Covalon Technologies Ltd.

Thank you, Mariana. 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 2019 first quarter ended December 31, 2018. 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 achievement 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 and its public security filings actual events to 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. On October 1, 2018 Covalon completed the acquisition of AquaGuard a Seattle, Washington based division of medical technology company.

Covalon acquired all the assets and employed all the staff dedicated to the AquaGuard business for consideration of approximately $15.5 million, which is comprised of an upfront payment, shares, contingent consideration and deferred payments. The assets acquired were receivables, prepaids, inventory, equipment, intangibles, brands and goodwill.

The largest asset acquired was goodwill and this is consistent with the rationale for the acquisition as Covalon now has a sales force in the United States and expects great sales synergies through the cross selling of products. The AquaGuard acquisition has performed as expected, with continued strong sales meeting the revenue target as outlined for the contingent consideration payment during the calendar year of 2018.

Covalon is encouraged by this maintained performance. To facilitate the transaction Covalon has drawn against the acquisitions line facility with HSBC.

This line has a repayment term of five years. The operating facility with HSBC has also been drawn against to fund working capital and this facility is revolving in nature.

Lastly the future payments due to the seller have been recorded on the balance sheet and the acquisition notes payable. As previously discussed, this non-dilutive financing has been used to advance our growth and acquisition strategy in a way that is both manageable for the company's operations and also beneficial for the current shareholder base.

For the first quarter ended December 31, 2018, Covalon's total revenue was $7.3 million with a net loss of 1.9 million or $0.09 per share. This compares to the prior year's first quarter which saw a total revenue of 6.4 million, a net income of 500,000 or $0.02 per share.

Operating expenses increased for the first quarter to $6 million compared to $4 million for the same period of the prior year. The overall gross margin for the first quarter was 63% compared to 71% for the first quarter in the prior year.

During the first quarter of fiscal 2019 Covalon saw a more balanced revenue figure with US customers representing about 75% and the Middle East representing about 20%. As previously discussed, the revenue associated with the Middle East contract is anticipated to be more heavily weighted towards the second half of the year as compared to the 2018 fiscal year where the delivery schedule as dictated by local ministries of health was more even through Covalon's fiscal quarter.

Covalon continues to ship and have product delivered under these Middle East contracts without issue. I would now like to turn the call over to Covalon's CEO, Brian Pedlar.

Thanks, Danny for the review of the quarterly results and good morning fellow investors. So Danny just walked through our results and I would like to focus on our plans for fiscal 2019 going forward.

But first off I’d like to repeat what we said in yesterday's press release. We are very much on track in executing on our fiscal 2019 plan that we talked about on past calls, and in the past press releases.

So we’re beginning to see the impact of the key objectives that we accomplished last year in this year's fiscal 2019's financial and operational performance. And these accomplishments of last year include wining a $100 million competitive contract that allow us to provide our products over a three year period and the completing of the acquisition of AquaGuard which is a US-based business that we completed on October 1.

So this past quarter was the first quarter where we had seen the impact of that acquisition and their revenue and costs included in our financials. We can see the impact of these milestones from last year on our outlook.

So there's two main things I think that I want people to understand that our revenue sources are diversified now, so we are no longer reliant on a single geographic region or product. And secondly, our lucrative Middle East business is secured and it is secured through long-term contracts.

I am very pleased that starting in fiscal 2019 we have achieved our strategic objective of revenue diversification. So we are no longer dependent on a single region for the majority of our revenue.

As a result, we expect our business to be approximately half from the Middle East and half from the United States and the rest of the world in fiscal 2019. I guess Danny articulated this quarter was tipped a little more towards the United States and I expect that by the end of fiscal 2019 the balance for the year will be about half and half.

We anticipate strong business growth in the United States, and this is partially achieved by the acquisition of AquaGuard which as I said closed on October 1. So I just want to remind everybody that part of the transaction to acquire AquaGuard we not only gained the market leading family of AquaGuard products but we also acquired the revenue and the contracts associated with the customer base of about 1500 hospitals in the United States who are currently buying AquaGuard products and we also took on board a very talented sales force and operational team that supports this customer base.

And I got to tell you I’m very pleased with the progress from our acquisition of AquaGuard. After most acquisitions, the combining companies take a pause while they digest the new business environment, we kept growing.

I credit our very strong and dedicated sales, marketing and operations staff from both the AquaGuard sided as well as the Covalon team for working cooperatively together so that we didn’t miss a step in our US business. Combined revenue from AquaGuard and other Covalon products and services in the United States is on track to exceed 25 million in fiscal 2019.

Sales of the recently acquired AquaGuard product line are growing according to plan and our US sales force has been engaged in the long process of educating our new customer base of 1500 hospitals thereabouts on Covalon’s infection prevention products. These two impacts of the AquaGuard transaction, the addition of the AquaGuard revenue and the opportunity for our new US sales force to sell many of Covalon’s infection prevention products directly in the hospitals, in the US gives our business further diversity and strength.

Training to the Middle East the 100 million of contracted revenue, we announced last year truly secures Covalon as a major medical products market leading company in the Middle East. These long-term contracts secure our Middle East business for the next three years.

They also provide a strong base for revenue and for growth with an estimated 30 million of revenue in this fiscal 2019 and strong revenue growth for a number of years thereafter. We anticipate delivering 30 million of contracted revenue this year.

I want to point out that that's more than double the contracted revenue, we reported in fiscal 2018. In addition, there are other potentially accretive and lucrative opportunities, so other contracts and other business open for us to compete on in the region and I can tell you we're working very hard to try to close as many of these opportunities as we can.

As I outlined in previous conference calls and press releases and as Danny talked about determining the quarterly revenue from the region is not an exercise in dividing the 30 million by four. Our contracted revenue in the Middle East is derived for bulk purchases that are delivered throughout the year, which we are not equally recognized in each of our quarters.

We reported lower revenue this quarter just due to the timing of deliveries under the contracts that does not reflect any other issues with the contracts or the business. We don’t control when these hospitals and clinics want our products.

They tell us when they would like them delivered and we deliver. We know the year will be approximately 30 million and we also know it's going to be heavily weighted to the second half of fiscal 2019 and that's due to how we look at the agreed-upon delivery schedule of products that roll out to the hospitals this year.

So again I want to reiterate, we're delivering to schedule on those competitive contracts, and I'm very confident and positive with our position in the Middle East and the revenue prospects for this year. So many investors have asked me Brian how certain are you about the delivery under these contracts that we can grow the business and that we can grow the business after the three years is up.

I want to be clear, I’m very confident that we will see full value from the contracts and that we will continue to grow our business in the region thereafter. In fact, I can tell you that I know many other companies that wish they were in our position in the Middle East.

I have been approached by many of them who want to find a way to gain access to our sales channels in the region. We are a stronger company today and we will leverage our competitive advantage that we have because of these contracts over the three years and leverage that into new business in the near-term.

Now turning to our emerging markets as I talked about on our last call, our efforts to enter the European and Latin American markets are expected to begin to materially contribute to our revenue in the latter half of this year. We are currently selling into the United Kingdom, and a number of countries in Latin America.

I anticipate that key markets like Mexico, Chile and Argentina will grow as our products begin to compete and win business in these regions. Now I want to spend a minute or two to talk about the underlying value of Covalon.

I can tell you, I believe the fundamentals of Covalon are very strong. I can't think of very many examples of companies like Covalon that have the depth of our FDA cleared products or the depth of our patents and our intellectual property or that have secured three years of contracted revenue in a key market or that have just doubled their US business and added over 1500 hospitals as customers or that have just acquired a full US based sales force that is extremely talented.

I think it is important for you as investors to understand that we have turned a number of heads in our industry. Our peers and our competitors have recognized that Covalon is on the upswing.

We have made a big impact in our market space. Not just because I believe we have, but because my fellow medical device CEOs and executives tell me they think so.

Believe me it's really hard to get compliments out of the competition. The thousands of doctors and nurses who use our products every week have also recognized the impact and growth that Covalon has achieved and what they can see as a very short period of time as we entered their hospitals and clinics with products.

I talk to clinicians all the time and believe me they are a tough audience to impress. It's also important for you to understand that there are tens of millions of patients who benefit from our products and technology every year.

Many of those people have contacted us personally to tell their story of how they believe their lives have been improved and in many cases they tell us saved in part due to our products being used with their treatments. These are indicators, strong indicators along with our year-over-year financial success and growth that tells me that as an investor in Covalon, Covalon is positioned for significant recurring revenue and our company is much more diverse, stronger and attractive as an investment for any investor who is looking for significant returns over the years to come.

Our business will experience strong revenue growth this year and for the reasons that I have articulated already on this call and in past calls. I expect us to end this year as well with a strong bottom line profit.

Now I talk to investors every single day. And many have recognized that Covalon truly is a significantly improved company, compared to one short year ago.

Many investors have done the math based on our recent announcements and recognized that our company has more than doubled compared to last year. Many more investors have speculated to me that they believe we can double again in as early as 2020, and almost every investor tells me that there is lots of opportunity for this incredible basket of upside that Covalon has to create more value for investors.

I can assure you that our team is working harder than ever to build our company into a truly strong player in all our markets, the United States, the Middle East, Latin America, Europe and the rest of the world. And I got to say I’m continually impressed with our product development team's ability to innovate, our operations team's ability to commercialize our products and get them to customers and our sales and marketing team's ability to engage with customers and educate them about our world-class portfolio of products and technology.

I think we have a good plan in place and I think we’ve demonstrated that we know how to execute to increase the value of Covalon in a significant way in a very short period of time. I would now like to open the line for questions and that I ask that you keep your questions to one or two questions at a time and there will be lots of time to get back into the queue for more.

Thank you, over to you Mariana.

Wondering if you can help me understand, I’m sorry I got on your call late, so if you covered this my apologies, but just trying to understand how gross margins might look, on a run rate given the Middle East contracts and the US business, I think in recent quarter we were 63% to 64%, just trying to understand how that might look as you scale.

Thanks for your question, we did see lower margins there were various things impacting it, lot of the margin fluctuations can be seen as what products are being delivered. I think that on the go forward we do anticipate margins being in that 65% to 70% range.

Some of the products that we were awarded tender business for, those have lower margins than we have seen historically and we do think that there is 65% to 70% range is something that we can look at on a go forward basis.

I just had just a question on US organic growth, do you have that number for the year, organically.

For last year we certainly do. We have not disclosed the US business separately organic versus the AquaGuard business and we consider it all one.

Last year we had a very strong growth in the United States. Year-over-year our business is up was 147% or so in the United States.

Our business continues to grow, as I said most companies, when you kind of go through an acquisition you put the businesses together and they spend a quarter or two trying to figure out how each other operates and we didn’t experience any of that. So I think from our perspective we are very much on track, both organically and with the AquaGuard business in the US.

And just on the Middle East contract, just prospect for second half of 2019, can you give some more detail on that.

I think we’re on track to deliver on the 30 million under the contracted business that we talked about. And I think there are lots of opportunities for us when you become a market leader and you take that amount of market share away from the competition, a lot of doors open and we see lots of opportunity to grow our business in the region.

So I think we're well on track for delivering on the contracts as well as looking at new business opportunities in that area of the world.

Just wanted to chat about working capital. You saw us pretty good drop off in working capital.

Obviously, you spent money with the acquisition, but just in terms of where your inventory levels are, just sort of where you expect things to turn to through the year.

It’s a good question. We ramped up a little bit in inventory as we look at what's coming at us in the back half of the year.

I think we’re in good shape, we have pretty strong relationships with our supply chain I think they have a pretty strong capacity. So we have the ability to grow to meet that demand.

But I think were in relatively good shape on a working capital basis we also have our backstop in our HSBC credit facilities that as a banking partner. So I think from a working capital perspective, we are very prudent both Danny and I are CPAs and so we do monitor our positions very closely and but we are very comfortable with where we are, we are very comfortable that we can meet the upcoming business growth that we see both contracted and run rate business for the back half of the year and I feel comfortable with the position that we are in on working capital.

And just looking at expenses and you noted in the quarter, there was about I think a $1 million of one-time expenses is that fair to say absent those one-time items that run rate we're sort of looking at in this quarter's representative of what we should expect through the year other than probably the variability around sales incentives in that.

You’re talking bottom line run rate.

I’m talking about expenses in general when I look at it and you said there is million dollars extra in the quarter. So I’m just looking at it…

I think so. There are couple of line items Brian that can fluctuate with top line revenue growth.

We have agency fees into the to support our Middle East business that will fluctuate but they move as revenue moves so up or down. So there is a little bit of growth maybe in the numbers over the back half of the year as we launch our products into the US channel, it takes little bit more resources to do that and as we’re looking at growth in some other markets, I talked last time about having invested into both Europe and Latin America, which have not appreciably impacted our top line and so we've got investment in expenses with a revenue that we anticipate that turning around for us this year and having a material contribution to the business.

So I think we’re in really good shape but as I said in my opening remarks, I expect us to end this year with a strong profit. So I think you can kind of guide on our expense base, with growth and some prudent growth in some areas to help support the growth of the business.

Thanks, Mariana. I just want to say thank you very much for participating on our call.

We are thrilled with where our business is and what’s coming at us. I think we are definitely on track, we have good visibility into our year this year and going forward our team is working very hard, we have a very good team, I encourage any investor who is able to join us at our annual shareholder meeting, which is held in March 7 at 3:30 pm at the offices of Stikeman Elliott here in Toronto to meet some of the talented Covalon team who will be there with Danny and I.

That’s an opportunity for you to hear firsthand what it's like to be part of a winning team at Covalon and believe me we're doing really well we're thrilled as a management team and as fellow investors. Thank you very much and I look forward to updating you on the 7th.