Inotiv, Inc. (NOTVQ) Earnings Call Transcript

Good day, everyone, and welcome to this Inotiv Third Quarter Earnings conference call. [Operator Instructions] And it's now my pleasure to turn the floor over to Mr. Bob Yedid. Please go ahead, sir.

Thank you, Jim, and good afternoon, everyone, and thank you for joining today's quarterly conference call with Inotiv's management team. Before we begin, I'd like to remind everyone that some of the statements that management will make on this call are considered forward-looking statements, including the statements about the company's future operating and financial results and plans. Such statements are subject to risks and uncertainties that could cause actual performance or achievements to be materially different from those projected. Any such statements represent management's expectations as of today's date. You should not place undue reliance on these forward-looking statements, and the company does not undertake any obligation to update or revise forward-looking statements, whether as a result of new information, future events or otherwise. Please refer to the company's SEC filings for further guidance on this matter. Management will also discuss certain non-GAAP financial measures in an effort to provide additional information for investors. Definition of these non-GAAP measures and reconciliations to the most comparable GAAP measures are included in the company's earnings release, which has been posted to the Investors section of the company's website, www.inotivco.com and is also available in the Form 8-K filed with the Securities and Exchange Commission. If you happen to obtain a copy of today's press release yet, you can do so by going to the Investors section of the company's website. Joining me today from Inotiv are Bob Leasure, President and Chief Executive Officer; and Beth Taylor, Chief Financial Officer; John Sagartz, Chief Strategy Officer, will join us for the question-and-answer portion of this call. Bob will begin with some opening remarks, after which Beth will provide a summary of the company's financial results for the third quarter of 2020 -- of fiscal 2024 and the 9 months ended June 30, 2024. And then we'll open the call for questions. With those remarks, it's my pleasure to turn the call over to Bob Leasure, CEO. Bob, please go ahead.

Thank you, Bob, and good afternoon to everyone joining our call today. Our third quarter was very productive for Inotiv. There were several critical events and accomplishments since our last quarterly call, which we believe will advance us towards our goal of being a leading midsized preclinical CRO in the marketplace. We're going to outline some of these for you now. These include, first, we reached a resolution of the Virginia DOJ investigation and related settlement, which we announced earlier. Second, we are announcing for the first time that on July 23, 2024, the U.S. Attorney's Office for the Southern District of Florida informed the company that it was no longer investigating the company or its subsidiaries with respect to the procurement of HPs from foreign suppliers or NHP importation practices. Third, we completed the U.K. site construction in Hillcrest and consolidation projects in our RMS segment as of the end of July and further reducing our expenses and allowing for additional contracts to start up in the U.K. to enhance our revenue. Fourth, further integrating and optimizing our transportation operations from which we are now seeing the benefits, including improved service levels, reduced costs through streamlined processes and increase efficiencies, producing faster response times and better experiences for our clients. Fifth, achieving year-to-date and quarter-over-quarter sales increases and margin improvements in our diet business globally. Sixth, achieving year-to-date and quarter-over-quarter sales increases and margin improvements in our European U.K. RMS business lines with the exception of NHPs. Seventh, achieving an approximate year-over-year -- year-to-date 32% increase in NHP boarding and breeding service revenues. Eighth, our newer safety assessment service offerings, including genetic toxicology and the biotherapeutic, biomedical service lines, we saw year-over-year growth in revenues and backlog year-to-date fiscal 2024 compared to year-to-date fiscal '23. Ninth, we implemented further integration initiatives and organizational changes, which allowed us to further reduce general and administrative expenses. Tenth, we are beginning to see early signs of recovery of the NHP market and increase existing purchase orders. If we deliver on these orders, we could double the volume of NHP sold in Q4 2024 compared to those sold in Q3 of '24 and estimate this volume would also see those would exceed those we sold in Q4 of fiscal 2023. Eleventh, we believe we are developing a solid foundation for a potential recovery in the NHP business starting in calendar year 2025. A key feature of some of the negotiations currently underway is the migration to long-term reoccurring contracts, and we will seek to continue -- to continue to diversify our customer base, a critical shift we initially announced in our February earnings call. Twelfth, we amended our loan agreement with our senior debt holders for the DOJ settlement received a waiver for non-compliance with our financial covenants as of June 30, 2024. And lastly, we finalized the sale of the assets we had listed for sale. All these positive items notwithstanding, we also still have headwinds, which we are watching closely and working to overcome. These include pricing pressures in our DSA business, which has impacted revenue growth and margins. Year-over-year declines in sales in our Discovery business, which are due to the softness of the market, we did implement a reduction in workforce related to our Discovery business, while increasing our sales and marketing efforts. The sales of the NHPs has come down along with the cost of acquiring them. The sale price of our NHPs, I should say it's come down along with the cost of acquiring them. And we expect pricing to remain in line with Q3, which is about 35% to 40% less than it was Q4 of 2023. However, we still have some higher cost HPs in inventory to sell. We will sell these higher-cost HPs and as we sell these -- our margins in Q4 of 2024 will be impacted within the RMS segment. NHP sales and margins for Q2 and Q3 of fiscal 2024 were down significantly compared to the same periods in fiscal 2023. NHP profits are down approximately $36 million for the first 9 months of fiscal year 2024 versus the same period in 2023. Overall, our adjusted EBITDA is roughly -- is down roughly $29 million year-to-date over the same period. As financial improvements in many other areas of our business are being recognized and some of the optimization projects are being completed. Now I'll give some comments on what we are seeing in the market today. In the DSA segment, the improved funding levels for biotech companies in the first half of calendar 2024 have been positive. We are seeing projects award -- project awards by some clients that have recently raised capital. However, we expect biopharma companies in the short term to continue to take a restrained conservative approach to the preclinical pipeline products in order to prioritize the use of limited capital to the most important projects. So far in fiscal 2024, our Discovery and Safety Assessment business has not seen the growth we have seen in recent years due to weakness in the Discovery market and related pricing pressures, which have impacted sales and margins. Our goal is to take advantage of our size and agility and continue to focus on quality, delivery and service. We are still a young company, which can grow with its existing customer base and attract new customers to gain market share. For the 9 months ended June 30, 2024, net new orders for DSA are running ahead of last year's pace by approximately 5%. Even with the industry price pressures we have seen in fiscal 2024 and approximately 10% decline in both revenue and orders in the early-stage Discovery business. We believe many of our NHP customers have been depleting NHP inventories they accumulated last year. As we've discussed on our last call, their on-hand inventory levels are now returning to more normalized levels. So we expect to see increased demand from these customers going forward as evidenced with the level of current purchase orders for Q4 of fiscal 2024 to date. The most significant challenge we faced financially this year-ending fiscal 2023 has been related to the volatility of sales and margins in our RMS business segment, and more specifically, our NHP business. As we have discussed in the past, the preclinical testing industry faced challenges and volatility resulting from the U.S. attorney's office permanently charging a Cambodian government official on alleged charges of conspiracy to illegally import HPs into the U.S. and the subsequent industry ban on the importation of Cambodian NHPs and to the U.S. in late 2022. This ultimately resulted in heightened concern among customers regarding their ability to access NHPs to develop the pipeline projects, which together drove higher HP pricing in fiscal 2023. The uncertainty and available supply in the U.S. also resulted in some discovery and preclinical studies moving to other countries, which further impacted drug discovery and development and overall demand for NHPs in the U.S. We previously indicated this year could be choppy as it relates to HP sales reflecting the after effects and volatility caused by the NHP market dynamics at the end of 2022 through 2023 and into the first half of fiscal 2024. We continue to evaluate options to reduce this volatility. And in addition to our qualified and existing suppliers, we continue to expand and work with multiple suppliers in multiple countries. Critically, as we evaluate new potential sources of NHPs, we continue to audit them rigorously for animal welfare and health centers and will not outsource from suppliers who do not and cannot meet those standards. This year, we have seen NHP customers work towards reducing some owned inventory and aligning their NHP purchases more closely with their immediate needs. As we enter long-term supply contracts for NHP starting in calendar 2025, we will hopefully be increasing and restoring the reliability consistency of our RMS revenues. Within our non-NHP-RMS business, over the last quarter, we have enjoyed solid demand in our small animal service business in the U.K. and Europe and globally for our diets and bedding business. Before turning the call over to Beth, I'd like to provide a review of our recent operational challenges and a broader strategic view of how the company has progressed over the last few years. Over the past 4 years, Inotiv has dramatically grown and added multiple new product and service offerings, while also integrating and optimizing the business we have acquired. Our operating goals included the company's effort to integrate and optimize facilities, improve our operations, take costs out of the business while improving service levels. We also completed significant investments to grow our service and to introduce ourselves to the market to obtain new customers and grow existing customers. Inotiv has faced some unexpected challenges over the past 2 years, as discussed above, but we continue to adapt and develop our business model for the long-term success. We believe we have improved our competitive position as a midsize full-service CRO and provider of research models and diet. We have made progress in consolidating our facility footprint over the past 3 years while also expanding and improving our existing facilities and operations. As a result, we have seen lower cost and improved service and efficiencies from our operations. We remain committed to building a business that can create value for our customers, employees and shareholders. As we have addressed some of the legal challenges and industry-related headwinds, we recognize our liquidity has been negatively impacted. We'll continue to evaluate our opportunities to improve our balance sheet and enhance our liquidity. In summary, starting in fiscal 2025, we expect to see a full year impact of the positive changes and cost efficiencies achieved to date as we are positioning ourselves to not be dependent solely on a potential market recovery to improve our operating results and cash flow. With that, I'll turn the call over to Beth, who will provide a more detailed synopsis of Inotiv's results for the quarter.

Thank you, Bob, and good afternoon, everyone. For the fiscal 2024 third quarter, total revenue was $105.8 million compared to $157.5 million during the prior year period, a decrease of 33% primarily due to a decrease in the number of NHPs sold and an approximate 35% reduction in NHP average price in the current quarter compared to the prior year period. The sale of the Israeli businesses in August 2023 and lower Safety and Discovery Services revenue. For the 9 months ended June 30, 2024, consolidated revenue was $360.3 million, down 16.5% compared to $431.7 million for the same period last year due to the decrease in NHPs sold and the sale of the Israeli businesses in August of 2023. DSA revenues in the 2024 third quarter decreased by approximately 6% to $44.2 million when compared to the prior year period of $46.8 million. The decrease in the DSA revenue was primarily driven by a decrease in general toxicology services due to a change in the mix of studies conducted in the 2024 third quarter compared to the 2023 third quarter and a decrease in DSA products and Discovery Services revenue. These impacts were partially offset by increases in genetic toxicology and biotherapeutic analysis revenue in connection with our newer service lines at our Rockville facility. DSA revenues for the 9 months ended June 30, 2024, were $135.5 million, which was slightly higher compared to the prior year period of $134.9 million. Overall, net new DSA orders this quarter were $40.4 million versus $48.6 million in the same quarter last year. For the year-to-date period ending June 30, 2024, we booked net new orders of $139.2 million versus $133.3 million for the 9 months ended June 30, 2023. The conversion rate this quarter was 31% versus 30% in the prior year. The DSA cancellations in Q3 were consistent with the prior year period. And in the first 9 months of fiscal 2024, they were slightly less than the same period in fiscal 2023. RMS revenue for the fiscal third quarter was down 44.4% to $61.6 million compared to $110.7 million the same quarter last year due primarily to the lower NHP related product and service revenue, mainly as a result of product volumes and pricing. In addition, there was a decrease in revenue of $3 million as a result of the sale of our Israeli businesses in August of last year. For the 9 months ended June 30, 2024, RMS revenue was down 24.3% to $224.8 million compared to $296.8 million in the same period last year. The decrease was due primarily to the negative impact of lower volumes of NHP sales, lower revenue as a result of the sale of our Israeli businesses in fiscal 2023. The remaining decrease in RMS revenue was due primarily to decreases in small animal sales and RMS services in the U.S., partially offset by an increase in diet and bedding sales on a global basis. Regarding NHP pricing, we indicated on our last conference call that NHP prices were expected to come down from the highs we saw in Q4 of fiscal 2023 and the first 2 quarters in fiscal 2024. We did see the average sales price of NHPs in Q3 of fiscal 2024 on average come down roughly 23% sequentially from Q2 of 2024. This was an approximate 35% decrease to the comparable period of fiscal 2023. As we are selling higher cost NHPs that were purchased in late calendar 2023 and early calendar 2024, we are realizing lower margins in fiscal year 2024. The current cost and anticipated costs in future contracts for the acquisition of NHPs are expected to be lower, which should favorably impact future margins. As we work through the higher cost in HPs in our inventory, RMS margins in the short term will continue to be depressed. Operating loss for the third quarter of fiscal 2024 was $20.8 million compared to operating income of $8.8 million from last year's fiscal third quarter, primarily due to a lower volume of NHP sales and lower margins on these sales, an additional $2 million charge related to the settlement agreement on June 3 with the DOJ to adjust our estimate that was recorded in Q2 fiscal 2024 and the impact of lower margins following the sale of our Israeli businesses. These items were partially offset by decreases in our provision of expected credit losses, restructuring costs, severance, remediation costs and legal and third-party fees. Consolidated net loss attributable to common shareholders in the third quarter of fiscal 2024 totaled $26.1 million or a $1 loss per diluted share. This compared to consolidated net income attributable to common shareholders of $1.8 million or $0.07 of earnings per diluted share in the third quarter of fiscal 2023. For the third quarter, adjusted EBITDA was $0.1 million or less than 1% of total revenues compared to $30.5 million or 19.4% of total revenue for last year's third quarter. For the 9 months ended June 30, 2024, adjusted EBITDA was $12.8 million or 3.6% of total revenues compared to the prior year period of $42.1 million or 9.8% of total revenue. Non-GAAP operating income for our DSA segment in the third quarter was $7.8 million or 17.6% of segment revenue compared to $10.2 million or 21.8% of segment revenue in last year's third quarter. As our new DSA services come fully online and we begin to fill newly added capacity, we believe we will see margin improvement through operating leverage. The book-to-bill ratio for DSA in the third quarter was 0.94:1. Our 9-month year-to-date fiscal 2024 book-to-bill was 1.06:1, and our trailing 12-month net book-to-bill was 0.95:1. Year-to-date June 30, 2024, we booked net new orders of $139.2 million versus $133.3 million for the 9 months ended June 30, 2023. The DSA cancellations in the third quarter were consistent with the prior year period. And year-to-date for the last 9 months were slightly less than the same period in the prior year. CSA backlog was $139.4 million at June 30, 2024, compared to $149.1 million at June 30, 2023. In our RMS segment, non-GAAP operating income in the third quarter of fiscal 2024 was $6.5 million or 10% of segment revenues compared to $35 million or 31.6% of segment revenues in last year's period. The lower non-GAAP operating income in Q3 fiscal year 2024 was primarily the result of a decrease in NHP sales and margins in the sale of our Israeli businesses in August of last year. And that was partially offset by favorable cost reductions related to legal and third-party fees, remediation costs, impairment charges, severance and a decrease in our provision for expected credit losses and restructuring costs. Interest expense in Q3 of 2024 increased to $12.1 million, up from $10.8 million in the last year's third quarter due to higher interest rates. Our balance sheet as of June 30, 2024, included $14.4 million in cash and cash equivalents as compared to $35.5 million on September 30, 2023. Total debt net of debt issuance cost as of June 30, 2024, was $382.4 million, relatively consistent with the $377.7 million at September 30, 2023. This includes $115.3 million of our convertible notes as of June 30, 2024. Net cash used by operations for the 9 months ended June 30, 2024, was $4.4 million compared to cash provided by operations of $9.1 million in the same period last year. Cash provided by operations for the trailing 12 months was $14.3 million. During the quarter ending June 30, 2024, the cash used in operations included $6.5 million paid under the settlement with the DOJ for the investigation related to the Cumberland facility that we closed in 2022. As of June 30, 2024, we were not in compliance with the financial covenants under our credit agreement, however, we received a waiver from our lenders. Capital expenditures in the third quarter were $4.4 million or 4.2% of total revenue. For the 9 months ended June 30, 2024, capital expenditures were $17 million or 4.7% of total revenue as compared to $21.3 million or 4.9% for the year-to-date period for 2023. The capital expenditures reflect investments in facility improvements, site expansion, enhancements to laboratory technology, improvements for animal welfare and system enhancements to improve the client experience. In terms of our capital improvements and site optimization plans, I'm pleased to report that we have completed many of the investments and initiatives started in mid-calendar year 2022. We expect these investments will be reduced further in the next 2 quarters and until we see a further recovery in revenue. Let's now turn to our guidance. We withdrew financial guidance last quarter for fiscal 2024. We expect to provide guidance for fiscal 2025 once we have greater clarity on the market and customer demand. And with that financial overview, we will turn the call over to our operator for your questions.

[Operator Instructions] We'll hear first from Matt Hewitt at Craig-Hallum.

A lot to unpack there, obviously, but it sounds like you're starting to see some signs of progress. Maybe first up regarding the NHP business. One, it's great to hear that the Florida DOJ situation is resolved. And I'm just curious, what does that mean from a legal expense standpoint, that goes down, goes away? And I guess, in general, it sounds like your legal expenses are going to drop pretty dramatically. Is that fair?

Beth, you want to address that, what we've spent so far in legal expenses. And yes, I hope they would begin to see those significantly reduce.

Yes. In regards to this particular matter, we hadn't received a subpoena since, I believe, June of 2021, but we were incurring some expenses in obviously monitoring the situation. So between that and the legal expenses for the Cumberland matter, I mean we should see expenses -- legal expenses come down for those matters by about probably about $2 million to $3 million a quarter.

Can you tell what we -- how much we spent over that on those cases in the last 2 years?

On the lone Cumberland case, in the last 2 years to address the legal inquiries and the closure of the site, we have spent -- in -- yes, before the settlement, it was approximately $21 million.

That's great to have that behind you finally. And it sounds like you're starting to see some signs of recovery. Do you expect that with Q4, we start to see the signs that that's improving? Or is it really '25 with the contracts in place, the kind of the pricing reset both on the sales side as well as on the cost side. I'm just trying to triangulate when that really starts to impact the numbers?

We're going to see, obviously, an improvement in Q4. We're going to sell potentially 130% more NHPs in Q4 than we did in Q3. As a matter of fact, I think we'll probably sell -- potentially sell 20% more than we did in Q4 of last year. So this will be one of the first quarter-over-quarter improvements we have seen in several quarters. The pricing will be in line with what it was last quarter and probably closer to what it was, again, in 2022 and early '23 before all this started taking, before the Cambodian issues started taking place in late '22. I believe that our margins, since we have higher cost NHPs and inventory right now for some we bought at the end of last year, we'll sell most all of those out in the Q4 period. So we'll start to see some of the margin improve going into 2025. And then I think we'll see much more consistency as we start to sell off the contracts in -- in calendar 2025. But I believe that the bump that we're seeing in Q4 is very encouraging, somewhat of a whiplash almost from where we've been in the last 2 quarters. And so that's probably an encouraging sign.

One of your peers reported yesterday and was talking a little bit about some of the headwinds that I think you're implying the industry is facing regarding not only small pharma. And I think you spoke to this a little bit, but small and medium-sized pharma and buyout -- pharma companies kind of holding that capital tight even if they recently raised. But then also even large pharma being a little more focused on clinical or later-stage programs versus earlier stage. It doesn't sound like you're necessarily seeing that some of -- given some of the commentary you made. But do you want to discuss that a little bit what you're seeing in the market?

Well, I'll remind everybody that in our DSA sales, less than 5% is to large pharma into the top pharma. So we are 95%, 97% of our sales is biotech. We still believe we've been able to differentiate ourselves on service, and we still are taking advantage of some of the services that we built that we're still, I think, developing and gaining some market share. So some of that, I think, has helped offset that, and I think still has the opportunity, again, to help us in the future. And remember, if you're comparing just other public companies in our space, we are still much smaller than they are. So again, we're $180 million, $200 million of DSA business. We can move the needle a little bit more with a $20 million increase in sales. We can also lose it a little bit more if we lose that $20 million. But so far, I think that we're focusing on what we can do to make sure we gain new accounts and grow with accounts that we have. And yes, I do think that we have seen a little bit of pricing pressure. And we've responded in case by case, where we have to. But for the most part, I think we still -- we feel -- we're in a pretty good position for what we see in the back half of this year. So we'll see what happens.

Congratulations on some of the progress that you've made here in a rather tough environment.

Thank you. Yes. So we're looking forward to maybe controlling our debts a little bit more next year.

[Operator Instructions] Our next question today comes from the line of Frank Takkinen at Lake Street Capital Markets.

This is Nelson Cox on for Frank. Good to hear you're starting to see some normalcy starting to return. Can you kind of touch on the end customer NHP inventory a bit more? I know it's maybe hard to quantify. But how do you think about that kind of reaching a normal inventory level? And is that kind of still 6 months out? Is it a year out? Or is it sooner than that with kind of the comments you've made?

Well, I think there are a couple of things that impact our customers' demand. One is their inventory level. Two is what volumes they have internally. Remember, many of these are CROs that have -- and some of the CROs are -- as you can see from the reporting are down or flat. So I think both of those things came back as but I believe many of them last year bought more than they needed and saw sales less than they expected. Those results had a lot more HPs. Right now, we've got good inquiry, good amount of POs in-house. I think people are being a little bit more cautious. But what we also don't have very good visibility to is what all of our competitor situation is. But right now, we feel like we're in a pretty good position. And I like 2 things. One, I like the current POs we have in house. I like the momentum I see towards our 2025 contracts, and 3, I really like the fact that we're diversifying our customer base. I think at one point, we had our customer base -- we had 25 -- one customer represented over 25% of our business. I think right now, in this quarter, we don't have anybody over 10% of our sales. Is that correct, Beth?

That's correct.

And so I think we've done a really good job of also diversifying our customer base, which is helping us a little bit.

And then maybe just quickly one more. Can you just talk a bit more about the investments you've made in the sales force and maybe the fruits you're starting to see from that so far?

I think last year, we announced about this time last year, we did not have a really early stage separate Discovery sales force. And we started building that last year and really through the end of the calendar '24 and into 2025, we were building that early-stage discovery sales force to go out and try to gain some market share. And as we continue to again to add to our services, our scientific talent and getting our scientists also more involved in the sale process. So that it doesn't happen overnight as we're developing relationships. But I think we're starting to see some of that -- the fruits of our labor there. Again, in the DSA business, we continue to look for ways to improve the way that we approach the market we're in and how to grow our customer base. And we have to balance that in line with our ability to add capacity, hire people and our equipment and brick-and-mortar and making sure that we can provide a great customer experience. We've -- so this goes hand in hand with really building our operations. What we don't want to do is acquire a customer and then not deliver. So we've been focusing on, again, our operations, our metrics, our systems to make sure we can deliver that client experience, and we feel comfortable, then we go out and try to grow. So to date, I think that some of the growth that we've had this year is not showing up because of some of the decrease in pricing. And a lot of the decrease in pricing, by the way, is in the NHP market because a lot of those -- or past due cost, we obviously, with the NHP costs being down, we're not passing that on as aggressive. So -- but I think that we still have the opportunity to continue to grow. I think we have a great team, a great group of scientists, believe in our team, and we look forward to seeing what we can do in 2025.

Our next question today will come from the line of Dave Windley at Jefferies.