Animal Health International Inc. F4Q08 (Qtr End 06/30/08) Earnings Call Transcript

Animal Health International Inc. (OTC:AHII) F4Q08 (Qtr End 06/30/08) Earnings Call Transcript September 9, 2008 10:00 AM ET

Executives

Jim Robison – Chairman, President and CEO
Bill Lacey – SVP and CFO

Analysts

Lisa Gill – JP Morgan
Julie Johnson – Piper Jaffray
Jeff Johnson – Robert Baird
John Kreger – William Blair

Operator

Good day everyone and welcome to the Animal Health International fourth quarter 2008 earnings results conference call. Today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to the Chief Executive Officer, Jim Robison. Mr. Robison, please go ahead, sir.

Jim Robison

Thank you, and good morning. Thank you to all of you for joining us for this call. With me this morning is Bill Lacey, our Senior Vice President and CFO. Bill will be discussing financial results for the fourth quarter and our fiscal year as well. I will then discuss highlights of our performance and we'll have a Q&A session. With that, I'll turn it over to Bill.

Bill Lacey

Good morning. Before we begin, I would 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 2009, 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 risks 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, AHI 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, 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 these forward-looking statements provided to reflect events that occur or circumstances that exist after the date on which they were made.

I’ll now provide you with the financial results for our fourth quarter and fiscal year 2008.

I'll talk about the fourth quarter first. Net sales increased 11.7% or $18.6 million to $178.3 million for the three months ended June 30, 2008, up from $159.7 million for the same quarter last year. Acquisitions accounted for $14.9 million of the increase in sales. Organic sales increased 2.3% from the same period last year.

Gross profit as a percent of sales was 20% compared to 17.7% in the same period last year. Transactional margins and rebates both increased in the quarter. EBITDA for the quarter was $8.7 million, which was an increase of $4.3 million from the year earlier quarter of $4.4 million.

Last year's EBITDA included a one-time legal settlement and related expenses of $2.5 million. EBITDA increased 27.2% to last year's EBITDA after adjusting for this one-time charge.

The increase in EBITDA was due to an increase in gross margin driven by the increase in sales volume, which contributed $3.7 million, and gross margin profitability which added an additional $3.8 million. SG&A expenses increased $3.2 million, driven by sales volume and acquisitions.

Net income for the fourth quarter was $2.7 million, up from the fourth quarter last year net loss of $0.2 million. GAAP diluted income was $0.11 per share for the quarter. The non-cash amortization of intangibles was $1.1 million for the quarter for those of you who add it back into your models. Earnings per share without non-cash amortization was $0.16 a share.

Now I’ll discuss the results for the year. Net sales increased $87 million, or 13.8% to $716.5 million for the 12 months ended June '08. Acquisitions accounted for $60.2 million, or 69% of the increase. Organic growth was 4.3%.

EBITDA for the year-to-date period was $36.1 million, an increase of $2.1 million for the same period last year. This year's EBITDA included a $1 million charge for the one-time severance costs and last year's EBITDA included a one-time legal settlement and related expenses of $2.8 million.

Adjusted EBITDA for these one-time items result in EBITDA of $37.1 million for the current year and $36.8 million for last year. The increase in EBITDA was due to an increase in gross margin driven by the increase in sales volume which contributed $16.8 million but reduced $1.3 million by decline in profitability. The decline in gross margin profitability resulted from a reduction in a rebate program with one of our vendors.

SG&A expenses increased $13.7 million, of which $9.7 million was driven by sales volume. Remaining increase in SG&A was caused by acquisitions, increasing group insurance of $0.5 million, stock option expense of $1.1 million, and the cost of being a public company of $2.2 million, which was not incurred, for the majority of last year as a private company.

Net income for the year-to-date was $11.1 million, up 112.3% from last year's net income of $5.2 million. Interest expense declined $8 million or $4.7 million after tax and amortization increased $0.8 million. GAAP diluted income was $0.46 per share for the year.

Earnings per share without the severance paid earlier this year and net of tax would be $0.48 a share. The non-cash amortization of intangibles was $4.2 million for the 12 months. Earnings per share without the severance net and without the amortization would be $0.65 a share.

At the end of June there were 47 days of working capital. Our average for the last 12 months was 43 days. That decline during the three-month period by $13.9 million driven by inventory reductions.

Capital expenditures for the quarter were $1.2 million and availability in our asset-based loan at the end of June was just over $30 million.

Talk a little bit about guidance for '09 at this point. Company expects its net sales to be in the range of $740 million to $780 million. EBITDA will be in the range of $38 million to $40 million.

And net income for the fiscal year ending June 30, 2009 is expected to be in the range of $12 million to $13.2 million. This guidance excludes the effect of future acquisitions. Earnings per share is expected to be in the range of $0.49 to $0.54 or $0.69 to $0.74 without the non-cash amortization.

And that's all I have. I turn it back over to you, Jim.

Jim Robison

Thanks, Bill. During our first fall year as a public company, our team performed well in the face of head winds from both slowing economy and record high grain costs which continued to negatively impact our production animal customers. We fought through these head winds with the customers and maintained our market leading position as evidenced by our new record sales revenue.

During the year we continued to grow our business organically, expanded our sales of company-branded products, and improved our operational efficiencies. One of the greatest achievements of the year was the acquisition of Kane Vet Supply of Canada and its integration in the Animal Health International family of companies.

This acquisition add a both strategic and financial value to our organization and we expect this acquisition to continue to generate value for our shareholders.

As part of our efforts to grow our business organically, we expanded our capacity and coverage to further utilization of our new facilities, expansion of stock items and inventory.

We continue to invest in technology to help our customers improve their businesses, and during the year we launched a new software solution for our beef customers that better enables them to access timely information about the performance and metrics within their operations.

Sales of key products including our proprietary brands were strong. In the beef market we worked with key manufacturers launch a long acting growth promotion and inter-nasal vaccine line. In addition, we introduced a comprehensive line of company branded insecticides as well as expanded our line of neutraceuticals and probiotics.

We launched a flea and tick product line as well as a non-steroidal (inaudible) anti-inflammatory product. Disappointingly, the launch of new generic products during the year continue to lag due to time-consuming on a regulatory approvals from the FDA.

Finally, we established a new service offering, Walco Environmental Services. This group helps our customers that manage animals in concentrated environments deal with environment issues, regulatory and operational challenges. Although small today, we are excited about the future of this business line.

In summary, we served our customers well during the year, invested in our business, and continued to develop our disciplines, we feel we're well-positioned for '09 and beyond.

With that, I'll open it up for questions.

Question-and-Answer Session

Operator

(Operator instructions) And for our first question we go to Lisa Gill with JP Morgan.

Lisa Gill – JP Morgan

Thanks very much. And good morning, Jim and Bill. I just had a couple of questions. I guess is it relates to, number one, the guidance, and then the secondly, some thoughts around the quarter. As we look forward, and we start thinking about where are the things came on in the SG&A line and we back out the one-time item. Can you maybe talk about any other additional costs that are going to continue as we go forward into the next fiscal year? And Jim, as we think about the gross margins especially being strong this quarter, can you talk about how much of that came from rebates or from other programs and things that are sustainable? And then just lastly, maybe if you could just give us some thoughts around your acquisition pipeline and what you see in the competitive marketplace right now? Thanks.

Bill Lacey

I'll take the margin question, Lisa. If you look at our year-to-date – again, we pointed out that volume accounted for about $16.8 million of our increase in margin, but we're down slightly in margin percent. Our profitability was, I believe, $19.1 million versus $19.3 million last year. It was driven by a reduction in rebates, but essentially offset on increase in margins. I think if you look at it'd be about $6.5 million reduction in rebates offset a $5.2 million increase in transactional margins. If I look at that on a quarterly basis, for the fourth quarter, we had about $3.7 million of direct margin increase from volume and about a $3.8 million increase from profitability. That profitability was driven by $2.2 million increase in rebates, a $1.3 million increase in transactional margins, and a couple hundred thousand dollars for everything else. What that got us was about a 20% margin in the fourth quarter, compared to 17.7% margin, the year prior. Jim, I'll turn it over to you for acquisition discussions.

Lisa Gill – JP Morgan

And also I mean how do you see things going forward from a rebate perspective. Are you seeing any changes though as far as the relationships you have with the pharmaceutical manufacturers?

Jim Robison

No, I think right now, our relationships with our vendors are very stable. We mentioned in the prior calls we had a problem with one of our largest vendors before, what seems to have evaded –

Lisa Gill – JP Morgan

Can you just remind us when you have to renegotiate that contract; doesn't that come up at some period?

Jim Robison

They're calendar year contracts, almost every one of them, and the thing is that, that they're usually not settled until sometime into the first quarter of the calendar year, and some may go in later than that. But our – basically our assumptions right now is that our – all of our contracts will be in the same basic format as they are this year. As opposed to last year we had large vendor who shifted a good bit of the stuff out of rebates into more transactional margins.

Lisa Gill – JP Morgan

Okay. Great. And I know I asked a lot of questions. Maybe if you could touch around that the outlook from an acquisition standpoint, and do you have anything that in the guidance for next year?

Jim Robison

Yes, Lisa, I think you asked about expenses in '08 versus '09 as well –

Lisa Gill – JP Morgan

Exactly.

Jim Robison

And then on acquisitions, I'll let Bill pickup expense issue, the market still consolidating, there's still too many participants on the channel. The multiples are high for the companion market I think because of what their – what they have public view of in the marketplace. We're not going to reach for companion animal acquisitions that uneconomic. We believe in our economic multiples. There is a drag in the production market, created by grain prices, namely, that is – I think causing some people to have relatively challenging year, so, as we try to get to – we try to get pass in terms of an offer and into diligence we're seeing. I think people pass and speculating on this. Because of the fact that there are numbers may not be what they were last year. However, having said that we're still very active with acquisitions and we're still anticipating although we're not budgeting, we're still anticipating some good activity this year.

Lisa Gill – JP Morgan

Okay, great.

Bill Lacey

Lisa, when you talk – I will answer your question about expenses now. We look at expenses broken down in basically two ways. It's selling and commissions which is an extremely variable piece of our SG&A, and then we look at corporate expenses or SG&A. From the variable side, we basically think they will increase exponentially with our sales, and where we do get some leverage – let me put it back, I'll put it back to you in other way. In the past year, we saw our sales increase because of acquisitions and where we thought we could, could have got some leverage was eaten up by increase in fuel costs. So our variable costs were pretty much – purely variable with our sales volume from a sales and commission standpoint because of fuel costs and acquisitions. Our G&A expenses which – I don't want to break this down and to granular on our any guidance that we're giving, but we will see some natural increases in our G&A line from inflation, but offsetting hopefully most of that will be a decline in our costs of being public as we now got through some of the major hurdles such as SOX 404 implementation and stuff like that.

Lisa Gill – JP Morgan

Okay, great. And what about any fuel costs, I mean, is that impacting any of your outlook for your SG&A costs as well? And I will stop there so someone else can ask a question.

Bill Lacey

Of course, it has impacted our history, and our history influences where we look at the future. So, yes, it has impacted our future to a degree.

Lisa Gill – JP Morgan

Okay, great. Thank you for all the comments. I appreciate it.

Operator

We'll go next to Julie Johnson with Piper Jaffray.

Julie Johnson – Piper Jaffray

Congratulations on the quarter. Thanks for taking my question.

Bill Lacey

Thank you, Julie.

Julie Johnson – Piper Jaffray

Hi, how are you?

Bill Lacey

Well, good.

Julie Johnson – Piper Jaffray

To follow-up on the gross margin question, can you talk a little bit about what you're doing to drive that improvement in the transactional margin if this is internal initiatives or what you're doing on that side?

Jim Robison

Yes, Julie. There's two things that we're doing. One is that we’re actively pursuing product mix within our customer base, trying to penetrate our accounts with higher margin, often times proprietary lines, that includes the launching of Walco Environmental Services, the products within that group have relatively high margins, and continued development of our sales and marketing disciplines. So we think that there's a good upside for margin as we continue to manage our mix, and focus on higher margin products. And then secondarily, we're doing a lot to give our sales force more guidance around how they should price in the marketplace. Historically, distributors in our business have priced off of cost which is a fairly arbitrary and unintelligent way to price and through the utilization of our systems we think there is greater information that we give our sales force complemented by new compensation system that we put in place that will allow them to compete as necessary, but we believe ultimately gain more margin through having better intelligence around competitive dynamics.

Julie Johnson – Piper Jaffray

Thank you. Could you next give a little bit of an update on the performance of your companion animal focus business? I know that last quarter you discussed having about 11 reps by the fourth quarter. Do you have those reps in place and how is that business doing?

Jim Robison

We have ten sales people that we added last year out in California, (inaudible) with the opening of our Visalia facility. That business is ahead of plan on the top-line and the bottom-line. That's growing very, very nicely. We also launched during the year – as I mentioned a new line of flea and tick products that replace products that were previously agency, along with a product to compete with an existing product in the marketplace, helps animals gain comfort through dealing with arthritis or joint problems. And those products are going very, very well.

So we move some products from agency to transactional and we are gaining more margins per unit, also recognizing the revenue. So just having a launch of those products grew the early spring and then most recently one of them in the fourth quarter. The effect from the top line is not material yet, but the trend is very positive. The companion animal business now is being handled out of eight facilities. All of our preexisting vet facilities have been fully stocked, products to serve the customers, and we got our entire – approximately 17 best sales reps focus on selling not only production animal products, but also companion animal products as well. Having said that of recent we noticed a pretty big drag in the equine market, we think given the general effects of the economy, that we historically not seen since running this business so that's bit of a drag on the business, but we're very confident that our execution has been good and we like long-term prospects for business.

Julie Johnson – Piper Jaffray

I guess one last question here. You've seen some improvement in some of the industry metrics that we track on the production animal side through the end of the summer and as we enter the fall. Can you talk in general terms about how that impacting your business over the last couple of months and what your expectations are going forward?

Jim Robison

I'd hate to speculate around a quarter or a season, but I'll tell you that, that the grain prices reaching unprecedented high levels during the fourth quarter. Really, recast the view of risk and owning animals, and we do have a concern – I don't know do you follow these things, but grain prices, corn namely hit almost $8 a bushel, previous high had been about $5.5. So although they've backed off most recently, and now are between, ranging between $5 and $6 a bushel, we're still concerned about that effect in our business.

The good news is that – and I've talked to whole host of people in Washington, and the government here in Texas, in the ethanol industry and in the corn business, and I spoke to people in Brazil, I can't find any one thinks that ethanol should be made out of corn, and it's I think universally, agreed upon, generally, bad economic, bad economic effect on our general economy. So I think that we'll ultimately see a straightening out of grain prices, and when we do, I think we'll see our production animal business come back very nicely and that our exports continue to expand and notwithstanding the effect of grain prices I think prospects are very good for the future.

Julie Johnson – Piper Jaffray

Okay, thank you.

Operator

We will go next to Jeff Johnson with Robert Baird.

Jeff Johnson – Robert Baird

Good morning, guys.

Jim Robison

Good morning, Jeff.

Bill Lacey

Good morning, Jeff.

Jeff Johnson – Robert Baird

Couple of things here if I could. First, Jim, just following up on your comments there, on looking at maybe the first half of the year versus the second half of the year for fiscal '09 dynamics seem to have improved off kind of the challenges over the last couple of quarters, but they're still – head winds are still there, and you come up against tougher comps the first two quarters of '09. So should we be thinking about organic growth this kind of more of a backend loaded year for you guys as it sets up at this point anyway for '09?

Bill Lacey

Yes, I would say that. Keep in mind in addition to what Jim said, we've seen a bit of a thinning of the beef herds, and all of the indications are that beef prices should rebound as a result of those, and the future around beef prices are up a little bit, but one of the interesting thing we've seen of very recent is a decline in the milk prices, into the 17, 18 range where last time we talked on this call, the future, the future were over 20, so we're concerned about milk prices, so there is still volatility on these commodity prices.

Jim Robison

And Jeff, it's extremely interesting, in October '06, corn prices spike around primarily speculation regarding demand from ethanol mandates, and we've seen corn prices move up from $2.50 to $3.50 a bushel all the way of almost to 8. The highest input cost in raising an animal and we have been in 18 months challenging time in the production industry and yet our business is pretty good. I mean it's no what we – it's not what historically been. It's not what we thought it would be on a forecast basis, we didn't see these grain prices coming, but I guess, unlike some other industry look to our industry has help up pretty well, even given a relatively challenging times.

Jeff Johnson – Robert Baird

Yes, thanks. Don't disagree with you at all, Jim. I guess if I could follow-up on a couple things here. You were talking about beef versus dairy, first I guess with no prices still about breakeven I think breakeven with these grain prices and dairy, Jim, is that still around $16 bucks a 100 weight?

Jim Robison

It really depends on whether it's on a cash basis or an accrual basis and what the state of their operation is. But I would say that the range is $15 to $17.5, and predominantly, customers are in that $16 to $17 range, but it's a – I think that assumption now with milk being just over $16 yesterday is that, that our customers are – in the dairy market, somewhat at a breakeven point plus or minus.

Jeff Johnson – Robert Baird

Okay. So I had been thinking of dairy kind of been above and beef below, from an organic growth standpoint, if you took a normalized 4% or 5% for '09. Should I think about it more as maybe those two been on par with each other?

Bill Lacey

Jeff, I can only speak to what we know about the futures as they are right now. And I would say that the beef market should improve in the back half of the year. I don't know whether this dairy deal with the dairy price – milk prices kind of suddenly went down is a trend or just a blurred anomaly. So I am a little bit confused by the dairy market right now, but I'm encouraged by the futures of the beef markets.

Jeff Johnson – Robert Baird

Well, something we will keep our eye on. I'm sorry, you can go.

Jim Robison

Really, our historical growth rate, dairy has been a little bit over double our beef growth rate and we still think that that's going to be a long-term trend.

Jeff Johnson – Robert Baird

You do. Okay. Fair enough. And Bill, I guess just a couple very quick one here for you. Tax rate assumption for next year – and if I'm hearing you right on gross margin, if it weren't for the rebate issue this year, you would have been up maybe 40 or 50 basis points year-over-year. Should we think of that, that sounds high to me for '09, but I like to get your opinion on that? And then is the companion animal business are you thinking breakeven in '09, or how should we think about that from a profitability? And that's all I've got.

Bill Lacey

I will address the margin issues, given the markets volatility, we typically look at margins holding steady and anything we get is gravy in that area. So we're not looking at a radical increase in margins or anything in the next year. The companion business – keep in mind that we don't track these things by exact breakouts like that. I believe that it's fair to say that our companion business should be at a breakeven or better next year. And when we say – we talked earlier about our concentrated companion business out of Memphis in that. That's the one that should probably achieve close to breakeven this year. We should be profitable in the other segments which is the mixed practice vets in the Visalia operations, and the other places where we're shipping out in addition to the Memphis operation, they should all be profitable.

Jeff Johnson – Robert Baird

Yes. That is how you described it in the past year, right. I'm sorry, just tax rate for next year, Bill?

Bill Lacey

Jeff, use 40%. That's pretty much where we came in this year, right at 40.2%.

Jeff Johnson – Robert Baird

Would the last couple quarters where it's been lower, those have been true up then?

Bill Lacey

Yes, this quarter had a Canadian tax deal where they lowered their corporation's income tax up there and affected our deferred tax as well. So I think the 40, use a 40% is a safe number.

Jeff Johnson – Robert Baird

Great. That’s all I’ve got, guys. See you tomorrow New York.

Jim Robison

Okay.

Operator

(Operator instructions) We go next to John Kreger with William Blair.

John Kreger – William Blair

Hi, thanks, guys. Jim, another question for you on the environment. If you just track corn prices, you would have thought that your June quarter would have been arguably worse than your March quarter, but you guys actually put up a nice sequential improvement. Can you just sort of step back and help us understand what allows you to do that? Did it come primarily from beef versus dairy or just any more granularity would be helpful?

Jim Robison

Yes, John, there is a bit of a lag in what we see it as far as corn prices are concerned, what – where our customers are actually paying. They're usually – they've usually got 30 to 60 days of inventory and in some cases they buy in advance of the market. So there is not an absolute correlation between what the Board is doing, and what our customers are actually realizing. And then secondly, as you may recall, during the quarter, the futures market, the deferreds got pretty good. In other words, the fall, but more with the '09 numbers, and I think you've got into a position where they felt like they can hedge a position of profitability in the marketplace. Since then, grain prices have come down, protein prices have come down as well, and I think people step back a little bit. So there is – the only part I can tell you, there is not an immediate – there is not an absolute correlation, there is not an immediate effect as these numbers move around.

John Kreger – William Blair

Okay. And then the other thing in what I would think you would say has been a probably a tougher market environment as you look back over the last two or four quarters. Can you give us an update on pricing? Are your competitors staying disciplined? Or has that prompted some, some discounting to grab volume?

Jim Robison

I think given the drag in the production animal market, and the policies of the manufacturers there is a little bit less frantic pricing into quarter end and we’re anticipating a little bit less frantic irrational pricing going into year end. So I think some of the competitive pressure around large transactions will abate a bit. By the way, John, let me – we did see some encouraging numbers during the quarter on a macro basis, but if you go back and look at the trends, placements from late April, May through June, we’re down 20% over '06 as baseline, if you will, roughly. And feed lot capacity was running about 58% versus a historical norm in the low 70. So some encouraging activity, but not anywhere close to historical norm. And then also animals are staying longer on grass. They are going into feed lots heavier, so generally they’re getting fewer animal meds.

John Kreger – William Blair

Okay. Another question, Jim, can you give us an update on what's happening with your sales force on the production side? Are you rolling it, is it stable, and can you comment on any turnover you had on that group?

Jim Robison

Turnover is still very, very good. Low single digit. Involuntary turnover, notwithstanding retirement is very, very low. 1% to 2% as it has been historically. We’re anticipating growing the sales force this year. I think the total number is roughly 4, is on the plan, it's not very many. That's organically. We’re primarily focused on sales productivity. We're seeing a real strong uptick in e-commerce activity. And there is a pretty high adoption rate among our producers. So we’re seeing on the production side a little bit of where our competitors, namely MWI have seen on the companion side. And we think that allow us to get better sales productivity on of our reps. So I think we can raise our growth numbers without a lot of headcount additions.

John Kreger – William Blair

Okay, and then lastly, if we think about rebates and fuel, over the next year should we assume those are helping or hurting you or about neutral compared to fiscal '08?

Bill Lacey

Neutral.

John Kreger – William Blair

Both of them are neutral?

Bill Lacey

Yes.

John Kreger – William Blair

Okay. Thanks, bill.

Operator

And with that, ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Robison, I will turn the conference back over to you for any closing remarks.

Jim Robison

Again, thanks for joining us this morning. We felt good about the year. And we're very confident about the company's long-term prospects. Thank you for joining us. Have a good day.

Operator

Again, ladies and gentlemen, this does conclude the Animal Health International fourth quarter 2008 earning results conference call. We do appreciate your participation.