Harvard Bioscience, Inc.

Good morning, ladies and gentlemen. Thank you for standing by. And welcome to the Harvard Spires Science, Inc. First Quarter 2022 Earnings Conference Call. At this time, all participants are on 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 the star, then the one key on your touch-tone telephone. Please be advised that today's conference may be recorded. If you recall operating systems at any time, please press star, then zero. I would now like to hand the conference over to your host today, Dave Sorais.

Thank you, Olivia, and good morning, everyone. Thank you for joining the Harvard Bioscience First Quarter 2022 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 Q1 2022 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, 2021, our subsequently filed 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, represents 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 represents 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 and today's presentation. These two documents, as well as a replay of this call, can be found on our website under investor overviews, 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. Let's go to slide four of the presentation and take a look at the highlights for the quarter. Revenue was up 7% over last year, with preclinical up 7% and cellular and molecular up 10%. We saw significant order delays from China from the lockdown there, though we do already see China recovering later this quarter and expect a strong second half. Cost of goods continue to run high from global supply chain disruptions, inefficient labor, and higher freight costs. Adjusted operating margin came in at 8% versus 12% last year, impacted by shipment revenue delays, inflation, and investments that we made for growth. Gross margins came in at 57%, flat the prior year, with mixed improvements offset by an increase in COGS. Higher COGS continued from global freight costs, material inflation, plus direct labor inefficiencies. OpEx was temporarily up on timing of sales and marketing activities versus a COVID-driven low prior year. Research and development investments increased as planned to support our long-term growth. Finally, the 8K-announced litigation settlement puts the legal distraction behind us. If we move to slide five of the presentation, we'll look at the details in the quarter. In spite of global supply chain headwinds and delays in shipments to China, we had solid revenue growth, with Q1 coming in at $28.8 million, up 7 percent over last year. Gross margin on GAAP basis came in at 56.2 percent. That's up 100 basis points. from last year despite the higher cost of goods. This quarter had GAAP operating income of negative 6.7 million, which included a $5 million charge related to the litigation settlement. Our adjusted operating income was 2.4 million, so our adjusted operating margin measured 8.2% of revenue. GAAP earnings per share in the quarter was a loss of 17 cents. Our adjusted earnings per share was 4 cents, down a penny from prior year. We consumed about $2 million in cash, and our net debt increased by $3 million in the quarter. Our leverage ratio measured 2.9 times EBITDA. I'll move to slide six, look at the revenue in the quarter by product family. Starting with the first row of the table, our cellular and molecular technology revenue was up 7% from last year, impacted by shipment delays to China on their lockdown, and global supply chain disruptions continue to hamper our revenue shipments. Order intake from North America remains strong across the portfolio. We saw delays from the China lockdown recovering late in this quarter, and also we see a real strong second half. European orders were delayed on COVID lockdowns in January and February, but have started recovering slowly. Looking at the second row of the table, our preclinical product revenue was up 10% over a strong prior year, However, we did experience revenue shipment delays in China and continue to be hampered by these disruptions in the global supply chain. Order intake was very strong in North America. We saw delays, though, in China from the lockdown, but as we said on CMT, we do see things recovering here later in this quarter, and we see a very strong second half. This quarter, currency impacted revenue by about half a million dollars. Our overall reported revenue was 7% over last year. Now I'll turn it over to Mike for a quick look at the key financials. Mike?

Thanks, Jim, and good morning, everyone. Needless to say, the global environment has experienced a historic level of volatility and change over the last two years. But as we have throughout this period, we stand with conviction on our ability to manage through bumps in the road like we're seeing in the order delays associated with China. Our core products and diverse customer base combined with actions we've already taken provide a foundation for the profitable double-digit growth we've been speaking to. And Jim will speak more in our outlook about how we see the full year shaping up in the context of some uncertainty on how the China market recovers from recent status. As we usually do, I'll walk through the full P&L and cash flow in more detail. As a reminder, my discussion will focus on adjusted results for P&L performance, which aligns with measurements we use to internally manage the business. Before I walk through margins, cost, and cash flow, I wanted to share an update on our investor reporting. Since 2019, we've reported our revenues as a split between our preclinical and CMT product families. Through 2021, our preclinical revenues, as reported, have been our telemetry and inhalation products that became part of the Harvard Bioscience Portfolio with the 2018 acquisition of Data Sciences International, or DSI. As we've discussed, the top focus for us since day one has been to integrate the brands and products in a logical way that addresses the needs of the market. As part of this, we have evolved our go-to-market model and product line management to include our behavior, isolated organ, and surgical products as preclinical solutions with common call points and applications to our TSI products. Accordingly, these products formally reported in our CMT product family are now reported in our preclinical revenues. as reflected in our actual and historical revenues. We look forward to sharing more examples in 2022 with our investor community on how we're evolving and investing in our core products and markets to drive growth. Now turning to our results on gross margin, we reported 57% for Q1 2022, similar to prior year but with substantially different underlying factors delivering this result, which remains favorable to industry benchmarks. Jim has discussed in detail the negative impacts of supply chain inflation and labor dynamics, which first showed meaningful increases in COGS in Q2 of 2021. These costs are now over $1 million per quarter, as previously reported, but we now have much more prescriptive targeted areas to mitigate these costs, and we expect COGS to begin improvement in the second half of 2022 as programs get implemented. Despite these cost increases, we've maintained stable gross margins due to continuous improvements in product mix and pricing. Our higher margin preclinical products and niche products within our CMT portfolio grew as a percentage of overall sales relative to prior year once again, and pricing actions implemented also benefited gross margin. Clearly, the supply chain will continue to evolve, but factors we can control around product and channel management will continue to positively impact margin improvement. Adjusting operating income for Q1 is down, as Jim discussed, due to planned investments in sales, marketing, and R&D to underpin our double-digit revenue growth objectives, as well as inflation impacts. Also, Q1 revenue is lower than internal plans due to the factors Jim has discussed. While we are investing responsibly for growth, we continue to see mid-teens operating margins and solid recurring positive cash flows as important financial objectives. And Q1 is simply softer on operating margins than we'd like given how rapidly the order flow declined in the second half of Q1. Finally, costs such as travel and trade show expenses were very low in the beginning of 2021 due to remote work for sales and others at that time. On cash flow and debt, our leverage ratio or total debt to adjusted EBITDA is 2.9 times up from 2.7 at year end due to softer earnings in Q1 as discussed. Also, net working capital typically drops down from Q4 to Q1, but remains higher than typical Q1 levels for us due to AR collection delays in China due to the lockdowns, which are timing issues versus bad debt exposures, plus higher inventory levels to deal with supply chain uncertainties, as well as lower than expected shipments in the first quarter. In terms of other uses of cash, I first wanted to speak to the litigation settlement referenced We recorded charges totaling approximately $5 million based on the settlement reported via AK in April. Cash outlays related to this event will largely be in Q2 2022. As disclosed in the AK, Biostage is seeking new capital to sustain its own efforts as a clinical stage entity, which may provide recovery for these outlays. But this is an uncertain outcome, and we are planning with new recoveries in our own on no recoveries from this in our own 2022 cash outlook. We secured an amendment in our credit facility recently to accommodate these payments and increase our maximum allowable leverage ratio for the rest of 2022. We expect this provides ample room to get any litigation payments behind us and execute our growth and improvement plans set for this year. CapEx for Q1 was $500,000. We expect capital expenditures for 2022 to be approximately $2 million with growth from a past annual run rate primarily associated with capitalizable development costs associated with telemetry product investments referenced. Additionally, we incurred $1.4 million in transformation costs in Q1, which are excluded from adjusted earnings consistent with past practice. given these are non-run rate investments in our business infrastructure designed to ensure solid long-term growth platform. Our cost in Q1 related primarily to a detailed review of our operations in Massachusetts and Minnesota, which manufacture and support the substantial majority of our global revenues. From this process, we have identified specific programs to increase productivity, supporting items such as planned COGS reductions, as well as to unify the processes and systems of these core operations to efficiently deliver long-term profitable growth. We expect roughly $1 million per quarter rest of the year in cash investments to support these improvement plans. Consistent with our message from our Q4 call, we expect 2022 cash flow from operations to improve versus 2021 based on earnings growth, and we do not expect the level of working capital growth experienced in 2021 in response to the supply chain dynamics discussed. With that, I'll turn it back to Jim to discuss the full year outlook.

Jim? Thanks, Mike. Just real quick, you know, in my opening statements, I misstated that the CMT was up 10 and preclinical was up 7. It's actually the reverse. Preclinical is up 10% and CMT is up 7%. And you'll see that that's correct in the numbers and in the presentation. So now let's move to the summary slide on slide 10. And taking a look forward, we continue to see strong growth and improved margins, but we are broadening our range of the outlook to account for potential volatility in China. We expect year-over-year revenue growth in the range of 8% to 13% versus last year. We expect solid growth in North America and EMEA, and we see China recovering late in this quarter, followed by a strong second half. Reported revenue will be net of further portfolio rationalization activities with the expected to prune, where we expect to prune somewhere between $2 and $4 million of low-quality, non-strategic product sales to really improve our mix and help us make this business a much more leverageable platform business. As for adjusted operating margin, we expect continued improvement to range from 14% to 16% of revenue. Gross margins to improve to 58% to 59%. driven by operating leverage on growth and continued cost-of-good sold reductions. We see the global supply chain stable, but remaining at some of these higher cost levels. Operating margin improvement will include a continued higher level of research and development for new products, along with higher margins and cost of sales and marketing. Thank you. Now I'll turn the call over to the operator, and we'll open the line for questions and answers. Thank you.

Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, please press the start and the one key on your touch-tone telephone. Please stand by while we compile the Q&A roster. And our first question coming from the line of Paul Knight. We keep your line open.

Hi, Jim. Can you talk to China is 1% of company revenue.

It's somewhere around 20%-ish.

Yeah, Asia overall is about 20% or so of revenue, and most of that is China sales.

And if China recovers, you would expect to what, get to the upper end of revenue guide?

I think, yeah, that's true. I mean, the reason we broadened the range is, you know, if You know, we did see, you know, a downtick in orders, and, you know, one of the things that we validated is it's not a loss if they're delayed. You know, there's people, you know, a lot of our people, you know, are in Shanghai. That's where our main operating offices are. A lot of them, they've actually all been forced to work from home, and their customers also have been forced to work from home. So companies, you know, their academic research sites there have really had to delay their placing orders with us in a number of cases. If they're recurring orders, those seem to come in just fine. But people are going back into the office and they are setting up their tools to be able to start picking up the orders. We don't see, we don't have any evidence of anything lost. It all seems to be delayed. So that's why we think not only will we get back to a strong second half, there's a good chance that a lot of what was delayed in the first First quarter and some of the second quarter will wind up and we may see some extra in the second half of that because there's no – the actual demand is there. It's just been the inability to process the orders. And early on in the quarter, you know, we had issues with shipping into China. Now, that seems to be resolving. We're seeing shipments working much faster now. And we're also getting – people are getting back on the phones. And that's why we see, you know, just looking even late in this quarter, we're starting to see indications that this is coming back. So, again, we expect that to continue to get better. The latest news we hear in China is that, you know, they know they've got to get things back up and running. And, again, but we're on the ground there, so we see it actually really happening. And, you know, talk to the folks. And we feel real good about the second half. And, in fact, the fact that we can see early indications that even in this quarter, you that order intake is picking back up. That sends us a nice positive sign.

And the pricing, meaning your COGS has obviously gone up and other parts, can you pass on pricing ultimately?

Yeah, we've been pretty good at passing that pricing on. Now, it takes a while for that to fit in. Sometimes there's longer-term contracts where it takes a while to actually implement the new pricing. We've had very little pushback in the areas where we've just rolled out the new pricing at the beginning of the year. You know, we're seeing that now in the order intake and then they'll follow into the revenue side. So we're pretty well able to pass on that. In some areas, in the less strategic areas, the things that we work with through distribution, it's a little harder there. There we have – we sometimes compete with, you know, multiple customers there, so that's a little bit harder there. But across the board, you know, we're seeing pretty much everybody taking those prices up to account for this. Where we sell direct in our high technology products with high barriers, you know, we have very, very strong pricing there and pricing power. So, you know, we will pass. We have been working to pass more of that along. But, you know, we think the inflation piece, the purchase price variance piece is going to stay high. We don't see a reason why that will come down. But with the changes in the business here and what we're doing on the operating side, we definitely are going to see significant improvements in our labor costs. So we'll see efficiencies there, and with the work that we're going through to use the tool set from Minneapolis and move towards the one tool set and one platform, that's going to give us an opportunity to start to really address some of the overheads across all of the companies. So, you know, again, the freight's probably going to stay high for a while. It's hard to predict that. We're kind of assuming that that may just stay like that. Purchase price is going to stay high, but our big driving component of labor and labor inefficiencies, that's going to be resolved here, and you'll see that resolved throughout the year. And as we exit the year, we're going to be much, much better on the COG side. And, of course, if there's pricing opportunities, we definitely will be pulling that lever, too.

Okay. Thank you. Thanks.

Our next question, coming from the lineup, Tim Chang from Northland Capital. Your line is open.

Hi, thanks. Jim, I think previously you had a target for about 60% adjusted gross profit margins. Do you think that's still achievable this year, just given some of the supply constraints?

Yeah, we're... Yeah, great question. What we think is you'll see it continue to get better through the year on volume. So as we get to the end of the year, we're confident we'll be at 60-ish percent, maybe right around that region. Some of the larger quarters will start to hit that anyway. And even for the year, we would think we'll be 58, 59 for the year. That will include a lower Q1 here. with all the impacts that we're still working through here. But, yeah, as we get to the end of the year, we should be at a run rate of right at around 60%.

And maybe just one follow-up. How quickly can you prune some of these low-quality products? Are they already coming out of the top line?

The way we've set this up is, like, whenever you take something out of the portfolio, it takes a little bit of time and you have to build up You have to go through from the sales organization back to the company and modify the process. And with that, typically what we do is we look at how many we'll sell off to customers as a last-time buy, and we'll often, you know, have to put a little higher price in it if we can't really – if it's inefficient for us to deliver it. But I would – you know, I'm expecting the second half of this year that the revenue products that are coming out will really start clipping out. So – It'll kind of build out through the second half of the year. As we get to the end of the year, I would expect that number around $4 million-ish to be out. And, again, that's net of us delivering, you know, our top line reported revenue. And a lot of what comes out, it won't just go away. Some of it we're able to replace with better products simply by offering, you know, the more strategic future product in place of it. but something that just doesn't really have a future. You know, my philosophy is a negative of a negative is a positive, and if it doesn't really fit our portfolio for the future, you know, we have to be moving it out and put our effort into what really matters for growing the business profitably.

Okay, got it. Thanks.

All right. Our next question coming from the line of Bruce Jackson with Benchmark. Your line is open. Thank you.

Hi, thanks for taking the questions. So you recently launched an upgrade to your respiratory products. Do you have anything else in the new product pipeline that we can look forward to during the year?

Sure. I mean, this last couple of years, we've been clipping along at around 15 or so new products being introduced, a combination of new and refreshed. You know, I publicly announced in a press release the new improvement pipeline and the launch of the, you know, the SMART study for inhalation, that we believe is a very, because it's so unique and we see it as a nice incremental driver for our business, that's why I want to start doing more speaking about these technologies as they come out. But there are some areas that, you know, we're really focusing on areas that will allow us to take a product that might be, has historically been sold into academic research and been used in more smaller batch level testing, you know, things like products that are going to be used in cell testing, in things that are going to be used, things that are used for things like the CRISPR-related products, things like that. We're looking now at what we have to do, because now we have such great exposure to the larger pharma companies, farmers and CROs. A number of our products fit well into that stream, too, and have never really had access to it. That's partly why Mike said that we're starting to readjust where we report the numbers. And one really good example is our behavior products. which has always really only sold into academic research, when you think about that along with telemetry, it's exactly along the lines of what the CROs and the pharma companies need. They have to do the same thing. And you know we have great exposure and we're the top shareholder into the telemetry side for safety pharmacology and toxicology. Well, behavior is a piece of that whole puzzle. So when you integrate behavior along with that and you might integrate it with telemetry. So you're able to cover a broader range of that cycle, that preclinical cycle that you have to go through in order to move into clinical. And also because our products are GLP compliant, that means they're usable. The data is collectible and usable with your filings to the FDA. So you're going to see something like that. That rolls out. We're already seeing an uptick in behavioral products, and that's where you see some of this uptick you see happening on our – Our preclinical side is happening because we're expanding some of the portfolio with things that we were already doing but had been limited in the past to academics. So you'll see more and more of these products start to tip over there. And as we start to get measurable improvements and growth there, we'll be announcing that. You'll see that happen. We'll continue to sell to academic research if it's a large site and they need our cellular products. But on the other hand, there's a lot of animal work taking place in very large academic sites where our products that are in preclinical, they also can be configured at the size for the research site. So we're actually seeing both sides have the ability to drive growth along their lines. But we do want to be able to report along the portfolio and report along the customer segment for you.

All right, that's it for me. Thank you.

Thanks, Bruce.

And I am showing no further questions at this time. I would now like to turn the call back over to Mr. Green for any closing remarks.

Okay. Well, thank you for joining us today. Today ends our presentation. We hope you'll join us in three months for our Q2 results. Thanks again, and have a great week. Thank you.

Ladies and gentlemen, that's our conference for today. Thank you for your participation.

You may now disconnect.