Harvard Bioscience, Inc.

Good day, and thank you for standing by. Welcome to the Q2 2022 Harvard Bioscience, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, David T. Royce. Please go ahead.

Thank you, Bella, and good morning, everyone. Thank you for joining the Harvard Bioscience second 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 Q2 2022, each file quarterly earnings presentation. and is located in the investor overview events and presentation 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 ending December 31st, 2021, 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 represents the ongoing economics of the business, reflects how we set and measure our incentive compensation plan, 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 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. We'll look at a quick summary. Revenue in the quarter was $29 million, flat to Q2 last year, with 17% growth in cellular and molecular, offset by preclinical, which was down 9%. Our focus on direct sales of high-margin cellular products is driving growth as we rotate out of lower-margin products, which are sold mostly through distributors. Our preclinical revenue had a tough comparison to a very strong prior year. The strong U.S. dollar versus a pound in the euro drove a currency impact of approximately $900,000 in the quarter. And China's COVID-related shutdowns caused added shipment delays for our shipments. Adjusted operating margin came in at 11%, and that's versus 15% last year, held back by order and shipment delays, inflation, and investments in R&D and marketing. Gross margins came in at 58%. That's up 100 basis points from last year. Higher costs continue 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, we announced actions in July to optimize our product portfolio, obsolete non-strategic product lines, and reduce our overall operating costs. These actions underpin our gross margin and operating margin targets for 2023 and beyond. As part of this action, we've announced a global workforce reduction of approximately 5% that completes by the end of this year. We see severance-related costs in line with previously discussed expectations at approximately $1 million a quarter during the second half of this year. Let's move on to the next slide. Q2 revenue came in at $29.2 million flat to last year. Gross margin on a GAAP basis was 57%, up 100 basis points from last year despite the higher cost of goods. This quarter had GAAP operating income of $4 million, or 13.7% of revenue, and includes a benefit of $4.9 million associated with the resolution of previously announced litigation. Our adjusted operating income was $3.1 million, or 10.5% of revenue. GAAP earnings per share in the quarter was $0.06, up from a negative penny last year. Our adjusted earnings per share was $0.05, down from $0.06 in prior year. We consumed about $200,000 in cash flow in the quarter, and our net debt increased by $600,000 in the quarter. And our leverage ratio measures 3.1 times EBITDA. Move on to slide six, take a look at our revenue in the quarter by product family. Starting with the first row of the table, our cellular and molecular technology revenue was up 17% from last year, driven by strong performance of our direct sales team. Both the U.S. and European direct sales teams did great work and saw strong growth. As we expected, we continue to reduce sales of lower margin products sold through distributors. We do see government-funded research in the U.K. continue to be impacted by Brexit, so we do expect that to recover over time. Look at the preclinical. Revenue was down 9% on lower demand from Europe and shipment delays to China relating to China's COVID policy shutdown. European CROs and pharma companies was slower than usual as compared to a very strong prior year. China was flat the prior year. However, we still see a return to growth coming later in the year, likely Q4. The U.S. was down modestly in Q2, though we see steady growth in the pipeline and expect a return to growth in the second half and a strong Q4. The strong U.S. dollar compared to the euro and British pound drove a currency impact of $900,000, which will likely continue to hurt us throughout the year. Overall, strong growth in cellular and molecular offset the combination of currency and lower sales in preclinical. I'll turn the call over to Mike for a quick look at our key financials. Mike? Thanks, Jim, and good morning, everyone. Before I jump into the details on the full P&L and cash flows, I wanted to provide some additional perspective on the current operating environment. For one, China is a critical market for life science tool companies, and this year, We accelerated moving into one united sales channel versus separate preclinical and CMT sales in China and see real evidence that this will serve us well when this market normalizes. But clearly, since we spoke on the Q1 call, the outlook for China in 2022 has become much more ambiguous given lockdowns and general economic conditions. And the prudent thing to do is to plan our revenue-related cost base at a lower level. Also, we've referenced volatility in Europe. In the markets we serve, we see steadiness in academics, but the place to hunt strategically, commercial biopharma with CROs and pharma, are quieter right now. Finally, we've been consistently speaking to focus on sales of high-end niche products through direct sales, a clear benefit for us in the long run. However, in this global environment where bottom-line-oriented operators are demonstrating fiscal prudence, sales of higher ASP equipment is slowing down. We looked really hard at this, and this is what we're seeing. So the environment is once again changing rapidly, but the conviction around delivering the profitable growth platform and fiscal discipline stands. Turning back to the P&L cash flow details, 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. Also, for investor reporting, as noted prior quarter, we are now reporting our preclinical and CMT product families to more tightly align with how we are driving the business. Our preclinical revenues are reported now, include our leading telemetry and inhalation products acquired in 2018 by the DSI acquisition, as well as behavior, isolated organ, and surgical products formerly reported as CMT products. This is reflected in our current historical revenues reported today. This not only aligns on how the product technologies align, but with the markets we serve, but also more and more on how we go to market. Turning to our overall financial results, On gross margin, we reported 58% adjusted gross margin for Q2 2022, or 100 basis points greater than prior year, despite lower volume than currency impacts. Pricing has driven gross margin improvements with product mix and labor and materials cogs as relatively neutral factors versus prior year. On cost of goods sold, we first saw the effects of the global supply chain and labor dynamics in early Q2 2021, So those impacts are annualizing in our results. Also, product mix had a modestly negative impact on gross margin as our preclinical products carry higher average gross margins. While preclinical margins are historically higher, the improvements in direct sales of niche cellular products we're seeing, as well as improving operating performance in the primary operations that manufacture our CMT goods and the portfolio actions to come, CMT margins will continue to improve. Adjusted operating income for the quarter is down due to planned investments in marketing and R&D that Jim has discussed, as well as general inflation impacts and the lower than expected revenue due to market dynamics noted. In the near term, we continue to see mid-teens operating margins and solid recurring positive cash flows as important financial objectives. And as indicated on our Q1 call, in the first half, we undertook efforts to ensure our cost base aligned with the market realities that have emerged in 2022. After our assessment of portfolio on a product and site level, we identified a workforce reduction of approximately 5% in areas that simply were not contributing to growth or margin expansion. This effort was completed very recently with employee and customer notifications completed post Q2 end. A number of these reductions relate to direct labor associated with low value products we are discontinuing with cost savings and more importantly, the marginal revenue benefits of eliminating very low margin high work products that burden internal operations and sales expected to meaningfully benefit 2023. In terms of immediate impacts of these actions, the fixed cost of managerial or overhead roles already eliminated is roughly $1.5 million on annualized savings. Based on these reductions and other efforts to curtail non-headcount spending for the second half, operating expenses for the second half will be down from the first half. On cash flow and debt, our leverage ratio or total debt to adjusted EBITDA is 3.1 times, up from 2.7 at year end due to software earnings in the first half discussed, as well as payments related to settling our litigation. Working capital did improve as both AR collections and APJs improved in Q2, which included improving our collections in China, which have been impacted by lockdowns. Bad debt exposure remains very low. Looking forward, DSO in the mid-50s is our planning assumption. So we're targeting bringing this down. On inventory, after growth over the last year to address the supply chain uncertainties of this environment, inventory was flat on a dollars level, and we believe we'll be stable for the rest of 2022 in terms of absolute dollars. As with our manufacturing cogs, job number one is to stabilize and next improve. That is where we are today, and this is factored into the cash flow expectations for the rest of the year. In terms of uses of cash, I wanted to go a bit more into detail on the litigation settlement. In Q1 2021, we recorded total charges of approximately $5 million based on the settlement reported in April. Cash outlays related to this event were paid in Q2 2022, and we do not expect any further material cash outlays beyond Q2 on this matter. This is an important milestone in terms of cash and overall leadership focus. Within Q2 and part of this overall set of minutes, we executed an agreement with the co-defendant to receive a convertible preferred stock with base value of $4 million, equivalent of what we paid to get out of this arrangement and under our indemnification agreement to get it satisfied. This preferred stock will convert to biostage common shares upon a new offering they anticipate completing Biostage is currently traded over the counter market and within Q2 received meaningful new cash flow in a private placement. Based on all these facts and circumstances, this warranted recording $4 million asset tied to this convertible preferred stock within Q2. The P&L gain on a gap basis in Q2 included $1 million of litigation fees paid by Biostage for which both parties were jointly liable. Both these deals with the settlement related transactions are in our 10Q to be filed this week. Within all this, we expect to seek to liquidate our position with BioStage on a qualifying event, such as relisting or an offering on NASDAQ. While positive indications of cash inflows to cover our payments were observed in Q2, currently we are not including any cash inflows on this in our 2022 cash flow or net debt projections. On the rest of the cash flow, capital expenditures in Q2 are $400,000 or $900,000 year-to-date. We expect CapEx for Q2 to moderate in the second half given market volatility and lower revenue trends noted. We incurred $1.1 million of transformation costs in Q2, which are excluded from adjusted earnings consistent with past practice, given these are non-run rate investments in our business infrastructure design to ensure a solid long-term growth platform. Our cost in Q2 related primarily to the detailed review of our operations in Massachusetts and Minnesota, which manufacture and support the substantial majority of our revenues, which ultimately led to the portfolio actions discussed. We expect cash transformation costs for the rest of 2022 to be roughly $1 million per quarter for the rest of this year to affect the plans setting up a strong 2023. No change from what we indicated last quarter. Consistent with our message from the Q1 call, we expect 2022 cash flow from operations to improve versus 2021 based on earnings growth and what we, and we do not expect the level of working capital growth experience in 2021 in response to the supply chain dynamics discussed and payments related to litigation settlement now behind us. With that, I turn it back to Jim to discuss the four-year outlook. Jim? Thanks, Mike. Now moving on to our summary slide, slide 10. Given significant currency impact, volatility in Europe and Asia, we're taking a more conservative view on the annual revenue outlook for the rest of this year. We expect year-over-year revenue growth in the range of 1% to 5% versus last year. We expect solid growth in North America, EMEA slowly recovering throughout the year, and continued impact for China shipments due to their COVID policy and returning to growth in Q4. Important revenue will be net of currency impacts, and a further rotation out of non-strategic product sales. All in all, we see a nice return to solid growth in the Q4 timeframe. As for adjusted operating margins, we expect to range from 13% to 14% of revenue, gross margins to improve to 58% in spite of higher purchase prices and shipping costs. We see continued potential shipping delays to China. Operating margin includes a higher investment in growth-oriented R&D for new product developments. And we expect positive improvements in free cash flow and reductions in net debt for the second half. Thank you, and I'll turn the call back over to the operator and open the line for Q&A. Thank you.