Q2 2023 Harvard Bioscience Inc Earnings Call
Participants
David Sirois; Director of Corporate Accounting & SEC Reporting; Harvard Bioscience, Inc.
James W. Green; President, CEO & Chairman; Harvard Bioscience, Inc.
Jennifer Cote; CFO & Treasurer; Harvard Bioscience, Inc.
Bruce David Jackson; Senior Equity Analyst; The Benchmark Company, LLC, Research Division
Paul Richard Knight; MD & Senior Analyst; KeyBanc Capital Markets Inc., Research Division
Unidentified Analyst
Presentation
Operator
Thank you for standing by, and welcome to Harvard Bioscience's Second Quarter 2023 Earnings Call.
(Operator Instructions)
I would now like to hand the call over to your host, David Sirois, Director of SEC Reporting. Please go ahead.
David Sirois
Thank you, Latif, and good morning, everyone. Thank you for joining the Harvard Bioscience Second Quarter 2023 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 Q2 2023, HBIO quarterly earnings presentation and is located in the Investor Overview, Events and Presentations section of our website.
Leading the call today will be Jim Green, Chairman of the Board, President and Chief Executive Officer; and Jennifer Cote, 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, 2022, 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 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 and today's presentation.
These 2 documents as well as a replay of this call can be found on our website under Investor Overview, Events and 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.
James W. Green
Thank you, David, and hello, everybody. I'm pleased to see Q2 supporting our strong start to 2023. Now let's go to Slide 3 of the presentation to look at the highlights for the quarter. Revenue in the quarter was $28.8 million, down modestly from last year on an as-reported basis. The year-over-year comparison includes a net effect of $1.6 million of discontinued products compared to the prior year period. I see this as a pretty smooth transition to our much improved and simplified portfolio as we are already seeing new product introductions from last year gaining traction. Gross margin improved to $16.7 million or 58% of revenue, which includes the typical puts and takes of product mix and volume, along with the impact of some financial process updates that Jen will describe for you further in a few minutes.
Adjusted operating profit improved to $3.6 million or 12.4% of revenue, up 2 percentage points from last year. Adjusted EBITDA measured $3.9 million or 13.6% of revenue, also up 2 percentage points from prior year. GAAP earnings per share was a $0.02 loss. This includes quite a bit of noncash related accounting complexity that Jen will discuss with you in a few minutes. Adjusted EPS measured $0.04 per share, down from $0.05 in last year. Cash flow from operations was $3.6 million versus a negative $200,000 last year. And in the appendix, you'll find the bridge from GAAP measurements to adjusted our non-GAAP measurements.
Now let's move to Slide 4, take a look at revenue in the quarter by product family. This slide shows Q2 '23 revenue adjusted to reflect Q2 '22s exchange rates. Starting with the first row of the table, our cellular and molecular technology revenue was down 12% as reported and down 3.6% when adjusted for currency and the impact of discontinued products. We had strong growth in Asia Pacific, EMEA was roughly flat to last year, and we saw slowness in the Americas.
We continue to rotate out of low-margin products primarily sold through distribution. And our revenue includes a net revenue -- a net reduction of $1.6 million from discontinued products compared to last year, which were predominantly cellular and molecular products.
Next, our preclinical product revenue was up 10% as reported and up 11.5% when adjusted for currency and discontinued products. Asia had strong growth, driven mostly by inhalation and respiratory products, EMEA had very strong growth across the entire preclinical product portfolio. Americas was down modestly on slower sales in inhalation and respiratory products. All said, we were down 1.5% as reported and up 3.9% when adjusted for currency and discontinued products.
Let's move to Slide 5. I can tell you about some of our exciting new products and new product introductions this year. Before I start, let me explain a little bit about this slide. Over the past 3 years, we've optimized our product offerings to target key technologies in the drug and therapy development continuum. Our product strategy is to continue to introduce new technologies and applications in leading academic research labs and at the same time, adapt these technologies for further penetration into the larger industrial applications of our customers in pharma, CRO and biotech. Following this strategy, we've introduced 2 more product technologies this year designed to support our growth opportunities in advanced cell-based testing. We expect initial demand in both academic labs and BioPharma discovery and expanding opportunity in preclinical regulatory testing for toxicology and safety pharmacology.
First, I'd like to highlight our new mesh array organoid MEA platform. Building on our relationship our leadership position in single well high-density multi-electrode arrays that are used today in academic research and discovery, we're introducing the first organoid centric MEAs that measure signals from inside the organoid. This technology is initially targeted to neuro and cardiac applications such as activation, metabolism and toxicology. We expect organoid level testing to enable applications that historically were performed using full organ systems or animal models.
We've next introduced our second-generation multi-well MEA platform. This multi-well platform is designed for higher volume MAA applications, giving us a vehicle to penetrate various industrial applications. This is another proof point where we leverage our leading position in high-density MEA and academic research and discovery and expand to industrial CRO and BioPharma applications. We plan for advanced applications such as organized to transition from the single to the multi-well and enable penetration of higher-volume industrial usage in CROs and BioPharma. This is an exciting time for Harvard Bioscience, and we continue to introduce leadership leading technologies in research and discovery and drive new opportunities in industrial applications with our CRO and BioPharma customers, where we already have a well-established relationship and a great reputation.
Now I'll turn the call over to Jennifer, our CFO, for a look at the key financials. Jennifer?
Jennifer Cote
Thank you very much, Jim. Let's jump into our Q2 and year-to-date financial results in greater detail. And if you can please refer to Slide 7, as a reminder, we include discussions about our adjusted and non-GAAP financial results, which aligns with information we use to internally manage the business. Our slide deck includes the reconciliation between adjusted results and the corresponding GAAP measures on Slide 12. Jim has already taken you through our revenue performance, so a few more details on our gross margin, adjusted EBITDA, EPS and cash flow.
Our FY '23 Q2 gross margin grew to 58% compared to 57% in Q2 FY '22. During Q2 of 2023, we aligned our global inventory costing process, which had a slightly unfavorable impact to gross margin. We aligned to a common time frame globally to amortize our capitalized inventory variances. This change happened in parallel with our annual standard cost roll this quarter, excuse me.
As described by Jim, our gross margins will fluctuate from period-to-period based on the revenue mix, volume inflation, et cetera, among other factors. But year-to-date, our gross margins of 59.6% are up 3 -- 4 percentage points compared to last year and our outlook considers the impact of any process changes this quarter. Now let's discuss operating expenses and adjusted EBITDA. Adjusted EBITDA during Q2 was $3.9 million compared to $3.4 million last year.
Our operating expenses are reduced since last Q2, primarily as a result of the restructuring and cost reduction activities we executed during the second half of 2022. Offsetting these reductions are increases in employee compensation related to annual merit increases as well as the fact that we've reserved for expected bonus payouts for 2023, which were not included last year.
Now let's take a few minutes to discuss the year-over-year variation in our GAAP EPS that Jim alluded to earlier. A large part of the variation is due to accounting charges related to the [satire] litigation, which was resolved in Q2 last year. Although this matter is behind us, the impact of these charges is reflected in our GAAP EPS. Our adjusted EPS excludes these impacts. On a GAAP basis, our Q2 2022 results included the reversal of litigation-related reserves originally recorded the prior quarter Q1 2022 of approximately $4.9 million. This favorably impacted last year's GAAP EPS. Also at that time, we received stock from Biostage as part of the settlement. Beginning in Q2 of this year, we adjusted the value of these shares to reflect mark-to-market accounting. This resulted in an unfavorable charge of approximately $1.6 million in this Q2. Taken together, these 2 litigation-related items create an unfavorable year-over-year swing in our GAAP EPS of $0.10 per share. We do not believe that these items reflect the fundamentals of our ongoing business. We do expect to see the impact of mark-to-market adjustments in future EPS numbers so long as these shares remain on our balance sheet.
Again, these items are excluded from adjusted EPS, and these mark-to-market adjustments are noncash and do not impact our liquidity. The year-over-year changes in our GAAP EPS also includes the favorable impact of approximately $0.02 per share as we wound down last year's restructuring activities. The above items are excluded in our adjusted diluted EPS.
Further detail on the above items is available in our 10-Q and the non-GAAP reconciliation tables included in our press release and in the appendix to this presentation. Now I'm excited to switch gears to highlight on cash flow and liquidity. We had solid cash flow from operations of $3.6 million this quarter, representing our fourth consecutive quarter of operating cash flows. Our year-to-date pay down against our credit facility is $5.4 million.
We expect modest additional investments in capital expenditures during the second half of 2023, as we invest in the consolidation of certain business tools and also invest in tooling and capital equipment related to new products. We are solidly executing against the financial targets we laid out at the start of the year, and I'm now happy to hand things back to Jim to cover our 2023 guidance.
James W. Green
All right. Thank you, Jen. Now moving to our summary on Slide 9 and a look to what we see for the year 2023. New product introductions and expanding service offerings are expected to continue to fuel new growth. For the year 2023, we expect reported revenue in the $116 million to $120 million range, inclusive of approximately 4 percentage points of discontinued product revenue compared to 2022. We expect gross margin to remain strong at around 60% level. We expect adjusted EBITDA margin in the 15% to 17% range. With expanded EBITDA, combined with improving working capital driving strong cash flows, we plan to continue significantly paying down our debt and expect to further reduce our net leverage ratio to approximately 2x by the end of 2023.
Finally, as I think about the remainder of 2023, I'm encouraged by our start of the year as our recent product launches are gaining traction, and we realized the benefits of last year's restructuring actions. We're also mindful of reports of possible headwinds affecting our industry and the broader economy that could affect us. That said, our company is in a much stronger position than we were just a year ago, and we look forward to continuing our progress. Thank you.
Now I'll turn the call over to the operator to open the line for questions.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from the line of Paul Knight of KeyBanc.
Paul Richard Knight
Jim, on the guidance you provided regarding product headwind, minus 4% headwind. Is that changed or kind of going to plan in terms of what you were phasing out of?
James W. Green
Yes. It's coming out pretty much right on what we expected when we looked at the revenue that was in last year of the discontinued products and the revenue of those discontinued products in this year, the net difference is at around 4%. It's been that, I think from -- we've seen that coming and it's turning out to be exactly that is the case. So that's a headwind of, again, that transition. And as you can see, we're predominantly replacing that even as it is going through here. So that's a great transition to the new much improved product line.
Paul Richard Knight
And the DSI sales force, can you say they're part of the way there, all the way there in terms of selling the legacy Harvard Bio product.
James W. Green
I would say part of the way we've been selecting which products really make sense as we -- basically, our strategy is take these products that historically have sold into academic research and into discovery and pharma companies, and to adapt them for a much higher level of commercial operations. So you see the introduction and now the traction with the new behavioral product, which I mean, as you know, I mean, historically, behavioral product sale in academic research for maybe $8,000 to $10,000 as a capital purchase.
And the first unit we're selling here this year to a large CRO. I mean the first of its own is $850,000, and they'll ship and recognize in the year. And that's certainly not the last of it. That's the start of a new product offering. So clearly, we're seeing great traction with our sales force able to bring the behavioral-type technologies into the CROs. And this is -- as you know, anything that sells into the CROs like this has to be GLP-compliant, so it has to meet all the regulatory requirements for being able to generate the regulatory report to the FDA and other regulatory agencies.
So this was, I think, the first one we see that happening with and there's more coming now. And as we've said, this things that I can package into higher-volume industrial use. And again, you'll notice on this call, I introduced the concept that we've introduced the very first organoid-type system that's initially selling in with where we have a great reputation, and we're the market leader with these high-density MEA system. But historically, that's always been in research and with academic researchers and discovery parts of industry. But that, we think, as we start to combine that then with a large higher volume, multi-well configuration, that's going to be a real opportunity for us to move brand-new growth for us with CROs and pharma companies. As we know they're going to move more and more toward testing at the cellular level and now at the organoid level where you can do so much more and you don't have to use full organs, so you don't have to use nearly the amount of animal models that have historically been used in the past.
So this is right in line with our strategy And certainly, we feel like -- I feel like the adoption is happening and our force is doing pretty good at adopting that.
Paul Richard Knight
With the MEA technology, be appropriate for small molecule, large molecule, cell and gene-based therapies. What's it most applicable for, Jim?
James W. Green
Well, I mean, initially, if you think about what's been done in the past, you look at something like patch clamp where you're using the testing at a particular -- one particular cell at a time. And then MEAs historically, you'd use a cluster, but now as you can -- if you can start to actually move towards having an organoid instead of looking at a handful of cells, let's say, liver, with every drug that goes through testing, there's something they have to do. They're going to go through -- everything goes through cardiac testing.
You want to make sure that those cells and now if you can use organoids, you can actually -- you have a proxy for the heart to see and how does the heart react. Once the metabolism change in that organoid, does the depolarization work properly? Does the drug have an effect on the QT segments. So that's one of the things that -- that's tested, I believe, on anything that's going to be eventually used in humans has to fit that level and that part of initial core testing for toxicology and safety pharmacology.
So this is going to be something that we'll see not only on the development side, this will be the big opportunity I see if this can start to really penetrate high-volume tox and regulatory testing. And as you know, if you can use organoids, you basically have a proxy for each of the organs. And we're our first initial version of this, we're testing with neuro and then we'd expect that will very quickly move to cardiac. And then, of course, they will be involved with everything from cancer to any other treatment. But neuro and cardiac are 2 of the very first things that you really want to get high-volume testing. And if you can deal with organoids as opposed to again, animal models or organs, it's a much more efficient and a much faster way to get these answers.
Paul Richard Knight
How long do you think before it would be an animal model replacement or a release reduction of?
James W. Green
It's a good question. I think in theory, you could start to reduce animals fairly quickly. But on the other hand, it's just as likely that there'll be a much higher ramp-up of the early testing at the cellular level or organoid level so that you avoid taking drugs that, at some point, still have to go through the next sets of animal models that you fail them quickly if they're going to fail. You want to know talks right away. If you can find it out in 30 days versus 6 months, that's really good for you.
And that actually lets you have a much higher yield of drugs that go through the regulatory cycle to get through the full preclinical set. So I mean, again, I think that's going to be one of those choices. It will either be -- at least they'll be able to test things quicker and have much higher yields as far as not having to risk more animals for early testing that can be done at the cellular level.
Paul Richard Knight
And then my last question, Jim, is regarding you've obviously got the business focus on the growth product lines that you want to have in your sales distribution strategy aligned as well. Is it making your view on to M&A situations easier? And are we ever going to get M&A targets at a price that makes sense to the public market?
James W. Green
Yes. That's a great question. I've always thought that as we have a clean year this year, really get to our targets that we're expecting for next year to be at our long-term targets, our balance sheet is going to be much stronger. You can see what we've done with debt. We're going to be in a much better position to be able to look at acquisitions. I'm accustomed to looking at not just acquisitions, but also licensing structures at products that will help me really fill out this portfolio as I go into and start to penetrate, you got bioproduction penetration. That's an area that has real interest that I might -- I'll be looking at areas there and whether that's acquisitions or whether that's licensing or some collaborations.
Same thing with expanding the use of these systems for earlier testing for tox stage pharmacology. It also gave us some time to better understand the market and the needs of the customer segments. Again, I always look at where do I have reps? I know they can knock on the door, they're going to get in. They're respected, they're understood. We have a relationship with these large CROs, these large pharma companies. what can I bring and put in their bag that's going to let me leverage what I've already got in place. So no question as we get to the end of this year, start to look at Q1, I'll be in a position to start to target things that make sense. We're looking now, but again, I always believe you have to earn the right to use the balance sheet or if we're going to do more investment in areas like that. I want to finish up what we're doing this year and as I get to Q1, we're certainly in a much better position to understand where those opportunities are and then how do we do that in a way that we can afford.
Operator
Our next question comes from the line of Bruce Jackson of Benchmark.
Bruce David Jackson
Jim, I was -- I wanted to talk about the discontinued product impact. So you put out an estimate for the year. How much of that have we seen so far? And how is that going to roll off over the remainder of 2023?
James W. Green
Sure. I think when we looked -- we gave a year-to-date view. I think it was around about $2.8 million or something like that as a 0.5 point of the year and we're expecting about $5 million to $5.5 million for the total year. Is that right, Jen?
Jennifer Cote
That's correct. That's correct. It's about $1.5 million a quarter, and we'll roll through pretty evenly.
James W. Green
Yes. So that will roll off pretty quickly here at the end of this year, you'll see that, again, fairly linear each quarter, up and down a little bit, like $1.6 million was this quarter. And again, about another $2.5 million or so to go.
Bruce David Jackson
Okay. And then is that hitting both of -- how is it hitting both of the business units? Is there one that is getting a disproportionate impact from the roll off of the discontinued products?
James W. Green
Yes, it's really predominantly in the cell and molecular side. These are more of the lower individual products that typically sold through distribution, not really part of what I would call our strategic selling proposition. So again, predominantly on the cell and molecular side, I mean, probably 95-plus percent of it there, I'm guessing, but it's really predominantly CMT.
Bruce David Jackson
Okay. Okay. And then a follow-up question on the new product front. So you talked about the MEA launch. Last quarter, you talked about the BTX for bioproduction and then also in previous quarters, you talked about glucose monitoring. Are those still growth drivers for you?
James W. Green
Yes. You bet they are because they're new for us. There are new areas, new spaces, new customers incremental growth. We know that certainly, bioproduction, we've seen some headwinds over, everybody is talking about headwinds, but for us because we haven't. Since we're going from a very small number, negligible to meaningful numbers it doesn't really affect us. But in the longer run, certainly, we hope to see all that turn around. We think we have a great offering. And we will be starting to showcase this morning we'll be at the bioproduction show coming up later this month in Boston. I want to make sure that we're ready for this, and I like the idea now that I've got real deals and I've got real customers already adopting it, I've got a great case and I think a good selling proposition here.
Operator
Our next question comes from the line of Christopher Sakai of Singular Research.
Unidentified Analyst
This is [Sean] for Chris. Just wanted to see if you can give us a little bit more color on gross margins, which decreased from first quarter to 58% from 61.2%. What were the drivers?
James W. Green
Yes. I guess, first of all, I'd say the -- we saw the a couple of things. First of all, there's always going to be puts and takes on mix and volume. We did have a couple of other things. We launched a new product that -- when you launch a new product like the new multi-well there's always going to be some start-up costs there and some inefficiencies associated with that. So that has some effect. And then really looking forward, we've looked through this, and I think Jen also mentioned some accounting level changes on how we put -- this company is it around for a long time and with multiple sites. There were some areas where the way things were accounting for manufacturing accounting, they weren't identical everywhere. And they needed to be synchronized so that we didn't have things like how you depreciate something through the cost rules, how things depreciate as far as purchase price variance in that. Again, I'm not an expert on it, so that's why I'm an engineer, I like to let the finance people do the hard work like that. But in general, I mean, just aligning that, there was some effect on gross margin with that realignment of that process. And we've considered all that going forward as we look to what we look at for the rest of the year and for our year outlook.
Unidentified Analyst
On the cellular and molecular products, if you can give us more color in terms of weakness in North America and also what's happening in EMEA.
James W. Green
Yes. It's interesting because we have -- they operate a little differently this year. Last year, EMEA was weak. U.S. was strong. This year, EMEA is very strong and we're talking about pretty much across the board. I mean, especially in the preclinical side, that really picked up nicely in EMEA. Asia is very strong this year. U.S. was a little slower in that. Now again, I said -- when I look at something slowing down a little bit, I look at and say, what slowed down and what we saw some slowing on was the inhalation related products. Now that could that be because we had a much larger year last year in the U.S. with inhalation, probably. So it is -- it does seem to be fairly narrow in terms of the product. And again, it could very well be more of a harder comparison on that level with last year, a lot of things still being purchased that we're really dealing with COVID, COVID-related products and inhalation was one of the key product areas that we introduced at about the right time with COVID and got heavy use very quickly. But we're kind of past the COVID world there, and I think that's going to settle into kind of a standard type of operation. But again, because it's growing, we see growing in Europe, we see it growing in China and not so much here. It does ask some questions, but again, it's limited again, just basically to one product line.
Well, at this line, I'll take those any more questions. I guess I should ask first the operator. Do we have any more questions coming in? Or I think we've cured them all.
Operator
No, sir.
James W. Green
Great. Well, then, I think that this will end the call. Let me thank you for joining us. This ends today's presentation. I hope you'll come join us in the fall for our third quarter results of fiscal '23. Thank you very much, and this end the presentation.
Operator
This concludes today's conference call. Thank you for participating. You may now disconnect.
