Hamilton Thorne Ltd.

Thank you very much. Good morning and welcome to the Hamilton Thorne Limited first quarter 2023 earnings conference call.

I'd like to reintroduce -- I introduce myself, David Wolf, President and CEO of Hamilton Thorne. On the call with me today is our CFO, Francesco Fragasso.

This morning's call will have the following format. First, I'll provide a summary of operational and financial results for the quarter ended in March, with a focus on our sales, markets and operational performance, Francesco will follow with a more detailed discussion of our financial results for the periods as well as a review of our financial position and liquidity.

I will then return for a few minutes to provide some information on our outlook for the balance of 2023 and we will then open up the line for questions. Since we had our year-end conference call just 45 days ago, we'll keep our remarks relatively brief.

I'd also like to remind participants that we do not provide financial guidance, so I'd ask you to limit your questions to either historical periods or general trends in the business. I'll begin with our sales results.

I am delighted to report that our 2023 has gone off to an exceptionally strong start. We had a record first quarter, posting sales of $16.7 million and adjusted EBITDA of $2.8 million versus $14.1 million and adjusted EBITDA of $2.5 million in the prior year.

This represents 19% sales growth on a reported basis and 24% sales growth on a constant currency basis. Our organic growth which eliminates the effects of both acquisitions and exchange rates, was up 15% for the quarter, reflecting continued market share gains.

As we have discussed in our prior calls, currency fluctuations and translating financial statements into our presentation currency of U.S. dollars continues to have a substantial, though somewhat lessened impact this quarter, reducing reported results by approximately 5%.

Fortunately, these headwinds are easing and I'll discuss this a little bit more in our outlook section. I'm also happy to report that while supply chain issues do continue from time to time, they are more normalized, leading to fewer delays in production and shipping.

Let me again give you some of the highlights from our performance. First quarter sales increased 19% to 16.7%, 24% on a constant currency basis.

EBITDA increased 13% to $2.8 million, 18% on a constant currency basis. Organic sales up 15% for the quarter.

Gross profit margin was 15.6% which is up 185 basis points versus the prior year. Net income did decrease to $77,000 for the quarter which Francesco will address in his remarks.

In Q1, we had strong demand across all of our product categories, with equipment sales up 20% and consumables, software and services up 18%. As I mentioned, I was particularly pleased to see our gross profit margins continue to improve, up over 180% versus -- 180 basis points versus the prior year.

This improvement is largely due to economies of scale, product mix, increased direct sales of our own products as well as the addition of the higher margin-cost whole quarter. I'll now turn the call over to Francesco to provide a more detailed discussion on the numbers.

Thank you, David. Good morning, everyone.

I'm Francesco Fragasso, CFO at Hamilton Thorne. I will briefly highlight the first quarter 2023 financial results.

David has already provided an update on sales and gross profit. So I'll focus on the other elements of the income statement as well as the cash flow and liquidity of the company.

Operating expenses increased 36% to $8 million for the quarter. Expenses increased were mainly due to the addition of Microptic expenses for the full quarter, expenses related to M&A, increased costs associated with investment in sales and other personnel to support growth and increased share-based compensation.

The return to the pre-COVID level for sales and marketing activities is also a factor for expenses increased in Q1 2023 compared to the same period of last year. Overall, increases in operating expenses were in line with our expectations.

Net interest expenses in Q1 2023 increased by $140,000 to $258,000, due to additional term debt incurred to finance Microptic acquisition in November 2022 and higher use of a bank line of credit to fund working capital, partially offset by the repayment of the outstanding principal on term loans. In the quarter, income tax expense decreased to $104,000 from $296,000 in Q1 2023, due primarily to the reductions in income before taxes and to the deferred income tax recovery of $122,000 in Q1 2023 compared to a deferred income tax expense of $44,000 in the same period of 2022.

The change relates to the temporary differences between income tax value and the carrying value of assets and liabilities. Net income for the quarter was $77,000 compared to $556,000 in the prior year quarter.

This is primarily due to the increased operating and interest expenses I previously mentioned about that, partially offset by a decrease in income taxes. Adjusted EBITDA increased by 13% to $2.8 million for the quarter, primarily due to revenue and gross profit growth, offset by planned increase in operating expenses.

In Q1, has continued the negative impact of foreign currency exchange headwinds, although to a lesser degree than in prior quarters. As a reminder, adjusted EBITDA is a non-IFRS measure.

Please see the reconciliation of adjusted EBITDA to net income for the quarter in our MD&A report we filed today on both SEDAR and on our website. Turning now to the company cash flow and balance sheet.

The company's cash balance at the end of March 2023 was $15.9 million compared to $16.7 million at the end of 2022, a decrease of about $800,000. The decrease in cash balance was primarily due to investment in working capital to support expected growth, the investment in product development and large payments to third parties related to the Microptic acquisition.

Those payments were accrued at the time of the acquisition and reflected in the acquisition price. The company used approximately $140,000 cash from operations for the quarter, primarily related to timing of increased accounts receivable and reduced accounts payable at the quarter end.

Inventories were slightly up at the beginning -- as they begin to unwind the significant investment we made during 2022, while continuing to support our growth. In the first 3 months of 2023, cash used in investing activity was $800,000 which included the purchase of equipment and the normal expenditure of ongoing investment in capitalizing tangible of product development activities.

Cash generated in financing activities in Q1 '23 was $120,000, $1 million proceeds were related to the use of working capital line of credit, net of payments on term loans and lease obligations. Note payables and term loans outstanding totaled $14.6 million at the end of March 2023, equal to about 1.4x, the 12 trailing month adjusted EBITDA.

At the end of 2022, the company continues to have a strong liquidity position of $26.4 million, including $15.9 million in available cash and $10.5 million in unused borrowing capacity which include $8 million line of credit for M&A approved in May and disclosed in the subsequent events section of the financials. This liquidity availability makes us well positioned to support our acquisition program and finance the expected growth.

I will now turn the call back over to David to comment on the Hamilton Thorne outlook. David?

Yes. Thank you, Francesco.

Looking forward into the balance of 2023, we feel that our company is in a great position. We continue to expect solid sales performance based on the positive trends in our field and as demand and growth have returned to pre-pandemic levels in nearly every market that we serve.

This will drive continued growth in the more recurring revenue parts of our business, including the sales of consumables, software and services. While we may see capital equipment sales growth moderate as several of our distributors who built up inventories during periods of supply shortage work through these positions, we note that underlying demand remains very strong.

As previously reported, our mentioned exchange rate headwinds had a 4% to 5% impact on reported results in Q1, a significant improvement over the fourth quarter. We expect foreign exchange to be relatively neutral in Q2.

And if this trend continues, it should provide some tailwinds in the second half of the year. Regarding our M&A activities, we have an extensive pipeline and continue to actively work on multiple acquisition opportunities.

As Francesco mentioned, with significant cash on hand and our unused lines of credit as well as further debt capacity, we are well positioned to continue to execute on our acquisition program. In summary, despite various day-to-day issues that we face, we feel extremely positive about our market position, confident in our team's ability to execute on our strategy and very -- as I said, very optimistic about the future.

We'll now open the lines for questions. Operator, please present the first call from the queue.

In the release, you mentioned a robust M&A pipeline in -- obviously, there was the transaction that was completed just recently. What's your view on M&A in the near term?

Any update on the multiples being asked? And then also the type of current assets that you're pursuing, if it's similar to Hamilton's business or perhaps in adjacent areas?

Sure. So I think there's a few questions.

Maybe I'll answer them in reverse order. We are clearly focused today on continuing our -- as we have done in the past to buy -- to do complete acquisitions that are in our current target markets which again is providing Assisted Reproductive Technologies and related products.

We look at and would be open to doing things in adjacencies, or I would say, show me -- possibly even outside that. But we certainly are putting proactive efforts into those.

We feel given where we are in relatively early innings of the consolidation of a highly, highly fragmented supplier market that there's still ample opportunity for us to stay within our market. I will note that the transactions tend to be relatively small, given the nature of the available targets.

And we've been, I would say, reasonably successful in both identifying, acquiring and integrating these in the smaller end, potentially sub-$5 million and maybe up to $10 million and a little bit higher revenue companies. So I would say, generally speaking, that's what you should continue to expect to see from us.

In terms of the actual pipeline, as you know, we're very cautious on getting ahead of ourselves and maybe accidentally signaling something to the market. So I'll just repeat our formal like comments that our pipeline is robust and we are actively working on a number of opportunities.

So hopefully, that was at least reasonably responsive.

Yes. And then on the outlook, there's commentary of continues strong underlying demand.

And obviously, quite a good organic growth number in the current quarter. But I was just hoping to square that with just in your opening remarks, there was a comment on moderation of equipment sales, if that's going to be impacting any of the organic growth in the near term?

Yes, I think in the near term, we might see some modest impact on the organic growth in the capital equipment side of our business. As I tried to indicate, perhaps in shorthand in remarks, as people following us know our consumables and recurring revenue parts of our business which are consumables, software and services parts, tend to be more or less linearly aligned to increase activity at the clinical level increases demand.

So we expect those to continue to grow strongly for the short, mid and long term. Consumer -- capital equipment by nature tends to be a little bit lumpy, both in terms of the cost of it at the ultimate demand level.

And then it's become clear to us as we've been surveying some of our distributors that distributors, I guess, as rational actors built their inventories a little bit during times when we had periods of supply shortage. So I think, in some cases, that's not an issue at all and they're buying as they always have in other cases, working through some inventories.

Again, I think that would be a relatively short term kind of transitory effect and the kind of thing you often see when you're dealing with large-scale capital equipment.

Maybe just in a summary of view. Would there be any material difference because it seems like there's a lot of moving parts there.

Just with the Q1 organic growth or the general range that Hamilton typically achieves which I believe is 10% to 15%, would that be impacted at all?

So the Q1 organic growth was 15%, including 20% -- wasn't pure organic for 20% growth in capital equipment. We would expect to see, as I said, potentially capital equipment moderate growth a little bit.

But we still would certainly view, again, in any particular quarter, anything can happen but we feel very confident that we can continue to be over 10% organic growth on at least on a continual basis for a solid period of time.

The first one is you said that supply chains are near normalized at this point. Does that mean that they have further to go to get back to normal?

And could your cost of goods get lower as you get back to full normal?

Yes. When I -- thank you for the question.

So when I think about supply chain issues, a -- general -- when I was in those remarks, generally, I was talking more about product scarcity or occasional inability to obtain whether it's finished goods that are resold or components that are built into products that we have. And that has pretty much normalized.

I will note that they're all in our field, there -- are seem to be and historically have always been some level of supply chain issues where we sell relatively differentiated products with a lot of components that it's insulated us in some ways from supply chain issues because they're so different. But on the other hand, relatively small volumes tend to have big impacts.

The -- on pricing, I would say pricing is -- has a little bit of -- hang. We might see some pricing improvements on certain commodities.

But on the other hand, though, we're not like overly stressed about it, obviously -- there's obviously a general inflationary environment that we're in. So we're certainly not expecting any significant pricing improvements over the next -- over the balance of this year or should I say cost improvements over the balance of this year -- prices to us.

Okay. Second question relates to Justin's last question.

You said you expect to continue 10%-plus organic growth. Is that at the end user level?

Or is that the level of Hamilton Thorne?

So we measure it at the level of Hamilton Thorne. That's very clearly a measure of our -- and it's spelled out in our MD&A in terms of definitions but I'll paraphrase.

We look at our sales on a constant currency basis pro forma as if we've done an acquisition, as if we own that business for the entire prior period. So it's at the Hamilton Thorne level.

Just one more for me. In terms of the geographical split, I think it looks like your mix of EMEA revenue has increased.

Americas seems to decrease. Can you talk about what are different geographies that you sell into and why this mix shift has occurred?

Yes. So our -- at a very high level, our geographic mix is not, I would say, changing dramatically.

The introduction or actions, the acquisition of Microptic did increase our European revenues somewhat. And we saw a little bit of that in Q4.

But in general, I think we're seeing strong growth across Europe, where we are very, very strongly positioned in consumables, strong growth in Asia and U.S. where we focus more on capital equipment.

So I'm not sure I'm seeing the kind of significant geographic split differences from year-to-year.

Okay, that's fair. And then actually one more, if I may.

You did mention that the decline in net income was partially due to significant M&A-related expenses. Could you talk to what these M&A expenses were?

Yes. So I'll just give you kind of a high level, then maybe I'll ask Francesco to drill a little bit deeper to the extent maybe -- don't want to get into this huge detail.

But we spent about $500,000 in M&A expense in the quarter. Some of that is related to continued M&A activities that we are doing.

So we can't really comment on those very much. And then as Francesco mentioned, there was a significant level of payment related to the Microptic acquisition that was dealt within the purchase price but incurred in Q1.

So I don't know if you want to have anything you want to add, Francesco?

Yes. No.

I think, Tania, you can see the difference between Q1 2022, $20,000 and Q1 2023, $508,000. So Q1 2022 was particularly low.

What do we include in that categories are all the activity related to building the pipeline of opportunity, do preliminary analysis, sometimes even due diligence or preliminary due diligence, tax planning type of service, not necessarily they translate in an actual acquisition. As I said, they are mainly or often related to building the pipeline.

But one clarification is that when we actually -- consumer acquisition, we don't capitalize any related expenses to that acquisition that the IFRS will allow us to do. We didn't do it so far.

So that describes a little bit the nature of those type of costs.

Congratulations on the quarter. I wonder if you could shed some light on seasonality in this industry.

And I recognize that working across so many geographies, this might be a challenging question to, ask given the different payer types. But I wonder if you could give a brief overview on seasonality, particularly relating to the first quarter?

Yes. So that's actually a great question, perhaps I should have touched upon in our remarks.

So generally speaking, there's not enormous seasonality, except Q4 tends to be higher in part because people particularly our capital equipment, the normal things people are spending through their budgets. People tend to get focused on calendar years to accomplish certain kinds of activities.

So historically, we've seen Q4 as being our highest quarter. And then Q1, I believe, in every quarter I've ever looked at, tends to be lower than Q4 in the prior quarter.

This year is an exception to that. This year is the first quarter but at least in the past 5 or 6 years or 7 years, where we had a Q1 that was over our Q4.

So, I'm clear whether there's going to be some big change in our seasonality or other events that led to that but that's an interesting thing. As you can imagine, summers tend to be a little bit lighter, particularly in Europe.

And then there's some seasonal effect of holidays but primarily in Q4 but that tends to get overwhelmed by the customer part of it. So long story short, I think the -- historically, Q4 has been much higher and then -- the other quarters show a normal consistent growth, maybe we're entering a new chapter who knows.

We'll know better in a year

That's right. All right.

David. That's helpful.

And now I wonder if you can describe the size of your direct sales team today and some geographies in which Hamilton Thorne seeks to grow its direct sales team during the next year?

Yes. So we have direct sales teams across most of the major markets in Europe across the U.S.

and potential new territories and say one comment which I'll add at the end where we are adding people to address market opportunities, either because the market is growing or we're underrepresented in those markets. I think you'll see more investment in Asia Pac where we've just added people in Australia and Singapore, as I mentioned.

We did just begin to sell into Spain on a direct basis and that's by virtue of the Microptic acquisition. Right now, we have a solid team there.

We may add there as we generate additional success. And then in other markets, I think you'll see somewhat incremental additions.

I should add, maybe I should have started with this, that in general, we tend to prefer to enter new markets in -- by acquisition of a -- ideally a solid product-based company that also has a direct sales team in that market so that we start with solid team experienced with a level of revenues and profitability kind of baked in versus the alternative which we have done but it's a longer road. The alternative being to just start in greenfields, hire several people that you need to have reasonable critical mass in any given country and then work hard to grow a business, get those people ultimately to breakeven.

And then as you start to show significant profitability and people get at the level of their capacity start to add people.

Apologies, I tried to remove my question from the queue.

All right. Well, thank you very -- sorry, I would like to reiterate my thanks to all of our employees for the great work they're doing and the dedication they show to our business and to our customers and to our business partners and shareholders, the support they show our company.

We'll be back for a conference call in -- ideally, in the second week -- first or second week of August and look forward to having continued discussions then. In the meantime, we encourage you to go to our website.

Again, our investor-oriented website is www.hamiltonthorne.ltd for more information on our company, products, initiatives and further investor information. With that, I'll sign off and thank you very much.