Neogen Corporation (NEOG) Q1 2013 Earnings Report, Transcript and Summary

Welcome to Neogen's First Quarter Fiscal Year 2013 Earnings Results Conference Call. My name is Christine, and I will be your operator for today's conference. [Operator Instructions] Please note, today's conference is being recorded. I will now turn the call over to Neogen's Chief Executive Officer, Jim Herbert. Sir, you may begin.

Thanks, Christine, and good morning and welcome to our regular quarterly conference call for investors and analysts. As we stated today, we will be reporting to you on the results of our first quarter, which ended on August 31. To start with, I'd remind you that the statements that are made here today could be termed as forward-looking statements, and these forward-looking statements, of course, are subject to certain risks and uncertainties. The actual results may differ from those that we discussed today. These risks that are associated with our business are covered in part in the company's Form 10-K as filed with the Securities and Exchange Commission. And our new Form 10-K for the 2012 fiscal year was filed with the SEC at the end of July and is now available. In addition, to those of you who are joining us today by live telephone conference, I'll also welcome those who may be joined by way of simulcast on the world wide web. These comments, along with some exhibits, will be available on the web for about 90 days. And following our prepared comments this morning, we'll entertain questions from participants who are joined on this live call. And I'm joined today by Lon Bohannon, Neogen's President; and Steve Quinlan, our Chief Financial Officer. Earlier today, Neogen issued a press release announcing the results of our first quarter of the 2013 fiscal year. And once again, we were able to report record numbers. Revenues for the company's first quarter were approximately $49.7 million or about 9% ahead of the first quarter last year. Though regarded as good growth, currency translation compared to prior year actually reduced that number by almost $1.2 million. Had it been absent, that negative impact to the currency translation, our revenues would have been approximately…

Thank you, Jim, and welcome to everyone listening on the conference call, as well as those joining us on the Internet. Jim has already reported on the overall sales and profit performance for the first quarter of our 2013 fiscal year. I would like to reinforce his comments that our first quarter results were very good, indeed. I was especially gratified to see us exceed our internal budgets for sales, gross margins, operating margins and net income in the first quarter. I think it is also worth repeating that applying the same currency rates that were in effect in the first quarter of last year to our revenues for the first quarter of this year would have resulted in Neogen reporting sales at just under $51 million and double-digit organic growth. In the next few minutes, I will cover noteworthy highlights for the first quarter and we'll begin by discussing the exceptional performance achieved within our Food Safety division. The Food Safety segment of our business delivered an outstanding first quarter with revenues up 12.5%, virtually all of which was organic growth. The sales growth was broad based across a number of market segments and product lines. Of the 14 different market segments tracked separately within the Lansing Food Safety division, 12 experienced solid sales growth in the first quarter compared to the prior year led by revenue increases ranging from 14% to 32% in the pet food, milling and grain, and commercial lab markets. International sales were also strong in the first quarter for Food Safety. As Jim discussed earlier, the Neogen Europe operations led this strong international growth, with sales up more than 18% despite the tough economic conditions that persist in the EU. Neogen do Brazil continues to gain traction in penetrating the growing Brazilian market. Sales…

Well, thanks, Lon. Though, I guess I might be likely branded as an eternal optimist, I always get a bit more of an optimistic buzz each time I hear Lon talk about where we're going in the future. Let me take the next few minutes and give you some feel of what we think we're seeing in the markets and what we may be giving you an idea of how they may impact our business over the next 3 quarters. First of all, let's look at weather conditions. I mentioned and Lon in his comments then, that parts of the European grain areas were hit by cold, wet weather in the late spring to early summer. This brought on an increase in the instance of one of the natural toxins deoxynivalenol, or DON. This problem helped to bolster a part of the Neogen Europe revenues that I talked about earlier. This was evident when I was over there in June. It was -- we could already begin to see some incidents of these toxins forming in the field. And though that crop will continue to be tested in the U.K. and Germany and France, as it find its way through the marketplace, it's out of the field now. So the harvest is completed. And probably the big surge in test kit sales will slow down. A bigger weather-related surge is now underway as a result of the drought-stricken areas across the U.S. and the impact on the nation's corn crop. This has been particularly critical since the major grain states across the central Midwest were the hardest hit by the high temperatures and inadequate rainfall. This kind of weather gives rise to another of the mycotoxins that come from molds that grow on corn kernels during a hot wet --…

[Operator Instructions] First question comes from Matt Hewitt from Craig-Hallum Capital Group.

First, very, very strong gross margin here right out of the gates here in FY'13. And I'm curious how sustainable you feel that, that 63% is as we look out later into the year.

Well, it was very strong gross margins, and it wasn't just specific to the Food Safety side. The Animal Safety side gross margins were strong in the quarter. Well, we've been talking for several quarters -- I didn't this specific one, but I bring out periodically the kinds of things we continue to do. I give our operations groups a lot of credit for continuously looking at ways to improve productivity and efficiencies. I, frankly, was a little bit surprised that we could generate all of that increase in sales in the first quarter with less direct labor and overhead than we had last year. And the mix certainly had something to do with that to the extent that we continue to develop these new diagnostic products and have a higher percentage of our sales come from that. That's going to drive that gross margin rate up. It's going to -- Matt, it's going to fluctuate from quarter-to-quarter. This one was above our internal budgets. But we're pretty confident that we can maintain gross margins above 50%, and we'll continue to see the benefits of those improvements that we're making in our operations so that over time it will drift up. It was a particularly good quarter, and it was -- we just have a favorable mix of products across all of our operating units.

Okay, that's helpful. As I look at Q2 though, you're going to have some of the similar impacts or positive impacts as far as aflatoxin and maybe a little bit more DON in Europe. But -- and those are very high margin, some of the diagnostic mix shift that you benefited from -- in Q1, you should still have in Q2. Is there any reason that it would dip below 53% in Q2?

Well, let me intervene here real quick. I'm better at making excuses this morning than Lon is. I think we're going to look at the second quarter. And our product mix is, I think you know, Matt, our product mix varies from quarter-to-quarter based on seasonality. We move into the second quarter. We'll be increasing our revenues in this September, October, November. We see people start to stock up on rodenticides. We're going to have a lot of cleaning and disinfecting activities that are going to be going on. We love those businesses, but they don't have quite the same kind of gross margins as we enjoy out of our bioinformatics that are a part of our DC [ph] programs. So it's -- we'll continue to see some variation. But what we see here, I think, is going to help as far as mycotoxin testing in the U.S. is concerned, but we're also going to see some other things that are seasonal begin to come into play. That make it very difficult to say if we're going to do the same thing next year and next quarter that we've done this quarter.

Okay. Along those lines, the rodenticides you mentioned is having better gross margins then the disinfectants. But correct me if I'm wrong, you think, aren't some of the grains used in the rodenticides. So how are you helping offset or how are you offsetting the higher cost of those -- the inputs in the rodenticides?

You're exactly right. And that's one of the things that's going to impact gross margins going forward. We're a significant buyer of wheat, of corn and oats that are going into the rodenticides. Just general, it's just really animal feed with the technical added to it that kills rodents. So we have done a pretty good job of booking our wheat in advance. We did not anticipate this kind of reaction out of the corn crop. We're buying corn on a hand-to-mouth basis now, so we, like the cattle feeders, are paying over -- around $8 a bushel for it. We think that, that price is, I mentioned in my comments, will come down. But it's going to impact our normal margins as far as rodenticides are concerned to the extent that we'll see some more fluctuations in the grain market. So you were exactly right to pick that up.

Okay, one last one for me, and I'll jump back in queue. You mentioned there was some incremental legal expenses in the quarter. I'm wondering if you could provide a little more color, maybe along the lines. What that's related to you and how much there was that impacted this quarter, whether or not that will occur in the next couple of quarters.

Yes, I really probably don't want to add any more color to it. We are confident that we are in a winning position as it relates to this. By the same token, you know legal activities, are sometimes unpredictable. We think we're very predictable in this situation. The numbers in excess, this quarter, compared to last quarter, were 6 digits. And we're not through with it. We'll probably see and we can see this litigation depending upon the appetite of our adversaries. We could see this litigation continue on for probably close to next year. We're never seemingly without some legal expenses as it relates to intellectual properties. We're just in that kind of business whether it's concerned about somebody in France, it's counterfeiting our detectable needles, or whether it's somebody that's using the trademark illegally or something else. So we're just in that kind of business. But given the current situation with the litigation, I probably don't want to go much further with the discussion on it. I'll then just call it to your attention.

The next question comes from Tony Brenner from Roth Capital Partners.

Could you give a sense of the size in terms of revenue generation of that natural toxin business on an annual basis?

You're looking for total revenues for that group of products that deal with natural toxins, is that right?

Correct.

I anticipate that business is probably exceeds or close to $20 million annually for us. When you factor in all the sales that we have in Europe and South America and Latin America, it's a sizable segment for us.

With the very first diagnostic test that we developed, Tony, 8 years ago now was for the detection of aflatoxin in grains. So I guess, we're probably the first one out with the biotechnology-based product and continue to do quite well and to be a leader in that area, Tony.

Okay. And along the same lines, the international business, I think, you said was 42% of the total. What does Europe -- Neogen Europe represent now say as a proportion of your international business with Brazil and China and Mexico coming on so strongly?

There are about -- I think, Neogen Europe would be in that 9% to 10% range of our total revenues. They're up to that. They've been growing as we've reported for quite some time now. They've been strong double-digit organic growth for a number of years and a couple of slow quarters at the beginning of last fiscal year. But even amidst of the difficulties in Europe, have come back strong in the last 3 quarters to report double-digit growth.

I think over there, Tony, by the fact we've got our own sales organization on the ground in major countries. We have our own the sales group that's headquartered out of Ayr, Scotland and in the U.K., in Germany, in France and in Holland. And then we also serve our distributors and the rest of those EU countries, typically most of them are EU countries, roughly 40 countries involved in total. So they're mostly distribution. Most of the product that they sell is produced in the U.S., goes over there. But we're up to about 100 people right now. So it's helpful to have a little more control over what's happening in those troubled financial markets than if we were just on the outside with the...

So your 9% or 10% is -- in other words, are you saying Europe over all is less than 25% of your international business, or just your own distribution part?

Yes, it's just under 25% of our total international business, but it's about 10% of our total revenues for the company.

A lot of growth opportunity there, Tony.

Okay. And then lastly, it sounds like foreign exchange, in terms of its income impact, was negligible. Is that, looking at the income statement anyway, is that right?

Yes. That's a fair statement. For the first quarter, there was not a lot of movement in the current...

[Operator Instructions] The next question comes from Paul Knight from CLSA. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: Could we go over the international one more time? The South American group is what percent of total Neogen sales now?

I'm not sure we can break out -- maybe they can. I'm not sure we can break out South America per se. We've got our Brazilian operations, which are company-owned, separate from our distributor organizations. We are in every country in South America and in fact every country in Central America also. We're in every country, but we have 2 different sets of distributors, some for the Animal Safety side of our business, some for the Food Safety. And then we have our own operations in São Paulo that cover all of Brazil. We can get -- I'm sure Steve can get to the numbers. But he can -- well, his Ouija Board is fast enough to do that in the next 30 seconds, I'm not sure. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: That's good offline. And then the Asian operations, what was the growth there in the quarter?

Specifically to the Asia Pacific rim? Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: Yes.

Yes, I think our growth there was right around in that -- around 15%, 16%. I know I combined and reported Latin America and Asia Pacific rim on the Food Safety side. But I think, they were both up certainly double-digit growth. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: And the -- there's a working capital demand for cash last year that seemed to -- working capital seemed to lessen up and generate some cash in Q4. Is that right? And then, what's the trend on working capital here this year?

Working capital -- we used a little working capital in the first quarter. Receivables grew by about $2 million. Inventories were basically flat. You saw some GeneSeek's inventory levels dropped by $500,000 or so. And as they had a real strong quarter, our Food Safety group's inventories rose by about $600,000 and they were building product for the aflatoxin outbreak. So overall, we -- cash from operations we generated about $4.4 million. So I think, we're going to see that kind of trend quarter-over-quarter. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: And then last, how fast will the GeneSeek business grow?

Well, it's growing from several aspects. We've started out with that business. It's grown very rapidly. We introduced -- in addition to just the overall genomics testing business, we've introduced more of our own bioinformatics products. That's what the acquisition of Igenity did coming in there. It will be a good strong double-digit producer for us. We are doing business throughout the world. Sometimes, I think, we had some significant testing business out of New Zealand this past quarter, which doesn't occur every quarter. But by the same token, as other areas are coming in, we're doing some things. We represent now on the beef side of things, the top 11 breed associations as we do all the genomic work for those registered animals. We have always had -- for a number of years, had the Angus business, which is #1 of the beef breeds. We also now have the other 4 that are right behind them, which will be Hereford and Charolais and Limousin and Simmental. So that side of our business is growing. This is new business. We just picked up -- this past month, just picked up the Charolais business. Those of you who don't follow cattle breeds, that's the white animals that originated in France. They're probably the third largest breed in the U.S. But we get Charolais business from all over the world too. So it's going to grow. I think, as it begins to get its footing, it probably won't be on a very steady same growth rate every month compared to the prior month. But I think, we'll continue to see it, if you will.

[Operator Instructions] The next question comes from Gregory Halter from Great Lakes Review.

Regarding the ANSR product line, just wondered if you could frame Neogen's opportunity in that particular area on what you guys see going forward.

Yes, let me look at the overall side. There are a number of places, but the size of the overall testing market that's here today, I can't remember what the latest numbers say it is. But it's a huge potential market. The largest of those market segments is for the detection of pathogens. So if you think about the testing market, there's some test for the aflatoxins. Like we talked about, there's a test for food allergens. Like we talked about, there's a whole test of bracket for drug residues as we've discussed from time to time. And 2 or 3 more that fit in there, the biggest of all of those is the testing for the microbiological contamination, and that includes those products that will make you sick, but not likely kill you. And then you get to the pathogenic bacteria, which is typically Salmonella, E. coli, Listeria and oftentimes Campylobacter, the 4 ugliest ones. But those are the biggest testing markets that have the biggest concern worldwide. We have not been the dominant -- we've not been in any way dominant in that market for probably 10 years. At one point in time, we were the first one out with the test for E. coli O15787 that the U.S. Department of Agriculture was used into -- for surveillance for that, particularly in ground beef and hamburger. So our business has been okay there. But we've had plenty of competition. And we were searching for a new platform that will let us have a test that is more sensitive and faster. That's the whole name of the game is easier, faster, cheaper. And this new technology what we've branded is our ANSR technology, we think, provides us that and puts us in a position to be more competitive against probably on a worldwide basis, probably half a dozen people that are somewhat playing in that pathogen market. Having said all that, that's the political side of the speech. But I'll let Lon give the more specifics of what we're seeing out here. Lon?

Well, Jim is right. Of all of our product lines that we talked about and mentioned, we have the smallest market share in that market that's testing for a specific pathogen. So and the part that we were missing was the high-volume, throughput users. The biggest 2 of which are right now testing is for Salmonella and Listeria. And so the ANSR platform gives us access to that market. And we've been pleased with the launch. I think, we've got 20 instruments already in placements. Our end users have another 10 or so in the hands of distributors that are now offering those. We've got well in excess of 50 active prospects that we're working only limited really by the number of people we've got on the sales force to be able to go out and sell it. So we're off to a good start with it. It gives us access to the biggest chunk of the specific pathogen testing market. And I think it really gives us -- has really helped us give us the broadest product line because you remember we do have lateral flows for quick screening in that market for specific pathogens and also have our dehydrated culture media that can be used to grow up those bugs for testing. So we've got a nice full product line out there to gain access to what's the biggest single testing market for specific pathogens. So the ANSR is a big part of our growth opportunity going forward.

Okay. I appreciate that. And back on the foreign exchange and the impact on operating income, did I hear correct that there was not much impact on operating income, even though the top line was $1 million-or-so impacted?

Well, that comparison was to last year. That's basically saying that if sales were made at the same rates as last year's first quarter, our sales would have been $1.2 million higher this quarter. But what we're talking -- what actually ran through the P&L due to currency this first quarter was about $27,000 of loss basically.

And would you happen to have available the operating profit by segment, the Animal Safety and Food Safety?

We -- the operating profit by segment will be released with the 10-Q, which will be released on Friday.

Okay. And finally, for the quarter, just wondering what the capital spending was, as well as depreciation and amortization.

The capital spending was about $1.9 million, and the depreciation and amortization was $1.6 million.

The next question comes from Steve O'Neil from Hilliard Lyons.

Just one quick question. I think, you mentioned that pathogen sales were up in the upper teens, so were -- or sales of sanitation monitoring equipment were also up at double digits. I don't think the whole category was up that much. So I'm just wondering if there were some areas of weakness within there.

Well, the only 2 areas I didn't mention was the drug residues, most of which right now are testing for beta-lactams in milk, and the Soleris instrument technology. It wasn't that they were bad, they just -- I just tried to focus on the ones that were -- generated the significant increases that drove that 12.5% increase. So that Centrus line of products was flat. The biotesting was up, but the placements of instruments were different from last year and stuff. We see that from quarter-to-quarter. And the drug residue testing was up, I don't know, 6%, 7%, but it's just not the kind of thing that drove the overall 12.5%. So you're right, they weren't as strong as the others, but they still did very well.

All right, and that's fine. I just -- so AccuPoint was up, but Soleris was about flat, you said?

Yes.

The final question comes from Peter Coyle [ph], a private investor.

I have a comment and a quick question then. The comment is I want to congratulate you on your record quarter and for being on track with your 5-year goal for $200 million in revenue. And the question is concerning rodenticide. You say it rebounded strongly this quarter. I'm wondering why that may be, and was there a particular area in this country or in some other part of the world that may account for that?

I think it was -- Peter, thank you for the comment on $200 million. As it relates to rodenticides, some of that growth is due to the fact that the first quarter was negatively impacted last year by the risk mitigation decision that EPA had put in place that stopped some of those retailers, and particularly from buying products. Some of that has been resolved. And the other thing was we had a very good effective program in the first quarter to rebound. And frankly, we put more sales and marketing emphasis on that area on the Animal Safety side because it is an important part of the biosecurity programs that we've got. We had some good success with some of the animal protein producers, and we're continuing to work on developing some new formulations here to continue to keep that product line growing as we go forward.

Thank you, Peter. Peter, for those of you that -- Peter has been with us for a while. We announced 5 years ago when we crossed over the $100 million mark that in 5 years, we're going to double the size of the company and be at $200 million, which would be at the end of this fiscal year -- for 2013 fiscal year. And yes, we are on track to be there at year end. So it's kind of good to be able to fulfill your campaign promises.

That was the last question for today. Please go ahead with any final remarks.

Good. Well, thank you for your continued support. Thank you for joining us this morning. Don't forget our Annual Meeting next Thursday, any of you that are in town and can be here. And if you've got a proxy you haven't voted, well, we'd appreciate you vote. It's been a good morning. Thank you, again, for the support, and we'll look forward to talking with you as a group at the end of the current quarter. And we're off.

Thank you for participating in Neogen's First Quarter Fiscal Year 2013 Earnings Results Conference Call. This concludes the conference for today. You may all disconnect at this time.