Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K.
In addition, any forward-looking statements represent management’s views only as of the day this Form 10-K was first filed with the Securities and Exchange Commission and should not be relied upon as representing management’s views as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our views change.
COMPANY OVERVIEW
Neogen Corporation and subsidiaries develop, manufacture and market a diverse line of products and services dedicated to food and animal safety. Our Food Safety segment consists primarily of diagnostic test kits and complementary products (e.g., culture media) sold to food producers and processors to detect dangerous and/or unintended substances in human food and animal feed, such as foodborne pathogens, spoilage organisms, natural toxins, food allergens, ruminant by-products, meat speciation, drug residues, pesticide residues and general sanitation concerns. The majority of the diagnostic test kits are disposable, single-use, immunoassay and DNA detection products that rely on proprietary antibodies and RNA and DNA testing methodologies to produce rapid and accurate test results. Our expanding line of food safety products also includes genomics-based diagnostic technology, and advanced software systems that help testers to objectively analyze and store their results and perform analysis on the results from multiple locations over extended periods.
Neogen’s Animal Safety segment is engaged in the development, manufacture, marketing and distribution of veterinary instruments, pharmaceuticals, vaccines, topicals, parasiticides, diagnostic products, rodent control products, cleaners, disinfectants, insect control products and genomics testing services for the worldwide animal safety market. The majority of these consumable products are marketed through veterinarians, retailers, livestock producers and animal health product distributors.
TRENDS AND UNCERTAINTIES
In prior years, production was negatively impacted by broad supply chain challenges and labor market disruptions. Additionally, input cost inflation, including increases in certain raw materials, negatively impacted operating results. In fiscal 2023, these negative impacts steadily improved throughout the year. In fiscal 2024, despite a slowing of inflation rates, there remains economic headwinds of softening consumer demand and higher interest rates, coupled with ongoing geopolitical tension in certain regions.
Interest rates have risen sharply, particularly in fiscal 2023, as a way to combat inflation. This, subsequently, increased our borrowing costs and raised the overall cost of capital. While the frequent increases have largely subsided, the overall interest rate is significantly higher than in recent years, which increases interest expense on the unhedged portion of our Term Loan. In response to the historically high inflationary environment, we took pricing actions to mitigate the impacts on the business in the prior two fiscal years. The impact of inflation continued to affect us throughout fiscal year 2024, although at a continually decreasing rate compared to fiscal years 2022 and 2023.
Beginning in the second quarter of fiscal year 2024, we implemented a new enterprise resource planning system and began the exit of our transition distribution agreements with 3M, which led to certain shipment delays and an elevated backlog of open orders, specifically in the Food Safety segment. As of the end of fiscal year 2024, order fulfillment issues have largely been resolved, and order fulfillment rates have improved to meet the needs of our customers in this improving end-market environment.
Although we have no operations in or direct exposure to Russia, Belarus or Ukraine, we have experienced intermittent shortages in materials and increased costs for transportation, energy and raw materials due, in part, to the negative impact of the Russia-Ukraine military conflict, which began in February 2022, on the global economy. Our European operations and customer base have been negatively impacted by the conflict. Similarly, the military
34
conflict between Israel and Hamas has increased overall geopolitical tensions. As the respective conflicts continue or worsen, they may further impact our business, financial condition or results of operations in fiscal year 2025.
We continue to evaluate the nature and extent to which these issues impact our business, including consolidated results of operations, financial condition and liquidity. We expect these issues to continue to impact us into fiscal year 2025.
RESULTS OF OPERATIONS
Historical Periods
Refer to Part II - Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Form 10-K for the fiscal year ended May 31, 2023 for discussion of the Results of Operations, Segment Results of Operations, and Financial Condition and Liquidity for the year ended May 31, 2023 compared to the year ended May 31, 2022, which is incorporated by reference herein.
Executive Overview
Year Ended May 31,
(in thousands)
2024
2023
Increase / (Decrease)
Total Revenues
$
924,222
$
822,447
$
101,775
Cost of Revenues
460,322
416,492
43,830
Gross Profit
463,900
405,955
57,945
Operating Expenses
Sales and marketing
182,872
141,222
41,650
General and administrative
199,889
201,179
(1,290
)
Research and development
22,476
26,039
(3,563
)
Total Operating Expenses
405,237
368,440
36,797
Operating Income
58,663
37,515
21,148
Other (Expense) Income
Interest income
6,362
3,166
3,196
Interest expense
(73,394
)
(55,961
)
(17,433
)
Other, net
(5,936
)
(6,762
)
826
Total Other Expense
(72,968
)
(59,557
)
(13,411
)
Loss Before Taxes
(14,305
)
(22,042
)
7,737
Income Tax (Benefit) Expense
(4,884
)
828
(5,712
)
Net Loss
$
(9,421
)
$
(22,870
)
$
13,449
35
REVENUE
Year Ended May 31,
(in thousands)
2024
2023
Increase / (Decrease)
% Change
Food Safety:
Natural Toxins & Allergens
$
82,240
$
82,567
$
(327
)
(0
)%
Bacterial & General Sanitation
171,217
134,934
36,283
27
%
Indicator Testing, Culture Media & Other
334,636
267,178
67,458
25
%
Rodent Control, Insect Control & Disinfectants
42,965
39,655
3,310
8
%
Genomics Services
24,283
22,463
1,820
8
%
655,341
546,797
108,544
20
%
Animal Safety:
Life Sciences
6,515
6,254
261
4
%
Veterinary Instruments & Disposables
65,848
63,843
2,005
3
%
Animal Care & Other
36,978
39,068
(2,090
)
(5
)%
Rodent Control, Insect Control & Disinfectants
88,732
87,423
1,309
1
%
Genomics Services
70,808
79,062
(8,254
)
(10
)%
268,881
275,650
(6,769
)
(2
)%
Total Revenue, net
$
924,222
$
822,447
$
101,775
12
%
Year Ended May 31, 2024 Compared to Year Ended May 31, 2023
Food Safety:
Revenue for the Food Safety segment increased $108.5 million in fiscal year 2024 compared to fiscal year 2023. The increase included a $98.6 million benefit from acquisitions, a $10.1 million adverse impact due to currency, and $20.0 million of growth in the business.
Natural Toxins & Allergens – Revenues in this category were relatively unchanged in fiscal 2024. Excluding first quarter revenue of the acquired allergen product line from 3M FSD, revenue in this category decreased 3% due to a decline in sales of natural toxin test kits, caused by product availability issues and prior year sales of discontinued dairy drug residue test kits. These declines were partially offset by growth in our line of allergen test kits.
Bacterial & General Sanitation – Revenue in this category increased 27% in fiscal 2024 compared to the prior fiscal year. Excluding the first quarter contribution of the Clean-Trace line of general sanitation products and the pathogen test kit product line, both acquired in the FSD transaction, revenue in this category increased 2% for the full year. This increase was driven by growth of the acquired product lines for the remainder of the year.
Indicator Testing, Culture Media & Other – Revenue in this category increased 25% in fiscal 2024 compared to the prior fiscal year, driven primarily from revenues resulting from FSD transaction. Excluding first quarter revenue of acquired Petrifilm ® and sample handling product lines, revenue rose 2% for the year. Continued growth of the acquired product lines for the remainder of the year combined with higher sales of the Neogen Analytics software product more than offset a large non-recurring sale of culture media in fiscal year 2023.
Rodent Control, Insect Control & Disinfectants – Revenue of products in this category sold through our Food Safety operations increased 8% in fiscal 2024 compared to the prior fiscal year. Increased Cleaner & Disinfectants sales in Europe and a government tender for insect control products in Brazil contributed to the overall growth.
Genomics Services – Revenue of genomics services sold through our Food Safety operations increased 8% in fiscal 2024 compared to the prior fiscal year. Increased revenue to existing customers in Europe as well as new business in Brazil and China added to the overall growth during the year.
36
Animal Safety:
Revenue for the Animal Safety segment decreased $6.8 million in fiscal year 2024 compared to fiscal year 2023. The decrease included $0.7 million due to discontinued product lines, a $0.6 million adverse impact due to currency, and a $5.5 million decline in the business.
Life Sciences – Revenue in this category increased 4% in fiscal 2024 compared to the prior fiscal year, driven by higher demand of substrate products from manufacturers of diagnostic tests.
Veterinary Instruments & Disposables – Revenue in this category increased 3% in fiscal 2024 compared to the prior fiscal year driven by higher sales of detectable needles and disposable syringes.
Animal Care & Other – Revenue of these products decreased 5% in fiscal 2024 compared to the prior fiscal year driven primarily by lower sales of small animal supplements and wound care products, due to supply constraints, and the discontinued Thyrokare product line. Higher sales of vitamin injectables products partially offset the decline.
Rodent Control, Insect Control & Disinfectants – Revenue in this category increased 1% in fiscal 2024, compared to the prior fiscal year, driven with higher sales of insect control products, partially offset by flat sales of rodent control products and cleaners and disinfectants.
Genomics Services – Revenue in this category decreased 10% in fiscal 2024 compared to the prior fiscal year. The decrease in this category was attributed to customer attrition in the poultry and porcine markets associated with a strategic shift in the business to focus primarily on large production animals.
Service Revenue
Service revenue, which consists primarily of genomics services provided to animal production and companion animal markets, was $102.4 million in fiscal 2024, a decrease of 5% over prior fiscal year revenue of $107.4 million. The decrease was primarily driven by customer attrition in the poultry market and a decrease in revenue in domestic porcine genomics testing, partially offset by strength in genomics testing in the U.K. and Australia, and new business gained with our Neogen Analytics software as a service.
International Revenue
Neogen’s international revenues were $459.0 million in fiscal year 2024, compared to $398.4 million in fiscal 2023, an increase of 15%. The increase was primarily due to $63.8 million of international revenue from 3M FSD during the first quarter of fiscal 2024. Excluding the first quarter of revenue from the FSD transaction, which did not occur in the prior year comparable period, international revenue slightly decreased, primarily driven by the adverse impact of currency.
37
GROSS MARGIN
Gross margin, expressed as a percentage of revenue, was 50.2% during fiscal year 2024 compared to 49.4% during the prior fiscal year. The margin expansion was primarily due to a full year of higher-margin FSD sales in our Food Safety segment, which generated gross margin higher than the legacy company average gross margin. The increase was partially offset by a lower gross margin, expressed as a percentage of revenue, in our Animal Safety segment. The decline was primarily driven by our domestic genomics lab, where fixed costs were unable to decrease at the same proportion as the reduction in revenue due to customer attrition.
Within each reporting segment, increased raw material costs continue to pressure gross margins in certain product lines. However, while inflation continues to impact the business, the rate of raw material price and freight cost increases have significantly declined throughout both the current and prior year comparative periods. Pricing actions taken during these periods also mitigated the impact of cost increases.
OPERATING EXPENSES
Year Ended May 31,
(in thousands)
2024
2023
Increase / (Decrease)
% Change
Food Safety
$
136,837
$
98,926
$
37,911
38
%
Animal Safety
46,035
42,296
3,739
9
%
Total Sales and Marketing
$
182,872
$
141,222
$
41,650
29
%
Food Safety
116,573
108,821
7,752
7
%
Animal Safety
20,213
26,127
(5,914
)
(23
)%
Corporate and eliminations
63,103
66,231
(3,128
)
(5
)%
Total General and Administrative
$
199,889
$
201,179
$
(1,290
)
(1
)%
Food Safety
17,851
20,981
(3,130
)
(15
)%
Animal Safety
4,625
5,058
(433
)
(9
)%
Total Research and Development
$
22,476
$
26,039
$
(3,563
)
(14
)%
Total Operating Expense
$
405,237
$
368,440
$
36,797
10
%
Operating expenses were $405.2 million during fiscal year 2024, compared to $368.4 million during the prior fiscal year. The increase during the year was primarily the result of costs added to accommodate the increased size and complexity of the Company following the FSD transaction, which was included for only nine months in the prior year comparable period.
Sales and Marketing:
Sales and marketing expenses were $182.9 million during fiscal year 2024, compared to $141.2 million during the prior fiscal year. For the Food Safety segment, the increase was primarily driven by incremental costs resulting from the FSD transaction, including compensation and related expenses for the acquired sales and marketing teams and higher costs related to inefficiencies as we took over distribution from 3M. For the Animal Safety segment, the increase was primarily driven by employee costs resulting from headcount increases.
38
General and Administrative:
General and administrative expenses were $199.9 million during fiscal year 2024, compared to $201.2 million during the prior fiscal year. For the Food Safety segment, an increase in these expenses was primarily the result of incremental intangible asset amortization and additional personnel hired to accommodate the increased size and complexity of the organization. These increases were partially offset by lower transaction fees and integration expenses compared to the prior year comparable period. For the Animal Safety segment, the decrease was driven by lower impairment expenses associated with discontinued product lines.
Research and Development:
Research and development expense was $22.5 million in fiscal year 2024, compared to $26.0 million during the prior fiscal year. The decrease during the year was primarily the result of lower contracted services and employee costs in the Food Safety segment, as we continue to integrate the 3M FSD business and realize synergies in certain areas.
OTHER (EXPENSE) INCOME
The net interest expense recorded during fiscal year 2024 was the result of debt incurred to fund the FSD transaction. In the first quarter of fiscal 2023, the Company had no debt outstanding. Interest income relates to earnings on our marketable securities and money market account portfolio. Higher balances in money market portfolios with higher yields drove the increase in interest income during fiscal year 2024. Other expense resulting from foreign currency transactions was the result of changes in the value of foreign currencies relative to the U.S. dollar in countries in which we operate.
PROVISION FOR INCOME TAXES
Income tax benefit during fiscal year 2024 was $4.9 million, compared to income tax expense of $0.8 million in the prior fiscal year. The net tax benefit in the current fiscal year was primarily related to pre-tax losses due to amortization expense and interest expense resulting from the FSD transaction. In the prior fiscal year, pre-tax loss due to the FSD transaction was offset primarily by nondeductible transaction costs.
The total amounts of unrecognized tax benefits that, if recognized, would affect the effective tax rate as of May 31, 2024 and May 31, 2023 are $2.7 million and $1.1 million, respectively. Increases in unrecognized tax benefits are primarily associated with transfer pricing, IRC Section 861 expense apportionment, and research and development credits.
NON-GAAP FINANCIAL MEASURES
This report includes certain financial information for the Company that differs from what is reported in accordance with U.S. GAAP. These non-GAAP financial measures consist of EBITDA, Adjusted EBITDA, and Adjusted EBITDA margin. These non-GAAP financial measures are included in this report because management believes that they provide investors with additional useful information to measure the performance of the Company, and because these non-GAAP financial measures are frequently used by securities analysts, investors and other interested parties as common performance measures to compare results or estimate valuations across companies in industries the Company operates in.
EBITDA
We define EBITDA as net income before interest, income taxes, and depreciation and amortization. We present EBITDA as a performance measure because it may allow for a comparison of results across periods and results across companies in the industries in which Neogen operates on a consistent basis, by removing the effects on operating performance of (a) capital structure (such as the varying levels of interest expense and interest income), (b) asset base and capital investment cycle (such as depreciation and amortization) and (c) items largely outside the control of management (such as income taxes). EBITDA also forms the basis for the measurement of Adjusted EBITDA (discussed below).
39
Adjusted EBITDA
We define Adjusted EBITDA as EBITDA, adjusted for share-based compensation and certain transaction fees and expenses. We present Adjusted EBITDA because it provides an understanding of underlying business performance by excluding the following:
• Share-based compensation
• FX translation (gain)/loss on loan revaluation and other revaluation
• Certain transaction fees and integration costs
• Restructuring
• Contingent consideration adjustments
• ERP Expense
• Other income and expense items
Adjusted EBITDA margin
We define Adjusted EBITDA margin as Adjusted EBITDA as a percentage of total revenues. We present Adjusted EBITDA margin as a performance measure to analyze the level of Adjusted EBITDA generated from total revenue.
These non-GAAP financial measures are presented for informational purposes only. EBITDA, Adjusted EBITDA and Adjusted EBITDA margin are not recognized terms under GAAP and should not be considered in isolation or as a substitute for, or superior to, net (loss) income, operating income, cash flow from operating activities or other measures of financial performance. This information does not purport to represent the results Neogen would have achieved had any of the transactions for which an adjustment is made occurred at the beginning of the periods presented or as of the dates indicated. This information is inherently subject to risks and uncertainties. It may not give an accurate or complete picture of Neogen’s financial condition or results of operations for the periods presented and should not be relied upon when making an investment decision.
The use of the terms EBITDA, Adjusted EBITDA, and Adjusted EBITDA margin may not be comparable to similarly titled measures used by other companies or persons due to potential differences in the method of calculation.
These non-GAAP financial measures have limitations as analytical tools. For example, for EBITDA-based metrics:
• they do not reflect changes in, or cash requirements for, Neogen’s working capital needs;
• they do not reflect Neogen’s tax expense or the cash requirements to pay taxes;
• they do not reflect the historical cash expenditures or future requirements for capital expenditures or contractual commitments;
• they do not reflect any cash requirements for future replacements of assets that are being depreciated and amortized; and
• they may be calculated differently from other companies in Neogen’s industries limiting their usefulness as comparative measures.
A reader should compensate for these limitations by relying primarily on the financial statements of Neogen and using these non-GAAP financial measures only as a supplement to evaluate Neogen’s performance.
For each of these non-GAAP financial measures below, we are providing a reconciliation of the differences between the non-GAAP measure and the most directly comparable GAAP measure.
40
Reconciliation between net (loss) income and EBITDA and Adjusted EBITDA is as follows:
Year Ended May 31,
(in thousands)
2024
2023
2022
Net (Loss) Income
$
(9,421
)
$
(22,870
)
$
48,307
Net (loss) income margin %
(1.0
)%
(2.8
)%
9.2
%
Income tax (benefit) expense
(4,884
)
828
11,900
Depreciation and amortization
116,717
88,377
23,694
Interest expense (income), net
67,032
52,795
(1,267
)
EBITDA
169,444
119,130
82,634
Share-based compensation
13,768
10,177
7,154
FX transaction loss on loan revaluation (1)
2,082
5,226
—
Certain transaction fees and integration costs (2)
15,521
59,812
25,581
Restructuring (3)
3,513
475
—
Contingent consideration adjustments
300
(300
)
—
ERP Expense (4)
7,467
—
—
Discontinued product line expense (5)
994
5,639
—
(Recovery) loss on sale of minority interest
(103
)
1,516
—
Loss on investment
—
500
—
Inventory step-up charge
—
3,245
—
Other
178
—
—
Adjusted EBITDA
$
213,164
$
205,420
$
115,369
Adjusted EBITDA margin %
23.1
%
25.0
%
21.9
%
(1) Net foreign currency transaction loss associated with the revaluation of non-functional currency intercompany loans established in connection with the 3M Food Safety transaction and other non-hedged foreign currency revaluation resulting from 3M agreements.
(2) Includes costs associated with the 3M transaction, including various transition agreements.
(3) Includes costs associated with consolidation of U.S. genomics labs.
(4) Expenses related to ERP implementation.
(5) Expenses associated with intangible asset impairments and inventory scrap amounts related to certain discontinued product lines.
Adjusted EBITDA increased $7.7 million in fiscal year 2024 compared to fiscal year 2023, primarily due to earnings generated from the 3M FSD business, which combined with Neogen on September 1, 2022. Expressed as a percentage of revenue, adjusted EBITDA was 23.1% in fiscal year 2024 compared to 25.0% in fiscal year 2023. The lower Adjusted EBITDA margin was driven primarily by higher operating expenses compared to the prior-year periods, reflecting additions to accommodate the integration of the 3M FSD.
41
FUTURE OPERATING RESULTS
Neogen Corporation’s future operating results involve a number of risks and uncertainties. Actual events or results may differ materially from those discussed in this report. Factors that could cause or contribute to such differences include, but are not limited to, the factors discussed below as well as those discussed elsewhere in this report. Management’s ability to grow the business and its profitability in the future depends upon our ability to successfully implement various strategies, including:
• developing, manufacturing and marketing new products with new features and capabilities, and having those new products successfully accepted in the marketplace;
• expanding our markets by fostering increased use of our products by customers;
• maintaining or increasing gross and net operating margins in changing cost environments;
• strengthening operations and sales and marketing activities in geographies outside of the U.S.;
• developing and implementing new technology development strategies; and
• identifying and completing acquisitions that enhance existing product categories or creating new products or services, and successfully integrating completed acquisitions, including the FSD transaction.
FINANCIAL CONDITION AND LIQUIDITY
Overview
Our primary sources of liquidity are cash and cash equivalents, cash flows from the operations of our business, and available borrowing capacity under our Credit Facilities. Our principal uses of cash include working capital-related items, capital expenditures, debt service, and strategic investments.
Our future cash generation and borrowing capacity may not be sufficient to meet cash requirements to fund the operating business, repay debt obligations, construct new manufacturing facilities, commercialize products currently under development or execute our future plans to acquire additional businesses, technology and products that fit within our strategic plan. Accordingly, we may be required, or may choose, to issue additional equity securities or enter into other financing arrangements for a portion of our future capital needs. However, we continuously monitor and forecast our liquidity situation in light of industry, customer and economic factors, and take the necessary actions to preserve our liquidity and evaluate other financial alternatives that may be available to us should the need arise. As a result, we believe that our cash flows from operations, cash on hand, and borrowing capacity will enable us to fund the operating business, repay debt obligations, construct new manufacturing facilities, commercialize products currently under development, and execute our strategic plans.
We are subject to certain legal and other proceedings in the normal course of business that have not had, and, in the opinion of management, are not expected to have, a material effect on our results of operations or financial position.
As of May 31, 2024, we had cash and cash equivalents and marketable securities of $170.9 million, and borrowings available under our revolving line of credit of $150.0 million.
Cash Flows
Year Ended May 31,
2024
2023
Increase / (Decrease)
Net Cash provided by Operating Activities
35,264
41,028
(5,764
)
Net Cash (used for) provided by Investing Activities
(29,309
)
201,039
(230,348
)
Net Cash provided by (used for) Financing Activities
1,918
(118,081
)
119,999
42
Comparing fiscal year 2024 to fiscal 2023, the lower inflow in cash from operating activities was primarily the result of working capital items, specifically a large outflow for inventory during fiscal year 2024 as we exited distribution agreements with 3M. This resulted in large purchases of inventory, as we are now stocking 3M FSD products.
In fiscal year 2024, the outflow in cash for investing activities was primarily the result of purchases of property, equipment and non-current intangible assets of $111.4 million. This was partially offset by the sale of marketable securities of $82.0 million. In fiscal year 2023, there were purchases of property, equipment and non-current intangible assets of $65.8 million and the maturity of marketable securities of $266.8 million, resulting in an inflow from investing activities.
Comparing fiscal year 2024 to fiscal 2023, the net inflow in cash from financing activities was primarily the result of the Company paying down $100 million of the $1 billion in debt incurred in connection with the FSD transaction in fiscal year 2023.
Net accounts receivable balances were $173.0 million as of May 31, 2024 compared to $153.3 million as of May 31, 2023. Days’ sales outstanding, a measurement of the time it takes to collect receivables, for the business was 61 days as of May 31, 2024, compared to 57 days for the legacy business as of May 31, 2023.
As part of transition services agreements between the Company and 3M, related to the merger of the Food Safety business, 3M invoiced our customers for products that 3M manufactured and shipped on our behalf through December 2023. We have completed the exit of distribution and back office-related service contracts and currently only have a contract manufacturing agreement in place with 3M for certain products.
Net inventory was $189.3 million as of May 31, 2024, an increase of $55.5 million, compared to $133.8 million as of May 31, 2023. The higher inventory levels are primarily the result of the Company now stocking 3M FSD products.
Contractual Obligations As of May 31, 2024, we have the following contractual obligations due by period:
Less than
More than
(dollars in thousands)
Total
1 year
1-3 years
4-5 years
5 years
Debt
$
902,350
$
2,350
$
34,063
$
515,937
$
350,000
Interest obligations
302,941
72,233
133,321
63,091
34,296
Operating Leases
18,022
5,263
8,238
3,515
1,006
Purchase Obligations (1)
112,641
110,341
2,300
—
—
$
1,335,954
$
190,187
$
177,922
$
582,543
$
385,302
(1) Purchase obligations are primarily purchase orders for future inventory and capital equipment purchases.
We continue to make investments in our business and operating facilities. Our estimate for capital expenditures in fiscal 2025 is $85 million. This includes approximately $55 million in capital expenditures related to the integration of the acquired 3M FSD products, the most significant portion of which is related to the construction of and equipment for our new manufacturing facility in Lansing, Michigan
CRITICAL ACCOUNTING ESTIMATES
The discussion and analysis of our financial condition and results of operations are based on the consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires that management make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates the estimates, including but not limited to, those related to receivable allowances, inventories and intangible assets. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
43
The following critical accounting estimates reflect management’s more significant judgments used in the preparation of the consolidated financial statements.
Income Taxes
We account for income taxes using the asset and liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and for tax credit carryforwards and are measured using the enacted tax rates in effect for the years in which the differences are expected to reverse. Deferred income tax expense represents the change in net deferred income tax assets and liabilities during the year. The determination of income subject to income tax in each tax paying jurisdiction requires us to apply transfer pricing guidelines for certain intercompany transactions.
Our tax rate is subject to adjustment over the balance of the year due to, among other things, income tax rate changes by governments; the jurisdictions in which our profits are determined to be earned and taxed; changes in the valuation of our deferred tax assets and liabilities; adjustments to our interpretation of transfer pricing standards; changes in available tax credits or other incentives; changes in stock-based compensation expense; changes in tax laws or the interpretation of such tax laws; and changes in U.S. generally accepted accounting principles.
Although we believe our tax estimates are reasonable and we prepare our tax filings in accordance with all applicable tax laws, the final determination with respect to any audit, and any related litigation, could be materially different from our estimates or from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on operating results and/or cash flows in the periods for which that determination is made. In addition, future period earnings may be adversely impacted by litigation costs, settlements, penalties, and/or interest assessments.
Goodwill
We record goodwill when the purchase price of acquired businesses exceeds the value of their identifiable net tangible and intangible assets acquired. We review our goodwill for impairment annually during the fourth quarter of our fiscal year. In addition, we review goodwill for impairment whenever adverse events or changes in circumstances indicate a possible impairment. We may elect to assess qualitative factors as a basis for determining whether it is necessary to perform quantitative impairment testing. If management’s assessment and conclusion of these qualitative factors indicates that it is more likely than not that the fair value of the reporting unit is more than its carrying value, then no further testing is required. Otherwise, the reporting unit is quantitatively tested for impairment.
Our business is organized into two reporting units: Food Safety and Animal Safety. The determination of our reporting units and impairment indicators also require us to make significant judgments.
In performing goodwill impairment testing, we utilize a third-party valuation specialist to assist management in determining the fair value of our reporting units. Fair value of the reporting unit is estimated based on a combination of an income-based approach consisting of a discounted cash flows analysis and the use of a market-based approach consisting of pricing multiples derived from an analysis of comparable public companies multiplied against historical and/or anticipated financial metrics of the reporting unit. The discounted cash flows approach is based on the reporting unit’s forecasted future cash flows, including forecasted revenue growth rates and gross margin assumptions, that are discounted to present value using the reporting unit’s weighted average cost of capital (WACC) as the discount rate. For the market-based approach, management uses the guideline public company method. The guideline public company method analyzes market multiples of revenues and earnings before interest, taxes, depreciation and amortization (“EBITDA”) for a group of comparable public companies. Valuation multiples are calculated utilizing actual transaction prices and revenue/EBITDA data from target companies deemed similar to the reporting unit. Management typically assigns more weight to the income-based valuation method. Management also evaluates the fair value estimates of the reporting units in the context of the Company’s total enterprise market value.
Based on the estimated fair value developed from the income and market-based methods, we determine the estimated fair value of the reporting unit. If the estimated fair value of the reporting unit exceeds its carrying value, the goodwill is not impaired and no analysis is required. However, if the estimated fair value of the reporting unit is less than its carrying value, the impairment loss is calculated as the difference between the carrying value of the reporting unit and the estimated fair value, limited to the amount of the goodwill assigned to the reporting unit.
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We develop our estimates based on information available as of the date of our assessment, using assumptions we believe market participants would use in performing an independent valuation of the business. Although we believe the estimates and assumptions used in the impairment assessment are reasonable and appropriate, it is possible that the assumptions and conclusions regarding the impairment of goodwill of the reporting unit could change in future periods. There can be no assurance the estimates and assumptions, in particular our long-term financial projections, that are based on information that are known or knowable by us at the time of our goodwill impairment assessment will prove to be accurate predictions of the future, if, for example, (i) the reporting unit does not perform as projected, (ii) overall economic conditions in future years vary from current assumptions (including a change in the discount rate), (iii) business conditions or strategies change from current assumptions, including loss of major customers or channels, (iv) investors require higher rates of return on equity investments in the marketplace, or (v) enterprise values of comparable publicly traded companies, or actual sales transactions of comparable companies, were to decline, resulting in lower multiples of revenues and EBITDA.
We conducted the impairment analysis in the fourth quarter of fiscal year 2024 and concluded that the fair value of our reporting units exceeded their respective carrying values, resulting in no impairment in fiscal year 2024.
Certain assumptions used by us in our impairment assessment for the food safety reporting unit are sensitive in nature. For example, an adverse 50 basis point change in the revenue growth rate or discount rate would result in an estimated fair value of the reporting unit that no longer exceeds the carrying value. As a result, a goodwill impairment charge would be recorded.
NEW ACCOUNTING PRONOUNCEMENTS
See discussion of any New Accounting Pronouncements in Note 1 to consolidated financial statements.