Harvard Bioscience, Inc. (HBIO) Q1 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the First Quarter 2013 Harvard Bioscience Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like introduce your host for today's conference, Mr. Tom McNaughton, CFO. Sir, please begin.

Thank you, Jason. And good morning, everyone. Thank you for joining us to discuss our results for the first quarter of 2013. Chane Graziano, our CEO; and David Green, our President are also on the call today. After the Safe Harbor statement, I'll turn the call over to Chane and David, who will present comments on the company's first quarter business performance. Following those comments, we'll open the call for any questions. In our discussion today, we'll make -- we may make statements that constitute forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Our actual results may differ materially from those projected due to risks and uncertainties, including those detailed in our annual report on Form 10-K for the fiscal year ended December 31, 2012, and our other public filings. Any forward-looking statements, including those related to our future results and activities, present -- represent our estimates as of today and should not be relied upon as representing our estimates as of any subsequent day. Further information regarding forward-looking statements and risk factors is included in the press release issued earlier today reporting our first quarter results. Please note that during this call, we'll discuss non-GAAP financial measures because we believe that those measures provide an enhanced understanding of how our businesses are performing. These non-GAAP financial measures approximate information used by our management to internally evaluate the operating results of our company. For each non-GAAP financial measure discussed, we have made available, as part of our press release or on our website in the Investor Relations section, a reconciliation to the most directly comparable GAAP financial measure. Additionally, any material financial or other statistical information presented on this call, which is not included in our press release, will be archived and made available in the Investor Relations section of our website. Look on the Investor Relations section of our website, and then click on the Investor Presentations or website icon as appropriate. A replay of this call will also be archived at the same location on our website. Our website is located at www.harvardbioscience.com. Lastly, all financial information presented on this conference call relates to our continuing operations, unless otherwise stated. I'll now turn the call over to Chane.

Thank you, Tom. And good morning, everyone. Revenues in the first quarter were disappointing as we saw delays in spending due to the sequestration cuts in the U.S. We believe this is a short-term issue since both houses of Congress appear to agree on the importance of scientific research. Historically, we have seen an increase in spending once government budgets are approved. Although revenues were down 8% in first quarter compared to first quarter 2012 and were below our expectations, the negative comparison was not as severe as it might appear since first quarter last year was a record quarter with strong organic growth in our Life Science Research Tools business. Therefore, it was a difficult year-to-year comparison. In view of these facts, we do not expect to see a decline in revenues for the full year of 2013 in our core business. And we expect to see an increase in operating profits for the year based on the operational improvements we have made. As per our announcement released last evening, I wish to confirm our intention to separate our HART business from HBIO, list the HART shares on the NASDAQ exchange and dividend those shares to the HBIO shareholders. Once this is complete, we will give more detailed guidance on HBIO for the year. Additionally, as we move to complete the separation of HART from HBIO, we are once again actively pursuing our acquisition strategy to acquire product lines or companies that are complementary to our base business and leverage our infrastructure, which will be key to achieving our long-term goal of growing revenues and profits by 15% to 20% per year. I will now turn the call over to David.

Thank you, Chane, and good morning, everyone. We're very pleased to report the success of the regenerated trachea transplant in the 2.5 year old girl, Hannah Warren, at Children's Hospital of Illinois announced on Tuesday this week. This procedure saves her from certain death and gives her a chance at a relatively normal life. This was the world's first pediatric transplant of a regenerated trachea using a synthetic scaffold. It was also the first in the U.S. and, hence, the first approved by the U.S. FDA. For us, it was also the first use of a scaffold made by us. The news of this transplant was reported in most major media outlets in the U.S., including on the Today Show, on NBC, the ABC and CBS Evening News and on the front page of The New York Times. NBC has told us that they plan to air an extensive documentary hosted by Meredith Vieira covering the entire story of the transplant later in the year. Because of the surgery has to be approved by the USFDA, we compiled extensive documentation of the scaffold and bioreactor system and submitted this data via Dr. Holterman, the principal investigator for Hannah's surgery, to the FDA. The FDA approved the use of our products under investigational new drug application. We intend to build on this successful FDA review of our products by approaching both the FDA and the European regulatory authorities within the next few months to agree a clinical trial plan aimed at obtaining approval to sell the products and enable many more patients to be treated using regenerated tracheas. In addition to this significant clinical milestone, I'm also pleased to report on the progress of the other patients treated with regenerated tracheas. The very first patient, Claudia Castillo, is now approaching her 5-year anniversary. Mr. Beyene is approaching his second anniversary, and the 2 Russian patients are approaching their one-year anniversaries. This is very encouraging data that will help support our submissions to the regulatory agencies. In addition, we expect further surgeries using our InBreath scaffold and bioreactor system, all under compassionate-use rules, to take place this year. At this point, the technique is still experimental and can only be used on humans when investigational device regulations have been followed. Last evening, we announced our plans to move forward with the separation of HART from HBIO. We believe that separating the HART business from the Harvard Bioscience business via a spinoff of shares will maximize value for Harvard Bioscience shareholders for the following reasons: We believe the Harvard Bioscience shareholders will benefit from owning shares in the 2 separate companies by having the continued earnings and cash flow generation of our core Life Science Research Tools business reflected in one security, the common stock of Harvard Bioscience, and the longer-term future potential of the regenerative medicine business reflected in another, the common stock of HART. The $15 million contribution to HART from Harvard Bioscience will provide funding for HART to advance the trachea transplant product into clinical trials. The immediate listing of 100% of the shares of HART will create significant liquidity in the HART stock. The spinoff will remove the HART operating losses, which were approximately $6.3 million in 2012, from the Harvard Bioscience income statement making the profits of the Harvard Bioscience business much more visible. The spinoff will give Harvard Bioscience greater borrowing capacity and will allow Harvard Bioscience to focus more aggressively on our core business's acquisition strategy after the spinoff. Our recently expanded credit facility will give Harvard Bioscience the ability to fund this acquisition strategy. And finally, Harvard Bioscience will retain the tax loss carry forwards generated by the historical investment of approximately $12 million in HART, which will reduce the income tax payments in a few years after the separation, which will improve Harvard Bioscience's cash flow even more than just removing the HART operating losses. This revised spinoff process requires the SEC to declare our Form 10 registration effective, and we anticipate this process, together with the NASDAQ listing process and updates to the IRS private letter ruling, could take up to approximately 4 months. We'll now open up the call to any questions.

[Operator Instructions]

No questions?

[Operator Instructions]

If there are no questions...

Actually, sir, we do have a question from Adam Ritzer of R.W. Pressprich.

I guess I'm kind of new to the situation, but I was wondering, you mentioned, I guess, the losses in HART last year of $6.3 million. Can you tell me what the results from, I guess, the Harvard Bio part that you're keeping would have been if you take out HART on a pro forma basis?

Sure. We always -- we've been disclosing that for the past couple of years in segment information on our financials.

Okay. Again, I'm brand new to the situation. I apologize if you've done this. But I'm happy to look it up, but maybe you could just give out the information to make it easy.

I mean, it's about $0.12 per share.

It was the -- no, that's the HART losses. $0.12 this year.

Yes, right. It impacts our Harvard Bio earnings by about $0.12.

Okay. And what did Harvard Bio earn last year? What did you report, I guess, is the question.

$0.38, I believe.

$0.38?

Yes, that was on a pro forma basis. That included that discount at the $0.12 from HART.

Okay, so you didn't earn $0.50. You maybe you would have reported $0.26.

Reported $0.38, subtract $0.12 from that, and that's what you got.

Right, if you reported $0.26, add back to $0.12 and Harvard itself did $0.38, okay.

That's right.

And what kind of CapEx does the Harvard business require or what do you think it's going to be this year?

Not much.

Well, the -- I would say maintenance capital is normally $1 million to $1.2 million a year in the base business. We currently have a capacity expansion going on a particular plant in Germany, so that's adding maybe a little more than $1 million this year to that number.

Okay, so call $2 million, half maintenance, half growth. That seems fair?

That's right.

And what is going to be your ongoing depreciation expense going forward after you separate the HART?

It will be just more than that $1 million.

Okay. So basically, D&A equals your maintenance CapEx for the sake of argument?

The depreciation, right. That's excluding the amortization of intangibles.

Right. Excluding the amortization. I saw you guys break that out. Okay. And in terms of your, I guess, acquisition strategy, is it -- how many of these, the smaller companies, are out there as potential acquisitions? I guess, you have some kind of a light list or there's a number of these smaller companies. How much revenue or how many of these things do you think you guys can roll up going forward?

Well, there's many you can roll up. It's -- we roll them up basically with debt, but literally there's hundreds of these companies.

There are -- there's that many? Hundreds of them?

Yes, absolutely.

Wow. And do you have a minimum size that even makes it worth your time and effort?

Well, it depends on the technology, it depends on a product. We take a million-dollar product line that we can consolidate in because we leverage the infrastructure and instead of getting a 20% operating margin, you get a 40% operating margin. But our ideal thing would be to buy something in the $5 million to $10 million.

Okay. $5 million to $10 million that maybe has a complementary technology and you could reduce costs, add it in. And like you said, instead of getting 25%, 30% margins, you're getting 40% because of that. Okay. Are there a lot of those type acquisitions out there?

The $5 million to $10 million, yes, there's a share of them out there. Yes.

So not hundreds but -- okay, got it.

Many -- there's enough to meet our requirements and our goal is to grow this business 15% to 20% a year through acquisition. And I believe that there's plenty of opportunity to do that.

Okay. And so it's 15% to 20% just from acquisition. What do you think the organic growth is if you did no acquisitions?

Organic growth in this business -- well, there's a lot of dynamics going on. But if you look at pure organic growth, it's relatively low. Low-single digits at best.

Okay. So kind of like GDP growth, let's call it?

Yes, probably. I mean, the dynamics that are going on, we sell through some distributors. One, it happens to be a very big distributor. Their sales have been decreasing by 20% a year. So we've been offsetting that by organic growth. So therefore, our overall organic growth looks low when, in fact, if you discounted that, our organic growth is probably 3% or 4%. So we have a few of those dynamics that are going on that impact what appears to be organic growth in the market and those are the things we're dealing with. So therefore, the fair way to look at us is, as you said, 2%, 3% or so.

Okay. And are there -- do you have any new product lines or any new technology coming out over the next 6 to 18 months that might impact the organic growth rate?

We introduced new products last year in our spectrophotometer line, which are microvolume spectrophotometers. We initially had one such unit that we had patents on, and we sold it exclusively through one of our major distributors. Last year, we introduced one. Mid this year, we'll introduce another. So we have a family of products in that marketplace. That is the one segment, it's spectroscopy, that's still growing at -- in the 5% to 10% range. So that is one of the things that is helping us offset the erosion from our major distributor. In addition to that, we've made some investments last year in our electroporation product pipeline, which will enable us to play in a broader segment of that market. So those are 2 major drivers that will help us with organic growth. Addition to that...

Adam, this is David. In addition to that, although we've talked about the spinoff of the regenerative medicine business and that, for the clinical applications, we're going into the separated HART business, there are still research applications for those same technologies. And even after the separation, Harvard Bioscience will remain the distributor of those regenerative medicine technologies into the life science research market. And that's a growth area on the research side as well as the clinical side. So when you take that, combined with the 2 new products Chane mentioned, I think there's good reasons to be optimistic about the organic growth opportunities within the Harvard Bioscience business going forward.

Okay. And again, I'm sorry if I'm asking questions everybody knows the answers to. But in terms of the HART IPO, could you give any color or commentary on why that wasn't successful and now you have to do the spinoff route?

Sure. So whenever a deal doesn't come together where you'd like it, there's usually multiple factors behind it. I think that was the case in this situation. I think some of those factors were the existence of the distribution of the shares post the IPO. If you go back and just review what the structure was, HART was only selling 20% of its shares in the IPO. And then the balance, the 80%, was going to be distributed to the Harvard Bioscience shareholders approximately 4 months later. And I think that was perceived as being a potentially volatile event with a very large percentage of shares being eligible to trade at a single point in time, and I think that was a negative in terms of the structure of the IPO, the way we had it planned. I also think having a relatively small capital raise and a small percentage of the shares in the public float made it a relatively illiquid stock, made it quite difficult for some of the larger funds to buy into it. And then the final thing I think was a significant contributor was the fact that we were proposing an IPO. It's obviously a public offering of a company that was already a subsidiary of a public company. And that allowed there to be a significant arbitrage opportunity between the Harvard Bioscience stock price and the anticipated HART stock price. So all 3 of those were factors that contributed adversely to that structure, and that's why we really revised that structure and are now proceeding with the process we outlined last night of a simple listing of the shares of HART and simultaneously the distribution of those shares and capitalizing the company with internal funds from Harvard Bioscience.

Right. I mean, I guess, this is a typical 80:20 structure, but this just makes it a little bit cleaner, gets it done, people who want to invest in HART directly, you'll have a little more liquidity. And okay, do you -- what about the ratio? What do you think a fair ratio is in terms of, I guess, Harvard has 30 million shares. Are you trying to target the 10 million shares similar to what you were going to do in the IPO?

Well, we're working on that. It's probably going to be something similar. But we haven't finalized anything. That's the sort of thing that'll be in the registry and the new filing.

Right. And I guess it's only going to take 4 months because you've already got to the effort to do the IPO. You've -- all that process is already done, so it should be fairly quick from now, I guess.

Yes, it's based on 2 things: One, our experience with the SEC's review of the S-1, which was fairly clean as far as those reviews go; and secondly, the fact that we'd already -- a key to this is the tax-free nature. The IRS has signed off on a PLR as a tax-free nature of the distribution. And we've been to that process, and we just have to refile with these new set of facts. And then, believe -- we believe, we've been advised it will be a different level of review because it's really just changing the facts as opposed to starting an agreement.

Our next question comes from Kelly Cardwell of Central Square Management.

I think you already addressed a lot of these questions. But just to clarify on the Harvard acquisition strategy, do you need to complete the IPO before you start to do deals? Or is there already a pipeline that you're working on, and can you share with us at what point you expect to get to that run rate where acquisitions are adding 15% to the top line?

Well, we're actively pursuing that now Kelly. And we have been since we were talking about doing the IPO. So we were still in the pipeline. So we're in negotiations with several companies at this stage, but it'll be the second half of the year, I'm sure, before we get anything concrete in place.

And you have a $50 million line of credit, is that right? So you feel like you've got plenty of liquidity to close the deals?

Yes, it's $50 million facility, yes.

And of the $50 million, only $15 million is used right now? And is the rest of the $35 million available to you?

Well, the $15 million basically refinanced, if you will, the outstanding debt at the time we moved into the new credit facility, and then the $15 million to capitalize HART will be drawn. And that will leave us $20 million. And then, on top of that, that's -- on top of the $20 million of cash in our European subsidiaries that will be available, the European acquisitions, I should say.

[Operator Instructions] And as there appear to be no further questions in queue, I'd like to turn the call back over to Chane Graziano, Chairman and Chief Executive Officer, for closing remarks.

Thank you. We're very pleased to have participated in a lifesaving trachea transplant surgery announced this week and saved the life of Hannah Warren. We're also very pleased to be progressing with the separation of HBIO and HART, and we are optimistic about the future of both of these businesses. Thank you, everyone, for joining the call today. Thank you.

Thank you, sir. And thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a great day.