Mesa Laboratories, Inc. (MLAB) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to the 44th Annual JPMorgan Healthcare Conference. My name is Tavon Wilson, Associate Healthcare Group based out of New York. Pleased to introduce Gary Owens and John Sakys, CEO and CFO of Mesa Labs. Thank you.

Thank you, Tavon, and thank you, JPMorgan, for hosting the conference again this year and having us come. Safe harbor statement. I'm pretty sure everyone has got out their legal prescription glasses to get through this one. Mesa Labs, for those of you who aren't over familiar with the story, we're a diversified tools who focuses on mission-critical quality controls for regulated markets. What this means is we enter the drug's life cycle in the development phase, typically clinical trial support, and then we help to make sure that those drugs are intact and get to the right people all the way through development, bioproduction and into the health care system. As such, you see our purpose is not -- doesn't come up with a big scientific statement, right? Our purpose is very human-centric, and we focus on protecting the vulnerable to make sure that the people get the right drugs and that those drugs are manufactured correctly and that they are of highest quality by the time they get to an arm, not just out of a manufacturing plant. So we are diversified. We do focus on biopharmaceutical. These highly regulated end markets have a natural stickiness to them as we'll talk about when we talk about our consumable and recurring revenue exposure. Because we focus on the development of drugs, right, we have no NIH funding, right? We're not in academia or anywhere else. We are a broad platform because of the unique needs of these regulated markets and the stability of underlying core technologies, we tend to do is we buy core technologies that are proven. We continue to evolve the applications that they can serve, and we then continue to have recurring revenue stream. The real focus there is then less on being a technology clear or dominant player in one mode of technology, but a market leader for a very important set of customers who have very distinct needs, and that's how we compete against those who have maybe a broader footprint. Also how we maintain focus for our commercial energy and our commercial efforts. We are a disciplined management team. We come from a long background at places you would know, Danaher, Thermo Fisher, Cytiva, Agilent, right, deep operating experience. And we do focus on our version of a lean operating model, which we call the Mesa Way. We operate in 4 segments today, 40, 20, 20, 20 is kind of how I think about them. The largest being sterility controls. So we ensure that the biologic-based drugs have no contaminants in them that might actually impact the patient safety. We operate then in biopharmaceutical development, which is a protein analytical platform as most drugs are either proteins or their effect on humans are based on proteins, a very critical technique. Behind that sits the genomic platform. Obviously, the proteins are created by genes. And so in as much as you have protein deviations, we help to understand the genetic backdrop to those protein deviations or -- and how those can patient safety and health. And our calibration solutions business is really about environmental monitoring. So what is the environment that those biologically based drugs are living in? And is that safe for them and healthy for them? So just to get some of the numbers out of the way. Last year, we were around $240 million in revenue. We've been on a 5-year CAGR of around 15%. I think actually, if you went back around 10 years, you'd see right around the same number. We are, for a small company of that size, highly profitable, so close to 63% gross margin. If you think about that, you take out things like amortization, depreciation on a cash gross margin basis, extremely accretive. So we do focus a lot on our organic growth because the operating leverage profile is there. And for this scale, I think we are the, if not one of the very 1 or 2 that are actually meaningfully profitable, and that's AOI, excluding unusual items is our version of an adjusted EBITDA number. We have been working on increasing our core organic growth rate. So we went from 1%, which is kind of a very obviously unexciting growth rate before to around 3.5% to 4% over the last few years. Obviously, during a lot of ups and downs in the marketplace, we would say that our main leading indicator for the health of our business is clinical trial starts. And so as clinical trial starts really crash during this period, we feel like we are picking up share against those. And obviously, as clinical trial starts to gain, we expect to see acceleration of the core business. We've been really conscious about changing the profile of the business. As you see, the difference between organic and the total growth, right, is obviously some inorganic activity that we've done to increase the quality of the portfolio, and that we really focus on our vertical market exposure or the end applications that we serve to try to drive that opportunity growth rate higher. And lean for something is not -- it's not like words and it's not shallow. Danaher used to call it fake DBS, right? That's not for us. We do 24 -- I'm sorry, 42 different lean events last year. And you'll see a regular cadence of how we think about improving using experimentation, the quality of our business processes and our ability to serve customers better. This is kind of back to a chart, right, shows that, that compounding has occurred, and this is the last 10 years or so. You'll see like a pretty steady underlying growth rate despite a lot of market turmoil. Additionally, what you'll see is that our AOI has increased in action or in line with that, meaning we focus on acquisitions and/or leveraging a highly profitable companies, not companies that are built off of revenue multiples or something like that. Okay. So a little bit deeper dive into where we focus, and I'll actually start in the upper right-hand corner. We focus on protein analytics, a highly automated singleplex ELISA platform. It turns out that this is exactly perfect for supporting clinical trials and engineering a bioprocess. So if you think about what are the first things you do in clinical trial support it's called the PK/PD assays. You inject the drug into somebody for the first time, and you see where it goes and what it does. You haven't been able to do that so far. And obviously, you're impacting patient safety. So a whole rigor around exact quantification of what that is. You're looking at things like dosing and everything else. Great trends here. Obviously, we've been able to -- now that we've gotten a certain amount of scale, expand our penetration globally. And so we have a number of -- we have 30 to 40 people on the ground in China who are helping us to penetrate that market, novel applications for the kinds of tools that we serve. We have a razor-razor blade model, and we expect to see both consumables and services associated with this dedicated analytical device continue to grow. And we do actually also play in the GLP-1s, where we have peptide synthesizers that are capable of helping with the screening and the efficacy and development of new peptide-based modalities regardless of whether they're GLP-1s or other adjacents. If you think about what underlies some of those protein analytical differences, so in clinical trials one, you might find that you have highly differentiated results for people based off of dosing and mechanisms. Well, there's often underlying a genetic background of that, that deals with how you metabolize those drugs. So in our genomics division, what we do is we analyze the background of some of these individual genes looking for markers that belong on the drug label and FDA-related drug label to make sure they get matched with the right therapy and/or that they get the right dosing associated with how quickly or how slowly they might those drugs. There, we're growing double digits outside of China. China has obviously been a bit of a challenge during the period where there's been a concerted effort to not have an American presence in the diagnostic supply chain. And so those things are offsetting. Obviously, from a sequential standpoint, we don't see any additional headwinds coming out of China related to this business, but that will take through liberation day impact of our coming fiscal year to see that show up in the year-over-year numbers. The -- likewise, we use that same protein analyzer to characterize each step in a biomanufacturing process. So if you have a tangential viral filtration filter, the kinds of questions that you're asking is good product in one side, good product out the other side. Did I happen to filter out tighter along with those viral particles? Did I get the viral particles out? Did I accidentally damage the protein going through this process? Did I actually introduce any new leachables into that? Those are all the kinds of questions we would answer with our protein analytics as well on the bioprocessing side. Then we ensure that because that is an organic process, lots of things like to grow in an organic process and spin-off, and we ensure that those things are indeed sterile as part of the manufacturing process itself. And then we ensure that the environment that those drugs are living in have the right chemical and physical parameters to ensure the integrity of those drugs in the long term and the integrity of the process itself. And often, we'll follow that into the health care system to ensure that they're not denaturing or whatever it might be, all the way to a customer's arms. So that kind of is maybe a little bit more detail, right, that some people might get into. Really think about it as we don't start in discovery. We start in drug development, clinical trials is one. We have a series of tools in these highly regulated markets that kind of complement each other. And that enables us both to have a differentiated set of technologies and regulatory barriers that keep larger players out of our market and the focus of our commercial efforts that we get commercial efficiency. And this happens both on the patient and the clinical trial support side as well as a parallel process that happens in designing and engineering your process and then using that in pharmaceutical QC in real time. This is just simply an example of the kind of solutions that we have. We call it pharmacokinetics. What does the body do to the drug, right? How does the drug persist in your body over time? How does it get metabolized and flushed out? Obviously that kind of curve profile is not what you're looking for in a drug. You want persistent levels of that drug, active drug in your body. Likewise, pharmacodynamics, we understand how much dosing needs to happen to affect that drug. Before then, you're playing around with cells on plates and squirting things on it. And there is no system in place, human body that affects that. These are the only times you start to begin to understand the complicated things of how the drug is reacting in the body, not only for the target of interest, call it lung cancer, but how much of it ends up on the back of your retina and what does that do? How much of it ends up going to your liver and causing toxicology. How do the metabolites as your body naturally attacks these organic molecules and metabolizes them, what happens to those and where are those? How does your immune system respond? Behind a lot of these things, when you look at outliers or you look at lots of different drugs going after the same kind of disease state, really end up affecting how does that person going to respond and that has a genetic underlying tone to it, which is called pharmacogenomics, pharmacogenetics. And those are the things that we measure with our other platform in genomics segment. So this is just an example of how we think about how we built this business before. We kind of rank these in terms of regulatory intensity. And obviously, for a company that focuses on regulated tools, regulatory intensity is actually a good thing. So we like pharmaceutical drugs, medical devices and the manufacturing of those is what we would say here, not the discovery of those, but the manufacturing, clinical genomics is the application of all that information that comes out of those clinical trials into the clinical setting to help match a patient to the right therapy. And then obviously, from a regulatory standpoint, a lot of the same regulations fall into health care services and FDA has food at the very beginning of it. And so you find that a lot of the regulations also cover food, and we take a more opportunistic approach for how those would affect our business. You take that same view on the left and you match it with the view on the right. So we would say we are 75% plus recurring revenue. That is consumables that are spec-ed into a drug manufacturing process, consumables that are dedicated to our platforms that are unique and required to run our platforms. The service associated with those, which in a regulated environment is not going out to the lowest bidder or Joe's body shop to come service. And that's really a core of our business. And really, what we're doing is placing the CapEx hardware at the top, big ticket stuff, right, to get that ongoing consumable revenue stream. How this all comes together and how you operate a business with a diverse set of technologies, but going to a common endpoint is really our application of that lean-based operating model, right? You start with the heart of protecting the vulnerable. We follow that through with the Mesa Way, a very experimental, if you're a scientist, right, everything you expect when you're writing a scientific paper, what's your hypothesis, what variables are you changing the equation? What outcome do you expect? How am I isolating that variable and understanding how it impacts it. It's no different in the business world. You're doing the same exact things over and over again that you would do in science instead of doing it on a bench lab, we do it in the real world with businesses. So we measure what matters and we run experiments to try to do that. That enables us to empower teams by having a common language for how we evaluate and improve our businesses, enables them to manage this diversity of technologies and portfolios. We focus on always improving. That's our goal, not to be perfect. Naturally, what we do in quality control, we demand perfect perfection for our customers. We're never going to be perfect ourselves. We're all humans, but we can always get better as well. And so we're always going to be improving and then constantly creating this learning loop and this learning cycle. It really makes it a fun and exciting place to be. And you'll find that we attract a certain number of people who've been in the space, right, and are really looking for that entrepreneurialism, but also looking for that customer intensity that maybe you don't get from a larger organization. We talked about our inorganic strategy. This is an example of the last one that we did, GKE, we had a relationship with this company for about 9 years. What they do is they make an alternative kind of sterility indicator. It's called the chemical indicator. It's more of a process monitoring, so they can ensure that your sterility process is working correctly. It has lots of utility and use. This complements our biologic indicators, which will tell you everything is indeed dead. So not the process work correctly, but actually the results of the process work correctly. These are highly complementary to what we do. These are the kind of companies that we would bring unique access to for some of you guys, right? These smaller entrepreneurial companies, right, that aren't in the public markets today, they become part of Mesa and we help them to grow and indirectly, you get exposure to that. There's a series of steps around sterility, and we work to integrate workflows and how we can have a complementary set products around the workflow that are unique to these highly regulated environments, and that's how we kind of build out our portfolio of businesses over time. The last acquisition because this was controversial isn't the right word. But to get there, we needed to increase our debt levels to approximately 3.8x, 3.9x. This was when interest rates are really high. So there was a little bit of trepidation, right, in terms of certain Bloomberg metrics or other things. So we had a committed target there. We overdelivered that by about 15% to 20%. We hit our core revenue growth of above mid-single digits. So it's accretive to our core revenue profile and accretive to our financial metrics, and this was acquired at about 9x for 100% consumable business. So these are the kind of things that we can do with access to capital that perhaps are more meaningful. You saw that was around 8%, 9% grower for us at the time that if you're looking at other large diversified tool companies, right, their acquisition programs have a hard time actually being meaningful to the total profile of the company. But when we do this right, we can make a real impact for the company and our long-term growth rate. So where do we go from here? Like I said, clinical trials, I think, for the last 1.5 years or so have kind of flatlined and started to tick up. As we see that market return to health, whether it's from biotech funding and other activities or contributions from outside the America, things going on in China right now that have growth or things kind of people having the funding to accelerate more things in the clinical trials, we expect to grow with that and see that 3%, 4%, 5% kind of percent growth rate accelerate. We continue to evolve core platforms. You noticed I didn't say something about protein analytics. That's a pretty broad statement, right, when you talk about how the body works, which is 100% on proteins. So we have generic platforms that have big domain space and then what people buy those lots of small applications within that. So we get a proven platform, and then we continue to do application development work that both builds our credibility as a resource to come to and the person you come to when you have a protein analytical question, which are hundreds of different questions and support of clinical trials and move from one application to the other over time to accelerate our organic growth rate. Now that we're getting large enough, we can continue to expand geographically and bring some of those products that might have gone distribution in other markets to where we can enhance that with direct sales and higher customer intimacy to continue to increase our growth rate. We experiment in our commercial ways and use the Mesa Way, which is a highly commercially focused implementation of lean-based operating model, continue to try to grow from there. Naturally, like we talked about before, our operating metrics are really good. So organic growth really has a great financial profile. Our balance sheet is now like I said we were at about 3.8x, 3.9x. Today, we would say I think we're below 3x. Obviously, we ended the last quarter, which was in September 30 right at 3x, and we expect that to continue to go. And when the markets open up again, we think we can find another series of different acquisitions, which will continue to enhance the story and give us scale and leverage in some of those other areas and enhance our financial profile long term. So way we go. Thank you very much. Appreciate your time.

Thank you, Gary, and I appreciate your time and your remarks. We'll take some questions from the audience, but I have a few prepared here as well. And I think a good format for this, we'll start broad and talk about Mesa sort of generally and even just like market generally, and then we'll kind of start to zoom in. So maybe going into the mid-range, and then we'll get maybe targeted to some discrete items.

But I guess to start, I heard you say that you said Mesa is very human-centric from like a vision and strategy perspective. Could you double-click a little bit on that? And how does it make you different from your peers in the LST market?

Yes. I think this is just from a business model perspective, a matter of being in the regulated markets, right? Every answer we have is not about seeing something cool that hasn't been seen before. It's about patient safety and efficacy of the drug being manufactured. That means that when we do our job poorly, people are at risk of dying. That then leads to this regulatory cycle where you're under the watch of the FDA. That means that to do your job well, right, for us, quality is job one. You don't ship a product if it's questionable about whether it's going to work, you don't ship, you focus on quality and the improvement of the quality of the products, maintain that integrity. That gives you integrity with your customers, which develops long-term reputation and where you go from there. The way that you get people motivated to do that, right, you remind them that when they're sitting around their holiday table, they can look out at their family and know that they, each one of those families probably has somebody with a disease state or is taking a drug or is using a medical device that we touch and feel. That gives people a pretty good motivation for doing their job well, gives us heart for what we do, right? And why I think a lot of us are in this sector to be able to do that. But for us, it's super tangible. It's not cool science for cool science sake. It is protecting, right, those people that you know, protecting those people that you care about. That enables you to have a greater focus. And that enables our team to give that 110% and be super happy about doing so.

One thing that I -- and I always do research on your company, it's -- I get back to this thing called the Mesa Way. And you mentioned it briefly up here. And I just wanted to kind of maybe double-click in your own words, like I kind of think of it as lean, right? But what is that for you? And how do you think that's really impacted, especially in the market dynamics we've been in, in the last few years?

Yes. In our language, right, a lot of lean-based operating models are a collection of tools. They're basically like little recipes for how to solve a specific problem. For our perspective, when you change that from solving like a problem for a turnover time for a lave to how do I improve a customer perspective, you click up a level. So we look at value streams or how things are created and interrelated across the business from the customer's perspective and pull a line all the way through that. That gives you a very different vantage point for how to satisfy customers. And that comes from this perspective that we don't solve incremental problems. We solve customer problems to solve customer needs. So we pull that all the way through. And instead of focusing on a tool, we focus on what I would say is the craftsmanship with the tools, right? Because a lot of times, that process might exist in a customer's mind or their decision-making process or it might exist in their flow. And so it takes a little bit more creativity and you can't be super dogmatic about the tool. You have to be very good with the craftsmanship of it. And that actually makes it a lot more fun because you're not just like cranking out a recipe, right? It's like a star chef versus being in one of these ordered online chefs where there might be a machine squirting fake mashed potatoes into a bucket. It's very different when you start to think about your world that way and you operate that way.

Maybe looking at Mesa just holistically and this portfolio, where do you see synergies across your business lines?

Yes. I mean I think if you look at the thematic things for how we really drive the business, it's really about application development, application marketing and customer intimacy. Those things are really consistent. How you then take and compress your time for application development to come up with the next application, how you prove it out, how you market it to customers, how you support people through that. There's a lot of commonality across our different techniques that we're able to learn from each other and apply and whether that's in how our website operates, how our CRM system operates, how we train people, how we teach them how to approach customer service, all those things are similar. Much less the fact that we focus on entering clinical trials, one, and our real goal is to get spec into a drug during that development process means that knowing where those drugs are, knowing where they are in their life cycle and having credibility with those customers actually does expand beyond our different portfolios. You're not going to find that with somebody who's calling on an academic researcher one day and then send them into somebody who's doing clinical trial support and think that they're going to be effective. They're simply not. And it's just a different context. So we scale this from that. And then, of course, you see like some of the knowledge things that follow through in terms of what that drug is and what they affect each other, where our tools start to complement each other. And obviously, we'll benefit the more scale we get, the more we'll see benefits from that process.

Great. I want to turn to the market now, but are there any other questions longer term, big picture on Mesa? Okay. So market, and I'd say the adage is this market headwinds, right? And you can pick your poison as to what do you want to say that is? I guess in your own words, just how has Mesa been impacted by headwinds? And then where do you think we are broad scale like in that sort of story in this moment?

Yes. I get the, what I call, headline fatigue, right, from the investor side of the table for what's going on in this industry lately, bioprocess destocking, academic funding, pharmaceutical CapEx cycles, LDT regulations, things that are going on in China, right? There's been a lot of changes to what was a pretty benign status quo for about a decade. I would say, other than China, which will lap at the end of this coming quarter, so we'll lap that essentially or the impact of that in either April, depending on how you think about it, but it's already lapsed sequentially. Those things to a large extent are over, right? So I don't know, I don't want to be -- sometimes the removal of pain is pleasure, right? And so just not kind of facing these headwinds, we expect to see a natural lift. I think as you look at our business in particular, right, we expect that lift to see in clinical trial starts that we hope to see, right? That will be a great longer-term leading indicator from us. But just the enthusiasm and positivity of the market means the investment cycle will hopefully naturally continue to grow, and that's our hope. I think if you look at what's happened, though, to the stock and how the investor community has responded, right? And I think this is across the board, not unique to life science tools, is that smaller companies have been savaged, right? Larger companies where maybe you guys want to be able to move in and out of the stock relatively quickly because the news can change any one day and you want to be hyper liquid, right, that's great. And that's, I think, driven money towards larger caps and the way out of smaller caps because we don't have that necessarily flexibility. As hopefully, as the market backdrop starts to clear and get more stable, that will become less of a headwind. And I think you'll see that hopefully, the multiple compression for what even during this most tumultuous time, I think we performed -- outperformed our diversified tool brethren. In the meantime, our multiple gap has expanded dramatically. And hopefully, as these things settle down, you'll see that close back again to what it was, which was a small discount to a small premium actually to some of the larger players in the diversified tool space.

Moving on, I guess, I'd say, let's maybe look into the midterm outlook. So maybe 3-ish, maybe 5-ish years into the future. How does this all add up? Like what are you kind of envisioning for the future of Mesa in that time frame?

Yes. I think for the last several years, right, as the clinical trial starts have probably been on like a minus 10%, we've been able to grow in the 3%, 4% range. You see that indicator start to go again. Again, a great long-term leading indicator for our business. I think you'll see us accelerate hopefully higher than that. Maybe that's possible. I think one of the things that's nice about the quality control markets, right, these things tend to move a little bit more steadily than some of the underlying volatility just given the vital nature of the products that we serve. So I think that's where we would like to see ourselves end up, right, that mid-single-digit plus range that would require the kind of market returning. I'm done guessing when the market is going to kind of behave more normally. But I'll just say we're ready for it. And when we're ready for it and that organic growth rate continues to accelerate, you'll start to see obviously a lot of really good financial ratcheting. I hope it's this year. But I think everybody else kind of says this is maybe a half step towards that. Maybe the next fiscal year will be the right one where we kind of get back to that 6% tools growth rate and healthy clinical trial starts. And I think, obviously, we'd be excited for that, but we're prepared for whatever comes.

I appreciate the realism there that I think you hear some folks who make pontificate as to what is happening in the future, but you can only control what you can control, right? And so...

Yes. I think that lean-based operating model for us has kind of proven out, right? So maybe a good example of that, right, in the first quarter of this fiscal year as the tariffs were hitting and as China was shutting things off and you're working around tariffs by shipping products, right? We had a bit of a profitability crunch in addition to FX changing dramatically during that period, unless you saw that we were able to respond, right, acknowledge where the market was our relationship with different countries, adjust our cost structure. So we added about, what, 300 basis points between the first and second quarter. So now we're operating about 150 basis points higher than we were last year despite all these headwinds, and we think we have more room to do that while continuing to ensure that we're investing for that long-term organic growth.