Harvard Bioscience, Inc.

Good day and thank you for standing by. Welcome to the Q3 2021 Harvard Bioscience Inc. Earnings Conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I'd now like to hand the conference over to your speaker today, Dave Zeroyf. Please go ahead.

Thank you, Alyssa, and good morning, everyone. Thank you for joining the Harvard Bioscience Third Quarter 2021 Earnings Conference Call. Before we begin, I would like to suggest that you take a moment and download a copy of a presentation that will be referred to during this call. The file is entitled Q3 2021 HBio Quarterly Earnings Presentation and is located in the Investor Overview Events and Presentations section of our website. Leading the call today will be Jim Green, Chairman of the Board, President and Chief Executive Officer, and Mike Rossi, Chief Financial Officer. Before I turn the call over to Jim, I will read our safe harbor statement. In our discussion today, we may make statements that constitute forward-looking statements. Our actual results and performance may differ materially from what we have projected due to risks and uncertainties, including those described in our annual report on Form 10-K for the period ended December 31st, 2020, our subsequent quarterly reports on Form 10-Q, and our other public filings. Any forward-looking statements, including those related to the company's future results and activities, represent our estimates as of today and should not be relied upon as representing our estimates as of any subsequent day. Also, much of today's call will focus on our non-GAAP quarterly results, which we believe better represent the ongoing economics of the business reflects how we set and measure our incentive compensation plans, and how we manage the business internally. The difference between our GAAP and non-GAAP results are outlined in the earnings release in today's presentation. These two documents, as well as a replay of this call, can be found on our website under Investor Overview, Events and Presentations. Additionally, any material, financial, or other statistical information presented on the call which is not included in our press release and presentation, will be archived and available in the investor relations section of our website. I will now turn the call over to Jim. Jim, please go ahead.

Thanks, Dave. Good morning, everybody. Let's go ahead and move to slide four of the presentation, look at the highlights for the quarter. Revenue is up 23% over Q3 20 and up 8% over pre-COVID Q3 19. Our preclinical revenue was up 28% on strong global demand and across all key product lines. Cellular and molecular technology revenue was up 19%, continuing its recovery as labs reopened. Again this quarter, we saw strong order growth and backlog growth. However, we continued to have fulfillment delays from global supply chain disruptions and issues associated with it. Adjusted operating margin came in at 13%. That's versus 15 percent in Q320 and versus 12 percent in Q319. Adjusted gross margins came in at 56 percent, impacted by over three percentage points from higher COGS. And higher COGS continued from Q2 on global freight costs, material inflation, plus direct labor inefficiencies. Q320 was a difficult comparison due to the dramatic one-times cost reductions we took last year to handle the COVID headwinds. Let's move on to slide five. A look at the details of the quarter. As expected, we continued to see strong revenue growth. Q3 coming in at 29.7 million. That's up 23% over last year. Gross margin on a GAAP basis came in at 55%, down 110 basis points from last year on higher cost in the global supply chain. This quarter had GAAP operating income of half a million dollars. That's 1.8% of revenue. On an adjusted basis, our adjusted operating income is 3.9 million, so our adjusted operating margin measured 13.3% of revenue. GAAP earnings per share was zero, up from a negative 3 cents last year. Our adjusted earnings per share was 6 cents, up from 4 cents last year. Our cash flow from operations was negative $700,000. And our debt increased by 2.7 million as we prepare for a strong Q4. And our debt ratio measured 2.5 times EBITDA. Move on to slide six. Starting with the first row of the table, our cellular molecular technology revenue, which is primarily from academic research labs, is up 19% from last year, with orders and backlog up significantly. We experienced significant revenue shipment delays caused by global supply chain disruptions in a number of our materials. We're seeing fulfillment improving with added hiring, though this does drive direct labor and efficiencies until new staff get trained and staffing levels get optimized. Planned pruning or removal of lower value product revenues impacted reported revenue by approximately $1 million in the quarter. European labs are still slow, though we do see demand improving as we go forward in the remainder of this year. Looking to the second row of the table, our preclinical product revenue was up 28%, driven by strong order growth across our product lines for our core customer segments of CROs, pharma, and academic labs, and that's globally. Asia Pacific saw very strong growth, and EMEA was also up double digits. Sales growth in the Americas was also positive with strong pharma demand, though U.S. government continues to trend lower. Overall preclinical is now well above pre-COVID levels, up 27% from Q3 2019. Overall reported revenue grew 23% over last year and 8% over the same quarter in pre-COVID 2019. Moving to slide seven, we'll look at major activities in the quarter. Starting with the post-COVID operating environment, global supply chain and labor sourcing and retention challenges continue, similar to what we saw in Q2. Operations are stabilizing, improving as we continue hiring, but we are running high use of labor in order to fill in the gaps. Pricing actions have been initiated to help combat material inflation over the upcoming quarters. For our European sales organization, we've completed the design and aligned the structure similar to what we've done in North America. Realignment of territories similar to North America will add territories and expand the reach. And preclinical sales team will also now start to rep the behavior products the same as we did last year in North America, and it was very successful in helping drive growth. Now I'll turn the call over to Mike for a quick look at the key financials.

Thanks, Jim, and good morning, everyone. We are very pleased as a leadership team to see continued momentum and top-line growth and on track to achieve our stated 2021 goal to drive long-term profitable growth. As we usually do, I'll walk through the full P&L and cash flow in more detail, but as a reminder, my discussion will focus on adjusted results for P&L performance, which aligns with measurements used to internally manage the business. Reconciliations are available in the appendix of this presentation. gap results. Consistent with Q2 reporting, it will make certain references against 2019 due to the unique comparability issues with 2020 due to COVID-19. On that note, our performance continues to reflect a fundamentally better business with adjusted operating margins of 13% exceeding Q3 2019 of 12% despite the roughly 300 basis point negative impact of supply chain and labor costs noted. Looking back to Q3 2020, The decline in margin from 15% includes the COGS impact as well as the unique one-time cost measures Jim noted to preserve cash flow during the height of COVID. Our operating expenses in Q321 include investments to return sales, marketing, and R&D spend to pre-COVID levels with a vastly improved set of capabilities to leverage as well as higher variable compensation accruals. In terms of bottom line performance as well as long-term value creation, Delivering superior gross margin levels remains in focus despite the impact of supply chain trends noted. Adjusted gross margin was 56% or in line with historical performance as headwinds and COGS were largely offset by improved product mix. Within the COGS increases, the majority of the impact is due to vendor cost increases starting in the first half of this year. We also experienced higher manufacturing labor costs due to both market forces on wages and but also inefficiencies in certain facilities where headcount reductions were made during the downturn in 2020, requiring rehiring and retraining in 2021. We've seen stabilization in these operations, which will position us for efficiency gains and leverage in 2022. On improved product mix, as we've discussed, our growth initiatives are focused on selling high-end niche products through more efficient direct sales channels, as well as the pruning of low-margin, low-growth SKUs. All of those actions have led to better mix that's improving our gross margin overall to keep us neutral against where we were with the COGS headwinds. On cash flow and debt, our leverage ratio or total debt to adjusted EBITDA is 2.5 times, relatively consistent from the prior quarter, but down from 3.2 times leverage at the end of 2020 due to higher adjusted earnings. Net debt of $40.9 million is essentially flat to the end of 2020 due to inventory growth. We have increased inventory levels in response to strong water growth and to ensure stable water fulfillment during this period of supply chain volatility. The increases in inventory levels have helped stabilize operations as noted as we exit Q3. Interest expense is down significantly over prior year due to the December 2020 refinancing. In terms of other uses of cash, capital expenditures in Q3 were $500,000, which included IT and manufacturing site investments to support growth and scalability in our core manufacturing centers. Additionally, we incurred approximately $900,000 of transformation costs, which are excluded from adjusted earnings, given these are non-run rate investments. Q3 costs included final expenses from Europe site consolidations completed in mid-2021, costs associated with organizational upgrades, as well as project costs related to improvements in our core business systems and operations. I noted on our Q2 call that we would invest roughly $1 million in the second half of 2021 to accelerate improvements in our core operations. A portion of Q3 spend is related to these efforts. The primary output of these efforts short-term will include global data warehouse and data visualization tool sets, which is already enabling our sales effectiveness efforts and has recently been extended to benefit our operations and supply chain analytics. These analytical capabilities in place are fundamentally different today and are another source of momentum as we enter 2022, supporting growth and margin expansion. With that, I'll turn it back to Jim to discuss the full year outlook. Jim?

Thanks, Mike. So looking forward, if we go to move to slide 11, our primary goal is sales growth driven by improved sales effectiveness, marketing, and new product introductions. Over the next few quarters, we'll be addressing COGS issues resulting from the global supply chain disruptions, specifically honing in on freight optimization, material costs, and labor inefficiencies, and tuning our overhead costs in various places such as Europe. As for our outlook for the year, we're taking up our revenue outlook and maintaining our operating margin targets despite the extended supply chain-related cost increases. We now expect revenue growth reported basis to improve to approximately 15 to 17 percent growth versus last year. We see strong order growth and a strong backlog driving sustained growth in our preclinical product revenue. Academic labs are expected to continue recovering with strong order growth and a strong backlog. Portfolio rationalization pruned low quality revenue of approximately 1 million from our FY19 baseline and another 4 million from FY20. Risks do remain on the impact of the global supply chain for certain materials, but we are managing it closely and brute-forcing manufacturing and supply to best meet our demand. As for adjusted operating margin, we are maintaining expected improvement to the mid-teens range. In spite of these global supply chain issues, we expect continued gross margin expansion on increased volume and improved margin mix, somewhat offset by higher supply chain costs. With that, I want to thank you, and I'll turn over the call to the operator and open the line for Q&A. Thanks.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Your first question comes from the line of Lisa Springer from Singular Research. Please go ahead.

Good morning, guys.

Hi, Lisa.

I wanted to ask you, so you've mentioned that supply chain issues have been a factor in terms of cost for labor and freight and materials. Have you encountered any issues in terms of sourcing components for some of your higher tech products? Or are things generally available just at a higher price?

You know, this happens off and on, especially in high tech development. But yeah, we've seen, you know, a mix of items being very hard to get. You know, a number of suppliers either shut down their operation and had to restart. In a number of cases, we've had to go out to the market and try and find parts that maybe you have to get through areas instead of directly from the original manufacturer. You have to sometimes go out and pay a fairly high price for something that's available, but somebody has to go out and put it together. So in those cases, the prices on an individual component basis can go up dramatically. But in time, that all settles out. Sometimes we have to do things like redesign part of a circuit to be able to move on with a different product, move on with a different set of chips. But definitely that's probably the largest problem we have in terms of supply chain disruption is with the supply we need from our suppliers. And we've done things like reached out and the team has evaluated basically the full suite of electronic chips that we use across the portfolio. And I've asked them to make sure that we've, where we can, make sure we've got a year supply available. And that means, that's why you're seeing things like inventory going up. And then also, if there's things that are just, you know, real hard to find, we end up having to pay a higher purchase price for it. But yeah, that's where the disruption is really hitting us, is with the supply of parts to our manufacturing sites.

Okay. And Jim, could you comment, what, Comment on the revenue contribution from newer products, say, you know, products introduced in the past 12 months, and how the gross margins compare to the average product.

Yeah, that's a great question, Lisa. You know, an example would be the inhalation product that was virtually a new product, you know, something like a year and a half ago. You know, that's become a significant contributor to revenue growth in the business. You know, that's just one to mention. We've introduced just in this last year 17 either new products or enhanced products of what we're already offering. Those are driving new growth in the business, incremental growth, and in some cases it's replacing existing growth with a product that's a better product and it's going to be more sustained. But certainly new product development is a key portion of our growth plan and will continue to be.

Okay. And Jim, my final question I wanted to ask you about, you commented that U.S. government contract reductions were a factor impacting preclinical. Could you provide a little more color on that and what you see happening with that in the fourth quarter?

Sure, sure. When COVID hit, we saw the government redirect a lot of their investment from things that they historically would have invested in. For instance, for us, we were pretty heavily exposed to what they were doing with trying to test for biohazards. So some of our products that were used for that were pretty significant. I mean, it was a measurable part of our revenue. But the government, basically those labs had either slowed down or shut down and redirected their focus from biohazards in areas like that to things that were more associated with COVID. So in that particular segment, there we saw a pretty good drop off of the revenue. It's in the numbers. But that's probably going to take a while for that to all come back. And I think a lot of it just is the government's focus shifted from worrying about biohazards to worrying about how are we going to make sure we accelerate things like vaccines. We do think that that will come back in time. But at this point, we've been able to replace any of that lost revenue plus some with areas that are core to our business.

Sure. Thank you very much, Jim.

Thanks, Lisa.

Your next question comes from the line of Paul Knight from KBank. Please go ahead.

Paul, you might be muted.

I don't know if you're speaking. I have my mute on. Could you go over your CRO exposure, your academic exposure level, and, you know, the growth you were seeing in those two markets, Jim? Sure.

And in the quarter, the CRO business for us is very big and it's very lumpy. So in this quarter, timing caused us to have a little bit lower than what we would typically see on the CRO side. But at the same time, pharma grew very strong. So that's why we saw global substantial growth on the pharma side with our preclinical products. So definitely that, and the academic revenue, the academic research sites, they're still coming back. It's solid and it's growing across our lines. So both the CMT lines and a lot of our growth that we've been seeing on the preclinical side is also going to academic research sites, especially sites where they're doing more animal model work and working on startups of new farm or new biotech type companies.

And Jim, you, I think, in the presentation had shown growth year over year compared to 2019 pre-COVID of about 8%. Is that kind of the normalized growth rate of a Harvard Bioscience, or are you guiding to what your long-term goal really is?

Our goal is to certainly, you know, get into that or close to that 10% region. That's the target for us is, you know, 10 plus. You know, looking at it, it's kind of hard to take and extract all the puts and takes from 19 to 20 to 21. You know, you think one of the things, you know, we took out revenue of, you know, something like $5 million in 21 that it would have been in 19. So when you do the puts and takes and adjust for all that, you know, the underlying growth, you know, we see is, you know, in the double digits. And, you know, that's kind of what we look at for how we're going to sustain that kind of growth. You know, I think our global targets, you know, formal targets were more in that six to eight originally. Well, certainly, you know, we see that as very achievable. And our target at this point is to get up to, you know, more like the eight to 12% region. That's where we're shooting for. But certainly getting to 10 would be, you know, a real, important milestone for us on a sustained basis.

Yeah, and then I know the earlier question was around products as well, but, you know, specifically electroporation, other, you know, were there any product highlights besides the inhalation product line?

Yeah, good question. You know, certainly we are investing. There's natural tailwinds with the electroporation technology, and we're introducing some new technologies and products along that phase. That's We expect that to be one of the fastest growing parts of our business. Also, in our net revenue growth, there are some areas that aren't really growing that fast, and we are looking at those now as to whether some of these other products that are not right in the tailwind of where we're really focusing, whether or not those make a lot of sense to make the investment to turn those into good growth additional drivers. you know, or whether there's something else that we should be thinking about doing with them. There's no question that there's still, you know, another, you know, somewhere in the neighborhood of four to six million that we think will likely need to be pruned out over the upcoming year or so. But then there's also a couple of areas that we want to look at that we just have to make a decision, can we turn those into something that contributes on an accretive basis to the kind of growth factor that we want that's really, that fits the sales rep's bags. That's going to take a little bit longer. That's probably another, you know, so you'll see some evolution of those. But, you know, I'd like to get to where I have, again, a good sustained double-digit growth. And part of that will be, you know, positive through extracting some negatives. And that's just part of the natural thing. And as we do that, we'll let you know, you know, what those numbers look like, like the last 5 million that we took out from, you know, the 19 timeframe. Yeah, okay, thanks.

Your next question comes from the line of Tim Chung of Northland Capital. Please go ahead.

So you talked a little bit about how European labs are improving sequentially. You know, I think that's still about, what, a third of your total revenues. Could you talk a little bit about how you see Europe coming back in the fourth quarter and into 2022? Sure.

There's clear strength that we see with a lot more order activity, a lot more quoting, a lot more things taking place on the European labs because they've really been slow for us. Certainly, as we look to Q4 and Q1 next year, the next couple of quarters, we do expect the European labs to get back where they were. That's going to be a piece of improving our overall business. But, you know, the good news for us is our fundamental businesses, you know, outside of there have been more than taking up the slack there. So that's going to help us as they get back to where they really should be. And at the same time, you know, we're tuning what our product offerings are going to be. So we want to stay in those areas that really make sense that have a good natural tailwind for them.

Okay, good. And maybe just one follow-up, which is, you know, how much – ability do you have to take up price on your CMT and preclinical product lines? Obviously, these costs are increasing, but are you able to take up costs or prices, especially, let's say, in the fourth quarter and into next?

Yeah, that's something that we know is always challenging, but what we've seen is it depends on the customer segment, depends on the product. If the things that we sell direct we have quite a bit of pricing power. So if our reps are out there and it's a highly technical sale, it's a sticky sale, areas like that, we have really good pricing power. Some of the things that we sell through distribution may take a little longer and may or may not have the kind of pricing power that we'd like to see. We've implemented some new pricing that's rolling out here now. It'll really start to stick as we get late into Q4 and then more into Q1. you know, new orders will be at a better pricing point for us. And it's a mix. In some cases, you know, we modified pricing very slightly. In other areas, there's things that, you know, really needed to go up pretty much. So, you know, you might see things move up from, you know, certain things might go up as much as 15% to 20%. On net average, you know, if we dial in, you know, 3% or 4% price increase net, you know, we'd expect to get, you know, 2% to 3% ASP average. So, That's kind of what I, if I can get 2% to 3% improvement on ASPs, that really helps us offset the inflation that's part of our cost structure that's come in. The other parts of COGS that are bothering us, those are things that we have a handle on. We'll get to the efficiencies on labor. There's no question about that. We'll get to what it takes to get COGS where they need to be. But some of the inflation on some of these parts, it's likely to be with us. But if that's... I don't know, two points or so of gross margin that we hope to be able to make up on its own with pricing and then get further improvements as we do the natural improvements of COGS.

Okay, great. Thanks, Tim.

Thanks, Tim.

Your next question comes from the line of Bruce Jackson from Benchmark Company. Please go ahead.

Hi, Bruce. Hi, thank you for taking my question. So you launched 17 new products this year. You've already discussed some of the stuff that you're working on in terms of inhalation products. Are you still working on the new cellular molecular testing products for CRISPR-CoV-2? And is the supply chain situation at all impacting your new product cadence for 2022?

We're working on a series of products across the portfolio. There's new things coming out on the cellular side with individual cell testing and batch cell testing. That's a natural growth area for us where we have great technology, not a lot of players there, high barriers, good pricing. You're going to see further improvements there. And with new products, you know, a lot of what we've also been focusing on is things that really fit the preclinical bag. And I've also mentioned that the behavioral type products that in the past typically sold on their own as individual products into academic research, we're now working to bundle those more with the technologies that we already sell into the pharmacy RO markets. So, you know, that's a nice fit for us, and that's why you're going to see The teams that rep the products for preclinical are having a broader integrated sale that they'll be able to sell. You put that together with our overall systems that are qualified for preclinical formal testing. That's a very nice barrier for us. It just makes sense. It's a piece of cross-selling, but it's more than that. It's actually realigning the portfolio best for driving growth to all of our primary segments. But there's new products coming out. We'll be announcing new sets as we get to our global sales meeting in January. This is a technology company. We have to keep innovating. A lot of companies aren't doing it these days. So that's a real advantage for us. And the fact that we're a little more nimble, we can put a lot of effort in one or two key places where the bigger companies tend to peanut butter everything and everything kind of moves along slower. So that's an advantage for us.

That's the only question I've got for today. Congratulations on the quarter, and thanks for taking my question.

Thanks, Bruce. Thank you.

Your next question comes from Alan Gershkin from NanoCap Growth. Please go ahead.

Hi, guys. I have more of a comment, because you're doing a great job, you know, turn the company around, growing again. making money, everything looks good. But I feel like from a stock perspective that you're failing. There's no investor relations. There's no press releases in your quarter. I feel like there's so much more you can do. And if I saw this company the first time and it was brought public, the thing would be worth $800 million to $1 billion in this market. So I feel like you have to do more on the investor relations front. And that's really my comment. I know you guys were supposed to try and start doing something, and I haven't seen anything yet.

Yeah, well, thanks for your thoughts. And first, I hope, you know, certainly I think the more we – the more our message is out there, you know, that will certainly help the business. You know, we are planning some roadshows. We're planning, you know, with our sell-side folks to get out there in front of more customers. No question that we – We have some opportunities there, and certainly thank you for your thoughts.

But also, with like 17 new product introductions this year, could you put out some press releases to, you know, just keep the name alive intra-quarter while nothing's going on? Just so, you know, we know you're alive and something's happening. Great.

Okay.

Appreciate your thoughts.

Thank you so much.

If there are no further questions at this time, I would like to hand the conference back to our speakers. Thank you.

Great. Thank you for joining us, and look forward to listening in at our Q4 call in February. Thanks. Take care, everybody.

This concludes today's conference call. Thank you for participating. You may now disconnect.