Neogen Corp (NEOG) 2013 Q3 法說會逐字稿

Welcome to the Neogen third-quarter fiscal year 2013 earnings results conference call. My name is Lorraine and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I would now like to turn the call over to Mr. Jim Herbert. Mr. Herbert, you may begin.

Good morning and welcome to our regular quarterly conference call for investors and analysts. Today, we will be reporting to you the results of the third quarter that ended on February 28. I would remind you that statements that are made here today could be termed as forward-looking statements and these forward-looking statements, of course, are subject to certain risk and uncertainties. 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 in this live telephone conference, I would 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 comments this morning, we will entertain questions from participants, as Lorraine indicated, who are joined by this live telephone conference.

Then I will make some introductory comments to start the call this morning and then turn the program over to Lon Bohannon, Neogen's President, who will talk about some of the color behind the specifics of this third quarter. Then followed by Steve Quinlan, our Chief Financial Officer, will follow Lon to fill you in on some of the details behind the numbers. And then I will play cleanup this morning to talk a little bit more about the current events and some future expectations.

Well, earlier today, Neogen issued a press release announcing the results of the third quarter of the 2013 fiscal year. Once again, we reported record numbers. Revenues for the quarter were up a bit over $51 million, which is an increase of 14% from the previous third quarter.

The net income increase is an even bigger story. The third-quarter income increased 27% to approximately $6.6 million, or $0.27 a share. That compares to third quarter of last year of $0.22 a share. We can also, of course, report to you now the nine month result, as we have ended this third quarter. Revenues increased 12% in this fiscal year to approximately $151.5 million as compared to last year's $135.5 million. Net income for the nine months increased 22% to approximately $20.2 million, or $0.93 a share. This compares to earnings per share last year through the first nine months of $0.69.

We continue to be proud of the consistent growth that the Company has enjoyed and frankly love, at the end of each quarter, to be able to add an extra quarter to that record. This quarter marks the 84th quarter in the past 89 when Neogen reported revenue increases as compared to the prior year. That is a span now of over 22 years. It has now been eight years since the last time that we failed to better our quarterly record.

Five years ago, Neogen reached revenues of a bit over $100 million and we probably set our goals at that point to double revenues to $200 million in the next five years. The 2013 fiscal year is that fifth year and at the end of nine months, we are on mark to make the goal.

The success of the quarter that we are going to talk about this morning is really pretty broad-based. Some of the success resulted from increases in marketshare. We also had revenues of at least -- for at least part of the quarter from three acquisitions that were not in place this time a year ago and we also saw increases from new products that were recently introduced to the marketplace and for that matter older products that saw some rejuvenation. An example of the latter would be our diagnostic test for the detection of horsemeat that created quite a controversy in the European Union.

In my closing comments, I will talk a bit more about some of what is happening internationally and some of the aspects of our business that we think will be the drivers of the future. But let me stop at this point and turn the program over to Lon to talk more about the color for the quarter. Lon?

Thank you, Jim and welcome to everyone listening on the conference call, as well as those joining us via the Internet. Jim has already provided some details on Neogen's 2013 fiscal third-quarter and year-to-date performance. I was very pleased with our Q3 performance that further contributed to what is turning out to be a very solid 2013 fiscal year for Neogen.

Let me begin by providing a few more details on the third-quarter results. I trust those of you who consistently follow Neogen took note that our third-quarter revenues of more than $51 million were not only 14% above last year, they were also higher than this year's strong second-quarter sales. Historically, the second quarter represents our strongest quarter for total sales, so I think our Q3 revenue performance is an indication of broad-based productline and market segment growth in both our Food Safety and Animal Safety segments.

For example, third-quarter sales were up compared to last year in 9 of our 10 operating divisions with increases ranging from 8% to 42%. Hacco was our only operating division experiencing lower sales with a slight decline of approximately 3% in Q3 sales compared to prior year. But this division remains a solid 7% ahead of FY '12 on a year-to-date basis.

Food Safety sales increased 15% in the third quarter to $25.3 million with all seven operating groups reporting higher revenues in the prior year. Food Safety sales growth was also broad-based from a productline standpoint. Sales of test kits to detect foodborne allergens increased 23% and sales of products to detect naturally occurring toxins like aflatoxin and vomitoxin were up 22% in the quarter.

We also experienced solid growth in sales of our AccuPoint test systems used in general sanitation monitoring, particularly in the beverage industry, up 13%. Products used for detection of spoilage and indicator organisms, including our proprietary Soleris optical microbial test systems were 15% higher in Q3 than last year and diagnostic tests used to detect drug residues, primarily in international dairy markets, were also up 15% in the third quarter.

In addition, dehydrated culture media sold by our Acumedia division to traditional pharmaceutical companies and vaccine manufacturers in domestic and international markets increased 23% compared to the prior year.

I think another example of the momentum we are building in Food Safety is the 234 new customers gained this fiscal year for our new Q+ quantitative lateral flow devices to detect natural toxins. This gain in marketshare is a direct result of the quality and robustness of new products being turned out by our research group, as well as a testament to the successful collaborative effort of our sales, marketing and product management teams.

The only Food Safety productline experiencing a decline in third-quarter sales was the area of test kits to detect harmful pathogens like salmonella and listeria, which fell 4% below the prior year. However, Neogen's unique DNA-based ANSR test platform represents a complementary addition to our Reveal lateral flow pathogen test devices and enables us to better compete in the overall market for detection of specific pathogens like salmonella and listeria going forward.

In fact, Neogen's new Test Drive promotion launched midway through the third quarter has already resulted in six ANSR unit sales and 12 signed trial agreements. We also have ongoing negotiations with an additional 17 prospects for the ANSR pathogen detection system.

Our Animal Safety division also achieved good revenue growth in the third quarter with total revenues equal to $25.7 million representing an increase of 12% over the prior year. Neogen's largest operating division in Lexington, Kentucky led Animal Safety growth with an increase of approximately $2 million, or 17% compared to last year.

Driving this strong sales growth was a significant increase in sales of the Company's care line, small animal supplements, and continued success in integrating the October 2012 acquisition of Macleod Pharmaceuticals. The MacLeod acquisition provided our Animal Safety sales team with a leading veterinary antibiotic sold under the trade name Uniprim. The Lexington division also experienced another strong quarter of growth in sales of our proprietary D3 detectable needle, which increased 21% over the prior year.

Rodenticide sales in our Hacco division continued their strong showing this fiscal year with a 19% increase in Q3. The rodenticide sales growth was offset by lower revenue from cleaners and disinfectants, some of which is due to increased competition in a tough economic environment for producers of animal protein and some of which was simply due to the timing of orders to international customers. As a result, our Hacco division sales finished the quarter slightly below prior year as I reported earlier.

Our genomics business also achieved excellent third-quarter growth with an increase of more than 20%. Some of this growth is a result of our Igenity and Scidera acquisitions, but revenues were also up due to higher sample volumes from existing customers. We continue to believe that our genomics business will play an important role in helping address the world's growing concern for food security, as well as a growing increase in demand for animal protein.

I am also sure our listeners noticed that our gross margins in Q3 remain strong at 53.5%, matching the performance of our first two quarters. While product mix is a big driver of the improved gross margins, we are also realizing the benefit of ongoing cost reduction and productivity improvement programs in a number of operating groups around Neogen. We have invested in new facilities domestically and internationally to ease capacity restraints and improve workflow and warehousing operations. We have installed new equipment to enhance productivity and automate time-consuming manual operations and we remain focused on achieving cost savings through better procurement and purchasing activities. Calculated savings derived from these programs and initiatives in FY '13 exceed $1 million on an annualized basis.

I think you should know we kind of evaluate ourselves a lot on the basis of how we perform at the operating profit line and the last comment I would point out for the third quarter is that Neogen's 14% increase in sales and strong third-quarter gross margins helped drive a $2.1 million, or 28% increase, in operating profit compared to the prior year. At this point, I would like to turn the call over to Steve Quinlan to provide our listeners some analysis on third-quarter operating expenses in addition to covering some balance sheet highlights. Steve?

Thank you, Lon. Jim and Lon have already reported on the overall (technical difficulty) and profit performance for the third quarter and the year-to-date for our 2013 fiscal year. I'm going to take just a couple of minutes to talk about our operating expenses, our balance sheet and other significant items for the third quarter.

Operating expenses were up 15% in the third quarter compared to the same quarter last year. Now we have discussed in prior calls our commitment to continue to build our sales, marketing and research organizations to take advantage of the significant opportunities that we see in our expanding Food and Animal Safety market and this investment continued in the quarter.

The majority of the increase in our sales and marketing expenses, which are up 18% for the quarter and year-to-date result from payroll-related expenses for new sales and marketing personnel, including those from our recent acquisitions, increases in royalty expense, higher shipping costs and increases in promotion and marketing support.

General and administrative expenses were up 10% in the quarter almost entirely due to personnel costs and related expenses and amortization of customer-based intangibles resulting from our acquisitions. Higher stock option and legal expenses from earlier in the year, as well as increased depreciation expense resulting from our continuing investments in our information technology infrastructure have resulted in year-to-date increases of 13%. Our research expense was up 13% over the prior year, primarily due to costs associated with validation and approvals for new products reflecting the continuing high levels of activity for this group.

In other income, we had favorable currency experienced during the quarter, a total of $200,000, about $90,000 better than last year's third quarter. As all of the currencies we do business in -- the euro, the pound, the peso and the real -- strengthened versus the dollar in the quarter. For the year so far, we are about even on currency.

Offsetting these pickups, in last year's third quarter, we reversed a secondary payment liability we had accrued for a total of about $220,000 based on that year's profitability for GeneSeek. In this year's third quarter, we actually recorded a $40,000 charge to income. Our effective tax rate for the quarter was 34.3% as opposed to 35.3% for the year-to-date and compared to 35.7% last year. This reduction in rate was due to legislation, which was enacted at the end of December of 2012, which extended the R&D credit effective for calendar years 2012 and 2013. Although we thought this credit would be extended, because it had expired at the end of 2011, we could not recognize it in our first two fiscal quarters.

We generated $8.4 million from operations in the quarter and have generated almost $20 million for the year. This cash has been put to good use on the two acquisitions we have done this year, Macleod Pharmaceuticals in October and the January purchase of Scidera genomics. We also bought a 36,000 square foot building in Ayr, Scotland in December to accommodate the expansion of our Neogen Europe operations.

Our working capital items, receivables and inventories, are in relatively good shape. Receivables have grown by less than the growth in revenues while inventories are up $6.1 million or 17%. $1.1 million of this increase is from the MacLeod acquisition. GeneSeek is up about $1.5 million year-to-date. Their inventory can fluctuate significantly from period to period as they buy large quantities of chips at one time. This balance should decline by the end of the year.

This concludes my prepared comments and at this point, I will pass it back to Jim for his closing comments.

Well, thanks, Steve and Lon for a nice wrapup on a good quarter. In my concluding comments, let me talk a bit about what is happening internationally, along with the flow of new opportunities that we see that are developing.

As we have mentioned before, we think that about two thirds of our potential markets in the Food and Animal Safety business lie outside the US. All of our principal operating divisions outside the US showed good results in this third quarter. Our Brazilian operations are gaining traction in both Food and Animal Safety products and their revenues for the quarter were up approximately 32% compared to the same quarter a year ago. Our Mexico operations saw similar growth with revenues up to 42%.

Neogen Europe celebrated its 10th anniversary as a part of Neogen this past week. That business, which is almost entirely Food Safety, has continued to show nice double-digit increases each and every year. This quarter, they were up about 18% compared to a year ago. Neogen Europe now accounts for a bit over 20% of our total Food Safety revenues. The growth here has been difficult considering the financial downturn of some of our major countries like Italy and Spain, but the strength is coming from the stronger economies with, as an example, German revenues for the first nine months of the year being up 40% and also strong revenues coming from both the UK and Ireland.

These countries benefited some in February due to the economic adulteration issue of horsemeat that was mixed with ground beef, referred to as the horsemeat scandal. Neogen has a group of diagnostic tests to detect various animal and fish species and these tests were developed to find attempted economic adulteration. One of the tests is very simple and in fact even easy enough to run in the backroom of a grocery store. One of the largest grocery store chains in the US is now running as many as 1000 tests a week using our products to monitor for not only horse, but other speciation problems, which points out that once the ground beef came under scrutiny for the presence of horsemeat, customers were also beginning to find the presence of pork that had been co-mingled and at least one case ground mutton that was mixed with ground beef. This concern about speciation has resulted in increased sales of our other products such as sheep and pork and not just the one for horsemeat.

Drug residues and meat products have been sort of the story of the month in other countries. A few weeks back, Russia put an embargo on the receipt of pork or beef from the United States due to their concern about the residue of a drug that is approved for use here in the US and in many other countries, but not approved in Russia. Neogen has a diagnostic test to detect the presence of this drug and use of this test is now increasing not only here in the US, but also in other countries that may be shipping products to Russia or they are concerned about similar bans occurring in other countries.

A few weeks ago, a different drug issue developed when Chinese regulatory agencies announced that they had found drug residues in chicken that was being sold by Kentucky Fried Chicken. Almost immediately revenues in its 4300 stores in China saw up to a 50% decrease in sales. It is interesting to note that there are almost as many Kentucky Fried Chicken stores in China as there are in the US. In fact, the very successful Yum! Brands restaurant chain derived approximately 40% of its income last year from Kentucky Fried Chicken and Pizza Hut restaurants in China.

The natural toxin area has not gone unnoticed either. Some of the drought-stricken corn in parts of the old Soviet bloc countries was found to be high in aflatoxin. As a result, that corn found its way to neighboring countries such as Romania and the Romanians have begun to feed that corn to dairy cattle. The highly carcinogenic M1 toxin has begun to show up in milk causing the milk to be condemned.

China once again made the news last week when perhaps more than 6000 carcasses of dead pigs were found floating in one of the principal rivers that supplies water to part of Shanghai's 23 million residents. Maybe those pigs died of natural causes and were illegally disposed of in this nearby river. However, when Chinese veterinarians began to run postmortem tests on the dead pigs, they found that they were harboring as many as five pathogenic diseases, including hog cholera and foot and mouth disease and swine fever. Some of these harbor diseases were likely (inaudible) could be transferred to humans.

Mexico is now undergoing tremendous issues due to an outbreak of avian influenza. The only practical method for the control of this disease is quarantine and destruction of the sick birds. At last report, over 0.5 million chickens have now been destroyed and the destruction plan was continuing. As these farms are depopulated, the concern now becomes adequate cleaning, disinfection and the destruction of the disease-carrying rats and mice that may be around.

I think that all of these instances, in some way or another, track back to the concerns that we have been discussing with you folks over the past number of quarters and that is about food security. As the world producers of food gear up to increase production of higher value foods, such as animal proteins, food safety and animal safety will continue to be a, what I would term, heavy hindrance to accomplishing this. Therefore, our programs of providing solutions in these areas I think will continue to be even more important.

We believe that our growth strategy is still properly placed. The market for our products should increase and we are continually working to try to increase our marketshare, our share of those markets. New product development is the strongest in Neogen's history with over 70 researchers now working on product development in five principal locations.

Though we have not announced any acquisition activities now, the last couple of months, we have an active program underway with several good prospects on the radar. Our balance sheet is certainly strong enough to take advantage of these opportunities.

This concludes our prepared comments for the morning and we would now like to open the telephone lines for any questions from participants, Lorraine?

(Operator Instructions). Paul Knight, CLSA.

Good morning. Congratulations on the quarter.

Thanks, Paul.

On the DNA testing side of the business, it was a nice sequential jump. Could you go over the components of what is going on there and is that a run rate on the business now? Could you give us a little color there?

Are you referring to the ANSR-based DNA test system or to the genomic side or --?

The GeneSeek portion of the business.

It is coming from a lot of different directions. Part of it, as Lon said, is we have had a couple of acquisitions that were in for a part of the quarter. I don't think either was the full quarter, but the Scidera acquisition that took place in January brought in some business that we didn't currently have at our GeneSeek operations. Part of this was -- I would guess probably the biggest portion of this increase has probably come from beef cattle as we look at both parentage and traits in beef cattle and we do business with the 11 top breed associations in the world.

We get business in from China. Our delegation just came back from China this past week. They have been over there as China is building its dairy operations. They are importing cattle and building huge tremendous dairies in inner Mongolia and genetics is going to be an important part of what they are doing. I think we had -- maybe in February, we had maybe like maybe 6000 samples in from China off of dairy heifers to determine their heifer replacement programs.

So it is pretty widespread and we have got new models that are under development now that are almost through development. We have the best model for genomics for Nelore cattle. That is the primary breed in Brazil and of course, the Brazilian business and beef production continues to grow. It is a major, major producer on the worldwide market. So that is going to enable us to do even more there.

And as we see what has happened on the beef side, we have got the smallest cowherd we have had since the 1950s and therefore, the price of beef regardless is high. There is a temptation for people to want to sell beef heifers. They are worth -- those heifers, they could go straight with the steers to feedlots where they are worth $1.70, $1.80 a pound now and do you save them back for replacement heifers or do they go to market?

That is going to lead I think to more -- easily to more genetic work. You want to save the very best ones and so we think that that is probably, even though cattle numbers are down on the beef side, there may even be some increase in our testing for beef. That is a longer answer I think probably than you intended for, but maybe it gives you sort of some color.

Yes, I think it is a good outlook. I think the other question I would have to wrap my side would be the operating margin down sequentially, but do you expect a margin pickup here in the upcoming current quarter?

Well, I think -- our quarters kind of -- are strongly influenced by the mix of the products in the different areas. I mean the gross margins are holding up very fine and even though sequentially it was down compared to last year, I think when you look at the total basis points increase compared to the same quarter of last year, it is following that same trend of showing an operating improvement -- operating profit improvement that is consistent every quarter compared to the same quarter of last year. So I don't think there is really anything that is disturbing there or that is any kind of a trend that is not perfectly consistent with what we are achieving and have been achieving each quarter this year.

Terri just called it to my attention that I misspoke earlier in my prepared comments when I said that the largest grocery chains -- one of the largest grocery chains -- I said the US. I meant to say the UK. We are running as many as 1000 tests a week to test for horsemeat. There is testing in a lot of countries. There is testing here. I can't tell you for sure whether anybody has ever found anything here or not. We do know that Nestle got caught with some bad meat that went into some lasagna, frozen lasagna that circulated in a lot of countries. IKEA I thought made furniture, but, in addition, they also have a few food items, including meatballs, I guess and some of that horsemeat maybe got into meatballs. I don't know whether we ate any of it here or not, but it is much more widespread than was expected, but it is not a US grocery store chain; it is a UK grocery chain. So my apologies for misspeaking there.

Thank you.

Steven Crowley, Craig-Hallum Capital.

Good morning, gentlemen and kudos on another good quarter.

Thanks, Steve.

In terms of the sales and marketing investment that you have cranked up by design, can you give us a little bit of a feel for the capabilities that you put in place at the Company maybe versus 18 months ago or 24 months ago so we have some sense of what you are doing with that investment?

I will let Lon add to it. I will start off. We have expanded what we are doing in the marketing area. Because we have got a large number of products and we serve multiple markets in multiple countries, our sales group is, if you will, is divided into three sections. We have what we call our product managers that are looking at all of the different products that are being developed that are under development to make certain that they are poised in the right direction.

Then we have our marketing group that looks at the markets for those, like they might be -- one group might be looking at dairy and beverage and another might be looking at meat and poultry. And then the third group is our sales group, which is under sales management and in many cases, in most cases, they are also divided.

So I don't -- hadn't looked -- Lon maybe can add a little bit to it, I haven't looked at the exact numbers, but we have probably done more to expand our marketing group than -- and the sales side of that product than we have the sales side of that over the course here of the past quarter. I don't know, Lon, if you have got better detail on that.

Well, it is really across-the-board increases in a number of areas. We've added staffing in all of those areas that Jim indicated and on both the Food Safety and Animal Safety side of the business. Some of that has been in marketing. Some of it has been in the direct salesforce. We have added both individuals and broken out additional market segments where we didn't think we were getting enough penetration and added staff there and have also added some inside salespeople to help support the efforts, which would free up some of our territory managers to focus on some of the larger accounts. So it has been a combination of items; the acquisitions have added to that. The Igenity acquisition brought with it some sales and marketing, particularly sales personnel, to call and I think you are seeing some of that. We talked about some of the success we have had in the genomics area. I think that has helped that and the same thing could be said on the Animal Safety in a number of markets, including some of our international markets where we have expanded our sales effort and staffing.

And that brings with it -- you have got increased travel costs as a result of that and all of the ancillary costs associated with having increased personnel. So it is pretty broad-based and across the board and it is all done because we think the opportunities are out there and we can achieve even higher organic growth rates going forward.

Have you seen some of the recent new product introductions like the Q+ line benefit from those enhanced capabilities? In other words, are you seeing some nice confirmation on having added capabilities to the organization? Or are those benefits still perspective?

I think we have seen and realized some benefits from adding the staff and I think it is reflected in the third quarter. It is reflected in what is really a very broad-based growth in revenues across a number of market segments and productlines. I think we are better able to take advantage of some of the things that we've seen that are being driven from the new regulations from FSMA in the area of things like allergens that we have talked about. The pathogen area we think is going to benefit more going forward and I think certainly in the mycotoxin area adding some staffing there as a result of our investment in those areas certainly helped when the outbreak occurred both in Europe, as well as here in the US last fall. So I think we are seeing benefits and we expect to see more going forward.

Great. Now on the R&D side, you have had a pretty active schedule of new product launches. I think that continues maybe for the foreseeable future. But could you give us a little feel for what is going on there and what kind of pace you are hitting on now in the new product introduction front?

Sure. And I would say that R&D, like sales and marketing, there's a leadtime in any of them. We spend the money today for products that are going to be released tomorrow that are probably not going to have an impact on revenues for another quarter. But we have gotten -- we had 20 products aimed throughout the Company for new product releases for this year. I have lost track exactly where we are. I said earlier that I thought we could get 17 of those out. We may do a little bit better than that. Realize that some of them are improvements of existing products like you mentioned our Q+ products. That's just an improvement on the products that we had that were going into the testing of natural toxins. They are new products, but they are an improvement on areas where we are already functioning.

So we expect, and we are in the budgeting process now, so for the new year starting the first of June, we will be looking at equally as many new product opportunities next year as we have been working on this year. So we won't let up there.

I think also, following up on your questions of Lon about sales and marketing people, it takes -- we get pretty quick traction on additions in sales and marketing within six months quite often. We have got the guy that is paying his own way when you add people there because of our nice gross margins, but we have always tried to lead the market with our sales and marketing expenditures. So I think this quarter is just an example of how we are leading the market for what you may not fully see until first quarter next year.

Great, thanks as always for taking my questions.

(Operator Instructions). Tony Brenner, ROTH Capital Partners.

Thank you, good morning. I would like to follow up on the comment that Jim just made about the productivity of the sales and marketing additions. You made a big investment in the middle of last year and there was roughly a 200 basis point increase at that time in your sales and marketing expense as a percent of revenue. And just gauging by that measure, it doesn't appear there has been any productivity improvement from those initial people and now you are adding again to that sales and marketing staff. So the sales increase doesn't appear to have been proportionate to your increased spending and marketing. Do you mean to imply that that is about to happen and that percentage begins to come down a bit in the next quarter or two?

Well, you are ahead of me on figuring percentages, Tony. I guess we would back up to when we had the last influx of expenses or additions, I'd say, to our sales and marketing group was a result of the fact that we had started eating a little better seedcorn the year before and we needed to get built back up to the kind of levels that we were talking about.

I do think that a big part of what you see is increase -- of our increase is due to the sales and marketing increase. We have got more people, we have got more activity, we are attending more tradeshows, we are doing more travel, we are making more sales calls. So I think with that -- I haven't gone back to try to develop those percentages, but I think that what we spent last year is paying off. I think that is what is responsible for what we are seeing this quarter and what we will see next quarter is a part of that. So we continue to believe that that is the right place to go.

For growth, if we are looking at internal growth, it has to come through either increased marketshare or new products and I think we are pretty fortunate with the kind of products that we have got and the kind of gross margin we have, it is pretty easy when you have got a product group out there that is got 60%, 70% gross margins that it is pretty easy to add some extra sales to that. So we ought to continue to add resources as long as we can bring in that kind of revenues at the top line. Lon, you might have a little bit closer look on actual calculation of percentages than I have looked at.

Well, thanks for the question, Tony. It's a good question. We do pay pretty close attention to those percentages and how they correspond and relate to our year-to-date revenue growth. I can tell you that a big chunk of the increase this year is also related to distribution costs. Generally accepted accounting principles requires us to record shipping and things in the sales and marketing area and we have had a big increase in that particular area this year, which drove up the percentage a little bit.

The other thing I would say is, just so that people know, we planned for this when we did our budgets last year and we are actually -- as a percent of revenues, we are actually running a little bit below our budget through nine months. So maybe we didn't do a good enough job of continuing to explain why and how we are investing in sales and marketing because we do have good margins in the products and we do think it will pay off. And so far this year, we are managing them to be certainly within our plan and our budget. So I think this quarter is higher than we have seen in the previous two quarters, but on a year-to-date basis, we are still very much in line with where we expected to be.

Fair enough. Thank you. One other question. So Jim talked about China in a couple of quarters. I wonder if you could drill down a little bit on just how rapidly your business in China is increasing and what percent of sales that now represents.

Well, overall, it is still -- I will answer it, start from the back and work back to the front I think. Overall, it still represents a very small percentage of the overall revenues for Neogen Corporation. Jim already addressed the fact that we are starting to see some progress over there in the genomics area. They certainly have placed more emphasis -- and you read almost daily about the kind of things that are happening on the Food Safety side. I know that our Neogen Europe operations through a distributor over there have had some good success this year in sales and general sanitation area for our ATP systems.

We have seen good placements of product the last two years over there for our Soleris optical microbial test systems to detect things like yeast and mold total coliforms indicator and spoilage organisms. The only thing that has fallen a little bit behind schedule is we expected to have some further increase over there with cleaners and disinfectants. Again, talking about some of the kinds of things from a viral and bacterial kind of standpoint that our problems in animal protein production facilities and we expect to get some approvals for our product there in China within the next three months I think. So that next fiscal year, we will start to see growth in that area as well. It is a market for our products and I think it will continue to grow as it has the last couple years.

Probably one of the biggest concerns there now is the Western companies that are producing food in China. I think you have heard me say that China has got a lot of the resources they need to do their own thing. They don't have enough resources to produce the quality or the quantity of quality food that they are going to need that is putting pressure on. So we have a number of US corporations that have gone to China or -- not just US. The largest dairy operation in New Zealand is there with large dairy operations.

So I think we will see more of that, US corporations producing food in China for the Chinese population and they have got more to protect. They have got a bigger reputation to protect and as a consequence, we think that there may be bigger opportunities for us, particularly with our diagnostic products, whereas the local Chinese companies, food production companies, they opt for cheaper diagnostics produced by Chinese diagnostic companies.

So it is just going to be interesting as we see that unfold. I do think we will continue to have a good opportunity there to grow our business because, as I have often said going way back, don't go buy Neogen's stock today based on the fact that we are going to make huge tremendous earnings out of China.

Thank you.

Steve O'Neil, Hilliard Lyons.

Yes, good morning. I was wondering if you would quantify the impact of currency on third-quarter revenue. And then along the same lines, Jim mentioned the 18% increase in Neogen Europe. I just wondered what that was in local currencies.

Steve, have you got those for the quarter?

Yes, currency effect on revenue in the quarter was very minimal. It was $18,000. And the second question was --?

On Neogen Europe.

The $18,000 I think was -- was that based on pound to the dollar conversion? I think in total, if I remember correctly, the positive impact of currency, of all the currencies was positive to the tune of maybe a couple hundred thousand dollars in revenues. I am quoting revenues, not earnings.

We have got -- when you go back to figure earnings, you have got to figure that we are paying 25% taxes in the UK and we are consolidating -- we are paying whatever the rate was, 34%, for quarter or whatever. Year-to-date, I think, Steve said in his comments that, on a year-to-date basis, we are about even. We have had wind at our back at times and wind in our face at times. So on the first nine months, we are (inaudible).

Yes, the European conversion gain was $76,000.

So it was fairly small?

Yes.

Thank you.

Greg Halter, Great Lakes Review.

Yes, good morning. I wondered if you could discuss your plans for research and development. I know you talked about 70 researchers and so forth and so on, but just wondered where you would like to see this program go over the next few years?

Well, every competitor we have will sooner or later listen to this call, I would guess. So I am a little reticent to talk about where we are going to spend our money. There is opportunities in a number of places both on the Food and the Animal side. Diagnostics will continue to be a major area for us. I think we have said before that we have got tests for a dozen allergens out there now, I guess, but there is more allergens of concern that are beginning to pop up. So we will likely do some more work there. We will likely do some work to fix our speciation product a bit. There's opportunity looks like out there in the fish business for specie identification in fish.

Over on the Animal side, we are continually working on the development of better rodenticides. In the drug area, we have got things that are underway in drugs now. We are doing some things in drugs. We will likely do so more things on drug diagnostics and of course, we are always working with the general micro side of our business, which is predominantly today than when we look at the pure general side of our business would be what we are doing with the Soleris productline. So it is pretty broad.

All right. In the quarter, what were the sales that came from acquisitions that you have made? And I guess, in other words, I am trying to get to the organic growth for the Company in the quarter.

Right. I don't have that one in my head. I think Steve probably has it here.

Yes, the organic growth for the quarter was almost 9% versus 8.8%.

8.8%. And that is versus a 13.7% that was reported, correct?

Correct.

That's correct.

And I would be remiss if I didn't introduce the fact that how we have measured organic growth versus how we measure growth from acquisitions and we are not an acquisitive company that is out there buying whatever is available at good prices. Everything that we buy is a fit somewhere within the organization. An example of that would be the MacLeod acquisition. We bought the MacLeod acquisition, and I don't have the numbers exactly on the top of my head, but our sales this quarter were a whole lot higher than they were this same time last year when it was owned by the previous owners.

So when we bring a product in, we put extra sales and marketing behind it. We have got extra activities we put behind it and do you count that -- we count that as growth from acquisitions, not organic growth. But I would say to you that the growth was responsible -- it was our existing organic group that caused that growth to be there.

So there's just different ways to calculate it. If we calculate for the first 12 months that we own one, well, we say whatever revenue came from that was by acquisition and thereafter, it is organic. But as long as you understand our model and how we calculate -- make the calculations I think is what is important.

Yes, thank you. Steve, I think I heard you say that cash flow from operations was almost $20 million year-to-date. Is that correct?

Correct, yes.

All right. What was the capital spending in the quarter? What do you expect for this year and do you see any rampup for 2014?

For the quarter, it was about $3.2 million. Year-to-date, it is $6.6 million and it will probably finish the year around $8 million, of which $1.5 million is the building we just purchased in Scotland. And I would say that next year's level is probably going to be -- we're still putting the budgets together for next year, so we have to see how -- if there is major projects that we are going to (multiple speakers).

All right, thank you.

So it will be somewhere in the $6 million to $7 million range for CapEx for next year.

Okay, great. Thank you.

Jeffrey Warshauer, Sidoti & Company.

Hi, good morning, two questions. First, I was hoping you could put an absolute dollar amount on the speciation kits and services for the quarter and about how far into the quarter you saw an uptick in that business?

Yes, we can begin to give you a little bit. Most of it didn't affect the quarter. It started to flow in February. So we had -- Neogen Europe had money from the sale of diagnostic test kits, plus the sale of an internal laboratory. We have got our own internal reference laboratory that we operate out of Scotland and we happen to be the only firm, the only laboratory in the UK that has what is termed a UKAS approval, so we were approved in our own laboratory to do -- actually to do DNA work on the detection of horse contamination. So we picked up some dollars there.

We scaled up a big part -- after things broke, a big part of it was getting the scale up of what we are doing. We did about $200,000 in February if my memory serves me correct. So some of that will continue to flow over into March. We had more orders than that on the books, but I think what we actually got plugged in was maybe a couple hundred thousand. My memory reasonably correct, Steve?

I think when you look at it as an increase over the prior year, we have had speciation tests that had some business there, but I don't think that is far off in terms of the increase we saw in the quarter. And Jim is right. We carried over a fair number of orders, actually a good amount of orders and that will be more of an effect on our fourth-quarter revenues likely than it was on our third-quarter revenues.

Great, that's helpful. And second, on the rodenticides and disinfectants, could you just provide a little more color on competition and market dynamics that you saw in the quarter?

Well, in the area of rodenticides, we are really getting back to what historical levels were as a result of the EPA issuing that risk mitigation rule that went into effect at the beginning of fiscal year '12. That affected our sales last year. We had some customers that bought some significant stocking orders, carried them through most of last year and we are now starting to see a recovery from that.

We are also coming out with some new formulations that are starting to have a positive impact on that particular side of the business, talking about rodenticides now and I think more importantly for us, it also comes with a higher margin. I mentioned that the Hacco operations actually were down slightly compared to last year, but their operating profit was actually higher than it was in the third quarter last year and it is up significantly through the first nine months. So the rodenticide story is a good story for this year and we expect even better things as we bring out some of these additional new formulations moving into fiscal year '14.

On the cleaners and disinfectants side, I think there has been a number of things. On the cleaners and disinfectants that we own, we are actually seeing an increase in sales on a year-to-date basis compared to the prior year. So the shortfall has been on disinfectants primarily that we distribute from third parties and mostly as it relates to business that is in the international markets. And there, we are seeing some increased competition and are doing some knockoffs of those products and I think equally though is just the timing of orders from quarter to quarter on that as well.

So overall, the cleaners and disinfectants is an important part of biosecurity for those animal protein producers. And I mentioned that we are continuing to look and get and obtain registrations in a number of countries, particularly in some areas in Latin America and I mentioned China and that will help kind of restore that business going forward.

Okay, thanks, everyone.

Steve O'Neil, Hilliard Lyons.

Thank you. Actually my question was answered.

Thank you. I am showing no further questions at this time. I will now turn the call over to Mr. Herbert for closing remarks.

Well, thank you, Lorraine. And we now are well into our fourth quarter. We are excited about where we are going. Unfortunately, we won't get to talk to you on one of these conference calls for awhile now since we don't get to report quite so quickly after the end of the fourth quarter. But watch as press releases develop. I think we look forward to some significant developments as we move out over the next few months and we will see you in one of these conference calls again -- when is it, Steve? September or some time?

End of July.

End of July. Okay, sorry, not quite that long. So thank you and we appreciate your participation and your continued support and that concludes our comments for the day. Thanks.

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.