Jack Bendheim - Chairman, President and Chief Executive Officer Richard Johnson - Chief Financial Officer.

Brett Wong - Piper Jaffray Erin Wright - Credit Suisse.

Good day, ladies and gentlemen, and welcome to the Phibro Animal Health Corporation Third Quarter Financial Results Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

[Operator Instructions] I would now like to turn to your host for today's conference, Mr. Richard Johnson, CFO. Sir, you may begin..

Thank you, operator. Good morning, everyone. Welcome to the Phibro Animal Health earnings call for our third quarter ending March 2017. On the call today as usual are Jack Bendheim, our Chief Executive Officer; and myself, Richard Johnson, Chief Financial Officer.

We will provide an overview of our quarterly results and then we’ll open the line for your questions. Before we begin, just the standard reminder that the earnings press release and financial tables can be found on the Investors section of our Web site at pahc.com.

We’re also providing a simultaneous webcast of the morning’s call, which can be accessed on the Web site as well. Today’s presentation slides and a replay and transcript of the call will also be available on the Web site 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 section 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 on our earnings press release for a discussion of these measures.

Reconciliation 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 now here is Jack Bendheim with some introductory comments..

Thank you, Dick, and thank you everyone who is joining us this morning. As you saw in our press release, our core animal health segment showed modest sales growth for the quarter. Double digit increases on nutritional specialties and vaccine products were the drivers of this segment growth.

These products have shown double digit increases every quarter this year. The MFA and other category declined 7% as we saw ongoing reductions in the United States sales of medically important antibiotics, as the U.S. industry fully implemented the voluntary guidance with regard to these products.

We also saw continued cyclical weaknesses in our Brazilian markets but we saw growth in other products and regions within this category. We made a decision to bulk up on our investments in both product development and organizational capabilities for the animal health segment, which reduced profitability in the quarter.

While we continue to actively seek business development opportunities, the current valuation of the many available assets make a build versus buy model increasingly compelling. I would also want to recognize the actions of our mineral nutrition team who are continuing to build share while delivering improved profitability.

We believe we have the opportunity to leverage capabilities of our minimal nutrition business and incorporate some of our high value products improving the efficiency for our customers. I will now turn it back to Dick and look forward to answering your questions at the conclusion of this presentation..

Thanks, Jack. So on page 4, just a reminder before we get into the numbers. We do present our results on both a GAAP basis and also on an adjusted basis.

Our adjusted results exclude various items including acquisition related items, things like intangible amortization, inventory, step up on purchase, accrued compensation cost, transaction cost, and accrued interest. We also exclude unusual and non-operational or non-recurring items.

Things like the pension settlement cost or gain on insurance settlement that have happened during our current fiscal year. Also excluded are some other income expense items, notably foreign currency gains and losses which mostly arise from inter-company transactions and inter-company balances.

And then also the income tax effects related to the pretax adjustments and any unusual or non-recurring income tax items. So on page 5, let's first review the highlights for our March 2017 quarter. Our consolidated sales were almost $190 million for the quarter, a 3% increase compared to the same quarter last year.

The increase was driven by volume growth in the animal health segment and volume growth in commodity pricing in the mineral nutrition segment. GAAP results included a $7.5 million gain on an insurance settlement. We reached the settlement of our claims under our liability insurance policies for damages that we had incurred a number of years ago.

We previously had recognized in our financials the cost of the damages.

GAAP results also benefited in the quarter from a reduced provision for income taxes due to a $3.8 million release of a valuation allowance related to certain foreign operations, and in addition the GAAP income tax provision included a $1.4 million benefit related to the exercise of employee stock options.

Our adjusted results exclude, among the other items, exclude the insurance settlement gain and the favorable tax items. Our adjusted EBITDA was $29.7 million for the quarter, even with the prior year. I will discuss segment performance in the coming slides. And adjusted diluted EPS was $.37 a share, a $0.03 decrease our 8% below last year.

Compared to last year, increased depreciation expense and a higher effective income tax rate were the primary reasons for the decline. Our effective income tax rate this year was 28.7%, about 2.6% above last year. On page 6, we present selected line items from our results. Looking at adjusted gross profit.

Adjusted gross profit increased by $300,000 or 1%. One of the reasons where the relatively low growth in gross profit was that depreciation expense increased $1 million year-over-year and pulled down the gross profit number.

On the adjusted SG&A line, adjusted SG&A increased $1.3 million in total, fundamentally due to a $1.6 million increase in the animal health segment. To position ourselves for future growth, we increased spending in this segment on product development and organization capabilities. On page 7, looking more closely at the animal health business.

Sales in the segment of $121 million grew $2.6 million or 2% over the last year. The growth was driven by double-digit increases in the nutritional specialties and vaccine product groups, offset by a decline in MFAs and others.

Nutritionally specialty products sales of $27.6 million grew $4.8 million or 21% over the last year on volume growth of products for the U.S. poultry and dairy industries. Vaccine sales of $17 million grew $3.9 million or 30% over the last year on volume growth across most of the product portfolio.

Sales of MFAs and others were approximately $76 million in the quarter, a $6 million or 7% decrease from last year. We saw reduced sales of medically important antibacterials in the U.S. due to regulatory and consumer preference factors. We saw sales decline in Brazil resulting from challenging economic conditions.

We did have sales growth of other products in the category that partially offset the declines. Adjusted EBITDA of $31.8 million for the quarter, decreased $300,000 or 1% compared to last year. Gross profit growth was offset by increased operating expenses for new product development and organizational capabilities.

On page 8, looking briefly at our other segments. Mineral nutrition net sales were approximately $57 million, increased $4 million or 8% from last year due to volume growth and to higher commodity pricing. Segment adjusted EBITDA of $4.3 million was an increase of $300,000 over last year, in line with the sales growth.

Performance products net sales were approximately $12 million, were slightly below last year but favorable product mix and input cost kept adjusted EBITDA approximately even. And corporate expenses at $6.9 million decreased slightly year-over-year. On page 9, looking at our capitalization and capital allocation.

Our leverage ratio continued to improve and the ratio of trailing-12 adjusted EBITDA to total debt was 2.6 times at March 31, 2017. Our positive cash flow continues to improve the leverage ratio. We also had $49 million of cash on the balance sheet at quarter end. For the quarter we generated $31 million of net cash flow before financing.

In addition to generating cash from earnings we also benefited from a $7 million favorable working capital and other source of cash and a $7.5 million benefit from the cash received from the insurance settlement. We invested $6.4 million in CapEx and other investing activities broadly consistent with recent trends.

We paid a routine quarterly dividend in the quarter and have declared the same amount to be paid in June. And on page 10, looking at our guidance. We have updated our annual financial guidance. The updated guidance on both a GAAP and on adjusted basis is presented in detail in the press release.

We now forecast Animal Health net sales in the range of $490 million to $495 million. A 1% to 2% increase over last year. We see consolidated net sales at $760 million to $765 million, also a 1% to 2% increase. And we forecast adjusted EBITDA in the range of $118 million to $120 million, a 4% to 5% increase.

So that’s the conclusion of my prepared remarks. Operator, if you would please open the lines for questions. Thank you..

[Operator Instructions] And our first question comes from Brett Wong with Piper Jaffray. Your line is now open..

First on the guidance. Can you provide a little more color on the breakdown of sales growth in Animal Health.

Should we expect similar strength in vaccines that we have seen in the past couple of quarters? And since we are coming up on easier comps from [indiscernible], and I know you talked about there being impact through June if not in the September, but we start to see some good growth there.

And also if you can talk to any preliminary thoughts around what type of growth we could see for the next fiscal year, that would be helpful..

I would say broadly our expectation for the remainder of the year is a continuation of the trends we have seen so far this year, Brett. So double digit growth in nutritional specialties and vaccines and continued decline in that MFA and other category, averaging out to, give or take, neutral to slightly positive growth.

Certainly positive growth for the full year. And looking ahead, we are in the middle of our budget discussions and reviews, so I think it's a little premature for us to be talking about next year. We will put out guidance in late August when we announce our annual financial results..

Okay. That’s helpful. Thanks. And talking about Brazil and the weakness that you keep seeing there. I know that you have previously talked about that really being driven by input cost. So we have seen grain prices falling significantly there.

And so just wondering if you are continuing to see the pressure you have seen from improvements here just recently and if you can just talk to your expectations in Brazil, given lower feed cost..

Right. It's Jack. Thank you for asking the questions. We are beginning to see sort of the -- I think we have seen the bottom and we are trying to see some of the increases reflected by the input cost having now come down. It was pretty dramatic they lost a planting. So corn prices were very very high. I think it has come back down now.

Business is getting better. The overall economy in Brazil is not getting a lot better so consumption of a lot of protein has been down in country, but exports are trying to pick up. I mean they lost sales with a high input cost. It's going to regain those sales.

So I think we are going to see better results in Brazil in the coming quarter and continuing better results for the coming years. We all know Brazil is an extremely important factor in the worldwide protein markets..

Thanks for explanation. And then at the dairy market, we are seeing some pressure in the U.S. dairy industry due to some tariffs that have been put in place in North America, and stress in trade and printed prices are still up year-over-year and we have seen a recent lift.

Do you expect to see any weakness there with ongoing pressure, potentially more trade issues..

So I think the bigger factor has been pricing. The low price for milk and milk derivatives has continued a lot longer than everyone has hoped for. I think it hasn’t declined so it' starting, again, as things sort of stabilize, I think our customers are feeling better and we have started seeing some growth.

I mean clearly, trade restrictions anywhere in the world affect the whole protein market, not just the milk, not just the diary, it's across every industry. So I think we hope that our leaders get this right and we don’t go into various trade wars..

Yes, of course. A lot to see with the DC in there. Last question from me. Just wanted to talk to M&A landscape. You mentioned in your prepared remarks that valuations support more build versus buy.

Can you just provide more color around that? Have you seen multiples actually getting higher and expanding recently or do they just continue to stay elevated near previous levels, and anything that you have been looking at that got more attractive here recently..

I don’t want to call out various deals that have been recently done, but you are in the business. There have been various deals we have seen done that have gone at multiple of many high -- relatively high multiple to the sales which clearly values our business a lot higher than you guys are currently evaluating it.

But on a going forward basis, it's making us, as I said in prepared remarks, deciding to spend more money internally developing products and sales capabilities than acquiring it. So long answer to the question. Yes, we see evaluations continue to increase in this business..

And our next question comes from Erin Wright with Credit Suisse. Your line is now open..

Given what seems to be a little bit more pronounced decline in animal health. In the fourth quarter implied in your guidance, what does this mean in terms of what you are seeing with the FDA guidance implementation, as well as the consumer driven pressure as it relates to the MFA business.

Is this incremental to maybe what your initial expectations were?.

So I think -- Erin, thanks for the question -- I think what we have seen and what we are continuing to see is the guidance has put a lot more focus on use of antibiotic in the United States. And there is a repositioning among our customers of their product offerings. And this is sort of being worked out as we speak.

So we are seeing in the market place some customers who are using products or raising animals that will call no antibiotics ever. There are customers who are raising animals with no human antibiotics, only animal-only antibiotics. We are seeing customers who are using these traditional methods of raising animals. And there market is segmented also.

A lot to do with what their consumers are prepared to pay. So that is being worked out. Besides that, this is all happening at a time when there is normal cycles in this business. I mean every dip in weather pattern, I mean what we have seen taking the chicken industry, as you know so well, basically the turnover happens every four to six weeks.

So we have to see this year play out and just get into a really -- to understand exactly whatever they are doing and however they are doing it in the various cycles. So our business has always been different quarter to quarter. This is being worked. The overlay now as this new demand and new usage of products, customers have to see if this works.

I mean different weather at different times of the year creates different demands, different disease patterns. What we have to remember is we are in business of supplying product that treats animals that are sick. And again, animals get sick differently depending on where they have been. This past winter we saw, not a very happy winter.

So we saw a drop in demand for our some of our [first] [ph] products because the pigs weren't as sick as they were a year before. So that’s the overlay we have been seeing. On top of it, as you know we have been introducing more of our vaccines and more of our nutritional specialty products into the same area.

And our customers have to get used to it again, different times of year using these products. So we want to be cautiously optimistic as we go forward.

We are very optimistic to the fact that we have managed and our customers managed to move very very quickly away from using some antibiotics that work extremely well to using these new nutritional products that work well but it's an ongoing cycle.

So it's hard to predict what's going to happen two months from now, three months from now, six months from now. We are seeing a continuing uptake in the use of our vaccines, continuing uptake in the use of our nutritional specialties as people are trying to replace some of these antibiotics. And this is unfolding..

Okay. Great.

And outside of the medically important MFAs but within that MFA category, where are you seeing, I think you mentioned it earlier in the prepared remarks, where are you seeing some of the offset outside of vaccines and nutritional specialties?.

So there is a range of products in our MFA category that are not antibiotics. And some of these older products, some of these are chemical products. And as customers move away from using antibiotics, they necessarily are going to move to products that are not antibiotics but perform quite well.

So within our portfolio, as Dick was mentioning, we have some of those products. Those products have increased sales while the antibiotics have dropped.

But again, holistically, we are treating an animal and we are going to treat the animal with a range of products and it's vaccines and it's nutritional specialties, [indiscernible] antibiotics and, again, we want our customers to raise their animals healthy and to create profitability..

Yes. And the only thing I would add to that, Erin, within that MFA category, the demand for our broad product range in many international markets continues unchanged. So the MFA concept is largely a U.S. concept..

Okay. That’s helpful.

Can you speak to some of the increased product development efforts that you were mentioning? What categories will this focus on and what areas, I guess, do you see more of a meaningful opportunity there by a therapeutic class or species type?.

So we have been spending our money on the products of our business that are growing rapidly. So we are increasing spending in the vaccine segment. We are increasing our spending on development and nutritional specialties that’s on the development side. These products are used across many species.

Easily for species and heavily our business in the poultry, where we increasingly look to move these products into the swine market and potentially even for the cattle market..

[Operator Instructions] And at this time I am showing no further questions. I would like to turn the call back over to Mr. Richard Johnson for closing remarks..

I will just say thank you to everyone and we will talk to you in late August when we announce our annual fiscal year results and talk about guidance for next year. So until then take care. Bye, everybody..

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