Neogen Corporation (NASDAQ:NEOG) Q3 2023 Earnings Call Transcript

Neogen Corporation (NASDAQ:NEOG) Q3 2023 Earnings Call Transcript March 30, 2023

Operator: Operator Welcome to the Neogen Third Quarter Fiscal Year 2023 Earnings Conference Call. All participants will be in a listen-only mode. Please note today’s event is being recorded. I’d now like to turn the conference over to Bill Waelke, Head of Investor Relations. Please go ahead.

Bill Waelke: Thank you for joining us this morning for the discussion of the results of the third quarter of our 2023 fiscal year. I’ll briefly cover the non-GAAP and forward-looking language before passing the call over to our CEO, John Adent, who will be followed by our CFO, Dave Naemura. Before the market open today, we published our third quarter results as well as the presentation with both documents available in the Investor Relations section of our website. On our call this morning, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the presentation, Slide 2 of which provides a reminder that our remarks will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act.

These forward-looking statements are subject to risks that could cause actual results to be materially different from those expressed in or implied by such forward-looking statements. These risks include, among others, matters that we have described in our most recent annual report on Form 10-K and in other filings we make with the SEC. We disclaim any obligation to update these forward-looking statements. With that, I’ll turn things over to John.

John Adent: Good morning, everyone, and welcome to our earnings call covering the third quarter of our fiscal 2023 year. We’re pleased to be with you today to provide an update on our performance and the ongoing integration of the Food Safety business we acquired from 3M last year. On our last earnings call I mentioned the trend we’re seeing in some of our macro-related softenings in our end markets. This continued in the third quarter with many feed producers seeing lower unit volumes, with inflationary pressure on consumers being a key driver. On the Animal Safety side of our business the macro weakening was driven primarily by a difficult comparison against extremely strong market growth in Q3 of the last fiscal year, and some destocking by our channel partners.

Despite the macro headwinds, we delivered core growth in both legacy segments, aided by diversification across product categories. In the recently added Food Safety business key product lines continue to be negatively impacted by the backlog situation at our transition manufacturing partner. After an unanticipated holiday shut down in December, we’ve seen intermittent improvement, but not the sustained progress we expected. To resolve this, we’ve elevated it to the highest levels of our contract manufacturer, where we’ve seen meaningful engagement to address the root causes and alleviate certain process constraints. We’re working with them to provide additional input into key production decisions and believe we have a path to successful resolution over the coming quarters.

As we’ve discussed before, the former 3M business is a high quality franchise with leading diagnostic technology for high replenishment environments, that in many cases is specced into their quality control processes. We understand the critical roles our products play, and are working closely with our customers to fulfil as much of their demand as possible, while we work to return supply to its more normal levels. With respect to the ongoing combination of the businesses, we continue to make good progress on the integration activities. Commercially, our teams have been combined and cross trained and we are navigating the tighter market conditions focused on a prioritized set of opportunities globally. We’ve seen significant growth in the sales pipeline over the last few months and are excited about the potential ahead.

Additionally, we opened a new distribution center in Mount Sterling, Kentucky, which will be our primary point of distribution in the U.S. for the combined business, allowing us to serve our customers more efficiently from a single location. We’re also continuing to make progress scaling up the infrastructure we need to fully accommodate the former 3M business within Neogen. The new facility we’re building in Lansing ultimately will house the production currently handled by our transition manufacturing partner. Construction is progressing on track. The foundation is being poured, sections in the frame are starting to go up and the customized equipment has already been ordered. Additionally our ERP implementation for the combined business is well underway with completion on schedule for the end of calendar 2023.

And finally, we continue to add critical personnel in the quarter with additions to our back office and related support teams, which play a key role in enabling our exit from the transition services agreements currently in place. Clearly, there’s more work to do. But we remain very excited by the opportunities, the addition of such a high quality business, and the contributions we’ve seen from our new employees who are now part of our one Neogen team. With that, I’ll turn the call over to Dave for some more insights into our results for the quarter.

Dave Naemura: Thank you, John, and welcome to everyone listening this morning. Jumping right into the results, our second quarter revenues were $218 million, an increase of 70% compared to the same quarter a year ago. Core growth, which excludes the impact of both foreign currency and acquisitions was 4% for the quarter. Acquisitions added 68% while foreign currency amounted to a 2% headwind compared to the prior year. At the segment level, revenues in our Food Safety segment were $152 million in the quarter, an increase of 141% compared to the prior year, including core growth of 6%. Sales in our Culture Media & Other category grew high teens on a core basis, benefiting from a large order from a vaccine manufacturer. Within Bacterial & General Sanitation, our microbial testing products had solid growth, partially offset by lower sales of general sanitation testing products, and in part to supply challenges.

Rounding out, our larger Food Safety product categories, Natural Toxins, Allergens, & Drug Residues had a slight core revenue decline, due largely to the discontinuation of our product line of drug testing kits for international dairy markets. Quarterly revenues in the Animal Safety segment were $67 million, up 2% over last year’s third quarter on both a core and reported basis, as the foreign currency impact was modest. Sales of our biosecurity products had the strongest core growth, led by insect control share gains in the animal protein market. This growth was partially offset by a decline in vet instruments and disposables, which faced a difficult compare against a new business win last year, and lower volumes of antibiotics and vitamin injectables in the animal care and other category.

Worldwide genomics revenue was up high single digits on a core basis, with growth in the global beef markets offsetting weakness in China from COVID related lab closures that continued in the quarter. As John mentioned earlier, the performance of the Food Safety business we acquired from 3M was impacted primarily by lower than expected production levels in our transition manufacturing partner. We had anticipated seeing some progress in reducing the backlog during the quarter. But the unexpected shutdown of production over the holiday prevented this from happening. This business is not included in our definition of core growth. But on a pro forma basis it experienced a core revenue decline of 2% in the quarter. Including the former 3M business core growth for Neogen as a whole would have been low single digits on a pro forma basis.

Gross margin in third quarter was 49.5%, representing an increase of 470 basis points or 44.8% in the same quarter a year ago, with the increase primarily driven by the addition of higher margin business in the 3M Food Safety transaction. Adjust EBITDA was $51 million representing growth of 106% from the prior year quarter driven by the merger with the former 3M Food Safety business. Adjusted EBITDA margin was 23.5%, a year-over-year increase of 410 basis points. The increase was driven by the gross margin expansion which more than offset costs added in the quarter to accommodate the larger scale of the combined business. Adjusted net income was $27 million for the quarter with adjusted earnings per share of $0.12, compared to $16 million and $0.15 respectively in the prior year period.

The increase in adjusted net income was driven by higher adjusted EBITDA more than offsetting the increase in interest expense, while adjusted earnings per share was impacted by the increase in weighted average shares outstanding from the Food Safety transaction. In February, we completed the strategic bolt-on acquisition of Corvium, a SaaS provider behind our Neogen Analytics Platform, accelerating our organic data strategy. Although we can’t always control timing of when certain strategically attractive bolt-ons become available, our capital allocation priorities are funding integration CapEx and deleveraging. Following our debt pay down in December, we ended Q3 with gross debt of $900 million, 67% of which is at a fixed rate and a total cash position of $183 million.

In addition to the Corvium acquisition, our cash position at the end of the quarter was impacted by integration CapEx and the timing of two interest payments in the quarter. As we look to the remainder of fiscal year ’23 we believe our previously communicate view of second half core growth in the mid-single digit range with an adjusted EBITDA margin in the mid-20s range remains intact. We expect to see sequential margin improvement in the fourth quarter, but believe our second half results will be pushed towards the lower end of those ranges as a result of the production loss during the December shutdown at our transition manufacturing partner. With respect to adjusted net income, we continue to anticipate a full year effective tax rate of around 20%.

For the fourth quarter interest expense is expected to be approximately $18 million. I’ll now hand the call back to John for some closing thoughts.

John Adent: Thanks, Dave. We’re excited about the progress we’ve made to-date combining Neogen and the former 3M Food Safety business into a clear pure play leader in the food security market, with a product portfolio that’s over 95% consumables. While our market is not immune to economic slowdowns, it has historically been resilient. And we believe there’s a number of attractive long term secular tailwinds, such as heightened pathogen awareness, the growing prevalence of food allergies, and increasingly health conscious consumers who want to know what’s in their food. It’s also a market in which we believe the aggregation of structured data and use of analytics are of particular importance. The effective use of data can allow auditing bodies and food companies to identify risks, and improve safety and testing processes to ultimately minimize outbreaks.

We are implementing our data strategy through Neogen Analytics, a software platform that capitalizes on our many touch points across the food supply chain and provides users with actionable data. Neogen Analytics can provide insights from industry best practices, predictive modelling, trend analysis with real time monitoring, and simplify compliance processes. The acquisition of Corvium last month will allow us to accelerate this strategy and further embed Neogen Analytics in the market, as customers are increasingly looking to leverage data. We’ve seen strong growth in the platform, and are planning to build on this leading presence by launching additional software modules and digital mapping capabilities in the near future. We’ve also begun working with one of the leading providers of generative AI search of potential opportunities to drive monetization for Neogen Analytics capabilities.

I appreciate the efforts and commitment of our team members around the world. We have numerous integration work streams underway across the organization. And I couldn’t be happier to have them working with us as we build the future of our Neogen. I’ll now turn things over to the operator to begin the Q&A.

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Q&A Session

Operator: Thank you . Today’s first question comes from Brandon Vasquez with William Blair. Please go ahead.

Brandon Vasquez: Hi, good morning, everyone. Thanks for taking the question. First I’ll ask maybe a couple of near term ones, and then maybe one or two kind of longer term ones. But kind of in the near term, curious, your thoughts around, it sounds like there was a holiday shutdown at one of the manufacturing facilities. But then you had issued guidance in January. So it sounds like maybe you would have been passed that already. So curious if that was — can you talk about if it was that the reason that things came in a little weaker than expected? Was there something post that January guidance that had developed differently?

John Adent: Brandon, it was a little bit of both. We didn’t realize — we looked in January, the full impact of that December shutdown, because our expectation was that we had a plan in place that the contract manufacturer is going to run. And that’s why it was unanticipated to us that they shut it down. And so we didn’t really realize that full impact. So we got a little bit later into that January period. It was a major disappointment. We were making progress and it really set us back and that’s why you’re seeing — I was talking about, we’re not meeting our customers demand right now on the 3M of the 3M business that we bought because the manufacturer just can’t make enough for us at this point now. 3M and we’ve had three meetings with myself and their CEO over the last 30 days.

We’ve got a new structure in place. We have, I think, the attention now of the group that this is no longer a business buried within 3M. This is a business they have to focus on. And I think we’re starting to see that focus. But it’s going to take us a while to get through it. I have seen now that, we’re directionally better. But we’ve been in that position before. So I want to see this stay directionally better, and not go the other way. So we’re optimistic that this is transitory and give us momentum going in the next year. But they need to prove to me also that they can follow what they say they’re going to do and get that stuff done.

Brandon Vasquez: Okay, got it. And then as you think — maybe this is a question a little bit more for Dave. But you have that mid-single digits core growth, maybe towards the lower end of that now. What is implied? My understanding is that Neogen is a core legacy business. What’s implied there in the 3M business? I mean, it’s a sizable revenue number, right? Should — can that sequentially improve as we go into the fiscal fourth quarter?

Dave Naemura: Yeah, hey, Brandon. I think I’d say we’re not anticipating too much improvement, maybe a little bit better. Obviously, there’s some more selling days. But from a growth perspective, we would anticipate it probably doing a little bit better, but more kind of that mid-single digit on an underlying legacy business and the acquired business, not showing significant improvement sequentially, I think, is what’s contemplated there.

Brandon Vasquez: Okay, and then, maybe going a little further out, just one on kind of long term guidance. It was encouraging, you guys still feel comfortable with the fiscal ’25 guidance, despite kind of the maybe the backlog in this quarter being a little worse than expected? Can you — David, now, we’re all going to start looking at our fiscal ’24 models. And I appreciate that you’re not going to give a number now. But how do we think of the recovery through fiscal ’24? Is this a linear event? Is this kind of like a hockey stick as we get to the back half of ’24, and into ’25? Any commentary you can give us to kind of level set?