Inotiv, Inc. Q2 FY2023 Earnings Call

Good afternoon, and welcome to Inotiv’s Second Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I will now turn the conference over to our host Devin Sullivan of the Equity Group. Thank you. You may begin.

Thank you, Devin, and good afternoon everyone. We appreciate you taking the time to join us today. Our results for the second quarter reflected growth across both of our business segments. Total revenues increased 8% to $151.5 million from $140.3 million in last year’s second quarter, with revenues at our DSA and RMS business segments increasing 20% and 3.3% respectively from last year’s second quarter. Our DSA business is benefiting from the targeted investments we have made and continue to make to expand our service offerings, and we are excited about the progress that we have made and what these enhancements can deliver for our clients, our industry, and our shareholders. As we continue to make progress as planned in filling our growing capacity, we expect improvements in DSA revenue and margins as we continue through the year. In our RMS business, during the second quarter, we did ship some of the NHPs in our inventory after verifying their origin as purpose-bred. Although NHP volumes were significantly below historical levels, we realized benefits from the favorable pricing we implemented during the second quarter. We have also continued to implement various consolidation and optimization activities in our RMS operating footprint, which are expected to improve production efficiencies and animal welfare as they come online and are completed. We returned to a positive adjusted EBITDA in the second quarter, achieving $17.1 million, which was below the $25.3 million we reported in the same period last year, but represented a significant improvement from the negative $5.5 million we reported in the first quarter of fiscal 2023. Adjusted EBITDA included an increase in G&A expenses in the second quarter of $7.7 million compared to the same period last year. G&A expenses in Q2 included $6.7 million of legal and third-party fees, primarily related to Cambodian NHP matters, the Cumberland, Virginia ongoing investigation, the third amendment to our credit agreement, and defense against pending securities litigation. By way of comparison, legal and third-party fees in Q1 were $3.4 million. These legal and third-party expenses are not being adjusted out of the adjusted EBITDA. Based on current information, we expect legal and third-party fees to be lower in the third quarter of fiscal 2023. Let’s move on to a discussion in performance over DSA and RMS business segments. I’ll then turn things over to Beth for a review of our results. Our DSA business generated second quarter revenues of $47 million, up 20.2% from revenues of $39.1 million in last year’s second quarter. Our performance rebounded as expected from what is typically a seasonally slow first quarter. The improvement in our DSA business was primarily driven by increasing revenue within the existing operating structure. Additionally, we are beginning to see new customers and increasing sales in the genetic toxicology services we brought online at our facility in Rockville, Maryland. Our facility build-out at Rockville is now substantially complete and we are continuing to validate the equipment and assays required to support growth in both the genetic toxicology and biotherapeutic businesses. We have also seen an increase in quoting and activity related to recently expanded areas in our discovery and histopathology service lines. The expansion of our Fort Collins facility remains on track and should be operational towards the end of fiscal 2023. The book-to-bill ratio at DSA in the second quarter was 0.95 times. Our backlog was $145.7 million, up from $133.6 million in Q2 of 2022. Turning to the RMS segment, revenues rose 3.3% to $104.5 million from $101.2 million in last year’s second quarter. Revenues at RMS increased nearly $23 million from the first quarter of fiscal 2023. As a reminder, we closed the Envigo transaction on November 5, 2021. For comparative purposes, we are for the first time since the acquisition comparing full quarter over quarter operational results. The increase this quarter was driven by favorable pricing for multiple product lines, including NHPs, while research models and Teklad diet helped offset lower NHP volumes as well as increased expenses, which we discussed and saw in Q1 fiscal 2023. Our site optimization plan for the RMS segment remains on track. We made good progress during our second quarter of 2023. We completed the plant shutdowns for the Haslett, Michigan and Boyertown, Pennsylvania facilities and their consolidation into our newly renovated facilities in Denver. The consolidation of two additional facilities in Indianapolis to other operating facilities is underway and that activity will be completed by the end of the current quarter. The relocation of our RMS facility in France to the recently updated operations in the Netherlands is now underway with respect to having this process completed by the end of the current third quarter. We have also completed the consultation and planning process to relocate our Blackthorne, UK facility to our other existing operations in the UK, and we currently expect this relocation to be completed in the third quarter of fiscal year 2024. During Q2 of fiscal year 2023, we announced that we will be closing the small RMS facility in St. Louis and relocating its operation into existing facilities in St. Louis. This will be completed by the end of this quarter, the third quarter. In connection with these closures and relocations, we are revising our product distribution plans, including our delivery routes and warehousing, which will allow us to further improve efficiencies, elevate customer service, and enhance margins. With respect to the NHP situation, as we indicated in previous calls, Inotiv sent a five-member team to Cambodia in early February 2023 to conduct an audit of the two facilities owned and operated by Vanny Science Development Limited. The audit consisted of a review of select animal history and health records, diet composition logs, water testing results, breeding records, animal treatment records, and animal welfare practices. The audit was conducted on a sample basis for a select number of NHPs. There were zero critical findings. They did demonstrate a commitment to future genetic testing for parentage with an investment in laboratory, analytical, and support equipment aimed at supporting future exports of NHPs from Cambodia. We’ll continue to work in concert with our suppliers and scientists both inside and outside our organization to develop a new long-term standard for DNA testing to verify the origins of NHPs and ensure that we and our clients will continue to only import and sell purpose-bred NHPs. I will remind you that any such testing we develop may be subject to review and acceptance by government agencies including the U.S. Fish and Wildlife Service. We’ll not be in a position to respond to any questions on any open matters concerning our suppliers or competitors or any ongoing government investigations. In the meantime, we are continuing to identify import and sell NHPs from sources other than Cambodian suppliers, and we believe that we have an adequate supply of NHPs to meet our internal DSA client demands to support the ongoing discovery of life-changing and life-saving therapies. As it relates to our outlook, we expect margin and earning improvements from the combined effectiveness of our DSA expansions, integrations, synergies, and RMS site optimization initiatives once completed and fully operational. We believe the additional capacity and services being added should eventually allow for an annualized 50% increase in DSA revenue compared to fiscal year 2022 revenue. DSA gross margins could increase from approximately 30% to the mid-to-high 30s. We also believe that once we complete all of our DSA and RMS site optimization integration synergy initiatives, we should produce approximately $20 million of annualized cost savings compared to fiscal year 2022. We expect to begin realizing more of these benefits early in the fourth quarter of fiscal 2023. We are reiterating our full year fiscal 2023 revenue guidance of at least $580 million in revenue, and as a result of the increased legal and third-party fees incurred during Q2, we are updating our guidance for adjusted EBITDA to be at least $70 million, down from the previous guidance of $75 million. We continue to expect that we will remain in compliance with our financial covenants for fiscal year 2023. We continue to expect that capital expenditures should moderate from 2022 and will be no more than 5% of sales during fiscal year 2023. As a reminder, this guidance is based on the assumptions that we continue shipping NHPs from Cambodian origins that have been reasonably confirmed to be purpose-bred from our existing inventory for the remainder of fiscal year 2023. In closing, I want to emphasize again how pleased I am with the progress being made to optimize our operations, our continuing response to the NHP situation, and the performance of our employees. Despite lingering headwinds with our RMS business, I’m convinced that we are headed in the right direction through investments, innovation, and hard work. We remain committed to maintaining our leadership role in helping our clients discover and develop life-changing therapies. With that, I’ll turn it over to Beth Taylor, our Chief Financial Officer. Beth, please go ahead.

Thank you, Bob, and good afternoon everyone. Total revenue for the 2023 second quarter rose 8% to $151.5 million from $140.3 million in last year’s second quarter, driven by a 20.2% or $7.9 million revenue increase in our DSA segment, and 3.3% or $3.3 million revenue increase in our RMS segment. Higher DSA segment revenue was primarily driven by increasing revenue within the current operating structure and continued increases of our genetic toxicology services at our new business facility in Rockville, Maryland. The increase in revenue at RMS was due primarily to favorable pricing across several of our animal models, specifically NHPs, but also including Teklad diet. The favorable pricing helped partially offset the negative impact of lower volumes of our NHP sales. Total gross profit improved slightly to $44.9 million, or 29.6% of total revenues from $44.7 million or 31.9% of total revenues in last year’s second quarter. Gross profit for our DSA segment improved to $15.1 million or 32.1% of segment revenue from $12.3 million or 31.5% of segment revenue in last year’s second quarter. The 600 basis point increase in margin was driven by higher sales within our current operating structure. RMS segment gross profit in the second quarter of fiscal 2023 was $29.8 million, or 28.5% of total revenues compared to $32.4 million or 32% of revenues last year. The decrease in margin in the current quarter was driven by several factors including product mix inflation and the absorption of duplicate costs as we implement our site optimization plan. We expect to begin seeing a decline in these duplicative costs and margin expansion in early Q4 fiscal year 2023. The margin decrease was partially offset by favorable pricing for certain of our product lines and some initial benefit from the closures of our Cumberland and Dublin facilities. General and administrative expenses rose to $29 million in the second quarter of fiscal 2023 from $21.3 million in last year’s second quarter. G&A expenses for the second quarter reflected $6.7 million in legal and third-party fees primarily related to Cambodian NHP matters, the Cumberland, Virginia ongoing investigation, the third amendment to our credit agreement, and defense against pending securities litigation. Based on current information, we expect legal and third-party fees to be lower in the third quarter of fiscal 2023. Operating loss for the quarter was $2.1 million, down from $7.9 million of operating income in last year’s second quarter, reflecting both the $7.7 million higher G&A expenses and a $2 million increase in amortization expense. Interest expense increased to $10.5 million up from $7.5 million in last year’s second quarter, reflecting our higher debt balance for borrowing obtained for the acquisitions and capital investments and higher interest rates. Consolidated net loss attributable to common shareholders in the second quarter of fiscal 2023 totaled $10 million or a negative $0.39 per share. This compared to consolidated net loss attributable to common shareholders of $6.1 million or a negative $0.24 per diluted share in the second quarter of 2022. Adjusted EBITDA was $17.1 million or 11.3% of total revenue as compared to adjusted EBITDA of $25.3 million or 18% of total revenue in last year’s second quarter, and a negative $5.5 million in Q1 of fiscal year 2023. DSA backlog was $145.7 million compared to $133.6 million at March 31, 2022. Net cash provided by operations was $5.4 million compared to cash provided from operations of $4 million in the same period last year. The increase in cash provided by operations was primarily driven by improved net working capital compared to the same period last year. CapEx in the second quarter was $8.5 million or 5.6% of total revenue and reflected investments in completing our DSA capacity expansions in Boulder, Colorado, Rockville, Maryland, and Fort Collins, Colorado, enhancements in laboratory technology and improvements for animal welfare. For the first six months of fiscal year 2023, capital expenditures totaled $16.8 million; we continued to expect that our fiscal 2023 CapEx will not exceed 5% of projected revenue. Our balance sheet as of March 31, included $24.6 million in cash and cash equivalents, up from $4 million from December 31, 2022, and we maintained $0 borrowing on our $15 million revolving credit facility. Total debt net of debt issuance cost as of March 31, 2023 was $374.1 million compared to $373.2 million at December 31, 2022. The company extended by one year the maturity of a $3.7 million unsecured seller payable pursuant to the stock purchase agreement with Orient Bio, Inc. The payable, which was originally due on June 27, 2023, is now due July 27, 2024. We were in compliance with our debt covenants as of March 31, 2023, and continued to expect that we will remain in compliance for fiscal year 2023. We remain pleased with our financial performance and the progress that we are seeing in higher revenue from the additional capacity investments in our DSA segment, and we remain optimistic as we continue to grow and capture a significant portion of the opportunities in our market.

Good afternoon and thank you for taking the questions. Maybe first up regarding the NHP situation, I realize you can’t answer many questions, but one I’m curious about, once you have the test in place, how quickly can you get things geared up from importing? I’m not sure what the exact quarantine period is, but how quickly once that test is in place, can you kind of get things turned around where you’re starting to record revenues from that market?

We’ve made great progress in our testing platform for being able to import. I think the bottleneck may be when U.S. Fish and Wildlife will again consider allowing imports from Cambodia. If they do allow us to import NHPs, that could be a longer lead time that is unknown to us. But once we have that, I think we could move very quickly. We have relationships in place, there are NHPs available to bring in, there’s transportation available, and we have quarantined space available. Now, there’s a normal quarantine time, but I don’t think that there needs to be a large time delay between when somebody says you may move forward and we can begin importing. Ever since November 16, we have focused on two goals: one is to be ready to import Cambodian NHPs when, and if they do allow us to import NHPs, and the other is to ensure we have a business model that is not dependent on imported NHPs from Cambodia. We’ve made great progress on both fronts, and we’ll be ready for either event.

That’s great, thank you. And then regarding the general business environment, obviously a lot of questions about the health of small pharma and biotech companies, but maybe what are you seeing from customers? I know the last couple of quarters cancellations were maybe a little elevated relative to historical levels, but has that come down? What are you hearing from customers? Thank you.

I think our customers have been and will continue to be very cautious in spending their money. As a result, they may choose to continue to cancel orders as they look and see what is best for them. Overall, last quarter, our award growth was up 20% over the prior quarter, and we had a book-to-bill close to one-to-one, but our sales were up 20%. Our new orders were also up 20%. Our quoting activity has been up even more than that due to new services we've introduced. We are a small business compared to the size of our industry. We’re trying to increase our market share during this time, and we’ve added sales, marketing, and new services to help with that. So, I’m pleased with what we’re seeing and I’m not underestimating the need to be aggressive in increasing our market share.

Understood. Maybe one last one and then I’ll hop back into the queue. As far as staffing is concerned, as you continue to roll out some of these new services and consolidate some of your sites in different locations, are you at the right level from a headcount perspective, and what are your expectations for hiring over the course of the year?

I think we’re in a much better shape now. Last year, we had to hire 850 people and onboard a lot of them. I don’t think we’ve net increased our headcount since the end of the last fiscal year. I believe we can see a lot of our growth without a significant increase in headcount going forward. We’ve done a good job of bringing people on board, training them, and helping us develop the assays and validate the equipment. Notably, last quarter we increased our sales by about $28 million, and if you back out the increase in legal fees, most of that, $25 million to $26 million, would go to the bottom line. We were prepared for growth because we had already onboarded those people, so I think it was a great performance by our team, and I don’t see a need to significantly add headcount for the growth we’re projecting.

Okay, good. Hi, it’s Dave. Good afternoon. I wasn’t hearing the confirmation tone, so I wasn’t sure if I was in the queue. Thanks for taking my questions. I was wondering if you could overall or in maybe an RMS more specifically breakdown for us the differences or the contributors in terms of volume and price? I know the growth was relatively smaller there, but I guess I’m just trying to understand the moving parts, probably volume down and price up, but if you could put numbers on that, that’d be great.

The volume of NHPs we sold in Q2 was actually less than the amount we sold in Q1, and significantly less than the numbers we sold in Q2 of last year. That indicates a fairly significant change in our business model.

Okay.

We did increase the small animal pricing in January and it is sticking. Our volumes remain fairly flat, but we’ve seen some increases in our Teklad sales. Overall, in terms of volumes, we remain somewhat flat. We’re also focusing on right-sizing our footprint and the number of facilities we operate. Now that we have made those changes, we can focus on increasing our sales volumes. Our average prices for NHPs started increasing in January and continued through the quarter.

Right. So, you mentioned the new business opportunities that you’ve invested in and are building out. It sounds like you’re getting some traction. Can you quantify how much of the bookings in the quarter are representative of your biotherapeutics and genetic toxicology and those new businesses within the DSA segment?

I wouldn’t say we had a 20% increase due solely to that. We started booking those services in late December, into January, February, and March, and we’re ramping up our quoting activities. The $7 million or $8 million increase in DSA bookings comes from various sources, and I would estimate it would have to be less than 20% from genetic toxicology.

I’m sorry, less than 20% of?

Less than 20% of the increase in bookings from Q1 to Q2. The significance of this is that it brings in new customers looking for these services. They often expand to multiple services once they start working with us, leading to further growth across our offerings. We are excited about this development.

Thanks for taking the questions. I was hoping to start with one on the plus/minus around the net bookings in the quarter. Could you just walk through how the demand has been? How have gross bookings trended? And I know cancellations came up in the past, so maybe if you could touch on cancellations and any changes in that area?

In Q2, cancellations were probably less than Q1, potentially significantly less, but I don’t want to assume that cancellations won’t exist in the future. Customers are still cautious about their spending, which is why we need to be proactive in sales and marketing efforts.

Okay. Fair enough. Second one for me on the income statement was hoping you could kind of bridge us to how you’re thinking about, beyond the income statement, the free cash flow profile for the back half of the year. And what I’m really looking to get at is just if we expect to generate cash through the year-end and if we can continue on the trend of putting a little bit more push in between where we are and where those covenant calculations are?

For our covenant calculations, we have a lot of ad backs not included in adjusted EBITDA. We've incurred close to $9 million in legal and third-party expenses to address some ongoing issues. We are confident that future quarters will be positive as we near the completion of our site optimization projects, which should help generate additional cash. We are nearly done with these projects, and we're eager to focus on optimizing our remaining operations and enhancing customer satisfaction.

Okay, perfect. Thanks for taking the questions. I was trying to drop out, not hog the mic in case there were other people that wanted to ask questions. I guess the list wasn’t that long. So, I did want to come back and ask if you could quantify the duplicative operating costs that I presume will, I think you’ve described a lot of those winding out of the business, maybe by the end of this quarter and through the second half of the year. Is it possible to quantify all those?

I have not quantified those costs well due to many hidden factors, including overlap in transportation, severance, and training for new hires. We have not done a good job of quantifying that and I believe it’s significant. Many are concerned about our guidance, which we look forward to helping clarify with our improving sales and the efficiency gains as we move forward.

So, related to that last part, I see that EBITDA guidance was adjusted from $75 million to $70 million. Is that change strictly from the increased legal and third-party expenses, or is that number bigger than that netted down by something else?

The change primarily relates to the increased legal and third-party expenses. That total has reached close to $9 million so far this year. Everything else is as we expected.

Got it. So last question for me, and maybe this is too close to the fire on NHPs, but how do you assure yourself that the animals are purpose-bred when, if the DOJ allegations are correct, those that slipped by previous audits?

I cannot confirm what the DOJ has exactly approved regarding purpose-bred versus wild-caught. We have halted imports from Cambodia since November 16. We have conducted our audits and discussed future improvements with the relevant parties. We have our veterinarians examine farms before imports. We continue to focus on sourcing NHPs from farms we trust and we plan to expand to avoid dependency on any single source. Thank you very much for your time and attention. Although challenges do remain, we’re making excellent headway in transforming our organization. We have several upcoming investor conferences and we look forward to engaging with investors. We welcome any follow-up questions or calls anybody may have, and I hope everyone has a good day. Thank you very much.

Thank you. And that concludes today’s call. All parties may disconnect. Have a great evening.