The conference will begin shortly. To raise your hand during Q&A, you can dial star one one. Good day, and thank you for standing by. Welcome to the Harvard Bioscience third quarter 2022 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, David Sirois. Please go ahead.
Thank you, Shannon, and good afternoon, everyone. Thank you for joining the Harvard Bioscience third quarter 2022 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 Q3-2022 HBio Quarterly Earnings Presentation and is located in the Investor Overview Events and Presentation 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 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, 2021, 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 differences 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.
Thanks, David. Good afternoon, everybody. Let me start by saying that in spite of a rough 3rd quarter, we continue to work through actions to dramatically improve our portfolio and resize the cost of our organization by the end of Q4. Let's go to slide four of the presentation and take a look at the highlights for the quarter. Revenue of the quarter was $26.9 million, down 9% from a strong Q3 prior year, with 6% growth in cellular and molecular, more than offset by lower sales of preclinical, which was down 17%. Reported revenue includes a $1 million impact from unfavorable currency. We experienced a very slow summer with lower sales to CROs and pharma across the regions. We continue to see a rotation out of obsoleted low-margin CMT products sold mostly through distributors.
Adjusted operating margin came in at 2.6% versus 13.3% last year, impacted by lower sales of preclinical products and higher cost of goods in the quarter. Gross margins came in at 51%, down from 56% last year, impacted by inflation and lower absorption and E&O charges. We had a poor mix in the quarter as we finished manufacturing of the low-margin products being obsoleted. Cost of goods was significantly impacted by lower preclinical revenue to absorb fixed overheads. Free cash from operations was $700,000, and net debt was roughly flat. Finally, as we previously announced last July, we're preparing for FY 2023 with portfolio and restructuring actions on plan to complete in Q4, which are designed to underpin our goal of 58%-60% gross margins and EBITDA margins in the high teens.
Let's move on to Slide 5. We'll look at the revenue in the quarter by product family, which shows Q3 2022 revenue adjusted to reflect 2021 exchange rates. Starting with the first row of the table, on a constant currency basis, our cellular and molecular technology revenue was up 6% from last year, driven by the strong performance of our direct sales team. We have solid growth across geographies, driven by strength of our cellular products in particular. CMT grew despite reductions in obsolete, non-strategic, lower-margin products sold through distributors. Looking to our preclinical products, again, on a constant currency basis, revenue was down 17% from a strong prior year. European CROs and pharma sales of telemetry and inhalation systems was down significantly from a strong prior Q2.
In Asia Pacific, China is recovering but had a tough comparable to a large prior year telemetry sale and lower sales in other APAC countries negatively impacted by the very strong dollar. The U.S. was slower in Q3 on lower telemetry sales to CROs, though we see the pipeline improving here in Q4. The strong U.S. dollar compared to the euro and British pound drove a currency impact of $1 million, which will likely continue to hurt us through the year. Let's move to Slide 6 and tell you a little bit about some of the exciting new product introductions. Starting with our cellular molecular technologies, after the quarter ended, we received a large order from a top pharma company for our BTX Electroporation systems for use in bioproduction. This order will begin shipping in Q4.
Over the longer term, this opportunity is expected to ramp to over $1 million annually, primarily driven by consumption of our unique Flatpack Chambers, augmented by expanded services. Furthering our initial inroads, we see an emerging value proposition for our BTX system in bioproduction, which is often used today in pharmaceutical research and development to create the initial strains of the therapeutics. BTX Electroporation has the potential to provide an ongoing stream of Flatpack consumables revenues that benefits from the production quantities in addition to those used in research and development. Secondly, after the quarter end, we introduced the new Ultrospec 7500, our premium spectrophotometer, building on our well-known Ultrospec line. This system replaces three existing models and is designed to penetrate pharma CRO companies and top academic labs.
Lastly, continuing to drive market leadership in preclinical wired-wireless continuous monitoring, we also introduced our exclusive continuous monitoring glucose implant. This new implant allows for continuous monitoring of glucose levels and avoids the cost, inconvenience, and variability inherent in periodic manual sampling. Glucose monitoring is expected to be an incremental growth driver in academic labs, government labs, and pharma companies in the pursuit of solutions to the ever-growing problem of obesity and diabetes. This new line of implants is expected to add over half a million dollars annually to our business. Now let me turn the call over to Mike for a quick look at key financials. Mike?
Thanks, Jim, and good afternoon, everyone. As a reminder, my discussion will focus on adjusted results for P&L performance, which aligns with measurements we use to internally manage the business. I'll skip over Slide 8 with the data table and go right to Page 9 to go through the full financials. On gross margin, we reported 51% for the quarter on an adjusted basis as compared to 56% in the prior year. This decline was due to higher costs associated with inflation, including uniquely high levels of price increases in electronic components, which we see moderating on a go-forward basis. Fixed cost absorption was also a major driver given the revenue decline noted, compounded by the decline in sales coming from our preclinical products, which carry higher than average gross margins.
Despite these short-term headwinds, we see go-forward traction and gross margin improvement with continued ability to increase our prices to our customers, and the mix within cellular and molecular technology sales continues to improve, with niche cellular products delivering higher growth within CMT. CMT and overall gross margins will improve meaningfully with the portfolio and restructuring actions Jim has discussed. Gross margin for the quarter on a GAAP basis was 45% due to $1.4 million of charges associated with these portfolio and restructuring actions, which relate to products manufactured in our largest CMT facility, primarily inventory write-downs for low-margin products we will exit in the coming months. Adjusted operating expenses were up approximately 3%, with higher labor costs associated with inflation and R&D investment growth, primarily related to investments in our next-generation telemetry products, but also supporting the new product introductions Jim discussed.
Adjusted operating expenses were down sequentially from Q2 2022 by approximately $800,000, reflecting initial benefits from the restructuring actions Jim noted, as well as lower overall discretionary spending than originally planned for 2022, given the softer revenue trends noted. While headcount grew in the second half of 2021 and early 2022 in reaction to the supply chain and labor dynamics that emerged over the last year, the restructuring plan we're finishing now will have headcount down approximately 10% from Q2 end with a workforce we believe can support growth and operating leverage in 2023. Adjusted operating income for Q3 is down meaningfully due to the factors noted above, most notably due to the drop in revenue discussed, which we believe represents a trough quarter for revenue due to the unique end market slowness experienced this past summer.
On cash flow and debt, net debt is up $4 million over prior year due primarily to the legal settlement we've discussed previously. Cash outflows related to this matter ended in Q2, and with improvements in working capital in Q3, particularly DSO, we were able to generate $600,000 of cash flow from operations and keep net debt essentially flat at $45 million. For the rest of 2022, expect net debt will be at a similar level to Q3. We expect to maintain strong collection efforts and to bring down gross inventory levels in Q4. However, net working capital typically increases overall in Q4 due to higher sales seasonally. Restructuring and transformation costs for Q3 were $1.7 million, with inventory write-downs and severance costs associated with the portfolio actions and restructuring.
These costs were partially offset by a reversal of accruals associated with the litigation. The line item detail of these costs are included in the GAAP to non-GAAP reconciliations included in this presentation. We anticipate up to $1 million of additional charges in Q4 rather, to complete the restructuring plans noted. Importantly, with these actions, we believe the major restructuring initiatives needed to construct the growth platform we've been discussing are behind us exiting 2022, and we're planning for significantly lower transformation costs in 2023. CapEx in Q3 was $400,000 or $1.3 million year-to-date, with manufacturing and technology infrastructure investments made. CapEx will be lower near term given the focus on cash flow improvement and deleveraging.
Our leverage ratio or total debt to adjusted EBITDA at Q3 end is 3.9 times, up from 2.7 at year-end due to the softening earnings, particularly in Q3. As you will see in more detail in the 10-Q to be filed shortly, we recently secured an amendment to our existing credit facility, which increases the maximum leverage ratio covenant and provides room for the company to complete its restructuring activities launched in the second half of this year. We believe this amendment, combined with the plans we are executing to set up 2023, which includes reducing inventory levels which spiked up over the last year due to address global supply chain dynamics, provides us the flexibility needed to continue to improve the business and deliver improved margins and cash flow, and ultimately return us to sustained leverage below 3 times.
Jim will give initial thoughts on the 2023 margin targets in his conclusion, and we are all laser focused in accompanying this with strong positive cash flows and deleveraging in 2023. With that, I'll turn it back to Jim to discuss the full year outlook. Jim?
Thanks, Mike. Now moving to our summary on Slide 11. First, looking at the upcoming 4th quarter. We expect 4th quarter revenue in the $30 million range. We see sequentially improving revenue and an improved product mix returning our adjusted gross margin to first half range and adjusted operating margin to the 14%-15% range, plus improving inventory and working capital management will further improve cash flow. For the full year FY 2022, we expect revenue of approximately $115 million, gross margin in the 55%-56% range, and adjusted operating margin in the 9%-10% range. Despite a challenging 3rd quarter, we continue to drive the transformation of our business to the profitable growth-oriented platform we envisioned. We're on target to complete obsoleting low margin non-strategic product lines by the end of Q4.
This, in combination with right-sizing and realigning manufacturing overheads and reducing operating expense also by the end of Q4. These actions support next year's targeted gross margins in the 58%-60% range and EBITDA margins in the high teens. New product introductions and improved portfolio with pricing power will underpin profitable organic growth for the future. Finally, our transformation costs are expected to be significantly lower with restructuring essentially complete at the end of Q4. Thank you. Now I'll turn the call back over to the operator and open the line for questions.
Thank you. As a reminder, to ask a question, you will need to press star one one on your telephone. Please stand by while we compile the Q&A roster. Our first question comes from the line of Paul Knight with KeyBanc. Your line is now open.
Jim, how are you? What's your goal now on organic growth potential?
Well, when I think about next year, our plan organically is to, you know, we're rotating out of something like $5-$6 million of non-strategic low margin products that typically sell through distribution. You know, I'm looking next year to get back to that kind of mid- to upper single-digit on a reported basis and a little better than that when I reaccount and look at a pro forma view as I extract out the revenue that we're no longer selling next year. You know, roughly speaking, somewhere in the neighborhood of 10%-11% on a pro forma basis.
accounting for the, you know, the revenue that we're exiting probably somewhere in that neighborhood of 6-ish% on a pro forma basis, or actually, I mean, on a reported basis.
On this BTX Electroporation configuration, you're mentioning that you had a sale to a major pharma. Is there more pipeline behind that?
Yeah. There, you know, we've been working on this for a while. You know, we've been very well known in the initial discovery of the various new drugs coming out. Our BTX Electroporation system's been used for a very large number of new drugs, you know, including things like the COVID vaccines. Historically, we were typically only used either in the development of the initial drug, in the research labs, academic labs, or in the pharma companies, but not necessarily in the production, bioproduction of those drugs.
What we've been working on is the ability to provide a bridge from if someone's using our equipment to generate the first line, if they're gonna be using electroporation in the line itself, we're now working on offering the ability to transition from that creation of the drug to the initial levels of production. You know, depending on the amount of demand, we're certainly seeing the initial production up through medium and maybe low levels of, or up to low to medium levels of production rates.
You know, that can change a lot, you know, based on the drug and based on how it's used and based on, you know, how much is actually specifically electroporated in that shows up in the vial and in the end drug. This is an area we've been working on for a while. It's an exciting time to be able to offer this. It's a new growth opportunity for us. We've been working with a number of companies, but this is, you know, we highlighted this one in particular because it's a large order. We see this becoming a multi-year opportunity, and reaching, you know, $1 million-plus in annual consumable revenues just with this one particular order alone.
When you add up, you know, the ability to bring others into this, you know, it's an exciting growth area for us.
The BTX, is that for cellular or cell and gene therapy, cell and gene therapeutic applications?
It can do that too. It actually is. It's a you know. It was actually one of the very first electroporation systems out there involved with, you know, the first cloning, moving on to the development of things like monoclonal antibodies. It's used in the development of not just the drugs, but also, you know, the drugs that are, you know, some are large molecule drugs, some are, you know, small. Anything that goes through electroporation for developing the initial cell lines. We're heavily involved in this and have been for many years.
You know, for us, just the ability to provide a you know, a transition or a bridge from the initial drug to something they can start producing in some level of volume is really important because they've especially if they've used our technology to create it's much you know, we think we'll be able to show that it's much safer, just expand that volume of it and start to enter you know, production you know, low-level productions and then you know, growing from there.
Lastly, the spectrophotometry tech product. Can you kind of give us a gauge of how big the overall spectrophotometry business is at Harvard Bio? Is it more than 10, less than 20? Is there any metric you can give us? I know it's been large, but if that'd be helpful. Thanks.
Yeah. The spectral business itself is somewhere, I would say in that kind of 5%-6% of revenue range. It's meaningful. It's not too large, but you know it is an area where we've tended to focus on selling through distributors and into academic research. This new version is also designed to be easier transition and sold into pharma companies where we have direct sales, where we have you know really good connections. You know it's an expansion on our, you know, spectrophotometry business.
Okay, thanks.
Thank you. Our next question comes from the line of Bruce Jackson with Benchmark Company. Your line is now open.
Hi. Good afternoon, and thank you for taking my questions.
Hi, Bruce.
I wanted to take a little time to talk about the inhalation business. Obviously, it got a big boost during COVID-19. You've got the leading products in that space. How much of the current downturn would you say is due to just general economic conditions, and how much could potentially be a shift in the market towards a more normalized level?
Yeah, that's a good question. I don't think there's any doubt, at least, you know, in hindsight, that given that we had offered the product about the time that, you know, that COVID was coming out, it had an immediate uptick. You know what we did was we worked on then a transition of new capability into the product to then be able to have it more targeted toward long-term use and then compete on, you know, the specifics of being able to measure exact amounts of what was delivered through the system and inhaled by, you know, by the model.
I would, you know, certainly expect that we had some buildup of additional sales of the inhalation units just because of everything happening with COVID. You know, we did see a lot of those sales go to pharma companies around the world, and, you know, they adopted it fairly quickly. We could very well be, like you say, moving toward more of a normalized level of revenue there and sales, and we'll grow off of this level then based on the new capabilities that we've added, including, you know, the ability to specifically measure the amounts inhaled.
Okay. Then you mentioned that there's going to be about $5 million-$6 million of revenue impact from discontinued products in 2023. Were there any discontinued products in this quarter that had any impact on the top-line number?
Yeah. Certainly, what we started is actually in Q3, we started identifying and telling customers that we were rotating out, that we were obsoleting certain products. You know, we did see a continued rotation out of. Again, when I look at what we sell through distribution around the world, again, mainly to academic research sites, some of the obsoleting products, we saw a downturn somewhat on those as we would have expected a rotation out of those. You know, I see that as a good rotation.
You know, with the introduction of the Ultrospec 7500, you know, that's a new premium unit that takes over and replaces a number of other units that were in production that were, you know, lower margin, lower capability. We think this is gonna bring back and keep us in that revenue stream, you know, doing well, even though it's rotating out of those lower margin products.
Okay. Last question from me. You discussed the fourth quarter CRO pipeline was starting to look a little bit better. I was wondering if you could maybe give us a little bit of color on either the types of the studies or the types of products that are catching some of this upturn in the 4th quarter. Thank you.
Yeah. You know, we've always done really well with our implantable telemetry continuous monitoring systems. You know, in this summer, you know, the summertime, July, August, you know, things really slowed down, you know, very much in Europe, and pretty much, you know, we saw the slowdown, you know, globally. It seemed to slow down fairly quickly in around, you know, in that kind of midsummer or late summer time frame and then start recovering. We saw you know, the recovery is happening. Of course, we're very happy to see it recovering in our implantable telemetry space. You know, so that's coming back nicely. Then it's gonna be augmented because, you know, the glucose, the new glucose product is brand new.
It's incremental business for us. It's something that academic research has really been looking for, including government labs and pharma companies. That will augment the growth in our high-margin telemetry and monitoring business. That's the piece where, again, when your highest margin products hit some delays like they did in the summer there, that had a real effect on us 'cause it was you're losing some very high-margin revenue in the quarter. At the same time, that also forces you then to have an issue with absorption of overheads.
To really fix the long-term overhead issue, I mean, to have the real kinda cushion that we need as a company, those are the structural changes that we're making to bring down the overall cost of the business. The 2 things that are happening is, you know, we see our great margin products and the introduction of the new glucose product, you know, getting us back to where we need to be and improving our margins.
At the same time, the cost reduction activity and the, you know, associated with changing and improving the portfolio and taking our cost of the organization down gives us the kind of cushion and headroom in our margins so that we could absorb when we have a, you know, a one-off quarter that happens to be, you know, particularly slow for whatever reason, whether it be something with COVID or something with the supply chain. If it's, you know, a company our size, you know, we tend to really get hit hard with the kind of things happening in the market when, you know, you have a very strong U.S. dollar. You know, countries like Japan are really struggling to buy almost anything.
You know, companies are, you know, countries that are buying in euros and pounds, you know, which is a significant part of our business, you know, that really turns into a currency translation problem. The only way to really solve that is to just get our cost structure down and to, you know, in good quarters and good years, we'll be, you know, in really good shape. If we have, you know, some issues that pop up for, you know, a point in time, you know, it's not gonna be quite as hard on us, you know, on a quarter basis.
Got it. Thank you.
Thanks, Bruce.
Thank you. Our next question comes from the line of Christopher Sakai with Singular Research. Your line is now open.
Hi, Christopher.
Hi, guys. This is C in for Chris. I was wondering if you can provide us a little bit more details on the preclinical revenue stream in terms of what happened this quarter and how do you kind of see it going forward?
Yeah. Yeah, I mean, you know, it was the preclinical revenue in the quarter that where we really saw slowing. A lot of it, you know, just seemed to be delays. We know, you know, much of our preclinical products go to, you know, pharma companies and CROs and, you know, companies that really, you know, have to pay attention to the top line and bottom, their bottom line. You know, we saw some of it was a, you know, belt-tightening, you know, in the quarter. Then some of it was just, you know, people getting back to work after COVID.
You know, we knew that, you know, the summer was gonna be a tough summer and people that, you know, Europeans who typically take, you know, four or five weeks off, you know, we saw, you know, people, you know, not nobody around to even call and talk to in some of the centers, until, you know, summer was fully done and be able to start to come back to work really in the September timeframe. I think it was a combination of that. I have no doubt that we have some belt-tightening happening, you know, in the CRO space. I think to what Bruce had mentioned, you know, there could very well have been some additional sales prior year.
We had a very strong prior year and very strong Q3 last year, you know, where, you know, some of the pharma companies, you know, made some major purchases. We had an individual $1 million purchase by, you know, one of the largest CROs in China, you know, which really, I mean, it's great news for us, except, you know, it kinda makes for a tougher comparable when you think about a $1 million incremental deal just in one case in the prior quarter. You know, we see that coming back. The mix is gonna start improving here. It improves already as we look to Q4. Then with the cost changes that we're making, you know, our revenue stream will have, you know, strong margins and strong drop-down.
Thanks. Look, in this, you know, we are aware of some of the slowdown we are seeing in U.S., especially in biotech, considering we are out of the high of IPO SPAC market for the last 2 or 3 years. You mentioned mostly this is OUS. Do you think that that is sort of similar situation, OUS and U.S., in terms of slowdown? Or
No
We might see slowdown in a little bit in U.S., which we haven't seen yet.
Yeah. Well, we did see some slowing in the U.S. and in the preclinical revenue stream. You know, you're mentioning, you know, bringing up a good point with the biotech. You know, that was something, you know, we always saw and still see as a great growth opportunity, especially now that we have some of the new products with the BTX and the ability to start to offer to, you know, smaller biotechs and pharma companies that are involved with more orphan drugs and such, you know, to help to provide them, you know, with other options for bridging to production. You know, but the biotech, I would say that wasn't really. There wasn't a lot of revenue for us.
When I look at our North American revenue, much of it is CROs and pharma companies. You know, with some slowing there in that quarter, and like I said, we've already seen the pipeline improving, you know, even going into our expectations, our natural growth from Q3 to Q4, as we look within this year and then going forward. You know, augmenting it with new products, especially with, you know, the new glucose is gonna continue to drive toward a very positive mix for us on implantable monitoring. And then just, you know, watching as we deal with the headwinds, you know, in Europe. China, we all believe China's...
You know, we see it improving somewhat. We think it's gonna do quite a bit better as we think about, you know, they have been going through these periodic shutdowns. There's strong feeling that China's gonna, you know, pick back up very strong. Europe is always a place where we always have some level of concern just 'cause of, you know, the market there and of course, you know, the currency situations.
Finally, you know, apart from the three new products that you talked about, in terms of early stages in R&D, if you can talk a little bit about, give us some update about you guys are thinking, what's you know, cooking over there, that'd be very helpful.
Well, good question. You know, you can see where we're making our investments. We're making the investments in areas where we have, you know, high barriers to entry, good pricing power, and a good ability to, you know, to sell our products. Investments, we continue to invest in the cellular and molecular side, very much on the cellular approach. We think there's gonna be a lot more adoption of cellular testing technologies into the stream of how you get products, you know, through the preclinical and into clinical. That's an area of continued investment. You saw that with BTX. You're gonna see that with more of our, you know, multi-electrode array type products that'll be coming in.
You know, the implantable telemetry, of course, is an area where we need to stay the market leader there. We'll continue to invest, and you'll see new products coming out on the software side. That's an area that, you know, we've talked about it in the past, but, you know, now, you know, we see the ability to really manage data and to provide the right kind of capabilities, not just to CROs, but also to pharmas and to have versions that sell well into academic research. You'll see more investment on the software side of our business, too.
Perfect. Thank you.
Thank you.
Thank you. This concludes the question and answer session. I would now like to hand the conference back over to Jim Green for closing remarks.
Well, thank you for joining us. This ends our presentation today. We hope you'll join us again for our Q4 results in February timeframe. Thank you very much, and we'll see you soon. Thanks.
This concludes today's conference call. Thank you for your participation. You may now disconnect.