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Neogen (NEOG -8%) is under pressure today following its Q3 (Feb) earnings report this morning. This food and animal safety company reported strong EPS upside although revenue was a bit light. However, the bigger issue was the pretty significant revenue downside guidance for FY24 revs. With just one quarter left in the fiscal year, that portends a pretty weak Q4 (May) result.

• Its Food Safety segment, which focuses on selling single-use diagnostic test kits for food producers to detect pathogens/spoilage/allergens, posted revenue growth of 4.1% yr/yr to $157.8 mln. Segment growth was led by the Indicator Testing, Culture Media & Other product category, which benefited from higher sales of Petrifilm. This was partially offset by a decline in culture media sales.
• Its Animal Safety segment sells veterinary instruments, pharmaceuticals, vaccines, topicals, parasiticides, diagnostic products etc. Segment sales rose 6.5% yr/yr to $71.1 mln. Core growth was led by its portfolio of biosecurity products, driven by new business wins and increased demand for cleaners and disinfectants and insect control products.
• So, why the disappointing guidance? A little context would be helpful. 3M (MMM) recently separated its food safety business which combined with Neogen in a Reverse Morris Trust transaction. This transaction has been completed, however, Neogen is now integrating the former 3M Food Safety business. Neogen says progress has been made. However, the resulting increase in volumes in its primary distribution facility, has created operational inefficiencies that Neogen continues to manage through.
• The good news is that Neogen believes these inefficiencies are temporary, but they are currently affecting order fulfilment rates and preventing Neogen from meeting end-market demand on a consistent basis. As such, Neogen lowered its full-year outlook to reflect the lower revenue it now expects to generate.
• Another good thing is that Neogen continues to see positive trends in its end markets. In Food Safety, sequential improvement in unit production volumes has generally continued across the industry, while channel inventories in Animal Safety have normalized after several quarters of destocking. Neogen says its primary focus now is improving order fulfillment rates to meet the needs of customers in this improving end-market environment.

Overall, we think investors probably expected some hiccups with the 3M integration, but the size of the downside guidance was more than expected. The good news here is that this issue does not appear to be a demand issue, which would be a more serious problem. What we have here is an order fulfillment / operational issue stemming from the integration of a major addition. These issues tend to work themselves out in time. However, investors appear to be taking a wait-and-see approach as the big downside guidance may be leading to fears of the problem lingering into FY25.