BALCHEM CORP 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (In thousands, except share and per share data) This report contains forward-looking statements, within the meaning of Section 21E of the Exchange Act, which reflect our expectation or belief concerning future events that involve risks and uncertainties. Actions and performance could differ materially from what is contemplated by the forward-looking statements contained in this report. Factors that might cause differences from the forward-looking statements include those referred to or identified in Item 1A of the Annual Report on Form 10-K for the year ended December 31, 2020 and other factors that may be identified elsewhere in this report. Reference should be made to such factors and all forward-looking statements are qualified in their entirety by the above cautionary statements. Overview We develop, manufacture, distribute and market specialty performance ingredients and products for the nutritional, food, pharmaceutical, animal health, medical device sterilization, plant nutrition and industrial markets. Our three reportable segments are strategic businesses that offer products and services to different markets: Human Nutrition & Health, Animal Nutrition & Health, and Specialty Products, as more fully described in Note 10 of the condensed consolidated financial statements. Sales and production of products outside of our reportable segments and other minor business activities are included in "Other and Unallocated". As of September 30, 2021, we had approximately 1,305 full time employees worldwide. We believe that, over time, we have been successful in attracting skilled and experienced personnel in a competitive environment and management believes that our human capital resources have been adequate to perform all business functions. Recent macro-economic challenges have created certain labor shortages which have impacted operations in select geographies. Management believes these impacts are transitory and that, over time, our human capital resources will be adequate to perform needed business functions. COVID-19 Pandemic Response The COVID-19 response effort has been a primary focus for us since early last year. Our focus has been on employee safety first, keeping our manufacturing sites operational, satisfying customer needs, preserving cash and ensuring strong liquidity, and responding to changes in this dynamic market environment as appropriate. As a result of our broad based risk mitigation efforts of the direct impacts of the Covid-19 pandemic, our manufacturing sites have been operating at near normal conditions, our research and development teams have continued to innovate in our laboratories, and all of our other employees have been effectively carrying on their responsibilities and functions remotely or in a reduced density hybrid setting. We are increasingly focused on managing the extraordinary supply chain disruptions that are challenging the markets we operate within that are, at least in part, related to the pandemic and/or the global recovery from the pandemic. We are experiencing severe input cost inflation, raw material shortages, logistics disruptions, and labor availability issues. These indirect pandemic related challenges have accelerated as 2021 has progressed and are likely to continue for some time. Segment Results We sell products for all three segments through our own sales force, independent distributors, and sales agents. The following tables summarize consolidated net sales by segment and business segment earnings from operations for the three and nine months ended September 30, 2021 and 2020: Business Segment Net Sales Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Human Nutrition & Health $ 111,200 $ 103,589 $ 327,187 $ 296,525 Animal Nutrition & Health 56,192 46,354 161,821 141,339 Specialty Products 27,615 23,003 89,645 79,193 Other and Unallocated (1) 2,862 2,194 7,237 5,874 Total $ 197,869 $ 175,140 $ 585,890 $ 522,931 27 Table of Contents Business Segment Earnings From Operations Three Months Ended September 30, Nine Months Ended September 30, 2021 2020 2021 2020 Human Nutrition & Health $ 19,801 $ 17,499 $ 58,512 $ 45,131 Animal Nutrition & Health 7,442 7,011 16,059 21,485 Specialty Products 6,455 5,348 23,373 21,342 Other and Unallocated (1) (1,185) (830) (4,263) (5,735) Total $ 32,513 $ 29,028 $ 93,681 $ 82,223 (1) Other and Unallocated consists of a few minor businesses which individually do not meet the quantitative thresholds for separate presentation and corporate expenses that have not been allocated to a segment. Unalloca ted corporate expenses consist of: (i) Transaction and integration costs, ERP implementation costs, and unallocated legal fees totaling $305 and $1,005 for the three and nine months ended September 30, 2021, respectively, and $161 and $2,179 for the three and nine months ended September 30, 2020, respectively, and (ii) Unallocated amortization expens e of $604 and $1,812 for the three and nine months ended September 30, 2021, respectively, and $399 and $1,205 for the three and nine months ended September 30, 2020, respectively, related to an intangible asset in connection with a company-wide ERP system implementation. RESULTS OF OPERATIONS (In thousands, except share and per share data) Three months ended September 30, 2021 compared to three months ended September 30, 2020. Net Earnings Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Net sales $ 197,869 $ 175,140 $ 22,729 13.0 % Gross margin 60,934 56,368 4,566 8.1 % Operating expenses 28,421 27,340 1,081 4.0 % Earnings from operations 32,513 29,028 3,485 12.0 % Other (income) expense, net 428 1,121 (693) (61.8) % Income tax expense 7,072 6,339 733 11.6 % Net earnings $ 25,013 $ 21,568 $ 3,445 16.0 % Net Sales Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Human Nutrition & Health $ 111,200 $ 103,589 $ 7,611 7.3 % Animal Nutrition & Health 56,192 46,354 9,838 21.2 % Specialty Products 27,615 23,003 4,612 20.0 % Other 2,862 2,194 668 30.4 % Total $ 197,869 $ 175,140 $ 22,729 13.0 % • The increase in net sales within the HNH segment for the three months ended September 30, 2021 as compared to 2020 was driven by strong sales growth within the minerals and nutrients business. • The increase in net sales within the ANH segment for the three months ended September 30, 2021 compared to 2020 was the result of higher sales in both monogastric and ruminant animal markets. • The increase in Specialty Products segment sales for the three months ended September 30, 2021 compared to 2020 was due to higher sales of products in both the plant nutrition business and the medical device sterilization market. • Sales relating to Other increased from the prior year due to higher demand. 28 Table of Contents Gross Margin Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Gross margin $ 60,934 $ 56,368 $ 4,566 8.1 % % of net sales 30.8 % 32.2 % Gross margin as a percentage of sales decreased for the three months ended September 30, 2021 compared to 2020 primarily due to a significant increase in certain manufacturing input costs and distribution costs, partially offset by higher average selling prices. Operating Expenses Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Operating expenses $ 28,421 $ 27,340 $ 1,081 4.0 % % of net sales 14.4 % 15.6 % The increase in operating expenses was primarily due to higher selling expenses, driven by an increase in compensation-related costs, and an increase in research and development, partially offset by the timing of an insurance recovery. Earnings from Operations Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Human Nutrition & Health $ 19,801 $ 17,499 $ 2,302 13.2 % Animal Nutrition & Health 7,442 7,011 431 6.1 % Specialty Products 6,455 5,348 1,107 20.7 % Other and unallocated (1,185) (830) (355) 42.8 % Earnings from operations $ 32,513 $ 29,028 $ 3,485 12.0 % % of net sales (operating margin) 16.4 % 16.6 % • Earnings from operations for the HNH segment increased primarily due to the aforementioned higher sales, favorable mix, and the timing of an insurance recovery, partially offset by higher manufacturing input costs and distribution costs. • ANH segment earnings from operations increased due to the aforementioned higher sales, partially offset by increases in manufacturing input costs and distribution costs. • The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by increases in manufacturing input costs and distribution costs. • The decrease in Other and unallocated was primarily driven by an increase in transaction and integration costs and an increase in costs related to a company-wide ERP implementation. 29 Table of Contents Other Expenses (Income) Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Interest expense $ 556 $ 953 $ (397) (41.7) % Other, net (128) 168 (296) (176.2) % $ 428 $ 1,121 $ (693) (61.8) % Interest expense for the three months ended September 30, 2021 and 2020 was primarily related to outstanding borrowings under the Credit Agreement. Income Tax Expense Three Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Income tax expense $ 7,072 $ 6,339 $ 733 11.6 % Effective tax rate 22.0 % 22.7 % The decrease in the effective tax rate was primarily due to higher tax benefits from stock-based compensation and the prior year being negatively impacted by clarifying regulations related to tax reform. Nine months ended September 30, 2021 compared to nine months ended September 30, 2020. Net Earnings Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Net sales $ 585,890 $ 522,931 $ 62,959 12.0 % Gross margin 179,108 167,079 12,029 7.2 % Operating expenses 85,427 84,856 571 0.7 % Earnings from operations 93,681 82,223 11,458 13.9 % Other (income) expense, net 1,594 3,853 (2,259) (58.6) % Income tax expense 20,932 15,909 5,023 31.6 % Net earnings $ 71,155 $ 62,461 $ 8,694 13.9 % Net Sales Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Human Nutrition & Health $ 327,187 $ 296,525 $ 30,662 10.3 % Animal Nutrition & Health 161,821 141,339 20,482 14.5 % Specialty Products 89,645 79,193 10,452 13.2 % Other 7,237 5,874 1,363 23.2 % Total $ 585,890 $ 522,931 $ 62,959 12.0 % • The increase in net sales within the HNH segment for the nine months ended September 30, 2021 as compared to 2020 was primarily driven by strong sales growth in both the food and beverage markets and minerals and nutrients business. 30 Table of Contents • The increase in net sales within the ANH segment for the nine months ended September 30, 2021 compared to 2020 was primarily the result of higher sales in both monogastric and ruminant animal markets and a favorable impact related to changes in foreign currency exchange rates. • The increase in Specialty Products segment sales for the nine months ended September 30, 2021 compared to 2020 was primarily due to higher sales of products in both the medical device sterilization market and plant nutrition business. • Sales relating to Other increased from the prior year due to higher demand. Gross Margin Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Gross margin $ 179,108 $ 167,079 $ 12,029 7.2 % % of net sales 30.6 % 32.0 % Gross margin as a percentage of sales decreased for the nine months ended September 30, 2021 compared to 2020 primarily due to a significant increase in certain manufacturing input costs and distribution costs and the costs associated with the recovery from the flash flood event that we experienced at our Verona, Missouri manufacturing site, partially offset by favorable mix, overall plant efficiencies, and increased average selling prices. Operating Expenses Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Operating expenses $ 85,427 $ 84,856 $ 571 0.7 % % of net sales 14.6 % 16.2 % The increase in operating expenses was primarily due to certain higher compensation-related costs, partially offset by lower transaction and integration costs, the prior year being unfavorably impacted by a goodwill impairment charge related to business formerly included in the Industrial Products segment, and the timing of an insurance recovery. Earnings from Operations Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Human Nutrition & Health $ 58,512 $ 45,131 $ 13,381 29.6 % Animal Nutrition & Health 16,059 21,485 (5,426) (25.3) % Specialty Products 23,373 21,342 2,031 9.5 % Other and unallocated (4,263) (5,735) 1,472 (25.7) % Earnings from operations $ 93,681 $ 82,223 $ 11,458 13.9 % % of net sales (operating margin) 16.0 % 15.7 % • Earnings from operations for the HNH segment increased primarily due to the aforementioned higher sales and overall manufacturing efficiencies, partially offset by higher manufacturing input costs and distribution costs, and the expenses associated with the recovery from the flash flood event that we experienced at our Verona, Missouri manufacturing site. • ANH segment earnings from operations decreased primarily due to a significant increase in manufacturing input costs and distribution costs along with the expenses associated with the recovery from the flash flood event. • The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by higher manufacturing input costs and distribution costs. • The increase in Other and unallocated was primarily driven by the prior year being negatively impacted by a goodwill impairment charge related to business formerly included in the Industrial Products segment and a decrease in transaction and integration costs, partially offset by an increase in costs related to a company-wide ERP implementation. 31 Table of Contents Other Expenses (Income) Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Interest expense $ 1,889 $ 3,609 $ (1,720) (47.7) % Other, net (295) 244 (539) (220.9) % $ 1,594 $ 3,853 $ (2,259) (58.6) % Interest expense for the nine months ended September 30, 2021 and 2020 was primarily related to outstanding borrowings under the Credit Agreement. Income Tax Expense Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Income tax expense $ 20,932 $ 15,909 $ 5,023 31.6 % Effective tax rate 22.7 % 20.3 % The increase in the effective tax rate was primarily due to a reduction in certain tax credits, lower tax benefits from stock-based compensation, and higher enacted state tax rates. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES (In thousands, except share and per share data) During the nine months ended September 30, 2021, there were no material changes outside the ordinary course of business in the specified contractual obligations set forth in our Annual Report on Form 10-K for the year ended December 31, 2020. We expect our operations to continue generating sufficient cash flow to fund working capital requirements and necessary capital investments. We are actively pursuing additional acquisition candidates. We could seek additional bank loans or access to financial markets to fund such acquisitions, our operations, working capital, necessary capital investments or other cash requirements should we deem it necessary to do so. Cash Cash and cash equivalents increased to $90,013 at September 30, 2021 from $84,571 at December 31, 2020. At September 30, 2021, the Company had $58,916 of cash and cash equivalents held by foreign subsidiaries. We presently intend to permanently reinvest these funds in foreign operations by continuing to make additional plant related investments, and potentially invest in partnerships or acquisitions; therefore, we do not currently expect to repatriate these funds in order to fund U.S. operations or obligations. However, if these funds are needed for U.S. operations, we could be required to pay additional withholding taxes to repatriate these funds. Working capital was $195,349 at September 30, 2021 as compared to $172,460 at December 31, 2020, an increase of $22,889. Working capital reflects the payment of the 2020 declared dividend in 2021 of $18,704, net payments on the revolving debt of $55,000, and capital expenditures and intangible assets acquired of $22,391. Nine Months Ended September 30, Increase (Decrease) (in thousands) 2021 2020 % Change Cash flows provided by operating activities $ 116,023 $ 102,540 $ 13,483 13.1 % Cash flows used in investing activities (21,119) (21,380) 261 1.2 % Cash flows used in financing activities (86,233) (69,619) (16,614) (23.9) % 32 Table of Contents Operating Activities The increase in cash flows from operating activities was primarily due to improved changes in assets and liabilities and increased earnings. Investing Activities We continue to invest in corporate projects, improvements across all production facilities, and intangible assets. Total investments in property, plant and equipment and inta ngible assets were $22,391 and $20,552 f or the nine months ended September 30, 2021 and 2020, respectively. Financing Activities We borrowed $5,000 against the revolving loan and made total debt payments of $60,000 during the nine months ended September 30, 2021, resulting in $391,431 available under the Credit Agreement as of September 30, 2021. We have an approved stock repurchase program. The total authorization under this program is 3,763,038 shares. Since the inception of the program in June 1999, a total of 2,715,595 shares have been purchased, and we had 85,272 shares remaining in treasury at September 30, 2021. The Company repurchases shares from employees in connection with settlement of transactions under the Company's equity incentive plans. We also intend to acquire shares from time to time at prevailing market prices if and to the extent we deem it is advisable to do so based on our assessment of corporate cash flow, market conditions and other factors. Proceeds from stock options exercis ed were $6,351 and $8,179 for the nine months ended September 30, 2021 and 2020, respectively. Dividend payments were $18,704 and $16,704 for the nine mont hs ended September 30, 2021 and 2020, respectively. Other Matters Impacting Liquidity We currently provide postretirement benefits in the form of two retirement medical plans, as discussed in Note 14 – Employee Benefit Plans. The liabil ity recorded in other long-term liabilities on the consolidated balance sheets as of September 30, 2021 and December 31, 2020 was $1,456 and $1,374, respectively, an d the plans are not funded. Historical cash payments made under these plans have typically been less than $100 per year. We do not anticipate any changes to the payments made in the current year for the plans. On June 1, 2018, we established an unfunded, nonqualified deferred compensation plan maintained for the benefit of a select group of management or highly compen sated employees. Assets of the plan are held in a rabbi trust, which are subject to additional risk of loss in the event of bankruptcy or insolvency of the Company. The deferred compensation liability as of September 30, 2021 and December 31, 2020 was $6,077 and $3,581, respectively, and was included in other long-term obligations on our balance sheet. The related rabbi trust assets were $6,076 a nd $3,581 as of September 30, 2021 and December 31, 2020, respectively, and were included in other non-current assets on the balance sheets. Chemogas has an unfunded defined benefit plan. The plan provides for the payment of a lump sum at retirement or payments in case of death of the covered employees. The amounts recorded for these obligations on our balance sheets as of September 30, 2021 and December 31, 2020 were $934 and $950, respective ly, and were included in other long-term obligations. Critical Accounting Policies There were no changes to the Company's Critical Accounting Policies, as described in its December 31, 2020 Annual Report on Form 10-K, during the nine months ended September 30, 2021. Related Party Transactions We were engaged in related party transactions with St. Gabriel CC Company, LLC during the three and nine months ended September 30, 2021. Refer to Note 17, "Related Party Transactions". 33 Table of Contents