Earnings Call Transcript - HBIO Q4 2020

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Q4 2020 Harvard Bioscience Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. I would now like to turn the conference over to Mr. Dave Sirois. Please, go ahead, sir.

Dave Sirois, Moderator

Thank you, Tiffany, and good morning, everyone. Thank you for joining the Harvard Bioscience fourth 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 Q4 2020 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 estimates 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 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 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, reflect 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 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 will now turn the call over to Jim. Jim, please go ahead.

Jim Green, CEO

Thanks, David. Good morning, everyone. Thank you for joining us today. Let's go straight to the slide deck and review the highlights for the quarter on slide four. Net revenue has returned to pre-COVID levels. The adjusted operating margin improved both year-over-year and sequentially to 19%. Preclinical product revenue increased by 19%, showing strong performance across all markets and product lines. Cellular and Molecular revenue is still down but is recovering as academic labs gradually resume operations. We have successfully refinanced from high-cost debt to commercial bank debt, saving approximately $3 million annually. Looking ahead, we anticipate reported revenue growth of about 8% to 12% over last year, and we expect further improvement in the adjusted operating margin to the mid to upper teens. This year, we will focus on high-value organic growth, marketing, and introducing new products. Now, let’s move to slide five for more details. As expected, we saw improvement with Q4 revenue coming in at $31 million, consistent with last year. The gross margin was 57.2%, an increase of 150 basis points from last year. This quarter we recorded GAAP operating income of $2.8 million, or 8.9% of revenue. Our adjusted operating income was $5.8 million, resulting in an adjusted operating margin of 18.7%. GAAP earnings per share was negative $0.02, while on an adjusted basis, our EPS was $0.08, unchanged from last year. Cash flow from operations was $2.5 million, and we reduced our net debt by $0.5 million during the quarter. Now, let's move to slide six. Starting with the first row of the table, we can examine our Cellular and Molecular product revenues, primarily sold to academic research labs. This segment was down 15%, but there has been sequential improvement from Q3, which was down 21%, and from Q1, which was down 33%. We are witnessing steady growth as these academic labs reopen and return to normal operations. We foresee continued improvement as they restart research and development on new therapies and vaccines. In the second row of the table, our preclinical product revenue increased by 19%, driven by strong performance in all core customer segments, including contract research organizations, pharmaceutical companies, and academic labs, although this growth was slightly offset by a modest decline in government and distribution business. Now, let’s move to slide 7 to look at some major activities from the quarter. Regarding growth drivers, we have realigned sales territories and expanded our coverage, harmonizing our direct sales approach with a separate distribution structure. Notably, we observed rapid growth in our preclinical telemetry and inhalation product lines, particularly within pharma, CROs, and academic labs. On the cost and cash flow side, our cost-cutting initiatives provided savings of $7 million to $8 million compared to previous run rates. We completed our debt refinancing, leading to around $3 million in annual cash savings, and this also provides us with greater flexibility to support our growth plans. Overall, these cost actions and improved margins from our business growth will enable further investments in new product development and upcoming product launches this year. Now, I’ll turn the call over to Mike for a summary of the key financials. Mike?

Mike Rossi, CFO

Thanks, Jim and good morning, everyone. I'll focus my discussion on the full P&L and our liquidity. In Q4, we saw growth in operating margins improved as a result of continued focus on business fundamentals. Gross margin improved year-over-year on strong sales from our higher-margin products and the positive impact of cost reductions. Sequentially, gross margin also benefited from a normal seasonal uptick Q3 to Q4 in revenue. The improvements we are seeing from focused sales execution and product portfolio management including, elimination of a number of low-margin SKUs at the beginning of 2021 has us on track to the 60% gross margin target we set forth in 2019 as academic lab productivity returns to pre-COVID levels later in 2021. Adjusted operating income increased its revenue returned to prior year levels in Q4 and product mix improved. In Q4, we continue to manage costs with discipline maintaining our focus on a lean structure. We recently communicated internally our plan to consolidate certain engineering operations and eliminate two small facilities in Europe. These incremental actions are expected to generate additional annualized cost savings of approximately $2 million and will be completed in the first half of 2021. All told, total cost reductions versus run rate prior to the July 2019 management changes are over $7 million annually with global headcount down over 15% creating a more operationally efficient business. These savings have enabled reinvestments in a much stronger sales and marketing organization and Jim will speak to our expected growth and other investments in the discussion of our 2021 outlook. Finally, operating expenses increased sequentially in Q4 due to variable compensation with higher sales incentives plus bonuses accrued based on achieving our original 2020 second half goals of over 17% adjusted operating margins and refinancing our debt all happening despite COVID-19. The ability to fund these incentives while also delivering improved sales and financials absolutely creates some momentum for 2021. Finally, on debt and cash flow, we continued to reduce net debt in Q4 with improved earnings plus significant improvements in DSO as accounts receivable were down $3 million year-over-year on the same revenue as collection focus improved significantly. Our leverage ratio, our total debt to adjusted EBITDA remained in the low 3s. With the new credit facility closed in December, as Jim noted, cash interest costs at current debt levels will be down about $3 million and overall debt will continue to come down in 2021 with earnings growth and the underlying strong cash flow profile of the business. As importantly with this new facility, we have substantial operating flexibility to execute our growth initiatives. With that I'll turn it back to Jim to discuss our outlook for 2021. Jim?

Jim Green, CEO

Thanks, Mike. Let's move to slide 11 and review the summary. Looking ahead, I want to highlight that most of the structural improvements are behind us now. There will be more work this year for final alignment on certain items, particularly in Europe, but the major tasks have largely been completed. This year, our main focus is on sales growth and effectively driving the business forward through improved sales strategies, ensuring we have the right coverage with a well-organized team that combines direct and distribution sales. We're also planning a significant enhancement in our marketing efforts to better communicate with our customers, as well as launching new products. As a technology company, we aim to introduce remarkable innovations that enhance people's lives, and that will be our central focus this year. You can expect a strong push towards sales growth in 2021, with revenue growth anticipated in the range of 8% to 12% compared to 2020. We believe that the favorable conditions in preclinical activities and solid sales execution will help create a sustainable growth foundation. Academic labs are also on track to recover as they resume operations. We've streamlined our portfolio by eliminating approximately $2 million in low-quality product revenues from our FY 2019 baseline and an additional $3 million from FY 2020. We expect adjusted operating margins in the mid to upper teens and anticipate gross margin expansion to around 60%, driven by higher sales volume and a better mix of high-margin products. Reinvesting in sales, marketing, and product development will support our long-term growth strategy. Thank you. Now I'll hand the call over to the operator to begin the Q&A session. Thank you.

Operator, Operator

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

Paul Knight, Analyst

Hi, guys. Impressive quarter.

Jim Green, CEO

Hi, Paul.

Paul Knight, Analyst

What are your thoughts on the normalized growth rate given your sales goal of 8% to 12%? There was a lot of disruption in 2020, and comparing 2021 to 2020 also shows a lot of variability. How do you see things moving forward after 2021?

Jim Green, CEO

That's a great question, Paul. To provide some perspective, I like to reflect on 2019, which was before COVID and before all the disruptions. We removed nonstrategic products from our portfolio—those that didn't make sense for growth or weren't essential to our business. With those products excluded, I focus on the growth in 2019 and adjust it based on what we are no longer selling, then do the same for 2020. By making these adjustments, it appears we could add about three to five points of growth compared to what it would have looked like if we had restated it based on our current sales going forward. On a normalized basis, we anticipate some level of noise this year since not all labs are back to full operation. While there's the possibility of another downturn or shutdown, we're not expecting it. Overall, we believe our business has the potential to grow at a high single-digit rate. I initially set a target of 6% to 8%, and I still stand by that, with the possibility of improvement. When looking at our business segments, we are confident that the preclinical products will see around double-digit growth. As laboratory equipment usage increases and research work normalizes, we expect growth in that area to fall between 5% to 6%. Additionally, we anticipate significant improvements in our sales efficiency as we enhance our coverage and operate our direct sales team more professionally. Therefore, targeting 6% to 8%, potentially approaching 10% growth on an underlying basis seems like a solid foundation for this business.

Paul Knight, Analyst

And what products in the quarter stood out to you as kind of highlights on their growth rates?

Jim Green, CEO

Certainly, we experienced 19% growth in our preclinical products, which we believe is due to strong and sustainable growth in those areas. A significant factor was the introduction of the inhalation technology, a rapidly growing segment. Additionally, our core business in telemetry, implantables, and base software systems, particularly the Ponemah analytics system, played a key role in driving this growth. We are also seeing increasing activity in single-cell testing and the expansion of newer CRISPR-related technologies. The BTX Electroporation technology is in demand among our customers as well. As we engage with our investors, we will provide a more comprehensive presentation that highlights the details of these products and the trends in our technology. We look forward to sharing this information with you, Paul.

Paul Knight, Analyst

And do you expect any further shrinkage on non-growth businesses in 2021, Jim?

Jim Green, CEO

I don't think so. It was important for us to identify what wasn't making sense in our portfolio. Overall, it's probably around five points that were dragging the business down. These were not in areas expected to grow; instead, they were eroding. It didn't make strategic sense to keep them, but I don't see any specific issues moving forward. I believe we've done a good job evaluating our entire portfolio, our target markets, the sales teams, and our marketing capabilities. We're in good shape overall. However, there may always be factors in the market that could alter our approach. We have limitations on our R&D spending, which means we have to make decisions. We'll focus on areas with the greatest potential for long-term growth, but at this moment, I don't anticipate needing to remove anything specific from the portfolio.

Paul Knight, Analyst

And then lastly, the CRO industry is having another merger. Do you see those two customers as a significant part of your sales exposure and your thoughts on that?

Jim Green, CEO

Historically, this issue tends to be temporary due to a chaotic period where there's uncertainty about leadership and processes. The good news is we have considerable exposure across those companies, so we don't foresee any risk of losing business. There might be some disruption during the transition, but sometimes the acquirer needs to broaden their scope, which can lead to more business for us. The important point is that we have the team ready, with skilled professionals in strategic account management and an effective sales leader who understands how to cultivate these important relationships. The CRO business is a significant component of our anticipated growth, and we expect it to continue. We're seeing positive developments in the US, and Asia is also showing considerable growth in the CRO and pharma sectors. Overall, we anticipate a strong year ahead.

Paul Knight, Analyst

Okay. Thank you.

Jim Green, CEO

Thanks, Paul. Operator, I think we have another question coming in.

Operator, Operator

And pardon me. Up next we have Bruce Jackson with The Benchmark Company. Your line is open.

Bruce Jackson, Analyst

Good morning and thank you for taking the question. So you talked about launching some new products here in 2021. I wanted to know if you would be willing to go into some more details about which areas you're going to be launching in this, and if there's anything that you're particularly excited about?

Jim Green, CEO

Sure. I will tell you that as we get to our roadshows that will be coming up, we're going to go into a lot more detail. But just in general, I think you're – it's fair to see that you're going to see investments in our BTX line, which is electroporation. It's part of the whole CRISPR world. You're going to see expansions there. You're going to see further improvements in some new product lines coming out in the individual cell areas that would be the multicell systems, the MCS systems. We're always coming up with new areas of expanding and expanding our infusion products. And then I'd say across the board for the products for preclinical, telemetry, there'll be some new telemetry technologies that we're working on for implantables. We'll continue to push the inhalation product. And there'll be a lot more effort on really making our best-in-class software platform. This is a product, as this goes into a large site, it really is sticky. And it makes – it's something that our customers get really good at using it. And it's areas where we can add new features fairly quickly to meet their needs. So that's a big part of adding the number of sockets that we had in the business.

Bruce Jackson, Analyst

Okay. Great. And then just generally on capital deployment, do you have like a target debt-to-capital ratio that you're going for? You've been doing a really good job of paying down debt. I'm just wondering what do you think is the optimal mix there for you?

Jim Green, CEO

Well, I think as we get down somewhere around 2x, that's going to be a pretty good number for us. We have a much better facility now. As we get to late in the year, it's likely that we may see some real opportunities to bolt-on some products or technologies that would help us build out the portfolio nicely. So we – that was the whole idea was to get our balance sheet clean. It will be clean this year. You can see how we're cash flowing very well. Much of that cash is to pay down the debt. There likely will be some level of capital expense or capital expenditures this year, just as we really tune the system and move the volumes up and work on improving our yields. But those would be the two main things, nothing big on the horizon right now though.

Bruce Jackson, Analyst

Okay. Great. Nice quarter. Thank you very much for taking my questions.

Jim Green, CEO

Thank you, Bruce.

Operator, Operator

And your next question comes from the line of Tim Chiang with Northland Securities. Please go ahead, sir.

Tim Chiang, Analyst

Hi, Jim.

Jim Green, CEO

Hi, Tim.

Tim Chiang, Analyst

Nice quarter. Could you talk a little bit just about your geographic segmentation? I mean it looks like what, about half your business is coming from North America and the rest comes from outside North America. How do you sort of see the year – the growth rates ex US or ex North America versus North America for this year?

Jim Green, CEO

Well, good question Tim. We – I mean, certainly North America is the bulk of our business. But Asia has been coming on very quickly and surprisingly fast, a tremendous amount of strength in Asia. Europe is a little slower. It's been slow in – for last year. In fact, Europe hasn't been running super well for us for a while. We are working on getting our structure in place and our ability to sell better there. We think in time – so I guess, if I were to say, the main driver with US fastest growth area probably is going to be Asia, because we do see continued – all indications are this is going to be a grower. We see our orders are coming in very solid backlog building. Europe will probably be able to be the last one to really come up. Part of it is Europe still has a lot of countries that are shut down pretty hard. But by the time they're all back to work and labs are open, we will – I expect Europe to turn back into a nice growth component of our business.

Tim Chiang, Analyst

Great. And Jim, maybe just one follow-up. I mean, how do you sort of see research labs reopening as the year progresses? Is it going to be more tied to the 2021 school year, or do you see the research labs opening up more this summer?

Jim Green, CEO

Yes, I would say it's going to be slightly different, likely depending on the region. Asia appears to be operating at full capacity, and we see a very strong outlook there. North America is progressing well, though some areas, particularly the Northeast, which are usually among the strongest, are still operating slowly. We believe they will pick up as we move into summer. I expect that as we approach the fall school year, things will really begin to take off with budgets being reallocated. We still have budget for this year that we anticipate will continue to grow as people return. Europe, however, will take a bit longer to recover. So, to summarize, China is nearly back to normal, North America is rebounding quickly, and Europe will be slower, likely not fully operational until the third or fourth quarter. Specifically for research labs, we anticipate more like the fourth quarter for them. The contract research organizations and pharmaceutical sectors are not facing issues; they are operational, as evidenced by the steady growth we're experiencing. We are also seeing an increase in small pharmaceutical activities emerging from large universities, which we believe will contribute significantly to growth in the academic preclinical space.

Tim Chiang, Analyst

Okay. Great. That’s great commentary. Thanks.

Jim Green, CEO

Thanks, Tim.

Operator, Operator

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

Lisa Springer, Analyst

Good morning. Congratulations on a great quarter.

Jim Green, CEO

Thanks Lisa.

Mike Rossi, CFO

Thank you.

Lisa Springer, Analyst

I wanted to ask, how much of the bump in preclinical revenues in the fourth quarter would you estimate as COVID related?

Jim Green, CEO

The only way to describe it would be that it isn’t exclusively COVID-related since these products are applicable for all vaccines and therapies in drug development. However, the inhalation products seem to have a stronger connection to COVID. We launched this product at an opportune moment, and it's gaining significant traction across various sectors. As academic researchers return, there is a notable interest in inhalation methods. We believe that as this trend continues, more drugs and vaccines will utilize inhalation techniques, enabling measurement of how much substance enters the lungs, how quickly it reaches the bloodstream, and the overall effectiveness of these drugs. Overall, while our general portfolio supports COVID, it’s not limited to it; it's more of a broad application. Nevertheless, the inhalation products do have a specific growth potential tied to COVID and the shift towards these vaccines.

Lisa Springer, Analyst

Okay. Excellent. And in terms of products that were introduced this year and ones you're planning to introduce next year or in 2021, how important are they to your revenue growth? Are they going to be a big contributor of it?

Jim Green, CEO

I believe that with these technologies, some will experience immediate growth, but generally, what we develop today will be utilized one to two years down the line. The product development efforts are more aligned with long-term growth, especially since this business has not seen long-term growth for quite some time. For us to achieve significant underlying organic growth, we need to aim for a range of 6% to 9% or higher. Ideally, we should be targeting double-digit growth or even more. There will always be factors that could hinder growth at times. However, I view our sales activities as providing an immediate boost to achieving sales volume capacity alongside effective marketing materials that solidify distribution arrangements. These factors are more likely to drive immediate growth. On the other hand, new product introductions typically have medium to long-term impacts. I've always believed in collaborating with key strategic customers and sharing the risk of launching innovative products that may not yet have widespread usage. We anticipate seeing progress in this area with newer technologies, which might not be immediately adopted but will eventually find their way into leading institutions and, subsequently, more general use.

Lisa Springer, Analyst

Okay. Thanks, Jim. And my last question concerns gross margin improvement. How much of that improvement came from product mix? And is there still room to even make the product mix better?

Jim Green, CEO

I don't have specific breakdowns, but there is definitely an improvement in our mix. Some products in our portfolio didn't quite fit and didn't help in driving higher-margin consumables, so we decided to remove them, either by selling them off or reallocating them. This change in our product offerings and mix is significant. We still maintain good pricing power, but we always need to be cautious about that. Ultimately, it also ties back to volume; a better mix combined with increased volume will naturally enhance our gross margin. Our initial target was to reach 60%, and I believe that is achievable this year. We will need to monitor how this unfolds, considering the trade-offs between price and volume and potential new areas we may enter. There are indeed opportunities we will explore for this portfolio.

Lisa Springer, Analyst

Okay. Great. Well thanks very much, Jim.

Jim Green, CEO

Great. Thank you, Lisa.

Operator, Operator

At this time, I'm currently showing no further questions in queue. I will now hand the conference back over to Mr. Jim Green.

Jim Green, CEO

All right. Well thank you everyone for joining us in today's presentation. I'll ask that you join us in May for our first quarter fiscal 2021. And have a great day, and thank you so much for your support. Thank you.

Operator, Operator

Ladies and gentlemen, thank you for participating. This concludes today's conference call. You may now disconnect.