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.

As a reminder, to ask a question, you will need to press star 1-1 on your telephone. Again, that is star 1-1 on your telephone. Please stand by while we compile the Q&A roster. And our first question comes from the line of Bruce Jackson with Benchmark. Your line is now open.

Hi, good morning and thank you for taking my questions. Looking at the new guidance, how does this impact your long-term perspective? I think that you've been looking at maybe 68% organic long-term revenue growth. When do you think you might get back on that trajectory?

Yeah, well, certainly we feel that much of the changes that we're making are really designed to help us get to that pure growth structure for 2023. Q4, though, looks like that's where we're expecting the recovery to really start to come in for the rest of this year and then extend into 2023. So if you look at removing some of the older technologies that were really non-strategic, not growth-oriented in the lower margin, that naturally helps us, gives us a natural mix improvement, also lets us invest more in R&D for new product development in the more strategic products that do have tailwinds, nice growth vectors on them, and good pricing power. So the combination of getting rid of, you know, oscillating the older technologies that were really not part of the future, not part of growth, not, you know, not really contributing at the level we need them to contribute, really puts 2023 right in line with where our plan has been. You know, our goal has been to be, you know, at that double-digit revenue growth target, Gross margins at 60% and operating margins in the mid to upper teens. 2023 looks to be right on track for that with Q4 being a nice pathway right into 2023 and getting us to the numbers that we really felt this company needs to be at.

Okay, great. And then one follow-up question on the guide and also on the gross margins. You didn't mention anything about inputs or inflation. Have you seen any changes in that?

Well, we've seen with 900,000 impact in the quarter, that's about three percentage points off our top line. Our expectation is we're going to continue to have that in our numbers. And that's one of the drivers in why we're taking the overall expectation and range down. And there's about three points right there. And then with the transition and rotation out of some of these lower margin products, that adds up. I think if you put that all back and think about it, it's really not too far off of what our original plan was. But as we get into next year, I expect that we're going to be at that double-digit number of what our plans are, and we think we've got this underpinned. And if you think about some of the volatility, some of the things that we're seeing that I think we're hearing a lot of other companies talk about, is that a lot of people in the U.S. and Europe, you have a long vacation process right now. So we think Q3 is going to be a little volatile. It's going to be second half loaded, second half of the quarter, lower second part of the quarter. But it really becomes Q4 when things really start marching back as we see it. But we've included inflation in these numbers. We've included the cost of higher interest rates. But we're also projecting, you know, what we're looking at as far as pricing and the new products that are being introduced into the portfolio.

Okay, great. That's very helpful. Thank you very much.

Thanks, Bruce.

And your next question comes from the line of Paul Knight with KeyBank. Your line is now open.

Hi, Paul. Jim, so the portfolio pruning, I think what you're implying, maybe a 300 basis point impact this year?

Well, we've got, you know, on the interest and on the currency alone, it's about 300 basis points right there. I mean, when you look at the currency inflation, you know, with the portfolio rationalization, you know, there's certainly going to be somewhere in the neighborhood of a couple of points there. But, you know, that's why I like to give you a recorded view. So net of currency, net of things coming out and the rotation out of some of these lower margin products, which, you know, we've talked about this a lot, that need to move away from and actually obsolete or sell off some of these things that really aren't part of a growth sector, that don't have natural tailwinds, and to really focus on these technologies that we know are really, you know, strong growth products for the future. And you're very much aware of what those are, Paul. Just to clarify, I think, make sure on the portfolio actions, I think what you asked about all what Jim said makes sense. But the real impact on that in terms of it's not substantial to this year. You know, those products will get sold out. It's really next year. But I think that, you know, if we've been 57, 58 percent, that action alone with the portfolio, you know, getting us back above 60 percent. you know, at these run rate levels. So I think that 300 basis point-ish, you know, that supports us getting back over 60% in 23. As you'd expect, you know, some of the rotating out of the lower margin products, a lot of that, most of that really goes to distribution and it's been kind of commoditized. Those are things strategically we just don't want to be in. But we will, a lot of it, you know, that we've now announced obsolescence of, you know, we'll still sell some of that off. We'd like to, you know, maximize getting that out the door you know, to sell off the inventory associated with it. So it'll be more, you know, we'll still see revenues for that as those last-time buys come in, but we expect to be done building anything to do with the obsolete products by the end of this year. And then there'll be some, you know, burning down of the sales of those. And we'll be able to next year give you a better view or perform a view of and be able to extract what are those product revenues that really shouldn't be looked at when we think about the performance of the company within the real strategic areas that we're in. But I'll always give you both the reported number and what we see as more of an adjusted basis of what's coming out and how that changes the portfolio and how that changes the vectors.

And what two products would you highlight were driving obviously some growth in cellular, molecular? What are the couple of products that stand out right now?

Well, the things that we're seeing that's naturally moving in the right direction, we had projected a lot more work happening at the cellular level. So some of the products like Patch Clamp and MEA, kind of those very high-end cellular-based testing products, You know, we see, you know, we expect to see more and more movement toward cellular-based testing in addition to our, you know, the normal, you know, late-stage preclinical work in terms of, you know, our safety pharmacology and toxicology. So that's been growing very nicely, and we've been investing in that space. You know, the inhalation has been a very strong growth for us. Last year, you know, we've introduced a whole new set of capabilities on inhalation. That's going to be a big driver as we go forward. That's a very recent introduction. And we've also introduced a new set of – a new line of spectrophotometers. You know, we've – we're moving – we've specifically selected the certain – in spectrophotometry, we're really only going to stay in the areas that are very high margins, that are, you know, very strong capabilities, where there's very few companies that can compete in some of these particular areas. So, you know, the growth areas that we see, you know, a lot of it on CMT is in the cellular side. And that's where we've been focusing, and that's not only growing in CMT, but we expect to see that to start to offer that more also into the pharma and CRO side as we get into next year.

Okay. Thank you.

Thanks, Paul. And, Paul, I just add that on the cellular side, the electroporation is selling well within that, and that's driving the growth. So everything Jim said about electroporation speaks to the market, and that's seeing real growth there. I just didn't want to leave that one out.

Yeah, one question on electroporation. It seems to me like some of your competitors out there sometimes would attach royalties to the instrument that they're selling, but you don't. Do you think you're gaining share in electroporation, or what's that market doing today?

Yeah, well, I can tell you where we've been growing electroporation, much of that's still been in the research side, but we are starting to see more being adopted into biopharma and You know, we're, as you know, we're investing in making that much more applicable to more industrial type users. So, you know, we will have an opportunity to start to look with startups, with some of these companies to look at actually being, inserting ourselves into the revenue stream of the actual product that they sell. That's certainly, you know, a goal of ours. And, you know, that'll make a very, that'll make a nice difference for us. Plus, as we sell the electroporation products, now that we have much more you know, exposure to pharma and CRO companies. You know, in the past, we didn't really even try to sell there because we didn't really have the exposure there like we do now, now that we have the DSI team in place and, you know, the products that we sell in there. But as we sell into there, you know, there we see when we sell even one system into those types of industrial customers, there we additionally get opportunities with the consumables, There's a lot more revenue associated with the sale into the industrial side than there is with just a one-time sale of a product like that into academic research. We're going to continue to get the academic research and the growth there, which is very strong. But incrementally, as we migrate more and more into the industrial side, that's going to be a very nice driver for business for us.

Thank you very much, Jim. Mike, thank you. Thanks, Paul.

And I see no questions at this time. I'll turn it back over to the presenters.

All right. Well, thank you, everyone, for joining us today. This ends the presentation. We hope you'll join us in November for a look at our results for the third quarter fiscal. Thank you very much. Have a great day.

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