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Animal Health International Inc. (NASDAQ:AHII)

F1Q09 (Qtr End 09/30/08) Earnings Call Transcript

November 4, 2008, 10:00 am ET

Executives

Jim Robison – Chairman, CEO and President

Bill Lacey – SVP and CFO

Analysts

Lisa Gill – J.P. Morgan

Natalie Nabern [ph] – William Blair

Jeff Johnson – Robert Baird

Mark Arnold – Piper Jaffray

Mario Cibelli – Marathon Partners

Operator

Please standby we’re about to begin. Good day and welcome to the Animal Health International First Quarter 2009 Earnings Result Conference Call. Today’s conference is being recorded.

At this time, for opening remarks and introductions I would like to turn the conference over to Chief Executive Officer, Mr. James C. Robison. Please go ahead sir.

Jim Robison

Good morning. I’m Jim Robison, Chairman and CEO of Animal Health International. Thanks for joining us this morning. Also with me this morning is Bill Lacey, Senior Vice President and Chief Financial Officer. Bill will discuss our results for the quarter. I will then make comments on our performance and I will open the call to questions. Bill?

Bill Lacey

Thanks Jim. Good morning. Thank you for joining us for today’s earnings release. Before we begin, I would like to point out that today’s conference call is being recorded and will be available for replay on our web page at www.ahii.com under Investor Relations.

In addition, I would like to remind everyone that some of the information discussed on this call, particularly our guidance for fiscal year 2009, our competitive position, future business prospects, revenue growth and market opportunities for the coming year contain forward-looking statements that involve risk and uncertainty. These statements are based on current expectations. Actual results may differ materially from those set forth in such statements. Additional information concerning risks and other factors that may cause actual results to differ can be found in the company’s filings with the SEC.

Please note that in addition to reporting financial results in accordance with GAAP, AHI reports certain non-GAAP financial results including EBITDA. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results which can be found in the press release.

Finally, AHI has provided in its earnings release and will provide in this conference call forward-looking guidance. We will not provide any further guidance or updates on our performance during the year unless we do so in a public forum. AHI does not assume any obligation to update these forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were made.

I will now provide you with the final results for our first quarter fiscal year 2009.

Net sales increased 2.8% or $4.6 million to $169 million for the three months ended September 30, 2008, up from $164.4 million for the same quarter last year. Acquisitions accounted for $11.3 million of these sales. Organic sales declined 4.1% from the same period last year.

Gross profit as a percentage of sales was 17.9% compared to 17.4% in the same period last year. Transactional margins accounted for 0.8% of the increase but were offset 0.4% by higher transportation cost. EBITDA for the quarter was $4.9 million which was a decrease of $1.1 million from the year earlier quarter of $6 million. The change in EBITDA was due to the increasing gross margin driven by the increase in sales volume which contributed $0.8 million and gross margin profitability which added an additional $0.8 million. In this profitability, transactional margins increased $1.4 million but were offset $0.7 million by higher transportation cost.

SG&A expenses increased $2.7 million driven primarily by the Kane Vet acquisition and fuel cost. Net income for the first quarter was $0.3 million, down from the first quarter last year net income of $1 million. The GAAP diluted income was $0.01 per share for the quarter. The non-cash amortization of intangibles was $1.2 million for the quarter for those of you who add it back to your models. Earnings per share without non-cash amortization was $0.06.

At the end of September, there were 45 days of working capital. Our average for the last 12 months was 46 days. Debt increased during the 3-month period by $4.4 million is driven by inventory purchases. Capital expenditures were $1.1 million and availability on asset based loan at the end of September was $31.8 million.

Due to lower spending by production animal customers whose profits have been constrained by fluctuating commodity prices, the company is reducing its guidance for 2009. Net sales are now expected to be in the range of $650 million to $680 million. EBITDA will be in the range of $29 million to $33 million and net income is expected to be in the range of $7.3 million to $9.3 million. This guidance excludes any affected future acquisitions.

Earnings per share are expected to be in the range of $0.30 to $0.38, or without non-cash amortization $0.49 to $0.58.

And now I’ll turn it back over to Jim.

Jim Robison

Thanks Bill. Although we anticipated a relatively slow quarter, first quarter coming into the fiscal year, results fell short of our expectations while the depth of our nation’s financial crisis and broad economic recession was a factor. Our short fall is largely caused by the high volatility and commodity prices which prompted our production and moved customers to the way of their decisions to buy and sell animals. In addition, many producers hedge their feed cost in then opportune time in response to the high-price volatility further increasing our losses. Also, the general economic downturn did affect our Companion Animal product sales most notably in the incline [ph] market.

Universally, these are very difficult times for our customers. In response to the results for the quarter and the challenging times in our industry, we have announced the following actions: freezing wage and salaries, suspending management bonuses, consolidating non-performing locations, reducing headcount where appropriate, reducing fuel utilization and freight cost, and adjusting our credit policies and pricing procedures. We regret the need for many of these actions. However, our primary intent is to better position the company for the long term by leaning up and refocusing our efforts during these challenging times. Most importantly we believe that the changes in our markets are not structural. In the near term, as commodity prices have moved downward and should prices stabilize the production animal market will likely return to normal levels. We believe that the long-term opportunity to expand our core business organically and through acquisition, grow our proprietary product sales, and grow our Companion Animal product sales remain strong. In spite of this very disappointing quarter, our management team is enthusiastic and executing well on our plans. We have more energy and focus on key initiatives than ever before and we’re positive about our long-term future.

I will now open the call up for questions.

Question-and-Answer Session

Operator

(Operator instructions) We’ll take our first question from Lisa Gill with JP Morgan.

Lisa Gill – J.P. Morgan

Hi. Thanks very much and good morning. Jim, can you just give us an idea of the timing aspect of when you think things potentially could return to normal? I mean, if we’re certain to see commodity prices come down as you’re having discussions with the farmers. I mean, are they giving you some timeline? And then, secondly, are you running into any credit – I think you’ve talked about credit procedures within your press release. I mean, are you running into any bad debt issues as you’re going through this period? And then just lastly, I think one of the bright spots in the quarter will just be that gross margin was better than what we are looking for. Can you maybe just talk a little bit through what you saw there and what your expectations are in the market inside and going forward? Thanks.

Jim Robison

Lisa, let me ask Bill to comment first on our experiences around our receivables.

Bill Lacey

Lisa, our day sales outstanding are right at 40 days. A year ago September, they were at 40.1. Our aging have not deteriorated and we don’t see – we haven’t seen any individual customers that give us any heartburn that we have had in the past. Of course, the agri [ph] business is made up of very conscientious people that are proud to pay their bills and they do so very regularly, so we’ve seen no deterioration on the receivable side.

Lisa regarding our – well, we think the market will turn around. We were very surprised to see the results of the last several months that we’ve seen. We usually see a building of activity that starts sometime as often as early August, and then builds through October, peeking at the end of October. This is called the fall-run in our vernacular, industry vernacular. We simply did not see that run this year. The causes are the rapid fluctuation in commodity prices that have caused real risks in buying in animals combined with the fact that most recently in the last 30 days we’ve seen feeder cattle fall off substantially. So people are holding back and allowing their animals to feed on grass or weed.

We have seen commodity prices come down across the board. The problem with this is that protein prices have come down as well. You still can’t invest in cattle right now and hedging economy, the profitability, and the transaction. Because of that, people are still holding back and waiting. I think the unprecedented volatility and the fact that historically we’ve seen corn as high as $5 a bushel in the last several months. We saw it approached $8 dollars in today’s trading. I think that concern and uncertainty about where grains will settle out is causing people to hold back. Having said that, the beef cattle are born and raised to be slaughtered in a 24-month period on average or so, and they’re going to come through at some point in time. It’s just a matter of when.

The placement of animals over 800 pounds is at an all time high. The placement of animals under 500 pounds is at an all time low. This is, again, primarily the effect of high corn prices relative to protein prices, but we do believe that ultimately commodity prices will normalize and that the markets will come back. We anticipate that this will begin in ‘09. We’ve made that statement in past conference calls and we’re anticipating that in the next calendar year we’ll see a normalization of markets.

Lisa Gill – J.P. Morgan

And when you say that booking of the guidance that you’ve given, would you say that that guidance is based on what you know today? Would you say that it’s more on the conservative side that perhaps things don’t come back right away in 2009 or that you are – you are assuming that the things are going to start to recover in 2009, so we understand how you’re thinking about things.

Bill Lacey

Lisa we – I hate to say this but I thought we were fairly conservative at our first guidance at 38% to 40% of EBITDA. These markets are strange and it’s hard to predict where the protein prices are going to go. As Jim said, the grain prices have dropped but protein prices have dropped just as fast and in much relief for our customers. So, I feel that these are conservative. We widened the range a little bit and dropped it obviously.

Another factor other than sales volume, well aside from volume there’s two other factors. One was a $1 million. If you take the mid points, there is an $8 million drop in the EBITDA. A $1 million of it was currency coming from our Canadian operation where we were at about parity when we put our original plan together, the nets, and the exchange rate is about 0.79 or 0.8 right now. So that causes to reduce our guidance by million dollars right there, and we missed an August rebate that we thought we would get for about $800,000. Those were the two outside issues other than volume that affected our change in guidance.

Lisa Gill – J.P. Morgan

Will that $800,000 come back at some other point Bill or is it just gone at this point?

Bill Lacey

I think it’s gone at this point. It is volume related. I could have marked it in, there was a volume when I said – because it’s all volume related.

Lisa Gill – J.P. Morgan

Okay. I guess I just have two other quick questions and I’ll hop up but can you maybe give us some indication as to how cash flow looks at the quarter? I didn’t see it in your release. So number one, if you can talk about cash flow and then number two if you could just talk about liquidity. I think that you have $32 million on your line of credit. Is that correct?

Jim Robison

Hey Lisa before Bill answers that let me – you’d ask about gross profit.

Lisa Gill – J.P. Morgan

Oh, yes. I’m sorry I forgot about that one.

Jim Robison

As components of gross profit, we think freight trend is certainly very favorable. We have an initiative in place to not only take advantage of low fuel prices, that’s a kind of a passive realization. We’ve also initiated a process to look at consumption and we’re seeing very favorable results in that area. Around routing of delivery and sales calls, we think there’s a meaningful opportunity to reduce cost which will improve gross profitability certainly with freight side.

And then secondly we – the second component is transactional margin. We have a plan in place. We’re seeing good results on better managing our transactional gross profit margin. So in the long-term, we do think that will gradually take off. And then rebates, we had some relatively uncertain and challenging times about rebates. We think this year we’ll hit a bottom on rebates and starts to graduate recover over time. So long-term, we’re relatively favorable about gross profit margins in that we’re seeing an uptake in the sale of our proprietary products. We think that will be accomplished.

Lisa Gill – J.P. Morgan

Okay. Great.

Bill Lacey

Lisa, as far as the cash flow, you honestly look at the cash flow statement when the Q comes up this afternoon. But the real major cash flow for us as a leverage company is an increase in our debt during the three-month period of about $4.4 million, which was all driven by inventory purchases as we had some advantage. We took advantage of some purchasing opportunities with two of our vendors at the end of the quarter, and compared to last year we have an overall effort to increase our bill rates and sales. But if you look it on a day’s basis, we had about 68 days in inventory at the end of September compared to about 62 days a year ago.

Lisa Gill – J.P. Morgan

Okay. But you said you feel pretty good about where you are from the liquidity and cash flows that you have enough cash to continue to run the business.

Jim Robison

I do. If you look at our debt covenants, we have a fixed charge ratio that we have to abide by, that is $1.1 million and we have about – I do like to calculate right in front of me, but we have about $13 million cushion between our last 12 months EBITDA and what it would take to violate that covenant.

Bill Lacey

Availability?

Jim Robison

Yes.

Lisa Gill – J.P. Morgan

Right.

Jim Robison

Availability is about $31 million at the end of the quarter.

Lisa Gill – J.P. Morgan

Okay.

Jim Robison

Make that $31.8 million at the end of the quarter.

Lisa Gill – J.P. Morgan

Okay, I think I saw that. Okay, great. Well thanks for the comments. I appreciated it.

Operator

We’ll go next to John Kreger with William Blair.

Natalie Nabern – William Blair

Hi thanks. It’s Natalie Nabern [ph], for John today. I was hoping if you could just give us an update on the beef, dairy, and poultry businesses and how each of those performed relative to your expectations? Were they all worse than you expected or are you seeing any bright spots there?

Jim Robison

We have not seen any bright spots here today. The worst performing business is our beef business. That is all, substantially. The dairy growth has slowed. That’s primarily around a tremendous supply of milk currently and protein prices falling from a high of about 21 to the current level of about 15. But the dairy business has grown at a compounded [ph] rate over ownership of the company of 11 years about 8% or so. That is not currently the growth rates that we’re experiencing. On the poultry and swine side, I think we’ve seen a couple of public companies reports, Smithfield and Pilgrim’s Pride, Pilgrim’s Pride with substantial problems relating to these fluctuations in commodity prices, so that’s a strained market as well.

Natalie Nabern – William Blair

Okay. And then, if you can just give us an update on Companion. I know you said that was lower this quarter but I think previously you expected that business to swing to an amount of profit this year. I’m wondering just what your latest thoughts are.

Jim Robison

Yes. We’re investing in new reps. We have about eight outside and eight inside reps more this quarter than we had last year, and we’re seeing improved profitability in the Companion business and we’re seeing encouraging signs.

Natalie Nabern – William Blair

Okay, great. And then, can you give us an idea of when you’ll expect some renegotiating contract with your large expenders. Is that still expected to be in the calendar first quarter event and do you expect any meaningful changes in those contracts?

Jim Robison

We’re always hopeful that we can get those scrimmages [ph] done earlier rather than later. Having said that, it jus really depends on where we start. We’re anticipating starting discussions over the next couple of weeks, and we’ve seen those negotiations become protracted but we’re hopeful to get that done in the first quarter of the calendar year.

Natalie Nabern – William Blair

Okay. Thank you.

Operator

(Operator instructions) We’ll take our next question from Jeff Johnson with Robert Baird.

Jeff Johnson – Robert Baird

Thank you, guys. Good morning.

Jim Robison and Bill Lacey

Good morning Jeff.

Jeff Johnson – Robert Baird

A couple of questions here if I could, one on guidance, how – as I back out your revenue guidance and then the last stop of Kane that will impact next quarter from an acquisition standpoint. It looks to be like organic growth for the year could be down in the 8% to 10% range versus 4% this quarter. So, do we think about things like take it getting worse here before they get better? Is that a fair characterization?

Jim Robison

Jeff, if you look at these points of guidance this time versus our original guidance, we’d be down about $95 million. And about $10.5 million of that is from currency exchange in Canada. So if you back that out, you’re pretty close. It would be about an 11% of decline in sales. Now, keep in mind that you mentioned Kane. Kane is pretty much apples and apples after this quarter. We bumped them in somewhere around the middle of October, so very little impact on the next quarter.

Jeff Johnson – Robert Baird

No. I understood that, I guess – will you say the 11% decline in sales after accounting for effects that’s on a reported basis for the year?

Jim Robison

Yes. And keep in mind about that number which would be net of currency would be $85 million decline. We’ve already seen 16% of it in the first quarter. So, yes, you could say we’re expecting a little bit worse before it gets better.

Jeff Johnson – Robert Baird

Yes. I just wanted to make sure that was my read as I went through it but – Jim, we’ve spoken in the past about the dairy business. I think in the history of the company, it is hit a low point of maybe 4% growth at high point of 12%, if my notes are accurate here anyway. Do we expect this could be a year of studying a new low then on dairy? I’m just trying to think if beef is down, and we know it was down just a little bit last year, getting into this organic growth number to me it almost has to be that dairy comes in pretty meaningfully versus last year is up 8% or 9%.

Jim Robison

Yes. We’ve never experienced the dairy business contracting. And as we look forward, there’s a pretty healthy buy back under way so we’re anticipating protein prices and milk prices either stabilizing or possibly going up. Some gradual improvement possibly in the dairy business but we’re not – we’re looking at the year as possibly being flat to prior year.

Jeff Johnson – Robert Baird

The dairy business being flat?

Jim Robison

That’s right.

Jeff Johnson – Robert Baird

Is that right? All right. And then, Bill, just last question I guess from me. You talked about this $13 million EBITDA question you have with your covenants. What would that be of – what number for fiscal ‘08 because there were a couple of adjustments if you remember last year? Is that off at $37 million EBITDA number in ‘08?

Bill Lacey

It’s a last 12 months so it’s always rolling. And following it down with million dollars is right at $36 million.

Jeff Johnson – Robert Baird

Okay. So $36 million on a rolling basis if you were to open the next 12 months to drop below $23 million I guess would be the max when we’d have to worry about the covenants?

Bill Lacey

That’s right.

Jeff Johnson – Robert Baird

And your guidance right now suggests that should not be an issue anyway?

Bill Lacey

That’s correct.

Jeff Johnson – Robert Baird

Fair enough. That’s all I’ve got guys. Thank you.

Bill Lacey

Thanks Jeff.

Operator

We’ll take our next question from Mark Arnold with Piper Jaffray.

Mark Arnold – Piper Jaffray

Good morning. I think a lot of my questions have been answered here. The last questions are asked about the dairy business and you talked about that being flat in your guidance. Can you give us a little more granularities in terms of how in your guidance at least directionally you see the beef and poultry businesses as well – what the assumptions that are baked into your lower end range?

Bill Lacey

Mark, we’ve never gone that granular on these things. And the only thing I would point out is that poultry is a minute piece of our business, so that’s irrelevant to this. But the dairy business is, Jim, I think pretty much said, is at – we’re looking at a flat to slightly down market for the dairy business and it’s the beef business that is – and the beef and the cattle operations that have hurt us the worst.

Mark Arnold – Piper Jaffray

Okay. And then, you talked a little bit about the fall-run that didn’t happen this year. Maybe just at a high level, can you talk at all about the behavioral changes that you might be seeing in your customers here in the last month or two as a result of the financial meltdown? And anything that’s surprised you or just behavioral changes in general that might be affecting how we look at the next few quarters as well?

Jim Robison

Let me give you as quickly as I can. You may want to call afterwards we can talk about it in more detail. But if you look at grain prices historically and corn is the bellwether of grain prices, corns range between $2.50 and $3.50 a bushel. The seed corn is at $8 a bushel was 50% higher than anyone had anticipated, and completely unprecedented as a price commodity use primarily to grow proteins. And we also saw wheat that is absorbing better than the $3 to $5 bushel range hit almost $13 a bushel. So these numbers have never been seen before.

Historically, people with cabin animals they would wean it. They would take it to either grass or weed. They’d wean it at 350 pounds to 500 pounds, take it to grass or weed, hold it there for four months or so and then take it to the feedlot. They might put it in earlier in the feedlot if corn prices were cheap. Let’s say under $3 a bushel. That behavioral set now is completely disrupted because of the cost of the grains. It used to be the price of proteins. You can’t make profit putting animals in the feedlot early today. Therefore, heavier animals have gone into the feedlots consuming. We estimate about as much as 35% less animal health products because they’re kept on grass longer, and people aren’t cycling the animals through the CalCAP [ph] stock or feedlot environment as that historically. Thus, that market is down substantially.

Again, we’ve seen record high placement of heavy animals and record low placement of light animals. As long as we maintain our ethanol policies, which we got a question given what we’ve read recently about producers going bankrupt in spite of subsidies. We’re going to see problems with corn unless proteins become more expensive. We think that ultimately people’s consumption patterns are going to remain what they’ve been historically but not only domestically but internationally. People are going to consume more proteins and the prices will provide producers a return. We just can’t exactly predict when that will be. But you can call us afterwards. We can go into more discussion about the behavioral changes.

Mark Arnold – Piper Jaffray

Sure.

Jim Robison

To point out one thing, our last call I believe we talked about milk futures being in the $20 and $21 range for, I think, that was actually November and December numbers. And right now, milk is in the $15 to $16 range, so there’s a wide swing in the price of milk and what people thought it was going to be, not 60 or 90 days ago. And I think the end total evidence is that the vast majority of our customers are just saying. “Hey, if I have a discretionary decision around any spending, I’m going to decide not to make it.”

Mark Arnold – Piper Jaffray

Okay.

Jim Robison

So if they have a relatively whole dairy cow, and it gets sick, are they going to treat it or they’re going to call it? Right now, because it’s either marginally profitable or not profitable on that dairy highlight, but it is not going to call it, they’re probably not going to replace it.

Mark Arnold – Piper Jaffray

Okay. And just one more followup on something you mentioned earlier. You talked about the high volatility and commodity prices that many farmers hedged their input costs in opportune times. How long do those hedges – how long or how far out are those hedges typically and – does that carry through for some period of time here or that we will start to see, with grain prices being down a bit from where they were this summer obviously, will we start to see some improvement there?

Jim Robison

Generally, people buy 60 days in advance. Sometimes a little bit longer. I think what happened recently was people became extremely concerned about viability. And we saw – all of the disclosures from Pilgrim’s Pride indicated that they bought corn, and I think in the six to mid-six range, and significantly hedged and that caused substantial losses. We’ve had customers that have gone out a year out of fear on volatility and that’s pretty unusual, and those who did generally did it at an opportune time. They’re realizing the substantial losses. Having said that, if you didn’t hedge and you’ve fettered [ph] a beef animal over the last four months, the likelihood that its average beef prices probably puts you in a position such that you’re going to lose $150 to $200 ahead right now, which is a very high loss in the beef business. So even if you weren’t – even if you did not have a long-term hedge on and you’re finishing up with production of a beef animal right now, the likelihood is that you’ve lost substantial money.

Mark Arnold – Piper Jaffray

Okay. I have just one more question. When we look at the September quarter and the volume weakness there, to what extent – I guess the question is across all products and to what extent has the weakness had any impact on mix and therefore your gross profit margins?

Jim Robison

It’s generally concentrated in – our short fall is, generally, most concentrated in the beef business and it’s been an area that we’ve seen is a substantial reduction in the high-end antibiotics, which are usually used for animals that are acutely ill and are anticipated to yield a profit. People will step down and use the cheaper antibiotic. I think that correlates the human rather than using a pork quinolone [ph], you will use an amoxicillin or something to treat your cold and you will. So, again, the customers right now are doing everything they can not to spend money and certainly not to invest in new animals.

Mark Arnold – Piper Jaffray

Okay. So you’re not really seeing the mixture of having an impact one way or the other on your margins overall though?

Jim Robison

Not really.

Mark Arnold – Piper Jaffray

The gross margins? Okay. Great, thank you.

Operator

(Operator instructions) We’ll take our next question from Mario Cibelli with Marathon Partners.

Mario Cibelli – Marathon Partners

Yes. I’m just wondering if you can talk a little bit about the hedging outside the CAPEX budget for fiscal 2009 and uses of free cash flow this year? To the extent that it’s substantial and you have to do something with?

Jim Robison

Yes. Mario, we have a business plan. We started this year with $5 million which is up about a $1 million dollars from our normal, and it evolves around some pricing software that we’re in the middle of implementing, as we speak. Given the recent downturn, we’re looking at everything in that budget. We’re still going to put the pricing stop, where we think that’s critical to maintain in improving our margins. But we have a covenant at $5 million. We’ll stay under our covenant. We spent $1.1 million in the first quarter but a lot of these, in fact 70% of our normal CAPEX, is just cards and those computers. And there’s nothing extravagant in that list except for the software for the pricing program. We’ll probably cut it back but it will be somewhere between $4 million and $5 million this year.

Mario Cibelli – Marathon Partners

And then on your free cash, I assume you’re going to be a bit more conservative around acquisitions in here and anything, maybe you’ll see some cash build or that pay down or something?

Jim Robison

First of all, we’re in a lot of discussions, we’re still – obviously it’s a tough quarter. We’re still enthusiastic about the long-term prospects and if we get an acquisition that makes sense for us and under normal market conditions, we believe, it’s accretive and digestible and it doesn’t cause undue risk, we’re going to do our best to make it. And Mario, our definition of undue risk is probably a little tighter than it was a year ago.

Mario Cibelli – Marathon Partners

Okay. Thanks.

Operator

At this time, we have no further questions in the queue. I’d like to turn the conference back over to Mr. Robison for any closing remarks.

Jim Robison

Thanks for joining us and we appreciate your interest. Good day.

Operator

This does conclude today’s conference. Thank you for your participation. You may now disconnect.

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