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Edited Transcript of NEOG earnings conference call or presentation 23-Jul-19 3:00pm GMT

Q4 2019 Neogen Corp Earnings Call

LANSING Jul 24, 2019 (Thomson StreetEvents) -- Edited Transcript of Neogen Corp earnings conference call or presentation Tuesday, July 23, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James L. Herbert

Neogen Corporation - Executive Chairman

* John Edward Adent

Neogen Corporation - CEO & President

* Steven J. Quinlan

Neogen Corporation - VP, CFO & Secretary

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Conference Call Participants

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* Brian David Weinstein

William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst

* Brian Gaines

Springhouse Capital Management, LP - Managing Partner

* David Michael Westenberg

Guggenheim Securities, LLC, Research Division - Analyst

* Kevin Kim Ellich

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Paul Richard Knight

Janney Montgomery Scott LLC, Research Division - MD, Head of Healthcare Research & Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good morning and welcome to the Neogen Fiscal Year 2019 Year-End Earnings Call. My name is Brandon, and I'll be your operator for today. (Operator Instructions)

I will now turn the call over to your host, John Adent, Chief Executive Officer. You may begin, sir.

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John Edward Adent, Neogen Corporation - CEO & President [2]

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Thank you, Brandon. Good morning, and welcome to our regular quarterly conference call for investors and analysts. Today, we'll be reporting on our fourth quarter of 2019 fiscal year, which ended on May 31 as well as our entire 2019 fiscal year.

As usual, some of the statements made here today could be termed as forward-looking statements. These statements, of course, are subject to certain risks and uncertainties. The actual results may differ from those we discuss today. The risks associated with our business are covered in part in the company's Form 10-K as filed with the Securities and Exchange Commission.

In addition to those of you who are joining us by live telephone conference, I also welcome those of you joining us via the Internet. Following our prepared comments this morning, we're going to entertain questions from participants who have joined this live conference. I'm joined this morning by our Chairman, Jim Herbert, who will provide his perspective on our international business; and our Chief Financial Officer, Steve Quinlan, who will provide more detail on Neogen's financial results for the quarter and year.

Earlier today, Neogen issued a press release announcing the results of our fourth quarter and our 2019 fiscal year. As stated in the release, our revenues for the quarter were up 2% to approximately $110 million, and our year-to-date revenues were up 4% to $414 million. These revenue increases included minor contributions from our recent acquisitions, including Delta Genomics in January.

Our net income for the fourth quarter was $15.8 million or $0.30 per share compared to last year's quarterly net income of $17.5 million or $0.33 per share. For our entire 2019, our net income was $60.2 million or $1.15 per share compared to $63.1 million or $1.21 per share. As a bit of perspective on our net income performance, last year at this time we reported to you a net income increase of more than 40% for both the quarter and the entire 2018 fiscal year. That percentage increase represented a $0.35 increase over 2017 and was primarily due to benefits from the U.S. corporate tax rate reform enacted in December of 2017.

As we've said on previous calls, we're in the same position as other American companies when a substantial percentage of their sales come from outside the United States. A strong dollar increases our buying power overseas, but hurts our top and bottom lines when the foreign currencies are converted to U.S. dollars. As we stated in our press release, in a neutral currency environment, our sales would have been $2.3 million higher in the fourth quarter and $8 million higher for the entire year. At the bottom line, this cost us $0.015 per share in the fourth quarter and $0.055 for our 2019 fiscal year.

Last year at this time, we reported that we benefited from corporate tax reform and recorded an unusually low effective tax rate. As we informed you in previous calls, our effective tax rate for this year was significantly higher. The impact of that change is seen in our net income comparisons that I mentioned earlier. I'm going to leave it to Steve to provide more color on all of our financial results.

I will hit some of the highlights to give you an idea of what's driving my optimism about Neogen's future and then discuss some of the challenges that we faced in the year to provide some additional perspective. Our Food Safety business had some impressive results in the year that were driven by both capture of additional market share with existing products and greater acceptance in the marketplace of our newer testing technologies. Global sales of our tests to detect natural toxins increased 15%, driven by strong sales of test kits in the U.S., Brazil and Canada. Sales of our tests for aflatoxins were up 21% for the year. This increase was due to our ability to expand our market share in key geographies, led by Brazil, and grow our new Raptor test systems worldwide. We continue to gain strong customer acceptance of our Raptor platform as it greatly simplifies the entire testing process.

One of our goals is to work to extend our 2019 success in our natural toxin segment across all of our product lines, to find new markets for our current products wherever in the world they may be and to create new opportunities and markets everywhere using our R&D and innovative teams. Our pathogen detection product line also had outstanding performance. For the year, we had a 24% increase in global sales of our test kits to detect foodborne pathogens, including Listeria and Salmonella. This increase was the result of solid sales growth of our existing technologies and robust sales for our Listeria Right Now test systems. As I've repeatedly said, our Listeria Right Now test system is a game changer. To accurately test for Listeria in under 1 hour for the time you take the sample to the time you receive results has delivered tremendous value to our customers.

Another of our core Food Safety product lines is our AccuPoint Advanced test systems, which also had strong growth as it increased sales by 11%. Sales of our test kits to detect food allergens, including gluten, milk, soy and peanuts continue to grow with a 7% increase for the year.

Revenues from our worldwide animal genomics business increased 12% in 2019, largely due to significant increases in beef and companion animal sales in key global markets, such as the United States, Europe, Brazil and Australia. As with our natural toxin and pathogen products, the increase in our genomics revenue was due to new products and increased penetration with existing products.

We've had a number of new product developments with our genomic group that have gained an almost immediate acceptance with our customers. For example, cattle producers use our improved DNA test to better predict traits their bulls or cows will pass on to their offspring, helping them make more profitable breeding and ranching decisions. Aside from our genomics group, as mentioned in the press release, it was a difficult year for our Animal Safety segment due to ongoing challenges in the animal protein markets we serve. We did produce significant new sales within our veterinary needle and syringe business and also grew our companion animal product sales. Unfortunately, these increases were offset by lower sales of animal care products, other veterinary instruments and rodenticides due to toll manufacturing business we lost in the prior year.

At this point, I'll turn to Jim for his perspective on our international operations.

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James L. Herbert, Neogen Corporation - Executive Chairman [3]

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Thanks. And as John mentioned, our international operations performed well for the just-finished quarter and the fiscal year. For the quarter, they were 9% ahead of the prior year and up 11% for the total year. This year, 40% of Neogen's total revenues came from international sources and that compares to about 37.5% the same -- for the same equation for last year, about 37.5% of our revenues came from international sources. Of course, one of Neogen's 4 major growth strategies for the past many years has been to grow international sales and to expand our international operations. And we always dealt -- played whatever hand got dealt to us as it relates to currencies. But this year, native currencies were always in our -- seems the winds were always in our face. If you look at native currencies, our growth was even stronger. For FY '19, international revenues were approximately $166 million, but would have been about $8 million higher had it not been for that negative currency translation.

I think it's interesting here for -- quickly this morning to look at what's happening in an area-by-area basis. First, looking at our Brazilian operations, where we have actually 3 operating companies. One in biosecurity and animal products, another in genomics and the third in the food safety test products. In U.S. dollars, we generated about $23 million in annual revenue, which is up 16% compared to the prior year. They were benefited by aflatoxin contamination in significant portions of the corn crop. There's also an increase in forensic revenues there. Those forensic revenues were reported in another part of -- another unit of Neogen last year.

Genomic revenues have helped to push the Brazilian results and quite excitingly, I think. We introduced Neogen's new indicus cattle model for the genomic side, which is specific for the unique breed of cattle in that country. And remember, we've told you in past calls that Brazil has the largest population of cattle of any country in the world. I think, also interesting to note is that Brazil and the United States combined own 37% of the world's beef cattle. I think that's a pretty amazing number.

Mexico and Central America operations also showed nice increases, up about 13% for the year. Food Safety diagnostic test kits in Mexico alone were up 25% as compared to a year earlier, and our Animal Safety products going into the South American countries showed some notable increases.

While still small, our China revenues for the year were up about 13%. Indian revenues were almost double from a year ago. And prospects in both of these countries continue to look good as we move into the New Year.

Australia is the newest addition to our international operations with company-owned facilities, and our genomics business there, primarily in sheep, more than doubled compared to the prior year.

The flagship international operations continues to be Neogen Europe operations. For the year, their revenues were approximately $59.3 million or up 8% compared to the prior year in U.S. dollars. In local currency, that'd be pound sterling, their revenues were actually up about 12%. Neogen Europe acts as the distribution center for all of the Neogen -- the European Union countries as well as some countries in Africa and Eastern Europe. I think it's about a total 50 countries that we may distribute product into. One of their highlights for the year has been the integration of our culture media operations in the U.S. with those in the U.K. to provide the only harmonized worldwide culture media business in the world today. That -- I think we'll see a lot from that going forward in the face of competition where we have an advantage to those might not.

Our traditional food safety diagnostic products to detect pathogens and particularly other microorganisms had good growth. The biosecurity and Animal Safety business in Neogen Europe is beginning to flourish with annual revenues up about 17% in U.S. dollars and 21% in pound sterling. I just returned from a week in Scotland with that team, and I can report to you that they are excited as new revenue opportunities seem to unfold almost daily.

I think without exception, we're pleased with the performance of our international operations this past year and even more excited about their continued growth as a part of the overall Neogen growth strategy.

To do a little bit of a quick mind-shift here, as he indicated in his earlier comments, the timing of this call coincides with John Adent joining Neogen as the company's CEO 2 years ago in July. John began to take over the animal side of our business almost immediately because of his prior background, and over the next few months, he transitioned into new areas of the business. John, I think, pretty much has been running all of the operations of the business for the past year, while I have been endeavoring to help complete, I guess you'd say, the onboarding. I think he is about finished building his own new management team for the 2020 -- his 2020 vision.

I hope to stay on a bit longer. For now, I have direct responsibilities for our Neogen Europe operations that I just got through talking about. It's interesting to look back. We bought this business as a small distributor about 16 years ago, had about a dozen employees. Since then, we've grown revenues at a compound annual growth rate of an astounding 27%, and we now have 240 employees.

This call does give me the opportunity to thank the analysts and the shareholders who have given me the opportunity to help build what I think is truly a world-class company over the past 37 years. The opportunities today have never been better, greater for our overall business, any time in our history so long as we stick with our mission. Of course, I guess I probably said this 37 years ago too when we had 2 employees and less than $100,000, but we're -- I do believe there's no doubt that we're at the right time, at the right place, with the right people to continue to building on this strong company.

Thanks, again, to those of you who have provided advice and support to me. Let me turn the program over to Steve now to give you some color on last year's financial performance. Steve?

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [4]

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Right. Thank you, Jim, and good morning to everyone on the call today. John and Jim have discussed some of the revenue highlights, and as Jim mentioned, I'm going to give you some color on our operating results for the quarter and full year.

Our gross margins for the quarter were 46% and that compares to 44.9% in last year's fourth quarter. That's aided by an overall shift in mix towards Food Safety products in the quarter. Gross margins were 46.3% for the year compared to 46.8% last year. Animal Safety gross margins decreased 80 basis points, primarily due to lower sales of higher-margin products like rodenticides and certain animal care products. Our Food Safety gross margins moved lower by 60 basis points. Higher sales of lower-margin products, particularly at our international operations, which sell the complete portfolio of the company's products and which report in through Food Safety, were the primary reason for this move. In fiscal 2019, these businesses sold a higher proportion of products such as cleaners and disinfectants.

Additionally, John noted the impact of the stronger dollar on our top and bottom lines this fiscal year. Our international operations buy their inventories from the U.S. in dollars. When their local currency weakens against the dollar, they have to spend more of that currency to pay for their inventory, which raises their costs and negatively impacts their gross margins.

Our operating expenses overall rose 11% for the fourth quarter and 7% for the year. Sales and marketing expenses rose by 2% for the quarter and were up 5% for the full year. Shipping expenses within sales and marketing rose by 11% due to higher rates and an increase in air shipments, which are more expensive. And personnel-related expenses rose 4%. Other increases were for tradeshows, exhibits and other marketing efforts. Our general and administrative expenses were up 14% for the quarter and 7% for the year. Increased personnel-related expenses from higher headcount and higher stock-based compensation, which has risen due to the increase in the price of the company's stock were the primary drivers of the increase.

We also continued to invest in our IT infrastructure and recognized higher depreciation expense related to information technology, software and equipment expenditures. IT licenses and maintenance costs were also significant components of the increase. Research and development expenses were $12.8 million for the year compared to $10.9 million last year, an overall increase of 18%. The increased spending here for both the quarter and full year is due primarily to development cost for next-generation products and expenditures to obtain product approvals and certifications. Although this is a significant increase, we're optimistic that the resulting products will be well received in the market when introduced late in fiscal '20 and early fiscal 2021.

So our operating income for the fourth quarter was $18.7 million or 17.1% of sales compared to $19.9 million or 18.4% of sales recorded in last year's fourth quarter. And for the full year, as John noted, our operating income was $68.1 million or 16.4% of sales compared to $70.2 million or 17.6% of sales in the prior year.

Other income for the year was almost $4.9 million compared to $3.3 million in the prior year and included $4.7 million in interest income as a result of higher cash and marketable securities balances and rising interest rates on those balances. Now rates appeared to have plateaued in the fourth quarter of the year.

Looking at the income tax front, our effective tax rate for the fourth quarter was 18.9% and for the full year was 17.5%. Corporate tax reform, which was enacted in December of 2017, lowered the U.S. statutory federal income tax rate from 35% to 21%. Fiscal 2019 was the first full year for us under the new rate. From that 21% rate, we recorded a $2.6 million benefit related to the exercise of stock options and also recorded a number of adjustments for the new taxes, deductions and credits from the tax reform, which relate to foreign-derived income and essentially those amounts netted out. In fiscal 2018, the effective rate for the year was 14%, which was the result of the lower statutory rate for a portion of the year, a net $4.8 million benefit for adjustments to deferred tax balances and repatriation tax amounts, $4.8 million in windfall benefits from option exercises and $1 million from the favorable outcome of an IRS audit. Those favorable adjustments totaled about $3 million -- $3.3 million in the fourth quarter of last year or about $0.06 a share and resulted in an effective rate in the fourth quarter of 2018 of 11.8%.

We continue to produce strong cash flow, generating about $21 million in cash from operations during the quarter, almost $64 million for the full year, and invested about $15 million in property and equipment and $6.4 million in acquisitions during the year.

Inventory balances increased 13% in fiscal 2019 or about $10 million. The company increased inventory levels in our European operations during the year by about $3.9 million to ensure that we had adequate stock to support our European customers in the event of a disorderly Brexit. Absent the impact of the higher Brexit-related inventory levels, inventories were up about 8%. And we continue to evaluate our inventories across the company for appropriateness and have established goals at each operation to improve our turns.

Our accounts receivable balances rose by 4% over levels at last year-end, consistent with the increase in revenues, and our days sales outstanding moved to 61 from 60 last year-end, primarily the result of our increase in international revenues, which generally take longer to collect.

So fiscal 2019 was a challenging year for the company. We're happy to put it in the rear-view mirror and we've got a lot of optimism regarding the year ahead. John?

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John Edward Adent, Neogen Corporation - CEO & President [5]

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Thanks, Steve. As Jim mentioned, last week marked my second anniversary as Neogen's CEO. I was really excited about Neogen's future then, but I'm even more excited now as I understand all that Neogen is and all that it can be. Neogen is in the right markets with the right products and the right people. We're ready to seize opportunities where they exist and create our own. We've responded to the African swine fever crisis devastating the swine industries in China, Mongolia and Vietnam as well as within parts of Europe with expertise and effective biosecurity products. We're ready to assist the global grain industry with their testing needs in response to the unusual weather in most of the world's leading agricultural regions. This year's season has been too cool and wet in some places and too hot and dry in others, and it's still a little bit early to tell what extent the weather will lead -- whether the weather will lead to increased testing or the size of the crops to be tested. But we have the right market-leading products and the right people to help.

As detailed by Jim, sales from outside of the United States remain a key focus for us. A recent report from the United Nations World Health Organization provided the extent of challenges still facing the global food industry. This report stated that every year more than 400,000 people die and an estimated 600 million people become sick from the food that they eat.

Neogen has a mission that matters and today even more than ever. So let me stop at this point and entertain any questions from those of you who have joined the call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) From William Blair, we have Brian Weinstein.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [2]

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So thought we'd just start just talking about Animal Safety and kind of what you guys are seeing in the end markets there. We've kind of gone through these last couple of quarters, asking that can we call the bottom or not, and I'd love any kind of thoughts about your ability to say whether or not we are kind of at the bottom here. Then also just anything that you are doing internally to really sort of adjust to what these end markets are doing. So from a business process standpoint, is there anything that you can do or are you guys simply kind of the twig kind of going down the muddy river on this one?

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John Edward Adent, Neogen Corporation - CEO & President [3]

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Thanks, Brian. So call it a bottom. I'm not very good at that. I tried that a couple of quarters ago and didn't work. So I think I'm going to punt on that one. Just looking at the markets, there's still a ton of uncertainty. I don't know what's going to happen, but the uncertainty hasn't decreased. I think that's the big take away. And if you look at some of the other businesses within the agricultural segment, I mean, I saw some results that came out the other day, they were -- agricultural companies are having some challenges too with this market. We're not a twig floating down the stream. We do get rushed along faster or slower by the speed of the stream, but we have to and we continue to find ways to drive market share within that segment. So whether the market is growing or not, we need to grow, and we're going to continue to push by doing that by driving market share attainment. And what we've done is we've put in together programs to try to help our distributor partners around the world pull product out to really help grow that share with that customer base. So those are the things that we're doing to really try to improve the performance of that segment.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [4]

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Okay. Great. And then, as it relates to kind of just from a broader perspective, the way that you are thinking about strategic priorities for fiscal '20. I think you guys kind of talked a little bit about some of those in the prepared remarks. But I'd love to hear just kind of what you as a management team are really focused on for 2020, maybe the top 2 or 3 things that you're going to be judged by internally as we look to the next year.

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John Edward Adent, Neogen Corporation - CEO & President [5]

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Yes. I think one is what we talked about, we got to continue to grow market share within the markets we operate in, right? That shows our success rate, right? The other is bringing in new products into the marketplace. So what can we bring that's new and innovative that's going to allow us to capture a bigger part of that pie and a bigger part of the share? We continue to look for new technology, whether it is our own or whether it's through acquisitions. So we've got to continue to make sure that we're filling the acquisition pipeline and execute on the acquisition strategy. So those aren't different from what we've done in the past. And the fourth piece is the same as the international growth. I mean, that's -- those are really the 4 pillars that Neogen's used since Jim started the business, and they're really well served for us today. Jim may change the order in different times, but really that's kind of how we're going to continue forward.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [6]

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Okay. Then last one for me just to kind of fill in on what you just said about filling that acquisition pipeline. It was such a big crucial part of the growth story for many years, taking a bit of a breather here over the last kind of 12 to 18 months. Can you talk about where that acquisition pipeline is today? What it looks like and the likelihood that you guys think that you will be able to complete something that's material in the next 12 months?

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John Edward Adent, Neogen Corporation - CEO & President [7]

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Yes. Thanks, Brian. It absolutely is critical. It's something that we're working on. We have a number of candidates within the pipeline today. The challenge is always timing, right? Making sure that we're ready and they're ready. So we are in the process of 2 to 3 deals now that we're actively working on and doing due diligence. And we continue to find and look for other opportunities within the markets that we think that we can either add customer bases to our current product lines or add new products and new customer base to products that match up with Neogen's mission.

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Operator [8]

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From Craig-Hallum, we have Kevin Ellich.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [9]

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John, just wanted to start off with the animal protein headwinds that you guys are seeing. Can you give us a little bit more color as to what sort of impact you're seeing from African swine fever? Is it a benefit for you guys with your biosecurity? And then what are you seeing in other markets like Brazil? It seems like there's really strong growth. We've seen the pork exports have gone up significantly. Just wanted to get a little bit of color on that front.

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John Edward Adent, Neogen Corporation - CEO & President [10]

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Yes. So there is an opportunity with ASF, and we've seen that with increased sales of products in Vietnam and in China and some of the markets where we've had outbreaks. ASF is a really tough virus. It's a double-envelope virus. It is really tough. So it's not something where you have got a magic bullet product, where you're going to walk in and say, just use this and everything's going to go away. So it's a tough, tough challenge. It's puts and takes, Kevin. Yes, I mean, if the hog population gets hit with ASF, our disinfectant sales go up, but our needle and syringes business goes down. All the other products would go down because of the number of animals and the usage just goes down. So -- but really what we try to focus on is making sure that we're helping our customers fix any challenge that comes their way. I mean, that's really what we've got to do regardless of what it is. Jim's always said we play the hand that's dealt, and that's exactly what we're doing. The second question, Kevin -- what was your second question you had?

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [11]

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What are you seeing in some of the other markets like Brazil? In the report, there is increased pork exports. Is that driving increased sales of other products in those markets, where production in China and other parts of Asia are being hit?

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John Edward Adent, Neogen Corporation - CEO & President [12]

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Yes, you've seen our strong results internationally, and I think there is some of that as -- and that's the benefit that Neogen has in being in so many places and exporting to 140-some countries around the world is, as those global trade tensions change, if production shifts from 1 to another, we're there to help those customers grow. So it's a benefit we have. It hurts on currency, but it's a benefit being there.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [13]

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Yes. No, that makes a lot of sense. And then, I guess, let's just switch over to the USDA contract that you guys announced yesterday for the foodborne pathogen tests. Provide a little bit of commentary there and is that going to drive any incremental growth for you guys in the upcoming fiscal year?

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John Edward Adent, Neogen Corporation - CEO & President [14]

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I mean, it's a great contract to have because we love working with the USDA. They're a great partner of ours. We try to help them as much as we can. And it's a bit of a bellwether, right? Because if the USDA is using the product, that's a pretty good -- it's a pretty good seal of approval for the rest of the industry. So while I can't tell you it's going to represent X percent, I do think it will have an impact.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [15]

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Got it. Okay. That's kind of what I thought. And then it seems like rodenticides was a little bit weak this quarter. We know there is legislation in California that looks like it's probably going to get passed, where they're looking to ban the use of second-generation anticoagulant rodenticides. Wondering how much business you have in California and if that would -- you think that will have a negative impact on your sales?

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John Edward Adent, Neogen Corporation - CEO & President [16]

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I'd like Jim to do this. He's been working on that exact issue for us. So Jim, you want to take that one?

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James L. Herbert, Neogen Corporation - Executive Chairman [17]

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Right. It's typical California. This one is entitled Raptors are the Answer (sic) [Raptors are the Solution], which abbreviated is RATS, of course, and it's based on what was learned from the last round, which was called CATS, C-A-T-S, and I can't quite remember what that stood for. But it's -- there's not a chance that they're going to ban -- in fact, this group is not coming after us. We're being pursued secondarily. They're going after the California EPA who are approving products like ours. And they are claiming that there's a secondary kill from -- if an eagle eats a rat in the field that had consumed a bunch of second-generation rodenticide, it kills the eagle and, I mean, those are facts. Some people who have less patience than I do say rodenticide manufacturers ought to just pull out of California for 6 months and let the rats have it, but we, obviously, don't want to do that. But it's -- we're on the side of government and well represented in the case. We, along with, gosh, I guess, it's 14 secondary -- California is first and then 14 secondaries. Interestingly, it was aimed at first -- second-generation and not first generation. So the first generation is the one that a lot of people are worrying about. That's warfarin and some of those. But we're still selling just as much rodenticide into California as we had and it's still going to be important and it's going to cost some money. At the end of the day, it's probably going to have to be some more regulatory testing done to prove that it is efficacious, but I wouldn't lose any sleep over it.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [18]

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Got it. Got it. And then last one, quick one for Steve. I don't know if you said it, but what was organic growth this quarter on a constant currency basis?

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [19]

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Kevin, I didn't say it. And I don't have that. I'll have to give that to you off-line from a -- on constant currency. It's going to be nominal. I mean, our growth was 1.5% in the quarter. So I would bet that, constant currency, we're going to be flat to slightly below. But I'll give you that off-line.

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Operator [20]

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From Janney, we have Paul Knight.

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Paul Richard Knight, Janney Montgomery Scott LLC, Research Division - MD, Head of Healthcare Research & Senior Equity Research Analyst [21]

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With the company now, what, 41% international sales, are you going to continue to drive that exposure? Do you want to go more direct, less a distributor? What you want to get done with international?

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John Edward Adent, Neogen Corporation - CEO & President [22]

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Yes. So Paul, we're going to approach opportunities where they are in the world and where we can execute. And there is a lot international, and there's also a lot in the U.S. So I don't get tied up in the percentages because I can grow the U.S. just as fast as I can grow internationally with the right products and the right people. I like our approach that we've done. We see opportunities around the world in a lot of places. The best way to approach those opportunities are through distribution, and we've had great distribution partners around the world for a long time. And then what we also do is we look at times when -- we've had this in the past and Jim mentioned it, with Europe. In the U.K., that was a distributor/partner, had been there a long time, done great work for us and they wanted to make a change. And we stepped in and went direct in that business and 27% compounded animal -- annual growth is just fantastic and that's something we do also. So when we have a distributor that's a strong distributor that wants to make a change, we're more than willing to step in and drive that so we can drive our business getting closer to the customers.

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James L. Herbert, Neogen Corporation - Executive Chairman [23]

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Yes. And just to butt in real quick, they're not mutually exclusive, if I left you with that impression. Our Neogen Europe operation has 17 distributors. So we go direct in few countries, some major ones. We go direct into the U.K., direct into France, direct into Germany and direct into Holland, but the most -- the rest of those countries are all served through that group of distributors.

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John Edward Adent, Neogen Corporation - CEO & President [24]

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And it's really a channel by product because we have some product lines where we're direct, we have some that we use distribution. So we really want to approach the marketplace that whatever the customer feels value, they want to buy from a distributor, great, buy Neogen products. They want to buy direct from Neogen, fantastic, buy from Neogen. You want to buy from a retailer, we're more than happy. So we take a channel-agnostic type strategy.

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Paul Richard Knight, Janney Montgomery Scott LLC, Research Division - MD, Head of Healthcare Research & Senior Equity Research Analyst [25]

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And could you give us an update on genomic services? I understand what you are expanding in Lincoln and what's the progress of Australasia? And I'm assuming Europe's still good, but if you could kind of highlight genomic services.

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John Edward Adent, Neogen Corporation - CEO & President [26]

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Yes. That business continues to grow. One of the things that, I think, is just phenomenal is this year we surpassed 4 million samples worldwide, which is just an absolutely tremendous number. We continue to stay on in front of competition and really continue to push and grow that marketplace. We had strong growth around the world. Steve, I don't know if I've got genomics by country, but we had strong growth in every single country we operated the genomics business in. We do have to expand. We've got to find ways to continue to stay up and stay in front of demand, and that's why you're seeing the investment in Lincoln. We're going to -- we're adding another facility there to make sure that we continue to grow that business as fast as we can and stay ahead of the demand curve, which is why we're investing now. Yes, and Steve pointed out, we did 12% increase worldwide across that business. So I'm really proud of that team.

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Operator [27]

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From Guggenheim Securities, we have David Westenberg.

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David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [28]

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I'm sticking with the ASF theme because I'm getting a lot of questions on that just generally across animal health. So the latest reports kind of suggest that maybe 50% plus of the pigs have been culled in China. Of course, we know that's the majority of the global production. Making us think that there's going to be major -- probably a major shift in species that consumers eat. So can you talk about maybe your product exposure? You're probably a lot more agnostic, but I'd like to maybe just feel comfortable if the global demand for proteins maybe shifts from swine to maybe other kinds of proteins?

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John Edward Adent, Neogen Corporation - CEO & President [29]

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Yes, we're -- that's an advantage. Thanks for the question, David. But that's an advantage we have is that we work with the largest poultry producers in the world from a genomics and a customer standpoint. We work with the largest swine producers in the world from a genomics and an animal safety standpoint. We work with the largest beef producers in the world from a genomics and animal safety standpoint. And lot of them, food safety also because they're fully integrated. And we work large dairy. So we feel very -- I wouldn't say comfortable. But we know that when those types of things move, and I'll give you another example, David, you're seeing increase in plant-based proteins increasing. We work with those companies too on the food safety side because they have the same issues, whether you are making a hamburger patty or a soy patty or a bean patty, you still have to protect that food chain from pathogens and toxins and you still have to look for allergens. So we're really comfortable moving within those spaces and having the ability to approach the customer bases when those opportunities hit.

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David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [30]

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Got it. And just kind of sticking with ASF, some of the more recent reports suggest that it's possible that you could see maybe 1/2 decade or more of increases in protein prices. Would that make -- do you believe that might be a macro tailwind for food safety as these farmers have maybe more -- are getting better prices for their herd that maybe they're going to be more inclined to protect the brand via safety? So just kind of want to think about maybe that as an opportunity in how you're thinking about it.

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John Edward Adent, Neogen Corporation - CEO & President [31]

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Yes, I think it could be. I mean, anytime you see more value in the chain, you're going to see people be more creative and use products to protect their brand, which is what we would do, right? We're going to help them protect their brand. I think it was interesting that -- and it kind of ties in. This week, actually right now, the IAFP meeting is going on, which is the International Association for Food Production. And yesterday, Frank Yiannas, who is the Deputy Commissioner for Food Policy and Response at the FDA; and Mindy Brashears, who is the Deputy Under Secretary for Food Safety at the USDA spoke. And it was interesting because Yiannas cited some of the tools he sees the future in food safety to be whole genome sequencing, AI and the Internet of Things, which is right in our wheelhouse. I mean, you think about we do whole genome sequencing in Lincoln, and we also have our 16s product, which is really -- what it allows us to do is quickly identify if harmful bacteria is present. And so we can now leverage what they're talking about to help our customers be more successful. And it's kind of the same thing. Mindy Brashears said that her "primary objective is to control pathogens." That's what we do, right? Think about what we've done with our LRN and ANSR products to help customers detect pathogens in their facilities. So I think we've got great alignments. I think everyone sees the challenge, and we're there to help our customers be successful and protect the food supply. That's really what we're here to do.

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David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [32]

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And maybe sticking with the macro theme. You called it out a little bit, I think, on your last call. But since your last call flooding in the Midwest has been -- it continued to be kind of challenging. I know that farmers, when weather affects the crop, they tend to plant soybeans, and then, of course, we know that trade dynamics have kind of affected soybean prices and the ability to transport. So since the last call, do you have any kind of maybe update in terms of macro there and whether or not you think that might be a headwind for the next quarter or 2 or maybe even into next season?

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John Edward Adent, Neogen Corporation - CEO & President [33]

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Yes. So some of the things that are going on from a macro standpoint is the USDA said that 91.7 million acres of corn were planted and 80 million acres of soybean were planted. There is a big question mark around that number because it was asked, of the number of acres you wanted to plant, did you plant? So a lot of farmers naturally said, "Well, I planted what I want to plant, but I reduced that number by 30% because the fields were flooded." So there's a lot of uncertainty on how much acreage is planted. The second is, then, can it catch up because it's so late? So we're not sure what yields are going to be. Now the reason you don't see corn running away is because we've got a significant carryover. I mean, there is 4.34 billion bushels in carryover today. There is over 1 million -- 1 billion bushels of carryover in soy, which is a near record. So we've still got old crop. We don't know when new crop's going to be. We don't know if it's going to catch up. This is what I was talking about, the uncertainty our customers are facing. Boy, people just don't know. And we don't know the quality of the crop. I mean, we -- that's kind of what we're waiting on. So it's just a lot of uncertainty. And the other thing we've seen is we've seen imports of corn coming on the coasts. We've seen a little bit of decrease because, I saw a report the other day that the ethanol business has now lost money for the longest time since its industry history. It's in the longest drought. So, therefore, they're not pulling corn, which frees it up for feed for animals. So that may benefit the producers. So you've got pluses and minuses, David, on both sides, that -- boy, I tell you what, if I had the answers to those, as much as I love Neogen, I could make a lot of money somewhere else, I'll tell you what, if I knew those answers.

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David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [34]

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So it sounds like pluses and minuses kind of might be evening out there.

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John Edward Adent, Neogen Corporation - CEO & President [35]

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Yes, there's not a slam-dunk one way or the other right now.

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David Michael Westenberg, Guggenheim Securities, LLC, Research Division - Analyst [36]

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Got it. Okay. No, very helpful. And just maybe one last one, probably maybe a little bit more for Steve. Traditionally, Food Safety has had the -- been the higher gross margin kind of products, but I think you've said the products within Food Safety that have been growing faster have been a little bit of lower margin. So maybe just thinking about, maybe Raptor, and I know genomics is kind of on both sides, but they're 2 growth areas. Can you talk about, as they become a bigger part of the overall portfolio, whether or not those maybe can get some cost reductions and start being maybe a margin improvers long term or intermediate term? And that's the last question.

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [37]

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Yes, thanks for the question, David. That's a great question. And I do think that as these products, as we get them up to scale, we're going to able to take cost out of them and get those margins up. I think the business overall, as it grows, the growth rates in the Food Safety side are faster than the animal side and those are the higher margins -- the core business, the core diagnostic kit business are the higher gross margin products. So I think as those markets grow, you should see the -- you should see our gross margins expand somewhat in those -- in that business.

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Operator [38]

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We have a follow-up from Kevin Ellich.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [39]

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John, just 2 quick follow-ups. First, I wanted to ask about Colitag, your water testing business. How's that been performing?

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John Edward Adent, Neogen Corporation - CEO & President [40]

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Good. Good. I mean, we've taken that business and moved it in-house. So we're now doing the manufacturing in-house. It's a bit of a complicated process that we're trying to simplify and grow and make more efficient. But we see tremendous opportunity there because we have such small share and it's really quite a sizable market for us to go after. And so it's getting the teams trained. It's a new customer base for us in a lot of these markets, so it's approaching new customers, it's getting those lists together and it's going out and driving the business.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [41]

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Great. Good to hear. And then I might have missed this in the first question, but did you guys give an update on your M&A pipeline? I guess, how many deals are you kind of vetting and looking at? And I guess, what's your outlook for the year?

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John Edward Adent, Neogen Corporation - CEO & President [42]

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Yes, we didn't talk specifically about how many in the pipeline. We have a number of them in the pipeline. We're actively working due diligence on 3 deals right now. And so we continue to fill that and negotiate and do due diligence on businesses. And we hope that we'll close those in relative short order.

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Kevin Kim Ellich, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [43]

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Are any of them sizable or are they kind of more tuck-in type deals?

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John Edward Adent, Neogen Corporation - CEO & President [44]

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Kevin, I don't know if I want to give, like, the specifics on that. We look for both.

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [45]

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And Kevin, if I could, I've got your constant currency organic growth. For the quarter, it was 3.1% and for the year -- full year was 5.4%.

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Operator [46]

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And from Springhouse Capital, we have Brian Gaines.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [47]

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Can you give the same organic growth rates by segment for Food Safety and animal? Do you happen to have those?

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [48]

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What was the question?

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John Edward Adent, Neogen Corporation - CEO & President [49]

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Organic growth rates for the segments. Steve is looking it at up.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [50]

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Okay. I guess, these are both for Steve, I think. The other one is going to be just housekeeping. Good -- what's a good tax rate to use going forward, if you have any feel for that?

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [51]

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Yes. It's a good question. I think I would probably use 18% for fiscal 2020. It's probably going to be reasonable.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [52]

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Okay. And then for R&D, is kind of -- the increase in the fourth quarter, is that a good kind of absolute dollar increase to assume happens for all of '20 or are there -- anything mitigating that number?

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John Edward Adent, Neogen Corporation - CEO & President [53]

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I think that's tougher to say because what we do is we're always looking at opportunities. And as the market, or our sales team, our marketing team, our product development team brings opportunities, we vet those and then put them in the pipeline for R&D. So it's not like we have a constant number that we fix. It's really reacting and that's why you see -- we saw, as Jim mentioned, we saw opportunities across the world in things. And we said, look, we need to invest here and do some research to bring the solution for our customers. So I don't know. I wouldn't say it's -- I don't know, Steve, if you differ, but I think, that's really variable based on what we see the opportunities are.

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Steven J. Quinlan, Neogen Corporation - VP, CFO & Secretary [54]

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No, I would agree. And I think you have look at the -- that increase over fiscal '18. '18 was a year where we made a lot of adjustments at year-end because they had a lot of accruals that were set up that we closed out at the end of the year because they hadn't been used. So I would tell you that the '18 number was probably artificially low. The run rate, the 3.5 million that we ran in the fourth quarter of '19, as John said, that, we're going to adjust that number based on the opportunities. That's probably a -- you go plus or minus off of that 4-year run rate going forward.

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James L. Herbert, Neogen Corporation - Executive Chairman [55]

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Just to quickly jump in and add to that. There is no shortage of new product opportunities. Just fresh off of the trip back from Scotland, we've got 6 products -- or 6 new product developments that are on the list for Scotland that they're working on because they've got their own -- well, it's not independent, they work closely with Lansing, but we have R&D contingency there. And there's 1 or 2 that could be in the way of regulatory for the EU that could be blockbusters. So there's -- don't -- want to make sure we haven't left you with the thought that there's not a -- still a lot of opportunity for new product development.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [56]

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Okay. And then on USDA contract, I just want to make sure I understand. You had that business, did you win new business? Or is it just basically you were recertified or you won the contract again, I guess?

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John Edward Adent, Neogen Corporation - CEO & President [57]

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You got to win it again. So we won it again.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [58]

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Got it. Got it. So that existed and it's just a matter of increase, because the USDA -- you rewon. Okay. And then if you could just elaborate on toll manufacturing. I think I know what it is, but if you could just elaborate. You said lost toll manufacturing business, is that just -- maybe you could just elaborate.

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John Edward Adent, Neogen Corporation - CEO & President [59]

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Yes, Brian. Toll manufacturing is where we make a branded product for someone else in our facility. So somebody may come to us and want to use our facility to make their product. And we do that opportunistically. If we have excess capacity, it's a great way to improve profitability. And if we don't, then we don't do it.

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Brian Gaines, Springhouse Capital Management, LP - Managing Partner [60]

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Got it. So when you said lost business, is it you elected not to do it because you had less capacity or because you lost a contract? Or is that just the general trends in the animal market caused that respective customer to not need as much?

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John Edward Adent, Neogen Corporation - CEO & President [61]

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Yes. They kind of -- it's a combination of both. If they saw demand for their products weakening and they decided not to do the line or it got so small it wasn't advantageous to us. It's a combination of all those things.

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Operator [62]

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No further questions at this time. And we'll now turn it back to John Adent for closing remarks.

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John Edward Adent, Neogen Corporation - CEO & President [63]

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Thank you, Brandon. Before we sign off today, there's a couple other things to mention. First, on Thursday, we're hosting our annual open house for investors here in Lansing. So if you can make it, but haven't signed up yet, please contact Rod for more details. And secondly, today marks the end of an era here at Neogen. As Jim talked about, his role here is transitioning and this is going to be his last quarterly conference call. For most of you and almost everybody, Jim has been the face and voice of Neogen Corporation. It's been 30 years since Jim took Neogen public and today marks the 120th time that Jim's provided our investors and analysts some perspective on quarterly performance. It's clear that Neogen would not exist without Jim's tremendous talent, vision and drive. He saw a need for what Neogen could be and he worked nonstop, tirelessly, to achieve his dream. I'm honored and grateful that Jim's granted me this opportunity. And I look forward to his continued guidance as we continue to work together and grow upon all that Neogen's been able to accomplish. So thank you, Jim. Appreciate it. Thank you, everyone.

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Operator [64]

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