Neogen Corp (NEOG) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter conference call for investors and analysts. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). I would now like to turn the call over to your host, President -- Mr. Jim Herbert. You may begin, sir.

Good morning, and welcome to our regular quarterly conference call for investors and analysts. Today we'll be reporting on Neogen's second quarter that ended on November 30th of 2005. I'll remind you that some of the statements that are made here today could be termed as forward-looking statements. These forward-looking statements, of course, are subject to certain risks and uncertainties, that actual results may differ from those that we discuss today, and that the risks that are associated with our business are covered in part in the Company's form 10-K as filed with the Securities and Exchange Commission.

In addition to those of you who are joining us today by live telephone conference, I'd also welcome those who may be joining by way of simulcast on the World Wide Web. These comments along with some exhibits will be available on the Web for approximately 90 days. And following my comments this morning, we'll entertain questions from participants who have joined us in this live conference. And I'm joined today by Lon Bohannon, our Chief Operating Officer, and Rick Current, our Chief Financial Officer.

Earlier today, Neogen issued a press release detailing the results of the second quarter of the Company's 2006 fiscal year. And again, we set new quarterly records for our 23-year-old company in terms of both revenues and income. The press release announced that net income for the second quarter was approximately $2.2 million, or a 32% increase compared to the same quarter last year. On a per-share basis, net income for the quarter rose to $0.26 a share compared to $0.20 a share last year.

We've continued the substantial increase in this net income that we began in the first quarter. In fact, our year-to-date net income for the first six months of this year is up 34% to approximately 4.4 million. This equates to $0.51 a share for the first half of this year as compared to $0.38 per share for a year ago.

The second quarter revenues increased 7% to approximately 18.3 million, which is also a quarterly record for the Company. Revenues for the first half of the year were approximately $35 million or an 8% increase over a year ago. We believe that our consistency of performance is noteworthy, and frankly, each quarter we proudly add to that score. This second quarter was the 51st consecutive profitable quarter for the Company and the 55th quarter in the past 60 that we showed increased revenues as compared to the previous year. It's a record that now spans over 15 years. I continue to be very proud of our team of employees, now scattered around the world, who set their personal goals each quarter to show increases in revenues and profits when compared to the prior year.

The quarter's improved profits in revenue growth came really from throughout the Company's operations. Gross margins for the quarter were approximately 52% as compared to approximately 47% a year ago. Operating income for the quarter was a little over 3.3 million or a 41% increase over the same quarter last year.

All is not good. We're not happy with that single-digit revenue growth for the quarter, and we continue to have active programs to accelerate that revenue growth. Lon Bohannon did point out in the press release that there is a timing difference of about $0.5 million in revenue that will fall into this year's third or fourth quarter that we enjoyed in the second quarter a year ago. Those numbers, if they had been added back in, would have pushed revenue growth into the double digits.

Let me take a moment, and -- is normal and review the performance of our two operating divisions, our Food Safety and our Animal Safety groups. The Animal Safety group showed revenue increases of approximately 8% for the quarter, and all of our various operating groups within that division showed increases. Our veterinary instrument group had an increase in revenues of 24% for the quarter, as we continue to show strong growth in our direct retail chain store business with companies like Tractor Supply and PetSmart. At the same time, our traditional over-the-counter distribution business is also growing, which [in totally] just to believe that we are in fact making gains in market share with this group of products.

Sales of our biological products are up compared to the prior year, and these are products that share very nice gross margins. Sales of our other injectable products also showed a nice increase for the quarter, although some of our vitamin injectables were in poor supply during last year's second quarter.

The diagnostic test kit business of our Animal Safety group continues to gain strength. Sales in the second quarter were up 13% compared to a year earlier. Our Animal Safety products to control rodents continues to be a good strong story for the Company, and we're finding more and more customers who are looking for practical solutions to control the spread of disease and the destruction of food products. Our rodenticide sales were up about 2% for the quarter, but 17% for the year. That slower second quarter growth was due largely to a decline in Central American sales due to the impact of the hurricanes that swept through that part of the world, but we fully expect that those sales were simply delayed to the third quarter, and were not lost.

Revenues of our Food Safety division for the quarter were approximately $7.8 million, up from 7.5 million, or about a 5% increase. Despite that overall rather unimpressive revenue performance from our Food Safety group, there are a lot of bright spots that are happening there. The sale of our diagnostic test kits to detect food allergens are well in excess of our planned budgets, and 44% greater than they were a year ago. This is partially due to a second format of test kits that we introduced for this market area that provides a simple dipstick procedure, giving customers rapid "yes" and "no" answers. This new format combines with our quantitative test kits that we've had in the market for a while that allows customers to tell exactly the amount of an allergen that might be present.

During the quarter, we also introduced two new allergen diagnostic tests that got off to a good start. One of those is to detect the presence of soy in food and food ingredients, and the other detects the presence of gluten. I'm particularly pleased in the way we are holding market share in this area, since we have three noteworthy competitors who are offering similar products, and two or three others that are offering product on a regional basis.

The continued growth of our dehydrated culture media business is also very promising. Sales of these products to the food industry this quarter were up about 24% compared to last year, and sales for the first half of the year are up 23% compared to a year earlier.

Sales of our test kits to test mycotoxins in the grain, nut, and spice industry showed a 25% increase for the quarter. This was impacted in part by above-normal contamination of aflatoxin in the corn harvest in the U.S. We believe that this opportunity will continue to exist as we move through the year, since there will be a longer tail on this market than normal.

This is partially due -- brought about, I guess, by the fact that hurricanes that disrupted the normal supply channels in the southern part of the U.S. early in the year disrupted a lot of the grain activities where grain moves through the Port of New Orleans. This has meant that significant amounts of corn are being stored outside under tarpaulins since the grain elevator system was overburdened. Much of that crop either has to be tested yet, or will require additional testing as it finds its way through the market channels.

Sales of our test kits to detect genetic modifications in grains were down in the second quarter as compared to the same quarter last year. But again, we believe that this is timing of requirements of the South American market, where our harvest won't begin yet for another couple of months.

We still have worked to do to gain our share of the diagnostic test market to detect bacterial pathogens. Sales of these products as compared to a year ago were weak. However, a number of measures have been taken that are beginning to show a strong promise. As an example, our test kit for the detection of listeria has required two manual steps by the user, and they were conducted several hours apart. Though we believe that our test kit is more accurate than that of our competition, it wasn't as user-friendly. We solved that problem last month with the introduction of a single-step medium.

Similarly, our GeneQuence productline that uses genetic probes for the detection of bacterial pathogens is now enjoying more favor among the larger testing facilities that may run as many as 50 to 100 tests a day for pathogens such as salmonella.

Our Neogen Europe operations continue their profitable expansion. I spent a week with our management and sales organization in Scotland just before Christmas, and was particularly pleased with their progress and the new activities that are underway there. We're gaining sales nicely in both Germany and France, which are probably the two largest Food Safety testing markets in Europe.

Returning to overall company operations, our sales and marketing expense for the quarter were approximately 21% of sales, which compares to about 20% of sales a year ago. Part of that increase is coming from additional staffing to take advantage of market opportunities that we see that we will be developing over the next several quarters. However, at the same time, our administrative expenses were actually dollar-per-dollar less than they were in the second quarter last year. And those numbers came in compared to a year ago at 8% this year of revenues as compared to 9% of revenues last year.

R&D expenses were up about $100,000 as compared to a year earlier. It's always been our strategy, I think, as most of you know, to put resources behind strong new product development when we see new opportunities.

If you've looked at the balance sheet, you noticed that accounts receivable are up compared to where they were at the beginning of the year. And we're now running at about 60 days -- receivables running about 60 days of revenues compared to 58 days at the beginning of the year. Part of this is due to increases in international sales, where we provide credit terms greater than 30 days. In review, however, less than 5% of our accounts are over 30 days past current.

Our inventory levels are also up compared to the beginning of the year, and probably a little higher than might be necessary. A big part of that is due to increased raw material inventories for our Acumedia operations. When we moved that business a year ago from Baltimore to Michigan, we weren't turning orders around as rapidly as we would have liked. We loaded up with some raw materials and finished goods to improve our service levels, and may have larger quantities than we could justify.

However, we completed steps in December that will help us get more to a just-in-time inventory system at Acumedia as well as other parts of the Company through the installation of new material requirements planning software. This new MRP system will undoubtedly help us do a better job of planning, and allow us to reduce inventories -- not immediately, but in the months that are ahead.

On December 20th, we did close the transaction with UCB to acquire the dairy antibiotic testing business that we originally announced back in July. As a consequence, we drew down something over $14 million from our line of credit to close that transaction. However, by the end of December, we paid that line down to $10 million in borrowed funds. We do have some secondary payments that we still have to make on that acquisition that we'll be making during the third quarter, and I suspect that we'll end up with about $12 million in borrowed funds when we conclude that transaction. The interest rate, by the way, on that money is on a LIBOR-based formula. And currently, we're paying about 5.5%.

I know that some people have questioned why Neogen wasn't doing more leverage through borrowed funds if we had a significant line of credit at attractive interest rates. And it has simply been because we hadn't found any use for those borrowed funds that we believe would strategically add to the business. The dairy antibiotics business is clearly a good fit, and an opportunity that we've been working on for sometime. We'll continue to see -- we'll begin to see with this new company revenues and bottom-line results that will be accretive and we'll begin to see those actually toward the end of this third quarter.

Having said that, the bottom-line performance of this new business will show ongoing improvements in the months ahead as we get the business integrated. We'll continue to operate that business through February in Barcelona, Spain in order to build up adequate inventories to allow us to move the entire operation to the U.S. For the next seven months, our cost of goods will be higher than they will be when we move into the next fiscal year and have our more streamlined production operations.

Our anticipated revenue on an annualized basis from the dairy antibiotic testing business we think is somewhere around $8 million. I'd expect that revenues for the remainder of this fiscal year will be over $3 million.

During the second quarter, Forbes Magazine again named Neogen to its annual list of the 200 Best Small Companies in America for the fourth time in six years. The Forbes list, by the way, in case you hadn't seen that, is based on growth in sales and earnings and return on equity.

As we look towards the remainder of this fiscal year, our opportunities for growth at both the top- and the bottom-line I think are very positive. We'll continue to strengthen our sales and marketing programs in order to capture a greater share of market. We have new products and product improvements that are coming through the pipeline. And our overall international sales growth continues to look very promising, particularly in Europe.

We still have strong financial resources, and continue to look for strategic acquisitions. Not only do we have a very significant line of credit still available to us, our cash generation is strong, having generated almost $3 million in cash from operations during the first half of this year.

We continue to believe that Neogen is building good value for its shareholders, and offers a continued, good investment opportunity. I think this is punctuated in part by the 9% increase in shareholder equity that we built during this last six months.

This concludes my formal comments for the morning. I'm now -- now open, Operator, the conference to questions that might be directed to, again, Lon Bohannon, our Chief Operating Officer; Rick Current, our Chief Financial Officer; or myself.

(Operator Instructions.) [Stan Rothschild].

(multiple speakers) On your associates -- we're very pleased with your results, of course. I wondered whether you might take advantage of the fact that an effort is being made by American Diabetes and other people to call attention to food that has high levels of gluten because of the fact that people in the past have just broadly mixed the general term starches or that type of thing, and now they're trying to make a differentiation between the ones that are heavy gluten and should be minimized?

The product that we introduced -- and frankly, we worked on it for a while until we got it right -- the diagnostic test kit for the allergen gluten, because it's also, as I'm sure you know, an allergenic food product -- is enjoying good early growth in the marketplace. And I think that and a lot of our allergen sales are fed by the new labeling requirements that come into place both in the U.S. and particularly in Europe -- Europe starting in the first of January. And one of the targets, of course, is gluten. And one of the, I think, worldwide activities is to quick disguising the name of allergenic foods and call them out, which is leading the industry to need to do more testing, not only to get their label requirements right, but to make certain going forward that the product that they put in the package does conform to that. So I think yes, gluten will probably play a bigger role in our overall mix of allergen tests going forward.

I meant to possibly take advantage of broadening it, because even when it isn't a culprit from an allergic standpoint, it's still a culprit from a standpoint of having too much of it in the diet from a buildup toward diabetes. And a loss of people don't know that yet, but there are some health entities that are trying to get across the message that gluten itself or high gluten is something to be avoided, even if it doesn't involve allergies.

Yes, and I think we're seeing that become more recognized in the general public. And typically, as you well know, that's what leads to -- demand or requirements from the buying public leads to better identification, better labeling. I'm not sure that I see that happening in Europe. But we obviously are beginning to see more of that concern in the U.S.

Yes, okay. Well, I just was hoping we could sort of take advantage of that, because even though gluten doesn't sound like a bad thing in and of itself, the less you take of the high gluten, the better off you are.

Well, and I appreciate your heads-up on that. And we'll certainly be looking for more opportunities as it fits into that extra niche in the marketplace.

Okay. It's just the health letters and the American Diabetes Association have both been making some noises about it.

Okay. Thanks for that heads-up.

[Joseph Potvin].

Another fine quarter. I have a question related to the milk testing business in Spain. Are there problems or restrictions related to going into Europe and buying a business and then moving it into the United States? Does the EU take a position in favor or against that? And secondly, I assume that the reason why we would move it here is because we can operate it more efficiently here? Is that the reason?

Well, the answer to your second question is yes, considerably more efficient. As a part of that, that now -- it's a small group of people. To have a small group of people located that far from home base always presents more management concerns. So from the very beginning, when we began to look at that business, that was one of the things that was a slow-up actually in our earlier negotiations as to whether we could in fact actually pick it up and move it. We've moved businesses around the U.S. before where we could put them on trucks and not have to cross large bodies of water. But this is the first time we've had to put one on a boat to get it home. So we're pretty conservative as we look at it. So yes, it will considerably -- we think we can improve cost of goods compared to the way they were operating, and certainly give us a lot more control than we could if we were trying to operate it from that distance.

The second question I'll let Rick comment further on it because he spent an ungodly amount of time dealing with all sorts of EU regulations. The first thing we had to do was prove to the Spanish government that this move was not -- a little piddly business like this, but they wanted to make sure that it wasn't violating Spanish antitrust laws, and that whoever was buying the products in Spain weren't going to have to pay more for it as a result of this.

And then there's the VAT taxes. And the EU is, of course, unified, and they all operate out of the same book, except about 20 of those countries, and one of those happens to be Spain. They have their own VAT tax procedures. So we were fortunate in that we had our European operations in Scotland, which, of course, are inside the EU. So we were able to make some transfers of product from Spain to Scotland to help in immediate inventory needs that were required over there.

But no, Europe doesn't have a "for sale" sign up on the coastline, trying to get Americans to come and take their businesses. I'd like to see them go the other way. And it's taken a fair amount of time, but we are in good shape. We're clear and we got a little bit of VAT tax that we pay that we're going to -- I don't know, Rick -- it will take us a little while to get it back, but we will.

Yes, they drag their feet pretty well in giving them back their VAT tax. But we've had some pretty good counsel, I think, on how to get that done. But I continued daily to have to fight through these regulations, particularly related to VAT over there. They say that they are a unified group over there, but they're not very unified when you get inside of them. So it's been an experience.

But a worthwhile one.

I guess the further -- is the cost structure of running a business in Europe significantly higher than it is in the United States?

Yes, higher. I don't know how you define "significantly." Their base wage rates are not that much different from what ours are. They work shorter hours. Most of Europe is -- they're trying to get them back up to 40 hours, but some of the major countries are still at 35 hours. And their overall fringe packages, and most particularly any severance packages, are extremely high, which is one of the reasons that we had to structure this -- we had a little difficulty with the seller structuring this, because we bought assets, if you remember, and not the stock of the company. So we left the seller with the responsibilities of severance for some 50-odd employees. And some of those people got two years' wages.

Also, in terms of this particular acquisition you'll recall a couple of years ago we made some expansion of our facilities here in the U.S., and so one of the things that we saw just from a standpoint of a particular acquisition like this is there were some synergies, there were some cost efficiencies that we could get if we could find something that was clearly a fit with what we were doing and bring the operations here to help fill up that excess capacity that we had. And it was one of the things that we said at the time that was going to be a goal and objectives. And it's some of the kind of thing that we're seeing as we grow the business that's helping those margins improve.

Will we use the Ayr, Scotland location mainly as a warehousing facility for the European demand for their product -- the Spanish products? Or is it just inherently more efficient in this country to make it here and ship it over there and --?

Well, freight has always been a consideration. And I think most of us in business today are looking at freight harder than we ever did before, given increased fuel costs that has smacked us in the eyes, between the eyes quicker than we -- we probably should have caught it earlier.

But yes, we'll use Scotland. Right now, over half of that business is sold to customers in Europe. So we will use our European operations as a distribution point for that, though after we get through the transition, we'll make product in the U.S., but it will be shipped to Europe to be distributed -- but it will be shipped in a [whip] form, meaning that we won't ship all the packaging direct to customers. We'll do the packaging in Europe, where we can -- over there, you can put it on a truck and carry it anywhere rather than have to fly it one box at the time from here to where the big part of our customer base is.

So our European operations are definitely an advantage here, an advantage that we didn't really anticipate at the time we set that operations up. But it's great to have a center -- a location there to be able to do these kind of things.

Now, we think that the real opportunity for growth is in the U.S. market. And at this point, we've got almost no sales of those products in the U.S., because they haven't cleared the necessary FDA requirements in order to be used by the milk industry in the U.S. We have a plan to get that done. You never like to predict those things when you're dealing with numerous government agencies, but we've been through this drill before. We think that within the year, we ought to have to our FDA approval, which will allow us to aggressively work in the U.S. market. We do have two strong competitors that right now have the U.S. market. But we think that we've got a product that's competitive, and we'll get part of that market.

Well, congratulations. It looks like to me you're going to have to grow some wall space for more plaques from the [new mayor].

We hope so.

[Frederick Russell].

We are in Oklahoma and we are new, recent shareholders. And we would like to congratulate you on the quarter, but we don't expect you to have such great results every quarter. That's not the way we view a company. But we'll take a great quarter. Could you expand upon your progress in China and tell us what's happening there?

I'll defer that to Lon, in that I was over there two months ago, but Lon is going back in two days. So I'll let Lon talk about where we are in China, both -- as well as shipping product to China as well as bringing product out of China.

We continue to believe that there are opportunities over there. I don't know how much you know about our history with China, but --

I don't know much. We are very recent shareholders.

Okay. We have a number of reasons to maintain a presence and make regular trips over there. We kind of characterize it from the standpoint that we are importing low-tech kinds of product into the U.S. from China. And we are exporting high-tech products in the form of our diagnostic kits on the Food Safety side as that country starts to develop its infrastructure in terms of the whole food safety market area.

In terms of our sales over there, they are still relatively small. We continue to want to do business over there because we think it in fact has grown this year. And when you look at it from a percentage standpoint, it's up significantly compared to last year, but the dollars are still small. But we continue to believe that there are opportunities. We're probably focusing a lot of our efforts right now on finding the right distributors in the right areas and locations over there so that we can continue to grow that business. We are not making large investments in assets over there. And we'll kind of grow as you go. It has been a very good supplier to Neogen, particularly for products on the Animal Safety side. And now we're starting to see some benefit of finding some products over there for some of the things we are doing on Food Safety. And I guess the last thing that I'll say is that we are also actively pursuing some very nice dehydrated culture media opportunities over there with the partner with whom we collaborate.

So so far, it's been a good relationship. We've always said you shouldn't be buying stock in Neogen on the basis of what's going on in China. We think the opportunities are good going forward. But it's going to take some time to realize those.

You don't have any plants in China --?

No direct investments in plants or equipment there.

You spoke of some market share gains and opportunities. Perhaps you could refresh a newcomer to a very exciting business, and tell us where your greatest market shares are and where you see logically the greatest opportunity, and just give us some more flesh in that matter, if you can.

Well, that's a big assignment you just gave us.

Would that question be better in another manner?

No, no. Let me cover that from 10,000 feet for you.

Okay -- or 15,000.

Okay. Part of the markets we serve are growing rapidly, and a part of the markets that we serve are growing at -- I'd have to say probably low single digits. In those low-single-digit markets, we've made some good gains by being able to take some additional market share. I think I talked in my comments about what we've been in the veterinary instrument business. That veterinary instruments business is primarily products to administer animal health medicants, either through the hide with a needle or down the throat and other similar products.

We've grown that business. Now, that business is probably not growing more than 2 or 3% a year, I would suspect, in the U.S. But I just announced that I think last quarter, we were up 23, 24%. And we've been done that by our people spotting where the market changes were, how the distribution system was changing, and been able to be more aggressive in our marketing programs and supplying products in the right fashion.

Then on the positive side, where we've got markets that are growing double digit, we've got a lot of opportunities there. It's still a fragmented market. There's still a number of players out there. But there's not in any one place a big, multinational giant that's going to beat our brains out in the morning. So we've got opportunities to grow at a faster rate than we're doing in some of the food diagnostic areas, as an example.

So those markets are growing. We would do okay if we stayed up with some of them just on the market share, just on the way the market is growing. But it's always our goal to be a dominant player, meaning that if we're not number one, we certainly want to be in the number one or number two spot in the markets that we serve.

What percentage of your markets would you say you are number one or number two and with positive trends?

Well, I'd say probably all but maybe a couple of minor markets we are certainly in positive trends. And we are working to change the trends on those. It's kind of hard for me -- I'd be happy to talk with you more about it in detail, because as an example, in the Food Safety market, we segment that into 30 separate market areas. So we serve 30 different markets in Food Safety, all the way from the beverage business to red meats to fruits and vegetables to grains to [miller], so it's a lot of segments that we work. And we try to market those products -- or we do market those products aimed at those segments. And each of them has a little bit -- our penetration is a little different in each one of them. Each one of them is growing at a little different rate. But it's something that we would love to talk to you more about, maybe off-line at another time.

Okay. That would be fabulous. Thank you very much. Keep up the good work. I [left] the call for your Chief Financial Officer. I'm looking forward to talking with him and to you, too. And keep up the good work.

Well, thanks for your faith in us with your billfold.

Well, and my clients' billfold -- and we are long-term investors.

Quinn Ruddick.

I had a question -- actually, a multipart question. In the current quarter, you experienced a deceleration in the Food Safety revenue growth. And I wanted to know -- maybe you could expand on what has changed in that segment, what efforts you are taking to reverse the deceleration? And is it fair -- should we expect that in the second half of the year, that that should begin to accelerate again as far as the Food Safety revenue growth? And that's excluding the UCB acquisition, obviously, because that's going to significantly bolster the Food Safety revenues in the second half.

And maybe a related question as well, you mentioned actively taking steps to improve your sales and marketing efforts -- if you could just expand on what steps you are taking?

Let me answer the second one. We'd be happy to talk to you more about the steps that we are taking, but it's not a subject that we normally like to cover in a big conference call like this, because it's a little bit like the Southern Cal coach standing on the sidelines knowing what Texas's next play is going to be. So we would just as soon not publicize that widely.

We are doing a number of things, and have continued to do a number of things. And to some of you "old-timers," I know you can remember like I did the third quarter of last year when we recorded one of those five quarters in 15 years that we showed downward revenues. And that will stick in our mind for a long time. And there was a case where the industry was making some changes. Somebody said the greatest cause for failure is success. We've been successful for so long that we just hadn't kept up with what we needed to do in certain areas that had nothing to do with the product, but it was just the way we were approaching the market out there. And the market was making some shifts on us in Food Safety.

Now, as I pointed out, we are recovering in a lot of areas. There are a lot of bright spots, and I talked about some of them this morning. The pathogen area -- the food pathogen area, the bacterial area, has become very crowded. There's some new people in there that are throwing a lot of product into the marketplace. A lot of people will try something for the first time in hopes that it's a better invention than what they have now. We've got some of that business that we've lost and gotten back. And if you're new in the marketplace, one of the things you do is you go in and chop the price down, because that's all you really got to sell. So we've had business that we've lost because we weren't willing to cut the prices to where the competition was, feeling that we'd get it back.

Let me -- Lon is particularly close to that on the pathogen side. Maybe I'll let Lon talk for a little bit about where we are. It's not as -- our management group here kind of criticized me a little bit for saying unimpressive growth at 5%, thinking that a lot of people would like 5%. But those of you that have been on very long know that I always try to be perfectly candid with you as to where my excitement and where my disappointments are. And I'm still not happy with the single digit growth in Food Safety. And all our folks know that.

Before I get into any kind of details, I would echo what Jim would say. Having been with the Company for over 20 years now, I think that one of the strengths of this Company is that we take an honest look at ourselves in the mirror and where we've got areas that aren't performing to what they need to be, we develop plans and take actions. And I think that's been a strength and has helped us with this sustained growth record over the time that Jim had talked about earlier in his comments.

To get to the specifics on a couple of your questions I think that after the third quarter of last year, we made some significant changes in the fourth quarter. And actually, I think we started to reap the benefits of those in the first and second quarters. Sales were actually down in Food Safety compared to the prior year -- in the third quarter last year -- we've kind of got them back to flat and a little bit ahead in the fourth quarter. And I think we built some momentum in the first and second quarters. In fact, I think if it had not been for those timing differences that we had in the second quarter on those international sales, if those had actually fallen into the second quarter this year like they did last year, you wouldn't have seen that deceleration that you mentioned, which is not very big.

Jim specifically talked about the pathogen area on a year-to-date basis. Those sales are exactly flat to where they were last year. And it has been an area of focus because it does represent a market that is growing and good opportunities for us. I think with the media, the new single-step listeria media that we have out there and the additional product improvements we've made that is a fit with our GeneQuence platform for those customers that are running a lot of tests in a day, I think that we are going to see actually an acceleration in growth of sales in that area as we move through the third and fourth quarters.

So I think -- without talking too much in detail about marketing strategies, I think we are building some momentum. And I think we can go forward from that and actually increase our sales growth on the Food Safety side as we move through the third and fourth quarters. And I think everybody in our sales and marketing organization and in the Food Safety group are optimistic about that happening.

[Fred Folks].

A great quarter and a long-term shareholder. I have two questions. One, what impact are you thinking in this year and next year in terms up the impact of stock option expensing. And second is I understand that now U.S. beef can get into Japan -- and we think about mad cow disease. Where is Neogen with respect to mad cow?

I'll let Rick cover the stock option expensing first.

Fred, so far this year, that effect has been $0.04. The calculation is made every quarter, and it's based on factors that take place during the quarter. My estimation is that it will be between $0.08 and $0.10.

For the year --?

For the year.

Okay.

And those -- of course, we'll have to go back and restate the prior years. So it will be compared to whatever they would have been in the prior years after they restated.

The terms will remain the same.

Yes.

Okay, great. Mad cow disease and the Company?

Japan is almost good news. The Japan market opened up, Korea has opened up for us. Japan opened up only, however, to beef from animals under 24 months of age, which leaves out some significant portion of our former exports going into Japan. But the beef industry was in pretty good shape, even with the curtailment of a lot of export products. You know, I'm in the cattle business myself, not on a full-time basis, but enough to keep my interest there. And I sold feeder calves this year for the highest price I ever sold feeder calves in the end of October. And that's indicative of what's happening in the U.S. market.

It's important to us from a couple of areas. It's important to us over on the Animal Safety side -- though it's a Food Safety issue, it's important to us on the Animal side because a significant portion of a lot of our Animal Safety products go into the red meat industry. And we believe that the red meat industry, of course, has been healthy during the last year. And we've think there's every indication that it's going to continue to be healthy, particularly as we open up some of those market that we didn't have last year.

During this two-year period of time, the Japanese and some of the Asian markets -- they didn't go without beef. It was a good opportunity for Brazil to get in. Brazil got in and picked up a big hunk of the market that the U.S. had. But you know, Brazil is our largest single market in South America. So we've got good products, good distribution in Brazil. We spend a lot of time down there, and we're growing with the Brazilian market. So from that standpoint, the health of the meat industry is, I think, good for us on the Animal Safety side -- the Food Safety side and BSE and what's happening in mad cow, we continue to hear good, positive reports that are coming out of the EU. They still do need to do something's with the ruminant animal meals and the nonruminant animal meals.

And we're still in the midst of a lot of ring trials throughout Europe with our diagnostic tests for the detection of ruminant products to make sure that they don't get into feed, those diagnostic test kits.

And you know, so far the sales kind of drift up a little bit every month. They're not real noteworthy, but they're bigger every month than they were the prior year. And we think that that's still a good opportunity of what's apt to happen in Europe.

So BSE is here to stay with us for a while longer. There's no question about that. They continue to find positive animals outside the U.S. Fortunately, we haven't found one in the U.S. lately. But there's just enough emphasis out there that it's certainly going to keep a lightning rod attached to that issue.

Thank you very much, and congratulations on the great quarter.

[Peter Coyle].

The 51st consecutive profitable quarter -- you have done really exceptional work there, and I hope you continue on.

I have two short questions. One is the UCB projections -- I think you gave a $3 million and an $8 million beyond this year. Are those projections for European sales only, or would it include U.S. sales?

Well, the $8 million on an annualized basis would include Worldwide Sales. Now, that doesn't have any numbers in it for the U.S. That's less than 10% of the current sales are into North America, which covers U.S., Canada, and certain Central American countries -- maybe even a little less than 10%. But -- in fact, that 8 million does not factor in the ability to get through FDA and get into the U.S. market. As I said, I don't expect that to happen for the next couple of quarters or so, though we know exactly where we're going and we think we have got a product that will fit there, and we don't think we'll have a problem getting through the approval process. That process itself is just somewhat lengthy.

And then the $3 million estimate -- you know, we've got roughly five months left in this fiscal year. And we are looking at what the revenues might be in those five months. I think I talked a bit about the fact that it will be accretive at the bottom line. Those sales will certainly generate some profits. But our cost of goods of producing that product in Spain today on an interim basis are higher than they will be. And we'll have that inventory to live with for about six or seven months. Those costs will be higher than when we get the business fully integrated.

But you've been around long enough to see what happens when we get product businesses integrated, anyway. And that's the reason we've been able to be up 30% plus increasing the bottom line in the past, I guess now, three quarters -- as long as we've been above 30% increase on the earnings side.

If you included the United States in those -- assuming the FDA does give approval for the antibiotic testing, have you made any projections on that -- on the revenues there?

Yes, but I'm not going to --

-- not going to talk about them --?

I'm not going to -- I never did like to overpromise and underproduce. I'd rather do the opposite, so --

Well, then, I'll hit you on another question. The GMOs you said were up significantly this last quarter. And I was wondering, are you seeing an increased trend? And if not a trend, is there a country that's buying more GMO tests, or -- I'm just wondering if you could operate a little bit on the GMO test kits, why they were up significantly?

They really weren't up. If I said that, I certainly misspoke. (multiple speakers) Actually, our GMO sales for this quarter were down compared to the same quarter a year ago. And that was primarily because of sales into South America. I don't think those are lost sales. In fact, we're pretty sure that those sales are beginning to come in here yet in the third and fourth quarters. Remember that South America is contraseasonal to us, so they are beginning to harvest the world's largest soybean crop in about two months -- that harvest will start down there. And that's one of the big market for our GMO products into South America is for soybeans for the detection of the herbicide-resistant soybeans. So we don't think that -- as I said, we don't think it's lost business; we just think it's delayed business.

There's going to continue to be opportunities in working with GMOs. We do have some programs in place. We've got a program in place with one of the major plant breeders that kicks off here I think later this month in the development of a new test for the detection of a quality issue, meaning that this product is going to be worth more at the first point of receipt because it has a higher content of a specific protein. And there will be a need to test in order to be able to prove that, to validate it at the first point of receipt. We see that business continuing to grow.

There's still concerns about Frankenstein foods in part of Europe, and people that don't want to eat product that came from genetic modifications, but that roar is slowly dulling down. And I think that we will profit by it as the major feed producers profit by it. And as they start putting product into the marketplace that has value from the output traits, meaning it's a better crop, it's a better product as compared to right now all of those changes have been from the input traits side, meaning that farmers could produce it cheaper because it was resistant to insects or it tolerated certain herbicides.

So we think it's still out there. And as that side of it develops, it has always been our strategy to be a more major player when the output trait issue became a bigger issue.

Very good. Keep up the good work.

[Mike Delow]. (multiple speakers) [Dave Murphy].

Just kind of a follow-up, you mentioned the allergen labeling laws and mentioned that Europe was starting January 1st. When is the U.S. starting? And I assume you're seeing that as a positive for Neogen?

The U.S. actually starts January 1st, too. I think there's still a lot of people out there -- though the regulation becomes effective January 1st, there's still a lot of people trying to figure out exactly what they're going to do. It hasn't been a landslide that everybody was three days ago doing exactly what they need to do. There's been some -- that will take a little while to develop, I think. Lon, you --?

One of the things that is part of this labeling law that they haven't had before is it does require the food companies, if you will, to have systems in place to prevent what is most common -- inadvertent contamination. So that is something that the companies are taking a look at and as part of their HACCP systems, they'll identify critical control points. They will do what we call a lot of environmental testing and checking for areas where they can prevent contamination of potential allergens, because of also increases in what they have to do from a labeling standpoint.

So it is something that we would expect to continue to help drive our sales and grow that market. And it's -- in fact, I don't know how much of it has been in anticipation of that, but as Jim mentioned, we are actually in excess of our budget this year in that product line.

(Operator Instructions). [Arthur Hall].

Does the bird flu present any opportunities? I realize that's not a bacterial infection, but since it's so widespread in Asia and Eastern Europe, I wonder if that has any possible opportunities?

We've got a product, a disinfectant product that came through our acquisition of the Hess & Clark businesses of over a year ago that is effective against that virus. Fortunately, we haven't had to face that in the U.S. The product is pretty widely spread, because it's a strong disinfectant that covers a lot of viral and bacterial pathogens.

We don't have good distribution of that product in those Asian countries where there concern of it becoming pandemic is most urgent today. And though I wish we were there and had the avenues open to be able to sell more product there, we are really just not in that position. So I don't think we're going to get any big sales as a result of that going into the Asian market, certainly.

In the U.S. market I think we're pretty well connected, should it become a real problem here, and let's hope we never face that. But I think everybody's looking that's involved anywhere in the food industry -- what happens if this does become pandemic proportions -- not just what do you do about the control of the birds themselves, but what do you do about your people who won't show up for work and all the other things that are going to be necessary to try to run a business?

(Operator Instructions). I show no further questions.

Well, thank you very much for your attendance in the conference call this morning. I gather that there are one or two people who might like to have questions in more detail answered. Don't hesitate to call any of the three of us if we can provide you with more information. And thank you for your continued support. And we look forward to giving you a report a couple or three months from now that extends those quarters by one more. Have a good day.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a wonderful day.