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

Good morning, everyone. My name is Balaji Prasad, I'm the senior analyst for the special pharmaceutical's coverage. For continuing with our next session of the today, we have the CFO of Phibro Animal Health Corporation, Damian Finio with us. Damian, thanks for joining us today. I know you have a busy week attending different conferences, but I appreciate you joining us here.

Thank you very much for having us again, and good to see you again, Balaji.

Likewise. Damian, start with considering that most of the companies had their earnings calls recently, just requesting maybe you can highlight the key highlights from your recent earnings calls and then jump into Q&A.

Yes, absolutely. So as you know, we are a June 30 year-end. So we just reported our second quarter results earlier in February. We had a really strong quarter, strong first half of the year. Sales for the quarter were $245 million, up 5% versus the same quarter prior year. Our adjusted EBITDA was up $31 million, 6% up versus same quarter prior year. And what we talked about on the call that we really wanted to highlight was within Animal Health, which is our biggest segment, 2/3 of our company, we have 3 product categories. As you know, MFAs and other vaccine, nutritional specialties, for 7 consecutive quarters versus same quarter prior year, sales have gone up in each of those 3 categories for 7 consecutive quarters. So really, our portfolio is hitting on all cylinders across regions, across product categories. So we feel really confident in the sales line. There was a little bit of noise in our GAAP numbers, I'll address that. We took an environmental charge of $6.6 million related to a legacy site, it's our smallest segment called Performance Products, a site that we bought a long time ago out in California. The lawsuits started in 2014. It was part of what was called the Omega Chemical Sites. We were downstream from -- and in the middle of the plume, long story short, we settled out of court before it went to court in July. So although the cash needs to be paid and the settlement was made outside of court, we're glad to have this overhang behind us. So going forward, we won't need to be concerned with that any longer. It's a disclosure we've had in our SEC filings since we went public in 2014. So that's behind us. So overall, great quarter, first half of the year.

And you also reiterated guidance here. So maybe just setting aside the guidance, as we think about 2023 broadly, can you take us through the key moving pieces that you're seeing within each of your major livestocks business?

Yes. So we reiterated our guidance for sales and adjusted EBITDA. So just as a reminder, sales, $960 million to $1 billion for this fiscal year. As you can imagine, myself, employees, Jack Bendheim and the rest, we're excited for the opportunity to hit $1 billion in sales, and $113 million to $118 million of EBITDA. When we look -- and that implies a stronger second half than first half of the year, but consistent with the half year split we saw last year. We tend to start off the year a little bit slow, our slowest quarter for seasonality reasons is the quarter ending September 30. So top line consolidated sales, stronger second half and growth over the prior year. When we look at where the growth is coming from, again, as I mentioned in our half year results, it's really coming across all categories in Animal Health. And Performance Products has been pretty steady. I'd say the one segment that's down a bit in the first half of the year was Mineral Nutrition. So Mineral Nutrition, rough number is about 25% of sales. Mineral Nutrition is a U.S. business, and it does have some exposure to beef cattle in the U.S. But we've also -- that was part of the reason why we were down. Another part of the reason why we were down is last year was such a strong year, so a tough comp. And third is the customers that we sell to, because of the cost of capital and other economic pressures, we see them lowering their inventories. So there was a bit of lowering inventories as well in the second half of -- or in the first half of our year. So Mineral Nutrition was a bit behind, and Animal Health picked up some of the slack whereas last year, it was a slightly different story. Mineral Nutrition had such a strong year. So overall, across segments, with the exception of Mineral Nutrition and across product categories with Animal Health.

Fantastic. And maybe just focusing on the cattle side of things. What are you seeing within the U.S. market and maybe ex U.S.? I think last year, we had a few, again, blips with the drought situation and then of course, the continued pressure on dairy. And so what are you seeing now currently?

Yes. So just to ground everyone, about 1/3 of our sales globally is in cattle. If I break that down, 20 of those 33 points are in dairy, and 13 are in beef cattle, okay? The dairy cattle business is primarily in the U.S., and the beef cattle is primarily in Mexico and Brazil. So really different markets, different cattle. On the dairy side in the U.S., we had a decent first half of the year and expect more growth in the second half of the year. So although you may have read about things like feedlot placements being down, et cetera, that's a beef cattle dynamic, not dairy. So we don't have exposure to that. In fact, I did read earlier this morning that I think dairy cattle was up in January. I haven't seen the February numbers, but some speculation that prices in 2023 on the dairy side may come down. We like to think whether our customers are making money or not, there's always a spot for our products because our products help animals reach peak performance and stay healthy. But obviously, if there's cost constraints on the farmers, we, at times, feel impacts of that as well. But overall, dairy is U.S., and we think it will be a stronger second half. On the beef cattle side, Mexico and Brazil, I'm sure people have heard about the inability to export to China. That's the majority of the exports in Brazil. I think it's about 2/3 of the exports. You can go back to 2021, a similar situation occurred. It took about 90 days, I think, for the embargo to be lifted. If you go back to 2019, again, similar dynamic, is about 30 days. The instance we have right now, I believe, is in the fourth week. Our team is confident in the next -- in the near term it will be remediated and exports will resume. So what it would mean for us is timing really. It's just a shift from one quarter to the next in terms of sales, but not an aggregate weakening of demand. So it's more of a timing blip than anything. That's the assumption we have at the moment, knowing what we know.

Understood. And of course, swine has been an important component for you after cattle. So again, multiple moving pieces there. But can you take us through what you're seeing there within Latin America and then China specifically?

Yes. So let me start with China. So we had a product on the market in 2019, taken off market in China. Since then, we've been doing our best to try to get back into China. To be fair, I would say progress has been slow. We don't have a product back in the market in China. Asia Pacific, in general, is our smallest segment, regional segment, but it's also the fastest growing. So we have other business in other categories outside of China but in Asia Pacific. So that's China. In general, we think on the pork side, again, I think we're steady as it goes, doing pretty well in pork across regions, across products.

So with regard to China, when do you expect to get back into the market with the products, and what's causing the delay?

Yes. It's hard to put a finger on it. I would say, partially the U.S. and China relationship has been strained for some time, partially because of COVID and thankfully, the restrictions have recently been lifted, so things should open up. And partly, the registration is -- the regulatory authorities' concerns about antibiotics, et cetera. So although we continue to try to get back in the market, I'd say it's not in short term. So it's not assumed in any of the guidance we've given. Which at this point, given the June 30 year-end, only goes out another 3, 3.5 months or so.

Understood. And the question on swine again. A couple of years ago, we had multiple entities developing ASF vaccine, and we had discussed that in detail. Do you have any projects, programs there? What kind of expectations should we have on this segment?

Yes, I think we've talked about on many of our calls, at least it's come up, is the African Swine fever and some of the development work that we're doing. We continue to partner with a developer in China. Again, similar to what I just mentioned about China, I would say progress has been slowed for all the same reasons I said before. So we don't expect anything in the short term. Again, nothing in our guidance, but are still doing our best and maybe it would be something in more the medium term or 18 to 24 months is we'll know a little bit more. But it's not something that would be immediate.

Got it. And you've also been making a couple of investments in, of course, companion animal business, that's a switch -- a shift that you have been articulating, and your vaccine facility, which is coming up in Quincy. So take us through the various investments that's happening in the business right now.

Yes. So our strategic investments, and are implied in our guidance, and I think we said explicitly back in August was about $37 million for the year. That was up $8 million over the prior year or about 25%. The split of that $37 million is roughly equal between companion animals, nutritional specialties and vaccines. I'll start with companion animals. So companion animals, we've said it's more of a medium-term opportunity than a short-term. There are several projects in the mix. So we have oral care for cats and dogs, pain management, atopic dermatitis. We did a deal with Rejuvenate Bio, which I'll mention in a second; and then also a Lyme vaccine. Those first 3, dermatitis, pain management, oral care, those are big markets, $1 billion to $2 billion markets. We'll often get the question, "Can you compete with the Zoetis or the Elancos of the world in those categories?" I mean for us, if you do the math, just use easy numbers, $2 billion market, even if we had a 5% share, that's $100 million of sales at decent margins, call it, 50%. That's $50 million. Our guidance midpoint was, what, about $115 million. So even a sliver of one of those large markets is meaningful for Phibro. I think that's important to keep in mind. What's the more near term of those projects and probably the most exciting one at the moment is a smaller one, which is the deal with Rejuvenate Bio. So that is a product for mitral valve disease. The product profile that we're shooting for would make it better than what's on the market today. And mitral valve disease is very prevalent. 8% of small dogs in the U.S. show signs of mitral valve disease. If we were to be successful and launch this product, it would be a onetime vaccine. Fairly costly. But from what we understand, something that I joke, I have 2 daughters, they both have -- one has dog, and the other one wants a dog, neither of them want children. So then they would spend anything on those pets. So that's -- the market is changing, as you know, in companion animals. So Rejuvenate Bio and Scout Bio are the 2 companies leading the gene therapy for animal health. So I think it's a good sign that we have a deal for 1 product with 1 of those 2 companies. Of course, the hope is if we're successful, there'll be other products that would come down the pike, but let's start with that first one. They've said, they being Rejuvenate Bio, that they will have their filing for a conditional approval with the FDA before the end of this calendar year. That's about a $200 million market. We haven't disclosed anything more than what I've just said. But that submission would occur before the end of the year, and that would be the nearest term of our companion animal pipeline.

So that would kind of take us through a potential Q4 next year launch?

Yes. Depending on timing -- feedback and timing of feedback from the FDA. Now the other 2 categories, nutritional specialties and vaccines, again, a lot going on in both of those categories. So nutritional specialties for us includes -- that's where our companion animal sales are for Rejensa, but it's also where our probiotics business is. We bought Osprey Biotechnics, back in August 2019. That was a supplier of ours. We now own the company and have for several years. We continue to dig into that project and that process. We've moved some of the technology into our existing facilities in Brazil. So we continue to find opportunities for probiotics and for the work that they're doing in Osprey. I'm actually headed there tomorrow. So a lot going on in there, and the investments are around more the manufacturing and the technologies, et cetera. On vaccines, we have facilities in the U.S., facilities in Israel. We talked a lot about our facility in Sligo, Ireland that we acquired a few years ago. We continue to invest there. We had our first sales from Sligo, which really opens up markets in the Middle East for us primarily. We had sales in our last fiscal year. Ramp up of the vaccine facility is slow because the registrations are country by country. So we continue to slowly ramp up Sligo facility. And we're also opening up an autogenous facility in Brazil. And in fact, the soft opening ceremony is today. And that's why our management team today is there for the soft opening in Brazil. So that's exciting, too.

The impact on the vaccine facilities commissioning coming through is still going slow, especially on the EBITDA side?

Yes. I think that's correct. It's just the way that the vaccines work. Again, it's country by country. So you have to register each country individually, wait to hear back and eventually, you ramp up. But it's slow. Yes.

Kind of get back to your companion animal pipeline and programs and get a sense of where you are and everything with your medium term program, on your oral care program as of last week.

Yes. We have yet to disclose too much detail, I think, other than to say, medium-term. So -- and beyond that, we haven't said anything specific. I think as we get further along the development time line and closer to launch, we'll share information as we get closer. But at this point, we've said medium-term and haven't really said beyond that for any other projects.

Fair enough. And particularly on the pain space we are looking to license like any commercial product?

Same deal. So our license in the product that's in development, but it would be a medium-term opportunity.

A medium-term opportunity?

Yes. All the variants. With the exception of Rejuvenate Bio, which could be shorter term.

And of course, I just want to get your thoughts around Alejandro Bernal joining the Board recently for PetDx. So what's the strategic...

Yes. So Alejandro Bernal joined the Board in February. He is an industry veteran, I would say. He worked at Mars. He worked at Zoetis. He was most recently announced as the CEO and President of PetDx. So he's got a long history in companion animals, joined the Board in February. I think we're excited to have him. It's a fresh perspective. And I think it just further emphasizes our intent to grow our companion animal franchise by including Alejandro on the Board. So he joined our first Board meeting in February, already making contributions, already seeing a difference, and we're excited to have him on board.

I don't think I've ever asked you this before, but any potential interest in diagnostics itself?

I think our company has shown over the years, we're open to a lot of ideas. I think you know Jack and me. So we're always open to ideas. I think specifically, we haven't talked about diagnostic, we did say on our last call. In companion animals at the moment, given our balance sheet, some other things, we feel like let's focus on these 5 projects. If one was to drop out, maybe we'd pick another one out. And of course, we're always opportunistic. But as right now, there's nothing specifically targeting a diagnostic opportunity. But we're open.

Understood. Maybe just on the operating margin side. I think last year, we had multiple moving pieces between inflation, labor and everything else. So what are you seeing on the ground now? And how are -- how is operating in the ground now?

Yes. So I think it was about 1.5 years ago, we started to raise price. We've been pretty successful as evidenced by our growing top line sales. But over that same time, we've had modest growth on an adjusted EBITDA basis. You see it when I'd say gross margin is down a couple of percentage points. I'd say going into COVID, we were maybe at about 32%, 33% consolidated gross margin. It's closer to 30%, give or take now. There's a couple of points relate to all the things that we read about. So higher labor costs, higher input costs and freight also plays a factor. So for us, we manufacture in 17 sites. We sell in 80 countries. Some of our material, as you know, is big, bulky material, expensive to ship or slow to ship by freight or by boat, by barge. Some of the issues with the shipping lines in China to the U.S., et cetera. We've had to work through and pass-through some surcharges, expected that, and raise price where we can. But for the most part, with a bit of exception, I would say those prices -- raises were more to offset our increased costs rather than anything else. But we'd hope, I should say, too, going forward, if we see the freight -- we are seeing some freight charges come down, shipping lines open, if our prices are sticky, which we assume they will be, we should start to see some margin improvement as the economy improves going forward. Again, we haven't given guidance past June 30, but our guidance will be through fiscal year '24, would be in August when we'll need to speak to some of those things, some of those dynamics.

Sure. Well, I really need us to speak on that, but before we get there, Rejensa, latest updates on it. And at what point do you think its acquired a critical size. It's now been a couple of years that you have this product but you've not had more on the nutritional supplement side, especially to CA. What's the strategy? Is there just going to be a sole product in the nutritional specialties side?

All right. So, you are right, we've had Rejensa on the market for a couple of years. Of course, things were slowed a bit with COVID and visits to the vet clinics and, et cetera. We've seen and been very happy with the growth of Rejensa. Our guidance this year, we said explicitly that Rejensa sales would double this year versus last year. I would say, we'll come up a little bit short of that target, but still some really strong growth. We sell that through a distributor. We have an exclusive arrangement with one of the bigger name distributors who we have not disclosed, and the product continues to grow. What's interesting about that product and the approach we took, it's an OTC product, but it's only available at the vet. So you can't find it on Chewy or Petco, et cetera. And it was a way for us to keep some of those profits and revenues at the vet, and you start to build a relationship because, as you know, we're new to the space with intent to grow the franchise. So I'm not saying that model will be sustainable if we launch these bigger products in bigger markets or not, and we'll make those decisions as those products come closer to commercial launch. But right now, we're happy with Rejensa's performance and the arrangement we have with the distributor.

Great. Probably last question from me. Again, I know that you'll come out with a guidance in August. But as we look forward to the next 12 months, what are the big moving pieces between both on the positive and the negative side?

Yes. I think it will be largely driven by the macro economy. Again, we sell in 80 countries. So there's dynamics in each of the countries where we sell. But some of our bigger markets, Brazil, we'll need to see. I think it will be whether or not we see the relief from freight charges, input cost, labor and we're able to keep our pricing. And if so, our existing portfolio should grow year-over-year. And then incremental to that, it's other opportunities may be seeing some return on these strategic investments that we've made. I mentioned the facility opening in Brazil. So there should be incremental sales from there in fiscal year '24. Sligo should continue to ramp up. Maybe something will occur with Rejuvenate Bio in our fiscal year '24. So we'll need to see some of these other investments and hopefully start to get a payoff on top of our existing business growing and building operating leverage.

Fantastic. Look forward your next update then, Damian.

All right. Thank you very much for having us. Appreciate it.

Thank you for joining us, and I wish you to be productive at the conference.

All right. Thank you very much. You too.