Phibro Animal Health Corporation

Good morning. My name is Chantal, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fibro Animal Health Corporation first quarter 2022 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Damian Finio, CFO, you may begin your conference.

Thank you, Chantel. Good morning, and welcome to the Fiber Animal Health Earnings Call for the quarter ended September 30th, 2021, which is the first quarter of our fiscal year 2022. My name is Damian Finio, and I am the Chief Financial Officer of the Fibro Animal Health Corporation. I'm joined on today's call by Jack Benheim, Fibro's Chairman, President, and Chief Executive Officer, and Daniel Benheim, Director and Executive Vice President of Corporate Strategy. On today's call, we will cover financial performance for our first fiscal quarter, as well as revised financial guidance for our fiscal year ending June 30, 2022. At the conclusion of our opening remarks, we will open the lines for questions. I'd like to remind you that we are providing a simultaneous webcast of this call on our website, pahc.com. Also, on the investor section of our website, you will find copies of the earnings press release and first quarter form 10-Q filed with the SEC yesterday, as well as the transcript and slides discussed and presented on this call this morning. Our remarks today will include forward-looking statements and actual results could differ materially from these projections. For a list and description of certain factors that could cause results to differ, I refer you to the forward-looking statements section in our earnings press release. Our remarks include references to certain financial measures which were not prepared in accordance with generally accepted accounting principles or US GAAP. I refer you to the non-GAAP financial information section in our earnings press release for a discussion of these measures. Reconciliations of these non-GAAP financial measures to the most directly comparable U.S. GAAP measures are included in the financial tables that accompany the earnings press release. We present our results on a GAAP basis and on an adjusted basis. Our adjusted results exclude acquisition-related items, unusual, non-operational, or non-recurring items, including stock-based compensation and restructuring costs, Other income and expenses are separately reported in the consolidated statements of operations, including foreign currency gains and loss of net. And lastly, income tax effects related to pre-tax adjustments and unusual or non-recurring income tax items. Now, let me introduce our Chairman, President, and Chief Executive Officer, Jack Benheim, to share his opening remarks, which will include his perspective on FIBRO's first quarter financial performance and revised financial guidance for our fiscal year 2022.

Jack? Thank you, Damien, and good morning, everyone. Let me start by saying that we are most encouraged by the 10% growth in both our consolidated net sales as well as in our animal health segment. Growth in the animal health segment was driven by 6% growth in the MFAs and other and even stronger growth in nutritional specialties and vaccine product lines, which grew 10% and 25% respectively. Overall, our first quarter financial performance was in line with our internal expectations. While we were encouraged by our sales growth, our adjusted EBITDA reflected a decline of 8%. Our SGA costs were up because, as discussed in our last call, we're committed to increasing our incremental investments in strategic initiatives to fuel future growth. but also driven by an increase in compensation-related costs, including travel. I have to say it's good to see our sales team getting back out there to visit customers and attend conferences face-to-face. But with Fibro and other companies, I'm really feeling the pressure is on gross margin. Before I speak more to the pressure on gross margin, I was also very pleased to see the start of a return on one of our key strategic investments. The vaccine facility in Sligo, Ireland, As I said earlier, vaccine sales grew 25% in the first quarter. Part of what drove this impressive growth is the fact that we recorded our first sales from slide up, a very important and much anticipated milestone that we reached ahead of schedule. I look forward to the incremental sales and other opportunities this new vaccine manufacturing facility presents to our company. I'm also pleased to report that our companion animal development pipeline continues to progress nicely. Shifting back to gross margin, This is where we are really feeling the pressures because supply chain and labor challenges, among other things, persist. These challenges clearly had an impact on our first quarter profitability, reflected in the 270 basis point consolidated gross margin decline in comparison to the same quarter last year. While we raised prices of select products and realized increased volumes, these increases did not fully compensate for the higher cost of freight, labor, materials, and unfavorable currency movement. Combined, these items more than offset improvements in volume and price and reduced first quarter margins. Subject to normal competitive conditions, we will continue taking steps to adjust pricing to reflect changes in cost and pass through incremental freight costs in the form of a surcharge. the benefit of which should be realized primarily in the second half of the current fiscal year. Because of these market dynamics and the actions we've taken and will continue to take, we are revising our financial guidance. We are raising full-year net sales guidance from a range of $840 to $870 million to a range of $860 to $890 million. However, we are maintaining our previous issue adjusted EBITDA guidance for $110 to $114 million. Our revised financial guidance reflects that we will continue to focus on what we can control and that we are committed to taking the actions needed to maintain the company's profitability. But let's keep in mind that COVID-19 variants remain a risk. Vaccine and booster availability and administration varies, and the virus continues to have an adverse impact on the economies of many of the countries where we sell our products. As the economic impact varies, the strength of the respective currencies opposite the U.S. dollar also varies. In addition to adding pressure to gross margin, this variability impacts comparisons of actual results of prior periods, our actual results versus our projections and our projections going forward. As many of you know, I have been in this business for a few years, but some dynamics occurring in the marketplace are at first even for me. We've seen frequent shipping delays and variability, yet carriers are raising prices. We're seeing a shortage of qualified workers, while the workers that are available can demand a higher wage. We're seeing fluctuations in the value of foreign currencies relative to the U.S. dollar, yet hearing those economies are recovering. The economic effect of the COVID-19 pandemic has been difficult to predict and continue to persist. Overall, our first quarter financial performance was in line with our internal expectations, and I'm encouraged by our top-line sales growth across all segments, especially animal health. and I'm also pleased about the first sales out of the facility in Slido. We are focused on what we can control and committed to taking the actions needed to maintain the company's profitability despite the continued COVID-19-related challenges. Now, let me hand the call back to Damien to review our results and discuss in more detail how we plan to improve margins going forward. Damien.

Thanks, Jack. I will start with consolidated financial performance on slide four, then cover segment-level performance, key balance sheet metrics, and conclude with a review of our revised financial guidance for the full fiscal year 2022. And as Jack mentioned, I will provide a bit more detail related to the animal health adjusted EBITDA margin this quarter and how we're managing and plan to continue managing the evolving market dynamics. Consolidated net sales for the quarter ended September 30, 2021, were $214.7 million, reflecting a 10% increase over the same quarter one year ago. This increase was driven by improvements in each of our three business segments and our four regions. Gap-based net income and diluted EPS declined 47% versus the same quarter a year ago. The decline was driven by the increased cost that Jack spoke to earlier and an increase in selling general and administrative expenses, which was related to our incremental investments in strategic initiatives and increased travel-related costs. But the primary driver of the decline in the gap-based metrics is a $5.8 million unfavorable change in foreign currency gains and losses, which is reported below operating income and driven mostly by the effect of translating intercompany balances to the U.S. dollar for reporting purposes at the end of a reporting period. After making our standard adjustments to GAAP results, including acquisition-related items, foreign currency movements, and one-offs, first quarter adjusted EBITDA, adjusted net income, and adjusted diluted EPS were down 8%, 6%, and 6%, respectively. These declines were driven by declines in animal health gross profit and an increase in selling general and administrative costs, offset partially by strong performance in our mineral nutrition and performance product segments. Moving to segment-level financial performance on slide five, I'll start with first quarter financial performance for our largest segment, animal health, which includes three product lines, namely MFAs and other, nutritional specialties, and vaccines. Net sales for our animal health segment increased 10% versus the same quarter prior year. Within the animal health segment, we reported a 6% increase in MFAs and other versus the same quarter prior year. This was driven by stronger international demand, primarily for poultry and cattle products in the Latin American and Southeastern Asia regions, partially offset by timing of certain domestic and other international customer orders. Ten percent growth in nutritional specificities, which was driven by strong international growth in dairy products. And lastly, a 25 percent improvement in vaccine net sales, driven by growth across all major markets, but primarily stronger demand in Eastern Europe and India. In terms of profitability, animal health adjusted EBITDA was $27.6 million, a decline of 8%, driven by lower gross profits and increases in SG&A costs, reflecting the challenges that Jack spoke about earlier on the call. That said, I wanted to share how we're looking at top and bottom line first quarter performance of our animal health segment. Please see the schedule on slide 6 for a reconciliation of animal health fiscal year 2021 first quarter sales and adjusted EBITDA performance versus this year's first quarter performance. In simple terms, net sales are up while adjusted EBITDA and adjusted EBITDA margin are down. Note, because we do not report gross margin by business segment, I'm using adjusted EBITDA margin here as a proxy for the gross margin pressure that Jack mentioned. And as you can see, the animal health segment adjusted EBITDA margin decreased 380 basis points. from 23.4% to 19.6%. In the first quarter, the three product lines within Animal Health each posted incremental net sales, which combined totaled $12.6 million. MFA's and other contributed $5.6 million, nutritional specialties contributed $2.8 million, while vaccines contributed $4.2 million. This $12.6 million of incremental sales drove incremental animal health adjusted EBITDA of $5.3 million. $2.7 million and $2.6 million were attributable to price and volume, respectively. The $5.3 million of incremental adjusted EBITDA on the $12.6 million of incremental net sales equates to a 42% gross margin, which is roughly in line with what we'd expect. However, $6.7 million of incremental cost of goods, inclusive of labor, materials, and freight, coupled with unfavorable currency movements of $1.6 million and incremental selling general and administrative expenses of $1.1 million, driven by those investments in market expansion initiatives and sales and marketing-related travel costs, combined to more than offset the improvements in volume and price. So on a net basis, both adjusted EBITDA dollars and margins declined relative to the same quarter in the prior year. And although not called out separately on this reconciliation, there's a bit of product and geographical mix impact embedded in each of these reconciling items. Although our non-gap adjusted results exclude the foreign currency gain and losses, we do not typically call out the impact of currency movements on our reported gap-based gross profit or operating income results. However, we wanted to share our estimate of these impacts with you today as we believe it helps to provide further clarity on first quarter animal health financial performance. Subject to normal competitive conditions, we have and will continue to take steps to adjust pricing to reflect the changes we're seeing in costs and pass through incremental freight costs in the form of a surcharge. These tactics take time to go into effect, and of course, some of the improvement ends up in inventory and doesn't work its way through the P&L until the product is sold. So generally speaking, our assumption is that we'll realize the benefits of these actions primarily in the second half of this fiscal year. Okay, hopefully that helps to better explain the first quarter financial performance of our animal health segment. Now let's move on to first quarter financial performance for our other business segments on slide seven. Starting with mineral nutrition, net sales for the first quarter were $54.4 million, an increase of 6% versus the same quarter prior year, driven by increased average selling prices, partially offset by lower volumes. Mineral nutrition adjusted EBITDA was $4.5 million, an increase of 49%, and reflects an improvement in adjusted EBITDA margin of 240 basis points, driven by increased average selling prices partially offset by lower volumes. The strong financial results posted by our performance product segment last fiscal year continued into the first quarter of this fiscal year. Net sales of $19.2 million for the three months ended September 30, 2021, reflect an increase of 25% over the same quarter prior year, driven by strong demand for copper-based products coupled with increased selling prices correlated with underlying raw material costs. The increased gross profit drove $2.1 million of adjusted EBITDA for the quarter, an 8% increase versus prior year, same quarter, and an adjusted EBITDA margin of 11.1%, which is a 170 basis point decline from a year ago. Lastly, corporate expenses increased 9% versus the prior year as planned due to incremental investments in strategic initiatives and higher compensation-related costs. Turning to key capitalization-related metrics on slide 8, free cash flow, which we define as cash flow from operating activities, less capital expenditures, for the 12-month period ending September 30, 2021, was $21.1 million. Our gross leverage ratio, calculated by dividing total debt of $406 million by trailing 12-month adjusted EBITDA of $106 million, was 3.8 times at the end of the first quarter. In terms of liquidity, we had $234 million available as of September 30, 2021. This includes cash and short-term investments of $97 million and $137 million of unused and available revolving credit. Now, as a reminder, the accessibility of available revolving credit is subject to leverage ratio limitations outlined in our loan agreements. Lastly, consistent with the past several quarters, we announced a quarterly dividend of $0.12 per share, or $4.9 million in aggregate. All right, that wraps up our opening remarks on our first quarter financial performance, so let's focus now on revised financial guidance for our fiscal year 2022. As Jack and I both mentioned previously, we're taking actions to adjust pricing and pass through certain incremental costs subject to normal competitive conditions. As a result of these actions, we are raising our full-year net sales projections by $20 million, from the initial range of $840 to $870 million to the revised range of $860 to $890 million, which, as revised, implies a full-year growth rate of approximately 3% to 7% and a 1% to 6% growth rate for the remaining three-quarters of our fiscal year 2022. These projections assume growth for each of our three business segments, but driven mostly by animal health. specifically our nutritional specialty and vaccine product line. We are maintaining adjusted EBITDA guidance in the range of $110 to $114 million. This implies a full year growth rate of 2% to 6% and a 5% to 9% growth rate for the remaining three quarters of our fiscal year 2022. We are still planning to spend a year-over-year incremental $10 million on investments in strategic initiatives relating to our companion animal development pipeline, the facility in Sligo, Ireland, where work continues despite recording our first sale from the facility this quarter, African swine fever vaccine development activities, and the cost of ongoing product registrations. We are maintaining our adjusted net income projections in the range of $50.7 million to $53.3 million and projected adjusted diluted earnings per share in the range of $1.25 to $1.32. Our revised guidance reflects the projected adjusted EBITDA margin of 12.8%, which is comparable to the 12.9% we realized in the prior fiscal year. Lastly, on a GAAP and adjusted basis, our revised guidance assumes the return to a normalized effective tax rate ranging from 29% to 31%, consistent with guidance provided previously. To reiterate what Jack said, we are focused on what we can control and committed to taking the actions needed to maintain the company's profitability despite the continued COVID-19-related challenges. That concludes our opening remarks. Chantel, could you please open the lines for questions?

At this time, I would like to remind everyone, in order to ask a question, press star, the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Erin Wright with Morgan Stanley. Your line is open.

Great. Thanks for taking my questions. Across what categories are you seeing some of the supply chain headwinds and break costs? And is this across the board or across specific subsegments? And then are you seeing competitors implement surcharges or associated price increases as well?

So that's a very broad question, Erin, but it's a great question. Obviously, we're hearing what everyone's reading in the papers. Freight rates, ocean freight rates are up dramatically across the board and in all markets. So, we know everyone's focusing on freight from the far east of the United States, and that's up dramatically. We've seen rates go from $4,000 a container to $18,000 a container. But It also is true for ships coming from South America, the United States. There is just this great imbalance around the world where the containers are, where the boats are, and also the ability of the companies to charge more. The surcharge we're seeing more in the U.S. and in other markets of delivery of sort of finished goods from our factories to the customers. And that's driven by some labor shortages. That's driven by increased energy costs, oil and diesel costs, et cetera. And there we're seeing and we're able to pass on. It's sort of a normal condition in the U.S. to have surcharge, oftentimes freight, but now just tied to various increases. So that's a phenomenon here. And, you know, again, we're hearing from everybody. And, you know, our customers see it on products that, you know, they're importing themselves. So there's not that difficult an ability to pass on these higher costs.

Okay, great. And then could you give us an update on the underlying demand trends and performance across the MFA category? Are you seeing certain pockets of growth that you would call out? And then also is the regulatory environment around that category relatively status quo at this point? Thanks.

It's, you know, some of it, again, remember last quarter, is just the recovery from COVID around the world. Some countries, obviously, the U.S. has recovered almost 100%. Some markets, even the Far East, are not fully recovered. They were seeing some growth. So part of it is the continued recovery. The demand is strong everywhere for protein. And so I wouldn't pick on one market specifically.

Okay, great. Thank you.

Your next question comes from Michael Riskin with Bank of America. Your line is open.

Great. Thanks for taking the question, guys. I have a couple quick small ones. First, I just want to follow up on something Aaron brought up in terms of the surcharges and the price raises and whether your competitors are doing the same. Are there any areas where you're worried that it could hurt demand or you could see customers switch to alternatives? And how quickly would you be able to sort of adjust and fine-tune that level of surcharge or the level of price raise if you start seeing that? You know, is there any communication with your customers now to sort of gauge their willingness to absorb the cost? Just talk us through those dynamics.

Hi, Michael. No one wants to see price increases. No one wants to see price increases. As you know from many, many times of talking, we're in direct contact with all of our customers. We're either selling direct or we're promoting the product in markets where we use distributors. So it's not like there's something anonymous. We're not like listing something on Amazon and don't know exactly what the results are going to be. So we're talking all the time. and I believe our customers are seeing the same requests from across the board. Nothing here that we've mentioned is unique to us. So one would resist. I don't blame the customer for resisting. And we'll work with the customers. Again, it has to fit into the timing. You know, sometimes we're trying to raise prices where we have understandings that, We're going to keep prices for a year or for six months. So that requires, you know, more talk, more negotiations. But overall, there's a great understanding across the world that costs have gone up, costs are going up. So it's not that difficult time to raise prices.

And maybe I could just add to that. I mean, there's two tactics, right? One is passing through some of the costs. We use shipping as an example in the form of a surcharge. The other is a price increase. I mean, keep in mind, Michael, we're four months into our fiscal year now, so we've already done some of this in the first quarter. We're doing it as we speak, and it will continue. I think generally speaking, you know, we're not the only ones doing this, as Jack said. There's other price increases. Others are passing through freight. So we're certainly not standing out as an outlier. And, you know, from a customer's perspective, they may be more willing to take a freight surcharge than they are a price increase because a freight surcharge may be more temporary. And in those instances, you know, it will vary by customer, by region, by product. But that's the way, you know, we're looking at, I think, using these two tactics to help improve gross margins, which is reflected in our updated guidance for the year. Okay.

Okay, thanks. That's really helpful. And maybe if I could ask a follow-up on China in particular and African swine fever situation there. We've heard some very conflicting reports and the data points continue coming out mixed in terms of the status of the recovery and the status of demand. I'm just wondering if you could provide an update on what you're seeing on the ground and what your expectations are for China as a whole this year, sort of as you think back to where it was a couple years ago pre-ASF. How close are you to a full recovery?

So what we've done... since um we've lost some registration in china which we as we said before we have reapplied for and it's you know sort of held up in some bureaucracy it's held up on the fact that china is still looking to do a get zero covered which means they shut down cities or buildings and it's you know this week and it wasn't that way last week so the re-registration of our virginia product is going more slowly than we had hoped. But in the meanwhile, we shifted our business in China into a nutritional business, concentrating on the dairy market. And there we've seen the sales growth. So again, that's not answering the question of what's happening to the pig market there.

And I can add, again, I think moves specific to Asia Pacific, the numbers we posted today reflected a 25% growth in sales. The combination of volume and price, and the volume portion of that, some of the market share, and we recognize that a portion of it is also recovery compared to the same period prior year. But we saw 25% growth. We think that sector will continue, or that market region will continue to grow. post-gains over the remainder of the year, and we're seeing increases in all regions. So the U.S. is up 6%, Latin American Canada is up 13%, and the EU and MENA is up 15%. So we're seeing increases across all regions, across all product lines, and that's assumed in our guidance going forward.

Right. Great. That's really helpful. Thanks, Jack, Damian.

again if you would like to ask a question press star then the number one on your telephone keypad your next question comes from david westenberg with guggenheim securities your line is open hi um thanks for taking the question uh amazingly only two people out of me and i still uh i still get all my answered questions are that they still got all my questions but i'll try to ask things a slightly different here um so first in in kind of in regards to the pricing increases Can you kind of maybe give us a sense of the price increases or the magnitude of the price increases relative to the normal year? So, you know, if the normal year is 1% to 2%, is the price increase going to be 3% to 4%? Or is it going to be somewhere in the magnitude kind of higher than that?

So, David, we don't typically – we're not a company that just raises prices across the board on the same day every year. So our price adjustments that we refer to and what we've done in the past are more market specific and they're based on competitive market conditions at the time. Rather not comment on whether they're single digits or double digits. Again, things will vary across products across countries.

Can I maybe then – I mean, you are mentioning that the industry as a whole is kind of raising prices. So I don't know. Maybe you just don't have that number or a sense on that number. But is there – kind of an industry aggregate price increase that is, you know, a certain percentage magnitude higher than normal. I'm just trying to get a sense of the exact same question that everyone else has been getting at, which is how much different of what you're doing is different than what everyone else is doing. I mean...

We're in a competitive business. Everyone, you know, figures out what they need for themselves and goes to the market. The market, you know, adjusts, accepts it or doesn't accept it. Dynamics of competition. You know, I think just to reiterate what I said before, everyone is seeing cost increases across the board, and everyone is going to do what they need to do, what they have to do, or what they can achieve to get their prices up.

Gotcha. And maybe I'll just do the last question on the companion animal business. I mean, looking out, you know, five, ten years from now, I mean, do you see this as a definitive second stool to the Fibro Animal Health story? Or is this just kind of, you know, you think you have good products and you can sell one off, but the heart of Fibro is a livestock company?

Hey, David. It's Donnie. So I think what we've talked about in the past is not necessarily a second leg of the stool, but a fourth leg of the stool within our animal health division or segment. So, you know, you look at MFA and others, which is the largest. We have nutritional specialties and vaccines. You know, we anticipate that, you know, nutritional specialties or vaccines is probably a good proxy for where we'd like to see the companion animal segment within, you know, the time period that you mentioned.

We said in our original guidance, David, that regents with sales would double in fiscal year 22 over fiscal year 21, and that same assumption is in the revised guidance that we gave today.

Thank you, guys.

There are no further questions at this time. Damian, I turn the call back over to you.

All right. Thank you, Chantel, and thank you, everybody, on today's call for your time, attention, questions, and interest in Fibro Animal Health Corporation. Hopefully, we were able to provide the clarity needed, but as always, feel free to reach out to us via the Investors section of our website should you have any further questions. Have a great rest of your day, and please continue to stay safe. Thank you.

This concludes today's conference call. You may now disconnect.