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

Great. Thanks for joining us for our next session. My name is Mike Ryskin. I'm on the Bank of America Life Science Tools and Diagnostics team, and I also have the pleasure of covering animal health. And for our next fireside chat, we're pleased to be joined by Phibro Animal Health. With us, we have Damian Finio, CFO; and Daniel Bendheim, Executive VP. So Damian, Daniel, thanks for joining us again. Good to see you guys.

Good to see you, Michael, and thanks for having us.

Of course, always a pleasure. I think just to get the ball rolling, I would [ that ] sort of just as an introductory question to make sure everyone is on the same page, you reported your fiscal second quarter results a few weeks ago, strong quarter, nice updates to the guide. Can you give us a sort of a brief recap of the key points from the call and the guide raise sort of just summarize the latest thoughts for you.

Yes. Happy to do it. I will start and good afternoon, everybody. So we did report earnings on February 10. Just to remind everybody, we're a June 30 year-end. So that was the end of our second fiscal quarter, the quarter ending December 31, 2021. Start off with top line, we reported sales of $233 million. That's the biggest single quarter of sales in the company's history, keeping in mind, we've been around since 1946. So out of 300 quarters or so, that was the #1 quarter. From an adjusted EBITDA perspective, little bit better than last quarter. We had a tough first quarter of $29.1 million in the second quarter, up 2% year-on-year. But I wanted to highlight adjusted EBITDA margins were about 12.5% compared to 10.5% in the first quarter. So we had talked in our November call that we were taking some actions to raise prices, pass through some incremental freight that we were saying, and we started to see some of the benefits of that in the second quarter. We expect more benefit from that in the third and fourth quarter. So I'm sure later in the call, we'll talk about our updated guide, as you referenced. But overall, we're seeing -- we saw some of that price drop through to the bottom line in the second quarter. We also had a nice uptick in net income and earnings per share both on an adjusted and unadjusted basis, primarily driven by an update to our projected effective tax rate. We had a bit of a mix in what we would call the jurisdictional mix of earnings between high exception tax or high country -- I'm sorry, I'm saying that wrong. Companies with high exception taxes. So when you have a mix of income across those countries to change your effective tax rate in the U.S. as it relates to GILTI tax. So saw a nice uptick on the net income and EPS related to that. And then if you break down by segment, every segment was -- did really well. So Animal Health is our biggest segment. It's about 2/3 of the business. Sales were up 11%, adjusted EBITDA, up 1%. So still some pressure on margins, but again, expected that to improve in the second half. Mineral Nutrition sales were up 23%. Adjusted EBITDA was up 32%. I'm sure we'll talk a little bit more about that. And then Performance Products, which is less than 10% of our business from a top line perspective even less on adjusted EBITDA. Sales were down about 4%, adjusted EBITDA was down 42%. A lot of that related to timing shipping delays that shipping that we assumed would come in the second quarter will just get bumped to the third quarter. So it's more just timing with Performance Products. So that's the P&L. Balance sheet-wise, leverage ratio is flat quarter-on-quarter. So that's good. We still have $235 million of liquidity, $95 million of that is cash. The rest comes from our revolving credit facility. Sorry about my phone there. From a cash perspective, we're using some cash to increase finished goods inventory. So our inventories are up a little bit. That is combination of seasonality. So for instance, in our Quincy plant, we generally bring more finished goods in before the Mississippi River freezes, but it's also safety stock, which we've been carrying to manage through supply chain disruptions. So overall, P&L, really strong quarter, especially the top live best quarter ever. Balance sheet is strong. So we feel like we're poised for a pretty strong second half of the year.

Great. Great. And then just sort of exactly on those points. As you look forward to the second half of the year, I think the first -- one of the biggest questions our investors have had, thinking about what's changed in the recent months has been the inflation backdrop. We're seeing it across industries, across sectors. And with the last stock markets, there's a sense that some of those customers may be a little bit more sensitive to inflation. So I think you've done a really strong job in the last couple of quarters being able to manage the portfolio for inflation and taking price where possible, passing on some of those costs. Could you give us an update on your thoughts for that for the second half of your fiscal year and just sort of how you're positioning for higher costs?

Yes. So as you mentioned, inflation is the highest it's been in about 40 years or so, right? We break it down where we're seeing the pressures in cost of goods and just breaking down cost of goods further. There's the labor portion. For us, we feel like the peak of the Omicron variant is behind us in terms of people being out for work, calling in sick, et cetera. It definitely created some scheduling challenges from us, but not to the point where we lost any time in production or anything along those lines. So again, more of a headache. But thankfully, we feel like that's behind us. We have a little bit higher vacancy rate this year, as I'm sure others do as well. And that's helping to actually save a little bit of money to offset some of the extra overtime we may have to pay folks when other folks are out of the office. So all in all, it's not really a labor issue. It's more about input cost for us. Freight being one of those. There's freight that we can pass through to our customers, but the portion of our freight is also intercompany. We operate across 16 or so manufacturing sites, supplying the markets we sell to around the world, which is more than 80 countries. So some of that freight, you can only pass through in the form of a price increase, which, as you mentioned, we took some action to raise price at the back end of the first quarter, beginning of the second quarter. We start to see some of the effects of that in the second quarter. Again, that will continue to drop to the bottom line in the third and fourth quarter. As far as input cost, though, it depends. It depends on what you read. So supply chain, we're hearing like others do maybe the back half of calendar year, things will start to open up a little bit. Just keep in mind, for us, that's the next fiscal year, right, because our fiscal year is June 30. So through our year-end and through our guidance, we expect the supply chain challenges to persist, and we'll continue to take those actions that we have, as you said, to manage margins. So overall, I think we're doing our best to manage inflation. We'll see if any of the government intervention around, for instance, raising interest rates and things like that, if that helps to dampen the economy and what that does to input prices, we'll see. But at the moment, the people we sell to are making money. Chicken prices are at the highest they've been in a while. And we tend to think of our cost as a small portion of the investment that they have in their herds. So we feel that positions Phibro pretty well.

Yes. And just exactly on that point, we've been following even following rising input cost to your customers, such as feed prices, such as corn prices, you mentioned that the end product price, the protein price is still elevated. So your customers are profitable, and therefore, they're in a good financial position to do business with you. But is there any concern, is there any chatter as you look at their input costs feed remains elevated? Is that going to become a pressure point at some point? And just to tie it into the current geopolitical situation, obviously, what's going on with Russia and Ukraine, we had a presentation earlier today where one of the presenters really highlighted risk to fertilize your cost and fertilizer your production. So when you think about the production side of things in terms of your customers, how are they positioned based on those conversations? Are they worried about any of these factors? Or are they just seeing the high prices in the market today, and that's enough to keep them satisfied?

Yes. Donny, do you want to take a crack at that first and then I'll jump in.

Okay. I mean, I think, in general, as you noted, our customers are doing well. So my -- I think we all are conditioned right now to accept higher prices. And to the extent that they continue to get higher inputs, I think their conditions and the consumer is conditioned to accept those prices. So I do -- at this point, I think any increases are going to be passed along to the consumer. So we're not terribly worried. You did hit upon -- well, you hit on Ukraine and Russia, bird flu is out there as well. I think one concern that has been raised is not so much bird flu affecting the industry because the industry here is actually pretty calm about it. They have raised their bio-security level, but not to the point where they might have in the past. I think they feel pretty good about what they're -- how they're running their businesses. But what we have seen in the past is it does become a political tool for countries to close their borders with bird flu. So there is a risk to some of our -- some of our customers could have some of their -- with chicken prices at all-time high, you could see someone like China saying, "Hey, we're going to close the border to U.S. chicken." Unlikely because bird flu is around the world right now, and it's hard to kind of just cut off 1 or 2 markets, or you'd have to cut everybody. But that's the risk. So I think if that were to happen, if they lose some export markets, you could see some pricing pressure, and that could play its way through the industry. In general, though, as long as our customers are making money, they're buying our products, as Damian had mentioned, such a small part of the input cost, and it's like insurance. And if you don't use the product and your birds do get sick and die, obviously, you've lost the whole investment. So -- and that's just birds, but it's true across different species. So we feel pretty good about the cycle right now and where we're sitting and where our customers are sitting.

Okay. Okay. That's very helpful. That matches a lot of what we've heard in the market and how we sort of approach it if you think about the cost-benefit ratio. And if you look at the input cost for livestock producers, the drugs and the therapeutics are 3% to 5% of their total cost. So it seems to be unlikely to be the first thing they were cut out, but still -- Dam, you touched on a couple of times on the poultry markets. And when we think about relative species exposure. You guys are probably overexposed to poultry relative to other species and relative to some of your competitors. And poultry is just the market that's doing a lot better historically, and that continues to do really, really well. Any thoughts on sort of expectations for that market going forward, both U.S. and internationally? And then maybe if you could sort of take that and then transition to beef and dairy cattle, and then also to swine. If you could give us an update for how you think about each of those markets, each of those species, both in the latter part of this fiscal year and then going forward?

And maybe as Donny thinks about the 2, maybe just to ground everybody. So if I quote some numbers from our 10-K June 30, 2021, just to give everybody a sense of how exposed we are to those different species. Poultry is about 36% of our top line sales. That's down from when we went to IPO back in 2014. I think then it was closer to like 50%, give or take. So about 36% poultry, 20% is dairy cattle, 13% beef cattle, 9% swine. And then that last 22% we refer to as other, it's companion animals, it's plant science, it's performance products. So a little more than 1/3 of our business is poultry.

I mean, I guess, jumping to your question. I think, overall, we feel pretty good about our business across species, across geographies. I think even in our worst-performing geography, we're up high single digits last quarter. So overall, the -- we've talked about chicken prices probably all-time highs right now in certain elements of it within the United States. Our guys are -- they're making money, we're seeing -- I think people that fully come to grips with the changes in food services that might have happened with COVID and they have diversified their ability to get products to the market. So from the [ poultry ] room -- from the U.S. poultry, which is -- we're probably over-leveraged or overexposed maybe just to U.S. poultry relative to the rest of the world. In the U.S. Just to take a step back, we don't sell that much to the U.S. cattle industry. We sell to dairy, but not in beef. So we have less exposure in the U.S. to that category. Our swine customers are doing well in the U.S. Overseas, we do sell a lot into the cattle industry growing there. I think what we did see is in certain countries, in certain geographies, in light of COVID, people have depopulated their herds. And we're the chicken and poultry, it's a very quick cycle. You can get back up the size very quickly. For beef, it takes a longer time to do that. So we're overlapping kind of 2020, where maybe some of our customers did not have their full herd size. And now we're seeing them bring it back up to 2019 levels. So I think those guys are doing well as well. And so we feel good. We're looking at our customers who are doing well and doing really well, and then we think we will go up with them as they profit we'll profit.

Okay. And you touched on just to pivot off that question, you touched on in the international markets and some of your other exposure I mean, I have to ask African swine fever question. We can't -- we're not allowed to go through a call without asking about it. It's the new rule of Animal Health. Obviously, situation has changed a lot since it was first discovered in China. I think the market kind of bottomed there. A lot of revenues got cut out. And then if I could characterize it, it feels like there's been a lot of fits and starts since then. What's your view on African swine fever and China swine in general? Where are we in the recovery phase? Is it a real recovery? Or is it -- are we going to have another fall start? And how long until sort of back to normal and we can stop talking about it?

Yes. So for Phibro, we're a little bit different than the market as a whole, because as you may recall, we were doing about $40 million in China of our antimicrobial called virginiamycin. African swine fever hit, that obviously, we sell virginiamycin mainly to swine, but as well as for poultry. ASF hit, destroyed, decimated our market on the swine side. It was followed by a regulatory change where we have to take it off the market and change the label. So we are actually out of the market for swine and poultry in China. We have actually pivoted our sales force, and we're selling other products right now and gaining ground on the dairy side within China. But specifically to swine, we finally have a registration actually filed with the Chinese authority. So we have progressed that. That was slowed by a combination of ASF having doing the test work that you need to do in order to get a registration, as well as in COVID, where just the world shut down. But now finally, we have a registration in. Don't have a time line necessarily as far as, I mean, we have internal expectations as far as when we'll start selling, it won't be this fiscal year. But we do expect sooner or later we back up in the Chinese market, and we don't expect to get back to that $40 million level, but we do expect it to be significant. So that's Phibro specifically. As far as ASF in China, as you mentioned, I think there has been fits and starts. There was a move by the Chinese government and the Chinese industry to move to larger farms, and we've seen that. And that's good for us. The larger farms are typically our customers. We'd like to talk about -- we want us to be able to count, not because we're disparaging the smaller customer, but these products work very well. But when there's a lot of outside noise, and you're only looking at 2 pigs to see if it's working, as maybe a lot hard to discern versus looking at 2,000 pigs to see if that's working. So the move to bigger farms is good for us, good for our competitors, and that's what's happened in the restock, but ASF remains. And like with COVID, the virulence has changed, and I think last year, the strain that was hitting was a little bit less severe, there are reports that there's a more severe version back out this year. We continue on our vaccine work. It's slow but steady progress. We have, and I hate to hit the COVID button, but we have been slowed by COVID because we are unable to bring in our people. This vaccine was licensed or a lot of the technology [indiscernible] the vaccine was licensed from a company in Israel. It's run by our Israeli vaccine team. They can't get access to China. No one really can, right? As a COVID zero country or as a policy for China, they are not really allowing outsiders in. So we have been slowed in our ability to run tests there. We are uncomfortable running tests without our people there. We have done some work. We've kind of gone further than we thought we would go just by necessity as far as doing stuff without our folks there. We have done some tests. We've seen some nice progress, but it definitely slowed down. But we are -- as we look at this -- at our products that we're working on, the vaccine we're working on, if we do reach the finish line, we think it will be something that will play a strong part in the future way that it's treated within China.

Any color you can provide? I'm obviously not asking you very specific answers unless you want to provide them, but any color you can provide on timing, how we should think about regulatory process? Is this a 3 to 5-year window, 1 to 3 years? Just it's hard to tell with some of these programs.

Yes, I don't think we know. I think this was a traditional vaccine. I'd say, you're probably 3 to 5 years out. What I would say though is it's meat or pig meat is so important to China. I look at it a little bit like -- possibly like COVID, where the vaccines that came out to treat COVID, obviously, shortcut by years, would historically had been the case. So until COVID happened, ASF was probably the #1 virus challenge in the world as far as -- obviously did not affect the U.S., but as far as just mind share. And in China, it's a huge deal. So China has pork reserves, like we have oil reserves as a country, right? So it's a key part of what the government needs to provide to their people. And so I would say if someone were to come out with a safe, effective vaccine, it would not shock me if the Chinese government accelerated its approval.

Okay. And how would you think about adoption of that? I mean both in China and then also in Western Europe, obviously, Poland and Germany have a situation going on. You've got parts of the Caribbean that have now had cases spotted, Vietnam, really, it's across the world. So would you imagine this will be broadly adopted across the world? Or are there differences geography by geography in terms of appetite for this also, both from a vaccination perspective, also from an export market perspective, and then finally, from a price perspective?

Yes. So I mean, we're -- it's getting a little ahead of ourselves. I think, ASF depends on the type of vaccine, right? But the attenuated live vaccine or some other type of vaccine that will determine whether countries decide to adopt it prophylactically or only to treat disease, et cetera. I mean, our expectation in China, truthfully, is that there's 1 customer, and that's the Chinese government. And we would expect that -- if someone -- and again, hopefully it does, so if someone would really come out with a solution, there would be new universal adoption within China. And then as far as these other markets, hard to tell. I think the Chinese opportunity in and of itself that 800 million pigs a year, whatever dollar you want to sign to the vaccine, it dwarfs everything else. These other markets, Poland, Germany, whatever those might be nice opportunities, but it's still nowhere near what the Chinese opportunity is. And the threat to them right now is nowhere near what's actually happening in China. So I would say is I'm sure in a different world. There's other opportunities we look at huge opportunities within animal health. Today with China and the opportunity there, it still dwarfs everything else that you're just concentrating on that, and we'll be happy to tackle the rest of the issues after we solve China.

Okay. Fair enough.

Can I add 1 thing, Michael, too, just brought it in a little bit. Just -- he mentioned earlier in his comments that we're growing across regions. So Asia Pacific is our smallest region, about 6%, 7% of our sales. But it's also the fastest-growing region. So 6 months year-to-date sales in Asia Pacific for Phibro were up 23% year-on-year. So despite some of the losses we had in 2019, we're gaining back business in Asia Pacific.

Yes. I appreciate that. Donny, a quick follow-up to something you brought up earlier in terms of reentering to the China swine market. You said you're not going to get back up to that $40 million level. Is that because of a label exchange with the reregistration?

Yes. So our initial label was a feed efficiency or production claim, which more or less allowed usage for the full life of the pig in all circumstances. Now will be a disease-linked claim, and therefore, they will limit it.

Okay. Makes sense. Makes sense. And then maybe pivoting a little bit away from some of the broader market stuff back to your segments than those reals you saw in the first half. If we can look at the 3 animal health subsegments, right, MFAs and other nutritional specialties and vaccines, I think historically, we've kind of seen MFAs and others being a little more of a low single-digit grower just given your product exposure there and just trends in the global markets, whereas vaccines and nutritional specialties, we thought of double-digit plus growers, newer products, more innovative, more exposed to some of the faster-growing species. I think what you've seen in the last year or 2 has moved some of that around. So I think we're trying to parse out how much of that has been market-specific, how much of that has been COVID-specific or product-specific. And just if there's any changes to longer-term assumptions. So could you talk about, going forward, are those historical assumptions the same? Or is there any change where MFAs could be more of a mid-single-digit plus grower and maybe nutritional specialties isn't growing quite as fast as it would have been historically. Is this just temporary product-driven? Or what's going on between these different buckets?

Yes. Maybe I'll start, Donny, you can jump in. So MFAs and other was up 12% for the quarter. In terms of sales, 9% for the 6 months, right? We did mention, and Donny, can speak more to it, it's driven by the MFAs, but it's also driven by the other which are some products that we make that are used distillers grain products, et cetera, and Donny can talk to that around ethanol. Nutritional Specialties was up 3% for the quarter, 6% for the 6 months; and then vaccines, 20% for the quarter, 22% for the 6 months. So I think we haven't changed our general guidance about single-digit growth for MFAs and other in double digit for nutritional specialties and vaccines. I think you're seeing a little bit of noise quarter-to-quarter just timing of shipments, price going up, cost increases, et cetera. But I think over that medium term, that general guideline hasn't changed. Our view hasn't changed.

Okay. That's helpful. And as far as the growth you are seeing in vaccines, are any novel -- any new products we should be thinking of? Anything that's really driving that? Or is that across the entire portfolio? I'm just trying to get a little bit deeper into what you see.

Some of the year-on-year gains you've seen this year related to the business coming back in Eastern Europe, which we had talked about last year was some of the reason why we were down. So we're getting that business back as those economies improve and other things change around COVID. So that's vaccines. Nutritional specialties, Donny, can talk more about our companion animal product, Rejensa, but that's part of the growth behind nutritional specialties.

Yes. Sorry, on vaccines I mean I think it's not something necessarily that we do a good enough job highlighting. But we are -- we have a very strong portfolio of commercial poultry vaccines and we talked about we've opened up our cycle facility. We have some sales out of that now. We're actually ahead of schedule. And that's fully building up into different countries. We are doing a very good job. We have -- the number of registrations we have outstanding and looking in process for our portfolio of poultry vaccines. It's pretty large, and we're just entering new markets and getting our share. So we are a small global player, of maybe 4%, 5% of global vaccine market share. But in those markets that we participate, we're at 15%, 20%, sometimes even higher. So it's really just a matter of getting out into more markets and building our sales in those. And that's part of our underlying basis for why we believe we could do double-digit growth on our vaccine side. In the U.S., we also are growing nicely. We have the -- our swine vaccines, which are custom-made vaccines. That's not really an export business, but that's a business that we are -- we believe the market leader in and growing very nicely as we differentiate ourselves with the unique technology within the United States.

Okay. And just because you -- Donny, you just touched on Rejensa. I want to make sure we cover that before we move on. I think you've had some very positive commentary on it, Rejensa is the companion animal drug launched that you've had for a couple of quarters now. Strong product uptake, continued positive commentary. I think in the past, you've spoken to eventually being as big as nutritional specialties as in terms of size or at least, not Rejensa, but specific about the companion animal portfolio. So can you give us an update on those views and also beyond Rejensa, other opportunities to complement that other products in companion animal space? Where are the right markets for you, the right product areas?

Sure. So just starting with Rejensa. So the commentary we've given was that last year, the second 6 months double the first 6 months, and that this year, we were forecasting that we would double this year over last year. And nothing has changed in that commentary. We still believe that. And we are growing really nicely. Again, as we've talked about, Rejensa we sell exclusive -- it's an over-the-counter product, but we sell exclusively through the vet channel with one of the big 3 distributors. And we're really -- what we're seeing is that we are gaining strong share, but also growing the market, which is great. So our distributor is enjoying the growth with us. Our product is an increasingly important part of their portfolio. And we still know we have barely touched the surface with even within Rejensa where we can go, where there's a lot of vet clinics right now that still have not heard of Rejensa. And our job or our distributors job with our partnering is to get them to do it the rebuy rate of Rejensa is much higher. As we look at where our successes have been, we're slowly getting into new vet clinics, and we're much higher as far as the [ sort of ] the lack of churn. So people who use Rejensa like it and are continuing to buy it, despite the fact that it's a high-priced item. So as we look at Rejensa, part of what we're doing is we're saying to ourselves, we doesn't need to pay for ourself at this stage. So we are building our sales force fully where we're looking to kind of put people into each of the districts of our distributor partner. It could be end of this year, we expect to have 10 people on the ground. Next year, potentially more than that, double that. It would be our plan. And that will be all funded by Rejensa. But that will then give us a certain amount of coverage as perhaps the rest of our pipeline starts to come through, not this fiscal year, maybe not next fiscal year, but sooner rather than later. And the other products that we've talked about continues to progress, the ones that we're most excited about, which is not in the next couple of years is dermacare product for atopic dermatitis. We're very, very bullish about that product. Our work continues to progress forward, and the size of the market continues to grow the way it has done a great job in growing that market. One of the problems with animal health is you don't have a lot of line of vision to your competitors' pipeline. So we don't know what's going to be out there by the time we get out there. If we get out there, obviously, there's risk associated with our product hitting the finish line. But as we get -- if we were to get out there, we get very confident though that this will be a multibillion-dollar category with many fewer competitors than you see in the parasiticide. So we, on paper, our product right now, we believe, is as good, if not better than anything that's out there. And again, not sure what will be out there when we eventually do come to market if we get there. But we know what -- if we get to market, we're going to have a nice product with a nice market share. So we're very excited about that. Early product that we're looking to progress and still is exciting are 2 oral care products for their pets, 1 for dog, 1 for cats. We believe that the regulatory process for those products will be -- because their medical -- will be classified as equipment or devices, excuse me, will be a faster sort of process, and those will come to market before dermacare assuming again, that we have to finish line with them. So those will build on our sales force. And then overall, we are seeing a lot of opportunities. We are in advanced discussions with a number of companies on licensing opportunities and we have no shortage of things that we're getting a nice chance to look at. And I think we're bringing pretty smart in the way that we manage our risk and manage our costs. And as we -- hopefully, we can get further down the road, we can give more color on some of these things. And I think the analysts or the market itself will be pretty impressed with the portfolio that we're building.

Yes, it's great color, Donny. I want to make sure I got all that right. When you say you're looking at licensing opportunities, you're talking about licensing in or licensing out?

In.

In.

Okay. And as far as, again, commercialization strategy, I mean, one thing you really highlighted was that the further you get this out there in the market, Rejensa, the better the uptake you're seeing. You've got a partnership with one distributor. Is there any thought on expanding that relationship to some of the other major players or other approaches, maybe partnering with an established companion animal company?

Yes. I would say we definitely have talked about expanding distribution relationships with other companies. We're pretty pleased, though, with how it's going right now. And our preference is just to see how far this could take us. If it plateaus, then we would look at other approaches. But I think our partner is doing a nice job. So we're pretty satisfied, which is not to say that the next product that comes out, we sell through the same manner. I think, like every industry, the vet industry is undergoing change just being in the 2000s, and then obviously, COVID on top of it, creating different changes. So how we get the customer, be it the vet or the pet owner, how that looks today could be very different 2 years from now. So we're -- one of the advantages, frankly, I think we have is not having a legacy sales force allows us to do some of the -- to take some risk and perhaps approach the market a little bit differently. And -- so that's definitely something that could happen.

Okay. All right. That's really helpful. And then is it fair to say that, going forward, when you think about companion animal products, they should all be growing above your -- the rest of the Animal Health portfolio and so they should be growth accretive, but they should also be margin accretive? Once they scale up to a certain size, realize that there's going to be a launch curve there. But is that a fair way to think about it, long-term drivers to the model?

Yes. I would assume so. I mean, in general, the margins on Animal Health products are higher. Obviously, the cost of detail are higher as well, right? So on the bottom line basis, I'm not sure how much more a pet product offers to the bottom line than the production animal product. But just looking at the gross margin line, I think that's a fair statement.

Okay. All right. I'm going to remind clients that if you've got any questions, feel free to submit them via the portal, otherwise we're going to keep going. I guess sticking on the innovation side of things. Can you talk about how we think about R&D within the SG&A line? You don't break out R&D separately. So sometimes it's a little bit hard for us to tell where the investment dollars are going.

Yes. We pull it up in the 10-K, but we did highlight, I think, in a call, maybe 2 calls ago, that we expected about an $8 million to $10 million increment this year in strategic investments. So that $8 million to $10 million increment, about half of it was in companion animals, and the other portions were in the Sligo, Ireland facility, I think Donny mentioned earlier, as well as African swine fever, which you also talked about. So that's roughly the allocation of the $10 million. That brings us to low $30 million, low $30 million, about $30 million, $32 million for the year. As a percentage of sales, that's about 3% to 4% of sales, which we would feel like is probably about where we'd like to target. We'll have to see with these companion animals that Donny talked about. There is a potential for a ramp-up in development costs on those products. But if we were to incur those costs, I mean, that's a good sign that we're pretty confident we have a pretty valuable, from a commercial, perspective product on our hands. So -- but obviously, we'd have to manage that for short-term quarterly results with the medium long-term gains one of those products could bring us.

Okay. And then I had a question come in from the audience. If you could touch on Mecadox. We saw the news a couple of weeks ago, and maybe a month ago, that there's a hearing coming up. Obviously, it's something that the FDA and you've been dealing with for a number of months. So what do you anticipate we could learn from the hearing? What are next steps from here and sort of just paint the various outcomes for us and what that would mean for your performance?

Sure. I'll take that, Damian. So it's more than a couple of months. We've been in discussions with the FDA for 5-plus years, been 7 years at this point. Initially, the FDA came to us and said, "Hey, we don't think Mecadox is safe." And we went back to them and they said we're going to do something called NOOH, those are opportunity of hearing and looking to remove the job because it's not safe. We presented to them a hell a lot of data. And about a year ago now or so, they came back and said, "Okay, we're no longer saying it's not safe. We are now saying, though, because it's a potential carcinogen that you don't have a test that shows that there's no residue." And mind you this is the product that's on the market for 40, 50 years. We've had the FDA-approved test from the get-go, and now the FDA is saying that their own test is not an effective test. And so when we say -- their approach now is to say, "Hey, you don't have a test that gives us confidence that there's no residue based on the test." And so when I talk about the safety of the drug, the safety of the effectiveness of the test. They've never asked us for another test. We've gone ahead and we've said to them, A, we disagree, we think the test is effective. But if you don't agree the test is effective, there's a whole lot of other tests out there in the world. Canada has a test, Mexico has a text, Japan has a test, why don't you look at those tests. So this hearing now is adhering to hear about our current test, to hear about other tests. It's not a scientific hearing. It's open to the public. We're not exactly sure what the goal of the hearing is. Perhaps it's a reflection of the pressure that they've received from the industry or from senators, or whatever it is, saying, "Hey, this does not seem to be the way America does business as far as due process things of those nature," to say we're taking away your test and we're not going to look to create a new test, even though there's other tests out there. So maybe just addressing that. We're optimistic that they come in with the proper -- with an open [ attitude ] to the FDA. So what happens afterwards, we're not sure. I mean, they told us that they're looking to remove our test and go through a new NOOH process. We think we have a very strong case, so that's not the way that the -- that's not a science-based approach. It's not the way that traditionally this country operates with the FDA operates. So I can't tell you exactly what the next step is, other than to say this has been something going on for many, many years. And everything that we've done, every test that we produce, which we believe answers the FDA has shown that carbadox is an extremely safe and effective drug. And frankly, the usage of carbadox by the U.S. swine industry is allowing them not to use some very important -- medically important antibiotics, which again is another driver of this country and WHO, in general, of lowering the use of medically important antibiotics in the food chain. And so we don't exactly understand why the FDA is taking the approach they are, but they can speak for themselves. And all we can do is continue to be transparent, to do the work that we can do, to show that this is a very safe and effective drug that continues to serve the industry and serve the American people thats' for the last 50 years.

Okay. That's great color. I appreciate all that detail, Donny. We're about a minute over, but I'm going to try to squeeze in 1 more question, if you guys don't mind. Just a little bit thinking about a lot. As far as it comes to some of the drugs that are becoming generic or going generic or have gone generic in the Animal Health mark in recent years. A lot of chatter about [ Rejensa ] and [ Intrexon ], I know that you already commercialized some of these in select markets. Could you give us an update on that? Sort of what are your thoughts on the generic opportunity for these drugs, both U.S. and OUS and sort of where you playing out where you could put in the future?

Yes. So I think we've announced 1 small deal, frankly, in Canada. We are not ourselves looking to -- we have not filed to produce generics or to manufacture self generics. There are people who come to us and say, "Hey, you have a sales force in country X, Y and Z." And then that's, for the most part, the role that we will play, I think in the United States, it's pretty well covered with the existing players. So I don't see us necessarily having a role in the U.S. market. But there's probably some small singles and doubles outside the U.S. that could potentially be something that we do.

Okay. That makes sense. Great. I think we're out of time. So I appreciate you joining us today, Damian, Donny, thanks again. Great to see you as always. And thanks, everyone, for listening. And I hope you enjoy the rest of the conference, rest of your meetings.

Great. Thanks a lot, Michael.

Thanks, Mike. Appreciate it.