Alpha Teknova, Inc.

Good day and welcome to Technova's second quarter 2023 financial results conference call. At this time, all participants are in a listen-only mode. After this speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Ms. Sarah Mitchell-Moore, with Investor Relations. The floor is yours.

Great. Thank you, Operator. Welcome to Technova's second quarter of 2023 Earnings Conference Call. With me today on the call are Stephen Gunstream, Technova's President and Chief Executive Officer, and Matt Lowell, Technova's Chief Financial Officer, who will make prepared remarks and then take your questions. As a reminder, the forward-looking statements that we make during this call, including those regarding business goals and expectations for the financial performance of the company, are subject to risks and uncertainties that may cause actual events or results to differ. Additional information concerning these risk factors is included in the press release the company issued earlier today, and they are more fully described in the company's various filings with the SEC. Today's comments reflect the company's current views, which could change as a result of new information, future events, or other factors, and the company does not obligate or commit itself to updating its forward-looking statements except as required by law. The company's manager believes that in addition to GAAP results, non-GAAP financial measures can provide meaningful insight when evaluating the company's financial performance and the effectiveness of its business strategies. We will therefore use non-GAAP financial measures of certain of our results during this call. Reconciliations of GAAP to non-GAAP financial measures are included in the press release that we issued this afternoon, which is also posted to Technova's website and available on the SEC website. Non-GAAP financial measures should always be considered only as a supplement to and not as a substitute for or as superior to financial measures prepared in accordance with GAAP. The non-GAAP financial measures in this presentation may differ from similarly named non-GAAP financial measures used by other companies. Please also be advised that the company has posted a supplemental slide deck to accompany today's prepared remarks. It can also be accessed on the investor relations section of Technova's website and on today's webcast. And now I will turn the call over to Stephen.

Thank you, Sarah. Good afternoon and thank you everyone for joining us for our second quarter of 2023 earnings call. Technova is a leading producer of critical reagents for the life sciences industry to accelerate the introduction of novel therapies, vaccines, and molecular diagnostics that will help people live longer, healthier lives. We manufacture high-quality customer agents with short turnaround times in our position to scale with our customers as they advance their products from discovery to commercialization. We had an excellent second quarter, both financially and operationally, against a difficult market backdrop. Our ability to deliver in these challenging conditions is a testament to the dedication of our very talented team and the diversity of our market segments. We increased revenue sequentially by 26% and continued to execute on our key initiatives to position the company for sustainable long-term growth. Our sales in the second quarter were $11.5 million, the second highest quarterly revenue in the company's history. We had a notable uptick in clinical solutions, benefiting from the migration of a large customer from Lab Essentials as it prepares to enter clinical trials. In addition, we have actively and effectively managed our operating expenses, reducing our free cash outflow in the second quarter to $6.2 million, giving us confidence that we will achieve our free cash outflow target of $30 million for the year despite a lowered near-term revenue outlook. We remain optimistic about the long-term potential of our target markets and are excited about the progress we've made in the second quarter to execute our long-term growth strategy. First, our new state-of-the-art modular manufacturing facility is now certified for GMP-grade production. We are enthusiastic about the potential this multi-year investment will unlock for the business. We have already hosted a number of high-profile customers and have been very encouraged by the reaction to the facility and the company's transformation. Our customer audit schedule is nearly full for the remainder of 2023, increasing our confidence that this investment will begin to bear fruit in mid to late 2024. As a reminder, we believe this new facility, plus our existing operating infrastructure, will give us the capacity to deliver approximately $200 million in annual product revenue when fully utilized. Next, On the R&D front, I am pleased to say our new product pipeline is progressing ahead of schedule. In July, we built upon the recent launch of our AAV2 buffer screening kit by extending the portfolio to include the AAV8 serotype. We expect to launch AAV6 and AAV9 by the end of the year. Early feedback on the product line has been very positive, with some customers already in discussions about scaling up with our proprietary buffer formulations. We believe this buffer kit can save our gene therapy customers months as they develop their production workflows. In addition, we launched more than 20 reagents to streamline and simplify the entire AAV bioproduction process. We expect to become an even more valued supplier to these customers as they advance their therapies towards commercialization. Lastly, I want to take a moment to discuss our view of the current market environment. In the near term, we continue to see emerging biotech, historically one of our larger growth segments, focused on conserving capital by delaying, reducing, or canceling clinical trials. We still believe this to be temporary, particularly against the backdrop of the total number of trials underway and encouraging recent clinical outcomes. We are particularly encouraged by the advancements in gene therapy. We saw a notable approval for an AAV gene therapy for Duchenne muscular dystrophy. We believe this approval demonstrates the potential value of AAV gene therapies, an area in which we have recently developed and will continue to develop a number of proprietary product offerings. The combination of our new products with our operational capabilities positions us well to participate in this segment as the market evolves. As we turn to our revenue outlook for the remainder of 2023, we now expect a mid-single-digit percentage year-on-year decline in top-line revenue with a return to year-on-year growth in the fourth quarter of 2023. Even with this change in guidance, we continue to track towards our previously communicated free cash outflow target of approximately $30 million for fiscal 2023. I will now hand the call over to Matt for discussion of the financials.

Thanks, Stephen, and good afternoon, everyone. Total revenue was $11.5 million for the second quarter of 2023, a slight decline from $11.7 million in the second quarter of 2022, reflecting the continued headwinds associated with lower demand from early-stage biopharma customers, but partially offset by delivery of a large order to a significant customer during the quarter. LabEssential's products are targeted at the research use only or RUO market and include both catalog and custom products. LabEssential's revenue was $7.6 million in the second quarter of 2023, a 10% decrease from $8.4 million in the second quarter of 2022. The decline was attributable to a decreased number of customers partially offset by higher average revenue per customer. Clinical Solutions products are made according to good manufacturing practices or GMP quality standards and are used by our customers primarily as components or inputs in the development and manufacture of diagnostic and therapeutic products. Clinical Solutions revenue was $3.7 million in the second quarter, a 24% increase from $2.9 million in the second quarter of 2022. The growth in clinical solutions revenue was attributable to an increased number of customers, partially offset by lower average revenue per customer. We expect revenue per customer to increase over time as they ramp up their purchase volumes. However, this metric can be affected by the mix of newer clinical customers who typically order less. Just as a reminder, due to the larger average orders in clinical solutions compared to lab essentials, There can be quarter to quarter revenue lumpiness in this category. As a case in point, during the second quarter of 2023, we delivered a large GMP order to a diagnostics customer who had previously purchased Lab Essentials products in 2022. Turning to the income statement, gross profit for the second quarter of 2023 was 5.1 million compared to 5.2 million in the second quarter of 2022. Gross margin was 43.9% of revenue in the second quarter of 2023, which is down from 44.9% of revenue in the second quarter of 2022. Despite increased overhead costs, including depreciation from our new manufacturing facility, our gross margins were down only slightly compared to the second quarter of 2022, as higher margin clinical solutions revenue represented a larger percentage of our total revenue in the second quarter of 2023 compared to the second quarter of 2022. Sequentially, gross margins were up significantly due to lower labor costs and also a favorable clinical solutions revenue mix. Operating expenses for the second quarter of 2023 were $12.1 million, compared to 11.9 million for the second quarter of 2022. Excluding a non-cash impairment charge related to certain fixed assets of 2.2 million in the second quarter of 2023, operating expenses were down 2 million compared to the second quarter of 2022. The decrease was driven by reduced spending, primarily in professional fees and occupancy costs. In the second quarter of 2023, the company decided to cease further use and development of certain manufacturing machinery and equipment as we completed qualification of our new manufacturing facility, prepared for our ISO recertification audit, and also consolidated facilities. Additionally, changes in the market price of previously impaired assets were identified. The company reviewed the recoverability of the carrying value of these assets, and as a result, recorded a non-cash impairment charge of 2.2 million related to these long-lived assets. Net loss for the second quarter of 2023 was 7.2 million or 25 cents per diluted share compared to a net loss of 6.2 million or 22 cents per diluted share for the second quarter of 2022. The company recorded Minimal non-current tax expense this quarter against its pre-tax losses due to increases in our valuation allowances against incremental net operating loss carry forwards. Adjusted EBITDA, a non-GAAP measure, was negative 2.3 million for the second quarter of 2023, compared to negative 4.9 million for the second quarter of 2022. The decrease was primarily driven by lower net loss after adding back the 2.2 million non-cash impairment charge recorded in the second quarter of 2023 compared to the second quarter of 2022. Turning to the cash flow and balance sheet, capital expenditures for the second quarter of 2023 were 2.3 million compared to 10.9 million for the second quarter of 2022. This marks the fourth straight quarter of sequential decreases in capital expenditures. We have now substantially completed the capital investment in our new manufacturing facility. Free cash flow, a non-GAAP measure, which we define as cash provided by or used in operating activities, less purchases of property, plant, and equipment, was negative 6.2 million for the second quarter of 2023. compared to negative $16.8 million for the second quarter of 2022. This decrease compared to the prior year period was due to both lower cash used in operating activities and a decrease in capital expenditures. Turning to the balance sheet, as of June 30, 2023, we had $23.7 million in cash and cash equivalents and $22.1 million in gross debt. For 2023 outlook, we are lowering our 2023 total revenue guidance to a range of $37 million to $40 million. At the midpoint, this assumes revenue decrease of approximately 7% compared to 2022. With respect to product categories, we now expect Lab Essentials revenue to be down 9% to down 5%. compared to 2022, and clinical solutions revenue to be down 15% to up 5% compared to 2022. The company continues to manage expenses aggressively. At the end of June, the company had 232 associates, down from 251 at the end of the first quarter of 2023 and 290 at the end of 2022. The company posted operating expenses, excluding non-recurring charges, Below $10 million the first quarter, we have done so since 2021. Similarly, the company saw a reduction in free cash outflow during the second quarter of 2023. This marks the fourth straight quarter of lower cash outflow and is consistent with the company's expectations for the year, despite our lower revenue outlook, as we anticipate operating expenses and capital expenditures to continue to trend downward over the course of the year. In addition to cash on hand, we have access to our revolver up to $5 million and ATM facility. Based on our guidance, we expect approximately $11.8 million in free cash outflow in the second half of 2023. We believe that we have already made the step-up investments needed to execute on our growth strategy and can scale without significant additional investments. With that, I'll turn the call back to Stephen.

Thanks, Matt. Overall, we were pleased with our performance in the second quarter of 2023. The long-term outlook for our end markets remains positive. We are committed to executing on our strategy to help our customers accelerate the introduction of novel therapies, diagnostics, and other products that improve human health. We will now take your questions.

Thank you. As a reminder, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Due to time restraints, we ask that you please limit yourself to one question and one follow-up question. Please stand by while we compile the Q&A roster. Our first question will come from the line of Steven Ma with Cowan. Your line is open.

Great. Thanks for taking the questions. Appreciate the call you gave on the macro landscape and how it's impacting Technova. You know, just, you know, looking at some of the recent guide down by your peers, some of them have guided down more significantly than you, you know, and I appreciate you know, the call you gave on the growth drivers, the new products that are coming online, the new GMP facility. But is there anything else that gives you confidence on the new guide?

Sure. Thanks, Steven. I would have to just kind of go back to when we lowered guidance last year when we started seeing the impact of the early stage biopharma customer. I think we were pretty early in the shoots there compared to others. a combination of being pretty closely tied to the spending patterns and not having a lot of our revenues tied up in stock and destocking allows us to get a closer view towards the end of this, the back half of this year. And I would also say that, you know, we are pretty diverse in our offerings. While a lot of the growth drivers of the business in the last two or three years have been these sort of early stage biopharma, we serve really all the way from research through commercialization and not solely biopharma, but also cover the life science tools and diagnostic skills. So I think we're a little bit more diverse. That said, obviously, you know, we do believe the long-term strategy in the business will be to migrate these customers from research to clinical, and we have seen a slowdown, and that slowdown has continued throughout the back half of this year, hence the reason we are lowering guidance.

Okay. That's helpful, Kalar. And I appreciate the call you also gave on the increased customer interest on your GMP facility. Can you give us a sense of what you think the sales cycle is to convert these people that are doing the facility audits to customers? Thank you.

Sure. Yeah, it takes a while. I mean, this is a long-term strategy to engage with these customers in their preclinical development and then scale with them as they go down that pipeline. You know, we did talk about a large customer here. That might be a great example for us to use, although it's not on the therapeutic side. It does follow very similar patterns. We engaged with this customer in 2021 to start a discussion. In 2022, in the back half of 2022, we delivered a research-grade product for their verification. Pre-clinical trial work, but basically to demonstrate that we can manufacture the product, that their product worked as they would like it to work before going on to make a GMP-grade version of that product. After delivering that, an order came in in the first half of 2021. 2023, actually the first quarter of 2023, for GMT grades for validation so they can use those products to go into clinical trials. And so we delivered that in Q2. And you can see the revenue there. And of course, you can see as well as the financial impact that has when we do shift towards more clinical solutions, as well as the type of size of those orders. And so that's just getting them into the clinical trials. Now it's probably another year for this one and this particular diagnostic. So it's probably a different timeline than some of these others. But just from the onboarding process, you can see that we're talking anywhere between 12 and 24 months until these customers really scale up. But that is essentially the strategy. The more we get in that early stage funnel, we believe that not only will they scale up, they'll become extremely sticky as we are their manufacturer for this product going forward. Great. Thank you.

Thank you. One moment for our next question. And that will come from the line of Matt LaRue with William Blair. Your line is open.

Hey, good afternoon. First wanted to ask about OpEx. And so obviously you talked about it being sort of flat year over year, excluding the impairment charge. you know, volumes start to scale back next year, particularly at the new facility. You may just remind us or think about the level of objects that need to scale versus just sort of the capacity and the things right now that you'll be able to absorb as disorders start coming in.

Hey, Matt, you're a little bit quiet. Did you get that? I think you were saying that flat year and year exclude the impairment charge. Are you asking how those scale over time, the objects?

Sorry, I was just, as the capacity at the new facility really starts to come online next year, just how to think about OPEX trends throughout 2024, if they're going to be sort of flat year over year in 2023.

Yeah, I think, thanks for the question, Matt. Yeah, first of all, I mean, I think we've obviously been very happy with the way we've been able to manage OPEX costs down here during the course of this year, and you know, expecting those to stay at or slightly down from these levels. So we're, you know, demonstrating that we've been able to manage costs. In terms of what that means for the future, as I said a little bit in the remarks, I mean, when we say we feel like we've made the investments necessary to be able to scale the business, you know, with limited additional investment, you know, of course, we're not providing any specific FY24 guidance at this point. But I think you can assume that as we start to grow back, which we expect to do in FY24, that we would not need to increase those expenses or substantially in any way. So we haven't gotten to all the detailed preparation of our budget or anything. But in principle, we believe that we can grow this business with holding those operating expenses. Does that help answer your question?

Yes, yes, it does. Thank you. The second question, Matt, you reclassified some long-term debt into current portion this period. And notice that I think there's a covenant related to TTM revenue as of December 31st. So is the reclassification related to the guidance reduction? And I guess just maybe help us get comfortable with that amount of debt, you know, standing relative near. cash position and cash out from this year.

Yes, good observation, Matt. We did reclassify our debt from long-term to short-term for this quarter. Just to be open, we did have a covenant. We're out of compliance with the covenant following the quarter, actually in July period here. And we have notified our lender of this situation and are in discussions with them on a preliminary basis so far. They've not issued any kind of notice to us at this point and don't plan to until after the quarter statement is filed here. So that is the reason why the debt has been reclassified from from long term to short term until we're able to resolve the situation with them.

Thank you. One moment for our next question. And that will come from the line of Paul Knight with KeyBank. Your line is open.

Matt, I guess it's fair to say the ATM, no action on that.

Right. We will, of course, be filing the 10-Q tomorrow. And at this point, there has been no use of the ATM.

And, Stephen, I guess regarding the macro, it does look like if ARM data is correct, we have had overall trials start to grow a little bit in the first quarter. half of the year. Are you seeing that?

It's a hard one to measure at the moment because we have multiple competing factors here, right? We've scaled up our commercial organization. We do see our funnel increasing, which would indicate that that's true, but also we're putting our efforts towards attracting those customers. But I will say that the cycles are longer and the size of the trials still seem to be smaller than they used to be. But I'm in agreement with you. It does feel like when you talk to customers that they are starting to think about how to move these things forward. That said, we still have the, you know, the conversations with customers that they're really stuck in trying to maintain their capital and the timing of when those actual builds happen is still undetermined.

Would it be fair to say that the kind of the components of the XBI or the larger, more medium-sized biotechs are not really deteriorating. Would that be fair? And then the last follow-on would be what portion of revenue is emerging biotech right now, do you think?

Yeah, I'm not sure I can comment on that. We have had, you know, you mentioned our new facility opening. We probably had, you know, four or five customers come through there now, and they've been both large and small. And so we have not necessarily seen a specific trend on the size, but I will say that, you know, wherever you're engaging with customers is very early on, given the fact that, you know, the facility is just now coming online. Okay. Thanks.

Thank you. One moment for our next question. And that will come from the line of Mark Massaro with BTIG. Your line is open.

Hey, guys. Thanks for taking the questions. You know, Stephen, obviously you've called out some soft climate in biotech and cell and gene therapy that's very much consistent with what all of your peers have said. So there's really no surprise there. But I'd be curious to hear your thoughts on, you know, other areas of your business which are diversified. In areas like diagnostics, food, agriculture, I guess, what are you seeing across those other segments of your end markets?

Yeah, great question, Mark. And so outside of the sort of biopharma, early stage biotech, we do serve across all those segments from everything from academic to life science tools, diagnostics to food and ag. And I would say, generally speaking, the majority of those are kind of within line of expectations historically. We are coming over a tough year-on-year comparison, as you can see. You know, if you look at the first half of last year, the end of 21 and earliest part of 2022, we had a lot of larger biotech builds being made for clinical trials, and those were put on hold. So a year-on-year comparison is not significant. exactly fair from a financial perspective. But when you look, take a step down, we do see hotspots within spatial genomics, which I'm sure you're aware of. That group is growing quite nicely. And then some of the more novel diagnostic sites, like liquid biopsy and other genomic type of diagnostics, we're seeing some pickup there that is probably favorable or equal to what has been previously in like in a 21 time period, excluding, you know, COVID related diagnostics. So, you know, we do benefit from that and being a diverse business that can support all these customers.

Yeah, that makes sense. And congrats on the ribbon cutting of the GMP grade facility. Maybe can you just remind us what the new facility is likely to enable, whether it's from new customers, size of customers? Maybe just walk us through sort of how you see the business changing in the next couple of years.

Yeah.

Yeah, this is something we're really proud of. You know, we spent the last two years building out this facility. It really takes the company to a position where we can bring customers in and they're not concerned about the long-term ability for us to deliver for them. And like I said, we've had a number of customers through already and every one of them said, this is where we want our stuff made. This is perfect and what we're looking forward to moving towards over time. So that's all very positive. from the capability of the facility, you know, combined with our existing other facilities, we can get to about 200 million in total revenue from a capacity standpoint. But probably more relevant here is the fact that we have built a facility that specializes in these sort of less than 1,000 liter batch sizes. All the way down, we can do, you know, one liter bags or even smaller in this facility. And it's extremely flexible in how we operate with a number of redundancies. as well. So what we're finding and we bring some of these customers in is that it's not just the sort of the fact that we have this capacity, but we've built a purpose-built facility that can do this custom manufacturing at these small scales and then scale with them all the way up through commercialization. And they're excited and we are too. So I think, you know, the early indicators on us is that this is the right type of capability for them for the long term. And we're now kind of working them through the audit schedules and bringing them in. We'll do the pilot lots, and then over the course of the next couple years, you know, hopefully get and become one of their key suppliers as they go into clinical trials.

Okay. Thanks for the call.

Thank you. One moment for our next question. And that will come from the line of Jacob Johnson with Stevens. Your line is open.

Yeah, thanks for taking the question. Good afternoon. Maybe just another one on guidance as it relates to clinical solutions, kind of the implied back half number there. And I understand you had kind of lumpy order in 2Q, but it's still at the midpoint implies something kind of lighter than 1Q. And I understand the macro environment, but could you just speak to You know, why such a step down in the back half and maybe related, you know, the softness you're seeing, is it customers ordering less than you thought they would previously or are some of these orders getting pushed into 2024?

Yeah, I'll take it first and then Stephen can comment if he wants. So, yeah, I think your observation is fair, Jacob, the back half. guidance or implied guidance for the clinical solutions business and certainly a step down from what we've seen here in Q2. In general, what we're seeing is the environment is essentially unchanged from what we've been seeing earlier in the year. And of course, in Q2, we did have this particularly large order from one customer go through during the quarter. So we've gotten a nice boost during Q2. So Q3 and Q4, we'd expect it to go back to more normal, what we're seeing in this environment. Although, of course, we are expecting that to come back as the environment improves. But in terms of smaller orders or fewer customers, I think I've got Stephen community.

Yeah, I don't think there are fewer customers. I think we're getting smaller orders or delays. mostly, and it's a combination of both. I mean, some customers that used to order, you know, seven figures last year are still, you know, dedicated to using Technova for their builds, but they're talking about, you know, small six figures now for this year instead of seven figure type of thing. So that is a primary piece. And we do have some customers that have planned that originally there would be like a Q3 order Q4 delivery or Q2 order Q3 delivery that have gone out one or two quarters, right? And I think even they are not sure about the timing of when they are going to exactly meet those based on their own capital constraints. So that's what we're seeing. I mean, the excitement is there, and it's not like we're losing customers. It's really very much a market dynamic.

Got it. That's really helpful. Thanks for receiving. And then... We haven't talked about AAV tech in the Q&A, so maybe a question on that. Just one, how has initial reception been? And then two, can you just talk about initial launches from here? It sounds like two more this year, but how many more potentially beyond that? And then also, can you just remind us kind of how we should think about the revenue contribution from this? And I'll leave it there. Thank you. Yeah, great.

I'll start with the revenue contribution. I mean, Obviously, the products we're selling now in these AAV tech buffer screening kits is relatively insignificant to the overall business because the whole point of the screening kit is to get customers to try out a set of buffers that we know are going to work for them to help on that polishing step where they separate empty from full capsids and then get them into the right reagent that then they can scale up through process development and into the clinical trial. So, This is a long-term strategy here that will then play out over time and allows us to engage with them and get them into those trials faster than they would otherwise be able to do. The revenue contribution there is relatively small, but the portfolio itself is important to make as broad as possible. We want to support all of their production for AAV from end-to-end and across many serotypes. Yes, we have two out now. We plan to have two out again by the end of the year, two more. And we'll continue to go through. I think there's probably 10 or 11 stereotypes, but of which four or five are the most popular, which we're kind of knocking out at the moment. And then we launched this other suite of reagents that are going to make it so instead of people making their own standard reagents for lysis or purification or TFF, they can just buy our off-the-shelf reagents. And we'll continue to build out that portfolio throughout the rest of the year so that they can be kind of a one-stop shop for them as they start going down that process development piece and capture more dollar share as they move into the clinical trials. So, again, you know, altogether, maybe over time they will add up to be a decent amount of revenue in the early stages, but certainly as these go into clinical trials, that's where we'll see the biggest update.

Got it. Thanks for the questions.

Thank you. As I'm showing no further questions in the queue at this time, this concludes today's program. Thank you all for participating. You may now disconnect.