Mesa Labs (MLAB) Q2 2027 Earnings Call Transcript

The relevant definitions and reconciliations to the most directly comparable GAAP measures may be found in our earnings release in the supplemental reconciliation posted in the Investor Relations section of our website at mesalabs.com. With that, let me turn the call over to Siddhartha.

Siddhartha Chandrakant Kadia:Thank you and good afternoon, everyone. In August, I told you I would use every 1 of these calls the same way. To be direct about what is working, what is not yet working, and what we have decided to do about it. That has not changed. I also told you that August was the appetizer and that the dinner would come in November. Full year guidance alongside our first half results. This is that call. So before anything else, let me read back what we said we would do. Because I think consistency is the first thing you should be able to hold us to.

We said I would give you a clear read on the durable fix in SDC. I will give you that read in a moment. And it is a mixed 1. Which is why I want to be precise about it. These are the next Gyrolab platform we will launch in fiscal 28. That is still the plan. We said clinical genomics was being managed deliberately and that we would have more to share as that work progressed. On October 13, we announced how we are changing the way we manage that business for profitability. We said we will keep strengthening the balance sheet towards 1.5 to 1.75 turns of net leverage by the end of the fiscal year.

We are at 1.75 times already within that range with 2 quarters to go. Down from 1.85 at the end of June. I said acquisitions were not my near term priority, and then I would come back to capital allocation today. I will. And we said we would give you full year guidance on this call We are doing that today and you will see that it shows real and growing earnings power. So a quarter of real progress, 1 franchise that had a disappointing quarter for reasons, I will explain. The decisions we made in October, and our first full year guidance. Let me take you through it. Before I do, 1 welcome.

Sanket Shah joined Mesa on November 2 as General Counsel. As we announced today. He strengthens the leadership team we are building and I am glad to have him with us. Next, I have 4 core messages for you. If you take 4 things away from this call, let it be this. First, growth is building led by our 2 steadiest franchises. Organic revenues grew 2.6% in the second quarter up from 1% in the first. Excluding clinical genomics, which we are reshaping, revenues grew about 5% in the quarter and about 3% in the first half. Sterilization and disinfection control grew in the mid teens organically, and calibration solutions grew in the low single digits.

The 2 franchisees doing what they are built to do. Biopharmaceutical development had a weak quarter for reasons that are about timing rather than demand. And I will be specific about them. Revenues will move quarters in a business like ours. What I want you to watch is the direction and the direction is up. For the full year, we expect adjusted EBITDA to grow faster than revenues. Second, we acted on clinical genomics and we are reinvesting where the returns are. On October 13, we announced a savings plan that is expected to reduce our annualized operating cost by approximately $9.3 million.

We are reinvesting approximately $4.3 million of those savings primarily in commercial capacities in the businesses and regions where we see the most opportunity for profitable growth. And in key corporate positions. Our total expected net annualized cost reduction is $5 million. Clinical genomics is now being managed for a profitability not for scale. Third, a capital allocation strategy agreed with the board that starts with the balance sheet. Our capital allocation started in October when we moved capital out of clinical genomics and into our more profitable businesses. And that work continues. Because every business competes for capital on the returns it earns.

Together with the board, we have now completed a review of our capital allocation strategy and the priorities are simple. We invest in our businesses where we see the best returns for profitable growth. We keep the balance sheet strong. We have paid $20.1 million of debt in the first half and our net leverage is 1.75 times. As we earn it, we will bring distributors in house and then add small tuck ins our quality control businesses. Alongside those priorities, the board has authorized a share repurchase program of up to $40 million through December 31, 2028. Which gives us the flexibility to repurchase shares opportunistically while we continue to reduce debt. Fourth, our first full year guidance.

Today, are giving full year guidance for the first time. Revenues and adjusted EBITDA. I built it the way I told you I would, On a first half year of data under the operating changes we made and conservatively because a number you can count on is worth more than a number that flatters a quarter. In the first half, adjusted EBITDA grew 20.9% on revenues up about 1.8%. For the full year, our guidance says it is growing 5% to 8% even after the reinvestment and lower clinical genomics revenues. Next, let me address sterilization and disinfection control, the read that I promised. Let me start where I spent the most time in August.

I told you SDC had a delivery reliability problem, not a demand problem. And then I would give you a clear read on the durable fix in November. Here it is. First, the results. STC grew 14.6% organically in the second quarter. I want to be precise about what that number is. Most of it is comparison delivery delays, cost, past due backlog to build, in the second quarter last year During the second quarter of this year, past due backlog remained roughly steady and at a substantially lower level than a year ago, For the trailing 12 months, STC revenues were $104 million up 8.5%. The highest 12 months in this franchise's history.

And on a first half basis, SDC grew about 5%. Those are the right lenses for this franchise. Second, the fix. In August, I said the job was converting search work into standard work. On most of our product lines, we have done that. The manufacturing issues behind the delays have been resolved. And then those lines allow shipping on a schedule Our customers can plan around. That is real, and it is our team's work. In September, the FDA inspected our Bozeman facility where we make biological indicators and issued no observations. But I promised you a clear read, not a victory lap. So here is the part that is not finished.

1 key product line the 1 that carried the largest share of our past due backlog, has only been partially resolved. We understand the problem, We have the right people working on it. And it remains the single biggest priority in this business. Until it is fixed, SDC will not be as reliable as it should be and I will not tell you it is. So the honest truth is this. The durable fix is in place for most of the franchise It is not yet in the place for all of it. And demand has been there throughout. Our customers have continued to order from us, and as product has become available, it has moved.

That tells you what this franchise is worth once delivery is fully reliable. Next, calibration solutions. That business grew about 3.5% organically, on top of nearly 11% growth a year ago. Calibration Solutions is a recurring service driven business that compounds quietly and it did that again this quarter. We are adding business development capacity here as part of the reinvestment I described to expand the geographic reach of this business. Now on to biopharmaceutical development. Biopharmaceutical development had a weak quarter. Revenues declined 8.2% organically. And I want to tell you exactly why. Because the reasons are not a lack of demand. The first reason is export controls.

As I said in August, export control processing on certain in hand orders has been taking longer than we expected. And delays have continued through the second quarter. The second reason is simpler and more disappointing. A number of shipments missed our second quarter close by a few days. Those orders were in hand and shipped by mid October. So they will be third quarter revenues. I will not pretend that is a good quarter. It is not. it is a quarter where revenues moved from 1 period to the next. Not 1 where the customers walked away. The commercial rebuild around our general manager is continuing. The Gyrolab next generation platform remains on track to launch in fiscal 28.

And I continue to expect this business to grow for the full year. Finally, clinical genomics, what we announced on October 13, In August, I said we are managing clinical genomics deliberately with full attention to its cost structure and returns and that we have more to share as that work progressed. On October 13, we shared our restructuring and savings plan. Clinical genomics revenues declined 8.8% in the quarter mainly from the timing of consumers' orders from a large customer with China modestly lower. But over several years, the pattern has been 1 of declining revenues and that is the reason we decided to restructure the business.

Going forward, we will focus clinical genomics on pharmacogenomics and oncology, and on customer accounts that use the mass array at scale and we size the organization for that. Revenues will be lower as a result but we expect the profitability to be meaningfully higher in dollar terms as cost come out. Further, gross profit percentage is expected to improve because the revenues we are stepping away from are the lowest margin revenues in this business. We are already seeing what that focus looks like with customers. Our 3 largest clinical genomics customers have each renewed with us for the terms of 2 to 3.5 years in fact, the longest, 3.5 years with our largest customer.

Commitments of that length from account that use the mass array of scale are exactly the kind of relationships we are building this business around. Let me say a word about why. Whatever business we own, our job is to run it as well as it can be run. To be good stewards of it. A business that consumes cash leaves very few choices about how to invest in it. The business that earns its keep and generates cash. Gives us many more options. In clinical genomics, we are building a focused profitable business that we expect to generate cash.

That is the right way to run any business we own and it is what puts us in a position to make good long term decisions. The restructure was not a decision to exit any specific end market. If a customer use the instrument at scale, we want to serve them wherever they are. It was a difficult decision for the people affected which is why we have approached that with due care. How I am starting to think about the company Before I discuss the company as a whole, I want to share how I am starting to think about our portfolio. Because it is how I will think about where we put capital.

When I look across our 4 businesses, they fall naturally into 2 pairs. Sterilization and disinfection control, calibration solutions have a great deal in common. They serve many customers primarily regulated manufacturers, and healthcare providers, They run on a high volume of transactions with a similar commercial approach and then make products in regulated manufacturing environments. What they have in common is that our customers use them to show that their processes are under control. I started to think of them as our quality control businesses. Similarly, biopharmaceutical development and clinical genomics are different than quality control businesses. there is a fewer customers, mainly biopharmaceutical companies contract research organizations, and clinical research laboratories.

With fewer commercial transactions, and longer sales cycles. I started to think about them as our life sciences tools businesses. To put numbers to that, I can simply add together the segments we already report. In the first half of fiscal 27, revenues from our quality control businesses were $77.2 million And from our life sciences tools businesses, $45.3 million. Our quality control business is generated combined gross profit a non GAAP measure, of $51.3 million or 66.4% of revenues. Compared with $27.6 million or 61% of revenues for our life sciences tools businesses. We also incur more sales and marketing and research and development in our life sciences tools business than we do in our quality control businesses.

As I started to think about the company this way, I see our quality control businesses as the foundation we build on. Through both internal investments and acquisitions. The natural home for tuck in acquisitions such as adding products and technologies that complement what we already sell. Our life sciences tools businesses will build primarily through internal investment like the new platform. BPD is investing in for the growth. We will continue to report our 4 segments. And that is how John will take you through the quarter. The savings plan and margin is the next thing I will talk about. Let me step up to the company as a whole.

The savings plan we announced on October 13 is expected to reduce annual operating cost by approximately $9.3 million through a global restructuring program a smaller facilities footprint in San Diego, and reduce third party spending We plan to reinvest about $4.3 million in business development capacity in calibration solutions, commercial resources primarily in Asia, and key corporate positions. For an expected net annualized cost of approximately $5 million. The actions are underway, and we expect them to be substantially complete by the end of this fiscal year with the full benefit in our cost base by the end of fiscal 28.

I said in August that I would reinvest a portion of our operating leverage rather than maximize 1 year's margin. That is what this is. Cost moving out of the part of the portfolio with lowest returns and into the parts with the highest. Let me now turn to capital allocation because this is where the. Way I think about the portfolio, becomes decisions that matter. For the value of the company. The journey started with the decision we announced on October 13, moving capital out of clinical genomics where it earned the least and into the businesses where it earns the most. That was the first step, not the last.

We will keep testing every business against that same question and more resources to where they earn the most. I gave you all priors at the top, and the order matters. We have options because our business generates significant cash from our operations. Our own business comes first. The best returns available to us are inside Mesa. The commercial capacity we are adding to solutions and in Asia the next generation Jiro lab platform and reliable manufacturing, and sterilization and disinfection control If we find more opportunities to grow organically than we expect, that is where the capital goes first. Next is the balance sheet. We reduced debt by about $20 million this year, and we will keep reducing it.

A strong balance sheet is what lets us act when the right opportunity comes. Other than when we have to. On acquisitions, let me pick up exactly where I left off in August. I said then acquisitions are not my near term priority. And that this might change later in the second half with small distributor buyouts or tuck in acquisitions. And then I would come back to it today. Here is where that stands. Our first job is still earnings. Delivering the savings plan, delivering the guidance I will give you in a moment. And keeping the balance sheet strong. Within those parameters, we expect to bring a small number of distributors in house. Those are capability building moves.

In markets where we already sell through others they give us direct access to our customers and the service relationship that goes with it. And when our earnings record is in place, we expect to turn our attention to the small tuck ins in our quality control businesses. Markets that we know channels we already own, and the kind of deal we have done well before. That is a sequence I described in August and we will earn our way to it. Acquisition opportunities in life science tools tend to be larger or to come at higher valuations. So we would expect to be much more selective there.

With the balance sheet where it is now, our board has authorized the share repurchase program of up to $40 million through December 31, 2028. I want to be clear about how we intend to use it. Opportunistically and with discipline, and never at the expense of the balance sheet. The test for every 1 of these capital allocation decisions is the same. Does this dollar earn more here than anywhere else we could put it? Now the guidance I promised you. From today, we guide on adjusted EBITDA the measure most of our PSUs, and close to the measure in our current facility.

Through the end of this fiscal year, we will also report existing operating income the measure I used in August, and John will take you through how the 2 reconcile. For fiscal 27, we expect revenues of $250 million to $255 million and adjusted EBITDA of $66 million to $68 million. 4 things about how to read that. It is company level guidance, We are not guiding individual businesses. It includes the savings plan and its reinvestment. And the lower clinical genomics revenue that comes with the decision we made. And excludes the restructuring charges which John will take you through. Finally, compared with adjusted EBITDA of about $63 million in 2026.

The guidance has adjusted EBITDA growing about 5% to 8% on revenues up about 0% to 2%. I built this guidance conservatively on purpose. In August, I said I would rather give you a number I can stand behind than anchor you to 1 in my first 100 days. The same principle applies now on a full half year of data. Our job is to deliver it, and then do it again. 1 more point on timing. With the changes we are making, our results will not move a straight line from quarter to quarter. We expect third quarter revenue to be about flat compared with last year, mainly because clinical genomics revenues stepped down as we reshape that business.

Outside clinical genomics, we expect our businesses to keep growing Please judge us on the full year. Finally, let me close where I begin in August. Mesa is a set of durable, regulation embedded franchises with real and growing earnings power. And fixable execution problems that we are fixing. This quarter, more of that fixing showed up in the numbers, and 1 important piece did not yet. You will hear about both from me every quarter. With that, let me hand it to John.

John V. Sakys:Thank you, Siddhartha, and good afternoon, everyone. I will stay in the numbers for today's call. I will first discuss the income statement, the restructuring, statement of cash flows, and the balance sheet. And then the mechanics of our guidance. Unless I note otherwise, comparisons are to the second quarter of fiscal year 26. Total revenues were $62.3 million, million up 2.6%. With no acquisitions in the past 12 months, organic growth was also 2.6%, and constant currency organic growth which excludes a currency headwind of about 50 basis points was 3.1%. For the first half, organic growth was 1.8%. Gross profit was $39.9 million or 64% of revenues, up 250 basis points from 61.5%. Now by division.

SDC gross profit as a percentage of revenues increased 260 basis points to 69.9%, primarily due to lower contract labor and consulting costs as the prior year included spending on manufacturing process improvement initiatives and third party production support. And higher revenues on a partially fixed cost base. BPD's gross profit percentage increased 76 basis points to 65.1%. Primarily due to favorable product mix as higher margin immunoassays revenues and consumables representing a greater proportion of the division's revenues. And lower margins in the prior year from the impact of tariffs and foreign currency. Calibration Solutions gross profit percentage declined a 110 basis points to 59.6%.

Primarily due to unfavorable product mix and higher transportation costs, and clinical genomics declined 80 basis points to 53.9%. Primarily due to unfavorable product mix as higher margin consumables represented a lower portion of revenues as well as lower revenues on a partially fixed cost base. Operating expenses declined 3.4% to 31.5 million primarily due to lower stock based compensation as the prior year included costs associated with multiyear equity awards granted to our former CEO, lower expense related to estimated uncollectible accounts receivable, and lower amortization as certain intangible assets became fully amortized. GAAP operating income increased 77.6% to $8.4 million. Net income was $4.3 million or $0.75 per diluted share compared with $0.45 a year ago.

Adjusted EBITDA increased 21.1% to $17.3 million or 27.8% of revenues compared with 23.5% a year ago. Beyond depreciation, amortization, and stock based compensation, we adjust for the foreign currency impact of certain intercompany loans. A $200 thousand loss this quarter. As Siddhartha mentioned, we will continue to report adjusted operating income or AOI and AOI excluding unusual items through end of this fiscal year. The 2 measures were within $10 thousand of each other this quarter, but adjusted EBITDA grew faster than the 13.7% growth in AOI, excluding unusual items, because of how last year's severance costs were treated.

The $848 thousand of severance included in the second quarter last year reduced adjusted EBITDA as it was not under an approved restructuring plan, and therefore did not qualify for exclusion under our definition. AOI, excluding unusual item contrast, excluded those costs resulting in a higher prior year comparison. On a trailing 12 month basis, adjusted EBITDA was $68.6 million or 27.3% of revenues. Compared with 53.5 million a year ago. Turning to the restructuring. We incurred no restructuring charges in the second quarter because restructuring program was approved after quarter end.

We expect total pretax charges of $2.6 million to $3.4 million net of approximately $300 thousand of noncash stock based compensation reversals, primarily in the second half of this fiscal year. Related cash costs are expected to total approximately $2.9 million to 3.7 million substantially all of which we expect to pay within the next 12 months. Using cash generated from operations. Because these charges are incurred under a board approved plan, we will exclude them from adjusted EBITDA measures and show them separately in our reconciliations. During the quarter, we also amended our credit facility to increase the restructuring related charges that may be excluded from our covenant leverage calculation.

Below operating income, nonoperating expense was 2.4 million compared with 2.7 million in the second quarter of the prior year. Interest expense declined 25% to 2.1 million reflecting lower average debt. Lower rates on our variable rate borrowings were offset by replacing the 1 3/8% convertible notes which matured in August 15, 2025 with higher rate borrowings under our credit facility. The remainder is primarily the intercompany loan remeasurement which will continue to create quarter to quarter volatility. While the loan is outstanding. Income tax was $1.7 million, an effective rate of 28.1%, which differs from the 21% statutory rate primarily due to the valuation allowance on US deferred taxes.

As disclosed in our Form 10 Q, there is a reasonable possibility that we could partially release our US valuation allowance within the next 12 months. Which would favorably affect our effective tax rate. The time and amount of any release remains subject to our ongoing assessment and other factors could also affect our effective tax rate. Net income was $4.3 million or $0.75 per diluted share compared with $0.45 in Q2 of the prior year. An increase of 75%. Turning to cash flow and the balance sheet. Operating cash flow for the first half was 18.8 million up $8.7 million driven by higher op income and strong first quarter collections and capital expenditures were $900 thousand.

We used the cash to repay $20.1 million of debt net in the first half including $11.4 million in the second quarter and we ended the quarter with $22.3 million of cash and $57.8 million available under our revolver. And that leaves our total net leverage ratio at the 1.75 times Siddhartha mentioned, against a covenant maximum of 3.5 times. Since quarter end, we have repaid an additional $5 million of revolver borrowing. With that, operator, ready to open the line for questions.

Operator:We are currently troubleshooting a technical difficulty Please stand by. Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star 1 to raise your hand. To withdraw your question, press star 1 again. We ask that you pick up your handset when asking a question to allow for optimum sound quality. If you are muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster. Your first question is from the line of Matt Stanton. With Jefferies. Your line is now open. Please go ahead.

Matt Stanton:Hey. Thanks. Maybe just to start on the guide. I think the midpoint suggests kind of 1% or so in the back half of the year here. Guys 2% in the first half. So I guess maybe just talk about, what gets worse into the second half. that is just comps or a decision in clinical genomics. And then just more broadly, guidance philosophy, sounds like you want kind of a prudent, realistic bar to execute against. But just talk about kinda the back half setup and just general philosophy. And if you were to per. Point to some upside drivers in the back half of the year, on the guide, what would those be? Thanks.

Operator:We are currently experiencing a technical difficulty. Please stand by. While we resolve this issue. Thank you for your patience. We are currently experiencing a technical difficulty. Please stand by. As we resolve this issue. Thank you for your patience.

Siddhartha Chandrakant Kadia:Matt, can you hear me?

Operator:Thank you for your patience. We are currently live again. Matt Stanton, please go ahead.

Siddhartha Chandrakant Kadia:Matt. I am picking up on your question. I am assuming you can hear me. You asked about the guidance. First of all, we are not guiding half or quarters. We are guiding for the full year. The second half does carry the clinical genomics reset we chose it is now reduced the clinical genomics revenues. Also, the reinvestments that we made are actually starting ahead of the savings. And a comparison with a very strong fourth quarter last year, if you recall, when s STC shipped a large part of its past due backlog, as the production record in the fourth quarter. So in balance, I think it is a pretty well balanced forecast.

And our job is to deliver the full year number. I would rather be held to that than to a quarter. Sounds like you are gonna kinda manage it for profitability. But it is gonna be a bit of a headwind here in the back half of 27 and in the 2028. Just maybe any update just in terms of, after you spend more time on this asset, like, why it makes sense to hold on to it at all? It sounds like you have done it for profitability and some of the cost savings will show up there. But it is dilutive to growth. Maybe it is accretive to margins after the restructuring.

But just any broader thoughts on, you know, the clinical genomics business within the portfolio here? Thanks. Yeah. I think it is a great question. And, look, I think, of course, we have filled all consideration to that question. No decisions been made about the portfolio itself. What we decided in October, Matt, is to run the clinic just to be profitable and generating cash. focused on pharmacogenomics and oncology and on some super high utilization accounts. And I think as you saw, we announced that the top 3 accounts since we actually did all of that, have renewed multi year contracts with us, and the largest 1 being for almost 3.5 years. Ongoing.

And so our philosophy is actually to run every business we own as if we are the best stewards for that. Once the business is in the right shape, the profitability, it gives us more choices. And the 1 that does not produce cash and does not have the same level of profitability. So our job is to get it there, then we can, think about more things that we can do Every dollar of cash it generates, right now. Is a great value for our shareholders no matter what kind of value they put to it. And I think our work is going to make significant more profit By restructuring that we just announced. Super. Thank you.

Operator:Your next question is from the line of Paul Knight with KeyBanc Capital Markets. Please go ahead.

Paul Knight:So, Arthur, thanks for the time. The China market grew 20% in the quarter. What was that, genomics? What was driving China growth?

Siddhartha Chandrakant Kadia:No. Paul, very nice to talk to you again as well. No. Genomics actually declined slightly in China. Most of the growth is coming from pretty robust, businesses that we have in China for all the businesses, especially SDC and, you know, portions of BPD as well. And if you recall, solutions does not have any China footprint per se. But it is a small amount. Okay.

Paul Knight:And then these top 3 customers and clinical genomics, are they a third, a half? What portion are they of the business?

Siddhartha Chandrakant Kadia:I do not think we have exactly disclosed that in the because I think it depends on sort of what the total business will be. But I think it is closer to 25%. Okay.

Paul Knight:And then as you kind of evaluated these businesses in the short time, that you have had Well, I guess you see acquisition opportunity in SDC and calibration Is it a fragmented market? what is the nature of what is in that SDC and calibration m and a environment.

Siddhartha Chandrakant Kadia:Yeah. In fact, if I can directly contrast it with life sciences tools, which is, of course, much more heavily contested marketplace. And valuations seem to be premium, or, should I say, full oftentimes. The assets are of scale. That, frankly, they are much larger for us compared to sort of where our balance sheet will permit us right now. And frankly, our strength and market position in SDC and Cal Solutions is very strong, and there is a lot more availability of tuck ins in that marketplace. Not to speak of our own access to our own channels because we still have a lot of business going through distribution there.

So we have multiple ways to actually add to our portfolio whether that is a product or a complementary product in a current market that we serve or going and accessing our own channels directly. Or frankly going into adjacencies of what we do every day. And valuations tend to be valuations tend to be much less full than the genomics or bioprocess kind of businesses. Yep. Okay.

Operator:There are no further questions at this time. I will now turn the call back to Doug Farrell for closing remarks. Please go ahead.

Doug Farrell:Thank you very much, operator. As a reminder, management will be hosting 1-on-1 meetings at several upcoming financial conferences including the Raymond James Small Cap Conference in Napa Valley next week, as well as the Southwest SmallCap Ideas Conference in Dallas next week. And then subsequent to the Thanksgiving break, the team will be at Piper Sandler in New York for investor meetings there as well. Thank you very much for joining us today.

Operator:This concludes today's call. Thank you for attending. You may now disconnect.

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