MWI Veterinary Supply, Inc. Q2 2008 Earnings Call Transcript

MWI Veterinary Supply, Inc. (MWIV)

Q2 2008 Earnings Call Transcript

May 1, 2008 11:00 am ET

Executives

Mary Pat Thompson – SVP of Finance and Administration, and CFO

Jim Cleary – President and CEO

Analysts

July Johnson – Piper Jaffray

John Kreger – William Blair

Robert Willoughby – Banc of America Securities

Aubrie Fine – JPMorgan

Amy Stevens – Susquehanna Financial Group

Presentation

Operator

Good day everyone and welcome to the MWI Veterinary Supply's Second Quarter Fiscal 2008 Earnings Conference Call. Today's call is being recorded. At this time, for opening remarks, I'd like to turn the conference over to Mary Pat Thompson, Senior Vice President of Finance and Administration, and Chief Financial Officer. Ms. Thompson, please go ahead.

Mary Pat Thompson

Good morning, and welcome to MWI Veterinary Supply's second quarter fiscal 2008 earnings conference call. This is Mary Pat Thompson, Senior Vice President of Finance and Administration, and Chief Financial Officer. And 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 reflect management views only as of 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.

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

Jim Cleary

Good morning, and welcome to MWI Veterinary Supply's second quarter fiscal 2008 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 year ending September 30, 2008. Lastly, we'll open the call to questions.

Today, MWI reported revenue growth for the second quarter ended March 31, 2008 of approximately 11% to $195 million compared to $175.1 million in the second quarter ended March 31, 2007, and revenue growth of approximately 19% to $398.3 million for the first six months ended March 31, 2008 compared to $336.1 million for the same period in the prior fiscal year. Of the approximately 11% revenue growth during our second quarter, revenue from product sales grew by approximately 12%, revenue from sales of product to Feeders' Advantage grew by approximately 1%, and commission revenue grew by approximately 24%.

Net income for the second quarter of fiscal-year 2008 increased approximately 19% to $4.4 million or $0.36 per diluted share as compared to $3.7 million or $0.31 per diluted share in the second quarter of fiscal year 2007. Highlights for the quarter included continued growth from our value-added services, including growth in our pharmacy sales of approximately 22%, and our Internet sales to independent veterinary practices and producers grew by approximately 41%.

Our product sales from the Internet as a percentage of sales improved to 27% compared to 23% for the quarter ended March 31, 2007. Additionally, we successfully negotiated and renewed vendor contracts with two of our largest vendors, which have more favorable terms than our prior contracts with these vendors. I was pleased by our team's strong performance this quarter and during the first six months of fiscal-year 2008; in particular, our growth in revenues, profitability, and value-added services. These results are due to our team's continued focus on our five core values of customer service, integrity, dedication, innovation, and quality.

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. As Jim indicated in his remarks, we experienced continued growth in our revenues during this fiscal quarter as compared to the same period in fiscal-year 2007. Revenue growth was approximately 11% for the quarter ended March 31, 2008. Revenue growth in the quarter was lowered by a shift in the timing of price increases from two of our largest vendors. These price increases were announced effective February 1, 2007 in the prior fiscal year, but were announced effective January 1, 2008 in the current fiscal year. This resulted in a shift of certain revenues that otherwise would have been earned in the current quarter, to our first fiscal quarter 2008, when revenues grew by approximately 26% from the same period in the prior fiscal year. We estimate that approximately 5% of the 26% growth in the first fiscal quarter was due to the shift in the timing of price increases. The increase in revenues was attributable to an increase in product sales volumes for both new and existing customers.

Revenues attributable to new customers represented approximately 75% of the growth in total revenues during the quarter ended March 31, 2008, while growth from existing customers was approximately 25%. Also contributing to revenue growth was the increase in commissions on our agency sales of approximately 24% to $3.6 million for the quarter ended March 31, 2008, from $2.9 million for the same period of the prior fiscal year. Revenues from sales to Feeders' Advantage increased approximately 1% for the quarter ended March 31, 2008 compared to the same period of prior fiscal year.

Gross profit increased by approximately 16% to $28.3 million for the quarter ended March 31, 2008 from $24.4 million for the same period in the prior fiscal year. Gross profit as a percentage of total revenues was 14.5% and 14.0% for the quarter ended March 31, 2008 and 2007, respectively. Our product margin improved in the quarter as we experienced higher companion animal revenues in the quarter ended March 31, 2008 compared to the same period in fiscal 2007, as a result of the shift in timing of price increases, as well as increased commissions on our agency sales of approximate 24%.

Vendor rebates decreased approximately $52,000 for the quarter ended March 31, 2008 compared to the quarter ended March 31, 2007. In our press release issued January 31, 2008, we reported that rebates for the three months ended December 31, 2007 were approximately $1 million less than anticipated due to a difference with a key vendor over the amount of rebate dollars that were expected during the quarter under their program. We earned approximately $400,000 of this amount in the three months ended March 31, 2008. We expect to earn the balance of these rebate dollars over the remainder of fiscal-year 2008.

Operating income increased approximately 18% to $7.1 million for the quarter ended March 31, 2008 from $6 million for the same period in the prior fiscal year. SG&A as a percentage of revenues was 10.5% for the quarter ended March 31, 2008 compared to 10.2% for the quarter ended March 31, 2007. SG&A expenses increased approximately 15% to $20.4 million for the quarter ended March 31, 2008 from $17.8 million for the same period in the prior fiscal year. The dollar increase in SG&A expenses was primarily due to increased compensation costs, and location and occupancy costs. These costs increased as we added 34 new build sales and telesales representatives, as well as the employees from the Tri V and Securos acquisitions, and the new distribution center in Edwardsville, Kansas in October, 2007. This distribution center also increased our capacity by approximately 105,000 square feet.

Our effective tax rate for the quarter ended March 31, 2008 and 2007 was 38.8% and 38.5%, respectively. Net income increased approximately 19% to $4.4 million for the quarter ended March 31, 2008 compared to $3.7 million for the quarter ended March 31, 2007.

Diluted earnings per share were $0.36 per share for the quarter ended March 31, 2008 compared to $0.31 per share for the quarter ended March 31, 2007; an increase of approximately 16%.

Total revenues grew approximately 19% to $398.3 million for the six months ended March 31, 2008 compared to $336.1 million for the six months ended March 31, 2007. The increase in revenues was attributable to an increase in product sales volumes for both new and existing customers. Revenues attributable to new customers represented approximately 53% of the growth in total revenues during the six months ended March 31, 2008, while growth from existing customers was approximately 47%. Also contributing to revenue growth was the increase in commissions on our agency sales of approximately 43% to $6.5 million for the six months ended March 31, 2008, from $4.6 million for the same period in the prior fiscal year. Revenues from sales to Feeders' Advantage increased approximately 9% to $20 million for the six months ended March 31, 2008, from $18.4 million for the same period in the prior fiscal year.

Gross profit increased by approximately 16% to $58.1 million for the six months ended March 31, 2008, from $50.2 million for the same period in the prior fiscal year. Gross profit as a percentage of total revenues was 14.6% and 14.9% for the six months ended March 31, 2008 and 2007, respectively. The reduction in margin was partially due to actual rebate dollars decreasing by approximately $819,000 for the six months ended March 31, 2008 as compared to the same period in the prior fiscal year because of the shift in timing of when certain rebates were earned.

Operating income increased approximately 10% to $14.8 million for the six months ended March 31, 2008, from $13.5 million for the same period in the prior fiscal year. SG&A as a percentage of revenues was 10.5% for the six months ended March 31, 2008 compared to 10.6% for the six months ended March 31, 2007. SG&A expenses increased approximately 18% to $41.7 million for the six months ended March 31, 2008, from $35.5 million for the same period in the prior fiscal year. The dollar increase in SG&A expenses was primarily due to the same reasons that I previously discussed for the second quarter.

Our effective tax rate for the six months ended March 31, 2008 and 2007 was 40.0% and 37.9%, respectively. Net income increased approximately 9% to $9.1 million for the six months ended March 31, 2008 compared to $8.3 million for the six months ended March 31, 2007. Diluted earnings per share were $0.74 per share for the six months ended March 31, 2008 compared to $0.70 per share for the six months ended March 31, 2007. The change in diluted shares reflects the issuance of 348,974 shares of common stock from our offering that occurred in April 2007.

Now, I will turn it back over to Jim.

Jim Cleary

Thank you, Mary Pat. Now I'd like to turn our attention to MWI's outlook for the fiscal year ending September 30, 2008. Consistent with our guidance provided earlier this fiscal year, we project revenues will grow approximately 16% from $710 million in fiscal-year 2007 to approximately $825 million in fiscal-year 2008. Diluted earnings per share are forecasted to be approximately $1.62 per share. Incorporated into this guidance is our expectation that the animal health products market will continue to grow in 2008, but at a slower rate of growth than in recent years.

Actions planned for fiscal year ending September 30, 2008 include: First, we'll continue our focus on value-added services, including our e-commerce platform, inventory management system, pharmacy fulfillment program, capital equipment consulting, and other value-added services. Second, we'll expand our sales force into new sales territories. Third, we'll continue to invest in productive infrastructure. Fourth, we'll evaluate potential acquisitions that are a strategic fit for MWI and add to our shareholder value. And fifth, we are continuing focus on our Great Places to Work initiatives.

With these efforts, we'll continue our mission to become the best resource to the veterinary profession by delivering superior value, efficiency, and innovation. Now, I'd like to open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) And our first question comes from July Johnson, Piper Jaffray.

July Johnson – Piper Jaffray

Hi, thanks for taking my question and congratulations on the quarter. My first question, just kind of on a broad basis – after VCA has noted that they're seeing a slowdown in spending at the clinic level for companion animal, can you discuss a little bit more about what you're seeing on the companion animal side of your business?

Jim Cleary

Sure. I'd be happy to do so. As we said during the call, we expect that the U.S. animal health products market will continue to grow this year, but we expect the rate of growth to be slower than it has been in recent years. If we look at our March quarter, the three months ended March, and if we look at the companion animal part of the business, the companion animal part of the business grew faster this quarter than did the food animal part of the business. And we saw growth rates in all of our regions north of 5% in the companion animal market. And so we do expect, based on what we've seen, that the market is going to grow at a slower rate this year. But we still feel that it's a good market and we feel very good about the long-term prospects for the market, July.

July Johnson – Piper Jaffray

Thank you, that's helpful. That just segues nicely into my next question. Can you talk a little bit about the performance of your new territories, maybe specifically, the Midwest, the new Kansas City Distribution Center?

Jim Cleary

Sure. We're seeing growth rates in the Midwestern portion of the United States, which are significantly higher than our overall company growth rates. And so, we feel good about the expansion. But of course, it all doesn't come at once. And so, it's really going to be a multi-year process of trying to build market share in the Midwestern United States, but it's off to a good start.

July Johnson – Piper Jaffray

That's great to hear, thank you. And then more of a housekeeping level. What are your expectations for full-year cash flow from operations and CapEx?

Mary Pat Thompson

Yes, as I said earlier, we'll spend about $2.5 million annually on CapEx. And I think we're still definitely in line for that. Our growth rate for the March quarter slowed down, so of course we generated positive cash flow this quarter of $2.1 million. As I said earlier, I'm anticipating break-even or slightly negative cash flow for June. And really what we do is when we're growing at 20%, it's [ph] negative cash flow, when your growth slows down to 15%, it becomes break-even or slightly positive. So, you can do some modeling from that.

July Johnson – Piper Jaffray

Great. Thank you.

Operator

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

John Kreger – William Blair

A question about rebates. If we back out the $400,000 recovery from the vendor dispute, it looks like your rebates would have been down about $450,000, but you have very nice gross profit improvement. Can you just give us a comment on that? Are you pleased with the rebate number? Is it on track? And are you perhaps seeing a shift away from rebates towards other more transactional-oriented gross margin?

Mary Pat Thompson

Good question. Thank you for asking that. I'd say the biggest impact on our rebates was a shift in the timing of one of our rebates that's earned. One of our more significant rebates is measured on a trimester basis. That first trimester ends April 30. In the prior year, we achieved some of this rebate early, approximately $700,000 of it, due to the price increases that took place during the quarter a year ago. So, for this quarter, the price increases put the business into December, so we'll see that rebate being earned in the April trimester, of course, which will be our June quarter. In addition, there's also remaining $600,000 roughly of the $1 million that we expect to be earned over the balance of the fiscal year. And yes, to your earlier comment, we are seeing a shift somewhat away from rebate more to gross margin transactions, which we view as a positive. And because of that, we view rebates probably flat for 2008.

John Kreger – William Blair

Okay. And then a second question – can you remind us, did you guys see any benefit last year in the margin, June quarters, from the pet food recall that will make the comparisons tougher this year? Or is that a non-factor for you?

Jim Cleary

It's a very small factor for us. We did see some benefits that would have impacted both the margin, to some extent, the June quarter last year, but given the diversity of our business, that benefit was relatively minor for us. And so it does make the comps just a little bit harder this year than last year, but not significantly so.

John Kreger – William Blair

Okay, thanks. And then Jim, if you – just to expand on July's question about the companion market, as you talk to your customers and the feedback you're getting from your reps, are we seeing any impact from the tougher economy on your customers?

Jim Cleary

Yes, that's a good question. And as I've commented in the past, we do hear anecdotal stories coming in from the field about business being slower in hospitals. But it is not showing up as much in the numbers as it is showing up in those anecdotal reports that we're hearing.

John Kreger – William Blair

Okay. How is the pricing environment from your perspective?

Jim Cleary

We are seeing somewhat increased price competition in the market. And so the pricing environment is not improved, and it's somewhat more competitive, John.

John Kreger – William Blair

Okay, great. And then one last question on the production side of your business. Are you seeing any impact from the surge in commodities pricing in areas like corn and wheat?

Jim Cleary

Yes. And if you look at our overall business – as you know, our business mix is about two-thirds companion animal and one-third production animal. And that's a mix that we very much like. In the production animal market, the largest segment for us would be dairy. And the dairy market continues to be good and a profitable one for dairy producers. And so, the dairy market continues to be good. Probably the next largest segment for us is cow/calf ranching. And that market is okay. And then the market that's probably impacted right now, more than the others, would be the feedlot segment, which is probably the smallest for us. And we are seeing placements declining into feedlots, which is, in our opinion, more of a timing difference. But we do think that commodity prices are having some small negative impact overall on the production animal market for us. But it's not – once again, it's not a huge impact on us, given the diversity of our business.

John Kreger – William Blair

Great. Thanks very much.

Operator

We'll go next to Robert Willoughby, Banc of America Securities.

Robert Willoughby – Banc of America Securities

Hey Jim or Mary Pat, can you speak to any change in behavior or economics for your leading chain customer there on the companion side?

Jim Cleary

Sure. Our largest companion animal customer, Banfield, continues to perform very well, and is doing very well as a business and is continuing to open new hospitals. And so, while we don't disclose growth rates for Banfield, their business continues to perform well, Bob.

Robert Willoughby – Banc of America Securities

Back a ways [ph] there was a change in the profile – they'd opened fewer locations but add more vets for location. Now, has that happened or is there any change in that kind of growth profile that they've been on?

Jim Cleary

Their growth profile is staying very much the same and is very positive, and they're adding vets per location as well as new locations, Bob.

Robert Willoughby – Banc of America Securities

Okay. You did mention price competition out there in your markets. Is there any change in terms of the acquisition outlook, either for yourself or how you see the industry shaping up?

Jim Cleary

Yes. I think that the rate of consolidation in our industry is accelerating. And I think that there will be more consolidation of some of the regional distributors in 2008 than there has been in past years. And I think that's being driven by a number of factors, but we definitely see more consolidation activity in the next six to 24 months than we've seen in the past, Bob.

Robert Willoughby – Banc of America Securities

And are you a leader of that, Jim? Or are you just on the sidelines watching how things fall out and picking out some bodies on the side or –?

Jim Cleary

You know, I think that there's a small handful of players that will be participating as acquirers. And we'll definitely participate. But we'll also be as disciplined in the future as we've been in the past. And we definitely know the companies that we are interested in and we'll continue to be disciplined in what we do.

Robert Willoughby – Banc of America Securities

And would you anticipate any major shifts in your mix from companion versus production? Or would that largely hold going forward?

Jim Cleary

We think that would largely stay the same.

Robert Willoughby – Banc of America Securities

Okay. And just lastly, obviously some upside to consensus here. Any primary reason why the numbers for the year, of the guidance, would not have ticked higher?

Mary Pat Thompson

I think right now everybody is somewhat concerned about the impact to the economy. And so we feel that at 16% growth top line is an aggressive forecast in this environment. And we're very comfortable with $1.62.

Robert Willoughby – Banc of America Securities

Okay. Thank you.

Operator

We'll go next to Lisa Gill, JPMorgan.

Aubrie Fine – JPMorgan

It's Aubrie Fine in for Lisa. Could you perhaps provide us an update on your private label initiative? And in terms of leveraging costs going forward, I think you had talked about your distribution centers a little bit, but any further update on the benefits from consolidation in the balance of fiscal '08 and hopefully looking out to '09?

Jim Cleary

Yes. I will address the private label sales, and then I'll let Mary Pat address things we're doing and opportunities and operating leverage.

With regard to our Vet One line, our sales during the quarter were just over $6 million. And that was 89% growth from the same quarter the prior year. And the number of SKUs at the end of the quarter was 327 products, up from 194 at the end of the same quarter the prior year.

And so, as I've said in the past, we're continuing to roll out our private label brand in kind of a slow, methodical manner. And it's going quite nicely and meeting our expectations.

Mary Pat Thompson

Great. And while our SG&A margin did look worse in the March quarter, I think it's important to look at the six months because of the shift in revenues from the price increases definitely did affect the gross margin percentage improvement. We're still very comfortable with the 10 to 20 basis points improvement for the year. The way we're going to go about managing that is making sure that we monitor our labor spend. From a facilities and infrastructure perspective, when we added Kansas City, that gave us 105,000 square feet. And so from an infrastructure perspective, we have excellent capacity. We felt all the cost of that going forward. We do anticipate at some point moving out of our facility into Dallas into a larger facility in Dallas, but I don't anticipate those costs impacting fiscal-year 2008.

Aubrie Fine – JPMorgan

Okay, thanks. And if I could just add a follow-up to the private-label question. Is there any particular – between the companion and production segments, is there one particular one that you're favoring the product lines into? Or is the uptick generally distributed between both the segments?

Jim Cleary

It's distributed between both the segments, and we feel that there are private label opportunities in both the companion animal and production animal markets.

Aubrie Fine – JPMorgan

Okay, that's great. Thank you.

Operator

(Operator instructions) And we'll go to Amy Stevens, Susquehanna Financial.

Amy Stevens – Susquehanna Financial Group

Yes. Thanks for taking the question. I just wanted to follow-up on a couple things. One is, I know you said it's more anecdotal at this point in terms of pressure on growth in the companion health market, but to the extent that you are seeing any beginning signs of that, could you give any color in terms of geographically where you're seeing more and/or kind of less of that? And then, second, in terms of the pricing issues that you discussed, when you're saying that the competition has increased in terms of pricing, has that been more a result of you guys putting out price increases and seeing resistance from customers? Or is that a matter of you having customers come to you and say, “We're being offered lower prices by your competitor, so you meet that?”

Jim Cleary

Sure. Let me address both of those. With regard to the first one – are there certain parts of the country which are being impacted more by the economy? I think that was generally the first question. I'll just say, it's very hard to answer that based on our company's data, because of course, our market share is much higher than the Western United States than it is in the Midwestern and Eastern portions of the United States. And so, we would naturally see more – to the extent that there is an impact, we would naturally see it more in the West than we would in the East and the Midwestern portion of the United States, because we're still small there and gaining a lot of market share. And so, that's really the best way that I can answer that first question based on our company's data.

And with regard to the second question, I think that, to the extent we are seeing more price competition in the market, it's probably driven more by the competitive nature of our market and distributors wanting to show growth rates and that sort of thing, rather than being driven by other factors.

Amy Stevens – Susquehanna Financial Group

Okay, thank you very much.

Operator

And now, we'll go back to July Johnson with Piper Jaffray for a follow-up.

July Johnson – Piper Jaffray

Just a quick follow-up. Could you give us an update on the number of sales reps that you have in the field – sales reps position and the telesales rep position?

Jim Cleary

Sure, let me give that to you. At the end of the quarter, we had 173 sales reps in the field, and that compares to 170 at the end of the December quarter, and 159 at the end of the March quarter last year. And then sales reps on the phones, we had 130 at the end of this March quarter as opposed to 128 at the end of the December quarter, and 110 at the end of the March quarter last year. So our total was 303, up 5 from 298 at the end of the December quarter, and up from 269 at the end of the March quarter last year.

July Johnson – Piper Jaffray

Okay, thank you. And could you give us an update on your plans for hiring to the balance of the year?

Jim Cleary

We basically plan to continue to hire for the rest of the year as we have in the past. And we don't have a target number of sales reps. We have a target profile that we are hiring to, and as we can hire to that profile, we'll continue to do so. And so, as I've said in the past, I think that the numbers that we're hiring annually will stay about the same.

July Johnson – Piper Jaffray

Okay, great. Thank you.

Operator

And there are no further questions at this time. Ms. Thompson, I'll turn the conference back to you for any closing remarks.

Jim Cleary

Yes, I'll just make a couple of closing remarks. Once again, I was quite pleased with the results for the quarter and for the first six months of the fiscal year, both in terms of revenue growth, profitability growth, the progress we saw in our value-added services, and then progress we saw in a number of other metrics that we measure internally also. So, thank you very much for participating on the call and have a great day. Good bye.

Operator

That concludes today's conference. Thank you for your participation.

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