NEOGEN CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations contains both historical financial information and forward-looking statements. Neogen does not provide forecasts of future financial performance. While management is optimistic about the Company’s long-term prospects, historical financial information may not be indicative of future financial results. Safe Harbor and Forward-Looking Statements Forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, are made throughout this Quarterly Report on Form 10-Q. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “seeks,” “estimates,” and similar expressions are intended to identify forward-looking statements. There are a number of important factors, including competition, recruitment and dependence on key employees, impact of weather on agriculture and food production, effects of the ongoing COVID-19 pandemic on our business, identification and integration of acquisitions, research and development risks, patent and trade secret protection, government regulation and other risks detailed from time to time in the Company’s reports on file at the Securities and Exchange Commission, that could cause Neogen Corporation’s results to differ materially from those indicated by such forward-looking statements, including those detailed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In addition, any forward-looking statements represent management’s views only as of the day this Quarterly Report on Form 10-Q 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 management may elect to update forward-looking statements at some point in the future, it specifically disclaims any obligation to do so, even if its views change. COVID-19 As we continue to closely monitor the COVID-19 pandemic, our top priority remains protecting the health and safety of our employees. While operations continue in our locations around the world, many of our non-manufacturing employees continue to work remotely and, although it is starting to increase, business travel remains limited. Safety guidelines and procedures, including social distancing and enhanced cleaning, have been developed for on-site employees and these policies are regularly monitored and updated by our internal Emergency Response Team. In the first quarter of fiscal 2022, the COVID-19 pandemic continued to impact our business operations and financial results. There has been a positive impact in sales of our biosecurity product lines, as the pandemic has created increased demand for these products, and sales into companion animal markets have benefitted, as remote work and stay at home orders have driven increased pet ownership. A number of our food safety diagnostic product lines have been negatively impacted due to decreased demand in many of our customers’ businesses around the world, particularly those serving restaurants, bars and other institutional food service markets. A number of our markets across the world are recovering, but the pandemic has continued to adversely impact our customers and, ultimately, our revenues. We have also experienced supply chain difficulties including vendor disruptions, border closures, shipping issues and significantly increased shipping costs; labor shortages and higher labor costs, as we have had to use staffing agencies and increase our base pay in many areas of the company to fill open positions; and restricted travel, which hinders our ability to connect with customers. During the current fiscal year, we have incurred less expense for travel, meals, trade shows and some other customer-facing marketing activities; some of these activities have resumed but have not yet returned to pre-pandemic levels. Higher spend on shipping and labor are offsetting these savings. We expect the COVID-19 pandemic will continue to impact our business operations and financial results through at least the end of our current fiscal year. 17 Table of Contents Executive Overview • Consolidated revenues were $128.3 million in the first quarter of fiscal 2022, an increase of 17% compared to $109.3 million in the first quarter of fiscal 2020. Organic sales increased 14%. • Food Safety segment sales were $62.7 million in the first quarter of the current fiscal year, an increase of 16% compared to $54.2 million in the same period of the prior year. Organic sales in this segment rose 10% for the comparative period, with revenues from the acquisition of Megazyme (December 2020) providing the remainder of the increase. • Animal Safety segment sales were $65.6 million in the first quarter of fiscal 2022, an increase of 19% compared to prior year first quarter sales of $55.1 million. Organic sales in this segment also rose 19%. • International sales in the first quarter of fiscal 2022 were 39.4% of total sales compared to 38.4% of total sales in the first quarter of fiscal 2021. • The effective tax rate in the first quarter of fiscal 2022 was 21.4% compared to 19.9% in the prior year first quarter. • Net income for the quarter ended August 31, 2021 was $17.1 million, or $0.16 per diluted share, an increase of 8% compared to $15.9 million, or $0.15 per share, for the same period in the prior year. • Cash generated from operating activities in the first quarter of fiscal 2022 was $23.2 million, compared to $25.1 million in the first quarter of fiscal 2021. Neogen’s results reflect a 20% increase in international sales in the first quarter of fiscal 2022 compared to the same period in the prior year. Revenue changes, expressed in percentages, in the first quarter of fiscal 2022 compared to the same quarter in the prior year are as follows for each of our international locations: Revenue Change USD Revenue Change Local Currency U.K. Operations (including Neogen Italia) 9 % (2 )% Neogen Italia 228 % 217 % Brazil Operations (15 )% (17 )% Neogen Latinoamerica 16 % 4 % Neogen Argentina 15 % 54 % Neogen Uruguay 15 % 17 % Neogen Chile 71 % 63 % Neogen China 59 % 47 % Neogen India 15 % 14 % Neogen Canada 89 % 75 % Neogen Australasia 49 % 41 % Currency translations increased comparative revenues by approximately $2.3 million in the first quarter of fiscal 2022 compared to the same quarter a year ago, primarily due to increased strength of the British pound and Mexican peso relative to the U.S. dollar. Combined revenues at our U.K. operations increased approximately 9%, with our Neogen Europe and Neogen Italia operations experiencing combined 17% growth in diagnostic test kits and genomics services. This growth was partially offset by a 10% decrease in the first quarter at Quat-Chem, as the prior year quarter included a large shipment of hand sanitizers to the U.K. government’s health organization and strong cleaner and disinfectant sales to China, Africa and the Middle East. Due to shipping and tax issues caused by Brexit, Neogen Italia is fulfilling orders to many European Union customers that were previously managed through Neogen Europe in the U.K. At our Brazilian operations, fiscal 2022 first quarter sales decreased 15% as the prior year first quarter included a large non-recurring insecticide sale to a government health organization. Additionally, an extended drought led to a significantly reduced corn crop and the associated testing, resulting in a 36% decrease in sales of aflatoxin test kits. At Neogen Latinoamerica, the growth in local currency in the first quarter was led by strength in environmental sanitation and culture media. Sales at Neogen China increased 59% from new sales of Megazyme products and strong growth in genomics, as the commercial dairy, swine and sheep markets have increased sampling volumes. Service revenue, which consists primarily of genomics services to animal protein and companion animal markets, was $24.3 million in the first quarter of fiscal 2022, an increase of 14% over prior year first quarter revenues of $21.4 million. The growth was led by strong increases in genomics revenues in our Australia, China and Canada genomics operations; growth in our domestic operations was reduced by lower sales in companion animal markets, the result of difficult comparisons from a 61% increase in the prior year first quarter. 18 Table of Contents Revenues Three Months ended August 31, (in thousands) 2021 2020 Increase/ (Decrease) % Food Safety Natural Toxins, Allergens & Drug Residues $ 20,408 $ 19,015 $ 1,393 7 % Bacterial & General Sanitation 11,165 9,931 1,234 12 % Culture Media & Other 18,046 12,171 5,875 48 % Rodenticides, Insecticides & Disinfectants 7,649 8,830 (1,181 ) (13 )% Genomics Services 5,454 4,238 1,216 29 % $ 62,722 $ 54,185 $ 8,537 16 % Animal Safety Life Sciences $ 1,363 $ 1,325 $ 38 3 % Veterinary Instruments & Disposables 15,337 10,375 4,962 48 % Animal Care & Other 9,219 7,658 1,561 20 % Rodenticides, Insecticides & Disinfectants 22,149 19,914 2,235 11 % Genomics Services 17,515 15,868 1,647 10 % $ 65,583 $ 55,140 $ 10,443 19 % Total Revenues $ 128,305 $ 109,325 $ 18,980 17 % Food Safety Natural Toxins, Allergens & Drug Residues – Sales in this category increased 7% in the first quarter of fiscal 2022 due primarily to a 17% increase in sales of our allergen test kits, as customers have increased their testing compared to the prior year when many were shut down or operating at lower capacity due to COVID-19 restrictions. Sales of our natural toxin test kits rose 6%, as higher sales of deoxynivalenol (DON), zearalenone and fumonisin test kits were partially offset by lower aflatoxin test kit sales in Brazil, as a drought significantly reduced crop size and associated testing. Drug residue test kit sales declined 22% due to the termination of a European distribution agreement and competitive pressure within the marketplace. Bacterial & General Sanitation – Revenues in this category increased 12% in the first quarter, led by a 14% increase in sales of our environmental sanitation product line, in which we launched a new reader in the previous quarter. Pathogen test kit revenues increased 15%, led by a 32% increase in sales of Listeria products, including our innovative Listeria Right Now ™ system. Sales of our Soleris product line to detect spoilage organisms increased 6% as 9% growth in our consumable vials was partially offset by flat sales of equipment. Our Soleris ® NG instrument was launched in the first quarter of the prior year; equipment sales, although flat to prior year, are approximately double compared to the first quarter two years ago. Culture Media & Other – Sales in this category rose 48% in the first quarter of fiscal 2022 compared to the same period in the prior year; excluding sales from the December 2020 acquisition of Megazyme, sales increased 21%. Sales of Neogen Culture Media products increased 36%, due to high demand with diagnostics customers globally and a large domestic sale to a vaccine manufacturer. Rodenticides, Insecticides & Disinfectants – Sales of products in this category decreased 13% in the first quarter of fiscal 2022, compared to last year’s first quarter. The prior year first quarter included a 73% increase in sales of hand sanitizing products at our U.K. based Quat-Chem operation and a large non-recurring insecticide order, recorded at our Brazilian operation, to a government health organization. Additionally, sales of cleaners and disinfectants into China in the prior year more than doubled, primarily due to increased demand resulting from the African swine fever outbreak in that country and the COVID-19 pandemic. Sales of cleaners and disinfectants into Asia in the first quarter of fiscal 2022 continued to be strong, increasing approximately 18%. Genomics Services – Sales of genomics services sold through our Food Safety operations rose 29% in the first quarter of fiscal 2022, compared to the same period last year, as genomics services in China more than doubled, due to increased commercial dairy and swine business. Genomics revenue in Europe also increased 15% on strength in poultry testing. 19 Table of Contents Animal Safety Life Sciences – Sales in this category increased 3% in the first quarter, due to drug testing at doctor’s offices and workplaces increasing to more normal levels following COVID-19 restrictions that impacted testing in the prior year. The growth was partially offset by the loss of hair testing business with a large U.S. commercial laboratory that moved to a different testing platform. Veterinary Instruments & Disposables – Revenues in this category increased 48% in the first quarter of fiscal 2022 compared to the prior year. Veterinary instruments, including disposable syringes and needles, increased 52% as we gained new private label business. Animal Care & Other – Sales of these products increased 20% in the first quarter compared to the same period a year ago. Small animal supplements, including our recently re-launched ThyroKare ™ product, increased 78% and antibiotics increased 56%, both due to strength in the veterinary market. Partially offsetting these increases, sales of our dairy supply products decreased 81% due to termination of an agreement in which we distributed these products for a large manufacturer of dairy equipment, in the first quarter of fiscal 2021. Rodenticides, Insecticides & Disinfectants – Sales in this category rose 11% in the first quarter of fiscal 2022 compared to the same period in the prior year. Insect control products increased 23%, led by growth in the StandGuard ® product line which was acquired in July 2020. We also had higher sales to customers in the restaurant industry, due to many being affected in the prior year by COVID shutdowns. Sales of rodenticides increased 5% on a difficult comparison to the prior year, when sales had increased 47%, and cleaners and disinfectant sales rose 6%. Genomics Services – Sales in this category increased 10% in the first three months, led by increased business in the beef cattle and swine markets; a large non-recurring plant research project also contributed to the growth in this category. Partially offsetting these gains was a decrease in companion animal testing services in the U.S. due to lower sampling volumes. Gross Margin Gross margin was 46.8% in the first quarter of fiscal 2022 compared to 46.0% in the same quarter a year ago. The improvement was due primarily to a shift in product mix within the Food Safety segment resulting from the incremental sales generated by Megazyme, which has products with higher gross margins. Reduced sales of lower margin cleaners and disinfectants from our European and Chinese operations and insecticides from our Brazilian operations also contributed to the Food Safety gross margin improvement of 360 basis points. Animal Safety gross margins declined by 190 basis points, primarily due to lower sales of companion animal services (a higher gross margin product), a mix shift towards lower margin products in our rodenticide line, and significantly increased international freight costs, the result of ongoing global supply chain issues. Increased health insurance costs and the resumption of the 401k match, which had been suspended in last year’s first fiscal quarter, resulted in an incremental $530,000 expense within overhead on a consolidated basis. Operating Expenses Operating expenses were $38.3 million in the first quarter of fiscal 2022, compared to $31.4 million in the first quarter of fiscal 2021, an increase of $6.9 million, or 22%. It is important to note that in last year’s first quarter, with the economic impact of the COVID-19 pandemic uncertain, the Company took aggressive steps to control operating expenses and made cost reductions where possible. These steps included a reduction in workforce, temporary furloughs and reduced hours for a number of employees. In addition, the Company temporarily eliminated the match on the 401k plan during that period. These steps, in addition to the elimination of travel across most of the organization, and lower utilization of medical services by our employees resulting from stay-at-home orders and a reduction in non-emergency procedures, resulted in an approximately $2.5 million reduction in operating expense in the first quarter of fiscal 2021 compared to the prior year. The 401k match was restored in the second quarter of fiscal 2021, and medical service utilization has recovered, with procedures delayed in calendar 2020 now driving a significant increase in the last two consecutive quarters. These two expense items had an adverse impact on operating expenses of $546,000 in the first quarter of fiscal 2022 compared to the same period a year ago. Sales and marketing expenses in this fiscal year’s first quarter were $20.6 million, an increase of $4.0 million, or 25%, compared to $16.5 million in last year’s first quarter. Personnel related expenses rose by $1.2 million due to an increase in headcount and performance-based incentives, reflective of the revenue increases across the Company. Shipping costs increased by $900,000, due to the increase in volume and an increase in rates. Travel and trade shows, which had declined by $1.3 million in last year’s first quarter due to restrictions resulting from the COVID-19 pandemic, increased $780,000 in this year’s first quarter, as restrictions eased in a number of our markets and our sales force was able to resume face to face meetings. 20 Table of Contents General and administrative expenses were $13.4 million, an increase of $2.4 million, or 22%, compared to $11.0 million in last year’s first quarter, primarily due to a $791,000 increase in compensation related expense, the result of a number of senior management hires and higher performance-based incentives, a $608,000 increase in amortization expense resulting primarily from our acquisition of Megazyme in December 2020, higher depreciation and licensing costs related to continued investments in information technology infrastructure, and increases in legal and professional fees. Research and development expense was $4.3 million in the first quarter of fiscal 2021, an increase of $447,000 compared to the same period in the prior year, due primarily to personnel absorbed in the Megazyme acquisition and compensation increases for domestic employees. Operating Income Operating income was $21.7 million in the first quarter of fiscal 2022, compared to $18.9 million in the same period of the prior year. Expressed as a percentage of revenue, operating income was 16.9% compared to 17.3% in last year’s first quarter. The decline in operating income as a percentage of sales is primarily the result of the 22% increase in operating expenses for the quarter. Other Income Three Months ended August 31, (dollars in thousands) 2021 2020 Interest income (net of expense) $ 203 $ 722 Foreign currency transactions (151 ) 175 Other (70 ) 18 Total Other Income $ (18 ) $ 915 The reduction in interest income in the first quarter of fiscal 2022 compared to the prior year is primarily the result of lower yields on our cash and marketable securities balances, as interest rates have dropped significantly compared to rates in the first quarter of fiscal 2021. Other income resulting from foreign currency transactions is the result of changes in the value of foreign currencies relative to the U.S. dollar in countries in which we operate. Income Tax Expense Income tax expense for the first quarter of fiscal 2022 was $4,650,000, an effective tax rate of 21.4%, compared to prior year first quarter income tax expense of $3,950,000, an effective tax rate of 19.9%. For each quarter, the primary difference between the statutory rate of 21% and the effective rate recorded is the benefit resulting from the exercise of stock options; this benefit was $15,000 in the first quarter of fiscal 2022 compared to $421,000 in the first quarter of the prior year. The benefit was lower due to the decreased volume of option exercises during the comparative periods, and a reduction in benefit realized, on average, for each transaction. Additionally, as the result of a higher tax rate enacted in the U.K., effective in 2023, we were required to revalue our deferred tax balances at our U.K. operations to the rate we expect them to reverse in the future, resulting in $548,000 of expense in this year’s first quarter. Net Income Net income was $17.1 million in the first quarter of fiscal 2022, an increase of 8% compared to $15.9 million earned in the first quarter of fiscal 2021. The increased earnings were the result of higher sales and gross margins, partially offset by increased operating expenses, the $933,000 decline in other income and higher income tax expense. 21 Table of Contents Financial Condition and Liquidity The overall cash, cash equivalents and marketable securities position of Neogen was $400.9 million at August 31, 2021, compared to $381.1 million at May 31, 2021. Approximately $23.2 million was generated from operations during the first three months of fiscal 2022. Net cash proceeds of $1.0 million were realized from the exercise of stock options and issuance of shares under our Employee Stock Purchase Plan during the first quarter. We spent $1.3 million for property, equipment and other non-current assets in the first three months of fiscal 2022. Net accounts receivable balances were $87.3 million at August 31, 2021, a decline of $4.5 million, compared to $91.8 million at May 31, 2021. Days sales outstanding, a measurement of the time it takes to collect receivables, were 59 days at August 31, 2021, compared to 66 days at May 31, 2021 and 61 days at August 31, 2020. We have been carefully monitoring our customer receivables as the COVID-19 pandemic has spread across our global markets; to date, we have not experienced an appreciable increase in bad debt write offs. Net inventory balances were $102.1 million at August 31, 2021, an increase of $1.4 million, or 1%, compared to May 31, 2021 balances of $100.7 million. We increased inventory levels during fiscal 2021 to ensure we have adequate supplies of critical raw and finished products in the event our supply chain is adversely impacted by the COVID-19 pandemic and Brexit. Inflation and changing prices are not expected to have a material effect on operations, as management believes it will continue to be successful in offsetting increased input costs with price increases and/or cost efficiencies. Management believes that our existing cash and marketable securities balances at August 31, 2021, along with available borrowings under our credit facility and cash expected to be generated from future operations, will be sufficient to fund activities for the foreseeable future. However, existing cash and borrowing capacity may not be sufficient to meet our cash requirements to commercialize products currently under development or our plans to acquire other organizations, technologies or products that fit within our mission statement. Accordingly, we may choose to issue equity securities or enter into other financing arrangements for a portion of our future financing needs. 22 Table of Contents PART I – FINANCIAL INFORMATION