Earnings Call Transcript - PAHC Q2 2020

Richard Johnson, CFO

Thank you, operator. Good morning, everyone. And welcome to the Phibro Animal Health earnings call for our second quarter ended December 2019. On the call today are Jack Bendheim, our Chief Executive Officer and myself Richard Johnson, I’m the Chief Financial Officer. We’ll provide an overview of our quarterly results and then we’ll open the line for your questions. Before we begin, let me remind you that the earnings Press Release and Financial Tables can be found on the Investors section of our website at www.pahc.com. We’re also providing a simultaneous webcast of this morning’s call, which can be accessed on the website as well. Today’s Presentation slides and a replay and transcript of the call will also be available on the website later today. Our remarks today will include forward-looking statements, and actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statements section in our earnings Press Release. Our remarks today will also include references to certain financial measures, which were not prepared in accordance with Generally Accepted Accounting Principles or U.S. GAAP. I refer you to the non-GAAP financial information section in our earnings Press Release for a discussion of these measures. Reconciliations of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures are included in the financial tables that accompany the Press Release. Before we get into the numbers, we remind everyone that we present our results on a GAAP basis and on an adjusted basis. We present adjusted results that exclude acquisition-related items, unusual, non-operational or non-recurring items, including stock-based compensation and restructuring costs. Other income and expense is separately reported in the consolidated statement of operations, including, for example, foreign currency gains and losses, and the income tax effects related to any pretax adjustment plus unusual or non-recurring income tax items. So first, here is Jack Bendheim with some introductory comments.

Jack Bendheim, CEO

Thank you, Dick, and thank you everyone for joining us today. I'm quite pleased that our Core Animal Health segment returned to growth this past quarter. Time of issue is notwithstanding, I think the nutritional specialties product grew into double-digit growth in the quarter, while as expected our MFA and other performance was down 1% versus last year, driven by timing. I expect our Animal Health segment to continue to show growth for the remainder of this fiscal year. Just two examples, we are seeing very strong demand for our poultry vaccines in many international regions and the imminent launch of our next generation OmniGen product looks to take advantage of the improvement in the dairy market. As we have guided, our sales turnaround as a company is increasing as we look to position ourselves for the years ahead. The strategic growth initiatives we are undertaking are producing results. Just two examples, I just returned from the APP at the Annual Poultry Trade Show in Atlanta, and I can say without an exaggeration that our pHi-Tech vaccination device is one of the major innovations presented at the show. We've integrated from around the world signing of the trial. Our initial trials have begun a few months ago, have gone exceedingly well, and we have already signed up our first customers. I'm very confident pHi-Tech will meaningfully enhance our revenue and EBITDA beginning in our next fiscal year. Perhaps even more important, it is clear that producers that are introduced to pHi-Tech have begun to understand that Phibro is one of the market leaders in animal health technology. This is critical as we rollout our poultry vaccine to additional countries in South America and Asia. I am similarly encouraged by the progress we are making with Rejensa, our first foray into the U.S. pet market. We have begun rolling out Rejensa nationwide and today we are in more than 500 clinics. We are working closely with our distribution partners, which are allowing us to limit our fixed expenses as we enter this extremely competitive market. We are receiving tremendous feedback both directly and indirectly through social media, and I'm excited to see our continued enhancement here. Finally, we continue to make headway on our vaccine against African swine fever. To date, the coronavirus outbreak has not affected our efforts, but this could change if the virus remains unchecked for the months ahead. We expect the trial on our initial candidate agent page later this spring, assuming no delay due to the coronavirus. I likely will not have a significant update to provide next quarter on this project, but certainly, I expect to have some results to share on this initial candidate later this year. With that, I look forward to your questions at the conclusion of the presentation, and I will now hand it back to Dick.

Richard Johnson, CFO

Thanks, Jack. For the quarter, I’m looking at Page 5 of the presentation. Consolidated sales were $214 million for the quarter, reflecting a 2% decline compared to the same quarter last year. Sales increases in the animal health segment were offset by lower average selling prices in mineral nutrition and a slight drop in performance products volume. The rise in animal health sales was driven by our nutritional specialties and vaccine products, although this was partially countered by lower sales of MFAs and others. We will provide more details about segment results later in the presentation. Reported net income was $11.9 million, which is a decline of $2.9 million due to higher operating expenses, including costs for strategic investments and increased interest from a higher debt level, partially offset by improved gross profit from product mix. Diluted earnings per share was $0.29 for the current quarter, a decrease of $0.07 compared to the same quarter last year. Now, let's examine adjusted results on the next page. Overall net sales fell by about $4 million. I will discuss the changes in net sales in more detail for each segment. Adjusted gross profit increased by nearly a million dollars, or 1%, compared to the prior year. Growth in animal health volume, along with nutritional specialties and vaccines, was partially offset by decreased volumes in MFAs and others. For mineral nutrition, gross profit declined because lower selling prices and a negative product mix outweighed reduced raw material costs. In performance products, gross profit decreased due to lower volumes, partially countered by a favorable product mix. Overall, operating expenses, which we refer to as selling, general and administrative expenses, rose by $4.4 million or 10%, driven by investments in strategic growth initiatives and the effects of the recent acquisition of the Osprey business. Our adjusted net interest expense grew by about $300,000 due to a higher debt level from quarter to quarter. From a tax perspective, our effective tax rate for this quarter was 28%, compared to 29% last year. Looking at the animal health business specifically, net sales of nearly $144 million increased by about $4 million or 3% year over year. Sales of MFAs and others declined by $1 million or 1%. Increased U.S. demand was more than offset by lower volumes in China caused by African swine fever. Customers in China made some purchases at the end of the quarter in advance of regulatory changes effective January 01, 2020. In nutritional specialties, net sales were $33 million for the quarter, an increase of $3.6 million or 12%. The recent Osprey acquisition contributed roughly two-thirds of the growth in this category. We also saw organic volume growth in our U.S. dairy and poultry businesses, though this was partially offset by the timing of sales in certain international markets. The increase in the domestic poultry segment resulted from the launch of a new product, Provia Prime, a direct-fed microbial product that optimizes the gut microbiome in poultry for improved health, immunity, and productivity. Vaccine net sales of $18.7 million rose by $1.6 million or 10% from last year, driven by strong international demand and market penetration. For the segment, adjusted EBITDA was $33.8 million, down about $2 million or 6%, mainly due to higher SG&A costs, only partially offset by sales growth and increased gross profit. The SG&A increase was a result of investments in growth initiatives and the impact of the Osprey acquisition. Looking at our other segments, mineral nutrition net sales were $55.7 million, a decline of $6.6 million or 11%. This drop was primarily due to lower average selling prices related to underlying raw material costs, along with slightly lower volumes compared to last year. In gross profit terms, mineral nutrition reported $3.7 million of adjusted EBITDA, down $400,000 from the same quarter last year. Performance products net sales of $14.6 million decreased by $1.7 million or 10%. We experienced volume decreases in copper-based products, slightly offset by continued growth in personal care ingredients. Segment EBITDA also declined slightly by about $100,000. Corporate expenses were $10.5 million, an increase of $600,000 from last year, again primarily due to higher costs from strategic initiatives and investments in public company expenses. Our gross leverage ratio of debt to adjusted EBITDA was 3.6 times at the end of December, with total debt of $374 million based on a trailing 12 months basis and $105 million of adjusted EBITDA. We had $75 million of cash and short-term investments on the balance sheet at quarter end, resulting in a net leverage of just under 3 times. We experienced a strong cash flow month during the quarter, generating $23 million before financing and excluding changes in short-term investments. We updated our full fiscal year guidance, with no major changes. We maintained our adjusted EBITDA guidance at $103 million to $107 million for the full year. However, we lowered our overall net sales expectations due to lower pricing in the mineral nutrition segment, which correlates to raw material costs. We also tightened the range for our Animal Health segment. For adjusted earnings per share, we now expect a range of $1.15 to $1.22 for the full year, a decrease from the prior year but an improvement compared to our previous expectations. Our expectations now are for lower interest expense than previously projected, hence the improvement in earnings per share is primarily related to better interest expense metrics. That concludes my prepared remarks. Operator, please open the floor for questions.

Operator, Operator

Thank you. Your first question comes from David Risinger from Morgan Stanley. You may go ahead.

David Risinger, Analyst

I have a couple of questions. First, maybe it'd be helpful, Jack, if you could just help us to better understand the competitive marketplace that OmniGen competes in? Who the key competitors are? How much of an inflection for OmniGen this is going to be that you're launching at next generation. So that would be very helpful. And then, Dick, if you could comment please on the MFA growth excluding China, so we have a better sense for the growth ex-China in the quarter and also, if you could comment on the outlook for MFA growth prospects ex-China going forward. Thanks very much.

Jack Bendheim, CEO

OmniGen has been a very successful product primarily for smaller dairies, particularly those with around 500 cows or fewer, which were the norm in the United States a decade ago. However, there has been a significant shift over the past ten years toward larger dairies. The total number of cows in the U.S. remains roughly the same at about 9.2 million, but the distribution has changed from smaller to larger operations. As a result, we recognized the need to adapt OmniGen, which has been effective for smaller dairies, where farmers could directly observe health improvements due to its impact on immune strength. We reformulated the product to include additional components and adjusted the manufacturing to better address the needs related to milk production, which is increasingly important for dairies with 5,000 to 20,000 cows. This adjustment allows us to reach new markets and cater to the evolving requirements of larger operations. Even though we have a solid track record and a strong sales team, we understand there will always be competition at all levels in the U.S. Nevertheless, we are confident in our ability to expand this business and grow the segment.

Richard Johnson, CFO

David, to your second question sort of other numbers around MFAs and in the second quarter just to reiterate, we saw overall MFAs down about a million dollars or 1%. If we exclude the China MFA effect, we did see growth. We saw growth in the probably 3% range year over year. On a full-year basis, we are expecting MFAs ex-China to be somewhere around, I'll call it breakeven to a slightly positive number. We will continue to overlap the effect of not having much if any China VM sales for really all of the year.

Operator, Operator

Your next question comes from the line of Erin Wright from Credit Suisse. Your line is open.

Erin Wright, Analyst

A follow-up on China. How big was that stocking dynamic in terms of the purchasing ahead of the regulatory changes? And can you just describe what that's all related to in terms of that purchasing dynamic and if we should anticipate a pullback in the next period here regarding these stocks? I guess any color you can give there would be helpful. Thanks.

Jack Bendheim, CEO

As we sort of had forecasted, we didn’t expect to do any business in China this fiscal year. Our distributors, our customers really in China added inventory, which we expected them to sell with the old registration. The old registration was a growth mode registration, and we have been for the last many years, two, three years, as we've done in most markets to change the registration from growth mode to a therapeutic claim, and we've been successful. Part of the problem with African swine fever in China was obviously, well, the pigs aren’t there so the market was declining. Just a little long to answer your question, but bear with me. So the pigs aren't there. But it's also the government was not allowing us or anybody to move pigs around for testing. So our ability to test and on farms and to show we need to go for the therapeutic claim was slowed down. So that's really where we want to be going forward on a therapeutic claim. But in the meanwhile, the price that pays in China rose so high that people felt even though some pigs were going to die rather than swine fever, it still pays to grow pigs because even if you only had a 30%, 40% yield, you can make more than enough money to cover the loss. So our customers there saw a big increase, and with their calculation, they had made enough inventory to get through the first six months of 2020, they felt they were wrong, and they knew they had to get material on before the end of the year by Chinese regulations. So that was a spur. It was not a huge bump; it was a bump, a couple of million dollars, and that's done.

Erin Wright, Analyst

And then can you give us an update on just the U.S. market across the species groups here at U.S. poultry, swine, and dairy markets? I guess in particular, I'd be curious around if you're seeing real stabilization across dairy markets as well. But yes, if you could give us some color on where we stand today in the industry, that would be great. Thanks.

Jack Bendheim, CEO

I think generally, we are seeing stabilization at least from the feedback we hear from our customers. It depends on where you are in the market. I think if you're still out there with a farm of 100, 150 cows, you're under pressure, you're in trouble, and you will most likely be out of the business. But I think for the larger dairies, they are making money at these levels. And again, part of it is because China is looking for all sorts of protein and so somehow that affects directly, indirectly all the big producers around the world of any protein.

Operator, Operator

Your next question comes from the line of Balaji Prasad from Barclays. Your line is open.

Balaji Prasad, Analyst

So I had, coming back to the subject of ASF, I had a couple of questions on there. Firstly on the, as you may have seen from the recent report of global pork exports have increased by 10%. And of course, you mentioned that you have some restoration changes underway to be able to sell more. I wanted to understand which of the export markets you would be able to target and what are the timelines that you can see net recovery here? And secondly, specifically also from a re-herding prospect, how would that play into your Animal Health growth? The second comment of my question was on the ASF vaccines. I'd love to hear your thoughts on the various development programs currently ongoing, including the progress at USDA, and specifically from Phibro's perspective. Can you help me understand how your epitope-based development compares to the vaccine targeting the IEU 177 of gene that the USDA is working on? Does this make any difference from a commercial or a timeline perspective? Thank you.

Jack Bendheim, CEO

So let's just talk first about you know overall dynamics of protein and sort of quality proteins versus the effect of African swine fever in China. So I mean as we sit here right now, there is no vaccine that will control African swine fever, and the effect of it as we've seen it sort of played out slowly. It is in excess of 50%, maybe even up to 70% of pigs have gone missing. That doesn't mean pigs necessarily have got the virus and die; people see they put pigs down, they get the virus, they die. So I'm not going to put new pigs on the market; it doesn't pay overall. So that has affected a huge shortage of protein, new protein in China, and they're out there all over the world looking to buy all sorts of protein from every market. So yes, we are seeing our sales into customers raising again, all proteins specifically, yes, pig protein, but chicken protein, fish protein, and cattle protein around the world, all those customers are doing better. Now in the U.S., it’s a little bit of ex, I don't want to get into it because of the continuation on the trade and the tariffs; it’s not clear, but I think that will get clear. But the business around the world, our business is getting better. Can you make up for the loss of, I don't know, 500 million pigs in a world that only is currently raising 250 million pigs, the answer is no. It could take a long time if ever, but I think at some point there will be that. Coming to your second question, where there will be a vaccine developed that will be able to slow or to control some of the ASF, where there will be a meeting point where the Chinese will be able to stop growing pigs again at decent prices, good prices, economic prices and the world will grow producing more pig meat and it will all be at meat somewhere happily in the middle. We've taken an approach on our vaccine. We've taken an approach different than what we see and what the USDA we see coming out of Plum Island; we're working mostly with the proteins that are found in the virus, and we're not working to attenuate a virus. So to that extent, often I'll say it again, we don't know yet if our vaccine is going to work. I mean we're doing a lot of work and there are some positive indications, but you don't want anyone to listen to this and think we're saying that it works. We have work to do, and we will have a better indication as I said earlier in my remarks by late spring, but it's a different approach. So what there is an update start to make vaccines is you basically attenuate a virus, you make the virus sort of softer, you can vaccinate the virus, the pigs' own immune system starts acting, and it will protect the pig against whatever the disease is in this African swine fever. The initial work on the virus was not successful. They were unable to do it. And now with the USDA out of Plum Island, it looks like they have a candidate that could be very effective. So that’s great; I think we're in the business of making sure people have protein and are successful and live a long time so that we are 100% behind that. Our approach is a different approach, and there is some logic to say since we're not absolutely injecting, vaccinating the virus that our approach might be safer and that might get to markets faster than the approach which attenuates the virus. So that's a different approach, and again remember, there were 800 million pigs in China; it’s a huge market. Hopefully, everyone will be.

Operator, Operator

Your next question comes from the line of Michael Ryskin with Bank of America. Your line is open.

Michael Ryskin, Analyst

I want to follow up on a couple of things. I think you people walked through a lot of the market implications, and I'll sort of dig into guidance comments. First on the revenue guide. It looks like, you know, I can see that most of the update did come from mineral nutrition, and you talked about how that sort of flows through from the underlying commodity prices. But also you did trim the top line for Animal Health the high end of the guide by about 10 million from 557 to 547. So I'm curious if that had anything to do with nutritional specialties in vaccines and more specifically with Osprey because I think by my prior notes I had Osprey is about $20 million contribution for the year. By my math for the quarter, it was only about $2.5 million. And so first question is, is that where the delta is coming in; is that Osprey is not contributing quite as much as you thought, or sort of where's that in the numbers?

Richard Johnson, CFO

You know, all your numbers make sense, Mike? This is Dick. I think we trimmed the top end of the Animal Health number for a variety of factors. I would say, just in terms of expectations, we continue to see that our strongest growth expectations are going to be in the vaccine product area, then followed by nutritional specialties. Yes, we're seeing some customer order patterns in Osprey where those may reverse themselves later in the year. We'll have to see. But nutritional specialties otherwise, you know, we've talked a lot about dairy. We've talked about products that are going into poultry, and those are all doing well. And MFAs really outside of China are holding their own. So, you know, not a huge modification I think to the sales guidance overall. But, you know, that gives you a little more color.

Michael Ryskin, Analyst

And then follow up sort of similar line on the P&L. The delta in the SG&A, I mean, you talked consistently about 2020, or fiscal year is an investment year both on sales force and R&D, you know, the companion animal product, a lot of the investment in R&D for that as well, including the ASF vaccine. You still trim the SG&A guidance pretty meaningfully by 7 to 10 million. Just curious where is that extra spend coming from; is that flexible spend you can take out of mineral nutrition, because the lowered expectations there or sort of sales force is on R&D line. Just trying to get a better sense of where the delta comes in there.

Richard Johnson, CFO

I think the trimming comes in two places. Some of these strategic investments are, the timing of the spend is driven by a lot of factors that we can't necessarily control exactly the timing. So some of these strategic initiatives have been extended out a little longer than we initially expected. We've also just reduced our expectation for the base spend on operating expenses; it’s maybe specifically it’s really not around minerals. This spend is, the bulk of the business is the animal health segment. And so when you're talking about changes in spending, you're really fundamentally talking about changes in the animal health business.

Michael Ryskin, Analyst

And then sort of one last one along the lines for me, you talk about ASF vaccine, you talk about OmniGen expansion. I would say the third product that, in terms of innovation that's gotten a lot of attention, a lot of focus is the companion animal sort of direction you're moving into. Can you give us an update there, how that's trending, sort of continued feedback and how you see that progression in the next couple of years?

Richard Johnson, CFO

Yes, I will give you two answers. I'll give you a number answer. The numbers in the P&L are still small; we don't break them out, and they're not at this point really meaningful to trends. And, you know, I think where this go is still open to question. We're optimistic about what we're seeing. And with that, I'll turn it over to Jack for more of the color.

Jack Bendheim, CEO

There are 25,000 vet clinics in the United States, and we have successfully introduced one product, Rejensa, into 500 of those clinics. We continue to add more clinics each week and are still investing in this initiative. We are very optimistic about the product; the feedback from customers on social media is very encouraging. If anyone listening has an older dog with potential arthritic issues, I recommend visiting our site to purchase the product. We are continuing to invest, and if this positive trend persists, we may increase our spending next year. The companion animal product appears promising, and we anticipate expanding to over 1,000, 1,500, or even 2,000 clinics next year. Regarding the vaccines mentioned earlier, our products are performing well in various markets, and we are making investments to establish a new facility in Sligo, which is still 18 months from completion and will enhance our sales capacity, as we are currently reaching the limits of our Beit Shemesh facility. We recently launched OmniGen Pro, and following a successful launch meeting last month, we expect significant growth in that area. While spending money can be viewed skeptically in terms of analyst numbers, successful products lead to increased EBITDA. We are confident in the potential of our products and are making judicious investments. None of our initiatives are frivolous; they are all serious products with significant opportunities for the company. We are excited about the prospects of our new products and our overall company outlook.

Operator, Operator

Your next question comes from David Westenberg from Guggenheim Securities. Your line is open.

David Westenberg, Analyst

So most of mine have already been answered, so mine will be pretty short. So first on the Mineral Nutrition business, I know it's very susceptible to input prices. Now, can you remind us if you're maintaining gross margin or if you're maintaining gross profit? I'm just trying to figure out the distinction between the two as prices go up and down. What the objective is in terms of maintaining?

Richard Johnson, CFO

David, we have two objectives. One is on the traditional sort of base business; we are looking to make a profit for every unit we handle, and we talk in terms of tons in the mineral business. So, you know, we're looking to make ex-dollars per ton. So whether the selling prices are higher or lower, we want to make a certain amount of money on every ton we handle, and get paid for the value we add, which is blending, sourcing, warehousing, logistics, etc. We are also adding over time and continue to add more differentiated, higher value-added, and therefore higher margin products into the minerals business, and we're seeing some early success in that. We've frankly, against our expectations, not so much against last year but against our expectations, we've been seeing the bite of some of the tariffs because some of these raw materials, many of the raw materials come from China and have been subject to a 25% tariff. So depending on the competitive situation in some cases, we've not been able to pass those costs through. So that's been something we've been dealing with lately.

David Westenberg, Analyst

So back onto the pHi-Tech vaccination device, it looks like kind of one of those products that could have maybe a portfolio effect. So is that the case? And could you see this contribute to better sales of the overall portfolio and not just vaccines, but kind of one of those things where it could have a halo effect on other sorts of businesses? And then just generally speaking on that pHi-Tech device. Are there any maybe comps for us to look at in terms of peak sales and sales ramp? I mean, is it Embrex from Zoetis? I mean, how can we look at that, and that's all my questions. Thank you.

Jack Bendheim, CEO

I think we're the first in the market with this type of machine, and it's not so much the fact that, you know, we replace finger power on a vaccine device with a battery-powered machine that just pulls and ensures your finger is protected, and so on and so forth. The main thing is the amount of information the grower, the producer will get from what's going on. In other words, not just in terms of human resources, who is doing the right job, but at what temperature are the vaccines being put in, what percentage of the birds are getting back to what not. That makes it very powerful; that's why this was a very, very exciting addition at the poultry show last week. So we don't have the full range of vaccines that growers used to go through this thing. So right now, it's probably neutral. I mean it started many, many years ago; they tried to control the vaccines. They went through it, they made lease equipment, but you had to use the vaccine, that is no longer the case. They have competition. So we’re not even starting there; I don't think that's important. But at the end, you know, we are building solid relationships with poultry producers around the world, and you build those kinds of relationships, then eventually enhances our relationships, and then they will look at our vaccines like they will look at anyone else's vaccine.

Operator, Operator

There are no further questions at this time. Mr. Johnson, I turn the call back over to you.

Richard Johnson, CFO

We appreciate everyone listening and thank you for your questions. We'll talk again next quarter. Thank you and goodbye now.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.