Earnings Call Transcript - PAHC Q3 2021

Operator, Operator

Good day and thank you for standing by. Welcome to the Phibro Animal Health Corporation Q3 2021 Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to Damian Finio, Chief Financial Officer. Please go ahead.

Damian Finio, CFO

Thank you, Tabitha. Good morning and welcome to the Phibro Animal Health earnings call for our third quarter ended March 31, 2021. I am Damian Finio, Chief Financial Officer of Phibro. And I'm joined on today's call by Jack Bendheim, Phibro's Chairman, President, and Chief Executive Officer; as well as Donny Bendheim, Director and Executive Vice President of Corporate Strategy.

Jack Bendheim, CEO

Thank you, Damian, and good morning, everyone. Let me share what I see as our four key themes for the third quarter. First, we posted solid financial performance. In the third quarter, consolidated net sales and adjusted diluted EPS were both ahead of guidance, and sales were comparable to the same quarter of the prior year. While it's difficult to quantify, the comparable performance relative to last year has masked a little bit of year-over-year growth as our industry saw some customer stocking in those crazy last days of March 2020, where the world was just beginning to grapple in earnest with COVID.

Damian Finio, CFO

Thanks, Jack. Turning to slide 4. The amended and restated credit agreement represents an upsizing of $50 million and includes a $300 million Term Loan A and $250 million revolver. We're most pleased with the terms, conditions, and pricing of the new credit facilities that are substantially the same, if not just slightly better than our previous terms. And the new facilities mature in April 2026, which provides us with operational flexibility for years to come, enabling us to focus on driving the business forward. We remain committed to continued debt and leverage reduction. Closing this agreement on such competitive terms during these challenging times reflects both the company's and lenders' confidence in the future of our business. Moving on to our financial performance on slide 5. I'll start by reviewing consolidated and segment-level financial performance for the third quarter ended March 31, 2021, but I'd also like to spend a few minutes today reviewing our year-to-date comparative results. The year-to-date performance tends to help put in perspective some of the volatility in year-on-year quarterly comparisons. I'll close out my portion of the call with our projections for the fourth quarter and full year. Looking at the consolidated view, third quarter financial performance was ahead of guidance while profits reflect a decline in comparison to the same quarter prior year. Net sales of $211.7 million were up slightly, $1 million or less than 1%, while both GAAP and adjusted profitability metrics lag on a comparative basis. Net sales for the third quarter were driven by increases in Mineral Nutrition and Performance Products, partially offset by a decline in our Animal Health segment. Declines in GAAP-based net income and diluted EPS were driven by a lower gross profit related to unfavorable changes in product mix, as well as increases in SG&A costs and provision for income taxes, offset partially by lower interest expense. After making our standard adjustments to GAAP results including one-off acquisition-related items and foreign currency movement, third quarter adjusted EBITDA, adjusted net income, and adjusted diluted EPS were down 7%, 11%, and 11% respectively, due to unfavorable product mix and an increase in certain corporate costs and incremental investments in our future.

Operator, Operator

The first question comes from the line of David Westenberg. David, your line is open.

David Westenberg, Analyst

Thank you for taking my question. This is David from Guggenheim. Can you discuss the long-term outlook for MFAs? Could you provide a five-year or ten-year perspective? I understand that no one can predict the future perfectly, but with the percentage of revenues coming from MFAs, it would be helpful to hear your updated thoughts on this.

Jack Bendheim, CEO

Well, number one, MFA sort of the text for me we have MFA and others. So, there are a lot of products that come into the MFAs. But typically, MFAs would be products that are regulated that we sell to the feed. We see a growth in that business. We see a growth around the world. Obviously, after COVID is over, people will go back to eating protein and sort of enjoying the trend line that we had until a year and a half ago. So, it's hard to put numbers on it, but it's a product line that we keep investing in and we see growth across the world in various markets.

David Westenberg, Analyst

Okay. Yes. I realize it's pretty but a little bit more abstract question. Can you kind of maybe talk about the reopening of the US economy whether it be schools, restaurants, etc., and kind of maybe the impact on the overall business? And I guess more outside the US too as well with reopening? And I have just one more. Thank you.

Jack Bendheim, CEO

Thank you. What we've observed is a clear divide between wealthier countries, starting with the United States, which is obviously the wealthiest. Our efforts have focused on two main areas: putting money into people's pockets and increasing vaccination efforts nationwide. As a result, we've seen a return to business. The protein sector in the U.S. now operates through different outlets, with a shift from restaurants to supermarkets, and overall, it has largely returned to pre-COVID levels, despite some exceptions. The business remains strong and is poised for continued growth. Looking globally, as I mentioned earlier, we operate in 75 countries, each with its unique situation. While some nations have successfully managed COVID and their economies are rebounding, others have struggled. The impact of COVID extends beyond health issues to the economy at large. Our business depends heavily on consumers' ability to afford protein, which is a crucial part of their diets. We are witnessing recovery in some regions, but it may take at least a year in others. In key markets like the U.S. and South America, we anticipate quicker rebounds. We are optimistic that by the time we meet again in August to discuss next year’s plans and projections, COVID will no longer be a central topic in our conversation.

David Westenberg, Analyst

Got it. I think you brought up an interesting point and I was wondering maybe for my last question you talked about the kind of the inflating of the economy here. We've been seeing a lot of increases in commodity prices across the board. I mean can you talk about maybe just the correlation between commodity prices and then agricultural and prices of meat and dairy? And then finally, the kind of effect on your business as we kind of see assets being a little bit more inflated than we've seen in the past? And then I'll just hop off queue after that. Thank you.

Jack Bendheim, CEO

In the production animal business, the main factor is the cost of feed, which primarily consists of corn and soybean. This represents the largest expense in raising chickens, pigs, and dairy cattle. As these prices rise, it becomes more expensive for growers to raise these animals, leading to an increase in prices for consumers, which we have already begun to observe and expect to continue. Currently, there is no relief from the rising costs of feed components. Additionally, other factors are affecting the business. We frequently read about global shipping issues, such as disruptions caused by incidents like a stuck ship in the Suez Canal. Higher freight costs have been present even before such events due to imbalances created by changing purchasing patterns. Ports, including those in California, are congested, and this situation is not limited to the United States; it extends to other regions as well. I have encountered challenging situations trying to secure shipping for our products, especially when there is a pressing need to return containers to China. Consequently, the complexities are increasing, and costs are rising. We will make efforts to raise our prices in response to these ongoing cost increases that we are experiencing daily.

David Westenberg, Analyst

Thank you very much.

Operator, Operator

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

Erin Wright, Analyst

Thanks. Can you speak a little bit more specifically on the drivers and your competitive positioning across the nutritional specialties business at this point? And on an annualized basis, will this be more consistently a double-digit grower for you kind of going forward on a longer-term basis?

Jack Bendheim, CEO

Thank you for that. We expect our nutritional products to grow at a double-digit rate across our markets. However, this doesn't guarantee that all products in that category will experience growth due to competition and market changes, which also influence the underlying feed dynamics. Overall, we have made substantial investments in nutritional specialties and anticipate continued double-digit growth. It's important to note that COVID significantly impacted our results last year, but as we move beyond it, we expect to see that double-digit growth continue.

Erin Wright, Analyst

Okay. Perfect. And then, could you give us an update on your companion animal initiatives where that stands and what your expectations are for that business over the next few years?

Jack Bendheim, CEO

I'm going to pass this to Donny.

Donny Bendheim, EVP of Corporate Strategy

Okay. So we continue to execute well with Rejensa which is our product on the market right now. We had talked about last quarter that it had doubled in the six months over the previous six months, and we're expecting that trajectory to continue throughout the fiscal year. And then we are steadily building up our pipeline. So we had foreshadowed last quarter that we were working on an oral care deal and we successfully completed that, an early-stage product. What excites us about these two products actually is that we believe that they will fall under the medical device standard as far as regulatory is concerned. So that is a more streamlined process. So, that would allow us to get to market a little faster than if we went through different processes within the FDA. So, our pipeline is fairly early stage still with all the products that we have, but we are seeing that we've filled some gaps as far as the timeline. And we are pretty excited about where the next number of years will bring us as far as the products just assuming we can bring them to completion.

Erin Wright, Analyst

Okay. Perfect. Thank you so much.

Operator, Operator

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

Michael Ryskin, Analyst

Thank you for the question, Jack. I apologize if I missed it during the prepared remarks, but I don't believe you mentioned China or provided an update on that market. I appreciate your honesty and insights on the ASF recovery and the trends you've observed there. We've encountered many conflicting reports regarding herd rebuilding and new ASF outbreaks. Could you share your thoughts on what you're observing in China? How is that market rebounding for you, and what are your expectations for the next quarter?

Jack Bendheim, CEO

China is showing signs of recovery. We can observe improvements in both the products we sell that are not MFAs and those offered by our competitors. The business environment is getting better, as China is encouraging many high-growth businesses to enhance their biosecurity measures and is increasing its pig population. It's worth noting that African Swine Fever appears to be coming under control. However, while there may be sufficient facilities, they might not be at full capacity. Therefore, I anticipate some fluctuations in the market over the next few years. The Chinese government is committed to investing significantly to achieve self-sufficiency. Meanwhile, exports from the US, Mexico, and Brazil to China continue to be strong and are expected to remain so for the next few years. It's important to highlight that China has been releasing pigs from its frozen stock every few months to ensure adequate market supply. This rebuilding process will take time and involves millions of pigs. Overall, as China rebuilds its herd, we expect positive conditions for producers globally for at least the next two to three years.

Michael Ryskin, Analyst

Thank you. I have a quick follow-up regarding the fiscal fourth quarter guidance. The performance looks impressive, showing nice sequential growth and strong year-over-year results. Is this primarily due to the comparisons in the MFA segment? I understand that last year there were some unusual one-time issues in fiscal fourth quarter that affected that figure. I'm trying to gauge the underlying trends and the sequential progression. Can I interpret this guidance to mean that you've moved past the earlier challenges and that the recovery is ongoing?

Damian Finio, CFO

Yes. I can take that question. So yes, keep in mind that the fourth quarter of 2020 was our first full quarter in the pandemic and we were hit hardest then and have since then quarter-on-quarter grown topline and seen a return to profitability and as we mentioned ahead of our expectations. So our fourth quarter guide sequentially compared to the first, second, and third quarters of this fiscal year we continue with the same profitability and top line perhaps at or slightly above. I think our biggest risk between now and year-end as Jack sort of alluded to is the timing of shipments and some of the backlog at some of the ports. But we feel pretty confident that the fourth quarter guide is a good number and reflects growth much of the same that we've seen in the last couple of quarters since that low point last year.

Michael Ryskin, Analyst

Great. Thanks gentlemen. Appreciate it.

Operator, Operator

Our next question comes from the line of Kevin Kedra with G. Research.

Kevin Kedra, Analyst

Thank you for the question. To follow up on the Q4 guidance, is there anything in that outlook that suggests it may not carry over into fiscal '22? Are there specific areas of performance you anticipate in Q4 that could be seasonal or temporary, which we should not expect as we move into the next fiscal year?

Jack Bendheim, CEO

No. We believe, as Damian mentioned, that this year is returning to a more typical state compared to the pandemic's impact in the fourth quarter of last year. As previously stated, we are experiencing a recovery globally. Some countries are seeing much better growth, as you may have read recently. With the vaccines being distributed worldwide, it's worth acknowledging the efforts of Pfizer and Moderna for their remarkable work. Many of us on this call have transitioned back to the office after working from home. This represents a significant step forward, and we are witnessing this progress globally. Our outlook for the fourth quarter is optimistic, and we anticipate continued growth beyond that.

Kevin Kedra, Analyst

Great. Appreciate that. So I was wondering if you could talk a bit about what you're seeing in poultry. One of your peers has noted that they've been seeing some trade down within the US poultry market in particular. Just wondering what you're seeing there and expectations for that market?

Jack Bendheim, CEO

Our poultry customers seem to be more hesitant to increase their flock sizes compared to previous years due to various challenges, including economic factors. This has led to slower growth in the US poultry market, as they are also dealing with higher input costs. In response, many are looking for alternatives or cheaper options. However, we will continue to rotate our products because all of them serve a purpose. As I've mentioned before, customers choose our products because they believe it helps in the growth of their animals, whether they are chickens, pigs, or cattle. I don't see any major issues, and overall, our customers in the United States appear to be doing fine.

Kevin Kedra, Analyst

Great. Appreciate the color. Maybe two more. First, maybe this is for Donny. Can you say a bit more about those companion animal products that you brought in? It sounds a little bit interesting from the standpoint of potentially going down the medical device pathway. So, any sense you can give us on kind of timelines when we might be able to see those come to market? And then secondly on the Ireland facility that should open up some new markets for you in vaccines. What can we expect from vaccines as we start heading into fiscal '22? Can we get back to that sort of targeted realm of double-digit growth for that business?

Donny Bendheim, EVP of Corporate Strategy

I will start by discussing our oral care products. We are not providing specific timelines, but it's important to note that developing medical devices is a more straightforward process. Currently, we are in the early stages, so it will definitely not be ready in the next fiscal year. Additionally, we plan to introduce a grooming product specifically for cats, which will be our first offering in that category. We are gradually expanding our portfolio at a steady pace and are satisfied with the progress we are making. We are also encouraged by the number of innovative ideas that are being presented to us, indicating that we have established ourselves as a notable player in the market. Overall, we anticipate some promising developments moving forward.

Jack Bendheim, CEO

On the vaccine side, it's a great question. The slowdown in the vaccine business really varies by country. In some markets, vaccines have been more impacted by the pandemic than in others, which is just the nature of our customer base and our competitors. We are the last to enter the vaccine business in most of these markets where we have our registrations. This combination has made the pandemic more challenging for us compared to many of our competitors. That said, the situation is closely linked to the recovery from the pandemic. We are on track for recovery, though I'm not sure if that will take one quarter, two quarters, or a year. However, over the next year, I believe all of our markets will recover, and our vaccine business will grow rapidly, similar to how it did before the pandemic.

Kevin Kedra, Analyst

Sure. Thanks.

Operator, Operator

At this time, there are no further questions. I'll turn it back over to Damian Finio for closing remarks.

Damian Finio, CFO

All right. Thank you, Tabitha and thank you everybody. That was a great round of questions as always and we appreciate your attendance on today's call. Our next call will be towards the back half of August, when we will be discussing financial performance for our full fiscal year 2021, as well as forward-looking projections of financial performance. Until then let's all continue to keep ourselves and one another safe and have a great rest of your day. Thank you.

Operator, Operator

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