Business Context and Reporting Period
Phibro Animal Health Corporation is a global developer, manufacturer and marketer of animal-health, mineral-nutrition and performance products. The company serves poultry, swine, dairy and beef cattle, aquaculture, personal care, industrial chemical and chemical catalyst markets.
This unaudited Form 10-Q covers the three and six months ended December 31, 2019, representing fiscal second-quarter and year-to-date results, compared with the corresponding 2018 periods. The company adopted ASC 842 lease accounting on July 1, 2019.
Key Financial Metrics
| Metric | Three months ended Dec. 31, 2019 | Change vs. 2018 | Six months ended Dec. 31, 2019 | Change vs. 2018 |
|---|---|---|---|---|
| Net sales | $214.0 million | Down 2% | $403.7 million | Down 4% |
| Gross profit | $69.1 million | Up 1% | $126.8 million | Down 6% |
| Gross margin | 32.3% | Up from 31.5% | 31.4% | Down from 32.1% |
| Operating income | $19.6 million | Down 24% | $29.8 million | Down 39% |
| Net income | $11.9 million | Down 19% | $14.4 million | Down 54% |
| Diluted earnings per share | $0.29 | Down from $0.36 | $0.36 | Down from $0.77 |
| Adjusted EBITDA | $28.5 million | Down 10% | $48.1 million | Down 22% |
Net interest expense was $3.4 million in the quarter and $6.8 million year to date, increasing 14% and 17%, respectively, primarily because of higher Revolver borrowings. The effective tax rate was 29.6% for both periods in 2019.
Segment and Operating Trends
- Animal Health: Second-quarter sales increased 3% to $143.7 million, but year-to-date sales declined 2% to $265.5 million. Nutritional specialties and vaccines grew, while MFAs and other products declined. Year-to-date Adjusted EBITDA fell 18% to $58.9 million.
- Mineral Nutrition: Second-quarter sales declined 11% to $55.7 million and year-to-date sales declined 8% to $108.3 million, reflecting lower average selling prices and lower unit volumes. Year-to-date Adjusted EBITDA increased 8% to $7.2 million.
- Performance Products: Second-quarter sales declined 10% to $14.6 million and year-to-date sales declined 2% to $29.9 million, primarily due to lower copper-based product volumes.
- Cost structure: SG&A increased 15% in the quarter and 13% year to date. Excluding specified stock compensation, restructuring and acquisition-related items, management said SG&A still increased 11% in the quarter and 10% year to date due to product-development, strategic-initiative and corporate costs.
Cash Flow, Liquidity and Debt
- Six-month operating cash flow was $28.5 million, compared with $16.6 million in the prior-year period.
- Investing cash outflow was $96.7 million, including $54.5 million for the Osprey Biotechnics acquisition, $25.0 million invested in short-term investments and $16.1 million of capital expenditures.
- Financing activities provided $36.9 million, including $53.0 million of net Revolver borrowings, partly offset by $9.7 million of dividends and $6.4 million of debt and other payments.
- Cash and cash equivalents declined to $26.2 million from $57.6 million at June 30, 2019. Cash plus short-term investments was $75.2 million, compared with $81.6 million at June 30, 2019.
- Working capital was $238.9 million and the reported current-asset-to-current-liability ratio was 2.82:1.
- At December 31, 2019, debt consisted primarily of $149.0 million outstanding under the $250.0 million Revolver and $225.0 million of Term A Loan principal, with $15.6 million classified as current. The Revolver had $98.3 million available after $2.7 million of letters of credit.
- The credit facilities mature June 29, 2022. The company reported compliance with its financial covenants at December 31, 2019 and stated that available cash, operating cash flow and financing arrangements should support ongoing needs, subject to operating and economic risks.
Material Changes, Acquisitions and Unusual Items
- In August 2019, Phibro acquired Osprey Biotechnics for $54.5 million in cash. The acquisition added approximately $32.4 million of definite-lived intangible assets and $25.3 million of goodwill. A contingent payment liability of $7.6 million was recorded; the future payment is based on performance for the year ending June 30, 2021, has a minimum of $4.8 million and no stated maximum.
- Osprey contributed approximately two-thirds of the nutritional-specialties sales growth in the quarter and year to date, according to management.
- The company recorded $0.4 million of restructuring charges in the first six months and expects approximately $0.5 million of additional employee-separation charges by June 30, 2020.
- The company adopted the new lease standard and recognized $18.6 million of right-of-use assets and $19.4 million of lease liabilities at adoption. Total operating lease liabilities were $24.1 million at December 31, 2019.
- Quarterly dividends were $0.12 per share. On February 3, 2020, the board declared another $0.12-per-share dividend payable March 25, 2020, subject to the stated record date.
Outlook, Commentary and Risks
No formal quantitative revenue or earnings guidance is provided in the filing. Management stated that its operating plan projects adequate liquidity throughout the year and that it expects to comply with debt covenants, but cautioned that adverse operating results, covenant violations, economic disruption or difficulty obtaining financing could affect liquidity.
- Animal-health demand is affected by disease pressures, weather, seasonality, regulatory changes and livestock-production trends. African Swine Fever reduced Chinese demand for MFAs, although customers purchased some products ahead of regulatory changes effective January 1, 2020.
- Key business risks include restrictions on antibacterials, product safety or efficacy concerns, regulatory and product-approval requirements, competition, raw-material pricing and availability, customer consolidation, currency fluctuations and dependence on manufacturing facilities and international operations.
- The company faces environmental investigation and remediation matters, including the Omega Chemical Superfund Site groundwater matter involving Phibro-Tech. Estimated environmental liabilities were approximately $5.1 million at December 31, 2019, but potential additional costs cannot be predicted with certainty.
- The company is party to ordinary-course litigation and stated that it does not expect current claims to have a material adverse effect, although environmental and product-liability exposures remain relevant contingencies.
- Management reported that disclosure controls and procedures were not effective as of December 31, 2019 because of previously disclosed material weaknesses in internal control over financial reporting. Remediation is underway, but the company cannot determine when it will be complete or assure that it will be successful.
Most Important Facts to Verify
- Whether the decline in MFA sales, including China-related effects, persists after the January 2020 regulatory changes.
- Whether Animal Health growth from nutritional specialties, vaccines and Osprey offsets continued pressure in MFAs and other products.
- Progress toward restoring operating margins and reversing the year-to-date decline in Adjusted EBITDA and net income.
- Osprey’s performance relative to the contingent consideration estimate and the resulting cash and leverage impact.
- Revolver utilization, covenant headroom and liquidity after acquisition spending, dividends and capital expenditures.
- Completion and effectiveness of remediation for the disclosed material weaknesses in internal control over financial reporting.
- Developments in environmental investigations, litigation and potential liabilities beyond the $5.1 million currently estimated.