Neogen Corporation

Good day and welcome to the Neogen Corporation Third Quarter Fiscal Year 2022 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on a touch-tone phone. To withdraw your question, please press star, then 2. Please note, this event is being recorded. I would now like to turn the conference over to John Aden, President and CEO. Please go ahead. Good morning.

Good morning. and welcome to our regular quarterly conference call for investors and analysts. Today we will be reporting on the second quarter of our 2022 fiscal year, which ended on February 28th. As usual, some of the statements made here today could be termed as forward-looking statements. These statements are subject to certain risks and uncertainties, and our actual results may differ from those that we discussed today. The risks associated in our business are covered in part in the company's Form 10-K as filed with the Securities and Exchange Commission. In addition to those of you who are joining us by live telephone conference, I also welcome those of you joining us online. Following our prepared comments this morning, we will address questions from participants who have joined this live conference. I'm joined this morning by Steve Quillen, our Chief Financial Officer, who will provide some additional details on our results for the quarter. In our press release this morning, we announced continued revenue growth with an increase of 10% over the prior year. It's been an exciting quarter for us as we've made a number of announcements that really showcase our vision for the future and growth mindset under which we are operating. In our second quarter call, I talked at length about our agreement to combine 3M's food safety business with our existing operations, but I want to mention it again, as we continue our mission to be the leading company in the development and marketing of solutions for food and animal safety. The combined company will be well positioned to become the global innovator in food security, and I'm pleased with the progress we've made since the announcement. I also, once again, want to state how excited I am to welcome the 3M Food Safety employees to the Neogen team upon closing and thank our team here at Neogen for their hard work and dedication both throughout this process and over the years. On top of this, we announced two new acquisitions this quarter. On December 1st, we announced our acquisition of United Kingdom-based manufacturer and supplier of animal hygiene and industrial cleaning products, Delft Limited. Delft's more than 40 years of experience in UK's dairy hygiene market will be a huge benefit to us as we look to expand our offerings of performance dairy chemicals. These products will enhance our product portfolio, synergistically complementing our quad chem disinfectant and cleaning offerings. On December 9th, we announced our acquisition of Genetic Veterinary Sciences, Inc. a companion animal genetic testing company based in Spokane, Washington. As we've noted in previous calls, we feel the companion animal market is one of our relatively untapped markets, especially with the growth in pet parenting around the world in the last five years. We can now expand and diversify our portfolio of genetic tests available for companion animals. We're pleased with our integration process of each of these locations and feel optimistic about how they will continue to contribute to our business in the future. Neogen has a proven ability to grow new acquisitions. For example, the Stangard insecticide product line has grown significantly since we acquired it in August of 2020. Additionally, our Megazyme acquisition continues to grow and gain acceptance both domestically and internationally, recording growth of approximately 16% in the first year since we acquired the food diagnostic company. The products have had a particularly strong showing this quarter as we completed integration with our U.S. sales and marketing teams and have been detailing the benefits to our customers. We are confident that we'll be able to do the same with these new acquisitions as well, dedicating the proper resources to make them not only grow, but flourish within the marketplace. In this quarter, our products continue to perform well in the market, with solid increases in our allergen testing kits and equipment sales of our Solaris next generation spoilage detection system. I'm very pleased to see that both our core product lines and our next generation detection equipment are performing well in the marketplace. Another highlight comes from our sales of veterinary instruments, where we see yet another quarter of exceptional growth. This signals to us that we're continuing to gain market share from our competitors by offering high-quality and reliable instruments, and that these tools are becoming more trusted and recognizable in the marketplace. However, this quarter was full of challenges for us that impacted our performance. COVID-19 and Omicron hit us particularly hard in December and January, sidelining many of our workers. Our first priority always is maintaining the health and safety of our employees, so we took all the necessary steps to make sure our workplaces around the world were safe and that we were slowing the spread of the virus. Because of the resurgence, we saw a significant increase in overhead costs. And Steve will get into the specifics here in a minute. But we saw healthcare costs increase. We also had increased labor spend as we brought in temporary workers to fill in for those with COVID. In addition, we continued to manage... The rising raw material costs as supply chains were disrupted, price increases were implemented, and freight costs continued to rise. Thankfully, we've seen case numbers decreasing significantly, and we're already feeling the effects on the members of our team and our business. We've constantly had to adapt throughout the COVID pandemic, and we continue to demonstrate the resiliency of our business as we've managed through these challenging times. Now I'll turn it over to Steve for some insights into the numbers for the quarter. Steve?

Well, thanks, John. As John indicated, it was a busy quarter with two closed acquisitions, our announced merger with 3M's food safety business, and a resurgence of COVID-19 and its variants. John has spoken to the why of the acquisitions we closed during the quarter, as well as the 3M merger. The 3M combination in particular will clearly be a transformative deal for the company, and we've continued to incur significant costs in the quarter on it. I'll go into the details in a few minutes, but I need to point out that these costs will continue through the remainder of our fiscal year and into the deal closing in the first half of the next fiscal year, as there's still a lot of work to be done to finalize the combination and also to continue the preparation for the integration of the businesses. I'll now get into some of the details on our third quarter results. Sales for the quarter were $128.2 million, a 10% increase over the prior year quarter. Revenues for our food safety segment increased 7% to $62.8 million, while revenues in our animal safety segment were $65.5 million, a 12% increase. Our food safety revenues were positively impacted by the December 2020 acquisition of Megazyme, our Ireland-based producer of food quality and nutritional analysis products, and our December 2021 acquisition of Delph UK Limited, a manufacturer of cleaners. On an organic basis, sales for the food safety segment increased 4%, negatively impacted by the Omicron variant of COVID-19 in a number of our markets worldwide. Animal safety organic sales rose 9% with additional sales from our acquisition of Capino Vet in September of 2021 and Genetic Veterinary Sciences in December of 2021. On a constant currency basis, revenues were approximately $900,000 lower in the third quarter than the same period last year, as the number of currencies and countries in which we operate in were weaker versus the U.S. dollar compared to last year's third quarter. During the first half of the year, we saw improved economic conditions in many of our markets with returns to pre-COVID levels of activity. However, as John noted, in December and January, the Omicron variant affected a number of our manufacturing locations as well as numerous markets in which we operate, further disrupting the supply chain and impacting both our operating costs and our revenues. COVID pressure started easing in February and markets across the world began to open again. Having said that, a number of areas in China, including where our operation is located, have gone into lockdown as that country attempts to stop the spread of the virus there. On the food safety side, allergen sales increased 12% and sales of our Accupoint Environmental Sanitation product line which includes a recently launched next-generation reader, rose 16%. Our innovative Listeria RightNow test system continued its growth with a 13% increase over the prior year. Sales of Neogen Culture Media products increased 11% in the third quarter compared to the prior year. This was primarily driven by strength in the UK as our new workflow, One Broth, One Plate, continues to penetrate the commercial lab market. Sales of our dairy drug residue kits declined 55%. As I've mentioned on previous calls, we ended our exclusive agreement with our European distributor and have discontinued some sales of non-core and low-margin products in this product line. Within the animal safety segment, our veterinary instruments line, which includes needles and syringes, once again had a strong quarter with 43% growth, resulting in large part from recently won private label business. Our line of animal care products increased 12% on strength in the equine and companion animal markets, with strong growth in vitamin injectable and antibiotic business. In the third quarter, insect control products increased 11% on strong demand in the farm and home channels from several large distributors. Rodent control product sales declined 5% in the third quarter due to a difficult comparison to the prior year in which we had very strong sales due to rodent outbreaks in the US. Genomic services reported through the animal safety segment increased 11%. Growth resulted primarily from our Australia operation on increased volume in beef cattle and sheep testing resulting from improved economic conditions in these markets and newly won business. Revenues at our Lincoln lab decreased 6% due to lower volumes in companion animal services, the result of difficult comparisons due to strong growth in the prior year. On a worldwide basis, genomic revenues increased 10% with robust growth in our Scotland and Brazil labs in addition to the increase in Australia. Overall, international revenues rose 10% in the third quarter. Excluding the Megazyme and Delph acquisitions, international sales were up 5%. As I mentioned earlier, currency wins were in our face during the quarter and took about 2% off the international growth numbers. Our UK operations were up 9% organically in the third quarter on continued strong cleaner and disinfectant sales into the UK and Asia, driven by African swine fever and strengthened culture media sales related to our new one broth, one plate workflow. Sales in Brazil decreased 2% with lower sales of dairy drug residue test kits as we discontinued sales of certain non-core low-margin kits, offsetting increases from genomic services and natural toxin test kits. Revenues in China decreased 17% as the country's zero-COVID strategy created lockdowns and restricted travel in a number of markets. Additionally, lower pork prices at the producer level resulted in lower sales of cleaners and disinfectants. Gross margins in the third quarter were 44.8% compared to 46.1% in the prior year third quarter, primarily the result of lower gross margins in the animal safety segment due in large part to lower sales of higher margin rodenticide products and genomic services to the companion animal market and higher raw material costs. In addition, as I've mentioned previously, supply chain issues continue to drive increases in freight costs. In the third quarter alone, freight costs rose $2.2 million over the prior year, and in a number of cases, we air freighted products in at significant cost penalty to ensure we'd have adequate product on hand to serve our customers. We have taken price increases as necessary to help cover these cost increases, and will continue to do so. Other significant cost increases were for selected salaries to drive employee retention, health insurance costs as employees utilize services postponed during the pandemic, and scrap and contracted services. Sales and marketing expense for the quarter was $21.5 million, an increase of 15% over the prior year. This increase is the result of higher personnel costs due to additional headcount and sales volumes, higher shipping expenses, and also increased spend on travel, trade shows, and other customer-facing activities. As I've noted on prior calls, the increased travel expense was planned as prior year activity was minimal due to COVID restrictions. General and administrative costs were $25 million, including $10.6 million of consulting and legal fees related to the 3M deal. This compares to $15.1 million in the third quarter of the prior year. As I noted last quarter, we'll continue to incur significant professional fees through the close of the 3M transaction, primarily for legal and consulting as we continue to work on integration activities to ensure we're ready to execute on day one. Excluding these deal costs, and additionally adjusting for $2.3 million incurred in last year's third quarter for an acquisition which we were unsuccessful in completing, run rate GMA expense increased $1.5 million, or 12% in the third quarter. The increase was primarily due to increased personnel costs, senior management hires, and amortization expenses from recent acquisitions. Research and development expense was $4.6 million, an 8% increase over the prior year. The increase is primarily the result of personnel-related expenses and includes personnel absorbed in the Megazyme acquisition. Operating income for the third quarter, after excluding the $10.6 million of 3M deal-related costs, was $17 million, or 13.2% of sales, an increase of 8% compared to $15.8 million, or 13.5% of sales in the prior year quarter. Our effective tax rate in the third quarter was 18.1% compared to an effective tax rate of 16.3% in the prior year. The increased effective rate is due to lower benefit resulting from a significant reduction in stock option exercise activity. Our tax benefit from option exercises in the quarter was $33,000 compared to $1,083,000 in last year's third quarter. On the balance sheet, inventory levels have risen 12.7 million, or 13% since May 31st. Approximately 2 million of that increase is the result of our recent acquisitions. The remainder of the increase reflects higher raw material costs and higher safety stock levels as we've increased balances in several areas to ensure adequate quantities of key raw materials to minimize back orders to our customers as supply chain issues persist. I expect higher levels of inventory to continue for the near term until we see some relief from these supply chain issues. We've generated $47.6 million in cash from operations during the first nine months of the year and have invested $38 million in our acquisitions. To wrap up, considering the headwinds we had in our face, overall it was a solid quarter and we're cautiously optimistic for the remainder of the fiscal year and excited for the future of the company as we prepare for the combination with 3M's food safety business. I'd be remiss if I didn't thank our more than 2,000 employees worldwide for all their efforts in making this company what it is today. We'll continue to drive for improved operating performance while working on the integration planning for the 3M combination. I'll now return it to John for his closing comments.