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Animal Health International, Inc. (NASDAQ:AHII)

F2Q10 (Qtr End 12/31/09) Earnings Call Transcript

February 2, 2010 10:00 am ET

Executives

Bill Lacey – SVP and CFO

Jim Robison – Chairman, President and CEO

Analysts

Atif Rahim – JP Morgan Chase

Mark Arnold – Piper Jaffray

Jeff Johnson – Robert W. Baird & Co.

Andrew Cash – Point Clear Value Management

John Kreger – William Blair

Alan Weber – Robotti & Company

Operator

Greetings and welcome to the Animal Health International second quarter 2010 conference call and webcast. At this time all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Bill Lacey, Chief Financial Officer for Animal Health International. Thank you, you may begin.

Bill Lacey

Good morning. I'm obviously joined by Jim Robison, our Chairman and CEO, who will be available to answer questions after I go through our scripted earnings release.

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 principles or GAAP, AHII 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, 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 second quarter of fiscal year 2010. Net sales for the quarter 170.5 million compared to 184.5 million for the same period last year. Gross margin declined 2.9 million with 2.5 million due to lower sales volume. Margins in the second quarter were 17.3% of net sales compared to 17.5% in the second quarter last year.

SG&A expenses declined 0.9 million from last year as a result of lower variable selling expense and cost reductions, partially offset nonaccrual of 0.4 million for the final settlement and cost associated with a legal dispute.

EBITDA for the quarter was 6.2 million, which was a decrease of 2.2 million from the year earlier quarter of 8.4 million. Excluding the one-time legal settlement, EBITDA was 6.6 million, down 1.8 million from last year, but an increase of 3.2 million from the first quarter.

Net income for the second quarter was 1.2 million compared to the second quarter last year net income of 2.3 million. Fully diluted earnings per share were $0.05 versus $0.09 last year. Earnings per share without amortization or on a cash basis EPS was $0.10 per share.

Year-to-date results, net sales for the first half of the year were 331.8 million compared to 353.5 million for the same period last year. Gross margin declined 7.2 million with 3.8 million due to lower sales volume, and 3.4 million due to reduced profitability with one of our suppliers.

Margins in the first half was 16.7% of net sales compared to 17.7% in first half last year. SG&A expenses declined $3.7 million from last year as a result of lower variable selling expense and cost reductions partially offset nonaccrual of 0.4 million for the final settlement and cost associated with the legal dispute.

EBITDA for the year-to-date is 9.6 million, which is a decrease of 4 million from last year. Excluding the one-time legal settlement EBITDA was $10 million, down 3.6 from last year.

Net income for the year-to-date was 0.5 million compared to the first half, last year net income of 2.6 million. Fully diluted earnings per share were $0.2 million -- were $0.02, I am sorry, versus $0.10 last year. Earnings per share without amortization or cash basis EPS was $0.11 for the first six months. At the end of December there were 49.8 days of working capital; our average for the last 12 months was 47.5. Capital expenditures were $0.3 million for the quarter. The fixed charge ratio was 1.19 on a trailing 12-month basis. The Company is in compliance with its bank covenants.

Let’s talk a little bit about our guidance for the remainder of the year, which has not changed since last quarter. Revenue for the first fiscal year-ending June 2010 is expected to be between $650 million and $685 million. EBITDA is estimated to be $22 million to $27 million and net income is expected to be $2.3 million to $5.3 million or $0.09 to $0.22 per share.

At December 31st, the Company's availability under its revolver totaled $29.1 million and we are in compliance, again, with all of our financial covenants.

With that I’ll turn it over to Jim for any comments before we take questions.

Jim Robison

Good morning, everybody. Brief comments, and then Bill I will take questions. Results for the quarter were favorable to plan mostly because of our efforts around managing our sales mix, improving our pricing management and our efforts around reducing our selling, general and administrative expenses. In December, we added Summit VetPharm nationwide to our company. That's a (inaudible) product. We are very excited about the addition of Summit line. Also in January, we added the whole line of Novartis Companion Animal products.

Our veterinary business is growing and is growing profitably, so we are very pleased with that. On the production side, commodity prices were not as favorable during the quarter as we had hoped. Volatility is decreasing, but we have seen the trends not showing up as we had hoped. Customers on the dairy side are just slightly below breakeven, we estimate, and on the beef side with prices nearly 80s, for finished cattle. The beef customers were also marginally profitable, but the greatest challenge being around grain prices. Corn was fairly volatile for the quarter. Most recently it went into the 4s again. It’s back up 10 cents now around 360 bushel. But we continue to see strains in our production animal customer caused by uncertainty around commodity prices.

The sale’s shortfall was mostly caused by -- irrelatively disappointing beef market, given the uncertainty around the grain prices and the finished prices also (inaudible) were heavy. People are still holding calves on forage for extended period given the relative cost obtained. Commodity prices were improved in the dairy business, but again, most recently they backed up slightly. I think the highlight for the quarter was the success and adding both Summit VetPharm and Novartis to our company.

We also get questions at this time of the year about vendor contracts. We got mostly through the challenges regarding Pfizer’s acquisition of Fort Dodge through their acquisition of Fort Dodge is current Wyeth and fearing they will go high and has absorbed about 85% of the sales that we did with Fort Dodge products. The contracts with VI [ph] relative to Fort Dodge are slightly positive to prior year and the contract with Pfizer this year will be very, very slightly positive. And so, we really don’t see changes versus 2009 regarding vendor contracts other than again the addition of Novartis and Summit VetPharm.

With that we will open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Lisa Gill with JP Morgan Chase. Please state your question.

Atif Rahim – JP Morgan Chase

Hi, thanks, it’s Atif Rahim for Lisa. I guess two more, but the first question, I guess in past quarter there on this timeframe, we've seen some revenue flow through from the March quarter to the December quarter, here is a little purchasing opportunities available to your clients. So, do you see any of that in this quarter?

And then the second question, you said corn has been volatile but it seems to have been much lower so far this quarter than it was last quarter. So, do you think that bodes favorably for the March quarter and perhaps beyond?

Bill Lacey

Okay, I'll answer the first part of that question about price increases, and we didn’t have a lot of activity this December, where prices increases going into effect January 1st was pretty much the same as last year. It was really not a lot of volatility around price increases this year and last year.

And we did see last year some four dollars price increases but they were effected February 1st, so that had no effect on this quarter and we'll have very little on the second quarter because you’ll be buying – any buy-ins would have happened in January and they normalized in February. And other part of that volatility in corn price is --

Jim Robison

Yeah. Right, corn has backed up. We had an all-time record crop with about 13.2 billion bushels. There is uncertainty on a forward basis, as you may know the EPA is contemplating raising the blending standards. We consumed about 4 billion bushels or approximately a third of the normal corn crop for the production of ethanol. And so I think if EPA comes through and raises blending standards, we could see corns fight back up. That’s really the only concern we have. Notwithstanding that happening we are anticipating continued improved economics around the perfume markets over the next couple of quarters.

Atif Rahim – JP Morgan Chase

All right, that’s helpful. Thank you.

Operator

Our next question comes from Mark Arnold with Piper Jaffray. Please state your question.

Mark Arnold – Piper Jaffray

Good morning. I guess we kind of knew this was going to be a challenging quarter but I thought you guys actually performed quite well, particularly on the EBITDA line. So congratulations on that.

I guess, I just wanted to follow-up Jim on your comments about the vendor rebates for 2010. So based on your comments, your comments here this morning, is it fair to say most, if not all of those are already finalized then for the year?

Jim Robison

Generally, yes. We haven’t signed everything but we're just in the final stages of reviewing contracts, most discussions around what we're going to focus on and how we’re going to market then complete it.

Mark Arnold – Piper Jaffray

And in terms of those contracts, there really weren’t any material changes in terms of the structure of them?

Jim Robison

That’s correct.

Mark Arnold – Piper Jaffray

Okay. Then one other thing I wanted to kind of follow-up on was that, you made comments about managing the sales mix in the quarter, and I think your gross margin here in the quarter was quite strong. Can you talk a little bit more about that, what that means, what you have you done there to drive those at pretty strong growth margin here in the quarter?

Jim Robison

Yes, Mark, we're going to – on a forward basis, we are going to continue to see more margins transactionally than we've historically seen with less margin coming through rebates.

Bill can comment on that in a moment but we've done several things. One, we focused, continued our focus on relatively high margin products. We have a sales and marketing discipline to sell products where we have superior margins, and we’ve continue to refine those efforts and they are going quite well.

I think the category of focused products were up over 30% last year, that was a universe. They are still fairly small from a volume standpoint but we're getting good traction around selling price that are either semi-exclusive or some parts – somehow part of our key area of intellectual property holdings. And so that’s going very, very well. Again, volumes are relatively small.

And then secondly, we're doing a lot to price intelligently, and what I mean by that, we've got a compete where we have high volume low cost to serve transactions, while at the same time where we have relatively low volume high cost transactions are not as competitive, we got to optimize the margin there. So we put a lot of systems and processes in place to improve our margins generally, so that they were both competitive at the same time we are optimizing those profit margins.

Mark Arnold – Piper Jaffray

And when you said the move towards more margins transaction, that's something been discussed for a number of years, it was a bigger move that way of this year then we have seen in the last number of years, and is that across all vendors or more vendor-specific?

Bill Lacey

Mark, if you look at, I will address the issue with Q1 and Q2 when we saw such a nice increase. It's not unusual that we would see a better and improved second quarter because we do all of our rebate programs that are annual in any nature gets tied up in the second quarter or the December last calendar quarter. But let me point out that this year our Q2 was up 94% versus Q1, if we went back to last year our Q2 was only up 60% versus Q1.

In Q2, we had an improvement of $3.2 million over Q1 and it was about $1.5 million in volume, which is somewhat seasonal with October being our historically high-sales mark. Margin was up $2 million were up at a time what Jim said, our margin was up $2 million and it was evenly split between transaction margins and rebates. And everything else was almost nil. So, when you take the legal settlement out of $0.4 million that kind of rounds up after that $3.2 million difference, if that helps to answer your question?

Mark Arnold – Piper Jaffray

It does. Just moving on, you talked about the dairy market, we have seen some improvement in price in there in recent months. Can you talk about even in 2009 quite a fewer smaller produces went out of business and I guess -- can you talk about the impact that, that has kind of the change in makeup of producers, kind of the impact that has on your business and on the size of the producers that remain?

Bill Lacey

This had from a debt standpoint absolutely zero impact on our business. We’ve had no decline or degradation in our hedging or our DSO. So our receivables have had weathered the storm to me amazingly well. There have been some of the smaller end dairies, and particularly, they have gone out of business. Typically those are not the ones that we deal with. We deal in dairies that usually have over 500 of cattle, and so those smaller ones have been bought up or gone out of business or either bought up by other larger ones which is -- it helps us to a small degree.

Mark Arnold – Piper Jaffray

Okay. And I just have one last question. The March quarter historically has been a seasonally weakened quarter for you. Somebody addressed this earlier with buy-ins ahead of prices, but also you brought your vendor programs coming in completion typically in the December quarter. Can you give us any directionally any guidance as to how we should look at the March quarter relative to the December quarter this year, both on topline and margins?

Bill Lacey

Mark, we’re are going to stay away – we are going to not give any guidance for this quarter, but I will say this, for the first time in several years we are annualizing pretty much against apples-to-apples. If you look at every quarter in the 2009 calendar year we would still on a year-over-year decline in rebate opportunities with our largest vendor. This year, for a change, like Jim said, the contracts are clearly the same this year versus last year. So we will be annualizing on an apples-to-apples basis for the first time in probably four years.

Mark Arnold – Piper Jaffray

Great. Thank you, guys.

Operator

Thank you. Our next question comes from Jeff Johnson with Robert W. Baird. Please state your question.

Jeff Johnson – Robert W. Baird & Co.

Thank you. Good morning, guys.

Bill Lacey

Hi, Jeff.

Jeff Johnson – Robert W. Baird & Co.

Bill, wondering if I could check first -- I am assuming the $350,000 legal settlement tax can be excluded for tax covenant purposes?

Bill Lacey

Correct.

Jeff Johnson – Robert W. Baird & Co.

Okay, and so nice back of the envelope math, and obviously I don’t have all the line items, but someone in the neighborhood of about $1.5 million EBITDA cushion at this point, is that a fair range?

Bill Lacey

It’s between 1 and 1.5.

Jeff Johnson – Robert W. Baird & Co.

Okay, and then I guess if you are not providing fiscal third quarter guidance, I want to stay away from that, at least a bigger picture, would it surprise you if EBITDA were to fall in the third quarter or visibility just limited to this point with the recent fall off in dairy prices?

Bill Lacey

Let me -- I am not going to answer that about the quarter that EBITDA did – and so it is. Last year, running off of a tail of interest grade swap, it was costing us about $900,000 a quarter. That's going to have a bigger impact probably than any change in our EBITDA numbers.

Jeff Johnson – Robert W. Baird & Co.

Okay.

Bill Lacey

So and we – week days that lying up at September, so we've seen a little bit of benefit in the December numbers, we will see them in March and June as well.

Jeff Johnson – Robert W. Baird & Co.

That's helpful. And Jim, I guess bigger picture question for you. The Archer [Ph] CEO was on the sales this morning talking about, he is being optimistic that the US will boost ethanol blend demand, things like that. So if that goes up and corn spike, we’ve seen a pretty sizeable call off in dairy prices or future contract here just over the last week or two. Where do you think that tipping point comes where we can actually see the dairy market dynamics start to improve and these guys get above breakeven and start spending again on products?

Jim Robison

We probably see it by now. The legislation that was put in place in January of '07 is set to expire I believe December of this year. I think it would be pretty tough of the production market if the EPA raise its blending standards doesn’t do something with import tariffs.

Jeff Johnson – Robert W. Baird & Co.

Yeah.

Jim Robison

They can make ethanol in Brazil from sugarcane, import it pay a rough cut 50, 70 gallon tariff on it, and still is export to the US profitably. So, our hope is that some kind of insightful wisdom prevails, and there is an adjustment and a phasing in of the blending standard.

Jeff Johnson – Robert W. Baird & Co.

Do you get the sense that’s how it’ll go though. I understand that’s your hope and that would be back but for your guys, but I am just – my read of it is doesn’t quite there?

Jim Robison

I mean, I obviously do a lot of research on this and I think that the prevailing thought today in Congress is not favorable towards corn-based ethanol, because all of those things that are fairly commonly known. I’ll have Bill comment on them but it's probably not appropriate venue. And again as earlier stated, I think there is real risk to the protein production market around EPA policy regarding blending standards.

Jeff Johnson – Robert W. Baird & Co.

Okay. That's helpful. And then any insight just why we’ve seen such as big head down on the dairy contract here just over the last couple of weeks, it seem like we are going in the right direction and that has reversed? And then I guess the second question just on these prices, any sense that exports may improve in the near-term and that could help drive beef prices up or are we going to stay in the 70 to 85, $90 range here near-term?

Bill Lacey

I am not the greatest at prognosticating commodity prices on milk and protein or milk and beef, I will tell you I’m very surprised by milk prices backing up at recent. I can't exactly explain it. I believe that overtime demand for beef will increase both domestically and internationally, and that our export markets will increase, but we do not see that happen to a meaningful extent today.

Jeff Johnson – Robert W. Baird & Co.

All right, great. And then just last question, I think I know the answer to this but last quarter in the press release you kind of talk about the second half of the fiscal year to turnaround, it just seems to me where some of this stuff is gone, maybe we need to think about that being push a quarter or two or how we should we think about that?

Bill Lacey

I read all of the reports, those reports this morning, and I think the keyword is that visibility is just very, very limited right now.

Jeff Johnson – Robert W. Baird & Co.

Okay.

Bill Lacey

And we are literally looking at business month to month, and so it's very difficult to nail down exactly what the business going to look like period to period.

Jeff Johnson – Robert W. Baird & Co.

Yeah, I understood. Thanks guys, I appreciate it.

Bill Lacey

Thank you.

Operator

Our next question comes from Andrew Cash with Point Clear Value Management. Please state your question.

Andrew Cash – Point Clear Value Management

Hi, Jim, hi, Bill, how are you doing?

Jim Robison

Hi, Andy.

Andrew Cash - Point Clear Value Management

Just couple of things, one on sales and one on EBITDA. As far as the sale is concerned, if you look at your minimum expectations for the year at 650, that’s going to be $14 million decline on the second half versus the first half. As we go back to 2006, and so there the second half were about even with the first half. 2007 same was true but then in '08 and '09 where the commodities are dropping, that you had a 19 million then a 40 million drop in sales for the second half versus the first for ‘08 for ‘09. So, I am just curious, do you think that the $14 million decline, which are minimum, is that sort of an getting back to normal or is that, do you think you might get back to the ‘06, ‘07 where sales for second half were flat?

Bill Lacey

I think the Qs 3 and 4 will be relatively strong for the company relative to one and two in historical norms, Andrew.

Andrew Cash – Point Clear Value Management

So what you are saying is, you kind of getting back to the 2006, 2007 where the second half is similar to the first half, perhaps even better?

Bill Lacey

I really don’t want to comment on that exactly, but again, the visibility is so limited.

Andrew Cash – Point Clear Value Management

Okay, I understand, I just directionally --now Summit VetPharm and Novartis, have those come in to play as far as helping out the second half?

Bill Lacey

We dropped Merial in January in the price that we went to did not -- January ‘08 the price that we went to did not do well in the marketplace. So, we really didn’t have a full offering around the flea, tick and heartworm market until recently. And so, it’s a big opportunity for the business. I think it will impact us nicely and it’s certainly on the positive side of the ledger to the extent that it will impact us is not fully known yet. As you know, there is a lot of movement in the flea and tick market with Merial eliminating their exclusivity clause in the contracts. So, but, being able to participate in that part of the companion animal markets is going to be great for business.

Andrew Cash – Point Clear Value Management

Tell me is it something it can add 5 million sales, 10 million, 15, 20, what sort of, could you range it for us, not necessarily in the second half but on an ongoing basis, on an annualized basis, what are your hopes and dreams there?

Bill Lacey

Yes, I am afraid if we could do that, I don’t want to mislead anybody and (inaudible) the timing, and pretty soon we will talking about quarters. And I just really would like to – you know I will tell you this, the Morris is a $250 million to $300 million participant companion animal business in North America. Some of that normally (inaudible) as a 45 million. The flea and tick part of the companion animal business is over half of it. They ought to be great for our vet business.

Andrew Cash – Point Clear Value Management

And I just really tied into the second question on EBITDA that I had for you, again looking at the second half of the year compared to first half, if you go back over the last two years, the second half, back in ‘06, ‘07, you are well over 4% EBITDA margin, and then in ‘08 over 4% and then of course, ‘09 you had a tough second half less than 2%. So, when you think about the second half 2010, fiscal 2010, to get to a minimum you again have to do closer to your, kind of, normal 4%. I mean is that -- with the Summit VetPharm and Novartis will that play into boosting your EBITDA in the second half of the year compared to the first, which will be very unusual because you haven’t done that in the last few years?

Bill Lacey

Andy, I am going to address for just a second and go back to some of these other years that you referenced. The December quarter has historically been really big for the company, which is the end of the first half for us. And there are a lot of big rebate programs that got through at that point and accrued, and those things have dwindled over the years. So, the importance of the first half relative to the second half has declined over -- really for the last four years. So, we’ve got a less of an issue between these two, although, the December quarter does have an increase in it because of rebates.

But again, when I look at the first quarter versus second quarter profitability here, it was split between an increase in transactional margins and an increase in rebates, equally. We are real excited about that change which unfortunately for us we like to see those big rebate programs, but without it brings a little bit more stability to the business probably in our ability to influence these transactional margins has start to show up.

Andrew Cash – Point Clear Value Management

It doesn’t make sense, I guess, it doesn’t makes sense, otherwise if you are changing your guidance for the full year, does the second half EBITDA margin could very well be greater than the first half EBITDA margins, which could be a change in the trend over the last three years. Is that a fair assumption? If Archers fails that much, much, much greater in the second half of the first half, your EBITDA margins will have by definition the last three data.

Bill Lacey

Our EBITDA margins, that’s fair to say, EBITDA margins will be a little better in the second half.

Andrew Cash - Point Clear Value Management

Okay. And then just finally, if you could – could you give us the fix charges that you use for the fixed charge, our fixed coverage ratio in the second quarter? And do you expect that to move sideways that went far, do you expect growth and that would look better, it sounds like you expect a down a little bit?

Bill Lacey

Yeah, let me give you some of those components there. Our CapEx has been and first of all – I’ll give you the numbers other than a few that you probably don’t have but I am not going to try to give you.

Andrew Cash - Point Clear Value Management

Right.

Bill Lacey

Guidance into our EBITDA margins or our fixed charge ratio. But a couple of things, it's – last 12 months EBITDA and it's a bank EBITDA, which includes Board of Directors fees. That runs about, for us it runs about 600,000 for a 12 month.

Andrew Cash - Point Clear Value Management

Okay.

Bill Lacey

We also add back the $2.7 million of bad debt that we wrote off in the last quarter. We wrote that off in June, I’m sorry, in June, that bad debt from our rebate program with one of our large vendors. Our CapEx on a trailing 12 months is $2.3 million and declining, our CapEx in the last quarter was only like 300,000, it’s $1.2 million for the six months. And taxes paid are 2.3 million for the last 12 months and because of certain programs we got, that’s probably going to be very little cash tax paid in the next six months other than some taxes paid on our Canadian operation. So --

Andrew Cash - Point Clear Value Management

That’s going to be big now?

Bill Lacey

So that number is going to be a dwindling number. Our guest service and cash interest is about $10.7 million and going down by about $900,000 each of the next three quarters. So, that – those are all of the components, we are about 1.2 right now. And mainly because we’re anticipating obviously little increase in our EBITDA but the $900,000 decline in interest expense for the next two quarters each, 900 each should have give us a bigger boost in anything.

Andrew Cash - Point Clear Value Management

Okay, that’s helpful. Just a comment, I mean, you’re talking about grain prices coming off the air, I mean, they always come off in January, February. So what's the big deal about that, is it the magnitude so much greater, I mean, it sounds like there’s a lot of concern about grain price is coming down?

Jim Robison

The challenge is Andy, that our production was added very unusual and prolong loss in their business really starting about 18 months ago.

Andrew Cash - Point Clear Value Management

Right.

Jim Robison

And many of them are – they have been increasingly leveraged and cage strapped [ph] given the reduction in size, the thought was that no prices would be higher than they are right now. We estimate the breakeven to $14 to $15 range. There are operators that are higher than that lower than that but, so with corn running back up most recently into the mid to low fours and then back number with the fear over last week or so, there is still uncertainty around when that variable will become profitable, and therein lies the challenge, so restrain able last 18 months and then continued uncertainty when the diary operations will become generally profitable.

Andrew Cash - Point Clear Value Management

I mean you have – I mean it kind of expected, do you have overhanging inventory of cheese and, but now you have exports starting to improve or should be improving so. It seem to me that things are now on the up and up and not on the way – if you adjust for the seasonality of the thrive demand from also milk markets.

Jim Robison

We've got a lot of good things going on in the industry and the company specifically. It’s just -- there is a lot of -- there is a very limited visibility as to when things will stabilize and start this trend favorably. So we don’t want to be either overly tired or overly optimistic because there is still uncertainty in the marketplace.

Andrew Cash – Point Clear Value Management

When you talk about the half or replacement market, a few quarters back either you or Bill talked about it and I have been reading half or replacement market starting to look up, how does that play into your thinking?

Bill Lacey

We don’t think it’s going to -- report of better results materially.

Andrew Cash – Point Clear Value Management

Okay. Well I just want to congratulate you on the first half EBITDA margin, I mean, if you adjust for the legal you are up compared to the first half of last year, and that’s a testimony that you guys are (inaudible) proprietorship there and hopefully you are going to win to get back.

Bill Lacey

We appreciate the compliment and we are not pleased with the results, we have got a long way to get back.

Andrew Cash – Point Clear Value Management

So, I am glad you are not. Thank you very much.

Bill Lacey

Okay.

Operator

(Operator Instructions) Our next question comes from John Kreger with William Blair and company. Please state your question.

John Kreger – William Blair

Hi, thanks very much. First, Bill, I wanted to just clarify your comments about interest expense, with the interest rate SWAP rolling actually were you suggesting interest expense will go down further sequentially?

Bill Lacey

Yes.

John Kreger – William Blair

And so 900,000 from the December level?

Bill Lacey

Correct.

John Kreger – William Blair

Okay. And then (inaudible) out or continue to decline further?

Bill Lacey

Continue to decline until we get to September of next year.

John Kreger – William Blair

Got it. Okay. Excellent. Thank you. Could you tell us a little bit more about the legal settlement? What’s background there and would there be any other expense from that?

Jim Robison

I will answer that. There will be no more expense burden from it and it’s a confidential settlement, so we don’t go into any more details than that.

John Kreger – William Blair

All right. Like you are fully reserved?

Jim Robison

Correct.

John Kreger – William Blair

And now switching over to the environment, Jim, could you give us an update on two things. One, what’s the pricing environment like, any changes there of note? And what do you are seeing in terms of herd sizes, have they stabilized, any possibility they might start to pick up here in the coming months?

Jim Robison

The cowherd size is the lowest I think in 47 years. I maybe wrong at that number, but by historical norms it’s very, very low. And what I mean by cows, those are cattle that those are female cattle that had calf. So, way down to almost, I think it's $31 million or so and that's a very, very low number, which we think goes fairly well for the beef industry. Again, our business doesn’t move so much on numbers as it does on how animals are treated. Very herd sizes have contracted. I have not really heard of people adding numbers recently. I think if people are adding numbers we would see stronger prices because certainly in the beef side you are contracting the number of animals are slaughtered when you do that.

But I think a forward economics as when they do straighten out for both the beef and dairy business be relatively good. Notwithstanding the EPA concern mentioned earlier, because I think that demand will pick up in time, yield for prime and (inaudible) costs improve yield differentials, and I should say grading differentials. And I believe that, again, both domestic and export demand will improve. So, with the number of things as well as they are, I think the long-term economics looks pretty good.

John Kreger – William Blair

Great. Thank you. And are you seeing anything unusual or any update on pricing?

Jim Robison

Pricing has always been competitive or remains competitive and will (inaudible) more the same.

John Kreger – William Blair

Okay. Thanks. I had a couple of questions though, and did you have any additions to your bad debt reserve in the quarter?

Jim Robison

John, let me make one exception, let me make one additional comment. When I say all of the people in the industry that had retail opportunities in the fourth quarter generally chase volumes in the fourth quarter, and discount it heavily, to get the rebates, and obviously we are seeing people move away from that behavior. So that’s one favorable change on the pricing front.

John Kreger – William Blair

Great. Thanks. Bill, just to repeat that. Did you make any changes to your bad debt reserve in the quarter?

Bill Lacey

We did not.

John Kreger – William Blair

Okay, so that’s stable. And then what about your rebates, what was the change in rebates realized this quarter versus a year ago?

Bill Lacey

This quarter versus a year ago it was about $1 million less and it was mostly Pfizer did away with the logistics program that cost us about $1 million in the quarter.

John Kreger – William Blair

Right, so Pfizer related.

Bill Lacey

Yes.

John Kreger – William Blair

Okay, great, that’s it from me. Thanks very much.

Operator

Our next question comes from Alan Weber with Robotti and Company. Please state your question.

Alan Weber – Robotti & Company

Good morning. Can you talk about for the balance of the year, the direction of the balance sheet given first half receivables and inventory might have increased?

Bill Lacey

Okay, Alan, inventories are pretty high at this point and they will flap off as we go to the June period. June is probably our low point. We take a lot of physical inventories in the fourth fiscal quarter and pretty much liquidate out the inventory, it’s not a very – not a say of month nowhere as July, so we're pretty low point in June, we probably are heaviest right now. As I mentioned earlier we stood – even though there weren’t any more, they are different than last year, we still had some tie-in opportunities ahead of price increases. So our December quarter numbers were pretty much in inventory. And our DSO, are the sales on our receivables side were very comparable to last year. I think we might have been let up one day but it was more of a mix of customers than it was change in aging.

So our receivables are going to stay in the range that we are, which is low 40 days and our inventory is going to turn little over six times a year.

Alan Weber – Robotti & Company

Okay. Thank you.

Operator

Our next question comes from Mark Arnold with Piper Jaffray. Please state your question.

Mark Arnold – Piper Jaffray

Thanks guys. I just had a couple of follow-ups. I just want to make sure I understood this, Bill, so you were talking interest expense, somebody asked the question about, that continued to go down, and I was little confused by that. When you said go down over the next few quarters, you mean on a year-over-year basis, is there any reason why that would continue to fall sequentially?

Bill Lacey

Yes, because in every quarter, we had an interest swap that was 4.95, fixed rate of 4.95 on $92 million, actual LIBOR is about 0.25. So virtually that 4.5%, 5%, is when you can do the math on $92 million, its $4.5 million or so.

Mark Arnold – Piper Jaffray

So, what you are saying Bill is that the trailing 12 months interest expense, you think, they will go down, but the quarterly interest expense now that we saw in the last quarter is going to be, assuming interest rates stay where they are, would be about the same.?

Bill Lacey

That’s right.

Mark Arnold – Piper Jaffray

I just want to make sure that was clear. And then on the EBITDA margin in the quarter, is there anything in there that would, in terms of the mix in the December quarter, you talked a little bit about some of the companion animal products you guys have added, but anything in terms of mix that you would expect to be materially different in the next couple of quarters, absent a more significant recovery in some of the production markets?

Bill Lacey

To be frank, no.

Mark Arnold – Piper Jaffray

Okay. And then, the last thing I had just as it relates to the covenants issue, I mean, this was the quarter that if I had any concerns, was related to this quarter, and when we look at the trailing 12 months, in the next quarter you are going roll up for your anniversary against a very weak $3.7 million EBITDA number. So, as we look forward here the next three quarters, your anniversary is really, probably your three worse quarters ever, so does that make you feel more confident in the -- going forward here that you made up to the December quarter in your ability to stay compliant with covenants?

Bill Lacey

Absolutely, Mark. When we look at these forecasts and we have seen at this bench point come in, we always felt like December was the tightest -- the tightest calculation we would have. And because of exactly what you said annualizing against the same programs year-over-year and dropping off that interest rate swap amount, it clearly was the bench point and we feel that calculation will have more cushion as we go forward.

Mark Arnold – Piper Jaffray

So even if you underperformed your low-end of your guidance here for the rest of the year, you are likely to see an improvement in your fixed charge ratio over the next six months.

Bill Lacey

That is correct.

Mark Arnold – Piper Jaffray

Okay. Great. Thank you, guys.

Operator

Thank you. Our next question comes from Jeff Johnson with Robert W. Baird. Please state your question.

Jeff Johnson – Robert W. Baird & Co.

Thanks. Just one follow-up here guys. Bill the tax rate has been at about 37.5% in the last couple of quarters, is that the right number to use going forward?

Bill Lacey

37.6%.

Jeff Johnson - Robert W. Baird & Co.

You will keep us there or (inaudible) closer to 40% that we have been thinking for the year?

Bill Lacey

Yes, I think that’s probably fair.

Jeff Johnson – Robert W. Baird & Co.

Okay. That was it. Thanks guys.

Bill Lacey

Okay.

Operator

Ladies and gentleman, there are no further questions at this time. I’ll turn the conference back over to management for closing comments. Thank you.

Jim Robison

Thanks for joining us this morning and have a good week.

Operator

Thank you. Ladies and gentleman, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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Source: Animal Health International, Inc. F2Q10 (Qtr End 12/31/09) Earnings Call Transcript
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