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MWI Veterinary Supply, Inc. (NASDAQ:MWIV)

FQ210 (Qtr End 03/31/10) Earnings Conference Call

May 6, 2010 11:00 AM ET

Executives

Mary Pat Thompson – SVP, Finance and Administration & CFO

Jim Cleary – President and CEO

Analysts

John Kreger – William Blair

Mark Arnold – Piper Jaffray

Ann Wilson [ph] – Bank of America

Derek Leckow – Barrington Research

Operator

Good morning, and welcome to the MWI Veterinary Supply’s second quarter fiscal 2010 earnings conference call. Today’s call is being recorded. At this time, I would like to turn the conference call over to Mary Pat Thompson, Senior Vice President of Finance and Administration and Chief Financial Officer for introductory remarks. Ms. Thompson, please go ahead.

Mary Pat Thompson

Good morning, and welcome to MWI Veterinary Supply’s second quarter fiscal 2010 earnings conference call. This is Mary Pat Thompson, Senior Vice President, Finance and Administration and Chief Financial Officer. Joining me today is Jim Cleary, MWI’s President and Chief Executive Officer.

Certain statements contained in this conference call that are not descriptions of historical facts are forward-looking statements as such term is defined in the Private Securities Litigation Reform Act of 1995. Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.

Factors that could cause results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to those discussed in filings made by MWI with the Securities and Exchange Commission. Many of the factors that will determine the company’s future results are beyond the ability of management to control or predict.

Listeners should not place undue reliance on forward-looking statements, which reflects management’s views only as the date hereof. MWI undertakes no obligation to review or update any forward-looking statements or to make any other forward-looking statements whether as a result of new information, future events or otherwise.

Another note that I would like to point out during the call is related to financial comparisons that are made. All financial comparisons are for the second fiscal quarter or six months ended March 31, 2010 compared to the same period in prior fiscal year, unless otherwise noted.

Now, I would like to turn the call over to Jim Cleary to begin our remarks.

Jim Cleary

Good morning, and welcome to MWI Veterinary Supply’s second quarter fiscal 2010 earnings conference call. Today, I will walk you through an overview of the results that were presented in our earnings announcement released earlier today. Mary Pat will provide additional detail and explanation of the financial results. Then I will briefly discuss the company’s business outlook for the fiscal year ending September 30, 2010. Lastly, we will open the call to questions.

Highlights for the quarter included, first, total revenues grew 34% to $286.6 million. Of the 34% growth, 18% was due to organic revenue growth in the United States and 16% was related to our acquisition of Centaur Services Limited. In February 2010, we acquired Centaur, which is a supplier of products to veterinarians in the United Kingdom.

Second, selling, general and administrative expenses as a percentage of total revenues improved to 8.9% compared to 10%. Included in SG&A expenses were $915,000 of direct acquisition-related costs incurred in connection with the Centaur acquisition. Excluding these costs, our SG&A expenses as a percentage of total revenues improved to 8.6%.

Third, operating income increased 37% to $12.7 million and our net income increased 33% to $7.7 million or diluted earnings per share of $0.62 compared to $0.47.

And fourth, we generated $8.5 million in cash from operations during the quarter, compared to $15.1 million in cash used in operations and we had borrowings under our credit facilities of $23.1 million, which includes the borrowings to finance the Centaur acquisition.

I am very pleased with MWI’s results during the March quarter, particularly our growth in revenues, from both existing and new customers, our growth in earnings and value-added services as well as our expense control and generation of cash from operations. These results demonstrate our employees’ continued dedication to providing high quality service to our customers and vendors. I would like to thank our employees both in the United States and the United Kingdom for their excellent work during the quarter. We are very pleased with the addition of Centaur and our collaboration with the Centaur team.

Now I will turn the call over to Mary Pat Thompson, Senior Vice President and Chief Financial Officer who will provide additional detail of our financial results.

Mary Pat Thompson

Thank you, Jim. Revenue growth was 34% to $286.6 million for the quarter with 18% due to organic growth in the United States. Included in total revenue were $33.6 million related to the acquisition of Centaur. Excluding this acquisition, our revenue to existing customers represented 63% of the growth of total revenues. Commissions grew 12% to $4.2 million. At the end of March, we had 205 field sales representatives and 149 telesales representatives, an increase of 16 field sales representatives since the start of our fiscal year on October 1.

Gross profit increased 25% to $39.5 million. Gross profit was benefited by our revenue growth and the addition of Centaur. Gross margin was 13.8% compared to 14.7%. Gross margin decreased due to the addition of Centaur. Centaur’s gross margin is generally lower than MWI’s. This reduces the overall gross margin of the consolidated company. Gross margin also decreased as we earned additional incentives during the March quarter in the prior fiscal year related to large inventory purchases made in December 2008 that we did not have in this March quarter. Vendor rebates increased by $475,000.

Operating income increased 37% to $12.7 million. SG&A expenses increased 19% to $25.6 million. SG&A expenses increased primarily due to the acquisition of Centaur and our revenue growth. SG&A expenses as a percentage of revenues improved to 8.9% compared to 10.0%. SG&A expenses as a percentage of revenues decreased due to the addition of Centaur. Centaur’s SG&A expenses as a percentage of revenues are generally lower than MWI’s. This reduces the overall SG&A expenses as a percentage of revenues of the consolidated company. Also included in the increase in SG&A expenses are direct acquisition-related cost of $915,000 incurred with the acquisition of Centaur. Excluding these costs, SG&A expenses as a percentage of revenues improved to 8.6%.

Our effective tax rate for the quarter was 39.5% compared to 38.3%. This increase is due to the non-deductibility of direct acquisition-related expenses for tax purposes.

Net income increased 33% to $7.7 million. Diluted earnings per share were $0.62 per share compared to $0.47 per share, an increase of 32%. The impact in diluted earnings per share as a result of the Centaur acquisition was neutral after given effect to the operating expenses of Centaur and the after-tax direct acquisition related expenses.

Revenues growth was 17% to $522.7 million for the six months ended March 31, 2010. Commissions grew 17% to $7.8 million.

Gross profit increased by 16% to $75.5 million. Gross margin was 14.4% compared to 14.6%. Vendor rebates decreased by $375,000. This decrease was due to the elimination of the livestock rebate opportunity from one of our largest vendors, partially offset by improvements in rebates from other vendors.

Operating income increased 34% to $25.4 million. SG&A expenses as a percentage of revenues improved to 9.2% compared to 10.0%. SG&A expenses increased 8% to $48 million. Included in the increase in SG&A expenses are direct acquisition-related expenses of $1.1 million incurred year-to-date with the acquisition of Centaur. Excluding these expenses, SG&A expenses as a percentage of revenues were 9.0%.

Net income increased 32% to $15.5 million. Diluted earnings per share were $1.25 per share compared to $0.95 per share, an increase of 32%.

Our cash balance as of March 31, 2010 was $866,000 and we had $23.1 million outstanding on our credit facilities. Compared to September 30, 2009, receivables increased 25%, inventories increased 24% and accounts payable increased 27%. These increases were due to the balances acquired through the acquisition of Centaur as well as our revenue growth.

Now I will turn it back over to Jim.

Jim Cleary

Thank you, Mary Pat. Now I would like to turn our attention to MWI’s outlook for the fiscal year ending September 30, 2010. We estimate revenue will be from $1.16 billion to $1.18 billion, which represents growth of 23% to 25% compared to revenues in fiscal year 2009. We estimate that diluted earnings per share will be from $2.40 to $2.45 per share, which represents growth of 19% to 21% compared to diluted earnings per share in fiscal year 2009. All of these estimates give effect to the acquisition of Centaur from February 8, 2010 through September 30, 2010. Our previous guidance for the fiscal year ending September 30, 2010, which was provided February 8 after our acquisition of Centaur, was revenues of approximately $1.14 billion to $1.18 billion and diluted earnings per share of $2.26 to $2.32 per share.

Actions planned to fiscal year 2010 include, first we will continue the integration of Centaur into our business and providing high quality service to veterinarians in the UK. Second, we will continue our focus on value-added services including our ecommerce platform, our pharmacy fulfillment programs for both production and companion animal products and other value-added services. Third we will continue to stay committed to improving our low operating expense structure and making smart decisions with both our operating expenses and capital investments. Fourth, we will continue to invest in technology and distribution center infrastructure as we review the needs of our distribution centers and fifth, we will evaluate potential acquisitions that are a strategic bid for MWI and add to our shareholder value.

Now I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from John Kreger of William Blair. Your line is open.

John Kreger – William Blair

Jim, could you just take a step back and maybe review the strategy behind the Centaur deal? Should we view that as a bigger push to expand into Europe or other geographies? And then the second follow-up to that would be what’s your current thinking about your ability to drive Centaur’s margins up to your average levels or even above that?

Jim Cleary

Yes, sure. The rationale for the acquisition, there are really several reasons for it, John, as we discussed. One is that provides an additional platform for MWI’s growth. We think there is still plenty of growth opportunity here in the U.S. but we think international growth provides an additional platform. Second reason was one to evaluate potential joint sourcing of products overtime and any value that that could bring, and then also we really felt that there would be opportunities for us to learn from them on the warehouse automation front. They are really quite advanced in terms of warehouse automation and what they have done there to bring down there SG&A cost is very impressive. So we thought that MWI would be able to learn from them on that front, which I still continue to think is the case.

And then in terms of strategic opportunities, I mean it’s really a little too early to comment we are only few months in. And then with regard to margins, I don’t see a lot of opportunity to bring their margins up. It’s a really different distribution model there in the UK and so I don’t see an opportunity to bring their margins up to our average margin, particularly in the short to intermediate term. And so – but I think it’s important to recognize that they also have very efficient SG&A expenses and very efficient working capital. And so, even though it’s a lower margin business, it’s a good return on net asset business.

John Kreger – William Blair

And just one last question. Your organic revenue growth improved pretty substantially over the last quarter, I think about 16 points. Can you just talk about what you think drove that? Was there anything unusual such as pulling revenues forward that might have distorted that 18%?

Jim Cleary

No, I don’t believe there was anything that really brought revenues forward. And I think really the great thing about it and the impressive thing is it was so broadly based. I mean it was across geographic regions, it was across species, and it was across product categories. I mean even in areas like capital equipment, we have really seen a comeback there and strong double digit growth in capital equipment during the quarter.

And so, one other comment I will make is that the quarter started okay, but finished really strong. And so we saw a lot of the strength during the quarter towards the end of the quarter.

Operator

Our next question comes from Mark Arnold of Piper Jaffray. Your line is open.

Mark Arnold – Piper Jaffray

Good morning. It’s hard to ask questions when you guys put up this strong of a quarter.

Jim Cleary

Thank you.

Mark Arnold – Piper Jaffray

I guess, Jimmy, just following on something you just said about kind of how the quarter progressed. Can you give us any sense as to whether weather had any impact on your results in Q1? I know you guys aren’t as exposed to the East Coast as some. But our surveys of veterinary clinics definitely indicated some impact from weather and I think that has been reflected in some public companies’ results as well. Can you give us any sense as to what kind of impact it had on your results?

Jim Cleary

Yes, I am sure it did have some impact on our results. But I think the good – one of the many good things about our business is we have such diversity in terms of species and in geographic coverage and in products. And so, I think that weather, while it had some impact, it would be minimal for us because of the diversity of our revenue sources.

And one other comment I will make on revenue growth, that’s one thing that did – we did benefit from in the quarter is that we now carry a broad array of flea, tick and heartworm products. And so, having some of those additional products, I think helped us not only in sales of those products but also from the standpoint of our customers being able to call us up for really almost everything that they need for their veterinary practice probably just helps us overall in terms of growth.

Mark Arnold – Piper Jaffray

Question for you, Mary Pat. The SG&A expense in the quarter, if you take out the acquisition cost, it was, what, about 8.6%. Is that sustainable here for the rest of the year or will we see a little bit of a popup in the next quarter?

Mary Pat Thompson

Yes, sure, correct. The 8.6% was an excellent performance for the quarter. Of course, it was post acquisition expenses. But you will see a slight uptick in the balance of the year because with our exceptional growth we do have additional headcount plan to support that growth. And as we said earlier, we will see an improvement – continued improvement over SG&A but not as good I should say as the March quarter.

Mark Arnold – Piper Jaffray

And then one other question. You gave the contribution for Centaur to MWI’s results in the quarter. Could you possibly give us what Centaur’s total March quarter revenues were? So we could get a sense as to the run-rate.

Mary Pat Thompson

From February 8, they were a little over $33 million of revenues. We could only record them from February 8 through March 31.

Mark Arnold – Piper Jaffray

Just I guess two other questions for you, Jim. Can you give us just in general sense an update on your production animal business and kind of your expectations for that segment for the rest of the year?

Jim Cleary

Production animal is still a tough market in terms of economics and competitiveness, but it performed quite well during the March quarter. As I look at the rest of the year, I think it will probably grow slower than our companion animal business will. I think that they still will be economic challenges particularly in the dairy market. I don’t think we are through that yet. But I think we are very well poised as a company to compete well and perform well in that market and are still committed to it.

Mark Arnold – Piper Jaffray

I guess the final question I had, you brought up kind of your focus for the rest of the year, and I think the last piece was potential acquisitions. Can you just talk about how you are looking at acquisitions right now? I mean you guys have availability, your debt agreements to do it, everything seems to be clicking in the core business. But how are you looking at acquisitions? And do you see any opportunities right now?

Jim Cleary

I think that there will be opportunities generally over the next couple of years. I think that there will further consolidation in our market. I think that there are a number of things that will drive that including manufacturer consolidation. That is something that we are going to continue to work on over the next couple of years and we do think that there will be opportunities.

Operator

Our next question comes from Robert Willoughby of Bank of America. Your line is open.

Ann Wilson [ph] – Bank of America

Hi, this is Ann Wilson in for Bob today. After a strong quarter here, you seem to have put yourself kind of on an improved trajectory here, and with the latest results, your guidance doesn’t seem to reflect that sort of I mean the enthusiasm or strong enthusiasm. Is there some seasonal components involved that we should be thinking about maybe in relation to the new business or something that will not be recurring in the coming quarters, I guess?

Mary Pat Thompson

There are two things you need to remember from the prior year and this is regarding earnings per share. First, we made some very large inventory purchases in December 2008 ahead of some significant price increase and it gave us significant margin through May of last year. We didn’t see the same benefit this year. Second, we earned a large rebate in September 2009 from the vendor that we don’t anticipate making up again this year. So those two factors have leveled out the earnings expectation compared to the first half of the fiscal year.

Jim Cleary

And what I would add to that on the revenue front is when we started the fiscal year prior to the effect of any acquisitions, we were talking about 6% to 10% topline growth. And while we had substantially better than that organic performance during the first quarter, we don’t want to change our view on the economy and the market based on one quarter’s results. And so, we are, as you can tell from the guidance, looking at lower topline forecast for the second half of the year than we had in the last quarter.

Ann Wilson – Bank of America

And also, do you have any plans to pay down your debt?

Mary Pat Thompson

We will expect positive cash from operations for the year and of course, that will be used to pay down the debt as well as to make further capital investments in our infrastructure, warehouses and technology.

Operator

Our next question comes from Derek Leckow of Barrington Research. Your line is open.

Derek Leckow – Barrington Research

Just on the strong internal growth rate here, last quarter we saw double digit companion animal growth, then we saw sort of negative production animal growth. What were those two in this quarter?

Jim Cleary

Both were positive and we were very pleased by the results of both. And one thing that happened and I will take step a year back to explain this. There was heavy selling of production animal products in December 2008. That didn’t happen in December 2009. And so that phenomenon made our production animal growth much stronger in the March 2010 quarter because it hadn’t been presold in December.

But we saw very strong growth in both companion and production during the quarter with companion growing faster.

Derek Leckow – Barrington Research

Okay and then you had the companion part, I realize that was not exactly an easy comparison, so that’s a very strong performance. You mentioned the increase of about 8% in terms of field sales representatives, so it seems like you’re growing there. But I wanted to maybe zero in a little bit more on the capital goods comments. I guess it’s the first time in a while I’ve heard strong growth in the capital equipment side and maybe you could tell us what types of products are really highest demand out there.

Jim Cleary

It’s across the range. And capital equipment is our relatively small part of our business. It’s probably about 3% of our overall sales and it’s probably about 5% of our companion animal sales because most of it is in the companion animal market as opposed to production animal market. And we have seen the last couple of quarters that coming back and I think that’s – it’s just a – even though it’s a small part of our business, it’s a very good sign that our customer base is spending not only on the consumables but on the larger items also.

Derek Leckow – Barrington Research

On a regional basis, where was most of the growth coming from in terms of the new sales representatives?

Jim Cleary

Most of the growth in sales reps is coming from areas where we have lower market shares, in the Eastern and Midwestern United States. And we are doing some fill in the Western U.S. also. But most of the sales rep growth is coming in the Eastern and Midwest.

Derek Leckow – Barrington Research

East and Midwest. And you’ve opened a new distribution center in the Midwest, how is that operating?

Jim Cleary

In Indianapolis and it’s going extremely well.

Derek Leckow – Barrington Research

And is that where we’re seeing most of the leverage in terms of your distribution expenses? Is it coming from that region mainly or is it across the board?

Jim Cleary

Yes, it’s coming across the board because we had – in the past few years, we had opened, moved or expanded most of our distribution centers. And so, what we are really seeing this fiscal year is the operating leverage provided by having done that in past years.

Derek Leckow – Barrington Research

Is there anything planned in terms of CapEx this year or next, anything major?

Mary Pat Thompson

Yes, we are currently estimating to spend about $2.5 million for the rest of fiscal year 2010 based on our current and projected projects both in the United States and in the UK. One of them we are looking at is moving our California warehouse. The growth there has been excellent and we have opportunities to improve technology and opportunities like that.

Derek Leckow – Barrington Research

Anything for next year, any big projects planned for next year?

Mary Pat Thompson

I will expect to continuing to see probably between $1.5 million and $2 million of CapEx more of it at that time probably in technology improvement.

Operator

I am showing a question from John Kreger of William Blair. Your line is open.

John Kreger – William Blair

Jim or Mary Pat, could you please give us an update on what you’re seeing in the flea and tick class now that some of the channel strategies of the suppliers have changed?

Jim Cleary

We did see one of the major manufacturers of parasiticides start to sell to some of the pet specialty stores and some of the online retailers. That does have an impact longer term on our customers. And so, it’s not something that we view as a favorable to our customers and therefore not favorable to our business. I think at the present time we are seeing that fully being offset by the fact that we had prior to this year an exclusive agreement with a single manufacturer of parasiticides and now we really carry all of the brands, which is providing additional opportunities for us.

John Kreger – William Blair

Just a general question. What sort of feedback are you getting from your customers about where the market environment stands? Are you hearing reports of a robust improvement in traffic for animal hospitals or is it more subdued?

Jim Cleary

I would say, John, that it is improving and we are – and it really depends on the particular practice, the particular location of the practice, how it’s managed. And so I would not say it’s a uniform but I would definitely say it’s improving.

John Kreger – William Blair

And then lastly, we’re about a quarter into the past the last major bit of consolidation in the industry. Are you seeing any change in competitive pressures now that we’re past that deal?

Jim Cleary

No, I would say that competitive pressures are about the same in the companion animal market and the production animal market.

Operator

I am not showing any additional questions at this time.

Jim Cleary

Okay, well, thank you everyone for participating in our call today. Have a great day.

Mary Pat Thompson

Thank you.

Operator

Ladies and gentlemen, this does conclude today’s conference. Thank you for your participation and have a wonderful day. You may all disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

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