Prepared remarks
Good morning, ladies and gentlemen, and welcome to the Neogen Corporation First Quarter 2025 Earnings Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Tuesday, October 10, 2024. I would now like to turn the conference over to Bill Waelke, VP, Investor Relations and Treasury. Please go ahead.
Thank you for joining us this morning for the discussion of the first quarter of our 2025 fiscal year. I'll briefly cover the non-GAAP and forward-looking language before passing the call over to our CEO, John Adent, who will be followed by our CFO, Dave Naemura. Before the market opened today, we published our first quarter results as well as the presentation, with both documents available in the Investor Relations section of our website. On our call this morning, we will refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliations of historical non-GAAP financial measures are included in our earnings release and the presentation. Slide 2 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 any obligation to update these forward-looking statements. With that, I'll turn things over to John.
Thanks, Bill. Good morning, everyone, and welcome to the earnings call for the first quarter of our 2025 fiscal year. At the beginning of September, we crossed the two-year anniversary of the closing of the 3M Food Safety transaction, which solidified our position as the largest player with the broadest product portfolio and geographic reach in an attractive and important end market. That transaction strengthened our company in the food safety end market where we generate approximately two-thirds of our revenue from products and solutions that help protect the food supply. We provide an important and relatively inexpensive line of defense in the rapid detection of contaminants in the production and distribution of food and beverages. We believe the food safety market has a number of secular tailwinds. One of these tailwinds involves the expected increase in various food testing regulatory requirements around the world.
We saw another example of this recently in the U.S., with the USDA's declaration of salmonella as a known adulterant in raw, breaded, and stuffed chicken products joining E. coli and Listeria as the other known pathogen adulterants in different food types. The USDA and other international regulatory bodies continue to focus on reducing severe illness and fatalities stemming from foodborne pathogens, and we anticipate the emergence of additional regulatory requirements in the future. Other key tailwinds in the food safety market include the increasing expectation from consumers to know what is in and not in their food, as well as the high cost associated with contaminated products reaching the shelves. Beyond the obvious tragic consequences that can result from consuming contaminated food or beverages, the cost to companies of the associated product recalls, litigation, brand damage, and even facility closures can be tremendous, as evidenced recently by several unfortunate high-profile outbreaks.
These occurrences reinforce the value proposition of Neogen's solutions and industry expertise, which have never been more relevant than they are today. Our commercial teams have been engaging in an increasing number of these conversations with customers, offering not only the breadth of our products and services, but also the long-standing knowledge and expertise we can provide in structuring robust food safety testing programs. We expect these factors to continue to support growth in the food safety end market and a continuation of the progress we've made in expanding and in some cases, winning back market share. In Animal Safety, we continue to manage through end market conditions we believe are at or near cyclical lows, particularly in the United States, where most of our business in this segment is focused. Our Animal Safety sales are influenced by net farm income, which after peaking in 2022 in the U.S., declined in '23 and is declining again in 2024.
The majority of our business in this segment goes through large distributors. And despite weaker conditions, sales of our products out of the distribution channel have continued to grow. However, our sales to our distributor partners are subject to movements in the timing of orders and inventory levels, as well as any other factors or initiatives specific to individual distributors. In the first quarter, some of our key distributors reduced inventory levels due to order timing from the fourth quarter, while others did so as a result of some specific challenges they're experiencing in their particular business. We are not seeing indications of a destocking trend and believe the sales out of our products support an improvement in our Animal Safety growth rates in the coming quarters. And of course, we'll continue to monitor the channel dynamics closely. In our Genomics business globally, first quarter revenue was down on a year-over-year basis, but improved from the decline we saw in the fourth quarter.
We began to round-trip the impact of the strategic shift towards larger production animals in the quarter and did see growth in our large animal business. This growth was offset by weakness in the companion animal side of the business, driven by a lower number of new puppies and increased inflationary pressure on customers. We are continuing to focus on driving growth in the direct-to-producer beef and dairy segments while also targeting actions to right-size the cost base to better align with the current level of revenue. With respect to our integration progress, the ERP-related challenges that we've been experiencing in our primary distribution center have been resolved, and we are no longer constrained by shipping. That being said, we do see opportunity to drive improvements in the efficiency of that operation, and our teams are focused on executing a number of initiatives there. On the production side, we've completed the relocation of the former 3M sample collection product line.
While we've been in the process of ramping up our production, we haven't been able to fully keep up with end user demand, which weighed on our sample collection sales in the quarter. We currently have all lines operational with the line of sight to reach normal production levels in the third quarter. Our new Petrifilm facility is progressing well and the first of our two major shipments of equipment is expected to land in Lansing in January. It will take several months to uncrate everything and get it moved into the new building, but the receipt of the equipment is clearly an important milestone in that process. With the recent shipping challenges behind us, regaining market share is the top priority. The response to our initial efforts in this area have been encouraging. We are a known and trusted partner in the industry with leading products that are globally validated, and most customers are primarily focused on a demonstrated period of reliable supply.
Because of this, share recapture will not happen overnight, but the progress we've made so far is in line with our expectations. Our commercial teams are executing detailed tactical plans that are driving constructive dialogue with previously impacted customers, and we're looking forward to continuing to demonstrate our capabilities as a reliable, knowledgeable source of leading food safety testing solutions. I'll now turn the call over to Dave for some more insights into our results for the quarter.
Thank you, John, and welcome to everyone on the call today. Jumping into the results, our first quarter revenues were $217 million. Core revenue, which excludes the impact of foreign currency, acquisitions and discontinued product lines, declined 1% for the quarter, while foreign currency was a headwind of 390 basis points compared to the prior year. The first quarter is historically our seasonally lowest of the year with this year's first quarter seeing the impact of lost sales related to our shipping challenges in the second half of fiscal 2024. At the segment level, revenues in our Food Safety segment were $159 million in the quarter, a decrease of 4% compared to the prior year, including core growth of 1%. The core growth was led by the Indicator Testing, Culture Media, and other product category, which benefited from strong growth in our Petrifilm product line as well as in Food Quality, Nutritional Analysis, and Culture Media.
This growth was partially offset by a decline in Sample Collection as we fell behind demand during the process of ramping up production in our facility. The Bacterial and General Sanitation product category saw modest growth in Pathogens, which was offset by declines in General Sanitation and Microbiology. Within the Natural Toxins and Allergens category, modest growth in Allergens was offset by a decline in Natural Toxins. Quarterly revenues in the Animal Safety segment were $58 million, which includes a core revenue decline of 8% compared to the prior-year quarter. Within Biosecurity, strong growth in Rodent Control products was offset by declines in Insect Control and Cleaners & Disinfectants. The Vet Instruments and Disposables product line had a slight core revenue decline, while the Animal Care and other product category had a larger core revenue decline, driven in part by supplier-related product availability issues.
Worldwide Genomics revenue was down mid-single digits on a core basis. Solid growth in beef markets was offset by the shift away from small production animals in the U.S., the impact of which we have mostly anniversary as of the end of Q1. From a regional perspective, core revenue growth in the first quarter was mixed. Growth was led by Latin America, which saw double-digit growth with a strong performance across most key product categories. The growth was driven by continued build-out of inventory across the distribution channel as well as some new business wins. Our business in Europe was roughly flat on a core basis, with growth in Petrifilm, Cleaners & Disinfectants, Culture Media, and Vet Instruments, offset by declines in Sample Collection, General Sanitation, and Genomics. Asia Pacific core revenue was down slightly on a year-over-year basis, with growth in Petrifilm, Cleaners & Disinfectants, and Food Quality, offset by declines in Pathogens and General Sanitation.
Our U.S. and Canada region saw the largest carryover impact from the shipment delays last year, with core revenue down in the mid-single-digit range. Despite this impact, Petrifilm and Culture Media had solid growth, which was offset by declines in most other Food Safety product categories. In the Animal Safety segment, strong growth in Rodent Control products was offset by declines in the other major product categories. Gross margin in the first quarter was 48.4%, representing a decrease of 260 basis points from 51% in the same quarter a year ago and an improvement sequentially due mostly to some reclass and one-time items that impacted Q4. Adjusting for transaction and integration-related costs as well as discontinued products, the year-over-year gross margin decline in Q1 was 90 basis points. The decline was driven primarily by lower volume and continued higher distribution costs. Adjusted EBITDA was $44 million in the first quarter, representing an adjusted EBITDA margin of 20.1%, a year-over-year decline of 280 basis points.
The decline in adjusted EBITDA margin was driven by lower revenue in the quarter and the decline in gross margin, with additional negative impact from having the full cost to exit the various transition agreements, including some impact from higher shipping, a portion of which is reflected in operating expenses. First quarter adjusted net income and adjusted earnings per share were $14 million and $0.07, respectively, compared to $24 million and $0.11 in the prior-year quarter. The declines in the current year Q1 were driven primarily by the lower adjusted EBITDA. We ended the quarter with gross debt of $900 million, 67% of which remains at a fixed rate and a total cash position of $120 million. Compared to the fourth quarter, the lower first quarter cash position was driven by higher capital expenditures, a semi-annual interest payment on our senior notes, and the negative impact from working capital.
The working capital increase was the largest in payables, which is mostly timing-driven, and inventory where we built stock of higher running products. Q1 represented the high point in the year for CapEx spending. We believe we are still on track with the free cash flow guidance we provided in July, but are off to a slower start than we had anticipated. Moving to our outlook for the 2025 fiscal year, we are maintaining our previously issued guidance. First quarter revenue developed in line with the expectations we communicated regarding lower-than-normal first-half seasonality, and we are encouraged by the performance we saw in September, which was an improvement over the first month of Q1. We expect our first quarter adjusted EBITDA margin to be the lowest of the year and expect margin improvement in the balance of the year to be driven by higher revenue volumes, gross margin improvement, including actions in our shipping and distribution operations, and operating expense efficiency.
As I noted on capital expenditures, we anticipate our first quarter spending to be the highest level of the year, followed by the second quarter. We also continue to believe higher adjusted EBITDA combined with lower CapEx and the 3M working capital load-in not repeating will result in free cash flow for this year being positive. I'll now hand the call to John for some closing thoughts.
Thanks, Dave. In a separate announcement this morning, we shared that Doug Jones, our Chief Operating Officer, has communicated his intent to retire in the early part of calendar 2025. Doug has had a long career across a number of industries and his experience has been invaluable to Neogen, particularly his broad expertise and contributions to the integration of the 3M transaction. In preparation for Doug's coming retirement, we have begun the search for a Chief Commercial Officer, who will report to me and have responsibilities for our global sales, marketing, and communications organizations. With Doug assisting with the transition once that role is filled. Our new Vice President of Global Operations will transition to report to Dave Naemura, our CFO, who has worked closely with the operations team here at Neogen as well as other organizations in the past. This realignment will provide a dedicated focus on our commercial activities while also enabling Dave to work more closely with the operations and supply chain teams to further tap improvement opportunities.
Our Head of Latin America also recently announced his impending retirement after a long career with Neogen, and we have hired his replacement, Enrique Carballido, who brings commercial experience from a number of multinational corporations in the diagnostics space, most recently as the Head of Latin America for Bio-Rad. Finally, we recently announced the addition of a new member of our Board, Thierry Bernard, who is the current CEO of QIAGEN, a leading global provider of molecular diagnostic solutions and insights. This addition brings the valuable insights and perspectives of an independent public company CEO to our Board, including those gained from experience in the food safety industry in prior roles. The goal of these additions and organizational realignments is to continue to bring experience and capabilities in Neogen that puts us in the best position to execute on the significant opportunities we have in our primary end market of food safety.
We are the established leader in this market and look forward to continuing to build on that position to drive sustainable long-term growth. Now, I'll turn things over to the operator to begin the Q&A.
Questions and answers
Thank you. Your first question comes from David Westenberg with Piper Sandler. Your line is now open.
Hey, guys. Thank you for taking the question. So, you've had 3M for a little while now, and there are definitely some great products that fit with your overall portfolio. How are you looking at maybe investments this year in sales and marketing, R&D, et cetera, in terms of allocation towards food safety overall, now that you have these new tools in the portfolio?
Hi, David, it's Dave. Good question. I think what you've heard from us over the last year is a couple of things. A lot of commercial investment, particularly building out the international regions. We think there continues to be a lot of opportunity. And now that we have critical mass post 3M acquisition, we've been putting a lot of energy there. And also, you've heard us talk about Petrifilm as a platform. It's very exciting, and clearly, an R&D priority for us to invest in. And of course, in Q1, we announced the new reader as well, the new feeder for higher volume processing. So, I think you've heard that from us and your take is right. It's very exciting. And I think hopefully, we'll continue on that theme.
Yeah. Thanks, David. We've talked a lot about capital allocation, right, and where we're going to spend our money, and that's something we do and look at as a group and understand. And we see the profitability profile of those products and really a number of our other products in the food safety, and that's where we're going to continue to invest. It was the thesis of the deal. That's why we're still excited about the deal. That's why we're going to continue to put money behind it.
Definitely sounds right. And then, in terms of debt and how we're thinking about debt over the course of the next three years, I know you don't give three-year, four-year out-year guidance, but just in terms of the priority to pay debt down, I still think that is a big capital priority for you, though I know you guys continue to think about tuck-ins on a pretty ongoing basis.
Yeah. Look, I think you've heard us consistently talk about capital allocation priority, first funding the integration, which is vital, but then on a net basis, reducing leverage. And as we do so, that frees up M&A capacity. So, I think, no change there. We got to keep getting the integration work done, which we made, obviously, huge strides in 2024. And as the years progress here, we think we'll be on an okay path. The guide implies around three times net leverage at the end of the fiscal year, a little higher than where we thought we would be a few years ago at this time, but clearly manageable and I think reflective of our priorities.
Perfect. And then just one last one here. The stock out of the Petrifilm, that is now well behind you. Can you talk about the customer recovery ratio, what kind of inning you are in terms of winning all those back? Is there still a big group that you have left to win back, or did you get them pretty much all back over the last, say, year or so now that you've had product on a pretty consistent basis? And that's my last one. Thank you.
Thank you, David. There are two main points to discuss. First, regarding Petrifilm in Japan, we have successfully regained our customers after experiencing significant issues. We are now witnessing growth in Japan, which is a positive development for us. Previously, we faced several quarters of decline, but we are starting to see a turnaround in that business, supported by a strong team. On a broader scale, we encountered some challenges with our EWM system at the warehouse, which affected our customers. Regaining their trust remains a priority for us, though it may take some additional time. I've engaged in several discussions with our customers, and as I mentioned earlier, they are looking for consistent supply. We have achieved that for a quarter, and they expect us to continue this trend. We are still progressing on this path, which is why we anticipated that the first quarter might be our most challenging period of the year. We recognized this and believe we are moving in the right direction.
Thank you.
Your next question comes from Brandon Vazquez with William Blair. Your line is now open.
Good morning, everyone. Thank you for the question. Let's begin by discussing the customer losses you just mentioned. John, can you provide any details on the customer losses from the past couple of quarters? I recall that when you lost customers in Japan, you gave us a number, so I'm wondering if you can do the same this time. Additionally, could you take a few more minutes to explain what these accounts are expressing in terms of their expectations from you moving forward, and if you believe that showing them one or two quarters of consistent supply will lead to them returning for most of the lost share.
Hey, Brandon, it's Dave. Just briefly quantifying things, as we began the year, we mentioned that we anticipated a couple of points of headwind to our share growth for the year. What we observed in the first quarter was fairly aligned with that expectation. The data suggests that our share headwind impact was around $8 million in the first quarter, predominantly in the U.S. I’ll let John address the customer interactions and how those are progressing.
Thanks, Dave. Brandon, I've had many discussions with our customers, and first, they want to express their frustration. I assure them that I'm just as frustrated as they are about our inability to meet their needs. After that, we discuss the improvements we’ve made. For instance, with MDS, we’ve seen efficiency improvements in just six months since taking it over, compared to its time at 3M. I'm really excited about this because we've dedicated significant time and energy over the last two years to integrate the business. Now, our teams at Neogen are starting to shift their focus from integration to efficiency and growth, which is very encouraging. I can show our customers specific examples, like how we've increased the availability of the Petrifilm product line and improved efficiency in MDS. These advancements help us maintain ongoing discussions, which often lead to contract renewals.
Okay, great. Dave, with one quarter completed and a month into the next quarter, based on your conversations with customers, I’m interested to know if you have a guidance range for the year and whether those discussions are indicating any leanings towards the high or low ends of that range. Could you also share what factors influence those endpoints as we move through the year?
Yeah. Thanks, Brandon. I think you're just with the first quarter behind us and yes, a view of September, which for a first month of the quarter, we saw some improvement for the first month of Q2 versus Q1. I don't think it informs that we would narrow the range per se. There's still uncertainty around the timing and pace of share recovery. There's uncertainty more broadly in our end markets. And so, I think the things we talked about when we set the guide kind of still exist kind of one quarter in here. And most importantly, when we talked about the guide, we talked about this year being a little more second-half weighted. So historically, maybe we'd be 48% in the first half, 52% in the second, and we see that shifting to a little more second-half weighted, which I think creates the need for the volume ramp makes it a little bit bigger. So, I think we still remain where we are. And to your point, as the year develops here, hopefully, we can help color it a little better.
Okay. And maybe I'll throw two quick ones out there. John, is there any feedback in the early days of the high-volume Petrifilm feeder that you could share with us at this point? And then, Dave, just for you, just so that we can kind of talk about it on the broad call, any impacts that we should keep in mind from the past two hurricanes in the Southeast? Thanks, guys.
I have one anecdote, where we had a customer testing our product and when we told him it was time to take it back, he insisted that we couldn't take it back. This quarter has been difficult for our industry. We've experienced two major outbreaks affecting significant companies and their consumers, highlighting the importance of our work. During a meeting, we presented data on the number of people affected by foodborne illnesses in the U.S., emphasizing our mission to prevent such incidents. It's crucial to maintain a forward-looking approach, as many companies go long periods without issues until they encounter a problem. This reinforces the significance of our environmental monitoring programs and risk assessments, which help customers stay proactive rather than complacent amid constant change. Factors like environmental shifts, such as unexpected floods or increased humidity, necessitate updated risk assessments to safeguard the food supply. I'll let Dave discuss the hurricanes, but it's important to note that two significant events occurred this quarter that we should monitor.
Yeah, Brandon, I don't have a quantification of the recent storms in the South. Obviously, the results of Milton here are pretty fresh. And so, it's something we're keeping an eye on the logistical impacts and other things at this stage, but I don't have a quantification at this time.
Your next question comes from Thomas DeBourcy with Nephron Research. Your line is now open.
Hi, guys. Can you hear me all right?
Yeah, Tom DeBourcy, I can hear you.
Okay, great. My question is about the Chief Commercial Officer position that you're establishing. I understand it is being developed from an existing role, but it seems to be coming at an opportune moment as both your end markets have been weaker and we are moving back into a phase of strikes and revenue generation opportunities. You might be engaging with more customers who are more open to your offerings. How are you approaching the C-suite role, and what additional strategies could Neogen implement in terms of revenue generation and acquiring new customers?
Yeah, great. No, thanks, Tom. A couple of things with that. I think that's why we're splitting it to a Chief Commercial Officer role and not a Chief Operating Officer role because we see the opportunity to continue to focus. And the reason we're able to do that is because Doug did such a fantastic job when he was here building out his team. And we have a really, really strong Vice President of Operations that we are very happy to have on board. Jim has been with us over a year or right around a year, and is making tremendous impact. And so, it gives us great confidence in him running the operational side and really then hiring someone that's going to focus fully on demand generation. And for those who don't know, I've worked with Doug for over a decade. He's done a great job. We're really happy that he's got the opportunity to retire and do some other things that he wanted to do, and I'm even happy that he built such a strong team that's allowing us to make these types of organizational moves in a way that is planned and allows us to meet the needs of the business going forward.
Got it. Just I guess as a follow-up to the cost side, kind of, I guess, the ongoing portfolio review, as I think about part of the 3M business you acquired, it seems like there were some areas where you might have some overlapping products and whether there's some, I guess, consolidation opportunities or maybe they serve different customers, but then also how you're looking at potential lower-margin products and whether exiting those products are selling subproducts maybe a good return on capital?
Yeah, I agree, Tom. We've already started some of that work, even though we haven't publicly shared it. We've collaborated with customers in the new bar to align some of our products from 3M. However, we also need to consider how that fits with our own product portfolio. This is something we've been focusing on for the past year. While we don't have any updates to share today, we are actively evaluating these areas, aiming to optimize our capital investments. Right now, capital allocation is crucial for us, and we are determined to invest in areas that provide the highest returns.
And then just maybe the last question. Geographically, China has continued to be a focus on the animal health, animal safety side, whether it's African swine fever or other issues that obviously have been happening over the last few years. Just how do you view kind of the importance of that market for Neogen's growth? That will do it for me.
I believe that the entire Asia Pacific region is crucial for us. It presents significant growth opportunities across various markets. We have a strong presence in Japan, Korea, the Philippines, Thailand, and China. We're not solely depending on China for our growth. As you know, China has faced challenges, which has proven beneficial since we maintain a diverse sales mix throughout the region. Our primary focus is on Asia Pacific. As Dave mentioned earlier, we're investing in all our international regions to expand our teams because we currently hold a small market share and see great potential for growth. We've observed Japan, our largest market outside the U.S., starting to recover and grow again, which is encouraging. We've also seen considerable growth in Latin America and Europe. If these markets continue to outpace North America, we will keep investing in them.
Great. Thank you. That's it for me. Appreciate it.
Thank you for joining us today. As we discussed, this quarter highlights the importance of Neogen in safeguarding the world's food supply. We witnessed major companies facing significant challenges that have impacted many consumers in the U.S. We remain committed to our leadership in this field by developing new and innovative solutions that help our customers identify and manage their risks. Thank you again, and we look forward to our next call.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.