PHIBRO ANIMAL HEALTH CORP (PAHC) SEC Quarterly Report (10-Q) for Q1 2017

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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For the quarterly period ended March 31, 2017

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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For the transition period from _____ to _____

Commission File Number: 001-36410

Phibro Animal Health Corporation

(Exact name of registrant as specified in its charter)

(201) 329-7300

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of May 1, 2017, there were 18,753,979 shares of the registrant's Class A common stock, par value $0.0001 per share, and 20,887,811 shares of the registrant's Class B common stock, par value $0.0001 per share, outstanding.

PHIBRO ANIMAL HEALTH CORPORATION

TABLE OF CONTENTS

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PART I-FINANCIAL INFORMATION

Item 1.   Financial Statements

PHIBRO ANIMAL HEALTH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements

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PHIBRO ANIMAL HEALTH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

The accompanying notes are an integral part of these consolidated financial statements

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PHIBRO ANIMAL HEALTH CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements

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PHIBRO ANIMAL HEALTH CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements

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Description of Business

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Phibro Animal Health Corporation ("Phibro" or "PAHC") and its subsidiaries (collectively, the "Company") is a diversified global developer, manufacturer and marketer of a broad range of animal health and mineral nutrition products for food animals including poultry, swine, cattle, dairy and aquaculture. The Company is also a manufacturer and marketer of performance products for use in the personal care, automotive, industrial chemical and chemical catalyst industries. Unless otherwise indicated or the context requires otherwise, references in this report to "we," "our," "us," and similar expressions refer to Phibro and its subsidiaries.

The unaudited consolidated financial information for the three and nine months ended March 31, 2017 and 2016, is presented on the same basis as the financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2016 (the "Annual Report"), filed with the Securities and Exchange Commission on August 29, 2016 (File no. 001-36410). In the opinion of management, these financial statements include all adjustments necessary for a fair statement of financial position, results of operations and cash flows for the interim periods, and the adjustments are of a normal and recurring nature. The financial results for any interim period are not necessarily indicative of the results for the full year. The consolidated balance sheet information as of June 30, 2016, was derived from the audited consolidated financial statements, which include the accounts of Phibro and its consolidated subsidiaries, but does not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP"). The unaudited consolidated financial information should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report.

The consolidated financial statements include the accounts of Phibro and its consolidated subsidiaries. The decision whether or not to consolidate an entity requires consideration of majority voting interests, as well as effective control over the entity. Intercompany balances and transactions have been eliminated in the consolidated financial statements.

Summary of Significant Accounting Policies and New Accounting Standards

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Our significant accounting policies are described in the notes to the consolidated financial statements included in our Annual Report. As of March 31, 2017, there have been no material changes to any of the significant accounting policies contained therein, except for the application of Accounting Standards Update ("ASU") 2015-03, Interest-Imputation of Interest (Subtopic 835-30) , as of July 1, 2016. Prior periods have been adjusted to reflect the retrospective application of this guidance. For further discussion, see "-New Accounting Standards."

Revisions of Previously Issued Financial Statements

During the three months ended June 30, 2016, the Company determined that amortization expense related to product-related intangible assets should be recorded in cost of goods sold rather than in selling, general and administrative expense within the consolidated statement of operations. The Company has revised its prior period financial statements, to correct the classification of amortization expense to increase cost of goods sold and reduce gross profit and selling, general and administrative expenses by $1,165 and $3,072 for the three and nine months ended March 31, 2016, respectively. These revisions had no impact on the Company's previously reported net income (loss) or cash flows. The Company evaluated the impact of the revisions on prior periods, assessing materiality quantitatively and qualitatively, and concluded the errors were not material to any previously issued financial statements.

Net Income per Share and Weighted Average Shares

Basic net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period.

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Diluted net income per share is calculated by dividing net income by the weighted average number of common shares outstanding during the reporting period after giving effect to potential dilutive common shares equivalents resulting from the assumed exercise of stock options. For the three and nine months ended March 31, 2017 and 2016, all common share equivalents were included in the calculation of diluted net income per share.

Dividends

We declared and paid quarterly cash dividends of $0.10 per share, totaling $3,959 and $11,841 during the three and nine months ended March 31, 2017, respectively, to holders of our Class A common stock and Class B common stock.

New Accounting Standards

Financial Accounting Standards Board ("FASB") ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment , supersedes the current guidance by establishing a one-step goodwill impairment test. This new guidance requires an entity to compare the fair value of a reporting unit to its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. This ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early application is permitted for goodwill impairment tests performed after January 1, 2017. We will apply this guidance when performing our next goodwill impairment test. We do not expect adoption of this guidance to have a material effect on our consolidated financial statements.

ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, amends the current guidance for determining whether a transaction represents the acquisition of a business or assets. This guidance provides updated criteria to make the determination and clarifies the definitions of key terms. This new standard is effective, on a prospective basis, for annual reporting periods beginning after December 15, 2017, and early application is permitted. During the three months ended March 31, 2017, we elected early application of this ASU, and it did not have a material effect on our consolidated financial statements.

ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments , provides specific guidance for the classification of certain transactions within the statement of cash flows. The issues addressed by this guidance include, but are not limited to, debt prepayments or debt extinguishment costs, contingent consideration payments made after a business combination and proceeds from the settlement of insurance claims. This ASU is effective for annual reporting periods beginning after December 15, 2017. Early application is permitted, as long as all provisions under the guidance are applied simultaneously. The provisions of this guidance are to be applied using a retrospective transition approach. We do not expect adoption of this guidance to have a material effect on our consolidated financial statements.

ASU 2016-02, Leases (Topic 842) , supersedes the current lease accounting guidance and requires an entity to recognize assets and liabilities for both financing and operating leases on the balance sheet and requires additional qualitative and quantitative disclosures regarding leasing arrangements. This ASU is effective for annual reporting periods beginning after December 15, 2018. We are evaluating the impact of adoption of this guidance on our consolidated financial statements.

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ASU 2015-11, Inventory (Topic 330), requires entities to measure inventory at the lower of cost and net realizable value ("NRV"). NRV is defined as "the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation." The guidance is effective for annual periods beginning after December 15, 2016, and interim periods within those years. We do not expect adoption of this guidance to have a material effect on our consolidated financial statements.

ASU 2015-05, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) provides guidance regarding the treatment of cloud computing arrangements and if an arrangement includes a software license. We adopted this guidance during the three months ended September 30, 2016, and it had no material impact on our consolidated financial statements.

ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30) , requires debt issuance costs to be presented as a reduction of the related liability. These costs were previously included in other assets. Debt issuance costs associated with line-of-credit arrangements may continue to be recognized in other assets. We adopted this guidance during the three months ended September 30, 2016, and applied the guidance retrospectively. Debt issuance costs of  $2,538 as of June 30, 2016, have been presented as a reduction in long-term debt on our consolidated balance sheets.

ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern (Subtopic 205-40) , requires management to assess an entity's ability to continue as a going concern within one year after the issuance date of the financial statements, and to provide related footnote disclosures in certain circumstances. Management will need to consider relevant conditions that are known and reasonably knowable at the issuance date. Substantial doubt exists if it is probable that the entity will be unable to meet its obligations within one year after the issuance date. Under the new standard, the definition of substantial doubt incorporates a likelihood threshold of "probable" similar to the current use of that term in GAAP for loss contingencies. ASU 2014-15 will be effective for annual periods ending after December 15, 2016, and for annual periods and interim periods thereafter. We do not expect adoption of this guidance to have a material effect on our consolidated financial statements.

ASU 2014-09, Revenue from Contracts with Customers (Topic 606) , establishes principles for the recognition of revenue from contracts with customers. The underlying principle is to identify the performance obligations of a contract, allocate the revenue to each performance obligation and then to recognize revenue when the company satisfies a specific performance obligation of the contract. ASU 2015-14, Deferral of the Effective Date , amended ASU 2014-09, resulting in a one-year deferral of the effective date. ASU 2016-08, Principal versus Agent Considerations ; ASU 2016-10, Identifying Performance Obligations and Licensing ; and ASU 2016-12, Narrow-Scope Improvements and Practical Expedients also amended ASU 2014-09 . The amendments are effective concurrent with the effective date for ASU 2014-09 for annual periods beginning after December 15, 2017, and interim periods within those years. We are evaluating the impact of adoption of this guidance on our consolidated financial statements.

Statements of Operations-Additional Information

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The provision (benefit) for income taxes for the three and nine months ended March 31, 2017, included a benefit of  $3,780 due to the reversal of the valuation allowance we previously had recorded against certain foreign deferred tax assets and also included a $1,442 benefit related to the exercise of employee stock options. Based on continued profitability in a foreign subsidiary, we concluded that it was more likely than not that the value of the related deferred tax assets would be realized, and it was no longer necessary to maintain a valuation allowance.

The provision (benefit) for income taxes for the three and nine months ended March 31, 2016, included a benefit of  $2,536 and $21,323, respectively, due to the reversal of the valuation allowance we previously had recorded against domestic deferred tax assets. Based on continued domestic profitability, we concluded that it was more likely than not that the value of domestic deferred tax assets would be realized, and it was no longer necessary to maintain a valuation allowance.

Balance Sheets-Additional Information

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Goodwill balances did not change during the nine months ended March 31, 2017.

We evaluate our investments in equity method investees for impairment if circumstances indicate that the fair value of the investment may be impaired. The assets underlying a $4,049 equity investment are currently idled; we have concluded the investment is not currently impaired, based on expected future operating cash flows and/or disposal value.

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Debt

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Revolving Credit Facility and Term B Loan

We have a revolving credit facility (the "Revolver"), where we can borrow up to $200,000, subject to the terms of the agreement, and a term B loan (the "Term B Loan," and together with the Revolver, the "Credit Facilities"). The Revolver, as amended, has applicable margins equal to 2.50%, 2.75% or 3.00%, in the case of LIBOR loans and 1.50%, 1.75% or 2.00%, in the case of base rate loans; the applicable margins are based on the First Lien Net Leverage Ratio. The Term B Loan has applicable margins equal to 3.00% in the case of LIBOR loans and 2.00% in the case of base rate loans. The LIBOR rate on the Term B Loan is subject to a floor of 1.00%.

The Revolver requires, among other things, the maintenance of a maximum consolidated first lien net debt to consolidated EBITDA leverage ratio, calculated on a trailing four quarter basis, and contains an acceleration clause should an event of default (as defined in the agreement governing the Credit Facilities) occur. As of March 31, 2017, we were in compliance with the covenants of the Credit Facilities.

As of March 31, 2017, we had $30,000 in borrowings under the Revolver and had outstanding letters of credit of  $14,518 leaving $155,482 available for borrowings and letters of credit under the Revolver. We obtain letters of credit in connection with certain regulatory and insurance obligations and other contractual obligations. The tenors of these letters of credit are all one year or less.

The weighted-average interest rates for the Revolver and Term B Loan were 3.39% and 4.00%, respectively, for the nine months ended March 31, 2017.

Long-Term Debt

Related Party Transactions

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Certain relatives of Jack C. Bendheim provided services to us as employees or consultants and received aggregate compensation and benefits of  $339 and $1,387 during the three and nine months ended March 31, 2017, respectively, and $388 and $1,515 during the three and nine months ended March 31, 2016, respectively. Mr. Bendheim has sole authority to vote shares of our stock owned by BFI Co., LLC, an investment vehicle of the Bendheim family.

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Employee Benefit Plans

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The Company maintains a noncontributory defined benefit pension plan for all domestic nonunion employees employed on or prior to December 31, 2013, who meet certain requirements of age, length of service and hours worked per year. Plan benefits are based upon years of service and average compensation, as defined.

In July 2016, we amended our domestic noncontributory defined benefit pension plan to eliminate credit for future service and compensation increases, effective as of September 30, 2016. The amendment resulted in a curtailment of the pension plan. During the three months ended September 30, 2016, we recorded a pension curtailment gain of $6,822 in other comprehensive income and an offsetting reduction in the liability for pension benefits included in other liabilities. We also modified the 401(k) retirement savings plan, effective October 1, 2016, to include, for all domestic employees, a non-elective Company contribution of 3% of compensation and an additional discretionary contribution of up to 4% of compensation, depending on the employee's age and years of service.

Separately, we offered a lump sum settlement option to certain pension plan participants. During the three months ended December 31, 2016, we recognized a partial settlement of the pension plan with respect to the lump sum settlement, which resulted in a charge to the consolidated statement of operations of  $1,702, which we recorded as a component of selling, general and administrative expenses.

Net periodic pension expense was:

Commitments and Contingencies

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Environmental

Our operations and properties are subject to extensive federal, state, local and foreign laws and regulations, including those governing pollution; protection of the environment; the use, management, and release of hazardous materials, substances and wastes; air emissions; greenhouse gas emissions; water use, supply and discharges; the investigation and remediation of contamination; the manufacture, distribution, and sale of regulated materials, including pesticides; the importing, exporting and transportation of products; and the health and safety of our employees (collectively, "Environmental Laws"). As such, the nature of our current and former operations exposes us to the risk of claims with respect to such matters, including fines, penalties, and remediation obligations that may be imposed by regulatory authorities. Under certain circumstances, we might be required to curtail operations until a particular problem is remedied. Known costs and expenses under Environmental Laws incidental to ongoing operations, including the cost of litigation proceedings relating to environmental matters, are included within operating results. Potential costs and expenses may also be incurred in connection with the repair or upgrade of facilities to meet existing or new requirements under Environmental Laws or to investigate or remediate potential or actual contamination and from time to time we establish reserves for such contemplated investigation and remediation costs. In many instances, the ultimate costs under Environmental Laws and the time period during which such costs are likely to be incurred are difficult to predict.

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While we believe that our operations are currently in material compliance with Environmental Laws, we have, from time to time, received notices of violation from governmental authorities, and have been involved in civil or criminal action for such violations. Additionally, at various sites, our subsidiaries are engaged in continuing investigation, remediation and/or monitoring efforts to address contamination associated with historic operations of the sites. We devote considerable resources to complying with Environmental Laws and managing environmental liabilities. We have developed programs to identify requirements under, and maintain compliance with, Environmental Laws; however, we cannot predict with certainty the effect of increased and more stringent regulation on our operations, future capital expenditure requirements, or the cost of compliance.

The nature of our current and former operations exposes us to the risk of claims with respect to environmental matters, and we cannot assure we will not incur material costs and liabilities in connection with such claims. Based upon our experience to date, we believe that the future cost of compliance with existing Environmental Laws, and liabilities for known environmental claims pursuant to such Environmental Laws, will not have a material adverse effect on our financial position, results of operations, cash flows or liquidity.

The United States Environmental Protection Agency (the "EPA") is investigating and planning for the remediation of offsite contaminated groundwater that has migrated from the Omega Chemical Corporation Superfund Site ("Omega Chemical Site"), which is upgradient of a facility in Santa Fe Springs, California, operated by our subsidiary Phibro-Tech, Inc. ("Phibro-Tech"). The EPA has named Phibro-Tech and certain other subsidiaries of PAHC as potentially responsible parties ("PRPs") due to groundwater contamination from Phibro-Tech's Santa Fe Springs facility that has allegedly commingled with contaminated groundwater from the Omega Chemical Site. In September 2012, the EPA notified approximately 140 PRPs, including Phibro-Tech and the other subsidiaries, that they have been identified as potentially responsible for remedial action for the groundwater plume affected by the Omega Chemical Site and for EPA oversight and response costs. Phibro-Tech contends that groundwater contamination at its site is due to historical operations that pre-date Phibro-Tech and/or contaminated groundwater that has migrated from upgradient properties. In addition, a successor to a prior owner of the Phibro-Tech site has asserted that PAHC and Phibro-Tech are obligated to provide indemnification for its potential liability and defense costs relating to the groundwater plume affected by the Omega Chemical Site. Phibro-Tech has vigorously contested this position and has asserted that the successor to the prior owner is required to indemnify Phibro-Tech for its potential liability and defense costs. Furthermore, a nearby property owner has filed a complaint in the Superior Court of the State of California against many of the PRPs allegedly associated with the groundwater plume affected by the Omega Chemical Site (including Phibro-Tech) for alleged contamination of groundwater underneath its property, and a group of companies that sent chemicals to the Omega Chemical Site for processing and recycling has filed a complaint under CERCLA, RCRA and the common law public nuisance doctrine in the United States District Court for the Central District of California against many of the PRPs allegedly associated with the groundwater plume affected by the Omega Chemical Site (including Phibro-Tech) for contribution toward past and future costs associated with the investigation and remediation of the groundwater plume affected by the Omega Chemical Site. Due to the ongoing nature of the EPA's investigation and Phibro-Tech's dispute with the prior owner's successor, at this time we cannot predict with any degree of certainty what, if any, liability Phibro-Tech or the other subsidiaries may ultimately have for investigation, remediation and the EPA oversight and response costs associated with the affected groundwater plume.

Based upon information available, to the extent such costs can be estimated with reasonable certainty, we estimated the cost for further investigation and remediation of identified soil and groundwater problems at operating sites, closed sites and third-party sites, and closure costs for closed sites, to be $7,205 and $7,024 at March 31, 2017, and June 30, 2016, respectively, which is included in current and long-term liabilities on the consolidated balance sheets. However, future events, such as new information, changes in existing Environmental Laws or their interpretation, and more vigorous enforcement policies of regulatory agencies, may give rise to additional expenditures or liabilities that could be material. For all purposes of the

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discussion under this caption and elsewhere in this report, it should be noted that we take and have taken the position that neither PAHC nor any of our subsidiaries is liable for environmental or other claims made against one or more of our other subsidiaries or for which any of such other subsidiaries may ultimately be responsible.

Claims and Litigation

During the three months ended March 31, 2017, we recorded a $7,500 gain in selling, general and administrative expenses resulting from a payment to us by an insurance carrier. The payment reflected the settlement of our claims against the carrier under our liability insurance policies, which arose from damages incurred in fiscal year 2010 by certain customers resulting from the use of one of our animal health products. We previously paid our customers for the damages and recognized the cost in the consolidated statement of operations prior to fiscal year 2017.

PAHC and its subsidiaries are party to a number of claims and lawsuits arising out of the normal course of business including product liability, payment disputes and governmental regulation. Certain of these actions seek damages in various amounts. In many cases, such claims are covered by insurance. We believe that none of the claims or pending lawsuits, either individually or in the aggregate, will have a material adverse effect on our financial position, results of operations, cash flows or liquidity.

Derivatives

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We monitor our exposure to foreign currency exchange rates and use derivatives (currency option contracts) to manage certain of these risks. These derivatives generally have an expiration/maturity of two years or less and are intended to hedge cash flows related to the purchase of inventory. We designate derivatives as a hedge of a forecasted transaction or of the variability of the cash flows to be received or paid in the future related to a recognized asset or liability (cash flow hedge). We record the portion of the changes in the value of the derivative, related to a hedged asset or liability (the effective portion), in accumulated other comprehensive income (loss). As the hedged item is sold, we recognize the gain or loss recorded in accumulated other comprehensive income (loss) to the consolidated statements of operations on the same line where the hedged item is charged when released/sold. We immediately recognize in the consolidated statements of operations in the same line as the hedged item, the portion of the changes in fair value of derivatives used as cash flow hedges that is not offset by changes in the expected cash flows related to a recognized asset or liability (the ineffective portion).

We routinely assess whether the derivatives used to hedge transactions are effective. If we determine that a derivative ceases to be an effective hedge, we discontinue hedge accounting in the period of the assessment for that derivative, and immediately recognize any unrealized gains or losses related to the fair value of that derivative in the consolidated statements of operations.

We record derivatives at fair value in the consolidated balance sheets. For additional details regarding fair value, see "-Fair Value Measurements."

The following table details the Company's outstanding derivatives that are designated and effective as cash flow hedges as of March 31, 2017:

The fair values at March 31, 2017, are unrealized and will fluctuate based on future exchange rates until the derivative contracts mature. Other comprehensive income (loss) for the three and nine months ended March 31, 2017, included $758 and $1,062, respectively, of net unrecognized gains related to these contracts. Accumulated other comprehensive income (loss) at March 31, 2017, included $3,717 of net unrecognized gains on derivative instruments; we estimate that $1,082 of those gains will be recognized in

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earnings within the next twelve months. At June 30, 2016, realized losses of $1,528 related to matured contracts were recorded as a component of inventory and subsequently recognized in cost of goods sold during the six months ended December 31, 2016. At March 31, 2017, realized gains of  $580 related to matured contracts were recorded as a component of inventory. We anticipate the gains will be recognized as an offset to cost of goods sold within the next twelve months. We recognize gains (losses) related to these derivative instruments as a component of cost of goods sold at the time the hedged item is sold.

Fair Value Measurements

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Fair value is defined as the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. Financial assets and liabilities are measured at fair value using the three-level valuation hierarchy for disclosure of fair value measurements. The determination of the applicable level within the hierarchy of a particular asset or liability depends on the inputs used in the valuation as of the measurement date, notably the extent to which the inputs are market-based (observable) or internally derived (unobservable). Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs based on a company's own assumptions about market participant assumptions developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1-Quoted prices in active markets for identical assets or liabilities.

Significant observable inputs, other than quoted prices included within Level 1, that are observable for the asset or liability, either directly or indirectly through corroboration with observable market data.

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Unobservable inputs for which there is little or no market data available, and that are significant to the overall fair value measurement, are employed that require the reporting entity to develop its own assumptions.

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In assessing the fair value of financial instruments at March 31, 2017, and June 30, 2016, we used a variety of methods and assumptions that were based on estimates of market conditions and risks existing at the time.

Current Assets and Liabilities

We consider the carrying amounts of current assets and current liabilities to be representative of their fair value because of the current nature of these items.

Letters of Credit

We obtain letters of credit in connection with certain regulatory and insurance obligations, inventory purchases and other contractual obligations. The carrying values of these letters of credit are considered to be representative of their fair values because of the nature of the instruments. The tenors of these letters of credit are all one year or less.

Long Term Debt

We record the Term B Loan and the Revolver at book value in our consolidated financial statements. We believe the carrying value of the Term B Loan is approximately equal to the fair value, which is based on quoted broker prices that are Level 2 inputs. We believe the carrying value of the Revolver is approximately equal to the fair value due to the variable nature of the instrument.

Deferred Consideration on Acquisitions

We estimated the fair value of the deferred contingent consideration on acquisitions using the income approach, based on the Company's current sales forecast related to the acquired business.

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Derivatives

We determine the fair value of derivative instruments based upon pricing models using observable market inputs for these types of financial instruments, such as spot and forward currency translation rates.

The table below provides a summary of the changes in the fair value of Level 3 liabilities:

Business Segments

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The Animal Health segment manufactures and markets a broad range of products for food animals, including poultry, swine, cattle, dairy and aquaculture. The business includes net sales of medicated feed additives and other related products, nutritional specialty products and vaccines. The Mineral Nutrition segment manufactures and markets a broad range of trace mineral products for food animals. The Performance Products segment manufactures and markets a variety of products for use in the personal care, automotive, industrial chemical and chemical catalyst industries.

We evaluate performance and allocate resources based on the Animal Health, Mineral Nutrition and Performance Products segments. Certain of our costs and assets are not directly attributable to these segments and such costs are referred to as Corporate. We do not allocate such items to the principal segments because they are not used to evaluate their operating results or financial position.

We evaluate performance of our segments based on Adjusted EBITDA. We define Adjusted EBITDA as income before income taxes plus (a) interest expense, net, (b) depreciation and amortization, (c) (income) loss from, and disposal of, discontinued operations, (d) other expense or less other income, as separately reported on our consolidated statements of operations, including foreign currency gains and losses and loss on extinguishment of debt, and (e) certain items that we consider to be unusual, non-operational or non-recurring.

The accounting policies of our segments are the same as those described in the summary of significant accounting policies included herein.

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Item 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is provided to assist readers in understanding our performance and summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and cash flows as of and for the periods presented below. This MD&A should be read in conjunction with our consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q. Our future results could differ materially from our historical performance or our future expectations as a result of various factors, such as those discussed in "Forward-Looking Statements" and "Risk Factors."

Overview of our business

Phibro Animal Health Corporation is a diversified global developer, manufacturer and marketer of a broad range of animal health and mineral nutrition products for food animals including poultry, swine, cattle, dairy and aquaculture. We also are a manufacturer and marketer of performance products for use in the personal care, automotive, industrial chemical and chemical catalyst industries.

Trends and uncertainties

Our business depends heavily on a healthy and growing livestock industry. Some in the public perceive risks to human health related to the consumption of food derived from animals that utilize certain of our products, including certain of our medicated feed additives products. In particular, there is increased focus, primarily in the United States, on the use of medically important antibacterials, as defined by the FDA. Medically important antibacterials include classes that are prescribed in animal and human health and are listed in the Appendix of the FDA-CVM Guidance for Industry (GFI) #152. Our products that contain virginiamycin, oxytetracycline or neomycin have previously been classified by the FDA as medically important antibacterials. This may lead to a decline in the demand for and production of food products derived from animals that utilize our products and, in turn, demand for our products. Livestock producers may experience decreased demand for their products or reputational harm as a result of evolving consumer views of nutrition and health-related concerns, animal rights, and other concerns. Any reputational harm to the livestock industry may also extend to companies in related industries, including us. In addition, campaigns by interest groups, activists and others with respect to perceived risks associated with the use of our products in animals, including position statements by livestock producers and their customers based on non-use of certain medicated products in livestock production, whether or not scientifically-supported, could affect public perceptions and reduce the use of our products. Those adverse consumer views related to the use of one or more of our products in animals could have a material adverse effect on our financial condition and results of operations.

Our sales in the United States of products classified by the FDA as medically important antibacterials were approximately $27 million for the twelve months ended March 31, 2017, a decrease of $10 million compared with the twelve months ended June 30, 2016.

Our business is subject to product registration and authorization regulations. Changes in these regulations could have a material impact on our business. In April 2016, the FDA began initial steps to withdraw approval of Mecadox (carbadox), due to concerns that certain residues from the product may persist in tissues for longer than previously determined. This initial action by the FDA does not prohibit the sale or use of Mecadox in the United States. Mecadox has been approved and sold in the United States for more than 40 years and is a widely used treatment for controlling bacterial diseases including Salmonella and swine dysentery. Mecadox is not used in human medicine and the class of drug is not considered a medically important antibacterial. The approved Mecadox label requires a 42-day withdrawal period pre-harvesting, and to date we have not seen any hazardous residues of carbadox being detected from pig meat treated in accordance with the approved label. We have complete confidence in the safety of Mecadox. In response to FDA inquiries several years ago, we began rigorous new studies of the continued safety of the product when used in accordance with the label. Our studies were completed in July 2016, and we submitted our data, analyses and information to the FDA that we believe support the continued safe use of

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Mecadox. As of March 31, 2017, we await the response of the FDA as the timing of their response to our submission is not subject to a predetermined deadline. Should we be unable to successfully defend the safety of the product, the loss of Mecadox sales would have a negative impact on the results of our operations.

Our sales of Mecadox in the United States were approximately $14 million for the twelve months ended March 31, 2017, a decrease of $1 million compared with the twelve months ended June 30, 2016, as a result of normal variation in customer order patterns.

Analysis of the consolidated statements of operations

Summary Results of Operations

Certain amounts and percentages may reflect rounding adjustments.

Calculation not meaningful

​

Net sales, Adjusted EBITDA and reconciliation of GAAP net income to Adjusted EBITDA

We report net sales and Adjusted EBITDA by segment to understand the operating performance of each segment. This enables us to monitor changes in net sales, costs and other actionable operating metrics at the segment level. See "-General description of non-GAAP financial measures" for descriptions of EBITDA and Adjusted EBITDA.

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Segment net sales and Adjusted EBITDA:

Reflects ratio to total net sales

​

Calculation not meaningful

​

The table below sets forth a reconciliation of net income, as reported under GAAP, to Adjusted EBITDA:

Amounts and percentages may reflect rounding adjustments.

Calculation not meaningful

​

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Comparison of the three months ended March 31, 2017 and 2016

Net sales

Net sales of $189.9 million for the three months ended March 31, 2017, increased $6.4 million, or 3%, as compared to the three months ended March 31, 2016. Animal Health and Mineral Nutrition grew $2.6 million and $4.1 million, respectively, while Performance Products declined $0.4 million.

Animal Health

Net sales of $121.0 million for the three months ended March 31, 2017, grew $2.6 million, or 2%. The growth was primarily due to volume increases in the nutritional specialty and vaccine product groups within the segment. Nutritional specialty products grew $4.8 million, or 21%, primarily due to volume growth of our products for the U.S. poultry and dairy industries. Vaccines grew $3.9 million, or 30%, primarily due to volume growth of our products for the poultry and swine industries. Medicated feed additives ("MFAs") and other declined $6.1 million, or 7%, primarily due to volume declines. Domestic net sales of MFAs and other declined $4.3 million, primarily due to reduced volumes of medically important antibacterials. International net sales declined $1.8 million, primarily due to economic conditions in Brazil.

Mineral Nutrition

Net sales of $57.2 million increased $4.1 million, or 8%, for the three months ended March 31, 2017. The increased revenue was due to increased volumes and higher average selling prices resulting from underlying raw material commodity price increases.

Performance Products

Net sales of $11.7 million decreased $0.4 million, or 3%, for the three months ended March 31, 2017, due to lower average selling prices of personal care ingredients and copper-based products and lower volumes of copper-based products. Higher volumes of personal care ingredients partially offset the declines.

Gross profit

Gross profit of $60.6 million for the three months ended March 31, 2017, increased $1.8 million, or 3%, as compared to the three months ended March 31, 2016. Gross profit decreased to 31.9% of net sales for the three months ended March 31, 2017, as compared to 32.0% for the three months ended March 31, 2016. The three months ended March 31, 2016, included $1.6 million of acquisition-related cost of goods sold. Depreciation expense included in cost of goods sold increased $1.0 million due to recent capital expenditures. Excluding the effects of the acquisition-related cost of goods sold and increased depreciation, Animal Health gross profit increased $1.2 million due to volume growth in nutritional specialty and vaccine products, as well as lower unit costs from improved operating efficiencies. Mineral Nutrition gross profit increased $0.3 million due to volume growth and higher average selling prices, partially offset by higher raw material costs. Performance Products gross profit decreased $0.3 million due lower average selling prices of personal care ingredients and copper-based products, partially offset by higher volumes of personal care ingredients.

Selling, general and administrative expenses

Selling, general and administrative expenses ("SG&A") of $30.6 million for the three months ended March 31, 2017, decreased $7.0 million, or 19%, as compared to the three months ended March 31, 2016. During the three months ended March 31, 2017, we recorded a $7.5 million gain in SG&A resulting from a payment to us by an insurance carrier. The payment reflected the settlement of our claims against the carrier under our liability insurance policies, which arose from damages incurred in fiscal year 2010 by certain customers resulting from the use of one of our animal health products. We previously paid our customers for the damages and recognized the cost in the consolidated statement of operations prior to fiscal year 2017. SG&A for the three months ended March 31, 2016, included $0.6 million of acquisition-related transaction costs. Without the effects of the gain on the insurance settlement and the acquisition-related transaction costs, SG&A increased $1.1 million, or 3%. Animal Health accounted for $1.6 million of the increase, driven by timing of spending.

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Interest expense, net

Interest expense, net of $3.9 million for the three months ended March 31, 2017, decreased $0.3 million, or 8%, as compared to the three months ended March 31, 2016. Interest income increased $0.3 million from interest on deposits in foreign jurisdictions. Interest expense decreased $0.1 million due to decreased borrowings under our Revolver, compared to the three months ended March 31, 2016.

Foreign currency (gains) losses, net

Foreign currency (gains) losses, net for the three months ended March 31, 2017, amounted to net gains of $0.4 million, as compared to $2.2 million in net gains for the three months ended March 31, 2016. Foreign currency gains in the three months ended March 31, 2017, were primarily due to the movement of the Brazilian, Argentinian and Mexican currencies relative to the U.S. dollar. Foreign currency gains and losses primarily arise from intercompany balances.

Provision (benefit) for income taxes

The provision for income taxes was $2.8 million for the three months ended March 31, 2017, as compared to $0.6 million for the three months ended March 31, 2016. The effective income tax rates for these periods were 10.6% and 3.0%, respectively. During the three months ended March 31, 2017, we concluded it was more likely than not that the value of deferred tax assets related to a foreign subsidiary would be realized, and it was no longer necessary to maintain a valuation allowance. The provision for income taxes for the three months ended March 31, 2017, included a $3.8 million benefit from the valuation allowance release and also included a $1.4 million benefit related to the exercise of employee stock options. Without the benefit of the valuation allowance release and the benefit related to employee stock options, the effective income tax rate was 30.4% for the three months ended March 31, 2017. The provision for income taxes for the three months ended March 31, 2016, included a $2.5 million benefit from the release of a domestic valuation allowance and a $2.1 million benefit related to previously unrecognized tax benefits. Without these benefits, the effective income tax rate was 27.2% for the three months ended March 31, 2016.

Our future effective income tax rate may fluctuate due to various factors, including the relative amounts of income earned in different taxing jurisdictions, changes in statutory tax rates, potential strategies to reduce our overall income tax expense, discrete items, the benefit of employee stock option exercises and certain non-deductible items.

Net income

Net income of $23.6 million for the three months ended March 31, 2017, increased $5.1 million, as compared to net income of $18.6 million for the three months ended March 31, 2016. The increase was a result of the factors described above, including the $7.5 million gain on insurance settlement.

Adjusted EBITDA

Adjusted EBITDA of $29.7 million for the three months ended March 31, 2017, increased $0.1 million, or less than 1%, as compared to the three months ended March 31, 2016. Animal Health Adjusted EBITDA decreased $0.3 million, or 1%, due to increased SG&A, partially offset by sales growth and increased gross profit. Mineral Nutrition increased $0.3 million, or 8%, due to improved operating margins from volume growth and from higher average selling prices, partially offset by higher raw material costs. Performance Products decreased less than $0.1 million, as lower average selling prices were offset by higher volumes. Corporate expenses decreased $0.1 million due to lower compensation costs and lower professional fees.

Comparison of the nine months ended March 31, 2017 and 2016

Net sales

Net sales of $569.4 million for the nine months ended March 31, 2017, increased $7.1 million, or 1%, as compared to the nine months ended March 31, 2016. Animal Health grew $9.2 million, while Mineral Nutrition and Performance Products declined $0.9 million and $1.2 million, respectively.

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Animal Health

Net sales of $369.2 million for the nine months ended March 31, 2017, grew $9.2 million, or 3%. The growth was primarily due to volume increases in the nutritional specialty and vaccine product groups within the segment. Nutritional specialty products grew $13.8 million, or 20%, primarily due to volume growth of our products for the U.S. poultry and dairy industries. Vaccines grew $11.7 million, or 32%, primarily due to volume growth of our products for the poultry and swine industries. The vaccine sales growth included products acquired from MVP Laboratories, Inc. in January 2016. MFAs and other declined $16.3 million, or 6%, primarily due to volume declines. International net sales declined $10.0 million due to economic conditions in Brazil, partially offset by growth in other regions. Domestic net sales of MFAs and other declined $6.3 million as reduced volumes of medically important antibacterials were partially offset by growth in other products.

Mineral Nutrition

Net sales of $165.5 million decreased $0.9 million, or 1%, for the nine months ended March 31, 2017. The reduced revenue was primarily due to lower average selling prices resulting from underlying raw material commodity price declines. Volumes were approximately level with the prior year.

Performance Products

Net sales of $34.8 million decreased $1.2 million, or 3%, for the nine months ended March 31, 2017, due to lower average selling prices of personal care ingredients and lower volumes of copper-based products and chemical catalyst products. Higher volumes of personal care ingredients partially offset the declines.

Gross profit

Gross profit of $185.1 million for the nine months ended March 31, 2017, increased $5.7 million, or 3%, as compared to the nine months ended March 31, 2016. Gross profit increased to 32.5% of net sales for the nine months ended March 31, 2017, as compared to 31.9% for the nine months ended March 31, 2016. The three months ended March 31, 2016, included $1.6 million of acquisition-related cost of goods sold. Depreciation and amortization expense included in cost of goods sold increased $3.5 million due to recent capital expenditures and the MVP acquisition. Excluding the effects of the acquisition-related cost of goods sold and increased depreciation and amortization, Animal Health gross profit increased $5.5 million due to volume growth in nutritional specialty and vaccine products, as well as lower unit costs from improved operating efficiencies. Mineral Nutrition gross profit increased $1.6 million due to lower raw material costs, partially offset by lower average selling prices. Performance Products gross profit increased $0.5 million due to higher volumes of personal care ingredients and lower product costs of copper-based products, partially offset by lower average selling prices of personal care ingredients.

Selling, general and administrative expenses

SG&A of $110.7 million for the nine months ended March 31, 2017, decreased $3.1 million, or 3%, as compared to the nine months ended March 31, 2016. During the nine months ended March 31, 2017, we recorded a $7.5 million gain in SG&A resulting from a payment to us by an insurance carrier. The payment reflected the settlement of our claims against the carrier under our liability insurance policies, which arose from damages incurred in fiscal year 2010 by certain customers resulting from the use of one of our animal health products. We previously paid our customers for the damages and recognized the cost in the consolidated statement of operations prior to fiscal year 2017. SG&A for the nine months ended March 31, 2017, also included $1.7 million in costs relating to the partial settlement of the pension plan and $1.3 million in acquisition-related transaction costs for professional fees and other items in the evaluation and negotiation of an unsuccessful acquisition. SG&A for the nine months ended March 31, 2016, included $0.6 million in acquisition-related transaction costs. Without the gain on the insurance settlement, the pension settlement costs and the acquisition-related costs, SG&A increased $2.0 million, or 2%, for the nine months.

Animal Health accounted for $2.1 million of the increase, driven by increased sales force and development costs. Mineral Nutrition decreased $0.3 million due to one-time costs in the prior year.

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Performance Products decreased $0.2 million due to lower environmental costs. Corporate increased $0.4 million primarily due to increased business development costs.

Interest expense, net

Interest expense, net of $11.7 million for the nine months ended March 31, 2017, decreased less than $0.3 million, or 3%, as compared to the nine months ended March 31, 2016. Interest income increased $1.3 million from interest on deposits in foreign jurisdictions. Interest expense increased $0.8 million due to increased borrowings under our Revolver, compared to the nine months ended March 31, 2016, and increased acquisition-related accrued interest.

Foreign currency (gains) losses, net

Foreign currency (gains) losses, net for the nine months ended March 31, 2017, amounted to net gains of $0.6 million, as compared to $5.1 million in net gains for the nine months ended March 31, 2016. Foreign currency gains in the nine months ended March 31, 2017, were primarily due to the movement of the Brazilian, Turkish and Mexican currencies relative to the U.S. dollar. Foreign currency gains and losses primarily arise from intercompany balances.

Provision (benefit) for income taxes

The provision for income taxes was $14.1 million for the nine months ended March 31, 2017, as compared to an income tax benefit of $8.8 million for the nine months ended March 31, 2016. The effective income tax rates for these periods were 22.2% and (14.9)%, respectively. The provision for income taxes for the nine months ended March 31, 2017, included a $3.8 million benefit from the valuation allowance release and also included a $1.4 million benefit related to the exercise of employee stock options. Without the benefit of the valuation allowance release and the benefit related to employee stock options, the effective income tax rate was 30.5% for the nine months ended March 31, 2017. The benefit for income taxes for the nine months ended March 31, 2016, included a $21.3 million benefit from the release of a domestic valuation allowance and a $3.7 million benefit related to previously unrecognized tax benefits. Without these benefits, the effective income tax rate was 27.6% for the nine months ended March 31, 2016.

Our future effective income tax rate may fluctuate due to various factors, including the relative amounts of income earned in different taxing jurisdictions, changes in statutory tax rates, potential strategies to reduce our overall income tax expense, discrete items, the benefit of employee stock option exercises and certain non-deductible items.

Net income

Net income of $49.2 million for the nine months ended March 31, 2017, decreased $18.3 million, as compared to net income of $67.5 million for the nine months ended March 31, 2016. The decrease was a result of the factors described above, including a $21.3 million income tax benefit in the prior year period, an unfavorable change of $4.5 million in foreign currency (gains) losses, net, and the favorable $7.5 million gain on insurance settlement.

Adjusted EBITDA

Adjusted EBITDA of $90.8 million for the nine months ended March 31, 2017, increased $4.9 million, or 6%, as compared to the nine months ended March 31, 2016. Animal Health Adjusted EBITDA increased $3.1 million, or 3%, due to sales growth and increased gross profit, partially offset by increased SG&A. Mineral Nutrition Adjusted EBITDA increased $1.7 million, or 15%, due to improved operating margins from lower raw material costs, partially offset by lower average selling prices. Performance Products Adjusted EBITDA increased $0.9 million, due to higher volumes and lower product costs, partially offset by lower average selling prices. Corporate expenses increased $0.7 million due to increased compensation and benefit costs and business development costs.

Pension Plan and Retirement Savings Plan Changes

In July 2016, we amended our domestic noncontributory defined benefit pension plan to eliminate credit for future service and compensation increases, effective as of September 30, 2016. The amendment

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resulted in a curtailment of the pension plan. During the three months ended September 30, 2016, we recorded a pension curtailment gain of $6.8 million in other comprehensive income and an offsetting reduction in the liability for pension benefits included in other liabilities. We also modified the 401(k) retirement savings plan effective October 1, 2016, to include, for all domestic employees, a non-elective Company contribution of 3% of compensation and an additional discretionary contribution of up to 4% of compensation, depending on the employee's age and years of service.

Separately, we offered a lump sum settlement option to certain pension plan participants. During the three months ended December 31, 2016, we recognized a partial settlement of the pension plan with respect to the lump sum settlement, which resulted in a charge to the consolidated statement of operations of  $1.7 million, which we recorded as a component of SG&A.

Analysis of financial condition, liquidity and capital resources

Net increase (decrease) in cash and cash equivalents was:

Net cash provided (used) by operating activities was comprised of: