Neogen Corp (NEOG) 2007 Q1 法說會逐字稿

Good day everyone. Welcome to the Neogen Corporation first quarter fiscal year 2007 results conference call. Today's call is being recorded.

At this time, I would like to turn the call over to Mr. James Herbert, Chief Executive Officer. Please go ahead, sir.

Good morning and welcome to our regular quarterly conference call for investors and analysts. Today we will be reporting on Neogen's first quarter that ended on August 31.

I would start by reminding you that statements that we make here today, could be termed as forward-looking statements, and these forward-looking statements of course, are subject to certain risks and uncertainties. The actual results may differ from those that we discuss today. The risks associated with our business are covered in part in the Company's Form 10(K), that is filed with the Securities and Exchange Commission.

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

Earlier today, Neogen issued a press release detailing the results for the first quarter of our 2007 fiscal year, which of course ended on August 31. Once again we set a new quarterly record for the Company, in terms of both revenue and income. The Company's revenues for the first quarter increased 21% over the previous year's first quarter to approximately 20.2 million. First quarter net income also increased 21% from the prior year's comparable quarter to approximately 2.4 million. On a per share basis, net income per diluted share increased to $0.26, from a restated $0.24 in the previous year's first quarter.

Now I want to make sure to call to your attention that this first quarter results does reflect Neogen's adoption of the Fiscal Accounting Standards Board Statement No. 123 R. This requirement is of course being implemented by all publicly held companies, and requires the Company to recognize the cost of stock options as compensation expense. Neogen adopted using the modified retrospective transition method, whereby all prior periods are restated on a consistent basis with the current accounting.

As a result of this implementation the Company recognized to compensation expenses on a preliminary basis of $270,000 in the first quarter of this fiscal year '07, and $230,000 in the first quarter of fiscal year '06. These amounts will be finalized prior to the filing of the Company's 10(Q) in early October. I know that all our Company employees take appropriate pride, and at the same time make a dogged effort to continue to maintain the Company's consistent performance. This first quarter of this year marked the 54th consecutive profitable quarter from operations for the Company, and was the 58th in the past 63 quarters, when Neogen reported revenue increases as compared to the previous year.

Some of you may have received your copy of this year's Annual Report within the last few days. I pointed out in that Annual Report that the consistency of performance has been important, and will be important to the Company's continued success in many ways. Standing behind these results has allowed us to hire talented employees, has helped us win customer confidence, has helped us receive great cooperation in the communities in which we operate, and of course, provided an exceptional investment opportunity for our shareholders.

In a few minutes, Lon will talk more specifically about the performance of the Food Safety division and the Animal Safety division. However, there are a few general areas that I would like to cover, before I turn the call over to Lon.

First of all our balance sheet has been significantly strengthened. The Company's cash position increased from about $2 million at the end of May, to approximately $5.5 million at the end of August, and long-term lines of credit have been paid down from approximately $10 million at the end of May, to zero at the end of August.

As most of you perhaps know in early June, Neogen generated approximately $12.2 million in cash through the offering of 650,000 shares of common stock. Through the years this approach has been Neogen's strategy, to use debt when appropriate for growth, and to replace that debt with equity when the timing seemed right, so that we could make sure that we had immediately available capital for expansion opportunities. Neogen now has no long-term debt and available bank line of credit is $17.5 million in consistent cash flow generation from operations.

Though we do not currently have any definitive acquisition activity, Neogen does continue to maintain several potential strategic opportunities on the radar screen. Taking another look at the general situation, we were pleased with the NASDAQ announcement in early July, that Neogen had been selected as one of approximately 1200 companies, to be listed on the new NASDAQ Global Select market, their top tier market group.

Let me turn a moment and briefly talk about some of the things that are happening in the various markets in which we operate. This is always the time of year in which Neogen attempts to better assess the various Food and Animal Safety opportunities that may be available, due to shifts in weather and regulatory requirements, and this is particularly true in North America, especially as it relates to the weather.

Weather patterns across major portions of the Nations's corn producing areas have been problematic. Much as that crop has just started coming out of the fields, so it's impossible to tell what kind of aflatoxin or other micro toxin levels that might be present. As an example, we know that Texas had extreme drought conditions that were expected to result in high aflatoxin levels in that state's corn crop. However, the drought was so bad that in many areas, production was so low that no harvest actually even took place.

Right now we are closely following the conditions in Kansas, Missouri and Nebraska, as well as concerns that we are hearing from the grain industry in South Dakota, parts of Iowa, and Wisconsin. It will likely be another month before we have a good reading on the micro toxin contamination in these areas.

Of course I think most of you are aware of the problems that were encountered by the fresh cut vegetable industry in the past week or so, when it was announced that there have been deaths, and perhaps 200 reported severe illnesses, as a result of E. Coli 0157-H7 contamination in fresh cellophane-packed spinach.

The fresh cut and vegetable is one of the 23 markets that Neogen does serve. We sell some product to several of the significant players in this business. In fact, we were the first to recognize the needs of the industry, and provided educational material and suggested programs, in order for them to comply with the guidelines that had been established by the Food and Drug Administration. Though we have some increases in activity in this market over the past couple of weeks, it's too early to tell how much benefit we may see from any increased testing on the part of this industry.

Food allergens still pose a threat to U.S. foods, and Neogen's group of products aimed at detecting food allergens continues to find favor. The Food and Drug Administration issued a statement a couple of weeks ago, that some food manufacturers are not doing enough, to prevent the cross-contamination of their products by allergenic foods. Allergen contamination is a big problem for manufacturers, especially if they have to make constant recalls, if the products that happen to get to the shelves contain allergenic foods that are not listed on the label.

Last time I reviewed the annual summary of cases of food recalls, the recalls that were due to contamination by food allergens, were about equal to all other recall causes. We believe that the FDA will continue close scrutiny of this problem. It's one that's estimated to cause about 150 deaths a year, and results in about 30,000 emergency room treatments, because of allergenic food contamination. In a mid-September announcement, FDA went further to state and say that it was impossible to determine the amount of allergenic contamination in the U.S. food supply, but called on manufacturers to use robust testing techniques to ensure public safety.

I just returned from a week in Europe, and time with our Scotland-based European operations. That portion of our business continues to also do well, and I suspect by year end they will help push our percentage of revenues from outside the U.S. to well over 30%. The changes in regulations that are occurring in the European Union are particularly noteworthy.

There are more regulations being put into place, and/or being discussed, concerning several food safety items. In fact I suspect that probably 50% of these regulations are now more stringent than those that we see in the U.S. I believe that we can expect to see this market for our food testing products grow, and believe that Neogen becomes better positioned every day to take advantage of those opportunities.

Let me stop now, and with that kind of a brief overview, and turn the call over to Neogen's President, Lon Bohannon, to talk more about the specific areas of our two operating divisions. Lon?

Thank you, Jim. I too would like to welcome our listeners on the conference call, and those who are participating via Internet access. Let me begin by saying I was extremely pleased with our first quarter results, since comparisons are being made to what was an exceptionally good first quarter last year.

For the first time in Neogen's history we achieved quarterly revenues in excess of $20 million, and as Jim already mentioned, the 21% revenue growth compared to the same quarter last year, continued our sustained growth record of reporting increases in quarterly sales compared to the prior year. Now for those of you who listen in on these calls on a regular basis, you know this track record is a source of pride for management, but more importantly, I think it's reflective of the commitment and talent of the Neogen's entire workforce of almost 440 employees.

I would like to take this opportunity to formally thank the Neogen team of employees, who have worked hard to maintain this remarkable growth record that is now approaching 16 years. In looking at first quarter results for each of our two operating divisions, I will start by covering a few key points pertaining to our Animal Safety division. First quarter sales for the Animal Safety group were $8,829,000. This revenue total was actually 3% below sales for the first quarter last year.

However, last year's results for Animal Safety included some unique sales opportunities and international orders, that make it difficult to compare this year's first quarter to the prior year. Last year the Animal Safety group experienced large shipments of Rodenticides to Mexico, and a biological product to Sweden in the first quarter, that will fall in future quarters this year.

The timing of these international shipments along with one-time stocking orders, first for vitamin injectable products obtained from new suppliers in the first quarter last year, and second for a wound care product launched in last year's first quarter, after FDA approval also contributed to the difficult first quarter comparison. In addition, and of even more significance, the Pacific Northwest experienced a significant outbreak of voles in the first quarter last year. This outbreak resulted in unprecedented shipments of Neogen's Prozap rodenticide leading our Haco rodenticide operations to a 38% increase in sales for the first quarter last year.

Now sales of Prozap this year were significantly higher than historical levels and that was due in part to the increased market share. Still overall sales of Prozap fell approximately $530,000 below last year's artificially high levels. Now some of this shortfall in Prozap was offset by a solid 8% growth in Ramik, the Company's top selling rodenticide product. Furthermore, our Haco rodenticide manufacturing operations are currently working overtime, to meet order demand that picked up significantly in August, and has carried over into the second quarter.

I think it's also important to point out that the Animal Safety group did have a number of product lines that exhibited strong performance in the first quarter. Sales of diagnostic test kits sold to the forensic market for the detection of drugs of abuse increased 15%, including significant sales growth to distributors in Poland and South Africa.

Sales of the Company's care line of pharmaceutical products for the small companion animal market were up 11%. Equine supplements sold primarily through distribution to veterinarians increased 30%, and sales of the Company's Gold Nugget and Squire Pharmaceutical products sold in the over-the-counter market, were up over 21%.

Due to the reasons just outlined I can actually make a case that a more realistic percentage comparison for Animal Safety same store sales in the first quarter is closer to 7 or 8%. But I think that might be going too far to rationalize first quarter performance. What I will say is that I am confident that Animal Safety's first quarter results represent an anomaly, and not any kind of trend.

The Animal Safety sales team has a solid record of achieving consistent organic sales growth, and we are looking forward to returning to strong sales growth in the upcoming quarters. Now one of Neogen's strengths is that we do not rely on a single product, customer, or even division, to generate consistently good operating results for our investors. This was again in evidence in our first quarter when our Food Safety division picked up the slack, to drive Neogen's overall sales and operating profit growth.

Our Food Safety growth had a truly outstanding first quarter with sales up 48% to 11,391,000. In addition to significant sales contributions from last year's acquisitions of UCB's dairy antibiotic test products, and Eastman Chemicals Soleris optical microbial detection system, existing product lines also exhibited strong sales growth compared to the prior year, resulting in overall organic sales growth of more than 10% for Food Safety.

Neogen's AccuPoint ATP test system for general sanitation continued the sales growth momentum that began in the last two quarters of fiscal year 2006, with first quarter sales 26% higher than last year. Sales of diagnostic test kits to detect natural toxins, such as aflatoxin, fumonisin, and histamine increased 25%, and tests to detect food allergens were up another 10% in this year's first quarter, following exceptionally strong growth throughout all of last fiscal year, and Jim touched upon some of the issues helping to drive allergen test kit sales in his opening comments.

Overall Food Safety results were also bolstered by superb first quarter performance in our Neogen European operations, this division achieved overall sales growth of 28% in the first quarter, with strong performance across many product lines. Of particular note were significant sales of Neogen's pesticide detection ticket test sold to the British government ultimately for military use, and a 46% increase in sales within France, led by sales of test kits for micro toxins.

You will recall that an important part of our overall strategy for Europe, was to take advantage of Neogen's physical presence in Ayr, Scotland as a base of operations for direct sales into important countries, like Germany and France. This strategy was obviously successful in France in our first quarter, and as Jim commented earlier Neogen is well-positioned in Europe, to take advantage of future growth opportunities for our Food Safety products.

The strong performance of our Neogen Europe group, in combination with some new international sales for dairy antibiotic tests, and microbial tests for spoilage organisms resulted in a new record for international revenues. In the first quarter sales derived from sources outside the U.S. were 38% of total company revenues.

Last year's acquisitions and the accelerated growth we've seen in the Food Safety division, made it necessary for Neogen to purchase additional space to accommodate operations that are being transferred or have been transferred into Lansing, Michigan, from locations outside the state, and in some cases outside the country, and to provide adequate space for future expansion.

Renovation has begun on an 80 year old, 55,000 square foot facility, purchased last fiscal year, and located within 1 mile of Neogen's existing headquarters. This facility will be used to increase manufacturing capacity, expand our laboratories for research and technical service, and to provide some much needed office space for the Food Safety division. Utilization of this new facility will most likely begin to take place in our third fiscal quarter that begins on December 1.

Looking at other key operating line items, I would say our ongoing efforts to contain costs made steady progress again this quarter. This is mostly reflected in the operating expense areas, where sales and marketing and R&D categories declined as a percentage of sales. In total the total operating expense areas represented 33.4% of sales this year's first quarter, compared to 35.6 last year.

You will probably note that gross margins were lower in the first quarter this year, than for the same period last year. However I can assure you that this is due almost entirely to product mix, and that we continue to aggressively look for improvements in systems, to increase manufacturing productivity within each operating division. In fact our first quarter gross margin percentage was actually 20 basis points better than we had budgeted for the first quarter, based on the expected product sales mix.

We continue to look at operating profit as the best overall measure of bottom line success, and we were certainly pleased to see our hard work pay off this quarter. The strong first quarter sales growth combined with our ongoing cost control efforts, resulted in a 25% improvement in overall operating profit to 17.7% of sales, compared to 17.1% for the same period last year.

I think Jim covered the key balance sheet items in his remarks, so I am going to close by saying that we continue to focus our sales efforts, on finding ways to sell more of our complete product line to existing customers, and increasing sales to large customers, where we have less than acceptable market share. Of course this includes opportunities that continue to develop internationally.

We also continue to focus on development and/or acquisition of new innovative products and test formats, that are complementary to our mission statement. All-in-all it was a very satisfying first quarter, with favorable results especially considering some of the unique and difficult comparisons to last year faced by our Animal Safety group. That concludes our prepared comments for today.

At this time, Rick Current, Neogen's Chief Financial Officer, Jim Herbert, and myself will be happy to answer any questions you may have.

Thank you. [OPERATOR INSTRUCTIONS]. We'll go first to Tony Brenner, Roth Capital Partners.

Thank you, I have two questions. One is you broke out for the total company what the sales increase was, excluding the businesses that you acquired. I'm a little curious about your international sales which were up 28%, how much of that increase represents those acquisitions?

It's actually up, Tony, I will take this, it's Rick Current. They are actually up 38%, and without those international sales there would have been, or without the new products, they would have been up 26%.

Okay. So that the 28% in the release is just Europe?

Tony, let me correct that. They would have been 26% of sales without the new products. They were 38 with the new products.

Okay. So that still represents an increase, right?

Yes.

The second is, I'm a little confused about your share count. One of the reasons for the restatement of last year's fully diluted shares outstanding, and second, why with 8.8 million shares in the fourth quarter, and another 650, you're at such a low share count. Did a bunch of options fall out of the money in this quarter?

No. There are some options are out of the money, but there were some fairly significant option exercises in the quarter. And 123-R, the adoption of that changes the calculations of the fully diluted amounts. So that those, those option amounts will not be the same as they've been historically.

Okay.

There's a different computation, Tony.

Okay. Thank you.

Thank you. Next question will go to Laura Engel at Stonegate Securities. Please go ahead.

Good morning, gentlemen, how are you?

Good morning, Laura.

I was wondering with the new facility and just looking at the results you just posted, especially in the area of R&D, do you expect those costs going forward to remain in that 4 to 5% of revenue range that you've historically shown, or do you expect those to increase based on the additional space? And then can you also give us any examples of what those R&D dollars are going towards these days?

Thanks for the question, Laura. This is Lon. I would say that we do expect our R&D expenses to run, or continue to run anywhere from 4 to 6%, and I think we spend as much as 10% on core product lines, in areas where we think there is significant potential for growth, in terms of new products. And this new facility and the build-out of that, we will be increasing some laboratory spaces particularly for the microorganism area. So we certainly expect to do that.

I will also comment since you asked the question about R&D, and that being down as a percent. That there were some, we've actually increased our staff in both Animal Safety and Food Safety in the R&D area. We are doing more internal development because we know that is important to the future growth of the Company, and last year was kind of unique in another way in the first quarter, in that we did have some expenses in the first quarter both on the Food Safety and Animal Safety side, that went out for either approvals, or to other third-parties, for completion of major projects that we had under way. Okay. So we really are transferring more in-house or doing more work in-house.

I would also I guess take this opportunity to say that one of those approvals, or a lot of those approvals are with third-party, known as the Association of Analytical Chemists, and the Asian corporation has more approvals from that organization than any other company.

I guess the last thing I would be a little hesitant to talk in great detail about some of the things that we have going on from an R&D standpoint, we continue to look at areas that are complementary to our existing business. Obviously we are always looking at ways to improve our tests, to come out with new formats, and to improve the speed of those tests.

Right.

And we are looking at a number of different things on the Animal Safety side, particularly in areas that might be able to allow us to have some products that would fit into the companion animal market, where there are some significant growth opportunities. So that gives you a little bit of an overview of what we are looking at, and what we are doing in the R&D area.

Great. I appreciate it, and again, good quarter.

Our next question will come from Steve O'Neil, Hilliard Lyons, please go ahead.

Good morning, Jim, Rick, Lon, how are you all doing? A couple of housekeeping items. Rick, will restated results be available for fiscal 2006 to reflect stock options?

The statements that are presented do reflect, they are on a restated basis.

I mean for the remaining quarters of 2006?

Oh, will they be available? Yes.

Or do you have a figure for last year's EPS for the full year, if that has that been adjusted for stock options?

I don't have that but I would, the best number I have today is, are the pro formas that are in the Annual Report. And so for '06 for the full year, it was $0.85.

Okay.

Fully diluted. And that's a $0.09, excuse me, a $0.07 reduction from what we reported.

Thank you. And also what was the total contribution, total percentage of revenue from international operations last year? I don't have that figure. You said 38% this year including acquisitions, 26% without acquisitions. What was it a year ago?

For the quarter.

Yes.

I remember, I should remember the quarter I guess, Steve, but I remember the progression has been 25%, 27%, 29% for each of the past three fiscal years, so we would have started off, it's a guess, but it was somewhere probably in that 26% I'm guessing in the first quarter, because international sales built as the year went along, but again, three years ago it was 25% of total revenues, two years ago it was 27%, and in fiscal year '06, it was 29%.

So, and as Rick announced or Lon announced earlier, for the first quarter this year it was 38%. So that's a big jump. That's not to say that the whole year will be that way, but that's what it was for the first quarter.

Also can you elaborate a little bit on the product mix impact on gross margin? Was that something that was caused by the surge in rodenticide sales, or can you elaborate a bit on that?

I don't know that I would characterize it as being a caused by a surge in rodenticide sales. In fact I think in total, rodenticide sales were probably below last year, because of that Prozap product extravaganza, and excess of sales we had last year in the first quarter.

But I think that we have a lot of different products. Neogen doesn't have a single product that represents as much as 5% of our sales. So that mix in any given quarter, depending on the relationship of products that were sold, how much were buy and sell items versus internally manufactured products, does change as much as 2% from quarter to quarter. We look at it look at it primarily compared to our budgets, and we were almost dead-on, I think I indicated a little bit better than we had anticipated, based on that product mix.

So I think we had, I mentioned the shipment, the biologic that went to Sweden last year. That would have been a very a high margin product, and those markets on those shipments to Mexico of rodenticides would have been very high margins, that are going to fall in future quarters this year. So those are two things that would have helped the margin this year.

Steve, one of the other things too, to take into account is that this year's first quarter was penalized a little bit by dairy antibiotic sales, if you remember, we built that inventory in Spain before we moved the business, and it was that inventory that we built in Spain that we worked out of during the entire first quarter, so the gross margins on that product were not as good as they will be, now that we are in our own manufacturing, and those were some significant revenues during the first quarter.

That's a good point. A couple of product notes. You didn't mention the performance of the veterinarian instruments sold through farm retail stores. I am wondering how that did?

It had a good quarter. It was solid. It was up, we are used to seeing strong double-digit growth there. We've had very good orders. We just had a meeting a couple of weeks ago, and we are really starting to see a pick up in orders, particularly from as you know tractor supply is a big customer there, and they were just talking about the increase in orders. As we move into the fall season, and those animals start to get worked, we see a pick up in sales of those, and we are looking forward to a very good year on veterinary instruments.

Lastly, you could discuss the microorganism testing and performance of the culture media? And that's all I have. Thank you.

The culture media business, our dehydrated culture media business continues to grow. It's fit very well in the strategy of that business when we bought it. We are still having a bit of a problem with our pathogen tests. In the total world of microbiology, if you look at that market 100% of the total testing market somewhere in the range of 20 to 25% of the total market potential is for the testing of Listeria, Salmonella, and E Coli. I'm pleased with the product performance.

I think we have made a few good modifications in that product. It was a good product all along, but I think it's an even better product now. The competition is strong out there. We are still wrestling to get our market share back particularly with the E. coli market that's the smallest of the three, but still pretty sizeable.

Our Salmonella business looked very good for the quarter. In fact it was up as I remember some for the quarter, as compared to prior year. But we are still, we are not losing any ground, but we are not gaining ground on the sales of diagnostic test kits for E. coli and Listeria, like I would like to see us do. On the other hand, we are gaining ground in both competitively, as well as that total market grows.

On the total bacteria side of the business, total plate count, total viable count, general microorganism detection that our Food Safety problems, and also food spoilage problems.

So that's one of the things that we are doing with the new building, it has now become I think unofficially referred to as the new center for microbiological excellence. We are in the process of putting in that big 55,000 square feet building. We are in the process of putting in 4 new micro labs, and we are increasing our microbiological staff, increasing our capabilities there. We will be doing some getting a little more room, we will be doing some things that I think are very exciting going forward to, to recapture, and to grow our share of this overall microbiology market. I am hoping that we will get occupancy there. We are building it out with our own crew and subcontractors, and I am hoping that we will be in there by Thanksgiving.

Thank you. Once again, [OPERATOR INSTRUCTIONS]. Amy Stevens, Susquehanna Financial Group.

Yes, good morning, congratulations on the strong quarter.

Thank you.

I just have a few questions. I did drop briefly during the first question, so I apologize if this is redundant. The first question was, in terms of the remainder of this fiscal year, I know you can't comment specifically on your pipeline, et cetera, for competitive reasons, but if you were to think about it in terms of just a number of new product launchings, either or potential approvals or improvements that might be introduced, either broken down between the two main lines of business, or just as a total company, what would be your expectations for the remainder of the year, how should we think about that?

New products that are in the pipeline now? On the Animal Safety side, there's a couple of nice ones that I suspect won't see the cash register by year end. They are going pretty close, but there's some, I'm thinking around three or four new products in the drug testing area that, in the diagnostic side, that are coming along that will begin to come in on a quarter by quarter basis.

We've got over on the Food Safety side a couple of new products there, a new allergy product that will be coming in probably mid-year. Another one that will probably be toward the end of the year. None of them big blockbusters, but will be important. Those, for instance, the allergy side that just helps flesh out our total allergy product line as people continue. We don't have anything for instance, for crustation now. That's not near as big a market as the peanut market would be, for instance, but there is a market out there, and it helps us to have the full product line particularly for those labs that want to test for those.

Probably the biggest opportunity is the potential for our dairy antibiotic test approval. That is in the process to go through FDA, which will eventually give us an FDA and an interstate milk shippers approval. We expect it will we have done the internal laboratory work on it. It will go to the outside labs for validation sometime, probably the first part of next month now. I think there's a distinct possibility that we might have that product ready in the February time zone.

And we won't get to a lot of competitive gain the first week it's out there, but there's a piece of a $10 million market that's available to us here in the U.S., that we can't play in now. So that's in the approval category. I don't know, Lon, I may have left out something.

I would just add to that. Actually I think we may have even released three new drug tests on the Animal Safety side for the racing and/or forensic market in the first quarter. As Jim indicated, some of those kinds of diagnostic tests in terms of market potential are relatively small but they do complement our line, and make us more important to our customers. We probably have as many as 10 or 12 of those scheduled for this year.

I know that there are a couple of approvals that are out there. One for histamine. Another for official methods for Listeria that we are taking a look at, that will help on the micro organism and natural toxin area. We expect to get those this year. Maybe even as early as next quarter.

We also have, I think as many as 3 or 4 new tests that are being worked into that Soleris technology, for the general spoilage organisms that will start being released as early as next month, and then go on throughout the year. It's across the board. We continue to look at new products, ways to enhance the product lines. And I think we have a nice pipeline for the rest of this fiscal year.

Thank you. That's very helpful. In terms of acquisitions, you mentioned obviously it's an ongoing effort. Do you think mostly in terms of potential company acquisitions, or are these products you are looking at, or intellectual property that you are looking at?

I don't know that we differentiate those. We've been successful in buying product lines that were very synergistic, or what I call bolt-ons, and we've done the same thing with companies. We bought a division of UCB, which was kind of an old self-standing division. The Centrus operation we actually bought that company from Eastman, so in both of those cases it was an acquisition of the entire product line, or the entire company.

We look at, when we think about acquisitions we have sort of the three question acid step before we get started and that's, do we know something about the technology? Are we comfortable with the technology that's in use. Second, do we know the marketplace, do we have access to that marketplace? We don't want to, we have enough market opportunities now without trying to invent new ones. So do we have access to that marketplace? And number three, would we be come comfortable in the manufacturing of the product, since it's been our strategy all along, that we are going to make the products that we sell as much as possible. So it could be a product, or it could be a company that fits there.

Okay. Thank you. Then the final question was just in terms of the aflatoxins, your natural toxin testing products, you mentioned that you really, the data is not fully in, in terms of some of these other states. I guess it will be harvesting during the, either just started to or during this quarter. Are those, you mentioned Kansas, Missouri and Nebraska, sort of the first three, is there a possibility that what happened as you described in Texas, would happen there? Or do you actually anticipate at this point, that this should be an increase for you in sales?

I think it's kind of early for me to predict how big the micro toxin problem is going to be. I don't think there is much question, there will be pockets of micro toxin problems, but there won't be crop losses, crop failures. Part of the Texas issue was it just stayed so dry and so hot for so long, that they never really got the corn to mature in a number of places. It was cut early, when they saw what was happening, it was cut early for silage. They went to the dairy operations, or just nothing happened there, but the rest of these states, we don't know of any place where we got real crop failure.

The state of Texas didn't have a crop failure either, but there were some severe pockets where there would have been real aflatoxin problems. One of the things that happens in toxins, particularly in aflatoxin, is there tends to be more testing when there are pockets of the toxins, versus whole counties that were infected, because that means that every truckload of corn that comes in, you don't know where it came from, it could or could not have high levels of one of these micro toxins.

So actually we do better if the problem is spotty, versus being widespread. And these are all major corn states. There is going to be a big corn crop. I think we've all agreed it will probably be a record corn crop this year, so lots of us are going to go to ethanol. We don't know exactly how much of all that is goes to be dehydrated, or wet or dehydrated, millers grain coming from the ethanol plants. It's got to find it's way back into livestock feeds.

It's kind of an interesting thing that's happening out there now with Agriculture. Sometimes maybe in the case of corn, energy is going to get the priority over food. So it will be interesting to watch what happens this year. I am just reluctant to say because, of the complex situation and the earliness of not knowing what that crop looks like, I'm just reticent to say how big of a testing situation that may result in.

So, it's another thing to think about too, is there are going to be places where the crop may be a little bit later coming out of the field. Typically it comes out of the field at a higher moisture level an dried down with using fossil fuel for drying, and they are going to leave the corn in the field, I suspect as long as they can this year, let it dry down naturally to reduce the drying costs, because of the high price of diesel. So it's early to tell. I just ran that out as kind of one of those unusual things that we normally get into about September, trying to figure out what we think is going to happen, and we are a few weeks early to make that prediction.

Okay. Thank you very much. That's all.

Again, follow up from Steve O'Neill, Hilliard Lyons.

Thank you. Just one quick follow up. The $270,000 pretax for stock option expense, where would that appear on the P&L?

It's in administrative expense, Steve.

Thank you.

Once again, [OPERATOR INSTRUCTIONS]. Another question from Kip Hewitt at Healthcare 250. Please go ahead.

Hi, several questions. First we get these things like the spinach crisis, that hit the big headlines frequently. Is anything different in the follow on effect that this may have on your business, that would be different from other periodic crisis of this kind?

Well, and lines pretty close to the spinach deal, closer to it than I am, but I think what we've typically seen is it raises awareness. The first thing that happened when they announced, the announcement came out that there was illnesses associated with the cello bagged spinach, we saw spinach disappear from grocery store shelves, and then it also hit the iceberg lettuce and everything else, that was going on the fresh cut side. Had to reduce some demand there, increase the level of concern by the Dole's, and the other people who were in that marketplace. I think we've typically seen, and we've been through this several times with E. coli on the beef side.

You see some surge in testing as people try to re-establish their benchmarks, as to where they are and then it let's off some, but it always stays at a higher level because of increased awareness. It's an industry that obviously doesn't want to make anybody sick, and they are trying to do everything they can to protect their reputation. Of course, what's happening in the fresh cut fruit and vegetable side now, has got somebody's name on it. A few years ago when it was a case of iceberg lettuce, you didn't have anybody to blame. Now it has somebody's name on it, so people are trying to protect that franchise.

The second question, is there anything going on competitively right now, that you are particularly focused on? And then if so, how are you responding?

I don't think of anything, I mean, we've still got some little rascals out there, and they are still trying to steal part of our market, but I don't know if it's much different than what we had, I haven't see anything new that seems like a bigger threat than we've faced.

I think your revenue guidance for the year has been in the range of 18 to 20%, with this quarter being where it was, are you more confident of being at the high-end of that range?

Well, we don't give revenue guidance.

I'm sorry. I was thinking back to a presentation had you given. Maybe that was looking at you historically.

I think it was historically. We've got several, we think, very competent analysts who look like sometimes look like they are even smarter than we are, so we let them give guidance, and the Company has never offered guidance as to revenues or bottom line.

Here with the food safety increasing quarter over quarter as a percentage of the total revenues, and understandably, this is in part because of what happened in the first quarter of '06 in the Animal Safety, is that, would you say that you are now going to continue to have a higher percentage of your business more in the range of 50%, as opposed to 45% in the Food Safety? Is that mix going to be changing going forward?

I would say if you are, when you are looking at a individual fiscal year like we are in right now, it is I would say, it is probably likely that for this fiscal year, Food Safety will move up to closer to that 50%, or maybe even a little bit over 50% of the total corporate revenues. There is no grand plan or design to make that happen. And in fact they were at that level several years ago, and then depending on growth of particular product lines, and acquisitions we make, that swings back and forth. But it's never gotten very far out of balance from that 50/50 split between Food Safety and Animal Safety.

And I, you may have this in your 10(K) and I just haven't looked but what is the difference in your margin from the Food Safety versus Animal, if you can't put a number just give us a sense of size or relationship of that? Are the food safety margins higher?

In general the food safety margins are higher. Those diagnostic tests particularly, most of which are manufactured inside, carry a better margin. The Animal Safety group, we supplement some of our manufactured product with more proportionately products that compliment the line, that are buy and sell, or what we call buy and sell items, that have more standard, almost distributor type margins on them. So that tends to pull down the Animal Safety side.

We have some Animal Safety products, diagnostics and some other products including rodenticides, and biologicals, that have margins every bit as good as the Food Safety side. But overall the Food Safety margins are higher, and represent a greater percentage of the overall gross margin.

All else being the same that would imply a higher operating margin year over year for '07, unless anything is happening in your other operating costs to offset that. Can you give us some color there in terms of your, whether the sales and marketing as a percent of sales, or your R&D or administrative costs will offset that, or will it be more, will your margins, will your costs as a percent of sales tend to be where they are, or have been historically, so that in fact this higher proportion of Food, would in fact imply a higher margin for the year.

I think my comment there would be to go back to the brief note that I made in the comments, and that is you really need to look at the operating profit line as the best measure of performance, in terms of profitability.

The reason that I say that is, we spend a higher, we do spend a higher percentage of sales and marketing on the Food Safety products, that carry a higher margin and they may support that. You may make up something on the margin line by getting additional overall growth in Food Safety, higher than what we have in Animal Safety, but you tend to lose some of that when you get down to the operating expense area, where sales and marketing and for that matter R&D we spend a little bit more, a higher percentage of the sales dollar to support it. So.

Okay.

We are continually looking at ways to improve gross margins in all areas, and control costs, so we can get that operating profit up as high as we can.

Okay. Great. Thank you very much.

Thank you. Our next question will come from Joe [Potvin] at Wachovia Securities.

Good job, guys, impressive quarter again.

Thanks, Joe.

Jim, I would like to congratulate you on successfully pronouncing, modified retrospective transition method.

I appreciate it, you know. For an old boy that has a mouthful of mush sometimes, I had to practice that two or three times, Joe, before I could get it right.

I new it had some coaching behind it, but it was fabulous. Could you guys please make some comments about this recent incident with the spinach out in California? Again I look at an outbreak like this and just wonder what could these people be thinking, not having an aggressive testing program in place when you are out killing, I mean this is going to cost these guys millions of dollars, and for a little testing, they could have quite possibly avoided it.

Well, thanks for that question, Joe, sometimes we sit around here and scratch our heads wondering the same thing. I think in the past when we've had these kind of outbreaks, as Jim already indicated, to some extent, we do see an increase in awareness. We see people that are on the fence taking a look at putting in quality control, and what we call [have some] plans, to ensure a safer product move over. This becomes the incentive for them to do something.

We have been a member of the United Fresh Produce Association for a lot of years. We will put an ad out on their Website, because a lot of these producers will go out there and take a look at that, and try and see where they might get additional information, and how they can go forward. That has worked for us in the past when there has been outbreaks like this.

We continue to have good relationships with a number of those fresh cut people. This provides again an opportunity for us to talk to them, and encourage them in terms of putting a testing program in, and where we can provide help to get them to do that, and provide a real value that will be economic for them.

And then lastly, I think because of our relationships with independent testing labs, they are going to get some inquiries related to this whole issue, and of course, we've already been talking to a number of them, and they've already asked us, and wanted to make sure that our test will work on that commodity on spinach. It does. We feel good about that.

So we will be working kind of in an indirect route with laboratories, who may start to get some of the samples in. So I think all of this, is just this whole area over concern of Food Safety, it continues to support our efforts, and these kind of outbreaks do increase awareness, and people do over time start testing. Sometimes it's not as fast as what we would like to see, but in the end I think we've got a good reputation with industry, in terms of how we work with them, and it will result in some good new business over time for us.

And Joe, it depends a bit on the industry just a little bit there too, in that, when we still sold spinach in wire-bound wooden cases with nobody's name on it, you could make 200 people sick over 5 states, and nobody would have ever known the difference. Now that it's in a bag, and it has somebody's name on it and it's more easily traceable, and our overall system of food safety has become better. It's probably not that we have got more problems. In fact I continue to believe that our industry is probably safer, but it's easier to identify those problems than it has been.

Of course, the next question is how much testing can you actually do? I think one of the key things of testing, is that you are not going to be able to test every leaf of spinach, or every head of lettuce that goes out, but what they are able to do is be able to determine Best Practices in the testing process, if they find that they treat water in a particular way, or if they change their harvesting method, that they are apt to have less problems, that helps them in the overall management of the business, and they are still trying to learn those things.

So, yes, it's unfortunate we made a lot of people sick, and unfortunately there are going to be some deaths related to it, but I don't think it's because of gross neglect on the part of the industry. They are still trying to figure out what to do. There was no fresh cut industry to speak of five years ago.

Jim, is there any reason to think that this would be isolated to just spinach? This could happen to any fresh cut product in a bag?

Yes. Fruits. We have a lot more fresh cut fruits out there today. It's hard to think about buying apples already cut up instead of cutting your own apples up, but they are being sold that way. I guess there's some question, as to whether they have fully decided it was spinach or not.

One of the concerns is that particularly, I guess California, this is coming from California, California produces I think 70% of the fresh leaf spinach that's consumed in this country. California continues to have a water problem, takes a lot of water to grow green crops like spinach. I can't say what was used in this irrigation water in this particular area, but there is some gray water used in California for irrigation of food crops. Was there gray water here? Did it get through, did it get absorbed?

There are some people who would say that the spinach leaf stem is big enough to absorb organisms. It's been a while since I took Agronomy, I can't remember the molecular size of the holes of the spinach. By themselves as compared to the size of a bacteria, I don't know whether they can get through there or not, but nevertheless, we are still learning a lot about what happened, or what may have happened there. But all of it says that there's a greater awareness of food safety concerns, and there's going to be more testing.

Good job, guys.

We will go next to Peter [Coyle]. Please go ahead.

Yes, good morning, gentlemen. And congratulations on a good quarter.

Thanks Peter.

And I think I will withhold my questions until the Annual Meeting in October. I presume that's when it's coming up, and I will formulate it in a better way, and I think that's perhaps a more appropriate time to ask it. Keep up the good work.

Thanks, Peter.

Thanks, Peter. Thanks for bringing up the Annual Meeting. We certainly want to make sure that we invite all of the listeners on the conference call to the Annual Meeting. It is scheduled for, I believe it's Thursday, October 12, 2006, at 10 a.m. That meeting is held at the University Club of Michigan State University in Lansing, Michigan, and I guess we would encourage you to vote your proxies. I don't think there's any unusual items on the proxy this year, but we would encourage to you vote your proxies, and then come to the Annual Meeting. We will have more opportunity to answer questions and talk to investors.

Mr. Herbert, we have no other questions. I would like to turn the call back over to you for any closing comments, sir.

Well, thank you for your questions. Thank you for your continued interest in the Company. We will look forward to providing you with similar record-breaking results here in another couple of months. Thanks again and good day!

Thank you. That does conclude the call. We do appreciate your participation. At this time, you may disconnect. Thank you.