NEOG Neogen Corporation

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 performance. While management is optimistic about the Company’s long-term prospects, historical financial information may not be indicative of future financial performance.

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, 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.

Critical Accounting Policies and Estimates

The discussion and analysis of the Company’s 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 those related to receivable allowances, inventories, accruals, goodwill and other 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.

There were no significant changes to our contractual obligations or contingent liabilities and commitments disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2015.

There have been no material changes to the critical accounting policies and estimates disclosed in the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2015.

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Executive Overview

Revenues for the Company for the third quarter ended February 29, 2016 were $76.7 million, an increase of $8.3 million, or 12.2%, compared to the same period in the prior year. For the year-to-date period ended February 29, 2016, revenues were $231.2 million, an increase of $26.7 million, or 13.1%, compared to the prior year. Food Safety segment revenues increased by 8.2% and 10.9%, respectively, for the comparative three and nine-month periods ended February 29, 2016, while Animal Safety segment revenues rose by 15.6% and 15.0%, respectively, for the same comparative periods. Recent acquisitions contributed $1.5 million of revenue for the third quarter, and $5.5 million for the year-to-date period. Overall organic sales growth was 10.0% for the third quarter and 10.4% for the year to date, each compared to the same period in the prior year. Revenues and operating results continued to be adversely impacted by the effects of currency movements for the comparative quarters, as the U.S. dollar strengthened against the currencies in the countries in which we operate, primarily the U.K. pound sterling, the euro, the Mexican peso, and the Brazilian real. Revenues in these countries were reduced when translated into the dollar as compared to the prior year conversion. On a constant currency basis, revenues would have been $1.8 million, or 2.4%, higher in the third quarter and $6.3 million, or 2.7%, higher for the year-to-date period.

International sales were $25.5 million, or 33.3% of total sales, in the third quarter, compared to $24.9 million, or 36.4% of total sales, in the prior year. For the nine months ended February 29, 2016, international sales were 34.0% of total sales compared to 37.9% of total sales for the same period in the prior year. Revenues at Neogen Europe declined 1.3% for the third quarter (4.3% increase in local currency) and 8.2% (2.2% decrease in local currency) for the year-to-date period. Neogen do Brasil revenues increased 0.3% in the third quarter (47.6% increase in local currency), and rose 0.8% (increased 50.6% in local currency) for the year to date. Revenues for Neogen Latinoamerica increased 6.7% for the third quarter, and 19.5% for the year to date (increased 28.3% for the quarter and 45.4% year to date in local currencies, respectively).

Service revenue was $12.3 million in the third quarter ended February 29, 2016, an increase of 19.1% compared to the prior year. For the nine-month period, service revenue was $33.0 million, or 16.6% higher than the comparable prior year period. The increase for both periods was due primarily to incremental genomics business with a large poultry producer and increased sales in the porcine and canine markets.

Gross margin was 45.9% for the third quarter ended February 29, 2016 compared to 49.3% for the third quarter in the prior year. The decrease in gross margin percentage for the comparative quarter was due to adverse product mix toward products and services with lower gross margins within each segment, the negative impact of currency movements during the quarter, a shift in the proportion of Animal Safety segment revenues (which have lower than average gross margins) to the overall total revenues, and standard cost adjustments at our Mexican operations. On a year-to-date basis, gross margin was 48.1%, compared to 49.9% in the prior fiscal year. The decrease in gross margin percentage for the year to date was due primarily to the negative impact of currency movements, mix shift toward products and services with lower gross margins and the shift in the proportion of total revenues towards Animal Safety products.

Sales and marketing expenses were $14.0 million for the quarter ended February 29, 2016, an increase of $1.3 million, or 10.3%, compared to the third quarter last year, and increased 10.9% for the year-to-date period. Increases in this category for each comparative period were from higher personnel related costs resulting from increased headcount and higher revenues, shipping, advertising and other marketing support costs. General and administrative costs were $7.5 million for the quarter, an increase of $1.0 million, or 15.6%, and were up 13.2% for the year-to-date period. For each comparative period, higher salary and stock based compensation expenses, and amortization of intangible assets and legal expenses from recent acquisitions drove the increase. Research and development expenses were $2.5 million for the third quarter of fiscal 2016, an increase of 3.6% over the same period a year ago. For the year-to-date period, research and development expenses were 5.5% higher than last year, primarily due to increased headcount and higher expenditures for product improvement and development projects. Expressed as a percentage of sales, overall operating expenses were less than the prior year for both the quarter and year-to-date periods.

Operating income was $11.3 million, or 14.7% of revenues, in the February 2016 quarter, compared to $12.2 million, or 17.8% of revenues, in the February 2015 quarter, and for the year-to-date period was 17.6% compared to 18.8% in the same period in the prior year. For each comparative period, the percentage decline is due primarily to the lower gross margin percentages recorded for the respective periods.

For the third quarter of fiscal 2016, the Company recorded $385,000 of other income, comprised of $120,000 in interest income, $43,000 in royalty income, and $182,000 in net currency gains, including hedges put in place to protect the Company from the strengthening U.S. dollar, partially offset by currency losses recorded at foreign subsidiaries. In the third quarter of fiscal 2015,

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$526,000 was recorded to other expense including $470,000 of currency losses, and an $84,000 charge for additional contingent consideration payment to the former owner of Chem-Tech as sales for that business during the earnout period were higher than the threshold level. For the nine month period ended February 29, 2016, net other expense of $492,000 is comprised of currency losses totaling $986,000, partially offset by interest income of $238,000 and royalty income of $151,000. For the same period in the prior year, other expense of $728,000 is comprised of a charge of $454,000 recorded for additional contingent consideration for the Prima Tech acquisition, an $84,000 charge for Chem-Tech contingent consideration, and currency losses, offset by $241,000 of income recorded for an overaccrual of contingent consideration for the SyrVet acquisition.

The effective income tax rate for the third quarter of fiscal 2016 was 28.8%, compared to 36.3% in the prior year third quarter. For the year to date, the effective tax rate was 33.6%, compared to 36.1% for the same period last year. During the quarter, the Company completed a review of its calculations for research and development tax credits and domestic production activity deductions claimed on company tax filings; the lower effective rate recorded in the third quarter of fiscal 2016 reflects the lower expected tax provision for fiscal 2016 as well as the filing of an amended return for the Company’s fiscal year ending May 31, 2012 and a return to provision adjustment for the fiscal 2015 return. The Company will file amended tax returns for fiscal years 2013 and 2014 in the fourth quarter of fiscal 2016. We expect our effective tax rate to return to the historical average of approximately 36% in fiscal 2017.

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Revenues for the Company’s Food Safety segment were $34.6 million in the third quarter of fiscal 2016, 8.2% higher than the same period of the prior year. On a year-to-date basis, Food Safety revenues were $106.3 million, 10.9% higher than the comparable period of fiscal 2015. Sales from the acquisition of Lab M, completed on August 26, 2015, contributed $1.3 million to the growth in the third quarter. For the nine months ended February 29, 2016, Lab M provided $3.0 million of sales and BioLumix, an acquisition the Company completed on October 1, 2014, contributed an additional $1.9 million to the overall growth.

Natural Toxins, Allergens and Drug Residues increased 2.6% in the third quarter and rose 3.9% on a year-to-date basis, each compared to the same periods of the prior year. Sales of allergen test kits rose 19.1% in the third quarter and 20.0% for the year to date, as demand for this product line continued to increase due to higher consumer awareness and increased recalls due to allergenic contamination. Partially offsetting the third quarter increase, sales of natural toxin test kits decreased 3.6% in the third quarter, due to higher sales of kits to detect deoxynivalenol (DON) in the same quarter of the prior year, a result of outbreaks in Eastern Europe and Canada which did not recur this year. Despite the third quarter decline, Natural Toxin sales increased slightly on a year-to-date basis, primarily the result of higher first quarter fiscal 2016 DON revenues due to isolated outbreaks in the Midwestern U.S. and Europe.

Drug residue test kit revenues were down 5.5% in the third quarter and decreased 6.5% on a year-to-date basis, primarily due to currency translation.

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Bacterial and General Sanitation revenues increased 5.4% in the third quarter and 18.3% for the year to date, each compared to the same period a year ago. Excluding the BioLumix acquisition, year-to-date sales in this category rose 9.4%. The AccuPoint sanitation monitoring product line recorded increases of 13.7% for the quarter and 16.7% for the year-to-date period, due to the continued successful introduction of an improved, next generation product line. Sales of the Soleris and BioLumix product lines, which detect spoilage organisms, declined 1.2% in the third quarter, due to significant equipment placements in the third quarter of fiscal 2015 which did not recur in this year’s third quarter; disposable vial sales increased 7.3% for the quarter. On a year-to-date basis, this product line recorded revenue increases of 33.2% (6.1% organic), with increases in both equipment and disposable vials. Pathogen test kit sales increased 4.8% for the quarter and 4.5% for the year-to-date period, primarily due to increases in sales of Listeria test kits to the commercial lab market.

Dehydrated Culture Media and Other sales increased 19.1% for the third quarter and 16.6% for the year-to-date period ended February 29, 2016, each compared to the same period in the prior year. Excluding the Lab M acquisition, which closed on August 26, 2015, sales increased 6.1% in the third quarter and 6.2% for the year-to-date period. Organic increases in this category for both the three and nine month periods were led by Acumedia dehydrated culture media sales to the traditional media market. Genomics revenues in Europe, Brazil, China and Mexico, which are recorded as Food Safety revenues in these countries, were flat in the third quarter and down 13.6% on a year-to-date basis, due in large part to prior year chip revenues in Europe which have not recurred in the current year. Additionally, sales of Animal Safety products to customers in Mexico, which are also reported in this category, decreased 20.0% in the third quarter primarily due to order timing from large distributors, and were flat on a year-to-date basis.

Animal Safety segment revenues were $42.1 million for the quarter ended February 29, 2016, a 15.6% increase and year-to-date revenues were $124.9 million, up 15.0%, each compared to the same period in the prior year. The growth was led by strong increases in the Animal Care and Other product line, up 28.1% in the third quarter and 36.8% for the year to date. The increase in both the three and nine month periods was primarily from revenues resulting from a new distribution agreement with a large manufacturer and supplier of dairy equipment and strong sales of the Company’s line of thyroid replacement therapy for companion animals. Also contributing to the growth on a year-to-date basis were increased sales of wound care products and veterinary antibiotics, the latter due to focused marketing efforts and a competitor exiting the business.

Life Sciences sales decreased 5.8% for the quarter, and were 16.3% lower on a year-to-date basis, primarily due to lower sales of the Company’s forensic kit sales to commercial labs in Brazil, the result of delayed implementation of new testing requirements in that country for commercial drivers until spring of 2016. The prior year comparative periods included sales of forensic kits to those labs, made prior to the delayed implementation date. Revenues of Veterinary Instruments and Disposables decreased 8.5% for the quarter and were flat for the year-to-date period, as sales of instruments to a large distributor decreased in the third quarter due to order timing.

Rodenticides, Insecticides and Disinfectants revenues increased 27.9% for the quarter and 16.1% on a year-to-date basis, with minimal impact from the Company’s acquisition of the Virbac line of rodenticides in December 2015. Sales of rodenticides increased 60.2% in the third quarter and 55.9% for the year to date; contributing factors include the expansion of a contract manufacturing relationship with a large marketer of residential rodenticides, increases in retail market share, and continued demand relating to a vole outbreak in the northwestern U.S. Insecticide sales rose 30.0% in the third quarter, the result of strong acceptance of a spring booking marketing program and, to a lesser extent, sales of a new product. For the comparative year-to-date period, insecticide sales increased 4.0%, with third quarter gains somewhat offset by weak first quarter sales. Sales of cleaners and disinfectants declined 10.2% in the third quarter and were 15.4% lower on a year-to-date basis, primarily due to the strength of the U.S. dollar, which has made the Company’s products less competitive.

DNA Testing Services revenues increased 24.4% in the third quarter and 23.9% for the year-to-date period, each compared to the same period in the prior year. For each comparative period, incremental business with a large poultry producer drove the growth. Sales to the porcine and canine markets also increased in both periods due to higher sample volume from large customers.

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Financial Condition and Liquidity

The overall cash, cash equivalents and marketable securities position of the Company was $125.2 million at February 29, 2016, compared to $114.2 million at May 31, 2015. Approximately $28.0 million was generated from operations during the first nine months of fiscal 2016. Net cash proceeds of $8.3 million were realized from the exercise of stock options and issuance of shares under the Company’s Employee Stock Purchase Plan during the first nine months of fiscal 2016. The Company spent $11.1 million for property, equipment and other non-current assets and $16.6 million for its Lab M, Virbac and Sterling Test House acquisitions in the first nine months of fiscal 2016.

Accounts receivable balances were $56.2 million at February 29, 2016, a decline of $3.1 million, or 5.2%, compared to $59.2 million at May 31, 2015. Average days’ sales outstanding improved from 63 at May 31, 2015 to 61 at February 29, 2016. Inventory levels rose by $13.8 million, or 26.8%, compared to May 31, 2015. The increase is due primarily to a concerted effort by the Company to improve service levels to the customer and reduce backorders. The timing of receipts of large international and bulk orders, stocking requirements for new business, and inventories acquired as a result of business acquisitions also contributed to the increase.

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 the Company’s existing cash and marketable securities balances at February 29, 2016 along with available borrowings under its 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 the Company’s cash requirements to commercialize products currently under development or its plans to acquire other organizations, technologies or products that fit within the Company’s mission statement. Accordingly, the Company may choose to issue equity securities or enter into other financing arrangements for a portion of its future financing needs.

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PART I – FINANCIAL INFORMATION