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

Okay. Good afternoon or good morning, sorry, everyone. My name is Erin Wright. I'm the health care services and distribution analyst at Morgan Stanley. I'm pleased to have Phbro's CFO, Damian Finio, with us today as well as Daniel Bendheim with him as well. And Phibro is one of the leading production animal pharmaceutical companies globally, and we're happy to have you here. So thank you.

Thanks for having us.

Thank you.

I'll start out with some disclosures. So for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, I think we'll get started with Q&A, if that works for you.

Sure.

So let's talk about a little bit of your expectations for the year. Your guidance expectations call for 2% to 6% top line growth, 11.8% kind of EBITDA margin. Can you break out a little bit about what you're seeing in of volume versus pricing? I'm sorry, we're getting right into it here. But if you can kind of break down the drivers, that would be all right?

I'll take that one. So let's start with baseline performance. So we're a June 30 year-end, as you know, we just gave guidance a few weeks ago in our annual earnings call. Last year, in year ending June 30, 2022, we ended the year at $942 million of sales. Our guidance for fiscal year '23 is $960 million to $1 billion of sales. If you take the midpoint of that, just use that for a rough math, about $980 million. It's about a $40 million increase year-on-year in sales. It's a 30% margin. That's about a $12 million increase in bottom line. So we started bottom line. Last year, we did $111 million. Adding that $12 million would get you to $123 million. But we also mentioned when we gave guidance that we're increasing our investments in the future about $8 million. To take that $8 million off your $123 million, you're at about $115 million, which is right in the middle of our guidance for fiscal year '23, which is $113 million to $118 million of adjusted EBITDA. Moving down to earnings per share, et cetera, and what goes on below the line on EBITDA. I'll start with net income. In the current year -- prior year, we had a foreign exchange gain we don't forecast gains or losses in our guidance. So you have to strip that gain out of the net income, so you're starting out a little short. If you look at interest, we have about $450 million of debt, 2/3 of that or about $300 million is under an interest rate swap. So we moved to a 0.62% fixed rate rather than floating with LIBOR or what would eventually become SOFR. So there's a little bit of an increase in interest expense. Taxes, maybe a little bit of favorability in the fiscal year '23 numbers, not much. And then depreciation and amortization has ramped up a little bit year-on-year because we've continued to spend capital expenses more in line with trying to increase manufacturing capacity as we have manufacturing sites around the world. So our guidance on bottom line net income and EPS is a little bit lower than the guidance that you'd see on EBITDA or in sales.

Okay. Great. That's helpful. I wanted to kind of get that out of the way first. And then let's take a step back and talk a little bit about fundamentals in livestock. And can you -- how would you characterize some of the key trends that you're seeing across your livestock categories, including ruminant, swine, poultry and aqua?

I'll take that. So the protein industry in general is doing well. I think almost all of our customers across different industries are profitable. Of those that you mentioned, I think swine has a little bit of an issue right now. They're probably a little bit negative for the next few months, turning back positive. But cattle is making money, Poultry is making money, dairy is making money. For everyone, the prices that they're selling their products are elevated, but their costs are elevated as well. But for the most part, the industry is pretty healthy, and you kind of see that reflected in how those companies are doing on their P&L to the extent that they're public, et cetera. So it's a good place to be the protein industry right now.

Great. And can you discuss a little bit more about what you're seeing from a macroeconomic perspective, how that's embedded into your guidance expectations as well as how that can influence kind of livestock demand trends?

Yes, going to start?

Sure.

And also, I guess, breaking it down by geography is probably important to some extent.

All right. A couple of things there. So last year, we said we were growing across all species all countries and all business segments. So it was good to see growth across all segments. When we look at some of the headwinds that we talked about, they're the headwinds that most other companies are facing too. So there are still some labor shortages. There are input cost increases. If you look at our guidance, fiscal year '23 versus fiscal year '22, it implies consistent margins year-on-year. But recognize that when costs go up or go down, we had a significant inventory build the last year or 2, and that's where some of our cash has gone is into working capital. We've had that higher inventory levels, both to fuel growth on the top line, but also to manage any supply chain disruptions. And given our sales growth last year, was well above our initial guidance. It was driven by price increases but also by volume and being able to keep those customers and keep filling orders, et cetera.

And can you speak to your ability to continue to pass on price? I know that some of these surcharges that you initially talked about. I mean, are your competitors responding in the same way? How is the response from your customer base and your ability to continue to do that?

Yes. So our growth on the top line historically has probably been driven more by volume than price. We would take a modest price increase here and there and as competitive conditions allow. I'd say in the last year, given the inflationary environment we're in, prices played a bigger role. But even in our fiscal year '23 guidance, the majority of the growth is volume. Let's say, maybe 2/3 to 3/4 is volume and the remainder is price. Going forward, we'll continue to raise prices where competitive conditions allow. It really depends on the product, the market whether it's a price increase or a freight surcharge. It depends. The price increase tends to be a bit more sticky than a freight surcharge. So depending on the relationship with the customer and what the competition is doing, et cetera. Those decisions are made more out in the field, but it's a combination of those 2 things to try to maintain margins.

And so -- and then -- more broadly, can you talk about the durability of your end markets during kind of varying economic environments? What you saw in the past, and I know you're relatively newer, but past the economic cycles in terms of underlying livestock demand?

I think in general, protein people need to eat. So they're going to continue to eat. Historically, there's been a trading down, right? So this crab maybe doesn't worry about the price of a steak. But a lot of people do trade down. So you go from the Grand Hyatt to the Sheraton. And...

That was a good one.

So I think poultry is a better place to be. It's where historically, when the economics get tough, people move to poultry or even down to fish is the best feed conversion, right? So that's the underlying mechanism here is given a bushel or whatever it is, how easily can the animal turn that feed into protein -- into meat on the bone. So poultry is much more efficient than is cattle, and that's why chicken will be cheaper. So I think historically, you'll see a move into poultry. It's hard to say though. I mean, just because people are -- and again, this is getting into your business more than ours. People seem to be flushed with cash. So we haven't seen it necessarily. There might be a trading down from a brand to a non-brand. But from our perspective, we don't see that. right? Because the chicken growing up doesn't know that it's a purdue chicken. So it's from -- we're not -- and this is not an area that we have a lot of insight in nor do we have a lot of concerns truly on how that develops. As a holistic approach for a company, we aim to be agnostic. We aim to being every species, and we're not there, obviously, in every geography. But we are in the major species and in the major geographies. So if economics get tough in Brazil, but they're stronger in the U.S. or someone exports to rush or other people don't export to Russia or whatever it is. At the end of the day, our products are in those markets that are feeding those people.

Okay. Got it. So let's take a step back, and I remember back during the IPO process, part of the story was that you have a core MFA business where you can leverage relationships, but then you also have a nutritional specialty and vaccine business, and I'll exclude the other businesses for now. But like just talking about that core animal health. And it was about growing nutritional specialties, growing vaccines as higher -- faster growing, higher-margin businesses that should kind of lift the overall growth and profit profile of the consolidated business. So where are we at in sort of that being part of the strategy? And how do we think about the long-term growth profile for each of those Animal Health segment?

I'll take that. Yes. So just to ground everybody. So we have 3 business segments. Animal Health is our biggest. It's about 2/3 of the business, then we have Mineral Nutrition and Performance Products. If we look within Animal Health, the biggest 2/3 of the business, there's MFAs and others, as you mentioned, there's nutritional specialties and there's vaccines. MFAs is about 60% of animal health. Vaccines, the smallest, call it, 8% to 10%, and then the difference is nutritional specialties. MFAs and others has been -- is -- we're less concentrated in that than we were at the IPO. Just so people are aware, we went IPO in 2014, so it's about 8 years ago. We have less concentration in MFAs, Donny could probably explain more of the details about that. Nutritional Specialties, we did an acquisition in 2019, Osprey direct-fed microbials probiotics -- that's part of what's fueling the growth in nutritional specialties. We also have our 1 companion animal product, Rejensa, which is growing nicely, which is also rolls up into nutritional specialties. And then we have vaccines. We've talked a lot about a new vaccine facility in Sligo, Ireland, which opens up new markets to us. And we're also making investments in vaccine manufacturing outside the U.S. going forward. So of those 3, what are the bigger drivers? It's nutritional specialties and vaccines. We typically say like low double-digit percentage growth, whereas MFAs and others more grows with population or geographic expansions. It's more like single-digit percentage growth. So that's roughly what's implied in the fiscal year '23 guidance and also what we saw in our actual results in fiscal year '22.

And I think you used to give some sort of overall as a business within the Animal Health segment, how much your products can improve productivity across livestock. Do you have like a general framework or something that you can give the audience here something about what your products actually do to help enhance the productivity?

Well, I think the rule of thumb in the industry, and this just doesn't just apply to fiber, but the rule of thumb is a 3:1 return on a product for a customer. So that's kind of the basis as -- especially when you introduce a new product, as a product becomes more established, maybe we'll try to go after more than that 3:1. The rationale behind it historically has been these are live animals. These are life things. There's so much going on that it's hard to figure out what the noise is versus what the product impact is, which is why you kind of require an outsized return to the producer for him or her to kind of be convinced that the product itself is doing the work. So that still is -- when we introduce a product, that's kind of the rule of thumb out there that you seek. But I think as times change, people adjust.

Okay. And then the regulatory environment, could you give us an update on Mecadox, but also just bladder restrictions on medicinal feed at it is? And has a lot of that played out in most geographies at this point in your view? And where does that stand? Or is there any isolated areas that you're focused on from a regulatory standpoint?

Yes. So I'll answer the second part of your question first. So on the antibiotic side, I would say we're in the eighth inning of regulatory. Almost every major market has made the changes that they're going to make. And harking back to your question a little while ago about, hey, we were going to MFA nutrition on vaccines, what has played out, we probably had bigger hits to the MFA business than we anticipated 8 years ago, and we have -- but we have grown in nutritional and the vaccines as we laid out. So the MFA has taken a hit over the years. We've lost more or less the U.S. market. We've lost the Chinese market that we're still trying to get back into that one. And everyone else that matters has made changes. A lot of the places made changes that were as we anticipated, did not severely impacted our business or allowed us to have label changes that allowed us still to be competitive. But in other areas, the impact was greater. And in those areas where you have a greater impact on antibiotics true fully there's more of a need for nutrition, those are vaccines. So you'll pick up there. But specifically with the antibiotics, I think there's probably a few more countries to play out. But overall, I think we've seen where it's going to be. And from a big point of view, again, chicken, poultry, it's easier to raise a chicken without antibiotics just based on the fact that they're alive for 40 days and you can get through. On the cattle side, like a product, an animal at the life for 2 years or more, it's much more difficult. So -- that's kind of where it's laid out across the world is the poultry antibiotic business is tougher than it once was. The beef side still exists. And if you look within kind of the species numbers, we've shifted a lot of our MFA business 2 ruminants from poultry. So that's kind of been the historical trend. I think swine somewhere in the middle there. And then -- regarding your question on Mecadox really, there has not been any change since our last update. The FDA had a public hearing. It was -- we appreciated it. At the same time, it's not what they needed to do based on what regulatory -- historical regulatory expectations and necessities would mandate. So I think they're truthfully, it's in their cart. So we're waiting. It's been a while. We continue to show the fact that this has been a product that's been out there for decades. It's safely used is important, prevents truthfully the use of medically important antibiotics and it is important to the U.S. industry. And I think there's U.S. industry support and recognition that the FDA is -- went down this pathway without having full information for whatever reason. And I think today, my guess is just would not have been brought today if the information that's available today would have been available when they brought this hearing.

Okay. Great. And then let's talk about China. Can you give us an update on China and your potential reentrance into that market? And will this be an important market for you 5 years down the road?

So I mean, that will be an important market for us, no matter what. But China, just to recall, was a $40 million market for us on antibiotics, which today, we're selling 0 of antibiotics in China. We are now selling millions of dollars worth of nutritional products, but not antibiotics. So we've shifted there. We are seeking to reenter the Chinese market. Truthfully, the goalposts have moved on us as we've gone through it. So I think our level of confidence of being able to get back in is not where it was a couple of years ago. We're still trying. We still believe that we should. From the get-go, we've known that if we were to get back in, it wouldn't be at the full $40 million level. So it would be significant, but not at that level. That still remains our hope. It's not built into any guidance for this year. So we're not expecting it to happen this year. And we continue though to look at other avenues within China. Obviously, we're working on the ASF vaccine that we talked about. But most of our efforts as far as sales are concerned, our dairy products in the nutritional segment right now.

And what is the latest on your ASF vaccine development process?

So we have installed by COVID by not being able to get into China. So the technology is based out of China. Historically, in the beginning stages of this project, we would have people go virtually weekly to China to kind of shepherd the project and to shipper the technology with COVID that stopped. It's still next to impossible for a foreigner to get access to China today without spending a huge amount of time quarantine. So it's very, very difficult. We are looking at ways of shifting some of the research outside of China. Obviously, if you can't -- if a country does not have ASF, they're not going to let you bring it in or for most countries, let you bring it in to do work. So it's -- there's very few places in the world that you can actually do work on ASF. ASF is spreading. And it remains a problem both within China. I believe Thailand has a huge issue right now. It's been seen throughout Western Europe and wild boars. So we're nowhere near where we hope to be on the solution. I can't -- we don't know if we'll reach that. But it definitely is going slower than we would have hoped.

Okay. Let's switch gears here a little bit to companion animal and some of your efforts there. How should we think about the investments in R&D in the coming years as you ramp up across companion animal on the projects you have ongoing there, and we can get into some detail. But if you could talk a little bit about R&D efforts to split maybe that you're contributing to companion animal efforts versus livestock, for instance?

Do you want me start and then you talk about companion. So in terms of the investment I mentioned earlier, $8 million increase in fiscal year '23. If we look at how that's a little south of $40 million a year, it's called today. I think it's $38 million. It's roughly split evenly between companion animals, nutritional specialties and vaccines within vaccines is the ASF that Donny talked about. As we get closer to a commercial launch, hopefully, of a companion animal product, we would expect the companion animal investment to increase over time, but that would be good news as well. So although it may take away a bit from the short-term earnings, there is a big upside potential as we all know, in the companion animal market, which could be a game changer for us in the medium term and meaningful, certainly to a company that does about $115 million, give or take, in EBITDA. So that's why we're excited about companion animals, and that's why we're still investing in that even though input costs are high and inflation, et cetera. Maybe Donny can tell you a little bit about some of the projects in companion animals. If you want to have specific questions, Erin?

Yes. I guess, specifically on you've disclosed derm products as well as oral care products. Can you talk a little bit about where you're at in the development process? How we should think about the timing and magnitude of when these could even come to market and give us a little bit of a time line or any sort of detail on that you've kept at pretty high level in terms of your focus there?

Yes. No, I guess I had the benefit of reading your transcript of your questions as Zoetis the other day. And they also said -- the benefit of being in this industry is there is no kind of clinicaltrials.com or whatever it is on the human side so we don't disclose really that much information on the pipeline. Derma Care and Zoetis has built a tremendous franchise there. And it's a growing franchise, $1.2 billion to $1.6 billion. It's -- I would say none of this is -- the spend is in this next year. There's no expectation that we'll have any sales of either of those types of products within the next year. We -- Derma Care is going to take longer. It's still in -- back to the baseball in early innings, but we -- it's the #1 spend within our -- within the discretionary spend that Damian talked about. You can be sure that we'd be quick to kill it if it was not making progress because it is the #1 spend and we view it as a huge opportunity. Without getting into kind of the product profile versus the products that are out there, we just look at it and say, "Hey, this is a market that eventually will be a $2 billion market, huge market." There'll be more players than they are today. We know that. But still relative, let's say, to flee and tick or parasiticides or whatever it is, it's just going to be a handful of people. So if you can get a product that's at all differentiated that has FDA approval. It's going to be significant for any company. And then you layered on Phibro, which is we're starting from close to 0 on the pet side, but even as a company as a whole, a company that will be roughly $1 billion in sales, getting -- whatever number you want to throw out there in a $2 billion market where you're 1 of 5 players, it's going to be a significant proposition. So we're really excited about that. And while we're not, again, close I guess you can just take from the fact that we're continuing to spend that we're pretty optimistic that we're going to -- we have something here. On the oral care, -- those are closer only because -- if only because we believe that they will be treated by the FDA as device and medical devices, which is a much easier regulatory pathway. And we're working with a large university, lots of really good stuff there. 2 products, 1 for dogs, 1 for cats. The dog product is the lead product there as far as timing. And while the products are different, the technology being developed for the dog will also be helpful for the cat. And again, not in this fiscal year, but between that and Derma Care, that's clearly going to -- assuming success in both of them, that will hit the market first.

And I do want to give some time for questions from the audience, if you do have one, please raise your hand and we can get a mic over to you. But in the meantime, are you partnering with the derm product with any one could you partner to accelerate the process or accelerate commercialization efforts? And then -- and then a segue into that is the Rejuvenate Bio relationship with them?

Sure. So we're not partnering -- we've licensed that molecule from a European company. We are working with CDMOs, CROs, NEC, you put in front of somebody will work with them. And so we certainly have partners in that sense. What I would not be shocked about is if we got U.S. approval, which is what we're looking for, first, that we decide for European distribution to work with a partner. So that's not something that we're at the stage yet that we're talking to anyone, but it could be something that obviously does happen before we even get U.S. approval as we progress here and get closer to that hopefully, it could be something we could go out to some potential partners on. I'm glad you mentioned rejuvenate, so that's a gene therapy startup that has a product for mitral valve disease MD which is -- affects call it, 7% to 10% of dogs out there. It's something we're really excited about. So they have publicly stated that they are seeking to submit for a conditional license by the end of 2023. And we certainly hope that they hit that time line. It's an exciting market. Right now, there's no -- there are products on the market that slow the progression of MVD, but don't cure it. So it's -- the lead product, a product called Vetmedin, it works with other products. It's probably about $100 million a year of spend right now. And what's interesting from our point of view is if the progression right now has slowed and dogs that are on this product are typically alive for 2 years, it's kind of $50 million a year is what the community is spending on it. Well, if you have a product like Rejuvenate believes it does that can stop or even reverse MVD, and you take a 2-year death sentence and turn it into a 5- or 6-year extension of life, you kind of do the math of if people -- or the dog owners as a whole are spending $50 million a year. Well, that becomes a $250 million to $300 million opportunity. Now there's obviously challenges in how you have people pay upfront. This is a challenge we're seeing on gene therapy on the human side. We'll have to work on that on the pet side as well, but it's a product what's very exciting about it is you're entering a market where there's really nothing that is stopping the disease today. Again, it just slowing it. So if you can come up with a cure, it's a huge opportunity. This is mainly small dogs, so it's the Kardashians, and people who follow them. And so it's a market where you want to be, and it's -- there's obviously some affluence there and you're treating dogs that people usually will spend money to do the right thing for.

Any questions? Okay. And so in here with kind of a more margin question for Damian here, but margins have -- are still below sort of peak levels in 2018 or your fiscal 2018. Do you think they can return back to those levels eventually? And over what sort of time frame is it 3 to 5 years? Or what is contingent for instance, on some of the companion animal efforts that would be inherently higher margin once they do come to market, but how do we think about the margin expansion profile over the next, yes, 3 to 5 years?

Yes. So it's tough to compare back to 2018. So the world has changed a lot, but fiber as well. So Donny mentioned some of the regulatory challenges we had in China, just so everybody knows that was 2019. So that was $40 million of business, pretty good margin business that we've had to replace. Now going forward, we mentioned nutritional specialties, vaccines, those tend to have better margins. So the more they grow, that should help our margin profile. And again, if we hit 1 of these companion animal products, the margins are much better in companion animals as well. And that could again be a game changer not just from a bottom line, but from a margin perspective as well. So our guidance this year is roughly, like I said, consistent with last year from a margin perspective. We did build inventory at a time when costs were high, so the replenishment cost was high. So even if prices were to go down, we have to burn through that inventory before we'll start to see some of the benefits of that. But there's definitely room, I think, for improvement from a margin profile, given where we're investing and the margin profile of those products relative to the ones we had, say, back in 2018 and prior. So there's definitely an opportunity for that going forward.

Great. Thank you so much for the time. I really appreciate it.

All right. Thank you, Erin. Thank you, everybody.