Phibro Animal Health Corporation (PAHC) Earnings Call Transcript & Summary

[Audio Gap] CFO of Phibro Animal Health. We'll do the same format that we did earlier, it will be a fireside chat for about half an hour, and then open up to Q&A. If you've got any questions, raise your hand. So thank you for joining us, Richard.

You're welcome.

Always appreciate you coming in.

I guess maybe to start, same thing, you reported earnings a few weeks back. Give us an update on sort of calendar year 2019? The last couple of months, sort of what were the major moving pieces in the story? What surprised you to the upside? What surprised you to the downside as the year went ahead?

So our December quarter was a decent quarter. I think we were encouraged by the results, both in -- certainly, in our Animal health business, which is the really what we're going to be talking about today, it's $550 million out of the total company. And we were encouraged by our vaccine progress and uptake demand for those products in a number of international markets and additional market penetration. We've launched some new products recently, and we're seeing good uptake on those products. We're also encouraged by the recovery, if you will, and growth in our nutritional specialty category that we're seeing the dairy industry, where we're mostly exposed in the United States. Dairy products did well in the quarter. We had a fairly recent launch of a gut health product. It's a living organism, direct-fed microbial, for the poultry industry that's seeing some good initial acceptance. And then we were pleasantly surprised to see the MFA business be relatively strong. And part of that was the uptake of some additional product going to our customers in China, which we had not anticipated earlier in the year. So that was -- and some of that was in anticipation of some regulatory changes that went into effect January 1, but really a positive for the quarter. So I think looking forward for the second half of the year, we reaffirmed our guidance, certainly, on the profitability side. And we'll expect to see a number of these same trends continue, and I think, strengthen in the second half of our fiscal year. Probably on the downside, our minerals business has been in a competitive market, more so than, historically, we've seen. It's been in the situation now for 4, 5, 6 quarters. And so we're not seeing the profitability growth there that we might have hoped for, but we're getting some offsets in other places. So we still like that business. It's a good long-term business, touches the same customers as our Animal Health Business touches and that's just something we have to work through and find some answers to.

Great. I appreciate that overview. So maybe just to start on some of the topics you touched on. I think the biggest theme, when we've talked about Phibro in the last couple of quarters, has been the dairy markets and some of the challenges you've seen there. Some of the segments that were your biggest drivers of growth in the past are now seeing a lot of challenges with that market. So could you give us an update on what you're seeing in terms of overall dairy and maybe some of the moving pieces between the consolidation, the larger customers versus smaller customers? And how you're positioned?

We're encouraged that the dairy industries is seeing better prices. And when your customer is seeing better prices for his products, he is more willing to open his wallet and add some other products to his mix. So that's been a positive for us. So I think the dairy industry is on an upswing. Part of that, Mike mentioned, is consolidation. Consolidation in the dairy industry has been going on, of course, for decades. But it's really accelerated as we're in one of these periods of acceleration where the smaller producer is simply not economical anymore. And production is going to larger and larger farms. I saw a chart the other day, which kind of surprised me that there's about -- there's a little over 9 million dairy cows in the United States, over half of those cows are on -- are with producers who milk at least 1,000 cows. And then there's producers who are milking 2,000, 5,000, 10,000 cows. So it's -- that just is an illustration of the amount of -- where consolidation is heading. And so the bucolic image of the red barn and the farmer and the green fields that's -- it's a nice image, but that's not the dairy industry in the United States anymore.

And what's your product portfolio? Sort of what's your customer relationship, both with the large consolidators and the smaller farms? Are you better positioned from one or the other?

We were in -- and we've talked about this. One of our flagship products is a -- it's a nutritional specialty product. What does that mean? That means it's not an FDA-regulated drug. It's a sort of lightly regulated, some combination of natural ingredients. That -- but it helps the animal's overall health. In this case, we've been able to show, with markers that it really helps the animal's immune system. And just to digress for a moment, when you're -- when you have a dairy cow in production, her job is just to give as much milk as she can. And so your -- and your -- you're pushing that cow by the feed you give, the high energy feed to produce. So that produces a lot of stress on the animal's body. And so this product is -- we've grown this product over 10 years to -- from nothing to a very substantial product for us. The last few years, it's taken a downturn because we were more focused on kind of the mid-sized producer who's in, some measure, gone away or he's had such financial difficulty that he doesn't -- that he's not able to really afford the product anymore. And so we've refocused on the larger producer, refocused our sales force. We've reformulated the product, added more value, which -- and repositioned the product to show the large producer of a much more direct relationship between use our product, get more milk. It's -- there's a lot of technical words in between. But that's the fundamental message. We just relaunched the product within the last few weeks, and we think this is going to have a nice benefit to us and bring us some additional sales as we move forward in the coming quarters. A good-sized portion of our overall nutritional specialty sales is dairy-focused. And most of that dairy focus today is in the United States. Although, we are growing in a number of international markets where there's, obviously, the other parts with other major dairy producing markets around the world.

And so the product you're talking about is Omnicell (sic) [ OmniGen ]?

That's right.

Omnicell and Omnicell Pro (sic) [ OmniGen Pro ]?

Yes.

So are you expecting -- you mentioned that you've had some challenging conditions over the last couple of years, are you expecting Omnicell Pro to return to growth in the second half and go off that?

Right. We've -- so the start of -- the product had been declining for -- declining slightly, but declining for 1.5 years, 2 years. And then given the turnaround in the industry, we saw stability in the product recently. And now we're definitely expecting growth as this new and improved and better value product is offered to our customers.

Okay. And then sticking on nutritional specialties, just while we're in that segment. The other major event there is you have the Osprey acquisition a few months ago. Could you give us an update on sort of what's in that business? Why you're interested in making the transaction and how that's done since then?

The Osprey business is a microbials business. So it's living organisms, Bacillus and Pseudomonas, and other words that I don't really have a lot deeper understanding of than that. And it's in the Animal Health space. It's also in crop protection or plant protection, where you'll coat -- you'll use these organisms to coat seeds to protect them as they're growing and planted, then -- which is an agricultural -- related to our main line of business. We got to know this company as we were developing the direct-fed microbial, I mentioned it earlier, gut health for poultry. And as we got to know them, and they make the primary ingredients in the poultry product, we saw a good fit with Phibro and talked to them about combining our businesses, and we ended up acquiring the company, I think it was in August and moving forward. We continue to be very encouraged about the prospects. We just -- I just sat in an internal review the other day of all of the prospects that are out there on the near-term horizon for the business. We've seen some short term, I'd say, sales that are less than our initial expectations just because of some customer order patterns. And -- but that's -- we view it as short term, and we think the business is still going to be a real nice contributor as we move forward.

Great. I was actually -- I was going to ask you right on that point. So I'm glad you addressed that. I think the contribution from Osprey in fiscal 2Q was a little bit lighter than expected, but it sounds like that's just timing you're mentioning that. And then your initial expectation was $20 million to $22 million for fiscal year?

Yes. Yes.

Okay. Great. And then, I guess, turning to the other growth segment, vaccines, you've had a nice little rebound after a couple of challenging quarters. Could you give us an update of what you're seeing in that product class, whether it's by species or geography?

The -- most of the growth is in our poultry vaccine line. Most of the growth is in emerging markets, whether that's Southeast Asia, Eastern Europe, some of the Middle Eastern countries, other specific markets around the world. We have introduced some, I'll say, new products. And when I say a new product, we're not -- it's a vaccine against an existing well-known disease, and it's not a -- I don't think there's any unknown poultry diseases. But we've come out with an improved version, which works better than other versions. So we've been -- we've seen good additional penetration and very nice demand. So I don't remember the exact numbers. I think we grew around 10% in the second quarter. And we're expecting continued and really solid growth moving forward.

Sticking on the sort of on the vaccines and on the viral front, and moving on to the end markets. I think the other big theme we've had in this space over the last year, 1.5 years, has been the African swine fever outbreak in China. It's been a disease that's been around for many, many decades, but popped up in China in, I think, August 2018, and you saw the impact. It gets worse as we went through the year. As you said, your initial outlook for China for fiscal year '20 was you expect essentially 0 revenues. So in that sense, you surprised the upside in fiscal 2Q. Could you give us an update on how the disease is unfolding based on what you've seen? And sort of what the longer-term prospects are? When we met in Vegas in May, you talked about a potential for a rebound from other markets producing more in Latin America, is it still too early to see some of that?

There's -- right. So there's 2 -- so this disease left a big supply shortage in China. China, prior to the disease, produced and consumed something around 800 million pigs per year. And depending on the numbers you believe, it's maybe 400 million pigs now. It's maybe 300 million. It's something very significantly less. And as the disease has really decimated the production industry. So in the shorter run, absolutely, the -- there is a hole in the protein supply, which is going to be filled by protein producers around the world. And the big producers are the United States, Europe, to a certain extent, and certainly, Brazil. And Brazil is probably the most agile to have begun to supply some of that need. And it's coming about. There isn't enough swine in the rest of the world really to meet the demand. So a lot of the demand is going to be in poultry. And then there'll be some swine demand. The United States gets a little more complicated and has been complicated with the trade wars and the tariffs, which given recent developments that seems to be loosening. Producers in China are attempting to restore production and bring production back. It's a kind of a stop-and-start activity. If you put pigs back on and the disease reappears, because the virus can remain dormant in the environment for some time. And if it wipes you out again, then that's a problem. The government is very actively supporting the repopulation and then trying to do what they can to support additional local domestic production. And that's where it stands. It's -- I think it's still -- this is not going to be an easy and quick recovery. It's going to -- until if -- until or if somebody is able to come up with a vaccine that can control or eradicate the disease, it's going to be very difficult.

So are you working on a vaccine? And how is that going?

[indiscernible] and then, toss that swap. Yes. We're -- we, like I'm sure everyone else in the industry, are working on a vaccine. We think we've got some really smart partners and people we're working with and some novel ideas. And we are spending money and one of the -- one of the themes in our discussions have been that as an aside, that we're investing for the future on a number of initiatives. One of those is investing research dollars into this attempted development of a vaccine against African swine fever. So we like what we're seeing so far. We're encouraged by early results. Can't tell you if it's going to be successful or not, probably by the time we're talking about our year-end results, we'll probably be able to have a much better view of where we're at and what next steps might be.

Okay. On that front, I mean, we've seen, as you mentioned, we've seen some positive news elsewhere. I know the USDA Agricultural Research Service, ARS, had a couple of publications end of 2019, and I'd say, about some very early work with the vaccine, but that was seen very positively as people were commenting that out. It's right around the corner, and then they kind of came back and said, well, realistically, commercialization is 3 to 4 years away by the time you move it from macrophages to the other sell-ons, et cetera. Could you give us a sense of what the vaccine R&D process is? Just because there's some place where people are debating. Is this a 1-year, a 3-year, a 5-year process? Sort of how quickly, given that it's an emergency, given that there should be a lot of ability to sort of expedite it? What's the time line for something like this?

All right. The standard time line and normal circumstances would be at the longer end. I don't think there's any question. Given the severity of the problem, if somebody came to the Chinese authorities and could show efficacy and a -- I'll say, a good safety profile, then the speculation is that the Chinese authorities would likely fast track some -- the testing in the market. And it -- but it's all -- we'll have to see when somebody gets there, what really happens. But those are the -- that's the thinking around it.