Harvard Bioscience, Inc. (HBIO) Q1 2022 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Thank you for standing by and welcome to the Harvard Bioscience, Inc. First Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised, that today's conference maybe recorded. [Operator Instructions] I would now like to hand the conference over to your host today, Dave Sirois.

Thank you, Olivia and good morning, everyone. Thank you for joining the Harvard Bioscience first quarter 2022 earnings conference call. Before we begin, I would like to suggest that you take a moment and download a copy of our presentation that will be referred to during this call. The file is entitled Q1 2022 HBIO quarterly earnings presentation. It is located in the Investor Overview, Events and Presentations section of our website. Leading the call today will be Jim Green, Chairman of the Board, President and Chief Executive Officer; and Mike Rossi, Chief Financial Officer. Before I turn the call over to Jim, I will read our safe harbor statement. In our discussion today, we may make statements that constitute forward-looking statements. Our actual results and performance may differ materially from what we have projected due to risks and uncertainties, including those described in our annual report on Form 10-K for the period ended December 31, 2021, our subsequently filed quarterly reports on Form 10-Q and our other public filings. Any forward-looking statements, including those related to the company's future results and activities, represents our estimates as of today and should not be relied upon as representing our estimates as of any subsequent day. Also, much of today's call will focus on our non-GAAP quarterly results which we believe better represents the ongoing economics of the business, reflects how we set and measure our incentive compensation plans and how we manage the business internally. The difference between our GAAP and non-GAAP results are outlined in the earnings release and today's presentation. These two documents as well as a replay of this call can be found on our website under Investor Overviews, Events & Presentations. Additionally, any material, financial or other statistical information presented on the call which is not included in our press release and presentation, will be archived and available in the Investor Relations section of our website. I will now turn the call over to Jim. Jim, please go ahead.

Thanks, Dave. Let's go to Slide 4 of the presentation and take a look at the highlights for the quarter. Revenue was up 7% over last year, with pre-clinical up 7% and Cellular Molecular up 10%. We saw significant order delays from China from the lockdown there, though we do already see China recovering later this quarter and expect a strong second half. Cost of goods continue to run high from global supply chain disruptions, inefficient labor and higher freight costs. Adjusted operating margin came in at 8% versus 12% last year, impacted by shipment revenue delays, inflation and investments that we made for growth. Gross margins came in at 57%, flat to prior year, with mix improvements offset by an increase in COGS. Higher COGS 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, the 8-K announced the litigation settlement, puts the legal distraction behind us. If we move to Slide 5 of the presentation, we'll look at the details in the quarter. In spite of global supply chain headwinds and delays in shipments to China, we had solid revenue growth with Q1 coming in at $28.8 million, up 7% over last year. Gross margin on a GAAP basis came in at 56.2%. That's up 100 basis points from last year despite the higher cost of goods. This quarter had GAAP operating income of negative $6.7 million which included a $5 million charge related to the litigation settlement. Our adjusted operating income was $2.4 million, so our adjusted operating margin measured 8.2% of revenue. GAAP earnings per share in the quarter was a loss of $0.17. Our adjusted earnings per share was $0.04, down $0.01 from prior year. We consumed about $2 million in cash and our net debt increased by $3 million in the quarter. Our leverage ratio measured 2.9x EBITDA. I'll move to Slide 6. Look at the revenue in the quarter by Product Family. Starting with the first row of the table, our Cellular and Molecular Technology revenue was up 7% from last year, impacted by shipment delays to China on their lockdown and global supply chain disruptions continue to hamper our revenue shipments. Order intake from North America remains strong across the portfolio. We saw delays from the China lockdown recovering late in this quarter and also we see a real strong second half. European orders were delayed on COVID lockdowns in January and February but have started recovering slowly. Looking at the second row of the table, our pre-clinical product revenue was up 10% over a strong prior year. However, we did experience revenue shipment delays in China and continue to be hampered by these disruptions in the global supply chain. Order intake was very strong in North America. We saw delays though in China from the lockdown. But as we said on CMT, we do see recovering here later in this quarter and we see a very strong second half. This quarter, currency impacted revenue by about $0.5 million. Our overall reported revenue was 7% over last year. Now, I'll turn it over to Mike for a quick look at the key financials. Mike?

Thanks, Jim and good morning, everyone. Needless to say, the global environment has experienced a historic level of volatility and change over the last two years. But as we have throughout this period, we stand with conviction on our ability to manage through bumps in the road like we're seeing any order delays associated with China. Our core products and diverse customer base combined with actions we've already taken, provide a foundation for the profitable double-digit growth we've been speaking to. And Jim will speak more in our outlook about how we see the full year shaping up in the context of some uncertainty, on how the China market recovers from recent status. As we usually do, I'll walk through the full P&L and cash flow in more detail. As a reminder, my discussion will focus on adjusted results for P&L performance which aligns with measurements we use to internally manage the business. Before I walk through margins, cost and cash flow, I wanted to share an update on our investor reporting. Since 2019, we reported our revenues as a split between our pre-clinical and CMT product families. Through 2021, our pre-clinical revenues, as reported, have been our telemetry and inhalation products that became part of the Harvard Bioscience portfolio, with the 2018 acquisition of Data Sciences International, or DSI. As we've discussed, the top focus for us since day one has been to integrate the brands and products in a logical way that addresses the needs of the market. As part of this, we have evolved our go-to-market model and product line management to include our behavior, isolated organ and surgical products as pre-clinical solutions, with common call points and applications to our DSI products. Accordingly, these products formerly reported in our CMT product family are now reported on our pre-clinical revenues, as reflected in our actual and historical revenues. We look forward to sharing more examples in 2022 with our investor community on how we're evolving and investing in our core products and markets to drive growth. Now, turning to our results. On gross margin, we reported 57% for Q1 2022, similar to prior year but with substantially different underlying factors delivering this result which remains favorable to industry benchmarks. Jim has discussed in detail the negative impacts of supply chain inflation and labor dynamics which first showed meaningful increases in COGS in Q2 of 2021. These costs are now -- are over $1 million per quarter as previously reported but we now have much more prescriptive targeted areas to mitigate these costs and we expect COGS to begin improvement in the second half of 2022, as programs get implemented. Despite these cost increases, we've maintained stable gross margins due to continuous improvements in product mix and pricing. Our higher-margin pre-clinical products and niche products within our CMT portfolio grew as a percentage of overall sales relative to prior year once again and pricing actions implemented, also benefited gross margin. Clearly, the supply chain will continue to evolve but factors we can control around product and channel management will continue to positively impact margin improvement. Adjusted operating income for Q1 is down, as Jim discussed, due to planned investments in sales, marketing and R&D to underpin our double-digit revenue growth objectives as well as inflation impacts. Also, Q1 revenue is lower than internal plans due to the factors Jim has discussed. While we are investing responsibly for growth, we continue to see mid-teens operating margins and solid recurring positive cash flows as important financial objectives and Q1 is simply softer on operating margins than we'd like, given how rapidly the order flow declined in the second half of Q1. Finally, costs such as travel and trade show expenses were very low in the beginning of 2021 due to remote work for sales and others at that time. On cash flow and debt, our leverage ratio, our total debt to adjusted EBITDA is 2.9x, up from 2.7% at year-end due to softer earnings in Q1 as discussed. Also, net working capital typically drops down from Q4 to Q1 but remains higher than typical Q1 levels for us, due to AR collection delays in China due to the lockdowns which are timing issues versus bad debt exposures plus higher inventory levels to deal with supply chain uncertainties as well as lower-than-expected shipments in the first quarter. In terms of other uses of cash, I first wanted to speak to the litigation settlement referenced. We recorded charges totaling approximately $5 million based on the settlement reported via 8-K in April. Cash out lease related to this event will largely be in Q2, 2022. As disclosed in the 8-K, Biostage is seeking new capital to sustain its own efforts as a clinical stage entity which may provide recovery for these outweighs. But this is an uncertain outcome and we are planning with our new recoveries in our own -- no recoveries from this on our own 2022 cash outlook. We secured an amendment in our credit facility recently to accommodate these payments and increase our maximum allowable leverage ratio for the rest of 2022. We expect this provides ample room to get any litigation payments behind us and execute our growth and improvement plans set for this year. CapEx for Q1 was $500,000; we expect capital expenditures for 2022 to be approximately $2 million from growth -- with growth from a past annual run rate primarily associated with capitalizable development costs associated with telemetry product investments referenced. Additionally, we incurred $1.4 million in transformation costs in Q1 which are excluded from adjusted earnings consistent with best practice, given these are non-run rate investments in our business infrastructure designed to ensure solid long-term growth platform. Our costs in Q1 related primarily to a detailed review of our operations in Massachusetts and Minnesota which manufacture and support the substantial majority of our global revenues. From this process, we have identified specific programs to increase productivity, supporting items such as planned COGS reductions, as well as to unify the processes and systems of these core operations to efficiently deliver long-term profitable growth. We expect roughly $1 million per quarter rest of the year in cash investments to support these improvement plans. Consistent with our message from our Q4 call, we expect 2022 cash flow from operations to improve versus 2021 based on earnings growth and we do not expect the level of working capital growth experienced in 2021 in response to the supply chain dynamics discussed. With that, I'll turn it back to Jim to discuss the full year outlook. Jim?

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

[Operator Instructions] And our first question coming from the line of Paul Knight with KeyBanc. Your line is open.

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

It's somewhere around 20%-ish.

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

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

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

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

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

Okay. Thank you.

Our next question coming from the line of Tim Chiang from Northland Capital. Your line is open.

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

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

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

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

Okay, got it. Thanks.

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

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

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

All right. That’s it for me. Thank you.

Thanks, Bruce.

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

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

Ladies and gentlemen, that concludes our conference for today. Thank you for your participation. You may now disconnect.