Richard Johnson - CFO Jack Bendheim - CEO.

Michael Ryskin - Bank of America Merrill Lynch David Risinger - Morgan Stanley.

Good morning, ladies and gentlemen, and welcome to the Phibro First Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Richard Johnson, Chief Financial Officer..

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

We’ll provide an overview of our quarterly results and then we’ll open the lines for your questions. Before we begin, let me remind you 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 for this 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 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.

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 so with that out of the way, here is Jack for some introductory comments..

Thank you, Dick, and thank you everyone taking time to join us this morning. We had a very strong performance this past quarter. Our Nutritional Specialties sales were up 17% and sales of Vaccines were up 25%.

This tremendous growth is a direct result of our efforts to work with our customers, especially those in the United States who have moved to limit or eliminate the use of medically important antimicrobials. This growth more than made up for the sales decline in MFAs and other, which we had expected, as we overlap with last year’s quarter.

We expect one more quarter of negative overlap in U.S. sales of medically important antimicrobials. This quarter was also marked by improved economic conditions in Brazil, a key market for us.

Common indications are that this economic rebound is sustaining and we continue to see the cattle market in Brazil and globally as a key focus for our continued growth. We see cattle as an attractive species for sales and growth across all of our Animal Health segments.

And it was with this in mind that we acquired the Biotay business as we look to leverage Biotay’s well-respected presence in the Argentine cattle sector.

We see many opportunities to strengthen our internal product development and organization capabilities as we seek to fully capitalize on our existing portfolio, our pipeline and adjacent opportunities. It is my belief that we are only just scratching the surface of these internal growth initiatives.

As we noted in our guidance for the year, we have increased operating expenses for developing the opportunities. While the results of this increased spending may not be apparent this fiscal year, it will pave the way for above-market growth in the years to come.

We continue to be active on the business development front, particularly where we can use synergies from our product portfolio and/or our organization to drive profitable growth. I will now turn it back to Dick and look forward to a discussion after our prepared remarks..

Thanks, Jack. Before we get into the numbers, I’d like to remind everyone that we do present our results on a GAAP basis and also on an adjusted basis. The adjusted results exclude all acquisition-related items, such things as intangible amortization, inventory step-up, accrued compensation costs, transaction costs and accrued interest.

We also adjust and exclude unusual non-operating or nonrecurring items, some other income and expense items that would include foreign currency gains and losses that are reported separately in our financials and also the income tax effects relating to each of those pre-tax adjustments plus any unusual or nonrecurring income tax items themselves.

So with that, let’s turn to Page 5 and review the highlights of our September quarter. Our consolidated sales were $193 million for the quarter, a 3% increase versus the same quarter last year. The increase was driven by volume growth in the Animal Health segment and by commodity pricing in the Mineral Nutrition segment.

We reported net income of almost $16 million and diluted EPS on a GAAP basis that we improved substantially from the prior year. Our sales and gross profit improved over last year and offset increased investments and operating expenses.

In addition to the sales and operational increases, our reported results benefited from several other factors, including we had reduced acquisition-related transaction costs in the current year and the current quarter, we reported reduced net interest expense due to lower financing or borrowing rates from our new credit facilities that we recently entered into and our provision for income taxes.

The effective tax rate was favorable due to the benefit of both employee stock option exercises and a favorable mix of international income. On adjusted basis, adjusted EBITDA was $30.1 million, up $300,000 or 1% over last year, and we’ll discuss that in more detail as we discuss segment performance in the coming slides.

Adjusted diluted EPS was $0.38 a share. That was a $0.02 per share or a 6% increase over last year.

Adjusted EBITDA – the improved adjusted EBITDA was offset by increased depreciation expense, but adjusted net income and adjusted diluted EPS benefited from the lower net interest expense and a lower effective income tax rate due to that mix of international income. On Page 6, these are selected line items from the P&L.

And as we – I’ll just skip past the sales growth because we’ll handle that in more detail when we look at the segments, but in total, adjusted gross profit increased $2.6 million or 4% due to the volume growth and the sales increase, also due to favorable product mix and due to certain production efficiencies, manufacturing cost savings basically.

Adjusted SG&A increased $2.7 million in total, roughly the same amount as the increase in gross profit, and that was due – primarily due to increased spending in the Animal Health segment.

To position ourselves for future growth, we’ve increased spending on product development and organizational capabilities as we called out in our expectations and our guidance for the year.

Our adjusted net interest expense was favorable, as I said, on the improved borrowing rates and adjusted income taxes, favorable due to the mix of international income. So looking at Page 7 and looking more closely at Animal Health, sales were almost $129 million. That was growth of $4.3 million or 3% over last year.

The sales growth was driven by strong increases in the Nutritional Specialties and Vaccine product groups, offset by a decline, as we expected, in the MFA and other category. Nutritional Specialty products were almost $31 million in the quarter. That category grew $4.5 million or 17% over last year on volume growth of products for the U.S.

poultry and dairy industries. Vaccine sales were $18.5 million for the quarter and that – those sales grew $3.7 million or 25% over last year on volume growth across the product portfolio. Looking at sales of MFAs and other, those sales were just under $80 million in the quarter, a $3.8 million or a 5% decrease from last year.

Looking at that between the U.S. and international, our U.S. sales of MFAs and others declined $10.5 million. Of that decline, 4.2 million of the decline was due to reduced sales of medically important antimicrobials, primarily on the change in consumer preferences and the lower use of certain antimicrobials in the market.

It was also due to unfavorable timing of certain customer orders. Internationally, our sales of MFAs and others increased $6.7 million due to growth across most of our regions and including the benefit of improved economic conditions in Brazil.

Our gross profit, calculated on an adjusted EBITDA basis for the segment, gross profit for the segment increased $3.7 million on the volume growth, favorable product mix and production efficiencies.

Within the segment, we increased our operating expense spending by $2.5 million, as I said, for increased product development costs and improvements in our organizational capabilities.

And that all lead to adjusted EBITDA of $33.7 million, which was an increase of 1.1 million or 3%, and due to the sales growth and favorable gross profit, partially offset by the investments we made in operating expenses. And now looking at the other segments on Page 8.

Mineral Nutrition net sales of approximately $52 million increased $500,000 or 1% over last year primarily due to commodity pricing. Segment adjusted EBITDA of 3.7 million was down $300,000 from the prior year on higher raw material costs.

Performance Products net sales of 12.5 million were a bit ahead of last year, but adjusted EBITDA declined on higher product cost and corporate expenses were approximately even [ph] with last year. Looking briefly at our balance sheet capital – capitalization and capital allocation.

On a gross basis, our leverage ratio of debt to adjusted EBITDA was 2.8x at September. We had 62 million of cash on hand at that point in time so that was roughly half a turn of leverage. So on a net basis, our leverage – our net leverage ratio would be about 2.3%.

For the quarter, net cash flow before business acquisitions and financing was approximately breakeven. We saw ordinary course use of cash from the timing of sales and collections in our ordinary business. We also saw use of cash from the routine timing of payments of annual incentive compensation.

We invested approximately $12 million in a business acquisition in the quarter. We acquired an Argentine Animal Health business as a platform for growth in the Argentina beef sector. And we paid a quarterly – routine quarterly dividend in the quarter and declared the same amount per share to be paid in late December.

And then lastly, we have reaffirmed our annual guidance and have presented it here in the webcast presentation for ease of reference. No need to talk through again, no changes to the number. We have reaffirmed what we put out a couple of months ago. So that’s the conclusion of our prepared remarks.

So operator, if you would open the line for questions, please..

[Operator Instructions]. Your first question comes from the line of Derik De Bruin from Bank of America. Your line is open..

Hi. Thanks. It’s actually Mike Ryskin on for Derik. Congrats on the quarter. I just want to touch on a couple of quick points. You mentioned the – some of the impact in the MFA and other segment in the U.S. was due to unfavorable timing in the purchase orders from customers.

And are you expecting to make some of that up in the second quarter or second half, or is that tied more to the comp from prior year’s results?.

It’s more – it’s forward – we’ll see the offset going forward. So Q2 or the remainder of our fiscal year, we’ll see some of that business come back..

Okay..

But overall, this decline that we’ve seen now for three quarters will continue through the fourth quarter. And as we’ve noted and as everyone’s noted with the VFD and with consumer preferences, the use of antibiotics in general and medically important antibiotics has come to a – come down to a level which, we think is sustainable.

We’ll see us going in the first quarter of '18..

Okay, great. Thanks. And actually right along those lines, I want to follow up with the Biotay acquisition. You talked about its strength in Argentina, South America and particularly in the cattle segment. I’m wondering if you could talk a little bit about what type of products is this.

Is it antibacterials or MFAs or is this more Nutritional Specialties and any opportunity to move that or expand that in the U.S.

along those lines?.

We try to run our business around the world and be in places that have the ability to raise lots of animal protein. Argentina is the third or fourth largest producer of cattle in the world. They’ve gone through some political upheavals the last couple of years. Now, it’s clearly stable again. And it’s a market where we had a small office.

We were doing some business, but we wanted to increase our presence in the cattle market. And the products we look to sell there, it’s a whole range of products and products we’re doing around the world, whether we’re doing in Mexico and Brazil and Australia, et cetera, et cetera. So these people have a range of products.

We are going to look if they have something unique that we could take elsewhere, but our focus is going to be bringing our Nutritional Specialties, our Vaccines and some of our antibiotics to that market to help them maximize efficiency and produce healthy animals and help them regain their exports around the world..

All right, great. Thank you. That’s actually – I really appreciate the color there. If I could squeeze in one last one on the SG&A bump. Is the focus there in terms of innovation still in the Vaccines and Nutritional Specialties businesses? And then, as well you mentioned some work on the organizational sales force. Is that primarily in the U.S.

or overseas and any particular area you’re focusing on?.

So I think it’s a yes, yes and a yes. We are increasing our efforts in Nutritional Specialties and Vaccines, both in the U.S. and around the world. So as we hire more sales people and technical people around the world, we need more back office support. So it is both headquarters. It’s both in region.

And the focus is on these new products that we’ve been very successful in launching here in the States and get them across the world..

All right. Thank you so much and congrats again on the quarter..

Thanks, Mike..

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

Thanks very much. Hi, Jack and Dick. So congrats on the results. I just want to ask for any more color you might be able to provide on the December quarter just so that we understand.

You mentioned the MFA comment earlier, but any other anomalies we should think about either year-over-year or sequentially when we’re forecasting the December quarter? And then, Jack, if you could just add any more perspective on ex-U.S. positives or negatives. Obviously, it’s very hard for us as investors in the U.S.

to understand what’s happening in Brazil or what’s happening in some of the other markets you serve globally. So if you could just discuss some pushes and pulls with respect to the outlook for your business in ex-U.S. markets; that would be helpful..

So let me take the first part on Q2 and looking forward. I would frame that as we’ve reaffirmed our guidance for the year. Our initial guidance said that the first half of our year would be, on an EBITDA basis, roughly flat with the prior year. That’s what we saw in our September quarter and we’ve stayed with that same guidance.

We haven’t updated that guidance. I think, as you mentioned, we’ve talked about the overlap on the U.S. decline of medically important antimicrobials and we are – continue to expect, over the course of our fiscal year, sales and EBITDA growth in line with our guidance..

And, Dave, that’s a very good question. And so let me take it in two parts. One, in terms of our business, we see a huge growth around the world in cattle. So as Brazil returns that we will benefit from that.

We continue to have good presence in Southeast Asia, in Africa and South America and sort of trying to look and gain a little bit in North America. Overall though, I just came back. A couple of weeks ago, I was in China. Health for Animals, the organization which normally meets in Brussels decided to meet in China.

And it’s sort of what we saw there and what we’ve heard in the past represent what’s going around the world. The Gates Foundation, for example, is spending a lot of money with the WHO because it’s not just about human health, it’s human health tied to animal health.

As population grows and people try to grow out of poverty, their need and ability to get food which is nutritious and healthy, proteins, which is available and cheap is very, very important to feeding the population of the world and increasing human health around the world. So, the Gates are putting billions of dollars into this.

And we see this around the world. So we see a very, very rapid movement to what we have grown to expect in the United States now for 50, 60 years. And countries around the world have the benefit of not going through the trials and errors that we’ve done here or the Europeans have done.

They’re going right away to first line forms of feeding animals, of taking care of animals. So we’re seeing rapid growth in Indonesia in one population to – in the protein business, which is predominantly poultry.

In China, we’re seeing a rapid change in – not in the consumption of pork, but in the quality of the pork, which means getting smaller farms to close and – because they don’t necessarily know how to or report how to take care and keep the pigs healthy, and they’re moving to larger farms. And we see that happening very, very rapidly now in China.

So all of these effects, whether it’s in Africa or Southeast Asia or in China or in South America will affect all of our business, not just Phibro, but all of the people in this sector because we have the technology, we have the expertise, we have the people and we have the reach. So it comes back to what I said earlier.

I’m very, very optimistic about growth for us as well as our competitors, but I’d concentrate a bit more about us as we take advantage of these changes around the world..

Great. That’s so helpful. Thank you..

I’m showing no further questions at this time. I’d now like to turn the call back over to Richard Johnson..

All right. Well, we’ll say thank you to everyone and have a happy Thanksgiving. We don’t have any cooking suggestions for this year..

I bought a new fryer. The last fryer I had, had some electric problems and now I have a slightly different one. So I can report based on we – how I do with my turkey..

All right, everyone. Have a good day and good talking. Thanks. Bye..

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day. You may now disconnect..