Alpha Teknova, Inc. (TKNO) Earnings Call Transcript & Summary

Well, good morning, everyone. Welcome to the 2022 Global Healthcare Morgan Stanley Conference. This morning, we have the pleasure of hosting the Alpha Teknova team. We have CEO, Stephen Gunstream; and CFO, Matthew Lowell. Before we get started, we have a research disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Thank you. My name is [ Rock Benham ]. I'm an Executive Director in the Morgan Stanley Healthcare Investment Banking Group. Stephen and Matt, maybe you could tell us quickly about kind of your company and your background just to get it started.

Sure. Great. Well, first of all, thank you for hosting us. It's been a great conference, and we're looking forward to the discussion today. I'll start. So my name is Stephen Gunstream. I'm the CEO and President of Teknova. I've been at Teknova since December of 2019. Prior to that, I was at BD Biosciences, before that Integrated DNA Technologies and before that, Applied Biosystems, before it eventually became Thermo. And here at Teknova we're a leading provider of reagents for the discovery, development and commercialization of next-generation therapies, diagnostics and vaccines, differentiated by our ability to make customer agents. So we make -- a customer can come to us, they provide us a list of formulation of what they would like, what QC they need, what container they need, and then we can get that into production in a matter of weeks instead of months. In addition, we operate in scales less than 2,000 liters, and we span from discovery all the way through clinical, so we can support those customers as they go all the way through that. As you can see, as I described those different attributes, the custom, the scale and the speed, we're a really good fit for companies in the early to midsized biotech, particularly cell and gene therapy that need these solutions. And that's kind of where we are today. We have 3,000 active customers. We have a 97% retention rate of those customers. We have over 80 cell and gene therapy customers purchasing from us today and are excited about what we're building. And we can talk a little bit more about in the future -- in the coming minutes here. But maybe I'll hand it to Matt to do his introduction.

Yes, sure. Thanks, [ Rock ]. I'm Matt. I'm the CFO of Teknova. Joined the company about 1.5 years ago and that's after spending about 20 years in the medical device space. I worked for Varian and Varex in corporate development, strategy and finance roles. And prior to that, I worked in the ophthalmology space for about 10 years. So it's been a pleasure to be a part of this team and very excited about the future here.

Well, great. Thank you.

Maybe we can start with kind of a general kind of thematic overview of the biotech funding environment, and at the highest level, to what impact how much of your business comes from biotech versus the tools and diagnostics companies and kind of any impact that you're seeing from your business perspective?

Sure. Let me start by just kind of offering a little bit about the company's products and then how that ties in here. So we basically offer 3 main products in the space. They are agar plates, so growing bacteria and other organisms in a 2D format; liquid media or broth to grow in 3D format; and then molecular biology buffers, which is everything from water, all the way to complex chromatography buffers with different [ stocks ] and [ elements ] and things like that. And because of that, we are kind of the lifeblood for the entire life science community. So to get back to your question, from a biotech funding perspective about approximately about 1/2 of our business actually is related to biopharma, whether that's biotech, large pharma, CDMOs, CROs. And then obviously, the -- because of the products we offer, yes, there is an impact from some of the biotech funding, particularly for us in that we didn't receive our certification to manufacture clinical reagents until 2018. And then real investments into that space to grow that area didn't really start happening until 2019-2020. So the majority of our clinical customers are actually in that early phase of preclinical Phase I. And so while we're very excited about supporting them and we see that we fit a great need there, obviously, the constraints on capital and things like that have affected our sort of near-term results. We see this as be largely transitory in nature. We had a fantastic first half of the year. We grew over 40% year-on-year. But when we look to the back half of the year, we had a couple of customers call us and say, we had these large orders coming. We still want those orders. They're not being canceled. We just don't know exactly the timing. And so we lowered guidance for the back half of this year. But fully expect long-term to be in a great spot for us as well. As we see our funnel today in 2023, nothing seems to be moving -- sliding out there. So we're very comfortable with where we are and optimistic about the future. But yes, this sort of near-term biotech funding environment has hit us specifically just because of where we sit with these customers today.

And maybe just as an extension, you kind of alluded to this a little bit, but can you talk about your current revenue mix and your client -- customer type and kind of where you are now and where you want to be kind of on a run rate basis?

Sure. So we disaggregate our revenue into 2 different categories. One is what we call Lab Essentials, which is our research use only products. And the second is Clinical Solutions, which is our -- obviously, our clinical side of the business. And we look at our products as our customers move from what we call catalog to custom to clinical or GMP reagents. As they migrate down that pipeline they spend significantly more. So you think about, the company was actually founded in 1996. It's been around quite some time. We have a great base of customers, like I said, about 3,000. We serve every major pharma biotech, life science tools player, diagnostic company in the life science today with 3,000 active customers. That's because of the work that was done many years ago to establish ourselves as a key reagent supplier in your stock room for discovery purposes, right? Over time, we evolved in adding this custom capability. So this our unique modular manufacturing process allows us to take an order in, figure out how to manufacture it really quickly and get it into production. That is something very unique to us. And so that customer manufacturing capability is also within that research use only. So customers typically would buy or use our stock reagents. They're trying to figure out, for example, say, they identify a drug target. Now they want to figure out how to manufacture that in their process development phases. So they look at the reagents that are out there. They then custom order a number of different reagents to help them figure out how to say purify and AAV, for instance. Once they identify what they want, then they can then migrate to the clinical side, scale up in terms of volume, but also scale up in terms of quality standards, and then we could provide that for them. So as they migrate down that pipeline, on average, we see that the spend increase, it goes up about tenfold. So if a catalog customer spends on average $1,000 to $10,000, the custom customer spends $10,000 to $100,000 and then the clinical is hundreds of millions.

Got it. And if I'm a biotech company or I'm working in the academic lab and I'm trying to figure out like just running experiments and looking for reagents. Like who are -- like, who are some of the key players in the industry, including outside of yourself?

If you're -- I'm sorry, say it again, please.

If I'm looking for reagents and as a biotech company, like, who would I call?

Yes. So look, there's a number of players out there. It depends on what type of reagents you're looking for, right? So like I said, we provide a number of different reagents for your standard off-the-shelf type of products. We see our competition is -- maybe it's kind of more interested in -- is really 2 different categories. The first is large suppliers like the Sigma Millipores, the Danahers, the Cytiva, the Thermos, the [ GEPCO ] and things like that. They tend to be set up for large volumes in the bioproduction space, so for monoclonal antibody production. These are in the tens of thousands of liters. They're not typically yet built for a custom manufacturing environment at the scale which we offer. But they are obviously great suppliers for the space. On the other side, we have -- you have to think about in-house production, homebrew. A lot of these customers, because there hasn't been a supplier in the space for quite some time that can do this, the ability for us to make these -- manufacture these products at the scale we offer is pretty unique. Many of those customers have actually set up their own manufacturing processes, whether it's their own buffer manufacturing or medias manufacturing in-house.

Got it. So it sounds like kind of your real edge here is your ability to work with some of the smaller companies where you're trying to develop a custom process and providing custom reagents for such processes. Is that kind of the right way to characterize?

Yes, I think the easiest way to think about it is, look, if you're in the process of developing a novel therapy -- the vaccine, right, you do the discovery and then you have to figure out how to manufacture this at scale. In that process, you are going through multiple iterations, multiple different types of reagents, whether it is for plasma production, for upstream production or downstream production, you need a ton of different reagents in there. And each step of those needs to be customized now more than it ever has before, right? We're migrating from blockbuster drugs to personalized medicine. And then even with these things like mRNA or AAV or things like that, you really have to customize based on the size of the gene or the AAV capsids use. And so everything is a lot more custom than it used to be. So typically, our customers reach out to us in that process development phase and they say, look, we are struggling to figure out how to manufacture this. It's the efficiency we need. We'd like to try these 10 different buffers. We can get that to production to them really quickly. So they get that in weeks instead of months. And then they figure out which ones they need. And then, of course, we can then take that and quickly turn that into a GMP-grade reagent that they can then use in their clinical trials.

Got it. So maybe kind of going into your pipeline, one of the trends that we see is kind of the growth of this cell and gene therapy landscape. How -- in your pipeline, how robust is that cell and gene therapy segment at this time? And maybe you can talk a little bit about how much of your business comes from these services -- service lines now versus when you went public. And also kind of looking into the future, how you see that mix evolving?

Yes. I think what we believe and from talking to our customers as well is that, obviously, this next modality in medicine is coming. There are over 2,000 active clinical trials in cell and gene therapy today. The vast majority of those are preclinical or Phase I. So this will take some time to get through the system, but the impact that it can have on health care is tremendous. So our goal, of course, is to support them in making that happen. And from an exposure perspective, right, so we don't disclose exactly how much our revenue is from those, but I can say that we have over 80 active cell and gene therapy companies purchasing from us today, of which about 20% of those are in the clinical reagents buying from this now. So they're migrating down that pipeline. And we've seen progression of that over -- since we went public, where that was about 10% or so in the clinical side. So we're seeing significant growth there, and that's actually a big driver of business.

Okay. And can you talk a little bit about your margin profile with these various business lines?

Yes. Maybe I'll talk about it in the same way that Stephen did. So we have our Lab Essentials category of products and our Clinical Solutions. And basically, there's a difference in the margin profile for these 2 products for the research grade products. These are in the range of 40% to 60% type of gross margin. Some of these are catalog products. Some of them are custom products, and they can spend anywhere in the range there. It's not an exact precise percentage there. But we also have our Clinical Products, which come at a higher margin for us and typically those at attractive price premiums, because it's a higher quality product. And in addition, we sell those in larger volume formats, which also has a little better unit economics for us. So those tend to range from the 60% to 80% gross margin. So over time, as we see more of our business move towards the clinical side, we'll see some benefits from mix shift there. But really, what's driving our overall gross margin when you talk about product level margins is the utilization of our fixed cost investment in manufacturing. We have a pretty high fixed cost operation. In fact, we're building a new facility right now that will be ready at the end of the year, and it's going to fully revolutionize the way that we make product. But from a financial perspective, it's a big fixed cost. And just in general, growing the business is going to provide a lot of leverage and margin expansion down the road.

And maybe on that point, my understanding is that your new facility in Hollister could support up to about $150 million in revenue each year. But currently, you're guiding to about $38 million to $42 million in revenue this year. So could you maybe help us understand bridge to kind of going from kind of what you're guiding to this year and kind of the full capacity utilization? And also, how much of that do you think comes from new clients versus existing clients through upsells and cross-sells?

Okay. So yes, let's talk about the new facility. This is a pretty exciting event for us. We're rolling into the end of this year, which will turn as operational. And then we'll go through a couple of quarters to get it certified to be able to manufacture clinical reagents. The company is, like I said, been around since 1996. In the last probably 10 years -- 8 to 10 years really established this modular manufacturing process, where you can take these orders in, swap routings out and really be able to make products very, very quickly. That is doable now with that work, right, to do, say, tens of orders a day at customer agents, right? But to do hundreds of thousands, you really need to transform the manufacturing process. We've taken this process. We've, with that in mind, really designed an entire facility, utilities, clean rooms and equipment to match so that we can very quickly and continuously manufacture reagents in a custom format, in a clinical environment. And so, obviously, it's a big step change for us, and as you mentioned, we'll get an additional $150 million in revenue capacity out of that. We'd like to think of it as actually work order capacity, how many work orders can we turn today, not exactly how many liters are produced, right? So for us its, we take this orders, how fast can we get them into production. And so to get back to your question, right, this new facility provides us an ability to bring on new customers very quickly. And if you're a custom manufacturer, like we are, the last thing we want to do is run out of capacity, right? So we're leaning forward here, and making sure we have the capacity. If someone does have a big order, we can get it in production really, really quickly. And so the bridge there is, look, obviously, these customers are migrating from that catalog to custom to GMP, and as they do that their spend increases. So we will be working with the vast majority of these customers are already our customers. They're just using us mostly in the research side. They don't realize that we have the custom and the clinical piece, and that is why we're investing quite a bit in the commercial piece, right? And so the combination of this new facility and our commercial investments, we believe, is huge opportunity for us to expand over the next 5 years.

Can you maybe touch a little bit on, when you get a custom order, the turnaround time from order to fulfilling that order?

Yes, absolutely. So it obviously varies depending on the type of product and how much someone wants to order. But I think what we've set up internally is something that is very differentiated compared to the way others process orders. So we'll get a customer will say, look, I need this very specific, say, chromatography buffer. It's got these 15 different ingredients. We have 25 years' know-how and figure out how do you add those ingredients, how do you mix them, how do you sterilize them. And then we have our own engineering department that's built custom, automated dispensing machines, whether you want tubes, bottles, bags, we can then plug and play those and get that into those containers. And so, obviously, from the time they place that order, we have to create a part number, we have to create the routings. We also have to order the raw materials if they're not already in. If they're GMP-grade, we have to do raw material QC, and then we can have it hit the floor and make the product. So coordinating all those things is not a simple task, and I think that's what we do really, really well in addition to obviously the ability from a physical perspective. And so we typically, if a customer came to us today with the GMP reagent that we had the materials in stock, and it's something that we've pretty much made before, which we have made many things. We have over 4,000 active SKUs. We can probably get it into production in 2 to 3 weeks, and then they get their product in 2 to 3 weeks after that, because there's usually about a 14-day QC hold. In contract, if you were to go to another supplier, it might take months or quarters to get that right now just because they're not set up for the scale that these customers are looking for or the custom manufacturing process.

Thanks Stephen. And back to your earlier point on your commercial efforts. With your new sales teams, where are you focusing your efforts right now? And also, how much migration from working with distributors to direct sales do you think is possible as you grow?

Yes. So I joined the company in December 2019. And in 2020, really hired the first 2 sales reps for the company. The company was completely built over time without any external capital all the way until 2019 when our largest shareholder, Telegraph Hill Partners, acquired the majority of shares of the business. And so there are very little investments in the commercial side. So we're building this from scratch. So you had to imagine like most of our revenue is generated by a word of mouth from one individual to another, working with the company and passing that around. And so obviously, we're building a decent investment into the commercial side instead of being reactive to these customers coming to us when they figure out what we can do, to being proactive. So we're really targeting in the field, we're targeting the cell and gene therapy companies, particularly process development where they can customize those reagents before they go into clinical trials. We're hiring individuals. They are PhDs in cell and gene therapy, experts to have that science. It's a science conversation. Internally, we are establishing a group of what we call account executives that are the customers' primary point of contact. Like I said, we have contacts with almost all of these companies already. How do we manage their orders, what do they need from a quote perspective. Also, what else should they be buying from us. And then, of course, we have a number of other commercial operations roles and inside sales and other things that we're building, and all that's kind of coming to fruition towards the end of this year as well. So it's a combination of the facility, the new operating process as well as the commercial piece that's really timed nicely.

I know we don't have much time left. So maybe we can talk a little bit about your innovation efforts. Where will you be spending time and your efforts there? Can you try to give us a sense of where currently where you think your catalog is the most fulsome and kind of areas where you think there's still some room to add to your roster? And also what are some of the new product lines that you'd like to highlight for us today?

So for our perspective, there's innovation in multiple ways. So, obviously, this new platform for manufacturing is very innovative in how we set that up. We've talked about that. But in addition to the third sort of leg of the stool from our investment is R&D. So commercial capacity and R&D. And I'm very excited about the progress we've made in our team that we've established so far. We benefit from the fact that we have access to these customers. We know how complicated it is to manufacture these novel therapies. And so we actually started making some of those in-house to learn how to do it, but also recognize which type of reagents are needed and what are the biggest pain points. And so now we're partnering with our customers to figure that out and then solve those problems. And particularly, we're identifying different reagents are needed for different steps in the process, what is needed to be custom, what can be standard off-the-shelf product that we can put into our catalog as well, as a lot of the analytics are really challenging right now for this space. And so we feel like we're in a great position to start releasing products towards the end of next year that will help solve some of these bioproduction inefficiency issues.

Yes. Got it. Maybe talking a little bit about kind of growth potential and growth areas. You currently have about, what, 96% of your sales coming from the U.S. How do you think about international expansion? And also will the selling model be different in other countries versus U.S?

So from an international expansion, you're absolutely right, the vast majority of our sales in the United States. There is limited efforts, historically, into expanding outside the United States. What we want to do is we're establishing this new facility and operating model, and then we're going to replicate that and started putting that around the world, similar to I have done in a different company that I have worked with in the past. So we are going to get this right, and then we're going to replicate it. So you run the same equipment, the same SOPs and make sure customers are getting the exact same speed and quality of product no matter where you are. So we see that as a big opportunity. We want to get the model right. And I would say the same thing on the commercial side as well, right? And I would expect that to be in a couple of years of time.

Okay. Well, anything that you want to highlight about Teknova that we maybe haven't touched on today?

I mean, I would just -- I think the last thing I would say is, look, we didn't touch on the fact that we have a leadership team that's been well established. Been small company that knows how to build something to scale. We have the capital from our IPO that will get us to cash flow positive. We are investing heavily in areas that we know will allow us to scale in high-growth markets. And we're very excited about where we sit right now. And we're seeing all the indicators that this is going to be a great success story over the next 5 years.

Well, great. Well, thank you very much for your time this morning. It's been a pleasure and hope you entered the rest of the conference. Thank you.

Thank you.

Thank you.