Jack Bendheim – CEO Richard Johnson – CFO.

Brandon Folkes – Guggenheim Securities David Risinger - Morgan Stanley Erin Wilson - Credit Suisse Kevin Kedra - Gabelli & Co.

Good day, ladies and gentlemen and welcome to the Phibro Animal Health Corporation Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Later, we’ll conduct a question-and-answer session and instructions will be given at that time.

I’d now like to introduce your host for today’s conference Mr. Richard Johnson, Chief Financial Officer. Sir, please go ahead..

Thank you, Operator, and good morning everyone. Welcome to the Phibro Animal Health Corporation earnings call for our fiscal fourth quarter, ended June, 2016 and it’s also the end of our fiscal year. On the call today with me is Jack Bendheim, CEO.

We’ll provide an overview of our quarterly and annual results and our guidance for our fiscal 2017, and then we’ll open the lines for your questions. Before we begin, let me remind you that the earnings press release and financial tables can be found on the Investors Section of our website at pahc.com.

We’re also providing a simultaneous webcast to this morning’s call, which can be accessed on the website as well. Today’s presentation slides and a replay and transcript of the call will also be available on the website later today.

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 you to the forward-looking statements sections in our earnings press release.

Our remarks today will also include references to certain financial measures, which were not prepared in accordance with Generally Accepted Accounting Principles, or U.S. 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. And with that introduction, let me turn it over to Jack Bendheim for some introductory remarks.

Jack?.

Thank you, Dick, and thank you all for dialing in this morning. We've just completed our fiscal year 2016, it was and is our outlook for 2017 to be a year of transitions.

The US markets are moving away from various uses of antibiotics, and we have positioned ourselves to benefit from these moves by adding vaccines and nutritional specialties to our portfolio. Like life, all transitions are not smooth, but we're trending in the right direction, albeit slower than we would have wanted to see.

We remain very bullish about our industry, our customers, and for these trends to increase protein consumption. Phibro is benefiting from these trends in the US and around the world and we're looking forward to increasing our performance in the New Year - as the New Year progresses.

That’s my very short remarks, and we’ll take a bit later as we get the Q&A. Back to you, Dick..

Thanks Jack. As Jack was talking about just briefly, the Animal Health update, this is just an update of what we said when we talked about our March results that some US producers are reducing antibacterial usage. Our current, Phibro’s current annual sales of medically important antibacterials was $37 million at June of 2016.

On the other side and on the positive side, we've seen continued international volume growth of MFAs, and we're seeing very nice double digit growth both in our nutritional specialty, our portfolio as well as vaccines, in part because producers are looking for alternatives to maintain the health of their animals.

So now looking at Q4 results on a consolidated basis, consolidated sales were up 2% in the quarter year over year. That's about $4 million of sales growth driven by volume growth in the Animal Health segment. Mineral nutrition sales were below the prior year and we'll get into that in a moment. Performance products were up slightly year over year.

At the gross profit line, gross profit was, on a reported basis, down 1%. On an adjusted basis it was up 2% driven by volumes. We did see negatives in the quarter from the idle capacity cost of the production interruptions from upgrading our good manufacturing practices GMP in our vaccine plant so that hit the gross profit line in the quarter.

We do continue to see operating efficiencies in many of our production facilities. SG&A on a reported basis was up 1% to about $0.5 million and it was really due to largely to accruals in our Performance Products segment as well as some increased corporate costs. Adjusted EBITDA up 4% or just over $1 million to $28 million in total.

That was improvement in the operating ratio to 49.9% compared to 14.6% percent a year ago. And then coming down to adjusted diluted EPS $0.40 for the quarter. That was down $0.04 or 9% from a year earlier. The growth in adjusted EBITDA was offset by increased depreciation expense, interest expense and higher income taxes year over year.

There's a footnote at the bottom there that tells you in detail what adjustments we make to the GAAP numbers. Looking at page 6, Animal Health. Animal Health sales, the segments sales increased almost $9 million or 7%, really driven by volume growth across all of the product portfolio, all of our product groups. MFAs increased 3% or $2 million.

That was international growth in Brazil and other international markets, offset by reductions in the US. Nutritional specialties were up 14% percent year over year in the quarter. That was driven by volume growth in our products for the US dairy and poultry industries.

And the vaccines were up 29%, better than $3 million in growth as we saw volume growth there across our product lines as well as the benefit of the MVP acquisition. At the adjusted EBITDA, line Animal Health segment was $31.5 million of EBITDA, a $1.6 million increase year over year or 5%.

We saw the growth of sales drop down through with some negatives at gross profit due to the manufacturing costs that I talked about a moment ago, and we saw flat operating expenses in the segment for the quarter.

Looking at page 7, other segments, Mineral Nutrition, about $50 million of sales in the quarter, down roughly $5 million or 9% from a year earlier. Most of that topline decrease was related to commodity pricing. There were also slightly reduced volumes just on seasonal variations.

However, at the adjusted EBITDA line, despite the revenue decline, we saw adjusted EBITDA increase $200,000 or 5% as we were able to make up most of that margin shortfall either with -- sales shortfall either with margin improvement or favorable operating expenses. Performance Products sales increased $800,000.

However, adjusted EBITDA was down slightly $100,000 from a year earlier and we saw the operating margin decline on some increased accruals in the business. Corporate expense, $7.2 million, a $0.5 million increase over the prior year.

So turning just briefly now to the full year, fiscal year of June 2016, reported sales -- So in 2015, we say this in the footnote at the bottom, we had $8 million of milestone payments related to the licensing of some vaccine delivery technology.

We've made the comparisons, excluding that $8 million from the prior year numbers to give a better sense of the trends of the business. So excluding that, sales overall increased almost $11 million or 1%. In the Animal Health segment we saw $23 million increase or 5% and that really is all on volume growth.

Mineral Nutrition topline revenues decreased $10 million for the full year, related to commodity pricing and full year the Performance Products segment was reduced by about $2 million. If we look at the gross profit line, 31.8% of sales on a reported basis, a 6% increase year over year. On an adjusted basis, gross profit was up 8%.

Gross profit improvement was driven by volumes and mix, by improved operating efficiencies and favorable cost of goods from volumes and from currencies over the course of the year. SG&A overall, again on a reported basis about a 5% increase.

On an adjusted basis about 4% increase, and driven by investments in the Animal Health segment in the selling, marketing, and development areas as well as some increases in corporate costs. Adjusted EBITDA was $114 million this year compared to $102 million last year, which excludes the $8 million of licensing income.

So that's a 12% increase just driven by all of the factors that I just discussed, and an improvement in the operating margin overall to 15.2% for the year. On a full year basis, adjusted diluted EPS was $1.61. That’s up 6% from the year earlier.

That growth in adjusted EBITDA was partially offset by increased appreciation interest in income taxes for that net increase. Looking at page 9, capitalization and capital allocation, we continue to improve our leverage ratio. It was 3.1 times at June 30 with $353 million of total debt against $114 million of Adjusted EBITDA.

We had $34 million cash on the balance sheet at June 30. Cash flow during the June quarter was a $19 million source of cash, and routine quarterly dividends, $3.9 million paid in June and the same amount declared to be paid in September. So now turning to guidance on page 10, let's just walk down the table first.

Within our overall consolidated sales, we've broken out net sales for the Animal Health segment and we expect Animal Health segment sales for our fiscal 2017 to be between $495 million and $510 million, and that would be 2% to 5% growth over the comparable number for 2016. Total net sales, we are expecting to be $750 million to $770 million.

That's flat to up 2% over the prior year. Adjusted EBITDA expectations are to be between $116 million and $120 million, again 2% to 5% growth over the prior year, and that would mean our operating ratio, operating margin ratio would be 15.5% to 15.6%, roughly a 30 basis point improvement year over year.

Adjusted EPS, and this is comparable year over year with a newer revised method of adjusted income taxes, so we'll get to that in a moment, but adjusted EPS $1.38 to $1.45 compared to $1.43 for 2016. So that's somewhere between a 3% decline and a 1% increase. Then, if I just walk through the bullets.

Below the table, within that Animal Health segment and the overall 2% to 5% growth, we expect the nutritional specialties and vaccine product categories will continue to grow at double digit rates. MFAs and others will be between stable to a single digit decline for the year.

Mineral Nutrition revenues are expected to decline slightly as we continue to expect volume growth, but see some just year over year continued effect of reduced commodity pricing. In performance products revenue, performance product revenues are expected to be stable or decline slightly.

At the gross profit line, we expect an improved gross profit ratio just due to favorable business and product mix.

Adjusted EBITDA, we have announced to -- Adjusted EBITDA will exclude the cost of a partial settlement of the pension plan, which could be up to as much as $3 million, where we're offering a lump sum window to certain participants in the pension plan.

In addition, it will also -- they’re also be the same recurring adjustments to exclude acquisition related items and foreign currency gains and losses. So turning to the provision for income taxes and the effective tax rate, we expect our effective tax rate to be 29.5% for 2017, essentially the same as the revised adjusted effective rate for 2016.

We’ve revised our reporting methodology to now present the GAAP provision for income taxes adjusted for the tax effect of any pretax income adjustments, and also to remove any non-recurring or discrete items. For example, in 2016 we had a significant benefit from the release of valuation allowance mostly around net operating losses.

We revised our methodology in part to reflect recent SEC guidance on presentation of non-GAAP measures, which prescribes use of cash income taxes as a profitability measure. So when you look at Adjusted diluted EPS, the growth in Adjusted EBITDA is largely, it's really completely offset by increased depreciation expense and interesting expense.

So that's why growth in adjusted DEPS is fairly modest. On a quarterly basis, we expect our quarterly results will grow at similar rates as our full year expectations, with lower growth rates earlier in the year and increased growth rates later in the year.

Looking at cash flows, we expect to generate positive cash flows after satisfying our needs for working capital, capital expenditures, dividends, and scheduled debt repayments. CapEx is expected to be in the $30 million area. And finally, we remain interested in acquisitions and any positive cash flow could support potential acquisition activity.

And that’s the end of my formal remarks. So with that, Operator, if you would open it up for questions please..

[Operator Instructions] Our first question comes from the line of Brandon Folkes with Guggenheim Securities. Your line is now open..

Hi guys. I've just got 3.

The first one, do you think you can replace the full $37 million with alternative products in your portfolio? And if so, how long do you feel this transition would take? Secondly, just on vaccines, can you update us on the progress of winning back potential business lost during the upgrade of the vaccines plant? And then lastly, if you can just talk about pricing potential in 2017, and what you assume in your guidance.

Thank you..

Thank you. So the first question, first of all, we don't anticipate all $37 million going away. As we're trying to say the market has been shifting and adjusting. You read some reports of some poultry producers who are marketing to different segments. And clearly what's happening here is that it’s consumer driven, consumer preferences.

Also consumer is willing to pay the much higher prices that will entail for producing mostly poultry without the benefit of these certain antibiotics i.e. they’re going to see more diseases and see more disease pressure and they'll manage it, but they’ll manage it with various other kinds of product.

So to that point, we definitely anticipate whatever drops we see over the course and that's why I said earlier, it's a transition time.

It doesn't happen in a day, but I think over the course of this coming fiscal year, we fully anticipate to completely dollar wise replace any lost sales we've had in the US in the various antibiotics with other kinds of products, whether it’s vaccines, whether it’s nutritional specialties, whether it's other antibacterials that don't come under the guidance of 152.

So we remain optimistic and we’re already seeing that we're doing business today with some companies who moved in this direction earlier and we're doing more business with them today than we've done 3 or 4 years ago. So that's the one.

The interruptions we had when we took our Israeli plant through GMP had affected us, affected us in the last year, affected us even going to this quarter.

It's like anything, you disappointed a customer, we will get the business back, it’ll be with concessions and again, it won't happen immediately because you have to regain the trust, but we remain optimistic that we will regain market share in the markets we lost and grow from there. And finally ....

Your question was on pricing, Brandon. I‘d say our guidance for 2017 has very modest or minimal pricing assumptions in it. So as we’re talking about sales, we’re really talking about volume growth. There may be individual products or markets where we will take some pricing actions, but that’s not the driver of the business..

Great. Thanks very much..

Our next question comes from the line of David Risinger with Morgan Stanley. Your line is now open..

Thanks very much. Good morning guys. I have a couple of questions please.

First, with respect to the negative impact of some of your customers moving away from MFAs, could you just quantify how much of a negative impact you expect in your 2017 guidance as a result of that? Also, if you could just discuss the cash flow outlook for 2017 and finally how we should think about the September quarter sequentially relative to the June quarter results that you just recorded.

Thanks so much..

Thank you, David. It’s good to hear your voice. We think the market is still working out for itself where they’re going to come out on antibiotics. This trend which we’ve spoken about initially was driven by the movement away of antibiotics use of growth promotions, sort of the blanket use of antibiotics to prevent diseases.

So the market is definitely staying and most of our customers I think volume wise will stay with use of antibiotics for treatment. So it’s moving because we’re not sure yet. We haven’t gone through full cycles and cycles depending on quality of feed, depending on climate, depending on so many other things where you have disease pressures.

This business is not going to disappear and every customer is going to be changed. It’s not going to be so formulistic and the practices are changing as we go forward. So I think overall we will end up by the end of the year, unless -- we’re mostly talking about poultry.

Our overall poultry segment, our estimation is that our business this coming year will be larger than our businesses past year. It’ll be made up of different products through the cycle. To the cash flow ….

Our cash flow output outlook for 2017 is positive. I don’t have a more definitive number than that I can give you. But I think it basically says we will have moderate use of working capital after, and I think you see that in our June quarter where we’ve, we had a good quarter on working capital performance.

Not indicating that that’s going to continue for all of next year, but that’s more directionally where we expect to be. We’ve given you CapEx so cash, income taxes and interest expense will be in line with where we’ve been running. But I don’t have an overall number to talk to you about, David.

And then the third point was the September quarter sequentially. I’ll go back to what we said in our guidance is that we expect our quarters to see the same growth rates as we forecast for the full year, with slower growth starting out the year.

So I’d say our September quarter is going to be at the slower end of those guidance growth rates we’ve put out there for the full year numbers..

Got it. Thanks very much..

[Operator instructions]. Our next question comes from the line of Erin Wilson with Credit Suisse. Your line is now open..

Great. Thanks for taking my question. You mentioned strength in the international MSA business. What geographies are you seeing that sort of strength and what’s driving those trends? Thanks..

Thanks Erin. We’re seeing -- the geographies we’re seeing is around the world. So it’s true in South America, Latin America. We’re seeing it in the Far East. We’re seeing it in China. We’re seeing it in Eastern Europe. We’re seeing it in Africa.

So we’re seeing it in all markets around the world as -- again in the places where we have growing population or you have countries that want to control their own food sources and not totally rely on imports, as they get into these businesses and as they start moving and you know, you heard the story times, as some move into higher productive methods of raising animals, they then have the ability because then they have the vets and they have nutritionists to basically see what’s going on, see diseases and try to prevent the diseases.

So that’s the trends we’ve spoke about for a long time and those trends that we see continuing around the world. So as Dick mentioned earlier, overall for our fiscal year ending in June, kilos, a pound sold of overall MFAs were higher than they were a year before, but we’ve seen shifts.

The shifts in the United States we’ve spoken about is more driven by the consumer and then it’s driven by the needs, by the market needs. I would say we’re a consumer driven market and we’ll respond to that and then again for Phibro, it’s going to be fine..

Okay great.

And then from a regulatory standpoint, how far long is the industry in adopting the new FDA regulations that will -- the ones that will go into effect I guess in 2017? What percentage of your customer base has already sort of converted to the new standards and what’s left as we sort of assess that trend on a go-forward basis?.

I think it’s basically done. I think that the customers, just because the law goes in effect January 1, no one is going to wait till sometime after Christmas to get it done. Everyone is moving in that direction.

So everyone will be in compliance, but I would say we already are seeing across the country no use, I would say no, but I’m talking about plus 90% use of antibiotics for growth promotion. So I think most of the customers across the species we sell into, have already made the move.

We’re way past the regulatory side and now we’re into, as I said earlier, consumer preferences..

Right. Okay. And then ….

Erin, that $37 million number includes, it would include any regulatory risk as well as consumer driven products. It’s the same set of products. It’s both factors. The dollars aren’t separate. They’re all included in that $37 million..

Okay. Great.

And then can you speak, speaking to some of the offsets here, can you speak to some of the traction you are seeing on the poultry nutritional specialty products as well as OmniGen?.

I would say the dairy industry in the United States or really the dairy industry around the world is coming off a very, very difficult couple of years. Most of them have been losing money. I think with that sign to end, so we will see growth going forward both in the US and our exports markets in the use of OmniGen.

And some of the reflection we’ve seen already is the shifting by US poultry based consumers, poultry producers from the use of antibiotics to control diseases to try to control these same diseases with nutritional specialties, trying to get different attributes out of healthier animal and subsequently we benefit from the line of our products..

Great. One quick last one. Just can you speak to the capacity for acquisitions, what you’re looking at and are you potentially targeting also partnership licensing deals similar to what you’ve also done in the past. Thanks..

The partnership idea works well for us. It allows us to lower some of the risks in terms that we make sure that the products works well. It allows us to not overstretch in terms of leverage and I think that has always been our preference -- continues to be our preference in looking at acquisitions..

Okay. Thank you..

Our next question comes from the line of Kevin Kedra with Gabelli. Your line is now open..

Hey guys, thanks for taking the questions. I hopped on a little late so I wasn’t sure if you guys mentioned anything about carbon dioxide, any updates there and kind of what is built into your outlook for that product. And then secondly, we’re seeing some signs of, possibly a return of the H5N2 avian flu.

Just want to get a sense of, if we were to see an outbreak of that again, what kind of impact that might have on your business going forward?.

Those are 2 great questions and no one asked that before. So on the carbon dioxide, as I’m sure you read, within the timeframe, we responded to the NOOH and we’ve sent in all of our comments.

As we had stated, we had completed the studies that were sort of -- was likely the reason to the NOOH, because we had not -- it had taken us a long a time to get these studies in because it was a very, very complicated test methods and we were, we had to sort of create effectively the science, which we did using university partners overseas.

We’ve now gotten all those things in and I think they’re currently being reviewed by the FDA and there’s no timetable. They can take a long time to review it. They can come back and they could tell us they want to proceed. The average -- if they proceed to a hearing, it could take a couple of years.

Sometimes it’s taken as long as 4 years to get to the hearings. It’s very, very resource intensive, not just for us but also for the agency. In the meanwhile, we continue selling the product. We can continue selling the product.

The product is an extremely important product and sort of on -- in a crazy way -- and we talked some on this call about antibiotics, the removal of this product will cause the increased use of antibiotics. So it’s quite strange but anyway, that’s where we are and I don’t think we have any more information about that..

Well, we’ve said that this product is a $15.15 million product. And as Jack said, we continue to -- our customers continue to buy the product, need the product, so going forward that’s our expectation until we know something. The other one was avian flu..

Avian flu, we all read, you just read about this virulent strain that they found in some ducks somewhere. You just don’t know. What we saw a few years ago when it hit, it hit in a very, very aggressive way in Minnesota in the turkey industry and then down to Illinois into the egg industry. It did not hit any of the broiler customers.

So really pathway is important, fire security is important. Since that outbreak 2 years ago, people have beefed up their biosecurity. So it’s not easy to tell what, if anything, would be the effect if it would hit. But it is something that the US producers, everyone remains very, very vigilant about it. We hope it hits somebody else..

All right, thanks..

I’m showing no further questions in queue at this time. I’d like to turn the call back to Mr. Johnson for closing remarks..

All right everyone, thanks for taking the time to listen in this morning. We’ll be back talking to you in early November with our first quarter results. So until then take care. Bye..

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone have a great day..