Business Context and Reporting Period
Phibro Animal Health Corporation filed its Form 10-K for the fiscal year ended June 30, 2018. The filing includes unaudited fourth-quarter results for the three months ended June 30, 2018. Phibro is a global animal health, mineral nutrition and specialty chemicals company serving approximately 3,000 customers in more than 70 countries.
- Animal Health: Antibacterials, anticoccidials, nutritional specialties and vaccines.
- Mineral Nutrition: Trace-mineral products for livestock and other customers.
- Performance Products: Specialty ingredients for personal care, industrial chemical and chemical catalyst markets.
Financial Performance and Key Metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net sales | $820.0 million | $764.3 million | +7% |
| Gross profit | $266.9 million | $248.2 million | +8% |
| Gross margin | 32.5% | 32.5% | Flat |
| Operating income | $98.9 million | $97.9 million | +1% |
| Net income | $64.9 million | $64.6 million | Flat |
| Diluted EPS | $1.61 | $1.61 | Flat |
| Adjusted EBITDA | $129.0 million | $120.1 million | +7% |
| Cash flow from operations | $70.0 million | $98.4 million | -$28.4 million |
| Capital expenditures | $18.5 million | $20.9 million | -$2.3 million |
FY2018 segment sales were $531.7 million for Animal Health, $234.9 million for Mineral Nutrition and $53.3 million for Performance Products. Animal Health generated $141.9 million of Adjusted EBITDA, Mineral Nutrition generated $18.6 million and Performance Products generated $1.9 million.
- Cash and short-term investments totaled $79.2 million at June 30, 2018, including $29.2 million of cash and $50.0 million of short-term investments.
- Working capital was $205.7 million; the current-assets-to-current-liabilities ratio was 2.57:1.
- Total debt was approximately $312.4 million, consisting primarily of a $243.8 million Term A loan and $70.0 million drawn on the revolver.
- The revolver had approximately $175.8 million of remaining availability after borrowings and letters of credit.
- The Credit Facilities mature June 29, 2022; the Company was in compliance with its financial covenants at June 30, 2018.
- Quarterly dividends remained $0.10 per share, or $0.40 per share for FY2018.
Material Changes Versus the Prior Comparable Period
- Sales growth was led by international Animal Health demand, particularly MFAs and other products, nutritional specialties and vaccines.
- U.S. sales of medically important antimicrobials declined by approximately $5.9 million; management stated that domestic sales had stabilized at current levels.
- Mineral Nutrition sales increased primarily from higher average selling prices reflecting higher underlying commodity costs.
- Performance Products sales increased from higher volumes of copper-based and personal-care products and higher copper-based pricing.
- Gross margin was unchanged despite $1.7 million of acquisition-related cost of goods sold in FY2018.
- SG&A increased 12% to $168.0 million, reflecting investments in product and organizational development, higher employee-related costs and professional fees.
- Interest expense declined 20% to $11.9 million, primarily because of lower rates under the new Credit Facilities entered into in June 2017.
- Net income was essentially unchanged because operating improvements and lower interest expense were largely offset by higher income-tax expense. The FY2018 effective tax rate was 26.3%, compared with 19.8% in FY2017.
- Operating cash flow declined because inventory used $24.3 million of cash and accounts receivable used $11.9 million, partly reflecting commodity costs, production timing and fourth-quarter sales growth.
- Investing cash outflows increased to $84.6 million, including $50.0 million invested in short-term investments, $18.5 million of capital expenditures and $15.0 million for an acquisition.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal revenue or earnings guidance in the filing. Management expects approximately $42 million of capital expenditures in FY2019, primarily for Animal Health capacity expansion, manufacturing efficiency and environmental, health and safety compliance. The Company stated that cash on hand, operating cash flow and financing arrangements are expected to support planned needs, but noted that adverse results or covenant violations could impair liquidity.
- Antimicrobial regulation: Medically important antimicrobial sales in the United States were approximately $17 million in FY2018, down from $23 million in FY2017. Further restrictions, public pressure or changes in customer practices could materially reduce sales.
- Mecadox proceedings: The FDA’s withdrawal proceedings regarding Mecadox were indefinitely stayed in March 2018, but remain unresolved. FY2018 U.S. Mecadox sales were approximately $11 million.
- Tax Act: FY2018 tax expense included a $2.3 million reduction in deferred tax assets and a $0.4 million mandatory toll charge. The recorded Tax Act effects remained provisional.
- Environmental exposure: Environmental accruals totaled $6.8 million at June 30, 2018. The Company is a potentially responsible party in the Omega Chemical Superfund groundwater matter but cannot estimate its ultimate liability.
- Internal controls: Management concluded that disclosure controls and internal control over financial reporting were ineffective because two material weaknesses continued: insufficient formal accounting policies and procedures, and inadequate system access controls and segregation of duties. The auditor did not provide an internal-control attestation because Phibro remained an emerging growth company.
- Acquisition and strategic activity: Phibro acquired an Animal Health business for $15.0 million in September 2017. In July 2018, it completed the accelerated purchase of intellectual property and other assets related to the MJB animal vaccine business; $12.8 million was accrued at June 30, 2018.
- Other risks: The filing highlights foreign-exchange exposure, floating-rate debt, dependence on Israeli and Brazilian operations, raw-material volatility, manufacturing concentration, animal-disease outbreaks, customer consolidation, competition, product liability and environmental regulation.
Most Important Facts for Investors to Verify
- Whether international Animal Health growth can offset continued pressure on U.S. medically important antimicrobial products.
- The status and potential financial impact of the FDA’s Mecadox proceedings and related regulatory developments.
- Progress in remediating the two material weaknesses in internal control before auditor attestation becomes required for FY2019.
- Liquidity and leverage relative to the June 2022 maturity of the Term A loan and revolver, including compliance with the 4.00:1.00 maximum leverage and 3.00:1.00 minimum interest-coverage covenants.
- Conversion of inventory and receivables into cash, given the FY2018 decline in operating cash flow.
- Execution and returns from the planned FY2019 capital expenditures, the Sligo vaccine facility and recent acquisitions.
- Potential costs from the Omega Chemical environmental matter and other remediation obligations beyond the $6.8 million accrued balance.
- The sustainability of the $0.10 quarterly dividend under debt covenants, capital requirements and operating performance.