PHIBRO ANIMAL HEALTH CORP annual report, FY2014

Business Context and Reporting Period

Phibro Animal Health Corporation filed its Form 10-K for the fiscal year ended June 30, 2014. The filing also reports unaudited fourth-quarter results for the quarter ended June 30, 2014; the request metadata references “2013 Q4,” but the filing’s applicable period is fiscal 2014. Phibro develops, manufactures and markets animal health, mineral nutrition and performance products in more than 65 countries.

Segments: Animal Health, Mineral Nutrition and Performance Products.
IPO and refinancing: Phibro completed its IPO on April 16, 2014, issuing 8.3 million Class A shares and receiving approximately $114.4 million net proceeds. It also issued a $290.0 million Term B Loan and a $100.0 million revolving facility.
Governance: BFI controlled approximately 92.5% of combined voting power through Class B shares carrying 10 votes per share.

Financial Performance and Key Metrics

Metric	FY2014	FY2013	Change
Net sales	$691.9 million	$653.2 million	Up 6%
Gross profit	$207.8 million	$179.0 million	Up 16%
Gross margin	30.0%	27.4%	Up 260 basis points
Operating income	$63.8 million	$56.7 million	Up 12%
Net income (loss)	$(3.1) million	$24.9 million	Declined $28.0 million
Adjusted EBITDA	$90.6 million	$75.8 million	Up 20%
Cash from operating activities	$(0.7) million	$1.4 million	Declined $2.1 million
Capital expenditures	$19.8 million	$19.9 million	Approximately flat

Animal Health drove growth, with sales of $431.1 million, up 12%, and Adjusted EBITDA of $100.3 million, up 21%. Within Animal Health, MFAs and other sales increased 8%, Nutritional Specialties increased 21%, and Vaccines increased 44%. Mineral Nutrition sales declined 1% to $201.6 million, while Performance Products declined 9% to $59.3 million.

Reported profitability was affected by a $22.8 million loss on extinguishment of debt, a $5.4 million loss related to an insurance claim, foreign currency losses of $1.8 million and a $9.4 million income-tax provision. The resulting effective tax rate was 149.6%, and reported diluted loss per share was $0.10. Adjusted net income was $28.9 million, compared with $18.4 million in FY2013, based on the company’s non-GAAP adjustments.

Fourth-quarter FY2014 net sales were $183.7 million, gross profit was $54.3 million, operating income was $13.1 million and net loss was $17.6 million. The quarterly loss primarily reflected the $22.8 million debt-extinguishment charge and the $5.4 million insurance-related loss.

Cash Flow, Debt and Liquidity

Cash and cash equivalents were $11.8 million at June 30, 2014, compared with $27.4 million at June 30, 2013.
Working capital was $178.0 million, and the current ratio was 2.63:1.
Total debt was approximately $289.4 million, consisting primarily of the Term B Loan; the revolving facility was undrawn.
The revolving facility had $82.9 million available after $17.1 million of letters of credit and other commitments.
The Term B Loan matures in April 2021 and requires mandatory quarterly principal payments of $0.725 million beginning in September 2014.
FY2014 operating cash flow was negative because of $17.2 million in refinancing premiums and costs, unusually high interest payments of $45.4 million and increased receivables. Accounts receivable increased $14.7 million, and days sales outstanding rose to 56 days from 54 days.
Management stated that cash on hand, expected operating cash flow and available financing should support planned needs, but noted that adverse operating results or covenant violations could impair liquidity.

Material Changes Versus the Prior Comparable Period

Revenue growth accelerated through Animal Health, particularly vaccines and nutritional specialty products, while lower-margin lysine sales were deemphasized in Mineral Nutrition.
Gross margin expanded materially because of volume growth, favorable product mix, higher prices, lower unit costs, improved manufacturing efficiency and the elimination of royalties following the OmniGen acquisition.
SG&A increased 18% to $144.0 million, including the insurance-related loss and higher selling, marketing, development, professional and public-company costs.
Debt was substantially restructured: the company retired $300.0 million of 9.25% senior notes and related-party term loans and replaced them with the Term B Loan and revolving facility.
Shareholders’ equity improved from a deficit of $68.9 million to positive equity of $15.1 million, largely due to the IPO proceeds and related capital transactions.
Cash generation remained weak despite higher Adjusted EBITDA, reflecting working-capital investment and refinancing cash costs.
R&D expense increased to $8.2 million from $6.6 million, primarily supporting product lifecycle extensions and new product development.

Guidance, Outlook, Commentary and Risks

Management expected approximately $25 million of capital expenditures in FY2015, primarily for Animal Health production capacity, efficiency and cost reduction.
Management projected a normalized future effective tax rate of approximately 30% once domestic valuation allowances no longer materially affect tax accounting.
Management identified global animal-health market growth, emerging-market expansion, new product approvals, lifecycle development and operational efficiency as key growth opportunities.
Antibacterials represented approximately 47% of net sales, and global antibacterial and related-product sales were approximately $326.6 million in FY2014. Management estimated that withdrawing U.S. non-therapeutic claims without adding therapeutic claims could have reduced FY2014 MFA and Other sales by approximately $15 million to $20 million.
Regulatory risks include the FDA’s guidance on medically important antibacterials, potential restrictions on carbadox, product-registration requirements, and ongoing cGMP remediation relating to Stafac 20. The filing states that the observations had not affected the company’s ability to market products, but failure to resolve them could be financially material.
Other material risks include competition and generic products, animal-disease outbreaks, weather and commodity-price volatility, foreign-exchange exposure, dependence on Israeli and Brazilian operations, supplier and manufacturing interruptions, environmental liabilities and substantial debt service.
Environmental accruals were $7.3 million at June 30, 2014, and outstanding letters of credit included $12.5 million for environmental financial assurance. Potential liability relating to the Omega Chemical Superfund groundwater plume could not be estimated with reasonable certainty.
The company reported material weaknesses in internal control over financial reporting involving transaction processing, technical accounting resources, system access and segregation of duties. Disclosure controls were therefore deemed ineffective as of June 30, 2014.
The company intends to pay quarterly dividends, targeting approximately $15.6 million annually, subject to board approval, results, liquidity and debt-covenant restrictions.

Most Important Facts for Investors to Verify

Whether Animal Health growth and margin expansion can offset declines in Mineral Nutrition and Performance Products.
The sustainability of positive operating cash flow after the one-time refinancing costs and elevated interest payments in FY2014.
Term B Loan amortization, floating-rate exposure, leverage-covenant compliance and available revolving capacity.
The financial impact of FDA antibacterial guidance, carbadox regulatory developments and completion of cGMP remediation.
Progress in remediating the three reported internal-control material weaknesses and the effect on future financial reporting.
Potential costs from environmental proceedings, product-liability matters and unresolved insurance claims.
The company’s ability to maintain dividends while funding capital expenditures, pension contributions and debt service.
The effect of BFI’s concentrated voting control and the company’s reliance on controlled-company and emerging-growth-company exemptions.