Neogen Q2 2023 Earnings Call Transcript

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January 5, 2023

Key Takeaways

  • Neogen completed its acquisition of 3M’s Food Safety business, integrating CRM systems on day two and aligning manufacturing operations to accelerate synergy realization and profitability.
  • Q2 revenues rose 76% year‐over‐year to $230 million, driven by 7% core growth, a 48.9% gross margin (up 250 basis points), and a 116% increase in adjusted EBITDA to $64 million.
  • The Food Safety segment—now 70% of revenues—delivered 6% core growth led by indicator testing, while Animal Safety posted 7% core growth in genomics and biosecurity despite temporary PetriFilm supply constraints.
  • Neogen ended Q2 with $940 million in gross debt (3× net leverage) and has repaid $100 million since closing, maintaining a target of $1 billion in revenue and $300 million adjusted EBITDA by FY 2025, with full‐year mid‐single‐digit core growth and mid‐20% adjusted EBITDA margins.
  • Operationally, Neogen is investing in a new Lansing food safety plant, expanding its Kentucky distribution center, and building back‐office and IT capabilities to replace transition service agreements and support the combined business.
AI Generated. May Contain Errors.
Earnings Conference Call
Neogen Q2 2023
00:00 / 00:00

There are 7 speakers on the call.

Operator

Good morning, and welcome to the Neogen Corporation Second Quarter Fiscal Year 2023 Earnings Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Bill Wilkie, Head of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you for joining us this morning for the discussion of the results of the 2nd 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 Steve Quinlan, our retiring CFO and Dave Nomura, our current CFO. Before the market opened today, we published our 2nd 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.

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 Q2 of our 2023 fiscal year. We're pleased to be with you today to provide the first View of the company's performance since the completion of the food safety acquisition from 3 ms. We've delivered solid core growth in both of our segments and notably A level of profitability well ahead of where the company was prior to the acquisition. The former 3 ms Food Safety business is a great business And highly complementary.

Speaker 2

And we're excited about what we've seen in the 1st 4 months of our ownership. Clearly, we have still got a number of things to do And we're early days in the integration. We're off to a great start and we have numerous work streams fully underway across the organization to integrate our systems, products, Processes and people. Our integration philosophy has always been the best idea wins with the willingness to make any changes necessary to improve the business and ensure long We've made significant progress to date in the realignment and coordination of our commercial efforts. We combined CRM systems on day 2, modified geographic coverage areas and worked together to identify and prioritize The highest potential revenue and synergy opportunities.

Speaker 2

We've had successes within the marketplace with customers responding positively to the new products and solutions available to them. Neogen's reputation for technical expertise and excellent customer service has been a considerable asset as we began to move forward as one company with 1 combined portfolio. Planning the relocation of manufacturing operations for our new food safety facility in Lansing And maximizing their efficiency are also key integration items, receiving significant focus and attention. Manufacturing engineers from the former 3 ms business are assisting in the design and layout of the production process, while construction of the new facility continues on track. In the interim, the manufacturing and distribution of the acquired products will continue under transition service agreements And we've been collaborating with 3 ms to address the production and backlog issues that materialize between signing and closing of the transaction.

Speaker 2

There's still work to be done, but things are moving in the right direction and we're implementing plans that we believe will lead to further improvements as we move through the second half of the fiscal year. While the integration activities are a broad organizational priority, we're not losing our focus on our customers. Food Safety segment, which now comprises approximately 70% of our total revenues, grew nicely in the quarter on a core basis, including the indicator testing category, which is the most significant and profitable piece of the acquired food safety business from 3 ms. Our Our Animal Safety segment had a similar level of core revenue growth, led by genomics and our portfolio of biosecurity products. And tomorrow, we will be having the grand opening of our new expanded distribution center in Mount Sterling, Kentucky, which will shorten customer lead times and allow us to While the elevated level of macro uncertainty has led to some softening in our markets, We believe the business is resilient and well equipped to drive future growth.

Speaker 2

We have an excellent team in place with each member working hard to ensure the new Neogen We are creating will continue its upward trajectory, gaining market share and helping our customers around the world keep the people and animals they care about safe. Now I'll turn it over to Steve for some more insights in our results for the quarter.

Speaker 3

Well, thanks, John, and welcome to everyone listening this morning. Jumping right into the results, our 2nd quarter revenues were $230,000,000 an increase of 76% compared to the same quarter a year ago. Core growth, which we're introducing to replace our measurement of organic growth, excludes the impact of both foreign currency and acquisitions It was a solid 7% for the quarter. Acquisitions added a further 73%, while foreign currency amounted to a 4% headwind compared to the prior year. At the segment level, revenues in our food safety segment were $161,000,000 in the quarter, An increase of 140% compared to the prior year, included core growth of 6%.

Speaker 3

Sales of our culture, media and other category Grew mid single digits driven by increases in our Neogen Analytics platform and other culture media products. Our recently acquired Petrifilm product line performed well in its Q1 under our ownership. Sales of bacteria and general sanitation products were mixed, Up low single digits on a core basis with growth of Neogen Filters and ampule media and AccuPoint general sanitation products, partially offset by lower sales of rapid microbial testing products. Rounding out our larger food safety product categories is natural toxins, Allergens and drug residues, sales of which were down slightly on a core basis. Natural toxin test kit sales were up mid single digits on a core basis due to higher levels of aflatoxin in domestic and international grain harvests.

Speaker 3

Allergen test kits were roughly flat due to softening market conditions And supply disruptions for certain products, while drug residue test kits were down primarily due to lower sales to international dairy markets. Quarterly revenues in the animal safety segment were $69,000,000 up 8% over last year's 2nd quarter. Core growth was 7%, while acquisitions contributed 2% and partially offset by 1% in negative foreign currency impact. Sales in the rodent control, insect control and disinfectants category had a strong performance, up low double digits on a core basis. The growth was driven by share gains in the animal protein market and sales of dairy hygiene products as well as new insect control product introductions.

Speaker 3

Revenues in the Veth instruments and disposables category were up mid single digits on a core basis, led by strong market demand and additional sales to a large Retail customer. Worldwide core genomics revenues rose upper single digits on strong demand in U. S, Europe and Australian beef markets. Gross margin in the 2nd quarter was 48.9 percent, representing an increase of 2 50 basis points from the 46 point Excluding the inventory revaluation charge associated with the transaction, gross margin was up over 400 basis points on a comparable basis year over year. Adjusted EBITDA was $64,000,000 representing growth of 116% from the prior year quarter, driven primarily by the merger with the former 3 ms Food Safety division.

Speaker 3

Adjusted EBITDA margin was 27.8%, A year over year increase of 510 basis points. The increase was driven by the gross margin expansion and also by lower operating expenses as a percentage of sales. As part of the Food Safety acquisition, certain costs conveyed directly to us, while others did not And we'll need to be added over time to accommodate the larger scale of the combined business. The adjusted EBITDA margin in the second quarter is higher than what we would Expect to see over the next several quarters as we ramp up these additional costs. With respect to earnings, we reported a net loss of $42,000,000 or $0.19 a Share compared to net income of $11,000,000 or $0.10 a share in the same period last year.

Speaker 3

The decline in earnings was primarily the result of expenses related to the 3 ms Food Safety transaction, professional fees, interest expense and the amortization of intangible assets. Adjusted net income, a non GAAP measure we are introducing for comparability purposes was $31,000,000 for the quarter and adjusted earnings per share were $0.15 compared to $21,000,000 and $0.19 a share respectively a year ago. 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 were impacted by the increase in weighted average shares outstanding resulting from the Food Safety transaction. I'll now turn things over to Dave.

Speaker 4

Thanks, Steve. In connection with the acquisition of the food safety division, Neogen took on some debt, which we recognize as a new position for the company. However, key members of the management team have experienced operating with leverage and we believe the current debt level is very reasonable, particularly when considering our targeted revenue and profitability as well as resilient nature of our end markets. We ended the Q2 with gross debt of $940,000,000 and net debt of $664,000,000 for a net leverage ratio of 3 times last 12 months pro form a adjusted EBITDA. You'll note The gross debt amount is lower than at the closing of the food safety transaction and reflects $60,000,000 of term loan repayment in the quarter.

Speaker 4

Following the close of the quarter, we repaid an additional $40,000,000 in December. During the Q2, we also converted a portion of our floating rate term loan to fixed to be an interest rate swap and therefore we currently have a 60 five-thirty 5 fixed to floating ratio for at least the next 12 months, which we believe is a prudent course of action in the current interest rate environment. You'll recall that in November, we updated our outlook for achieving $1,000,000,000 in revenue $300,000,000 of adjusted EBITDA, shifting the timing to fiscal 2025 due to changes in the macro environment and exchange rates as well as the performance of the acquired business during the 1st 8 months of calendar 2022. The lower than expected business performance was related to some supply and productivity issues that we expect to be temporary in nature. And in fact, we did see signs of improvement in the Q2.

Speaker 4

We remain firmly committed to this outlook that we previously shared. As we look forward to the second half of fiscal year twenty twenty three, we anticipate continued core growth in the mid single digit range, which includes some level of macro softening. This would result in full year core growth on a pro form a basis, also in the mid single digit range. As Steve noted earlier, the Q2 adjusted EBITDA margin of approximately 28% was higher than we anticipate running in coming quarters as we continue to add cost in support of the larger combined organization. Our expectations for a full year adjusted EBITDA margin in the mid-20s range.

Speaker 4

Additionally, as we think about adjusted net income, We anticipate a full year effective tax rate of around 20% and interest expense for the full year of approximately 57,000,000 Under our new capital structure, deleveraging will continue to be a capital allocation priority moving forward. We will allocate capital to building our new manufacturing site And other organic growth drivers, but deleveraging will be a priority for us. As appropriate, we will continue to execute bolt on M and A that accelerates our growth strategy and provides for attractive returns. I'll now hand the call back to John for some closing thoughts.

Speaker 2

Thanks, Dave. Like Steve and Dave said earlier, there's a lot of things to be excited about as we move forward. We completed the transformational acquisition of a high quality asset firmly positioning Neogen as a pure play leader in food safety. This is an attractive growing end market With what we believe are long term secular tailwinds, including heightened pathogen awareness, the increasing prevalence of food allergies In increasingly health conscious consumers who want to know what's in their food, Neogen is a resilient business, having grown now in 122 Of the last 128 quarters, due largely to the consumable nature of our products, which played critical roles throughout the food supply chain. After the acquisition of the food safety division of 3 ms, approximately 95% of our total revenues come from consumable products, which we believe positions us to continue to grow despite the current level of macro uncertainty.

Speaker 2

The feedback we've consistently heard is that Former 3 ms Food Safety division has a great portfolio of products. It is the industry standard in indicator testing. We believe the focus we brought to the business compared to their previous situation is a very small piece in a very large organization has been energizing. Our new team members are eager to demonstrate their capabilities and strength of their products, which we are able to combine with our leading product It will offer even greater value to our customers. I appreciate their efforts and commitment, and I couldn't be happier to have them on board and working with us to build 1 Neogen.

Speaker 2

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

Operator

Thank you. We will now begin the question and answer session. Our first question comes from Brandon Vazquez from William Blair. Please go ahead.

Speaker 5

Hi, guys. Good morning and thanks for taking the question. I wanted to start first on the second half guidance for fiscal 2023. Can you talk a little bit more about what the investments you need to make are as you kind of scale more? And then the follow-up question to that would basically be, As you make these investments, which makes sense as you scale, when do you expect to see more ROI off of those?

Speaker 2

Hey, Brandon. Yes. Brandon, you cut out right in the middle of your question. Can you ask again, please?

Speaker 5

Yes. So, the question was around second half guidance. Just talking a little bit more about the investments that you guys said you were going to make, Why the step down in EBITDA margins just a little bit in the back half of the year? And then basically the timing for when you'll see ROI on those investments and when you start to see margins expand again.

Speaker 2

Yes. So what you're seeing there, Brandon, is us ramping up the business to be able to bring over The 3 ms and move off of the TSA and TDSA, which is the service and distribution agreements. So as you remember, we didn't with this merger, we didn't get any back office staff. So we have to ramp up The IT, the accounting, logistics teams, and kind of the back office HR and others. So that's where you're seeing that ramp up Because those agreements were 12 months with 6 months extensions.

Speaker 2

So you don't add all that headcount immediately when you close, it takes a small time to build those teams.

Speaker 5

Okay. And then, I guess The follow-up question to that is, are those investments that may take 6 to 12 months to start to see an ROI or are they upfront costs and then Right away, you can start to see some benefits.

Speaker 2

You'll see an offset because what will happen is it's really an offset of cost because as we roll off Those agreements, we no longer have to pay 3 ms for doing those service functions. So what you're saying more is the roll off of expense.

Speaker 5

Okay. And then one more on kind of the profitability side, just switching to gross margins though. Even when backing out the inventory step up, it came in a little bit Our expectations just given the proxy filings of 3 ms gross margin. So kind of curious if you guys could walk through What kind of margins you're seeing or gross margins on both the Neogen side and the 3 ms side, just to give a little bit more color on the progression of gross margins from here?

Speaker 2

Yes. I think I'm really pleased with what we saw on the gross margin side coming out of the legacy business. You saw early on Some margin deterioration even between sign and close with the historical 3 ms business and that was really around raw materials moving And that business not pricing to match the raw materials. I think we've had this discussion before right about NIAGEN did a 6% price increase, 3 ms business at a 2% price increase during the same period in 2022. We implemented price increases January 1.

Speaker 2

So we think We have an ability now that we run that business to really manage that closer to what we do than what historically was done.

Speaker 5

Okay. And then last one for me and I'll hop back in queue. Just around petrofilm, it sounded like from a high level the updates were positive. Hoping you'd give a little In terms of supply, are you kind of unconstrained at this point? It sounds like maybe not.

Speaker 5

What's the timeline to kind of get to a point where you guys feel comfortable you're not supply constrained there anymore. Thank you.

Speaker 2

Yes, you're right. We're not on constraint. We did see the business back orders Down in the quarter, we're continuing to work with 3 ms to drive performance to eliminate the back order issue. And We're hopeful that in the second half of the year we can get that fixed.

Operator

Our next question comes from David Westenberg from Piper Sandler. Please go ahead.

Speaker 6

Hi. Thank you for taking the question and congrats on the Q1, Don, of the full acquisition. So You gave a lot of you gave guidance and maybe I'm being a little bit Key here because I am pleased to get the guidance. But there's a lot of moving parts in terms of like what Core revenue is versus solid revenue and I think you gave this mid single digit guidance for the back half of the year. Can you maybe can you give me some kind of a guide rail in terms of what that is for revenue, Like an actual solid revenue number?

Speaker 6

Because I mean, I'm a little confused on whether I should do mid single digits on core and then I just kind of don't know what to do with 3 ms. Yes, so is there any kind of framework on what that means?

Speaker 4

Yes. Hey, Dave. It's Dave. So mid single digit core in the second half, if we look at Today's currency rates would imply some currency offsetting that still at a step down level. Acquisitions other than 3 ms don't have that Major of an impact going forward, it gets a lot lower.

Speaker 4

So we think on a reported basis, we would see growth in kind of a low single digit type range, which and that's on a pro form a basis. So I think what you'll see Is second half average around if not a little lower than what we saw in the second here With underlying core growth in that mid single digit range.

Speaker 2

Yes. And like we talked about, the markets A little bit tougher than last year and we're seeing some softening, but some of the stuff that I really like about being in these markets are a couple of things that Recently happened, one was that Allergan is now list or Sesame is now listed as a major food allergen. And so that's the first time the U. S. Has added a major Allergan since 2,004, we have 8, EUS 14.

Speaker 2

So we continue to see and we saw a nice bump in our sesame allergen kits because of this, because now you have to test. I think long term, you're going to continue to see that grow. Secondarily, we talked about in my release about pathogens. Last year over 1,300,000 Americans had salmonella and I was one of them. And trust me, you do not want it.

Speaker 2

It is a great way to lose weight, but you do not want it. And what happened in August was the USDA declared that going to start with frozen breaded chicken, then we're going to move to other chicken products. And again, that's going to continue to drive testing for Neogen. This is why we're in such relevant markets. And even though the overall general economy is softening, things like this happen to help us continue to drive growth

Speaker 6

Throughout the year. Got it. Okay. And going on the continuation Understanding that growth rate, I mean, I think you put core revenue as being 7%, and correct me if I'm wrong on core. So that's Without 3 ms and then food safety did do 8.4%.

Speaker 6

Does that imply the legacy Ian Food Safety business was about 5% to 6%. Is my math here all right?

Speaker 2

I think we had go ahead, Steve. I think you got it.

Speaker 3

Yes. Dave, I think maybe you had that a little backwards. Animal was at 7% core. I believe it was 8.5% maybe reported and then food was closer to 6% core. So that So those are kind of the numbers for the quarter.

Speaker 6

Perfect. Okay. No, no, thank you very much. Okay. And then, I just a little bit Question above of Brandon's question on the gross margin.

Speaker 6

I think over the longer term, I think Our out year guidance has a little bit more in the mid or approaching the mid-50s. So this was a little bit of down versus where were Expectations were. There was a mix thing. So I think Animal Safety, generally speaking, Has a lower gross margin than food safety. So I mean some of this could be mixed.

Speaker 6

Is there anything else you want to call it other than just that mix?

Speaker 2

Well, and I think not only mix between those units, but also as now the food safety 70% of the business, you've got to be aware of the mix within the food safety business. And again, we're not through the headwinds on the petrophone, but we are We've got still have back orders to where that's one of our highest profitability lines, and we have more demand than what we can sell today. So when we get that fixed, that's really going to help. And that's the one thing that I hope you guys are taking away too is like even just after The Q1, we bought a great business. I mean, it is a great margin profile.

Speaker 2

It's a highly profitable business. The new Neogen, the 1 Neogen is now much More profitable than we were pre acquisition.

Speaker 6

Got it. No, that's super helpful. So as We'll get the benefits as indicator test the indicators can actually come to market.

Speaker 4

Yes.

Speaker 6

Got it. No, that's incredibly helpful. I'll just ask one more and I guess I'll get the rest offline a little bit later. Can you talk about the H2 EBITDA assumption? It sounds like maybe you got a little bit of a Pull forward benefit in terms of timing, I mean is that kind of the case is You did have some cost avoidance in this quarter that will come into H2?

Speaker 4

Yes. Look, I think that's a fair way to think about it. We're on a ramp So we'll see that come up. That's why we wanted to say that we came in probably a little hot at the adjusted EBITDA margin line item here In the quarter just completed and we'll see those costs come in and we'll normalize back down in kind of the mid-20s. Got it.

Speaker 6

All really helpful. I'll let maybe Brandon have some follow ups and I'll ask the rest of those offline. Thank you so much.

Speaker 2

Thanks, Dave.

Speaker 4

There are

Operator

no more questions in the queue. This concludes our question and answer session. I would like to turn the conference back over to John Addon for any closing remarks.

Speaker 2

Great. Thank you. And I want to thank all of you for joining us this morning. And I hope that you had a happy and safe holidays and that your 2023 is off to a great start. We're really excited here at Neogen about what the New Year brings with our new OneNeogen business and really helping our customers perform in 2023.

Speaker 2

So thank you again for joining us and we look forward to talking to you again on our Q3 call in the spring.

Operator

Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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