 Results - Earnings Call Transcript

Covalon Technologies Ltd. (OTCQX:CVALF) Q1 2021 Earnings Conference Call March 1, 2021 9:00 AM ET

Company Participants

Brian Pedlar - Chief Executive Officer

Danny Brannagan - Chief Financial Officer

Conference Call Participants

Operator

Good morning, ladies and gentlemen. And welcome to Covalon Fiscal 2021 Q1 Financial Results Conference Call. My name is Joanna 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 Brian Pedlar, Chief Executive Officer and Mr. Danny Brannagan, Chief Financial Officer. Please go ahead, Mr. Pedlar and Mr. Brannagan.

Danny Brannagan

Thank you, Joanna. My name is Danny Brannagan and as Covalon's Chief Financial 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 first quarter ended December 31, 2020. 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 is 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 the 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 anticipate 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 its 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 in this call Covalon has provided non-IFRS measures that are meant to provide further understanding of our results by helping to highlight trends and to 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.

For the first quarter ended December 31, 2020, Covalon's total revenue was $6 million, with a net loss of approximately $0.4 million or $0.01 per share. This compares to the prior year's first quarter, which saw a total revenue of $8 million and a net loss of approximately $1.2 million or $0.05 per share. The overall gross margin was 60% in this quarter compared to 61% in the prior year's first quarter. The gross margin is influenced by the source revenue and mix of products sold. Operating expenses decreased by nearly $2 million, or 34% for the first quarter of fiscal 2021. The decrease was to $3.8 million, compared to $5.8 million for the same period of the prior year. The change is primarily driven by a reduction in staffing related expenses and other discretionary costs. The company also recorded approximately $300,000 of government subsidies that are netted out against operating expenses.

Consistent with the year ended September 30, 2020, the company is supplying more information to provide supplemental context for the gross margin and for the earnings figures to help compare these figures to other periods, but they should not be used in place by IFRS measures. The adjusted gross margin for the first quarter of fiscal 2021 was 61% compared to 64% in fiscal 2020. The adjusted EBITDA for Q1 was a loss of approximately $134,000 compared to a loss of approximately $126,000 in the same period for the prior year. The adjusted EBITDA removes the impact of government subsidies and other non-cash expenses as outlined in the MD&A. The company continues to assess subsidies and grants that are made available to companies that have been impacted by COVID-19. The company has been approved for and received a second draw under the US Paycheck Protection Program, which will be recorded as an offset to future operating expenses as the conditions of the program are satisfied.

We will continue to provide updates related to subsidies as we report on our future results. Revenue decrease was predominantly related to the United States or COVID-19 related delays at a contract manufacturing facility and a temporary slowdown in consumption of our products in the hospital settings. The production related delays are non-recurring in nature, and the hospital demand is anticipated to continue until hospitals and healthcare facilities resumed normal levels of elective procedures. Product revenue for the three months ended December 31, 2020 was $5.4 million compared to $7.2 million in the previous year. As mentioned, this was primarily driven by the decrease in the United States. Revenue in the Middle East was $0.8 million in Q1 of fiscal 2021 compared $0.9 million in Q1 of fiscal 2020. And revenue and other international markets was $0.7 million compared $0.6 million in the previous year.

Development and consulting service revenue for the three-month period ended December 31, 2020 was $0.5 million compared $0.7 million for the same period of the prior year. In the first quarter of fiscal 2021, the company had approximately 75% of revenue in the United States, and the remaining revenue was approximately split between the Middle East and the rest of the world. Subsequent to the quarter end, the company has received a waiver for all breaches related to our banking facility with HSBC that occurred as of December 31, 2020. At quarter end, the company was offside on financial covenants, which resulted in the full amount of the outstanding debt to be classified as a current liability. Covalon has a strong relationship with HSBC and the history of obtaining waivers for covenant breaches, which has been the approach taken as it relates to COVID-19 impacts. We believe that we will be able to obtain waivers in the future, but recognize that there are no guarantees. As previously discussed, Covalon continues to have access to an additional $1 million lending facility through HSBC, and the Business Development Bank of Canada.

This program is called the Business Credit Availability program. As discussed on previous calls, the acquisition note payable on the company's balance sheet relates to a vendor take back note from the acquisition of AquaGuard. The full amount is listed as a current liability. However, the note holder entered into a subordination agreement with HSBC that unconditionally and irrevocably deferred, postponed, and subordinated in all respects this note to the HSBC debt. HSBC debt is currently scheduled to be repaid in 2024. The note holder does not currently have recourse under the signed subordination agreement, and Covalon continues to make payments on this HSBC debt as scheduled.

I would now like to turn the call over to Covalon's CEO, Brian Pedlar.

Brian Pedlar

Thanks, Danny, for the review of our Q1 results for fiscal 2021. Good morning, fellow investors. Thank you for joining Danny and I on this call. Our first quarter of fiscal 2021 which ended on December 31, 2020 demonstrated continued sequential quarter-over-quarter improvements in our operations and financial performance as we continue to deal with the effects of COVID-19. In virtually all financial metrics revenue, gross margin, operating expense, net loss, adjusted gross margin and adjusted EBITDA, our results for the quarter ended December 31 were an improvement on our financial results for the quarter ended September 30, 2020. Just to remind everybody I thought at its heart Covalon is an infection prevention company that was founded on the strength of our lab. And over the years, we have developed patented technology platforms that we have leveraged to create highly competitive products and services to help protect patients from getting infections and help heal wounds.

We generate revenue by selling our products through over 30 established medical product distribution networks with a major focus on the United States. We also sell our products in Latin America, Middle East and Europe. In the United States, we have our own salesforce that calls on around 2,000 hospitals. And our AquaGuard product dominates its market category in the US and has become a key brand recognized by clinicians and our hospital customer base. COVID-19 is still affecting our customer base, and some of our suppliers. But our team at Covalon continues to work very hard to overcome the challenges facing us. And the improvement we saw this past quarter as a result of that hard work. As we look forward with fiscal 2020, fully in the rearview mirror, I absolutely believe the steps we have taken over this past year to mitigate the impacts that COVID-19 has positioned Covalon to overcome the pandemics impact on our company to grow ourselves and to return to profitability.

Last year's quarter ended December 31, 2019 saw full year and a bit ago, was the last quarter before COVID-19 impacted our business. So as we compare our results from this December to last December, we have to keep that in mind. We had undertaken an aggressive plan to significantly reduce our operating expenses over the year. And we were able to achieve a 34% reduction in operating expenses in the quarter ended December compared to last year. This allowed us to achieve year-over-year improvement in our net loss and a near breakeven adjusted EBITDA in Q1 which ended December 31.

This improvement occurred despite our Q1 revenue being down 25% year-over-year. As Danny mentioned, we use contract manufacturers to make many of our products and unfortunately as a result of COVID-19 related delays in production and shipments of our collagen products in the United States, we were unable to recognize revenue on a number of customer orders. Due to these delays these orders were not able to be manufactured and shipped until after December 31, 2020. Our team has worked closely with our contract manufacturing partners to get production and shipments back on track. And I'm happy to report that we have made significant progress in mitigating the delays. Restrictions imposed by governments and the significant deferral of elective procedures by hospitals in the United States and internationally, negatively impacted our product sales and our ability to sell to new customers most of last year.

We are seeing signs that these restrictions are beginning to lift as vaccinations continue in the United States, and we are able to gain access to key hospitals to advance new sales. We continue to monitor for signs of revenue recovery in our US hospital customers. And I'm optimistic that the improvements we have seen over the past several months will continue. In response to the challenges engaging with hospitals, we launched three new products during the second half of 2020 into our US hospital and clinic customer base. I'm happy to report that our sales team in the United States is experiencing strong engagement from clinicians in evaluating these new products despite the lockdown restrictions. We are leveraging our strong reputation with clinicians for protecting patients and solving clinical problems at the bedside to engage them on our new products.

I'm very pleased with the level of sales activity we have generated in such a short period of time. And under the very difficult circumstances our sales team has faced over the past year. I see strong potential for these products in our US hospital customer base. Now we are only beginning - at the very beginning of unlocking the significant value of having 2,000 hospitals and clinics as customers of ours in the US. We also develop antimicrobial products for big medical companies using our patented medical technology and we do that here in Mississauga, Ontario. This quarter, we engaged in approximately 10 customer development projects of various sizes with five medical product companies. We're very excited about these projects, including the various projects currently underway with our previously announced major contract, one of the world's largest medical device companies.

As we have previously discussed on calls and announced in press releases in response to expressions of interest made by medical industry and private equity organizations, Covalon's Board of Directors formed a special committee and hired advisors to assist in undertaking a strategic review process to ensure that all available strategic alternatives to enhance value for our shareholders are being evaluated. The special committee is carefully deliberating on what actions if any, are in the best interests of the company shareholders. While this process continues underway, our team continues to remain focused on executing on our growth strategy, promoting our life saving products to the medical industry and providing meaningful growth opportunities to all of our dedicated staff. Now as we look forward for the remainder of this year fiscal 2021; as I mentioned, we are seeing signs of improvement in product usage by our customer base in the United States. And internationally even though COVID-19 restrictions have not fully eased in many of the geographies in which we operate.

We do expect better top line results in fiscal 2021 than we experienced in fiscal 2020. I also expect that our gross margins will remain similar to Q1 for the remainder of fiscal 2021 with minor changes, as product mix changes quarter-to-quarter. Our operating expenses in 2021 are anticipated to be consistent with fiscal 2020 and further reduced by additional government subsidies as Danny discussed relating to COVID-19 relief programs. The changes we have made to our operations have placed the company in a position to return to growth and profitability in 2021. We are working hard to return Covalon to profitability and I expect to do so in our next fiscal quarter, which is ending this month on March 31, 2021.

With our cash on hand, and amounts available under our HSBC operating bank lines, we believe we have sufficient future cash flow to support our operating needs going forward. I would now like to open the line for questions. I ask that you keep to one question at a time. There'll be lots of time to get back into the queue to ask more. So I'll turn it back over to Joanna.

Question-and-Answer Session

Operator

[Operator Instructions]

First question comes from Tony Kim from Eastwood.

UnidentifiedAnalyst

Hi, Brian. It sounds like you're making some good progress returning the company back to a better trajectory. But my question is on the special committee on year-end press announcement, there was a lot more commentary from your Chairman that he was pleased with progress that had been successful in attracting additional bids that it showed how undervalued, this one was a much more concise commentary. And so I'm wondering, is there anything to be read into that or?

BrianPedlar

Tony thanks for the question. No, I mean, we just for the sake of that release came out only a short while ago. It's absolutely the same message. The special committee is continuing its work. There were strong expressions of interest. We continue to evaluate all options. And so that's going according to plan. So I wouldn't read anything in to the brevity of this of what we included in this release at all.

Operator

Next question comes from Arnold Shell, an investor.

Unidentified Analyst

Yes, Brian. I had a similar question, just wondering why the special committee is taking so long to come to some conclusions.

Brian Pedlar

Arnold, these things tend to have a timeline that runs. We, to be honest, we had such incredible interest that it does take a while to get through all of that process with everybody. And so I think that the committee and our outside advisors are efficiently working through that process. And they're taking it very seriously evaluating all the options. And it's - that process is continuing and going quite well. So please don't read anything negative into the length of time. I think it's just a factor of making sure that all options are considered and considered fully. I appreciate the comment.

Operator

Thank you. No further questions at this time, you may proceed.

Brian Pedlar

Okay, thanks, Joanna. I'm really confident that what the improvements we've made to Covalon over this past year, and quite honestly the progress to date in 2021 is going to demonstrate the significantly unrealized value that Covalon shareholders, I believe will experience and will realize in the near future. The hard work continues. And Danny and I both look forward to discussing our progress on the next call as we talk about our upcoming March 31 results. Thanks.

Operator

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