Harvard Bioscience Inc Q3 FY2020 Earnings Call

Thank you for standing by, and welcome to the Third Quarter 2020, Harvard Bioscience Inc, 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. Please note that I would now like to hand the conference over to David Sirois. Thank you. Please go ahead.

Thank you, everyone. Thank you for joining us for the Harvard Bioscience Third Quarter 2020 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, 2020, 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. All right, 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, 2019, our quarterly reports on Form 10-Q filed in 2020, 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 represent the ongoing economics of the business, reflect how we set and measure our incentive compensation plans, and how we manage the business internally. The differences between GAAP and our non-GAAP results are outlined in the earnings release and today's presentation. These two documents can be found on our website under Investor Overview, Events, and Presentations. Additionally, any material, financial or other statistical information presented on the call that is not included in our press release and presentation will be archived and available in the Investor Relations section of our website. A replay of this call will also be available at the same location on our website. I will now turn the call over to Jim. Jim, please go ahead.

Thank you, David. Good morning everybody. Let's go ahead and move to slide 4 of the presentation, and take a look at the highlights for the quarter. Despite revenue being down 12% from Q3 last year, our gross margin was up 80 basis points and adjusted operating margin was up nearly 3-4 percentage points. Academic lab sales continue to recover as labs reopen, and our combined CRO and Pharma revenue remained stable at 2019 levels or pre-pandemic levels. We are happy to see expanding growth in our new inhalation product line. As we look forward, revenue and profitability growth will support adding back certain organizational costs as our employees return. We will continue our disciplined cost and cash management approach with leverage around three times, and we expect to refinance our debt soon. Finally, we expect to deliver second-half operating margin in the mid to upper-teens, outperforming last year. Moving to Slide 5 of the presentation, we'll look at the details of Q3. As expected, we continued to see improvement with our Q3 revenue coming in at $24 million, that's down $3.4 million or 12% from Q3 last year. Remember, Q2 was down 21% from the prior year, all impacted by the COVID-19 situation. Our gross margin on a GAAP basis measured 56.1%, that's an improvement of 150 basis points from last year. Our non-GAAP adjusted gross margin was 56.4%, an improvement of 80 basis points from last year. This quarter, our GAAP operating income was $2,000 or 0.8% of revenue, and that's up from a negative $1.4 million in the prior year. Our adjusted operating income was $3.6 million, so our adjusted operating margin improved to 14.8%, up over 2.5 percentage points from the same period last year. GAAP earnings per share was negative $0.03. Our adjusted earnings per share was $0.04 flat to last year. Our cash flow from operations was $1.6 million, and we paid down our net debt by $0.5 million. Let's move on to Slide 6, and look at Q3 revenue by product family. Starting with our Cellular Molecular product revenue, which is primarily from academic research labs, was down 21% worldwide. It's an improvement though from Q2, which was down 33%. We see continuing improvement as labs reopen and restart their research and development for new therapies and vaccines. Looking at our pre-clinical product revenue, it is maintaining the recovery at pre-COVID-19 pandemic levels, and within that, our pre-clinical academic revenue is still down but improving again as labs reopen. Moving to Slide 7, we'll look at restructuring activities and major actions in Q3. Finishing up on the restructuring plan that was announced back in Q4 of 2019, the Connecticut manufacturing consolidation, and the UK downsizing are now complete. The COVID-19 related actions taken in Q2 and Q3 support getting us to a sustainable lower overall cost of organization. On the bright side, we're seeing expanding demand for our new inhalation products. Now, I'll turn the call over to Mike for a quick look at our key financials. Mike?

Thanks, Jim, and good morning everyone. I'll speak to our full P&L and our liquidity. As is our practice, I'll focus on our adjusted or non-GAAP operating results, which we use to run the business. We note, our GAAP results and related reconciliations to adjusted results are included in the appendix of this presentation. As noted, we continue to improve our margin profile despite the unique environment created by COVID-19. Gross margin improved versus prior year on product mix and the positive impact of our restructuring plan, which includes a modest benefit from eliminating certain low-margin products in the second half of 2019. We continue to accelerate our efforts on both sales effectiveness and product line improvements recently to ensure we're balancing cost management and driving profitable top-line growth. These efforts along with continued recovery in academic labs should provide us a path to the 60% gross margin target set forth in 2019. I do note that we were down sequentially in gross margin due to the uniquely strong mix in Q2 as well as seasonality. Adjusted operating income increased versus prior year despite lower revenue due to the gross margin improvement noted and continued execution of our restructuring plan. The plan announced in December 2019 is substantially complete with Connecticut and UK site activities fully executed, and other permanent cost structure changes implemented post COVID-19 provide an additional $1 million of annualized cost savings. As communicated last quarter, the combined effect of these activities is total annualized cost savings of $5 to $6 million. OpEx for the quarter was $10 million, or 20% down from the prior year and essentially flat to Q2. However, we note we relied more on permanent cost reductions in Q3. As a reminder, last quarter, we leveraged temporary work and pay reductions, and in Q3 much of our workforce returned to work full-time. Finally, on cash flow, we continued to reduce net debt with DSO and inventory reductions contributing to a $1.6 million cash flow from operations for the quarter. We have reduced net debt by over $5 million thus far in 2020, and nearly $10 million in the past year as the new management team. Our leverage ratio or total debt over adjusted EBITDA is stable at slightly below three times, and we are compliant with all debt covenants. Based on all the actions we are taking to improve the business and the underlying solid cash flow profile, we believe market conditions exist to refinance our debt to a lower-cost facility in the near term. With that, I'll turn it back to Jim for perspective on the rest of 2020. Jim?

Thanks, Mike. Let's move to Slide 11. Taking a look forward, we expect our combined CRO and Pharma revenues to continue to grow. We expect sequential growth as academic labs reopen over the upcoming quarters. We will maintain our leaner organization while continuing investment in targeted product lines. We'll manage our cash flows and continue to pay down debt and work to refinance to a much lower-cost repayment. In all, we expect continued sequential quarterly revenue improvement and we expect to deliver second-half operating margins at the mid to upper teens level. Thank you. Now, I'll turn over the call to the operator and open the line for Q&A.

Thank you. Please standby as we compile the Q&A roster. Your first question comes from Lisa Springer of Singular Research. Please go ahead.

Thank you. Good morning, and congratulations on pulling out a pretty decent quarter. Regarding the product mix, what was the product mix impact on gross margin, and was the product mix similar to the product mix in Q2?

I believe in Q2 we had a very strong product mix that was heavily focused on our telemetry products, which have some of the highest margins. Moving into Q3, which is typically one of our lighter quarters, we experienced a slight decline and our mix shifted more towards some of the newer CMT products that started coming back in the lab, resulting in a minor negative impact on our mix. You might have noticed that the gross margin decreased slightly compared to the previous quarter, but as we approach Q4, we expect our overall mix to return to its more natural state.

And could you provide me with a little more color around the demand for the inhalation products? Where is that demand coming from and how does that compare to demand in Q2?

It's a really exciting growth area for us. We introduced the inhalation product because it's the first of its kind that allows you to measure what you're putting into a subject in terms of what they're breathing. Then, at the same time, you get a real-time measure of what of that is getting through the lungs and into the bloodstream. The same goes for medications or other treatments for a particular disease, whether it be COVID-19 or another. The initial big demand we saw develop was in the CRO and Pharma side, and we got it started in China, where you would expect they returned to work very quickly working on vaccines and such. We also, as expected, saw that demand moving around the world, again primarily and initially in pharma and CRO. However, we believe that a significant driver for demand will be the academics as they return to work. It's going to be heavily targeted toward airborne type diseases, and this is a perfect kind of product, perfectly timed for large academic sites researching and developing therapies in this area to adopt this. We think this demand is really just starting. Overall, starting in CRO and Pharma and then expanding as all the academic sites come back. We do have a number of other products that are in a similar situation with cellular testing type of products like electrophysiology that are also very much involved with testing at the cellular level, and that will be an area that we also expect to see demand growing as academics return.

And my last question is about the refinancing of the debt. Do you anticipate that might happen still this year, and what kind of rate are you envisioning? What kind of reduction?

We're certainly targeting to get it done this year. It's always dependent on market conditions, but we would like to see it done here in the very near future. We're looking at the kind of savings that will generate, and Mike, do you want to comment on what we're thinking regarding bank-level interest rates?

Market conditions have improved, and people like our credit profile. We're paying close to over 9% right now, and it should be less than 5% given the opportunities in the marketplace currently.

Next question is from Bruce Jackson of The Benchmark Company. Please go ahead.

First off, good job on controlling the operating expenses during the quarter. Do you have any additional special charges coming in the fourth quarter?

Mike, roughly what do you expect?

Yes, there are still some things that we're finishing off. The way to think of it, Bruce, is with the $5 to $6 million of savings that we talked about between Q4 last year and this year, there will be about $5 to $6 million in total savings. There'll be some left, but it should be around what we incurred in Q3, which is less than a million.

And then, if we could just talk a little bit more about the academic market. How fast is that coming back? You mentioned the inhalation products in particular. Are there any other areas of demand coming from that market?

If you look, a good proxy for our labs coming back is our CMT level revenue that we report on. Initially, we thought the labs would be down about 50%, and then recovering sequentially. What we've seen in our numbers is, we were down around 33% to 34% in Q2, and that improved this quarter to about 21% down. So we're seeing slightly over a 10-point improvement per quarter as it moves back to normal. The good news is, with the new products coming out, we expect to see recovery and general growth, enhanced with these new products. As we get into next quarter and into 2021, I will be able to show you a better view of what we expect as far as natural organic growth, as we will show a much more valuable product mix with better strategic purposes and pricing power.

Speaking of the product portfolio, there is the pipeline modernization going on. Are there any new products coming up near term that we can look out for?

Certainly, you already know about the inhalation products. You'll see extensions in that area. There will be expansion in new technology in the implantable telemetry side; that's our fastest growing and fundamental business used in pre-clinical testing. Additionally, we see expansion in cellular level testing activities, more of what happens in the pre-clinical phases regarding safety and toxicology testing at the cellular level. That's going to be an area we're investing in. The area that has been left alone for a while is that we will be updating and refreshing technologies that haven't been improved in about 10 years. That is an area with real opportunity in the marketplace.

Thank you very much. Appreciate you joining us for Harvard Bioscience. We look forward to seeing you on our Q4 call next quarter. Thank you very much and have a great day. This is the end of the presentation.

Ladies and gentlemen, this concludes the conference call. Thank you for participating. You may now disconnect.