Covalon Technologies Ltd.

Thank you, Mariana. My name is Danny Brannagan and as Covalon’s Chief Financial Officer, I'd 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 second quarter ended March 31, 2019. 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 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 second quarter ended March 31, 2019, Covalon's total revenue was $13.3 million with a net loss of approximately $200,000, or $0.01 per share. This compares to the prior year second quarter, which saw total revenue of $5.7 million and a net loss of approximately $450,000 or $0.02 per share.

Operating expenses increased for the second quarter to $9 million compared to $5 million for the same period in the prior year. The overall gross margin for the second quarter was 69% compared to 76% in the second quarter of the prior year.

During the second quarter of fiscal 2019, Covalon saw a more balanced revenue figure with U.S. customers representing about 52% and the Middle East was about 46% of total revenue.

During the quarter, there were several unplanned items that impacted our overall profitability. These items related mainly to non-cash accounting items and the acquisition of AquaGuard that closed in Q1 of fiscal 2019, and in aggregate totaled approximately $1.5 million.

Growing our profits in lines with our revenue growth is the main focus of our management team. Management does not think our results on the bottom-line this quarter are reflective of the profit potential of Covalon on a go forward basis.

For the six months ended March 31, 2019, Covalon's total revenue was $20.6 million with a net loss of approximately $2 million or $0.10 per share. This compares to the prior year's comparative period, which saw a total revenue of $12 million and a net income of $44,000.

Operating expenses increased to $15.5 million compared to $9 million in 2018. The overall gross margin for the six-months decreased to 67% compared to 73% in 2018.

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

Thanks Danny for the review of our second quarter results. And good morning fellow investors.

So Danny just walked through our quarterly results and some of the results for us for the first six months of this year. And I'd like to spend a few minutes talking about and putting those results into perspective for our plans for the remainder of this fiscal year and going forward.

So overall, I think our second quarter financial performance is on track and we are executing to our plan. Can we do better?

Absolutely, but it's an important summary of where we are today. The revenue this past quarters Danny talked about was $13.3 million, which is more than double last year's second quarter results.

I think it represents something like 132% growth over last year. And to-date, we have reached about $20.5 million in revenue for the first six months of fiscal 2019.

That is a big change and a big improvement over the previous year. And we were very strong this year in the first half or the first six months of this fiscal year in the United States.

And I'm very pleased that we are achieving our strategic objective, which we've talked about in past calls of increasing our North American business and diversifying away from reliance on the Middle East. Revenue in United States accounted, I think for the first half -- first six months, is about 60% of our revenue.

And combined, we are still on track in the United States to exceed the target that we said earlier of $25 million in this fiscal year from the U.S. market.

Sales of the recently acquired AquaGuard product line are growing according to plan. Over the past several months, our U.S.

sales force has been engaged in the process of educating our new customer base of 1,500 hospitals on Covalon's broader infection prevention products. The first product we've introduced directly to hospitals through our sales force is IV Clear.

Now, to remind everybody as part of the transaction to acquire the AquaGuard business, which closed October 1st, so in our first quarter of this year, we not only gained the market-leading family of AquaGuard products but we also acquired the revenue and contracts associated with a customer base of about 1,500 hospitals in the United States who are currently buying the AquaGuard products, and the very talented salesforce and operational team that supports this customer base. Now, I believe that the IV Clear fits very well into our new hospital customer base and IV Clear is the only silicone adhesive IV dressing in the entire world that kills bacteria, while protecting patients from infection who have an IV line inserted into them.

And patients and clinicians simply love IV Clear. Now, even so selling into hospitals is a slow and difficult process.

We know that when we go out and try to make an appointment ourselves to go and get an appointment with the doctors, whether it's for a personal medical check-up or whether it's for a sales call, it takes time it doesn't happen overnight. I've been out with our field sales team and I can tell you I'm really, really impressed with their sales process and the talent we have.

Our U.S. team is very disciplined in our approach to building confidence with hospitals.

And over time, I anticipate very strong business growth in the United States. During the second quarter, we continued our deliveries on schedule into the Middle East under the competitive contracts that we previously announced.

Our contracted revenue in the Middle East, as we've talked about many times, is derived from bulk purchases delivered throughout the year, which are not equally recognized in each of the company's quarterly results. We don't control when those hospitals and clinics in the Middle East want our products delivered.

We expect deliveries to be more heavily weighted for the remainder of this year into our fourth quarter, which ends September. And we'll continue to update as we gain new information.

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 fiscal year. So we are currently selling into the United Kingdom and a number of countries in Latin America.

And I anticipate that key markets like Mexico, Chile and Argentina, will grow as our products begin to compete and win business in these regions, again it doesn't happen overnight, but we have we have a very small and talented team located in Florida that is driving the growth of our Latin American market. And I'm quite pleased with the progress we're making there.

During the quarter, there were several unplanned items that Danny talked about that impacted our overall profitability. Now, as Danny articulated, these items relate to non-cash or accounting related charges and also included trailing costs from the acquisition of AquaGuard that were not necessarily in the budget.

And remember the acquisition closed within the first quarter of this year. And those aggregated about $1.5 million of expenses that hit us this quarter.

We typically look at where we think we're going to end up, and I've talked about this on other calls as well. We prudently invest in markets to grow opportunities that will bear fruit and deliver revenue in future quarters.

And we did that this quarter as well and we also got hit with these items that were somewhat unplanned in our in our business plans. Again, I think Danny said it very well and I want to reiterate.

Our results for this quarter are not reflective of what we believe as a management team Covalan is capable of in delivering profits in line with our revenue growth on a go forward basis. So I want to spend a minute or two talking about our future and some of the other drivers for value creation.

We tend to think about and talk a lot about top-line revenue growth as the only barometer of how we're doing are we winning or losing based on our revenue. While this is often a driver of our successes as a company, it's not the only element that shareholders should be focusing on.

There's other fundamentals of Covalon that I think are very strong, and I think are very unique to Covalon. There's not many other companies that have this following combination; number one, our depth of FDA cleared products; number two, our depth of patents and intellectual property; and number three, that have the revenue opportunities that we have.

So we doubled our U.S. business this year so far.

And we've added 1,500 hospitals as customers this year. And number four that also have a U.S.

sales force that calls on hospitals combined with a world class lab that can drive new products into the market. Most other companies that I run into in our space that I talk with at trade shows or that I know the executives that run them, they have one or two and maybe three of those four things but very few.

And honestly, I've tried to compare ourselves to other companies that have all four that are the size of Covalon. It's just unique.

We've talked a lot about our U.S. sales force.

I think it's just as important that investors understand that our lab and our research and development teams are some of the brightest and best women and men in the medical industry today. We have assembled a team that innovates faster and more effectively than teams 10 times their size.

As a result, we have attractive some of the most successful medical companies in the world as customers of ours. And that's driven because our team is very, very strong and has a lot of credibility and respect in the marketplace.

Many of those same companies have started out trying to compete with us. They've tried to innovate around us and some have actually tried to replace us in the market.

Big and small companies have tried this and failed. And many of those companies have returned to be our customers and have continued to be good business partners for many years.

That's also tied to our intellectual property, our knowhow and our experience. I mean that combination within the four walls is truly -- our team is truly strength of Covalon.

This is something that as an organization, we protect vigorously and we are constantly adding to and improving. I can tell you that our staff are very proud of their accomplishments and have every right to feel that way.

And I'm very proud of them too. Our team is motivated to compete and win in the race to bring new innovation and new medical products to the market that help save people's lives.

And we're doing this. And the evidence of this is by the fact that there are thousands of doctors and nurses and tens of millions of patients who are benefiting from our products and our technology every year.

And we have one of the fastest growing brands in the medical consumable product markets today. Every week, a new group of patients and clinicians discover the positive impact that Covalon's products, our products have on their lives and in their hospitals and clinics.

So these are some of the indicators I believe along with our year-over-year financial success in growth that tells me as an investor that Covalon is positioned for significant recurring revenue growth and that our company is much more diverse and a stronger more attractive investment for any investor, myself included, it was looking for a significant return over the years to come. Now, I talk to investors every day.

Many investors have done the math, looking at our recent announcements, looking at our acquisition of AquaGuard, looking at where we've -- the markets that we've entered and looking at our results. And have come at a conclusion that we're going to more than double compared to last year.

And I've also had investors who speculated to me that we can double again in as early as 2020. And almost every investor says that, there is a lot of opportunity in the incredible basket of upside product our pretty talented team that's part of Covalon.

And they are very much looking forward to our ability to unlock that value for investors. And I think we are on our way, 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.

I am continually amazed and impressed with our product development team's ability to innovate, our operations team's ability to commercialize and to get our products into the market and to our customers and our sales and marketing team's ability to engage with those customers, educate them about our world-class products and portfolios and help them treat and save the patient's from infections and other complications. We are very aware that we also need to grow both our top line revenue and our bottom line revenue, and we saw bottom-line profits in tandem.

So I think we have a good plan in place. I think we've demonstrated that we know how to execute and increase the value of Covalon in a significant way in a short period of time.

So I'd now like to open the line for questions. I ask please that you try to keep your questions to one or two.

And if you want to ask another question please get back into the queue, and there will be lots of time to ask questions. Mariana, I'll turn it over to you.

Just wanted to get a little bit more clarity on the unplanned expenses that Danny said was about $1.5 million, I think. So just for clarity, those are expenses that will not repeat.

These are essentially onetime it was into Q2, and we shouldn't see anything related to these going forward. Is that right?

Yes, for the most part, yes.

And then relative to AquaGuard revenue, Brian, I don't know if you guys are willing to disclose what it was in Q3 or for the six months pending through Q2?

I don’t believe we have broken that out in our financials. So I certainly don't want to just hand out numbers on this call, that's something we'll certainly consider in our -- as we talk to our auditors about disclosures, but we're on track.

And I think we've talked about that revenue growing. I think if you do and I know you've done this, Brain, and though our numbers, probably just as well as we do, look at the business acquisition reports that we put out, I think you can figure out where they were last year.

I think we're definitely continuing to grow on the performance commensurate with how they've grown in the past with the AquaGuard business. So I'm really pleased with how we've -- how the team has come together.

I'm pleased that our customer base and our top-line has gone in a direction we anticipated. As you know, a lot of these acquisitions when you put two organizations often together one and one begin to equal one, but with us it's been very positive.

I think we got some good growth. Could we do better?

Sure. And I think the team is working very hard.

But I think the number that -- I think we're in definitely in line with our expectations, and we are continuing to grow that business, independent of additional revenue of introducing Covalon products into that channel.

Just to follow up on the question that was just asked in terms of the unplanned items. You made it pretty clear what those are all about.

Can you give us a sense of where they would reside in terms of the expense line on your income statement? Would that will be primarily general admin or how would they be reflected in the financials?

I think a big chunk of them would be in that line item. If you look at our operating expense growth, we did an acquisition.

So I think Danny mentioned, we went from somewhere around $5 million to $9 million. That's driven by the addition of AquaGuard largely plus we've looked at expanding our sales presence in the United States.

We made some investments in markets that we expect to bear revenue and profits in future quarters. And I think some of those items, I think there's roughly four possibly five items that were not in our plan that they all connected this quarter on us in the $1.5 million.

I think it's in G&A, but there's likely a little bit in margin as well.

Just bit of a follow up as well. The $1.5 million, does that start to reduce the gross margin figure?

Arnold, I think a little bit. I'm very conscious I don't want to try to play the game of adding and subtracting across the various line items in our income statement.

The gross margin, we know that our margins were in a range, it's highly driven on product mix. We know that the AquaGuard business that we brought on has slightly lower margins than the Covalon business has historically.

And we've also talked about on past calls that in order to secure the contracts in the Middle East, we have to give some modest price concessions and those impact margins. So our margin numbers are down a little bit from last year.

It's a product mix and it's a few other factors. So, I think there is some impact on the margin.

And do we know what the combined revenue of Covalon and AquaGuard would have been for the second quarter last year?

It's not a number, Arnold that we have disclosed in our financials. We're required to compare to our own performance.

But I can tell you we certainly up.

Just one last question. Do we have any sales yet in the UK, or in Latin America?

Absolutely. We've got -- again, our business in both of those geographies is at the early stages.

But we definitely have a number of customers in the UK that are buying our products. And again, they buy on a weekly basis.

So it takes a while for those weeks to add up to being material and we're adding new customers all the time, same in Latin America. We are in six to eight countries in a relatively strong way.

And that will begin overtime to grow and impact our revenue. So I think stay tuned and slowly over the next six months plus we will see those markets begin to really have a positive impact on us.

I was wondering if you could explain Covalon's quarterly report refers to Saudi Arabia. But the last PR about Middle East contracts refer to the council for Gulf Cooperation Council States for the $100 million of IV Clear -- estimated $100 million of IV Clear.

Have deliveries under those new contracts begun, or are we looking at revenue from previous contracts to Saudi Arabia?

It's a little confusing. The way it works in the Middle East, the dominant big country in the GCC, which is a group of countries in Saudi Arabia.

So sometimes we talk about Saudi, sometimes we talked about Middle East. But the largest player there is Saudi Arabia.

Yes, we've been delivering under those contracts for the last several quarters. And again, those deliveries follow a schedule and sometimes that schedule gets altered and changed, and sometimes it stays the same.

But we are fulfilling those contracts. A lot of the countries got together and their ministries of health acted as a buying group.

And that's why we talked about this GCC contracts, because it's more than just one country that is part of those agreements.

And additionally, in the report you break out U.S. sales in this quarter, it was $6,900,139.

Can we assume the development and consulting revenue and the licensing revenue is U.S. based?

That can vary in mix. But there is U.S.

element in there. And I know we don’t do a metrics where you can see exactly which geography each revenue item comes from.

But there is U.S. based business in there and there's conceivably business from other markets as well.

I was trying to figure if we could back out the development from the U.S. figure, I don’t know if we could back out development and consulting, and licensing and get U.S.

product sales?

Yes, unfortunately Paul, we don’t disclose the numbers that way. So again, we got to be real careful and I don’t want to provide information, it's not available to the public on this call.

When do you anticipate adding additional products into the sales channel?

We're in progress as doing that now. It just take some time.

We've got a team. They've gone through a lot.

They’ve gone some being part of another company to being part of Covalon. They have gone from having one product set in their sales bag to multiple product sets in their sales bag.

They've gone from knowing their product inside out to having to learn a product, like IV clear, which is when we started with. I'm a firm believer that once we -- they cut their teeth, so to speak, on IV Clear, rest of the products that we introduced are going to go relatively quickly, because they've already got that base of knowledge.

And quite honestly, I didn’t want to overwhelm the team. We recognize that they were fully employed and growing rapidly, and doing really well with their product set.

We've had to build the team out in order to create some bandwidth, so they can sell other products. And I think the term we use is shrink windshield time, so they are not -- and increase customer facing time hat all helps them to create the opportunity for them to sell more and more of our products.

So it's a process. I think we're gone through it in a very measured and responsible way.

We're not going too slow and nor are we forcing it to quickly. So I think we are on a good path there and I'm really excited about the team and their ability to engage with clinicians on new products I'm really impressed.

Thank you. Regarding the Centaur medical coating technology.

When do you expect the first FDA approved product to hit the market?

Centaur is an interesting technology. We've got a number of projects underway with that, as well as our CovaCoat technology stay tuned.

We're working on some really exciting things with some organizations. And obviously, I can't talk about the details, because we're plugged into the roadmaps and the development cycles of some really big companies for product sets that they're delivering and expect to introduce into the market in the near future of just seven year product development pathways.

So we're working on things that are coming soon, and we'll be coming in future years with these companies. So really exciting part of our business -- we'll expect that those products when they begin to hit the market will definitely have good revenue tails for us and have a strong recurring base.

So I'm excited about that part of our business, Trevor.

One quick question on the same topic. Can you explain or elaborate on the current licensing and royalty fees.

What product areas are associated it, is it the same area or…

A lot of that -- we've three main platforms of proprietary technology within Covalon, antimicrobial silicon adhesive, our medical coating technology that goes on top of medical devices that get inserted into people's bodies, and we have a biologics platform. And so those line items can involve the licensing of some of that technology for specific uses in the market.

It can involve development agreements where we are using our platform technology combined with other companies' products and developments, and creating new products that have new capabilities and doing that development in conjunction with the business partner that we would have. Sometimes there're massive huge medical companies and sometimes there are smaller niche players that want an edge in the market.

And so it's a model that involves services. It involves licensing of our technology.

And it involves royalties when those products are in the market. And then we have products in the market where we are receiving royalties, as we speak.

So it's an interesting part of our business and we've got a really good team focused on it. And I'm really excited about some of the things we're working on right now.

Good morning Brian. Great results, nice to see things progressing in the way you've projected.

My question is real simple. What progress regarding TSX listing that the company is finding?

We've said this before. I think we fully qualify and we're working on that.

It's probably not going as fast as we wish, but nevertheless it's in the works. So I think that that will be an exciting opportunity for investors as well for stepping up onto the big board.

So you have no idea of when?

We haven't publically laid out a timeline of when we expect to graduate. But I'm hopeful in the next short while we can be much more definitive on that.

I just had a question and like to just learn a little more about, or get your feeling on the revenue growth. I think the quarter was really a solid quarter.

The revenues where I thought you might be around a little disappointing in the profitability line, but you already discussed that. What I'd like to learn a little more about is that if you look at cash press releases and cash conference calls.

We talk about the Middle East revenue expecting to be around $30 million, the revenue from AquaGuard and U.S. coming in $25 million.

And then some additional revenues coming in from Europe and Latin America, some more potential revenue coming in. So in my mind, I'm looking at 2019 and $55 million to $60 million range, which I think is great.

I wanted, number one, confirm am I in the right ballpark? Are you guys looking at something like that and is that reasonable.

Now, if you look at what you've achieved in the second quarter and where you stand year-to-date, I think that's doable in the $55 million to $60 million range. But then we've also had comments in this conference call, as well as prior ones about possibility of doubling again in 2020 and that really, really amazes me.

Do you think that's really possible and is there anything behind that number?

I think it's a good question, Sal. And it's often hard -- I try to be very, very transparent with our business.

The fact that there are aspects of our revenue that we can count on and we can project forward and there are aspects that are lumpy and that we shift from quarter-to-quarter and sometimes like year-to-year. And that could be a positive or it could be a negative.

I look at our business and I look at what's happened to us this year versus last year. It's a bit of looking in the rearview mirror.

But we've added a significant presence in the United States that as we look at that and we start to move our products through that channel, it's a pretty interesting growth prospect if we can hit the ball out of the park, so to speak, because we have a very, very strong sales force that we can instantly increase their sales bag. So the sales cycle in the market is long, but I think we're doing the right things to build the foundation for that sales growth.

So we look at the individual markets and I think we have an opportunity to really grow them. And as some of these new markets come on line in Europe, in Latin America and we begin to introduce new products.

And also in our developments in licensing business lots of opportunities that can really have a big influence. We had an announcement of a major license deal last fiscal year that it'll put a lot of cash into the company and created a huge growth opportunity.

We're in discussions on a number of those kinds of deals on an ongoing basis. So yes, I think we have the opportunity to really, really be in a position to continue to grow.

Now, is it 2020? Is it halfway through 2021?

It's hard to predict, but we've got a great opportunity. And everybody reads the situation differently.

Some people I talk to are very conservative and are happy with modest double-digit growth and others look at our situation and say, boy, you've got an incredible portfolio of technology and products and IP and channels into the market. A few things break our way and absolutely, it's highly possible.

So I think we were on the right path. I'm certainly not -- when it happens, is little bit less relevant to me.

More relevant is that's the trajectory that we're on. So I hope I answered your question.

Yes, you did. And I've been thinking you guys are doing amazing job.

And I think that with the revenue growth that's out there to go and get and your goal of bringing profitability in line with that revenue growth, I think this is just a tremendous opportunity and I just hope you guys can pull this whole thing off, because I'm strongly behind you. Thank you very much.

Thanks, Sal. I appreciate it.

Great. So I think there is no more questions in the queue.

So I'm going to just sum-up here. Look, we've talked a lot.

I really want to thank you all for attending the call and listening to Danny and myself. And hopefully, our passion for Covalon and the strength of our business come through.

I think we're going in the right direction. I think it's very evident that we, both Danny and I, feel we can do better certainly on the bottom line and we are very conscious with that.

But I'd like to just sum-up Covalon's future with one word that word is more. And we are working on more R&D.

We are working on more patents. We are working on more FDA approved products.

We are working on more over-the-counter products. We are working on more sales.

We are working on more partnerships. We are working on more license deals.

We are working on more distribution arrangements. And we are working on more acquisitions.

So I think we are just getting started with what we are able to do. Again, thank you very much for participating in our second quarter conference call.

Have a good morning.