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

Great. So good morning, everyone. This is Dave Risinger from Morgan Stanley. I cover both major and specialty pharmaceuticals, and it's my pleasure to host Phibro for our discussion. I do need to start with a disclaimer, and that is, please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. It's not for members of the press. If you're a member of the press, please disconnect and reach out separately. For important disclosures, please see the website, www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. So I'm pleased to have Donny Bendheim, who is a company Director and Executive Vice President of Corporate Strategy, he's held a variety of operational and leadership roles at the company since 1997. And also Dick Johnson, who is the CFO, and he's been with Phibro since 2002.

So I thought, Donny, it'd be great to start with you. If you could just kick it off at a high level by discussing your vision for Phibro, including expanding into higher growth animal markets?

Thanks, David. Appreciate you guys hosting us. So I think on your stage, in person, over the last few years, we've discussed, our vision truly is to be agnostic as far as protein that people eat. And what that means is we'd like to be selling into all species in all markets and whether someone wants a conventional meat or organic or aqua or et cetera, we'd like to be there. So yes, we're not there yet. We are growing in our reach around the world. We continue to grow into more countries in Southeast Asia and strengthen organizations in Europe as well, which is, well, a huge market is one that we have had, historically, a small presence. And so as far as our ability to grow, we are looking at growing, obviously in aquaculture. And we've talked about that for a few years. And we're also looking to grow in the pet space. We are probably the largest multinational animal health company that does not have a real presence in pets. We are taking baby steps towards entering the space. We've launched our first product into that space. And we have other products in our pipeline. And we do see a tremendous amount of opportunity as that industry consolidates, most recently with Elanco buying Bayer. There are a fewer and fewer places where people with innovative ideas, and there are a lot of innovative ideas out there. There are fewer and fewer places for those folks to go. And we see ourselves as planting our flags that we're entering in this business for real, and we'll see over the next -- went to necessarily over the short-term of the next year or 2, but over the medium to long term, we see real opportunity there.

Excellent. And Dick, you had guided to roughly flat sales sequentially in the September quarter of $190 million. Could you just provide an update on that and discuss the pushes and pulls?

Yes. I think we're seeing similar dynamics in our September quarter that we saw in our June quarter, our customers and the industry is still dealing with COVID. We are seeing improvement. Our customers are seeing improvement. I think the darkest, the most difficult days are behind us. It's not good. Let's hope for that. And we're seeing recovery. Recovery is slow but steady. Some of the recovery is -- and let's just take a couple of examples. The U.S. swine is still kind of recovering from the shutdown of the slaughterhouses. And it's -- it will -- will that recovery will certainly continue through the rest of the calendar year. U.S. dairy prices, which were trending very nicely in favor of the producer pre-COVID. He really -- the producer really saw dramatic drop in prices during COVID. Prices now are back to at or above breakeven levels. So a lot more optimism for the dairy producer out there. And it continues to improve, but it's not back to the better pricing levels maybe roughly a year ago. We are starting to regain face-to-face customer contact. In many cases, it has to be still somewhat innovative. Because you can't have just the traditional person-to-person meetings. So we're -- as we said in our call recently, we're optimistic that the industry is recovering. I think we're seeing that in the quarter. And so that optimism and that expectation for ongoing recovery over the course of our fiscal year is still in place, and we haven't changed that.

Great. That's very helpful. So within your Animal Health segment, I wanted to start with the growth, the fastest growth areas first. So nutritional specialties and vaccines, I believe, are about 40% of Animal Health sales and have been key growth drivers for Phibro. Could you talk about future prospects for those areas?

Yes. Donny, you want to take that one?

Sure. So I think we've guided in general for a belief that over the -- maybe not on a quarter-by-quarter basis, but overall, we expect double-digit growth in those areas, and we still feel that way. Nutritional specialties. So these are the equivalent of, I'd say, on the human side of products you'd get at GNC or Vitamin shop. These are high value, relatively high-margin performance-based products, less heavily regulated than Medicated Feed Additives would be and typically help the immune system or something along those lines. And we have a very strong position. I'd say we have a leading position in dairy and in poultry, for sure, in the U.S. and rolling those out internationally. In both dairy and poultry in each of those categories, we have 2 products that are doing really well. And in general, we're very bullish about our ability to find and create new products in those categories for, truthfully, every species out there. Over the -- if you look at our acquisitions over the years, a number of them are in the nutritional specialties space, and we are getting more and more basic in our ability to really create those products. Most recently, a year ago, we bought Osprey Biotechnics, which is a direct-fed microbial producer or we got to them because they produce microbials that could be used in DFM's. We've launched over the last year, a product called Provia Prime, which is how we met Osprey. We developed it, but they created our strain and already, we're seeing a lot of success in that. And we see the technologies that we acquired at Osprey as being the key drivers as we continue to grow out our nutritional space in the years to come. On the vaccine side, also an area where we see a lot of growth. Truthfully, our numbers have been weighed down on the bottom line, the dollars, the OpEx that we're spending in creating a new vaccine facility in Sligo, Ireland. This will be in addition to our commercial vaccine facility in Israel that is doing extremely well. And we'll open up -- we'll further open up the European market for us as well as certain Muslim countries that for geopolitical reasons will not buy from Israel though obviously, that's changing as we speak. So we see -- and we've seen tremendous growth from the Israeli product line and we think that will be accelerated once Sligo opens up, which initial sales was within the next 12 to 18 months, but full-scale with registration is probably 2 years away. So that will also be a driver. And we have also a U.S.-based autogenous vaccine business, which is focused on swine and to a lesser extent cattle and poultry and that also has some very unique technologies that we're able to build on is growing nicely.

That's very helpful. And with respect to nutritional specialties, so I'm assuming that organic producers can utilize those products and still have an organic label? Or is that not always the case? Could you help us understand that?

That's not always the case. Nutritional specialty product is not necessarily mean it's an all-natural product. We do have products that have OMRI certification that we do sell into the organic space. But you could be using a GMO based product and they'll be in nutritional, for instance. So there are different categories within nutritional, though it's something -- again, the regulatory barriers are a little bit lighter. But there are still -- depending on the country, still regulatory areas, that they're typically sourced largely from plants or things of that nature or bacteria or direct-fed microbials today. But there's no one specific way to define it.

Okay. Got it. And so...

And just this -- sorry, David, to jump in. And maybe Donny said this and I missed it. But the majority of our -- really, the demand for this category of product is driven in fairly large measure because some of the traditional products, i.e., antibiotics are no longer being used for, in many cases, consumer preferences. And -- but the producer still needs to keep his animal healthy, still needs to deal with the same health challenges he's always dealt with. So he's looking for alternative products, substitute products and that's really what's driven a lot of the success and the growth in this product category for us.

I got it. Okay. And then just so that I understand nutritional specialties a little bit better. Are your larger competitors introducing offerings in this area? Or are they mainly focused on introducing new patented medicines?

Yes, I mean, I think -- sorry, yes. So our classical larger Animal Health competitors, David, maybe you cover companies like Elanco, Zoetis, they do have some presence in nutritional specialties. And certainly, they've stated that they look to have a stronger presence. Some of them have announced alliances with other companies. They're really not the people that we see right now so much in our space. It is a competitive space. The margin profile, I think, of a nutritional specialty product is probably slightly lower than the thresholds that they have publicly stated that they're looking to make for products. So I'm not necessarily assuming that they'll have a larger presence in the space. But there are certainly, companies like Novozymes, a company called Diamond V, which is bought by Cargill. So Cargill, Church & Dwight, with their specialty division. There's many large significant players in the nutritional specialty space that we compete with.

And what drives your leadership position in a couple of the animal categories?

I think it's a matter of products and people. And we have excellent products and excellent people with really strong relations. I think when we come out with the product, the industries know that these products deserve to be -- there's -- a look should be taken on them and not everyone has that. So there's a lot of people had come up with nutritional specialty products. And oftentimes getting the trial is the challenge. And I think the overall challenge in nutritional specialties products are repeatability. In other words, oftentimes you're going to have a product that works well once or twice, but the ability to in -- complex after complex, time after time to deliver the results is not something you see in a lot of products. And the products that we bring to market, the industry knows we'll show that. And I think we've earned a strong reputation on the back through that.

Great. That's very helpful color. Okay. And then pivoting to MFAs, could you just remind us what percentage of your Animal Health sales are MFAs? And then talk about some of the potential regulatory changes that we should be watching?

Right. So about -- well, within the Animal Health category, roughly 60% of our sales are MFAs. And just for the audience, MFAs are a broad category of really regulated drugs, regulated pharmaceuticals. So within that category are antibiotics, which have seen a lot of pressure on sales in the last few years. But there are also a large number of other products that are -- have other means of action and are not in that category. So the regulatory front is fundamentally around antibiotics. We saw it in the United States. The process really finished up about 3 or 4 years ago, where the historical labels for many antibiotics were -- there was sort of a general overall claim, which was called growth promotion or something similar. And the regulatory authorities around the world, it's happened in Europe, it's happened in the United States, it's happened in most countries, are in the process of either have completely done it or in the process of updating and requiring the producer to update the label for therapeutic use only. And typically, that also involves the active participation of a veterinarian. So -- and you got to have a script. And then that's happened. What's happened in some markets is consumer pressure is now outpaced the regulatory and so in the United States, where our antibiotic business is down to -- the sales are down to next to nothing. It's due to consumer preferences not due to regulatory. In other countries, regulatory can be more of an issue. In China, we got caught in a very quick transition of the regulations. We have our applications in and our data in to update our labels for therapeutic purposes. But in the meantime, we're precluded from selling those antibiotics into the market in China. In Brazil, for example, there's a transition in place. We have submitted our data, and we've submitted the applications for new therapeutic claims. We continue to sell under our existing labels at the moment, and that transition has some time to run, and we think we're in fine shape in Brazil. In China, coming back to that, we think we'll be back in the market once we get our labels updated. The timing really depends on the regulatory authorities and we're thinking perhaps a year, and we'll be back in that market with those products. And not to say that we do sell other products into China, but focusing specifically on MFAs and antibiotics, that's been a drag on sales the last 1 year, 1.5 years.