Q3 2023 Neogen Corp Earnings Call
Good day and welcome to the Neogen third quarter fiscal year 2023 earnings conference call.
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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 agents, who will be followed by our CFO, Dave Nomura before the market opened today, we published.
Our third quarter results as well as a presentation.
With both documents are 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 two 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.
Jim any obligation to update these forward looking statements with that I'll turn things over to John .
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 three of them last year.
On our last earnings call I mentioned the trend we were seeing in some of our macro related softening in our end markets. This continued in the third quarter with many food producers seeing lower unit volumes with inflationary pressure on consumers being a key driver.
On the animal safety side of our business. The macroeconomic 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 our diversification across product categories.
In the recently added food safety business key product lines continued to be negatively impacted by the backlog situation and our transition manufacturing partner.
After an unanticipated holiday shutdown 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 a successful resolution over the coming quarters.
As we've discussed before the former three in business as a high quality franchise with leading diagnostic technology for high replenishment environments than many cases specced into their quality control processes, we understand the critical roles our products play and are working closely with our customers to fulfill as much of their demand as possible while we.
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 are navigating the tighter market conditions focused on a prioritized set of opportunities globally.
We've seen significant growth in our sales pipeline over the last few months and are excited about the potential of HUD.
Additionally, we opened our 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 three in business within Neogen.
The new facility, we're building in Lansing, ultimately will house the production currently handled by her transition manufacturing partner.
Construction is progressing on track the foundations being poured sections of the frame or 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 'twenty two 'twenty three.
And finally, we continued 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 is 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. 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 and other category grew high teens on a core basis benefiting from a large order from a vaccine manufacturer within bacterial and general sanitation, our microbial testing products had solid growth, partially offset by lower sales of general sanitation testing products due in part to.
<unk> challenges.
Rounding out our larger food safety product categories natural toxins allergens and drug residues had a slight core revenue declined 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 bio security 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 anti Biotics 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 three M was impacted primarily by lower than expected production levels.
And our transition manufacturing partner.
We had anticipated seen 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 three M business core growth for Neogen as a whole would have been low single digits on a pro forma basis.
Gross margin in the third quarter was 49.5% representing an increase of 470 basis points from 44.8% in the same quarter a year ago with the increase primarily driven by the addition of higher margin business and the three M food safety transaction.
Adjusted EBITDA was 51 million representing growth of 106% from the prior year quarter, driven by the merger with the former three M 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 cost 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 <unk> 12 cents compared to 16 million and 15 cents 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 Corneum the SaaS.
As provider behind our Neogen analytics platform.
In February we completed the strategic bolt on acquisition of Corneum, the SaaS provider behind our Neogen analytics platform accelerating 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.
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 corium 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 'twenty. Three we believe our previously communicated view of second half core growth in the mid single digit range with an adjusted EBITDA margin in the mid twenties 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%.
Scent 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.
Thanks, Dave we're excited about the progress we've made to date combining neogen in the former three and 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 has a number of attractive long term secular tailwind 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 market, which we believe the aggregation of <unk>.
<unk> 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 modeling trend analysis with real time monitoring and simplify compliance processes.
The acquisition of Corium last month will allow us to accelerate the 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 its 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 on 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 it couldn't be happier to have them working with us as we build the future of <unk>.
Our one neogen.
I'll now turn things over to the operator to begin the Q&A.
Thank you.
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The first question comes from Brandon Vazquez, whereas more with William Blair. Please go ahead.
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 that.
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 no 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.
Brian There's there was a little bit of both.
We didn't realize you know 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 manufacturers in Iran.
And that's why it was unanticipated us as they shut it down and so we didnt, we didnt really realize that full impact till we got a little bit later into that January period.
It was a it was a major disappointment, we were making progress and it really set us back in.
That's why you're saying you know I was talking about we cannot and will not meet our customers demand right now.
Really on a three arm side or the.
Three M business that we bought because the manufacturer just can't make enough for us at this point now.
I will tell you Brian than we've had.
Three main areas with myself and their CEO over the last 30 days.
We've got a new structure in place we have alright.
I think the attention now the group that this is no longer in business buried within three of them. This is a business they have to focus on and I think we're starting to see that focus, but it's going to it is.
Going to take us a while to get through it.
I have seen though that you know, we're directionally better, but we've been in that position before so I want to see this stay directionally better not go the other way so.
We're optimistic that this is transitory and give us momentum going into 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.
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 has a core legacy business whats implied there in the three M business.
<unk> revenue number right should connect sequentially improve as we go into the fiscal fourth quarter.
Yeah, Hey, Brendan I think I'd say, we're not anticipating too much improvement, maybe a little bit better obviously, theres, some more selling days, but from a growth perspective.
We would anticipate that probably doing a little bit better, but more and more kind of that mid single digit.
The underlying legacy business and the acquired business.
Not not showing significant improvement sequentially I think is what's contemplated there.
Okay.
And then.
Maybe going a little further out just one on kind of a long term guidance. It was encouraging you guys still feel comfortable with the fiscal 'twenty guidance. Despite kind of the maybe the backlog in the next quarter being a little worse than expected can you.
David now, we're all going to start looking at our fiscal 'twenty four models.
Great.
Youre not going to give a number now but how do we think of the recovery through fiscal 'twenty. Four is this a linear event.
Just kind of like a hockey stick as we get to the back half of 'twenty four and into 25 any commentary you can give us to kind of level set.
Yes look more I think more to come obviously, when we get to year end Brandon but.
Underlying the performance we saw it look we participate in these food safety markets and you saw the legacy business grow solid mid single digits on a core basis in these markets and that's where we also participate with the acquired businesses as well. So we think that as we get through these these near term challenges.
We've got an underlying.
Good market, even with some production volume headwinds in some of our customer base. So it's really that underlying market that we think supports kind of as you're implying the bridge from where we see 23 coming in to 'twenty five the shape and pace of that I think is what John is referring to we said we need to see some momentum coming out of twenty-three into 'twenty, four and that'll that'll give us.
A little better frame on that so I would say more to more to come on that when we get to.
A quarter or so from now.
Okay, great. Thank you very much thanks.
Thanks Brendan.
Thank you and our next question today comes from David Washington, Berg with Piper Sandler. Please go ahead.
Hi, Hey, guys. Thank you for taking the question so why.
Why would you want to talk about kind of the debt and and <unk> in the quarter. I think you kind of gave a little bit here. When you said it was just kind of maybe timing of interest payments and I think you said some some additional capex for Friday on so.
I noticed.
It does look like that net debt went higher in the quarter. So can you maybe explain some of the some of that some of the things that maybe.
In addition to that and then how we should think about the EBITDA, an EV to EBITDA sorry.
[laughter].
Debt to EBITDA leverage ratio to EBIT.
The leverage ratio as we go further in the year, just given that interest rates are on the horizon.
And I cannot ask a question today.
Alright.
Yes.
I know, we know what you mean.
Hey, Dave.
So a couple of thoughts yes.
<unk> is a little bit elevated on a net basis here, where we would have typically expected to see it flat come down a little bit I would say that aside from funding our integration Capex deleveraging remains a top priority for us, but we can't always predict the timing of everything we are a serial bolt on acquirer, we've changed that focus.
Now to deleveraging, but the Korean deal that we completed in the quarter.
Timing was such that it needed to be transacted and Thats, a very strategic deal for us for I think.
All the reasons that John outlined in his prepared remarks.
So obviously.
Cash utilization of that of $24 million.
It was a headwind to net debt in the quarter. In addition, you noted.
The timing of interest payments, which I think had about an extra $12 million got.
Got it.
Increased to what you would think of as a normal underlying quarterly cash outflows and then our integration Capex, which is elevated and it will be elevated not not the same quarter on quarter site to be linear, but as we work through them.
More of the factory side, but also the systems side over the next couple of years and that's always been a known item. So we knew that would be a headwind to free cash conversion over time and it is but underlying all of that is a pretty strong historically free cash flow conversion business that we think we can make even more robust in the future with some opportunities off the working capital side of the balance sheet.
So that's what's going on and our priorities remain the same.
Having said that like in many cases, you might see that bounce around a little bit quarter to quarter, but our objective remains the same.
Got you I appreciate you being able to parse out my my terrible phrasing.
Secondly, just on that Petri film and the the manufacturing that on the.
Maybe I should say that the failure to fully get your all your orders and from from your.
Supplier here.
Can you talk about how you're prioritizing the products for your for your competitors than I am.
Sorry for your customers and kind of what I'm getting at with assays.
Keeping this product in the hands of your customers to make sure that you know, maybe they're not dual sourcing or theyre sticking with you through the process can you maybe talk about some of the discussions youre, having with the customers to make sure. They they feel that you're on.
As the Middle Man there.
That they're taken care of and I guess some of this is out of control because you're just [laughter].
You are in between that you're in between the two yeah I'm doing what we're doing David is to your point.
A little on the skus or having issues because we don't have it on every issue. We don't have it on every SKU in future for all of them are even sample handling so on the skus that are an issue.
We end up allocating.
Ended up working with customers to make sure that we're trying to do the bus but.
We're just not meeting their demand we're not getting the.
The manufacturing support we need.
And because of that because thats, a consumable, but they have to go and do something else. So by definition, you know, we're losing that sale and that share of market at that moment, because they're having to go because I have to continue to test.
Now we know it's a very resilient business.
And we know that our solution is better so we're very.
Confidence that we're going to be able to get those customers back.
That as I say, we lose that we don't get back its not like they can just say well, we'll wait until you're ready and you guys have enough in this.
Thanks, Seth buildup of demand comes back in later in future sales. So that's why we're working so hard at it that's why it's so frustrating to me and the team and that's why we're so focused on communications with the customers to make sure that.
The products that we have even though it's not enough we're trying to work with them in a way on an allocation basis too.
Yes.
Makes us the least painful but we recognize this is extremely painful for our customers I talk to our customers almost every week about this.
I know, they're frustrated they know we're frustrated.
We're seeing some incremental progress, but we've got a lot more work to do.
Got it.
And then in terms of is there any other maybe techno.
Technical issues or invoicing issues with feature film I mean like is the experience right now just kind of the stock out and everything else from the transition is going.
Yeah.
Pretty fine right now and and you know you are you would you feel comfortable that that frustration is isolated to really the product yes.
David the biggest issues manufacturer, that's not logistics, it's not.
There's nothing on the order to cash cycle, we don't see any issues with billing and receiving or anything like that is purely a manufacturing issue.
Yeah.
And Brian and then kind of brought this up about what 24 looks like.
During fiscal year 'twenty for some of those lines that would be coming over to us.
Just feature for more but the sample handling portions of that will be coming over.
Even the.
Pathogen side, so we will feel a lot more comfortable and we're working very hard to <unk>.
Continuing to move some of those products into our manufacturing into our hands, even at an accelerated rate and we.
Anticipated because we know we can get that fixed so all of those are some of the things we're doing.
Got it now really helpful. And then maybe just along those lines can you talk about some of the maybe the integration and some of the cost savings I don't know if you know your email you ready to quantify some of the integration of distribution.
And you know maybe faster the next decade manufacturing on what this could look like in terms of timing and speed I know you did reiterate the long term guidance. So I mean, I'm guessing and I don't know if this is maybe you can even talk about me linear versus exponential I mean, what are we talking about in terms of of some of that cost savings and in the near term.
Our integration savings.
David in the in the near term I think what you've heard us talk about us having to build up some costs that we will have some duplicate costs, where we're paying our partners and their various forms of transition services, where we're building up the cost to come off.
One of the things I think we will do here at a point in the future I think when we have a little better.
Fidelity into the timing of that is to us to help characterize some of that a little bit of what it means kind of over time, but not.
I'm not prepared to do that now, but we do think that we'll be able to gain efficiencies. Once we're through building up the cost of transition services and being able to bring these products into our existing existing processes, we think theres efficiency.
Over time with that.
Gotcha, and then maybe I'll just end with with maybe a fun long term positive kind of stories.
Can you talk about how you are and the data the data from truly from farm to table strategy I mean, I think over the.
Traditionally it's been really hard to get these companies to understand the importance of of really.
The food chain, so to speak or going down the food chain well what does that strategy.
It looked like to finally get to get that dream that we've talked about for years for that fall.
It's a full down the down the <unk>.
Farm to table.
Stream sure. Thanks, David Yeah, I mean.
Look the first is what we're doing now starting with our analytics platform and what that platform does is it allows us to work with our key customers in the food manufacturing too.
Help them, modernize and digitize or environmental plant mapping.
Policies and procedures, alright, so, let's say that as a.
A suite of products around.
Environmental plant mapping around.
Marketing around predictive analytics around.
We continue to develop.
New suites for that offering.
To be able to show customers the things that we can do to help them connect now the more we add in the ecosystem right. The easier. We earned to then connect the ecosystem where to have our blockchain solution. We can take one.
One of our customers.
Their stake in the supermarket and if you take a sample and send it to me.
I can tell you.
Every place that animal what everything at eight.
Every time I was sick every medicine that was given all the way from birth to your dinner plate.
Again, neogen tends to lead the industry. So while we have the capability and we.
We see that we don't see a huge demand for that because right. Now the question is who's going to pay for it.
The rancher says well that should be the process of the processor size will actually be the grocery at the grocery stores will actually be the consumer so but at some point, we know that we have the ability to tie that altogether that nobody else has so we're continuing to drive the solutions forward.
We know this will happen. This happened just like with our genomics business is more about the genomics business over a decade ago.
Yes.
We don't need genomics and I can look at that animal and tell you how it's going to grow.
Now you've seen the whole industry has changed in the decade.
Youre going to see that too on this side of the business. So we're really excited about our core game acquisition allow us to not only stay in front.
<unk> been in front of our competitors around this part of the marketplace.
And that really is just a big white space.
And we're excited we've got so much we've got so much data within the organization, we're not even sure Adam the value streams to provide which is why we're working with one of the largest generative AI companies.
So we're going to have to figure out what do we have and what can we make actionable. So those are the things that are really exciting about what is kind of.
Thank you guys and thank you for putting up with my inability to ask a question. This morning.
No problem, we know you've got other things on your minds, So I hope that goes well.
Thank you.
Thank you and our next question is a follow up from Brandon Vazquez with William Blair. Please go ahead.
Hey, guys. Thanks for taking the follow up just one last quick one on feature film are you guys able to quantify the backlog of feature film sales in the quarter and then second one there is just you said things have improved in January and February in terms of output is.
Is that we're basically done with March now is that true of March as well just so we can get an understanding of the cadence going forward. Thanks.
So I think the backlog number was.
It's about $7 million, I think which was about flat and Brendan.
Brendan the challenge is a little bit less absolute backlog number, but the fact that we're still in this allocation situation. So as John pointed out we don't lose the customer, but we lose we lose some sales.
I think.
Production absolute production was lower in December than January and February we saw an uptick.
Which which was good I think we again have seen some improvement to the backlog number here in the March timeframe, but again, we've seen periods like that.
We've seen periods like that before I think John alluded to that and it's about the sustainability here. So.
Yes.
At the end of the day, we've got to work through.
Getting continuity of supply for this high replenishment product, that's what's really going to do it so.
The key is to get the backlog down too.
Our sub.
Million dollar type number on a sustained basis, which is a better site that we're fulfilling at the rate we need to further requirements of this product category.
Got it Super helpful. Thanks, a lot. Thank you.
Thank you.
And ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to the management team for any final remarks.
So thank you all.
We appreciate you joining us this morning, and again as we work through this we're really excited about the future of this business. So we look forward to speaking you all again at our fourth quarter and end of year. This summer.
Okay.
Thank you Sir This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect. Your lines will have a wonderful day.