Harvard Bioscience, Inc. (HBIO) Q2 2017 Earnings Report, Transcript and Summary

Welcome to the Q2 2017 Harvard Bioscience Incorporated Earnings Conference Call. My name is Adrian and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Corey Manchester, Director of Finance and Investor Relations. Corey Manchester, you may begin.

Thank you, Adrian, and good afternoon, everyone. Thank you for joining us for the Harvard Bioscience second quarter 2017 earnings conference call. Leading the call today will be Jeffrey Duchemin, President and Chief Executive Officer, and Robert Gagnon, Chief Financial Officer of Harvard Bioscience. Before I turn the call over to Jeff, 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 detailed in our Annual Report on Form 10-K for the period ended December 31, 2016 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 date. 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 differences between our GAAP and non-GAAP results are outlined in the earnings release we issued today which can be found on our website under Press Releases. Additionally, any material financial or other statistical information presented on the call which is not included in our press release will be archived and available in the Investor Relations section of our website. A replay of this call will also be available for one week at the same location on our website at harvardbioscience.com. I will now turn the call over to Jeff Duchemin. Jeff, please go ahead.

Thanks, Corey. Good afternoon, everyone and thank you for joining us for our Q2 earnings call. On today’s call, I will start with a brief review of Q2 results, as well as an overall business update. Our CFO, Rob Gagnon will provide details on our financial results and our 2017 outlook. And after that, we look forward to taking your question s. During the second quarter, we produced solid business results and continued to execute our strategic objectives. Second quarter revenues were $25.2 million reflecting 1% organic growth excluding the impact of currency translation, and the disposition of AHN. We are encouraged by these results and believe we will continue this progress with 1% to 2% organic growth expected in the back half of the year. As a result, we expect 2017 revenue to be flat compared to 2016, which equates to the high end of our previously issued guidance range. Taking a look at our revenues from a geographic standpoint, our U.S. business grew approximately 3% in the second quarter. As I stated on our Q1 call, we are beginning to see positive signs of change with increased funding outlays from the NIH to academic labs. NIH outlays are approximately 7% year-to-date. We continue to be optimistic that the second half of 2017 will experience a sustained acceleration of academic funding from the NIH. While funding outlays don’t immediately translate to increased academic spending, we are encouraged by the directional shift and are optimistic that spending will increase with the sustained acceleration of academic funding from the NIH. Although a quarter or two of positive numbers does not yet demonstrate a trend, we believe that the U.S. result this quarter is an encouraging indicator that certainty and optimism maybe returning to our end-customers. We are confident that our commercial organization will continue to execute the plan and is well positioned to benefit from these tailwinds. We believe our U.S. business is poised for continued top-line growth. Revenues in China increased approximately 56% in the second quarter. As you may remember, our Q1 results in China declined due to the impact of timing of instrumentation orders and on our call, we indicated that we anticipated a rebound. This quarter shows that rebound, as well as a continued strong execution by our commercial team. Overall, we continue to be pleased with our performance in China, which is one of the fastest growing lab, products, and service markets globally. We are also working with our team to further expand our reach and to capitalize on expansion into complementary territories including Japan, Korea and Southeast Asia. Europe continues to be a soft end-market due to foreign currency headwinds and weakness in the funding environment. Excluding the impact of foreign currency, and the impact of AHN, our Q2 European revenues were down approximately 10% year-over-year. We are focused on improving results in the second half of the year based on a number of initiatives, including the launch of two new products in our electrophysiology product portfolio. Overall, we are encouraged to see some acceleration in our business following a slower start to the year. And I would like to highlight one of our product lines. Our BTX product line continues to be a growth driver for the company. BTX, which is our legacy electroporation product line is experiencing growth due to its application in the rapidly growing gene editing market as a result of CRISPR. Although BTX sales makes up approximately 6% of our consolidated revenues, the strong growth we are experiencing is an example of our positioning in a new and exciting innovative life science market. In sum, we are pleased by our results in the second quarter and encouraged about our prospects for the back half of the year. More specifically, U.S. revenues grew 3% during the quarter. Revenues in China grew almost 60% and our BTX product line continues to make solid gains. In addition to these top-line highlights, gross margins expanded and operating expenses declined in the quarter. We remain focused on the strategic vision of our organization and believe that we will continue to drive top-line growth, improved profitability through operational performance and ultimately create shareholder value. With that, I will turn the discussion over to Rob Gagnon, who will provide more insight into our financials. Rob?

Okay, thanks, Jeff. Beginning with the top-line, revenues for the second quarter were $25.2 million, a decrease of 4% year-over-year as reported, revenues were down 1% year-over-year in constant currency. Second quarter revenues were also impacted by the divestiture of AHN in October 2016, which included approximately $620,000 of non-recurring revenue during the second quarter of 2016. Excluding the negative impact of currency translation and AHN, revenues on an organic basis grew 1% in the quarter. Revenues year-to-date were $49.4 million, a decrease of $3.7 million or 7% compared with revenues of $53.1 million for the six months ended June 30, 2016. Revenues on a constant currency basis were $50.6 million, a decreased of $2.5 million or 5%. Included in that decline is the revenue impact from the prior year divestiture of AHN, which accounted for approximately $1.3 million. Excluding the negative impact of currency translation and AHN, revenues are down 2% year-to-date. Now turning to costs and expenses. Cost of revenue on a non-GAAP basis were $13.8 million for Q2, compared to $14.4 million for Q2 last year. As a result, our non-GAAP gross profit was $11.4 million this quarter, compared with $11.7 million for the second quarter of 2016. Gross profit margin was 45.1% in Q2, up from 44.7% in Q2 of last year. This 40 basis point increase in gross profit margin was partially muted by a few non-cash charges at some of our sites related to inventory write-downs. During our site consolidations in 2015, we increased levels of safety stock inventory to ensure a smooth transition. Most of that safety stock inventory has sold through to end-customers. However, some surplus inventory has remained on our books namely at our Coulbourn subsidiary. Through that amount we have on hand certain levels of reserve for as part of our own ongoing analysis of inventory. Excluding this item, which amounted to approximately $200,000 for the quarter, our gross profit margin would have increased over 100 basis points compared to Q2 of last year. And year-to-date, our gross profit margin was 46.4% essentially flat compared to the same period last year. Non-GAAP operating expenses for Q2 were $9.7 million, a decrease of $770,000 compared to $10.4 million in Q2 of last year. The decrease is due to the realization of continued cost containment measures as well as foreign currency favorability and the disposition of AHN. Year-to-date, non-GAAP operating expenses were $20 million, a decrease of $1 million compared to the same period last year. Operating income on a non-GAAP basis in Q2 increased to $1.7 million as compared to $1.2 million in Q2 of last year. Year-to-date, our operating income on a non-GAAP basis was $2.9 million as compared to $3.6 million for the same period last year. Our non-GAAP operating margin in Q2 was 6.7%, this compares to an operating margin in Q2 of last year of 4.8% and year-to-date our operating margin was 5.8%, compared to 6.8% for the same period of last year. Our non-GAAP effective tax rate was approximately 30% in Q2 compared to 25% in Q2 of last year. The increase in effective tax rate was primarily the result of jurisdictional mix of income and to a lesser extent changes in R&D tax credits. Our non-GAAP net income for Q2 was $870,000 or $0.03 per diluted share, compared with $0.03 per diluted share in Q2 of last year. And year-to-date, our non-GAAP diluted earnings per share were $0.04 compared with $0.08 per diluted share in the same period of 2016. Before moving on, I’d like to highlight one below the line fluctuation that had an impact on our quarterly profitability. Due to changes in currency exchange rates, and the functional currency in which certain working capital balances are recognized, we reported a $270,000 currency loss in the quarter. This compares to a $280,000 currency gain in Q2 of last year. That swing, based on current shares and tax rate impacted our earnings by approximately a penny. Although we don’t have control over fluctuations in currency exchange rates, we are actively reviewing our working capital and the functional currencies in which they are held to identify steps to minimize the impact of future fluctuations. Weighted average shares outstanding was 34.7 million in Q2 as compared to 34.1 million in Q2 of last year. I will now turn to the balance sheet. We finished the quarter with approximately $4.7 million of cash accounts receivables were $16 million as compared to $15.7 million as of Q4 last year, an increase of $230,000. Inventory at the end of Q2 was $20.4 million compared to $20 million at the end of Q4 of last year. And our capital expenditures were $240,000 for Q2 compared to $200,000 for Q2 of last year. Debt at the end of Q2 was $13.3 million, compared to $13.9 million at the end of Q4 last year. Turning now to our financial outlook, we expect to report 1% to 2% organic revenue growth for Q3 and Q4 which equates to the high end of our previously issued full year revenue guidance. In terms of dollars, 1% to 2% represents third quarter revenue of $24.6 million to $24.8 million and fourth quarter revenue of $26.5 million to $26.8 million. On the bottom-line, we are updating our full year 2016 earnings per share guidance to reflect current expectations including foreign currency rates as well as the negative impact of the non-cash inventory charge that we incurred in Q2. As a result, we now expect 2017 non-GAAP earnings per share of $0.13 to $0.15. From a quarterly standpoint, we expect to report $0.03 to $0.04 in the third quarter and $0.05 to $0.06 in the fourth quarter. We will now open the call to questions from participants. Operator?

[Operator Instructions] And our first question comes from William March from Janney. Please go ahead, your line is open.

Hey guys. How are you?

Hey, Bill.

Hey, Bill. Good, how are you?

Doing well. First question, Jeff, you called out the BTX product segment. This is the first time you are talking about it, maybe could you just give us a little more detail on the application and is it for clinical research kind of where, who is behind it? And then maybe a bigger picture, just in terms of your different product segment, if you could give us a sense of where you are seeing growth coming from, whether it’s cell analysis, lab equipment, molecular analysis, just kind of an underlying growth trend for each of the segments?

BTX is a product family that has been part of Harvard Bioscience for several years. It’s a legacy product. And it’s used in gene editing, transfections, it’s an electroporation device and because of the CRISPR transfection application that the industry is seeing the increase in gene editing. This product has been also increasing with the demand of this type of application. It’s one of the faster growing product families that we have in Harvard Bioscience today. One of the things that we’ve done this year is added resources to accelerate that growth over the years – over the last several years, we have increased our capabilities in Asia and we’ve seen very good results as you saw this quarter with 56% increase in sales. And one of things we’ve done is we’ve added a resource in China for our BTX product line. So we expect continued growth in this area. We will continue to add resources where needed. But BTX has been a fantastic product for us and we got a great commercial and marketing team executing to our plan this year around this family. In regard to some of the other product families, we have acquired three companies over the last couple of years in electrophysiology, our Multi Channel Systems business, Triangle BioSystems and HEKA Electronik. In electrophysiology, one of the things that we’ve done is we’ve added resources in the U.S. One of the opportunities for us when we bought Multi Channel Systems was taking advantage of their market presence in Europe, but lack of market presence here in the U.S. by adding resources and building an electrophysiology sales team we’re actually starting to see positive results come from that. It’s taken about a year to get our resources in place and trained and on the ground running, but here in the U.S. we saw positive results in the quarter from electrophysiology. In our Denville business, our lab products and supply business, we’ve added some new people in that business and we are actually seeing nice turnaround there. Bookings are increasing. We have a new Director of Operations in our Charlotte facility who has done a great job. And our sales and marketing teams are putting in new initiatives to help drive the growth of Denville. So, I think that really covers our three basic product families.

Got it. And then, in terms of capital deployment, you made a slew of acquisitions a few years ago, and in the past couple of years, you’ve been taking the cash flow and paying down debt. Maybe just where are you in terms of strategy on M&A and what areas are you looking for to maybe add products to your portfolio?

Yes, Bill, let me take a step back on this question, add a little color to it. Where we were, where we are today and where we expect to go? So, as you remember, three or four years ago, this was a very fragmented business. We had ten plus manufacturing facilities. We’ve reduced that in half. We had ten plus legacy systems – computer systems with our new ERP implementation, we’ve cut that in half. We had an outdated product portfolio. We’ve implemented new product development processes. There was a need for geographic expansion in our business. We’ve added a sales team in China in seeing the results that we’ve had in China over the last couple of years. Along with that, we faced some challenging headwinds. Foreign currency, devaluations has had an impact on this business. GE exited the spectrophotometer business. In the funding landscape specifically the NIH has been very difficult over the last years, but we are seeing a rebound this year. With all of that, with all of the work that’s been done internally, I think we are at a point right now, we are actually starting to see the benefits of building this foundation. But we knew we had to do this all along. We knew it would be difficult. We knew we would not be rewarded for it. But by building this foundation it’s allowed us now to grow organically and we believe we will continue to see organic growth moving forward and then also it puts us in a great position to start making acquisitions. And so that’s where we are today and we feel very positive about the position we are in today and where we are going in the future.

Got it. And then, just one last one. Rob, maybe more so, just if you could help walk us through the update for the back half of the year in terms of it seems like the one-off inventory thing was impact to gross margins, kind of how do you see margins playing out in the back half of the year both in terms of gross margin and then operating expenses? Thanks guys.

Yes, thanks, Bill. Let me – I want to go back and just repeat some of the guidance that we covered a few minutes ago just to make sure it’s clear to folks. On the top-line we are expecting 1% to 2% organic revenue growth. That means, for the third quarter $24.6 million to $24.8 million, that’s 1% to 2% organic growth. For the fourth quarter, it would be $26.5 million to $28. - $26.8 million, excuse me, $26.5 million to $26.8 million. So I want to make sure that that’s clear what the organic numbers are and what that growth would look like. On the EPS side, $0.13 to $0.15, you are correct, revised because of the inventory charges that we took in the second quarter relating to those site consolidations that we initiated back at the end of 2014 into 2015, we wanted to make sure that we had ample safety stock and over shot the market I think on a few of the markets. In terms of what that breaks down to on a quarterly basis, the fourth quarter always being the – typically being the strongest quarter of the business, so it’s going to have higher EPS. So for the third quarter, it’s $0.03 to $0.04, in the fourth quarter it’s $0.05 to $0.06. In terms of gross margins, so, Q2 last year was our lowest quarter in the year. We are certainly down sequentially in gross margins. But we are still expecting over the long run that gross margins will be in the range of 46% to 47%, sorry, 47% to 48%. And on operating expenses, we were favorable almost $800,000 in the quarter , real good result this quarter, any time we are below $10 million I think is good for our business. Wouldn’t expect that to repeat in the back half of the year, but we are certainly seeing good favorability around operating expenses. So hope that helps.

Yes, thanks guys.

Thanks, Bill.

And our next question comes from Raymond Myers from Benchmark. Please go ahead.

Yes, thank you. Rob, let me just clarify what you said, you don’t expect the really nice decline in Q2 operating expense to continue in the second half. You don’t expect the $800,000 sequential decline to repeat again or the rate of $11.3 million of operating expense. Will that return back to a higher rate in the second half?

No, no. I wouldn’t expect that to happen again. I would expect that this level of $9.7 million for the quarter would be a good level in terms of projecting forward for the next couple of quarters. Probably, actually slightly higher than that, but in that range of sort of probably $9.8 million to $10 million as an estimate.

Okay, great. That’s excellent cost control. Congratulations on achieving the positive organic revenue growth. That’s a real accomplishment. What are the factors that most contributed to that improvement now?

Ray, as you know, we put a lot of time and effort into many initiatives into our commercial teams globally in all three of our major product categories. Everything from continuing our geographic expansion and building up our capabilities in Asia, building electrophysiology sales team here in the U.S. and now, more than ever really adding some exciting initiatives and new product launches in Europe to help drive and offset the decline we are seeing in Europe, that’s really where the focus has been over the last couple of years.

Okay, great. Let me touch on that. You mentioned adding two electrophysiology products in Europe. Can you elaborate on those and what opportunity they create?

Yes, the two products there is, what we call an ME2100 and an MEA2100. One is an in vivo the other one is an in vitro system. And what this allows us to do is, obviously bringing incremental sales revenue for the back half of the year in Europe, but it also allows us to continue the growth that we’ve seen in the U.S. in the first half of the year. And really differentiate ourselves among some of our competitors. We are excited about this and one of the great aspects of acquiring a company like Multi Channel Systems was their ability to innovate and develop new products and launch new products and we are starting to see that now, not only with our electrophysiology business, but throughout the entire company.

That’s great. I’ve got an accounting question for Rob. These inventory charges in the second quarter that affect your full year guidance. Have you’ve given any thought to excluding them on a non-GAAP basis? Or are you just being conservative?

Yes. Hey, Ray, thanks. I am not sure that it’s - yes, I would, it’s probably some level of conservatism. But inventory reserves and write-offs come up from time-to-time, certainly not at this magnitude. So I think it’s more of a consistency thing. We have treated write-offs in the past this way and so we thought the best thing to do was to be consistent, but highlighted for folks that they were aware of what was driving that lower margin and the EPS charge.

Okay, great. Like the conservatism. Let me touch again on the pipeline for acquisitions. Do you have a robust pipeline to identify potential acquisitions? And would you still expect to be able to finance these with other cash or low cost debt?

Ray, we have a robust portfolio of companies that strategically make a lot of sense for Harvard Bioscience. But at this point in time, the focus of this company has been gaining organic growth. We will get to a point sometime hopefully in the near future where we will start to acquire companies again. But right now, I would say the focus of the organization is on organic growth and that’s where we are dedicating our time and resources.

And Ray, just in terms of capital available to us, to the extent we do execute on tuck-in acquisition s, we are going to look to cash on the balance sheet as well as that credit facility we have through Bank of America, which you know is a commercial rate facility 4%, 4.5%, very attractive yields. That’s what we would look to in terms of financing those acquisitions.

Okay, great. And thank you and congratulations for restoring the organic growth.

Thanks, Ray.

Thanks, Ray.

And your next question comes from Lisa Springer from Singular Research. Please go ahead.

Hello, Rob and Jeff. I wanted to ask a couple more questions about Europe. You mentioned new products is something that’s going to help shore up that business. Could you give us – or first of all are those products available right now? Or are they going to start selling in Europe in the third quarter? And secondly, could you give us a little bit of a big picture overview of Europe? What would it take for that market to become attracting? How low was the dollar has to go before you would start to see some meaningful sales growth there?

The new products will be launched this quarter and we are actually taking orders for those new products now. So, we will generate revenue in Q3 for these new products. In regards to get Europe to be a growth driver for Harvard Bioscience, I think we need a couple things to happen. Number one, we need currency to stabilize. We need the academic investment community to basically see, compete with what we are seeing here in the U.S. with the NIH and what we are seeing in China. I believe that will happen. I believe we will see a turnaround in Europe. The question is timing, when that will happen. But in the mean time, what we are doing is, we are installing many different initiatives that weren’t in place in the past to help drive and grow business and offset anything we are seeing in the lack of funding on the academic environment in Europe. So, right now, there are many sales marketing initiatives in place for our cell and animal physiology business, for our electrophysiology business that we believe will help reduce the decline we’ve seen in Europe over the last couple quarters.

Okay, thank you.

And our next question comes from [Indiscernible] Please go ahead.

Yes, it’s [Indiscernible] Capital. Good afternoon gentlemen and it’s a nice quarter. Congratulations there.

Thank you.

Could you guys just go over your CapEx for the back half of the year? And, just a little more granularity on your – taking your computer systems from ten down to five, where are you going to take that? What’s the goal there?

Hi, Matt. It’s Rob. Yes, so in terms of CapEx, we expect between $1.5 million and $2 million for the year. The business requires about $1 million of maintenance capital. And so it’s really that strategic capital that makes up the difference. In terms of ERP, the infrastructure is in place. The licenses are acquired. They were acquired a few years ago. So lot of that spend is behind us. There is certainly some cap out on our consulting dollars and service spend as we continue to wrap up the ERP program But we are not expecting them to be significant relative to capital and where it’s headed to next couple of years.

Great. Thank you very much and good work.

Thanks, Matt.

Thanks, Matt.

And our next question comes from Jon McCullough from Glacier Peak. Please go ahead.

Thanks for taking my call or my question. I know you might have dived into this in the past, and I have missed it. But I know currency has been a headwind, but we’ve kind of to the end of June had a pretty good move in the dollar/euro or the dollar has weakened. Should so, could we see the headwind either subside or reverse going forward? Just any clarity there would be helpful.

Yes, thanks for the question. So in terms of the back half of the year, we – currency is no longer a headwind. And so, as of the end of the quarter, June 30 and for the first couple of weeks of June, I would have said, if rates stay where they are, it’s actually somewhat neutralized in this and there is essentially no impact to the business, or very little impact to the business. But just over the last week or so, the euro has really strengthened from about the 112 level up to 117, 118, somewhere around there. So it is – still it’s very volatile, challenging to predict. 117 is still an awful far cry from 135 where it was two years ago. But certainly if it continues to strengthen would help with our European businesses. But difficult to quantify, those are long ways to go.

All right. And then it sounds like you guys are again doing great in China. I know you mentioned in the last quarter about starting to roll out or get going in Japan, possibly Korea, kind of any color there of how it’s going or just?

Yes, more Japan and I think Korea has been a great market for us for many years and we have great distribution partners there. But in Japan, we added a resource last year. We are building up our distribution network there. Things are progressing forward. We like what we see and I think there is a bright future for us there. So, we are still in the beginning stages of building up our business in Japan. But, we are moving forward with it.

Got it. And then, I know it’s always it’s a wildcard with political environment changing every minute. But, I guess with the budget NIH the whole nine yards, which is how you guys are looking at, thinking about it going into next year or sort of do you still feel that Bipartisan will still kind of protect NIH?

Yes, I mean, we like what we see with the NIH. Year-to-date, funding outlays is up 7%. Right now, there is a proposal for about $1 billion increase for the 2018 budget. So, yes, I mean, things are moving forward with the NIH. I think this Bipartisan’s support there and we like the position we are in moving forward because of that.

Perfect. Thank you so much guys.

Thanks a lot.

That concludes the question answer session. And I will turn the call back over to Jeff for final remarks.

Thank you, everyone and thanks for your continued support around Harvard Bioscience. We look forward to talking to all of you in the October timeframe. So thank you very much. I appreciate it.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.