Harvard Bioscience, Inc. (HBIO) Q3 2022 Earnings Report, Transcript and Summary

Good day, and thank you for standing by. Welcome to the Harvard Bioscience Third Quarter 2022 Earnings Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Dave Sirois. Please go ahead.

Thank you, Shannon, and good afternoon, everyone. Thank you for joining the Harvard Bioscience Third Quarter 2022 Earnings Conference Call. Before we begin, I would like to suggest that you take a moment and download a copy of the presentation that will be referred to during this call. The file is entitled Q3 2022 HBIO Quarterly Earnings Presentation and 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 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 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 and today's presentation. These 2 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, David. Good afternoon, everybody. Let me start by saying that in spite of a rough third quarter, we continue to work through actions to dramatically improve our portfolio and resize the cost of our organization by the end of Q4. Let's go to Slide 4 of the presentation and take a look at the highlights for the quarter. Revenue in the quarter was $26.9 million, down 9% from a strong Q3 prior year with 6% growth in cellular/molecular, more than offset by lower sales of preclinical, which was down 17%. Reported revenue includes a $1 million impact from unfavorable currency. And we experienced a very slow summer with lower sales to CROs and pharma across the regions. And we continue to see a rotation out of obsoleted low-margin CMT products sold mostly through distributors. Adjusted operating margin came in at 2.6% versus 13.3% last year, impacted by lower sales of preclinical products and higher cost of goods in the quarter. Gross margins came in at 51%, down from 56% last year, impacted by inflation and lower absorption and E&O charges. We had a poor mix in the quarter as we finished manufacturing of the low-margin products being obsoleted. Cost of goods was significantly impacted by lower preclinical revenue to absorb fixed overheads. Free cash from operations was $700,000 and net debt was roughly flat. Finally, as we previously announced last July, we're preparing for FY '23 with portfolio and restructuring actions on plan to complete in Q4, which are designed to underpin our goal of 58% to 60% gross margins and EBITDA margins in the high teens. Move on to Slide 5 to look at the revenue in the quarter by product family, which shows Q3 '22 revenue adjusted to reflect 2021 exchange rates. Starting with the first row of the table, on a constant currency basis, our cellular/molecular technology revenue was up 6% from last year, driven by the strong performance of our direct sales team. We had solid growth across geographies, driven by strength of our cellular products in particular. CMT grew despite reductions in obsolete nonstrategic lower-margin products sold through distributors. Looking to our preclinical products. Again, on a constant currency basis, revenue was down 17% from a strong prior year. European CROs and pharma sales of telemetry and inhalation systems was down significantly from a strong prior Q2. In Asia Pacific, China is recovering, but had a tough comparable to a large prior year telemetry sale and lower sales in other APAC countries negative -- impacted negatively on the very strong dollar. The U.S. was slower in Q3 on lower telemetry sales to CROs, though we see the pipeline improving here in Q4. The strong U.S. dollar compared to the euro and British pound drove a currency impact of $1 million, which will likely continue to hurt us through the year. Let's move to Slide 6. I can tell you a little bit about some of the exciting new product introductions. Starting with our cellular/molecular technologies. After the quarter ended, we received a large order from a top pharma company for our BTX Electroporation systems for use in bioproduction. This order will begin shipping in Q4. Over the longer term, this opportunity is expected to ramp to over $1 million annually, primarily driven by consumption of our unique Flat Pack Reaction Chambers, augmented by expanded services. Furthering our initial inroads, we see an emerging value proposition for our BTX system in bioproduction, which is often used today in pharmaceutical research and development to create the initial strains of the therapeutics. BTX Electroporation has the potential to provide an ongoing stream of Flat Pack consumables, revenues that benefits from the production quantities in addition to those used in research and development. Secondly, after the quarter end, we introduced the new U7500, our premium spectrophotometer building on our well-known ultra-spec line. This system replaces 3 existing models, and is designed to penetrate pharma CRO companies and top academic labs. Lastly, continuing to drive market leadership in preclinical wireless continuous monitoring, we also introduced our exclusive continuous monitoring glucose implant. This new implant allows for continuous monitoring of glucose levels and avoids the cost, inconvenience and variability inherent in periodic manual sampling. Glucose monitoring is expected to be an incremental growth driver in academic labs, government labs and pharma companies in the pursuit of solutions to the ever-growing problem of obesity and diabetes. This new line of implant is expected to add over $0.5 million annually to our business. Now let me turn the call over to Mike for a quick look at key financials. Mike?

Thanks, Jim, and good afternoon, everyone. 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. I'll skip over to Slide 8 with the data table and go right to Page 9 to go through the full financials. On gross margin, we reported 51% for the quarter on an adjusted basis as compared to 56% in the prior year. This decline was due to higher costs associated with inflation, including uniquely high levels of price increases in electronic components, which we see moderating on a go-forward basis. Fixed cost absorption was also a major driver given the revenue decline noted, compounded by the decline in sales coming from our preclinical products, which carry higher-than-average gross margins. Despite these short-term headwinds, we see go-forward traction and gross margin improvement with continued ability to increase our prices to our customers and the mix within cellular and molecular technology sales continues to improve, with niche cellular products delivering higher growth within CMT. CMT and overall gross margins will improve meaningfully with the portfolio and restructuring actions Jim has discussed. Gross margin for the quarter on a GAAP basis was 45% due to $1.4 million of charges associated with these portfolio and restructuring actions, which relate to products manufactured in our largest CMT facility, primarily inventory write-downs for low-margin products we will exit in the months. Adjusted operating expenses were up approximately 3%, with higher labor costs associated with inflation and R&D investment growth, primarily related to investments in our next-generation telemetry products, but also supporting the new product introductions Jim discussed. Adjusted operating expenses were down sequentially from Q2 2002 by approximately $800,000, reflecting initial benefits from the restructuring actions Jim noted, as well as lower overall discretionary spending than originally planned for 2022 given the softer revenue trends noted. While headcount grew in the second half of 2021 and early 2022, in reaction to the supply chain and labor dynamics that emerged over the last year, the restructuring plan we're finishing now and will have headcount down approximately 10% from Q2 end with a workforce we believe can support growth in operating leverage in 2023. Adjusted operating income for Q3 is down meaningfully due to the factors noted above, most notably due to the drop in revenue discussed, which we believe represents a trough quarter for revenue due to the unique end-market slowness experienced this past summer. On cash flow and debt, net debt is up $4 million over prior year due to -- primarily to the legal settlement we've discussed previously. Cash outflows related to this matter ended in Q2. And with improvements in working capital in Q3, particularly DSO, we were able to generate $600,000 of cash flow from operations and keep net debt essentially flat at $45 million. For the rest of 2022, we expect net debt will be at a similar level in Q3. We expect to maintain strong collection efforts and to bring down gross inventory levels in Q4. However, net working capital typically increases overall in Q4 due to higher sales seasonably. Restructuring and transformation costs for Q3 were $1.7 million, with inventory write-down and severance costs associated with the portfolio actions and restructuring. These costs were partially offset by a reversal of accruals associated with the litigation. The line item detail of these costs are included in the GAAP to non-GAAP reconciliations included in this presentation. We anticipate up to $1 million of additional charges in Q2 -- or in Q4 rather, to complete the restructuring plans noted. Importantly, with these actions, we believe the major restructuring initiatives needed to construct the growth platform we've been discussing are behind us exiting 2022, and we're planning for a significantly lower transformation costs in 2023. CapEx in Q3 was $400,000 or $1.3 million year-to-date, with manufacturing and technology infrastructure investments made. CapEx will be lower near term given the focus on cash flow improvement and deleveraging. Our leverage ratio or total debt to adjusted EBITDA at Q3 end is 3.9x, up from 2.7x at year-end due to the softening earnings, particularly in Q3. As you will see in more detail in the 10-Q to be filed shortly, we recently secured an amendment to our existing credit facility, which increases the maximum leverage ratio covenant and provides room for the company to complete its restructuring activities launched in the second half of this year. We believe this amendment, combined with the plans we are executing to set up 2023, which includes reducing inventory levels, which spiked up over the last year due to -- to address global supply chain dynamics, provides us the flexibility needed to continue to improve the business and deliver improved margins and cash flow, and ultimately return us to sustained leverage below 3x. Jim will give initial thoughts on the 2023 margin targets and its conclusion. And we are all laser-focused and accompanying this with strong positive cash flows and deleveraging in 2023. With that, I'll turn it back to Jim to discuss the full year outlook. Jim?

Thanks, Mike. Now moving to our summary on Slide 11. First, looking at the upcoming fourth quarter, we expect fourth quarter revenue in the $30 million range. We see sequentially improving revenue and an improved product mix returning our adjusted gross margin to first half range and adjusted operating margin to the 14% to 15% range, plus improving inventory and working capital management will further improve cash flow. For the full year FY '22, we expect revenue of approximately $115 million, gross margin in the 55% to 56% range and adjusted operating margin in the 9% to 10% range. Despite a challenging third quarter, we continue to drive the transformation of our business to the profitable growth-oriented platform we envisioned. We're on target to complete obsoleting low-margin nonstrategic product lines by the end of Q4. This, in combination with resizing and leaning manufacturing overheads and reducing operating expense also by the end of Q4. These actions support next year's targeted gross margins in the 58% to 60% range and EBITDA margins in the high teens. New product introductions and improved portfolio with pricing power will underpin profitable organic growth for the future. Finally, our transformation costs are expected to be significantly lower with restructuring essentially complete at the end of Q4. Thank you. Now I'll turn the call back over to the operator and open the line for questions.

[Operator Instructions]. Our first question comes from the line of Paul Knight with KeyBanc.

What's your goal now on organic growth potential?

Paul, I think about next year, our plan organically is to -- we're rotating out of something like $5 million to $6 million of nonstrategic low-margin products that typically sell through distribution. So I'm looking next year to get back to that kind of mid- to upper single digits on a reported basis and a little better than that when I reaccount and look at a pro forma view as I extract out the revenue that we're no longer selling next year. So roughly speaking, somewhere in the neighborhood of 10% to 11% on a pro forma basis. And then, again, accounting for the revenue that we're exiting, probably somewhere in that neighborhood of 6-ish percent on a pro forma basis -- or actually, I mean, on a reported basis.

And then on this BTX Electroporation configuration, you're mentioning that you had a sale to a major pharma. What -- is there more pipeline behind that?

Yes. Yes, there is. We've been working on this for a while. We've been very well known in the initial discovery of the various new drugs coming out. Our BTX Electroporation system has been used for a very large number of new drugs, including things like the COVID vaccines. But historically, we were typically only used either in the development of the initial drug, either at the research labs, academic labs or in the pharma companies, but not necessarily in the production -- bio production of those drugs. What we've been working on is the ability to provide a bridge from -- if someone is using our equipment to generate the first line, if they're going to be using electroporation in the line itself, we're now working and offering the ability to transition from that creation of the drug to the initial levels of production. Depending on the amount of demand, we're certainly seeing the initial production up through medium and maybe low levels, up to low to medium levels of production rates. That can change a lot based on the drug and based on how it's used and based on how much is actually specific electroporated that shows up in the vial and in the end drug. So this is an area we've been working on for a while. It's an exciting time to be able to offer this. It's a new growth opportunity for us. We've been working with a number of companies. This is -- we highlighted this one in particular because it's a large order. We see this becoming a multiyear opportunity and reaching $1 million plus in annual consumable revenues just with this one particular order alone. And then when you add up, the ability to bring others into this, it's an exciting growth area for us.

And the BTX, is that for cell and gene therapy -- cell and gene therapeutic applications?

It can do that, too. It actually is -- it's a -- it was actually one of the very first electroporation systems out there involved with first cloning, moving on to the development of things like monoclonal antibodies. It's used in the development of not just the drugs, but also the drugs that are -- some are large molecule drugs, some are small, anything that goes through electroporation for developing the initial cell lines. We're heavily involved in this and has been for many years. And for us, just the ability to provide a transition or a bridge from the initial drug to something they can start producing against some level of volume is really important because they -- especially if they've used our technology to create it, it's much -- we think we'll be able to show that it's much safer, just expand that volume of it, and start to enter production -- low-level productions and then growing from there.

And then lastly, the spectrophotometry product, spectrophotometry is -- can you kind of give us a gauge of how big the overall spectrophotometer business is? Is it Harvard Bio? Is it more than 10, less than 20? Is there any metric you can give us? I know it's been large, but if that would be helpful.

Yes. The spectro business itself is somewhere, I would say, in that kind of 5% or 6% of revenue range. So it's meaningful. It's not too large, but it is an area -- again, where we've tended to focus on selling through distributors, and into academic research. This new version is also designed to be easier transition and sold into pharma companies, where we have direct sales, where we have really good connection. So it's an expansion on our respective [indiscernible] business.

Our next question comes from the line of Bruce Jackson with Benchmark Company.

I wanted to -- so I wanted to take a little time to talk about the inhalation business. Obviously, pick out a big boost during COVID-19. You've got the leading -- alluding products in that space. How much of the current downturn would you say is due to just general economic conditions? And how much could potentially be a shift in the market towards a more normalized level?

Yes. That's a good question. I don't think there's any doubt, at least in hindsight, that given that we had offered the product about the time that COVID was coming out, it had an immediate uptick. What we did was we worked on the transition of new capability into the product to then be able to have it more targeted toward long-term use and then compete on the specifics of being able to measure exact amount of what was delivered through the system and inhaled by the model. So I would -- certainly, I would expect that we had some buildup of additional sales of the inhalation units just because of everything happening with COVID. And we did see a lot of those sales go to pharma companies around the world, and they adopted it fairly quickly. So we could very well be, like you say, moving towards more of a normalized level of revenue there and sales. And we'll grow off of this level then based on the new capabilities that we've added, including the ability to specifically measure the amounts inhaled.

Okay. Okay. And then you mentioned as there's going to be about $5 million to $6 million of revenue impact from discontinued products in 2023. Was there -- were there any discontinued products in this quarter that had any impact on the top line number?

Yes, there -- certainly what we started is in this last -- actually, in Q3, we started identifying and telling customers that we were rotating out, that we were obsoleting certain products. So we did see a continued rotation out of -- and again, if you look at just -- if when I look at what we sell through distribution around the world, again, mainly to academic research sites, some of the obsoleting products, we saw a downturn somewhat on those as we would have expected. A rotation out of those, I see that as a good rotation. And then with the introduction of the 7500, that's a new premium unit that takes over and replaces a number of other units that were in production that were lower margin, lower capability. We think this is going to bring back and keep us in that revenue stream, doing well even though it's rotating out of those lower-margin products.

Okay. Then last question for me. You discussed the fourth quarter CRO pipeline, was starting to look a little bit better. I was wondering if you could maybe give us a little bit of color on the types of the studies or the types of products that are catching some of this upturn in the fourth quarter?

Yes. We've always done really well with our implantable telemetry continuous monitoring systems. We -- in this summer, in the summertime, July, August, things really slowed down, very much in Europe and pretty much we saw the slowdown globally. And it seems to slow down fairly quickly around in that kind of mid-summer or late summer time frame and then start recovering. So we saw the recovery is happening. And of course, we're very happy to see it recovering in our implantable telemetry space. So that's coming back nicely. And that's going to be augmented because the glucose -- the new glucose product is brand new. It's incremental business for us. It's something that academic research has really been looking for, including government labs and pharma companies. So that will augment the growth in our high-margin telemetry monitoring business. So that's the piece where, again, with -- when your highest margin products hit some delays like they did in the summer there, that had a real effect on us because it was -- you're losing some very high-margin revenue in the quarter. At the same time, that would have been -- that also forces you then to have an issue with absorption of overheads and to really fix the long-term overhead issue, I mean that to have the real kind of cushion that we need as a company, those are the structural changes that we're making to bring down the overall cost of the business. So the 2 things that are happening is we see our great margin products and the introduction of the new glucose product, getting us back to where we need to be and improving our margins. At the same time, the cost reduction activity and the associated with changing and improving the portfolio and taking our cost of the organization down, gives us the kind of cushion and headroom in our margins so that we could absorb when we have a one-off quarter that happens to be particularly slow for whatever reason, whether it be something with COVID or something with the supply chain, if it's -- we just -- a company of our size, we tend to really get hit hard with the kind of things happening in the market when you have a very strong dollar. Countries like Japan are really struggling to buy almost anything and companies -- countries that are buying in euros and pounds, which is a significant part of our business that really turns into a currency translation problem. So the only way to really solve that is to just get our cost structure down. And in good quarters and good years, we'll be in really good shape. But if we have some issues that pop up for a point of time, it's not going to be quite as hard on us on a quarter basis.

Our next question comes from the line of Christopher Sakai with Singular Research.

This is [indiscernible] for Chris. I was wondering if you can provide us a bit more details on the preclinical revenue stream in terms of what happened this quarter? And how do you kind of see it going forward?

Yes, I mean, it was the preclinical revenue in the quarter where we really saw a slowing. And a lot of, it just seemed to be delays. And we know much of our preclinical products go to pharma companies and CROs, and companies that really have to pay attention to the top line and to the bottom line. So we saw some of it was a belt tightening in the quarter. And then some of it was just people getting back to work after COVID. And we knew that the summer was going to be a tough summer and people that -- Europeans who typically take 4 or 5 weeks off, we saw people -- nobody around to even call and talk to in some of the centers until summer was fully done and people start to come back to work really in the September time frame. So I think it was a combination of that. I have no doubt that we have some belt tightening happening in the CRO space. And I think to what Bruce had mentioned, there could very well have been some additional sales prior year. We had a very strong prior year and a very strong Q3 last year, where some of the pharma companies made some major purchases. We had an individual $1 million purchase by one of the largest CROs in China, which really -- it's great news for us, except it kind of makes for a tougher comparable when you think about million incremental deal just in one case in the prior quarter. So we see that coming back. The mix is going to start improving here. It improves already as we look to Q4 and then with the cost changes that we're making, our revenue stream will have strong margins and strong drop down.

In this -- and look, we are aware of some of the slowdown we are seeing in U.S., especially in biotech considering we are out of the high of IPOs back market for the last 2 or 3 years. But you mentioned mostly this is OUS. So do you think that, that is sort of a similar situation, OUS and U.S. in terms of slowdown? Or we might see a slowdown in a little bit in U.S., which we haven't seen yet.

Yes. Well, we did see some slowing in the U.S. in the preclinical revenue stream. You're mentioning -- bring up a good point with the biotech. That was something we always saw and still see as a great growth opportunity, especially now that we have some of the new products with the BTX and the ability to start to offer to smaller biotechs and pharma companies that are involved with more orphan drugs and such to help to provide them with other options for bridging to production. But the biotech, I would say that, that wasn't really -- there wasn't a lot of revenue for us. When I think about -- when I look -- think of our North American revenue, much of it is CROs and pharma companies. So with some slowing there in that quarter, and like I said, we've already seen the pipeline improving even going into our expectations, our natural growth from Q3 to Q4 as we look within this year and then going forward. So augmenting it with new products, especially with the new glucose, is going to continue to drive toward a very positive mix for us on implantable monitoring. And then just watching as we deal with the headwinds in Europe. China, I think we all believe China -- we see it improving somewhat. We think it's going to do quite a bit better as we think about -- they have been going through these periodic shutdowns. There's a strong feeling that China is going to pick back up very strong. Europe is always a place where we always have some level of concern just because of the market there and, of course, the currency situations.

And finally, apart from the 3 new products that you talked about in terms of early stages in R&D, if you can talk a little bit about, give us some update about you guys are thinking, what's cooking over there that will be very helpful.

Well, good question. You can see where we're making our investments. We're making the investments in areas where we have high barriers to entry, good pricing power and a good ability to sell our products. So investments, we continue to invest in the cellular/molecular side, very much on the cellular approach. We think there's going to be a lot more adoption of cellular testing technologies into the stream of how you get products through the preclinical and into clinical. So that's an area of continued investment. You saw that with BTX. You're going to see that with more of our multi-electrode array type products that will be coming in then the implantable telemetry, of course, is an area where we continue to -- we need to stay the market leader in there. And we'll continue to invest, and you'll see new products coming out on the software side. That's an area that -- we've talked about it in the past, but now we see the ability to really manage data and to provide the right kind of capabilities, not just to CROs, but also to pharma and to have versions that sell well into academic research. So you'll see more investment on the software side of our business, too.

This concludes the question-and-answer session. I would now like to hand the conference back over to Jim Green for closing remarks.

Well, thank you for joining us. This ends our presentation today. We hope you'll join us again for our Q4 results in February time frame. So thank you very much, and we'll see you soon. Thanks.

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