Animal Health International F1Q10 (Qtr End 9/30/09) Earnings Call Transcript

| About: Animal Health (AHII)

Animal Health International, Inc. (NASDAQ:AHII)

F1Q10 (Qtr End 9/30/09) Earnings Call

November 3, 2009 10:00 PM ET

Executives

William F. Lacey - Chief Financial Officer, Senior Vice President

Analysts

John Kreger - William Blair

Atif Rahim - JP Morgan

Chris Sassouni - Eagle Asset Management

Jason Bednar - Robert W. Baird

Andrew Cash - Point Clear Value Management

Presentation

Operator

Greetings and welcome to the Animal Health International first quarter 2010 conference call and webcast. (Operator's Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. William Lacey, Chief Financial Officer for Animal Health International. Thank you, Mr. Lacey, you may begin.

William F. Lacey

Thank you and good morning. This is Bill Lacey, and I'm the CFO of Animal Health International. Jim Robison our CEO and the normal host of this call are meeting with some of our key customers and could not be with us today. I'd like to thank you for joining us as we report our results for the first quarter of fiscal year 2010.

I will discuss our financial results for the quarter as outlined in the earnings release and then open up the phone lines to Q&A.

Before we begin I'd like to point out that today's conference call is being recorded and will be available for replay on our webpage at ahii.com under investor relations. In addition I'd like to remind everyone that some of the information discussed on this call, particularly our guidance for fiscal year 2010, our competitive position, future business prospects, revenue growth, and market opportunities for the coming fiscal year, contains 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 risk 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 generally accepted accounting practices or GAAP, AHII reports certain non-GAAP financial results including EBITDA. Investors are encouraged to review a direct reconciliation of these non-GAAP financial measures to the comparable GAAP results which can be found in the press release.

Finally, AHII has provided in its earnings release and will provide in its 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. AHII does not assume any obligation to update the forward looking statements provided to reflect events that occur or circumstances that exist after the date on which they are made.

I'll now provide you with the financial results of our first quarter of fiscal year 2010.

Net sales decreased 4.6% or $7.7 million to $161.3 million for the three months ended September 30th, 2009. That's down from $169 million for the same quarter last year. Lower spending by production animal customers whose profits have been constrained by commodity prices is primarily to blame. Gross margin declined $4.4 million with $1.4 million due to lower sales volume, $1.8 million due to lower margin at our largest supplier, and $0.6 million due to a one-time promotion in the first quarter of last year of one of our key proprietary brand products. Margins in the first quarter were 16.1% of net sales compared to 17.9% in the first quarter last year.

SG&A expenses declined $2.9 million from last year as a result of lower variable selling expense and cost reductions. EBITDA for the quarter was $3.4 million which was a decrease of $1.8 million from the year earlier quarter of $5.2 million.

Net loss for the first quarter was $0.7 million down from the first quarter last year net income of $0.3 million. GAAP diluted loss per share was $0.03 for the quarter. At the end of September there were 40.4 days of working capital, our average for the last 12 months was 46.7. Capital expenditures were about $900,000 for the quarter and the fixed charge ratio is 1.2 times on a trailing 12 month basis.

I'll discuss guidance for a minute here. The company believes that economic factors affecting our industry will improve in the next 12 months. Although the exact timing of the recovery is difficult to predict, the company is currently projecting that conditions will improve in the third quarter of fiscal year 2010. Revenue for the fiscal year ending June 2010 is expected to be $650-$685 million. EBITDA is estimated to be $22-$27 million and net income is expected to be $2.3-$5.3 million or $0.09-$0.22 per share.

The company does not expect significant improvement in its end markets in the second fiscal quarter. Revenue for the second quarter ending December 31, 2009 is expected to be $170-$175 million. EBITDA is expected to be $4.5-$5.5 million and net income is expected to be between a loss of $0.2 million and a profit of $0.4 million, or a loss of $0.01 to a profit of $0.02 per share.

At September 30, 2009 the company's availability under its revolver totalled $33.1 million and the company is in compliance with all of its financial covenants.

With that, I'd like to turn it over to questions and answers.

Question-and-Answer Session

Operator

Thank you. (Operator's Instructions) Our first question comes from John Kreger of William Blair.

John Kreger - William Blair

Thanks very much. Hey, Bill. So when we do a rough calculation of your trailing 12 month EBITDA for covenant purposes it looks like when the December quarter ends you'll be around $15 million. Does that seem about right versus your guidance, and does that put you in any sort of a dangerous position relative to the covenants?

William F. Lacey

December in our forecast will be our tightest covenant quarter and we will be slightly over — we will have about a 0.1 turn over our requirement in our term note which will be about — that will give us about a $1.2 million cushion in there if our projections hold out.

John Kreger - William Blair

A $1.2 million cushion in EBITDA?

William F. Lacey

Well, in the whole calculation — in the excess over the debt service and interest, tax interest over — the rest of the calculation is EBITDA less CapEx and taxes paid. And I believe that your number 15 is probably a little optimistic for EBITDA for the trailing 12, but we'll gt some benefit from taxes on a trailing 12 basis.

John Kreger - William Blair

Okay. But the key here is if you can get through the December quarter without a problem, that cushion should grow from that point?

William F. Lacey

I believe that is the case, John.

John Kreger - William Blair

All right, great. Second kind of related question, when we were doing the math it seems like your full year EBITDA guidance, about a third of that comes in the first half and maybe two-thirds in the second half. What's really driving the pickup that you expect? I know you mentioned that you think the market environment will improve, but is there anything else to point out to kind of build conviction that you can get that sort of ramp in the second half.

William F. Lacey

The thing that gives us comfort is the futures markets and through this whole downturn we've seen the futures markets, if you will, back up on us. And we would look out 60 or 90 days and we would see that milk prices were, for example, $13 or $14, and as we closed in on that date they would back up on us and end up in the $12 range. I'm just throwing numbers out there.

What we've seen right now is if we look at any of the numbers, the January futures right now are 14.79, February 14.90 — I'll just read, you know, 14.92, 15.07, and 15.12 for May. And these numbers have been fairly consistent now for some time and they have not backed up on us. The dairy herd has been thinned out. I haven't looked at any numbers this week. I think we're probably down to about a 9.1 million head dairy head population and I think everybody's consensus was that at around 9 million head it would start to turn and that's what these futures markets reflect.

The other thing is if you look at the live cattle markets, December’s 86, February's almost 88, April is 89, we’ve been trading in the low 80s most recently so there's a future out there in the beef markets, and I think Jim went into pretty good detail at the end of our last conference call pointing out that if you fed cattle right now you could probably lock into a small profit using your — locking into grain prices and all that kind of stuff.

All of the futures markets are going in our favor with the exception right now of corn markets which are probably in the 3.90-3.95 range right now and they're up because of all the moisture we’ve had in the Midwest. I was looking at something yesterday that said they expect a 10-day window of no precipitation in the Midwest which should be hopefully enough time to get this corn crop in and I think if we get this corn crop in as expected it'll be a bumper crop and these corn prices will drop back real quickly.

So, the reason they're up right now is just uncertainty around getting this crop in.

John Kreger - William Blair

Okay, got it. And next question —

William F. Lacey

Hey, John let me add one other thing I want to look at. If you look at our decline in revenue quarter over quarter for the last three quarters, if you go back to the second quarter of last year, our sales declined 9.2%, the third quarter down 11.6%, the fourth quarter of last year down 8.9%, and now we're down 4.6% in this quarter. So you can see, I think, in that trend, that we've kind of turned the corner there in the third quarter being our lowest decline year over year and we've been coming out of this a little bit and very slowly as we've moved forward.

John Kreger - William Blair

Great. Bill, how do you feel about collections given the pressure, especially in the dairy market? Have you seen any write-offs and what have you done to your bad debt reserve?

William F. Lacey

Our bad debt reserve has not changed materially forever. Our ageings have been very consistent, if not improving. We understand there's risk out there, but we've just not been able to put our finger on anything — our reserves are based on very specific calculations of ageings and average write-offs and different factors that go into it and there's nothing out there that we’ve seen so far.

We have seen individual cases where a dairy here or there has gone out of business and we’ve had some of them as you’ll find — this is a really great industry. We've had a couple of them go out of business that wrote us a check when they closed their business and paid everything they owed us. So it's a little bit different than business on the other side.

John Kreger - William Blair

Um-hum, great. And then one final question, can you give us your latest thinking on the supplier mergers that are happening now? In aggregate, do you view those new corporate entities as helpful or negative to your economics? And if you could get a little more specific which of the changed ownership structures has helped or hurt you?

William F. Lacey

I don't see anything with the Burt (inaudible) having an effect on us right now. But I will describe the Fort Dodge or the Wyeth acquisition by Pfizer. We've historically done — I probably shouldn’t' say exactly what our number is, but we've got about 75% of the Fort Dodge number is appearing to go to Boehringer Ingelheim and that's most of the large animal product. Mastitis tubes, cattle vaccines, de-wormers, all that. The only real large cattle product that was being manufactured by Fort Dodge that was kept in the Pfizer deal was growth implants and so it's about a 75-25 split. 75% of the product that we were getting from Fort Dodge is being moved over to Boehringer Ingelheim due to the federal trade regulations.

So we're pretty encouraged by that, and our relationship with Pfizer, I think, has improved. As we noted earlier in our last call we've started paying commissions again on Pfizer and had a pretty good month actually in September moving Pfizer products. As we know, Pfizer has lower margins than others and it contributed to the decline in our gross margin percent, but I think our relationship with them is improving.

John Kreger - William Blair

So do you think that 75% that goes to Boehringer Ingelheim, will those economics be pretty comparable to what you're getting from Fort Dodge or better or worse?

William F. Lacey

I don't know yet. I wouldn't expect them at all to be worse. I would expect that hey would be pretty even. We've got meetings going on — this is the time of the year where we meet with all of our vendors. We'll start to see their programs probably in late November and December for next year and so far we've held several meetings with vendors and to date I'd have to classify them as a wait and see by everybody. It's kind of a — Mr. Robison calls it like a jump ball for next year. Everybody is kind of waiting to see how it plays out and I don't think anybody wants to make the first move right now. So we'll see how this plays out. I think the worst case is that it stays like it is. I think we've got really nothing but upside for next year right now.

John Kreger - William Blair

Great, thanks very much.

Operator

Our next question is coming from Lisa Gill from JP Morgan.

Atif Rahim - JP Morgan

Hi, thanks. It's Atif Rahim in for Lisa. So Bill, last quarter I think Jim had mentioned you did see an improvement in dairy economics and now you're saying that there is a slight improvement in beef economics too. So as you look across your customer segments, did you say the dairy customers are kind of back in business and beef is just improving? I think relative to our revenue estimates you came in higher so I'm just trying to look where the revenue upside could have come from.

William F. Lacey

We do believe that we'll have, and this is only slightly reflected in these numbers, a fall movement of cattle this year as we've had some decent wheat pasture. We haven't had that in a couple of years so I do think that the beef markets are improving slightly, we have seen — but the milk hasn't moved — keep in mind that one of the things that drives this business is the calf markets and a milk producing cow has to calve every year in order to continue to produce milk. And with the thinning of these herds and the lack of demand for beef, these calves have pretty much just been rendered at birth.

And so as these markets improve, then they will begin to keep the calves either for beef or for replacement heifers into the dairy markets and as this happens then they start buying milk replacers and all kinds of things that go into the growth of a calf, not to mention implants and vaccines and stuff like that. So we're encouraged that that will happen. And again, I don't think that a lot has changed since our outlook of 60 days ago when we did our last call other than to say that our futures markets seems to have firmed up and continue to get better.

Atif Rahim - JP Morgan

Okay. And of the thinning of the herd, that seems to have stabilized at this point?

William F. Lacey

I think there's still a little bit to go at this point. I think there's probably another 100-200,000 dairy cow to come out of the population, but I think that'll be done around the first of the year.

Atif Rahim - JP Morgan

Okay, got it. And then second question on the revenues moving over to Boehringer Ingelheim, could you remind us how much business you do with them or what percentage of your COGS come from Boehringer at this time?

William F. Lacey

I'd really rather not do that. That's just kind of a competitive issue with us.

Atif Rhaim - JP Morgan

Okay, got it. Thanks very much for the comments.

Operator

Our next question is coming from Chris Sassouni with Eagle Asset Management.

Chris Sassouni - Eagle Asset Management

Yes, good morning. I wanted to know whether the breakeven point for both the production animal framers and the dairy farmers has changed much. I mean, not only has the demand gone down, but I didn't know if there fixed costs were such that their breakeven point can't really change all that much and/or the input prices have adjusted. So as we look out at the futures prices, there were some numbers that you had given us, I think in the high 90s, mid to high 90s was the breakeven point for the production animal farmers and I forget what it was for the milk farmers or the dairy farmers, so could you tell us where you think those breakeven prices might be today?

William F. Lacey

Yeah. I'll be glad to, and that's a moving target because of all the different input commodities as well. When we said that it was in the 90s for the beef range which is, I believe, what you're referring to, that was probably when corn got up to $8 a bushel. So now that corn is less than four and if we get a good harvest this time I think they'll get back down closer to $3.30-$3.50. Then I would estimate that a breakeven on the beef side would probably be in the lower mid 80s, and then on the dairy side we're probably talking around — and then this is all depending on the size and efficiency of a dairy in the $12-$14 range for milk prices. So when we talk about the upper $14-$15 range here, they should be making money again after the first of the year.

Chris Sassouni - Eagle Asset Management

Okay. And so that's where you're getting the confidence in a Q3 turnaround?

William F. Lacey

Yes, sir.

Chris Sassouni - Eagle Asset Management

Okay. And then what was the free cash flow for the quarter?

William F. Lacey

We did 3.4 — we spent 900 in CapEx —

Chris Sassouni - Eagle Asset Management

So about 2.9?

William F. Lacey

Yes. That's about right.

Chris Sassouni - Eagle Asset Management

Okay. And then what flexibility do you have if for whatever reason you end up touching the covenants during this upcoming quarter? Are there penalties that you pay, does the interest rate go up? What exactly happens?

William F. Lacey

Speculation is all I can do about that. I do have some control for things such as bonus and 401(k) accruals. That can be $0.5 million, somewhere in that range; to $0.75 million of bonuses which I will not accrue if I'm close to that covenant. What was the second part of that question, I'm sorry?

Chris Sassouni - Eagle Asset Management

What would the penalties —

William F. Lacey

Oh okay, right. We have two sets of vendors here. We've got an asset-based revolver group led by JP Morgan. These guys are much more concerned about collateral and availability than they are about a fixed asset coverage number. The penalty there would probably be a waiver fee of a couple hundred thousand dollars and we'd probably have to report collateral more often than we do so I don't see it being a real big deal with the asset-based guys. The term-note guy like I said we've got about 1.1-1.2 million, I don't know exactly how they would react. I think they would probably go for a pricing change since our term note is way, way under market pricing. It is at LIBOR plus 200, and if they had the opportunity by a breach of covenant they may come in and try to change pricing.

Chris Sassouni - Eagle Asset Management

But it's not specific in the agreement or you're just not willing to say?

William F. Lacey

It's really not specified what the (inaudible) rate is.

Chris Sassouni - Eagle Asset Management

Okay. Thank you.

Operator

The next question is coming from Jason Bednar with Robert W. Baird. Please state your question.

Jason Bednar - Robert W. Baird

Hi, thanks for taking the questions. First, wondering what efforts you might be taking to improve the drag that Pfizer's having on your gross margins as we enter into calendar 2010?

William F. Lacey

That's a question, Jason, I can't answer until I see the contract for next year and we will react to what their contract is in our customers’ and our company's and Pfizer's best interest, or any other vendors.

Jason Bednar - Robert W. Baird

Okay. But needless to say we should think of it a bit more positive as the relationship is improving or just can't really even comment on it yet?

William F. Lacey

Really can't comment on it yet. I mean it's not that I don't want to we just don't have any information yet on what next year's programs are going to be. I think the Pfizer, Boehringer Ingelheim, and — I mean, they are busy doing the integration of these companies right now. They haven't probably spent a lot of time on next year’s programs either.

Jason Bednar - Robert W. Baird

Okay. That's fair. I guess moving into the coverage ratio issue, wondering why you would have made some of the short-term strategic moves that you made after just closing some of the hedges. It felt like market dynamics improving a bit that wouldn’t need to be the case, but it still seems like in some of your comments earlier that we might still be worried a little bit on the debt covenant issue.

William F. Lacey

We did unwind an interest rate swap if that's your comment. And that saved us for the December covenant, probably save us about $900,000 to $1 million in that coverage ratio. And that was the reason for doing that and effectively the only cost of unwinding the thing is — I mean it is the present value of the future tax closed is what you pay in the unwind so it shouldn't have had a long-term cash flow effect on us. And we had the availability to do it so we it.

Jason Bednar - Robert W. Baird

Okay. And then I guess moving to the beef market and your business, and sorry if I missed it earlier, are your beef revenues up or down? Similar comments to last quarter or how would you characterize that?

William F. Lacey

Similar to last quarter.

Jason Bednar - Robert W. Baird

Okay. And then a final couple of questions on the companion business, first, could you provide an equine market update? And then same thing on the dog and cat side of the business just how things are trending there? And then last quarter you had talked about some expansion plans you're putting together for the companion business, wondering when you might begin executing those plans as well as any costs we should expert to be involved.

William F. Lacey

I'll comment on the vet markets. Our vet business has held up very well throughout this whole downturn, in fact, showing improvements in several quarters. The equine markets right now are kind of flat to down and the equine markets have been hit harder than the small animal markets. And when you look at our overall companion animal business, probably 70%-80% of our companion business is equine. So we don't have a large exposure to the small animals, but our companion business, our vet business in general has been relatively flat for the last couple of quarters the last year.

Jason Bednar - Robert W. Baird

Okay. And then the expansion plans that you had talked about last quarter?

William F. Lacey

Still in process.

Jason Bednar - Robert W. Baird

In process — and then nothing you can comment on the way of cost we should expect and just kind of wait for any update on that in the coming quarters?

William F. Lacey

We're working on both fronts of this thing to reduce expenses and to continue expanding our business. We're looking for ways to consolidate where we need to and provide better service to our customers and at the same time grow our business in strategic locations and we're doing both of those at the same time.

Jason Bednar - Robert W. Baird

Okay. Very helpful, thank you.

Operator

Our next question is from Andrew Cash with Point Clear Value Management.

Andrew Cash - Point Clear Value Management

Hi, Bill. How are you doing? I am just thinking about as we look toward the future here it looks like the worst is over from a fundamental perspective with the profitability of the dairy and cattle improving. My question is as you look out the next year or two and you think about where you were a couple of years ago, have you lost any earnings power? In other words, have you picked up any new customers, have you lost some good customers? Where do you stand in terms of your market share and how you might participate in the (inaudible)?

William F. Lacey

That's a great question, Andy. Here's what I think. I think if you look back at our business, we're going to regain the volume that we lost. If you recall we were sitting at about a $38 million EBITDA June of a year ago and we'll gain that back, which if I recall, was about a $10 million impact at the June period so we'll gain back our volume loss.

And then we had a significant loss in margin from our largest vendor and we'll just see what that comes back to us. But I think instead of counting on that large vendor coming back with big margins, we're going out and acquiring business in other ways. We've got an environmental service group that when the dairy markets turn can be very profitable for us and contribute a large amount to our EBITDA. There are lot of opportunities around the flea and tick and heartworm business going forward. And so I think we can fill this hole with a lot of smaller items other than counting on one large vendor to make up lost ground.

Andrew Cash - Point Clear Value Management

Yeah. I was talking to some of your dairy customers, they (inaudible) product that you had out there, and I understand you have an exclusivity on that?

William F. Lacey

We do.

Andrew Cash - Point Clear Value Management

Okay. So in short, I mean you don't think you've lost any major customers or picked up any major customers? You don't really think you're losing any share so as long as the industry comes back you should be a full participant, absent maybe part of the Pfizer margins?

William F. Lacey

I think, Andy, that we probably lost some market share in the Pfizer business with our stance of not paying commission and not discounting the product. So for the first eight months of the year I think we lost some share in that area. On September 1st we went back and said we would go back and begin paying commissions and we saw a significant pickup in our Pfizer business in September.

Andrew Cash - Point Clear Value Management

Well, didn't they also lose some share because of the way they treated not just you, but the other distributors? So they've got a little rebuilding to do themselves so maybe that would lead them to be a little more generous with their rebate?

William F. Lacey

I like the way you think, Andy.

Andrew Cash - Point Clear Value Management

Well, isn't it the truth?

William F. Lacey

I hope so.

Andrew Cash - Point Clear Value Management

They did this in the past and then they had to come back and patched things up many years ago.

William F. Lacey

Yeah. Pfizer's a big organization with a lot of clout in this industry and I'd really like to see them come back with a better program for us next year, but I have no idea what they're going to do right now.

Andrew Cash - Point Clear Value Management

Okay. Thanks a lot, Bill.

Operator

There are no further questions at this time. I'd like to turn the floor back over to Mr. Lacey for any closing comments.

William F. Lacey

Just a few — we looked at this quarter and we went into it and we said we had a guidance range of 2.5-3.5 in our last conference call and we got to the higher end of our range at 3.4. It's not a great quarter, but it was the kind of quarter I felt we needed to turn the corner with, and like I said, I felt like if you look at the — we have a better track on our sales declines, if you will, being down 4.5% instead of 9%. So I think we've turned the corner a little bit. We do think things will improve around the first of the year although that's very hard to put your finger on exactly when we'll see that effect, but I think the markets will start to improve.

We did have higher revenues than anticipated and margins were down a little bit. Part of that was going after some of that business that we lost. We're going to be more aggressive about protecting our market share in the future and I wouldn't call it a great quarter, but we were very encouraged by this quarter.

And so I really thank you for your comments and your questions and that'll be it for today. Thank you.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.

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