Earnings Call Transcript - PAHC Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for being here. Welcome to the Phibro Animal Health Corporation's First Quarter Financial Results Conference Call. I would now like to turn the call over to your speaker today, Richard Johnson. Please proceed, sir.

Richard Johnson, CFO

Thank you, operator. Good morning, everyone, and welcome to the Phibro Animal Health earnings call for our first quarter ended September 2019. On the call today are Jack Bendheim, our Chief Executive Officer, and myself, Richard Johnson, Chief Financial Officer. We’ll provide an overview of our quarterly results and then we’ll open the lines for your questions. So, before we begin, let me remind you as usual 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 earnings Press Release. Before we get into the numbers, let me 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 such as stock-based compensation and restructuring costs and other income, expense items that are separately reported in our consolidated statement of operations, including foreign currency gains and losses, and lastly, the income tax effects related to any pretax adjustments and in addition any unusual or non-recurring income tax items. So, with that out of the way, let me introduce Jack Bendheim with some introductory comments. Jack.

Jack Bendheim, CEO

Thank you, Dick, and thank you everyone who is joining us on the call. Much has happened at Phibro in the 10 or so weeks since our last call, and I’m pleased to be able to give you an update this morning. Our September quarter largely hit our top-line and bottom-line expectations, as we reported declines compared to the previous year, as we guided in August. We knew that the sales impact from the hit to our China business due to African Swine Fever, coupled with the final full quarter overlap with the exit of the U.S. vaccine distribution agreement, would be too much to overcome. However, the balance of our core animal health business was relatively strong, with nice growth in the poultry and dairy sectors for our nutritional specialty products, and despite some continuing macroeconomic headwinds in key countries, we achieved growth of approximately 5% in our vaccine product line, excluding the loss of the previously mentioned distribution agreement. The overall growth we have seen in our dairy and nutritional specialties business includes some very encouraging performance in our OmniGen line in the U.S. Our sales of OmniGen in the U.S. steadily increased throughout the quarter, and that strength has continued into October. This performance has undoubtedly benefited from the improving economics for our dairy customers and nicely set the table for us to accelerate our growth with the revamp of the OmniGen franchise being launched early in 2020. Our revamped product will deliver significant value to the dairy industry, so we have high expectations for industry uptake and financial performance beginning in the second half of this fiscal year. We have also seen strongly positive initial sales of our Provia Prime direct-fed microbial, or DFM, product for poultry. We believe Provia Prime is the best-in-class DFM available today and will have an important impact on our current fiscal year results as it continues to gain share. As we discussed on our last call, through our work to develop Provia Prime, we got to know the people at Osprey Biotechnics, and I’m really pleased with how we are integrating the Osprey business. Being basic in microbial production creates numerous opportunities, both in the traditional DFM space as well as with the novel emerging technologies that rely on a microbial backbone. This acquisition will be of strong benefit to Phibro in the short and long term. Turning to our projects that we expect to materially affect our company in the years to come, over the last two months, we have begun testing our new pHi-Tech vaccine injection device with a number of major poultry integrators across the USA. The feedback has been exceedingly positive, with integrators recognizing that the device will lead to better flock health with fewer missed or partial injections, as well as enhanced worker safety with the device’s safeguards against self-injection. We have an aggressive rollout plan across the globe with pHi-Tech product introductions being planned for five additional major poultry-producing countries over the next few months. We anticipate getting our first commercial order shortly in the U.S. and expect that pHi-Tech will be a meaningful part of our growth in our next fiscal year and beyond. Turning to our other announced vaccine initiatives, we continue to be on plan with our Ireland vaccine manufacturing facility and continue to anticipate our first sales of product from that facility to occur approximately June 2021. An update on the African Swine Fever vaccine we’re working on: we have made incremental progress over the past few months. We are one of the several companies and institutions working to develop a vaccine for ASF and I truly have no idea whether our initiative will play a role in coming up with a preventive cure for this devastating disease. However, I believe that the financial markets have not fully understood the potential financial impact that a successful vaccine or a series of vaccines would have on the animal health industry as a whole. This is a multibillion-dollar opportunity that, for the most part, didn’t exist 18 months ago. Finally, regarding our new Rejensa canine joint health product, we continue to run tests in several metro areas to determine the best way to reach the customer and are encouraged by the reception from veterinarians and the feedback we are getting from consumers. Perhaps most tentatively – while our sample size is small – we are seeing purchase rates significantly better than typical levels for consumer goods. I anticipate being able to share more about our Rejensa plans later this fiscal year. I want to thank my colleagues who are at Phibro for their hard work, which is evident in the progress of the initiatives I just discussed, as well as many other areas not covered in the call. Despite the headlines and the headwinds, this is a great time to be in the animal health business. With that, I look forward to answering any questions you may have at the end of the presentation. Dick, back to you.

Richard Johnson, CFO

Thanks, Jack. So, let me just briefly review our results for the quarter and then we’ll get to the Q&A session. Our consolidated sales were about $190 million for the quarter, which represented a 5% decline versus the same quarter last year. Animal health sales declined due to African Swine Fever in China and the overlap with a U.S. vaccine distribution arrangement we exited in October last year. Mineral Nutrition saw volume growth, but revenues declined due to lower selling prices driven by lower raw material costs. Our reported net income of $2.5 million was down almost $14 million due to the reduced sales and increased SG&A expenses coupled with increased interest expense and unfavorable foreign currency movements. That resulted in a reported diluted EPS of $0.06 per share for the current quarter, and that decline was in line with the change in net income. Now let me discuss the adjusted results on page six. Looking at selected line items from the P&L, adjusted gross profit declined $7.6 million, or 11%, compared to the prior year. The Animal Health business accounted for more than the entire decline due to the reduced sales and unfavorable product mix. Mineral Nutrition gross profit contributed almost $1 million of improvement over the prior year despite the lower revenues. Adjusted SG&A increased $3.3 million, or 8%, driven by strategic investments in key development projects to position ourselves for future growth, plus the inclusion of the Osprey acquisition in our operational results. All of the year-over-year increase was reported in the Animal Health and Corporate segments. Adjusted net interest increased to $0.5 million over last year, due to higher outstanding debt levels. Going all the way down to adjusted diluted EPS, it was $0.19 in the quarter compared to $0.39 last year, representing a 51% decline quarter-over-quarter. Looking in more detail and more closely at the Animal Health business, net sales of about $122 million declined $9.3 million, or 7%, compared to the prior year. Net sales of MFAs and others were $75 million, a drop of $12 million, or 14%. This drop was primarily due to the reduced demand in China caused by African Swine Fever, along with some unfavorable customer ordering patterns in other international regions. In Nutritional Specialties, our net sales were $30.4 million, an increase of $3.5 million, or 13%. We saw volume growth in our poultry and dairy product lines, coupled with sales from the Osprey acquisition, which drove the increase. In the Vaccine product group, net sales were $16.4 million, representing a decline of $800,000, or 5%, compared with last year. If we exclude the loss of that domestic distribution arrangement from October of a year ago, all other vaccine sales increased by 5%. For the segment, adjusted EBITDA was about $25 million, which was down $10.7 million, or 30%, due to the sales decline driving the gross profit decline, in addition to increased SG&A costs. Gross profit declined, as I mentioned, driven by lower sales volumes and by unfavorable product mix, with nutritional specialties providing some gross profit improvement. SG&A increased, as we continued to make investments in strategic growth initiatives and product developments. Looking at our other segments, Mineral Nutrition saw volume growth in the quarter, although net sales of $52.6 million declined $2.2 million, or 4%, due to lower average selling prices. Our selling prices in the minerals business are directly correlated with movements of the underlying raw material costs. Segment adjusted EBITDA of $3.5 million increased almost $1 million driven by the increased gross profit in the business. Performance products' net sales were about $15 million in the quarter and that was about a $1 million increase over the prior year, driven by higher volumes in sales of personal care ingredients. Corporate expenses were $9.7 million in the quarter, an increase of $800,000 over last year, primarily due to increased spending on strategic initiatives and public company costs. Looking at capitalization, our gross leverage ratio of debt to adjusted EBITDA was 3.7 times at the end of the quarter. The higher leverage ratio reflects the Osprey acquisition we completed in the quarter. We had $79 million of cash and short-term investments on the balance sheet at quarter-end, and in total, we used $66 million of cash before financing activities, including the $55 million purchase price before the Osprey acquisition. Looking at our guidance, we have reaffirmed our financial guidance for the fiscal year ending June 30, 2020. It was initially included in our August 27, 2019 press release, and that the guidance included full year expectations for items like net sales, adjusted EBITDA, adjusted net income, and adjusted net income per share. We repeated that guidance here in this presentation for your convenience. So that’s the conclusion of my prepared remarks. Operator, if you’d please open the line for questions. Thank you.

Operator, Operator

Your first question comes from Erin Wright from Credit Suisse. Your line is open.

Haley Christofides, Analyst

Hi, thanks for the question. This is Haley on for Erin this morning. First, I was wondering, how would you characterize the current MFA demand trends in the U.S.? And are you starting to see the impact or offsets from ASF in terms of increased demand from other geographies like the U.S. or Brazil? Thank you.

Jack Bendheim, CEO

Thank you for that. I think we are seeing – as we’ve said for a long time – the shortage of protein in China is affecting protein production around the world, including the U.S. Many options are available for keeping animals healthy, and healthier animals obviously put on more weight. So we are seeing stronger demand across the globe, both for MFAs, as well as nutritional specialties, and we’re experiencing strong demand in some markets for vaccines with the same purpose. Overall, I think it’s a good time to be in the protein business out of China.

Haley Christofides, Analyst

Great, thank you. And also, could you characterize a little bit the current trends across the dairy market? Are you seeing some stabilization?

Jack Bendheim, CEO

As I said in the presentation a few minutes ago, we are seeing the stabilization of dairy prices across the world and in the U.S. We’ve seen that typically our OmniGen business and our other products sold into the dairy market are increasing, with slight increases or at least a halt in declines. I think we’re observing fewer closures of smaller dairy producers in the U.S., which indicates some stabilization. It’s hard to say if it is directly due to China, but again, milk is a protein as well, and so indirectly it’s been affected by that. We are seeing stabilization and some growth in our business in the States for that sector.

Haley Christofides, Analyst

Okay, that’s helpful. Thank you so much.

Operator, Operator

Your next question comes from the line of David Risinger from Morgan Stanley. Your line is open.

David Risinger, Analyst

Thanks very much. So I have two quick questions for you, Jack and Dick. First, could you talk about African Swine Fever at a higher level? Is it spreading beyond China to any notable degree? And then second, with respect to the MFA issues that you touched on for Phibro outside of China, could you provide a bit more color on the customer ordering issues and whether that will continue into the December quarter or not? Thanks so much.

Jack Bendheim, CEO

Yes, sure. Hi David. We’ve already read that in the Far East, African Swine Fever has jumped borders and has become prevalent in Vietnam, and it’s been reported in South Korea and in several other countries in that part of the world. It’s very hard to contain African Swine Fever, but good biosecurity measures have always been an effective way to limit the damage. It’s been present in Spain years ago; it’s been in Eastern Europe, but we see the crisis that has unfolded in China. Yes, while it’s spreading, I don’t think we are going to see the same effect in other areas, at least so far we haven’t observed the same impact. I think China is unique; it is the biggest country in the world and the largest consumer of pork globally. The significant number of missing pigs in China due to African Swine Fever and the unwillingness of producers to raise pigs has had an incredible economic effect. There was an article that I believe was in the Journal discussing Smithfield and their increased exports to China. This trend will be true for many U.S. companies, including several animal health companies. Regarding MFA business orders, animals get sick when raised in close quarters. In a time when you’re earning more per kilogram or pound, you want to keep your animals healthy, and there are various solutions available. Some producers may use antibiotics or nutritional specialties, while others invest in vaccines. The key is keeping animals healthy and maximizing returns.

Richard Johnson, CFO

Yes, David, just to add a bit more specificity to your question: No, we wouldn’t expect this situation to carry on. Our forecasts do not indicate any continuation of this issue for the rest of our year. As Jack described, this was specific to this quarter.

David Risinger, Analyst

Great, thank you.

Richard Johnson, CFO

You’re welcome.

Operator, Operator

Your next question comes from the line of Kevin Kedra from G. Research. Your line is open.

Kevin Kedra, Analyst

Thanks for taking the questions. First, you talked about your excitement with Provia Prime and Osprey. Can you give us any further insights into what the pipeline looks like for the Osprey products and when we might start to see more outcomes from that acquisition? Secondly, you’ve indicated that the initial results for Rejensa are promising. Should we think about that as an opportunity for next year, or could we see something contributing to revenue later this fiscal year?

Jack Bendheim, CEO

I’ll take Rejensa first. I believe we should see Rejensa as a contributor next year. We are gradually building awareness; we are trialing the product, introducing it to vets, and figuring out the best channels to reach them. We’re experiencing modest successes and will update you on this journey in the next quarter and the following. I think this could become a product that yields meaningful numbers in the next fiscal year. Regarding Osprey, it is a bit too early to provide specifics. We’ve just begun working with their business. However, we are focused on increasing their production capacity. Our outlook for growth in that business is very strong. We are working diligently on both sales growth and production initiatives.

Operator, Operator

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

Michael Ryskin, Analyst

Thanks for taking the questions. I want to start with some of the new products you highlighted. You mentioned the next-generation OmniGen for the dairy industry and its contribution starting in January. How significant are we anticipating this, considering there are many moving pieces in the guidance this year versus last year, including the China MFA reduction and discussed distribution agreement? As we look to the second half of the year, will much of the improvement be from the new products, or is there something more factored in for this year?

Richard Johnson, CFO

Yes, I believe these new products will be a major contributor to accelerated sales growth in the second half of our year, Mike. It’s not limited to the refreshed OmniGen product; we have various vaccines and other offerings. Additionally, in our traditional MFA category, we are expanding geographically and introducing products that are well-received in several regions. The repositioned OmniGen will definitely contribute in the second half. Like all products, it will ramp over time.

Jack Bendheim, CEO

So, we are not saying to buy a bag and hold it to your ear.

Michael Ryskin, Analyst

I’ll keep that in mind.

Jack Bendheim, CEO

And another advantage is that it will definitely – I mean your kids won’t have a lot of screen time with it either.

Richard Johnson, CFO

We know this business very well, especially dairy. The market has changed significantly; we’ve discussed this frequently over the past few years. We were very successful with OmniGen at smaller dairies, but the economics of the dairy business have consolidated many smaller dairies. The number of cows in the United States has remained steady over the last five years. They have moved to larger operations, and while the marketplace is familiar with our product, we needed to introduce a product that brings more value to larger dairies, which is what we've done. We are comfortable with this product launch, as we have thoroughly tested and formulated it, and we expect it to launch in early 2020.

Michael Ryskin, Analyst

Great, that’s very helpful. Along those same lines, regarding shifts in the dairy industry in the United States and perhaps more broadly in the MFA segment internationally, with the gross margin declines you experienced this quarter, while much was attributed to volume and product mix, will the introduction of new products enable you to mitigate some of that pressure, possibly through pricing improvements?

Richard Johnson, CFO

Certainly. Our guidance and expectations for the year indicate we should see margins improve from where they were in Q1. I expect that margin improvement to come from new product introductions and improved product mix. This is not just about raising prices, but about delivering more value to customers through differentiated products.

Jack Bendheim, CEO

Yes, we expect our margins to increase.

Richard Johnson, CFO

Absolutely.

Michael Ryskin, Analyst

Great! And one last one if I may. On the leverage and balance sheet, you highlighted higher debt levels from the Osprey acquisition. Could you talk about your leverage going forward? How high would you be willing to leverage if opportunities to acquire assets in either companion animal or livestock markets arose?

Richard Johnson, CFO

We are actively looking at assets as they come to market. We are not comfortable with very high leverage, but we will consider leveraging up if it means purchasing right. We are not inclined to overpay simply to utilize our debt capacity; however, we will incur debt if we find an asset that is well-priced.

Operator, Operator

Your next question comes from the line of David Westerberg from Guggenheim Securities. Your line is open.

David Westerberg, Analyst

Hi, thanks for taking the questions. I have a question on the African Swine Fever vaccine. It’s interesting to hear about this multibillion-dollar market. Can you talk about some of the market sizing, in terms of price versus the average vaccine, the potential reach of a vaccine like that, and how accommodating do you think regulators would be in getting such a product out sooner rather than later?

Jack Bendheim, CEO

That’s a great question. People are indicating that in China, over 50% of the pigs are gone, though not all of them have contracted African Swine Fever. If you have a herd of 1,000 pigs and four contract it, it’s extremely virulent, and they die within 10 days. Authorities will thus cull the remaining healthy pigs. Consequently, if your operations suffer such consequences, you are less likely to invest again in raising pigs. China grows and consumes approximately 800 million pigs annually, which translates to a standing herd of about 400 million pigs. If we assume 50% are missing, that’s around 400 million pigs. The rest of the world collectively raises about 400 million. This situation cannot be resolved by China simply importing pigs; they need to tackle this issue domestically. Pork is the main source of protein in China and is integral to their food culture. If we successfully develop a vaccine—and I emphasize that it remains uncertain—it could help control outbreaks and generate significant revenues. Historically, with a vaccine that can safeguard livestock from serious diseases, pricing has typically been set at about 20% of the animal's value. If we consider a pig’s approximate value at $100, that leads to around $20 per vaccine. Just assuming we vaccinate all pigs in China, that’s 800 million pigs at $10 each—an $8 billion market. Thus, while many uncertainties persist, the potential market is staggering. There are many companies involved in this pursuit, and we are making progress, but this virus has been around for decades, making it a complex challenge.

David Westerberg, Analyst

I really appreciate it; that was great detail. On a higher level with poultry, whilst we’ve discussed dairy and ASF, what’s currently happening in your poultry portfolio? It was slightly down last year. How confident are you about rebounding in that sector?

Jack Bendheim, CEO

Poultry-wise, the status varies, but our largest markets include the U.S., Brazil, and the Far East. This year is looking quite robust. We have new vaccines that we’re introducing to markets and they seem to be well-received. We have fluctuations with some herds, but overall, our poultry business is strong, and our performance within that sector is even more robust. Additionally, we offer a unique nutritional product that performs well as producers transition away from antibiotics in poultry. We have had very positive acceptance of our Magni-Phi product in the U.S., and we are now introducing this product in Brazil and other markets as well. Thank you for raising this point regarding poultry—it’s an important area for us.

David Westerberg, Analyst

Thank you.

Operator, Operator

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

Richard Johnson, CFO

Alright, everyone. Thank you for your time and for listening, and we’ll talk again on our next quarterly call. Bye now.

Operator, Operator

This concludes today’s conference call. You may now disconnect.