Welcome to the Neogen Quarter 2 Fiscal Year 2014 Earnings Results Conference Call. My name is Joe, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. And I will now turn the call over to your host, Mr. Jim Herbert. Please go ahead, sir.

Thanks, Joe, and good morning and welcome to our regular quarterly conference call for investors and analysts. Today, as you know, we'll be reporting to you the results of our second quarter that ended on November 30. And now 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, and actual results may differ from those that we discuss today. And those risks that are associated with our business are covered in part in the company's Form 10-K that's filed with the Securities and Exchange Commission. In addition, to those of you who are join -- that are joining us today by live telephone conference, I'll also welcome those who maybe joined by way of the simulcast on the World Wide Web. Following comments this morning, we'll entertain questions from participants who are joined by 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 results of our second quarter that ended on November 30. Again, revenues broke all records for the company's second quarter at approximately $59.6 million or a 17% increase compared to last year's revenues of $50.7 million. Our year-to-date revenues through the first 2 quarters have increased by 18% to approximately $118 million from last year's approximately $100.5 million. The second quarter net income was 62 -- or $6.2 million compared to the prior year's $6.8 million. Adjusted for the 3-for-2 stock split that was effective on the 31st of October, earnings per share in the current quarter was $0.17 per share compared to $0.19 a share a year ago. The current year-to-date…

Thanks, Jim. Jim has already reported on the overall sales and profit performance for the second quarter of our fiscal year. And it was definitely a mixed bag. Good revenue growth with some earnings challenges as the result of gross margin changes. In the next few minutes, I'll address some of the significant highlights for the quarter and I'll start by discussing our Food Safety group. The Food Safety group recorded revenues of $28.4 million, an increase of 9% for the quarter. And all of that growth was organic. This was a difficult comparative quarter coming off last year's second quarter, when there were significant outbreaks of aflatoxin in the corn crop in the U.S. and mycotoxin outbreaks, both DON and aflatoxin, in Europe. These outbreaks occurred just as we were introducing our new quantitative lateral flow devices, and our sales in that period were up over 60% over the prior year. This year's corn crop in the U.S. was very clean. And although there are sporadic outbreaks in Europe, our overall mycotoxin kit sales for the quarter were down $1.1 million. Growth across almost all of our other product lines more than offset the lower mycotoxin numbers. However, this growth was at lower gross margins, which I'll discuss shortly. Revenues for our industry-leading product line to detect inadvertent allergen contaminations, which includes our diagnostic tests for milk, peanuts, gluten and processed soy, among others, continues to be very strong and were up by 25% in the quarter, as we continue to have a leading position in a rapidly growing market. Our gluten test kit sales were particularly strong, up 28%, as gluten-free food production continues to expand significantly. Our line of AccuPoint samplers and readers, which are used to monitor environmental cleanliness at food processors, rose by a robust…

Well, thank you, Steve Quinlan. I'd like now to turn the call over to Steve Snyder, who's soon going to be celebrating his 6-month anniversary with Neogen as our Chief Operating Officer. And he's catching on up pretty fast, and at the end of 6 months, I think we might just like him well enough to keep him around. Steve?

Thanks, Jim. It's been a good 6 months, and thanks, Steve, for the recap of the performance this quarter. In the call today, I want to comment briefly on the quarter's financial results, but then really focus on some examples of ongoing strategic programs, achievements and opportunities that we see as important to our growth and to our mission of delivering food and animal safety solutions to our customers. In the results reported earlier, I think it's interesting to note that revenues and gross margins did grow across-the-board in most of our product lines. This was true with the exceptions of just a few areas, which Steve mention, that struggled against prior year comparisons, and namely, that was mycotoxin. At the same time, our sales and marketing investment spend came into play this quarter. As you'll probably recall, we've been adding sales and marketing capabilities to help support our continued growth. In fact, we added 14 professionals in sales and marketing since the beginning of the year in just North America. This services a couple of points. First, while we've brought in new talent, we also know it takes time for even our best recruits to learn our product lines and become familiar with their territories before they can begin generating profits with customers. The second point on the product side is that we know it can take some time to get new products introduced, tested and adopted by customers. With both new commercial hires and new products being launched recently, both of these factors may come into play this quarter. Well, that's that about results. Let's shift over to our growth activities in the Food Safety business. I'm working closely with our Food Safety leadership team, including all of the functional leaders in sales, marketing, product management, technical service…

Well, thanks to the 2 Steves for their updates and outlooks. Now that we're already partway into the third quarter, I think you'd be interested to know some of the developments that we see ahead. We've not talked much here today about the international side of our business, but this is quite promising, with revenues from international sources up 21% on a year-to-date basis compared to a year earlier. Our Neogen Latino America operations in Mexico continue their growth, being up 11% for the quarter. We're completing a move there into larger quarters to accommodate the increase in growth, as well as to improve our efficiencies. This subsidiary markets both our Food Safety and Animal Safety products, as does Neogen do Brazil that Steve just referred to. Our Brazil revenues for the quarter are up 56%, albeit from a smaller base, but we're growing very nicely there. We still haven't achieved full traction, but I believe it's coming. Shifting in geographies a bit. Following Chinese New Year, we're set to make some important changes in consolidating our China business to move a significant portion of that business into our company-owned subsidiary, Neogen Bio-Scientific Technology Ltd., located in Shanghai. As pressure on Food Safety continues to increase in China, China officials are anxiously trying to come up with solutions. In our new unified program, we believe that we'll be able to more capably handle some of those opportunities. The other part of the world where the middle class is developing rapidly is in India. We are in India today, only in small ways through independent distributors. However, we've set a strategy to go forward with our own boots on the ground, and we're exploring some acquisition opportunities right now that will enable us to do this. Neogen Europe, headquartered in Ayr,…

[Operator Instructions] The first is from Mr. Paul Knight.

This is actually Bryan Kipp on behalf of Paul. Just to start off here on the operating level, I guess, on the gross margin level. So you guys alluded to the fact that there is 3.9% that can be accounted for and you're looking upstream to get back up to that 20%. With sales and marketing, G&A and R&D basically remaining at that 33.2% of sales that we saw last year, where do you see those upstream opportunities x mycotox coming back on or aflatox demand coming back on, where you guys can drive that up in the near term to get closer to that 20% margin level?

Well, that set of -- I know what the gross margins were on that set of products, but I'm not going to disclose it with all my competitors on the phone. That is a very high gross margin product, our diagnostic test for mycotoxins. So a dollar lost there could be as much as $3 or $4 lost someplace else. That mycotoxin testing is not going -- we didn't lose any market share, we don't believe. That market is not going to grow any until we begin to see some grain crops come back somewhere in the world. So there's little chance of anything happening in the mycotoxin area in our third quarter. Where I do think that we think we've got a lot of things coming, Steve talked about a -- Steve Snyder talked about a couple of new products that are coming on. We'll make up for it with revenues that won't have quite as good a gross margin as the ones in mycotoxin. But we think we've got opportunities for revenue growth out there that they're going to take care of that void.

On the Prima Tech and SyrVet, how long do you think that'll take to get accretive op margin levels? Is it a year out from now? Or do you think it can be more near term?

No, no, no. At the -- SyrVet is probably there now and I know it's certainly there at the top line and, at least most of the way there at the bottom line. We just simply moved everything that was in those warehouses in Des Moines, Iowa, to our existing facility where we had space, primarily in Lexington, Kentucky. By and large, the same sales force was -- that we already had is now selling more products. The customers were 90% the same as the customers we already had. So when you get a bolt-on that's a true bolt-on like that, it moves pretty fast. The Prima Tech one, I haven't really looked at. It's only been in the numbers for 1 month, the month of November. So Steve Quinlan can probably tell us, but I'm sure it probably wasn't accretive at the bottom line, because, given the new accounting rules, used to all of those cost that -- for bringing a new business on and the legal expenses for acquisitions used to get thrown into the capitalization of the business and depreciated out over some period of time. Now you put it all in the month that you closed the acquisition. So I'm sure we had some expenses related to that acquisition that hit the first month, that would have diluted out or obstructed any profits much that came through, but that'll get itself cleaned up. We get through the accounting gymnastics and I can't always predict, most of them non-cash, that we get through that through the next month or 2. I think by -- when we look towards the end of this quarter, it certainly will be accretive at the bottom line, probably not to it's maximum capacity, but coming on pretty quick.

We also have a question here from Mr. Steven Crowley from Hallum Capital (sic) [Craig-Hallum Capital].

It's Steve Crowley from Craig-Hallum Capital. In terms of trying understand some of the financial dynamics you have at work, you've certainly given us the landscape that you just dealt with. But in terms of understanding, with Prima Tech coming on for 3 quarters, in the February -- for all 3 quarters, so a full impact on the operating expense side, you referenced a couple of hundred thousand that were deal related. So I'm trying to get a sense for kind of the foundation operating expense run rate for the company. And it seems like it probably goes up a little bit from the $19.8 million that you just reported, but with some efficiencies, not that much, is that the right way for us to think about it?

I'm not sure, Steven, that I understand the question.

Well, expenses should go up from here. I'm wondering how much?

Oh, okay. Well, I'm not sure I know how to answer that because I don't know the total impact of noncash accounting that we may be facing. And let me give you some examples and I'd love to blame the world on FASB, but I can't. It's not that -- it doesn't matter, that's the hand that's dealt us. But at one point in time, goodwill is goodwill. Now, we buy a company, we take what was goodwill and we put a part of it in a customer-based intangible and that gets -- we think we know what that number is. We start to use that in our accounting. It gets tossed around by the auditors and several other people, sometimes it comes back, that number goes up, or goes down, based upon the outside opinion. Nothing there that ought to be of a concern at all to shareholders. It's a noncash item. But it certainly does impact our financial statements. I talked about the fact that, once, when you bought a business and you had inventory, you put it on the books at what it was from the seller and that was your basis going forward. Now with some new pronouncements, there's some sort of new calculation that says, to finished goods, you add 16% to those finished goods, perhaps, and then your basis, then, for profit, for the operating -- for that next quarter, or whenever you liquidate those, you have lesser profit. So all of a sudden, you had maybe a low gross margin group of products that were to -- say maybe they were at 30%, now, they're -- you've lost 16% of that gross margin, which is thoroughly[ph] not cash. So I sound like I'm giving you a politician's answer, which I probably am, but I wish that I could predict all that in advance. The basis of all of it is good. We know that we're buying businesses at 15x, 16x, 18x earnings, and we know that we're folding them in and we're getting a lot of economies of scale, and neither one of these 2 veterinary businesses, we're not using much of their old existing sales costs at all. We already had that built in place. I don't know how to tell you how much that will go up.

Now Steve Quinlan, in terms of the stock comp expense and those amortization expenses that hit in Q2, maybe a starting point for us who are forced to take a stab at the future income statement of your company, that data would be helpful. And if you have a best guess on what those numbers will be in Q3, but at least you have -- I know you have them for Q2?

Yes. Steve, the stock option expense for the second quarter is about 7 -- I'm sorry, about $900,000.

Okay. And the amortization number that you referenced?

Did you want both depreciation and amortization, or just...

Well, if you have both of them, somebody else will ask it anyway, so we could just get that out of the way.

Sure. Second quarter depreciation number is $1.2 million -- $1.3 million, let's call it. And amortization is another $920,000.

Okay. And the $920,000 will go up by some amount with a full quarter of Prima in Q3, is that the way we should think about that?

Yes.

Okay. Really, where I'm angling here is to try and figure out what your operating margin can do for this year. Through the first half of the year, it's down about 200 basis points year-over-year, for the 6-month period. And it looks like, given some of the margin trends we're talking about today, that it's going to be down for the total year versus the 19.4% you reported last year. And I'm just trying to figure out if you could make up some ground, so it's only down 100 basis points, or whether or not you do have some rabbits to pull out of a hat to make it more comparable to the 19.4% a year ago. As you've done the modeling, what's the range of outcomes there?

That's an interesting question, Steve. Obviously, it's all dependent on the gross margin levels. And it can range. We're at 49.5% here. It could go to as high as 51.5%, maybe, in the second half of the year. I can't give you an exact answer there. But it's going to be somewhere in between there. Maybe you split the difference and you say, it's 50.5% for the rest of the year.

And the biggest variables to drive gross margin higher in the product mix are -- which products -- you had a good quarter in dairy. Is the outlook -- I know that's a higher margin area. You've got some mix shifts in GeneSeek. How does the pipeline look there? Help us understand the bigger table-tilting variables to future gross margins and then I'll hop back in the queue and let some other folks ask some questions.

Well, it's no secret that, if you're looking strictly at gross margins, the Food Safety Division has always offered more gross margin, a better gross margin than the Animal Safety. However, we've always said, Steven, we look at running the company based on operating profit and, whereas -- as an example, Food Safety may be perfectly in a perfect position to spend 30% on sales and marketing expenses because they've got the margin to absorb it, and they've got the open market out there. Whereas, the Animal Safety division, with lower margins, is operating on sales and marketing expenses at, perhaps, 10% lower. So if you look at it, what's going to bring in the gross margins, the best opportunity to increase gross margins, it would be some of those products in the Food Safety side, though we've got a few products on Animal Safety that have gross margins in excess of 70%, probably. But the real opportunities are going to be -- big opportunity is going to be on the food side. However, as a friend of mine once said, it's hard to write a check for a percent. If we want to look at what's going to happen at the bottom line, I think we've got to carry it all the way through to the operating profit side and those places where we are bringing in at least 2 veterinarian instrument businesses, as long as the one we've owned for 28 years, are strong contributors to profit, strong contributors to growth that -- the original ones, and we think the new ones. But yet their operating profits -- or their gross margins are not all that good. But we spend 1% or 2% on R&D and they don't carry a lot of administrative expenses to go with them, so they're a great contributor. So if your question is, where are the gross margins going to come from, it's going to be the most promising, it would be some products coming out of Food Safety. If we're looking at what's going to be the greatest contributor to the operating profit side, that could come from either place.

And out of Steve Snyder's list of new products that you referenced coming in the second half, is there 1 or 2 of those products or product lines that has the highest potential for more immediate contribution?

Steve, I think NeoFilm is still very new, so we don't know exactly how that's going to go. We have great expectations and it's been adopted well, so far, and we're still early on. But I would probably have us look back to some of the areas of our traditional strength, allergens and areas where we've had success in the past, and just look at the continued steady effort and maybe combine them with some retooling and effort that we're given with the sales team to increase those sales. So nothing, no big flashes in the pan, per se.

Steven, here's an example. Steven, I spoke of having been in Scotland last week and it was -- the timing was not necessarily happenstance, but a report was given to -- that was ordered by the British Parliament on the whole issue of food security, based on what happened with the horsemeat that got introduced to beef, and everybody's been in an uproar on that. We've got a number of products that look at speciation. I think -- we think that that's going to be increased testing, certainly in parts of the European Union, not just for horsemeat and that's not where it is now. But they've talked about -- this special report talked about the fact that a lot of whitefish, turbot is being sold to be cod, and haddock is sold as cod. And as the economic adulteration that going on, we think that we're going to see some changes there. We're in a very strong position there competitively and we have very good gross margins in those products. So it's hard to say where lightning is going to strike tomorrow.

[Operator Instructions] And we do have a question here from Mr. Greg Halter of Great Lakes Review.

I know you talked a lot about the different areas of your international operation, but I wondered what the international sales are as a percentage of the total in the quarter?

Let's see if I can give you that. It's a -- though up good year-over-year, it's probably -- I'm guessing, probably not as quite as good, and that's as a percent of sales, as is this time a year ago.

For the second quarter, that number is 39%. Year-to-date, it's 40.7%.

Which is getting skewed, for instance, by Prima Tech, as an example, had no sales to speak of outside of the U.S., and that folded in this quarter. So -- however, you take a product line like that, we are already looking at opportunities to go to Mexico with that product line, we can move those out pretty fast, one of the great things about those. Where we've got feet on the ground, in places like Canada and Mexico and Brazil, we can take products that the existing owners, or the former owners, didn't have the power to do and we can push them into those markets pretty quick at no additional cost.

Would that be true also for Europe and other parts of the world, besides just Mexico, Canada, Brazil and so forth?

Yes. We don't have good footing on the ground in Europe for our Animal Safety group. We've got strong sales in some areas, such as our detectable hypodermic needles, it's -- in fact by Danish law, you can -- if it's a food animal, you have to use a needle that is detectable by a metal detector in their processing plant. So we've essentially got all that business. But we don't have the full line of business there. It's an area that we talked about, we continue to talk about, we need to be there. We need to have an Animal Safety presence in Europe. But at this point, it's pretty confined. So that's a huge opportunity for us going forward. We've got to find the time to get it done.

Okay. And Steve, relative to foreign exchange, what kind of impact did that have on sales and pre-tax income?

For sales, it was negligible, almost 0. And pre-tax income, it was actually a pickup of about $136,000 for the quarter.

Okay. So still relatively minor. Looking at your -- the cash flow statement. I don't know if you provided the cash flow from operations, either for the 6 months or for the quarter? Do you have that available?

I didn't, but I'll be happy to. Cash flow from operations for the quarter is $5.2 million. So that should be $10.7 million for the year-to-date period.

Okay. And that's down about, I don't know, $500,000 or so year-over-year. Any reason why you wouldn't see that number improve as the year progresses?

It actually should improve. I mean, we've got a little bit of a buildup of receivables and inventory that should dissipate over the rest of the year, so you should see that number improve.

Okay. And I can't remember what the number is, but any change on your capital spending plans, now that you have the Prima Tech business? I think, before, we had been looking at around $10 million for the year?

Yes. There's no change there.

All right. And I presume the tax rate around 36% is about where you'll come out. Are there any opportunities to bring that rate lower over time?

There are. Over time, I think we're -- maybe that's a longer period than the rest of this year. We don't have any plans right now to do anything that's going to move that rate markedly for the rest of the year. But we are looking at future tax planning strategies that'll make sense for the company.

I'm showing we do have another question here from Mr. Drew Jones of Stephens Inc.

A question just about longer-term opportunities. I guess, under the Food Safety Modernization Act, there's been a little bit of talk about animal feed and maybe doing a little bit more screening on that side of the business. Can you talk about how you guys are prepping for that, and when those opportunities might start to manifest?

Yes, thanks, Drew. And that's clearly one of the areas that we are addressing, are looking at. For some time, for -- a quick background, for some time, there's been a feeling that the -- I don't remember what the percentage is, it may be 70-something percent of all antibiotics in this country go to animals, maybe 80%. Very little of that goes to the humans, when you look at the total antibiotic usage. Most of that, in the past, has gone to animals, as, what I would call, a management crutch. We've fed them low levels of antibiotics to hold down infections so that we could improve performance in the animals. And this was, particularly, animals going to market, whether they were -- whether it was beef or sheep or hogs or whatever. There's been some feeling that the use of those antibiotics slipped through in the animal protein products into human consumption, and we've built up some resistance, as humans, to some of the antibiotics that we need to protect us in the event of -- we get sick. So there's been a lot of move to push, to restrict or, in some cases, even prevent the use of antibiotics in animal feed on a prophylactic basis, that you can only use it therapeutically and to make sure that the veterinarian has to sign a prescription. We've moved a lot in that direction, but still not very far. The way that, that will be controlled -- and it's going to be controlled in Europe first, in fact, we're seeing it in Europe now -- is they'll be testing the animal protein product for residue. So if you can find the residue in the liver of a calf, not just is that liver going to be thrown out, but that carcass would be condemned. So the testing is going to come there. How fast it will come? FDA is making noises now and it's a part of what we're looking at with the Food Safety Modernization Act. I don't know how far it'll go, but it's clearly an area that we're addressing. We have a new group, Ed[ph] does, it's a part of his group, that's looking strictly at more -- we've been looking at drug residues in milk, dairy products before, but now we're looking at it more seriously as it relates to animal proteins and the meat products. So it's there. It's probably not going to make a big difference in this quarter, though we'll be spending some more money this quarter. That's part of what's in R&D is the development and test it to meet that as those requirements get more stringent. So clearly important to us in the future, Drew, probably, it won't add a lot to the bottom line, though, in the next couple of quarters.

We do have another question here from Mr. Jonathan Weiss [ph] of Chiju Investment [ph].

I just wanted to go back a little bit to the gross margins. You've answered most of my questions, but how confident are you that you're going to be able to get back to over 50% gross margins in the next 2 quarters?

We have a pretty high degree of confidence, but there's a lot of moving parts there. We have a broad product line, and depending on how the pieces and parts come together is going to dictate what our margins are going to be. We were just below 50% and that's a fairly historical low, near-term low, for the company. So I think getting back to 50% is -- the probability is high there.

Yes. And it depends on some of these extraneous things that I talked about earlier, and we got to work our way through some of that. And obviously, any new acquisitions that might come along between -- we got half the year left. Anything that might come in the way of acquisitions makes that a little that less predictable. I can assure you we've now done 26, I believe it is, since the year 2000. And they've all worked. So -- and we have to have a bad one? Well, I don't think so. I think the things that we're doing to monitor what we're doing on acquisitions and how we do our due diligence and where we place our dollars is going to continue to work for us. So it's a [indiscernible].

And also a question here from Mr. Joseph Hartman from Wells Fargo.

Talk to us about acquisitions. What's going on out there?

Well, I did mention that we've got the soft circle around some opportunities that we think are interesting. I can't say any more than that right now. One might happen, one might not happen or may never happen. We don't know until -- you never know till the fat lady sings, and we're pretty tight on making acquisitions. We walked away from them in the 11th hour before. But we think that there is, particularly in -- and I've got some friends in the investment bank and they're talking to one of the big guys from New York yesterday. There's just a lot of activity out there now, particularly among private companies that are -- or privately owned that are selling and looking at taxes and where they might be. So that, of course, will tend to probably dissipate here in the next 2 weeks, but there's some opportunities. And some opportunities for us, as we continue to be a consolidator. So it's great to have bank lines available, no debt, cash in the bank. That's kind of worthless, but if we can use it, it'd sure be helpful to be going forward into somewhat troubled times. Regardless of which way we go, I think we're going to be in good shape in acquisitions, so it will continue to be an important part, Joe.

Are there sellers starting to pop up that you hadn't noticed before?

No. I don't think -- I mean, we've got a check list, it's on our radar that -- I talked about the Prima Tech. We've been -- we've looked at that one for 3 years. In fact, made offers in 2 different years to buy it and couldn't get together. It was a private owner and he came back and decided that he wasn't sure how much more taxes he was going to have to send to Washington if he sold it next year. So we've got that one done here, just before the end of the year. It's hard to say. There are some divestiture opportunities going on that we might be able to nab into. It's interesting that both Novartis and Merck came out within the last month or so, saying they don't know whether they were going to keep their -- the Animal Health divisions, that they might be interested in divesting those. We saw Pfizer spin theirs out into Zoetis, that we won't know whether that was successful from an operating standpoint for months ahead yet, because they're still trying to absorb it into this new company. Novartis has got a product or 2 that we'd like to have, if they don't end up going in a package. We don't know where Merck is going. Merck's picked up some things that -- of course, we're not in the position to either want -- to be in a position to either want to or have the wherewithal to go in and pick up either one of those divisions. But it's just going to be -- and I love -- there's going to be changes and I love changes. Every time there's a change, you can get in there and take advantage where you might not have been able to before. So we're kind of looking forward to the changes.

Do you find yourself bidding against acquirers like that?

No. Not against the Novartises and the Mercks. I guess, they're not acquiring good businesses, that's a reason they might be up for sale. But the others, we see some pretty sizable guys. I won't mention who they are, but we see -- we run -- in acquisitions, we run up against companies that are probably 5x our size or better. So we're not down playing marbles in the sandbox.

It looks like that was our last question. And I'll turn the call over back to Mr. Herbert.

Well, thank you, all. We appreciate your understanding and your patience. We perhaps fired the gun a little too quick on the tipping point, but it's all there and it's all future growth. And I think, listening to this management team this morning, hopefully, you've felt that we're confident as ever about where we're going and what we're doing. In the meantime, well, we wish you all a Merry Christmas and Happy Holidays. And we'll see you on the other side of the new year, when we make our next reports in 2014. Good day.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and you may now disconnect.