Business Context and Reporting Period
Phibro Animal Health Corporation develops, manufactures and markets animal health, mineral nutrition and performance products. This unaudited Form 10-Q covers the three and nine months ended March 31, 2016, compared with the corresponding 2015 periods. The request identifies “2015 Q3,” but the filing itself is for fiscal 2016 third quarter.
Key Financial Metrics
| Metric | Three Months Ended March 31, 2016 | Year-over-Year Change | Nine Months Ended March 31, 2016 | Year-over-Year Change |
|---|---|---|---|---|
| Net sales | $183.5 million | Down 2% | $562.4 million | Down less than 1% |
| Gross profit | $60.0 million | Up 1% | $182.5 million | Up 4% |
| Gross margin | 32.7% | Up from 31.5% | 32.5% | Up from 31.1% |
| Operating income | $21.2 million | Down 3% | $65.7 million | Down 2% |
| Net income | $18.6 million | Up 11% | $67.5 million | Up 35% |
| Diluted EPS | $0.46 | Up from $0.42 | $1.69 | Up from $1.25 |
| Adjusted EBITDA | $29.7 million | Up 8% | $85.8 million | Up 3% |
Net income benefited significantly from discrete tax items, including a $21.3 million release of the domestic deferred-tax valuation allowance and $3.7 million of recognized previously unrecognized tax benefits during the nine months. Excluding these items, nine-month income tax expense was $16.2 million and the effective tax rate was 27.6%.
Cash Flow, Liquidity and Debt
- Net cash provided by operating activities was $10.6 million for the nine months, down from $46.8 million in 2015. Working-capital changes consumed approximately $51.0 million, including $19.8 million for inventories.
- Investing cash outflow was $75.1 million, including $46.5 million for the MVP Laboratories acquisition and $28.6 million of capital expenditures.
- Financing cash inflow was $68.0 million, primarily reflecting $79.0 million of net Revolver borrowings. Dividends paid were $11.8 million.
- Cash and cash equivalents were $32.2 million at March 31, 2016, compared with $29.2 million at June 30, 2015.
- The January 2016 amendment increased Revolver commitments from $100.0 million to $200.0 million. Outstanding Revolver borrowings were $82.0 million, with $14.2 million of letters of credit and $103.8 million of remaining availability.
- Term B debt, due April 2021, was $284.9 million before discount and current maturities. Total liabilities were $512.2 million and stockholders’ equity was $77.7 million.
- Management reported compliance with debt covenants and expects available cash and financing arrangements to support planned needs, while acknowledging that adverse operating results or covenant violations could impair liquidity.
Material Changes Versus the Prior Comparable Period
- Reported sales declined modestly because 2015 included vaccine-licensing milestone revenue of $2.0 million in the quarter and $8.0 million in the nine-month period. Excluding those milestones, sales increased approximately 1% for the quarter and 1% for the nine months.
- Animal Health sales increased 1% in the quarter and 2% for the nine months, excluding the prior-year milestones. Nutritional specialties were particularly strong, while vaccines benefited from volume growth and the MVP acquisition.
- Mineral Nutrition sales declined 7% in the quarter and 3% for the nine months, mainly because lower raw-material prices reduced average selling prices.
- Performance Products sales declined 6% in the quarter and 7% for the nine months, reflecting lower volumes and pricing.
- Gross margins improved, driven by Animal Health volume growth, operating efficiencies and favorable currency movements. Adjusted EBITDA increased 8% in the quarter and 3% for the nine months on a reported basis.
- Interest expense increased 18% in the quarter and 14% for the nine months, primarily because of increased Revolver borrowings and acquisition-related accrued interest.
- In January 2016, Phibro acquired MVP Laboratories for approximately $46.5 million in cash. The acquisition added livestock vaccines and related products and generated $1.6 million of acquisition-related inventory step-up cost of goods sold and $0.6 million of transaction costs during the nine-month period.
- Inventories increased to $168.3 million from $149.8 million at June 30, 2015, while working capital increased to $203.4 million and the current-assets-to-current-liabilities ratio improved to 3.10:1.
Guidance, Outlook, Commentary and Risks
- No formal quantitative full-year revenue or earnings guidance is provided in the filing. Management states that its operating plan projects adequate liquidity throughout the year and that it intends to continue quarterly dividends of $0.10 per share, subject to Board approval and legal and contractual restrictions.
- The FDA began initial steps in April 2016 to withdraw approval of Mecadox, Phibro’s carbadox product, because of concerns regarding persistence of residues in animal tissue. The action did not prohibit U.S. sales as of the filing. U.S. Mecadox sales were approximately $15 million for the 12 months ended March 31, 2016. Phibro planned to submit supporting safety data by July 11, 2016 and requested an FDA hearing.
- Management expects domestic income-tax expense to increase in future periods because the domestic deferred-tax valuation allowance was released and domestic pre-tax income will no longer be substantially offset by that allowance.
- Key operating risks include additional restrictions on antibacterials in food-producing animals, regulatory changes, animal disease outbreaks, product safety or efficacy concerns, raw-material price and availability fluctuations, foreign-currency movements, customer and supplier concentration, substantial indebtedness and debt covenants.
- Environmental investigations and litigation include the Omega Chemical Site groundwater matter in California. The company recorded approximately $6.4 million for estimated environmental investigation, remediation and closure costs, but stated that potential additional liability cannot be predicted with certainty.
- Disclosure controls and procedures were not effective as of March 31, 2016 because of previously reported material weaknesses in internal control over financial reporting. Management is implementing additional policies, accounting resources and access controls, but cannot determine when remediation will be complete or assure its success.
Most Important Facts for Investors to Verify
- Confirm the outcome and timing of the FDA’s review of Mecadox and quantify any resulting sales or earnings impact.
- Assess whether the MVP acquisition is contributing sustainable vaccine growth and whether integration, amortization and acquisition-related costs affect returns.
- Monitor operating cash conversion, inventory levels and working-capital requirements after the substantial decline in operating cash flow.
- Track Revolver utilization, leverage-covenant compliance, interest costs and remaining borrowing capacity.
- Separate recurring operating performance from the nine-month $25.0 million discrete tax benefit and other acquisition-related and foreign-currency items.
- Evaluate progress and independent validation of remediation efforts for the material weaknesses in internal control.
- Review developments in environmental claims, regulatory restrictions on antibacterials and the potential effect on the company’s product portfolio.