Business Context and Reporting Period
Phibro Animal Health Corporation is a global developer, manufacturer and marketer of animal health, mineral nutrition and performance products. This unaudited Form 10-Q covers the three and six months ended December 31, 2016, the company’s fiscal second quarter and first six months of fiscal 2017, compared with the corresponding 2015 periods.
Financial Performance and Position
| Metric | Three Months Ended December 31, 2016 | Year-over-Year Change | Six Months Ended December 31, 2016 | Year-over-Year Change |
|---|---|---|---|---|
| Net sales | $191.6 million | Less than 1% decrease | $379.6 million | Less than 1% increase |
| Gross profit | $63.5 million | 3% increase | $124.5 million | 3% increase |
| Gross margin | 33.1% | Up from 32.0% | 32.8% | Up from 31.8% |
| Operating income | $22.6 million | Essentially unchanged | $44.4 million | Essentially unchanged |
| Net income | $13.4 million | Down 56% | $25.6 million | Down 48% |
| Diluted earnings per share | $0.34 | Down from $0.75 | $0.64 | Down from $1.22 |
| Adjusted EBITDA | $31.2 million | Up 10% | $61.0 million | Up 9% |
Net income was adversely affected by the prior-year recognition of approximately $18.8 million of income tax benefit in the quarter and approximately $20.4 million in the six-month period from reversal of a domestic deferred-tax valuation allowance. The 2016 effective tax rates were 30.5% for the quarter and 30.6% year to date, compared with prior-year negative effective rates.
- Animal Health sales increased 2% in the quarter and 3% year to date. Nutritional specialties and vaccines grew strongly, while medicated feed additives and other products declined.
- Mineral Nutrition sales decreased 4% in both the quarter and year to date, primarily because of lower average selling prices tied to raw-material commodity price declines.
- Performance Products sales declined 2% in the quarter and 3% year to date.
- Quarterly SG&A increased 5% to $40.9 million; year-to-date SG&A increased 5% to $80.1 million. Increases included a $1.7 million pension settlement cost and $1.3 million of unsuccessful acquisition-related transaction costs in the six-month period.
- Six-month operating cash flow was $47.7 million, compared with $5.6 million in the prior-year period. Capital expenditures were $10.6 million, and cash used in investing activities was $10.8 million.
- Cash and cash equivalents were $39.2 million at December 31, 2016, compared with $33.6 million at June 30, 2016. Working capital was $199.4 million, and the current-assets-to-current-liabilities ratio was 2.99:1.
- The company paid $7.9 million of dividends during the first six months and declared a quarterly dividend of $0.10 per share. Management stated its intention to continue quarterly dividends at that rate, subject to Board approval.
Debt, Liquidity and Capital Resources
- Debt consisted of $48.5 million outstanding under the revolving credit facility, $277.1 million of long-term debt net of issuance costs and current maturities, and $2.9 million of current long-term debt maturities.
- The revolving facility permits borrowings of up to $200.0 million. After $14.5 million of outstanding letters of credit, $137.0 million remained available for borrowings and letters of credit.
- The Term B Loan is due in April 2021. Six-month weighted-average interest rates were 3.30% on the revolver and 4.00% on the Term B Loan.
- The company was in compliance with its credit-facility covenants at December 31, 2016. Management believes cash on hand and available financing will support planned needs, but cautioned that adverse operating conditions or covenant violations could impair liquidity and access to financing.
Material Changes Versus the Prior Comparable Period
- Revenue was broadly stable, but mix shifted toward higher-growth nutritional specialties and vaccines and away from MFAs, mineral nutrition and certain performance products.
- Gross margin improved by approximately 1.1 percentage points in both the quarter and six-month period, reflecting volume growth, operating efficiencies and lower raw-material costs.
- Adjusted EBITDA increased despite essentially flat sales, while GAAP net income declined substantially because the prior year included a large deferred-tax valuation-allowance reversal.
- Operating cash flow improved by $42.1 million year over year, principally due to working-capital timing and the absence of prior-year working-capital uses.
- The company amended its domestic pension plan, recorded a $6.8 million curtailment gain in other comprehensive income during the first quarter, modified its 401(k) plan, and recorded a $1.7 million pension settlement charge in the second quarter.
- Prior-period financial statements were revised to classify product-related intangible amortization in cost of goods sold rather than SG&A. The revision reduced prior-period gross profit but did not affect net income or cash flows.
Outlook, Commentary, Risks and Unusual Items
- The filing does not provide formal quantitative revenue or earnings guidance. Management’s operating plan projects adequate liquidity throughout the year.
- U.S. sales of products classified as medically important antibacterials were approximately $32 million for the twelve months ended December 31, 2016, down $5 million from the twelve months ended June 30, 2016.
- The FDA began initial steps in April 2016 to withdraw approval of Mecadox, citing concerns about potentially persistent residues. The product remained saleable as of December 31, 2016, but the FDA had not set a response deadline to the company’s safety submission. U.S. Mecadox sales were approximately $14 million for the twelve months ended December 31, 2016.
- Key business risks include changing regulations and consumer perceptions concerning animal antibacterials, animal-disease outbreaks, raw-material costs and availability, foreign currency exposure, international economic conditions, competition, manufacturing interruptions, product liability and substantial indebtedness.
- Environmental investigations and remediation reserves totaled $7.2 million at December 31, 2016. The EPA and private parties have asserted potential claims involving groundwater contamination associated with the Omega Chemical Superfund Site; the company stated that ultimate liability cannot currently be predicted.
- The company uses foreign-currency and limited commodity derivatives for hedging, not speculation. Accumulated other comprehensive income included $2.96 million of net unrecognized derivative gains, of which approximately $0.36 million was expected to be recognized in earnings within twelve months.
- Management reported that disclosure controls and procedures were not effective at December 31, 2016 because of previously disclosed material weaknesses in internal control over financial reporting. Remediation is underway, but completion timing and effectiveness are not assured.
- The company adopted the debt-issuance-cost presentation guidance retrospectively and is evaluating the potential effects of new lease and revenue-recognition standards.
Most Important Facts for Investors to Verify
- Whether the FDA permits continued sale and use of Mecadox and the potential financial effect of any withdrawal.
- Whether the company’s growth in vaccines and nutritional specialties can offset continued declines in MFAs and pressure on Mineral Nutrition pricing.
- Progress in remediating the material weaknesses in internal control over financial reporting.
- Compliance with debt covenants, revolver availability and the company’s ability to refinance or repay the Term B Loan when due.
- Potential changes in environmental liability associated with the Omega Chemical groundwater matters and other remediation sites.
- The sustainability of improved gross margins and operating cash flow after working-capital timing benefits and other unusual items.
- The effect of regulatory changes, consumer concerns about medically important antibacterials, foreign currency movements and raw-material prices on future results.