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, global business disruption caused by the Russia invasion in Ukraine and related sanctions, 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. TRENDS AND UNCERTAINTIES During fiscal 2022 and the first quarter of fiscal 2023, we have experienced higher than expected input cost inflation, including higher transportation, supply chain and labor costs, that negatively impacted operating results. Pricing actions taken during fiscal 2022 and the first quarter of fiscal 2023 mitigated some, but not all, of the inflationary pressures. Ongoing inflation may also have an impact on our customer’s purchasing decisions and order patterns. We estimate inflation will continue to affect us in the remainder of fiscal 2023, although at this time it is impracticable to quantify the impact. Although we have no operations in or direct exposure to Russia, Belarus and 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 on the global economy. To date, our European operations and customer base have not been materially impacted by the conflict, however, as the conflict continues or worsens, it may impact our business, financial condition or results of operations in the remainder of fiscal 2023. As we continue to monitor the ongoing COVID-19 pandemic, our top priority remains protecting the health and safety of our employees, their families, and those in our communities. Safety guidelines and procedures have been developed for on-site employees and these policies are regularly monitored and updated by our internal Emergency Response Team. COVID-19 continues to impact our business operations and financial results. A number of our product lines have been negatively impacted due to decreased demand in our customers’ businesses around the world. Many of our markets 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 a number of areas of the Company to fill open positions and to cover for COVID-related absences, and restricted travel, which hinders our ability to connect with customers. Overall, the impact of COVID-19 remains uncertain and ultimately depends on the length and severity of the pandemic, inclusive of the introduction of new strains of the virus; government actions taken in response; vaccination rates and effectiveness; the impact of vaccination requirements; extent of protection provided by prior viral infection; and the macroeconomic environment. We will continue to evaluate the nature and extent to which COVID-19 has impacted our business, supply chain, including labor availability and attrition, consolidated results of operations, financial condition, and liquidity; we expect it to continue to impact us through at least the end of our fiscal year ending May 31, 2023. 20 Table of Contents Executive Overview August 31, (in thousands) 2022 2021 % Consolidated Revenues $ 132,349 $ 128,305 3 % Organic Sales Growth 0 % Food Safety Revenues $ 64,643 $ 62,722 3 % Organic Sales Growth 1 % Animal Safety Revenues $ 67,706 $ 65,583 3 % Organic Sales Growth 0 % % of International Sales 39 % 39 % Effective Tax Rate 21.8 % 21.4 % Net Income $ 5,209 $ 17,077 -69 % EBITDA* $ 11,419 $ 27,206 -58 % Adjusted EBITDA* $ 27,018 $ 28,896 -6 % Per Diluted Share $ 0.05 $ 0.16 Cash (for) from Operations $ (14,143 ) $ 23,210 * Refer to non-GAAP financial measure section in this document. • Food Safety organic sales exclude revenues from the acquisitions of Delf/Abbott Analytical (November 2021) and Thai-Neo Biotech (July 2022). • Animal Safety organic sales exclude revenues from the acquisitions of CAPInnoVet (September 2021) and Genetic Veterinary Sciences (December 2021). • Net income was $5.2 million in the first quarter of fiscal 2023 compared to $17.1 million in the first quarter of the prior year, adversely impacted by $13.7 million in legal, consulting and other expenses related to our agreement to combine with 3M’s Food Safety business. This transition closed on September 1, 2022, after the close of the first quarter. 21 Table of Contents International sales rose 2% in the first quarter of fiscal 2023 compared to the same period in the prior year. Currency translations decreased comparative revenues by approximately $3.9 million in the first quarter of fiscal 2023, due to the stronger U.S. dollar relative to currencies in the United Kingdom, Europe, Australia, and Argentina for the comparative period. On a neutral currency basis, international sales increased 10%. Excluding revenues from the Delf/Abbott Analytical and Thai-Neo Biotech acquisitions, the increase was 7% on a neutral currency basis. Revenue changes, expressed in percentages, for the three month period of fiscal 2023 compared to the same period in the prior year are as follows for each of our international locations: Three Months Ended August 31, 2022 Revenue % Inc (Dec) USD Revenue % Inc (Dec) Local Currency U.K. Operations (including Neogen Italia) 5 % 19 % Megazyme (13 )% 1 % Brazil Operations 13 % 14 % Neogen Latinoamerica 19 % 20 % Neogen Argentina 34 % 78 % Neogen Uruguay 1 % (6 )% Neogen Chile (4 )% 16 % Neogen China (18 )% (14 )% Neogen India 25 % 33 % Neogen Canada (7 )% (3 )% Neogen Australasia (8 )% (2 )% Combined revenues at our U.K. operations increased 5% in the first quarter, led by a 31% increase in sales of cleaners and disinfectants, aided by the acquisition of Delf (UK) Ltd. in December 2021; in local currency, the organic increase was 12%. For the Megazyme operation, located in Ireland, the prior year first quarter included end sales to customers in the U.S. These end customer sales were transitioned to our U.S. operations in August 2021. Sales in Brazil increased 13% in this year’s first quarter, driven by strong sales of the company’s mycotoxin test kits, including tests to detect aflatoxin and deoxynivalenol (DON), as well as increases in veterinary instruments, insect and rodent controls products, and genomics testing. Neogen Latinoamerica sales rose 19% for the first quarter, led by increases across the company’s diagnostic testing portfolio and culture media, as well as higher sales of rodent control products and cleaners and disinfectants. Sales at Neogen China decreased 18% for the three month period as the country’s COVID-19 related lockdowns continued to negatively impact sales in the first quarter of the fiscal year. Revenues at Neogen’s Australasia operations decreased 8% as a large non-recurring culture media order in the prior year was only partially offset by bovine genomic service increases. Service revenue, which includes genomics testing and other laboratory services, was $25.6 million in the first quarter of fiscal 2023, an increase of 5% over the prior year first quarter revenues of $24.3 million. Excluding the contribution from the December 2021 acquisition of Genetic Veterinary Sciences and negative currency impact, service revenue increased 2%. Growth in the beef markets in the U.S. and Brazil was partially offset by COVID-related shutdowns in China and a difficult comparison due to a large domestic research project recorded in the prior year. 22 Table of Contents Revenues Three Months Ended August 31, Increase/ (Decrease) % (in thousands) 2022 2021 Food Safety Natural Toxins, Allergens & Drug Residues $ 19,787 $ 20,408 $ (504 ) (3 )% Bacterial & General Sanitation 10,728 11,165 (437 ) (4 )% Culture Media & Other 19,254 18,046 1,091 7 % Rodent Control, Insect Control & Disinfectants 9,575 7,649 1,926 25 % Genomics Services 5,299 5,454 (155 ) (3 )% $ 64,643 $ 62,722 $ 1,921 3 % Animal Safety Life Sciences $ 1,589 $ 1,363 $ 226 17 % Veterinary Instruments & Disposables 14,673 15,337 (664 ) (4 )% Animal Care & Other 10,526 9,219 1,307 14 % Rodent Control, Insect Control & Disinfectants 22,214 22,149 65 0 % Genomics Services 18,704 17,515 1,189 7 % $ 67,706 $ 65,583 $ 2,123 3 % Total Revenues $ 132,349 $ 128,305 $ 4,044 3 % 23 Table of Contents Food Safety Natural Toxins, Allergens & Drug Residues – Sales in this category decreased 3% for the three month period ended August 31, 2022, compared to the same period in the prior year. In the first quarter, aflatoxin test kit revenues increased 25% primarily from an aflatoxin outbreak in Brazil and new business earned in Mexico and Central America. This increase was offset by a 9% decline across the company’s allergen testing portfolio caused by softening market conditions and supply disruptions for certain products. Bacterial & General Sanitation – Revenues in this category decreased 4% for the first quarter compared to the same period in the prior year. In the first quarter this year, there was a significant decrease in Soleris ® equipment sales due to a difficult comparison to strong prior year placements. Soleris ® consumables recorded a 6% increase over the prior year, and the ANSR pathogen detection product line grew 13% from new equipment placements and higher test kit sales. Culture Media & Other – Sales in this category increased 7% in the quarter ended August 31, 2022 compared to the first quarter in the prior year. Sales of food quality and nutritional analysis products increased by 9% over the prior year, as the products were integrated into U.S. channels. The recently introduced Neogen Analytics platform continued to make strong inroads in the market. Rodent Control, Insect Control & Disinfectants – Revenues in this category increased 25% in the first quarter of fiscal 2023 compared to the same period a year ago. Excluding the revenue contribution from the Delf acquisition in this category, the overall increase was 9%, primarily due to higher demand of cleaners and disinfectants in Europe, Brazil, Mexico and Central America. Genomics Services – Sales of genomics services sold through our international Food Safety operations decreased 3% for the three month period ended August 31, 2022. Increased beef business in Brazil was more than offset by unfavorable currency comparisons in the U.K. and COVID-related lab closures in China. Animal Safety Life Sciences – Sales in this category increased 17% in the first quarter, compared to the same period in the prior year. The increase was due to higher demand from customers purchasing substrates and reagents used in clinical diagnostic test kits. Veterinary Instruments & Disposables – Revenues in this category decreased 4% for the three month period ended August 31, 2022, primarily due to a 6% decrease in sales of veterinary instruments. This category had increased by a strong 52% in the first quarter a year ago. Animal Care & Other – Sales of these products increased 14% in the three month period ended August 31, 2022; excluding the contribution of parasiticides from the September acquisition of CAPInnoVet, revenues in this category increased 9%. Sales of other animal care products, including supplements and vitamin injectables, increased 16% on continued strong end customer demand. Rodent Control, Insect Control & Disinfectants – Revenues were flat for the three month period ended August 31, 2022, as compared to the same period in the prior year. Sales of insect control products rose 14% in the quarter and cleaners and disinfectants sales increased 7%. These increases were offset by a 12% decrease in rodenticide sales, the result of diminished rodent pressure in the U.S. Genomics Services – Sales in this category increased 7% in the first quarter compared to the prior year; excluding the contribution from Genetic Veterinary Sciences, revenues declined 3%. Domestic increases in the beef market were more than offset by unfavorable currency comparisons in Australia, lower sample volumes from a large customer in the porcine market and a difficult prior year comparison due to a large research project which did not recur. Gross Margin Gross margin, expressed as a percentage of sales, was 47.0% in the first quarter of fiscal 2023 compared to 46.8% in the same quarter a year ago. Animal Safety gross margins increased 200 basis points, with pricing actions taken in the prior fiscal year and a mix shift towards higher margin animal care products driving the improvement. Food Safety gross margins declined 160 basis points, primarily from the impact of lower gross margins from the Delf acquisition. Within each segment, increased raw material and freight in costs continued to pressure gross margins in certain product lines. 24 Table of Contents Operating Expenses Operating expenses were $56.2 million in the first quarter of fiscal 2023, compared to $38.3 million in the same quarter of the prior year. Legal, consulting and other professional fees and expenses totaling $13.7 million were incurred in the first quarter of the current fiscal year related to our combination with 3M’s Food Safety business, which closed on September 1, 2022. Excluding costs related to the transaction, run rate operating expenses for the first quarter were $42.5 million, an increase of 11% compared to the prior year. Operating expenses for businesses acquired in the past year totaled $2.1 million and represented 50% of the increase for the first quarter of fiscal 2023. Sales and marketing expenses were $23.4 million in the first quarter of fiscal 2023, compared to $20.6 million in last year’s first quarter, an increase of 14%. The increase in expense was driven by higher personnel related spending, the result of headcount additions and compensation increases. In addition, travel, trade shows and other customer facing activities increased significantly, as the prior year first quarter was affected by global COVID-19 restrictions. Shipping expense increased 10% for the quarter, primarily due to rate increases and fuel surcharges from both small package and truckload shippers. General and administrative expenses were $27.9 million in the first quarter, and included $13.7 million in legal, consulting and other professional fees and expenses related to our combination with 3M’s Food Safety business, which closed on September 1, 2022. After adjusting for these deal-related expenses, first quarter run rate general and administrative expenses were $14.2 million, an increase of $829,000, or 6%. The increase was primarily the result of incremental expense from acquisitions, including amortization, stock based compensation grants, and license fees relating to information technology infrastructure and software investments. Research and development expense was $4.9 million in the first quarter of fiscal 2023, an increase of $557,000, or 13%, compared to the same period in the prior year. The increase was primarily the result of external costs for testing and validation for new commercial products in the Animal Safety segment, and to a lesser extent, compensation and other personnel related increases. Operating Income Operating income was $6.1 million in the first quarter of fiscal 2023, compared to $21.7 million in the same period of the prior year. Expressed as a percentage of sales, operating income was 4.6% for the first quarter of fiscal 2023 compared to 16.9%, respectively, for the same period in the prior year. Adjusting for the costs resulting from the 3M transaction, operating income was $19.8 million, or 15.0%, for the first quarter of the 2023 fiscal year. Other Income Three Months Ended August 31, (dollars in thousands) 2022 2021 Interest income (net of expense) $ 969 $ 203 Foreign currency transactions (421 ) (151 ) Other 49 (70 ) Total Other Income $ 597 $ (18 ) The increase in interest income in the first three months of fiscal 2023, compared to the same period a year ago, was the result of improved yields on our marketable securities balances due to higher interest rates on fixed income investments. Other income or 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. 25 Table of Contents Income Tax Expense Income tax expense in the first quarter of fiscal 2023 was $1.5 million, an effective tax rate of 21.8%, compared to $4.7 million, an effective tax rate of 21.4%, in the same period of the prior year. For the first quarter of fiscal 2023, the primary difference between the statutory rate of 21% and the effective rates recorded is the impact of higher tax rates in international countries we do business in, and also state taxes. In both periods, there was minimal benefit from the exercise of stock options. Net Income Net income was $5.2 million in the first quarter of fiscal 2023, compared to $17.1 million in the same period in the prior year. The decline in earnings for the quarter was primarily the result of $13.7 million in legal, consulting, professional fees and other expenses from the 3M Food Safety transaction. Excluding those charges and adjusting to the effective tax rate, net income was $15.9 million. Non-GAAP Financial Measures This report includes certain financial information for the Company that differs from what is reported in accordance with 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). Adjusted EBITDA We define Adjusted EBITDA as EBITDA, adjusted for stock-based compensation and certain transaction fees and expenses. We present EBITDA because it provides an understanding of underlying business performance by excluding the following: • Stock-based compensation . We believe it is useful to exclude stock-based compensation to better understand the long-term performance of the respective core businesses and to facilitate comparison with the results of peer companies. • Certain transaction fees and expenses. We exclude fees and expenses related to certain transactions because they are outside of Neogen’s underlying core performance. 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 income (loss), 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. 26 Table of Contents 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. You 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. Reconciliation between net income and EBITDA and Adjusted EBITDA is as follows: Three Months Ended August 31 (Dollars in thousands) 2022 2021 Net Income $ 5,209 $ 17,077 Net income margin % 3.9 % 13.3 % Provision for income taxes 1,450 4,650 Depreciation and amortization 5,729 5,682 Interest income, net (969 ) (203 ) EBITDA $ 11,419 $ 27,206 Stock-based compensation 1,867 1,690 Certain transaction fees and expenses 13,732 — Adjusted EBITDA $ 27,018 $ 28,896 Adjusted EBITDA margin % 20.4 % 22.5 % Adjusted EBITDA decreased 6% for the first three months of fiscal 2023 compared to the first three months of fiscal 2022, due to operating expenses growth which exceeded revenue growth. Financial Condition and Liquidity The overall cash, cash equivalents and marketable securities position of Neogen was $347.7 million at August 31, 2022, compared to $381.1 million at May 31, 2022. Cash flow from operating activities was negative $14.1 million during the first three months of fiscal 2023, the result of deal-related expenses, inventory increases, and $1.3 million on business acquisitions. Net cash proceeds of $905,000 were realized from the exercise of stock options and issuance of shares under our Employee Stock Purchase Plan during the first three months of fiscal 2023. We spent $13.0 million for property, equipment and other non-current assets in the first three months of fiscal 2023, with a significant portion of expenditures on IT for items such as laptops and software related to the 3M Food Safety business. 27 Table of Contents Net accounts receivable balances were $93.1 million at August 31, 2022 compared to $99.7 million at May 31, 2022. Days’ sales outstanding, a measurement of the time it takes to collect receivables, were 60 days at August 31, 2022, compared to 62 days at May 31, 2022 and 59 days at August 31, 2021. We have continued to carefully monitor our customer receivables during the COVID-19 pandemic; to date, we have not experienced an appreciable increase in bad debt write offs related to the pandemic. Net inventory was $129.0 million at August 31, 2022, an increase of $6.7 million, compared to a May 31, 2022 balance of $122.3 million. The higher inventory levels are primarily reflective of the inflationary pressures on raw material costs. Additionally, we have been increasing inventory levels in an effort to reduce the impact of higher freight costs and to prevent backorders, as vendor order fulfillment has been erratic and certain suppliers are requiring higher minimum order levels due to their capacity constraints. On September 1, 2022, after the close of the first quarter of fiscal 2023, Neogen, 3M, and Garden Spinco, a newly formed subsidiary of 3M created to carve out 3M’s Food Safety business, closed on the transaction which had previously been announced in December 2021, combining 3M’s Food Safety business with Neogen in a Reverse Morris Trust transaction. On June 30, 2022, Garden SpinCo entered into a credit agreement consisting of a five-year senior secured term loan facility in the amount of $650.0 million and a five-year senior secured revolving facility in the amount of $150.0 million (collectively, the “Credit Facilities”), which became available in connection with the merger and related transactions. The loan facility was funded to Garden Spinco on August 31, 2022, and upon the effectiveness of the merger on September 1, 2022, became Neogen’s obligation. Financial covenants include maintaining specified levels of funded debt to EBITDA, and debt service coverage. Pricing for the term loan is term SOFR plus 235 basis points. The Credit Facilities, together with the Notes below, represent the financing incurred in connection with the merger of the 3M Food Safety business with Neogen’s. In July 2022 Garden SpinCo closed on an offering of $350.0 million aggregate principal amount of 8.625% senior notes due 2030 (the “Notes”) in a private placement at par. The Notes were initially issued by Garden SpinCo to 3M and were transferred and delivered by 3M to the selling securityholder in the offering, in satisfaction of certain of 3M’s existing debt. Garden SpinCo did not receive any proceeds from the sale of the Notes by the selling securityholder. Prior to the distribution of the shares of Garden SpinCo’s common stock to 3M stockholders, the Notes were guaranteed on a senior unsecured basis by 3M. Upon consummation of such distribution, 3M was released from all obligations under its guarantee. Upon the effectiveness of the merger on September 1, 2022, the Notes became guaranteed on a senior unsecured basis by Neogen and certain wholly-owned domestic subsidiaries of Neogen. In addition to the 3M transaction described above, our future cash generation and borrowing capacity may not be sufficient to meet cash requirements to fund the operating business, repay debt obligations, 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. 28 Table of Contents PART I – FINANCIAL INFORMATION