Neogen Corp (NEOG) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to Neogen Corporation third-quarter earnings 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, Neogen Chairman and CEO. Please go ahead, sir.

Well, 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 30th of 2007.

I will remind you that some of the statements that we make here today could be termed as forward-looking statements. These forward-looking statements of course are subject to certain risks and uncertainties. The actual results may differ from those that we discuss today. These risks that are associated with our business are covered in part in the Company's Form 10-K as filed with the Securities and Exchange Commission.

In addition to those of you who are joining us today by live telephone conference, I'd also welcome those who may be joined by way of simulcast on the World Wide Web; that number seems to grow more and more each quarter.

These comments along with some exhibits will be available on the Web for approximately 90 days. Following our comments this morning, we'll entertain questions from participants who are joined by this live conference, and I'm joined today by Lon Bohannon, Neogen's President, and Rick Current, our CFO.

Earlier today, Neogen issued a press release that detailed the results of the second quarter of the Company's 2008 fiscal year, which ended on November 30th. I believe that it is reasonable to characterize this as another great quarter for the Company in terms of both revenues and income. Neogen's net income for the quarter, the second quarter, increased 34% from the previous year's second quarter to over 3.2 million. Adjusted for that 3-for-2 stock split that was effective earlier in the year, net income for the quarter rose to $0.22 per share compared to last year's $0.17. Neogen's second-quarter revenues increased 23% from the prior year to $27.2 million; this was also a record quarter.

On a year-to-date basis for the first six months, Neogen's net income increased 30% to over $6.2 million compared to $4.8 million in fiscal '07. This brings our earnings per share for the first half of the year to $0.42, and that compares with $0.34 for the same period last year.

Revenues for the first two quarters were up 18% compared to last year's first half and now total approximately $50.1 million. Though we don't normally give guidance to the marketplace, we did say at the beginning of this year that we thought 2008 would be the year that the Company would move over the $100 million mark in total revenues, and as you can see we are on track to get that done because of what we've gotten done here in this first six months.

All of us at Neogen continue to take pride in the Company's consistent revenue and profit growth. This quarter marks the 59th consecutive profitable quarter for the Company and the 63rd quarter in the last 68 in which we've shown revenue increases compared to the previous year. This record now spans 17 years.

For some time it's been the Company's goal to grow revenues at the rate of 20% annually. Rick Current's update shows that we are almost achieving that goal with a compound annual growth of 19% for the past 15 years.

Our achievements in both the Food Safety and the Animal Safety areas in the past quarter were gratifying. Lon Bohannon will report more on those specifics in a few moments. However, I'd like to cover a few of the highlights of this second quarter.

Gross margins for the quarter continued to be solid at over 52%, and on a year-to-date basis for the first six months these margins have increased to 52.8% as compared to 51.9% a year ago. Of course we've always told investors that our Company is best judged by its operating profits, since gross margins are only a portion of that story. Those operating margins were up solidly for the quarter, and for the first six months, they now stand at 18.6% as compared to 17.2% for the first six months last year.

Sales and marketing expense as a percent of revenue decreased in both the quarter and on a year-to-date basis and for the first half of the year, are almost a full percent below where they were in the prior year, at approximately 20.2%. That's of total revenues.

Now, having said that, I should also point out that we've invested approximately $1.2 million more in sales and marketing this six months than the year earlier, and we'll continue to make sound investments in this area. We believe that our strong sales and marketing program has given us a competitive edge in a number of our activities.

G&A expenses were still a bit higher than I like to see them, totaling about 10.4% of revenues for the first half of the year, and that compares with 9.8% last year. Part of this increase is due to staffing, some higher costs attributable to stock options and legal expenses. We should begin to see some significant decreases in legal expenses as we move through the last half of the year, since we settled some legal challenges recently.

Sales in our international area continued their steady growth. For the first half of the year revenues from international sources were up 22% compared to the prior year, and for this past quarter they accounted for 38% of the Company's total revenues. This international growth continues to be led by our Neogen Europe Ltd. operations in Scotland that serves as our strategic doorway to the European Union. Their sales for the six months are up about 38% compared to last year, and I think it's even more important to note that their net income for the first half of the year has already exceeded last year's full year.

I can also give you a quick update on acquisitions that have occurred during this first six months. You'll remember that at the very tail end of the first quarter we acquired the assets of Kane Enterprises, a South Dakota-based manufacturer and marketer of animal safety products. During the four months since that acquisition we've relocated those assets to our already existing facilities in Kentucky, and I believe have the business pretty well integrated.

At the beginning of December, we announced that we had acquired the assets of Rivard Instruments, a Canadian company that was involved in the manufacturing and marketing of detectable hypodermic needles. This acquisition brought to an end a long and hard-fought and expensive series of litigation in both Canada and the U.S. regarding conflicting patents. Those legal expenses should now be essentially behind us. Furthermore, this collection of patents that are held by the two companies put us in a very strong position not only in the U.S. and Canada, but in several other important international markets such as France and Denmark.

I spent a week in Europe in mid-December to get our arms around those European opportunities, and can tell you that I came away very encouraged. This acquisition won't give us any substantial revenue increases in the next couple of quarters, but it will help us solidify our position as I believe the dominant manufacturer of detectable hypodermic needles.

Just as other portions of food safety has grown, there has been more and more concern about the possibilities of broken hypodermic needles remaining in an animal and finding its way to a consumer's table in a cut of meat.

Our progress has not gone unnoticed in the financial markets during this six months. During this past quarter, Forbes Magazine named Neogen for the third year in a row to its annual list of the 200 Best Small Public Companies in America. And this, by the way, is the sixth time that we've received that recognition in the past eight years.

Our progress has been at least partially reflected in the Company's stock price. Taking into account the stock dividend at December 31, 2007, the stock price was 79% ahead of the prior December.

Since our last conference call we held the Annual Meeting of Shareholders in early October, and I can report to you that all of the proposals from the Board of Directors were adopted by shareholders, including the reelection of Jack Parnell and Bob Book as directors for another three years, and officially bringing on board Dr. Clayton Yeutter as a new director. I think our shareholders should certainly take conference in directors such as these who have tremendous experience in food and agriculture and also understand Neogen's business.

In concluding my comments, I will have to admit that we are fortunate, I believe, in operating in a business climate such as the food and animal safety area. A recent independent study indicates that markets for our products are increasing about 6% annually and are expected to do so over the next three years. You know, obviously, we are proud that we are in a growing market but we're also proud that we can grow revenues at over 20% when the overall market is growing at 6%. It's nice to be producing products that have a good demand.

Our growth and our strength also bode well for our opportunities on the acquisition front. Though we don't currently have any letters of intent in place, there are several interesting possibilities that could be synergistic to our business, and it's also helpful to be sitting on over $10 million in cash, be generating cash on a monthly basis, and have very significant unused lines of credit.

I need to quit basking in all of these accomplishments and let Lon Bohannon, Neogen's President and Chief operating Officer, tell you more of the details about how he and his team succeeded in these accomplishments and more importantly, how he is looking at the last half of the year. Lon?

Thank you, Jim, and let me take a moment to wish all of our listeners a very happy and prosperous new year. As Jim commented earlier, for those of you who bought Neogen stock at anytime during the past twelve months or were fortunate enough to own Neogen stock for all of the last 12 months, 2007 was indeed a very prosperous year.

You can be assured that management will certainly endeavor to do everything in our power to continue our consistent and strong growth record as we finish out our 2008 fiscal year.

Let me take a few moments to expand somewhat on our second-quarter performance for each of their two operating divisions before turning my attention to ongoing cost-control initiatives and future opportunities.

Looking first at our Animal Safety Division, the second quarter was filled with a lot of success as we expanded sales to many of the largest animal health distributors, and as we continued to work on implementing programs to improve overall gross margins on key product lines. As Jim said, overall, the Animal Safety group had a terrific quarter as sales surged 21% over the same quarter last year. This strong second-quarter performance brought our sales on a year-to-date basis and the increase for this division to a very respectable 13%.

The Kane Enterprises acquisition did contribute significantly to the outstanding second-quarter sales growth and sales for this new group of products actually exceeded our second-quarter pro forma budget.

In addition, our Lexington division, which is the largest of our animal safety profit centers, achieved 10% organic growth in the second quarter, led by strong sales of veterinary instruments, including the launch of new hard packed syringes and needles, and strong growth in specialty products sold to large animal health firms. I think it was also very satisfying to see a 23% increase in sales of what we call ethical products, including particularly strong sales growth of products servicing the companion animal market. I think as we look ahead, we plan to develop more products for this important and growing segment of the animal safety industry.

Looking at Hacco for a moment, sales of rodenticides and disinfectants were sluggish for the second consecutive quarter, with sales falling approximately 4% below the prior year. Now as I commented in the first quarter, I do not believe we've lost any significant market share to competition. I continue to believe that this year's mild fall weather throughout much of the country resulted in far fewer rodent infestation problems that have negatively affected our rodenticides sales for the first six months.

I think the fact that our international business for rodenticides increased significantly in the quarter and is now ahead of last year for our first six months, does give some comfort that our overall sales activity in this area are still effective. But we are keeping a close eye on this area.

We will be introducing new bait stations and we have entered into a new distribution agreement aimed at the large Western agronomics market. We recently introduced a new packaging design; we have added two dedicated sales managers, and we continue to expand our portfolio of international rodenticide registrations to support and expand future sales of this important rodenticide and disinfectant product line.

Switching to the food safety, the performance of our Food Safety Division in the second quarter was nothing short of outstanding. This division completed the quarter with growth of 24%, which becomes even more impressive considering that all of this increase is same-store sales growth.

Those of you who have followed Neogen for some years know that we have set a goal for ourselves of trying to achieve somewhere around 10% organic sales growth, and the Food Safety Division has been far exceeding that objective for our last four quarters. On a year-to-date basis now organic sales growth for this division stands at 22%.

Once again, this growth was very broad based in the second quarter with sales increases coming from many segments and many product lines. We had increases in 12 of 15 market segments ranging from 4% to 44%. In two of those segments where we experienced shortfalls compared to the prior year, we really don't have any dedicated sales personnel, which is something we may need to look at in the quarters ahead.

Likewise, increase in food safety product sales for the quarter were very encouraging, with sales more than doubling for a specific product like our Reveal DON test, due to particularly strong demand in Europe.

Our broad product lines, including tests for microorganisms, general sanitation, dairy antibiotic residues, food allergens, natural toxins and dehydrated culture media, all achieved increases compared to last year's second quarter ranging from 5% to over 40%.

So, with all this good news, what's keeping me awake at night? Well, we do have some challenges to keep life interesting and I guess in some cases provide job security for some of us here at Neogen. First and foremost is what is happening to petroleum and commodity grain prices that skyrocketed in 2007. Of course, increases in petroleum ultimately results in increases in plastics, packaging, film and other components for many of our products, and a significant increase in grain prices has been largely the result of so much corn being diverted to ethanol production.

Now, these increases in petroleum-based products and commodity grain prices definitely have an impact on our costs, but they do sometimes represent somewhat of a double-edged sword as I will elaborate on a little bit later. The higher grain prices definitely increased the cost of our rodenticides, since grains represent the single largest ingredient costs in those products.

Higher grain prices also put a lot of pressure on many important customers in the food animal production markets that purchase a great many veterinary instruments from Neogen. Of course price increases in petroleum-based components impact many of our products and occasionally place us in the unenviable position of having to raise prices to maintain satisfactory operating margins. Now obviously as more suppliers attempt to pass along cost increases, greater pressure is placed on our buyers to find alternative sources and better prices without sacrificing quality.

More recently, we are experiencing a worldwide shortage in casein and several other peptones that are important in the manufacturing of dehydrated culture media. In some cases prices have risen as much as 25 to 50%, and some of these ingredients are just difficult to obtain at any cost.

Now, the danger of pointing out challenges like these in a conference call with investors and analysts is that, in doing so, I raise undue concerns among our best and most important supporters. Let me assure you that that is the last thing I want to do, and I certainly don't want to appear pessimistic at all. In fact, exactly the opposite is true, and I'm very encouraged about the remainder of our 2008 fiscal year and in general, Neogen's future.

For example, I mentioned earlier that the ethanol issue was a double-edged sword. On the positive side, we have now sold more mycotoxin diagnostic test kits to the ethanol producers in our first six months this year than we did in all of fiscal year 2007. I believe we have also identified additional new prospects as more of these ethanol plants come online and we can further expand our sales to this industry in the quarters and the years ahead with some new products and some new formats of existing products.

And although prices have increased in several areas, affecting our cost of goods sold, we believe we will be able to selectively pass along price increases to our customers to help maintain the strong operating margins we currently enjoy. We also believe the risk of losing business is minimized in many cases because of our quality products and the superior customer service we provide our customers compared to our competition. And we continue to move full speed ahead with new cost control initiatives to help offset higher costs and expand operating margins faster than we grow sales.

During the second quarter, we made our first ocean container shipments of inventory to our Neogen Europe operations. This change in logistics could result in annual savings of as much as $200,000 when compared to our shipping costs prior to this change.

The second quarter also saw a success in getting our new biologics production facility in Lansing, Michigan, added to our USDA license. Now we still plan to run the new facility in parallel with our Tampa operations for the rest of fiscal year 2008, but that means that full consolidation cost savings are expected to take place beginning in our 2009 fiscal year, that will start on June 1st.

Another cost-saving project that made significant progress last quarter involved the installation of automated equipment for one of our many disposable diagnostic products. This change should save us somewhere in the neighborhood of $150,000 on an annual basis when it's fully validated and operational. We expect this project to be completed late in the third or early in the fourth quarter of this fiscal year. We also installed a new custom piece of machinery in late December that will provide Neogen a completely new product, to be initially marketed to the beverage industry beginning as early as next quarter.

So, obviously, I'm very encouraged about the rest of fiscal year 2008, and overall about the future of Neogen. I am encouraged about the significant sales opportunities that exist in many of our markets, and that's both domestically and internationally. In fact, some of our markets appear to be growing faster than originally thought, as evidenced by an almost unprecedented number of recent food recalls. In the last six months, there have been ten highly publicized recalls involving harmful pathogens like E. coli, 015787, Listeria and Salmonella. In addition, there have been 104 recalls in the last year involving food allergens with inadvertent contamination of milk and egg being the leading culprits.

I am also encouraged with the cost-saving initiatives that I talked about and others that we continue to identify, and the commitment of our operations and personnel to make those cost-saving opportunities reality as we strive to improve operating margins.

I guess I'm going to close my remarks with something that some people make light of some of the comments that I make and motivational sayings, but I want to say just as it pertains to personnel, I continue to be amazed at both the intelligence and the extremely positive attitude of Neogen's employees. If one believes in the saying "It's your attitude and not your aptitude that determines your altitude", then Neogen's future is very bright indeed because I believe we're blessed with many employees who possess both a positive attitude and also have an outstanding aptitude.

Well, that concludes our prepared comments for today, and we will now entertain questions from our listeners.

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

Thank you. A couple of questions. First of all, can you bring us up to date on the approval of the BetaStar dairy test kit?

I don't know why I'm not surprised that that wasn't the first question. I guess we've been guilty of underestimating how long it takes to get through government bureaucracy sometimes. That project continues to, I think, move along well. We've, as far as I know, have completed all of the test work that the FDA required; it's a matter of getting some paperwork finished up now.

I believe that we should have the FDA paperwork out of the way and approval done sometime, I'm going to venture a guess and say the next month. Then we will need to get some approvals through the interstate milk shippers, which will take, depending upon how fast they move, it could take, I guess, Tony, it could take another month on top of that. Something it looks like to me we ought to be able to do in a couple of weeks but nothing ever moves at the speed that I think it should.

In the meantime, the product continues to do very well and you know outside of the U.S. in international markets. As I think Lon reported in his comments, sales of our dairy antibiotic business along with several of our drug-detection products continue to progress very well.

Tony, this is Lon. The dairy antibiotics have had two outstanding quarters, and I am just amazed at how long it takes to get through this process. I heard a comment -- we were talking to one of our competitors, who was talking about what we were doing here, and asked us how long we thought it would take to get this done, and of course we were saying like we thought we would get this done in six to nine months, and they just started laughing.

We continue to have conference calls, we provide them the information, they look at the information and then you know there is some statistician or somebody else who wants to see one more thing. So that's kind of in the mode we're in right now, but I think we are getting close and we think we've got a very good test there. And we're looking forward to having that available for the U.S. market.

And you know, it shouldn't be any indication that there's something wrong with the product. It's a very good product, we think, very competitive and I think that's borne out as I said earlier by the fact that we're able to continue to get increases in our international sales.

The second question was regarding the Rivard acquisition. Could you indicate what the cost of that was and what the potential corporate savings might be, if any, from that acquisition?

Well, it was a settlement of a lawsuit, Tony, so there's certain -- and the settlement was done with a confidentiality agreement, so there's a lot of things I can't talk about.

I can say that I thought we came out of it very, very well. You know, we had strong patent positions and particularly in the U.S.; Rivard had some good patent positions outside of the U.S., and we think combining those two put us I think as I said in my opening comments, in a position of being dominant as a producer of detectable hypodermic needles.

I think we're going to continue to see that market for detectable needles grow, and as it grows we should be -- given our patent position and our marketing structure and our cost structure there, I think we should be really kind of in the catbird seat as what we're doing.

I was in Denmark and in France a couple of weeks ago, and I was, I think I said came away very encouraged as I see the Danish market perhaps moving 100% it looks like to detectable needles, so they are a major producer of hogs, a major exporter of -- we've all seen the Danish canned hams. As they move toward 100% detectable needles, that gives us a huge opportunity there.

A similar situation is occurring in France; it's not moving quite as fast but it looks like that there may be a mandate there that would require that approximately 80% of the hogs produced annually in France would need to be injected with a detectable needle, as we see. You know, those are just two of the countries in the EU; those people all tend to fall together or follow together. And having seen that in two of the major pork-producing countries, one then has to look at what's going to happen particularly in countries like Germany, which is the largest of those.

So I think it looks good. I'm sorry I can't tell you how we ended up as far as the final cost, but I guess I could succeed and say if I could tell you, you would be proud of me!

Okay, my last question, Jim, you and Lon outlined a whole bunch of opportunities for growth in the food safety area. You mentioned that the organic revenue growth for the first six months was 22%, and you've got, you claim, an objective of 10% organic growth. That sounds like an awfully low bar, and if you actually came in at 10% I can't believe you would be very happy about it. What is a more reasonable objective?

Well, we've looked, Tony, at saying that we want to run at 20% total, and I think I reported our compound growth over the last 15 years has been about 19%, so we are near that mark.

We've said that as we look at how we grow revenues, that we think that we can grow at a 9 to 11% rate on pure organic growth and the reciprocal of that in new products -- new revenues that we bring on through acquisition.

Now obviously when we bring in a new company after the first year its revenues become organic. So when Lon is talking about a 10% growth looking at some of our older businesses, you know those businesses have to continue to grow at that same kind of rate.

You know, I think we still stick with the 20%, and we will get some of that organically and we will get some of that where we've got new products, and we can grow those pretty fast. You know, when you start off with a pretty low base, it's not hard to get to 20 or 30%.

So it depends on how you define what is organic growth and how you define what growth came from acquisitions.

Okay, thank you.

I can tell you, when we are doing our budgeting and when we establish our goals and objectives for our sales and marketing staff, we are certainly looking at higher numbers that are in the 13 to 15% range in terms of growth opportunities. And we just don't ever want to get caught in the position of over-promising and under-delivering. But overall, we [are needing] it to grow at 20% a year and that's our challenge, and in some quarters we're fortunate enough we can do all of that organically and in other quarters we're going to need an acquisition here or there to help us get there.

Thank you very much.

Steve O'Neil, Hilliard Lyons.

Good morning, gentlemen, a very good quarter. Just a few questions, and I know as your Company gets bigger and more complex you can't give quite as much details on the individual other lines, so I always wind up asking you some of these things, but let me just run down a few.

It sounds like the mycotoxins did well, or at least they did in sales to the ethanol industry. Can I infer from that that overall mycotoxin is doing well this year?

Yes, overall, mycotoxins are doing very well; they are up 18%. I actually have been a little bit surprised at how well they did in the quarter, because in the U.S. I would say that overall in general our crop was a little cleaner this year than it was last year. I think that's certainly true in the Upper Midwest and in some cases the Red River Valley. We still have pockets where there has been outbreaks. And of course our addition of new formats, like the lateral flow format, have helped.

We have seen a significant increase in sales of mycotoxins in our Neogen Europe operations. And they have certainly helped drive those sales this year. And in conjunction with that, I don't think it's included in the natural toxins although it could be, is also a new instrument that we use to measure those lateral flow devices, where they absolutely have to have an objective kind of answer. So it has been a very solid year and I think with a few more format changes I think we can see it grow even further.

Now, is 18% a year-to-date or a quarter figure, Lon?

The 18% is the quarter. Rick might have the year-to-date number, I don't know.

If you don't have it handy, that's fine; I can move on.

No, year-to-date was 13%.

Okay. And of course you mentioned the number of allergen-related recalls, and I'm just wondering, I guess that would mean the allergen business also performed very well. Although that business has gotten a lot bigger.

Yes, that business has gotten a lot bigger. It continues to grow. This year, year-to-date, it has dropped down into the single-digit area. It is one of the focus areas that we want to take a look at and see whether we ought to do some more seminars. I think it also is one of those where competition has started to nibble at some of our areas, at some of our customers, particularly with pricing and in some cases with some lateral flow format. So it's one of the areas of focus where I think we've got to take a look now at where we go. We've got quite a few allergens that are out there, but we've got to look and see what else we can add to the mix now to get a little revitalization in that particular product line.

And we're beginning to see a little bit of that, too, Steve, in what's coming out of Europe. The EU made an announcement, I believe it was last week, that they've added three more products to their allergen list. I think they added mustard seed and sesame seed, and there was still a third one that was in there; we don't have tests for those; the market is probably not very big for them now. But it's an indication that there may be a market developing, particularly in Europe, as they begin to look at more of those.

(multiple speakers) just to give you an idea, Steve, Ed Bradley made this presentation at the Board meeting so I've plagiarized some of the information in my report from the thing that he did. Of those 104 recalls, 38 were milk, 24 were eggs, and then it drops down to peanut, which was seven, which was the very first one that we came out with. Then you have soy, walnuts, almonds and of course we have tests in all of those areas.

Okay. You didn't mention AccuPoint, which I think was up 40-50% last year, and once again this may just that the product grew so much in the previous year it slowed, but I thought I would ask you about that as well.

Well, it is continuing to grow. You remember what the numbers were up (multiple speakers) --?

Yes, it's doing terrific. It's almost at 20% again this year through the first six months. And, frankly, we had anticipated some additional sales of instruments, internationally, that are still out there on the table, that haven't come to fruition that would have driven that even higher. It's clearly one of the top-performing product lines, it's very large in terms of its sales, and it continues to do very well.

We just signed on a major new account, and I know we don't, we typically don't like to use the names of those companies in these conference calls. We have trained those -- a lot of those plants but the single largest portion of those plants do a particular type of product that have yet to be brought on board, that we expect to get done sometime during the remainder of this fiscal year. So there remain a lot of good opportunities out there for ATP, both domestically and internationally, and we expect it to be one of those products that will continue to drive sales as we move through 2008 and into 2009.

And what was it, AccuPoint, and with the Soleris systems and all that, all the microorganism and bacterial testing is kind of getting buried in there, so I don't know if I can even ask you about microorganism testing for things like Listeria and E. coli and Salmonella. Does that even -- is that something that can be mentioned here or is it just blended in so much with the others?

It tends to get blended in. We are doing okay. We have an opportunity to do better, and you know those principal pathogens are ones that we continue to focus on, Steve, as to producing better products at less expensive costs, and that's a competitive area that several of our competitors have attached to, and are offering some pretty cheap prices in the marketplace out there. But we've still got some work to do there; we've still got some opportunities there.

Well, switching real quickly to animal safety, you mentioned in the press release I guess the diagnostic products were up 11% year to date. You didn't talk about the second quarter, so I didn't know if that was a signal maybe the second quarter wasn't quite as good or how I should read that.

Yes, the sales there slowed in the second quarter. Some of that is, I mean we've got products there that go both internationally through distributors and also into the forensic market, and some of those are based on tenders and bids and stuff. So that's a particular area that you cannot look at on a quarter-to-quarter basis; you need to look at that on a year-to-date basis to see how they are doing. And so far it's been a very solid year. The nice thing about that is, the growth this year so far has been led by sales of what we call our racing diagnostic test kits, particularly to a large international customer, where in the past several years most of that growth has come out of the substrates and in the forensic market. So it's nice to see those racing kits gain some momentum and start to get some sales this year.

And I think most all of that is probably competitive gains, Steve, because those markets are not growing that much.

We know about those in Kentucky, so that's something we are aware of.

One thing, I don't know if I'm reading this right; you didn't mention the veterinary instruments sold at retail that you'd been making, although you did talk about OTC veterinary products. So I don't know if that's altogether or if you're talking about two different things.

Well, it is --

It is altogether. The OTC includes what we sell through those retail farm store markets like tractor supply and Orscheln's. We did gain some business in tractor supplies. I forget what they call the name of that. They bought a number of stores out on the West Coast that they are continuing. Del's is the name of the store line that's out there; they are going to continue to maintain that, I don't want to call it a boutique; these guys at tractor supply know what they're doing from a retail, and we have made some inroads in getting in some products there.

I also happen to know, in fact I've got in front of me something to talk about with Jim and Rick after this meeting is over a product line review for some liquid products that go into tractor supply. So we do continue to build on that presence there, they continue to open stores, and it has been contributing to that overall growth in the OTC area.

Last thing I will ask, and I will let somebody else ask some questions. The gross margin was good, down slightly from last year, and I wonder if that was just mix or if there's anything else worth mentioning.

It is mix, and in fact Rick and I've spent a little time analyzing that. And I can tell you that what you don't -- you don't see this in the press release; I mean, all you see is the gross percentage. All of that decline in percentage is in the raw material area. Our cost for both labor and overhead as a percent of sales declined compared to last year, and in absolute dollars they're not up very much at all.

So we're making some good progress there. That gets at some of those things that I talked about that we're seeing where we've had some significant increases in grains and petroleum-based products, and we are in the process of instituting some price increases that will help offset those.

Now, the other thing in terms of the gross margin line that would have affected particularly the second quarter, is the acquisition of the Kane products are mostly buy and sell products, so they carry proportionately a little bit higher cost of sales and lower gross margins, but we didn't have to add sales personnel and so you did notice that the operating profit continues to go up. So that's the two primary areas, the increased raw material costs and the Kane things, are the two things; the Kane being the mix.

And then the other thing that I am aware of in the second quarter now that I think about it, is last year we opened up our biologics product to another distributor, where they took a large stocking order and we also had a large shipment to our largest customer, which is an international customer based in Sweden, and that would have affected the mix in this quarter this year compared to last year. Those kinds of things are just timing.

I will let someone else ask some questions. Thank you very much.

Stanford Rothschild, Rothschild Capital Management.

One question -- I've noticed some publicity about these small possibly portable ozone generators as a means of avoiding contamination of fruit and other food products, and I wondered whether that indirectly might have any impact on the market for the food safety market.

Well, yes, I think it does. I don't know how much impact they're going to have. If successful, I think it certainly does. But I believe it's a positive impact. We've spent some time I guess at the very beginning of the month with the fruit and vegetable people, I spent some time in Washington with the regulators as well as some of the trade people. And they are really up against a tough deal in trying to make sure that they are controlling pathogens in the fresh cut, particularly the vegetable side. They are looking for whatever they can to reduce that.

We are doing pretty well there, as they try to find the magic formula to reduce minor contamination. They are doing a lot of cleaning of field-harvesting equipment and checking the field-harvesting equipment. They are concerned, as they should be, about the irrigation water that's coming into those fields and how that irrigation water might be carrying pathogens. It gets uptake into the plants and the cleaning water, how often do they need to clean it and do certain things like that, which is where probably the ozone best fits, Stan. Is if you could -- that's probably the easy way to disinfect cleaning water as they go through the rinse cycles, etc., either onboard those field harvesters or in the produce sheds to be able to continue to make certain that the water that comes in contact is not carrying any pathogens with it.

Ozone has been around for awhile. There's been some large units that have been tried; I guess a few of them still operating in the poultry processing plants, where they can pump ozone into the chill tanks when they are cooling carcasses down, and it helps control. It does something similar to what chlorine would do but without leaving behind the concerns of chlorine residue.

But that whole fruit and vegetable area is a big opportunity, and that industry still has some substantial problems as they try to figure out what to do. They are scurrying to try to do that; regulatory is trying to do it; in Washington, they are trying to decide now, should USDA have authority or should it be FDA?

So I think we will continue to see more activity there, and the more activity we see I think it in fact increases our opportunity in testing because one of the things that your people say is, why test if I can't do anything about it? So I think it could be helpful to us.

Is there any opportunity for you to be a link between the people who are making these small ozone generators that probably don't reach out into the producing farm area, and the fact that you've got some distribution out there? Might that be an add-on product line from a marketing standpoint?

It could be. We've always shied away from businesses where you had to own pickup trucks with toolboxes hung on the side of them. They are just kind of difficult when a guy has got an operation running and his machine is down, and you know if it's here in Michigan it's 12 degrees outside now and the trucks don't run very well.

We like being in the disposable business. You know, I don't rule out that, Stan, at all, but it's not been one of the -- the large capital equipment area has not been one of the areas that's attracted us. We like those businesses in which you can build a relationship with the customer and sell them something every day or every week, rather than once every year or two.

We agree with that; I just noticed that they were modifying the size of these to be small and portable instead of big generators.

Well, and that's something that we certainly need to be keeping track of and appreciate your calling it out.

(OPERATOR INSTRUCTIONS). Vito Menza, Sandler Capital.

Nice quarter. A couple of these were answered, I just have one or two more. Could you disclose the amount of actual legal costs in the quarter?

Yes, legal costs were $390,000 for the six months, and $183,000 for the quarter.

Got it. And I guess a little more just on the gross margin. You know, how much of these price increases have you already started to implement, and how many are future price increases? Is there any way to break that out?

Have you been talking to any of our Board members? The question came up at the Board, and when they saw the percentage growth that we had in sales, how much of this was price increases. And we really, I would say less than 1% of that overall growth in the quarter is a result of any price increases. We are just now -- I mentioned Ed Bradley before and I know that he just had meetings this week on price increases in that dehydrated culture media area, where we need to get these things into effect.

I know that we just recently have looked at putting price increases in a couple of different areas on the animal safety side, with a number of the product lines there. So we've had up to this point, very little impact of price increases in any of the statements, and certainly on the statements through the first six months. So it will be between now and as we go through this third quarter that we will start to do that, and start to get back some of those margins.

Great, great. The next question would be, how much of these sales by each division was currency-related?

There would have been about just over $100,000 in the quarter that's related to currency.

Okay, so small.

Yes.

Great. And diluted share count, it looks like it crept up on us a little bit this quarter. You know, any plans -- I guess firstly, Rick, is there a target number that you're looking at for year-end? Then secondly, any plans to institute maybe a stock buyback just to offset some of that share creep?

Well, I will let Jim answer the question on the stock buyback. As far as the stock is concerned, the biggest effect that we have is the price of the share, that will cause that dilution number to go up. And you know, that's I guess -- I would just as soon have the price go up and have a little more dilution.

Understand, that's not a bad problem. And I guess on the share buyback, any plans there at all?

Not at this point. We think the market is getting close to fairly valuing the stock and you know we like to look at those times in which we think the market is not giving us fair values as to opportunity to buy back. So you know at this rate we think that we're not that far apart on what we believe the value is and where the market is, particularly on what we've reported to this point.

Okay. Great, guys, thank you very much.

(OPERATOR INSTRUCTIONS). [Joseph Pozzin], Wachovia Securities.

Great quarter, guys. The only question I have is related to Asia. What's happening over there and with their presence in the news, they must be willing to do something.

Well are you talking about China or the rest of Asia?

Well, let's start with China. I mean God knows, they get a lot of bad publicity.

Yes, I made a trip to China in September, another trip in December, and I will be making one in January. Obviously, part of the reason that we're going over there and doing that, I mean we have more than one reason to go over there because we do source some product over there, but in addition to that we do think we're getting close on some sales. I think particularly it would be in that general sanitation area, in the ATP area, where we can sell them both some disposable samplers to go along with the instruments.

I will tell you as it relates to the rest of Asia, we've had a good start to this year, and we've got some opportunities that we are seeing in Japan and the Philippines on several products that could add some significant sales as we move through the rest of the year.

The Soleris technology, when we started out, we took that over and selectively have introduced that and that's another product line that's got some opportunities in the Asia Pacific Rim.

So we've always approached and particularly getting back to China, you know we've been very careful about protecting our intellectual property when it comes to that country, and we've also been very careful about trying to get too far ahead of leading sales over there because of the way they do things and the way that infrastructure works.

So it does look like there's some opportunities there. So far, they are on budget even though they did not take, in the first two quarters, a large number of units. We actually did have some in the first quarter. They missed their order in the second quarter. I have been assured that they're going to catch up on that before we get through -- I think in their case they look at calendar years -- before we get through calendar year 2008. So we continue to believe there's some good opportunities on the general sanitation side in China.

What do you think the most significant problem is they have over there?

I think they want to produce good product; it's not -- by and large -- I mean, I think it's a responsible area. They are just not accustomed to the kind of scale-up they are seeing. As an example, 70% of the seafood that's produced in aquaculture is produced in China today. And I don't remember what the exact total is, but it's billions of pounds. And you know that is probably going to grow. The problems they are having over there is, they've got pollution in the waters in which they are growing that, and they are trying to offset the pollution in the water by adding more drugs and other things to the water to keep the creatures healthy, be they shrimp or tilapia or whatever. And then they get into a drug residue problem.

We spent some time in Washington with the National Fisheries Institute, and the guys on that side earlier in the month, and we said "what do you need?" And they said "we need the following three tests because we've got to test all this product that's coming into the U.S. from Asia. So though Asia may not be stepping up as fast as we'd like to see them, there's also the other side of checking on product as it comes onshore here, and of course there's been a tremendous amount of -- I don't know that we can identify this as building any real activity, but the President's special commission on protecting imported products, as a result a lot of it came from China, is now in place and beginning to get going, which should call for more and more testing of anything that we bring in from offshore, and most especially the food products.

But that problem and need is not going to go away. They need to produce product, we need to buy product, and somehow we need to make sure that it's safe.

(multiple speakers) other Southeast Asia countries, like Thailand?

Thailand continues to grow, but we also see places that I'd never expected to get this big, like Vietnam is producing a lot of shrimp that's coming into this country now. So you know, we are seeing all that Southeastern Asia area I think will grow.

Thank you.

It appears there are no further questions at this time. Mr. Herbert, I'd like to turn the conference back over to you for any additional or closing remarks.

Well, thank you very much for your participation this morning and most especially for your continued support of the Company, and we wish you a Happy New Year and we look forward to talking with you on a formal basis in about another three months. Good day.

Thank you. That concludes today's conference. We appreciate your participation. You may now disconnect.