Neogen Corporation's (NEOG) CEO Jim Herbert on Q1 2017 Results - Earnings Call Transcript

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Neogen Corporation (NASDAQ:NEOG)

Q1 2017 Earnings Conference Call

September 27, 2016 11:00 a.m. ET

Executives

Jim Herbert - CEO

Rick Calk - COO

Steve Quinlan - CFO

Analysts

Brian Weinstein - William Blair

Tony Brenner - ROTH Capital Partners

Paul Knight - Janney Montgomery Scott

David Stratton - Great Lakes Review

Charles Haff - Craig-Hallum

Kurt Kemper - Hilliard Lyons

Operator

Good morning, and welcome to the Neogen First Quarter Fiscal 2017 Earnings Results. My name is Brandon, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

Please note this conference is being recorded. And I'll now turn it over to Mr. Jim Herbert. You may begin, sir.

Jim Herbert

Good morning, and welcome to our regular quarterly conference call for investors and analysts. Today we'll be reporting to you the results of our first quarter of our 2017 fiscal year, which ended on August, 31. 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 risk and uncertainties. The actual results may differ from those that we discuss today, but again call your attention to the fact that risks that are associated with our business are covered in part in the company's Form 10-K as filed with the Securities and Exchange Commission.

In addition to those of you who are joining us today via live telephone conference, I would also welcome those who may be joined by way of simulcast on the World Wide Web. Following the comments this morning, we will entertain from here 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.

Today, Neogen issued -- earlier today, Neogen issued a press release announcing the results of our first quarter that ended on August 31. Revenues in that first quarter were $83.6 million, a 12% increase as compared to revenues of $74.9 million in the first quarter of last year. First quarter net income increased by 6% to $9.9 million or net it was $0.26 a share. This compares with the previous year's first quarter of $9.3 million or $0.25 a share.

As you would expect, both the revenues and the net income represent first quarter records for our 34-year-old company. The quarter also adds to a long string of consecutive growth quarters. This is the 98th quarter in the past 103 quarters that Neogen has reported revenue increases compared to the previous year. That's a record that now spans almost 26 years. And by the way, all consecutive quarters have been up for the past 11 years.

We did our budgets back earlier this year. I have said to our folks surely we've seen an end to being penalized by adverse currency translations. Well, unfortunately that's not yet happened. Steve will talk more about that later in the call this morning, but the Brexit vote in June caused the British pound to decline by 10% as compared to the U.S. dollar, and this is of course the currency of our sizable Neogen Europe operations. Mexican peso also continued its decline into the quarter. So the results that I just reported to you would have been markedly better if we'd had a neutral currency translation as we'd budgeted.

Of course, these adverse translations affect all the other numbers in the statements. Our gross margin for the quarter was 48.4%, and this compares to 50.5% in last year's first quarter. In addition to the impact of these currency translations, there were several other factors that contributed to the changing gross margins. This related some of it to incremental revenue from acquisitions that are on board and fine, but they're still being integrated, and the loss of significant sales of a small animal supplement with high gross margin was also significant.

You may remember back a couple of quarters ago I advised you that our thyroid substitute product for dogs would be required by the FDA to be temporarily withdrawn from the market. As a quick reminder, we've made that thyroid supplement product for dogs for a number of years with the full understanding and discretion of the Food and Drug Administration. However, FDA regulations require that if a company gets a registration on any one of these kinds of discretionary products, other companies are suspended from marketing until they can also have a registration.

Well, we had our registration in progress prior to the required withdrawal, but it hadn't been completed, but we are continuing to aggressively pursue that approval. However, effective July, 28, we ceased shipping the product to veterinarians and we asked them to return anything that they had in their warehouses. And of course, the canine thyroid care product is not a part of Neogen's core business, nevertheless it's been a nice revenue generator, and will be again in the future.

Our operating income for the quarter was 17.6% of sales; much of this of course tracks back to the gross margins and the currency translations and all the other things that we just talked about. This compares to an almost perfect 19.9% that we had a year ago in the first quarter. Looking at the components of that, sales and marketing expense increases were actually less than the revenue growth, but we did have some inordinate expenses that hit the administrative bucket for the quarter, and I'm sure Steve will talk more about that later here in the call.

There were a few disappointments in the quarter in addition to those currency translation headwinds, but I think the first quarter got the New Year off to a pretty good start. Again, my hat goes off to over 1,300 Neogen employees that I watched during the past three months as they worked hard to take on new responsibilities and the many new customers coming from our own internal food safety business, as well as newly acquired customers that came from acquisitions on the Animal Safety side.

I'll plan to come back toward the end of the call and talk more about several things that look promising going forward, but let me stop at this point and ask Rick Calk, our Chief Operating Officer, to talk about the growth and some of the exciting opportunities that he sees are happening in our Food Safety business. Rick?

Rick Calk

Well, thank you Jim, and welcome to everyone listening. Jim has already reported on the overall sales and profit performance for the first quarter of our 2017 fiscal year, and I'll try to provide some more detail on the performance of our Food Safety segment as well as offer some perspective.

As stated in the press release, revenues for our Food Safety segment increased 13% during the first quarter compared to the prior year's first three months, aided in part by the acquisitions of Lab M and Deoxi in the past year. Organic growth for the Food Safety segment was 9% for the quarter.

Sales of Neogen's rapid test for food allergens such as gluten and peanuts increased 17% in the quarter compared to the prior year. Neogen developed the first rapid test for food allergens in 1988, and we have remained the leading provider of food allergen test kits ever since.

With increasing industry and regulatory efforts to reduce food allergen contamination, our food allergen product line, which now detects 15 allergenic foods, should remain one of our Food Safety growth drivers going forward. In the quarter, sales of General Sanitation products, which includes our AccuPoint Advanced ATP sanitation monitoring system, increased 9% compared to the prior year. And like many of our food safety diagnostic products or test kits, AccuPoint is a key product to help food manufacturers comply with new regulations that require companies to test their equipment and facilities for contamination to reduce the risk of any food contamination. With AccuPoint, you can almost instantly know if a surface is clean or if it requires further attention.

Last week, we announced that the AccuPoint Advanced system is the only product to receive approval from AOAC Research Institute. The AOAC is an influential independent organization that verifies the tests performance expected. This approval of an ATP sanitation system was unprecedented in the food industry. We wanted the industry to know just how much we believe in the performance of our product, and proved it by seeking this very important approval.

One other high point in our first quarter on our Food Safety side was a 55% increase in sales of the company's BioLumix and Soleris test systems. These systems rapidly detect general microorganisms such as yeast and mold in food, nutraceuticals, and other consumer items. While the testing for specific bacterial pathogens such as Listeria, E. coli, Salmonella, gain the most attention, the vast majority of microbial testing in the food industry is for general microorganisms. These microbes are less likely to pose a risk for consumers, but can adversely affect a product's taste and the product's shelf life. And this is a key trend in reducing food waste. As an example, in the first quarter Neogen's R&D team developed a new testing solution using our Soleris system that allows yogurt manufacturers to test the full range of yoghurt products for yeast and mold using this single testing platform.

This solution represents a major breakthrough in food safety testing. It's notoriously difficult to test for yeast and mold in yoghurt. Yeast and mold are very slow-growing organisms compared to bacteria, and the number of live beneficial organisms in yoghurt can confound conventional testing methods.

Our new testing protocol can produce accurate results in only 48 to 72 hours, where conventional yeast and mould methods can take up to five days. Sales of our mycotoxin tests in the first quarter were up 2% compared to 2016 as we overcame a difficult comparison to an exceptional previous year quarter for mycotoxin sales. Going forward we are seeing reports of limited mycotoxin outbreaks in the 2016 harvest season, including reports of DON in wheat in Western Europe and Canada, as well as aflatoxin in corn in pockets in the United States.

One major natural toxin product that we rarely discuss in these calls is our test for histamine, which is a toxin that's produced when certain species of fish, including tuna, decompose of they are not stored properly following harvest. Sales of our test for histamine increased 11% in the first quarter as we have increased our commercial presence in this growing market. Sales of our products for pathogens increased by 5%, while our test kit to detect dairy antibiotics were up 7% in the first quarter compared to last year. Now, as you might have seen after much anticipation, the first major compliance date for regulations under the Food Safety Modernization Act, FSMA, passed on September, 19. And now larger businesses much comply with the new standards for preventative controls for human and animal food.

And this is the first of seven rules developed to drive down the incidence of food-borne illness here in the United States. Large facilities are now required to have a food safety system in place that includes an analysis of hazards and risk-based preventative controls to minimize or prevent those hazards. The standards that animal food facilities must meet marks the very first time that Good Manufacturing Practices have been broadly required for the safe production of animal food. As we've said repeatedly, we believe FSMA and similar regulations in other countries will help drive Neogen's growth going forward. The timing and magnitude of that added growth is yet to be determined.

Now on a personal note, I look forward seeing all of you who can make it to our annual meeting taking place here in Lansing in a couple of weeks. I hope to see you there. Jim?

Jim Herbert

Thanks, Rick. Steve Quinlan talks some about the highlights of the Animal Safety Division for quarter and go back and fill in the blanks on the financial results that I opened up including my favorite subject of currency issues if you would.

Steve Quinlan

All right, thanks Jim. As Jim indicated, we got off to a solid start for fiscal '17 with the 12% increases in revenues in that first quarter. And we were able to achieve these results despite the withdrawal of the ThyroKare product and the ongoing impact of currency primarily affecting our Neogen Europe operations' quarter as the pound devalued against the dollar following the Brexit vote in June. As Jim indicated, the pound was down 10% immediately following the vote, and hasn't yet recovered. Additionally, although the peso stabilized against the dollar late in last fiscal year, for the comparative quarters it was down an average of 14%. And the negative impact of the stronger dollar on our comparative revenues, primarily from those two currencies for the quarter was $1.9 million, and the cost at the bottom line was approximately $0.02 a share.

Now, Rick has already discussed some of the key highlights of our growth in the Food Safety business, so I'm going to focus on the Animal Safety Segment. Animal Safety recorded an overall revenue increase of 10% for the quarter, and that was aided by the Preserve and Virbac acquisitions in the latter half of our prior fiscal year. Organic growth was actually negative 1% primarily due to our market withdrawal of ThyroKare, that thyroid replacement supplement for dogs. But during the first quarter we removed ThyroKare from our distribution channels, and issued credits for return product totaling $1.1 million to our customers. In last year's first quarter, our sales of this product were $1.8 million. Now, this resulted in a $2.9 million negative impact on revenues for the quarter.

So if you exclude the impact of ThyroKare, Animal Safety would have recorded organic growth of 6% for the quarter. And as Jim mentioned, even though this product is not core to our strategy, we are aggressively pursuing our own regulatory approval allowing us to once again sell it, but that will not happen in the current fiscal year.

Increases in our Lexington-based business came from sales of consumable products to the commercial dairy market. This is the result of a new distribution agreement entered into in July of 2015 and strong sales of our vitamin injectables product line which rose 60% for the quarter. We had a 33% increase in sales of our life science products primarily forensic test kits for the quarter. The result of increased sales to commercial labs due to new regulations requiring drug testing of commercial drivers in Brazil. You may recall that I mentioned on our last call that we expected to see a nice increase to these drug testing products as that law went into effect.

Our Rodenticide business increased by 17% for the quarter, as our contract manufacturing business expanded further and we continue to penetrate the retail agricultural market. But this growth came despite a lessening of the rodent outbreak in the North Western U.S., which had resulted in strong fields to the market in the prior year quarter. Off-setting these gains are veterinary instrument product line was down 7% but this product line had very strong sales in our last fiscal fourth quarter and sales for Q1 were a little soft.

Sales for existing line of cleaners and disinfectants declined 25% for the quarter primarily due to continued difficult economic conditions in a number of our key international markets and the strength of the U.S Dollar which made our products less competitive in those markets. However I am really excited about our acquisition this May of Preserve and its sisters company Tetradyne which give us a leading position in cleaners and disinfectants in the U.S.

The genomics testing business that's reported through the animal safety segment was up 9% for the quarter. Now this is the revenue from our Lincoln, Nebraska location. However, worldwide revenues from genomic testing increased 21% as we open the lab at Neogen Europe up in the third quarter last year to better serve our European customers and provide us with additional capacity and also purchase Deoxi, a leading genomic laboratory in Brazil in April.

Corporate-wide, as Jim said, our gross margins were 45.4% for the quarter compared to 50.5% last year. Margins were adversely impacted by mixed changes from the two larger acquisitions from fiscal '16 which were Lab M and Preserve, which at present each have lower gross margin than the company's overall historical average.

The loss of ThyroKare and the adverse currency translations which reduced our comparative revenues and compressed margins also had an impact. Partially off-setting these shortfalls were favorable mix shifts towards more profitable product lines in the rest of the business. Our operating expenses overall were up 12% for the quarter and it's consistent with the 12% increase in revenues. This increase included about a million -- two in expenses related to our recent acquisitions.

Sales and marketing expenses rose 9% but actually decreased as a percent of revenues from 18.1% in the prior year to 17.7% this year's first quarter.

General administrative expenses rose 22% for the quarter with $700,000 of debt increase coming from additional expenses incurred as a result of our recent acquisitions, things such as legal expenses and amortization of purchased and tangible assets. Additional increases were for stock options and other compensation related expenses. The stock based compensation and amortization expenses are non-cash charges and total about $3 million for the quarter. R&D expenses increased 4% in the first quarter versus last year.

Operating income for the quarter was $14.7 million which was down about $150,000 compared to last year's first quarter primarily due to the 210 basis point decrease in gross margins and the increased operating expenses. Expressed as a percent of sales, operating income was 17.6% compared to 19.9% in the first quarter last year. However this represents improvement from Q3 and Q4 of last year which were 14.7% and 17.3% respectively. Other income was $492,000 for the quarter compared to expense of $456,000 in the prior year's first quarter. This shift is due in large part to realized currency gains at our international operations and we had favorable results from the company's hedging program.

Overall currency gains in the first quarter were $246,000 compared to a loss of $605,000 in the prior year quarter. We also had $123,000 of interest income and $45,000 of royalty income in the quarter. The company generated a strong $20.3 million in cash from operations in the first quarter aided by 12% decrease in accounts receivable and an increase in accounts payable. We invested $3.4 million in property and equipment this quarter primarily building improvements and equipment at our Lansing campus. Inventory balances increased $5.4 million from year end levels as we continue to work on minimizing back orders while also improving our inventory turnover.

So, in summary we feel really good about the start of our fiscal year here despite some of the challenges we faced and continue to be optimistic that we are well positioned for the growth opportunities which are ahead of us.

I will now turn it back to Jim for some additional comments.

Jim Herbert

Well, thanks Steve, and let me talk a little bit more about what's happening on the international front. We talked about currency swings, but there is a lot of positive things going on out there.

In the past number of quarters, our international business had been growing, but hadn't been keeping up with the rate of our domestic business, but in the quarter we just finished we made some gains in this first quarter. Our international sales were up almost 19% over the prior year as compared to total revenues being up 12%. That pushed our international sales up to about 35% of total revenue for the quarter, and this was of course this bite those adverse currency translations that we continued to mention, but even despite that our Scotland-based Neogen Europe operations showed revenue increases of 24%, our Mexico-based Neogen LatinoAmerica sales increased by 28%, our Neogen do Brazil revenues grew by 43%, and China sales were up 21%, even though of a little bit smaller pace.

The drivers that impact Neogen's growth are all continuing to be strong as both Rick and Steve have talked about, the Food Modernization Act that Rick mentioned, fortunately the compliance as a number of industries now scurrying in order to get into compliance.

Fortunately for the industries and for the agencies, staff and for consumers various facets that surround this Food Modernization Act don't all come do it one time and that way gives the food industry some time to continue their compliance activities. We think that we will continue to see increases in our diagnostic business as a result of this.

At the same time we are seeing regulatory pressure increase, we're also seeing some similar pressure coming from what I would call consumerism activities. Some consumers even though perhaps small in numbers want to feel good about the food that they eat, a good example of this is raised without antibiotics, activities going on, this is first sweeping the chicken, meat industry and this will be the one that will be the easiest to meet these demands, after meeting just this past week with a major broiler producer who speculated that in excess of 30% of all chicken meat going into the market during the month of December will be raised without antibiotics.

Neogen's tailor-made program to the industry to be compliant yet keep chickens healthy continues to bring attention and now that gives us some competitive edge. There are some other outer reaches of this consumerism movement that's going to be more difficult to satisfy, is an example some significant sized dairy product producers are now saying to farmers that they only want to buy milk from cows that have been fed with non-GMO corn.

Well, obviously all the regulatory agencies believe that these corn varieties are perfectly safe and have been for a number of years. However realizing that something like 83% of the nation's corn crop is planted to these new superior varieties only a small portion of the crop, the non-GMO crop would be available the kind of seed that your grandfather used to raise corn. A major food service company has told the industry that they'll no longer buy eggs from hens that are housed in cages. This is kind of interesting. We moved hens to cages 75 years ago to keep them from eating their own feces and pecking each other to death, but I guess as this develops we'll sell more diagnostic test kits in order to manage salmonella and another ten or more food pathogens are apt come into play.

As you know, we are the largest animal and genomic testing lab in the world today and as fact is more recognized in. We get a lot of different requests dealing with genome mixing. In this line of consumerism the latest one that's out that was a pretty big stretch was a request to own to know how to get all dairy cows to be polled. This means that the polled animal is born without horns. This group wanted to make certain that the animal didn't have horns, because the process of removing those horns prevented them from injuring each other with an inhumane practice. Well, interestingly we have a $5 genomic tested predicts if a cows case will be polled and obviously none of these things have anything to do with safety approved, but nevertheless it can't be ignored as long as consumers are pushing their supplier.

On a more generally positive approach to genomics comes our activities on using genomic capabilities to increase to help in the identification of pathogenic or spores organisms it would have been talking about. This kind of activity is much simpler than looking at the complex genetic system of animals and bacteria has a pretty small genome and it can be sequenced rather rapidly in our labs. Right now it's a lab process where we do lab service for hire but at some point I believe that we'll be able to develop that technology so it can be used as a field kit and I believe that Neogen is going to be one of the first be a game-changer in that area.

It looks like its becoming consolidation time within the food and animal businesses. Veterinary clinics are being acquired and consolidated by probably a dozen different firms today. Some of this is equity capital struggling to find a new homes since interest on money is non-existent. All this has a bearing on what we're doing in the animal safety side with various instruments, cleaners and disinfectants in a number of products.

We're also seeing consolidation on the food safety side. A couple of companies in the some segments of our business have sold recently at prices that could be as high as 80 times earnings. The buyers were equity capital folks not people with an industry background. So, without sounding cavalier it may be interesting to welcome some of these new players to the food safety club.

There appears to be some good sensible acquisitions out there too. Again, we'll be looking at places to do bolt-on acquisitions, and we'll continue to build on our international markets. So I think it's safe to say in closing that the same strategy that's grown our top line and bottom lines continuously for almost 26 years is still in place and the drivers are getting stronger. The overall market for food and animal safety products continues to grow and I think we have an opportunity to gain an additional share of that growing market.

Our R&D group has been working on making current products more robust and easier to use. These new or improved products coming into the marketplace should also continue to help our growth strategy. I just talked about acquisitions and of course the fourth leg is due is growth in the international markets, which should continue also to be strong for us.

I think this is probably a pretty good time to wind up our prepared comments for the morning. So let me stop and open the phone lines for any questions that you might have for Steve, or Rick, or for myself.

Question-and-Answer Session

Operator

Thanks, Jim. We will now begin the question-and-answer session. [Operator Instructions] And from William Blair, we have Brian Weinstein on line. Please go ahead.

Brian Weinstein

Hey, thanks for taking the question. First, kind of a revenue side, on ThyroKare, you talked about $1.8 million in the quarter and then you had the $1.1 million, Steve, I think you mentioned for credits. So as we just try and think about that business going forward, is about -- is removing about 1.8 million a quarter the right way to think about it? And are there going to be any of these additional credits going forward?

A – Steve Quinlan

Brian, there won't be any additional credits. We took all the product out of the market. Sales for that product last year were about 6.6 million. So, now I would just kind of annualize that for the remaining three quarters.

Q – Brian Weinstein

Okay, and then on gross margin, it was up sequentially, still down year-over-year, but you've talked a lot about you trying to get these acquisitions up to the corporate average. Can you talk about how far below the corporate average they are and what the process is to kind of get them up to corporate average? How long does it take and what are the specific steps that you guys are taking on that?

Jim Herbert

Well, thank you, Brain. That gets us from a couple of aspects, and first to talk about the gross margin side, we just brought the Preserve operations onboard, and that's a sizable piece in Cleaners and Disinfectants. We got operations in Turlock, California and Memphis, where neither of those two markets that we operated before. We had some changes as we increased -- moved around where the products came from, we ended up with some extra shipping costs coming out of California that in the future will probably get shipped out of Memphis. We had changes in personnel. We ended up with some people, I guess, it's safe to say we're not compliant with international citizenship in one of the locations. So we had -- came on with the part of the baggage with the business that took us a little while to get some of that reorganized. So, as Steve said, it's exciting, and that piece of the business is exciting.

At the same time, the Deoxi operations in Brazil are small, but we're getting that one churn to get a lot of stuff done. Some of our business, not an acquisition, but some of our business in Neogen Europe related to the genomics, we're beginning to hit our stride out there with some expenses that are now being well covered by increase in revenues. So it's a number of places. I think probably the most telling is what happened at the G&A expenses. And you know I mentioned months before that the new – I’d say not new, but the current FASB rules require that you expense acquisition expenses the quarter in which you spend them, we used to be able to put those in as a part of purchase price and amortize them over some period of time. But now if you spend $500,000 to buy a $10 million operation, you expense $500,000 in the quarter in which you spend it.

So that was accounted for a part of what Steve talked about. And I think he made it pretty clear that 20%-22% increase I think in G&A expenses against the 12% increase in revenues. So we're pretty happy with all of it. It's just a matter of kind of wringing the water out.

Q – Brian Weinstein

Got it. Last question for me on the DNA testing services, came in about $7.9 million for the quarter. That's up year-over-year but kind of down from more recent trend line. Steve, can you talk about just –- you were talking about the worldwide growth of 21% but only up 9% in Lincoln. Can you just describe kind of the difference between those two numbers? And was this down a little bit relative to your expectations given that trend line looked like it was closer to kind of $9.5 million to $10 million in the last couple of quarters? Thanks.

A – Steve Quinlan

Now actually, Brian, we were very happy with genomic revenues for the quarter. What I was trying to say is that what's recognized out of Lincoln was the $9 million, but when we talked about our worldwide revenues, those genomic revenues are reported inside Neogen Europe, which reports inside of Food Safety. So there's a little bit of noise in the numbers. But if you look at our overall genomics revenues for the company worldwide, it's up about, what I’d say, 21%?

A – Rick Calk

Yes, 21.

A – Steve Quinlan

So that was really in line with where it's -- I think we've been in the low to mid 20s the last few quarters. So I think we were actually very pleased with that.

Q – Brian Weinstein

All right. Jim, tell your buddy Dantonio not to take out his frustrations out on my Hoosiers this weekend, okay. Thanks, guys.

A – Steve Quinlan

Thanks, Brian.

Operator

From ROTH Capital Partners we have Tony Brenner. Please go ahead.

Tony Brenner

Thank you, and good morning. I have two questions. First, Jim, you've indicated previously I think that 40% of your European business is denominated in pounds. And given that devaluation I'm wondering what the effect has been on your European volume, your customer demand, and your pricing strategy as a result?

Jim Herbert

Gosh, that's a mouthful, Tony. Let me see if I can go back. The growth I think is real. We've had good growth. Sometimes I have to get out the Ouija board to figure out what's happening. Neogen Europe sales product in Euro is a product in -- actually it still sells some product in dollars and they sell a lot of product in pound sterling. They bring all of that into Neogen Europe, and then restate it at pound sterling is which is how they report it. The pound sterling numbers come over here, and we then translate those back to U.S. dollars, but…

Tony Brenner

So it's perfectly clean.

Jim Herbert

Yes, that's right. Sometimes I wonder which shell the pea is under when we start moving things around, but they struggled a bit last year because of -- and we were strongly competing with some international competitors over there. This quarter started off really strong, and really good and I'm awfully pleased with it. We did some more consolidating over there with our Lab M business, that’s the dehydrated culture media business that we bought some eight weeks [ph] or so ago. We did some more consolidation with that this quarter. They report through the Neogen Europe operations headquartered in Scotland. So I'm feeling good about where we are with the Neogen Europe Operations.

And Brexit is I think everybody has decided whatever is going to happen is not going to happen tomorrow anyway. And that's two to three years in the process. So we're looking at an acquisition or two over there. And Dr. Lily [ph] came the morning after said, "Do we want to change our thoughts?" And I said, "No, we still got strong movements over there, and this too shall pass." So I don't know whether I answered your question or not but we're pretty comfortable with what's happening here.

Tony Brenner

Second question is would you discuss the economics of your involvement with Contrapest?

Jim Herbert

I really can't discuss much. I can say to you that our people out -- and in fact I was on the phone with our people yesterday. Our people continue to -- they were there last week. We continue to have ongoing dialogues as it relates to the manufacturing of the business and where they are. And the reason I can't say much is that this is a NASDAQ company with whom we have a license as one on the Street filing for an initial public offering. So it would be inappropriate. And I'm so cautioned by our attorneys that I shouldn't be saying anything one way or another other than our relationship continues there. And I don't know when they might expect that to go final, but anyway there's an SEC offering document under consideration and on the Street. You know better about the status of S1s than I would, Tony. But that's probably all I should say.

Tony Brenner

Okay, thank you.

Operator

From Janney Montgomery Scott we have Paul Knight. Please go ahead.

Paul Knight

Hi, Jim. On the veterinary equipment and supply line that was a little soft. Could you talk to that? And then also I know your cattle prices are down 30% year-over-year on feeder prices along with corn prices down. Is that agricultural market affecting your product demand?

Jim Herbert

Yes, it's affecting some. And, you know, as some of you know I can speak first-hand on the cattle side. I was talking to one of my ranching friends the night before last, and he was lamenting the fact that he sold feeder calves this week for $1.21 -- last week for a $1.21 a pound and got $2.20 for them last year. And I reminded him that I'd advised him last year to take a picture of that check and put it on the wall because he'll never see another one like it. I think we're seeing that. The opposite side of it is it's all kind of funny out there right now. We look back in 2013, corn was $8.50 a bushel and now it's $3.5 a bushel. So, you know what a big change there. We saw cattle -- feeder calves and the whole beef increase go up. And now that's come back down toward reality.

It's probably impacting anybody that's buying -- well, it is impacting anybody that's got capital assets to sell. John Deere is not real happy. We're probably selling a few less syringes in cattle obstetrical equipment than we would and making the old stuff work a little longer. I don't think it's going to have any material impact on what we're doing on the vet instrument side. We got enough new stuff coming on the vet instrument side. I think we were down a little steep for the quarter, but we supply a lot of OEM stuff for big pharmaceutical companies that are out with a new vaccine or out with a new pour-on product, and then needed advise to be able to administer it. Sometimes they buy those devices from us and give it to the end ranch or user as a premium to sell our product. And I think we probably had a little bit of that a year ago, we didn't have it now, but I'm really excited about some of the things we've got coming on vet instruments. They're working on some new electronic instrumentation now. All this get's to be tied more and more together with RFID tags in animals ears, and scales you can run them up the headgate and it tells you how much they weigh. And you can record all this to permanent records. I think we're seeing a new era of that happening. And we just got to get used to $3.50 corn and $1.20 feeder calves, yes. And we'll still make it. I can remember feeder calves when they were $0.50, so that's maybe long ago, most people won't remember, but we can still make it out there.

Paul Knight

And then lastly, I know international expansion is a priority for your company now, Jim. How was demand in the quarter, specifically China, South America? And then any traction on getting more footholds in those markets from your [ph] acquisitions? And again, does it continue to be a top priority for you?

Jim Herbert

Yes, it does continue to be top. And our expansion in Brazil, we're continuing to look at Brazil, and that's the only thing I can announce today, but we've got our own people on the ground down there, and we are calling on major food processors and producers directly. We're working through a group of distributors for our Animal Safety cleaners and disinfectants. We're manufacturing actually cleaners and disinfectants in the country now to ship in water all across the world and paying high tariff costs to come in. That's beginning to work for us. There's obviously the real to the dollar compared to where it was a year-and-a-half ago is not favorable, but if you're buying the real to the dollar, maybe say there's some bargain opportunities there. Maybe not bargain, it's probably the wrong word, but more justly priced.

I think we're looking at some opportunities there again. Nothing new we can report, but Brazil is important to us. China is important to us. We continue to build that business. I was with a major U.S. company that's a major producer in China a week ago. And we talked about what's happening in the China market. They've got to have more animal protein to satisfy that demand of that population. It's happening. We sometimes are a little impatient about how. But we're clearly in the right place there in China, and with Brazil as a supplier. India is there, and not a lot I can say about India. I said at the end of last fiscal year, if we could break even in India in the first year I'd consider it to be an accomplishment. That's kind of by the way we are now, but some great opportunities there beginning to occur in India now.

So Mexico is strong, and getting stronger. Mexico, our Mexican operations have not taken on a direct responsibility for a lot our food industry distribution in Central America. So we've got our own boots on the ground that are working there in addition to some distributors that we had. So I feel good about what we're doing there. Nobody knows -- Brazil, we had some [technical difficulty] on the political front but Brazil is still solid as a producer. And I think that too will pass, we'll get that behind us. It certainly doesn't look like Venezuela. But Venezuela has got some marks. We got hurt a little bit in Venezuela because you can't –- there's demand down there but you can't get your money back out. So Venezuela, I think is where we're -- as year wears along, it will look a little better.

Paul Knight

Thank you.

Operator

From Great Lakes Review we have David Stratton online. Please go ahead.

David Stratton

Thanks for taking the question. Can you talk a little bit about the timeline of the thyroid dog supplement as you say you're trying to get it registered or reregistered?

A – Jim Herbert

Yes, and anytime you deal with the FDA you can tell you what we're going to do, I can't tell you what they're going to do. They have to be concerned. It's a pretty good -- I think they do. They have to be concerned that it's a pretty good size -- a big market that was served by half-a-dozen customer or half-a-dozen suppliers at one time, and now down to one supplier in that marketplace. And from time to time that supplier, well it's kind of anybody, can hit an FDA problem in which they have to shut down manufacturing. If that's going to happen you've got millions of dogs in this country that are going to be needing a product on a daily basis. So I can't see FDA trying to keep that –- I'm sure they're not going to try to keep it as a monopoly. But I think they would be encouraged to have it certainly not a monopoly.

We are in dog studies now. It's kind of interesting. We've been selling this product of years. It's been used to treat millions of dogs. We know that it works. We know that it's safe. That's been proven over, and over, and over. But in order to get the registration we've got to go back and put more data down on paper to show that it's safe, and to show that it is efficacious. And it'll probably take us six months to get through that as it's now -- as what we're looking at now. So if it takes us six months, and we got the right number of dogs, and you've got to have some dogs that are on a control that you don't treat compared to those that you do treat. And that's almost inhumane in some places, but nevertheless we're working on that. I'm guessing six months before we get those trials that are complete and ready to submit.

Steve said we probably won't get it done in this fiscal year. So we've only got -- I guess we've got eight months left in this fiscal year so I think that's probably pretty safe to say we won't get it done in between now and May 31. But a good product, and a lot of veterinarians that are on, they've been using the product, strong distribution into the marketplace. All of this will come back as soon as we get our product. Fortunately it's not one that's growing. We had a growing interest in it because we took a big market share. We were the only supplier a year-and-a-half ago.

Everybody else was out of the market because of non-compliance or whatever. But we took a big market share. But there's probably no increase in thyroid deficient dogs, so the market is not really growing, but it's a nice little market. So we'll get our piece of it back. But fortunately it's not one of those core products. It's not core to our Food or Animal Safety business as such.

David Stratton

And then the third quarter you talked about the competition from a German competitor due to the currency at that time. I was wondering, is that still a headwind given the changes that have transpired since or if you could talk about that for a second, please.

A – Jim Herbert

You know, I've been ridiculed by our own staff so much, I hate you brought that up again. They said, Herbert, you really misled the market. You had the Germans whipping us out there. And the answer was, no. No, we had more competition from a German competitor than we'd been accustomed to. And I guess they probably come out one of those weeks in which we had to reduce prices in order to stay competitive somewhere out there. But we've got several good competitors scattered around the world. This happens to be one that's -- they've got some diagnostic tests that they're used to detect food allergens. You know we were first out there, and it's kind of nice to be first. So they compete with us. The market is better as a result of competition. But I still think that by and large we're taking market share.

I haven't seen anything this quarter that would indicate that we're losing market share. Our market share is either stable to gaining where we are today. And the break on the devaluation for the European Union really wasn't the Euro; it was the pound sterling was where the break was. So we're still -- we're in kind of the same monetary situation we were with the Euro even after the Brexit break.

David Stratton

All right. Well, sorry for opening it up.

A – Jim Herbert

Oh no, no. No, that was okay. I deserved it, yes.

David Stratton

All right, thank you.

A – Jim Herbert

Yes.

Operator

From Craig-Hallum we have Charles Haff online. Please go ahead.

Charles Haff

Hi, thanks for taking my questions. I appreciate all the detail on the call. Jim, you talked about acquisitions a little bit. You had a couple of targets in the U.K., anything else that you see in the pipeline over the next year or so that you can talk about how robust is your acquisition pipeline right now?

Jim Herbert

It's pretty robust. I mentioned that we missed a couple that went at pretty exorbitant numbers I thought. They were pieces, they were you know not -- you know, they were double-digit kind of revenues. I don't remember exactly where 16 million, 18 million, 20 million that would have been to pick them up, but we've done well in the past by sticking with what we think we know in acquisitions. Number one, we need to understand the technology. Number two, we need to have the ability to manufacture it. Number three, we have to have access to the marketplace. And they didn't quite, neither one of those quite fit there, though we were bidders. We just didn't -- we weren't successful bidders, neither one of those.

I mentioned that there's a lot to cash out there, and I'm sure all of you are seeing it not just in our little area, but in other places where you got equity capital as earnings; two-tenths of 1% if you leave it in a bank somewhere and the people are looking for better opportunities. So they're looking for those places, where we probably have I don't know whether it's a -- you call it a "Disadvantage," but we're playing on a different playing field because we go out and buy a company and we pay a real high premium for it. Then we've got to do something with that goodwill. If I'm an equity capital guy and I've only got to report to the use of my cash, it's not such an issue, but Steve reported this time about the amount of expenses we had that were actually non-cash expenses.

And part of that is amortization of what we used to call "Goodwill," and now we restate it and we call it "Customer-based intangibles," and so it's a non-cash expense, but nevertheless it affects our earnings per share. So we're pretty sensitive to not overpaying something though we got cash. It's going to affect our earnings per share and you're going to judge us based on that whether it's cash or non-cash.

So I think there'll be some more. There is some consolidation going on. I suspect as we look on the horizon, that's probably one or two competitors. They compare it to say one piece of the market that may decide to not stay in business, or may decide that they want to sell it especially when they see the high multiples of the business are being so forth. So I think we'll have some fun. And fortunately, we're in a position where we pretty much got things integrated. We got little work that we need to scurry around and get finished up, but we're pretty stable with our management force and we got cash in the bank, so…

Charles Haff

Okay, great. And then, Steve, you rattled off a couple of numbers there, I just want to make sure that I got them right. On the CapEx, did you say $3.4 million in the quarter?

Steve Quinlan

Yes, I did, Charles.

Charles Haff

Okay. And the stock comp was $3 million? Did I hear that right?

Steve Quinlan

Stock comp, wait a second here. It was $1.5 million. The $3 million number I gave you was the combination of stock comp and amortization.

Charles Haff

I see. Okay, thank you. And then operating cash flow in the quarter, what was that?

A – Steve Quinlan

$20.3 million.

Charles Haff

Great, thank you. And then on the genomics tests, Steve, on the DNA business, so moving or opening up the Scotland facility there and you obviously probably are -- you were serving some customers in Lincoln, European customers that is, and now I guess they're being served out of the Scotland facility. Roughly how much would you approximate kind of the delta is from customers that were previously served through the Lincoln facility, but now are serving -- being served through the Scotland facility on the DNA business?

A – Steve Quinlan

For the first quarter, Charles, that number was pretty close to $800,000.

Charles Haff

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

A – Steve Quinlan

You're welcome.

Q – Charles Haff

Thank you, Haff.

Operator

[Operator Instructions] In from Hilliard Lyons we have Kurt Kemper on line. Please go ahead.

Kurt Kemper

Thanks for taking my questions. Most of them have been answered, but I wanted to go back to vet instruments quickly. I know last year had some tough comps, but a couple of products were mentioned as being weak in the retail market, and then one of your retail partners recently issued weak guidance. So I was just curious for this quarter how much of that weakness was from retail versus, you know, if you're seeing any buying power increased in the vet clinics market?

A – Jim Herbert

Yes, that's a good question. He's referring to tractor supply, which -- gosh, we took a lick this morning based on our results, but boy, they really took a lick based on this. And I own a little bit of that stock, and it fell out of the map in one day. I was in tractor supplies though it interestingly this past week and you know, they're still solid, they're strong. I guessed it was a disappointment to some analysts that caused that one to drop. I think they're still a good strong company. I don't think their -- they didn't have any impact on movement of our vet instruments going through retail you know, realizing that our veterinary instrument business, some of it goes through retail like the tractor supply businesses. They are exclusive tractor supplies, exclusive, and without their instruments around the United States, but we've got similar situations in other places in the world.

I think our sales of detectable needles maybe down a little bit for the quarter. That's a product that's used particularly in the swine business to make sure -- it's a patented product to make sure that if a needle were to have to be broken in an animal while it was being vaccinated, it would be detected when it went through the metal detectors in the process implant, not end up in somebody's pork loin on Sunday morning, but those -- that has to do with probably the swine numbers being down a little bit that might have impacted that, or quarter door, quarter changes or where the inventories were. I think it's still strong. I don't -- I think going forward, I can get kind of excited about what I see is going to happen. It's spread out in the vet instrument area over the next 12 to 18 months, but I see as this kind of life is normal in the next couple of quarters as we'll go forward. Is that right, Steve?

Steve Quinlan

Yes. Kurt, this is Steve. Our tractor was actually up quite nicely in the first quarter for us.

Jim Herbert

Tractors were attractive…

A – Steve Quinlan

Yes.

Jim Herbert

Okay.

A – Steve Quinlan

Okay.

Kurt Kemper

Okay. Yes, that's helpful. That's all I had. Thanks.

Jim Herbert

And those are all at decent margins too.

Kurt Kemper

Okay.

Operator

No further questions at this time. We will now turn it back to Mr. Herbert for closing remarks.

Jim Herbert

Well, don't let me forget to remind you that we have our annual meeting coming up on October the 6th at 10 o'clock here at in Lansing, Michigan at the University Club of Michigan State. If anybody is in the vicinity, or could be, we'd love to have you. Probably every bit is important or more important. If you hadn't voted your proxies, please find them and vote them. We've got Steve, who shared me this morning we have enough proxies in to have a formal holder [ph] meeting, but we still like to get all those proxies. And if you got some proxies that you hadn't voted, well, please get those in for us, so we can get a full cap.

So, it's -- thank you for staying with us this first quarter. I'm excited, and I think we're going to have an interesting year to report. So, once again as Rick said, we will look forward to seeing you in a couple of weeks if you can be here. Have a good autumn. Bye now.

Operator

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

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