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Questions Remain About HBIO s Capital Equipment Biz Despite Steps to Clarify

Faced with a stagnant stock price that has hovered in the $3 to $5 range over the past year and investors whose patience may be "wearing a bit thin," Harvard Bioscience held a conference call last week to provide a more complete picture of its two major business segments and how it intends to grow them.

The company, which is recovering from a hit to sales in its capital equipment business in 2004 that led to a restructuring in its Genomic Solutions unit in the second quarter of that year, decided that it would now split out financial information for the two major components of the company: the capital equipment business, which has been volatile and unpredictable, and its apparatus and instrumentation business, which has provided more consistent results.

But questions still remain whether the restructuring will produce results that satisfy investors and customers seeking some predictability and consistency from the firm. Some investors also have questioned whether Harvard Bio should even continue selling capital equipment.

"It has been the volatility of the capital equipment business segment that has given us the biggest surprises in our financial results," said Harvard Bio CEO Chane Graziano during the conference call. "Therefore, we feel at this time we need to provide separate financial information on these two segments, so our investors can better understand these dynamics."

The good news for Harvard Bio customers and investors is that the unpredictable capital equipment business accounts for roughly 30 percent of the business, compared with 70 percent for the relatively steady apparatus and instrumentation business.

The bad news is that the capital equipment business is still a significant chunk of the firm's revenue — and its difficulties have led some to question whether a company that is as relatively small as Harvard Bio should be competing in such a volatile space, where lulls in capital spending can have a significant impact on the firm's overall financial results and stock price.

Turning Around the
Capital Equipment Segment

Two of the main parts within Harvard Bio's capital equipment business that struggled last year are the COPAS and Genomic Solutions product lines. According to the firm, the COPAS flow cytometer, MEAS automated microscope, Genomic Solutions' microarray products, and Cartesian nanoliter dispensers account for 70 percent of the company's capital equipment revenues.

Sales for the COPAS line were disappointing in the first quarter of 2005, according to President David Green, because of a delay in capital spending by pharmaceutical clients.

He said the firm had expected sales of the COPAS line to be driven by high-throughput screening of small model organisms within pharma and biotech firms. But, "that application has not really taken off," Green said. "Where the application has been reasonably successful, but [still] not near our expectations, is in the academic world, where there [are] still a large number of worm, fly, and fish labs using the COPAS product line."

After a poor first-quarter 2004 for Genomic Solutions, Harvard Bio restructured the unit the following quarter. As part of that restructuring, Harvard Bio slashed costs by $3.6 million a year by shuttering one of the unit's three factories, closing its sales office in Japan, laying off 36 employees, and splitting the Genomic Solutions unit in two.

In a conference call last month, following its 2005 first-quarter results, Green said the company was pleased with the progress made at Genomic Solutions since the restructuring (see BioCommerce Week 5/12/2005).

Last week, he said, "We believe we've turned the corner with this business, and look forward to getting that back to good operating margins. The first quarter of '05 showed order growth over the first quarter of '04."

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Revenue for the capital equipment segment increased significantly from $2.8 million in 2001 to $35.2 million in 2003, primarily driven by the acquisitions of Union Biometrica — which makes the COPAS and MEAS product lines — and Genomic Solutions (see chart). But as sales fell off in 2004, operating margin for the segment suffered, going from a contribution of $2.8 million in 2003 to a loss of $1.7 million in 2004.

Harvard Bio officials are optimistic, however, that the capital equipment segment will return to profitability in the fourth quarter of this year. They said revenue growth would come from breakthrough applications, such as stem-cell and islet-transplantation applications and automated tissue research for the COPAS line, and DNA-based diagnostics for the Genomic Solutions microarray business.

"I think we can expect good quarters and bad quarters going forward [for the capital equipment business]," said Green. But "the potential long-term growth could be significant."

Given the recent struggles of the COPAS and Genomic Solutions businesses, Green said new acquisitions would not be a significant source of growth for the capital equipment segment.

However, with the firm aiming to grow operating income in the 15 to 20 percent range going forward for the apparatus and instrumentation business, Green said tuck-in acquisitions are expected to be a key driver of revenue growth for that segment.

He said that revenue growth for that segment has been strong since 1997, driven by both organic growth and acquisitions. Organic growth for this unit would come from expanding distribution channels and product offerings, according to Green. Among its current offerings are syringe pumps, ventilators, amino acid analyzers, and electroporation instruments.

Does the Capital Equipment Market
Make Sense for Harvard Bio?

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With the recent struggles of its capital equipment business and a stock price that has been in the doldrums for more than a year (see graph), Harvard Bio officials were asked during last week's conference call if the firm should even be playing in that market.

Matthew Arens, vice president and senior research analyst with Kopp Investment Advisors — a firm that holds nearly 3 million shares of Harvard Bio stock — said "patience is wearing a bit thin" for long-term investors in the firm. He said that while splitting out numbers for the two businesses is helpful, questions remain about whether a company the size of Harvard Bio should continue selling capital equipment.

Graziano responded that, following the restructuring, the firm does not view the capital equipment segment as "being a drag on the business as it has been over the last year. Under the structure we have it today I think it can give us a significant upside potential with very low downside risk."

He added, "The important message to take away is the restructuring. We've strengthened the sales and marketing side, [and we've] consolidated infrastructure, and combined manufacturing sites for Genomic Solutions."

Green pointed to the capital equipment segment's gross margins as a justification for staying in that market. "If you look at the gross margins we make in the capital equipment business, it is roughly in the 55-percent gross-margin range, and I think there is upside from there because of the restructuring," he said. "And if you look at the kinds of companies that make very good operating margins in capital equipment," they're typically in the 55-percent to 60-percent gross-margin range.

When asked about a potential exit strategy for the capital equipment business and whether there was a sense of urgency to sell a business that is not performing, Graziano said that discussion had "gone on at the board for the last two or three quarters."

He added, "The fact of the matter is we do have a sense of urgency to do what we have to do to create maximum shareholder value. We believe the presentation we presented today is the best option. If there is a better option going forward, clearly as investors we would seek that out."

Green and Graziano purchased Harvard Bio in 1996 and took the firm public in 2000. They still hold nearly a fifth of the company's outstanding shares themselves.

— Edward Winnick ([email protected])

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