Hamilton Thorne Ltd.

Thank you, and good morning, and welcome everybody to Hamilton Thorne's Second Quarter 2023 Earnings Conference Call. I would like to introduce Francesco Fragasso, who our CFO, will also be with me on the call.

Our call today will have the following format. First, I'll provide a summary of operational and financial results for the quarter and 6 months ended June 30, with a focus on our sales, markets and operational performance.

Francesco will follow with a more detailed discussion of our financial results in the periods as well as a review of our financial position and liquidity. I'll then return for a few minutes to provide some information on our outlook for the balance and we'll open the line up for questions.

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

I am pleased to report that our strong start to 2023 continued when we posted sales of $16.4 million and adjusted EBITDA of $2.8 million versus sales of $14.2 million, adjusted EBITDA $2.4 million in the prior year for this most recent quarter. This represents 15% sales growth for the quarter and 17% sales growth for the year-to-date.

Our organic growth, which eliminates the effect of both acquisitions and exchange rates, was up 5% for the quarter. This comes following an exceptionally strong 15% growth -- organic growth in Q1.

Therefore, we're about 10% for the year, which is essentially unplanned. As we have discussed in prior calls, due to stabilizing exchange rates, currency fluctuations and translating financial statements in our presentation currency of U.S.

dollars had a minimal impact this quarter, but did have an impact on the year-to-date reducing reported revenues by approximately 2% to 3%. 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 continue from time to time, as mentioned in our last call, the far more normalized, leading to fewer delays in production and shipping and even some cost reductions in some commodity products, which had increased prices significantly over the past year. Let me summarize the highlights of our performance.

As I mentioned, sales increased 15% year-over-year to $16.4 million for the quarter. Sales for the 6 months increased 17% to $33.1 million.

Sales increased 14% for the quarter and 19% for the 6-month period on a constant currency basis. Gross profit increased 21% to $8.5 million for the quarter and 22% and to $17 million for the 6-month period, essentially gross profit growth is outpacing sales growth.

Adjusted EBITDA increased 16% to $2.8 million for the quarter increased 15% to $5.7 million for the 6-month period. As mentioned, organic growth was 5% for the quarter and 10% on plan, 10% for the 6-month period.

Cash generated from operations was $1.8 billion for the quarter, leaving us with total cash on hand at June 30 of just over $16 million. Looking a little more deeply into the sales performance.

Equipment sales growth was in the single digits for the quarter and year-to-date, reflecting some delays, which we mentioned on our last call on orders until Q3 while consumables, software and services grew over 20% in both periods. Sales dropped across all the geographic areas that we serve with our Asia Pacific region showing the strongest growth in the quarter.

as sales in China returned to more normal levels following the relaxation of COVID restrictions early in the year, and our Australian business picked up significantly as well. Our strategy to increase sales of higher-margin proprietary equipment and software services and branded consumables combined with increased direct sales of products yielded gross profit margin increases to 52% for the quarter and 51.3% for the 6 months.

Ending after 6 months ended in June, versus 49.8%, 49.3% in the prior periods. So approximately a 200 basis point improvement over those prior periods.

I'll now turn the call over to Francesco to provide more detailed results on the numbers.

Thank you, David. Good morning, everyone.

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

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

Operating expenses in 2023 we had $8.9 million for the quarter and $16.9 million for the first 6 months, an increase of 36% for both period versus the same period of 2022. Expense increase was mainly due to the additional Microptic expenses for the full period of 2023.

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 a pre-COVID level for the sales and marketing activities is also a factor for expenses increase in 2023 compared to the same period of last year.

Overall increases in operating expenses were in line with our expectations. Net interest expense in Q2 2023 increased by $255,000 to $358,000 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 outstanding principal on term loans.

In the second quarter, income tax expense decreased to $271,000 tax credit, from $226,000 tax expense in Q2 2022. This was primarily due to the reductions in income before taxes and to deferred income tax recovery of $456,000 and in Q2 2023 compared to a deferred income tax expense of $20,000 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 loss for the second quarter was $439,000 compared to a net income of $275,000 in the prior year quarter.

Net loss for the 6-month period was $362,000 versus a net income of $830,000 in the prior year period. This is primarily due to the increased operating and interest expenses I previously mentioned, partially offset by a decrease in income taxes.

Adjusted EBITDA in which we consider an important metric of our financial performance, increased by 16% to $2.8 million for the quarter and increased 15% to $5.7 million for the 6 months period. This was mainly due to revenue gross profit growth, offset by planned increase in operating expenses.

As a reminder, adjusted EBITDA is a non-IFRS measure. Please see the reconciliation of adjusted EBITDA to net income for the quarter and the 6 months in our MD&A report filed today on both SEDAR and on our website.

Turning now to the company's cash flow and balance sheet. The company's cash balance at the end of June 2023 was $16.4 million, compared to $16.7 million at the end of 2022, a decrease of $320,000.

The decrease in cash balances was primarily due to investment in working capital to support expected growth, investment in product development and in expanding our manufacturing capacity and payment related to M&A activities. The company generated cash from operations of $1.7 million for the first 6 months of 2023 after having invested in inventories, increased accounts receivable and reduced accounts payable.

In the first 6 months of 2023, cash used in investing activity was $1.6 million. Of this, approximately $800,000 were related to the normal expenditure in PP&E and for ongoing investments in capitalizing tangible of product development activities and approximately $800,000 were related to these all of improvement, equipment and furniture related in expansion of manufacturing capacity in some of our operating business [units].

Cash used in financing activities was $386,000 for the 6 months of 2023. Those were mainly related to payment of scheduled term loan and lease obligations, net of $1.6 million proceed from a working capital line of credit.

Note payables and term loans outstanding totaled $14.4 million at the end of June 2023, equal to about 1.3x the last 12 months adjusted EBITDA. At the end of Q2 2023, the company continued to have a strong liquidity position of $26.4 million, including $16.4 million in available cash and $10 million in unused borrowing capacity, including $8 million line of credit for M&A, which was approved in May 2023.

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 company outlook.

David?

Thank you, Francesco. Looking forward into the balance of 2023, we continue to feel our company is in a great position as demand for our products and services remain strong based on the positive trends in our field.

For example, the World Health Organization's latest research revealed an increase in the prevalence of infertility from 1 in 8 families less than 10 years ago to 1 of their every 6 families of reproductive age today. While there are a number of factors driving this, the societal trend of deferring family formation until later in life when conception obviously becomes biologically more difficult place a significant role.

In addition, improved affordability and whether due to overall income growth, particularly in developing countries, added governmental benefits our private health insurance is also a trend that will continue to drive growth. As an example of this trend, adding to the benefits they already offer in the U.S.

and Canada, just last week, Amazon announced a partnership with benefits provider to offer family building support to its employees in the other 50 countries -- in over 50 countries in which they operate. We have seen the direct effect of this increase in demand in the more recurring revenue parts of our business, including sales and consumables, software and services.

As we expected, first half capital equipment sales growth moderated as several of our distributors who built up inventory during periods of supply shortages work through those positions, which dampen our organic growth in Q2. We reiterate that the underlying demand for our products remains strong and given our current order backlog and pipeline, we expect to continue to have organic sales growth in the 10% range in the second half of the year.

As previously mentioned, exchange rate headwinds have stabilized and as this trend continues, we expect foreign exchange fluctuations to actually provide some tailwinds in the second half of the year. Regarding our M&A activities, we continue to have an extensive pipeline and actively are working on multiple acquisition opportunities.

As Francesco mentioned, with total liquidity of over $26 million from our significant cash on hand, unused lines of credit for the debt capacity, we are well positioned to continue to execute on our acquisition program. In summary, we feel extremely positive about our market position and our confidence in our team's ability to execute on our long-term strategy.

of sales growth and EBITDA expansion by investing in our own organic growth while building scale, which enhancing our product offering and expanding our geographic and direct sales footprint through acquisitions. We will now open the line up for questions.

Operator, please assemble the queue and let me know when we're ready for our first question.

David and Francesco. First question, when you acquire businesses and geographies where you haven't had sales previously, you transitioned to direct sales from distributors over time.

I'm wondering how far you proceeded the longest path in the new markets you've entered over the past few years?

All right. Great.

So yes, I think you've articulated both our strategy and the fact that it does, in fact, take some time to accomplish that. And we also do value even though ultimately, our long-term plan is to move as much as we can to direct sales.

We do value distribution partners in particular markets where, for some reason, whether it's relationship or capability that might, in fact, have our segment, they might, in fact, have additional capabilities. So overall, I would say those plans are on -- well on track.

Our most mature major acquisition now again over 5 years ago that we completed this, which is the acquisition of Gynemed in Germany, which has a direct sales team servicing the entire Dutch region, Germany, Austria, Switzerland. I would say the conversion of direct -- our direct sales from our sales from distribution to direct is essentially complete.

We don't really work with any continued distributors in that market in our core markets of IVF. Now we may, in fact, work with distributors in the more tangential research and particularly in the animal market where there's a really strong specialty.

In other markets, it's a work in process. I think we've made great, even though it's not technically an acquisition, we did change our strategy by beginning to offer direct sales in the U.S.

in late 2000-teens. So I would say here as well, we're very far along in converting direct sales, and this is sort of the difference in a way from newly acquired entities or even some of the -- we've held for a while sales from distribution to direct.

There's always -- as I mentioned, there are always exceptions, but generally speaking, people will come to us to buy direct. Going along the time line, I would say the U.K.

is well along as well. And then our most recent acquisitions, which we completed in '21 and '22, which are in IVFTech in the Nordic region and Microptic in the Spain -- region in Spain are still work in process.

I would say, in Nordics, making good progress and essentially have a full sales team well trained. And again, it's just nothing happens overnight.

And Spain, I would guess -- I would say we're still kind of relatively in the early days. So maybe a little more granularity than you wanted.

But clearly, the goal is continuing. Again, I don't want to cherry pick 1 particular piece of data, both because it just happens to be very good.

And it -- and I don't want to find myself every quarter having to report on this. But in Q2 of this year, we actually had our highest percentage of sales from direct sales moving from our normal kind of ish 60% direct versus distribution into the high -- mid- to high 60s.

So very, very strong. Now that may be just 1 quarter, and I don't want to get in a strong paint a picture about a trend.

But that's one of the things that helped translate directly into improved margins.

And actually, my next question is about the margins. Do you think there's still room to move the gross margin up going forward, gradually putting aside quarter-to-quarter differences in product mix.

Is there still room to move the gross margin up?

So again, over -- I don't want to hit myself to a period, over the longer term, absolutely. The key drivers in our short-term margins, you picked up completely this product mix, we made just in 1 quarter, have 1 or another somewhat higher, somewhat lower margin.

But our key drivers for longer-term margin growth are increasing our direct sales percentage of sales that we sell direct versus through distribution because then we effectively keep the entire margin that we normally paid to a distributor. And I'll come back in a second and talk about how that impacts EBITDA and more increasing sales of products that we make ourselves or have made up for us by contract manufacturers versus third-party distribution -- in third-party distribution, as you can imagine, we're earning a distributor's margin, which is well below our -- what has been our historical past few years blended margin of 50%, whereas if we buy the product and own it, we're certainly going to give you much closer to, and in many cases, depending on the product category, far in excess of 15%.

In terms of impact on EBITDA, and that maybe ties back into your first question, in the short term, investing in greater direct sales actually has a dampening effect on EBITDA. And I think that's pretty obvious here.

You're hiring a direct sales team. They're not necessarily fully deployed at that point.

But over the longer term, as we can continue to increase the effectiveness of that force, that sales force, get more performance out of them, we can accomplish what I described, which is more and more direct sales. And while we may still have to add some direct sales personnel over time, we'll get essentially positive leverage from that sales team.

Nice to see the double-digit growth in both sales and EBITDA. Just on the equipment sales that got pushed into Q3, are you able to quantify that amount?

Yes. So I would say the quick answer is no.

We're not going to glorify that amount, but it's really a question of over the course, and I discuss this a little more in our last call, but I'll repeat it. Over the course of the first half of the year, it became obvious to us -- maybe we should have picked up on this earlier, that certain of our -- a couple of our large stocking distributors, 3 of our large stocking distributors purchased significant amounts of stock in really -- whether it's late 2021 or through 2022 as we were experiencing supply chain issues in order to protect themselves against those supply chain problems as our supply chain issues have diminished along with others in our category, they begin to work through those inventories.

So it's not like we had a big order teed up at the end of Q2 and for whatever reason, fell into Q3. That being said, we clearly are seeing those -- I don't want to be fundings are opening, but we're clearly seeing that backlog and inventory being worked through.

We received an order I have to actually check whether it was in the end of Q2 or early in Q3. From one of those stocking distributors for essentially a significant order for that will continue to draw down through the balance of the year.

Enough to make that product category back to really significant sales. And we're working on the others with various timings associated with them.

So it's not like a discrete event. It's more of a trend.

But as I mentioned, I feel confident that we'll return to kind of so we should have at least double-digit growth on those products in the second half of the year.

Okay. That's helpful.

And then one of Hamilton's larger peers, Vitrolife reported growth that missed estimates for the calendar Q2. And then spoke to a pandemic cycle that was returning to more normalized levels.

This appears to be contrary to Hamilton's outlook, including the 10% organic growth in the back half of the year. Are you able just to speak to that dynamic why Hamilton continues to achieve what appears to be higher growth than some of the other peers in the industry?

Yes. So first of all, I don't want to spend my call either commenting too much on or certainly discouraging another company in our field because they're a strong business, and we should never just don't think that's the right thing to do.

But clearly, Vitrolife has some discrete issues that we don't have. They have a purely robust but not -- can cover every base in the laboratory, but a feeling robust lines consumables.

And I think you noticed in the quarter the consumables business actually performed pretty well. Their capital equipment business is very narrow, really only 2-point solutions versus our capital equipment business, which is very broad.

And I think it's just classic portfolio of there when you have 2 products, you can have ups and downs that impact those. And that's one of the reasons that we've adopted our strategy of being able to provide a broad, broad range of products.

Because as I mentioned, we had our ups and downs in the quarter, particularly with 1 category, 1 set of orders that didn't come in, but had now have. And if that were our only product, we would have probably shown a fairly -- what I would call a disappointing quarter.

But again, it's balanced by the other broad product rate that we have, and I'm not thrilled with single-digit growth, but in one category, when you can understand it and explain it. I think that's fine.

And then, again, not to get too hung up on Vitrolife. They clearly did an acquisition of a genetics business, the genomics business a year ago that they are working through.

That business has declined, not clear to me whether it's because that business is actually declining for them for the specialty players or it's got to do with their execution. But I think those are kind of secular issues in a way relating to Vitrolife, not so much the trends in our field.

That being said, I think we have consistently outperformed the overall growth in our field for some of the reasons that we've discussed. We're continuing to invest and expand in direct sales, which is an opportunity to grow.

We're getting better synergies from the resale of our and cross-selling of our products across our multiple sales territories. And those all contribute to driving above-average growth.

That's helpful context. If I could just ask 1 follow-up question maybe in a different way.

is the higher interest rate environment impacting the consumer at all as far as the demand for IVF services, are you seeing any early indication of this?

So the quick answer is no, but that would be somewhat delayed, as you can imagine, and also maybe somewhat skewed from a geography perspective. in the sense that well over 50% of our business is based in Europe, where there's very strong social support.

Basically governmental support and subsidies for IVF. It doesn't mean people don't pay anything out of pocket, but the out-of-pocket payments are substantially limited.

People are, let's say, doing getting second mortgages on their house to be able to afford for IVF or doing home equity lines of credit. In the U.S., that's a different story.

It's still largely private pay, though, as I mentioned in the call, that trend is moving both states adding additional fertility benefits again slowly over time. And large employers, Walmart last year, added a fertility benefit.

Amazon has always had one in the U.S., but now it's adding it worldwide, and we're seeing more and more fertility benefit momentum. So again, I think the fact that somebody else is paying for it or largely contributing to it, that reduces the sensitivity, I guess, to interest rates.

And again, there's a fairly big lag in this. So quick answer is, we haven't seen it but I wouldn't -- I want to be completely [indiscernible] about it and say it won't have an impact over time.

David, just a question here on you guys' overall strategy. I know over the last few years here, you guys have been really pursuing market share gains over focusing on free cash flow growth.

Has this changed at all now given where the business is currently at with the current scale of the business? And I guess, will the near-term focus continue to be on grabbing more share here?

Or is there now more of an opportunity to start pulling on that free cash flow lever?

Yes. So let me respond briefly at sort of the high level on the strategy and how that has evolved over time that I'll let Francesco give a little more color on how we think about free cash flow and the emphasis that we have on that.

So overall, I would say it is still relatively early innings in this long-term game that we're playing. I hopefully haven't mixed too many sports metaphors in that.

We are still a meaningful player. We're one of the largest players, certainly top 10, if not top of 4 or 5 in our field.

But still highly, highly fragmented. So there's lots of opportunity for us to continue to gain market share, whether it's through our even though it can be seen on one hand, it's actually fairly aggressive by far the most aggressive acquisition approach in our field.

And through investing in all the things that drive organic growth. So I would say we are going to continue with our balanced approach to not necessarily maximizing sales growth and market share gains versus, let's say, what we could do if we dial back investments in those things and be able to improve EBITDA, which ultimately obviously translates to free cash flow.

We're going to take a balanced approach. I think there is opportunity even in that balance to improve and it's somewhat dependent on gross profit margins continuing to stabilize at the levels they are at or the other levels they're at.

and us being able to manage expenses. But I think this EBITDA -- potential EBITDA expansion, while we can continue to have that emphasis on growth.

But we're clearly not -- I think it's too early for us to sort of dial back on the growth side and say, that we should become -- what I think we can be, at some point, particularly when we get greater scale, which is much more of an EBITDA engine with much higher operating leverage. Francesco, if you don't mind maybe giving some comments on our perspective on free cash flow, how we measure it and how we're thinking about that, that would be very helpful.

Yes. We continue to focus on profitability and cash flow as well.

Of course, just to pick up from what that has just said, we have to invest in supporting future growth. And that creates some timing effect from a cash flow and EBITDA point of view.

So how we measure our, let's say, free cash flow conversion is trying to eliminate what is not recurring in a normal course of business. I mentioned, for -- first of all, on the expense side, we detailed in our MD&A, what are the recurring or one-off item that brings us to the adjusted EBITDA.

But there is also a capital expenditure component to it. And I mentioned before that this year out of 1.6 million of capitalized expenditure, half of it was related to unusual activity, which was a major expansion in our production capacity.

Of course, all of that is reported in our financials. So how we measure our clear cash flow conversion is trying to exclude those onetime expansion cost.

So that our, let's say, adjusted free cash flow conversion is defined as adjusted EBITDA less cash taxes, less interest expenses less lease payment, less normal level of capitalized expenditure tangible and intangible. And if you do that, you will see that -- for the last 12 months, our conversion rate of adjusted EBITDA to free cash flow was slightly above 50%.

I don't know if I answered your question fully.

Just on the commentary around M&A. Obviously, the balance sheet remains in solid shape here.

Any indication of the timing when we could see some additional M&A? And has there been any change in target multiples?

Yes. Thank you.

So I appreciate the question, but as you probably know, we've been pretty tied pretty careful in the past and we'll continue in the future about not signaling anything on the M&A front until we're ready to actually disclose the transaction. So on the timing question, I think I'm just going to again mixing my sport metaphors and I'm just going to have to punt on that one.

In terms of multiples, as I somewhat mentioned, we are by clearly the most active acquirer of mature -- again, still sometimes relatively small, but mature businesses. And we've been pretty influential in the way in setting the multiples.

We don't view that they've changed materially certainly over the last couple of years, maybe over the last 8 years since we started this, and there was no acquisition activity and it was a little bit easier to get lower multiples. But now the -- I think we're seeing some good solid businesses with the kinds of dynamics that we want with sales, sales growth, earnings momentum, some proprietary products.

And again, that can vary sales multiples EBITDA multiples in the 6% to 8% range. We could clearly see lower multiples, if there's lack of some of those things that we talked about, they may be less desirable to us are higher multiples.

Again, I said this in the past maybe somewhat glibly, but show me a business with 90% -- like a Software-as-a-Service business with 90% gross profit margins, 90% recurring revenue and 50% EBITDA, 30% to 40% and 15% growth, and that will deserve a greater multiple. So we try to be to the multiples that we're seeing.

We -- in our relatively small private company world where there's not a lot of private equity retrading and not a lot of private equity competition. we haven't really seen -- except in our attitude about things and our free cash flow -- our DCF models, a direct translation of higher interest rates into lower multiples, which I think you will definitely see for larger transactions and particularly private equity led transactions that depend on high leverage multiples to make sense.

And lastly, just in terms of recent transactions, there have been a couple of recent transactions in our field. One was beyond startup at a nonprofitable business with nice products, but not necessarily fitting our model.

So EBITDA margin EBITDA multiples we are not relevant, but multiples of sales was sort of like 3x multiple of sales. So maybe you can argue that, but had some pretty good technology and pretty good technology protections.

And then a recent transaction of a product in our field a little bit more on the pharma side, actually bought by pharmaceutical company that traded about at a very, very nice financial performance, traded about 9x EBITDA. So again, I think we're seeing Yes.

We're seeing reasonable EBITDA multiples continue in our reasonable valuations continue in our field.

Okay. Good to hear.

And if I could just slip in 1 more question, just around the AI strategy. I know with the Microptic, there was a level of of AI within that business.

Just how that’s going as potentially deploying that technology in a broader scenario across the business.

So we believe AI is – I’m not sure where it is on the Gartner hype curve, where things get hyped and then you into the value of field expectations. But we would never really been high on high tech things and therefore, maybe a little lower, lower in the lower expectations than you tend to meet them.

But we view AI in general and specifically on the proxy product is not some stand-alone game changing, they’re going to change the world kind of product, but a valuable adjunct to the products that we sell that are going to make our products work better and therefore, more competitive and more desirable in the laboratory. Overall, as some cumulative effect, maybe AI kind of like capital age, that live a more impactful effect.

But it’s really, in our view, is how do you make it actually useful by doing something better. So that being our strategy, it’s worked out very nicely.

We continue to see growth in those products. We continue to get strong product acceptance and accolades for the performance of our product, and we don’t believe those will continue over time, again, I’m not going to talk specifics here, we intend to incorporate other elements of AI into other.

Either on parts of our product line or potentially even parts of our operation to improve performance or efficiencies. But we’re not – we haven’t liked ourselves as an AI company.

And I think we’re much more focused on delivering something that, as I said, really has value and improved performance and as being a little more just to send a number of us words that people are excited about.

Yes. I just want to go back to the large stocking distributors who are working down their inventories.

I'm wondering, is there any way to quantify how far through the work down of the inventories they are in a combined sense or if not quantify, at least are they early in the process, midway through the process or almost on the process?

So I would say clearly almost done. So I'm glad you gave me that as opposed to an approach to quantifying in very difficult and quantify something that would become important.

But in terms of in terms of how you describe it, I would say we're nearly done. One of our major stocking distributors has placed large orders and we're expecting from 1 other -- and again, this is not like under-stocking, really just a handful, and we're working through with the others.

So I would say we're nearing the end of that curve. And where we're going to face COVID style supply chain issues in the past, but probably the lesson learned for us to keep a better handle on our inventory levels at our distributors.

Okay. Well, thank you very much.

I'd like to reiterate my thanks to everybody on this call for the good insightful questions, but more, I would say, as or more importantly, thanks to our employees for the great work they do. and the dedication they've shown to our business to customers, to our business partners around the world, our shareholders with support they've shown our company, which has allowed us to be cloud participants in our field where we play our part in large or small in helping millions of families have babies and fulfill their agrees.

So thank you very much for participating, and hopefully, we'll see you all in October.