Covalon Technologies Ltd. (OTCQX:CVALF) Q3 2020 Earnings Conference Call August 24, 2020 9:00 AM ET

Company Participants

Danny Brannagan – Chief Financial Officer

Brian Pedlar – Chief Executive Officer

Operator

Good morning, ladies and gentleman, and welcome to Covalon’s Fiscal 2020 Q3 Financial Results Conference Call. My name is Pam, and I’ll be your conference operator today. As a reminder, today’s conference is being recorded. All lines have been placed on mute to prevent any background noise.

At this time, I’d like to turn the conference over to Mr. Brian Pedlar, Chief Executive Officer; and Danny Brannagan, Chief Financial Officer. Please go ahead, Mr. Pedlar and Mr. Brannagan.

Danny Brannagan

Thank you, Pam. 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’s fiscal third quarter ended June 30, 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 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 the risks and uncertainties, including those identified by Covalon in its public security 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.

For the third quarter ended June 30, 2020, Covalon’s total revenue was $6.7 million, with a net income of approximately $300,000, or $0.01 per share. This compares to the prior year’s third quarter, which saw a total revenue of $6.9 million and a net loss of approximately $3.5 million, or $0.16 per share.

Operating expenses decreased for the third quarter to $2.5 million compared to $7.3 million for the same period of the prior year. The operating expenses were offset by approximately $1.8 million of government subsidies, which when adjusted for, shows the operating expenses were down $3 million over the comparative quarter.

The overall gross margin for the third quarter was 46% compared to 59% in the third quarter of the prior year. The gross margin was lowered by some one-time costs and the selling of personal protective equipment, which was at very low margin.

For the nine months ended June 30, 2020, Covalon’s total revenue was approximately $20 million, with a net loss of $4.8 million, or $0.18 per share. This compares to the prior year’s comparative period, which saw a total revenue of $27.5 million and a net loss of $5.6 million.

Operating expenses decreased to $14.8 million compared to $22.9 million in 2019. The overall gross margin for the nine months decreased to 54% compared to 65% in 2019.

Subsequent to June 30, 2020, Covalon entered into an amended and restated credit agreement with HSBC Bank Canada. The amended agreement provides relief under certain financial covenants until March 2021. The amended and restated agreement also includes access to an additional $1 million through HSBC and the business credit availability program offered by the Business Development Bank of Canada.

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

Brian Pedlar

Thanks, Danny, for the review of our Q3 results for fiscal 2020. Good morning fellow investors and thank you for joining Danny and I on this call.

Now, during the quarter ended June 30, most of the medical device industries focus was on dealing with COVID-19. At Covalon, our team worked night and day to assess the impact first off of COVID-19, adjust our business practices and make changes to our business in order to position us the best that we could during this pandemic.

I want to start off by thanking each and every Covalon team member for their very hard work over the past five months. It’s not been easy, but I’m very proud of what we’ve been able to accomplish over that period of time. This work continues, because we are not fully out of the grips of COVID-19. And I feel that we have made great progress over this time.

Now there are very – there are a few important events that happened during our third quarter ended June 30 and into July and August that I want to highlight. The first event is that our efforts in reducing operating expenses, which those efforts have been ongoing over the past 12 months, and our team’s ability to generate new sales allowed us to achieve a profit for the quarter ended June 30, with the help of government subsidies related to the COVID-19 relief. We still have a lot of work to do, and I’m confident that we are on the path to operational recovery.

The second event is that we are already seeing some signs of recovery in July and in early August in our United States hospital customers. We are seeing increased elective procedure volumes at consumer products and we are cautiously watching to determine if these signs of recovery continue.

Thirdly, as Danny mentioned, we amended our banking agreement with HSBC. And that does provide us relief under certain financial covenants, some of which are that relief ends in March 31, 2021 and others that are ongoing. They’ve also made available to us through the BDC BCAP program, as Danny talked about, an additional borrowing facility of $1 million.

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We have a very good relationship with HSBC and they have been very supportive of Covalon and management throughout this pandemic. Based on the numerous conversations I’ve had with the HSB team – HSBC team, I anticipate that their support will continue through future quarters.

Now the fourth event is that we’ve introduced new products that do not rely on our elective procedures for consumption in hospitals. So these new products have allowed our sales team to engage with existing and with new customers and to advance sales opportunities for our current products and these new products with these potential accounts.

So while these products have not materially contributed to revenue in the quarter ended June 30, I’m confident that we will see positive results over time. Now there is no question that we were hit hard by COVID-19 during the past five months, but we have been able to respond and to mitigate some and, in cases, much of the damage that other companies are still trying to figure out how to deal with.

Our revenue in our key markets is indeed down. And sales for the quarter ended June 30 were flat compared to last year. This is in stark contrast to the growth that we were seeing before the pandemic hit.

The fact that we have an incredible portfolio of product and technology has allowed us to respond quickly to generate additional opportunities. Many of the positive gains we’ve made in the United States, Latin America and the Middle East, are hidden by the negative impact of COVID-19 on our hospital sales.

Sales to hospital customers in the U.S. were down about 40% in the quarter due strictly to COVID-19, but sales to our wound care channel in the U.S. were up. Sales in Latin America were also up compared to last year. And we also completed the transition of our Saudi Arabian business to our new distributor in the region, and sales in the Middle East were up.

Our team has displayed determination and creativity and continuing to engage with current and new hospital customers. Parts of our sales cycle that were previously only done face-to-face were changed. Our team figured out how to be effective over video and over the phone.

We are seeing positive signs of hospital customers willing to trial our new products that we have introduced, and we’re beginning to be able to visit some hospitals face-to-face for sales calls again. Our team has assessed our current customer base account-by-account and the decline in business that we have experienced is temporary. We have not lost any major customers. I think these are all positive signs that recovery is beginning.

Overall, our operating costs for the past nine months are more than $8 million lower than last year. This is an important improvement. And, as needed, we are continuing to examine reducing operating expenses, reducing headcount and reducing discretionary spending in an effort to return Covalon to consistent profitability. I believe we are well on our way to doing so.

Now another area I want to highlight is the diversity of our technology and the strength of our ability as a company to adopt and innovate. And this has allowed us to launch new products in a very difficult time that are less affected by a reduction in hospital procedures. So our lab and our technology platforms are indeed world-class. And this is a very important asset for Covalon.

We recently announced our CovaGuard product line, and this has allowed our sales team to engage with new customers, both inside and outside of our traditional medical customer base.

We are also – we also introduced CovaClear and VALGuard products that are targeted at helping to prevent infections in neonatal and pediatric patients. Neonatal and pediatric departments in hospitals were much less affected by COVID-19 than other departments. And we are beginning to engage with literally hundreds of hospitals with these new products, which they – which help to solve real life-threatening clinical infection problems.

Collectively, these efforts over time, will contribute to revenue, help to reduce any long-term impact of COVID-19 on our existing product sales and make us a stronger company.

Now I talk to customers everyday. And one theme that continues to be present in almost every conversation is our customers appreciate the strength and depth of our infection prevention products. They see that our products can help them upgrade how they deal with the potential of infection within their hospitals and facilities and have far better outcomes for their patients. This is often overlooked as a strength of our company.

I also talk to fellow investors everyday, and there’s one theme that is present in almost every one of those conversations. The true value of Covalon is not reflected in our stock price. Our world-class platforms of technology are 2,000 hospital customers in the United States.

Our products that are so loved by clinicians and patients alike, the stability we’ve returned to our Middle East market, the growth underway in our other international markets, and the untapped massive potential of our products have not been fully reflected in our share price. I believe investors have a truly unique opportunity to realize significant upside on what I consider a heavily undervalued healthcare asset, which is Covalon.

We are an infection prevention company, with world-class technology and very talented people. I’m firmly convinced that protecting ourselves from bacteria and viruses is a focus area that is going to consume the thoughts of all of us inside healthcare and outside for the foreseeable future.

As the world emerges from COVID-19, I have no doubt that we, Covalon, will emerge as a stronger and much more valuable company because of our unique and highly respected infection control technologies that I think will be in greater demand than ever.

I’m confident in the steps we’ve taken in Covalon to get us into the best possible position for the long-term. And I have no doubt that we’re going to see positive impacts in increased revenue, better operating results and expanded opportunities.

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I would now like to open the line for questions. And I ask that you please try to keep to one question at a time and you can get back into the queue to ask more. Thanks. And over to you, Pam.

Question-and-Answer Session

Operator

Thank you. We will now open the floor for questions. [Operator Instructions] Your first question comes from [Sal Deturris,] [ph] private investor. Please go ahead.

Unidentified Analyst

Hey, good morning, Brian.

Brian Pedlar

Good morning, Sal.

Unidentified Analyst

Hey, a quick question. Just trying to understand the government subsidies that you spoke about that have an effect on Covalon’s this current quarter. As I understand, does these help you get to profitability in this quarter ended June 30? How will these subsidies or lack of these subsidies affect the future quarter profitability?

Brian Pedlar

Oh, two questions, Sal. So the subsidies are designed to bridge companies that were impacted by COVID-19 that saw a drop in the revenue. And we’re designed to help continue to pay salaries and rent, et cetera. And if you sort of do the math on where we would have been if we were not adversely impacted by COVID-19, our U.S. direct sales would be up 40%. It’s almost the same amount as what the subsidies were for us in the quarter.

So I think our impact would have put us in a very similar bottom line position, probably a little better. So as we go forward and our – and we recover, I think, the cost containment that we’ve done in cost removal, combined with recovery on our top line, will put us in a very good position.

There’s no question that the subsidies that we received during this quarter were very helpful. The following quarter, I think, the subsidies, if any, will be much lower, and so there won’t be as much of an impact. Thanks, Sal, for the question.

Operator

Your next question comes from [Arnold Shell,] [ph] private investor. Please go ahead.

Unidentified Analyst

Oh, thanks. Hi, Brian.

Brian Pedlar

Hi, Arnold.

Unidentified Analyst

Can you tell me how many – I think you’ve produced 750,000 bottles of the CovaGuard. Can you tell me how many of those have been sold? And if there’s any, how long they last and if there’s any kind of write-off risk if they – if a substantial number aren’t sold?

Brian Pedlar

Yes. So what we said in the past, Arnold, is that we were in process of manufacturing up to 750,000 bottles, and we did continue that. We have sales of CovaGuard, I don’t have an exact bottle count. But we – our business around CovaGuard, I think, is very promising.

We’ve – our manufacturing capabilities are limited in our facility here. We do have a high volume manufacturer lined up, that can take up excess volume as needed. And our sales efforts to date have focused on channels that have the potential for sustainable revenue.

So we’ve got several, what I would consider early wins and contracts, if you will, to supply CovaGuard into various channels. And I think, we’re seeing a lot of interest and that continues. So I have good – I think CovaGuard technology is very strong. And it’s – but you have to also understand that we’re not the only company offering hand sanitizers and disinfectants. It’s a very highly competitive space. And as a new entrant, I think, we’re doing very, very well.

So over time, I expect that we will be able to sell off all of our inventory. We’ll be able to manufacture more as volume dictates, and products like this have a couple of years shelf life. And believe me, I have no doubt that we’re not going to have any write-offs of CovaGuard inventory or raw materials. It’s just, I think, this is a very strong platform and it’s a very effective technology for us. And thanks, Arnold, for the question.

Operator

[Operator Instructions] Your next question comes from [Howard Pedrick,] [ph] private investor. Please go ahead.

Unidentified Analyst

Yes, good morning. It sounds if you’re doing a very good job of keeping things under control in very difficult circumstances. What I wondered, I know you referred to many overseas markets and the U.S. sales and Central and South American sales. But you very rarely referred to the sales within Canada itself. I just wondered how many hospitals and clinics you’re selling to here, and what that represents as a percentage of the total sales?

Brian Pedlar

Thanks, Howard, and thanks for the – acknowledging the Covalon team. I think, our team has worked very hard. And as I said, in my comments, the work isn’t done, but very proud of what they’ve been able to do in these difficult times.

Canada is a small market for us. I believe we disclose in our segmented information in the financials, our revenue in Canada. We do have a presence in few hospitals. But to be honest, it’s a difficult market. We’ve focused on markets where the potential is greater and unfortunately, mostly that’s outside of Canada. It’s a shame.

In my 25 years of selling to hospitals in around the world, there’s a thing in Canada about using and buying products from Canadian hospitals, which is unfortunate that they prefer to buy from American producers or Canadian products that are successful in other countries first.

So our business in Canada is small, but I see a lot of potential there. We’re in some good hospitals and we have very good relationships with clinicians in Canada. And I foresee over time that hopefully, we will be able to grow that business, but it’s not our main focus. The United States is the largest healthcare market in the world and it takes a lot of our attention. Thanks for the question. I appreciate it, Howard.

Operator

Your next question comes from [Jeff Shell,] [ph] private investor. Please go ahead.

Unidentified Analyst

Hi, Brian, in recognizing your comments that you don’t have a bottle count, order of magnitude, hundreds, thousands, tends of thousands, hundreds of thousands. How many bottles have you made and how many have you sold of the CovaGuard?

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Brian Pedlar

Yes. I think we probably manufactured about 500,000 bottles, roughly. And we manufactured to keep level of inventory we’ve been selling on our website we’ve been selling into several different countries. And we’ve got some channels into the United States outside of medical.

We’ve sold several hundred thousand dollars worth, and continue to see a lot of interest and a lot of opportunity around CovaGuard. We’re – a lot of the organizations we’re talking to, they start with small sales, trialing through their distribution channels. And as they sell through that orders continue.

We are targeting and looking for opportunities to have sustainable revenue around that product portfolio. And we’ve got lots of interests and lots of discussions ongoing that I think will over time translate. A lot of our traditional customer base for things like hand sanitizers and surface disinfectants have contracts in place.

So very difficult for us to displace them as a new entrant into the market. And we’re working very diligently to try to capture as much opportunity as we can. And I think that’s moving along at a reasonable rate. Would I like it if we had sold a lot more? Yes.

But I also think these – this just takes time. It’s not an overnight process. And – but I’m very encouraged with all the discussions ongoing, and we’ve got lots of good opportunities and lots of outside resources that are looking for distribution opportunities for CovaGuard as well. So I’m pleased with our progress. As I said, can we do better? Sure. But I think we’ve done quite well, as I said it, as a new entrant into the space.

Operator

There are no further questions at this time. Ah, my apologies. It looks like we do have one further question. The next question comes from Howard Pedrick, private investor. Please go ahead.

Unidentified Analyst

Yes, just as a matter of interest, are you looking at any product that can be worked with masks – face masks or PPE? Do you have anything under consideration, because that seems to be a fairly huge market that will be around for quite a while yet?

Brian Pedlar

So we’ve – we have our CovaGuard technology that we’ve extensively tested on porous and non-porous surfaces, i.e., your face masks, and it does a very good job of sanitizing materials and killing pathogens in masks. We have a product in the United States called CovaGuard mask.

In a lot of the healthcare settings, the initial emergency and shortage of supply in surgical masks has dissipated and the prices have come down on masks. So a lot of organizations have good supply. But certainly, there’s no question that masks are here to stay for a long time and having technologies that can help to sanitize and address that, I think, there’s a good market opportunity there.

But again, the market moves very quickly. And I think, we – I look at the CovaGuard platform, and there’s many opportunities with the CovaGuard platform for all kinds of products that are targeted at killing pathogens on surfaces, whether that skin, whether that’s hard surfaces or whether that is porous surfaces like masks.

Operator

Your next question comes from [Paul Lucas, ] [ph] private investor. Please go ahead.

Unidentified Analyst

Hi, Brian. I’m always interested in discussion about the development in consulting revenues. And I see the commentary in the MD&A says that the customers have considered those products nonessential. Could you comment on the outlook for your development in consulting services and developing coatings for perspective new medical devices?

Brian Pedlar

Sure. Thanks, Paul, for the question. So our medical coating business is one that’s focused on working with large medical companies to take our technology that adds a new surface on catheters and other devices that get inserted into patients bodies in the hospitals. And we work on these projects with large medical companies.

One of our major customers that we announced a license and development relationship with back in 2018 designated their R&D folks, not the project, but the R&D folks as nonessential, which meant that they were not allowed into their facility during the summer.

So that slowed our project down with them. We still continue, but it wasn’t going as fast as it was previously. That relationship is very strong. We’ve continued to do work with other companies. And actually, the discussions underway in that area of our business have increased tremendously, given what’s happened in the market. And we see a lot of opportunities for us to engage with large medical companies in order to work on products, taking their portfolio of products and helping them.

So they can fight bacteria that – in pathogens that may come in contact with or may help to reduce the opportunity for infections while undergoing procedures and involve their medical devices. So very – again, another testament to the fact that I think a lot of organizations and a lot of large medical companies are turning to Covalon to see how we can help them increase their infection prevention portfolio.

So, yes, it – service and development slowed, not through any other reasons, then some of our partners were not able to complete the work on their side of the fence as quickly as we were on hours, but those relationships continue and are strong. So I foresee that recovery is beginning in those as well, and we’re engaging with many new customers as well.

Brian Pedlar

So I see there’s no more questions. I’d like to say thank you for attending the call. I’m very confident that the fundamental improvements that we’ve made over the past year will over time demonstrate the significant unrealized value for our shareholders that I believe exists in the company. I can assure you that the hard work continues, and I look forward to discussing our progress on the next call. Thank you very much.

Operator

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



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