Phibro Animal Health Corporation

Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Fibro Animal Health Corporation third quarter 2023 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 then the number one on your telephone keypad. To withdraw your question, press star 1 again. I would now like to turn the conference over to Damian Finio, Chief Financial Officer. Please go ahead.

Thank you, Regina. Good morning, and welcome to the Fibro Animal Health Corporation earnings call for our fiscal year 2023 third quarter, ended March 31st, 2023. My name is Damian Finio, and I am the Chief Financial Officer of 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. Today, we will cover our third quarter and fiscal year-to-date financial results before opening the lines for your questions. I'd like to remind you that we are providing a simultaneous webcast of this call on our website, www.pahc.com. Also, on the investor section of our website, you will find copies of the earnings press release and third quarter Form 10-Q filed with the SEC yesterday, as well as the transcript and slides discussed and presented on this morning's call. Our remarks today will include forward-looking statements, and actual results could differ materially from those projections. For a list and description of certain factors that could cause results to differ, I refer to you the forward-looking statement 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 U.S. GAAP. I refer to you 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, other income and expenses separately reported in the consolidated statements of operations, including foreign currency gains and losses 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 perspective on Fibro's third quarter and fiscal year-to-date financial performance.

Jack? Thank you, Damian, and good morning, everyone. We posted strong fiscal year-to-date sales growth. Our third quarter net sales were $246 million, which reflected 3% growth over the same quarter last year. Despite the challenging market and economic conditions, our consolidated sales growth has been driven primarily by our animal health segment and with well-balanced improvements across our three product categories. Our animal health segment has achieved a remarkable 10% year-to-date increase in net sales compared to the same period of the previous year. We are unfortunately seeing some signs of recessionary pressure in our mineral nutrition segment as our customers are seeking to reduce purchases and lower inventories. We will take steps over the next few months to ensure our inventory is better balanced for our customers' needs. Overall, we have posted strong fiscal year-to-date sales growth despite the challenging conditions. We see continued opportunities for growth in our animal health segment. As I mentioned, on a year-to-date basis, our animal health segment has achieved a 10% increase in net sales compared to last year, and this segment continues to present us with multiple growth opportunities. We have posted eight consecutive quarters of year-over-year sales growth in each of our three major product categories. From a year-to-date comparative perspective, the product categories of MFAs and other is up 9%, while nutritional specialties are up 12% and vaccines up 9%. I am especially pleased with our vaccine growth in Latin America. We recently opened a new autogenous vaccine facility in Brazil and launched commercial poultry vaccines in the region. And regarding nutritional specialties, we continue to find ways to leverage the products and technologies we acquired with the 2019 acquisition of Osprey Biotechnics. I'm also happy to report that our companion animal development pipeline continues to progress. We see companion animals as a medium-term growth driver for the company, and we will provide updates as the pipeline progresses. In terms of profitability on today's portfolio over time, margins should be improved as input costs return to historical levels. The animal health segment adjusted EBITDA margin was 20.8% for the third quarter, which is a 110 basis point improvement over last year. Although the year-to-date EBITDA margin is still 30 basis points shy versus last year, we see signs that input costs are returning to normal levels. For margin improvements to continue, input costs will need to continue to decline, and we will need to work through higher-priced inventory on hand. We are taking other actions to manage working capital more closely, which we anticipate will help to improve our free cash flow. We continue to focus on raising prices when market conditions allow, and we remain bullish on our business and our ability to grow sales, given the strong demand for our current portfolio of products and the projected demand for the pipeline of future nutritional specialty, vaccine, and companion animal products we have in development. Lastly, Fiber had a strong third quarter, And as we approach our fiscal year end, we remain confident in our full year guidance. I will now ask Damian to review our third quarter financial performance and fiscal year 2023 guidance in more detail before opening the line for questions. Damian.

Thank you, Jack. I will start with consolidated financial performance on slide four, then cover segment level performance, capitalization metrics, and conclude with a review of our financial guidance for the full fiscal year 2023. Consolidated net sales for the quarter ended March 31st, 2023, were $245.7 million, reflecting a $6.1 million or 3% increase over the same quarter one year ago. This increase was driven by improvement in our largest segment, animal health, partially offset by declines in mineral nutrition and performance products. Gap-based net income and diluted earnings per share decreased 43%, driven by higher SDA, SD&A, and interest expense, offset partially by gross profit improvements and lower income tax expense. After adjusting GAAP results for one-offs and non-recurring and or non-operational costs, such as environmental remediation, acquisition-related items, and foreign currency movements, consolidated adjusted EBITDA decreased $.6 million, or 2%, in comparison to the prior year's quarter, driven by lower adjusted EBITDA in our mineral nutrition and performance product segments, coupled with an increase in corporate expenses offset by higher adjusted EBITDA in the animal health segment. Adjusted net income and adjusted diluted earnings per share decreased 13% respectively, driven by higher SG&A expenses and taxes, offset by higher gross profit. Moving to slide five, segment level financial performance, I'll start with third quarter financial performance for our largest segment, animal health, which includes three product lines, namely MFAs and other nutritional specialties and vaccines. The animal health segment posted $164.4 million of net sales for the quarter, which represents an increase of 15.8 million or 11% versus the same quarter of the previous year. Within the animal health segment, we reported an $8.9 million or 11% increase in MFAs and other versus the same quarter prior year, driven by increased demand for MFAs domestically and in the region of Latin America and Canada. as well as increased demand for processing aids used in the ethanol fermentation industry. $3.6 million or 9% growth in nutritional specialties, driven by higher domestic demand and selling prices for dairy products, along with growth in our companion animal product, Regensa. And lastly, a $3.3 million or very strong 15% improvement in vaccine net sales, driven by increased demand and new product launches in Latin America. In terms of profitability for the segment, animal health adjusted EBITDA was $34.2 million, a $5 million or 17% improvement over the same quarter of the prior year due to higher gross profit on higher sales, partially offset by an increase in SG&A. And the adjusted EBITDA margin for the segment improved 110 basis points to 20.8%. Moving on to third quarter financial performance for our other business segments on slide six, starting with mineral nutrition, Net sales for the third quarter were $62.9 million, a $6.1 million or 9% decline versus the same quarter prior year, driven by a decrease in demand for trace minerals, the consequence of customers lowering inventory levels in the face of economic challenges, partially offset by higher average selling prices, which are correlated with the movement of the underlying raw material cost. Mineral nutrition adjusted EBITDA was $3.9 million, reflecting a decline of $3.4 million, driven by lower gross profit. The adjusted EBITDA margin for the segment was 6.1%, a decline from the prior comparative period. Looking at our performance product segment, net sales of $18.3 million reflects a $3.7 million decline, driven primarily by decreased demand for copper-based products and personal care products, partially offset by higher average selling prices correlated with the movement of the underlying raw material costs. Adjusted EBITDA was $2.4 million, down in terms of dollars versus the comparative period, but reflective of a 20 basis point improvement in adjusted EBITDA margin. Lastly, corporate adjusted EBITDA declined 15%. Or said differently, corporate expenses increased $1.7 million for 15%, driven by the intentional increased spend on strategic investments. Turning into key capitalization-related metrics on slide seven, free cash flow for the 12-month period ending March 31st, 2023 was a negative $43 million, reflecting a slight improvement versus what we reported last quarter, and was comprised of trailing 12 months of negative operating cash flow of $5 million, less $38 million of capital expenditures. The negative $43 million of free cash flow for the 12 months ended March 31st, 2023 is driven primarily by a $43 million increase in inventory over that same period, representing slightly less than one month of additional inventory. As Jack mentioned in his opening remarks, we will be taking steps over the next few months to make sure our inventory is better balanced to the needs of our customers, particularly in our mineral nutrition segment. We are taking other actions to more closely manage working capital, which should also help to improve free cash flow moving forward. Consistent with the projections we communicated on our last call, free cash flow for the third quarter reflected a $10 million improvement over the second quarter. We are encouraged by the improving trend of operating cash flow, and as we continue to focus on cost control, lowering inventories, and keeping our accounts receivable current, we project this trend to continue in the fourth quarter. Note the $38 million of capital expenditure excludes the first quarter $15 million purchase of property. Although for GAAP reporting this purchase is categorized as a capital expenditure on the consolidated balance sheet and statement of cash flows, it was financed with the 2022 term loan referred to in the other long-term debt footnote included in our Form 10-Q. Moving on to liquidity, we had $192 million of liquidity available at quarter end. This includes cash and short-term investments of $77 million plus $100 million of unused and available revolving credit subject to the leverage ratio limitations defined in the 2021 loan agreement. In terms of our dividend, consistent with the past several quarters, we paid a quarterly dividend of 12 cents per share, or $4.9 million in aggregate. Turning to leverage, our gross leverage ratio at quarter end was 4.3 times. This is calculated by dividing total debt of $482 million by trailing 12-month adjusted EBITDA of $112 million. It's important to highlight that this is not the leverage ratio used to determine covenant compliance. For covenant compliance, we calculate a net leverage ratio as defined in the applicable loan agreement. And lastly, $382 million of gross debt is not exposed to current market interest rates. We have an interest rate swap in place at a fixed SOFR rate of 0.61%. The variable interest expense paid on the remaining $182 million of total debt is subject to rising interest rates, but it's partially offset by interest income earned on our short-term investments. Now let's turn to slide eight to discuss guidance for the remainder of our fiscal year, which as a reminder, ends in less than two months on June 30th, 2023. We are reiterating the fiscal year 2023 financial guidance communicated on our last earnings call in February. To confirm, our full year guidance is as follows. Net sales of $960 million to $1 billion. Net income of $34 to $38 million. Diluted earnings per share of 84 to 94 cents. Adjusted EBITDA of 113 to $118 million. Adjusted net income of 49 to $53 million. Adjusted diluted earnings per share of $1.21 to $1.31. And lastly, an estimated adjusted effective tax rate of 33%. Guidance for the full year gap metrics assumes actual foreign exchange losses for the nine months ending March 31st, 2023, and the company's projected currency exchange rates for the fourth quarter ending June 30th, 2023. Lastly, on slide nine, the momentum behind our ESG efforts continues to build, thanks in large part to the enthusiasm and engagement of our employees. Next week, we intend to publish our second ESG report titled Health at the Heart, which reflects the progress made in calendar year 2022. We will issue a press release when the report is made available. In closing, we are pleased with our third quarter and year-to-date financial performance. Our animal health segment growth, despite the challenging market dynamics, continues to outperform the market, and we are excited by the variety of opportunities for growth that we see for this, our largest business segment. With that, Regina, could you please open the lines for questions?

At this time, I'd like to remind everyone, in order to ask a question, press star 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Our first question will come from the line of Michael Riskin with Bank of America. Please go ahead.

Hi, this is Wolf Chan off on for Mike. Thanks for taking the question and congrats on the quarter. So I appreciate you guys flagging the recession and kind of macro impacts that you're seeing in mineral nutrition. I'm just wondering, how would you describe the possibility that these impacts spread beyond mineral nutrition to your broader animal health segment, just kind of a range of outcomes around this recessionary impact? And then I have a semi-related follow-up.

Thanks for the question, Wolf. I mean, we view our business as recession resistant. You know, we've been in the business a long time. We've been through recessions. And effectively, people eating protein is really among the very, very last things to go. And we see changes. I mean, people might give up steak and go to chicken or some combination. But overall, our business is more tied to population growth and to general wealth, which the recession sort of, again, it's sort of recession resistant.

I appreciate that.

And then, so sticking with mineral nutrition, last quarter you called out some kind of shoppiness in U.S. beef cattle feedlots. And I realize that's only a small part of your portfolio, but I was wondering if you have any updates on what you're seeing in terms of feedlot dynamics.

So for this last quarter, it still remains a very small part of our business. But what we're seeing is demand sort of is more driven by the fact that I spoke about in my opening remarks that over last year when shipping was so difficult and people were very concerned about supply chain, there was more of an increase in inventories, both at our customers and ourselves. And, you know, the worst thing to do is to run out. So prices were better, volumes were better, and I think as the shipping lines have straightened out and shipping has become less of a problem, less of a concern, there is this big adjustment. And I think that's a bigger part of this than anything else.

Much appreciated. Thank you.

Your next question comes from the line of Balaji Prasad with Barclays. Please go ahead.

Hi, good morning. This is Xiao An for Balaji. Thanks for taking our questions. Just a quick one on your Latin American business. China has recently lifted the embargo on the Brazilian beef import. Do you see this change as a potential tailwind for your Latin American animal health business, which has been performing well recently? Thanks.

So I think that is among the other tailwinds of Brazil being a phenomenal producer and a very big exporter of protein. So China, you know, removing any barriers to commerce is definitely helpful. And the state and the health of the poultry business, as well as the other businesses we see, is continuing to help Latin America, specifically Brazil, in its production and export of protein.

Got it. Very helpful. Thank you.

Again, for any questions, press star 1. Your next question comes from the line of Brian Wright with Roth MKM. Please go ahead.

Thanks. Good morning. I was hoping you could remind us on the... of the Brazilian vaccine facility and what that could mean to grow?

So the facility, thanks for the question. The facility that we built is a small facility. It's involved with the autogenous vaccine business. Autogenous vaccine business means it's a custom vaccine. We go on farms. We pick up, we try to isolate the viruses and we make a custom vaccine for that. So it's literally, it's a farm by farm business. The prices you get is a higher price. I would say it's more effective because we're dealing with farm-by-farm viruses, but it's not a huge volume business. But beyond that, we recently received approval for some of our vaccines that we produce, poultry vaccines that we produce in Israel, and we just started exporting to Brazil. So that's a new start to our business, and that obviously is a much larger business.

Great. Thank you. And then I just was hoping maybe we could kind of get some visibility on just, you know, the underlying like U.S. broiler volumes, kind of how they've progressed from January to now. Are they kind of higher now than they, you know, kind of, you know, began the third quarter?

The U.S. broiler volumes, I would say, are maybe down to flat. And, you know, holding steady. Yeah, that's it.

Okay. And then just same question for maybe Brazilian cattle.

It's, you know, cattle is not overly out-focused, even though it's a bigger part of a business in Brazil. I would say Brazil cattle business just remains flat to slightly up.

Okay, thank you so much.

We have no further questions at this time. I'll turn the conference back over to Damian Finio for any closing remarks.

Okay, thank you, Regina, and thank you everyone for participating in today's call. We appreciate your time, attention, and interest in Fibro Animal Health Corporation. Have a great rest of your day, and please be sure to check out our second ESG report when it's published next week. Thank you.

Ladies and gentlemen that will conclude today's call. Thank you all for joining.