Neogen Corporation (NASDAQ:NEOG) Q1 2024 Earnings Call Transcript October 10, 2023
Neogen Corporation misses on earnings expectations. Reported EPS is $0.11 EPS, expectations were $0.14.
Operator: Welcome to the Neogen Corporation First Quarter 2024 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded. I would now turn the conference over to Bill Waelke, Vice President of Investor Relations. Please go ahead, sir.
Bill Waelke: Thank you for joining us this morning for the discussion of the first quarter of our 2024 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 opened today, we published our first quarter results, as well as a 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.
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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: Thanks, Bill. Good morning, everyone, and welcome to our earnings call covering the first quarter of our 2024 fiscal year. We’ve made significant progress across a number of fronts on the integration of the former 3M Food Safety business, while continuing to navigate soft market conditions. Our results for the quarter were largely as anticipated with two primary exceptions, greater than expected weakness in Asia and in genomics, along with a couple of unanticipated cost items. For Neogen in total, we saw core revenue growth decline by 0.4% in the quarter on a pro forma basis, which includes a negative impact from China of approximately 1%. In our legacy Food Safety business, core revenue growth was in the mid-single digit range, including positive volume growth in an end market where food production volumes continue to be down on a year-over-year basis for many producers.
Additionally, certain producers have taken capacity offline in order to right-size the output from higher levels last year to the current environment. On our Animal Safety segment, we continued to see the impact of destocking in the distribution channel. Sales out of the channel to our end customers remained positive compared to the prior year with large veterinary distributors continue to reduce their purchases. Based on the data we have from the larger distributors in North America, channel inventories are at a three to four year low. In the former 3M Food Safety Division, the progress made with production levels at our transition manufacturing partner in Q4 of last year was maintained. For the former 3M division in total, core revenue grew by approximately 1% in the first quarter on a pro forma basis.
Backlog remains at reasonable levels following the progress in the prior quarter catching up on past due orders, which helped drive a strong fourth quarter. We continue to work on rebuilding demand through targeted initiatives as we demonstrate reliable supply of Petrifilm and progress has been notable. Although pro forma growth was lower in Q1, impacted by weakness in Asia, a tough comparison against some elevated activity last year and a strong Q4 where we caught up on fulfilling orders, we have seen good progress so far in Q2 and remain very optimistic about the opportunities ahead of us. As we operate through a rather dynamic market environment, we are encouraged by our performance. The destocking and Animal Safety will ease as inventories right-sized and end-user sales out of the distribution channels continue to grow.
On the Food Safety side, we are dealing with a few challenges unique to us in Asia Pacific and macro weakness in China specifically, that is common in most companies. However, outside of Asia Pacific, our Food Safety core revenue grew over 4% with positive volume despite the lower production volumes we see across much of the food production landscape demonstrating the resiliency of our business. On the integration front, the relocation of the former 3M pathogen and sample handling product lines in the Neogen facilities remain on track for completion in the third quarter. Hiring and training of new employees and inventory builds are underway as our initial equipment transfers with site preparation expected to wrap up later this month. These two product lines account for nearly 30% of the revenue of the former 3M business are a strong complement to the Neogen product portfolio that we’re looking forward to have fully embedded within our operations.
After these moves, we will have nearly 50% of the former 3M product lines fully integrated all but Petrifilm. The plan to exit the two transition services agreements. Those covering back-office functions and distribution are also on track to be completed in the third quarter. A key step that enables the exit of these agreements is the implementation of our new ERP system, which will allow us to take over order fulfillment services currently provided for the former 3M products. Last month, we had the initial go-live with our Food Safety business in the U.S. and Canada, as well as corporate, making the cut over to the new ERP on which we are now up and running. Implementation has generally gone well, in that we are fully operational on the new system, processing orders and shipping products, but as is typical, we are not as efficient yet on the new system as we were on the old.
As a result, we’ve exited the month of September with an elevated level of open orders in our legacy Food Safety business that we expect will mostly ship in October and November. But, as we continue to work our way up the efficiency curve, it is possible that some level of revenue will shift from Q2 into Q3. What will be most important, however, is continuing to see end-user demand in line with our expectations and working diligently to satisfy it. The final phase of integration activities involves the construction of our new facility in Lansing, which will house the production of Petrifilm and other products from the legacy Neogen portfolio. The new facility continues to progress on track with construction of the exterior expected to be completed during Q3, at which point the focus will shift to the completion of the interior work and the installation of the custom manufacturing equipment.
We’re pleased with the progress we’ve made on the integration to date and are focused on the execution of the upcoming key transition activities in the second and third quarters that will bring the former 3M business closer to full autonomy within the One Neogen we’re building. Now I’ll turn the call over to Dave for some more insights into our results for the quarter.
David Naemura: Thank you, John, and welcome to everyone on the call. Jumping into the results, our first quarter revenues were $229 million, an increase of 73% compared to the same quarter a year ago. Core revenue, which excludes the impact of foreign currency, acquisitions, and discontinued product lines declined just over 1% for the quarter. Acquisitions and discontinued product lines added a net 73%, while foreign currency was a 1% tailwind compared to the prior year. On a pro forma basis for the 3M transaction, core revenues declined modestly, down 40 basis points compared to the prior-year quarter or approximately $4 million to $5 million below our expectations, driven primarily by lower sales in Asia. In Asia-Pacific, customers were more impacted by the Petrifilm supply constraints we experienced last fiscal year, leading to what we believe will be a slightly longer path to demand recovery.
Our China exposure is small, representing less than 3% of total company revenue, but worsening macro conditions there contributed to significantly lower sales in the quarter. Moving now to the segment level, revenues in our Food Safety segment were $166 million in the quarter, an increase of 157% compared to the prior year, including core growth of 4.5%. The core growth was led by the Bacterial and General Sanitation product category, which benefited from new microbiological testing business in the U.S. and U.K. Natural Toxins and Allergens also had solid core growth with a notable increase in sales of milk and gluten allergen test kits. Within the Indicator Testing, Culture Media and Other category, modest core growth in Culture Media was offset by a decline in food quality and nutritional analysis sales due in part to international distributor ordering patterns.
Quarterly revenues in the Animal Safety segment were $63 million, a core decline of just under 7% compared to the prior-year quarter. Albeit generally in line with our expectations, Animal Safety revenue was a bit lighter than anticipated, driven primarily by the continued destocking at large veterinary distributors. This destocking was the primary reason for the core revenue decline in vet instruments and disposables, while supply constraints played a role in the lower sales of small animal supplements and vitamin injectables in the Animal Care and Other category. These declines were partially offset by solid growth in our biosecurity products with higher volumes in insect control products and cleaners and disinfectants. Worldwide genomics revenue was down modestly on a core basis with growth in international beef markets, offset by declines in poultry and porcine, driven primarily by the attrition of a couple of large customers in the U.S. In the former 3M Food Safety division, core revenue grew modestly on a pro forma basis, as John mentioned, which includes a compare headwind of a few points and also follows a very strong Q4.
The Bacterial and General Sanitation product category saw the highest growth in this quarter with particularly strong sales of Clean-Trace Hygiene Monitoring products. This growth was partially offset by a modest core revenue decline in Petrifilm with the largest driver being the aforementioned weakness in Asia and China, in particular. Importantly, we were pleased to see that the improvements made in transition manufacturing during Q4 were sustained into Q1, providing stability of supply and allowing us to focus on demand-generating activities. From a geographical perspective, results were mixed. Growth was led by EMEA, which grew in the high single digits, and LatAm in the mid-single digits. USAC was down low single digits due mainly to the destocking of large animal safety distributors, as well as the lower sales in genomics, while the Food Safety business grew in the low single digits.
Finally, APAC declined mid-single digits as a result of a slower-than-anticipated recovery in 3M demand following the Petrifilm supply constraints and also across-the-board softness in China. Recall that China represents less than 3% of our global revenues, but we experienced a decline in the high 20s, so the impact was measurable, particularly at the regional level. Gross margin in the first quarter was 51%, representing an increase of 400 basis points from 47% in the same quarter a year ago with the increase primarily driven by the addition of higher margin business from the 3M Food Safety transaction, as well as positive price cost. On a pro forma basis, gross margin expansion was 180 basis points. Adjusted EBITDA was $52 million, representing growth of 94% from the prior-year quarter, driven by the merger with the former 3M Food Safety division.
Adjusted EBITDA margin was 22.9%, a year-over-year increase of 250 basis points, including approximately 100 basis points of negative impact from a non-recurring billing adjustment from our transition manufacturing partner and transaction FX. On a pro forma basis, adjusted EBITDA margin expansion was 10 basis points, lower than we had anticipated due to the non-recurring items I mentioned and volume being a bit lighter than expected. Adjusted net income was $24 million for the quarter with adjusted earnings per share of $0.11 compared to $18 million and $0.16 respectively in the prior year period. The increase in adjusted net income was driven by higher adjusted EBITDA, which more than offset the increase in interest expense, while adjusted earnings per share was negatively impacted by the increase in weighted average shares outstanding from the Food Safety transaction.
We ended the fourth quarter with gross debt of $900 million, 67% of which remains at a fixed rate and a total cash position roughly unchanged from Q4 at $239 million, resulting in pro forma net leverage of 2.9 times and total liquidity of over $375 million. Although the first quarter is typically our lowest quarter seasonally, this year was a bit lower than we had anticipated, but generally aligned with how we anticipated the year developing. From what we have seen through the first month of Q2, the demand environment continues to appear consistent with what we had expected. As John noted, though, we are fully immersed in our ERP implementation, which will enable us to extract ourselves from the transition service arrangements we have with 3M.
The inefficiencies he mentioned will make shipments more challenging in Q2, and we will likely have carryover of some Food Safety open orders into the initial weeks of Q3 as a result. Based on this dynamic, we could see a broader range of outcomes for the second quarter, depending on how the backlog of open orders develops. Our current base case view is that, we should see a modest sequential increase in revenue, which assumes we exit the quarter with an elevated level of open orders, as well as a modest sequential increase in adjusted EBITDA margin. If we do see some amount of revenue shift from Q2 to Q3, this would correspondingly affect the normal seasonality of our business in which the second half of the year typically accounts for 52% of the year’s revenue.
Based on our first-quarter results and the normal seasonality of the business, as well as the expectation of an improved end-market environment in the second half, we are maintaining our full-year outlook. I’ll now hand the call back to John for some closing thoughts.
John Adent: Thanks, Dave. As you heard today, we believe we’re making solid progress on the integration of the former 3M business and are on track to be completely independent from 3M in the third quarter outside of Petrifilm manufacturing, but we feel that arrangement is in a stable place. Our new ERP system is up and running after the Phase 1 launch, which is a significant step to have behind us. And we will work diligently through the backlog of open orders as we continue to become more efficient in our new ERP system. We still have significant work ahead of us though. With key activities taking place in the second, and third quarters, as we implement the final steps needed to relocate production and exit the transition services agreements.
In addition to the important step of gaining full operational control of this part of the business there the associate — there are the associated savings we expect to see from exiting the agreements and we fully anticipate ultimately achieving greater efficiency and utilization in our footprint. Having now crossed the one-year anniversary of the 3M transaction, we are excited about the opportunities we have to leverage our leading position in the Food Safety markets. Our sales and R&D teams are now approaching one year of working together on the combined product portfolio, building momentum that will result in new commercial opportunities, particularly as the market conditions improve. Our team members around the world have worked tirelessly on advancing the integration process and I want to wrap up here today by thanking them for their hard work.
We have a shared goal that we are ever mindful of to remain the global leader in food safety and help protect the world’s food supply. I’ll now turn things over to the operator to begin the Q&A.
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Q&A Session
Operator: Yes. Thank you. At this time, we will begin the question-and-answer session. [Operator Instructions] At this time, we will pause momentarily to assemble the roster. And the first question comes from Brandon Vazquez with William Blair.
Brandon Vazquez: Good morning, everyone, and thanks for taking the question. And I guess, first just to start on guidance at kind of a high level. I think some of the weakness in the quarter was coming from worsening macro, especially like in China, given update seem to be kind of negative out of there. Just curious, what gives you guys kind of confidence around reiterating the guidance range? Obviously, that was encouraging to see maybe an indication of the underlying momentum you guys are seeing, but, again, in kind of a worsening backdrop in macro that seems to be out of your control a little bit, what are you guys seeing that’s giving you guidance or comfort in that guidance range?
John Adent: Yeah. Thanks, Brian, and thanks for being here. I think specifically to China, what we’re seeing is that, it’s a relatively small piece of the business, it’s only 3% of revenue. So, while China was a challenge, as we look forward, it was a particularly tough quarter that had a tough comp. But I don’t think it’s going to repeat, so we don’t see that big of a drag. For the overall markets, it’s pretty similar to what we’ve been seeing, food production volumes are slow, the distributor channels destocking, that’s kind of what we thought was going to happen for the year. And so, while this quarter was about a $4 million miss on what we expected it to be, we feel pretty comfortable about where we are on end-user demand.
I think, like we talked about kind of the wild card is making sure that we’re getting the product out the door with the SAP conversion. I’m really proud of the team on what we’ve been able to do under the SAP conversion. You hear all the horror stories, but you don’t hear the good stories. This is one of the good stories, right? We’re 40 days in, we’re immediately able to do order to cash, build customers, pick pack and ship, manufacturer, but we’re just not as efficient and it’s going to take us a little while to get that efficiency up, so we’re caught a little bit behind. We think we can catch up in October, November, but as Dave talked about, there may be a little bit of carryover going into the third quarter. So, I’ll let Dave talk a little bit more about guidance as we ever had.
David Naemura: Yeah, I think that — Hi, Brandon. I think John summarized it pretty well. I guess I’d just highlight, we’ve talked about the first half being softer and that’s what we’re seeing. But outside of Asia Pacific, where I think we have some challenges that we noted in the prepared remarks, we saw, particularly, the Food Safety business grow pretty good outside on a global basis outside of Asia-Pac. So there is some strength there but I think the environment is not too different than we had anticipated.
Brandon Vazquez: Okay. And Dave, maybe as a follow-up to that, you just hit on — you guys mentioned on the prepared remarks a little bit that there are some, I think, the phrase John had used was that, unique challenges to Neogen in APAC. Can you guys maybe talk about some of those challenges that are unique to you guys? What you’re doing to try to maybe fix some of those efforts?
John Adent: Yeah. What we — what we mean by that was, when 3M was struggling with their production of Petrifilm, APAC was asymmetrically hurt regarding supply. And so, you had almost 24 months of supply disruption, which really challenged customers because they just — they had to do other solutions and they had to find ways to continue to run their business without the Petrifilm product. And so, the unique challenge to us is, we have to earn back their trust, Brandon. We’ve got to show them we have supply. One quarter they’re like great, but show me another quarter. So now we’re two quarters in where supply is where it needs to be, but it’s going back to those customers and winning back their trust that, now under our regime, we fix the supply issues that weren’t able to be fixed for two years and earned their trust back and get that business back.
Brandon Vazquez: Okay. And maybe I’ll throw one last follow-up to that and then I’ll let someone else get in queue here, but as you look at APAC and you’re talking about winning trust back, you guys have a sense of where those customers are going. I think often when we talk to experts, they follow on kind of like backup plans, are they moving to competitors? Do you think this is kind of temporary? Any thoughts around that? Thanks.
John Adent: Yeah. It’s a little bit of both. It’s not so much traditional methods there. We did see some move to competitors, but we’re seeing those customers come back. That’s why I said in prepared I was encouraged, because we’re starting to see that move — that move back, but it’s — it takes you two years to lose them and it’s going to take us a little while to get them back, but I think we’re really confident that our solution and our — the things that we provide around our product portfolio of solutions and people are just head and shoulders above our competitors. So we’re going to get that business back.
Operator: Thank you. And the next question comes from Tim Daley of Wells Fargo.
Timothy Daley: Great, thanks. So, John, just could you give us a bit more details on the genomics? I think the term has attrition of two U.S. customers, please.
John Adent: Yeah.
Timothy Daley: And did that impact the kind of like a below expectations revenue in the quarter?
John Adent: Yeah. Thanks, Tim. So, we had two large customers that are in very challenging markets right now, in poultry and swine and we’re putting extreme pressure on pricing and other solutions for us. And for years these have been good volume customers but relatively low-margin customers. You’ve seen that we’ve been moving to transition the genomics business to different species that are higher value, higher margin, and when the pressure came and they wanted a significant price decrease, we declined. So we’ve made the decision that even though it’s going to hurt us on volume, it wasn’t as significant from a profitability standpoint. So that’s really what drove that decision.