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

Good morning, everyone. Thanks for joining the third session of the day today. My name is Joe Modisett. I lead our health care banking effort here in the U.S. I'm very glad to have Phibro Animal Health here today. With us, we have Jack Bendheim, Chairman, President and CEO; Damian Finio, CFO; and Daniel Bendheim, EVP of Corporate Strategy. So very good to have the team here. I'm going to read a disclosure before we jump into a few opening comments and Q&A. So for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please feel free to reach out to your Morgan Stanley sales representative.

So with that, I think we're about 2 weeks after your year-end earnings call given your June year-end. It'd be great just to hear from you based on that. What are some of the highlights that you thought would be good, just to kind of introduce, that you saw in 2021? And Damian, maybe you start.

Yes, I'll start. I'm sure Jack or Donny will add some color. So thanks for the question, Joe. So as you said, we're a June 30 year-end. So keep in mind June 30 -- the year ending June 30, 2021, we were 100% in the COVID year. So keeping that in mind, our year-on-year sales were up 4% and our adjusted EBITDA was up 6%. Now we ended the quarter really strong, our fourth consecutive quarter of increasing sales. Fourth quarter sales were $220 million. Adjusted EBITDA was $27 million. We also reported some stronger GAAP results, so net income and earnings per share. A little bit of noise in our numbers around tax. So we had some onetime tax benefits in the fourth quarter that were unanticipated, partially related to lower GILTI taxes than expected and other release of some tax reserves and some uncertain tax positions outside the U.S. So we don't expect those to repeat. So when we get into 2022 guidance, I'll probably talk a little bit more about that. So really strong in terms of numbers. If I go outside the numbers, we're excited about our product Rejensa that we launched in 2021 -- or 2020, companion animal product. I'm sure Donny will talk a little bit more about that. And our companion animal pipeline progresses. And last but not least, we are now fully SOX-compliant. So I'm very proud of the finance, IT teams around the world and the business for supporting that. So that was a big accomplishment as well. So overall, a strong year, a really, really strong quarter.

Congrats on the results in a dynamic market to say the least. I think you also provided -- or you did also provide fiscal 2022 guidance. Maybe you could talk a little bit both on the top line and the bottom line. What are some of the key drivers for 2022 as we sit here?

Yes. So we projected and gave guidance for the full year sales growth of 1% to 4%, adjusted EBITDA growth of 2% to 6%. Now we also mentioned, though, that we're reinvesting incrementally about another $10 million in the business and some investments for the future. About half of that is in companion animals. If we were to put that $10 million back into the -- not back into the business but rather let it fall to the bottom line, our adjusted EBITDA growth would be close to about 10% or 11%, which I think is better than market. We mentioned that the key drivers are -- we have 3 segments: Animal Health, Mineral Nutrition and Performance Products. It's really driven -- all 3 are going to grow next year but it's driven by Animal Health. And within Animal Health, we have 3 product lines, MFAs and other, nutritional specialties and vaccines. It's really driven -- the growth is driven by nutritional specialties and vaccines. We expect MFAs and other to grow in line with the market. So overall, next year, we're projecting continued growth into 2022.

Now obviously, you have a very diversified business both across geographies and different animal species. It'd be great just to get your perspective on kind of what you're seeing in the regions and potentially by species as we've had a very dynamic market here from a COVID perspective. And then also, if you see any of these kind of near-term impacts having a major structural change. So it'd just be great to hear kind of how are you seeing the world these days and where you're seeing very different trends because we are seeing kind of a different return to normalcy in different parts of the world.

So -- that's a great question. So I think we can learn from what we've seen in the states where the recovery from COVID has been pretty strong, I would say, back to normal. And it's back to the normal we had before. So I don't think restaurants are full yet. But all the changes we saw in COVID in the United States that people are just shopping the supermarkets, not going to restaurants, it puts some pressure on the producers to change how they present their animals. It's sort of returned. And I think we can expect that in the rest of the world. The rest of the world, as Damian was saying, is still fighting COVID, not that we're not in the United States but they're more affected. And so the recovery will be slower. I mean I just saw somebody in the Financial Times over the weekend talking some of these markets that they're not going to expect to fully come back till '24. So we've invested over the last couple of years in putting feet on the ground in some of the developing countries in the world. Bangladesh, Indonesia, parts of the world, though, in the Far East. And those countries have not come back. The economy is still slower. So people's available cash to invest in expensive protein that they were used to is not there. So that's going to be a slower recovery. But eventually, the recovery will be like this was just a blip.

Okay. And you had mentioned that a lot of your growth is going to be coming from nutritional specialties and vaccines in the Animal Health area. Maybe start with the nutritional specialty side. What's driving that growth? And I know you did an acquisition back in 2019 of Osprey. Just be great to hear how that's going and how you see that growth playing out over time.

The major driver for nutritional specialties is the movement away from antibiotics. And that has been sort of started in Europe but took very dramatic moves in the States. And now it's accepted around the rest of the world. So people are still looking for -- I wouldn't say the magic bullet. People are trying to still look for that nutritional product that can perform as well. No one has come up with anything. We haven't come up with anything. But you can put nutritional into the feed that will help in terms of antibacterial, will help in terms of protecting the animal. And so that's been the driver for nutritional specialties, a driver for this growth. The Osprey acquisition. We had come across Osprey, I think we said this a few times, as a supplier to us, one of the key ingredients for one of our products called Provia Prime. And we've been quite successful with that product. And we are developing an additional amount of different kinds of microbials to continue to supply the growing demand. And so we've been very satisfied with the Osprey acquisition. And we'll keep rolling our products over the foreseeable future.

And within this -- within nutritional specialties, if you think about the different species, I think you were initially focused on dairy. And are you kind of expanding past that? Or how should we think about it from that perspective?

Right. So dairy has been -- was how we got into the business in many ways on nutritional specialties and with our major products, Animate, OmniGen. But now I think we're concentrating a lot on the poultry market, also looking at the swine market. And I think we've been quite successful. So I think it will be across all species. And we're looking at some potential products for aqua as well.

Okay. Maybe turning to vaccines for a minute. As you think about your growth projections there, just give us an update of how you see vaccines playing out over time, another big growth driver. And also, if you could touch on kind of the -- I know you're developing a vaccine for African swine fever, which obviously has had a big impact and continues to have an impact in China. If you could just touch on those 2 things, that would be great.

So we started in the vaccine business by acquiring a division from Teva or Teva, and concentration is on poultry vaccines. We continued to expand that space initially. We continue to expand that facility. We are building out a sort of assisted facility to those vaccines in Ireland to market the products in countries where we have some marketing difficulties on coming out of Israel. And we expect to be licensed -- fully licensed at the end of this fiscal year in that facility. And the growth is in those markets. So a little held up by COVID because it goes into the same markets. As you can imagine, poultry is very strong in parties. And then to further our entry into the vaccine business, we acquired a company in the United States a few years ago. There was a base on swine business in the autogenous. Autogenous vaccines is not one vaccine fits all but you go into the farms. You pick up -- take out the blood. You pick up the viruses that are affecting that farm and neighborhood -- neighboring farms. And you create sort of a custom-built vaccine. That business is growing nicely as some of the viruses have become sort of immune to the existing vaccines. That business is growing and that's becoming a solid part of the vaccine strategy. African swine fever, we've taken a totally different approach. We all know how it devastated the swine market in China in '19 -- '18, '19. Our approach there is to not work with viruses but work clinical [indiscernible] which would make this product to be safe because you'd not be spreading the virus around. And it's been slowed down with all the problems China has faced with COVID and inability to send people in to run some of the tests that we need to run. We're proceeding slowly. So we're behind the schedule we thought we'd be. But my guess would be sometime at the end of this -- again, the fiscal year, we will have seen if the products that we have, we've seen some initial successes, can really be part of the vaccines to fight after the swine fever.

Okay. And maybe just while on that, how do you see China? As you think about China now, what do you see happening in that market just given that they have had the impact of African swine fever here?

I think they've done a very good job in controlling it. I mean they made huge investments in new farms with higher biosecurity than they ever had before. So they've made progress. They've had some outbreaks of the disease. So they are continuing to be major importers of swine from around the world, especially in the United States. They're living up to their commitments and even going beyond that. And so China, like in everything, with a market of 1.4 billion people and huge consumers of protein, will continue to remain a very, very strong importer of all kinds of protein and important to the United States.

Maybe switching gears a little bit. Any update on the FDA situation with carbadox?

So that's always like a long story as you know. You've been around that with us a few times. So far, we've responded. The FDA basically came to us and said, "All right, we're not going to look at the science of this whole thing, but we want it off the market. And we're going to make some moves that will say that the way you've tested it for the last 40 years, the way we've approved your testing for finding carbadox in the pig, we're going to say we don't like it." We've gone back and say, "That's not how the game is played. That's not according to the regulations." And we put our response in over 6 months ago. We haven't heard anything back from them. So we continue marketing the product in the United States. It's an extremely important product. It's used by over 70% of the hog producers in the United States. It saves the U.S. producers $300 million, $400 million a year in costs. And if they took it out, that's what the craziest thing is. If we removed carbadox from the market, the substitutes are antibiotics and important -- medically important antibiotics. So all the work we've done with the FDA for the last 7, 8 years about removing antibiotics in the United States, with this one move that makes no sense, they'd be putting tons and tons of antibiotics back in. So it doesn't make sense to us. It doesn't make sense to the growers, the pig growers in the United States. It doesn't make sense to many senators we speak to about this. So I'm not sure where this goes. But logically, it'll go nowhere.

Then maybe shifting from livestock to kind of a new area for you. You're very excited about -- you mentioned your companion animal product Rejensa earlier. Can you just give us an update? I think you launched it last year or this -- yes, last year. If you could just give us a little update about how that's going; kind of what you've learned as you've kind of been in this new market for you, obviously a very attractive tailwinds in the companion animal market broadly; and kind of how you see your companion animal business developing over time.

Donny?

I'll take that. So as you mentioned, Rejensa is our product. We -- it's an over-the-counter product. We actually sell it exclusively through the vet channel with an exclusive distributor. We haven't named that distributor but it's one of the larger distributors out there. It's going really well. It's been a difficult time, as you mentioned. It's been out there for the last year or a little bit more than a year. Obviously, launching more or less with COVID, it's -- COVID has been great for the pet market in general but it's been also great for pet meds. But if you're the incumbent, there's a lot of value there because it's hard to get to the vet. It's hard to pitch a new product. Despite that, this product is growing. I think we've mentioned in recent calls that 6 months -- over 6 months, it's been doubling. That's a rate that won't stay forever, obviously. But I think this year, we anticipate it doubling year-over-year again. And we're a little circumspect in talking -- giving more details because it's our only real product out there. We don't want to give specifics. It's a very competitive market. But it's a product we're proud of. And we're taking the opportunity to -- while we're working with a distributor, we are starting to build out our own sales force. By the end of this year, we'll have 10 people calling on -- directly on clinics with the distributors just detailing the product. And we see this as laying the foundation for our pipeline going forward. So it's a great entry. And behind it, we are building a pipeline. And frankly, one of the frustrations I think we have as a company is maybe not getting enough credit for that pipeline. But we're building a pipeline. Our lead product is an atopic dermatitis product. It's years away but it's a huge market. On paper, the product that we're developing is as good as anything else that's out there, if not better. But it's obviously -- there's a number of hurdles to get through. But if we do reach the finish line on that, that will be a game changer for Phibro and perhaps even for the industry. It's that big of a product. We also have a number of oral care products that we're working on, which are probably something that we can get to market sooner than our atopic dermatitis product, one for dogs and one for cats. And we're excited about the progress we've made on that. And then finally, we -- actually, our first product that we licensed is a product -- a unique delivery system for Lyme that has taken longer to get out of the lab into the clinic. We're still hopeful that, that will eventually get there. But that, more or less, rounds out our current pipeline but we are getting incoming all the time. And I think what we've managed to do is we've managed to be somewhat selective on those products that we see and I think pretty smart on the way that we've set up these in-licensing deals to develop these products that we have in our pipeline here.

And can you just remind people where within your 3 divisions the companion animal sits at the moment just as that grows? What part of the business that will be in?

Right now, it's in -- it's reported as part of MFA and other. It's part of the other in MFA and other. We talk about wanting to develop a fourth leg to our stool. MFAs, traditional specialties, vaccines and companion animals. So our goal is definitely for this to be a subsegment, the product area of at least $100 million in the midterm, I'd say.

Okay. So just maybe as we kind of start to wrap this up a little bit, you've talked about the growth in nutritional specialties. You talked about the growth in vaccines. I think you actually started, Damian, with a little bit about the investments you're making. Can you just talk a little bit more in detail about where you're targeting those investments and which ones are going to see more near-term returns and which terms maybe like companion animal are a little bit behind that? And just thinking about how the cadence of those investments and the returns on those investments over time would be great.

Yes. So some of those investments roll up into SG&A in our public filings, right? So our SG&A year-over-year is going up about $20 million. Half of that is the investments in the future. So -- and half of that is about $5 million-ish, is around the companion animal pipeline that Donny just talked about. The other half, I would say, split evenly across the facility in Sligo, Ireland, which is a vaccine facility we mentioned earlier. Not all those costs to stay in that facility up are capitalized. So some run through the P&L. Some other costs are allocated towards African swine fever in development with our partner. And then there's ongoing product registrations, which as we continue to execute our strategy to expand geographically and move into new countries, the ongoing product registration costs continue to escalate to keep those products on the market. So that's that half. The other $10 million is primarily driven by 2 factors. So one is what I just mentioned, is when you move into new markets, there's an infrastructure you have to build and head count you have to bring on board to set it up. So there's a cost associated with that. And the other is labor. So our labor force, we've continued to add people, grow the labor force year-over-year. And as you know, it's a competitive labor market in the U.S. and really everywhere. So a lot of movement in the job market. So that's the other half. But overall, that's where the $20 million is gone. Now if I look at the investments in the future, you talked about return time on horizon. So Sligo facility is probably in the next -- you guys correct me if I'm wrong, probably 1 to 2 years. The ongoing product registration is an ongoing thing. The companion animal is probably behind that. It's more medium term, so not short term.

Okay. As you think about even with these investments, how your margin profile is going to play out over time. I think in your guidance, you talked -- your EBITDA growth even with these investments was exceeding your top line. Can you talk about the drivers of that margin improvement over time?

Yes. There's a lot of puts and takes in the margin. It's primarily driven by 2 things. Where possible and where there's opportunities to take price, we'll do that, which as you know, drops right to the bottom line. The other is, as our top line continues to grow and volumes continue to grow, we're getting better per unit cost at our facilities. I think Jack mentioned earlier, we manufacture 70% of our products. The more product we can put through those facilities, the better per unit cost and the margin expansion. So it's primarily price and more volume through our existing facilities.

Okay. Maybe as we're wrapping up, I'll just open it up to you. Is there any other topics we haven't discussed that you've been -- that you think are kind of underappreciated by the investment community that you just wanted to highlight a bit more that we haven't touched on?

Well, I think Donny mentioned these investments in these interesting pipeline products. But let's spend a little time talking about -- maybe Donny can, about the unique approach we've taken to get into the companion animal business.

So as I touched upon a little bit earlier, I think there's been various methods of getting in. Obviously, you can buy a big business. There's been a number of biotech start-ups within our space that have spent an awful lot of money developing their own pipeline. I think we've looked at this and said that we're trying to find a middle way. We are the largest multinational out there, we believe, that does not really have a pet business, which allows us to take advantage of certain in-house capabilities that we have on the regulatory side, the product development side and spread it out. But what we've done is that we've got incomings. About half the work that we're doing, we have set up product milestones, where the R&D is actually being done by the companies that had come to us with the product and its milestone-based payments. And really, none of that risk is on us. It's all on the company that we're partnering with. There might be a little bit of upfront payment. But for the most part, it matches with achievements. And then I guess at the other half -- and I took chiefly the atopic dermatitis product. We have taken -- we've licensed the product. We've taken the R&D risk on ourselves. And the outlay for the R&D belongs to Phibro. We are ourselves working with leading third parties, CROs, CDMOs, every contract -- every C out there. And it's a big job. And again, the addressable market, the Zoetis products alone, atopic dermatitis, have reached $1 billion of annual sales. The market is growing really fast, pretty much very uncrowded at this point. It's going to get a little more crowded by the time we get out there. But still, compared to the parasiticide market, which may be twice as big or 3x as big but has 15x more competition, we see this as a huge opportunity. And that's why we decided to take a little bit more risk on our own P&L and balance sheet because it will allow us to get a bigger share of that opportunity.

So maybe in conclusion, in kind of the near term, you've got a diversified business. You've got growth drivers in nutritional specialties and vaccines that are driving that growth. You've got kind of a toehold in the companion animal market in Rejensa. Then you've got these bigger opportunities coming behind it as you head into that market. And obviously, Animal Health now, just given what we've seen, is obviously dynamic and getting a lot of investor attention. So appreciate you joining us here today. And I think with that, we'll conclude today's session. So thanks, everyone, for joining.

Thank you, Joe.

Thanks.

Thank you.