Phibro Animal Health Corporation (PAHC) Q4 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Phibro Fourth Quarter Financial Results. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. I would now like to introduce your host for today’s conference, Mr. Richard Johnson, CFO. Sir, you may begin.

Thank you, Operator and good morning everyone. And welcome to the Phibro Animal Health earnings call for the fourth quarter ended June. We’ll also talk about briefly about our full fiscal year ended June 2018, and then get into our guidance for our new fiscal year 2019. On the call today are, Jack Bendheim, our Chief Executive Officer, and me Richard Johnson, Chief Financial Officer. And before we begin, let me remind you that the earnings press release and financial tables can be found on the Investors section of our Web site at pahc.com. We’re also providing a simultaneous webcast for this morning’s call, which could be accessed on the Web site as well. Today’s presentation slides and a replay and transcript of the call will also be available on the Web site 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 presented 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. Reconciliation 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, here is Jack Bendheim with some introductory comments. Jack?

Thank you, Dick. And thank you everyone for joining us in today’s call. We completed our fiscal year with strong results and good momentum. And as we enter our new fiscal year, we have a number of development initiatives planned for 2019. But first a few words about our results. For the fourth quarter, we saw 9% growth in sales and 12% growth in adjusted EBITDA. For full year, consolidate sales and adjusted EBITDA each grew 7%. For the year, international sales growth of 21% in the animal health segment with the key contributor to the results. Overall, animal health sales grew 7% for the full year as the international growth was offset by domestic decline due to reduced antibiotic sale, and a continued weak dairy industry and other factors. We believe our domestic business has poised to growth in fiscal 2019 as we overlapped some of the negative trends. Animal health's adjusted EBITDA margins expanded for the year due to sales growth and a favorable product mix, and despite substantial increase in operating expense. The Mineral Nutrition segment also saw good comparability growth for the full year. Our strategy in Animal Health is to focus on the profitable growth of our portfolio, primarily lead by nutritional specialties and vaccines. We plan to make strategic investments in our business in fiscal 2019 that we expect will lead to longer term, broader growth to major initiatives. We plan to find new developments, additional registrations and additional geographic expansion of our existing nutritional specialties and vaccines. We also expect to invest in new novel technologies for the nutritional specialties category to expand our portfolio and strengthen the offerings to our customers. We will invest in developing additional vaccines production capacity at our newly acquired Ireland facility. This will enable regional expansion and give us access to markets we do not serve today. And finally, we will also continue product development and refining our go to market strategy for the companion animal space where we see unmet needs through in-licensing of novel technologies. These investments take time to bear fruit. We expect it to be approximately 18 to 24 months before we see the financial results. While we remain open to acquisitions, we believe these investments offer better return. These investments show my confidence in our business, our technologies and our people. Because these investments will require significant P&L expense dollars, our earnings guidance for fiscal 2019 is approximately even with fiscal 2018 despite strong sales growth and gross profit improvement. Our fiscal 2019 financial guidance shows sales growth of up to 7% and adjusted gross profit is expected to improve more than the sales growth. However, increase of up to 14% in operating expense in large part related to the spending on future growth initiatives, but largely offset the sales growth and gross profit improvement. As a result, we expect fiscal 2019 adjusted EBITDA to be approximately the same and/or slightly better from the prior year. While we see good momentum in our business, we also recognize pressures on our customers from the potential ongoing disruption of international trade and from volatility of certain international economies and currencies. Also, I am pleased to announce a planned 20% increase in our dividend effective with the December 20, 2018 payment. The consistent positive cash flow of the business and the strength of our balance sheet and the tax changes support this increase. I remain very positive about the opportunities ahead of us and I look forward to answering your questions later in the session. Now, back to Dick for more details on the numbers.

Thanks, Jack. Before we get into the numbers, we want to remind everyone that we present our results on a GAAP basis and also on an adjusted basis. Our adjusted results exclude acquisition related items, various items listed on the slide, unusual non-operational or non-recurring items, including stock based compensation. Last year we had pension settlement cost, a gain on insurance settlement and loss on extinguishment of debt; other items as separately reported in the P&L, including currency gains and losses; and finally, income tax effects related to any pre-tax adjustments plus any unusual or non-recurring income tax items. So with that, let me step into the numbers, looking at the highlights for the June quarter. Net sales were approximately $212 million that was $17 million or 9% increase over the prior year. We saw good sales growth across all segments of our business. We’ll look at the sales growth by segment in more detail on a couple of slides. GAAP net income increased substantially 44%, driven by both the operating results, as well as favorable tax items; and we have the one-off loss on extinguishment of debt last year; and GAAP diluted EPS of $0.55 increased at about the same percent due to the same reasons. Our adjusted EBITDA was $33 million for the quarter that was 12% growth, so we grew adjusted EBITDA faster than we grew sales and obviously, thereby, expanded our margins. That adjusted EBITDA growth came -- with the adjusted EBITDA growth then with the additional benefits of favorable interest expense and favorable income tax effective rate, we saw adjusted net income and adjusted diluted EPS grow by 20% and 18% respectively. So adjusted EPS, diluted EPS in the quarter was $0.46, a $0.07 increase over last year. Looking at selective line items for Q4, this gives a little more of a picture of the full P&L. Adjusted gross profit was up 7% and the 9% sales increase. We saw good favorable mix from animal health but declining or reduce margins in mineral nutrition brought the overall gross profit increase down. Adjusted SG&A was a modest increase of only 4% for the quarter, mostly on the timing of expenses. We continue to make spending or investments in development cost to position ourselves for the future growth. As I mentioned a minute ago, interest expense nicely favorable compared with the year earlier. This reflected mostly the benefits of a refinancing we did in June 2017. And the effective income tax rate was favorable compared to last year, largely due to the benefits of the tax reform. So that was -- all of those factors drove then the adjusted diluted EPS of $0.46 again an 18% increase year-over-year. Turning to the animal health segment. For the fourth quarter, about $138 million in sales overall $9 million or 7% growth just looking at the individual categories product categories. First looking at nutritional specialties; roughly flat with last year, as we saw good growth in the poultry sector of our products for the poultry sector. However, the weak industry conditions in dairy, primarily the U.S. drove -- offset that that poultry growth. I think the point we'll make here is that we continue to diversify this category, both geographic diversification moving these products into some of our international markets, as well as diversifying beyond dairy. The vaccines 7% growth in the quarter good volume growth in the international markets, lower domestic growth; I would note that for the full year, our vaccines grew 11%. So this a relatively small category so we'll see larger or smaller percentage increases one quarter versus another. And then MFAs and other, the biggest component sale of the animal health segment; grew almost $8 million or 9% and driven by international sales growth, the same thing we saw for most of the year; that international growth was driven by penetration into the cattle segment sector and a number of international markets where we operate. There was also a small benefit from a recent acquisition that was the Argentine acquisition we did in September of last year. Domestic sales of MFAs and other were roughly level with the prior year; as we've essentially seen we believe the stabilization of antibiotic sales in the United States; we continue to have other parts of our MFA portfolio perform strongly, largely in the anticoccidial area that there continues to be a good demand for. So dropping down to adjusted EBITDA for the animal health segment; adjusted EBITDA was almost $37 million, an 18% year-over-year increase; mostly driven by sales growth, which in turn drove the $5 million gross profit increase; and SG&A in the segment was slightly favorable on the timing of expenses. Turning to other segments. Looking first at mineral nutrition; good sales growth, 14% sales growth, largely driven by commodity pricing which again as we mentioned many times, this is a transparent pass-through type of business; but at the at the profit line, whether its gross profit or adjusted EBITDA, we saw decrease due to some unfavorable product mix; and we also saw some tighter margins in the quarter. Performance products was modest sales growth and a slight profit increase of about $400,000; and our corporate expenses, which are unallocated expenses that we don’t allocate to business segments, increased on development costs as well as higher professional fees. And on Slide 9, I’ll put up one slide here on the full year; and this is selected items for the full, the full 12 months; and net sales overall grew 7%, driven by the Animal Health segment, the biggest part of our business also grew 7%; and within that, as Jack mentioned, we saw 21% growth on the international part of the Animal Health segment, in part offset by a decline in domestic sales. Adjusted gross profit across the entire Company grew 8%, faster than sales and really driven by a favorable mix in Animal Health. For the full year, operating expenses or adjusted SG&A grew 8%, largely investment in these development costs that we’ve been talking about. Interest expense was favorable for the full year taxes were favorable for the full year on the benefit of tax reform. And so as a result of the full year, we reported $1.74 of adjusted diluted earnings per share that’s 15% increase year-over-year. Looking briefly at our capitalization, our leverage continues to improve 2.4 times at the end of June based on $314 million of total debt; we had $79 million of cash and short-term investments on the balance sheet; and we generated good solid cash flow, both in the quarter and for the full year; $5 million in the quarter and $50 million for the full year, which is before any financing types of activities and also setting aside the business acquisition and the investment in short-term; the use of cash to invest in short-term investments, which shows up in the cash flow statement. Quarterly dividend, we’ve declared the typical $0.10 dividend to be paid in late September; and then as Jack called out, we expect to increase our quarterly dividend by 20% or up to $0.12 a share effective with the December dividend payment; of course, it will be subject to approval by our Board of Directors prior to when we declare it; and it does reflect the positive cash flow and balance sheet strength. So turning now to guidance on Page 11, and so this is -- we’ve given you a much more detailed set of guidance in terms of P&L line items' and the attachments to the press release that these are the key lines. So at the revenue line, we expect our Animal Health segment sales to grow to up to $565 million that could be as much as 6% sales growth. And net sales, consolidated sales the entire Company, up to $875 million or up to 7% growth year-over-year. Adjusted EBITDA is expected to be approximately even with 2018, a range of $129 million to $131 million, at most a slight increase in our guidance. And that's due to the spending in operating expenses that I'll get into as Jack discussed earlier and I'll also talk about in another slide or two. So that will bring us to adjusted earnings per share on a diluted basis to between $1.72 and $1.77, again plus or minus, roughly equal with this year. Looking at Page 12, we talked about the first item within the Animal Health segment; we expect for the full year the nutritional specialty categories will continue to grow at double-digit rates; we expect the vaccine category to grow at a high single-digit rate; international sales will contribute most of the growth; the domestic business will be partially offset by the loss of a distribution arrangement that we previously had; that will happen in early part of our fiscal year; and then the MFA and other category, we expect to increase at low to mid-single-digits with continued international growth and stabilized domestic business. Mineral nutrition, we expect to grow at high single digits, primarily due to volume and new product introductions, new product growth; and performance products revenues expected to increase slightly. We do expect adjusted gross profit to increase faster than sales by up to 9% compared to -- and up to 7% sales growth, driven by the favorable mix; and that would drive a 50 to 60 basis point improvement in the gross profit ratio. Looking at Page 13, this is the expectation for operating expenses, or what we call selling, general and administrative; we expect these expenses to increase by up to 14%, primarily as we make strategic investments for future growth; Jack called these out, it's new developments, additional registrations, increased volumes, existing products and including expansion into new geographic markets; increasing and further strengthening our nutritional specialties portfolios with new technologies; developing additional vaccines production capacity at our Ireland facility to enable regional expansion; continued development in the companion animal space; we expect that it will take some time, 18 to 24 months, before we see the commercial benefits of investments and where we see these as having a better return than some of the business acquisition opportunities we think might be out there. Due to the investments, adjusted EBITDA is expected to be approximately even with the prior year; so good sales growth, even better gross profit growth; substantial spending on operating expenses; adjusted EBITDA the roughly flat year-over-year Finally, just some technical notes adjusted -- on our income tax effective rates; we expect a rate of 26% to 27% for this coming year; we will have the full benefit of tax reform in our fiscal 2019, because of our fiscal year, we had blended 28% rate in fiscal 2018; so we’ll see some additional benefited income taxes year-over-year. And bringing all that to the bottom line, we expect the adjusted diluted EPS in that $1.72 to $1.77 range, similar to what we reported for this year. On a cash flow basis, we expect to generate positive cash flows after satisfying all of our needs, whether it'd be for working capital, CapEx, dividends or scheduled debt repayments. We expect to spend substantially more on CapEx in fiscal 2019 or slightly more than double on what we spent this year; we’re going to increase capacity for some products; we’re going to in-source production of certain products and ongoing efficiency and cost reduction initiatives as well. So that’s the end of my prepared remarks. Operator, if you’d open the line for questions please. Thank you.

[Operator Instructions] Our first question comes from the line of Erin Wright of Credit Suisse. Your line is now open.

Just how would you characterize the ongoing dynamics in livestock demand, how do the trends defer between the domestic and international market? And I understand there's so many variables that plays here but how should we be thinking about NAFTA global trade dynamics. And have you thought about any of these or contemplated these in your fiscal '19 expectations, or how should we think about your exposure there? Thanks

I think we always come back to look at demand as being generated by where people live, and ability for them to have the money to buy the food. And while all these other factors you mentioned, whether it's NAFTA or we named NAFTA, or whether it's trades wars and currencies and everything else. The bottom line is that it's the job of whatever country and whatever leadership of the country is to get food at decent prices to their population. So we’re going to see shifts along the way and it's one of the reasons that’s driving us to expand some of our productions, because I think what we’re going to see is some countries in reaction to what they’ve seen this past year, bring more production in country. And because they don’t not going to want to risk not be able to get food or food prices going out of hand. So even though it might be more expensive to raise a pig in countrywide than in the United States, I think we’re going to see some of those shifts. So that’s our preparation that’s why we’re expanding to various markets, that’s why we’re looking to expand some of our production. We’re going to see a little bit longer supply lines, et cetera et cetera. But at the end of the day, how many people will be what drives our business and that trend continue.

And then how should we be thinking about the timing and magnitude of the incremental development expenses in the coming quarters from a modeling prospective. And when we think about the 18 to 24 months, how much could new products or new geographies, or other developments contribute? How should we be thinking about the size of the contribution is long-term?

I think the returns that will see earliest are the returns that will come from increasing our capacity in various markets or are entering various markets, because there we’re focusing on exciting products that we have registrations, so we have a lot of product information. So I think that we'll see towards the last quarter of the coming fiscal year, maybe even a bit earlier. The longer developments will be like in the companion animal space, there we’re dealing with what we view as unmet needs, we’re dealing with new molecules and we’re taking those molecules into the lag or into the -- just to get to see how -- what the effect will be, so they will be the longest. And so that we'll see I think towards the end of the 18 to 24 months and I think it will be -- the rest we'll put forth somewhere in between.

And to your modeling question, Erin, we're calling EBITDA to be roughly equal year-over-year. And I would say just the quarterly pattern will be similar, so we'll be roughly equal on a quarterly basis.

Thank you. And our next question comes from the line of Kevin Kedra G. Research. Your line is now open.

Just wanted to ask two quick ones, one on companions. Just how aggressively do you want to move into that market? And do you feel that you need to have a certain level of scale to readily compete there. Can you do it with one -- with one-off type products? And then secondly that you mentioned some of the -- the increased CapEx, including some in sourcing opportunities. How should we be thinking about what that could do longer term to your gross margins?

So I think our view is that we can enter the companion animal business without having to scale. I mean, we’re up against a lot of very well known and very successful competitors but the market is still large that some products, which for them might not be interesting, because it might be only be $20 million or $30 million opportunity for us starting from when we're starting could be very, very exciting. So I think we're looking again at innovative technologies, maybe innovative products. And with the changes also, especially in the U.S. and then growing around the world but how these products get marketed, we see more opportunity to get products to market. So I think, yes, there is a lot of competition but I think the product movement to market, I don’t think people have any problems since that way. To the second half of the question, the reason we’re bringing products in house is partly driven by the margins, but more driven by the security of having these products. I mean we’ve seen so many disruptions this last year, trade wars, environmental protection in China, et cetera, et cetera that we feel more comfortable on the long-term, and these are important products for us to have it under our own belt or in our own control.

Controlling our own destiny…

Yes, so I think it’s more that than what driven by margins.

Thank you. Our next question comes from the line of Derik De Bruin of Bank of America Merrill Lynch. Your line is now open.

This is Mike Ryskin on for Derik. A couple of quick questions on various components of the Animal Health business in 2019 and some of your outlook there, also with nutritional specialties. You highlighted in the quarter that you have some challenges in dairy. Obviously, we’ve all been following what’s being going on in that end market. And then you called out you expect to return to double-digit growth in nutritional specialties. Is this more about strength in poultry and some of the other end markets there, or you’re seeing early signs of stabilization in dairy markets. Could you just talk us through what’s contributing to that double-digit growth for the year?

So the growth is coming from and I think we mentioned earlier. I think we are moving more products and more and more species in more countries, so it’s across the board. Diary remains weak, both in the U.S. and around the world, and it’s going to be a while, maybe not fast enough clearly if you're in a dairy business, but maybe year or maybe enough a bit longer till thing settles out. And so we’re not looking for lot of growth in dairy but we are continuing to expect growth in our poultries line and cattle business around the world.

And on the MFAs and other segments, you talked about the different dynamics of international versus domestic and particularly about medicate and fee-additives versus some of the other components. What’s your expectation for the U.S. market longer-term, especially now that it's rebased at a lower level? Do you still think that this been recovered to low single-digit mid single-digit growth profile over the long run, not just this fiscal year?

I think about it when we make the presentation. One of the products was the category MFA, because everyone think that A stands for antibiotic, and it doesn’t. These are Medicated Feed Additives and this is just the way in the industry for a very, very long time gets products to the animals the most efficient way. And the A is not just an antibiotics they're anticoccidial, there is a whole range of products in there. And the U.S. is still in main areas the largest producer of those species and is the most efficient, and export is am extreme part of our business. So we will continue to see growth even in the U.S. of the MFA category. What we won't see in growth is antibiotics that we use to grow for most in the United States those products are pretty much off the market. And so there is no growth obviously when it's off the market. But everything else we will see growth, including therapeutic use. And one thing which is very high when we get talking about the financial side is that business is driven by animal disease. So if the farmer or the grower sees the animal as healthy, they're not going to put anything into the animal. But we've got lots of challenges there as viruses, bacteria that you can name. I mean there is 50 different challenges in raising animals and raising people -- people raising and the farmers do a great job. And you just don’t know necessarily, a lot it's driven by weather, a lot of different various other conditions. So overall we raise a lot of animals, you're going to have lots of challenges and some of the best solutions are handled by putting it through this MFA category. So the long answer to your question. But yes, we continue to see growth as long as the U.S. remains a major producer of animals.

And then one last one on the companion animal, you mentioned that that was one of the areas where you're focusing the investments over the next couple years. Are you -- when you talk about in-licensing of the companion animals, is it technologies and platforms, or is it more towards completed products that are ready to go-to-market? And then at the same time, could you give us an update on what you announced the last quarter on the canine Lyme disease vaccine development? I realized it's early, but curious if there's any updates.

So we're not going to be licensing technologies as such or ideas that in the 18 to 24 months would be years and years. But we are looking to license products. One we have called out I think last quarter or the quarter before was on potential for Lyme diseases. And these products -- that product is still in the early testing mode and we haven’t thrown it out, meaning it's hitting where it's supposed to be hitting. But that’s about all I can say to that.

Thank you [Operator Instructions]. Our next question comes from the line of David Risinger of Morgan Stanley. Your line is now open.

I have a couple questions. I guess, first it would be helpful to understand how you’re thinking about investment spending growth a little bit further out, so beyond 2019. Obviously, you're making these investments to grow the Company for the longer term. So I am assuming that the spending growth will continue to be above revenue growth in fiscal 2020. But I'd love to hear your comments on that and then I have a couple of other question.

David, we've known each other for a long-time, we would not be opposed to doing acquisitions. I mean we’ve done a lot of acquisitions in our past. I think right now what we don’t see for us interesting opportunities at what we would believe to be a right price. So we are looking at these other avenues but this is a short-term. I think this is to bring us up -- everything goes to step changes and I think we've done it and want to be more modest. And we’ve done a pretty good job with our portfolio in these last 10 years, 15 years, considering the time when you took us out public date to today, we’ve grown this business very, very nicely. But now to get up another level we have to spend money, we can't acquire it we need to spend money, it’s the most prudent thing to do for our shareholder for ourselves to get this business up. But I don’t think it's something we’re going to be planning to doing out for the 10, 15 years. This is -- we see bunch of opportunities, we can do this now, we do to over this fiscal year, make it carry somewhat over the next fiscal year. But I think then we'll stop mining the results of this -- and be at a high level, I mean that’s what we’re doing.

Okay, that’s fair…

You’re cutting in and out, David, we’re not hearing anything you’re saying.

Jack are you still on?

You’re we're here…

So then just pivoting to the next question on dairy. Could you just talk a little bit more about when you might see that pressure in U.S. dairy dissipating and some improvement in prospects?

The business we’re in is the optimistic praying side. All of our customers, everyday go to bed and every morning wake up praying that the dairy economics will get better. So we pray with them. So I don’t see anyone really knows. I mean dairy is a truly international business. I mean so much of dairy, I mean a lot of you invested I am sure of unlike think about dairy in terms of liquid milk, that’s the smallest part of the business. I mean a lot of it is having -- a lot of is cheese as long it could be shipped a lot, so it's a truly international business. And again some of the things we’ve been put up with the last six months, because some of the biggest export placing and I would say it's in dairy business is Mexico and China very, very important part. So if you asked me last week, people would be more depressed if we really have a renewed NAFTA and Mexico opens up and maybe opens up more products to United States, business can get better. So this is a changing business, it's ultimately driven by supply demand. The supply on the dairy side internationally is very strong against a broken up demand. And our dairy farm is both in the U.S. and around the world are producing more today than ever produced historically and with fewer cows. And that trend will continue, I mean much around in the U.S. but definitely continue around the world. So it can take a while and some of the smaller producers, I mean people with 500 dairy cows might not be able to make it unless they become a boutique. There we had a meeting here about a month ago in a room with a lot of people, some people raising 30,000 cows and some people raising 500 cows. The guy with 500 cows is doing well, because he was upstate in New York and he found some barista in some coffee shop in Brooklyn which had a sign on who was just pushing his milk and that guy was getting the higher price of milk than the guy who has 10,000 to 20,000 had. So this is a changing business so you can't just blankly say the big guy is going to make and little guy is not. But overall this trend we’re in on a long-time and a low price, and it will be available in a couple of years.

And then Dick I have a few financial questions. Could you just provide a little bit more color on the loss of distribution agreement in the U.S. in early in fiscal '19 if you could quantify that at all that would be helpful, and then if you could comment on the tax rate, the non-GAAP tax rate for fiscal '19?

The distribution arrangement, this is something that we've been selling someone else's product for several years, the supplier was bought by someone else. So we will -- they changed arrangement, we'll lose that business. It will cost us low single-digit million in sales come '19 compared to '18. And the tax rate, we’re expecting 26% to 27% as much as 140 basis point improvement over this year it's driven by the full year of the domestic rate dropping down to 21 from 28. But a substantial part of our income is generated in a number of international locations or jurisdictions. So as we put together the blended rate that's our best estimate at this point.

Thank you. And I am showing no further questions at this time. I would now like to turn the call over to Mr. Richard Johnson for closing remarks.

All right everyone. Well, we thank you for your time and attention. And we'll talk again on our next quarterly earnings call, and bye for now.

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program you may all disconnect. Everyone have a great day.