Earnings Call Transcript - PAHC Q3 2023

Operator, Operator

Hello, and thank you for standing by. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Phibro Animal Health Corporation Third Quarter 2023 Conference Call. I would now like to turn the conference over to Damian Finio, Chief Financial Officer. Please go ahead.

Damian Finio, CFO

Thank you, Regina. Good morning, and welcome to the Phibro Animal Health Corporation Earnings Call for our Fiscal Year 2023 Third Quarter ended March 31, 2023. My name is Damian Finio, and I am the Chief Financial Officer of Phibro Animal Health Corporation. I'm joined on today's call by Jack Bendheim, Phibro's Chairman, President, and Chief Executive Officer; and Daniel Bendheim, Director and Executive Vice President of Corporate Strategy. Today, we will cover our third quarter and fiscal year-to-date financial results before opening the lines for your questions. I'd like to remind you that we are providing a simultaneous webcast of this call on our website, www.pahc.com. Also on the Investors section of our website, you will find copies of the earnings press release and third quarter Form 10-Q filed with the SEC yesterday, as well as the transcript and slides discussed and presented on this morning's call. 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 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 earnings press release. We present our results on a GAAP basis and on an adjusted basis. Our adjusted results exclude acquisition-related items, unusual, nonoperational or nonrecurring items, other income and expense as separately reported in the consolidated statements of operations, including foreign currency gains and losses net, and lastly, income tax effects related to pretax adjustments and unusual or nonrecurring income tax items. Now let me introduce our Chairman, President, and Chief Executive Officer, Jack Bendheim, to share his perspective on Phibro's third quarter and fiscal year-to-date financial performance.

Jack Bendheim, CEO

Thank you, Damian, and good morning, everyone. We posted strong fiscal year-to-date sales growth. Our third quarter net sales were $246 million, which reflects a 3% growth over the same quarter last year. Despite the challenging market and economic conditions, our consolidated sales growth has been driven primarily by our Animal Health segment, with well-balanced improvements across our three product categories. Our Animal Health segment has achieved a remarkable 10% year-to-date increase in net sales compared to the same period of the previous year. We are unfortunately seeing some signs of recessionary pressure in our Mineral Nutrition segment as our customers are seeking to reduce purchases and lower inventory. We will take steps over the next few months to ensure our inventory is better balanced for our customers' needs. Overall, we have posted strong fiscal year-to-date sales growth despite the challenging conditions. We see continued opportunities for growth in our Animal Health segment. As I mentioned, on a year-to-date basis, our Animal Health segment has achieved a 10% increase in net sales compared to last year, and this segment continues to present us with multiple growth opportunities. We have posted eight consecutive quarters of year-over-year sales growth in each of our three major product categories. From a year-to-date comparative perspective, the product categories of MFAs and other is up 9%, while nutritional specialties are up 12% and vaccines, up 9%. I'm especially pleased with our vaccine growth in Latin America. We recently opened a new autogenous vaccine facility in Brazil and launched commercial poultry vaccines in the region. Regarding the Seasonal Specialties, we continue to find ways to leverage our product and technologies we acquired with the 2019 acquisition of Osprey Biotechnics. I'm also happy to report that our companion animal's development pipeline continues to progress. We see Companion Animal as a medium-term growth driver for the company, and we will provide updates as the pipeline progresses. In terms of profitability, on today's portfolio over time, margins should improve as input costs return to historical levels. The Animal Health segment adjusted EBITDA margin was 20.8% for the third quarter, which is a 110 basis point improvement over last year. Although the year-to-date EBITDA margin is still 30 basis points shy versus last year, we see signs that input costs are returning to normal levels. For margin improvements to continue, input costs will each continue to decline, and we will need to work through a higher price inventory on hand. We are taking other actions to manage working capital more closely, which we anticipate will help to improve our free cash flow. We continue to focus on raising prices when market conditions allow, and we remain bullish on our business and our ability to grow sales given the strong demand for our current portfolio of products and the projected demand for the pipeline of future nutritional specialty vaccine and Companion Animal products we have in development. Lastly, Phibro had a strong third quarter. As we approach our fiscal year-end, we remain confident in our full-year guidance. I will now ask Damian to review our third quarter financial performance and fiscal year 2023 guidance in more detail before opening the line for questions.

Daniel Bendheim, Director and EVP of Corporate Strategy

Thank you, Jack. I will start with consolidated financial performance, then cover segment-level performance, capitalization metrics and conclude with a review of our financial guidance for the full fiscal year 2023. Consolidated net sales for the quarter ended March 31, 2023, were $245.7 million, reflecting a $6.1 million or 3% increase over the same quarter a year ago. This increase was driven by improvements in our largest segment, Animal Health, partially offset by declines in Mineral Nutrition and Performance Products. GAAP-based net income and diluted earnings per share decreased by 43%, driven by higher SDA, SG&A and interest expense, offset partially by gross profit improvements and lower income tax expense. After adjusting GAAP results for one-offs and nonrecurring and/or nonoperational costs such as environmental remediation, acquisition-related items and foreign currency movements, consolidated adjusted EBITDA decreased $0.6 million or 2% compared to the prior year's quarter, driven by lower adjusted EBITDA in our Mineral Nutrition and Performance Products segments, coupled with an increase in corporate expenses, offset by higher adjusted EBITDA in the Animal Health segment. Adjusted net income and adjusted diluted earnings per share decreased by 13%, respectively, driven by higher SG&A expenses and taxes, offset by higher gross profit. Moving to segment-level financial performance. I'll start with the third quarter financial performance for our largest segment, Animal Health, which includes three product lines, namely MFAs and other nutritional specialties and vaccines. The Animal Health segment posted $164.4 million of net sales for the quarter, which represents an increase of $15.8 million or 11% versus the same quarter of the previous year. Within the Animal Health segment, we reported an $8.9 million or 11% increase in MFAs and other versus the same quarter prior year, driven by increased demand for MFAs domestically and in the regions of Latin America and Canada, as well as increased demand for processing aids used in the ethanol fermentation industry. We saw $3.6 million or 9% growth in nutritional specialties, driven by higher domestic demand and selling prices for dairy products, along with growth in our companion animal product, Rejensa, and lastly, a $3.3 million or very strong 15% improvement in vaccine net sales, driven by increased demand and new product launches in Latin America. In terms of profitability for the segment, Animal Health adjusted EBITDA was $34.2 million, a $5 million or 17% improvement over the same quarter of the prior year due to higher gross profit on higher sales, partially offset by an increase in SG&A, and the adjusted EBITDA margin for the segment improved 110 basis points to 20.8%. Moving on to third quarter financial performance for our other business segments, starting with Mineral Nutrition. Net sales for the third quarter were $62.9 million, a $6.1 million or 9% decline versus the same quarter prior year, driven by a decrease in demand for trace minerals. This decline was the consequence of customers lowering inventory levels in the face of economic challenges, partially offset by higher average selling prices, which are correlated with the movement of the underlying raw material costs. Mineral Nutrition adjusted EBITDA was $3.9 million, reflecting a decline of $3.4 million, driven by lower gross profit. The adjusted EBITDA margin for the segment was 6.1%, a decline from the prior comparative period. Looking at our Performance Products segment, net sales of $18.3 million reflect a $3.7 million decline driven primarily by decreased demand for copper-based products and personal care products, partially offset by higher average selling prices, correlated with the movement of the underlying raw material costs. Adjusted EBITDA was $2.4 million, down in terms of dollars versus the comparative period, but reflective of a 20 basis point improvement in adjusted EBITDA margin. Lastly, corporate adjusted EBITDA declined 15%, driven by a $1.7 million increase in corporate expenses, which reflects the intentional increased spend on strategic investments. Turning to key capitalization-related metrics, free cash flow for the 12-month period ending March 31, 2023, was a negative $43 million, reflecting a slight improvement versus what we reported last quarter and was comprised of trailing 12 months of negative operating cash flow of $5 million, less $38 million of capital expenditures. The negative $43 million of free cash flow for the 12 months ended March 31, 2023, is driven primarily by a $43 million increase in inventory over that same period, representing slightly less than one month of additional inventory. As Jack mentioned in his opening remarks, we will be taking steps over the next few months to ensure our inventory is better balanced to the needs of our customers, particularly in our Mineral Nutrition segment. We are taking other actions to more closely manage working capital, which should also help to improve free cash flow moving forward.

Jack Bendheim, CEO

As I mentioned in my opening remarks, the momentum behind our ESG effort continues to build, thanks in large part to the enthusiasm and engagement of our employees. Next week, we intend to publish our second ESG report titled 'Health at the Heart,' which reflects the progress made in calendar year 2022. We will issue a press release when the report is made available.

Operator, Operator

Could you please open the lines for questions?

Wolf Chanoff, Analyst

This is Wolf Chanoff on for Mike. Congrats on the quarter. I appreciate you guys flagging the recession and kind of macro impacts that you're seeing in Mineral Nutrition. I'm just wondering how you would describe the possibility that these impacts spread beyond Mineral Nutrition to your broader Animal Health segment, just a range of outcomes around this recessionary impact? And then I have a semi-related follow-up.

Jack Bendheim, CEO

Thanks for the question, Will. We view our business as recession-resistant. We've been in the business a long time. We've been through recessions. Effectively, people eating protein is really among the very last things to go. People might switch from steak to chicken or some combination. But overall, our business is more tied to population growth and general wealth, which the recession somewhat affects but is still recession-resistant.

Wolf Chanoff, Analyst

Got it. I appreciate that. So, sticking with Mineral Nutrition. Last quarter, you called out some kind of choppiness in the U.S. beef cattle feedlots. I realize that it's only a small part of your portfolio, but I was wondering if you have any updates on what you're seeing in terms of feedlot dynamics.

Jack Bendheim, CEO

For this last quarter, it still remains a very small part of our business. What we're seeing is demand is more driven by what I spoke about in my opening remarks. Last year, shipping was difficult, and people were very concerned about the supply chain. There was more of an increase in inventories, both at our customers and ourselves, as the worst thing to do is to run out. Prices were better, and volumes are better. I think as the shipping lines have stabilized and shipping has become less of a problem, there is a big adjustment occurring, and I think that's a bigger part of this than anything else.

Unidentified Analyst, Analyst

This is Shaw on for Balaji. Just a quick one on your Latin American business. China has recently lifted the embargo on Brazilian beef imports. Do you see this change as a potential tailwind for your Latin America Animal Health business, which has been performing well recently?

Jack Bendheim, CEO

I think that is among the other tailwinds of Brazil being a phenomenal producer and a very big exporter of protein. So China removing barriers to commerce is definitely helpful, and the health of the GILTI business, as well as the other businesses, should help Latin America, specifically Brazil in its production and export of protein.

Brian Wright, Analyst

I was hoping you could remind us of the capacity of the Brazilian vaccine facility and what that could mean for growth?

Jack Bendheim, CEO

The facility we built is a small facility involved with the autogenous vaccine business. This vaccine business means it's a custom vaccine. We go on farms, we pick up samples, we try to isolate the viruses and we make custom vaccines for that. So it's a farm-by-farm business. The prices you get are higher because we're dealing with farm-by-farm variances, but it's not a huge volume business. Additionally, we recently received approval for some of our poultry vaccines produced in Israel, and we just started exporting to Brazil. That obviously represents a much larger business for us.

Brian Wright, Analyst

Great. And then I was hoping we could get some visibility on the underlying U.S. broiler volumes and how they progressed from January to now. Are they higher now than at the beginning of the third quarter?

Jack Bendheim, CEO

U.S. broiler volumes are maybe down to flat and holding steady.

Brian Wright, Analyst

And same question for Brazilian cattle?

Jack Bendheim, CEO

Cattle is not a primary focus for us, although it is a bigger part of our business in Brazil. I would say the Brazilian cattle business remains flat to slightly up.

Damian Finio, CFO

Okay. Thank you, Regina, and thank you, everyone, for participating in today's call. We appreciate your time, attention and interest in Phibro Animal Health Corporation. Have a great rest of your day, and please be sure to check out our second ESG report when it's published next week. Thank you.

Operator, Operator

Ladies and gentlemen, that will conclude today's call. Thank you all for joining.