Earnings Call Transcript - HBIO Q3 2021

Operator, Operator

Good day, and thank you for being here. Welcome to the Q3 2021 Harvard Bioscience, Inc. Earnings Conference Call. I will now turn the conference over to your speaker today, Dave Sirois. Please proceed.

David Sirois, Speaker

Thank you, Elissa, and good morning, everyone. Thank you for joining the Harvard Bioscience Third 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 Q3 2021 HBIO Quarterly Earnings Presentation and is located in the Investor Overview, Events & 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, 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 in today's presentation. These two documents as well as a replay of this call can be found on our website under Investor Overview, 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'll now turn the call over to Jim. Jim, please go ahead.

James Green, Chairman, President and CEO

Thanks, Dave, and good morning, everybody. Let's go ahead and move to Slide 4 of the presentation and look at the highlights for the quarter. Revenue was up 23% over Q3 '20 and up 8% over pre-COVID Q3 '19. Our pre-clinical revenue was up 28% on strong global demand across all key product lines. Cellular and Molecular Technology revenue was up 19%, continuing its recovery as labs reopen. Again, this quarter, we saw strong order growth and backlog growth. However, we continue to have fulfillment delays from global supply chain disruptions and issues associated with it. Adjusted operating margin came in at 13%, that's versus 15% in Q3 '20 and versus 12% in Q3 '19. Adjusted gross margins came in at 56%, impacted by over 3 percentage points from higher COGS. Higher COGS continued from Q2 due to global freight costs, material inflation, plus direct labor inefficiencies. Q3 '20 was a difficult comparison due to the dramatic one-time cost reductions we took last year to handle the COVID headwinds. Let's move on to Slide 5. Looking at the details of the quarter, as expected, we continued to see strong revenue growth. Q3 coming in at $29.7 million, that's up 23% over last year. Gross margin on a GAAP basis came in at 55%, down 110 basis points from last year on higher costs in the global supply chain. This quarter had GAAP operating income of $0.5 million, that's 1.8% of revenue. On an adjusted basis, our adjusted operating income was $3.9 million, translating to an adjusted operating margin of 13.3% of revenue. GAAP earnings per share was 0, up from a negative $0.03 last year. Our adjusted earnings per share was $0.06, up from $0.04 last year. Cash flow from operations was negative $700,000 and our debt increased by $2.7 million as we prepare for a strong Q4, with our debt ratio measured at 2.5x EBITDA. Moving on to Slide 6. Starting with the first row of the table, our cellular and molecular technology revenue, primarily from academic research labs, was up 19% from last year with orders and backlog significantly up. We experienced significant revenue shipment delays caused by global supply chain disruptions in several of our materials. We're seeing fulfillment improving with added hiring, though this does create direct labor inefficiencies until new staff get trained and staffing levels get optimized. Planned pruning or removal of lower-value product revenues impacted reported revenue by approximately $1 million in the quarter. European labs are still slow, although we do see demand improving going forward in the remainder of this year. Looking to the second row of the table, our pre-clinical product revenue was up 28%, driven by strong order growth across our product lines for our core customer segments of CROs, pharma, and academic labs globally. Asia Pacific saw very strong growth, and EMEA was also up double digits. Sales growth in the Americas was also positive with strong pharma demand, though U.S. government continues to trend lower. Overall, pre-clinical is now well above pre-COVID levels, up 27% from Q3 '19. Overall reported revenue grew 23% over last year and 8% over the same quarter in pre-COVID 2019. Moving to Slide 7, we'll look at major activities in the quarter starting with the post-COVID operating environment. Global supply chain, labor sourcing, and retention challenges continue, similar to what we saw in Q2. Operations are stabilizing and improving as we continue hiring, but we are running high use of labor in order to fill in the gaps. Pricing actions have been initiated to help combat material inflation over the upcoming quarters. For our European sales organization, we've completed the designs and aligned the structure similar to what we've done in North America. The realignment of territories, like in North America, will add trading areas and expand the reach. The pre-clinical sales team will also now start to represent the behavioral products, same as we did last year in North America. It proved very successful in driving growth. Now I'll turn the call over to Mike for a quick look at the key financials. Mike?

Michael Rossi, CFO

Thanks, Jim, and good morning, everyone. We're very pleased as the leadership team to see continued momentum and top-line growth and are on track to achieve our stated 2021 goal of driving long-term profitable growth. As we usually do, 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 internally manage the business. Reconciliations are available in the appendix of this presentation to GAAP results. Consistent with Q2 reporting, I will make certain references against 2019 due to the unique comparability issues with 2020 due to COVID-19. Our performance continues to reflect a fundamentally better business with adjusted operating margins of 13%, exceeding Q3 2019 of 12%, despite the roughly 300 basis point negative impact of supply chain and labor costs noted. Looking back to Q3 '20, the decline in margin from 15% includes the COGS impact as well as unique one-time cost measures Jim noted to preserve cash flow during the height of COVID. Our operating expenses in Q3 '21 include investments to return sales, marketing, and R&D spend to pre-COVID levels, with a vastly improved set of capabilities to leverage as well as higher variable compensation accruals. In terms of bottom-line performance and long-term value creation, delivering superior gross margin levels remains in focus despite the impact of supply chain trends noted. The adjusted gross margin was 56%, in line with historical performance as headwinds and COGS were largely offset by improved product mix. Within the COGS increases, the majority of the impact is due to vendor cost increases starting in the first half of this year. We also experienced higher manufacturing labor costs due to both market forces on wages and inefficiencies in certain facilities where headcount reductions were made during the downturn in 2020, requiring rehiring and retraining in 2021. We've seen stabilization in these operations, which will position us for efficiency gains and leverage in 2022. Our growth initiatives focus on selling high-end niche products through more efficient direct sales channels as well as the pruning of low-margin, low-growth SKUs. All of these actions have led to a better mix improving our gross margin overall to keep us neutral against where we were with the COGS headwinds. On cash flow and debt, our leverage ratio, or total debt to adjusted EBITDA, is 2.5x, relatively consistent from the prior quarter, but down from 3.2x leverage at the end of 2020 due to higher adjusted earnings. Net debt of $40.9 million is essentially flat to the end of 2020 due to inventory growth. We have increased inventory levels in response to strong order growth and to ensure stable order fulfillment during this period of supply chain volatility. The increases in inventory levels have helped stabilize operations as noted as we exit Q3. Interest expense is down significantly over the prior year due to the December 2020 refinancing. In terms of other uses of cash, capital expenditures in Q3 were $500,000, which included IT and manufacturing site investments to support growth and scalability in our core manufacturing centers. Additionally, we incurred approximately $900,000 of transformation costs, which are excluded from adjusted earnings, given these are run-rate investments. Q3 costs included final expenses from European site consolidations completed in mid-2021. Costs associated with organizational upgrades as well as project costs related to improvements in our core business systems and operations. I noted on our Q2 call that we would invest roughly $1 million in the second half of 2021 to accelerate improvements in our core operations; a portion of Q3 spend is related to these efforts. The primary output of these efforts short term will include global data warehouse and data visualization tool sets, which is already enabling our sales effectiveness efforts and has recently been extended to benefit our operations and supply chain analytics. These analytical capabilities in place are fundamentally different today and another source of momentum as we enter 2022, supporting growth and margin expansion. With that, I'll turn it back to Jim to discuss the full year outlook. Jim?

James Green, Chairman, President and CEO

Thanks, Mike. So looking forward, if we move to Slide 11, our primary goal is sales growth driven by improved sales effectiveness, marketing, and new product introductions. Over the next few quarters, we'll be addressing COGS issues resulting from the global supply chain disruptions, specifically honing in on freight optimization, material costs, and labor inefficiencies, while tuning our overhead costs in various places such as Europe. As for our outlook for the year, we're increasing our revenue outlook and maintaining our operating margin targets, despite the extended supply chain-related cost increases. We now expect revenue growth on a reported basis to improve to approximately 15% to 17% growth versus last year. We see strong order growth and a robust backlog, driving sustained growth in our pre-clinical product revenue. Academic labs are expected to continue recovering with strong order growth and a strong backlog. Portfolio rationalization pruned low-quality revenue of approximately $1 million from our FY '19 baseline and another $4 million from FY '20. Risks do remain on the impact of the global supply chain for certain materials, though we are managing it closely and brute forcing manufacturing and supply to best meet our demand. As for adjusted operating margin, we are maintaining expected improvement to the mid-teens range. In spite of these global supply chain issues, we expect continued gross margin expansion on increased volume and improved margin mix, somewhat offset by higher supply chain costs. With that, I want to thank you. And now I'll turn over the call to the operator and open the line for Q&A. Thanks.

Operator, Operator

Your first question comes from Lisa Springer from Singular Research.

Lisa Springer, Analyst

I wanted to ask you. So you've mentioned that the supply chain issues have been a factor in terms of cost for labor and freight materials. Have you encountered any issues in terms of sourcing components for some of your higher tech products? Or are they generally available just at a higher price?

James Green, Chairman, President and CEO

This happens off and on, especially in high-tech development. But yes, we've seen a mix of items being very hard to get. A number of suppliers either shut down our operation or had to restart. In many cases, we've had to go out to the market and try to find parts that we need, which means we sometimes have to pay a fairly high price for something that's available, but we need someone else to source it. So in those cases, the prices on individual components can go up dramatically. But in time, that all settles out. Sometimes we have to redesign part of the circuit to keep things moving along with a different product set of chips. But definitely, that's probably the largest problem we have in terms of supply chain disruption with the supply needed from our suppliers. We've done things like reach out and evaluated basically the full suite of electronic chips that we use across the portfolio. I've asked them to ensure that we have a year's supply available. And that's why you're seeing increases in inventory. If there are things that are just real hard to find, we end up having to pay a higher purchase price for it. But yes, that's where the disruption is really hitting us with the supply of parts to our manufacturing sites.

Lisa Springer, Analyst

Okay. And Jim, could you comment on the revenue contribution from newer products, say, products introduced in the past 12 months, and how the gross margins compare to the average product?

James Green, Chairman, President and CEO

Yes. That's a great question, Lisa. An example would be the inhalation product that was introduced about 1.5 years ago. That's become a significant contributor to revenue growth in the business. That's just one to mention. We've introduced 17 new products or enhanced existing products over the last year. Those are driving new growth in the business, incremental growth. In some cases, it replaces existing growth with a product that's better and will be more sustained. New product development is a key portion of our growth plan and will continue to be.

Lisa Springer, Analyst

Okay. Jim, for my last question, you mentioned that reductions in U.S. government contracts were a factor affecting pre-clinical. Could you provide more details on that and what you anticipate for the fourth quarter?

James Green, Chairman, President and CEO

Sure, sure. When COVID hit, we saw the government redirect a lot of their investment from areas historically funded. For instance, we were exposed to what they were doing to test for biohazards, so some of our products used for that were significantly impacted. Those labs either slowed down or shut down, redirecting focus to COVID, which caused a measurable drop in our revenue. The government’s focus on bioweapons transitioned to accelerating COVID-related investments. We expect some of that revenue to return over time, but it's going to take a while for everything to come back. At this point, we've been able to replace any of that lost revenue plus some with areas that are core to our business.

Operator, Operator

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

James Green, Chairman, President and CEO

Paul, you might be muted. I don't know if you're speaking.

Paul Knight, Analyst

Could you go over your CRO exposure, your academic exposure level, and the growth you are seeing in those two markets, Jim?

James Green, Chairman, President and CEO

Sure. In the quarter, the CRO business is very significant and lumpy. So in this quarter, timing caused us to have a little lower than what we would typically see on the CRO side. However, at the same time, pharma grew strongly, leading to substantial global growth in the pharma side with our pre-clinical products. The academic research side is solid and growing across our lines. So both the CMT lines and much of our growth seen on the pre-clinical side is also directed to academic research sites, especially where they're doing more animal model work and working with start-ups of new pharma or biotech companies.

Paul Knight, Analyst

And Jim, you, I think in the presentation, had shown growth year-over-year compared to 2019 pre-COVID of about 8%. Would this be the normalized growth rate of Harvard Bioscience, or are you guiding to what your long-term goal really is?

James Green, Chairman, President and CEO

Yes, our goal is to reach the 10% area, which is our target. It's challenging to analyze all the factors from 2018 to 2021. If we consider that we removed about $5 million in revenue from 2021 that would have existed in 2019, the underlying growth we see is actually in the double digits. Our original targets were in the 6% to 8% range, which we believe is achievable. Our current target is more in the 8% to 12% range. Reaching 10% is an important milestone for us over the long term.

Paul Knight, Analyst

Yes. And then I know the earlier question was around products as well. But specifically, electroporation, were there any product highlights besides the inhalation product line?

James Green, Chairman, President and CEO

Yes. Good question. Certainly, we are investing. There are natural tailwinds with the electroporation technology. We're introducing some new technologies and products along that phase, which we expect to be one of the fastest-growing parts of our business. There are also areas that aren’t being prioritized, and we are considering whether to turn those into good growth drivers or to trim them as there are currently around $4 million to $6 million that need to be pruned over the next year. However, a couple of aspects will be analyzed to ensure they contribute positively to our growth vector. The timeline for this evolution will take some time. Ideally, we want sustained double-digit growth, but also improving margins.

Operator, Operator

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

Timothy Chiang, Analyst

So you talked a little bit about how European labs are improving sequentially. I think that's still about one-third of your total revenues. Could you talk a little bit about how you see Europe coming back in the fourth quarter and into 2022?

James Green, Chairman, President and CEO

Yes, there are clear strengths that we see with much more order activity, quoting, and other engagements taking place in European labs as they regained momentum. Looking to Q4 and Q1 next year, we expect European labs to return to their usual operations. The good news is our core business outside of Europe has compensated for this slowdown, contributing positively. We aim to fine-tune our product offerings to ensure strong positioning in these areas.

Timothy Chiang, Analyst

Okay, good. And maybe just one follow-up, which is how much ability do you have to increase prices on your CMT and pre-clinical product lines? Obviously, costs are increasing, but are you able to adjust prices, especially in the fourth quarter and beyond?

James Green, Chairman, President and CEO

Yes, that is a challenge. It depends on customer segments and the product. For direct sales, we have strong pricing power, as it’s a highly technical and sticky sale. However, distribution sales may take longer and may not have the same pricing leverage. We've rolled out new pricing that will begin to take hold late in Q4 and into Q1, leading to better pricing for new orders. In some areas, pricing has increased by 15% to 20%. On average, we aim to achieve a 2% to 3% increase in ASP, which would significantly help mitigate inflationary costs. While parts of COGS will need efficiency improvements, inflation on certain parts is likely persistent. We’re focused on achieving a 2-point gross margin increase through pricing adjustments.

Operator, Operator

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

Bruce Jackson, Analyst

So you launched 17 new products this year. You've already discussed some of the ongoing developments in inhalation products. Are you still working on the new cellular molecular testing products for CRISPR? Is the supply chain situation affecting your new product cadence for 2022?

James Green, Chairman, President and CEO

Yes. We're developing a series of products across the portfolio, with new individual cell testing and back cell testing developments. This area has high barriers and pricing potential. We're also focused on products fitting within our pre-clinical package, and behavioral-type products are being bundled more with technologies we sell into pharma and CRO markets. This alignment supports growth across primary segments. We are working on innovations across our offerings, ensuring we keep our momentum going. Unlike larger companies who spread efforts thin, we are nimble and can focus on critical areas. We're set to announce more products at our January global sales meeting.

Operator, Operator

Your next question comes from Ailon Grushkin from Nano-Cap Growth.

Ailon Grushkin, Analyst

I have more of a comment because you're doing a great job turning the company around, growing again, making money, everything looks good. But I feel like from a stock perspective that you're lacking; there’s no investor relations, no intra-quarter press releases. I believe there’s more you can do. If I saw your company for the first time, I would think it should be worth $800 million to $1 billion in this market. You need to do more on the Investor Relations front. That's my comment. You were supposed to try and start doing something, and I haven't seen anything yet.

James Green, Chairman, President and CEO

Well, thanks for your thoughts. I certainly hope that the more our message gets out there, the more it will help the business. We are planning some roadshows, along with our sell-side partners, to engage more directly with customers. Thank you for your input.

Ailon Grushkin, Analyst

But also with seventeen new product introductions this year, could you put out some press releases to keep the name alive intra-quarter? Just so we know you're active and something's happening.

James Green, Chairman, President and CEO

Great. Okay. Appreciate your thoughts, and thank you so much.

Operator, Operator

There are no further questions at this time. I would like to hand the conference back to our speakers. Thank you.

James Green, Chairman, President and CEO

Great. Thank you for joining us, and I look forward to listening in on our Q4 call in February. Thanks. Take care, everybody.

Operator, Operator

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