Neogen Corp (NEOG) 2014 Q3 法說會逐字稿

Welcome to the Neogen Corporation third-quarter fiscal year 2014 earnings results conference call. My name is Sherri, and I will be your operator on today's call. (Operator Instructions) Please note that this conference is being recorded.

I would now like to turn the call over to Jim Herbert. Jim, you may begin.

Thank you, Sherri, and good morning and welcome again to our regular quarterly conference call for investors and analysts. Today, as you know, we'll be reporting to you the results of our third quarter that ended on February 28. And I'll remind you that some of the statements that are made here today could be termed as forward-looking statements, and these forward-looking statements of course are subject to certain risks and uncertainties. Actual results may differ from those that we discussed 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 joined via live telephone conference this morning, I'd also welcome those who may be joined by way of the simulcast on the World Wide Web. Following comments this morning, we will entertain questions from participants who are joined in this live conference. And I'm joined today by Steve Quinlan, our Chief Financial Officer, and Steve Snyder, Neogen's President and Chief Operating Officer.

Earlier today, Neogen issued a press release announcing the results of our third quarter that ended on February 28. And again, those revenues broke all records for the Company's third quarter at almost $62 million, or a 21.4% increase compared to last year's $51 million.

On a year-to-date basis, revenues through the first three quarters have increased approximately 19% as compared to a year earlier to a bit over $180 million. This compares with last year's three quarters of $151.5 million.

Third-quarter net income was approximately $6.6 million and about even with the same number of 2013. Adjusted for the 3-for-2 stock split that was effective back at the end of November, our earnings per share in the current quarter were $0.18 a share as compared to $0.18 a year ago.

On a year-to-date basis through the first three quarters, net income is approximately $20.6 million as compared to approximately $20.2 million, or that equates to $0.56 a share as compared to $0.55 a share a year earlier. I think it should be noted that the number of fully diluted shares is approximately 2% greater than it was a year ago.

This third quarter marks the 88th quarter in the past 93 quarters that Neogen has reported revenue increases as compared with the prior year. And I at this time sure want to take thanks -- special thanks to our 915 employees scattered around the world for this continuation of our steady growth record that's been established now for 23 years.

You no doubt noted that, even though we had a 21% increase in revenues, bottom-line earnings were the same as the prior year. Or put more harshly, the $11 million increase in revenues didn't provide additional bottom-line profits. The explanation is generally the same as what we reported to you last quarter. The third quarter a year ago was a part of that perfect storm.

The third quarter a year ago, we reported gross margins of 53.5%. This 53.5% gross margin compares to the third quarter of this year of 49.5%.

At the same time, I can tell you that after a thorough investigation, we have not seen a slippage in gross margins within our various product lines. It's just the fact that some of our products have higher gross margins than others. And when we have an unusual mix of those products, it changes the metrics.

A year ago, we benefited significantly from a contaminated grain harvest both in the US and major portions of Europe that provided sales of high-margin test kits. And this just didn't reoccur this year.

As you've heard us say in the past, we found success in overall management of the Company if we work around the goal of a 20% operating profit, 20% of revenues. When this drops below 20%, we look back upstream to find out where we might have invested too much money for topline growth or where we might have a leak somewhere. When it goes above the 20% mark, we feel kind of like we're eating seed corn, and we need to be investing more in order to grow that top line.

We knew that during these past two quarters that we were up against some tough year-ago comparables. At the same time, we knew that we needed to invest more heavily for revenue growth or see these opportunities go to competition. This quarter, we invested 14% more in sales and marketing than we did in the prior year. We also invested more in our R&D effort.

Earlier in the fiscal year, we also had an opportunity to make three strategic acquisitions that put us in a very strong position in our biosecurity efforts for our animal safety group. Though all this will continue to be accretive at the top line and at the bottom line, there have been nonreocurring expenses that are associated with these acquisitions and the integration of them.

On top of that, we had harsh weather across the Midwest and even down into the Carolinas that slowed this integration process. Every one of our US operations had closures during the quarter because of extremely cold temperatures, snow and ice. And this kept us from absorbing some overhead and building of inventory.

I am proud of our continued growth in revenue. I'm sure that we made the right decisions to make these strategic acquisitions. I'm also sure that the money we invested in sales and marketing to push revenue growth was a wise decision, even though it temporarily penalized the bottom line.

At this point, let me stop and ask Steve Snyder, our Chief Operating Officer, for his comments. As most of you know, Steve has been with us now for most of this fiscal year, and his leadership and organizational ideas have been helpful in preparing us for continued strong growth. Steve has spent most of his time recently working with our food safety group and, frankly, has given me some much-needed time to work on more strategic longer-term opportunities. Steve?

Thanks, Jim, appreciate that. On the call today, I want to focus my comments on our results in both food, animal safety as it relates to selected markets. I'll also provide some more specific examples of product lines within segments where we see particular strength going forward and some areas where we're still working to improve.

In our food safety business, we saw solid organic revenue growth of 10.7%, with most market segments showing significant quarter-to-quarter growth, the major exception being our milling and grain market segment. In that segment, it was another difficult comparative quarter due to last year's outbreak, which generated unusually high margins for mycotoxin test kits.

Bottom line for milling and grain was that we had the right new product for the market with Reveal Q+ in a year with significant mycotoxin outbreaks in both US and European crops. Otherwise, there were no big surprises across the food safety business.

In terms of product and marketing highlights for the quarter, our grocery products segment showed healthy gains of 10% compared to the same quarter last year, driven largely by our industry-leading food allergen test kit product line. These products allow our customers to detect inadvertent allergen contamination of a full range of consumer food products. Some of the more popular test kits were for milk proteins, eggs and soy.

Market demand is really growing -- driving the growth for fast and easy detection of these allergens. An example of this is the plant-based dairy alternative beverage market, which includes product based on soy, almond, rice and other substitutes designed to address lactose intolerance, milk allergies, and generally provide nondairy options. This segment is reported to be growing at 15% annually, reaching a value of $14 billion in consumer sales by 2018.

Neogen is well positioned to address these opportunities.

In addition to allergen detection and grocery products, sales of our AccuPoint 2 ATP detection system added to the results. As customers continue to look for ways to improve sanitation and to implement new cleanliness protocols, AccuPoint 2 and AccuPoint 2 with RFID provide a logical and easy-to-use tool. The RFID product comes enabled with RFID tracking capability that allows you to monitor results by specific locations within your facility. Our AccuPoint business grew 11.1% overall this quarter compared to quarter three of 2013.

Other strong markets for us were the beverage and nutraceutical segments. Together, they grew 31% when compared to last year's third quarter, driven by continued strong product sales of our Soleris line of rapid optical microbial testing systems. Soleris systems are used to detect spoilage organisms like yeast and molds in foods. Our convenient ampuled media and Neogen filter tests also contributed to the advance in beverage market sales, showing growth of 26% this quarter versus same quarter last year.

Overall, we had global sales growth of 17% in our Soleris line, including both disposable vials and instrument sales. Instrument placements grew nicely for the quarter, and we also have a strong pipeline of newly identified applications and customer prospects, which bode well for the future vial and equipment sales.

Dairy is another strong market for food safety products. Neogen's products address the needs for detection of spoilage organisms, residual antibiotics in fresh milk, and the presence of allergens. The world dairy market is expected to show above-average growth in emerging markets such as Brazil and China, where we are already adding resources.

Growth in the US and Europe is expected to grow in further process categories like cheese and yogurt. This includes new consumer dairy products such as the currently popular Greek yogurts and the drinkable healthy beverages.

In order to capitalize on market opportunities like dairy, we've stepped up our attention on a range of microbiological-oriented products. One example of this is our recently launched film-based general micro product called NeoFilm, where we're seeing promising initial orders. Our solutions-based approach to selling our micro line of products is perfectly suited to generate growth in NeoFilm sales. As mentioned earlier, these advances helped offset our disappointing milling and grain mycotoxin-related sales that were off 34% due to this year's clean grain crop.

Switching over to our animal safety markets, we had overall growth of 32% versus the same quarter last year. Successful integration of recent acquisitions by our team in Lexington is really the important headline here.

In the quarter, we concluded the acquisition of Chem-Tech, a Pleasantville, Iowa-based leader in insect control to the food and animal industry. This business folds nicely into both our animal safety and food safety businesses. The Chem-Tech products are an important aspect of our biosecurity offering, which includes rodenticides, cleaners and disinfectants. These other products are made by our Hacco division, located in Randolph, Wisconsin.

Chem-Tech also brings insect protection for food-related storage facilities, providing a natural link to our food safety business. Integration is going well and will continue into the next quarter as normal seasonal demand is expected to grow.

Back in October of 2012, we acquired Macleod Pharmaceuticals. This provided us with a strong product in the animal safety business called Uniprim. Uniprim is an antibiotic powder used to treat a wide spectrum of bacterial infections. Sales of Uniprim were up 28.4% in this third quarter compared to the same quarter last year.

The strong performance of Uniprim was offset by a tough comparison quarter to quarter last year with our ThyroKare pet pharma products, where sales were up versus historic levels, but were below the 2013 figures, when we benefited from competitor outages during the year.

The vet instrument market has become significantly stronger for Neogen with the SyrVet and Prima Tech acquisitions earlier in the fiscal year. We now offer a full line of veterinary instruments and many well-known brands in this space. Sales in our historic Ideal instrument line were up 14.1% this quarter, even before the addition of acquisition revenues.

A strong year for cattle ranchers is a positive factor for sales of many of our animal safety products. After the droughts of 2012 and 2013, 2014 could shape up to be a record year, driven by lower cattle numbers and grain prices.

This certainly applies to our trademark D3 detectable needles, one of our star product lines in our animal safety business. Developed over 10 years ago using proprietary alloys and design factors, this product line continues to grow, with revenues up 9.5% in quarter three of 2014 versus same quarter of 2013. They were up 11.7% on a year-to-date basis versus last year.

This product is a great example of how Neogen's food safety strategy reaches back inside the farm gate to deliver food safety. This product prevents broken needles from getting into the food supply by allowing simple needle detection prior to the shipment of product.

GeneSeek, our animal genomics-based testing and bioinformatics business located in Lincoln, Nebraska, achieved growth of 6% for the quarter versus last year's quarter. This indicates that our moves into this cutting-edge technology are showing utility in easy-to-use applications within the segment. We continue to find new ways of leveraging this technology across our platforms. Our NeoSeek test that allows positive DNA-based confirmation of dangerous E. coli strains is a good example of that.

Throughout the quarter filled with acquisition integration and unusually difficult weather conditions on top of all our usual challenges, our team of employees gave the extra effort needed and did a great job making sure we stayed on track taking care of our customers.

I believe the key for us right now is continued emphasis on execution of our strategy to deliver customer solutions. With the ongoing support of our product development, manufacturing, and the rest of our Neogen team, we are optimistic about finishing the year strong.

With that, I'll turn it back over to you, Jim.

Well, thanks, Steve. It's pretty easy to call on Steves around here now. We used to have a lot of Jims; now we're outnumbered by Steves. So that was Steve Snyder. And I'd now like to call on Steve Quinlan, our Chief Financial Officer, to give you a bit of the numbers color behind these general comments. Steve?

Thank you, Jim. Jim has reported on the overall sales and profit performance for the third quarter of our fiscal year. And Steve is taking you through some highlights of our revenues and markets. I'd like to give you some color on our earnings for the quarter and year to date, and talk as well about some of our significant balance sheet changes.

Gross margins on our $62 million in revenues for the quarter were 49.5% compared to 53.5% on the $51.1 million in revenues in the February 2013 quarter. This decrease was due in large part to the shift in overall Company revenues toward animal safety products, a result of the three acquisitions the Company has completed this fiscal year. These acquisitions -- SyrVet, Prima Tech, and Chem-Tech -- were all on the animal safety side of the business and added $7.8 million of revenue to that segment for the quarter.

As we discussed on the second-quarter earnings call, these businesses are bolt-ons. And although their gross margins fall somewhere in the middle of the animal safety average, they generally require less operating support and should provide nice contributions to operating income once fully integrated into the Company. The SyrVet and Prima Tech acquisitions also significantly improve our market-leading position in the animal protein veterinary instruments business, while the Chem-Tech purchase broadens our product portfolio for our biosecurity offerings for that same animal protein market.

I think it's important before we go on to note that the 53%-plus gross margins last year were the highest the Company had ever achieved, primarily due to the aflatoxin outbreak we've previously mentioned and the capture of high-margin small-animal supplement business. If we analyze Neogen gross margins for the past four years before fiscal 2013, we find gross margin averages of about 50.8%. The good news is that gross margins have not deteriorated in our existing product lines. The margin percentage decline is truly a mix phenomenon.

Gross margins were strong in the food safety segment, even with the continuing natural toxin revenue shortfall that we discussed in our second-quarter call and earlier today, caused by the aflatoxin outbreak in the corn crops in the prior year. In our third quarter, we had a $500,000 shortfall in the natural toxin product line. And this is a high-gross-margin product. And our gross margin percentage declined only slightly for that segment as other products largely made up for that shortfall.

In the animal safety segment, margins on Lexington's base business were stable, and GeneSeek's gross margins improved compared to the second quarter as its mix turns toward higher-margin chip platforms.

Both disinfectant and rodenticide sales were negatively impacted by weather and order timing. And this did result in slightly lower margins for these products due to unabsorbed overhead. On a year-to-date basis, gross margin was 50.3% compared to the unusually high 53.5% in the prior fiscal year. Now, this decrease in gross margin on a year-to-date basis is due to an overall shift in total revenues, which I just discussed regarding the quarter, and shifts in product mix within each segment.

Looking at operating expenses, our sales and marketing expenses increased $3.3 million for the first nine months. And as a percentage of sales, they were 19% compared to 20% a year ago.

General and administrative costs for the first nine months increased from 9.5% of revenues to 10%, and primarily due to amortization of certain intangible assets from the recent acquisitions, compensation and stock option expenses, and legal fees. The amortization charges and stock option expense are non-cash charges.

Expenses of almost $700,000 for the first nine months from new locations in Colorado, North Carolina and Iowa resulting from the acquisitions in the past year are included in the increase.

Year to date, research and development expenses were 10.1% higher than last year, primarily due to contracted services expenses for various projects. However, they were only 3.6% of our total revenues.

Our operating profit was $10.3 million for the quarter, an increase of 6.5% compared to last year. And our operating margin decreased from 18.9% in the February 2013 quarter to 16.6% in the February 2014 quarter.

On a year-to-date basis, operating margin was 18% compared to 20.1% in the same period of the prior year. For both the quarter and year to date, the decline in operating margin percentage was due to the decrease in gross margin percentage, as I have already described.

For the quarter ended February 28, currency losses were minimal. In last year's third quarter, other income included $180,000 of currency gains, as well as some royalty income. On a year-to-date basis, other expense of $522,000 was largely the result of currency losses recorded at foreign subsidiaries as the Brazilian real and the Mexican peso devalued against the US dollar during the first half of fiscal 2014.

Our income tax expense in the third quarter of last year benefited from a federal research and development credit for calendar year 2013. That credit expired at the end of 2013, which has resulted in a higher effective income tax rate in the current quarter.

As Jim mentioned at the beginning of the call, we achieved net income of $6.6 million or $0.18 a share in both this quarter and the year-ago third quarter, and for the year to date have earned a total profit of $20.6 million or $0.56 a share compared to $20.2 million or $0.55 per share last year.

We finished the first nine months of the year with a strong cash position, even after spending $39 million on the SyrVet, Prima Tech and Chem-Tech acquisitions. The Company has generated $17.2 million from operations in the first nine months of the year.

On the balance sheet, our revenue balance is up 14% since last year, primarily reflective of our revenue increase. Inventory levels have increased from last-year-end levels, but $9.1 million of that increase is inventory from the acquisitions. And we'll be rightsizing this over the next few months.

To wrap up, we're going to close out the year strong, execute our plan, and continue to earn the trust that you've placed in us. Our entire management team is excited about our continued growth opportunities.

That concludes my prepared comments, and I appreciate your attention. At this point, I'll turn the call back to Jim for his closing comments.

Yes, thanks, Steve. As we continue to build the organization and the product lines to take advantage of both food and animal safety opportunities, the drivers for our business continued to even be stronger.

For instance, even though we generally regard the US food as being safe compared at least to other parts of the world, the nationwide recalls in the last three months of 2013 by the Food and Drug Administration totaled 134. In that same three-month period, the US Department of Agriculture reported 19 recalls of meat, poultry and processed egg products.

All this regulatory activity is taking place even though the infamous Food Safety Modernization Act has still not been implemented. Though regulatory recalls are certainly a driver to our business, an even bigger driver is the increased activity by major food producers and processors who are working harder to make certain that their food is safe.

As Steve reported, we are seeing healthy growth in a number of our products back inside the farm gate that have significant impact on animal protein safety. Even though acquisitions have aided growth, as you would expect, the organic growth or same-store sales continues to be persuasive, with our food safety group increasing same-store sales somewhere approaching 12% and animal safety same-store sales over 8%.

Some of the strategic opportunities that I spoke of earlier involve our international business. I expect that two-thirds of our total market opportunities actually lie outside the US. And then the emphasis on international revenue growth, as some of you will remember, has always been one of our drivers and one of our objectives. Revenues from international sources in this third quarter were 12% higher than in the prior year. And these revenues come from over 100 different countries around the world.

However, we give major emphasis to those countries where the Neogen flag is planted and our own boots are on the ground. Our Neogen Europe operations continues to be a star in revenue and earnings growth, with revenues up this third quarter by 22% as compared to the prior year. And this isn't a one-quarter phenomenon since on a year-to-date basis Neogen Europe revenues are up 32%.

Though most of our Neogen Europe revenues come from food safety-based products, our business in animal genomics in Europe is becoming a stronger driver. We have our own sales organization in the UK, France, Germany and Holland, and Neogen Europe also takes care of or is responsible for sales of all of our independent distributors throughout the European Union.

Though working from a smaller base, our revenues for Neogen Latino America headquartered in Mexico City also continue to show good strength during the quarter, up almost 31% for the quarter and 25% for the first nine months. Bottom-line profits in Mexico have been fragile because of this rapid growth, but Neogen LA is reporting an operating profit for the quarter and, in fact, the first half of this year.

Neogen do Brasil showed strong revenue increases of 31% for the third quarter and almost 47% on a year-to-date basis as our traction improves there. Brazil will continue to be important to Neogen and to the world as it becomes a major worldwide supplier of food.

I feel good about the way our new organization is shaping up for China. And it's very clear that China is concerned about food safety and food security for its developing middle class.

In addition to Chinese companies, the acquisition of Smithfield Foods back two quarters ago -- by the way, Smithfield is the world's largest pork producer and processor -- the Chinese government continues to encourage Western companies to come to China to help produce the increasing amount of animal proteins that are going to be necessary to support that growing middle class.

Food safety concerns in China continue to be overwhelming, even with the tight controls that are put in place by the central government. China has prosecuted over 10,000 people in the last three years for the production and sale of substandard or poisonous foods.

China has just published a new food safety standards regulation to once again try to set up a system for strong implementation. Key in this decision has been to require that every processed food company to name to the central government the person to be responsible for food safety within that company.

More processed food will be a key to the China master economic plan as urbanization grows. This will be spurred by a plan that was in fact just approved this week to move 100 million people to cities over the next few years. Food security to middle-class China is already becoming a serious issue. We think that this gives us a good opportunity going forward.

The other major world growth in middle-class is coming from India. And of course, this one is also going to grow. I'm just back from a week ago where I led a Neogen delegation as we began to pursue establishing our own Company operations there to work with both the food and animal safety operations.

India is just beginning to embrace the new technologies for food safety. Until now, their food safety issues have not been as pronounced as in some parts of the world since food is consumed within a short period of time from when it's actually been produced. However, as the middle class there grows and as urbanization becomes more prevalent, food safety or processed food is becoming a much bigger concern. This is particularly true of that middle class that we speak of.

I think it's obvious that with 18 million people in Mumbai and maybe 17 million in New Delhi, along with more than 50 other cities with populations in excess of 1 million people, that better and faster methods of testing for food contaminants is going to offer some real opportunities.

I guess in conclusion, I'd say that I feel pretty good about where we are at the end of our first nine months. I know that these topline revenues are and will produce good bottom-line results. Though we don't have any acquisitions to report to you this morning, there continues to be some opportunities on the radar screen. And we, of course, have, as Steve said, sufficient cash, I think, to take advantage of most anything that might come along.

The challenge for Neogen management going forward is to balance that topline growth with bottom-line earnings and to get that operating profit back to the 20% revenue position.

I think I'll stop at this point, conclude my prepared comments, and, Sherri, open the lines for any questions.

(Operator Instructions) Paul Knight, Janney Capital.

Congratulations. You had I think touched on a little bit, and that is the food safety market seems to be such a consistent grower. And so my question is twofold: one, more color on why you continue to see that double-digit growth; and two, I guess phase one of the food safety regs are having to be rewritten here this year. What is your forecast on food safety regulations? Is it another year before we see it, or does it even matter?

(laughter) Paul, I'm beginning to think maybe it doesn't even matter. I was continually with people in the food industry yesterday with -- in fact, had the opportunity to -- we had a couple of [investors] in with major significant food production in this country, and we spent some time discussing it yesterday afternoon.

They're kind of to the point of saying, if the regulation was in effect, we think we would be compliant. But we don't know when it's going to be in effect. I think the first one -- it was, I believe, seven major areas in which FDA wanted to establish stronger compliance stronger compliance and stronger regulations. And the first one, I think, was fruits and vegetables. And it's been -- they've published that for comment well over a year ago. And at the end of the comment period, they decided they didn't have enough comments, so they reopened it for additional comments. And it was scheduled to be a regulation, gosh, several months ago. And FDA came back a couple of weeks ago and said, well, we're not sure we got enough comments yet. We're going to reopen it for comments.

So it's hard to explain. I don't know how much of that we lie at the doorstep of the administration or how much we lie at the doorstep of just general confusion. But I think sooner or later, we're going to see these regs come in. In the meantime, it's maybe good for us and good for the industry that they are leaking out slowly rather than having an abrupt impact. I think people are beginning to -- producers and maybe exporters or importers for us are beginning to look at those regs and see what they'd have to do in order to be compliant. And maybe they'll come nearer to being compliant with less stress when -- I guess I shouldn't say if, because I think they will -- they've got to be implemented at some point, but when they get implemented.

So that's a long political answer to a rather short question. But it's about what I see there. So I think the drivers are going to continue to be there both with food and animal safety. And as Steve Snyder talked about -- we go by last names around here, so that is the only way. But some people think that's kind of irreverent, to be referred to always in the last name. But Steve S. talked about the Chem-Tech acquisition and the fact that we brought our product in there that -- some strong products that's going to help inside the farm gates is going to be important, because insects are one of the vectors that carry disease and problems, especially flies.

But it's also impacting what's happening in food safety. You know, we've got large warehouses that are storing things like ready-to-eat cereals that have to be concerned about keeping the insects out. Otherwise, they get -- the cereal boxes got little holes in the side, and you wonder where it came from. But that's a big issue. And we've got, quotes, green product that is being used in those warehouses for insect controls. So it's going to be interesting to watch that grow too.

And then last, the growth point you brought up, 11% food safety, about 8% animal, I think that translates, what, into a roughly 9% to 10% total organic growth rate in the quarter?

I defer to Mr. Quinlan on that one.

Those numbers given were year-to-date numbers. So that would be 9% or 10%, year to date, yes.

And how about year-over-year organic, quarter?

Quarter -- food safety was about -- well, it's 10.7%. All of their growth was organic, and animal safety was about 1%, 1.1%, so blended around 5%.

Okay, thanks.

Tony Brenner, Roth Capital Partners.

Steve Q., I guess, mentioned that natural toxin kit revenues were down I think $500,000 in the quarter. What percentage decline is that for those products?

Give me a second, Tony.

Sure. It's a [tough one].

Yes, if we're talking specifically -- we just have so many natural toxins, Tony, but we're talking -- we're trying to do the comparative on the aflatoxin one. That's probably about somewhere in the 30% range.

Decline, Tony, quarter over quarter. Quarter over prior-year quarter.

And then that comparison should begin to improve significantly this quarter; is that correct?

And I should know the answer, because I knew you'd ask a question like that. I think the comparables are going to be less tough. Remember, though, that a crop that was harvested in October/November gets to be tested for better part of a year because it goes into storage and is tested as it comes out of storage. But I'll stick my neck out and say they're going to be less onerous this quarter, this fourth quarter, than they were last year. I think that's right, Steve.

I think so, yes.

Fair enough. And I believe you also said that GeneSeek sales were up 6% in the quarter year over year. Last quarter, the increase was 56%, I believe. And you attributed that to some new tests and products resulting in incremental market share. So I'm wondering, if that's the case, why so much volatility?

Quarter-to-quarter variation is hard to predict. We've got some of that as we are working with some of the major animal breeders in the world, and they're pulling animals samples for grandparent, great-grandparent use in breeding. And those samples will build up, and we will get them a slug at a time. We've got our GeneSeek people in here. We spent some time yesterday trying to figure out how to better predict where that's coming from.

It was a strong third quarter this past year, so it was one of those divine-intervention quarters in Q3 of 2013. So we were up against a tough comparable, so I don't think that 5% is probably -- may not be indicative of anything, Tony.

How large a customer base is there for GeneSeek? Is it still very small, or is it a broad sampling?

I'm looking. It so happens that the controller for our GeneSeek group is sitting in the room with us this morning. And I turned to him, and he said, if we look at all the individual ranchers out there, it's probably up to 4000 or 5000. If we looked at how many customers we have that make up the top 50%, what would we guess, 100 -- yes, 100 customers make up probably the top 50%, Tony, of our revenue.

Got it. Okay, thank you very much.

Charles Haff, Craig-Hallum.

Thanks for taking my questions this morning. I had a question for you on the acquisition environment. In terms of available targets out there, do you see more targets on the animal safety side or the food safety side right now? Thank you.

Well, we've seen more targets on the animal safety side. We made three. The food safety side, it's kind of, I think, the difference between mature and immature businesses. Food safety is still pretty immature, so consolidation hasn't begun. We've picked up a few along the way. But there's no real consolidation that's begun yet, so the offerings are not there. Animal safety -- if you look back, it is a part of the old animal health business -- is much more mature. And so consolidation is easier to do and continuing there.

I think we might have a couple of three food safety candidates on our radar screen, but nothing imminent with those.

So on the animal safety side, you probably have a few more than the food side on your target list right now?

Yes. I'm just trying to think. I don't know; I don't think there's probably much difference.

Okay. And then my second question is on the international side, you did a really good job of kind of breaking out your growth rates by your divisions there. Just wondering in terms of kind of where the most materiality is -- I realize they're all kind of in different stages with India being real early, and obviously EU, you've been there for quite a while with your Scottish efforts there. In terms of kind of where the biggest bang for your buck is right now, is it Neogen LA, or is it Neogen Brazil, or Neogen China? How should we kind of think about where the biggest return on invested capital may come from over the next couple of years? Thanks.

A couple of years, I guess I could look at where are we with currently and as we look out over the next few quarters. We're in budget, and our new year begins in June. So we're beginning to start formulating our plans for next year, and I don't see any slowdown in the growth of Neogen LA. It's working in mature markets, where food safety gets to be a bigger and bigger issue. As we look at the European Union, European Union is putting out more regulations than anyplace else in the world today and forcing compliance.

And, you know, I think the economy is going to be okay over there. We suffered a little bit with Italy and Spain, but not now. It looks like we're okay. We've got independent distributors in those markets.

So I think we're going to continue to see probably some more investment. We're looking at some additional investment perhaps in Europe, and we'll see that piece continue, that Company group continue to be the centerpiece. As you look at dollars, percents are great, but as a friend of mine once said, did you ever write a check for a percent? (laughter) And so some of these big percent growths are nice, but if you know what the base you're working from.

Neogen LA, the Mexico side, the reach that they potentially have into Central America and what we're doing in Mexico, I feel real good about that organization, how it's grown and become of age.

The China operations could be big in a hurry. They could be just lackadaisical. Just depends on how fast we can get some things done. We're going through some reorganization and building of a new group there. And I think we're welcomed by the China government and welcomed by the producers, particularly the Western companies that are producing protein in China. It could be big. Right now it's not, but -- well, it's pretty respectable, though, on both the food safety and the animal safety side.

We're going in there with some cleaners and disinfectants, particularly disinfectants, into that China market where there was already the -- we already had kind of a base, but a difficulty in getting product in there at a reasonable price. That's opening up for us.

India is clearly the last place. It's going to develop slowly. I think we'll probably be able to make an acquisition or two that will serve as the base for us to move out there. But it's not going to develop real rapidly. I think, however, it's the right -- now is the time to be there so we can be a part of that growth as it starts to mature.

Okay.

That's kind of where we are looking in the world. Everyplace else in those 100-plus countries, we've got pretty good distributors. There's a spot or two where we might a year out look at putting our own boots on the ground, but not in the next 12 months.

Yes, I like the way that you're looking at it in terms of dollars instead of the percentages. So if you had to kind of rank-order those opportunities in terms of dollars of incremental growth or profit over the next couple of years, could you kind of rank-order those for me?

Yes. I think Europe is first; Neogen Europe is first. And then it may be a horse race between Neogen LA and Neogen Brazil. Brazil may be running faster than the Mexican operations, but those will be good. I guess I have to put China in, reluctantly, in the next spot, because it could be bigger. And then, of course, India is -- it's yet unknown.

Sure. Okay, great. Thanks for taking my questions.

I'd like to get $1 million out of India in the next 12 months, if that helps you at all.

Okay, thank you.

Steve O'Neil, Hilliard Lyons.

Just wondered if you could provide us some information on how much food allergen testing increased in the quarter and how much dairy testing increased?

I think that's a Steve Quinlan question.

Yes, dairy was up about 5% in the quarter.

Okay.

Hold for allergens. Allergens were up about 20 -- give me a sec.

Did you put the two dairy pieces together? There are antibiotics and dairy market.

Dairy market was up almost 9%.

Yes, we've got one piece that's -- we kind of split our products up just to keep ourselves confused. But one piece which is strictly focused on dairy antibiotics sales, antibiotic residues, and then another piece that is our more full-line dairy products like those that both the Steves were talking about, where we're going with allergens and pathogens and spoilage organisms. So you kind of have to add the two together (multiple speakers) talked to you long enough for you to come up with the answer.

Well, both -- yes, the one -- the dairy antibiotics one, Steve, I think is the one you normally are looking for. And the other one is kind of -- it's buried inside of our Lansing diagnostics group. That dairy market is up 9%. Our overall dairy antibiotic line is up about 5% -- 5.5%.

Okay.

And then the allergens line for the quarter was up about 17%. And that's pretty much in line with -- I think it's up year to date around 24%. So consistent growth.

And then for the $7.8 million from acquisitions, was that a year-to-date figure or a quarterly figure?

That was for the quarter.

Okay. Great. That's what I need. Thank you.

(Operator Instructions) Jason Rodgers, Great Lakes Review.

Looking at the animal safety segment, the organic growth of 1%, how much of the impact did weather have on that figure?

Well, it's -- it had some. Stuff is moving off the shelves pretty slow. You think of Tractor Supply as one of our big customers that fit there on the retail side, with -- it's up over 1000 stores out there now. Those things probably didn't -- bad weather being such as it is, a lot of that stuff didn't move off.

It's kind of a hard question to answer. We're early for the fly season yet, so there's nothing really developing there. It's hard to clean and disinfect when you're using water-based products and it freezes before you can get it out of the end of the sprayer.

So I'm sure it had some impact. It's pretty hard for me to, you know, other than just kind of imagine to know exactly what it did. I know that slowed us up at our Hacco group, which is cleaners and disinfectants and rodenticides.

It's kind of a between quarter, anyway. And we're getting ready to start to fill in this fourth quarter. We'll be shifting from, as the rats and mice start to leave their winter quarters and head for the vacation campgrounds, we'll have probably put out less rodenticides, but we're going to put out a lot more insecticides as we get insects built up and cleaners and disinfectants. I think we'll see probably a kick here in this quarter as people start trying to catch up.

And you talked about Europe's strength. You mentioned animal genomic testing. What were some of the other areas that drove results in Europe for the quarter?

Well, they were up all over. We got a good bit of speciation testing over there, more there as a percentage of sales in other places. You know, the horse -- what they refer to over there as Horsegate, when they found the horse meat back earlier in the year, you know, that drove a lot of interest in testing particularly meats for contamination, for economic adulteration, where somebody is slipping 10% horse into a beef product and getting beef prices for it, or chicken or lamb or whatever. And that continues to be strong. So I guess speciation is certainly part of it.

Allergens is a big part of it. We do a pretty good internal reference lab business to help our customers over there in addition to the test kits that we sell. So both from a standpoint of the reference lab business and the test kit sales, our allergen sales are particularly strong over there.

We're seeing that probably -- we are sitting to be the leader on the allergen side, though allergen sales in the US have been awfully good, too. They're not quite there yet in Mexico and Brazil, and of course they're nonexistent right now in India, maybe China, too.

And then finally, could you give an update on the ANSR product and any traction you're getting there?

Not enough. We're still -- we've got such a good full line of products out there for solutions to microbiological contamination and pathogens, all the way from the new product that Steve Snyder talked about, our NeoFilm, which is a quick way to be able to get a quick test for salmonella or E. coli. It's not quite as precise as some of the other methods. But that went all the way through -- our lateral flow devices are what we call our Reveal product lines that also are quick -- they're lateral flow devices that can be used on the line, can be read visually. You don't have to have a machine.

Those all kind of compete with what we're doing with that ANSR product line. And we probably haven't given it as much attention as we need to. We are reupping our emphasis, both from the standpoint of additional development -- we don't have a complete product line developed there yet. For instance, we are short Listeria monocytogenes, which is one of the products that a lot of people like to have. And so if they're going to use our test for salmonella, they'd also like to have the same format for another one. So we are working on that. But it's coming, but it's not what I'd hoped it would be this time a year ago.

Thank you.

Bryan Kipp.

Janney Capital. Just a follow-up for Paul and I. You highlighted two-thirds of the market ex-US; there's a two-thirds of the market kind of existing ex-US opportunity going forward. Just want to get an idea, just future margins kind of story. Is that more food safety -- levered to food safety, or is it more animal safety side, those opportunities?

More food safety, simply because the animal safety markets are going to be bigger, but there's more competition. And we do awfully well, for instance, in veterinary instruments, which are very important because that's what you've got to have delivery devices for anything that's going to make animal products safer when they leave the farm gate.

And we do much better in more developed markets than we will -- we won't ever sell many veterinary instruments, as an example, in China, though they use a lot. But they're going to buy something cheap that's China-made. And we get some of the same issues as we deal with with South America, where we've got cheaper competitors down there that are putting products out that work, but they are not what the rest of the world is looking for.

So that's just an example. I think we will, by the same -- on the other hand, we're clearly a leader with much less competition as we look at the full line of food safety products, again emphasizing the fact that we are the only one out there with that full line, going all the way from pathogens to natural toxins to allergens to speciation to unique proteins. Right now, we're the only one that can offer a full line of potential solutions. And I think that's continuing to work more and more for us.

Okay, so it's safe to assume as well that Latin America, Brazil, China and India, those kind of more emerging-market stories you're going to see even more weighted toward food safety because of those dynamics?

Yes. Now, it's hard to say. Cleaner and disinfectants and rodenticides are going to be a big player, we think, in Brazil. And those numbers pile up pretty quick when you start talking about, instead of test kits, you start talking about trailer loads of 50-gallon drums. So I think Brazil is going to be -- and Mexico, to some degree -- we're going to do rodenticides and disinfectant business in those markets, and insecticide business is there. So they're going to be okay.

Appreciate it. And just, I guess, a follow-up on the acquisition revenues that you guys had. Are those companies tracking towards profitability for you, or is it still kind of dilutive? And what's your expectations for those going forward?

No. No, no, no, no. Hell no. Every acquisition that we've done is accretive at both the top line and the bottom line. No. Every one of those, those three that we've brought in this year, the first month they were on board I think -- at least the first quarter, they were on board. They were putting profit to the bottom line.

Is that in regards to the animal safety business or overall corporate averages?

I'm not sure I understood your question.

The profitability that you're citing, I was just thinking is it, because it's in animal safety, are you using that as the metric? Or is it overall business, which is a little bit higher?

Okay. I can't tell you -- I can't from memory tell you exactly what the operating profit was for -- which is, of course, where we look -- what the operating profit was for each of those. I would say they're profitable. I wanted to make sure that you knew that. It was not that they were unprofitable at all, because they have all been profitable the first month that we brought them on board.

Are they less or more profitable than the overall? Well, I would say to start with, they're less profitable, because we've still got the integration costs involved there.

We work to achieve -- we were on some budgets yesterday, and we were looking at about a 19% operating profit. And we were saying, let's work on those budgets and see if we can't get that one to 20%. So that 20% operating profit, total corporate as well as within groups, is part of our objective.

Okay, yes, I guess I was just referring more to dilution. Appreciate the color. And I guess finally, cash flow from operations, can we get a number there, just so we can work through? What was your (multiple speakers) in the quarter?

Sure, for the quarter it was $6.5 million.

$6.5 million. Thank you.

Steve O'Neil, Hilliard Lyons.

Sorry, I had a couple of follow-ups. Can you discuss the performances of the rodenticides and the disinfectants separately? You talked about some weather impact. I was just kind of wanting a little additional detail.

I can't, but maybe Steve Q. can.

Yes, rodenticides were down about 12.5%, and that was more driven by weather. Particularly, one of our bigger markets is Puerto Rico, and that really -- they had some real wet weather that didn't lend itself to rodenticide sales for the quarter.

Cleaners and disinfectants were down about 7%, and that's more international. No significant weakness there, except that one of our larger countries is Venezuela. And that market has been down all year because of currency or getting cash out of the country to pay for the product.

Yes, I don't know that we had any -- we suspended sales into Venezuela, reluctantly. We've got good distributor, good customer base down there. He's got money in the bank; he could pay us. The government just won't let him ship it out. Now, that did get corrected, I think, Steve, within the last two or three weeks. And we're getting some money to flow, to come out. The government is releasing some cash. So we should be able, in this fourth quarter, to resume, I hope, down there.

And just finally, I had a note I meant to ask you about ractopamine, about a test you had developed for that. And that's something that's cropped up with some of the animal health companies. Can you talk about that product a little bit?

Yes, ours is a diagnostic test for the detection of ractopamine. There are two beta agonists that have been used. Ractopamine was used mostly in the hog business, some in the beef cattle business. Merck had a product that was used mostly in the feedlot business. Both of them have come under fire. Merck pulled their product, or I think they've pulled it from the market everyplace. Eli Lilly is still selling ractopamine. It's an improved product in the US, but in a big part of the rest of the world it's unapproved. So --

I think (multiple speakers) sells it, too.

Yes, they've got a similar product to the Merck product, I think. But at any rate, I don't have the numbers right on the tip of my tongue, but they haven't been anything overwhelming this quarter.

We know of two or three of the major swine producers or pork producers that have said we're just going to take this group of farms and we're going to take them off. We're not going to let them have -- not going to let any ractopamine get there. So, therefore, we don't have to worry. That's the product that we're going to kill and ship to Russia or wherever.

So there's probably less testing as they're beginning to get more of that in hand. It's still there, and I guess it's the next time somebody finds something and turns down a shipload of pork, it will pick up heavy again, but nothing to write home about this quarter.

All right, thank you.

Yes, thank you, Steve.

Thank you, and then at this time, I would like to turn the call back to Jim Herbert for closing remarks.

Well, thank you, and thank you all. We appreciate your continued support, and it continues to be fun. We're off to a good start in the fourth quarter, and we're looking forward to -- I guess we don't get to talk to you officially until, gosh, now we'll have to wait until after we get all of the filings done. So it's probably going to be July before we get to officially talk again.

So, in the meantime, thank you for your support.

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