Earnings Call Transcript - HBIO Q1 2022

Operator, Operator

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 speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded.

David Sirois, Host

Thank you, everyone, 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, represent 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 represent 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.

James Green, CEO

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 10% and Cellular Molecular up 7%. We saw significant order delays from China due to 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 the 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, which puts the legal distraction behind us. If we move to Slide 5 of the presentation, we'll look at the details for 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. Looking 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 from 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?

Michael Rossi, CFO

Thanks, Jim and good morning, everyone. 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 with order delays associated with China. Our core products and diverse customer base, combined with actions we've 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 regarding 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 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 the 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. 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 accounts receivable 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 outlay 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 outlays. But this is an uncertain outcome and we are planning with our new recoveries in 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. Capital expenditures for Q1 were $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 a 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.

James Green, CEO

Thanks, Mike. Just quickly, in my opening remarks, I mistakenly stated that Cellular Molecular Technology was up 10% and pre-clinical was up 7%. It's actually the other way around. Pre-clinical is up 10% and CMT is up 7%. You'll find the correct numbers in the presentation. Now, let's move to the summary slide on Slide 10. Looking ahead, we continue to see strong growth and improved margins, as we are expanding our perspective to consider potential volatility in China. We anticipate year-over-year revenue growth in the range of 8% to 13% compared to last year. We expect solid growth in North America and EMEA, and we see China recovering towards the end of this quarter, followed by a robust second half. Our reported revenue will account for further portfolio rationalization activities, where we plan to eliminate approximately $2 million to $4 million of low-quality non-strategic product sales to enhance our mix and strengthen our business platform. Regarding adjusted operating margin, we expect ongoing improvement in the range of 14% to 16% of revenue, with gross margins rising to 58% to 59%, supported by operating leverage from growth and continued reductions in cost of goods sold. We observe the global supply chain being stable but remaining at these elevated cost levels. The improvement in operating margin will also involve a sustained level of research and development for new products, along with enhancements in cost of sales and marketing. Thank you. Now, I’ll turn the call over to the operator to open the line for questions and answers. Thank you.

Operator, Operator

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

Paul Knight, Analyst

Hi Jim. Can you discuss that China represents 1% of company revenue?

James Green, CEO

It's somewhere around 20%-ish.

Michael Rossi, CFO

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

Paul Knight, Analyst

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

James Green, CEO

I think yes, that's true. The reason we brought in the range is, we did see a downtick in orders. One of the things that we validated is it’s not a loss if they’re delayed. A lot of our people are in Shanghai. That's where our main operating offices are. A lot of them have all been forced to work from home and their customers also have been forced to work from home. Companies and 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 anything lost; it all seems to be delayed. So that's why we think we not only will get back to our strong second half, but there's a good chance that much of what was delayed in the first quarter and some of the second quarter will wind up in the second half because there's no actual demand missing, it’s just been inability to process the orders. And early on in the quarter, we had issues shipping into China, but that seems to be resolving. We're seeing shipments working much faster now. And we're also getting people back on the phone. That’s why we see indications that this is coming back. The latest news we have in China is that they know they've got to get things back up and running. We're seeing it actually really happening and talking to the folks, and there's no negativity around it; we feel real good about the second half. We’re even starting to see indications that late in this quarter that order intake is picking back up, which is a nice positive sign.

Paul Knight, Analyst

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

Michael Rossi, CFO

Yes. We've been good at passing that pricing on. Now, it takes a while for that to start fitting in. Sometimes there are 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 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. We’re mostly able to pass that along. In some less strategic areas, where we work through distribution, it's a little harder. But across the board, we’re seeing everyone taking those prices up to account for this. Where we sell directly in our high-technology products with high barriers, we have very strong pricing and pricing power. We'll pass on these costs with new pricing adjustments. We've been working to increase that pricing as needed. We think the inflation piece is likely to remain high, and we don’t see a reason for it to come down. But with the changes we are implementing in the business, we are going to see significant improvements in our labor costs. So we will see efficiency gains. As we move towards using the number one tool set and one platform, that's going to give us an opportunity to start addressing some of the overheads across all of the company. The freight remains hard to predict and may stay high. But labor efficiencies should improve throughout the year, and that's where we expect to see improvements in COGS. If there are pricing opportunities, we'll definitely pursue them.

Paul Knight, Analyst

Okay. Thank you.

Operator, Operator

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

Tim Chiang, Analyst

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

Michael Rossi, CFO

Yes, good question. We think we'll continue to improve as the volume increases throughout the year. So as we get to the end of the year, we're confident we'll be at around 60%. Some larger quarters will start to hit that anyway. Even for the year, we would think we'll end up around 58% to 59%. That will include a lower Q1 here because of all the impacts we are navigating. But yes, we believe we can reach that mark toward the end of the year.

Tim Chiang, Analyst

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?

James Green, CEO

Whenever you take something out of the portfolio, it takes a little bit of time as you have to go through the sales organization and modify the process. Typically, we look at how many we’ll sell off to customers as a last-time buy, while often having to adjust prices accordingly. I'm expecting in the second half of this year that revenue from products coming out will start to clip out significantly. We expect that number around $4 million to be out. And some of what comes out won't just disappear; we can often replace it with better products. A negative of a negative can be a positive. If something does not fit our portfolio for the future, we have to move on from it and focus our efforts on what truly drives profitable growth.

Tim Chiang, Analyst

Okay, got it. Thanks.

Operator, Operator

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

Bruce Jackson, Analyst

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?

James Green, CEO

Sure. I mean we've been consistently launching around 15 new products over the last couple of years, a combination of new and refreshed. I publicly announced the improvement and the launch of the SMART study for inhalation. We believe this is unique and a nice incremental driver for our business, which is part of why I want to speak more about these technologies as they come out. We're focusing on products that have historically been sold into academic research but will also be used more broadly in the industry, particularly with CROs and larger pharma companies. A number of our products now fit well into that stream due to our increased exposure there. We've always been the top shareholder in the telemetry side for safety pharmacology and toxicology. By integrating those with our behavior products, we cover a broader range of the preclinical cycle that goes through to clinical trials, especially since our products are GLP compliant, which makes them usable data for FDA filings. We are seeing an uptick in our behavioral products and this growth is contributing to some of the uptick you see happening on our pre-clinical side. We want to ramp up reporting along the portfolio and by customer segment to provide clarity into our growth strategy.

Bruce Jackson, Analyst

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

James Green, CEO

Thanks, Bruce.

Operator, Operator

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.

James Green, CEO

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.

Operator, Operator

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