Phibro Animal Health Corporation (PAHC) Q4 2015 Earnings Report, Transcript and Summary

Good day ladies and gentlemen and welcome to the Phibro Fourth Quarter and Fiscal Year June 2015 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] I would now like to introduce your host for today's conference CFO, Richard Johnson. Please go ahead sir.

Thank you, operator and good morning. Good day everyone. Welcome to the Phibro Animal Health Corporation earnings call for our fiscal fourth quarter and fiscal year ended June 2015. On the call today as usual are Jack Bendheim, our Chief Executive Officer and myself Richard Johnson, the CFO. I will provide an overview of our quarterly and annual results. We'll also talk about our fiscal 2016 guidance and then we'll open the lines for questions. Before we begin, let me give you the standard reminders that the earnings press release, financial tables, can be found on the Investor Sections of our website at pahc.com. We're also providing a simultaneous webcast of today's call which can be accessed on the webcast as well. Today's presentation slides and a replay and transcripts of the call will also be available on the website later today. Our remarks today may include forward-looking statements and actual results could differ materially from those projections. For a list and descriptions of certain factors that could cause results to differ we refer you to the forward-looking statements sections 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. We 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. And with that, I'll turn it over to Jack Bendheim for some inductor remarks and we'll take it from there. Jack? Good morning.

Good morning, thank you, Dick, and thanks to all of you for joining us on this call this morning. Our fourth quarter results were solid and capped a fiscal 2015 that we are very proud of. Our fourth quarter adjusted EBITDA grew a healthy 12%. While we are disappointed with our overall topline growth of 1% we were able to drive revenue growth in our core Animal Health unit in low single digits. Nutritional Specialty products and Vaccines led the growth in another double-digit growth performance. Our MFA categories experienced negative quarter-over-quarter growth due in large measure to the transitional effects of the currency shocks in some of our markets. As a reminder, we largely sell our products around the world based in U.S. dollars and the effect of a rapidly strengthening dollar is that when our prices translate into local currencies, our customers can see their price increases dramatically which in turn can slow their purchasing. The strength of our business model is that we are still able to grow despite turbulence in the markets and we saw more and more of our high margin vaccines and nutritional specialty products markets where our products have tremendous room to grow. As we look to our new fiscal year, we are expecting another very strong year, led again by double-digit growth in Nutritional Specialties and Vaccines. While currency volatility remains a wild card we expect MFAs and others to deliver mid single digit growth as certain markets transition away from the use of antibiotics for growth promotion. Of course some of this transition is driving our impressive Nutritional Specialties revenue expansion. We anticipate that the investments we made in this last year in growing our sales and technical teams by approximately 50 employees will continue to drive growth as we enter more markets and sub markets and see more customers with more products on a regular basis. We will continue to invest in people and operations in 2016. Our CapEx will be focused on expanding our capacity in nutritional specialties and vaccines as well as driving continued cost reductions. Entering fiscal 2016 with our net leverage ratio at our comfortable blow two and a half times EBITDA we are well positioned to invest in acquisitions that will meet our strategic and financial objectives. I will now turn it back to Dick to give you some more color on our completed quarter and our guidance for the coming year and I look forward to answering any questions you may have at the end. Thank you.

Thanks Jack. So, turning first to the fourth quarter consolidated results on page four of the webcast presentation, we had net sales of $185 million in our June quarter. That's about $1 million or 1% growth over the same quarter last year. That growth was led by the Animal Health segment with over $3 million growth or 3% Mineral Nutrition just above last year and Performance Products with a down quarter compared to last year. Overall it was a volume story throughout our businesses, volume growth in Animal Health, in Mineral Nutrition and volume declines in Performance Products. We did see pricing declines in Mineral Nutrition, that's the nature of that business where prices are very flexible and transparent to our customers as they move with the commodity markets and as I think we all know commodity markets have been in some steep declines lately. More on that as we get to a little more detail on that segment. In spite of only $1 million of sales growth we grew gross profit to almost 33% of sales, growth of $6.5 million or 12% that was driven by a number of favorables that was favorable business mix. So growth in the Animal Health segment versus the other parts of the business, it was driven by favorable product mix even within the segments and it was also driven by reduced manufacturing costs from beneficial currency movements. We manufacture several of our significant products either in Brazil or in Israel and the dollar has strengthened against both of those currencies, in particular the dollar has strengthened against the Brazil currency and that makes our manufacturing costs, our local costs lower and favorable to us. At the SG&A line, we reported, actually reported a decline in SG&A, but when we set aside a one-off item that we had last year and that item was also excluded from our adjusted EBITDA measure, our SG&A grew $4 million in the quarter or 11%. And the entire growth was in our Animal Health segment and really driving it reflects the manpower additions, the selling and marketing investments we're making and also development spending that we're putting behind our growth initiatives. And put that all together adjusted EBITDA grew 12% to $27 million this year and of course were $3 million increase over the prior year and dropping that down to our per share number and adjusted diluted earnings per share of $0.44 that compares with $0.22 against our last year's pro forma numbers. So I’ll turn now to Animal Health and here we see again the $117 million of sales about $3 million of growth or 3%. Within that the Nutritional Specialties showed very strong growth of $5 million or excess of 30% and vaccines close to $12 million of sales, up $1 million and 10% growth over the prior year. So both of those driven by volumes, vaccines also in part due to the transaction we did a few months ago where we're now selling a swine vaccine product from a company called MJB. In the MFA and other category about $84 million of sales down $3 million or 3% from the prior year. Most of the decline was in foreign markets and that was the - we saw some customers tighten up their inventories as the currency has affected their buying patterns. We also saw customers perhaps delay purchases of some of the lower value products that we have in our portfolio. We saw ongoing strong sales of our higher value and higher margin products. At the EBITDA line, despite the only $3 million of sales increase we had adjusted EBITDA of just under $30 million, $3.7 million or 14% increase and that's what I talked about in the consolidated section, driven by the gross profit growth, favorable volumes, favorable product mix, favorable manufacturing cost, offset by the selling expense investments we're making in that business to continue to drive growth. Looking at the other segments, Mineral Nutrition sales about the same as last year and adjusted EBITDA about the same as last year, so we had forecast this or given guidance of this that the business was evening out after some volume increases we'd had. So this was in line with our expectations. Performance Product, we saw some reduced demand for several products really across many of the products in that segment, so sales of about $12 million down 19% and corporate expenses were essentially unchanged from last year. Looking at capitalization and capital allocation, our leverage ratio is 2.6 times on gross debt basis $110 million of trailing EBITDA with $290 million of total debt we get $29 million of cash on the balance sheet. For the June quarter we generated $10 million of net cash flow before financing activities and that included funding of about $5 million, actually $4 million of acquisition activity in the quarter. The dividend $3.9 million was paid in June and we've declared a routine quarterly dividend to be paid later in September. So turning to guidance on page eight, looking first at the net sales line, our guidance on sales is $782 million to $800 million of sales for fiscal 2016. Compared to 2015 adjusted to exclude the milestone vaccine licensing revenues which were somewhat of a one-off item in 2015 that represents 5% to 8% growth on the topline. Adjusted EBITDA $113 million to $117 million and as a ratio to sales around 14.5% that compares with $102 million on that same ex-licensing basis 11% to 15% growth and a nice improvement in the EBITDA ratio. And so when that comes down to adjusted EPS we're forecasting or giving guidance of adjusted EPS of $1.65 to $1.75 and that compares with $1.52 last year and that's – I think that was an 8% to 15% or 16% growth. Looking at it in a little more detail on the sales line, we expect the Animal Health segment to drive most of the total sales growth, most of the dollar growth and that will mean the Animal Health segment will grow somewhere between 7% and 11%. Within Animal Health we expect Nutritional Specialties and Vaccines to continue to grow at double-digit rates. MFAs and others we expect to grow in the mid single-digit range. Mineral Nutrition we expect in the low single digits and Performance Products expectation is for continued slight decline. Looking at operating margins, we expect operating margins to expand. That's an improved gross profit to a combination of both favorable business mix, the growth of coming out of our higher margin Animal Health segment as well as favorable product mix. We will continue to see favorable currency benefits our manufacturing costs and we'll see some leverage on operating expenses as we grow sales and gross profit faster than we grow selling, general and administrative operating expenses. On a quarterly basis we expect to grow our quarterly results at somewhat similar rates as our full-year expectations ex-vaccine licensing last year. We expect somewhat lower growth rates earlier in the year and the growth rates to increase later in the year. Cash income taxes, which is the basis we use for forecasting giving guidance on adjusted net income are in the $13 million to $14 million range. We do expect positive cash flows for our full-year 2016. We're stepping up our capital expenditures. We're forecasting CapEx in the $35 million range, that's after roughly $20 million CapEx number for the year we just finished and obviously any positive cash flow would be available to support potential acquisition activity. And finally, just to give a little more background on the vaccine licensing arrangement, we booked the final $8 million of milestone revenues and so its topline and bottom-line in fiscal 2015 and now beginning in fiscal 2016 and for approximately a 10-year term the agreement converts to a royalty structure where we earn royalties at a low single-digit percentage of the licensee's product sales using the technology. There are annual minimums on the royalties. We expect that we will earn something less than $1 million in fiscal 2016 and it will fall primarily in the second half of our fiscal year. So those are my prepared comments and with that operator, I'll turn it over to Q&A.

[Operator Instructions] Our first question comes from the line of Louise Chen with Guggenheim Securities. Your line is now open.

Hi it's Brandon Folkes on for Louise. Just firstly, has avian flu impacted far Phibro at all and do you have any insights or thoughts on when it may peak again and how we should think about the potential impact going forward?

I mean that is the question that everyone in the industry thinks about all the time. So, the avian flu which affected the U.S. poultry business last year did not have a very big effect on our business. It hit the turkey producers in Minnesota pretty hard and hit the egg industry, the layer industry very hard in the Midwest. And as you know, no different than even the flu warm weather flu subsides and in cold weather it reemerges. So, everyone is sort of is waiting to see as the birds migrate again south as it gets colder and the birds, strange Avian, right the birds that are carrying the flu, the influenza, how virulent and what path they will take. So I think there was expectations it will hit, no one exactly knows on which corridor. I mean clearly the industry is buttoning up their facilities, increasing its bio security, but it still remains an unknown. So I mean, a long answer for a short question, so far has no effect on our business, has had a minimal effect and remains to be seen what happens this coming year.

Great, thanks very much.

Thank you. The next question comes from the line of David Risinger with Morgan Stanley. Your line is now open.

Great. Thanks very much. Good morning Jack and Dick. I have a couple of questions. I guess maybe two for each of you if that’s okay. So Jack, maybe you could just talk about the MFA business in terms of just how the market is evolving and your share trends versus competitors and the pricing outlook? And then if you could maybe expand upon your comment that you could pursue external transactions that would be helpful also? And then Dick could you just please characterize what the FX hit is that you’re expecting in fiscal 2016 or said another way, what would your organic revenue growth guidance be ex-currency? And then with respect to the tax rate outlook beyond 2016, can just tell us what you expect to have at the end of the year in terms of NOLs and how we should think about the tax rate beyond fiscal 2016? Thanks very much.

David, thanks. Outlook on medicated feed additives, overall our business is still growing around the world. And as you know so well, I mean the more animals that get raised the more exposure that you have to bacteria, the more - the greater the movement from small farms to larger farms and is the right thing to do is to treat sick animals as opposed to them getting sick. So, on balance we see our business growing around the world. Now there is obviously some, there were changes because in the markets, predominantly the United States, the industry, the protein industry which is our biggest customer they are moving away from the use of antibiotic for growth. It was always a misnomer, but the just - the standard feeding of antibiotics without presence of that prediction of seeing a bacterial disease is something clearly the industry has shied away from and will move from completely within the next year and a half. So that is lessening the business. At the same time, the effect that those products have had again, as you know so well the protein industry is one industry that knows how to count and doesn’t waste money. So it doesn’t for the fun of it feed antibiotics because of the calcium carbonate you get as a carrier to have bones strong. I mean it is doing some effect. So, what we're seeing is a shift and we are shifting to some of our nutritional specialties to aid the farmers, the growers in preventing and controlling the various bacteria that you are going to get. So what we’ve seen here and we look at our business, I mean in the way we told you many times, I mean our goal is to service this industry wherever they are. Our goal is to be agonistic, what protein gets consumed as long as somewhere in the world, someone is consuming our products. And that's how we view the business. So while we've seen some people move away, some of the lesser users of medicated feed additives thus our sale is down a little bit, plus some of the discussion that they put around what we call the sticker shock of being in a currency where the value drops and the price of the drugs remain the same, so that takes some correction. We see an overall growth in the use of additives whether it’s medicated feed additives or whether it’s going to be nutritional specialty additives as the markets grow around the world. So we are quite excited and I really want to answer that, I mean a question you didn’t asked and I want to get ahead of next week's questions, if you think of what’s happening now is they move layer chickens from cages to the ground it’s a nice idea, no one likes to see animals in cages, but they were put there for a reason. So what’s going to happen on the ground, I mean they’re going to be exposed to high disease pressure. So what we see ex avian influenza coming in United States, we see overall growth in the need to protect these animals as best as you can. I mean you’re not going to protect them from pecking which will cause a significant percentage of death, but you need to protect them against cocci outbreaks, against bacterial outbreaks, et cetera, et cetera. So overall we are, I don’t think we’ve been as positive about this business in a very long time. We’re quite positive about all these active unintended consequences, growth in population, and in a manner what is happening. So if you even look at, if you look at China, I mean we all absorb with the decline of the economy in China, but our business in China remained strong because the bottom line is the people there have gotten used to eating proteins, they’ve gone off the farms and they need and they will continue to consume pigs and chicken and fish, et cetera. That was our timing here. The next thing is, we as you know, we are always on the outlook for acquisitions. There is some sticker shock these days and prices are high. Clearly I understand why people pay value of Phibro, but it’s always hard to understand the value of other companies that we want to look to acquire. So we are looking, we’re looking for opportunities. We, last year we did a couple of small acquisitions that will be additive to our business, so we got us into swine vaccine business and we’re looking around the world for more opportunities like that.

That is helpful, thanks.

So, the couple of things you asked about, so first on revenues, we expect very little difference between our revenue guidance from - we don’t expect currency to have a significant effect on our revenues for 2016 or a significant direct effect let me put it that way. Again we sell these products are priced or referenced in dollars in most markets around the world where we’re selling internationally. So our dollar sales price stays more or less unchanged. We do have the indirect effect of the sticker shock as the phrase go that we may – people maybe a little more reluctant to buy a product. We’re taking limited actions in very targeted specific areas if we need to go in with some transitional discounts to help our customers sort of make that transition to the new reality of the exchange rates they’re facing. Short answer, our sales growth is and the guidance is really our organic growth. Looking at the tax rates, I’d say we probably have a good two years of NOLs. We will enjoy a low tax rate as we go through our NOLs. We probably have two more years of that. I think our tax guidance for 2016 gives an effective tax rate in the call it 17% neighborhood and that will climb over time, it will climb once the NOLs are exhausted, it will probably climb to the low to the mid 20s without having a lot more detail here in front of me. But that will be two or three years from now. Okay?

Great, thank you again.

Our next question comes from the line of Erin Wilson with Bank of America. Your line is now open.

Hi just a quick follow up on that tax rate question, you said low to mid-20s longer term, I think previously you had said 30%.

Yes, right. So I’m mixing a little bit of apples and oranges here and I apologize for that. The low to mid-20s is on an adjusted net income basis. The 30% was a GAAP tax provision basis. So I still think on GAAP, we will call it 30, but I think we will be on a cash basis we'll be below that number for several years still.

Okay. Great and where do we stand now with the regulations regarding antibiotics? I know there were some small adjustments at the VFD more recently, you had originally estimated a potential impact of like $15 million to $20 million associated with these changes potentially. Have you started to see some of the label changes, basically where do we stand broadly speaking with the FDA?

We released our 10-K at 6:00 AM this morning, and so I’m sure you’ve gotten to Page 99 or whatever it was where we updated the risk factor language and we updated those numbers and the numbers now updated are $10 million to $15 million. So basically what that means is, we’ve seen and it is down from the 15 to 20, you calculate, you quoted, so that means that we’ve seen a bit of a drop there in that area. Yes, the VFD regulations came out recently and I’ll let Jack talk more about it.

Basically, what’s going to happen, the industry is in negotiations with the FDA over exact language. But right now the thinking of the FDA is to do everything at one time over a 48-hour period, sometime in the winging days of December 2016. So everyone will have a chance, the government will look at everyone’s labels, suggest the changes. It will be up and then at the push of a button the old labels will no longer be in use and new labels. And I did a lot of research around this as you can imagine, inventories in the field, people may use it and all of this and the FDA has been very conscious of the industry, very conscious of the uses. I mean remember these products are safe and effective and they have been for 30, 40 years. So it’s not a safety issue. We just want to, just getting it right to make sure that nothing gets wasted and the consumers are protected which is obviously FDA, the reason FDA exists.

Okay, great and the EMA recently outlined some regulations around the maximum residue limits with virginiamycin. If I’m understanding it right this could be a positive for your business, can you kind of elaborate on that?

Virginiamycin as you know so well, we spoke about it often is a great antibiotic, great molecule which basically leaves no residues by the way of applications. We’ve never taken a few years. We have applied for basically what is the called the minimum residue level, MRL maximum residue level and so I think we’ve applied, took us about four or five years and they just released it. It’s good, it just shows what we’ve been saying the product is safe and effective. It leaves no residues. People are going to use it comfortably. So, half a peg growth, but it’s we think it’s going to be very positive for the business continuing with some growth going forward.

Okay. And one – sorry, one last question on OmniGen in Europe and then also the efforts in China for that product?

Sorry, could you repeat that?

Could you speak to the traction overall that you’re seeing with OminGen in Europe as well as your efforts in China and where that stands?

We’re increasing our headcount in Europe, we might be the only people hiring in Europe. We are increasing our headcount in Europe to market the product. We have seen some of the effects, but also some of the side effects you read about the protest in Belgium of all farmers complaining that things are not as nice and neat. I mean, what we had said and the reason we're there is promise that just not get paid anymore just sort of for having cows and producing milk. It's going to be a competitive market and the most productive farmer with the most milk and the best quality milk is going to win and that’s where our products come in. We've been in that business a long time in the United States. So the trend is good and our business in Europe continues to grow. In China we've begun doing some in China tests with product at various large dairies. So far the results look positive, but it takes a while to do all the calculations. We remain optimistic about China, Europe is growing. Our business in the United States continues to grow as well as in other markets and in Latin South America we are certainly increasing our penetration of some of these specialties in the dairy industry. And now we saying in fact the dairy prices are down internationally. Again it pulls for all kinds of products because the quality, the healthy animal, all these things that we’re dealing with, it really pays for the farmer to spend the money.

Great, excellent, thanks.

[Operator Instructions] Our next question comes from the line of Matthew Brooks with Macquarie Group. Your line is now open.

Good morning guys. I was wondering, you've made some comments about the impact of commodity prices on sales, can you say a little bit of more about that, maybe use of specific commodities example of how it sort of impacts the sales line?

Yes, so our mineral nutrition business which is $225 million business last year, it sells, fundamentally it sells trace minerals for animal feed. So it’s all of those trace mineral elements that just like a human an animal needs for a healthy diet. So its products like copper sulfate, zinc sulfate, iron oxide, manganese oxide, cobalt, iodine, selenium, et cetera, etcetera, etcetera, I’m showing off and so for example Zinc, I think Zinc six months ago was, help me out Jack, $15,00 a ton and now it is…

No, Zinc was – dollar a pound and now it's in the selling of the $0.80 a pound.

Now it’s $0.80 of pound.

Copper is dropping, I mean all the metals around the world is dropping.

Yes, so copper used to be a year ago it was 3.25 and now it is 2.25 somewhere in there. And so this is a business that our mineral nutrition business in the entire industry pricing is completely transparent. So our customers, know they can, they have the internet too, they can look up commodity prices and they see what copper is at. So these derivatives are all priced off of the base metal. And so our prices move up and down, this absolutely in lock-step with the market prices and we tend to keep our unit dollar margin. So typically we sell this by the ton, so we’ll keep X dollars a ton, whether we’re selling it at a dollar or pound or $0.80 a pound, so that’s a long answer.

Okay, that’s good and you said the CapEx was going to increase, can you tell us what’s behind that, what you’re going to spend extra money on?

Well, we try never to spend money until we absolutely have to on CapEx. So we had forecast CapEx for our fiscal 2015 to be higher than it came in at. So some of that is just deferred or delayed spending on projects that have been in the works for a while. New projects are really around capacity expansion I would say entirely in our animal, capacity expansion in our animal health segment, whether it’s expanding for nutritional specialty products, for vaccine. And the other thing we're continuing to do is when we see good cost say, when we see a good return on a capital investment manufacturing that gives us good quick cost savings, we'll spend that CapEx also. So it isn’t any one big thing. It is just a number of initiatives and but they add up to a bigger number.

Okay and on China and OmniGen can you tell us, do you sell that product directly to the dairies, I know some other animal health products in China gets sold to sort of the local government body which then sells it to the farmers?

So we have our own people who are sort of detailing products, promoting the product, but we don't do the actual sales. We work through a distributor. As it happens in this case a company which is probably owned by the Chinese government, they are the importer of record and they do the actual distribution of the product, but we are out there with their sales people promoting the product and running technical seminars, et cetera, et cetera.

What's the name of the company?

I don't think we released it.

Okay. And can you say lastly what percent of the cost of your products come from manufacturing in Israel and Brazil?

We in our risk factors in the 10-K it tells you individually that our Brazil operations account for something and that Brazil accounts for something and I'm scrambling to look it up here and…

Yes, we'll look it up for you.

So our Israel, both our manufacturing and local operations accounted for 22%, I'm sorry, 20% of sales. Brazil, between what we make there and what we sell there, 21% of sales.

Okay.

Okay?

Thank you. I'm showing no further questions at this time. I would like to turn the call back to Richard Johnson for any further remarks.

Well, we wish you all a good shanah tovah and talk to you next time. Take care everyone.

Thank you.