Neogen Corporation's (NEOG) CEO Jim Herbert on Q4 2016 Results - Earnings Call Transcript

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Neogen Corporation (NASDAQ:NEOG)

Q4 2016 Results Earnings Conference Call

July 19, 2016, 11:00 AM ET


Jim Herbert - Chairman and CEO

Rick Calk - President and COO

Steve Quinlan - VP and CFO


Bill March - Janney Montgomery Scott

Jason Rodgers - Great Lakes Review

Brian Weinstein - William Blair

Charles Haff - Craig-Hallum Capital Group

Kurt Kemper - Hilliard Lyons


Welcome to the Neogen Fourth Quarter and Year End Fiscal Year 2016 Earnings Results Conference Call. My name is Richard, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Jim Herbert, Chairman and CEO. You may begin.

Jim Herbert

Good morning, and welcome to our regular quarterly conference call for investors and analysts. As you know, today we will be reporting to you the results of our fourth quarter that ended on May 31st and the company's 2016 year end.

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 risks and uncertainties. Actual results may differ from those that we discuss today.

And these risks that are associated with our business are covered at least 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 by live telephone conference, I'd also welcome those who may be joined by the simulcast on the World Wide Web.

Following comments this morning, we will entertain questions from participants as announced that are on this live conference. And I am joined today by Rick Calk, Neogen's Chief Operating Officer; and Steve Quinlan, Neogen's Chief Financial Officer.

Earlier today, Neogen issued a press release announcing the results of our fourth quarter that ended on May 31. Revenues for the fourth quarter increased 15%, compared to the same quarter last year, to approximately $90 million compared to last year's fourth quarter of $78.6 million.

For the 2016 fiscal year, Neogen's revenues totaled $321.3 million, that's a 13.5% increase over last year's $283 million. Once again, the 1,235 Neogen employees around the world kept the growth record going.

In the past 102 quarters, Neogen has now reported quarterly revenue increases 97 times, that's a record that now spans 25.5 years. And also I'd hasten to add that we have not missed a quarter in furthering that record in the last 11 years.

Our net income for the fourth quarter was approximately $9.9 million, or 5% ahead of the same quarter last year. Net income for the 2016 year was approximately $36.6 million, or 9% greater than our 2015 year. On a per share basis, we earned $0.97 for the year versus $0.90 a year ago.

And if you've kept up with our quarterly conference calls, you know that meeting our expectations was tough this year due to a lot of external factors like political issues that impacted some of our South American customers and the general devaluation of almost all currencies as compared to the dollar during the year.

Despite all this, I believe we've managed to hold market share and essentially we played the hand that was dealt us. Steve will talk more about the currency conversion issue a little bit later this morning.

But I can say that the strong dollar certainly showed itself in our share of revenues coming from international markets. In the 2015 year, that's last year, we received 37% of our revenues from sources outside the U.S., whereas this year that percent dropped to about 33.5%.

Our international sales have actually grown in native currency, but given the currency losses and a greater growth here in the U.S., the percentages have dropped. But that leaves us open for some good gains in this new 2017 year.

Expensing acquisition costs in the quarter in which they were spent has also had some income impact. We made five acquisitions during the year. And though all of these are getting integrated, the organizational expense has often surpassed earnings return in the quarter in which they came on board.

I'll talk more about those acquisitions as a part of our overall strategy at the end in my comments this morning. But let me stop at this point and ask Rick Calk to talk about growth of some of the exciting areas that Rick is fostering with our Food Safety division. Rick?

Rick Calk

Well, thank you, Jim, and welcome to everybody who is listening. Jim has already reported on the overall sales and profit performance for the fourth quarter of our 2016 fiscal year as well as the entire fiscal year. I'll provide a bit more detail on the performance of our Food Safety segment as well as try to offer a little perspective.

As stated in the press release, the negative effects of the currency conversions obscured what was a solid operational performance for our Food Safety segment. For example, Neogen Europe finished the year strong with revenues up 13% in dollars in the fourth quarter.

Now, this was primarily the result of allergen and AccuPoint Sanitation product growth, but declined for the full year by 3% with the impact of lower genomic revenues and the pound declining by 6%.

Brazil sales grew by 49%, which was reduced to 7% once converted, and Neogen Latin America by 44%, which was reduced to 20% once converted to U.S. dollars. We reported a food safety revenue increase of 11% for the fiscal year, with an overall organic growth for the segment of 6% for the year.

On a constant currency basis, the organic increase would have been 12%. Steve will talk more about the impact of the strong dollar in just a few minutes.

So, currency aside, our products in this segment experienced solid growth during the year. Neogen is well-placed. The trends within the food industry and regulatory food environment point to even better days ahead.

Our line of food allergen tests were up 20% for the year. As sales of tests for each of the 12 allergens we offer increased by double-digits, except for one, and that was the test for almonds, which has largely been replaced by our new test for multiple tree nuts, which includes the almond.

Sales of our AccuPoint advanced sanitation monitoring system products, including both the durable instruments and the disposable samples, increased by 18% in 2016. This increase comes as our innovative system continues to gain market acceptance and food companies respond to increasing requirements to test food production environments for the presence of possible contaminants.

Sales of our mycotoxin test ended 2016 flat compared to 2015, which, as I share that with you and it crosses my lips, doesn't sound great. But it was actually a very strong accomplishment as our commercial teams overcame difficult comparisons with a strong previous year for mycotoxin sales.

A year-over-year comparison of the grain crop shows the 2016 crop was healthy, with very low mycotoxin levels. The exceptional prior year was largely caused by our response to significant outbreaks of DON in Europe and in North America.

Sales of test kits for Listeria also continued their upward momentum, with sales up 14% when compared to 2015. Listeria and other foodborne pathogens, including E. coli and Salmonella, have been in the news quite a bit lately as the food industry has escalated its efforts to ensure the safety of its products in the hands of its consumers.

In some cases, pathogens are now being detected in food products that once seemed unlikely to be contaminated with dangerous bacteria. For example, ice cream was recently found to be contaminated with Listeria monocytogenes -- excuse me, monocytogenes that led to a large recall. And now there is a significant recall of sunflower seeds based on testing that has detected Listeria monocytogenes in the edible seeds. Neither had been previously thought as carrying a high risk for this type of contamination.

Currently, there's also a large ongoing recall of flour and products that contain flour, such as your home cake mixes, because of testing that detected E. coli O121 in the flour. Now, for those of you who have been following Neogen, E. coli O121 is a strain of E. coli that we refer to as one of the six ugly sisters of E. coli O157H7. The six strains and H7 are known to produce deadly Shiga toxins and are collectively known as Shiga-producing E. coli, or STECs.

Here, Neogen is there once again. We developed NeoSEEK, a pathogen detection and identification technology that provides next day, DNA-specific test results for the seven pathogenic E. coli strains. As recent worldwide food recalls have clearly shown, regulators and the food industry need a rapid DNA-definitive test for bacterial pathogens.

Now, as you may know from listening to these quarterly calls, the Food Safety Modernization Act was signed into law in January 2011. And now, a full five and a half years later, all seven elements of the law have finally been officially released. The purpose of this law is to change the national focus from reacting to food safety recalls to preventing them.

As such, the new rules require food producers and processors to look closely at their operations to ensure they are doing all they can do to prevent unsafe food from entering the food supply chain. We think this implies more food safety testing in the future.

The first of the seven pillars of the law was introduced last September, while the last of the seven was just released in May. Depending on its size, a company has one, two or three years to comply with the law. But our view is the fuse is now lit. And going forward, we can expect many more companies to come into compliance with the Act.

Further, as we here in the U.S. and in the European Union raise our food safety standards, the world follows suit, opening up huge worldwide markets for Neogen products for years to come. As an example, on April 25th, 2015, China announced its new food safety law. This is the final rule and was implemented in October of 2015.

It's worth noting that while advancements in modern agriculture and food processing help feed a hungry world quicker and faster than ever before, the process can also create food safety issues. And the speed of distribution can send that problem around the world in just a matter of hours.

With the World Health Organization estimating that one in every 10 people, or 600 million people have food-borne illnesses every year, and there's 420,000 deaths, Neogen becomes a natural partner for customers looking for global brand protection from behind the farm gate all the way to the dinner plate. We believe Neogen's mission to be the leader in food and animal safety is more relevant and timely now than at any other time in the company's history.

I really look forward to talking more with those of you who can make it to our Annual Investor Open House this Thursday. Jim, can I turn it back to you?

Jim Herbert

Thanks, Rick, and let me turn it over to Steve Quinlan. Steve, cover a little bit of the highlights of our Animal Safety Group as well as more in-depth look at quarters and the year-end financials.

Steve Quinlan

All right, thanks, Jim. As Jim indicated, the year was a solid one for the company, as we finished with a 15% increase in revenues in the fourth quarter and were up 14% for the year. We were able to achieve these results despite the considerable currency headwinds that we continue to experience during the year.

As we've discussed on previous calls, all the currencies we operate in declined against the dollar for the year. The euro was down 9% on average, the real was down 28%, peso was down -- declined 17%, and the pound sterling was down 6% on average for the full year.

The currency pressure did ease somewhat in the fourth quarter, but the negative impact of the stronger dollar on our comparative revenues for the quarter was $1.4 million and for the full year was $7.7 million.

In constant currency, our growth was 16% for the full year versus the 13% reported and reported organic growth of 10% would've been 13%. For the Food Safety segment where those -- where our international operations report, the impact was even more pronounced. Their 11% growth would've been 17% in a neutral currency environment. And as Rick mentioned, organic growth of 6% would've been 12%.

During the fourth quarter there was some weakening of the dollar in more stable currency markets, but the Brexit vote last month has resulted in uncertainty and volatility in world currency markets as people try to understand exactly how and when this exit will occur and just how messy it may be.

There was an immediate 10% drop in the value of the pound relative to the dollar the day after the vote, and it remains at that level today. About 40% of our European business is conducted in pounds, so there will be a negative impact for us on the topline in fiscal 2017 if the current pound value remains at that level.

Now, Rick has already discussed some of the key highlights of our growth in the Food Safety business, so I'm going to focus on the Animal Safety segment. Animal Safety recorded overall revenue increases of 16% and 14% of that was organic for the year.

Increases in our Lexington-based business came from sales to the commercial dairy market, the results of a new distribution agreement entered into last July and strong sales of our small animal supplements product line up 17% for the year. Jim will discuss some recent developments regarding one of those products that will negatively impact sales in the 2017 fiscal year.

We had a 10% decline in sales of our life science products, primarily forensic test kits for the year, the result of ongoing delays and implantation of laws requiring drug tests, testing of commercial drivers in Brazil.

Last year, we had significant sales of these products to the commercial lab market in anticipation of the regulations going into effect early in this fiscal year. These laws are now in place, so we expect to see nice growth in this product line in fiscal 2017.

Our biosecurity product offering of cleaners, disinfectants, rodenticides and insecticides were strong, with revenues up 17% over last year. The rodenticide business rose by 58% as our contract manufacturing business expanded nicely. We also had market gains in our retail agricultural market with new formulations and benefited from a continued rodent outbreak in the Northwestern U.S.

Offsetting these gains, sales of cleaners and disinfectants declined by 9% for the year, primarily due to lower demand from international customers resulting from weak economic conditions in a number of our key markets and the strength of the U.S. dollar, which made our products less competitive in those markets. Our acquisition this May of Preserve and Tetradyne gives us a leading position in this market and we should see nice recovery in this important product line next year.

The agrigenomics testing business headquartered in Lincoln, Nebraska, was up 34% for the quarter and 27% for the full year due to sample volume increases resulting from incremental poultry business, end market share gains, and testing services for the cattle, swine and canine markets.

Corporate-wide, gross margins were 47.6% for the year compared to 49.3% last year. Margins were adversely impacted by currency, which reduced our comparative revenues and compressed margins.

Mix changes within the Food Safety segment toward products and services which have lower than average margins, such as our Lab M revenues, and standard cost adjustments at our Mexican operations also had an impact.

Our operating expenses overall were up 12% for the year. Sales and marketing expenses rose 11%, with the largest components of this increase personnel-related expenditures reflecting primarily the additional staffing over the last year, and selling expenses including shipping resulting from the revenue growth.

General and administrative expenses rose 16% for the year, with increased salaries, stock-based compensation and fringe costs, higher amortization of intangible assets, and increases in legal and professional fees primarily related to acquisitions.

Operating expenses were -- operating income was $56.4 million, up 6%, compared to $53.1 million last year. Expressed as a percent of sales, operating income was 17.6%, compared to 18.8% last year, with the percentage decline somewhat less than that of our gross margin percentage as our operating expenses rose less than the rate of revenue growth.

Our effective income tax rate for the year was 34.2% of our pretax profit compared to 35.5% in fiscal 2015. And the lower rate was primarily the result of utilization of available research and development tax credits and increased domestic production activities deduction.

The company amended its tax returns for fiscal years 2012 through 2014 based on revised calculations of its R&D and domestic production activities during those periods and claimed higher credits and deduction.

The company generated $35.6 million in cash from operations for the year, very similar to the net income of $36.5 million that Jim reported earlier. We invested $42.5 million in our five acquisitions this year and another $13 million in property and equipment.

Our inventory balances increased $12.8 million from last year end, approximately $4 million of that increase is from inventories acquired during the year, with an additional $1 million from stocking requirements for the new dairy distribution business. The increase in inventory at our existing operations is due to increased volumes and continuing efforts by the company to improve service levels to our customer base and reduce backorders.

Our accounts receivable balance rose 14%, in line with the increase in revenues and our days sales outstanding have improved by two days since the beginning of the year.

To conclude, we really do feel good about the year we just completed in spite of the challenges, we continue to face from currency and economic uncertainty in our international markets, and believe that we're well-positioned for the growth opportunities which are ahead of us.

Now, I'll turn back to Jim for some additional comments.

Jim Herbert

Thanks, Steve. Earlier, I mentioned strategic moves that we made during the year. Let me elaborate on those because I think it points to the direction for our 2017 year and even beyond.

Neogen considers itself to play a role in the worldwide food security issues and we define food security as the ability to provide quantity and the quality of food that's needed for a growing population.

Neogen's strategy is even more focused and looks at the requirements for the rapidly growing middle-class population. Of course, it's pretty easy to see that the big growth in middle class is going to come in both India and China and thus that Neogen reason to be established there.

In fact, one of this year's five acquisitions was the purchase of Sterling test house, a 25 year old company located in Cochin, India, which is India's leading region for the export of spices, teas, and fresh fruits, and vegetables.

The use of rapid tests at manufacturing points in India is still behind most of the rest of the world, but we think that Sterling gives Neogen the launch pad to get its rapid diagnostic test for food safety introduced into the major parts of that country.

Our China operations strengthened considerably during the past year, with revenue increases of 86% through our offices located in Shanghai and Beijing. The rapid growth of the middle class in these two countries as well as others is and will create a demand faster than those countries can accommodate.

Therefore, one must look at who the major supply countries are going to be going forward. It's for that reason that we began establishing ourselves in both Brazil and Mexico a few years back.

So, our strategy further focuses not just on geographic area, but also on key market areas within that geographic coverage. One of these is genomics. Some of you may remember when we purchased the GeneSeek operations in Lincoln, Nebraska in 2010, the revenues the prior year had been $12.5 million. Our 2016 year just finished, those revenues had increased to $43 million on a worldwide basis, giving us a compound annual growth of 19% since the acquisition.

We expanded our laboratory space in Lincoln twice since the acquisition, and it now accommodates the world's largest animal genomic testing laboratory. Even at that, we saw the need to take genomics testing closer to the markets.

In the third quarter, we expanded our laboratory operations in Ayr, Scotland, to establish equipment and personnel to do genomic testing there for our European customers. Near the end of the year, we -- Neogen acquired Brazil-based Deoxi, and this is a leading animal genomics laboratory in that country.

This acquisition is intended to help us accelerate the growth of animal genomics business in Brazil and maybe just as important to develop some superior genomic trait testing for a country that's home to more than 200 million cattle. Brazil has the most cattle in the world, but it's also a leading producer of both chicken and pork.

Another of the products where we focused our strategy -- markets where we focused our strategy for the past several years is in the biosecurity area. Back inside the farm gate is the best way to ensure the quality of meat, eggs and milk products and to maintain control over any infections that would become food safety problems as that food passes through the farm gate.

Maintaining the security of those animal facilities with cleaners and disinfectants is probably obvious, but there's also other requirement to control rodents that not only damage food, but carry diseased organisms.

Third in the biosecurity lineup is our insecticides to control farm-based insects. Biosecurity becomes increasingly important today as the raised without antibiotics move in animal production continues to grow.

During the year, we made a couple of acquisitions that have an important strategic -- puts us in important strategic position in the biosecurity area, though neither of them had much impact on this year's financial statement.

At the end of December, we announced that we had acquired the complete rodenticide assets of the Virbac Corporation. These acquired assets included a key rodenticide, the active ingredient that had not been available to us before, and more than 40 regulatory approvals for a variety of formulations in the United States, Canada and Mexico.

A more prominent acquisition to this group was done right at 1st of May when we acquired Preserve International and the Tetradyne companies from Nevada-based private owners, and Steve mentioned that in his comments.

This company founded in 1991 has offered the livestock and food processing industry with cleaners and disinfectants and associated products for a long time. In addition to a nice share of market that, frankly, went along with the nice market that we already had and the group of products that we already had has certainly been helpful as far as becoming more of a leading producer in those areas.

But the company also owned patents on some very innovative disinfectant products and more than 100 EPA and FDA-registered products. That brought to us a nice manufacturing warehouse space in both Memphis, Tennessee, and Turlock, California. The revenues of that operation last year before we acquired it was about $18 million.

We continue our expansion in the leading areas of food safety -- the food safety market. A lot of this comes from just good old organic growth and the introduction of new products.

In addition, at the end of last year's first quarter, we acquired Lab M, a manufacturer and supplier of microbiological culture media and diagnostic products. This Haywood, England, acquisition not only brought new products, but also put us in a strategic distribution space. This company sells products into more than 70 countries worldwide. In many ways, it's a little sister to Acumedia, our supplier of culture media products that's located here in the U.S.

Though there were a lot of great accomplishments during the year, the year also brought a few challenges. As an example, even though our Animal Safety Group had an increase in revenues this year of 16%, we faced a few setbacks. One of those had to do with the companion animal product that we called ThyroKare, that's used to treat thyroid deficiencies in dogs.

For years, this product was manufactured under what's known as FDA indiscretion. Simply put, FDA acknowledged that they could exert their regulatory authority over the product, but were not concerned so long as the product was safe. There was, however, an opening for anybody who wanted to go through the procedure from getting an FDA approval.

We determined about a year ago that we would go that route just to be safe. One of our competitors elected the same route, and they got their approval from FDA, and we're not quite through the process yet, but we're aggressively pursuing it. But as a result of their approval, all other products were shut down by FDA.

FDA gave us a number of months to use up our inventories, but we will temporarily no longer be selling that product as of the end of July. This loss of $5 million to $6 million this year in revenue, along with some attractive margins, will have an impact on our Animal Safety Group, but remember that they had total revenues this year of approximately $175 million.

All of us are curious to see what the impact will be of Brexit. But I class this as just another one of those cases that we will play the hand that's dealt us. We really don't think that there will be a significant impact on our business inside the EU or inside the United Kingdom.

The one area of vulnerability that Steve pointed about is that what might happen with currency value of both the euro and the pound sterling as they relate to each other and as they relate to the U.S. dollar.

As both Steve and Rick have commented, we pushed a number of new products into the market this year for both the food and animal safety businesses. That same new product stream looks good as we move into the New Year. In fact, we have about, I think, a dozen new products that are significant improvements to existing products that will find their way into the market here in the next few months.

Our R&D groups in Lansing; Lexington, Kentucky; Lincoln, Nebraska; and Ayr, Scotland; and England now number approximately 85 people. And I think there are some exciting new products that are in offering coming from that group.

In summary, the drivers that have propelled us every quarter are still in place and getting stronger. New products, as I just discussed, is just one of those. I think that most of our markets are growing and it's our goal to keep up with that growth and to take a bit away from competition every time we get a chance.

The third driver is acquisitions. And though we did put away five acquisitions during the past year, we still have a good opportunity with at least a few more as we look at the year ahead.

The fourth driver is to accelerate our growth in international markets. And we said before growth this past year was solid on a local currency basis, even though the strong dollar did camouflage that.

I've been able to spend some time with the sales and marketing groups of each of our international operations over the past couple of months, and I'm encouraged by the strength and growth of those groups as we look forward.

I think we stop at this point and conclude our prepared comments, and open the call for questions.

Question-and-Answer Session


Thank you. We will now begin the question-and-answer session. [Operator Instructions]

Our first question online comes from Mr. Paul Knight from Janney Montgomery. Please go ahead.

Bill March

Hey guys, this is actually Bill March on behalf of Paul. How are you guys doing?

Jim Herbert

Good. Good.

Bill March

Doing well. First question, maybe if you could -- highlighted at the end -- just talk a little bit about the M&A strategy, just with the company now north of $300 million in revenue, and almost $100 million on the balance sheet.

How do you think about maybe the size of acquisitions as you think about the next year or two? Do you think that there's a need for maybe something bigger than kind of the historically smaller acquisitions?

Jim Herbert

Well, that's a good question. Clearly, there is the need. In fact, there's been the need; it's not just now occurring. Just really the problem is that there's not anything out there that's bigger that fits what we are doing.

And I kind of regret that when we look around, we've had a couple of opportunities to do some bigger things. We didn't do them and frankly, I don't think either of them have even been completed at this point. But though I look upon it and say we're doing $10 million to $20 million businesses, and I sure wish we could be doing $50 million to $100 million businesses, and frankly, I think we can do that, with the cash we've got, plus we have no borrowing at this point and good access to bank borrowing. And though I don't think we'd go there, we've got I suspect, good access to the produce market for additional capital.

But what we've been doing has worked. I think we've done 34 acquisitions since the year 2000 and all of them have been accretive both at the topline and the bottom-line. And that hadn't been by accident, it's been -- I think we've made good buying decisions. But, more importantly, we had the right integration strategy, and have been typically bolt-on.

We have sort of a guide that we look anytime we look at new products or potential acquisitions; they have got to fit into three categories. Number one, do we understand the technology? Number two, could we manufacture the product if we wanted to? And number three; do we have access to the marketplace?

So, though we're going to be looking for bigger stuff, you can't invent it. We haven't missed anything that's come on the market that we missed buying. And I think we continue to do what we're doing, we'll be okay.

Bill March

Got it. And maybe just as we think about margins, with Animal Safety running at a slightly lower gross margin than Food Safety, to get that closer to that 20% operating margin, do you think that comes more from gross margin or operating efficiencies? Thank you.

Jim Herbert

I think operating efficiencies -- and I don't have the numbers in my head, but I can tell you that our Animal Safety division plots every month the gross margin to its top 50 customers. And in order to protect those gross margins as we move going forward.

So, if I've got a gross margin below 50%, I can -- some people would say below 40% or 30% -- but anyway, a lower gross margin product I can't afford to invest as much in research and development, nor in sales and marketing as a percent of sales.

Whereas, on the Animal Safety -- or the Food Safety side, where we have got product that can run up to beside a 70% gross margin, those are the places that we ought to be willing to increase expenditures in the operating side.

So, we've always talked about not gross margins so much as gross margins just being one of the ingredients, the operating profit. And I'm disappointed that our operating profit this year was in the mid-17% range when those of you that follow the company know that it's our goal to keep it at 20%.

I think there were -- without relying on excuses, I think there were some reasons that that happened. Our operating profits were struck pretty solidly by what happened to the currency. And also in a few cases, where in order to maintain market share we might have a reduced selling price in a marketplace, to make sure we didn't reduce that market share.

So, I think we played the hand that was dealt us. But at the same token, let me assure you that it's our goal to get that operating profit back up into the 20% range.


Thank you. Our next question online comes from Mr. Jason Rodgers from Great Lakes Review. Please go ahead.

Jason Rodgers

Hello. I wondered if you could, just speaking of the operating margin, talk about what the impact of FX was on the operating margin for fiscal 2016.

Jim Herbert


Steve Quinlan

Sure. I would say, Jason, that the impact -- we talked about at the topline about $7 million, $7.7 million in revenue that flowed through, and it has had about an $0.08 per share impact flowing through. So, it was pretty marked impact.

Jason Rodgers

And do you happen to have the organic growth for the company in total and by segment for just the fourth quarter?

Steve Quinlan

Sure. So, for the quarter, organic growth overall -- the overall organic growth was 10%, Food Safety was 6.4% and Animal Safety was 13.4%.

Jason Rodgers

And then how about an estimate for CapEx and the tax rate for fiscal 2017?

Steve Quinlan

Tax rate is probably going to be somewhere right around 36%. And CapEx, we were at about -- I think we're at 12.7 this year. It is probably going to be somewhere in the $14 million area next year.

Jason Rodgers

Okay. I might've missed it, but did you break out the acquisition-related costs in the quarter?

Jim Herbert

No, I don't think we did. And these costs, they sort of pile up. You do the due diligence, oftentimes ahead of the time that you actually do the acquisition, where you close it. So it gets you a month or two in advance of the like position. Then you are cleaning up the tail end a month or two afterward. So, I know what the total dollars are, it would be difficult, I think, without a lot of work to figure out on a month-to-month, quarter-to-quarter basis.

Jason Rodgers

Okay. That's fine. Just final question, just looking at the company in total, are you running up against any capacity constraints in any area?

Jim Herbert

No, we -- the GeneSeek operation in Lincoln was pushing up against some constraints. We will do this year over 2 million samples there and that pushes that lab. However, there's a lot of automation that's installed there now. We've got -- it's kind of fun to watch robots moving stuff around.

We can virtually run that operation better part of 24 hours. We -- in that location and here in Lansing and in Lexington, we've got some groups on staggered shifts so that we're running -- I think, probably running seven days both places. So, we still have that capacity to increase.

That was one of the reasons that we wanted to do something with GeneSeek, however. And we got a nice laboratory operation already in place where we're doing lab business or service in Ayr, Scotland, and we're generating a lot of new business in Scotland. So, it made sense to install some of the more expensive equipment in Scotland and bring our technical lab force up enough to do business there.

So it's -- that's going to relieve some of what was happening at GeneSeek. Plus, it's going to give us turnaround time -- there's a class of turnaround times and it will increase our business.

Same thing is true with Brazil. We have a lot of samples from Brazil actually going to Lincoln, Nebraska, that are now being processed in Brazil, plus the new stuff that we picked up there.

Lexington is probably pushing at the walls a bit. They'll need something for expansion in FY 2018; I think most of them make it through 2017. We're going to do some expansion this year at our Hacco operations in Nebraska -- in Wisconsin to accommodate some of the things that we're doing with our insecticide business, give us some extra capacity there.

But nothing that -- it's -- I think we're in good shape for another year and we're looking at some additional space in a couple places. So, I think we're going to be okay.

Jason Rodgers

Thanks a lot.


Thank you. Our next question online comes from Mr. Brian Weinstein from William Blair. Please go ahead.

Brian Weinstein

Hey guys, thanks for taking the questions. So, you guys had talked about pressure on gross margins at least through the end of kind of the fiscal year and certainly we saw that again. But can you talk about when you think gross margins actually start to move higher in the drivers there?

So, when do you start getting the benefits from some of the acquisitions? I mean ignoring FX, of course, but just on an organic basis, when do we really start to see the gross margin start to trend higher?

Jim Herbert

Well, that will occur in a couple places, of course. Number one is -- as volume gross -- cost of goods being raw materials, labor overhead and we get some efficiency out of labor by pushing through more product through. And our overhead unfortunately doesn't change, so we get some gains there.

But we also can get it another way and that's price increases. We are under some price pressures in certain parts of the world today. The other places where we will be able to and are increasing prices to take -- to bring into account additional -- frankly, additional labor costs that haven't seen anything much on the raw materials side it's going to have any measurable increase. But you need to continue to bring it in place along and both from a fringe benefit in play and salaries standpoint.

So, I think every one of our divisions has some price increases that are planned to take place, some of them this fall. One or two of them normally do price increases effective first of January. So, that will also have an impact on obviously the gross margins.

Brian Weinstein

So, just to be a bit more specific about it, are you guys expecting that you will see an increase in your gross margin in about a year-over-year basis as we think about 2017 over 2016, recognizing you are not giving guidance. But just directionally, should we be thinking about an improvement in gross margin -- a noticeable improvement in gross margin excluding FX for 2017?

Jim Herbert

Well, from where I sit today, I think yes. Now, I can't predict what's going to happen with the currency translations. I'm a bit concerned about what the euro and the pound sterling might do. It's not going to impact our sales in the local currencies, but when we convert it -- over there, it's kind of an interesting phenomenon.

Our Neogen Europe operations reports on back to corporate on a pound sterling basis. And they sell product on the basis of the euro, the pound sterling and the U.S. dollar. All that gets converted into their statements in pound sterling, pound sterling comes back over here and we convert it to U.S. dollars.

So, by the time you go through that gymnastics about twice, it's -- it will be important to see how those two currencies behave. That's not something we can do anything about, and we'll play whatever hand gets dealt there.

But I think we're going to see strong growth on the food safety side this year. We will look at where those margins are coming from. I think we're going to see some strong gross margins there. I mentioned earlier the loss of the ThyroKare product for at least some period of time.

It was a product that had high gross margins, but it was a part of $175 million worth of business, too. So, I still shed a few tears over it. It's not something that's going to cripple us and may not even be noticeable as the year goes along with new products coming in.

Brian Weinstein

Got it. And then one more question for you on G&A. It was up 16% in both, I think, the third and the fourth quarter, so you're not getting any kind of leverage in that part of the P&L. Can you just describe the dynamics in play with G&A, and are there opportunities to kind of lower that to get better leverage out of G&A going forward? Thanks.

Steve Quinlan

Yeah Brian, I think there is some -- this is Steve. I think there is some opportunities to leverage our growth. A lot of that growth in the G&A part, particularly, was stock-based compensation expense growth. But we are doing, I think, a very good job of controlling our expense growth, actual cash expenses.

And some of the growth that you saw flowing through there, particularly in the second half of the year, was growth of businesses that we acquired. So, I do think that going forward, though, we will be able to leverage some of our growth and get that through the operating income line.

Brian Weinstein

Thank you.


Thank you. Our next question comes from Mr. Charles Haff from Craig Hallum. Please go ahead.

Charles Haff

Hi, thanks for taking my questions, and congratulations on a good quarter. I had a couple bigger-picture questions here. You mentioned the final food safety law in China was signed April 25th, and I know there have been other efforts to talk about food safety in China. Should we expect that maybe this one is more impactful, or how would you kind of characterize this one versus prior efforts that have been made in China?

Jim Herbert

That's a difficult question. It's no question whatsoever that the Chinese government knows that they've got to do some things to improve food safety. And as that middle class is growing and I think if you look at the impact of a middle-class growth, it's probably greater in China today than it is in any country in the world.

That government has done a good job of controlling that economy and sort of running it by plan. But one of the big problems they have got to figure out how to do, and that's to make food safer. They are facing problems now where those -- that middle class is buying products that are made outside of China from a safety standpoint.

So, I don't know how much you can do. I mean they have offenders now that if they put bad product into the marketplace knowingly, they get the opportunity to walk off the top of tall buildings, and all sorts of things that you would think would have an impact on -- and sooner or later I'm sure it will.

But for me to -- I know that that government needs to do something. I know they are well aware of the fact that they need to do something. As I've said before, the next time they go to Tiananmen Square, they might not leave quite so quickly. I think we can expect it's going to happen.

Charles Haff

Okay. Thank you. And on the poultry side, the trend towards cage-free and free-range poultry, are you seeing an impact right now on your cleaners and disinfectants, or any other businesses from that trend that's going on in the marketplace?

Jim Herbert

Yeah, I think we are. And that's right in the middle of the biosecurity area. And the more that occurs, the greater opportunity we have with cleaners and disinfectants and rodenticide and insecticides. Probably the biggest occurrence now is in the raised without antibiotics side, as far as the impact is concerned.

And the first of the animal protein segments to be confronted with that is the broiler industry, the chicken meat industry. Friends of mine in that business say that they believe that, by the end of this year, 30% of the chicken sold in this country is going to be raised without antibiotics. Which means that biosecurity is going to be critical if I don't have anything that I can -- in the past there had been some antibiotics that were used as crutches. And there have been some antibiotics, a lot of antibiotics, used because there was a need.

But the lifecycle of chicken meat is pretty short, takes 21 days to hatch the egg, and you have got a day-old chick. And 42 days later, it can be in the fryer at Kentucky Fried. So, if I can keep that little chicken healthy for seven weeks, I don't need any antibiotics.

And to do that, I need to make sure I have got the house clean and disinfected properly when it goes in. And I've got to keep the rodents out, and I've got to make sure the trucks that are coming back and forth through the property are clean so that they are not bringing organisms in with them. I've got a few insects I need to kill. So, all of this is doable, probably more so, clearly more so, in chicken meat than anything else.

The cage-less eggs is going to be interesting. It's getting to the point that it's -- where there is that demand. And I don't know what percent of the market demands cage-less eggs now; still pretty small percent. But the cost there is getting to be phenomenal. It costs -- cost of goods on a dozen eggs is $1 in regular cage operations; it could well be $2 because of the additional management that goes in.

They've got a certain square footage now that's provided either to be defined as organic or to be defined as cage-less. These birds are given a certain amount of square footage each. But a new regulation is pending before the Congress that says it's not just square footage, but they have to be in a space where they don't touch each other.

So, I'm not sure how big that is, but those are going to have some impact on eggs, egg production. But each time we see that, it calls for more concern about biosecurity. So, it may not be the most economical thing to happen to production -- in animal production in some cases, it probably makes our products even in greater demand.

Charles Haff

And Jim, just as a follow-up to that, have you seen any estimates in terms of where antibiotic chicken or antibiotic-free chicken meat is today as a percentage of the market, and any estimates on what that might look like a couple years from now?

Jim Herbert

No, I think it would be a guess today. And, frankly, as a charlatan view of it, I suspect that a lot of the antibiotic-free chicken that is on some restaurant's storefront, they probably don't have the slightest idea whether it's antibiotic-free or not. It's just the place to be.

But it's possible. We're never going to get -- there's always going to be sick birds. And if we want to be concerned about animal welfare and we want to be concerned about doing things right to provide safe food, we have to have ability to use antibiotics or whatever. I think there are some companies like Tyson Foods are the largest poultry producer in the United States.

My friend Donnie Smith there said, we're going to try to get away with antibiotics every place we can, but where we have to use them we're going to use antibiotics that are not used in human medicine.

And I think that's one of the big concerns is we can -- the concerns out there today about are we developing antibiotic-resistant organisms affecting human health, we can back away from that, that's going to be a big help. So I don't know. It would be a pure guess. Is it 10%? Maybe. I don't know.

Charles Haff

Okay. And my last question is on Brazil. So, there's been a lot of instability there from many different areas, and you guys have been making a push into Brazil. And you know, this year the currency was a debacle. But your organic business grew okay, and you have increased your manufacturing operations down there.

Do you see fiscal 2017 as being kind of a normalized year for you all? Or are some of these political issues and some of these other things going to kind of muck up the works? How do you kind of view Brazil over the next year for you all?

Jim Herbert

Ed Bradley, who is obviously very close to that, is -- the reports directly to his office when it's done. I think his take the last time we talked was that the strength of the economy looked like strong enough at this point that maybe overpower the political unrest that's going on. I think it is one of those cases there had to be a fall guy somewhere and there was the President was convenient.

So, I'm not sure -- we're projecting good solid growth there next year and good solid growth not only one of the -- not only with what we already had but what we bought. And there's been one advantage: when you deal with the strong dollar, if you're making acquisitions against a weaker dollar, they are pretty nice. So, we bought the Deoxi business in Brazil a good bit cheaper because we bought it on the basis of the real, and we bought it a good bit cheaper than we would've paid for it a year earlier.

And we've got some other opportunities. I can't tell you we're going to do one, but we have got some other opportunities for international acquisitions now that could play in our favor with the strong dollar.

Charles Haff

Okay, great. Thanks for taking my questions.

Jim Herbert



Thank you. [Operator Instructions]

Our next question online comes from Mr. Kurt Kemper from Hilliard Lyons. Please go ahead.

Kurt Kemper

Good morning. And thanks for taking my questions. Just to kind of follow-up on some geographical issues, I noticed that Neogen Europe grew about 3% in local currencies this year. Obviously, that's lagged some of the emerging markets, but also domestically as well. I was just wondering if you could comment on whether that was more of a macro issue or competitive concerns.

Jim Herbert

Steve, you've got --

Steve Quinlan

Yes. Actually their business was affected a little bit by some genomics. We went into a new distribution agreement with Illumina in fiscal 2016, and that started off a little bit slower than we anticipated.

So their genomics revenues were not as strong in the first half as they were last year's first half. But they closed with a 13% revenue increase, so -- and they've come out of the gate here in 2017 fairly strong. So I think it was a temporary blip, I would say, for Europe.

And we have to remember as well that Europe has been on the heels of double-digit growth for the last three or four years, I know. So, I think you're going to see some nice growth from Neogen Europe going forward.

Jim Herbert

And we've got the price pressure over there. We've got -- I guess three -- Rick, three, I guess, strong competitors that are domiciled in Europe. If they are making product in euro and selling in euro, they've got an advantage over our operations that are buying it in U.S. dollars and selling in euro.

So, there's been some downward pressure on selling prices in a few places. I don't think we've given away any market share, and we haven't cut our wrists either. But all that has had an impact, I think, on where they are. What Steve mentioned, I think, is key.

Kurt Kemper

Okay. And then can you kind of help us with the timing of the ThyroKare impact?

Jim Herbert

We will -- we're selling that product through July 28. So, that product -- we will have sales of that product essentially in the first two months of this quarter. Then we will be out for some period of time. And before you ask the question, I don't know the answer. How long would it be until we get our FDA approval is a logical question? And my illogical answer is nobody knows.

When you're dealing with what's happening with the government, it's always difficult to get anything through a regulatory agency during the summer. For some reason, things just slow down. I guess it's the heat in Washington or whatever. It will be back, and we'll be waiting for a lot of people to get back to work at the end of September.

And you've also got an election year; I guess we're going to have one. And it's going to be interesting to -- everybody is wondering about who's going to have a job and where the political appointees are and what's going to happen.

So, it will be kind of an interesting year in Washington. Now, if you're dealing with regulations going forward. I'm not worried about it, but it's just -- it just slows things up.

Kurt Kemper

Okay. That's all I had. Thanks.


Thank you. Our final question comes from Mr. Peter [Indiscernible], Private Investor. Please go ahead.

Unidentified Analyst

Good morning. I guess it's--

Jim Herbert

Good morning Peter.

Unidentified Analyst

How are you doing?

Jim Herbert

Good. You?

Unidentified Analyst

Not too bad, thanks. Jim, I'm wondering what you see for growth opportunities in the seafood testing area -- aquaculture and importing of seafood and the testing. I know you have some small operations that -- or small testings that you do. Do you see any growth there?

Jim Herbert

Yes I do. And I think we're going to see business is going to have the Food Safety Modernization Act is probably going to have more impact on imported seafood than any place else I believe, Peter, in our market.

I just got back last week from 10 days in Australia, and the Australians are already talking about they need our test kits for -- we've got three test kits out there for shellfish poisoning.

And they are -- that's just a great big island with lots of shellfish around it. And they are a major exporter of shellfish, but facing some of these problems of red tide and therefore paralytic shellfish poisoning and a number of those things. That plus we've strengthened -- our sales and marketing group has put on at least one new person that's going to be focused strictly on the seafood market I think this year.

So, I think it's there. I'd love to find the right entry into the aquaculture market. I think it's kind of wide open for diagnostic products for the detection of poisons and toxins, both for the welfare of the aquaculture animals as well as the food they produce.

And those opportunities are out there. And it hadn't moved as fast as one might, but I still think there's enough of an election to make a good business out of. So, we're continuing to look at it and don't quit asking me that question, would you?

Unidentified Analyst

I won't. I hope to be there Thursday and --

Jim Herbert

That would be wonderful.

Unidentified Analyst

Perhaps we could have more a discussion on. I've got some other questions relating to aquaculture and we can discuss them.

Jim Herbert

That would be great. I'll be interested in your input.

Unidentified Analyst

Okay. And the microbiome, too, we can talk a little bit about that.

Jim Herbert


Unidentified Analyst

Thanks again and congratulations on a good quarter and a good year.

Jim Herbert

Thank you, sir.

Rick Calk

Thank you.


At this time, we have no further questions. I'd like to turn the call back over to Mr. Herbert for any closing comments.

Jim Herbert

Well, thank you again. Thank you for your support throughout this fiscal year. And as you represent closer to our shareholders and our owners, we always need your help, two-way communications. And I believe that's been present and thank you for that.

Again, make sure to invite anyone who is with -- within proximity or can get to Lansing, Michigan, on Thursday afternoon, we're doing our annual investors' summer picnic, and we'll have an opportunity to have a lot of our products on display and be able to talk to a lot of the management team that's there.

So, thank you once again for your support during the year and we look forward to talking with you next when we report the first quarter.


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

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