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Animal Health International, Inc. (NASDAQ:AHII)

F1Q2011 Earnings Call Transcript

November 15, 2010 10:00 am ET

Executives

Jim Robison – Chairman, President, and CEO

Bill Lacey – SVP and CFO

Analysts

John Kreger – William Blair

Mark Arnold – Piper Jaffray

Jason Bernard [ph] – Robert W. Baird

Operator

Greetings and welcome to the Animal Health International first quarter 2011 conference call and webcast. At this time, all participants are in a listen-only mode. A brief 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, Jim Robison, Chief Executive Officer for Animal Health International. Thank you, Mr. Robison. You may begin.

Jim Robison

Thank you. Good morning, everybody. Bill Lacey is going to start off my reviewing our results for the first quarter and then I’m going to make comments and then we’re going to take questions. Bill?

Bill Lacey

Thanks, Jim. And good morning. 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 web page 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 ‘11, our competitive position, future business prospects, revenue growth, and market opportunities for the coming fiscal year contain forward-looking statements that involve risk and uncertainty. These statements are based on current expectations. Actual results may differ materially from those set forth in such statements. Additional information concerning 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, we report certain non-GAAP financial results, including EBITDA or adjusted EBITDA. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release.

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

Before I talk about the first quarter, I’d like to point out that we refinanced – we completed the refinancing of our debt on November the 10th. We amended our existing asset-based loan revolver to basically a five-year extension. It expires on August 10th, 2015. It’s a $130 million facility. The amended revolver has interest rates based on the company‘s leverage ratio ranging from LIBOR plus 225 to LIBOR plus 300, or 3%. The New Term Note has a face amount of $43 million and matures on November 10, 2015. The cash interest rate is 2.25%, with 2.00% payment-in-kind and an original discount of 2%.

I will now provide you with the financial results of our first quarter of fiscal year 2011. Net sales compared to last year increased 9.4%. Net sales for the quarter were $176.5 million compared to $1613 million for the same period last year. Gross margin increased $1.4 million, with $2.4 million due to sales volume partially offset by an unfavorable shift in product mix. Margins in the first quarter were 15.5% of net sales compared to 16.1% in the first quarter last year.

Several things contributed to the margin making up the product mix and change, one of which was a Pfizer program, which began in July and runs until October. And we did not recognize any of the rebates associated with that. We won’t recognize those until the next quarter. So that drove down the Pfizer margins, which made up about 19% of our sales. Net sales were up 15%, but with lower margins due to the competition for the PVP sales. And also, if you recall, last year, this quarter was the last operating quarter of Fort Dodge, which carried some nice margins.

SG&A expenses were 14.1% of sales in both periods. SG&A expenses were $24.8 million compared to $22.8 million last year. Our provision for bad debt increased $400,000 in expenses associated with the acquisition of certain assets of a competitor's were $200,000. The remainder of the increase was volume-driven.

EBITDA was $3.2 million, which was a decrease of $0.2 million from the earlier quarter of $3.4 million. Net loss for the quarter was $0.5 million compared to the first quarter last year net loss of $0.7 million. Fully diluted loss per share was $0.02 versus $0.03 loss last year. Earnings per share without amortization or cash basis EPS was $0.02 per share.

At the end of June, we had 41.2 days of working capital. Our average for the last 12 months was 44.6. Capital expenditures were $0.8 million for the quarter. Fixed charge ratio was 3.6 times on a trailing 12-month basis. The company is in compliance with its bank covenants. And at June 30, 2010, the company's availability under its revolver totaled $27.5 million. We have not changed our guidance for the year. We still expect to be in the range of $25 million to $27 million of adjusted EBITDA.

And with that, I'll turn it back over to Jim for any final comments.

Jim Robison

Thanks, Bill. I’d like to comment about specific groups of our business. First, our production animal business. Our production animal business is growing in the mid-to-high single-digit range, and for the quarter, grew approximately 7%. The big component of our production animal business was relatively strong, and we believe it will remain strong through the fiscal year.

Our dairy customers, as you’d probably know, have weathered very tough couple of years. They are doing better, but there is some uncertainty on a forward basis given future’s pricing regarding grains and milk. Generally, our production animal business continues to improve, and I think the potential to have a much more favorable environment on a forward basis is good.

Our mixed animal vet business is realizing double-digit sales growth. This has been driven by a gain of market share from our competitors, impact of new representatives, and an outstanding performance by our sales group in the sale of push and focus products. The prospects for our vet business are very good.

Overall, the sale of emphasis product, which we refer to as push and focus products, grew by 15% during the quarter. Our sales force has demonstrated an unparalleled ability to impact market share, and thus as new products return to the market that have been pulled from the market due to manufacturing problems over the next several quarters, we are anticipating an improvement in gross profit margins.

As you may be aware, commodity prices have been rather volatile over the last quarter. Really, if you look back to the initiation of ethanol legislation back in 2007, there has been an increase both in prices and price volatility. Just since June of this year, corn has spiked up 75% to just over $6 a bushel.

As our customers are usually long on feed grains by 60 to 90 days, the effect of this spike was not realized during the quarter. Most recently, the spike has caused our customers to pause out of caution, given that their primary input for creating proteins is corn. (inaudible) to $6 a bushel this last week. Markets backed up significantly with corn settling down Friday to $5.40 a bushel.

Market commentary around the cause of the volatility in grain prices generally focuses on three areas. It was initiated by global demand, change in global supply and demand. Russia announced that they are going to be closing their export of wheat for up to two years, and that caused China to go long on US corn immediately. Most recently, given a view that the demand on domestic grain markets might not be what it was initially anticipated to be, there has been a washout of the speculation, and the belief is that this is what drove corn prices down last week.

Also there is speculation that the ethanol policies that were put in place in 2007 could be modified. They are all set to expire December 31 of this year, given the concerns about global hunger, food prices, the environment, and the trade with Brazil. There is a lot of pressure to modify our existing ethanol policies. So we are anticipating that there is at least a likelihood that on a forward basis, we could see less volatility in grain prices and this would be viewed very favorably by our customers.

We are encouraged by sales growth during the quarter. Also most recently, we had two key manufacturers return to the market with meaningful products and helping us manage our product mix. And we also continue to make significant progress on products and service initiatives, and thus we believe that margins will strengthen throughout the year. Our confidence about opportunities on a forward basis let us the higher 25 sales and sales management employees during the quarter. Although early with this group of new salespeople, the results are very encouraging.

We are on track with our facility expansions with new facilities planned for the Northeast, Southeast, and the Midwest. And through new marketing initiatives and the introduction of new technology, we will impact sales growth and productivity during this quarter. Given generally favorable trends, the return of important products to the market, the introduction of new products and services, the impact of expansion initiatives, we believe that sales growth should strengthen as well as earnings throughout the remainder of the year.

In summary, as we have successfully refinanced our business, on balance, our trends are favorable. We are very upbeat and encouraged by the prospects for our business. With that, I’ll open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question is from John Kreger with William Blair. Please proceed with your questions.

John Kreger – William Blair

Hi. Thanks, guys. Bill, you mentioned that your guidance hasn’t changed for the year in terms of adjusted EBITDA. Any change in your thinking for either revenues or margins?

Bill Lacey

Not yet, John. It’s – we're still – if anything, what we’ve seen so far – and the reason I wouldn’t change anything yet is it’s just one quarter. It’s too early. We’ve seen probably heavier revenues than we anticipated and slightly lower margins than we were hoping. And those two will probably be offset each other. And John, I would point out something that I might have missed. I might have mis-spoke the interest rate on the new term note when I described it earlier. The term note is a five-year facility. It has a fixed rate of interest; a 12.25% cash and 2% PIK, 2% discount. I think I might have said 2.25% interest. That would have been nice.

John Kreger – William Blair

Yes, thanks. That’s good clarification. Since you brought up the refi, did the expected rate that you are paying on the revolver change?

Bill Lacey

Yes, it went down. We were paying 3.75 or LIBOR plus 375, and we’ve negotiated that down to LIBOR plus 300.

John Kreger – William Blair

Great. Okay. One other comment about your expectations for the rest of the year. Jim, I think you may have said you expect gross margin to improve as you go through the year. Just wanted to clarify that.

Jim Robison

Yes, that’s correct.

John Kreger – William Blair

Great. What do you think the drivers of that will be – the Pfizer rebate capture?

Jim Robison

Yes. I think there will be some rebate realization that we – that looks, to a limited degree, promising. But more importantly, one – Intervet-Schering their Vista vaccine in the first quarter of last year. And we were growing very, very nicely with that product. We are anticipating it’s going to be re-launched over the next couple of months. It’s a very strong product. Also Boehringer Ingelheim has set some challenges with the manufacturing of their vaccines, which we believe they will work through. And then finally, Diamond Labs, who also make some modified live cattle vaccine, has been off of the market as well, and they are coming back to the market with their modified live vaccine.

So we have the return of very important products to us, which we think will allow us to grow sales in those product lines and that category very, very nicely on a forward basis. And then also we are doing very well with our emphasis products. We have annualized sales of just under $90 million with emphasis products, and they are growing in total about 15%. Those products carry higher gross profit and net profit margins than our general products do.

John Kreger – William Blair

And when you say emphasis products, are these just products you are putting particular muscle behind or are these private-label products?

Jim Robison

They are branded products as well as products that we’ve – come from other people’s brands, but are of strategic importance to us because of the impact to our business or the gross profit margins.

John Kreger – William Blair

Okay, great. And then one last question. What’s the size of your vet business at this point?

Jim Robison

I think the run rate on it is approach $200 million.

John Kreger – William Blair

Great. Thanks.

Operator

Our next question is from Mark Arnold with Piper Jaffray. Please proceed with your question.

Mark Arnold – Piper Jaffray

Good morning. I guess maybe just to start with Bill. Can we just talk about the debt financing? I assume there is no floor – LIBOR floor on the revolver. Is that correct?

Bill Lacey

There is no LIBOR floor.

Mark Arnold – Piper Jaffray

Okay. And then on the term loan, the $43 million term loan, are there are any prepayment conditions or penalties on that or are you able to prepay that at any time?

Bill Lacey

It’s 103, 102, 101.

Mark Arnold – Piper Jaffray

Okay. And that’s mixed – that's on an annual basis or each year (inaudible)?

Bill Lacey

Yes, that’s right.

Mark Arnold – Piper Jaffray

Okay. Okay. And then in terms of covenants on that, what are the more restrictive covenants in the new term loan?

Bill Lacey

Basically there are three covenants. Before we – and we had two of them before. We had the fixed charge coverage and we had the CapEx. We have both of those in the new deal.

Mark Arnold – Piper Jaffray

And the fixed charge is still at 1?

Bill Lacey

Yes. And the – I believe we are at 3.2 times now. So fixed charge doesn’t appear to be an issue at this time. And we also now have a leverage covenant that starts at 6.75 times and ramps down slowly in the first several years and then gets down to about 3.75 times into the fifth year.

Mark Arnold – Piper Jaffray

Okay. Are you planning on filing that along with your Q in the December quarter?

Bill Lacey

The refinancing documents will be filed with this quarter’s.

Mark Arnold – Piper Jaffray

Great. Okay. Then just past that, I’m curious to know to what extent the hiring of the 23 sale reps in PVP and the new sales and service center in Omaha that you guys acquired and set up in September. How did that affect your gross margins and SG&A in the quarter?

Jim Robison

Very little. We hired most of the employees in either late September or early October. We didn’t have a lot of SG&A specifically around that group. And I don’t think that group contributed anything to the sales and gross profit line.

Jim Robison

Okay. And then just the expansion initiatives of the new facilities that you mentioned in the prepared remarks, how should we think about that in terms of being a short-term – is there any short-term drag there to margins, you know, gross margin or SG&A?

Bill Lacey

They are in our forecast.

Mark Arnold – Piper Jaffray

Okay. And that will ramp through the year or how should we think about that?

Jim Robison

We are not certain as to what quarter we will actually complete those growth initiatives that will ramp through the year. I don’t think they are material for our results and they are in the forecast. The hiring of the PVP reps, that event was not in our forecast, and rough cut here, we’re spending couple of hundred thousand a month in SG&A to support that group.

Mark Arnold – Piper Jaffray

Okay. And then –

Bill Lacey

Keep in mind, Mark, that those guys came in only in the last seven to ten days of September – to Jim’s point, they had little or no effect on our business in this quarter. They had no effect on our business in this quarter. However, I think our margins were slightly impacted as the existing sales force went after the sales that were out there for grabs during that quarter from PVP, as our vet margins were down about 20 basis points.

Mark Arnold – Piper Jaffray

Okay. That makes sense. I guess – I lost my train of thought here. One last question. As we think forward here – you know, I’ll jump back in queue and let somebody else ask a question and I’ll jump back in. Thank you.

Jim Robison

Thanks.

Operator

(Operator instructions) Our next question is a follow-up question from John Kreger with William Blair. Please proceed with your questions.

John Kreger – William Blair

Thanks. Hi again, guys. My follow-up relates to the top line. We were only expecting something like 6% growth. So you guys did a lot better than that. Would you mind trying to just break down that 9% that you generated? What do you think your markets are growing at? And I assume they are a lot lower than that 9%. So the remaining growth that you are getting, how much of that do you think is coming from new continue additions versus just more sales and new existing customers?

Bill Lacey

John, I’m going to break that into pieces. Our vet business, like I said, was up about 15%, driven mostly by increased – well, the vet business has been up for several quarters now. So it was enhanced. During the quarter, we picked up some volume from the PVP failure.

John Kreger – William Blair

Yes.

Bill Lacey

It’s very hard for us to isolate how much was just PVP and how much was growth in the segment, but it was 15% for the vet group. The beef business in general has been up strong during the quarter. Our West Coast operations were up as a result of the camp operations out there, and our beef business in the Midwest was strong. And our dairy business continues to improve. It’s going to be interesting as we go forward and see the impact of the higher corn prices and – but – and milk prices. Milk prices went down a little bit during the quarter.

John Kreger – William Blair

So would it be reasonable for us to expect maybe flat or even a decline in dairy in the coming quarter, but still growth in beef?

Bill Lacey

It’s really hard to tell right now. Jim, do you have any –?

Jim Robison

Yes, John, we had a – really up until – through ’08, we had about – we had high-single digit growth rate in the dairy business. And as you know, dairymen have been through the most protracted and significant as far as losses realized, difficult periods that – we've

certainly ever seen it, I think they’ve ever seen. It’s been a very, very tough couple of years. So I think most – there has been a washout. The number of milk cows down almost 9 million from a peak around 9.6 million. And dairymen have many dairies folded, ceased to operate. I think the washout has been largely realized. I think they are generally in the range of breakeven to slightly profitable on a cash basis for dairymen, I should say. And so I think that we’ll see a return to growth in the dairy market probably in the mid-single digit range, 4% to 6%. The beef business has been relatively strong. There is – the cow numbers were low. And with the high-end markets returning, there has been a pretty nice pickup in demand for premium cuts. I think that the beef business will outpace that probably growing in the 5% to 7% range.

John Kreger – William Blair

Great. Thanks for the detail. Bye.

Operator

Our next question is also a follow-up from Mark Arnold with Piper Jaffray. Please proceed with your question.

Mark Arnold – Piper Jaffray

I remembered by question. Rebates, you talked a little bit about the timing of some things here in the quarter. But can you just give us any outlook, Jim, on kind of what you expect if you have any thoughts about 2011 rebate programs?

Jim Robison

I think what will happen is, with key suppliers coming back to the market with important products and the market starting to grow again, I think the rebate climate will generally be favorable. When people are contracting and they are concerned about spending less money and reducing the cost of our operations, very often they give up on realizing budgets or plans for any given fiscal year. I think that the industry is going to be relatively healthy on a forward basis. And I think that as people start to reach for share, they are going to reincorporate or use incentive rebates to drive channel participants to affect share. So I think it’s a relatively favorable climate albeit coming off of a very, very low base.

Mark Arnold – Piper Jaffray

Okay. And then just one other question, you guys built inventories in the quarter a bit. I assume that was related to what was going on with PVP.

Jim Robison

It was.

Mark Arnold – Piper Jaffray

I’m also curious though, given that you now have the debt refinancing behind you and you’ve got the extendable timeline on that, does that put you in a better position over the next year versus where you’ve been over the last one or two years in terms of your ability to use your balance sheet a bit to your benefit from an inventory perspective? Any opportunities on the buy that are available or any negative that you may have had over the last couple of years in terms of how comfortable you were withholding more inventories given the volatility in your business? Can you just talk a little bit about what the debt refinancing mean to you from that perspective going forward?

Jim Robison

First, it’s great to have it done, build an outstanding job on it. And it’s a very solid structure and it’s on a – from the standpoint of forward interest rates versus historical, it’s slightly favorable. So it’s great to have it done. We’ve not seen a lot of buy-side margin opportunities in our business, much like we’ve not seen a lot of performance rebate opportunities. I think given – for the same reasons, that is, people not chasing numbers or share in the marketplace, we don’t think that having the financing done is going to give us a lot of opportunity on the balance sheet to buy a product or extend terms, and we don’t anticipate using the balance sheet in any way on a forward basis. But I think it does allow for our suppliers to breathe a sigh of relief, if you will. And they will probably be slightly more lax, although they have been pretty supportive of us, with slightly more lax on a forward basis.

Mark Arnold – Piper Jaffray

Great. Thank you, guys.

Operator

Our next question is from Jason Bernard [ph] with Robert W. Baird. Please proceed with your question.

Jason Bernard – Robert W. Baird

Good morning. Just a few questions here. I don’t want to get into just I guess line item guidance, but hoping you could at least discuss or provide some color around SG&A expectations for the year, given the PVP sales force adds?

Jim Robison

Jason, what was the – I didn’t hear specifically what you want the information on?

Bill Lacey

SG&A.

Jason Bernard – Robert W. Baird

Guidance on SG&A.

Jim Robison

Okay.

Bill Lacey

Jason, we don’t want to get into line item discussions around our guidance. But I will say that we don’t anticipate that the PVP additional salespeople will have a bottom line impact on our business this year. We will start out heavy in SG&A cost because of them with probably not as much contribution. So it will be a drag on the business in the first four to six months, and then we’ll start to see a benefit from them in the fourth quarter of our fiscal year. And I think it’ll net up for about a zero impact this year and have a much better impact next year.

Jason Bernard – Robert W. Baird

Okay. That’s helpful. And then is there any update you could provide on the lagoon product, kind of where we are at the launch and then any other updates you could discuss just around where that product is?

Jim Robison

Yes, it’s – we’ve gotten all the technical work done. We’ve made all of our finds with the regulatory authorities. We believe the science is very, very strong. We’re in final negotiations on a forward contract regarding the sale of carbon credits. And it’s really a week-to-week project right now. When we do launch, it is going to be a fairly slow ramp period. We’re going to take the first 90 to 180 days to make sure that we understand how our customers react to the opportunity and then we can manage the process effectively. And so I doubt that it’s going to have a material impact on the company financially this year, but we are extremely excited about it.

Jason Bernard – Robert W. Baird

Okay. And then just a few other housekeeping numbers and I’ll jump off. Just wondering, first, if you could provide what if any kind of impact was from currency in the quarter? And then just last one, what the cash flow from operations was in the quarter?

Bill Lacey

The currency is certainly going in our favor from the Canadian side. We were running at 97 exchange ratio. It’s probably about 98 or 98.5. So it really hadn’t had much effect on us and certainly hadn’t influenced any buying issues. Most of that is in our Canadian operation. So, not much impact from currency yet and really none expected. Cash flow for the quarter – I believe I’ve got that number on hand right now. Hold on just one second –

Jim Robison

(inaudible) any other questions –?

Bill Lacey

Move on to the next question. I’ll have that for you in just a second.

Jason Bernard – Robert W. Baird

Actually I thought you got it. So I don’t know if there are any follow-ups anywhere else, but –

Jim Robison

Do what, Jason, give us a call. We’ll handle that offline.

Jason Bernard – Robert W. Baird

Yes, sure thing. Thanks, guys.

Operator

There are no further questions in the queue at this time. I would now like to turn the floor back over to management for closing comments.

Jim Robison

Thank you for joining us this morning. We appreciate your interest and the time you spent with us this morning. Have a good day. Thank you, operator.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect at this time. Thank you for your participation.

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