Neogen Corp (NEOG) 2007 Q2 法說會逐字稿

Good day, everyone, and welcome to the Neogen Corporation second-quarter fiscal year 2007 results conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. James L. Herbert, Chief Executive Officer. Please go ahead.

Good morning and welcome to our regular quarterly conference call for investors and analysts. Today we will be reporting on Neogen's second quarter that ended on November 30 of 2006.

To begin with, I will remind you that some of the statements made here today could be termed as forward-looking statements. These forward-looking statements, of course, are subject to certain risks and uncertainties, and the actual results may differ from those that we discuss today. 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 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 approximately 90 days. Following my comments this morning, we will entertain questions from participant who are joined by this live conference, and I am joined today by Lon Bohannon, Neogen President, and Rick Current, Chief Financial Officer.

Earlier today Neogen issued a press release detailing the results of the second quarter of the 2007 fiscal year which ended on November 30. Once again, we set new quarterly records for the Company for both revenue and income. The Company's revenue for the second quarter increased 22% over the previous year's second quarter to approximately $22.2 million. The second-quarter's net income increased by 25% from the prior year's comparable quarter to approximately $2.4 million.

On a per-share basis, net income for the quarter was $0.26 compared to the prior year's restated $0.23. The year-to-date revenues for the Company's first six months showed a 21% increase to approximately $42.4 million as compared to about $35 million last year. Year-to-date net income for the first six months shows an increase of 23% to about $4.8 million as compared to about $3.9 million in fiscal year '06.

Once again, I am proud of the operational strength throughout Neogen that quarter after quarter is providing this consistent growth. This second quarter was the 55th consecutive profitable quarter from operations for the Company, and it is the 59th quarter in the past 64 in which the Company has shown increased revenues as compared to the previous year. That is a growth record that now spans 16 years.

The results from this second quarter represent a combination of healthy organic growth of our core products along with successful integration and startup of new product lines that we have acquired over this past 12 months.

Looking back last December, we closed the transaction to acquire the dairy antibiotic testing business, successfully relocated those operations from Michigan -- to Michigan from Barcelona, Spain and solidified our distribution system. We managed to accomplish this without back ordering any customers, and in fact, our revenues over the past 12 months from this new product line have been in excess of what we had anticipated at the time we put together our budgets.

We acquired Centrus Inc. from the Eastman Chemical Company last February, and that business is now well along in integration. This provides Neogen access to a large market opportunity and customer base who are interested in detecting spoilage organisms in food, beverage and nutraceutical products. A few weeks ago we closed the office and labs for Centrus that were located in Ann Arbor, Michigan and have successfully incorporated them into a new facility here in Lansing. The Centrus move was a part of an overall consolidation of all of Neogen's microbiology research and technical service groups. They are now a part of five microbiology groups that are located in new laboratories in a building that we acquired last year, and that has been named the Center for Microbiological Excellence.

When we complete staffing this month, we will have 20 microbiologists all in the same facility doing work on micro test kits, improvement and development of new dehydrated culture media products and important group of customer technical service personnel to support these products. This consolidation of personnel, five new laboratories and a much closer coordinated working relationship I am sure will allow us to make competitive strides in the important microbiology area that heretofore have not been possible. In fact, I am so excited about the future developments from this group that I have moved my offices along with the corporate development group into that same building.

In a few minutes, Lon Bohannon will talk more specifically about the performance of our Food Safety and Animal Safety division; however, I would like to make a few comments, general comments, before turning the call over to Lon.

You may have noticed from this morning's press release that our G&A expenses for the first six months of this year have climbed from about 9.5% of revenues up to about 9.8%. A part of this is due to increased legal expenses that we have incurred over the past six months. Unfortunately I guess it is just a matter-of-fact that if you are involved in a business with a high level of intellectual property, you can expect legal expenses to defend those properties.

Neogen is involved in litigation both as a plaintiff and a defendant with respect to certain patents related to its detectable hypodermic needles. While these cases are in the very early stage, both management and our legal counsel believe that the possibility of loss is remote. But, of course, these outcomes can never be totally predictable.

In addition, the Company is involved in some legal activities in the normal course of business, and these expenses also fall into the G&A area. It is the opinion of management that the outcome of these legal matters will not have any material effect on the future results of operations of the Company or its financial position. However, as in the past, we are aggressively defending our legal positions with an outstanding team of attorneys, and this does bring on some added expense.

Other portions of the increase in G&A expenses are attributable to the non-cash amortization of goodwill that is associated with the dairy antibiotic test business and the Centrus acquisition.

Remember also that to meet the new FASB requirements, we now are expensing on a formula basis for stock options. These non-cash costs related to options reduced net income by $425,000 for the first six months.

R&D expenses are up about $200,000 over a year ago for the second quarter but are planned expansion in that we have several outstanding product opportunities that we are pursuing.

Though Lon will talk more about operational specifics, I would like to point out our continued growth of Neogen Europe Limited operations in Scotland. These revenues for the quarter are up 24% and for the first half of the year up 26%. This is a result of our continued penetration in the Food Safety product sales into the UK, Germany, France and other EU countries. A significant portion of this is coming from increased market share, but there is also what I believe to be a substantial new product coming from our R&D activities in Scotland.

There are continued changes that are occurring in Europe in the food loss and for that matter changes throughout the world that we believe bode well for the growth of our markets. Of course, changes can sometimes bring about unwelcome results unless the Company is anticipating and preparing for these. This has certainly been the case with transportation costs throughout all of our operations; however, we have embarked on several transportation cost savings programs in the early part of this year that we believe will help us going forward. It is doubtful that we're going to see any real reduction of transportation costs, but I think this day and time if you're able to stabilize against increases, that is very important.

For those of you that follow the grain market, I'm sure you have seen an almost unprecedented change in what has happened since mid-September. Though the US is producing the third-largest corn crop on record, corn prices have risen about 30% as a result of additional demand for ethanol production. This time a year ago the US had 31 ethanol plants that were dedicated to alternative fuels. As we close the year, I think we have about 120 plants that are online, and 30 more plants that are either under construction are in the final planning stages. This whole issue of grain as fuel versus food is an interesting phenomena that really none of us have ever seen before. I won't spend a lot of time on this conference call this morning elaborating further on that other than to say that these changes I think offer some opportunities for Neogen, and at the same time, we must closely watch the cost of grain, the grains that we consume primarily as a part of our rodenticide production program.

As you may have noted from this morning's press release, Neogen's balance sheet continues to strengthen. We have added about $5 million to our cash position since the first of June, have no long-term debt and a significant unused bank line of credit available to the Company at attractive interest rates. Shareholder equity has also shown a $20 million increase since the beginning of the year.

Neogen continues to be in a good position to add synergistic acquisitions to help fuel our growth. Though we have not announced any acquisitions in the past 10 months, I believed that we're sufficiently far enough along in integrating those earlier ones that I spoke of to start with this morning to be in a position to start to focus on some additional possibilities. We are currently exploring some interesting opportunities. However, I would again caution you to say that none of these might, in fact, actually take place.

It has been a good six months, and I believe that the last six months of the year will offer equally outstanding prospects. We are, by the way, pleased that during the last quarter to have Forbes magazine name Neogen again to its annual list of the 200 Best Small Public Companies in America. This is the fifth time in the last seven years. That Forbes list, by the way, is based on growth in sales, earnings and return on equity for the past five years and then the past 12 months.

Well, let me stop at this point and turn the call over to Lon who is going to talk more specifically about our operations and the future expectations of those.

Thank you, Jim, and welcome to our listeners on the conference call and those participating by Internet access.

Before I make some specific comments pertaining to our performance in Food Safety and Animal Safety, I would again like to just take a moment to recognize the employees of Neogen for their significant contributions to our outstanding second-quarter results.

Neogen's dedicated team of employees do take great pride in providing the best possible service to our customers and make it possible for senior management to report excellent results like those included in this morning's press release. They certainly are deserving of our thanks and appreciation.

I would like to continue our formal presentation by first discussing second-quarter results for the Food Safety division. This group led the second-quarter growth with sales of $11,691,000. This represented an increase of 50% compared to last year. And while the two acquisitions that Jim mentioned earlier contributed a great deal to the overall growth for Food Safety, organic sales increased 11% for this group in the quarter.

Now, as we have discussed before in these conference calls and in presentations to investors, Neogen believes we have the opportunity to grow same-store sales in the range of 9 to 11% annually. Obviously we're achieving the high end of this goal with our Food Safety division.

Jim already commented on the outstanding performance of the Neogen Europe operations that led this organic growth for the Food Safety group. In addition, significant growth was achieved in a number of important product lines within our Lansing Diagnostics and Acumedia groups. Sales of diagnostic test kits for naturally occurring toxins were up a solid 11% in the second quarter and are now up 18% for the year. I think this growth is noteworthy since weather did not impact overall crop conditions as much this year as it did last year when this product line also achieved excellent growth.

Sales of tests to detect aflatoxin and fumonisin led the way, but sales were also higher for (indiscernible) toxins, zearalenone, ochratoxin and histamine test kits. Another important growth area in the second quarter and on a year-to-date basis is Neogen's AccuPoint general sanitation monitoring system. This unique and proprietary product line achieved sales growth of 41% for the quarter, bringing year-to-date sales growth up to 34%. We continue to see some very significant opportunities for the AccuPoint test system throughout many of our market segments, and we expect this core product line to maintain an exceptional growth rate for the remainder of this fiscal year.

Test kit sales for food allergens continued what is now a very consistent double-digit growth record with sales increasing 14% in the second quarter compared to last year. Life test kits for naturally occurring toxins, growth for the allergen test product line was broad-based with peanut, egg, milk, soy and almond test kits all showing growth compared to last year's second quarter.

One other area of growth that is worth pointing out for the Food Safety division, sales of dehydrated culture media achieved exceptional growth in two separate areas. First, sales of media used by Food Safety customers for testing harmful pathogens, including E. coli, salmonella and Listeria increased 33% in the second quarter. Secondly, sales of dehydrated culture media -- what we call the traditional media market, primarily representing (indiscernible) plate manufacturers and customers making human and animal vaccines, were up more than 20% compared to the same quarter last year.

Before I leave Food Safety, I would like to add just a couple of comments to Jim's remarks regarding dairy antibiotics. You know one of the things that we look at when making an acquisition is opportunity for future growth once the acquisition has been integrated into existing operations. We are very pleased that sales for dairy antibiotic tests as near as we can tell are up 15% under Neogen's ownership than achieved in the year prior to our acquisition of this important product line.

In addition, we have now submitted the Beta Star test format for FDA approval to sell in the US and have a chance of obtaining that approval by the end of this fiscal year in May. Gaining access to the very large US dairy antibiotic test market with the Beta Star format and expanding distribution into some key international markets like Mexico provide significant growth opportunities for this product line as we move through the rest of this fiscal year and look forward to fiscal year 2008.

Let's turn our attention now to the Animal Safety division. Second-quarter sales for this group came in at $10,498,000. At first glance this sales total may appear somewhat disappointing since it represents a growth of only 1% compared to last year. However, the Animal Safety group made significant progress in our second quarter, and these results represent a marked improvement over our first quarter when sales actually fell 3% below the prior year.

There were two primary factors that kept this division from reporting even higher sales growth, both of which pertain to unusual events that occurred last year making for a difficult comparison to this year.

First, as we reported in our first-quarter conference call, last year's rodenticide sales were greatly enhanced by a major outbreak of voles in the Pacific Northwest that did not occur this year. The impact of this outbreak contributed to approximately $200,000 of sales shortfall for our ProZap rodenticide in this year's second quarter from last year's artificially high levels. Fortunately the impact of this unusual sales anomaly was concentrated in our first and second quarters last year and is not expected to impact quarters going forward.

The other factor affecting the quarter to quarter comparison for our Animal Safety division was the FDA approval of a unique wound care product at the end of last year's first quarter. Through no fault of ours, this product has been on backorder since Neogen acquired the rights to it as part of the acquisition of certain assets from ConAgra in November of 2003. Once we received the FDA approval to market this product in August of last year, the Animal Safety division experienced significant sales for several months as customers ordered very high quantities to replenish inventory stocks and fill distribution channels. Obviously sales for this product in the second quarter of this year did not come close to the sales for distribution channel fill experienced last year.

Now the difference in product sales for the first six months of this year compared to the same period last year for these two unusual items total more than $1 million. In spite of these two significant comparison hurdles, the Animal Safety group was able to show solid improvement and report second-quarter sales growth as a result of strong performance in many other product lines. Sales of drug test kits for use in the forensic market were up 48% in the second quarter. Sales of Neogen's proprietary K-Blue substrate that is sold to other diagnostic kit manufacturers continues to win market share and achieve growth of 26% compared to the second quarter of the prior year. Sales of biologic vaccines consisting of the high margin [VaxB] and [Xstem] injectable products were up a solid 13% compared to the prior year. Veterinary instrument sales added to its impressive record of strong double-digit growth that now spans several years with growth of 14% in the second quarter. Our OEM disposable needle and syringe sales were up 91% for the quarter and OEM rodenticide product sales increased 63%. On a year-to-date basis, both of these areas have experienced growth of approximately 50%, and significant opportunities have been identified to continue to help drive OEM sales growth going forward.

It is also good to see our international rodenticide sales turn around with significant growth in the second quarter. Some of this sales growth represented timing from orders not placed in the first quarter. Still year-to-date international rodenticide sales are now 25% higher than for the same period last year.

Now because of this solid performance and so many market areas and because the unusual situations that impacted quarterly comparisons should not have a significant effect on future quarters, I continue to be confident that the Animal Safety division will build on that positive momentum established in the second quarter to achieve better sales growth in the quarters ahead.

Before I close today's formal presentation, I would like to make a few comments regarding our overall efforts to reduce costs and improve productivity. You will likely notice that or you would probably likely notice that the second-quarter gross margin was a very strong 52.8%, representing an improvement of 80 basis points over last year's second quarter and an even more impressive improvement of 180 basis points over our first quarter's gross margin of 51%.

Now, as you all know, product mix certainly has a significant impact on Neogen's quarter to quarter gross margin percentage and larger overall sales mix of Food and Animal Safety diagnostic product sales, along with higher sales of biologics certainly helped in improving overall gross margins for the second quarter. However, Neogen is also actively pursuing cost reduction strategies and productivity improvement programs in an attempt to further improve our overall gross margin percentages going forward.

Jim already touched upon some of our efforts in the areas of freight costs and grain supplies for the rodenticide products. In addition to negotiating specific freight contracts, we're looking at warehousing and distribution alternatives to further control and if possible reduce freight expense with the added benefit of improving delivery service for our customers. Neogen also expects to gain operating efficiencies by consolidating our biologics production currently housed in a leased facility in Tampa, Florida into the same building that was just renovated for our microbiology research and technical service groups. This consolidation is expected to be completed before the end of our current fiscal year in May and should start yielding cost benefits immediately upon full integration. We continue to look at opportunities to bring manufacturing in-house what makes clear sense based on cost payback, capacity and manufacturing expertise, and we are also evaluating automated filling and assembly equipment to improve productivity and manufacturing for both Food and Animal Safety. I believe our disciplined approach to aggressively seek out ways to control costs without sacrificing quality will enable us to maintain and hopefully improve our operating margins even in the face of stiff price competition.

Now let me close by saying that we have developed some very good momentum over the first six months in a number of core product lines and markets within our Food Safety and Animal Safety divisions. Significant opportunities have been identified, and we are focused on selling more of our product line to large elite accounts and distributors. We're excited about our future prospects, and we certainly appreciate the support shown to us by our shareholders, analysts and other partners in the investment community.

That concludes our prepared comments for today. Rick Current, Jim Herbert and myself will be happy to entertain questions at this time.

(OPERATOR INSTRUCTIONS). Tony Brenner, Roth Capital Partners.

Two questions. One is, you have outlined a number of businesses, particularly in the Food Safety area, where you have shown some pretty strong gains. But it looks like overall a lot of the growth in that business is occurring in Europe. So I wonder if you can talk about some of the domestic product lines that are declining in the food safety area?

While Lon gathers his thoughts, I'm not sure we've had got anything that is declining. Europe looks good, but remember they are working from a small base too, a smaller base than obviously we are here. I think total sales, organic sales in Food Safety were up, what was it, 12%, Lon, for the -- ?

It was over -- yes, it was almost right at that 11% number that was overall for organic sales for the company. Jim is right. Neogen Europe is certainly from a percentage standpoint showing some very solid growth, but their overall sales volume is much less than what we have got based here in Lansing and with Acumedia combined, and they are showing solid growth as well. So it is pretty broad-based.

I mentioned a number of those product lines -- the AccuPoint product line, the allergens, and Acumedia -- all of which are showing strong growth, and we've just got a lot of things going in the right direction. We don't have any one of our profit centers that are showing declines in sales.

Okay. Fair enough. On the Animal Safety side of the business, I understand that the comparison is affected by the rodenticide situation year-over-year. But, as I recall, your sales increase in the second half of last year was actually bigger than the first-half sales increase, which might imply that it is a tougher comparison for you going forward. Can that Animal Safety business be a 10% topline growth business over the short-term?

Yes, I think we certainly believe that to be the case. I think I have spent a great deal of time in the first-quarter press release and conference call and in this one talking about what I refer to as anomalies. We just had a couple of unusual situations. We have got a lot of things that are moving in the right direction there. I talked about the OEM business. The veterinary instrument business continues to show that 14 to 15% growth range. We have got a couple of new products there. The disposable needles and syringes are doing well. The diagnostics group has been very consistent in terms of being able to turn in growth performance, and we really -- I know that our Animal Safety group believes they can get to those kinds of growth percentages in the quarters ahead.

And we have -- there, Tony, we have got new products that are in the pipeline too that are just -- they are not there. I could not really tell you exactly which quarter they occur, but the pipeline is not empty as far as new products to aid in the Animal Safety growth.

Laura Engel, Stonegate Securities.

On the topic of growth, I have heard a few things mentioned. I guess my first question is, on the Beta Star waiting on the US approval, are there any estimates or can you give us any general guidance based on what you have seen internationally how that will affect your topline once the US approval is given?

Yes, you know we're dealing with the vagaries of governmental approvals, though we are pretty optimistic as I think Lon indicated in his comments. All the early work that has been done there has moved along pretty much on schedule. The results all look pretty good. I think we may be looking at the year-end before we get the final stamp of approval from two different agencies there.

The US market is somewhere in the range of about 12 to $14 million just US only, and we have got two competitors out there that own all of that market now. So it is a matter of how do we -- how rapidly are we able to accumulate some market share. We have got our ideas; I suspect they have theirs. But we do think that there is an opportunity for us to penetrate there.

We are also doing some things that is currently outside of the distribution system where we don't have any distribution in Mexico. We have already begun to open up the Mexico market with establishing what we believe is going to be some solid distribution there. So that is some of the ways that Mexico and Canada in some ways are coat-tailed to what happens in the US, too. So it is kind of hard to say right now.

Right. And as far as continued organic growth, you touched on the ethanol and then you had some of the other comments I was noting based on your press release and in this call on the Animal Safety market. If you had to pick like say your two top two to three growth drivers in the final quarters of the year, where would you say that growth is going to come from?

Help me a bit. Products or markets or -- ?

Products.

Well, I think the microproducts are going to continue to grow. That is the biggest piece of the Food Safety market is those test for microbiological diagnostics, and we continue to be very encouraged. My comment is, it is pretty exciting to be over there and one new -- not new -- old but shiny refurbished building with 20 microbiologists. We are a few short of that right now, but we will add 20 pretty quick. They are all working together in the same concerted effort, and that is the big piece of the market, the total (indiscernible) of market share. So I think we will see some growth there both as a result of what we're doing for spoilage bacteria, as well as for pathogens. Our dehydrated culture media business continues to grow as we broadened the niche that we're working in there. So that piece will grow.

I think the things that we're doing over on the Animal Safety side we have really been able to grow -- our guys have really been able to grow what we're doing in the syringe and needle business. We are -- Lon mentioned the OEM supply. We are a supplier now to a couple of the major animal health companies who are supplying syringes and needles along with the vaccine, and that business is growing. We think that that looks good.

The other one that I guess I should make sure when we talk about microbiology that we also not fail to talk about what is happening with AccuPoint. Our AccuPoint business for the detection of proper sanitation Lon announced had grown I think 41% for the quarter, which that is starting off of a pretty decent base to start with. We see that growing. We see that growing in terms of our gain of competitive share, but we also see those markets growing. We picked up -- over the course of the past quarter, we picked up a couple of major grocery stores that are concerned, or grocery chains, that are concerned about proper sanitation in their delicatessen area. Some of those delicatessen areas look like small food manufacturing plants now. Also, in the press fresh produce area, places where they are displaying fresh meats and produce and seafood. So the AccuPoint productline we think bodes well for us is the momentum it has now that should continue to carry on through this next six months.

Okay. Well, I appreciate your time, and congratulations on the quarter.

Well, thank you.

Steve O'Neil, Hilliard Lyons.

A couple of housekeeping items. Lon, you talked about the veterinary instruments. You referred to performance of the OEM products such as disposable syringes, and I did not get how much you said that was up?

Well, those percentages are really significant. On the -- 91% for OEM in disposable needles and syringes, a couple doing work on private labels with a couple of very major animal health firms, and then the rodenticide OEM business is also up 60%-some. Year-to-date both of them are up around 50% for the year. Fortunately we continue to see some very good opportunities out there going forward. One of the areas that Jim mentioned certainly we would expect to continue to be a driver in sales over the rest of this year.

Okay. And when you're referring to veterinary instruments being up 14%, can you talk a little bit about the sales through farm retail stores and then I guess the rest of the OTC veterinary instruments?

Yes, we continue to make inroads in that farm retail store market. It continues to lead the growth. We still have other opportunities out there in that retail market to get more of our productline into those stores. Of course, you have heard us say before we're the primary instrument supplier to tractor supply. I can hardly keep track with how fast they are growing in terms of how many stores. I don't know if they are up to 600 yet or not, but they are well over 550 I think. I think they were around 300 when we started doing work with them. Of course, that brings other opportunities for us. Once you can get in there with a major productline, then you can start looking at line reviews for other of our animal health products and rodenticides. So that represents clearly a focus area for us going forward, and we have got some new products there that helped that growth.

But we had a good year so far with what you indicated on the OTC market with things like the old standard needle extractors, and we had a great program for that, and it looks like that is going to be a good year. So it is really broad-based in terms of vet instruments.

One last kind of small item. You referred to forensic drug testing being up 48%. I'm wondering there has been some move towards testing in the Thoroughbred racing industry for EPO. And I wondered now is that considered part of the forensic testing, or would that be a different area?

It would not be considered part of the forensic area. The drug testing that we do on Animal Safety is in two primary markets. One is in what we call that racing industry. There is a concern about that product. We have got a test for that and have seen some growth with that product in that particular market selling to those racing jurisdiction labs where they do the testing of the racing animals. That is separate from the forensic market. We like that racing market. It has got great margins on the diagnostic tests; it is just not growing very fast. So where we are getting our growth in terms of drug tests is in the forensic market.

Okay.

Same test, Steve. Just a different market for them.

Okay. Can you comment a little bit on the microorganism testing such as E. coli and products such as those, and then I guess also as a follow-up, have you seen any positive impact from some of the E. coli outbreaks?

In terms of the E. coli outbreaks, we have seen some increase. The two market segment groups that have really benefited from this has been the commercial lab group and then secondarily our fruit and vegetable group. A lot of these producers and growers do not do their own testing in-house. They send their samples out to labs.

Interestingly, in terms of E. coli, our eight-hour and 20-hour systems, we have seen some increases up to four times what the orders were last year and not just based in areas like Arizona and California. We have also seen increases in sales to labs in Chicago and New York, Atlanta, Dallas and San Antonio, places like that. So we have seen some growth in there.

The fruit and vegetable group, of course, is assigned the responsibility of selling direct to the fresh-cut producers and processors. They too are -- even though I said before a lot of those guys like to send their samples out to labs for third-party validation, we are seeing some increase focus on trying to get some products in as I guess what we described within our own sales group as a front line of defense. And just as an example, our AccuPoint hygiene monitoring system in that particular group is up 200% compared to last year.

So we are seeing that. I think that whole industry is still trying to find out how to best deal with this problem, and I think that we will continue to be part of that overall process. We have also to try to help in that area have come out with a fresh-cut safety testing guide that we can supply to that industry, and we will be sending that out and working with them to see and help them use our products to help control that problem.

Lon, just kind of continuing that, if you exclude AccuPoint sales from microorganism testings, and I know this is a competitive market, were sales up, down, flat in that business excluding AccuPoint just to kind of get an idea of how it is performing?

You really have a number of different areas there. Jim mentioned the general spoilage organism in the micro area for general E. coli, total viable counts. That is clearly up. The portion of the media that we sell that is used for specific pathogen testing is clearly up and is growing. I would say that the Reveal Rapid Diagnostic Test System is off a little bit from previous years. I think that is really more maybe an indication of where that industry is going in terms of running more samples and looking at automation and also looking at more in the area of D&A based testing.

Now fortunately we have got a product there with our GeneQuence productline where we can gain access to that market, and I think we're making some progress there. We need to get a couple of approvals for some of those products, and then we will be able to be a more major player in that side of that business.

Thank you now and I will leave you. I had one last question. This is just kind of more for Jim just to see if he would have any comment on the recent activities that 3M has been making in this business. They have acquired Biotrace, which had a product used to distribute, and they formed a collaboration with a company called Gen-Probe, which actually your GeneQuence comment could lead into that because I think they have built some DNA testing for detecting pathogens. I know 3M has a product called Petrifilm, and maybe you can refresh my memory on how it differs from yours. But I would be curious to just hear your comments in general about their activities in Food Safety which they designated as a growth area?

Well, we know the guys at 3M. We do a little business together. In fact, back and forth they -- we buy a little Petrifilm from them, and we sell them a little media along the way. But my note back to the senior guys at 3M when they announced the acquisition was congratulations and welcome aboard, and we think you will help add stability to the business.

We have not -- when we look at major multinationals, they tend to be good competitors if there is such an animal. And as far as price cutting and unorthodox movements in the marketplace, we have known the guys at Biotrace for a lot of years, and we think that their purchase at Biotrace, frankly, is not upsetting to us. We know that 3M is out there. They are a good competitor in the market, and I think they do bring some stability to it, and I think we won't see the price cutting and price erosion and margin erosions that we have seen in the past.

Secondly, I guess we also are kind of pleased to see them make a move with the Gen-Probe group in that tends to validate our belief on what the best way to go about DNA/RNA testing would be is we have approached it from the standpoint of the same approach that Gen-Probe has used over time.

In fact, there was before we bought the current productline from the former owners, there was a long protracted legal activities in which both sides spent millions and millions of dollars and ended up deciding to cross-license each other. So the Gen-Probe technology is essentially the same approach as our GENE-TRAK, GeneQuence technology. And so I think that helps to authenticate, if you will, that being a good solid approach as compared to the more problematic other areas that some people are using in an effort to try to detect the DNA/RNA side of the diagnostic.

So it was not a surprise. The 3M move was not a surprise, and we are going to always have competitors, so this is a competitor that I think does add stability to the market and certainly does not cause us to have any fear about what is happening but causes us to perhaps look at the market a little different.

Amy Stevens, Susquehanna Financial.

Good morning and congratulations on the quarter. Just a few questions. You talked a little bit about the E. coli outbreaks and what impact that has said and some of the grocery chains trying to address some of those concerns and picking up some of the grocery chains. Do you think that the result of the national focus on importance of Food Safety testing will be addressed more on the private side by grocery chains concerned whether they are about liability or bad press, if you will, or will there also be a legislative aspect to that as well? Do you see any increase in that kind of activity going on right now?

Well, I will let Lon add to this, but we do have a change in leadership in the Congress this year. There does tend to be more passage of rules and laws under Democratic leadership than there is under Republican leadership. However, the legislative process is long and protracted, so anything that happens there is not apt to take effect any time within the near future. I'm sure that there will be more concern in the Congress as it relates to Food Safety, not just because of a change in the control, but because of the additional publicity and as we get a better handle on what kind of Food Safety problems we really have.

But I think you probably hit the nail on the head a bit better when you started out to say people are protecting their own name and protecting their own franchise. We get daily reports from around the country of outbreaks here and there that most of them don't make the national press, but when you get major chains that have outlets in four or five cities that all of a sudden had to close down because the health department found that they had a problem and they made 300 people sick, it is sort of a more grass-roots concern.

So yes, I do believe that there will continue to be more pressure added for more testing for safe food. Now whether that pressure is pushed from the retailer back to the processor, I'm sure a lot of that is going to take place which is going to require the processor to do more testing versus the retailer himself trying to do that testing. The retail testing side is where our AccuPoint product fits well because it is not protracted. Anybody can use it. It is a matter of taking a swab sample, putting it in the machine, and less than a minute you have got results and you know whether the surface clean or dirty. That is probably about the extent that the retail side needs to be working on. But I think I said in my comments I think we're going to see not only an increase in regulations on a worldwide basis, but the increase in concern from those people who are feeding the world's population.

Well, you alluded to that in your comments in the beginning right about the international food laws in Europe in particular. I wanted to ask you about that. You have a sense of how the US political environment shifting, but what is the sentiment in Europe right now in terms of Food Safety laws? What are those changes you are alluding to?

Well, they are tending, one, to look at tighter regulations, less tolerance levels, particularly in the natural toxins in the plant chemical side and the drug residue sides. They are also -- and that is spreading even over into Asia. They also are I think probably by necessity changing a bit their attitude on genetically modified plant material. It is coming slowly, but whereas they were objecting to the use of any GMO-based products in parts of Europe, they have become a bit more tolerant there, which we think opens a big door going forward for more genetic modification in plant material for output traits. Those output traits, meaning it is important to you and I as a consumer to be able to buy a product that has higher levels of the right amino acids or whatever in it. So we think the changes there could be less stringent even in some areas that will allow the growth of the GMO side of business, whereas they are going to be more stringent as it relates to the pathogens.

Okay, that makes sense. And you also talked a little bit in the beginning about the legal, the trial regarding the detectable hypodermic needles and how that had the contributed to your legal expenses. In terms of -- you said it is in the early stages. In terms of how you expect the timeline to progress over the next year or so in how those costs will be incurred, do you have any sense of when they might increase or when trials -- when legal expenses might heat up even from where they already are?

Well, of course, what I would like to do is to the guys on the other side to throw in the towel and we can stop all of this. But they are a bit galvanized perhaps to do that quite yet. I think we're probably in the heat of the expenses right now. We expect sometime over the course of the next six months both of these cases to probably go to trial. The same legal team is essentially working on both cases, so we get more bang for our buck I guess if you will in that we're better prepared to handle both of them.

Okay. So you feel like you are pretty much at the high-level right now?

Yes.

[Joe Putnam], Wachovia Securities.

Great quarter, guys. I have four questions. Let me just run them by you quick and I will listen.

In the report that I pulled off the system that I'm looking at at the bottom, it says the recent addition of major food retailers as AccuPoint customers bolstered product sales. Are you at liberty to say who that is? If so, who is it?

The second question, is there any pathogen concern for ethanol manufacturers? And kind of related to that, does the price increase in corn that we have seen create a situation where more bad corn is being pushed out into the marketplace?

The third question, the Ted Doan estate I assume is in the process of settling. Any foreseeable impact from any stock that Mr. Doan held?

Lastly, is there a gross margin breakdown between Food Safety and Animal Safety, and will you disclose it? That is it.

Okay, that was a lot of questions. Thank you. In terms of the major retailers, I will handle a couple of these. In terms of the major retailers for the AccuPoint line, we really have -- our major customers really prefer that we not name specific names in these conference calls unless we think that it is so important that we ought to do it, and we specifically ask them like Tractor Supply with the veterinary instruments. They would prefer that we not do that.

Jim alluded to the fact you've got some major retailers there in terms of grocery stores that are taking a look at this. We have got some large, very large beverage companies, that have employed this AccuPoint system and are taking a look at it, and I guess I would leave it at that in terms of the comment related to those. Obviously they are the size of companies that would be well recognized and represent significant opportunities, and that is kind of why we're excited about that productline going forward.

In terms of the gross margins related to Food Safety and Animal Safety, that is another area where we have been hesitant from a competitive standpoint to get down to the specifics on that. I mean you are aware that overall in general the Food Safety diagnostic tests have better gross margins than some of the Animal Safety rodenticides and veterinary instruments. But we have got -- overall we're working on ways to bring up the gross margins on the Animal Safety side and looking at ways to further enhance the gross margins on the Food Safety side so that overall we can consistently report gross margins in excess of 50%, 53%, like we did this particular quarter. That is where we are at today, and we're just looking at ways to strengthen our productivity to maintain and improve those, and we are going to continue to do that on both sides of the business.

To add on to what Lon said about the gross margins, remember we still look at operating margins. Whereas our gross margins are clearly less on the Animal Safety side than the Food Safety side, but we also spend considerably less percentage of total revenue on sales and marketing. We're able to get those products into the marketplace at less sales and marketing expense. Plus, the research and development cost is considerably less on the Animal Safety products as a whole as compared to the Food Safety products. So again, I like to look at the business from the operating profit standpoint more so than the gross margin, though I know the whole world likes to look at gross margin.

Picking up on the pathogen possibilities and what is happening at ethanol, Joe, I think one, yes, there is the possibility of some pathogen tests. There is some possibility of what happens with dehydrated -- with distillers dried grains. You know, when you make -- a bushel of corn makes about 2.8 gallons of ethanol and leaves behind distillers dried grain, which has some feed value for animal feed. So the testing of that distillers dried grain is important. The testing of the ethanol is we don't know any reason why you need to test it, but the distillers dried grain is important. So there are some testing opportunities there.

Yes, one would think that, and I think we will eventually see this, is this whole grain for food versus fuel gets some kind of equilibrium. We will see that the poor quality grain goes into ethanol production where we keep the higher quality grain to go into human foods and animal feed. Right now that is not the case because they want to try to hold up the value of those distillers dried grains. But you know as an example high aflatoxin corn, there's no reason why not to put that in a fermentor and make ethanol out of it rather than trying to push it into the food chain or the animal feed chain. That means that the distillers dried grain will have less value on the other end, but that is where that kind of product ought to be going. If that happens and I think it will as we strive toward this equilibrium, then we will see more reason to test because the segregated grain crop of that is going to go for fermentation versus otherwise.

So I do think that -- we think we're pretty close to what is happening there. The Ted Doan estate, I think most of you on the conference call know that Ted was a member of this board and a close friend for a lot of years and passed on in May. He was one of the two largest shareholders in the Company and held about 380,000 shares at the time of his death. The estate said in the very beginning when we and when we maintained continual contact with the family and the estate since Ted's death, that based on what they felt they needed to do with the estate that they needed to liquidate that position. And as of a couple of weeks ago, that position has been orderly liquidated in the marketplace. I think they have got 4000 or 5000 shares left. So all of those shares have gone, and anybody who has followed the market, the market absorbed them in an orderly fashion I think. There is no (indiscernible).

And I still on?

Yes.

You know I think just as a comment, Ted was such a good friend to the Company and certainly will be sorely missed.

Ted was a good friend. He left behind a good legacy. So we appreciate that and have a building named after him.

[Arthur Hall], [Laring Associates].

Could you just quickly go over your operations and activities in Asia and the opportunities there?

Lon talked specifically about China. But we continue -- and if we throw Asia and the Pacific Rim in together and we continue to I guess move along in Japan, we kind of hold our own there, pick up a little bit of business from time to time, a little increase in business, Japan is a difficult market certainly, at least difficult for us. We think there is growth opportunities, but that growth takes time, and we think we're properly positioned for that.

What is happening in Southeast Asia? You know, as there is more movement toward what is happening in Thailand and that cluster of countries, they are supplying food back to Japan. That I don't think has slowed up a lot. We're continuing to see a lot of shrimp production, seafood production, coming out of Thailand. We're seeing fresh vegetable production coming out of Thailand going into the more developed Asian markets such as Japan. We think that we are in a good position. We see that growing.

China continues to be -- and I will shut up and let Lon handle that because Lon talks to China on a minimum of once a week and is over there I think every three or four months, so he is the Company's expert on China. But remember in China we are both an importer as well as an exporter to China, which has been helpful to us. Lon?

Just a follow-up on the Asia Pacific Rim, that particular sales group has done very well this year, and from a Food Safety standpoint, it is the top performing international group in terms of sales growth. So we've got a very solid year just in general in the Asia Pacific Rim with a number of products.

I think overall since you have asked the question that is kind of international related, overall our international sales represented about 37% if I remember right, Rick, of total revenues for the quarter. If you take out -- a lot of people ask, well what about, you know you got the dairy antibiotics that came in and has got a lot of international business. If you take that out, it was said 29% this year compared to 26% last year. So we are continuing to see growth internationally.

As it relates to China specifically, probably our sourcing of product over there continues to be more important to the Company than the markets that have developed over there so far for our products although we are seeing progress there particularly in the areas of Acumedia or the dehydrated culture media product and the AccuPoint general sanitation system. Both of those are getting a lot of interest right now. We're pretty much on target in terms of our budgets for sales in China. It is just taking a lot longer for that infrastructure to develop over there.

But China is a very good source of product for both Food Safety and the Animal Safety, and we certainly are not putting a lot of dollars over there that is hurting our bottom line as we grow our sales over there.

Great. Thanks.

(OPERATOR INSTRUCTIONS). Jeremy Steele, Lansing State Journal.

I'm wondering how much considering that now you have got folks in your Center for Microbiologic Excellence, it sounds like some more folks maybe moving in up from Florida, how much extra capacity you have got in your facilities here in Lansing for either organic growth in the future or to absorb future consolidations?

That last building we are in the process of remodeling was about a 55,000 square foot building. It is in three floors. We have totally occupied one floor with the microbiology unit and administrative offices. The first floor we will have it totally occupied before year-end as we move the Tampa operations in there, as well as expansion of some of the other things that we're doing. So we will have two-thirds of that space filled.

The upper one-third of it is unspoken for at the moment. So we've got about a third of that space left. And we moved a few people out of some of the other buildings which are here on this campus, which is helping us a little bit. We had a few people kind of wedged in some or at least they thought they were, and so we're getting probably (indiscernible) six to 10 desk space around. So we have still got a little bit of growing room left, but we don't have a lot of excess capacity certainly.

Having no further questions, Mr. James Herbert, I would like to turn the conference back over to you for any additional or closing comments.

Well, we thank you for the participation in the morning's call, and we feel very good about where we are going. I think beyond all of the progress that we reported today what has taken place and occurred here over the first six months of this year is we have refocused a bit on our overall senior management program and added another -- begun to add another layer to help with the growth with the people like Ed Bradley and Terri Morrical as they are building their staffs both on the Food and Animal Safety side. Of course, Lon has done just the tremendous job that everybody expected, so that is hardly noteworthy because that was what we expected anyway. So we're moving along, and I feel like from the standpoint of having a great organization to continue to keep this 16-year growth trend growing, I feel like it is in good hands.

So thank you for your participation this morning, and we look forward to talking with you when we have the next major announcement. Good day.

This does conclude today's conference. Thank you for your participation. You may now disconnect.