Neogen Corp (NEOG) 2016 Q2 法說會逐字稿

Welcome to the Neogen second-quarter FY16 earnings results conference call.

(Operator Instructions)

Please note that this conference is being recorded. I will now turn the call over to Jim Herbert. You may begin.

Good morning and welcome to our regular quarterly conference call, as Christine announced. Today, we will be reporting to you the results of our second quarter of the 2016 year which ended on November 30.

As is usual, I will 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 risk and uncertainties. The actual results may differ of course, 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 by live telephone conference this morning, I'd also welcome those who may be joined by way of simulcast on the worldwide web and following the comments this morning, we'll entertain questions from participants who are joined in this live conference. And I'm joined today by Rick Calk, Neogen's Chief Operating Officer, and Steve Quinlan, Neogen's Chief Financial Officer.

Earlier today, Neogen issued a press release announcing the results of our second quarter that ended on the November 31, date. Net income for that second quarter increased by 16% to $9.1 million or $0.24 per fully diluted share. That's an increase from last year's approximate $7.8 million that equated to about $0.21 a share. On a year-to-date basis, net income now stands at $18.4 million or that's $0.49 a share compared to $0.45 for the same period last year.

Revenues in this second quarter also increased by 16% to $79.6 million from the previous year's second quarter of approximately $68.5 million. The quarterly revenue and net income results for the quarter both represent second quarter records for our 33-year old Company. On a year-to-date basis, our 2016 revenues increased by 14% to approximately $154.5 million.

I suppose you might kind of classify this quarter as a centennial quarter in Neogen's history. In the past 100 quarters, Neogen has reported quarterly revenue increases 95 times. That includes all consecutive quarters for the last 10 years. As I've said to you in this call in the past, this record is a credit to the 1,200 Neogen employees that are located in a number of places around the globe who just are determined that the record won't be broken on their watch.

Our operating income for the quarter came in at 18.4% compared to 18.8% in the Company's second quarter last year. Gross margins for this year's second quarter were 48% compared to 50% in the same quarter last year. That change in gross margins was due to some degree in product mix and a couple of new acquisitions that are just really starting to come on board. But adverse currency translations were the biggest detriment to both gross margins and operating income.

We faced even stronger headwinds this quarter related to the strong dollar and conversion of local currencies. Steve will talk a little bit more about that during the call. However, we did report to you this morning that the adverse currency effect compared to one year to the next amounted to about $0.02 a share in earnings. The second quarter saw us again build on our strong balance sheet, increase our shareholder equity now by 8% when we compare it back to the year that we began on June 1.

I'll plan to come back on a little bit later in this call and talk about our international activities, what's happening in regulatory activity and see if I can point out some trends that I believe are occurring along with some potential acquisition opportunities. But however, let me stop at this point and ask Rick Calk -- some of you have been around for a while remember that for many, many years we had a guy by the name of Rick Current and the names are just too close together sometimes. Has nothing to do with dementia I might or might not be suffering.

At any rate, I wanted to ask Rick Calk to talk about some of the growth in exciting areas in our food safety division where Rick's really been spending diligently providing a lot of leadership for the past several quarters. Rick?

Thank you, Jim, and welcome to everyone who's listening. Jim has already reported on the overall sales and profit performance for our second quarter and our press release provided additional details related to our overall quarterly results. As Jim mentioned, I have concentrated my efforts on the food safety segment, so I'd like to provide a bit more detail on the performance of our food safety segment for the quarter.

At the risk of sounding like a broken record, our food allergen product line continues to lead the way in revenue increases for our food safety diagnostics. The entire line was up 24% for the quarter and sales of every single food allergen test increased at least 13%, except for almond and that's because our active R&D program has largely replaced that test with our new test for multiple tree nuts which detects six different tree nuts including almonds.

Now, we've dominated the rapid testing market for food allergens for years and the second quarter was a continuation of that trend. Moving forward, the increasing consumer fueled demand for products that are verified to be free of gluten and other food allergens is only likely to grow the market for rapid food allergen testing.

Another bright spot in the quarter was a 25% increase in our sales of our general sanitation line of products which includes our new AccuPoint advanced sanitation monitoring system. Our new generation system has been on the market now since June and is living up to our expectations that it would immediately become the best sanitation monitoring system available, not only to the food industry, but to food animal production facilities back inside the farm gate or any facility that needs immediate, accurate sanitation testing results.

One point I want to make here is that our AccuPoint sales increase is not just the result of additional revenues by replacing the old model product of the AccuPoint unit. Sales of our AccuPoint samplers, the disposable component of the system, also increased 25% in the quarter. That means 25% more testing was done in this year's second quarter using an AccuPoint system regardless of the model unit used.

Another of our major safety food diagnostic product lines is our test for mycotoxins and other natural toxins. Now, these dipped slightly in the quarter compared to last year's second quarter. Last year, we experienced a spike in sales of DON test kits as we responded to isolated outbreaks, especially in the European market. This year, we return to a more normal year for mycotoxin testing as the worldwide grain crops were cleaner overall.

Our foodborne pathogen line of products increased 11% in the quarter, led by a 27% increase in our sales of test kits to detect Listeria. Listeria has gained increasing interest in the food industry recently as it has shown to be a concern in an increasing number of food items. Historically, the threat of Listeria contamination was thought to be the highest in raw foods, items such as raw milk, uncooked meats and vegetables and as well, processed foods that became contaminated after processing in items such as soft cheeses and cold cuts. Recent Listeria outbreaks have included items as varied as caramel apples and ice cream.

In the quarter, we added to our pathogen line with our answer for E.coli O157:H7 test kit for rapid detection of the pathogen's DNA in food and environmental samples. And shortly after its launch, the test received an important third-party approval from the AOAC research institute. While sales of the new tests are just beginning, it's noteworthy here because it provides another key test in our answer line along with tests for salmonella, Listeria species and Listeria monocytogenes. All of which bring third party AOAC approval.

Food companies and laboratories can now use our single format answer products to test for the most significant bacterial threats to the food industry. Our analysts who follow the food industry closely, likely noted the publication of the first five rules of the seven total rules that make up the Food Safety Modernization Act, or FSMA, and that happened in September and November.

An obvious question that you may have now is with those publications, what will that mean to Neogen? North American test volumes should see increases due to the Food Safety Modernization Act. FSMA is the most sweeping reform of the US Food Safety Law in more than 70 years. A major focus of the Act is on prevention at the processing facility. Large food processing companies have already begun to revise their food safety programs by adding continuous monitoring and product testing as part of their food safety plan.

Global test volumes will increase as the requirement for importers of record to ensure the quality of the products they market and the facilities in which they are produced one step back will make Neogen a natural choice as a partner allowing global standardization of their food safety plan on a Neogen platform. It's important to note that with the regulations come provisions that allow for a phase-in for compliance. This phase-in period allows smaller companies up to three years to comply and on top of that, questions remain on just how much bite the FDA is going to put into the enforcement of these new regulations. And the magnitude of that enforcement may also depend on the outcome of budgetary battles in Washington.

So, while we believe FSMA will likely drive additional business to us as food companies seek to comply with the new regulations, it's an open question as to how much and when. We do believe that the new provisions of FSMA will certainly help Neogen.

Now, before I turn the call back to Jim, let me just close by wishing you all a very happy holiday and a prosperous 2016. Jim?

Thanks, Rick. Let me turn the phone back to Steve Quinlan to talk about -- a bit about the currencies as I promised. Steve talk some about the highlights of the animal safety group and kind of the overall financials of where we ended up for the first half of the year.

Thanks, Jim. Second quarter of FY16 looked a lot like the first as currency headwinds masked some pretty solid underlying growth, particularly in the food safety segment. Similar to the first quarter, all the currencies in which we operate have weakened versus the dollar compared to the second quarter of last year.

The euro was down 15% on average, compared to last year's second quarter. The real was down 58% for the comparative quarter. Peso was 24% lower and the pound sterling was down 5% on average.

The negative impact of the stronger dollar on our comparative revenues for the second quarter was about $2.2 million and about $0.02 on the bottom line. In constant currency, our growth was 20% versus the 16% reported and reported organic growth of 13% would have been 16%. On the food safety segment, the impact was even more pronounced. Their 13% growth would have been 20% and their organic growth of 6% would have been 13%.

Rick has already discussed the highlights of our growth in the food safety business so I'm going to focus on our international operations and the animal safety segment. Top line results for our international operations, which are primarily focused on and report in through food safety, were mixed and were negatively impacted by the strong US dollar during that second quarter and the first half of 2016.

Neogen Europe revenues declined by 6% in local currency in the second quarter primarily the result of difficult comparisons from strong genomic sales in last year's second quarter, which did not recur this year, and as Rick mentioned, lower mycotoxin revenues due to cleaner crops in this year's growing season. Revenues declined by 10% when the pound sterling was converted to US dollars. Year-to-date, reported revenues have declined by 11% in dollars with currency and genomics weakness the primary explanations.

Neogen do Brazil continues to grow its business in very difficult economic conditions and recorded revenue increases of 38% in its local currency, the real, for the second quarter. However, after accounting for the devaluation of the real for the comparative quarters, revenue denominated in dollars were down 12%. Year-to-date, revenues are up 1% after accounting for the 51% decline in the value of the real for the six month period.

Revenues at Neogen Latinoamerica, our Mexican subsidiary, rose 58% in local currency in the quarter and we're still up 28% in spite of the peso weakness with broad based increases across all of our product lines. Year-to-date, revenues are up 27% after converting to dollars.

The animal safety segment recorded overall revenue increases of 19% in the second quarter, almost entirely organic, with some minor incremental revenue from the Sterling Test House acquisition. Increases in our Lexington based business came from sales of disposable products to the commercial dairy business as a result of a new distribution agreement to that market entered into in July and strong sales of our veterinary antibiotic and wound care products.

Our line of small animal supplements, in particular our canine thyroid replacement therapy, continued its recent strength. The second quarter was down only slightly compared to a very strong second quarter of FY15 and is up 22% year-to-date. These increases offset a 13% decline in our life sciences product line, the result of delays in the effective date of legislation requiring drug testing of commercial truck drivers in Brazil which has deferred sales of our forensic kits to certain commercial laboratories into the third or fourth quarters of this fiscal year. Now, we had sales of those kits in last year's first half in anticipation of those laws being in place.

Our biosecurity product offering of cleaners, disinfectants and insecticides were mixed, but in total, revenues were up 20% over last year's second quarter. The rodenticide business alone rose by 69% as our contract manufacturing business for a large marketer of residential and commercial rodenticides ramped up and we also had some nice market gains in our direct farm store markets with new and improved formulations. For the year-to-date, rodenticides were up 54%. I think our manufacturing operations in Randolph, Wisconsin deserve special recognition for their efforts in delivering on these volume increases.

Our insecticide business recovered -- sorry, our insecticide business recovered from a relatively weak first quarter to record a 25% increase in the second quarter. We had trouble getting some key technical raw materials for our cleaners and disinfectants in the second quarter and sales were down significantly in that quarter. We expect them to bounce back here in the third quarter as the raw materials are now available.

Our agrogenomics testing business located in Lincoln, Nebraska, was up 35% for the comparative quarter due to sample volume increases resulting from incremental poultry business and market share gains primarily in testing services for the swine market. For the year-to-date, revenue growth in this business was 23% in a very important market for us.

Corporate-wide, our gross margins of 48% compared to 50% in last year's second quarter and for the year-to-date, they were 49.2% versus 50.2% last year. As Jim mentioned, margins were adversely impacted by the currency issue, revenues from acquisitions which were at lower than average gross margins and mix changes both within and between segments. Operating expenses overall were up 11% in both the second quarter and for the year-to-date.

Sales and marketing expenses also rose by 11% for the quarter and year-to-date with the largest components of this increase personnel related expenditures, primarily reflecting the additional staffing investments we've made over the past year and selling expenses resulting from the revenue growth. G&A expenses rose 11% for the quarter, with increased compensation and fringe costs and acquisition related legal and professional expenses the primary drivers of these increases. For the year-to-date, these expenses were also up 11%.

Our research and development expenses were 6% over the prior quarter and also rose 6% for the year-to-date, as the Company continues its active investment in new product development. Our operating income was $14.6 million or 18.4% of sales compared to the $12.9 million or 18.8% recorded in last year's second quarter. Currency conversions from the weaker euro, pound, real and peso resulted in charges recorded in other income and expense of about $562,000 compared to $164,000 in last year's second quarter. For the year-to-date, currency charges running through other expense totaled $1.167 million versus $220,000 in FY15.

The Company generated $14.3 million in cash from operations during the quarter, $20.9 million in the first half of the year, and has invested about $13.3 million in the Sterling Test House and Lab M acquisitions and $7.8 million in property and equipment. Inventory balances have increased 19% year-to-date in part due to the Lab M acquisition and stocking requirements for the new dairy distribution business.

Accounts receivable balances declined in spite of the increase in revenues for the quarter and our days sales outstanding improved by a day as our collection group did a nice job in collecting outstanding balances. So overall, the second quarter and first half of 2016 were both very solid from a financial perspective and we're excited about the prospects for the remainder of the year. I'll now give it back to Jim for additional comments.

Thanks, Steve. I don't want to belabor the currency translations that Steve's already mentioned but they continue to be troublesome. Our international sales for the second quarter were approximately $28.7 million which equated to about 36% of total revenues. On a year-to-date basis, international sales stand at about 34% of total. Some of you may remember that at one point in the past they were as high as 42%.

International sales continue to increase but just about as much as the Company's overall sales do. This is important to us because a big piece of our total market we know lies outside of the US. Neogen does business in 100 countries, most of these are through independent distributors. However, we have our own offices and operations for direct service to 16 different countries.

The biggest of these groups is our Neogen Europe operations, where we have direct sales representation to what we believe to be the five most important EU countries. Plus we also service all of our distributors in the European Union through that office. Neogen Europe sells products in euro, pound sterling and in some cases in US dollars. All of this gets converted to pound sterling for their consolidated statements and that gets shipped back to the US and then we convert it back to US dollars.

In the first six months of last year, we were converting the pound sterling at approximately $1.65 to the US dollar. For the same period this year, it's been n $1.54. Now, not only do we suffer the conversion but it also puts us in a more difficult competitive situation from a pricing standpoint. This is especially true for our food safety group where major competition comes from companies that are based in Europe.

This past quarter was the first in I don't know at least 25 quarters that Neogen Europe has shown nice increases compared to -- actually the only quarter that haven't shown nice increases as compared to the local currency. All said, however, I don't think we're losing any market share there. I do believe that the market, total market might be suffering a bit.

I just returned from Mexico and got to spend a good bit of time with our Neogen Latinoamerica group. That group provides direct service to Mexico and seven smaller Central American countries. This group is strong and getting even stronger.

I think Steve talked about the fact that if it's on a peso-to-peso basis, in the first half of the year, they're up somewhere around 56%. Even after we shrink the peso value to the dollar, they still came in at a strong 27%. But we're looking at a peso that was worth about $0.075 a year ago and today or when I was down there, it was worth about $0.06.

So we have some currency hedges in place. We continue to look for more opportunities. But frankly, the risk/reward equation is kind of difficult to calculate today. So much for the frustration. It's all it is, I guess. We'll continue to play the hand that's dealt us and still we're going to do fine.

As an example, food safety recalls continue to put more pressure on food industries in most countries. US is a good example. Since we last talked at the end of the first quarter, there have been 78 food recalls here in the United States in the last 90 days. 53 of these were due to allergens and 25 have been related to pathogens, such as E.coli, Listeria and Salmonella. These are the contaminants that of course, kill people.

For the year, almost 12 months now, we've seen 248 recalls in the US. If you calculate that out, that's about one recall every 1.5 days for this year.

Rick talked some about the latest news in FSMA and, yes, it's going to have an impact on us. I think maybe the first impact is going to be what's happening on imports as in the past, the old rules were an acquiring exporter was responsible for the quality of whatever was shipped to the US. Whereas going forward, the obligation is going to be the US importer who is going to be required to take one step back.

We tend of course to think about, I think often about ocean going vessels being the big issue as Asian products are imported through the West Coast and European products come through the East Coast. But our Southern border is clearly an important part of that concern. In fact, last week in Mexico we talked about our product, our program for helping existing customers on both sides of the Mexican border, which is already coming into play.

Several other trends continue to be revenue drivers. One of these is a continued concern about antibiotic residues in meat and milk products that's causing a number of companies to declare that they will only buy meat that's raised without antibiotics. The first of these meat classes has been chicken since it's the easiest.

However, one of the first companies that made the announcement that they would only buy product raised without antibiotics is now seeing several food safety problems in locations that span from the East Coast to the West Coast. A logical question is, is the industry ready to supply safe animal products in the absence of antibiotics?

Nevertheless, Neogen is very appropriately placed on both sides of this equation. Our biosecurity products, rodenticides, cleaners, disinfectants and insecticides in our animal safety group help producers provide better management to keep animals healthy. At the same time, we make diagnostic tests to detect the presence of drug residues to provide the customer seeking this quality to be successful.

The organic business is continuing to grow. It too is coming under more pressure, particularly as it relates to labeling. The world is beginning to understand that there is a difference between natural and organic.

Organic products must come from a system that's been inspected and approved by the US Department of Agriculture. They too require different management systems. Neogen is working with the organic food industry and helping them with methods to ensure production of high quality, safe food in an organic fashion.

In conclusion, I can say once again that I believe we're at the right place at the right time with the right people and the right products. Obviously, this is a fast moving business and technology doesn't stand still. We'll continue to work toward developing both intervention technologies as well as our diagnostic abilities.

We'll continue to grow the Company as we have in the past with one of our strategies being new products for our existing markets. Market share growth is going to be our continued second driver. There's no doubt that all of our markets are growing and I believe that we continue to grow slightly faster giving us some increases in market share.

The third basic strategy has been acquisitions. We announced two acquisitions in the first quarter and have none to announce here in the second quarter. However, we have several on the radar screen and odds I think are good that we'll bring one or two of these to fruition maybe even in this third quarter. At this point, all of these acquisition opportunities fit our criteria of being bolt-on to the Company's current mission and our strengths.

And the fourth continues to be our emphasis on international growth but we've already talked about that. Let me stop at this point and open for questions. Please feel free to direct questions to Rick or Steve or myself. Christine?

Thank you.

(Operator Instructions)

Our first question is from Paul Knight of Janney Montgomery Scott. Please go ahead.

Hi, guys, this is actually Bill March on behalf of Paul Knight. How you guys doing?

Good.

I was just hoping we could maybe talk a little bit about underlying strength we saw out of GeneSeek in the quarter? How much of that came from the July Illumina partnership? Is this higher growth rate sustainable? And then maybe are there any new markets or countries that you're penetrating?

Good question. Unfortunately, not a lot came from the Illumina partnership. We still feel good about that but if you look at the revenues that we got from the Illumina, quote, partnership, as compared to the chips that we sold outside of that partnership during the same period last year, I think that revenue would actually be down. So none of that came through Illumina.

Though as I said, they're reaching out to some companies around the world that we couldn't reach. That was the intent to start with. They're a little slow and this is kind of a new venture for them. They're a little slow in getting things together. So none of the increase was due to that.

Secondly, yes, we are doing some penetration outside. We are now up and running with a full Illumina system in our laboratories in Ayr, Scotland. Before we brought European product through the Ayr location where we in many cases extracted the DNA and then sent that to Lincoln for the final work.

Now we're actually doing complete work in Ayr, though we work with the bioinfomatics through the cloud back to what's going on in Lincoln. That's taken some pressure off of Lincoln and it's also given us faster turnaround. So we are where we had a competitor or two in Europe that was touting local service, we now can tout local service and we're doing well there.

We picked up some new business in Mexico. I think we got work in the seven breed associations now in Mexico, along with sort of a pseudo arm of the Mexican government as they strive toward trying to pick cattle particularly I think sires to start with, what they can do to improve the beef cattle genomics in Mexico.

Our Brazilian operations I think for genomics are probably up a tad this month. I think it's pretty widespread. That's a long way to get to that answer but I think our genomic business is pretty widespread.

That's helpful. And then maybe if you guys could just provide the M&A accretion from Sterling House and Lab M? And then just in terms of kind of bigger picture on the M&A front, as you're looking at targets, are you looking more at food or animal safety or are there any areas that look more attractive than others?

You wanted to know first amortization cost? Is that --

No, I think he wanted revenue.

Oh, revenue. I don't have the numbers before me now. Steve will are have to get back to you probably later on that or whenever.

That's fine, thank you.

Sterling House, I think we told you in the beginning, that those of you not familiar with that term, that's our Indian operations. It's come on board. Like I've learned about India, nothing happens real fast, though it's moving fast enough that I can say it's going forward. At least it's measurable progress.

And we feel real good about it. We are now part of that food safety community and we are doing a lot of lab testing. It's a big spot where spices come through that -- those ports and through our labs to go throughout the world. So we feel good about that one.

Lab M is -- gosh, it's going to be really good. It's just now beginning to get its legs under it. And these -- Steve talked a little about acquisitions and what their gross margins are.

We always know the next morning after we write a check what we're going to do with an acquisition. But sometimes it takes a few months in order to get them lined out and running efficiently. And Lab M, we probably had some changes there that we needed to make that might have had some impact as I remember it. But they've been on board like, 90 days now and we're feeling real good about where they're going and where they're going to go.

We haven't integrated them back to the US side of the business yet. We of course have Acumedia which is a big sister to Lab M that serves a big part of the world. But there's some really great integration between those two locations that we'll start to look at probably the beginning of the fourth quarter. In the meantime, they're doing well.

So not sure whether I answered all of your questions there or not. But if not, we'll come back to me.

The only other thing is maybe just on the target front, what food or animal safety or any specific areas you see as attractive for acquisitions?

We don't go out hunting with a different gun depending upon what we're hunting for. We look for opportunities as they become available. Oftentimes, we have our nose to the ground and we have an idea of what's going to become available.

But we're not particularly shopping in one area or another because we think they're both important to us. We've never worried about whether we kept one exactly the same percent of revenue as the other, as long as they made sense. Today, there's so much synergy between the two products. What happens back inside the farm gate has a big influence on what happens in the overall food safety program.

We continue to look at acquisitions and some of you probably heard us tell this before. It's really not that difficult if you stick to your focus. We look at acquisitions that first of all where we know and understand the technology that's embodied there.

Secondly, we want to be able to manufacture the product if we want to. And number three, do we have access to the marketplace? And as long as we've answered those three in a positive fashion, we've done well. So the things that we're looking at going forward would fit there.

And in a lot of cases we can bring a product in where we already have manufacturing capability and don't need to add the manufacturing. We bring them in. A lot of times where we already have access to the market, we have plenty of salespeople in the field that are already calling on the right customers and we don't need to integrate the one or two people that came from the acquisition.

I think as I've -- we of course, can't announce anything today. As I look at what we've got going forward, kind of anxious to get Christmas behind us so we can get started with one or two that look good going forward.

Got you. Thanks for your time. Have a merry Christmas, guys.

Same to you.

Thank you. Our next question is from Tony Brenner of ROTH Capital. Please go ahead.

Thank you. Good morning.

Good morning, Tony.

Jim, in talking about the Food Safety Modernization Act, you mentioned that the burden would be on the importer, not the exporter. First of all, does that mean that the incremental business would show up in domestic sales, not international sales? And secondly, I know it will take a while before these rules are actually effective, but I wonder if you're at this early date seeing a pickup in that related business?

Thank you, Tony. I don't know that we're seeing any dollars going to the cash register. We're hearing a lot of conversations. I mentioned the Mexico situation. We kind of have been there before.

One of our good customers on both sides of the California border is in the avocado business and guacamole. We do a lot of tests over on the Mexican side through the Mexican company and then when because they want to make certain when it gets to the US side, it's not going to make people sick. I think it works both ways.

I talked a little about India. That's one of the things that we focused on India and where we located there, that we thought was going to be important. Such a large number of spices come from that part of the world and you've got American companies with American names that are operating in India.

So they've kind of always been there. Those companies have. But like a McCormick, McCormick is obviously a major producer of spices around the world and they produce a lot of spices because the climates and other things. And again, a lot of those spices come to the US as well as other places. So it gives us a chance to test on both sides of the border.

Yes, I think it depends on which Company gets credit for the sale but I think the fact that we do have hands across the border kind of relationships is important to us going forward. And within the last few weeks, I've talked to the US guys that said gosh, I'm glad to know you've got a location and service for instance for China so that we can make sure that the product that we're bringing in is being tested and looked at properly on that side. So I think it's -- it's a year away from enforcement for the big companies. I guess three years away for the little ones if they mean anything, they probably don't in spices.

It's going to come on -- I don't think we'll see a floodgate, but I do think that we'll start to see more money come into the cash register. We're already hearing more conversations.

Okay. My other question has to do with operating margins. Sequentially compared to the first quarter there was 150 basis point decline in margins in the quarter. It appears that a good portion of the foreign currency hit was below the operating line. So I'm wondering what else accounted for that sharp decline in operating margins and what the outlook for that might be for the balance of the year. Thank you.

I'll let Steve talk to that.

Yes, Tony, there actually is a pretty significant piece that's above the line because when those revenues get converted back it also compresses the gross margin. So you'll see there's two pieces of the currency impact.

There's some that's down below the line, down in other income and expense, but to the extent that our revenues are impacted, our gross margins are also impacted. And that would have been the biggest piece of the perceived deterioration.

Then there is as Jim was saying, there's the new acquisition revenues that have come on. To the extent that those are from margins from the mix that was in place in the first quarter, you would have seen some change there.

The rest of that is product mix on both sides of the business. And then finally, there's just the shift in business between food and animal safety. Those are -- that's a smaller piece but when you add all those pieces up, those are -- those kind of get you there.

And Tony, that's the reason you've heard me say over and over, we don't really like to be measured solely on gross margin. It's just one of the increments of net operating.

I wasn't asking about gross margins. I was asking about operating margins.

Okay. I'm sorry.

But my explanation still --

Right.

Still holds.

Right. So the outlook then given that these -- many of these factors remain in place for the next quarter or two, it doesn't look like we should assume a sharp rebound in operating margins, is that fair?

I think it's fair. I think it's probably fair.

Okay. Very good. Thank you.

Thank you.

Thank you. Our next question is from Jason Rodgers of Great Lakes Review. Please go ahead.

Good morning.

Good morning.

Just wanted to follow up on the margin question. Looking at the gross margin, do you have what the year-over-year impact from currency was on the gross margin for the quarter?

I don't have an exact number but it's somewhere in the -- we calculate it at maybe 8/10 of a --

Somewhere around 1%.

It's about 1% of the 2% change.

Were there any one-time costs or one-time hits to the gross margin from the acquisition area or are these costs expected to be pretty much similar in the third quarter? Is it just lower margins or are there any one-time costs in the acquisition?

Well, that's kind of hard to measure sometimes. We bring up -- you bring inventory on and you put a valuation on it and you value it as best as appropriate for the use of the funds. And you might have put raw material on at a higher cost than what might be deserved.

So therefore, that could drive it down. Obviously, the other thing is you brought raw material on at lower than its replacement value.

It just kind of takes about a quarter or two to get these acquisitions leveled out if they've got full inventories and raw material, finished goods, they're going to marketplaces that -- where prices are getting stabilized. We do well and we don't show any losses anywhere but it's kind of difficult to start trying to pick them apart for the first several months.

Right. And just looking at the growth rate, obviously very strong organically on the animal safety side. Would you consider any of these factors to be more one-time in nature or would you expect the rodenticide growth and so forth to continue at a similar rate for the remainder of the fiscal year?

No, I think -- I'm thinking back on where we are with those products. We've got seasonal impacts on some of them. For instance, we showed good increases this quarter for insecticides but this is not a good insect quarter normally.

Cold weather comes along, the flies get killed. So the fact that we're up this quarter I think bodes well for where we're going to be in the next quarter or two.

Overall in the rodenticide side, all rats and mice are now trying to find a warm place for the winter so that business is going to continue to be good looking forward over at least the course of the next three or so months. We didn't see this year the impact of animal diseases like we saw in avian influenza, thank goodness, a year ago when the migratory birds infected a big part of the laying hen flock in the United States.

But our cleaner side of that business looks good. The disinfectant side is standard. And those are going to be I think we'll see the sort of trickle down effect.

They're going to be more important as we look at raised without antibiotics. If we're going to keep animals healthy, we're going to have to have better biosecurity systems and those cleaners and disinfectants are going to play a major role there. The organic guys, there's a limit to the number of products they can use and still maintain the organic status. Cleanup in advance is going to be more important.

I guess I feel good that we didn't see anything that had any kind of a positive impact. Rick, did you see anything there?

No, I can't think of anything off the top that I would want to point out directly, other than the issues you've stated already year-over-year.

Has there been any supplier capacity constraints in rodenticides in UNIPRIM or anywhere else in the business?

Yes. We're keeping up, but not by much. We've got a couple of spots where we're biting back orders. The UNIPRIM product line is -- we've moved that from -- when we made that acquisition, it was a Colorado based company.

We moved it and incorporated in our FDA pharmaceutical plant in Kentucky. It's competing for mixer space with a couple of other very big pharmaceutical products. So that's a plant that's up to -- I guess we're running 24/5 now, not 24/7. We're putting in some new capacity.

We're putting in a new wax block line that we ought to have finished by the end of this month that our Hacco operations in Wisconsin as we got two wax blocks, those weather resistant blocks of rodenticide that you can use inside, outside, whatever. They don't deteriorate in the weather.

We've been running kind of hand to mouth at Hacco because in addition to our own products, we make rodenticides on a private label basis for two of the larger, actually competitor rodenticide companies in the US. They actually sell into other marketplaces. We're producing our products as well as some others there. In both cases, we're coming out.

So I notice in my building here on the Lansing campus, I was pleased to see that we didn't have any cars in that parking lot on Saturday or Sunday. We've been running a part of that operation, some as much as 24/7 to keep caught up on our vial production for some of the spoilage organisms that we have. We've got that caught up now.

We continue to add new space, new equipment. We're just moving into a new I guess 20,000 square foot. I saw them this morning. The last lab was being loaded up to go to a new 20,000 square foot facility here in Lansing that's expanded lab space for our R&D group. So it's been touchy, but we're getting on top of it.

Thanks a lot.

Thank you.

(Operator Instructions)

Our next question is from Kurt Kemper of Hilliard Lyons. Please go ahead.

Thanks for taking my question. Just to get a little more narrow on that last question, do you care to provide some more commentary around the animal care and other product lines and especially going forward?

We run a couple of different product lines there. We've got some companion animal products that are sort of legacy products, been around a while. We're sitting right in the middle of horse country.

The horse business is and always has been important to us. So a part of that business is horse business. It goes along with the companion animals, a couple of good products that go into the canine area.

Whereas the big part of it is still the food safety back inside the farm gate kind of thing. Both of those businesses grow well.

We've got I guess, one of the horse products we've had a couple of competitors in that field. One of them announced that they were going to discontinue a particular product line. We sort of -- that was the UNIPRIM product.

We've been the leader in that business and held a big share of the market anyway. I don't think we saw them -- as far as I know, they're still selling our product. They just announced they're going out. We should pick up that little bit of business.

One of the important areas that goes through there is what we're doing with the dairy market. Dairy is important to us as a part of the overall food and animal safety business. It's a major emphasis of what we're doing with GeneSeek with genomics and our dairy heppa replacement program where we're helping dairymen around the world, even including China, pick the best female calves to save for their replacement, going back into the milking herds.

We did make a good license I suppose, distribution agreement much better word, with the group called GEA. They're one of the world's largest manufacturers of milking equipment that are used for milking parlors around the world. They head a group of distributors here in the US. In fact, in Mexico and in Canada where they -- it was a little too far reach for them and they were interested in somebody else coming in and picking up a supply of those and we worked out an arrangement where we're picking up that side of the business.

We were already there. We didn't have to add any extra people and it's going to be nice additional business. It's some business that some of the things that they were distributing to those dealers we already had and in others, they fit well. So I guess that's probably one of the real highlights of what happened this quarter as far as that animal business down there is our continued expansion into the dairy market.

Okay. That was very helpful. And my other questions have been answered, so thank you and happy holidays.

Thank you and welcome to the team.

Thanks, Jim.

Thank you. And our next question is from Charles Haff of Craig-Hallum. Please go ahead.

Hi, guys. And congratulations on the good progress this quarter. I had some questions for Rick here on the food safety side. It seems like you have so many things going in your favor and now that we have the FSMA regulations starting to get some teeth to them, it seems like that organic growth should be accelerating maybe in the back half of this year and going into next year. Just wondering if you could give us some more color on that, Rick? I know it might be a little bit early but just trying to understand how material these changes could be to your business?

Thank you for the question, Charles. I think it's an excellent question and I think the important thing to note is where have I been spending my attention and why. And that's why I highlighted that in what I'm talking to all of you about, because I think it's so important that we're on top of that opportunity and the organic growth that we see coming.

Just in the World Health Organization this week, they talked about the fact that every year there's over 600 million people who are getting ill from eating contaminated food and it's important that we're on top of that. Of that, 420,000 people a year die. So we understand the importance of it. We're focusing our attention on that organic growth opportunity and we're going to be there.

Okay. That's the one thing I'm just a little bit confused by is the organic growth coming in at about 6% but allergen tests up 13% across the board. I realize mycotoxin was down a little bit and the answer did really, really well.

It seems just intuitively like you should have had a little bit stronger organic growth. I'm just trying to understand what's pulling down that number and if that's going to be a function of tough comps and we should see a reacceleration there.

Charles, the biggest piece there is currency. In my presentation I talked about the fact that food safety at 6% reported organic but without currency, without the currency impact they were up a nice 13%. So --

I got you. I missed that.

That is the (multiple speakers).

Okay. Thank you. Can you remind me, Steve, how much of the GeneSeek business is in the food safety side? I know you break it up into different parts.

Give me a second, I'll find that number.

Okay. Thank you.

Little bit of what's in Europe, it goes through Neogen or European operations gets reported on that side. I guess a little bit -- there's been a little bit this time in Mexico, not a whole lot.

Charles, that number's about $1.5 million for the quarter.

Okay. Thank you very much.

That's been through primarily Mexico, Brazil and China.

Okay. Great. And you didn't talk about China too much on this one. I know there's -- on this call. I know there's been some challenges over there on the macro side and the distributor that you purchased and have been working with for quite some time but purchased recently is getting up and running.

Wondering, Jim, if you could give us an update on China? Is there anything that we should be thinking about over the next few quarters going on there? I realize it's still relatively small in the scope of your overall business.

Well, it's still small but it's important and getting more important. And we really are doing well. The acquisition that we did there, we put two distributing organizations together, that goes back, Charles, to close to a year now I think.

But making good progress. I'm on the phone with them at least once a month. Chuck Byrd, our guy here that's got 25 years of international experience with the Company helped build a lot of these markets. He doesn't live there but he's on the phone with them, I expect him to show up, talking in Mandarin any day now.

Really close to what's going on there and some really good, solid growth. Mostly food safety at this point, a little bit of animal safety stuff, a little bit of genomic stuff. I guess we'll probably do -- we'll do $1 million in genomics this year maybe. It's pretty important as we work with that big dairy industry.

There are three super large dairy companies that are Chinese companies in China that control a big piece of the milk business, the overall dairy business and we're doing business with all three of them. All three of them have head people here in Lansing. So that piece just continues to grow. So China's okay.

Okay. Great. And then Jim, on the rodenticide, I saw that SenesTech completed their filing for ContraPest. And just wondering if there's any progress or anything that's going on your end or are you guys just kind of waiting for the EPA process to go through? Or anything you can start to work on the manufacturing side? Any color there would be helpful.

No, they actually completed that filing, I don't know, several months ago. But it's in the hands of EPA now. We have a license to whatever they get as far as approval process, but no real way to be able to predict what's going to happen or how fast it will happen.

In the meantime, we're continuing to do some very exciting things in rodenticides. As you may know, Charles, we've got our own, what we call our own rat lab, our own rodenticide lab at Hacco, which is a free-standing building. We're running experiments all the time on new and better products to use.

A big part of it is palatability. If you can get a rodent to eat -- we've got a lot of products that will send them to the happy hunting ground if we can just get them to eat it. And so we're continuing to work on new, more palatable products because it's not the rodenticide, it's not their only choice of something to eat. They've got all kinds of other good goodies around that are more palatable, more interesting than some kind of anti-coagulant would be.

I'm real excited about some of the stuff we're doing. It's too early to say anything about what's happening in SenesTech other than the fact they've filed for a registration and we hope they're successful.

69% growth in rodenticides is nothing to shake a stick at. Thanks a lot, guys. Appreciate it.

You bet.

Thank you. I will now turn the call back over to Jim Herbert for closing remarks.

Thanks, Christine. And thank you all for your continued interest and support as we draw another calendar year to a close. I know lots of you have certainly benefited from your advice along the way and we appreciate your questions and your support. Wish everybody a happy holiday season and a prosperous new year and we'll look forward to talking to you again in 2016. Good day.

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