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

Okay. Great. Thank you. Thank you for joining us today at the Credit Suisse Healthcare Conference. I'm Jonathan Yong, and I will be monitoring today's fireside chat. Today, we are pleased to have Phibro Animal Health Corp., a global diversified animal health and mineral nutrition company. From the company today, we have Damian Finio, Chief Financial Officer, who joined the company a year ago; and Donny Bendheim, EVP of Corporate Strategy, who has been with the company since 1997. This will be a fireside chat, and you can e-mail me questions at [email protected], which should also be on your screen as well. With that, welcome Damian and Donny.

Thank you, Jonathan.

So let's just jump right into the questions here. So Phibro just reported their F 1Q results on November 2. Can you give us a brief recap of the key point from your earnings call and public filings and communications?

Sure. I will take that, and good afternoon, everyone. So as Jonathan said, we just reported our first quarter results, where we are a fiscal year-end June 30, company. I'll give you some of the highlights of our first quarter. For one, we were really enthusiastic about our sales growth for the year. So we had 10% top line sales growth. That was driven by our biggest business segment, which is Animal Health. Within Animal Health, there's 3 product lines: MFAs and other, Nutritional Specialties and Vaccines. The MFAs and Other category was up 6%, Nutritional Specialty sales were up 10% and Vaccine sales were up 25%. So we had really strong sales growth on the top line. So we also reported a couple of other things. One of the things driving the vaccine growth we saw was our new facility in Sligo, Ireland. We've talked about it on the last couple of calls. We were expecting our first sale towards the end of our fiscal year. We ended up actually beating what we thought and having our first sale in the first quarter. So we're really excited about that. But we also mentioned, as I know a lot of our competitors did as well and companies that have nothing to do with that and will help mention it also, we're seeing increased costs, whether that be labor, freight, materials. We've also seen some currency movements that we can talk about a little later in the call. But all of those things put some pressure on our margins. So ultimately, we made the decision to revise our guidance for the full year. So we raised our full year sales guidance, the lower and high end of the range increased by $20 million, respectively, but we maintained our adjusted EBITDA margin. So we talked about some of the actions we need to take. So although we started to adjust prices in the first quarter, that will -- we said we need to continue to do that. And maybe in hindsight, we could have done a little bit earlier a little bit more aggressively. But we're confident that, that -- those actions are being taken and will continue to be taken and that will help us achieve our top line guidance as we said. We also said, though, that we need to pass on some of these freight costs in the form of a surcharge. So we think, coupled with those 2 actions, adjusting price, passing on some of these freight costs, we can improve margins over the latter 3 quarters of our fiscal year and deliver the guidance of higher sales and the profit that we set out to meet earlier in the fiscal year when we first gave guidance. But overall, it's a really, really strong quarter. And we also just mentioned that COVID-19 is still out there. We sell products in more than 80 countries. The recovery from COVID really varies depending on the region. And we continue to see that marketable business as well. So I would say, in a nutshell, that was our first quarter, a strong first quarter.

Great. Can you talk a bit more specifically about some of the items that are putting pressure on margins and kind of the overall steps that you're taking to address them, kind of beyond some of the items that you just talked about?

Yes. So just elaborating maybe a little bit more across those. So again, we're not a company that raises prices on the same day every year at some set percentage. So we adjust prices accordingly as the competitive conditions dictate. So whether that be by product or by geography, it really varies. But as I mentioned, we started to take some action on price in the first quarter. Some of those, they take time to take hold. If you're under a contract, for instance, or it comes up for bid, et cetera. So it's always going to be a little bit slower on the sales side. So there tends to be a bit of a time line between when you see a cost spike and when you're able to pass that through in the form of a price increase. The freight surcharges, again, not unique to Phibro [indiscernible]. I mean, we've all heard that the cost of a container has gone from a couple of thousand, $3,000, $4,000 up to, I've heard, $20,000. We would hope that over time, that's somewhat temporary. But given, like I said earlier, our fiscal year ends June 30. We assume that these kind of challenges will persist through the end of our fiscal year. So it's baked into our guidance. But our assumption is that we'll be able to share or pass through those costs in the form of surcharge to our competition. In terms of labor, again, not specifically to Phibro, but we're all hearing about labor shortages and those workers who are available are demanding a higher wage and better benefits. We're seeing a bit of that ourselves. The example we give is, we may have a higher vacancy rate in one of our plants, but not so much that we're having any problems with production. So, knock on wood, we haven't had any lapses in production throughout the entire pandemic. But a higher vacancy rate means some other people that are on the job need to [ fill ] in and we need to pay them over time. So we're seeing increased costs in the form of overtime. But once we're able to [ fill ] those roles, even though the new worker may work a little bit more than the person who resigned or left, not so much as overtime. So again, that feels somewhat temporary and we'll see it will vary by market, but we think those will eventually kind of work their way through the system. And then currency movements is kind of tricky for us. As I mentioned, we obviously report in U.S. dollars, but we sell in countries -- 80 countries around the world. Some countries where the economies are really struggling with places like Turkey, Mexico, Brazil or Argentina, whereas in the comparable quarter prior year, those currencies relative to the U.S. dollar weakened. However, in this quarter, things started to turn around as those currencies started to strengthen versus the U.S. dollar. So in terms of where it hits us, currency movements. On the sales side, if we see a change in currency movement, we can adjust your pricing in those 2, that action almost offsets the currency movement. So you kind of net to an immaterial amount that doesn't really impact your sales line. However, we're [indiscernible] where you do that, that's been a bit of an issue. So that's where we're seeing it in the margins.

Okay. You mentioned several costs that are up and putting pressure on your margins. How does the rising cost of things like corn factor into the outlook? For instance, if the profitability of your customers suffer, will there be less demand for your products?

I'll take that. Jonathan, it's Donny. I'd start by saying that our customers seem overwhelmingly to be doing very well in this environment. So when they do well, hopefully, we're in a position to do well as well. But specifically to the question that you raised, the products that we sell are animal health products. And they are there to allow the animals to live healthy lives, but also for the farmers to be able to produce them cost efficiently. And feed is actually the #1 cost in raising animals. So when the price of feed goes up, it actually becomes more important for the farmers, for the growers, to be efficient in their usage of the feed. And that often means using judiciously, but using these products that we sell and our competitors sell. I mean when you imagine, as a human, right, when we get the flu, we're losing weight, right? Or often, we're not -- we lose our appetite, we're often using the bathroom and the same holds true for animals. And so ultimately, you want to prevent your animals from getting sick or have them sick as short of a time as possible because you can't -- as feed cost goes up, if they're actually not retaining that feed and it's passing through the system -- their systems, that's not good for the grower. So it becomes more important for the grower to keep weight when feed costs are rising. And then just, I guess, one other kind of larger point is, as a company, our aim is to be agnostic. We're not there yet, but are aim is to be agnostic as far as the species that's being used. So when consumers see the rising price of steak or whatever it is, they'll trade down, they'll trade to pork, down from pork to poultry, and ultimately to aqua. And Phibro, as a company, we're in each of those segments, not necessarily equally. But our goal overall is to be ultimately in each of those segments and to be agnostic as far as where the consumer wants to get his or her protein.

Okay. Great. You had strong growth in your vaccines business. Could you give us a little bit more color on what drove that?

Yes. So we actually -- we had -- in the last quarter, we had strong growth in both vaccines and nutritionals. Our vaccine growth, I think, was -- we attributed it to a lot to Eastern Europe and to India. Our vaccine business is based out of Israel for the commercial poultry, and we just opened up a new facility in Sligo, Ireland. The Sligo, Ireland facility is still actually in the process of opening. We received earlier than we expected our first kind of sale through the registration process, but that will play out over the course of the next 3 quarters and longer as we register in more countries. So we're excited about the growth there. We've also seen growth in the United States in our vaccine markets, where we have an autogenous facility, and we're a very strong player in the swine market, and we're expanding into poultry and into cattle there. On the nutritional side, there's 2 main areas where we sell nutritional products, and that's poultry and dairy and our growth is strong in both of those areas. Historically, we've been focused on the United States in starting those nutritional products. But as we grow, we're seeing more success in bringing those products overseas as well. So we're excited about our portfolio for both of those segments.

Great. And I believe you mentioned that your first companion animal product is doing well. Tell us a bit more about how you approach commercializing that product and how that might change as more products are launched.

Yes. So our first product is a product called Rejensa, and we launched it right when COVID got started, more or less. But despite that, we've been successful. Now Rejensa is over-the-counter joint product, but despite the fact that it can be sold through Chewy or through anything else or direct-to-consumer. We are selling exclusively through the vet channel, and we've teamed up with 1 of the 3 largest distributors in the United States where they have been exclusive, and they are unusually for distributors in the vet channel. They are detailing this product. So they historically -- distributors detail equipment, but they play more of a logistics role when it comes to products. But for us, our partner is detailing. And as you can expect, they are making a larger margin than they typically would. But it's an important relationship for a distributor, as they are looking for ways to increase their profitability, and it's great for us because we're able to leverage their much larger sales force. So we are using their sales force to reach the vet, we are enhancing their success with building out slowly our own sales force where we're looking to put people into each of the regions of our distributor, and we're growing this product very nicely. Last year, the last 6 months of our fiscal year '21 grew as fast as we doubled the business of the first 6 months. And likewise, the guidance that we've given so far is that we will double in fiscal year '22 what we did in '21. So we see that continuing to grow and grow nicely. And as -- this is how we're selling this product. We make no kind of promises that, that future products are going to be sold the same way. But clearly, as we build out our footprint and build out our own sales force, it does give us more options as more products come through our pipeline and the way that we will approach the market with them.

Okay. Great. And then kind of on the pipeline, can you share some color of what's in your companion animal pipeline now?

Sure. So we've published a new investor presentation on our website, where we kind of give some details on this as well. But our main product or the product we're most excited about is a product to attack the atopic dermatitis market. Now atopic dermatitis is a market that has grown extremely rapidly over the last few years. So [indiscernible] has a couple of products that have done very, very well, have taken a relatively sleepy category and made it into a $1 billion-plus category, and we're really excited about our opportunity here. We still have a ways to go. There's definitely no guarantee that we've hit the finish line. But what is exciting to us about atopic dermatitis is it's a market that's still relatively in its infancy. It's going to grow a lot. And relative to the parasiticide market, for instance, there's many fewer competitors. So we do expect that there'll be more competitors by the time we get to the market, if we get to the market. But having said that, we're pretty confident that no matter -- that if you do get FDA approval, there will be a significant share for all those participants. And the product profile we have, we think is very competitive relative to what we see out on the market. So that's our flagship product. Beyond that, we have a couple of oral care products, one for dogs, one for cats. We really haven't given that much detail about it. But we do see those as being products that actually can come to the market faster than our atopic dermatitis product. And the opportunity there are as well as pretty unique that these are large categories, probably cumulatively $1 billion categories. The approach we're taking is pretty unusual, and we think that we will create some decent space for ourselves if our products do get to market, and we are excited about their opportunities. Finally, we also have a unique Lyme delivery system for dogs. And Lyme is, as we appreciate on the human side, is a growing threat. It's also a growing threat for dogs. Lyme has been -- Lyme disease is now in all 50 states. And this was actually our first licensing deal. It's been slowed heavily by COVID. We haven't had the pace of the success that we had hoped for, but it is indicative of kind of the way that we go about a lot of the deals that we do, do in so far as -- for instance, in this year, we'll only have to pay out if we hit some significant milestones. So we do create these barriers, and we limited our risk and oftentimes in how we set up these license deals. And if this thing does come to market, which has a ways to go, it's another branch that we're excited about. So in total, we view companion animal in the midterm to be a segment that we think will equal the other -- the size of our other segments, at least the smaller sizes. So our vaccine and nutritional specialty segments, we consider them each legs in a stool along with our MFA and other, and we think companion animal in the midterm will be another leg to the stool.

Okay. Great. Just trying to add a little bit more numbers-oriented question. You highlighted on your call that free cash flow is about $21 million on a trailing 12-month basis. Your dividend is almost $5 million annualized, that's about $20 million, which is about 95% of free cash flow, give or take. Help us understand how you're thinking about balancing things like capital allocation versus the dividend policy versus free cash flow for organic growth?

Yes. Okay. Thanks, Jonathan. I'll take that one. So as with many things, it's more challenging to balance some of these factors when you're going through a global pandemic. So I appreciate the opportunity to explain a little bit about how we're looking at this. So Donny mentioned a bit earlier, I think, something about transparency. So we're trying to fine-tune some of our materials for investors. Donny mentioned there is a new company overview deck out on the website. Our earnings call deck, our scripts, we're trying to be as transparent as we can. A good example of that was we walked investors through on last week's earnings call when all of that will help margins as an example. And we talked about some of those increased costs. We also showed free cash flow. And I think it's the first time we've showed free cash flow in a way that's comparable to some of our peer group. So our free cash flow, as you mentioned, was about $21 million over the trailing 12 months. Although our company has been around since 1946, we only went public in 2014. At the time, the dividend was about $0.10 per share. It's now $0.12 per share, which, as you correctly said, is up to about $20 million a year. So if you look at the dividends as a percentage of free cash flow, it's about 90% or so, right? So -- and that's a higher percentage than we would target. I think we would try to get back to more like normal 50% to 70% ratio. There's really 2 reasons driving that. So in our guidance and as part of our last couple of earnings call, Donny mentioned it as well, we increased our investment, our strategic investments. So in total, we spent about $32 million in fiscal year '22 is what we're projecting. But that's about $10 million over the prior year. In that -- so one is that our investments are higher and the future investments, which is one of the reason why free cash flow is where we're at. In that $10 million increment, about half of it is dedicated to incremental spend in companion animal to cover those development projects that Donny just spoke to. The other half of that, so $5 million, is spread across the facility in Sligo, Ireland, our ongoing development program around African Swine Fever in China, and then just ongoing registrations for our existing products across the world. So we're spending a little bit more on strategic investments. As those start to return and a return in the form of free cash, that would -- all things being equal, would improve that issue. The second thing is capital improvement. So Donny also mentioned, we expect our growth drivers are vaccines and nutritional specialties. So we're making further investments to increase capacity in those 2 growth areas. So that's increasing our capital projects. And plus, there was some carryover from capital projects that were slowed due to COVID and fell into this fiscal year. So I would say strategic investments in capital projects are both a little bit higher than normal. And as a consequence, free cash flow and the relationship of free cash flow and dividends is higher than what would be. But over a period of time, as these things play out, we hope to get back more to like that [ 50% to 7% ] range as we see a return on our investments.

Okay. Great. Just turning to kind of market conditions right now, both U.S. and internationally. Have things started to normalize yet? Or are you still seeing a drag related to COVID?

Yes. It's a broad question. I mentioned already that we saw a lot of countries, so it really varies. We have big production facilities and really, we have multiple sites, but Israel, Brazil and the U.S. Israel was sort of the first out of the gate with vaccines. They're also well ahead many other countries in terms of boosters. Brazil got kind of a slow start. But once the vaccines were readily available, the Brazil numbers went up considerably to the point where both Israel and Brazil have more percentage vaccine of their population than even the U.S. does. So we've seen recovery across the globe. It's reflected in our sales numbers. I should have mentioned in those sales numbers, there's a little bit of recovery versus the same quarter prior year, but in the volume numbers that we saw. But we also increased market share. So it's not all just because of COVID that our sales went up. It was price, it was volume. And within volume, it was partially increased market share and partially recovery. So right now, we said with our guidance that we have to just caveat it and say this is still assuming that things continue to rebound and recover across the world, recognizing it can vary by country. But from what we're seeing, there does seem to be recovery. I think people will ask us, what about our customers. We should like our customers globally across species are making money. And that's good for us. So if they're making money, it should be a win-win for everybody. So overall, I'd say we are cautiously optimistic that economies are recovering. But as you know, after almost 2 years of this, we don't know what we don't know, right? So we'll continue to caveat things. But right now, based on what we know today, we feel pretty good that there's decent recovery across the markets where we compete.

No, that's good. Let's hope this continues to ease as we move forward. So we've been hearing a lot about African Swine Fever. Any thoughts on what's going on in the market and how it might impact your intent to develop a potential vaccine?

I'll take that one. ASF has been around -- well, it's been around for decades, but obviously, it's only been in China for the last few years. And it seemed like they had done control a little bit last year, but it's -- we suddenly, had it again this year. Our feeling is it's endemic. It's always going to be in China from here on end. And our work on a vaccine continues. Now Unfortunately, for us, COVID played a role in really slowing our progress here on this vaccine and it's played really a two-found role. On the one hand, we have -- our technology is based on technology that we've licensed in Israel and our technologists, our vaccine specialists, are based in Israel. And they have been unable to get to China, much like anyone in the world has been unable to get to China because China is still looking to get to zero Covid and has barred foreigners for the most part from its border. So we can't bring our people in there, which is necessary for us to make the strongest level of progress. Secondly, the world obviously has turned its attention to a vaccine or multiple vaccines for COVID. So the high -- the top-level security labs that are necessary to test for African Swine Fever are now dedicated towards COVID. So as you can imagine, you can't just decide to do work on a vaccine for something as virulent as African Swine Fever in any lab that you want. There's a limit to a handful of labs within China, a handful of labs around the world that will handle this virus. And most of those labs with that level of security have turned their attention to COVID. Now that we're in a world where there are multiple vaccines available for COVID, some of those labs are now returning their focus to other things, and we do believe we will have access to them to work on ASF. While this has all been going on, we have been making some progress within Israel on the work that we're doing. But the pace of our progress is much slower. And until we're really able to get people into China, we don't see us really being able to push this forward as aggressively. But ASF continues. It's growing. There's been reports around the world of it popping up. It's a problem that the world needs to face. We think we have a relatively unique solution, by no means are we having a -- are we prepared to say that we have a complete product. We're not there yet, but we are making progress and we think that sooner or later, we will continue to progress and get to the finish line here.

Okay. Great. And then kind of given you were mentioning China, you've been out of China. Can you give us an update on the registration time line and kind of the timing to get back into China?

Okay. Well, so specifically, I think you're referring to our virginiamycin, our Stafac product. We had been -- we've called out in the past a couple of years ago, we were doing about $40 million a year of virginiamycin into China, mostly into swine. We had got hit by 1, 2 punch there. First, we got hit by the rise of African Swine Fever, where more or less the swine industry shut down. And then there was a change in regulatory regime within China as far as what antibiotics, what the labels they could coming on. So we were shut out by ASF and then we were withdrawn because of the change in labeling. We are seeking to get back in, and we believe that eventually we will get back in, but it's like everything else, I hate to blame it on COVID, but it is taking us longer to go through the process necessary to reregister. It's not something that we anticipate happening this fiscal year. When we do get back in, we do anticipate reaping back some level of our sales, though not the same $40 million that we had once been. So a subset of that. At the same time, we have shifted our sales force within China and pivoted to dairy and where we're selling our nutritional specialty products that I had mentioned earlier on the call that initially had, had successes in the United States. We are seeing a lot of success within China on those nutritional specialty products and one hopes to see a future where we have both the virginiamycin products as well as the growing nutritional specialty products, in which case, this will have turned into a positive for us. But beyond that, within the Asia Pacific region as a whole, we are continuing to see strong growth, growth in virginiamycin, growth in other products. And that is an area that the entire production animal, the entire animal health industry is looking to for growth as we move forward.

Okay. Great. And I guess just a last question here before we kind of wrap up. ESG is obviously a hot topic within the investment community and just in general, overall. You highlighted in May your intent to issue Phibro's first ESG report. Can you give us an update on how that effort is going? When do you think it will be published and any early insights you've learned from it that you want to highlight?

Yes, absolutely, I am sure. And let me just add to Donny's answer about China, too. If we broaden that look at the region of Asia Pacific, our sales in the first quarter were up 23% in APAC. So we had sales increases across all regions. The biggest increase, though, was in Asia Pacific. In terms of ESG, you're right, we did mention back in May that we would publish our first-ever ESG report. As I mentioned earlier, the company has been around since 1946. So we all know the concept of ESG may be new to Phibro, the principles and the values underlying ESG have been part of the fiber of Phibro probably since day 1, since well before I was here for sure. So in my role as the Chairman of the ESG Council, the first step is to do an inventory of all the things that we're already doing and then determine from there, what do we want our targets to be across the E, the S and the G. Donny was on our call today, is chairing the subcommittee for the environmental section, and it's up to him as the leader of the social and governance groups, to come up with what are our targets. And once we know those, we'll map out our plan of what are the next steps to get there. We engaged an external adviser to help us in this process. It's one of the bigger accounting firms in the U.S. to help us with a lot of experience in this state -- in the space, I should say. And one of their first steps is to put together a survey that we just recently got the results of that we went through late last week. And it was what's important to our internal and external stakeholders. So between knowing what we already do, where we want to go, what our stakeholders, both internally and externally care about, we have all the components we need to lay out, what our objectives are and put together a report that we hope will be meaningful. So our plan is still to get that report out before the end of our fiscal year, which, as I mentioned earlier is June 30. So we're excited that progress is underway, and we continue and hope to have our report out soon.

Okay. Great. And then, I guess, is there anything we missed or you want to highlight before we wrap up here?

I'll let Donny answer that. I don't think we've missed anything. I mean, maybe I would just summarize that. Again, we were really happy with our sales growth in the first quarter. It was driven by price and volume. Some of that volume is recovery, but some of it's market share. As we mentioned on our earnings call, we have a plan to improve margins, which includes passing through costs and continuing to adjust prices. We hope things like currency and labor will normalize over time. And lastly, we've been asked this before, we talked about incremental strategic investments. Despite the pressure on margins, that's the last thing that we want to cut. So we have some other levers we can pull before we get there. But our intent is to continue investing in the nutritional specialties, vaccines, and especially for the medium-term growth driver, which is companion animals that Donny was talking about. So overall, a good quarter, and we see a bright future ahead. Donny, do you want to just add anything or...

I think you hit the high notes.

Right. We [ want ] to hit the high notes.

All right. Well, with that, I'd like to thank Phibro for attending. And thank you, Donny and Damian, for presenting today. Thank you.

Thanks for moderating. We appreciate it. Have a good day.

Thanks, Jonathan.