Neogen F2Q08 (Qtr End 11/30/07) Earnings Call Transcript

Neogen Corporation (NEOG)

F2Q08 Earnings Call

January 3, 2008 11:00 am ET

Executives

James L. Herbert - Chairman of the Board, Chief Executive Officer

Richard R. Current - Chief Financial Officer, Vice President, Secretary

Lon M. Bohannon - President, Chief Operating Officer, Director

Analysts

Tony Brenner - Roth Capital Partners

Steven O’Neil - Hilliard Lyons

Stanford Rothchild - Rothchild Capital Management

Vito Menza - Sandler Capital

Joseph Potvin - Wachovia Securities

Presentation

Operator

Good day, everyone, and welcome to the Neogen Corporation third quarter earnings results conference call. Today’s call is being recorded. For opening remarks and introductions, I would like to turn the call over to Mr. James L. Herbert, Neogen's Chairman and CEO. Please go ahead, sir.

James L. Herbert

Good morning and welcome to our regular quarterly conference call for investors and analysts. Today we’ll be reporting on Neogen's second quarter that ended on November 30th of 2007.

I’ll remind you that some of the statements that we make 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. These risks that are associated with our business are covered in part in the company’s Form 10-K as filed with the Securities and Exchange Commission.

In addition, to those of you who are joining us today by live telephone conference, I’d also welcome those who may be joined by way of simulcast on the world wide web. That number seems to grow more and more each quarter.

These comments, along with some exhibits, will be available on the web for approximately 90 days. Following our comments this morning, we’ll entertain questions from participants who are joined by this live conference and I’m joined today by Lon Bohannon, Neogen's President; and Rick Current, our CFO.

Earlier today, Neogen issued a press release that detailed the results of the second quarter of the company’s 2008 fiscal year which ended on November 30th. I believe that it is reasonable to characterize this as another great quarter for the company in terms of both revenues and income. Neogen's net income for the quarter, for the second quarter increased 34% from the previous year’s second quarter to over $3.2 million. Adjusted for that three-for-two stock split that was effective earlier in the year, net income for the quarter rose to $0.22 per share compared to last year’s $0.17.

Neogen's second quarter revenues increased 23% from the prior year to $27.2 million. This was also a record quarter.

On a year-to-date basis for the first six months, Neogen's net income increased 30% to over $6.2 million compared to $4.8 million in fiscal ’07. This brings our earnings per share for the first half of the year to $0.42 and that compares with $0.34 for the same period last year.

Revenues for the first two quarters were up 18% compared to last year’s first half and now total approximately $50.1 million. Though we don’t normally give guidance to the marketplace, we did say at the beginning of this year that we thought 2008 would be the year that the company would move over the $100 million mark in total revenues and as you can see, we’re on track to get that done because of what we’ve gotten done here in this first six months.

All of us at Neogen continue to take pride in the company’s consistent revenue and profit growth. This quarter marks the 59th consecutive profitable quarter for the company and the 63rd quarter in the last 68 in which we showed revenue increases compared to the previous year. This record now spans 17 years.

For some time, it’s been the company’s goal to grow revenues at the rate of 20% annually and Rick Current’s update shows that we’re almost achieving that goal with a compound annual growth of 19% for the past 15 years.

Our achievements in both the food safety and the animal safety areas in the past quarter were gratifying. Lon Bohannon will report more on those specifics in a few moments. However, I’d like to cover a few of the highlights of the second quarter.

Gross margins for the quarter continue to be solid at over 52% and on a year-to-date basis for the first six months, these margins have increased to 52.8% as compared to 51.9% a year ago. Of course, we’ve always told investors that our company is best judged by its operating profits, since gross margins are only a portion of that story. Those operating margins were up solidly for the quarter and for the first six months, they now stand at 18.6% as compared to 17.2% for the first six months last year.

Sales and marketing expense as a percent of revenue decreased in both the quarter and on a year-to-date basis and for the first half of the year are almost a full percent below where they were in the prior year at approximately 20.2%. That’s of total revenues.

Now, having said that, I should also point out that we’ve invested approximately $1.2 million more in sales and marketing this six months than a year earlier and we’ll continue to make sound investments in this area. We believe that our strong sales and marketing program has given us a competitive edge in a number of our activities.

G&A expenses were still a bit higher than I like to see them, totaling about 10.4% of revenues for the first half of the year. That compares with 9.8% last year. Part of this increase is due to staffing, some higher costs attributable to stock options, and legal expenses. We should begin to see some significant decreases in legal expenses as we move through the last half of the year, since we settled some legal challenges recently.

Sales in our international area continue their steady growth. For the first half of the year, revenues from international sources were up 22%, compared to the prior year. This past quarter, they accounted for 38% of the company’s total revenue.

This international growth continues to be led by our Neogen Europe Limited operations in Scotland that serves as our strategic doorway to the European Union. Their sales for the six months are up about 38% compared to last year and I think it’s even more important to note that their net income for the first half of the year has already exceeded last year’s full year.

I can also give you a quick update on acquisitions that have occurred during this first six months. You’ll remember that at the very tail end of the first quarter, we acquired the assets of Kane Enterprises, a South Dakota based manufacturer and marketer of animal safety products. During the four months since that acquisition, we’ve relocated those assets to our already existing facilities in Kentucky and I believe have the business pretty well integrated.

At the beginning of December, we announced that we had acquired the assets of Rivard Instruments, a Canadian company that was involved in the manufacturing and marketing of detectable hypodermic needles. This acquisition brought to an end a long and hard fought and expensive series of litigation in both Canada and the U.S. regarding conflicting patents. Those legal expenses should now be essentially behind us.

Furthermore, this collection of patents that are held by the two companies put us in a very strong position not only in the U.S. and Canada but in several other important international markets, such as France and Denmark.

I spent a week in Europe in mid-December to get our arms around those European opportunities and I can tell you that I came away very encouraged. This acquisition won’t give us any substantial revenue increases in the next couple of quarters but it will help us solidify our position as I believe the dominant manufacturer of detectable hypodermic needles.

Just as other portions of food safety has grown, there’s been more and more concern about the possibilities of broken hypodermic needles remaining in an animal and finding its way to a consumer’s table in a cut of meat.

Our progress has not gone unnoticed in the financial markets during this six months. During this past quarter, Forbes magazine named Neogen for the third year in a row to its annual list of the 200 best small public companies in America. And this, by the way, is the sixth time that we’ve received that recognition in the past eight years.

Our progress has been at least partially reflected in the company’s stock price. Taking into account the stock dividend, the December 31 2007 stock price was 79% ahead of the prior December.

Since our last conference call, we held an annual meeting of shareholders in early October and I can report to you that all of the proposals from the Board of Directors were adopted by shareholders, including the reelection of Jack Parnell and Bob Book as directors for another three years and officially bringing on board Dr. Clayton [Yider] as a new director. I think our shareholders should certainly take confidence in directors such as these who have tremendous experience in food and agriculture and also understand Neogen's business.

In concluding my comments, I’ll have to admit that we are fortunate I believe in operating in a business climate such as the food and animal safety area. A recent independent study indicates that markets for our products are increasing about 6% annually and are expected to do so over the next few years.

You know, obviously we’re proud that we’re in a growing market but we’re also proud that we can grow revenues at over 20% when the overall market is growing at 6%. It’s nice to be producing products that have a good demand.

Our growth and our strength also bode well for our opportunities on the acquisition front. Though we don’t currently have any letters of intent in place, there are several interesting possibilities that could be synergistic to our business, and it’s also helpful to be sitting on over $10 million in cash, be generating cash on a monthly basis, and have very significant unused lines of credit.

I need to quit basking in all of these accomplishments and let Lon Bohannon, Neogen's President and Chief Operating Officer, tell you more of the details about how he and his team succeeded in these accomplishments and more importantly, how he’s looking at the last half of the year. Lon.

Lon M. Bohannon

Thank you, Jim and let me take a moment to wish all of our listeners a very happy and prosperous new year. As Jim commented earlier, for those of you who bought Neogen stock at any time during the past 12 months or were fortunate enough to own Neogen stock for all of the last 12 months, 2007 was indeed a very prosperous year. You can be assured that management will certainly endeavor to do everything in our power to continue our consistent and strong growth record as we finish out our 2008 fiscal year.

Let me take a few moments to expand somewhat on our second quarter performance for each of the two operating divisions before turning my attention to ongoing cost control initiatives and future opportunities.

Looking first at our animal safety division, the second quarter was filled with a lot of success as we expanded sales to many of the largest animal health distributors and as we continued to work on implementing programs to improve overall gross margins on key product lines.

As Jim said, overall the animal safety group had a terrific quarter as sales surged 21% over the same quarter last year. This strong second quarter performance brought our sales on a year-to-date basis and the increase for this division to a very respectable 13%.

The Kane Enterprises acquisition did contribute significantly to the outstanding second quarter sales growth and sales for this new group of products actually exceeded our second quarter pro forma budget.

In addition, our Lexington division, which is the largest of our animal safety profit centers, achieved 10% organic growth in the second quarter, led by strong sales of veterinary instruments, including the launch of new hard pack syringes and needles and strong growth in specialty products sold to large animal health firms.

I think it was also very satisfying to see a 23% increase in sales of what we call ethical products, including particularly strong sales growth of products servicing the companion animal market. I think as we look ahead, we plan to develop more products for this important and growing segment of the animal safety industry.

Looking at Hacco for a moment, sales of rodenticides and disinfectants were sluggish for the second consecutive quarter, with sales falling approximately 4% below the prior year. Now, as I commented in the first quarter, I do not believe we’ve lost any significant market share to competition. I continue to believe that this year’s mild fall weather throughout much of the country resulted in far fewer rodent infestation problems that have negatively affected our rodenticide sales for the first six months.

I think the fact that our international business for rodenticide increased significantly in the quarter and is now ahead of last year for our first six months does give some comfort that our overall sales activity in this area are still effective.

But we are keeping a close eye on this area. We will be introducing new bait stations and we have entered into a new distribution agreement aimed at the large western agronomics market. We recently introduced a new packaging design. We have added two dedicated sales managers and we continue to expand our portfolio of international rodenticide registrations to support and expand future sales of this important rodenticide and disinfectant product line.

Switching to the food safety, the performance of our food safety division in the second quarter was nothing short of outstanding. This division completed the quarter with growth of 24%, which becomes even more impressive considering that all of this increase is same-store sales growth. Those of you who have followed Neogen for some years know that we have set a goal for ourselves of trying to achieve somewhere around 10% organic sales growth and the food safety division has been far exceeding that objective for our last four quarters.

On a year-to-date basis now, organic sales growth for this division stands at 22%. Once again, this growth was very broad-based in the second quarter with sales increases coming from many segments and many product lines. We had increases in 12 of 15 market segments ranging from 4% to 44%. In two of those segments where we experienced shortfalls compared to the prior year, we really don’t have any dedicated sales personnel, which is something we may need to look at in the quarters ahead.

Likewise, increase in food safety product sales for the quarter were very encouraging, with sales more than doubling for a specific product like our Reveal DON test due to particularly strong demand in Europe.

Our broad product lines, including tests for micro-organisms, general sanitation, dairy antibiotic residues, food allergens, natural toxins, and dehydrated culture media all achieved increases compared to last year’s second quarter ranging from 5% to over 40%.

So with all this good news, what’s keeping me awake at night? Well, we do have some challenges to keep life interesting, and I guess in some cases, provide job security for some of us here at Neogen. First and foremost is what is happening to petroleum and commodity grain prices that skyrocketed in 2007. Of course, increases in petroleum ultimately results in increases in plastics, packaging, film, and other components for many of our products and a significant increase in grain prices has been largely the result of so much corn being diverted to ethanol production.

These increases in petroleum-based products and commodity grain prices definitely have an impact on our costs but they do sometimes represent somewhat of a double-edged sword, as I will elaborate on a little bit later.

The higher grain prices definitely increase the cost of our rodenticides, since grains represent the single largest ingredient cost in those products. Higher grain prices also put a lot of pressure on many important customers in the food animal production markets that purchase a great many veterinary instruments from Neogen. Of course, price increases in petroleum-based components impact many of our products and occasionally place us in the unenviable position of having to raise prices to maintain satisfactory operating margins.

Now obviously as more suppliers attempt to pass along cost increases, greater pressure is placed on our buyers to find alternative sources and better prices without sacrificing quality. More recently, we are experiencing a worldwide shortage in casing and several other [peptones] that are important in the manufacturing of dehydrated culture media. In some cases, prices have risen as much as 25% to 50% and some of these ingredients are just difficult to obtain at any cost.

Now, the danger of pointing out challenges like these in a conference call with investors and analysts is that in doing so, I raise undue concerns among our best and most important supporters. Let me assure you that that is the last thing I want to do and I certainly don’t want to appear pessimistic at all. In fact, exactly the opposite is true and I am very encouraged about the remainder of our 2008 fiscal year and in general, Neogen's future.

For example, I mentioned earlier that the ethanol issue was a double-edge sword. On the positive side, we have now sold more microtoxin diagnostic test kits to the ethanol producers in our first six months this year than we did in all of fiscal year 2007. I believe we have also identified additional new prospects as more of these ethanol plants come online and we can further expand our sales to this industry in the quarters and the years ahead with some new products and some new formats of existing products.

And although prices have increased in several areas affecting our cost of goods sold, we believe we will be able to selectively pass along price increases to our customers to help maintain the strong operating margins we currently enjoy. We also believe the risk of losing business is minimized in many cases because of our quality products and the superior customer service we provide our customers compared to our competition.

And we continue to move full speed ahead with new cost control initiatives to help offset higher costs and expand operating margins faster than we grow sales. During the second quarter, we made our first ocean container shipments of inventory to our Neogen Europe operations. This change in logistics could result in annual savings of as much as $200,000 when compared to our shipping costs prior to this change.

The second quarter also saw success in getting our new biologics production facility in Lansing, Michigan added to our U.S.D.A. license. Now, we still plan to run the new facility in parallel with our Tampa operations for the rest of fiscal year 2008 but that means that full consolidation cost savings are expected to take place beginning in our 2009 fiscal year that will start on June 1st.

Another cost-saving project that made significant progress last quarter involved the installation of automated equipment to one of our many disposable diagnostic products. This change should save us somewhere in the neighborhood of $150,000 on an annual basis when it’s fully validated and operational. We expect this project to be completed late in the third or early in the fourth quarter of this fiscal year.

We also installed a new custom piece of machinery in late December that will provide Neogen a completely new product to be initially marketed to the beverage industry beginning as early as next quarter.

So obviously I am very encouraged about the rest of fiscal year 2008 and overall about the future of Neogen. I am encouraged about the significant sales opportunities that exist in many of our markets and that’s both domestically and internationally. In fact, some of our markets appear to be growing faster than originally thought, as evidenced by an almost unprecedented number of recent food recalls. In the last six months, there have been 10 highly publicized recalls involving harmful pathogens like Ecoli-0157:H7, Listeria and Salmonella. In addition, there have been 104 recalls in the last year involving food allergens with inadvertent contamination of milk and egg being the leading culprits.

I am also encouraged with the cost-saving initiatives that I talked about that we continued to -- and others that we continued to identify and the commitment of our operations personnel to make those cost-saving opportunities reality as we strive to improve operating margins.

I guess I’m going to close my remarks with something that -- some people make light of some of the comments that I make and motivational sayings, but I want to say just as it pertains to personnel, I continue to be amazed at both the intelligence and the extremely positive attitude of Neogen's employees. If one believes in the saying it’s your attitude and not your aptitude that determines your altitude, then Neogen's future is very bright indeed because I believe we are blessed with many employees who possess both a positive attitude and also have an outstanding aptitude.

That concludes our prepared comments for today and we’ll now entertain questions from our listeners.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll take our first question from Tony Brenner with Roth Capital Partners. Please go ahead.

Tony Brenner - Roth Capital Partners

Thank you. A couple of questions; first of all, can you bring us up to date on the approval of the Beta Star dairy test kit?

James L. Herbert

I don’t know why I’m not surprised that that wasn’t the first question. I guess we’ve been guilty of underestimating how long it takes to get through government bureaucracy sometimes. That project continues to I think move along well. We’ve as far as I know have completed all of the test work that the FDA required. It’s a matter of getting some paperwork finished up now. I believe that we should have the FDA paperwork out of the way and approval done sometime -- I’m going to venture a guess and say the next month and then we’ll need to get some approvals through the interstate milk shippers, which will take, depending upon how fast they move, it could take I guess, Tony, it could take another month on top of that. Something it looks like to me we ought to be able to do in a couple of weeks but nothing ever moves at the speed that I think it should.

In the meantime, the product continues to do very well and outside of the U.S. and international markets, as I think Lon reported in his comments, sales of our dairy antibiotic business along with several of our drug detection products continue to progress very well.

Lon M. Bohannon

The dairy antibiotics have had two outstanding quarters and I am just amazed at how long it takes to get through this process. I heard a comment that we were talking to one of our competitors who was talking about what we were doing here and asked us how long we thought it would take to get this done. And of course, we were saying like we thought we’d get this done in six to nine months and they just started laughing.

We continue to have conference calls. We provide them the information. They look at the information and then there is some statistician or somebody else who wants to see one more thing. And so that’s kind of in the mode we’re in right now but we’re -- I think we are getting close and we think we’ve got a very good test there and we are looking forward to having that available for the U.S. market.

James L. Herbert

It shouldn’t be any indication that there is something wrong with the product. It’s a very good product, we think very competitive and I think that’s borne out, as I said earlier, by the fact that we’re able to continue to get increases in our international sales.

Tony Brenner - Roth Capital Partners

Second question was regarding the Rivard acquisition. Could you indicate what the cost of that was and what the potential corporate savings might be, if any, from that acquisition?

James L. Herbert

Well, it was a settlement of a lawsuit, Tony, so there’s certain -- and it was -- the settlement was done with a confidentiality agreement, so there’s a lot of things I can’t talk about. I can say that I thought we came out of it very, very well. We had strong patent positions and particularly in the U.S. Rivard had some good patent positions outside of the U.S. and we think combining those two put us, I think as I said in my opening comments, in a position of being dominant as a producer of detectable hypodermic needles. I think we are going to continue to see that market for detectable needles grow and as it grows, we should be, given our patent position and our marketing structure and our cost structure there, I think we should be really kind of in the catch [inaudible] seat as what we’re doing.

I was in Denmark and in France a couple of weeks ago and I was I think I said came away very encouraged as I see the Danish market perhaps moving 100% it looks like to detectable needles, so they are a major producer of hogs, a major exporter of -- we’ve all seen the Danish canned hams. As they move towards 100% detectable needles, that gives us a huge opportunity there.

A similar situation is occurring in France. It’s not moving quite as fast but it looks like there may be a mandate there that would require that approximately 80% of the hogs produced annually in France would need to be injected with a detectable needle.

Those are just two of the countries in the EU. Those people all tend to fall together or follow together and having seen that in two of the major pork producing countries, one then has to look at what’s going to happen particularly in countries like Germany, which is the largest of those.

So I think it looks good. I’m sorry I can’t tell you how we ended up as far as the final cost but I guess I could say if I could tell you, you’d be proud of me.

Tony Brenner - Roth Capital Partners

Our last question, Jim, you and Lon outlined a whole bunch of opportunities for growth in the food safety area. You mentioned that the organic revenue growth for the first six months was 22% and you’ve got, you claim, an objective of 10% organic growth. That sounds like an awfully low bar and if you actually came in at 10%, I can’t believe you’d be very happy about it. What’s a more reasonable objective?

James L. Herbert

Well, we’ve looked at -- saying we want to run at 20% total and I think I reported our compound growth over the last 15 years has been about 19%, so we are near that mark. We’ve said that as we look at how we grow revenues, we think we can grow at a 9% to 11% rate on the pure organic growth and the reciprocal of that in new products that we -- new revenues that we bring on through acquisition.

Now, obviously when we bring in a new company, after the first year its revenues become organic, so when Lon’s talking about a 10% growth looking at some of our older businesses, those businesses have to continue to grow at that same kind of rate. I think we still stick with the 20% and we’ll get some of that organically and we’ll get some of that when we’ve got new products and we can grow those pretty fast. You know, when you start off with a pretty low base, it’s not hard to get to 20% or 30%.

So it depends on how you define what is organic growth and how you define what growth came from acquisitions.

Lon M. Bohannon

I can tell you when we’re doing our budgeting and when we establish our goals and objectives for our sales and marketing staff, we are certainly looking at higher numbers that are in the 13% to 15% range in terms of growth opportunities. We just don’t ever want to get caught in the position of over-promising and under-delivering and -- but overall, we’ve -- to grow at 20% a year and that’s our challenge and in some quarters, we’re fortunate enough we can do all of that organically and in other quarters, we’re going to need an acquisition here or there to help us get there.

Tony Brenner - Roth Capital Partners

Thank you very much.

Operator

We’ll take our next question from Steve O’Neil with Hilliard Lyons. Please go ahead.

Steven O’Neil - Hilliard Lyons

Good morning, gentlemen. Very good quarter. Just a few questions and I know as you get, your company gets bigger and more complex, you can’t give quite as much details on the individual product lines, so I always wind up asking you some of these things, but let me just run down a few. It sounds like micro-toxins did well, or at least they did in sales to the ethanol industry. Can I infer from that that overall, micro-toxin is doing well this year?

Lon M. Bohannon

Overall, micro-toxins are doing very well. They are up 18%. I actually have been a little bit surprised at how well they did in the quarter because in the U.S., I would say that overall in general, our crop was a little cleaner this year than it was last year. I think that’s certainly true in the upper Midwest and in some cases, the Red River Valley. We still have pockets where there’s been outbreaks and of course, our addition of new formats like the lateral flow format have helped.

We have seen a significant increase in sales of micro-toxins in our Neogen Europe operations and they have certainly helped drive those sales this year and in conjunction with that, it’s not -- I don’t think it’s included in the natural toxins, although it could be, is also a new instrument that we use to measure those lateral flow devices where they absolutely have to have an objective kind of answer.

So it has been a very solid year and I think with a few more format changes, I think we can see it grow even further.

Steven O’Neil - Hilliard Lyons

Is the 18% a year-to-date or a quarter figure, Lon?

Lon M. Bohannon

The 18% is the quarter. Rick might have the year-to-date number, I don’t know.

Steven O’Neil - Hilliard Lyons

If you don’t have it handy, that’s fine. I can move on.

Richard R. Current

No, year-to-date was 13%.

Steven O’Neil - Hilliard Lyons

Okay, and of course you mentioned the number of allergen related recalls and I’m just wondering, I guess that would mean the allergen business also performed very well, although that business has gotten a lot bigger.

Lon M. Bohannon

That business has gotten a lot bigger. It continues to grow. This year year-to-date, it has dropped down into the single digit area. It is one of the focus areas that we want to take a look at and see whether we ought to do some more seminars. I think it also is one of those where competition has started to nibble at some of our areas, some of our customers, particularly with pricing and in some cases with some lateral flow formats, so it is one of the areas of focus where I think we’ve got to take a look now at where we go. We’ve got quite a few allergens that are out there but we’ve got to look and see what else we can add to the mix now to get a little revitalization in that particular product line.

James L. Herbert

We’ll begin to see a little bit of that too, Steve, in what’s coming out of Europe. The EU made an announcement I believe it was last week that they’ve added three more products to their allergen list. I think they added mustard seed and sesame seed and there was still a third one that was in there. We don’t have tests for those. The market is probably not very big for them now but it’s an indication that there may be a market developing, particularly in Europe as they begin to look at more of those.

Lon M. Bohannon

Just to give you an idea, Ed Bradley made this presentation at the board meeting so I’ve plagiarized some of the information in my report from the thing that he did, of those 104 recalls, 38 were milk, 24 were eggs, and then it drops down to peanut, which was 7, which was the very first one that we came out with. And then you have soy, walnuts, almonds, and of course we have tests in all of those areas.

Steven O’Neil - Hilliard Lyons

Okay. You didn’t mention AccuPoint, which I think was up 40% or 50% last year and once again, this may be just that the product grew so much the previous year, it slowed but I thought I would ask you about that as well.

James L. Herbert

Well, it is continuing to grow. Do you remember what the numbers were up in the first --

Lon M. Bohannon

Yeah, it’s doing terrific. It’s almost at 20% again this year through the first six months and frankly, we had anticipated some additional sales of instruments internationally that are still out there on the table that haven’t come to fruition that would have driven that even higher. It’s clearly one of the top performing product lines. It’s very large in terms of its sales and it continues to do very well.

We just signed on a major new account and I know we don’t -- we typically don’t like to use the names of those companies in these conference calls. We have trained those, a lot of those plants but the single largest portion of those plants do a particular type of product that have yet to be brought on board that we expect to get done sometime during the remainder of this fiscal year.

So there remain a lot of good opportunities out there for ACP, both domestically and internationally and we expect it to be one of those products that will continue to drive sales as we move through 2008 and into 2009.

Steven O’Neil - Hilliard Lyons

And with AccuPoint and with the Soleris systems and all that, all of the micro-organism and bacterial testing is kind of getting buried in there, so I don’t know if I can even ask you about micro-organism testing for things like Listeria and E-coli and Salmonella. Does that even -- is that something that can be mentioned here or is it just blended in so much with the others?

James L. Herbert

It tends to get blended in. We’re doing okay. We have an opportunity to do better in all those principal pathogens are ones that we continue to focus on, Steve, as to producing better products at less expensive costs and that’s a competitive area that several of our competitors have attached to and are offering some pretty cheap prices in the marketplace out there.

But we’ve still got some work to do there. We’ve still got some opportunities there.

Steven O’Neil - Hilliard Lyons

Switching real quickly to animal safety, you mentioned in the press release I guess the diagnostic products are up 11% year-to-date, didn’t talk about the second quarter. I didn’t know if that was a signal maybe the second quarter wasn’t quite as good or how I should read that.

Lon M. Bohannon

The sales there slowed in the second quarter. Some of that is, I mean, we’ve got products there that go both internationally through distributors and also into the forensic market and some of those are based on tenders and bids and stuff, so that’s a particular area that you cannot look at on a quarter to quarter basis. You need to look at that on a year-to-date basis to see how they are doing and so far, it’s been a very solid year.

The nice thing about that is the growth this year so far has been led by sales of what we call our racing diagnostic test kits, particularly to a large international customer where in the past several years, most of that growth has come out of the substrates and in the forensic market. So it’s nice to see those racing kits gain some momentum and start to get some sales this year.

James L. Herbert

And I think most all of that is probably competitive gains, because those markets are not growing that much.

Steven O’Neil - Hilliard Lyons

Yeah, we know about those in Kentucky, so that is something that we’re aware of. One thing, you didn’t -- I don’t know if I’m reading this right -- you didn’t mention the veterinary instruments sold at retail that you had been making, although you did talk about OTC veterinarian products. I don’t know if that’s all together or if you are talking about two different things.

Lon M. Bohannon

It is all together. The OTC includes what we sell through those retail farm store markets, like Tractor Supply and [Orchelin’s]. We did gain some business in Tractor Supply’s. I forget what they call the name of it. They bought a number of stores out on the West Coast that they are continuing -- Dell’s is the name of the store line that’s out there. They are going to continue to maintain that and I don’t want to call it a boutique. These guys in Tractor Supply know what they are doing from a retail.

And we have made some inroads in getting in some products there. I also happen to know, in fact, I’ve got in front of me something to talk about with Jim and Rick after this meeting is over, a product line review for some liquid products to go into Tractor Supply. So we do continue to build on that presence there. They continue to open stores and it has been contributing to that overall growth in the OTC area.

Steven O’Neil - Hilliard Lyons

The last thing I’ll ask you and I’ll let somebody else ask some questions, the gross margin was good, down slightly from last year and I wonder if that was just mix or if there is anything else worth mentioning.

Lon M. Bohannon

It is mix and in fact, Rick and I had spent a little time analyzing that and I can tell you that what you don’t -- you don’t see this in the press release. I mean, all you see is the gross percentage -- all of that decline in percentage is in the raw material area. Our cost for both labor and overhead as a percent of sales declined compared to last year and in absolute dollars, they’re not up very much at all.

So we’re making some good progress there. That gets at some of those things that I talked about that we’re seeing where we’ve had some significant increases in grains and petroleum based products and we are in the process of instituting some price increases that will help offset those.

Now, the other thing in terms of the gross margin line that would have affected particularly the second quarter is the acquisition of the Kane products are mostly buy-and-sell products, so they carry proportionately a little bit higher cost of sales and lower gross margins but we didn’t have to add sales personnel and so you did notice that the operating profit continues to go up.

So that’s the two primary areas, the increased raw material costs and the Kane things are the two things, the Kane being the mix. And then the other thing that I am aware of in the second quarter, now that I think about it, is last year we opened up our biologics product through another distributor but they took a large stocking order and we also had a large shipment to our largest customer, which is an international customer based in Sweden, and that would have affected the mix in this quarter this year compared to last year.

Steven O’Neil - Hilliard Lyons

Great. And I’ll --

Lon M. Bohannon

Those kinds of things are just timing.

Steven O’Neil - Hilliard Lyons

I’ll let someone else ask some questions. Thank you very much.

Operator

We’ll take our next question from Stanford Rothchild with Rothchild Capital Management. Please go ahead.

Stanford Rothchild - Rothchild Capital Management

One question; I’ve noticed some publicity about these small, possibly portable ozone generators as a means of avoiding contamination of fruit and other food products and I wondered whether that indirectly might have any impact on the market for the food safety market.

James L. Herbert

I think it does. I don’t know how much impact they are going to have. If successful, I think it certainly does. But I believe it’s a positive impact. We spent some time I guess at the very beginning of the month with the fruit and vegetable people. I spent some time in Washington with the regulators as well as some of the trade people and they are really up against a tough deal in trying to make sure that they are controlling pathogens in their fresh cut, particularly the vegetable side. So they are looking for whatever they can to reduce that.

We’re doing pretty well there, as they try to find a magic formula to reduce the amount of contamination. They are doing a lot of cleaning of field harvesting equipment and checking the field harvesting equipment and they are concerned as they should be about the irrigation water that’s coming into those fields and how that irrigation water might be carrying pathogens, it gets uptake into the plants and the cleaning water, how often do they need to clean it and do certain things like that, which is where probably the ozone best fits, Stan, is if you could -- that’s probably the easy way to disinfect cleaning water as they go through the rinse cycles, et cetera, either on board those field harvesters or in the produce sheds, to be able to continue to make certain that the water that comes in contact is not carrying any pathogens with it.

Ozone is -- you know, it’s been around for a while. There’s been some large units that have been tried. I guess a few of them are still operating in the poultry processing plants where they can pump ozone into the chill tanks when they are cooling carcasses down and it helps control -- it does something similar to what chlorine would do but without leaving behind the concerns of chlorine residue.

But the whole fruit and vegetable area is a big opportunity and that industry still has some substantial problems as they try to figure out what to do. They are scurrying to try to do that. Regulatory is trying to do it in Washington. They are trying to decide now should the U.S.D.A. have authority or should it be FDA. So I think we’ll continue to see more activity there and the more activity we see, I think it in fact increases our opportunity in testing because one of the things that you hear people say is why test if I can’t do anything about it? So I think it could be helpful to us.

Stanford Rothchild - Rothchild Capital Management

Is there any opportunity for you to be a link between the people who are making these small ozone generators that probably don’t reach out into the producing farm area and the fact that you’ve got some distribution out there, might that be an add-on product line from a marketing standpoint?

James L. Herbert

It could be. We’ve always shied away from businesses where you had to own pick-up trucks with toolboxes hung on the side of them. They are just kind of difficult when a guy’s got an operation running and his machine is down. You know, it’s -- if it’s here in Michigan, it’s 12 degrees outside right now and the trucks don’t run very well.

We like being in the disposable business. I don’t rule out that, Stan, at all but it’s not been one of the -- the large capital equipment areas has not been one of the areas that’s been, that’s attracted us. We like those businesses in which you can build a relationship with the customer and sell them something every day or every week, rather than once every year or two.

Stanford Rothchild - Rothchild Capital Management

We agree with that. I just noticed that they were modifying the size of these to be small and portable instead of big generators.

James L. Herbert

Well, and that’s something that we certainly need to be keeping track of and I appreciate your calling it out.

Stanford Rothchild - Rothchild Capital Management

Okay, thanks.

Operator

(Operator Instructions) We’ll take our next question from Vito Menza with Sandler Capital. Please go ahead.

Vito Menza - Sandler Capital

Nice quarter. A couple of these are answered, I just have one or two more; could you disclose the amount of actual legal costs in the quarter?

Richard R. Current

Legal costs were $390,000 for the six months and $183,000 for the quarter.

Vito Menza - Sandler Capital

Got it. And on the -- I guess a little more just on the gross margin. How much of these price increases have you already started to implement and how many are future price increases? Is there any way to break that out?

Lon M. Bohannon

Have you been talking to any of our board members? This question came up at the board and when they saw the percentage growth that we had in sales, how much of this was price increases. And we really -- I’d say less than 1% of that overall growth in the quarter is a result of any price increases. We are just now -- I mentioned Ed Bradley before and I know that he’s just had meetings this week on price increases in that dehydrated culture media area, where we need to get these things into effect. I know that we just recently have looked at putting price increases in a couple of different areas on the animal safety side with a number of the product lines there.

So we’ve had up to this point, very little impact of price increases in any of the statements and certainly on the statements through the first six months. So it will be between now and as we go through this third quarter that we’ll start to do that and start to get back some of those margins.

Vito Menza - Sandler Capital

Great, great. Next question would be how much of the sales by each division was currency related?

James L. Herbert

There would have been about just over $100,000 in the quarter that’s related to currency.

Vito Menza - Sandler Capital

Okay, so small. Great. And diluted share count, it looks like it creeped up on us a little bit this quarter. Any plans -- I guess firstly, Rick, what are you -- is there a target number that you are looking at for year-end? And then secondly, any plans to institute maybe a stock buy-back just to offset some of that share creep?

Richard R. Current

Well, I’ll let Jim answer the question on the stock buy-back. As far as the stock’s concerned, the biggest effect that we have is the price of the share that will cause that dilution number to go up. That’s I guess -- I’d just as soon have the price go up and have a little more dilution.

Vito Menza - Sandler Capital

I understand. It’s not a bad problem. And just I guess on the share buy-back, any plans there at all?

Richard R. Current

Not at this point. We think the market is getting close to fairly valuing the stock and we like to look at those times in which we think the market is not giving us fair value as an opportunity to buy back, so at this rate, we think that we’re not that far apart on what we believe the value is and where the market is, particularly on what we’ve reported to this point.

Vito Menza - Sandler Capital

Okay, great, guys. Thank you very much.

Operator

(Operator Instructions) We’ll take our next question from Joseph Potvin with Wachovia Securities. Please go ahead.

Joseph Potvin - Wachovia Securities

Great quarter, guys. The only question I have is related to Asia. What’s happening over there and with their presence in the news, they must be willing to do something.

James L. Herbert

Well, are you talking about China or the rest of Asia?

Joseph Potvin - Wachovia Securities

Well, let’s start with China. I mean, god knows they get a lot of bad publicity.

Lon M. Bohannon

I made a trip to China in September, another trip in December, and I will be making one in January. Obviously part of the reason that we are going over there and doing that -- we have more than one reason to go over there because we do source some product over there, but in addition to that, we do think we’re getting close on some sales, I think particularly it would be in that general sanitation area and the ACP area where we can sell them both some disposable samplers to go along with the instruments.

I will tell you as it relates to the rest of Asia, we had a good start to this year and we’ve got some opportunities that we are seeing in Japan and the Philippines on several products that could add some significant sales as we move through the rest of the year.

The Soleris technology, when we started out, we took that over and selectively have introduced that and that’s another product line that’s got some opportunities in the Asia-Pacific rim.

So we’ve always approached, and particularly getting back to China, and we’ve been very careful about protecting our intellectual property when it comes to that country and we’ve also been very careful about trying to get too far ahead of leading sales over there because of the way they do things and the way that infrastructure works.

So it does look like there’s some opportunities there. So far, they are on budget, even though they did not take in the first two quarters a large number of units, we actually did have some in the first quarter. They missed their order in the second quarter. I have been assured that they are going to catch up on that before we get through -- I think in their case, they look at calendar years -- before we get through calendar year 2008, so we continue to believe there’s some good opportunities on the general sanitation side in China.

Joseph Potvin - Wachovia Securities

What do you think is the most significant problem they have over there?

James L. Herbert

I think that they want to produce good product. It’s not -- by and large. I mean, I think it’s a responsible area. They are just not accustomed to the kind of scale-up that you are seeing. As an example, 70% of the seafood that is produced in aquaculture is produced in China today. And that’s -- I don’t remember what the exact total is but it’s billions of pounds and that is probably going to grow. The problems they are having over there is they got pollution in the waters in which they are growing that and they are trying to offset the pollution in the water by adding more drugs and other things to the water to keep the creatures healthy, be they shrimp or [tilopi] or whatever. And then they get into a drug residue problem.

We spent some time in Washington with the National Fisheries Institute and the guys on that side earlier in the month and we said what do you need? And they said we need the following three tests because we’ve got to test all this product that’s coming into the U.S. from Asia.

So though Asia may not be stepping up as fast as we’d like to see them, there’s also the other side of checking on product as it comes onshore here. Of course, there’s been a tremendous amount of -- I don’t know that we can identify this [inaudible] activity, but the president’s special commission on protecting imported products, as a result, a lot of it came from China, is now in place and begin to get going, which should call for more and more testing of anything that we bring in from offshore, and most especially the food products.

But that problem and need is not going to go away. They need to produce product. We need to buy product and somehow we need to make sure that it’s safe.

Joseph Potvin - Wachovia Securities

-- southeast Asia countries like Thailand?

James L. Herbert

Thailand continues to grow but we also see places that I never expected to get this big, like Vietnam is producing a lot of shrimp that’s coming into this country now, so we are seeing all that Southeastern Asia area I think will grow.

Joseph Potvin - Wachovia Securities

Thank you.

Operator

Thank you. It appears there are no further questions at this time. Mr. Herbert, I’d like to turn the conference back over to you for any additional closing remarks.

James L. Herbert

Well, thank you very much for your participation this morning and most especially for your continued support of the company and we wish you a happy new year and we look forward to talking with you on a formal basis in about another three months. Good day.

Operator

Thank you. That concludes today’s conference. We appreciate your participation. You may now disconnect.

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