Earnings Call Transcript - HBIO Q2 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the Q2 2021 Harvard Bioscience Conference Call. Thank you for participating in our conference call today.

David Sirois, Investor Relations

Thank you, Alicia, and good morning, everyone. Thank you for joining the Harvard Bioscience second quarter 2021 earnings conference call. Before we begin, I would like to suggest that you take a moment and download a copy of a presentation that will be referred to during this call. The file is entitled Q2 2021 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, 2020, 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, reflect 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 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.

James Green, CEO

Thanks, Dave. Good morning, everybody. Let's move to Slide 4 of the presentation and take a look at the highlights for the quarter. Starting off, revenue was up 25% over Q2 2020, improving to pre-COVID levels. Preclinical DSI revenues were up 20% on strong demand with growth across all of our key product lines. Cellular and molecular revenue was up 22%, continuing its recovery as labs reopen. We saw very strong order growth and backlog growth. However, we had some fulfillment delays from global supply chain disruptions that all companies these days are having to deal with. Operating margin came in at 15%, compared to 18% last year and 12% in Q2 of '19. Gross margins were impacted as we experienced significant COGS increases in the quarter, driven by material costs, freight, and direct labor with COGS of approximately $1 million in the quarter. With gross margin being a focus of ours, you can be sure that this has our attention, and we'll be dealing with it. Q2 was a difficult comparison because of the cost actions that we took last year in response to the developing COVID situation. Let's move to Slide 5 of the presentation and look at the details. As expected, we continue to see strong revenue growth with Q2 coming in at $29.2 million, that's 25.3% over last year. Gross margin came in at 56%, and that was down 340 basis points from last year, but on higher costs from the global supply chain issues, which we've talked about, and we'll talk a little more about in the future. This quarter had GAAP operating income of $100,000 or 0.2% of revenue, our adjusted operating income was $4.3 million, thus our adjusted operating margin measured 14.6%. GAAP earnings per share was negative $0.01, up from a negative $0.04 last year. Our adjusted earnings per share was $0.06, up from $0.05 last year. Our cash flow from operations was $800,000, and we paid down debt by an additional $900,000 in the quarter. Move on to Slide 6, take a look at the revenue in the quarter by product family. Starting with the first row of the table, our cellular and molecular product revenue, which is primarily from academic research labs, was up 22% from last year, with orders and backlog up significantly. We experienced significant revenue shipment delays caused by global supply chain disruptions in a number of materials. Planned pruning or removal of lower-value products impacted our reported revenue by approximately $1 million in the quarter. European labs are still slow, but we see signs of recovery looking later in this year. Looking to the second row of the table, our preclinical products revenue grew 20%, driven by strong order growth across the product lines from our core customer segments of CRO, pharma, and academic labs globally. Sales in the Americas was up 28% and Europe was up 32%, with expanding academic lab demand for our preclinical product lines. Our new inhalation product is growing at a clip of over 50%, and our preclinical revenues are now exceeding the pre-COVID levels of 2019. Overall reported revenue grew 25%, and on a currency-adjusted basis, revenue was up 21%. Moving to Slide 7, taking a look at the major activities in the quarter. The post-COVID dynamics continue to impact global supply chains, and that really has hit us with material purchase price variance issues, freight and labor costs. European restructuring actions for the 2020 plan are complete. We completed the move of our U.K. engineering to Boston, and we closed 2 smaller sites. As for new product introductions, we introduced 9 new or refreshed products, which were announced at our June global sales meeting. So far this year, we've introduced 17 new products, which we expect to contribute meaningfully next year. Now I'll turn the call over to Mike for a quick look at the key financials.

Michael Rossi, CFO

Thanks, Jim, and good morning, everyone. The first half of this year demonstrates true momentum from our stated 2021 focus on organic sales growth while continuing to deliver improved bottom line performance and an overall more efficient business. I'll walk through the full P&L and cash flow in more detail. But as a reminder, my discussion will focus on adjusted results for P&L performance, which aligns with the measurements we use to run the business. Reconciliations of adjusted results to GAAP are included in the appendix of this presentation, including a reference to adjusted EBITDA we've added this quarter given this is a common metric utilizied by the investment community. Clearly, year-over-year expectations or comparison versus 2020 will be influenced by the unique cycles and reactions due to the COVID onset last year, which is why we'll make certain references back to 2019. On that note, our performance continues to reflect a fundamentally better business with an adjusted operating margin of 15% compared to 12% in Q2 '19 on comparable revenue levels. We reported 18% adjusted operating margins in Q2 2020 with significantly lower operating expenses in the prior year, given the rapid progressive interim cost measures put in place with the onset of COVID and related revenue reductions. Also, as Jim noted, this year, we experienced significant increases in cost of goods sold due to higher materials, freight, and direct labor costs driven by the global supply chain disruptions and other macroeconomic factors we are seeing globally in this post-COVID world. I'll expand on the gross margin dialogue a bit as we continue to believe strong sustainable organic top line growth and high gross margins are important outcomes for long-term shareholder value creation. Product mix is a significant driver behind gross margin for us, and today, this mix is stronger than ever. This is a direct result of our focus on driving growth in high-end niche products through more efficient direct sales channels as well as the pruning of low margin, low growth SKUs, all contributing to gross margin expansion. As Jim will detail in the guidance section, we're expecting margins will be modestly lower than planned in 2021 based on the inflation we are all seeing, but gross margins will uptick sequentially as volume and mix continues to improve, and we accelerate actions to address new realities. On our cost base overall, operating expense levels are in line with our planned expectations and also reflect the completion of our 2019/'20 restructuring program in Q2. As previously noted, the turnaround restructuring program initiated in 2019 created $7 million of annualized cost savings. In terms of business optimization in the rest of the year, we anticipate we'll spend around $1 million in the second half to accelerate improvements in our core manufacturing operations, which we will record as transformation costs and exclude from our adjusted earnings, given these are non-run-rate investments to support scaling our operations for expected growth. Our run rate OpEx is lower than pre-COVID levels with a fundamentally new and improved organization in place as well as compensation plans, including variable comp accruals to ensure to reward and retain the strong workforce in place. On cash flow and debt, our leverage ratio, our total debt to adjusted EBITDA is less than 2.5x, relatively consistent with the prior year, but well below our roughly 3.5x leverage about a year ago. Cash flow from operations was lower than the prior year due primarily to higher working capital, in line with higher revenue and certainly a strong outlook, including inventory growth to improve our fulfillment operations to make sure we take the backlog down and achieve our revenue goals given the disruption in the supply chain we've discussed. Finally, I called out in the slides here, our higher share count for adjusted EPS calculations. Diluted shares have increased over the last year due to the significant improvement in our share price since 2020. Option exercises aligned with the price appreciation contributed to this, but the majority of this is based on the dilutive effect of outstanding stock awards. The calculation of our GAAP is based on assumed share buybacks. And as the stock goes up, the theoretical amount of buybacks is lower, thus the higher share count. With that, I'll turn it back to Jim to discuss the full-year outlook.

James Green, CEO

Thanks, Mike. Let's move to Slide 11 and take a look at the outlook here. With most of the structural improvements behind us this year, our primary goal is sales growth, driven by improved sales effectiveness, marketing, and new product introductions. In addition, we'll be addressing COGS issues resulting from the global supply chain issues and disruptions, specifically honing in on freight optimization, material costs, labor, and efficiencies and also looking to tune our operating expenses in areas in Europe. As for our outlook for the year, we're taking up the revenue outlook and narrowing the operating margin target to account for the potential of extended sales and our supply chain-related cost increases that we've seen. We now expect revenue growth on a reported basis to improve approximately 12% to 15% growth versus last year. With the strong order growth and a strong backlog, driving sustained growth in our preclinical product revenues, academic labs are expected to continue recovering with strong order growth and a strong backlog there too. Portfolio rationalization improved low-quality revenue of approximately $1 million from our FY '19 baseline and another $4 million from FY '20 baseline. Risks do remain on the impact of global supply for certain materials, so we're managing it closely and proactively in manufacturing and supply to meet the demand for our customers. As for adjusted operating margin, we're narrowing our expected improvement to the mid-teens range. In spite of these global cost issues, we expect continued gross margin expansion on increased volume, improved margin mix somewhat offset by the higher supply chain costs, which we've been dealing with more recently. Thank you. Now I'll turn over the call to the operator and open the line for questions and answers.

Operator, Operator

Your first question comes from the line of Paul Knight of KeyBanc.

Paul Knight, Analyst

Could you talk about how the supply chain issues? Is it fixable in the quarter? Is it taking the year? What's the timing on that?

James Green, CEO

Yes, it's a great question. When you think about $1 million of incremental COGS in the quarter, that represents about 3 to 4 points of operating margin. It is pretty well split up between purchase price issues, which we think some of that is going to stay. We know there's some general inflation in there. But on the other hand, as we continue to improve the way we manage our supply chain, we know we'll achieve better purchase pricing for the actual materials. On the freight side, that was a big piece of it too. That's going to improve given the delays that we saw; many times we had to fly in materials to customers, which added extra costs. We believe that over the course of the next couple of quarters, that situation will smooth out and we'll return to a reasonable level of freight cost. We've focused much more on it and have the team in place to manage both purchasing and freight effectively. The labor inefficiencies we faced due to the disruptions were also a cost burden. We anticipate that a significant majority of these issues will improve as we approach the end of the year. Moreover, the strong order growth we have, including the substantial backlog we've built, will provide the operating leverage to cover these costs. It's crucial to address the cost issues and improve efficiencies as we navigate through this period, and we believe this growth would likely compensate for the operational challenges we've faced.

Paul Knight, Analyst

And Jim, could you highlight any of the products that were driving this 25% Q2 growth?

James Green, CEO

It was pretty much across the board. First of all, the DSI preclinical products drove significant growth. The inhalation product continues to excel as well, and we're making more investments in that area. We had some issues with shipments on the BTX line, but those have largely been resolved. The market has substantial tailwinds, indicating a bright outlook. While we faced some shipment delays, the order intake, particularly for the BTX line, has been strong. Academic labs were down historically, but their demand is recovering, and we expect substantial incremental demand with the return of European labs. Overall, despite the hurdles, this year looks very promising with a strong outlook for the remainder of the year.

Paul Knight, Analyst

And lastly, Jim, I have based on guidance, your revenue growth will decelerate from 25% in Q2 due to comps, I'm assuming is one part of that question. Second part is what level of organic growth do you think the company has with these low-growth product lines being pared and you entering a more normal environment?

James Green, CEO

When I look at our expectations, I truly believe we can achieve sustained double-digit revenue growth as we optimize the business. We are on a good trajectory, and while supply chain delays are challenging, they are not permanent. We expect a very good year overall and aim to build upon our backlog. I must exercise caution regarding separate supply chain risks but remain confident about our growth potential.

Operator, Operator

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

Timothy Chiang, Analyst

Jim, could you talk just a little bit about the rollout of new products? Has the supply chain disruption also impacted the launch of new products in the second quarter? I mean, will some of those products be delayed into the second half of the year?

James Green, CEO

I don't think there's any doubt that we'll have some delays depending on which materials we are struggling with. Like Mike mentioned, we've increased our working capital to overbuy especially for materials that we believe won't obsolete. Generally, we view a major portion of our sustained revenue growth being driven by new product introductions. New and exciting products will be vital for our sales growth. Inhalation products, for instance, are experiencing significant demand, which will help our revenue trajectory.

Timothy Chiang, Analyst

And Jim, just one follow-up. You mentioned that academic labs are recovering. Do you expect an increase in demand as we get to the fall school year starting?

James Green, CEO

We do. We anticipate an uptick in demand tied to the new academic year, which often results in renewed budget cycles. The academic labs are getting closer to pre-COVID operating levels, with delays primarily on the supply side. Our proactive order-based strategy puts us in a strong position to capitalize on renewed demand as academic labs fully ramp back up.

Operator, Operator

Your next question comes from the line of Lisa Springer of Singular Research.

Lisa Springer, Analyst

My question is regarding the backlog. You mentioned there's been a pretty significant lift in the backlog for CMT products. I wonder if you expect to work through that entire backlog in the second half of this year.

James Green, CEO

Yes, I don't anticipate that we will clear the entire backlog, but we should be closer to what normal sustained backlog levels should look like by year-end. Although it's challenging and will incur some costs, the incremental general order intake growth trajectory looks solid, which will help in burning down the backlog as we progress through this year.

Lisa Springer, Analyst

Okay. Very good. And regarding new products, are the vast majority of new products in the preclinical line? Or are there some CMT products under development?

James Green, CEO

Most of the new introductions primarily focused on the preclinical line, with significant investments being made there. We’re also targeting the cellular and molecular areas for growth. Some of the growth has been held back due to supply constraints; however, we continue to see strong demand for certain technologies like electroporation and COVID-related products.

Operator, Operator

Your next question comes from the line of Bruce Jackson of The Benchmark Company.

Bruce Jackson, Analyst

You mentioned that you launched 17 new products this year. Can you tell us a little bit about what areas those products were in? And then to the extent you can disclose the ones that you're working on for the next couple of quarters, that would be great.

James Green, CEO

Sure. In general, most of the new product introductions were on the preclinical side. A lot of that was software systems to lock in large companies as customers, which increases their reliance on our consumables. This focus aligns well with the market's demand for innovative cloud capabilities and data analytics. The inhalation products also continue to show great promise, and we're actively developing more exciting new technologies to fulfill that potential. Additionally, we are making strides in the cellular side targeting the increase in cellular testing capabilities.

Michael Rossi, CFO

To follow up on Jim's point, there's a strong focus on the tailwinds in the preclinical area. We are placing a significant emphasis on our cellular side where the future demands lie with electroporation and other cellular advancements. We're capitalizing on market trends, especially in biotech and biopharma.

James Green, CEO

An example is the BTX line, which has played a crucial role in the development of new vaccines, and its utilization is projected to increase as demand for large molecule drugs rises.

Bruce Jackson, Analyst

Okay. That's great.

Michael Rossi, CFO

Just to follow on to Jim's point, there's a lot of opportunity in the preclinical and cellular side, where the tailwinds lead the demand curve in the future, and we will continue to invest there.

James Green, CEO

There was not a lot of investment in R&D in the company for some time, but now new product introductions are the primary driver for expanding the business, and that’s my focus moving forward.

Operator, Operator

There are no further questions at this time.

James Green, CEO

Okay. Well, thank you, everyone, for joining us. This ends today's presentation. We'll hope you'll join us in November for the results of our third fiscal quarter. Thank you very much. Have a great day.

Operator, Operator

This concludes today's conference call. You may now disconnect.