Neogen Q1 2024 Earnings Call Transcript

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October 10, 2023

There are 7 speakers on the call.

Operator

Welcome to the Neogen Corporation First Quarter 20 24 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. Would now turn the conference over to Bill Welleke, Vice President of Investor Relations.

Operator

Please go ahead, sir.

Speaker 1

Thank you for joining us this morning for the discussion of the Q1 of our 2024 fiscal year. I'll briefly cover the non GAAP Before passing the call over to our CEO, John Adient, who will be followed by our CFO, Dave Namura. Before the market opened today, we published our Q1 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.

Speaker 1

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 ks 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.

Speaker 2

Thanks, Bill. Good morning, everyone, and welcome to our earnings call covering the Q1 of our 2024 fiscal year. We've made significant progress across a number of fronts on the integration of the Forman 3 ms Food Safety Business, while continuing to navigate soft market conditions. Our results for the quarter were largely as anticipated with 2 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 form a basis, which includes a negative impact from China of approximately 1%.

Speaker 2

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 output from higher levels last year to the current environment. In our animal safety segment, We continue to see the impact of destocking in the distribution channel. Sales out of the channel to our end customers remain positive compared to the prior year, The 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 3 to 4 year low.

Speaker 2

In the former 3 ms 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 Q1 on a pro form a basis. Backlog remains at reasonable levels following the progress in the prior quarter catching up on past due orders, which helped drive a strong Q4. We continue to work on rebuilding demand through targeted initiatives as we demonstrate reliable supply of petrofilm and progress has been notable. Although pro form a growth was lower in Q1, impacted by weakness in Asia, a tough comparison against some elevated activity last year In 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.

Speaker 2

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 size 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 to 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 3 ms pathogen and sample handling product lines in the Neogen facilities remain on track For completion in the Q3, 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 3 ms business Our strong complement to the Neogen product portfolio that we're looking forward to have fully embedded within our operations.

Speaker 2

After these moves, we will have nearly 50% of the former 3 ms product lines fully integrated, all but Putrefill. The planned exit to the 2 transition services agreements, those covering back office functions and distribution are also on track to be completed in the Q3. 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 3 ms products. Last month, we had the initial go live with our food safety business in the U. S.

Speaker 2

And Canada, as well as corporate, making the cut over to the new ARP on which we are now up and running. Implementation has generally gone well food safety business that we expect will mostly ship in October 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, It's continuing to see end user demand in line with our expectations and working diligently to satisfy it. The final phase of integration activities It involves the construction of our new facility in Lansing, which will house the production of petrofilm and other products from the legacy Neogen portfolio.

Speaker 2

The new facility continues to progress on track with construction of the exterior expect 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 3 ms business closer to full autonomy within the 1 knee engine we're building. Now, I'll turn the call over to Dave for some more insights into our results for the quarter.

Speaker 3

Thank you, John, and welcome to everyone on the call. Jumping into the results, our Q1 revenues were $229,000,000 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 form a basis for the 3 ms transaction, core revenues declined modestly, down 40 basis points compared to the prior year quarter or approximately $4,000,000 to $5,000,000 below our expectations, driven primarily by lower sales in Asia.

Speaker 3

In Asia Pacific, customers were more impacted by the petrofilm supply constraints We experienced last fiscal year leading to what we believe will be 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 $166,000,000 in the quarter, an increase of 157% compared to the prior year, including core growth of 4.5%. The core growth was led by Bacterial and general sanitation product category, which benefited from new microbiological testing business in the U.

Speaker 3

S. And UK. 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 the Animal Safety segment were $63,000,000 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 continued destocking large 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.

Speaker 3

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 3 ms Food Safety division, core revenue grew modestly on Pro form a 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.

Speaker 3

This growth was partially offset by a modest core revenue decline in Petri Film with the largest driver being the aforementioned weakness in Asia 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.

Speaker 3

Finally, APAC declined mid single digits as a result of a slower The anticipated recovery in 3 ms demand following the petri film 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 region level. Gross margin in the Q1 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 3 ms Food Safety transaction As well as positive price cost. On a pro form a basis, gross margin expansion was 180 basis points. Adjusted EBITDA was $52,000,000 representing growth of 94% from the prior year quarter, driven by the merger with the former 3 ms Food Safety division.

Speaker 3

Adjusted EBITDA margin was 22.9%, a year over year increase of 2 50 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 form a 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 $24,000,000 for the quarter with adjusted earnings per share of $0.11 compared to $18,000,000 $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 4th quarter with gross debt of 900,000,000 67% of which remains at a fixed rate and a total cash position roughly unchanged from Q4 at $239,000,000 resulting in pro form a net leverage of 2.9 times and total liquidity of over 375,000,000 Although the Q1 is typically our lowest quarter seasonally, this year's was a bit lower than we had anticipated, but generally aligned with how we anticipated the year developing.

Speaker 3

From what we have seen through the 1st 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 3 ms. The inefficiencies he mentioned We'll 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 Q2 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.

Speaker 3

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 Q1 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.

Speaker 2

Thanks, Dave. As you heard today, we believe we're making solid progress on the integration of the former 3 ms business And are on track to be completely independent from 3 ms in the Q3 outside of petrofoam manufacturing, where 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.

Speaker 2

In addition to the important step of gaining full operational control of this part of the business, 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 1 year anniversary of the 3 ms transaction, We are excited about the opportunities we have to leverage our leading position in the food safety markets. Our sales and R and D teams are now approaching 1 year of working together on the combined 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.

Speaker 2

I'll now turn things over to the operator to begin the Q and A.

Operator

Yes. Thank you. At this time, we will begin the question and answer session. And the first question comes from Brandon Vazquez with William Blair.

Speaker 4

Good morning, everyone. Thanks for taking the question. 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 updates 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.

Speaker 4

But again, in kind of a worsening backdrop in macro that

Speaker 2

Yes. Thanks, Brandon. 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.

Speaker 2

So while China was a challenge, as we look forward, It was a particularly tough quarter that had a tough comp that I don't think is 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 And so while this quarter was about a $4,000,000 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 wildcard 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.

Speaker 2

And then 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, bill customers, pick, pack and ship, manufacture, but we're just not as efficient. And it's going to take us a little while to get that efficiency up.

Speaker 2

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 Q3. So I'll let Dave talk a little bit more about guidance if you guys have anything to

Speaker 5

add. Yes. No,

Speaker 3

I think that hey, Brandon, I think John summarized it pretty well. I guess I'd just highlight, we 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. Yes, there's some strength there, but I think the environment is not too different than we'd anticipated.

Speaker 4

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 unique challenges The Neogen and 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?

Speaker 2

Yes. What we mean by that was when 3 ms was struggling with their production of petri film, 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 Continue to run their business without the PetriFone 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.

Speaker 2

1 quarter, they're like great, but show me another quarter. So now we're 2 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 fixed the supply issues that weren't able to be fixed for 2 years And earn their trust back and get that business back.

Speaker 4

Okay. And maybe I'll throw one last follow-up to that and then I'll let someone Get in queue here. But as you look at APAC and you're talking about winning TrustVac, do you guys have a sense of where those customers are going? I think often when we talk Experts, they fall on kind of like backup plans. Are they moving to competitors?

Speaker 4

Do you think this is kind of temporary? Any thoughts around that? Thanks.

Speaker 2

Yes, 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. Why I said I'm prepared. I was encouraged because we're starting to see that move back.

Speaker 2

But It takes you 2 years to lose them and it's going to take us a little while to gain them back. But I think we're really confident that our solution and our The things that we provide around our product portfolio 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 with Wells Fargo.

Speaker 5

Great. Thanks. So John, just could you give us a bit more details on the genomics, I think the term is attrition of 2 U. S. Customers, please?

Speaker 5

Yes. And did that impact the kind of like a Low expectations revenue in the quarter.

Speaker 2

So, yes, thanks, Tim. So, we had 2 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.

Speaker 2

And when the pressure came and they wanted a significant price decrease, we declined. So we've made the decision that even though it was going to hurt us on volume, it wasn't as significant from a profitability standpoint. So That's really what drove that decision.

Speaker 5

All right. No, I appreciate that detail. And Just thinking about those 2 customers, is there something that we could take out of the rent model here in terms of 23 revenues? Any Color, percent of revenues, maybe those 2 customers accounted for or would have accounted for going forward?

Speaker 3

Tim, hey, it's Dave. I think it's in the guide. I would say the new news for us a little bit in the quarter wasn't these folks. I would say, things came in generally a little bit lighter, I think, because of some of the end market pressures. But I think this more describes the kind of the absolute growth rate.

Speaker 3

I would say it's contemplated in the guide.

Speaker 5

All right. Got it. Perfect. And then, thinking about the destocking, just I know new commentary around, I think the channel is at low, pretty low levels here. Just when should we think this rebound or how long should Just when should we think this rebound or how long should these low levels sustain of inventory before going back to normal Or are we at new normal at low levels?

Speaker 5

Just additional thoughts here and timing.

Speaker 2

Tim, I don't think we're at new Normal. I think this is abnormally low. And based on what we're seeing on End user demand, so we see what goes in and what goes out on end user demand. Like I told you, I've always been bad at calling the bottoms. But To me, this is not a sustainable model.

Speaker 2

So I feel pretty comfortable like we talked about second half of the year, where We think that you can't drive inventories down that low and still provide the type of service levels that I know the distributors want to provide to their customers. I think this is a it's something that we contemplated and we think probably in the back half of the year is going to improve.

Speaker 5

All right. Got it. Then Dave, final one for me and I'll pass it along. So could you just walk us through the Transition agreement here in terms of the pathogen and sample handling Lines as a percent of like you called it out as 30% of revenues. How much of the, I guess, transition manufacturing agreement Cost, are those product lines?

Speaker 5

And how should we think of like the day 1 margin impact as those dual costs roll off, if you will?

Speaker 3

Yes. Tim, look, we're obviously standing up a reasonable amount. There's costs from Kind of move and kind of one time in nature, but we're standing up recurring costs to accept those product lines in. And when those happen, to your point, We won't be paying the manufacturing transition fee. I think net net that's accretive to us.

Speaker 3

Tough to quantify too sharply and some of the costs are overlapping. But you had seen us put forward a schedule in the spring About where we expected to be from an integration standpoint at the end of our Q3, hopefully, you took away from the call that we feel at least after the first, We continue to track to that. I think the other thing I'd add is that on the OpEx line, we have some duplicate costs as well that we'll see come out for the 4th Yes, when we're able to get to that point of integration we previously noted. Just under 23% adjusted EBITDA margin for the first, I talked about 100 basis points of some kind of unanticipated headwinds. But there's probably another 100 basis points of duplicate cost in there.

Speaker 3

So we got to manage it well, but I think the Q4 and really the exit rate for the year is how I think about it is where we should see us down to Just manufacturing transition fees related to manufacturing the Petri film, and then of course that becomes an issue in the coming years. So Maybe not as precise an answer as you're looking for, but hopefully that contextualizes it.

Speaker 5

That was great. I appreciate the time. Thanks everybody.

Operator

Thanks, Tim. Thanks, Tim. Thank you. And the next question comes from David Westenberg with Piper Sandler.

Speaker 6

Hi, this is John on for Dave. Thanks for taking the questions. So can you give any additional details on the ERP implementation? So there was some revenue that was shifting from between the different quarters from the second quarter. So can you just walk Sure.

Speaker 6

What the implementation issues were, what the degree of the shift was and what the areas where that shift was mostly around?

Speaker 2

Yes. Thanks, John. Like we talked about in the prepared remarks, when you go to a new RPA system, You will not be as efficient day 1 as you were on the old system because you'd spent 20 years on the old system and you knew it backwards and forwards. So Like I said, the good news was the business is up and running. We were able to do all the functions.

Speaker 2

Nothing stopped. It's just we're not as fast And really around warehousing than we are and everything else that we were before. So We're finding a way to continue to train the teams. We're seeing sequentially daily that that is improving day by day. But we had a period of time where that wasn't at our average and so we have to over perform to get to the average.

Speaker 2

And I know Dave's got a couple of comments on this.

Speaker 3

Just to make sure we're clear. So this didn't affect the end of the Q1. So we went live for the 1st day of the 2nd quarter. So what we're looking at is The 1st month of our Q2 here and now shipments are out the door and we carry over Open orders from September into October. And that was low double digit millions, Whereas it usually be much, much lower than that as we ship at a slower rate, we got to make that up, right?

Speaker 3

So the question is, do we carry over some of that Out of the second, so our goal here was to share, I think, 1st and foremost that the implementation went well. I think that's the headline. And as anticipated, maybe we're shipping a little bit slower than we otherwise may have and that We got our we're kind of calling it out as potentially a shipment timing risk for the second. Some of that might push to the third. But, what we really got our eye on is the demand backdrop.

Speaker 3

And I would say through the 1st month, hopefully you heard from us, that feels supportive.

Speaker 6

Got it. Thank you. So also, we heard that Walmart had suggested the consumers are They're reducing their buying because of GLP-one. Are you actually hearing food producers saying anything similar?

Speaker 2

We're hearing the same things that you're hearing. Most of them are watching. They're understanding that It may have an impact. And we're looking at the same thing, John. I think if you look at it in the relative scale and size of our business, GLP-one will be a headwind, but it is going to be a relatively small headwind compared to the big tailwinds we have around this business, around increased regulatory environment, increased customer usage, expanding into new geographies, developing new products.

Speaker 2

So while it may be a headwind going forward, it's going to be, I think, a de minimis headwind.

Speaker 6

Got it. Thank you. And just one last one. Sorry if I missed it, but Do you think that any customers stocked Petri film earlier in the year during supply constrained environment?

Speaker 3

Sorry, I didn't get the question.

Speaker 4

Yes, can

Speaker 3

you say it again, John? Yes.

Speaker 6

Yes. Sorry if I missed it. But is it your understanding that any customers stock Petri film earlier in the year During more supply constrained environments?

Speaker 3

No, I don't think we've seen that. No, I mean, I just know.

Speaker 5

Got it. Thank you.

Speaker 2

Thank you.

Operator

Thank you. And this concludes the question and answer session. I would like to turn the floor to management for any closing comments.

Speaker 2

Thank you. Yes, As we stated earlier, while the quarter was a little softer than anticipated, I think what we wanted to talk about Was the success really of the integration and moving off our 2 Transition services agreements and standing up ERP. And for those of you that have been involved in a lot of different companies, those were significant risk that could derail organizations. And I'm really proud of the team and the work they've done and the ability to plan and execute kind of seamlessly to continue to move to the new Neogen and the 1 Neogen environment. So we're really excited about the future.

Speaker 2

We look forward to talking to you at the end of the second quarter. Thank you.

Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.

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