The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and related notes of Avid Bioservices, Inc. included in Part I Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022.

Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements, including the anticipated future impact of the ongoing COVID-19 global pandemic on our business operations, that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results of operations to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are "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 (the "Exchange Act"). Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "plan," "project," "seek," "should," "target," "will," "would" and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. These forward-looking statements are subject to numerous risks and uncertainties, including the risks and uncertainties described under the section titled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022, those identified in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q, and in other filings we may make with the Securities and Exchange Commission from time to time. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements and, except as required by law, assume no obligation and do not intend to update these forward-looking statements.





Overview


We are a dedicated contract development and manufacturing organization ("CDMO") that provides a comprehensive range of services from process development to Current Good Manufacturing Practices ("CGMP") clinical and commercial manufacturing of biologics for the biotechnology and biopharmaceutical industries. With 29 years of experience producing monoclonal antibodies and recombinant proteins, our services include clinical and commercial product manufacturing, bulk packaging, release and stability testing and regulatory submissions support. We also provide a variety of process development services, including upstream and downstream development and optimization, analytical methods development, testing and characterization.





Strategic Objectives


We continue to execute on a growth strategy that seeks to align with the growth of the biopharmaceutical drug substance contract services market. That strategy encompasses the following objectives:

· Invest in additional manufacturing capacity and resources required for us to

achieve our long-term growth strategy and meet the growth-demand of our

customers' programs, moving from development through to commercial

manufacturing;

· Broaden market awareness through a diversified yet flexible marketing strategy;

· Expand our customer base and programs with existing customers for both process

development and manufacturing service offerings;

· Explore strategic opportunities both within our core business as well as in

adjacent and/or synergistic service offerings in order to enhance and/or

broaden our capabilities; and

· Increase our operating profit margin to best in class industry standards.












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First Quarter Highlights


The following summarizes select highlights from our first quarter ended July 31, 2022:

· Reported revenues of $36.7 million, an increase of 19%, or $5.9 million,

compared to the same prior year period;

· Reported net income of $1.6 million, or $0.03 per basic share and $0.02 per

diluted share;

· Expanded our customer base and programs with existing customers and ended the

quarter with a backlog of approximately $157 million, representing our highest

backlog to date;

· Continued to advance the second phase of expansion of our Myford facility and

the construction of our cell and gene therapy facility; and

· Announced plans to further expand the process development capacity of our


   mammalian cell culture services.




Facility Expansions



During fiscal year 2021, we announced plans for a two-phased expansion of our Myford facility. The first phase, which expanded the production capacity of our Myford facility by adding an additional downstream processing suite, was completed in January 2022. The second phase, which was initiated during the fourth quarter of fiscal 2021 and is anticipated to be online during the first calendar quarter of 2023, will further expand our capacity with the addition of a second manufacturing train, including both upstream and downstream processing suites. We estimate that as of July 31, 2022, the remaining cost to complete our Myford facility expansion will be approximately $22 million to $25 million.

In October 2021, we announced plans to expand our CDMO service offerings into viral vector development and manufacturing services for the rapidly growing cell and gene therapy ("CGT") market. This expansion will consist of a two-phased approach including constructing a world-class, single purpose-built CGT development and CGMP manufacturing facility in Costa Mesa, California (the "CGT Facility"). In June 2022, we completed the first phase with the opening of our new analytical and process development laboratories. This phase is now operational, and we are actively scheduling new business into the laboratories. The second phase of construction includes the build out of CGMP manufacturing suites, which are expected to be online in mid calendar 2023. We estimate that as of July 31, 2022, the remaining cost to complete our CGT Facility construction will be approximately $42 million to $47 million.

In June 2022, we announced plans to further expand the process development capacity of our mammalian cell culture services, by adding new suites within our existing process development laboratory space. This expansion is expected to be completed by the end of calendar 2022 at an estimated total cost of approximately $6 million.

Upon completion of these expansions, we estimate that our combined facilities will have the potential to bring our total revenue generating capacity to up to approximately $400 million annually, depending on the mix of future customer projects.





Impact of COVID-19 Pandemic



To date, the COVID-19 pandemic has not had a significant impact on our operations, as we have been able to continue to operate our manufacturing facilities and provide essential services to our customers.

We will continue to assess the potential impact of the COVID-19 pandemic on our business, financial condition, and results of operations. For a further discussion of potential risks to our business from the COVID-19 pandemic, please refer to "Part I, Item 1A-Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended April 30, 2022.

Performance and Financial Measures

In assessing the performance of our business, we consider a variety of performance and financial measures. The key indicators of the financial condition and operating performance of our business are revenues, gross profit, selling, general and administrative expenses, operating income and interest expense.











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We intend for this discussion to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those consolidated financial statements from period to period and the primary factors that accounted for those changes.





Revenues


Revenues are derived from services provided under our customer contracts and are disaggregated into manufacturing and process development revenue streams. Manufacturing revenue generally represents revenue from the manufacturing of customer products derived from mammalian cell culture covering clinical through commercial manufacturing runs. Process development revenue generally represents revenue from services associated with the custom development of a manufacturing process and analytical methods for a customer's product.





Gross Profit


Gross profit is equal to revenues less cost of revenues. Cost of revenues reflects the direct cost of labor, overhead and material costs. Direct labor costs include compensation, benefits, recruiting fees, and stock-based compensation within the manufacturing, process and analytical development, quality assurance, quality control, validation, supply chain, project management and facilities functions. Overhead costs primarily include the rent, common area maintenance, utilities, property taxes, security, materials and supplies, software, small equipment and deprecation costs incurred at all of our manufacturing and laboratory locations.

Selling, General and Administrative Expenses

Selling, general and administrative ("SG&A") expenses are composed of corporate-level expenses, including compensation, benefits, recruiting fees, and stock-based compensation of corporate functions such as executive management, finance and accounting, business development, legal, human resources, information technology, and other centralized services. SG&A expenses also include corporate legal fees, audit and accounting fees, investor relation expenses, non-employee director fees, corporate facility related expenses, and other expenses relating to our general management, administration, and business development activities. SG&A expenses are generally not directly proportional to revenues, but we expect such expenses to increase over time to support the needs of our growing company.





Results of Operations


The following table compares the unaudited condensed consolidated statements of operations for the three months ended July 31, 2022 and 2021 (in thousands):





                                           Three Months Ended July 31,
                                         2022          2021       $ Change
Revenues                              $   36,692     $ 30,754     $   5,938
Cost of revenues                          27,575       19,363         8,212
Gross profit                               9,117       11,391        (2,274 )

Operating expenses: Selling, general and administrative 6,382 4,460 1,922 Total operating expenses

                   6,382        4,460         1,922
Operating income                           2,735        6,931        (4,196 )
Interest expense                            (518 )       (703 )         185
Other income (expense), net                   50           76           (26 )
Net income before income taxes             2,267        6,304        (4,037 )
Income tax expense                           703            -           703
Net income                            $    1,564     $  6,304     $  (4,740 )










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Three Months Ended July 31, 2022 Compared to Three Months Ended July 31, 2021





Revenues


Revenues for the three months ended July 31, 2022 were $36.7 million compared to $30.8 million for the same period in the prior year, an increase of $5.9 million, or 19%. The increase in revenues can primarily be attributed to an increase in manufacturing runs during the current year period compared to the prior year period. The increase in revenues was attributed to the following components of our revenue streams:





                                                $ millions

Net increase in manufacturing revenues $ 5.8 Net increase in process development revenues

            0.1
Total increase in revenues                     $        5.9




Gross Profit


Gross profit for the three months ended July 31, 2022 was $9.1 million (25% gross margin) compared to $11.4 million (37% gross margin) for the same period in the prior year, a decrease of $2.3 million. The $2.3 million decrease in gross profit for the current-year period can primarily be attributed to increases in compensation and benefit related expenses and facility and equipment related costs, partially offset by increased revenues. Excluding the prior year's margin benefit from unutilized capacity fees, and the current quarter's increase in costs associated with the establishment of our cell and gene therapy business and ahead of our mammalian capacity expansions, including increasing our headcount and incremental depreciation from newly released facility expansions, our first quarter gross margin was on par with the prior year period.

We expect our gross profit will continue to be impacted in the short-term by these and future costs as we continue to increase the hiring of personnel and incur additional facility and equipment related costs to support our rapidly growing capacity and expanded service offerings.

Selling, General and Administrative Expenses

SG&A expenses were $6.4 million for the three months ended July 31, 2022 compared to $4.5 million for the same period in the prior year, an increase of approximately $1.9 million, or 43%. As a percentage of revenues, SG&A expenses for the three months ended July 31, 2022 and 2021 were 17% and 15%, respectively. The net increase in SG&A expenses was attributed to the following components:





                                                         $ millions

Increase in compensation and benefit related expenses $ 1.2 Increase in facility and related expenses

                        0.2
Increase in legal and accounting fees                            0.2
Net increase in all other SG&A expenses                          0.3
Total increase in SG&A expenses                         $        1.9




Operating Income


Operating income was $2.7 million for the three months ended July 31, 2022 compared to $6.9 million for the same period in the prior year. This $4.2 million decrease in year-over-year operating income can primarily be attributed to a $2.3 million decrease in gross profit combined with a $1.9 million increase in SG&A expense.









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Interest Expense



Interest expense was $0.5 million for the three months ended July 31, 2022 compared to $0.7 million for the same period in the prior year, a decrease of $0.2 million, or 26%. The decrease of $0.2 million can be attributed to interest expense capitalized as construction-in-progress during the current year period compared to no interest capitalized during the same prior year period.





Income Tax Expense


Income tax expense was $0.7 million for the three months ended July 31, 2022 compared to no income tax expense for the same period in the prior year. The increase in income tax expense can be attributed to the recording of a full quarter of income tax expense in the current year period whereas in the prior year period there was no income tax expense due to a full valuation allowance in place.

Liquidity and Capital Resources

Our principal sources of liquidity are our existing cash and cash equivalents on hand and cash flows generated from operations. As of July 31, 2022, we had cash and cash equivalents of $115.1 million. We believe that our existing cash on hand and our anticipated cash flows from operating activities will be sufficient to fund our operations for at least the next 12 months from the date of this Quarterly Report.

If cash flows from operations are not sufficient to support our operations or capital requirements, including our mammalian and cell and gene therapy facility expansions, then we may need to obtain additional equity or debt financing to fund our future operations and/or such expansions. We may raise these funds at the appropriate time, accessing the form of capital that we determine is most appropriate considering the markets available to us and their respective costs of capital, such as through the issuance of debt or through the public offering of securities. These financings may not be available on acceptable terms, or at all. Our ability to raise additional capital in the equity and debt markets is dependent on several factors including, but not limited to, the market demand for our common stock. The market demand or liquidity of our common stock is subject to a number of risks and uncertainties including, but not limited to, our financial results, economic and market conditions, and global financial crises and economic downturns, which may cause extreme volatility and disruptions in capital and credit markets. In addition, even if we are able to raise additional capital, it may not be at a price or on terms that are favorable to us.





Cash Flows


The following table compares our cash flow activities for the three months ended July 31, 2022 and 2021 (in thousands):





                                                Three Months Ended July 31,
                                                 2022                 2021            $ Change

Net cash used in operating activities $ (5,034 ) $ (6,942 ) $ 1,908 Net cash used in investing activities $ (6,924 ) $ (4,199 ) $ (2,725 ) Net cash provided by financing activities $ 929 $ 918 $ 11

Net Cash Used in Operating Activities

Net cash used in operating activities for the three months ended July 31, 2022 was a result of a net change in operating assets and liabilities of $11.0 million, offset by $1.6 million of net income and non-cash adjustments to net income of $4.4 million primarily related to stock-based compensation and depreciation and amortization expense.











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Net cash used in operating activities for the three months ended July 31, 2021 was a result of a net change in operating assets and liabilities of $15.8 million, offset by $6.3 million of net income and non-cash adjustments to net income of $2.6 million related to stock-based compensation, depreciation and amortization and amortization of debt issuance costs.

Net Cash Used in Investing Activities

Net cash used in investing activities for the three months ended July 31, 2022 and 2021 consisted of $6.9 million and $4.2 million, respectively, used to acquire property and equipment primarily related to projects associated with the expansion of our manufacturing operations.

Net Cash Provided by Financing Activities

Net cash provided by financing activities for the three months ended July 31, 2022 consisted of $1.0 million in net proceeds from the issuance of common stock under our equity compensation plans, offset by $0.1 million in principal payments on a finance lease.

Net cash provided by financing activities for the three months ended July 31, 2021 consisted of $0.9 million in net proceeds from the issuance of common stock under our equity compensation plans.





Cash Requirements


Our material cash requirements include the following contractual and other obligations.





Convertible Senior Notes



In March 2021, we issued $143.8 million in aggregate principal amount of 1.25% exchangeable senior notes due 2026 ("Convertible Notes") in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act. The net proceeds we received from the issuance of Convertible Notes was $138.5 million, after deducting initial purchaser discounts and other debt issuance related expenses of $5.3 million.

The Convertible Notes are senior unsecured obligations and accrue at a rate of 1.25% per annum, payable semi-annually in arrears on March 15 and September 15 of each year, beginning on September 15, 2021. The Convertible Notes mature on March 15, 2026, unless earlier redeemed or repurchased by us or converted at the option of the holders. The Convertible Notes are convertible into cash, shares of our common stock or a combination of cash and shares of our common stock, at our election in the manner and subject to the terms and conditions provided in the indenture governing the Convertible Notes.

As of July 31, 2022, the aggregate principal amount outstanding or our Convertible Notes was $143.8 million. For additional information regarding the Convertible Notes, see Note 3 of the notes to unaudited condensed consolidated financial statements.





Leases


We lease certain office, manufacturing, laboratory, and warehouse space located in Orange County, California under operating lease agreements. Our leased facilities have original lease terms ranging from 7 to 12 years, contain multi-year renewal options, and scheduled rent increases of 3% on either an annual or biennial basis. We also lease certain manufacturing equipment under a 5-year finance lease that expires in December 2026. As of July 31, 2022, we had outstanding lease obligations of $51.4 million, of which $3.8 million is payable in the remainder of fiscal 2023, $4.8 million is payable in fiscal 2024, $4.7 million is payable in fiscal 2025, $4.8 million is payable in fiscal 2026, $4.6 million is payable in fiscal 2027, and $28.7 million is payable thereafter.









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Capital Expenditures


During the three months ended July 31, 2022, our capital expenditures were $6.9 million, and additionally our accrued capital expenditure balance was $16.4 million. We currently anticipate that our capital expenditures for fiscal 2023 to be approximately $85 million to $95 million, related to our mammalian and cell and gene therapy facility expansions in Orange County, California as further discussed in the "Facility Expansions" section above.

Critical Accounting Policies and Estimates

Our discussion and analysis of our consolidated financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States ("U.S. GAAP"). The preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. We review our estimates and assumptions on an ongoing basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results. During the three months ended July 31, 2022, there were no significant changes in our critical accounting policies as previously disclosed by us in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended April 30, 2022.

Recent Accounting Pronouncements

For a discussion of recent accounting pronouncements applicable to us, please refer to Note 2, Summary of Significant Accounting Policies, in the accompanying notes to our unaudited condensed consolidated financial statements.





Backlog


Our backlog represents, as of a point in time, future revenue from work not yet completed under signed contracts. As of July 31, 2022, our backlog was approximately $157 million, as compared to approximately $153 million as of April 30, 2022. While we anticipate the majority of our backlog will be recognized as revenue over the next twelve (12) months, our backlog is subject to a number of risks and uncertainties, including but not limited to: the risk that a customer cancels its commitments prior to our initiation of services, in which case we may be required to refund some or all of the amounts paid to us in advance under those canceled commitments; the risk that a customer may experience delays in its program(s) or otherwise, which could result in the postponement of anticipated services; the risk that we may not successfully execute on all customer projects; the risk that commencement of customer projects may be postponed due to supply chain delays; and the risk of a potential negative impact from the COVID-19 global pandemic, any of which could have a negative impact on our liquidity, reported backlog and future revenues and profitability.

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