Neogen Corporation (NEOG) Q2 2013 Earnings Report, Transcript and Summary

Welcome to the Neogen Q2 Fiscal Year 2013 Earnings Results Conference Call. My name is Trish, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the call over to Jim Herbert. Please go ahead.

Thanks, Trish, and good morning and welcome to our regular quarterly conference call for investors and analysts. Today we'll be reporting to you on the results of our second quarter that ended on November 30. I'll remind you that some of 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 risk and uncertainties and the actual results may differ from those that we discuss 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. In addition to those of you who are joining us today via live telephone conference, I'd 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 approximately 90 days. And following our comments this morning, we'll entertain questions from participants who are joined by this live call. I'm joined today by Steve Quinlan, our Chief Financial Officer; and Lon Bohannon, who's normally on this call, is in Brazil today working with our management team there. So he won't be with us on the call. Earlier today, Neogen issued a press release announcing results of the second quarter of our 2013 fiscal year. Once again, we reported record numbers. Revenues for the company's second quarter were approximately $50.7 million, and that's 13% ahead of the second quarter of last year. Net income for the second quarter was slightly under $6.8 million or roughly 30% ahead of last year's net income of $5.2 million. This translates to $0.28 a share for this year's second quarter as compared to $0.22 a share for the same period last year. We can…

Thank you, Jim, and welcome to everyone listening on the conference call as well as those joining us via the Internet. Jim has already reported on the overall sales of profit performance for the second quarter and the year-to-date for our 2013 fiscal year, and I'd like to echo his comments that we were very pleased overall with the results. Similar to the first quarter, we again exceeded our internal budgets for gross margin and operating margin percentages while also achieving some strong revenue growth. In the next few minutes, I'll address some of the significant highlights for the second quarter, and we'll begin by discussing the exceptional performance achieved within our Food Safety division. The Food Safety segment of the business built on the momentum generated by their strong first quarter and really delivered an outstanding second quarter with revenues up 18.1%. Almost all of that growth was organic. The sales growth was broad based across most of the market segments within the Lansing-based diagnostic business, with increases ranging from 7% to 43% in the beverage, pet food and grocery product markets. Milling and grain revenues, aided by an aflatoxin outbreak in the U.S. corn crop, more than doubled in the quarter. Our international operations were also strong in the second quarter for Food Safety. Our Neogen Europe business unit led the strong international growth with sales up more than 31% despite the tough economic conditions that persist in the EU. Neogen Europe capitalized on a DON mycotoxin outbreak in the wheat crop in Germany, recording a 69% increase in DON test kits. They achieved a 13% increase in allergen test kits and a 21% increase from resurgent sales to distributors. Neogen do Brazil continued to make inroads in penetrating the growing Brazilian market with sales up 51% in…

Well, thank you, Steve. I think you can tell from Steve's comments that we continued our revenue building activities throughout the second quarter, but at the same time, were able to show a very nice increase in earnings per share. Let me conclude our prepared comments this morning by giving you a view of both the food and animal safety issues around the world and what we think may lie ahead of us. Probably the biggest news in the last few months has been the big spike in U.S. Food Safety recalls in the past quarter. In this 3-month period, recalls totaled 414 separate incidents. This is an occurrence of about 4 per day or 2.5x the number of food recalls that we saw in the previous 3 months. 50 different food products were incriminated in these recalls. Peanut butter, salad ingredients and ready-to-eat meats were the foods that were most impacted. Salmonella and Listeria, 2 of the 3 most deadly food pathogens, were the most prevalent causes of the recalls. Despite the fact that we've increased our testing and we've improved diagnostic tests and we've implemented more intervention programs, these 2 pathogens are still on the rise. Fresh vegetable producers who were the first to push back against USDA and FDA programs 1 year or so ago, are now much friendlier with both of those agencies. At the end of last month, the spinach contaminated with Salmonella forced to recall in 18 states. It still hasn't been determined what farms might have actually produced the product that was eventually purchased and sold through Fresh Express, one of the nation's largest suppliers of fresh salad mixes. In an effort to reduce the meat recalls, the Food Safety and Inspection Service at USDA has now instituted a program requiring that meat…

[Operator Instructions] Our first question comes from Paul Knight from CLSA. Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division: I was calling on the GeneSeek. And can you talk about, I guess, revenue down a little bit, year-over-year what are the plans for that business, dynamics going forward?

We're really well pleased with that business. When we bought it, I think some of you -- you probably heard the story that it was -- we thought that at that time that probably the strongest genomics company, certainly in the U.S. and probably in the world in animal genomic testing. We also wanted to add more proprietary bioinformatics to that product line. The acquisition of the Igenity group from Merial brought in some of that. And we're continuing to add other bioinformatics that's more proprietary to what we're doing. So I think it's going good. We started off and there's terms that I don't -- I'm not good enough to make you an animal geneticists, so I won't try. But we start -- we were doing a lot of 50,000 SNP tests as we've worked through, trying to be able to separate what the traits were that made an animal improve, make an animal grow faster or make the steak go more marbled. As we've gotten further down the road, we've learned that we don't have to use 50,000 SNPs anymore. We can do it with a few thousand because we've identified the good ones from the bad ones, and we want to expand that business. I think we're the largest -- I'd kind of bet on being the largest, but we think we can gain more dominance there, and one of the ways to do that is expand it from the seed stock guys or the pedigree beef producers, as an example, down to the commercial guys that are -- commercial cow/calf guys that are producing calves to go to the feed lot. And to do that, we had to drive price down from $50 to $70 a test, down to $25 a test because we were looking for a lot of fewer traits. I think that's what we're seeing happen. As Steve reported, I believe our total numbers were -- of tests were up, even though our revenues were down some. But there's lots of opportunities, there's a lot of tests coming. We're ready to embark on a yet new platform in that area that's going to, I think, give us even increased credibility as we look into what would be our fourth platform. So I feel good about where we are, and maybe that gives you a little idea as to why the dollars might be down. I'm not at all disturbed about that at this point.

The next question comes from Steven Crowley from Craig-Hallum.

Just maybe following up on GeneSeek, the nature of that business that you've advertised to us is that it's project oriented often and it's lumpy, and we've had periods with good lumps and bad lumps. And I'm wondering in terms of the project backlog, how does that look for the back half of the year? And should we think about the business as having a decent chance at growing year-over-year because it hit kind of a low point here in Q2.

Yes, I don't think there's any -- I don't have any concern about year-over-year growth as we look at the last half of the year. And it is a little lumpy. I think Steve said we had $200,000, $300,000 in tests that we probably, from the same customer did last year, we didn't do this year. They just arrived a little late. And those, by the way, came from New Zealand. It's still a short plane ride, but when you're just trying to put together samples of dairy cows in New Zealand we tested, it's a little bit different than doing it in Wisconsin. But it's -- it is lumpy, but we got a lot of things that are going in the right direction. One of the things I'm looking forward to is we do a little -- a few things outside of the food animal area. We do the work with Mars for their Wisdom Panel on dog pedigrees, dog parentage. That's always a big business for Mars and for us in the Christmas time period for those people who already have everything that you want, well, you say, "What do I give them?" Well, I'd give them a test so that they can see whether their poodle is really a poodle. And so we do -- Mars does good business and we do good business in December. That business -- I talked to the guys yesterday and they're very, very busy. So I think it's -- we're going to be all right for the year and it'll smooth out over time. But right now as we're adding new customers, we just picked up 2 new customers that had been over at a competitor's shop in the beef cattle business, and they'll take a little while to move from…

Well, that's great. Now in terms of a business that did really well in the quarter. Obviously, the natural toxins business, the aflatoxin testing business, what can you tell us about how big a problem you've dealt with so far, what kind of tail there might be to the testing bolus? And how much of a revenue boost versus normalcy we're seeing right now so that we can keep seeing about normal periods in the future?

That's an interesting question and I don't know what normal is. I think normal is a continued problem somewhere in the world. We were talking just before we went on the air today about what's happening here and there. Somewhere in the world, it's always hot and dry, and somewhere in the world it's always cold and wet, and there are different natural toxins that come in, in each place. Some would tell you that if we are truly seeing global warming occur, that we may see more hot and dry weather, and that may give a rise in certain places. Certainly, we're not seeing the aflatoxin being a problem in Germany before this year. So it's difficult to say. Ed Bradley, he heads up our Food Safety group, tells me that he thinks that this corn testing in the U.S. has probably got a long tail on it. I don't know exactly how much that is going to mean as we go forward except for the fact that we had spots in the country where aflatoxin was extremely bad. The corn was almost not fit for any kind of consumption, but you could go across the county line 50 miles and you could find corn that was perfectly natural. So when you get a situation like that, you got co-mingled corn, it's going to require that the testing continue more than it might if it was just one state and you could write it off and forget it. So I think we'll probably see some of that as this corn is now in the elevators and it's going to begin to -- is beginning to come out or is coming out. I think that we're seeing some issues now. Grain is going down -- of course downriver is a problem because the river is a problem right now with the low water levels and difficulty in getting barge traffic all the way out. But I think we'll continue to see a tail on the mycotoxin problem in corn for aflatoxin. I'm not so up to speed as to what we're going to see in Germany and in that area for vomitoxin out of the wheat crop. I've got a feeling that it was probably more centralized and that crop has probably been segregated a little better than the corn crop, but I don't know that.

Our next question comes from Scott Gleason from Stephens.

I guess just to start off with, you guys mentioned you had this $1.3 million benefit in the Animal Safety segment from an animal supplement that was where your competitor had a supply disruption. How should we kind of think about that going forward? Was that kind of more of a one-time event or were you guys able to capture some incremental market share where, on a go-forward basis, that would continue to be there?

Well, I think we'll get some continued -- we'll keep some of that. The competitor -- we have a high regard for the competitor who was out of the marketplace and I think is probably beginning to come back into the marketplace now. Been a longtime player in the market, has treated his customers very well. They've been a good company, and we got business because of the fact that they had no product to supply. Having said that, I suspect that we'll keep some of it. We won't go back to where we were. One of the issues that affects the thyroxine in dogs, in fact, frankly just like in people. Once you get an animal on a regime that works and get the right dosage from the right product, veterinarians are reluctant to change brands to another product. And so I think we've been in that market long enough now that I think we've got some conversions that go all the way back to the pet owners. So I expect that we'll keep some of that. Will we keep it all? Probably not, but we got other things coming along that will certainly fill -- backfill behind it. So that new FDA or that new plant in Lexington that we moved is now complete. And if you remember, that is an FDA-approved plant. We've got some new product to go through there as soon as we get the FDA approvals completed. So where we might lose some of the advantage that we got last quarter for T4 tablets for dogs I think will make up in other areas as we move out through the rest of the year.

Is there any chance you could give us maybe a little bit more granularity on what's going on in terms of the molecular side? What your current installed base of systems out in the field is? And I guess maybe when a customer gets fully up and running with the ANSR platform, kind of what's your expectation of kind of dollars per system per year might look like?

Yes, I don't have those numbers right in hand. I know that we've got faster traction in some markets than others. As an example, I think the Salmonella product testing with the ANSR system has gone into pet food very rapidly. Of course we almost have a dominant position there in natural toxins and I think that's been a part of it. It's not quite been quite as fast in some of the other areas, but it's again this situation of people sitting on their hands. I've talked to customers in the last few weeks and said, "This is a better deal. Why aren't you looking at it?" And they said, "Well, what we're doing, it's not that bad and we just don't want to do much of anything unless we have to. If it's not broken, we're not trying to fix it." And I think we're seeing a little bit of that out there. That's got to give. It's got to give way, but it's coming a little slower than it might. Steve was showing me, it was Steve or Ed [ph], one was showing me numbers yesterday or sometime this week of a number of new customers, which was impressive. Steve, what'd we -- the tally you had, that was over 500 new customers. It's something like 500-and-some-odd new customers that bought from us in this past quarter that had not bought from us in like the last 18 or 24 months. So that's -- I'd categorize that as a new customer. If we hadn't had their business in the last 1.5 years, I think that's new. And you may remember the line reported to you last quarter, we had numbers of about the same size. So we're continuing to pick up a lot of new customers. And that's got to be mostly coming in as market share increase, because most anybody out there that's got much concern today is already using some kind of product, so we're gaining some market share somewhere.

Great. And I guess just last question, I'm sorry if you guys already said it on the call, I didn't pick it out. Could you give out the growth rates for the business, both U.S. and O U.S.?

Yes. You have that...

The growth rate for the business overall was 9.4% -- I'm sorry, 13% overall. 9.4% was what we call organic growth. We don't break out -- we didn't break out the international piece of the growth. International as a percent of our overall sales was 37.4% in the quarter and almost 40% year-to-date.

Okay. I guess can we take from that, that maybe international was a little bit softer this quarter?

Yes. There's no question about that. I don't think softer. It did not grow as fast as the domestic business group, I think is a safer way to say on it.

Our next question comes from Tony Brenner from Roth Capital.

Two questions. First, I wonder if currency translation affected your revenue comparison in the quarter.

It did. Steve, I think you got those numbers.

It was a pretty small number, Tony. It was $215,000 decline -- hit to revenue for the quarter. Remember the first quarter was about $1.2 million headwind. So we're at $1.4 million for the year-to-date.

Okay. And my second question is in the previous quarter, you entered a water testing distribution agreement with CPI. And that's -- water testing is a pretty huge area that Neogen hasn't been much involved with in the past. And I'm curious whether this is an area that's become now a focus of your R&D efforts or of your search for acquisitions or was that agreement just a one-off special situation?

We've actually been distributing that product to special customers for a while. Water is clearly an area that's got good opportunities. We have not -- we're not there yet. We need to be there. We want to be there. We will be there. We are in a few places with customers like the 2 major bottlers on a worldwide basis. We supply them with product that they use to test incoming water that's going into make actual product, that's going into carbonated and still beverages. So we play around the edges, but the big market there, I think, Tony, is not in industrial water. And you got both sides of it. You've got the affluent as well as the -- where there's a lot more pressure that's coming to bear, as well as the safety of the water that's going into products being used. But it's in municipal areas and in water for municipal water supplies, which is a market area where we don't have any touch right now. We'd like to be there. We need to be there. We're looking at opportunities. And we may just do it ourselves without aid of somebody to help carry us in. But it's not anything that I've got on my drawing board for the rest of this year. So now I can't tell you that one of our guys might have a brainstorm and already be well ahead, because I don't know about it. But I don't believe we will probably -- I don't see us moving into the water market for the next 6 months.

Our next question comes from Greg Halter from Great Lakes Review.

I just wanted to ask about the competitive landscape generally. And obviously, with Pfizer spinning off their unit, if you anticipate any changes from that or competition generally?

Well, the Pfizer spinoff will have -- we don't cross sabers with Pfizer in very many places. We've got some 1 or 2 antibiotic products that are in common, and Pfizer is a player in the genomics area, I don't think very big. This time 1 year ago, we were doing Pfizer's actual genomic testing for them. We did their testing in the lab and fed them raw materials back that they went to customers with. So I don't see that, that's going to -- that the Pfizer deal is very big or will have a very big impact on us. The market in general, there's more competitors out there than the market -- than deserve to be. We got some folks that have got more business than they really ought to have and ought to be ours. And it's like many new technologies. You see a lot of new companies that enter and then you see a concentration of those. And I think we're kind of heading in that direction of concentration. You're see some acquisitions of some bigger companies buying smaller companies, and I think we'll see that. But there's a lot of technology out there. There's enough that certainly keeps us on our toes. We don't have a competitor that covers all areas of the markets like we do, Food and Animal Safety. Or even in the Food Safety side that covers really all the areas from pathogens to allergens to natural toxins. We've got some pretty formidable competitors in one segment or another. So I think we're, as I said in a case or 2, I think we must be gaining a little market, but it's not easy.

And Steve, you talked about the foreign exchange on sales. Any impact on operating income?

It was in that same range. And I will tell you, it was about $165,000 hit to operating income.

And can you provide the cash flow from operations for the quarter or 6 months?

Sure. For the quarter it was -- from cash flow from operations was $6.9 million.

That's for the quarter, okay.

The year-to-date?

No, that's okay, I can calculate the year-to-date. The capital spending plans for the company for the year, have those changed at all?

No. No, we're at about $3.4 million year-to-date and we're tracking towards -- our number is overall $6 million, $6.5 million. So no change there.

All right. And one last one. I didn't hear specifically the geographic breakdown on how Europe did in the quarter in terms of revenue.

Neogen Europe, if we're talking about that portion of our operation, is up nicely for the quarter, up about 25%, if I remember.

30%.

30%, yes. 30% and almost 50% at the bottom line. Now I told them they should've made a few more sales to push that on up so it would round up to 50%. But a good quarter in Europe despite the fact -- in Neogen Europe, despite the fact that Spain and Greece and Italy are still problematic. They're still buying and they're still paying their bills. But the amount of the purchases has declined from where it was.

All right. That's very helpful. The international piece, I think, Steve you mentioned 34.4% of total sales which is obviously down from the 6 months...

Yes, Greg, that was 37.4%. And the 2 biggest pieces there are, Greg -- Chr. Hansen, our largest European distributor, that's the dairy antibiotic sales which we talked about a little bit, that's down for the quarter. That's really timing of orders just [indiscernible] puts in various orders at any given time and that should come back in the second half of the year. And a smaller impact but our cleaners and disinfectants to some of the bigger distributors into Europe was a little bit soft. That was probably about a $300,000 shortfall. And that, again, it's order timing. These distributors order large quantities at any given time so...

Yes, as I remember, we had a big order last year, Steve, of Soleris instruments that went to China in the second quarter which were repeated this year.

[Operator Instructions] Our next question comes from Steven Crowley.

Just a quick follow-up. You probably gave us the components, Steve, but you referenced an organic growth rate for the 6 months that included the impact of FX at 10.3%. The 9.4% organic growth rate that you've referenced for Q2, does that include the impact of FX or exclude that impact?

That excludes it. Those are actual results.

Okay. So if we were to go apples-to-apples with the 10.3% for the year, I guess, we'd just add the $200,000 back, but I'm getting lazy.

No, the year-to-date organic growth, Steve, is 8.8%. And then to that number, you would add the FX hit, which was about $1.4 million, and that gets you to your 10.3%.

Okay. But for the quarter you gave us 9.4% which relates to the 8.8%. So I'm wondering what the FX adjusted organic growth rate for the quarter is.

Oh, okay. That would actually be 9.9%. Let's call it 10%.

That's very helpful. And then in terms of bacterial and general sanitation, we talked about Soleris and the fact that there's some opportunities there. Is there anything to note about AccuPoint in new applications or where there's an opportunity set for you in the pipeline with AccuPoint?

That probably continues to grow. We are doing some things, some substantial things in the pipeline. Since my competitors always listen to our call, I'd probably -- I don't want to say much more than that.

Okay, that's helpful. And then on the acquisition front, given some of the tax law changes that we're all staring at, it looks like that, that was probably a driver for one of the opportunities that you capitalized on. We're running out of time to buy and close something before the end of the year for the benefit of the sellers. Or are there some things in the hopper that, that deadline might work for you?

I guess I'll let you speculate on that.

We have no further questions and I'll turn it back to Jim Herbert for final remark.

Okay. Well, thank you so much and thank you all for your participation this morning. We want to make sure and wish you happy holidays. And to each of us, I guess, we want to wish ourselves a prosperous 2013. So we'll look forward to talking with you next year. And we're off.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.