Business Context and Reporting Period
Phibro Animal Health Corporation filed an unaudited Form 10-Q for the three months ended September 30, 2016, the first quarter of fiscal 2017. The company develops, manufactures and markets animal health, mineral nutrition and performance products globally.
- Animal Health includes medicated feed additives, nutritional specialty products and vaccines.
- Mineral Nutrition supplies trace-mineral products for food animals.
- Performance Products serves personal care, automotive, industrial chemical and chemical catalyst markets.
Financial Performance and Liquidity
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $188.0 million | $187.1 million | Less than 1% increase |
| Gross profit | $61.0 million | $59.2 million | 3% increase |
| Gross margin | 32.4% | 31.6% | Up 0.8 percentage points |
| Operating income | $21.8 million | $21.9 million | Essentially flat |
| Net income | $12.2 million | $18.8 million | 35% decrease |
| Diluted EPS | $0.31 | $0.47 | Decrease of $0.16 |
| Adjusted EBITDA | $29.8 million | $27.7 million | 8% increase |
| Operating cash flow | $21.5 million | $(2.4) million | Improved by $23.9 million |
- Net income was reduced primarily by the comparison of a $5.5 million foreign-currency gain in the prior-year quarter with a $0.3 million foreign-currency loss in the current quarter, as well as a higher effective tax rate of 30.7% versus 20.2%.
- Animal Health sales increased 4% to $124.5 million, driven by nutritional specialty products and vaccines. Mineral Nutrition sales declined 5% to $51.6 million, and Performance Products sales declined 5% to $11.9 million.
- Adjusted EBITDA increased 8% to $29.8 million, with growth in all three operating segments, partly offset by higher corporate costs.
- Cash and cash equivalents were $37.4 million at September 30, 2016, compared with $33.6 million at June 30, 2016. Working capital was $203.9 million and the reported current-asset-to-current-liability ratio was 3.07:1.
- Capital expenditures were $5.9 million. Financing activities used $11.7 million, including $7.0 million of net revolver repayments, $3.9 million of dividends and $0.7 million of scheduled debt payments.
Debt and Liquidity
- Total reported debt consisted primarily of $62.0 million drawn under the revolving credit facility and $277.7 million of long-term debt, including the Term B loan due April 2021.
- The revolver has $200.0 million of total capacity. After $14.2 million of letters of credit, $123.8 million remained available for borrowings and letters of credit.
- The company was in compliance with its credit-facility covenants at September 30, 2016 and stated that cash on hand and financing arrangements should support expected needs. Management cautioned that adverse operating results, covenant violations, economic conditions or financing disruptions could impair liquidity.
- The company declared a quarterly dividend of $0.10 per share and stated that it currently intended to continue quarterly dividends, subject to board approval.
Material Changes Versus the Prior Comparable Period
- Sales were broadly stable, but the mix shifted toward Animal Health, particularly nutritional specialties and vaccines.
- Gross margin improved due to volume growth, operating efficiencies and lower material costs, while SG&A increased 5%, including $1.3 million of transaction costs for an unsuccessful acquisition.
- Operating income was flat despite higher gross profit because of increased SG&A.
- Adjusted EBITDA improved despite the loss of the prior-year foreign-currency benefit; however, GAAP net income declined substantially because of foreign-currency and tax effects.
- Operating cash flow improved sharply, aided by favorable changes in receivables and inventory compared with significant working-capital uses in the prior-year quarter.
- The company retrospectively reclassified $0.953 million of product-related intangible amortization from SG&A to cost of goods sold in the prior-year comparative presentation. The revision did not affect prior-year net income or cash flow.
- The company adopted debt-issuance-cost presentation guidance, reporting qualifying debt issuance costs as a reduction of long-term debt.
Guidance, Outlook, Risks and Unusual Items
- No formal revenue or earnings guidance was provided in the filing. Management stated that its operating plan projected adequate liquidity throughout the year.
- U.S. sales of products classified as medically important antibacterials were approximately $33 million for the twelve months ended September 30, 2016. Management cited evolving regulatory and consumer concerns regarding these products as a demand risk.
- The FDA began initial steps in April 2016 to withdraw approval of Mecadox, which generated approximately $14 million of U.S. sales during the twelve months ended September 30, 2016. The company submitted supporting safety data in July 2016 and was awaiting the FDA’s response; loss of the product would negatively affect results.
- The domestic pension plan was amended to eliminate future service and compensation credits, producing a $6.8 million curtailment gain in other comprehensive income. A partial pension settlement was expected to generate an approximately $1.7 million operating charge in the quarter ending December 31, 2016.
- Environmental liabilities for estimated investigation, remediation and closure costs were $7.0 million at September 30, 2016. Separate EPA and civil proceedings concerning contaminated groundwater in California could result in additional liabilities, although the amount and timing were not estimable with certainty.
- The company uses foreign-currency and limited commodity derivatives for hedging and remains exposed to currency, interest-rate and raw-material price fluctuations.
- Disclosure controls were deemed ineffective because of material weaknesses in internal control over financial reporting identified at June 30, 2016. Remediation had begun, but management could not determine when it would be complete or assure its success.
- Other key risks include dependence on livestock demand, animal disease outbreaks, product registration and regulatory changes, competition, manufacturing disruptions, supplier availability, indebtedness and debt covenants, litigation, and economic conditions in Brazil and Israel.
Most Important Facts for Investors to Verify
- Progress and outcome of the FDA’s review of Mecadox and the associated risk to approximately $14 million of annual U.S. sales.
- Whether the company’s internal-control remediation eliminates the disclosed material weaknesses.
- Actual debt reduction, revolver availability and compliance with leverage covenants as operating conditions change.
- Timing and magnitude of the expected approximately $1.7 million pension-settlement charge and the ongoing cost of enhanced 401(k) contributions.
- Developments in the California groundwater remediation and related litigation, including any change in the estimated $7.0 million environmental liability.
- Sustainability of Animal Health growth, particularly vaccines and nutritional specialties, amid continued weakness in medically important antibacterial products.
- Conversion of improved operating cash flow into sustainable free cash flow after capital expenditures and dividends.