BALCHEM CORP 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (All amounts 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, 2021 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 11 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". Balchem is committed to solving today's challenges to shape a healthier tomorrow by operating responsibly and providing innovative solutions for the health and nutritional needs of the world. Sustainability is at the heart of our company's vision to make the world a healthier place, and we proudly support the Ten Principles of the United Nations Global Compact on human rights, labor, environment and anti-corruption. In January 2022, Balchem was named one of America’s Most Responsible Companies by Newsweek magazine for the second consecutive year. This list, compiled by Newsweek in partnership with Statista Inc., recognizes the most responsible companies in the U.S. across a variety of industries, and is based on publicly available environmental, social and governance (ESG) data. Our Sustainability Framework focuses on the most critical ESG topics relevant to our business and stakeholders. We are very proud of our ESG accomplishments to date and are pleased with the recognition by 27 Table of Contents Newsweek. Balchem will continue to foster these fundamental principles broadly along our entire value chain, develop new ideas and technologies that help us work smarter, and help build a world that is a better place to live. As of June 30, 2022, we employed approximately 1,359 f ull time employees worldwide. Although we are facing challenging labor markets, we believe that we have been successful in attracting skilled and experienced personnel in a competitive environment and that our human capital resources are adequate to perform all business functions. In addition, we continue to enhance technology in order to optimize productivity and performance. Acquisition of Kappa On June 21, 2022, we completed the acquisition of Kappa (as defined in Note 2 "Significant Acquisitions"), a leading science-based manufacturer of specialty Vitamin K2 for the human nutrition industry, headquartered in Oslo, Norway. Details related to the Kappa acquisition are disclosed in Note 2, "Significant Acquisitions". The acquisition strengthens our scientific and technical expertise, geographic reach, and marketplace leadership, which should ultimately lead to accelerated growth for Balchem's portfolios within the Human Nutrition & Health segment. COVID-19 Response The COVID-19 response effort has been a significant focus for us since early 2020. 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 against 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 accelerated as 2021 progressed, continued into the first and second quarters of 2022, 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 six months ended June 30, 2022 and 2021: Business Segment Net Sales Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Human Nutrition & Health $ 131,628 $ 111,471 $ 254,073 $ 215,987 Animal Nutrition & Health 62,600 54,481 131,942 105,629 Specialty Products 36,647 34,022 69,981 62,030 Other and Unallocated (1) 5,818 2,391 9,564 4,375 Total $ 236,693 $ 202,365 $ 465,560 $ 388,021 28 Table of Contents Business Segment Earnings From Operations Three Months Ended June 30, Six Months Ended June 30, 2022 2021 2022 2021 Human Nutrition & Health $ 23,705 $ 19,021 $ 44,008 $ 38,711 Animal Nutrition & Health 7,586 3,561 18,907 8,617 Specialty Products 9,919 9,729 17,680 16,918 Other and Unallocated (1) (1,290) (1,718) (2,339) (3,078) Total $ 39,920 $ 30,593 $ 78,256 $ 61,168 (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 $872 and $1,176 for the three and six months ended June 30, 2022, respectively, and $466 and $700 for the three and six months ended June 30, 2021, respectively, and (ii) Unallocated amortization expens e of $741 and $1,479 for the three and six months ended June 30, 2022, respectively, and $604 and $1,208 for the three and six months ended June 30, 2021, respectively, related to an intangible asset in connection with a company-wide ERP system implementation. RESULTS OF OPERATIONS (All amounts in thousands, except share and per share data) Three months ended June 30, 2022 compared to three months ended June 30, 2021. Net Earnings Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Net sales $ 236,693 $ 202,365 $ 34,328 17.0 % Gross margin 71,876 59,447 12,429 20.9 % Operating expenses 31,956 28,854 3,102 10.8 % Earnings from operations 39,920 30,593 9,327 30.5 % Other (income) expense, net 662 574 88 15.3 % Income tax expense 9,476 7,288 2,188 30.0 % Net earnings $ 29,782 $ 22,731 $ 7,051 31.0 % Net Sales Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Human Nutrition & Health $ 131,628 $ 111,471 $ 20,157 18.1 % Animal Nutrition & Health 62,600 54,481 8,119 14.9 % Specialty Products 36,647 34,022 2,625 7.7 % Other 5,818 2,391 3,427 143.3 % Total $ 236,693 $ 202,365 $ 34,328 17.0 % • The increase in net sales within the Human Nutrition & Health segment for the second quarter of 2022 as compared to the second quarter of 2021 was driven both by sales growth within food and beverage markets as well as higher sales within the minerals and nutrients business. Total sales for this segment grew 18.1%, with average selling prices contributing 16.2%, volume and mix contributing 2.2%, and the change in foreign currency exchange rates contributing -0.3%. • The increase in net sales within the Animal Nutrition & Health segment for the second quarter of 2022 compared to the second quarter of 2021 was the result of higher sales in monogastric and companion animal markets, partially offset by lower 29 Table of Contents sales in ruminant animal markets and an unfavorable impact related to changes in foreign currency exchange rates. Total sales for this segment grew 14.9%, with average selling prices contributing 28.1%, the change in foreign currency exchange rates contributing -3.4%, and volume and mix contributing -9.9%. • The increase in Specialty Products segment sales for the second quarter of 2022 compared to 2021 was due to higher sales of products in the medical device sterilization market, partially offset by lower plant nutrition sales, and an unfavorable impact related to changes in foreign currency exchange rates. Total sales for this segment grew 7.7% with average selling prices contributing 17.4%, volume and mix contributing -7.0%, and the change in foreign currency exchange rates contributing -2.7%. • Sales relating to Other increased from the prior year due to higher demand. • Sales may fluctuate in future periods based on macroeconomic conditions, competitive dynamics, changes in customer preferences, and our ability to successfully introduce new products to the market. Gross Margin Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Gross margin $ 71,876 $ 59,447 $ 12,429 20.9 % % of net sales 30.4 % 29.4 % Gross margin dollars increased in the second quarter of 2022 compared to the second quarter of 2021 due to the aforementioned higher sales of $34,328, partially offset by an increase in cost of goods sold of $21,899. The 15.3% increase in cost of goods sold was driven mainly by the higher sales as well as the significant inflation of manufacturing input costs, primarily related to raw materials, partially offset by the timing of costs associated with the recovery from a flash flood event at our Verona manufacturing facility in the prior year. Operating Expenses Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Operating expenses $ 31,956 $ 28,854 $ 3,102 10.8 % % of net sales 13.5 % 14.3 % The increase in operating expenses was primarily due to certain higher compensation-related costs of $1,544 and higher advertising and marketing expenses of $555. Earnings from Operations Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Human Nutrition & Health $ 23,705 $ 19,021 $ 4,684 24.6 % Animal Nutrition & Health 7,586 3,561 4,025 113.0 % Specialty Products 9,919 9,729 190 2.0 % Other and unallocated (1,290) (1,718) 428 24.9 % Earnings from operations $ 39,920 $ 30,593 $ 9,327 30.5 % % of net sales (operating margin) 16.9 % 15.1 % • Earnings from operations for the Human Nutrition & Health segment increased primarily due to the aforementioned higher sales. Gross margin as a percentage of sales remained relatively flat as a significant increase in certain manufacturing input 30 Table of Contents costs, largely related to raw materials, was offset by the timing of costs associated with the recovery of a flash flood event at our Verona facility in the prior year. Additionally, total operating expenses for this segment increased by $1,453, primarily due to higher compensation-related costs of $785. • Animal Nutrition & Health segment earnings from operations increased primarily due to the aforementioned higher sales and a 500 basis point increase in gross margin as a percentage of sales, due to the timing of costs associated with the recovery of a flash flood event at our Verona facility in the prior year, partially offset by a significant increase in certain manufacturing input costs, largely related to raw materials. Additionally, operating expenses for this segment increased by $550, primarily due to higher advertising and marketing expenses of $317 and higher compensation-related costs of $250. • The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by a 160 basis point decrease in gross margin as a percentage of sales, due to a significant increase in certain manufacturing input costs, largely related to raw materials. Additionally, total operating expenses for this segment increased by $502, primarily related to higher compensation-related costs of $458. • The increase in Other and unallocated was primarily driven by the aforementioned higher sales, partially offset by an increase in transaction costs, primarily related to the Kappa acquisition. Other Expenses (Income) Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Interest expense $ 960 $ 608 $ 352 57.9 % Other, net (298) (34) (264) 776.5 % $ 662 $ 574 $ 88 15.3 % Interest expense for the three months ended June 30, 2022 and 2021 was primarily related to outstanding borrowings under the 2018 Credit Agreement. Income Tax Expense Three Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Income tax expense $ 9,476 $ 7,288 $ 2,188 30.0 % Effective tax rate 24.1 % 24.3 % The decrease in the effective tax rate was primarily due to the prior year being negatively impacted by clarifying regulations related to tax reform, which was offset by lower tax benefits from stock-based compensation in the current quarter. 31 Table of Contents Six months ended June 30, 2022 compared to six months ended June 30, 2021. Net Earnings Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Net sales $ 465,560 $ 388,021 $ 77,539 20.0 % Gross margin 143,382 118,174 25,208 21.3 % Operating expenses 65,126 57,006 8,120 14.2 % Earnings from operations 78,256 61,168 17,088 27.9 % Other expense, net 1,368 1,166 202 17.3 % Income tax expense 18,176 13,860 4,316 31.1 % Net earnings $ 58,712 $ 46,142 $ 12,570 27.2 % Net Sales Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Human Nutrition & Health $ 254,073 $ 215,987 $ 38,086 17.6 % Animal Nutrition & Health 131,942 105,629 26,313 24.9 % Specialty Products 69,981 62,030 7,951 12.8 % Other 9,564 4,375 5,189 118.6 % Total $ 465,560 $ 388,021 $ 77,539 20.0 % • The increase in net sales within the Human Nutrition & Health segment for the six months ended June 30, 2022 as compared to 2021 was primarily attributed to sales growth within food and beverage markets. Total sales for this segment grew 17.6%, with average selling prices contributing 16.2%, volume and mix contributing 1.7%, and the change in foreign currency exchange rates contributing -0.3%. • The increase in net sales within the Animal Nutrition & Health segment for the six months ended June 30, 2022 compared to 2021 was primarily the result of higher sales in monogastric markets. Total sales for this segment grew 24.9%, with average selling prices contributing 30.1%, volume and mix contributing -2.4%, and the change in foreign currency exchange rates contributing -2.8%. • The increase in Specialty Products segment sales for the six months ended June 30, 2022 compared to 2021 was primarily due to higher sales of products in the medical device sterilization market. Total sales for this segment grew 12.8%, with average selling prices contributing 16.7%, volume and mix contributing -1.6%, and the change in foreign currency exchange rates contributing -2.3%. • Sales relating to Other increased from the prior year due to higher demand. Gross Margin Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Gross margin $ 143,382 $ 118,174 $ 25,208 21.3 % % of net sales 30.8 % 30.5 % Gross margin dollars increased for the six months ended June 30, 2022 compared to 2021 due to the aforementioned higher sales of $77,539, partially offset by an increase in cost of goods sold of $52,331. The 19.4% increase in cost of goods sold was mainly driven by the significant inflation of manufacturing input costs, primarily related to raw materials, partially offset by the timing of costs associated with a flash flood event at our Verona manufacturing facility in the prior year. 32 Table of Contents Operating Expenses Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Operating expenses $ 65,126 $ 57,006 $ 8,120 14.2 % % of net sales 14.0 % 14.7 % The increase in operating expenses was primarily due to higher compensation-related costs of $4,201, an increase in advertising and marketing of $1,043, and higher travel expenses of $735. Earnings from Operations Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Human Nutrition & Health $ 44,008 $ 38,711 $ 5,297 13.7 % Animal Nutrition & Health 18,907 8,617 10,290 119.4 % Specialty Products 17,680 16,918 762 4.5 % Other and unallocated (2,339) (3,078) 739 24.0 % Earnings from operations $ 78,256 $ 61,168 $ 17,088 27.9 % % of net sales (operating margin) 16.8 % 15.8 % • Earnings from operations for the Human Nutrition & Health segment increased primarily due to the aforementioned higher sales and a 100 basis point increase in gross margin as a percentage of sales, primarily related to the timing of costs associated with the recovery of a flash flood event at our Verona manufacturing facility in the prior year, partially offset by a significant increase in certain manufacturing input costs, largely related to raw materials. Additionally, operating expenses for this segment increased by $4,110, primarily due to higher compensation-related costs of $2,086. • Animal Nutrition & Health segment earnings from operations increased primarily due to the aforementioned higher sales and a 530 basis point increase in gross margin as a percentage of sales primarily related to the timing of costs associated with the recovery of a flash flood event at our Verona manufacturing facility in the prior year, partially offset by a significant increase in certain manufacturing input costs, largely related to raw materials. Additionally, operating expenses for this segment increased by $1,759, primarily related to higher compensation-related costs of $932 and an increase in advertising and marketing of $505. • The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by a 250 basis point decrease in gross margin as a percentage of sales, primarily due to a significant increase in certain manufacturing input costs, largely related to raw materials. • Earnings from operations relating to Other increased from the prior year primarily due to the aforementioned higher sales, partially offset by an increase in transaction costs, mainly related to the Kappa acquisition. 33 Table of Contents Other Expenses (Income) Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Interest expense $ 1,505 $ 1,333 $ 172 12.9 % Other, net (137) (167) 30 (18.0) % $ 1,368 $ 1,166 $ 202 17.3 % Interest expense for the six months ended June 30, 2022 and 2021 was primarily related to outstanding borrowings under the 2018 Credit Agreement. Income Tax Expense Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Income tax expense $ 18,176 $ 13,860 $ 4,316 31.1 % Effective tax rate 23.6 % 23.1 % The increase in the effective tax rate was primarily due to lower tax benefits from stock-based compensation and a reduction in certain tax credits. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES (All amounts in thousands, except share and per share data) In June 2022 we drew down an additional $345,000 from our revolving credit facility to fund the acquisition of Kappa. In connection with this transaction, the seller has an opportunity to receive an additional payment in 2024 if certain financial performance targets and other metrics are met, and therefore we recorded a contingent consideration liability of kr245,000 (translated to $24,793) as of June 30, 2022. Excluding the events previously mentioned, there were no other material changes during the six months ended June 30, 2022 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, 2021. 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. On July 27, 2022, we entered into an Amended and Restated Credit Agreement with a bank syndicate providing for a revolving loan of $550,000, due July 27, 2027. The revolving loan proceeds were used to pay down the existing debt under the 2018 Credit Agreement and may be used for working capital, letters of credit, and other corporate purposes. 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 decreased to $76,183 at June 30, 2022 from $103,239 at December 31, 2021. At June 30, 2022, the Company had $61,390 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 $232,998 at June 30, 2022 as compared to $178,430 at December 31, 2021, an increase of $54,568. Working capital reflects the payment of the 2021 declared dividend in 2022 of $20,704, payments on the revolving loan and acquired debt of $70,648, and capital expenditures and intangible assets acquired of $20,799. 34 Table of Contents Six Months Ended June 30, Increase (Decrease) (in thousands) 2022 2021 % Change Cash flows provided by operating activities $ 55,261 $ 76,389 $ (21,128) (27.7) % Cash flows used in investing activities (316,412) (13,520) (302,892) (2240.3) % Cash flows provided by (used in) financing activities 239,694 (65,727) 305,421 464.7 % Operating Activities The decrease in cash flows from operating activities was primarily driven by changes in working capital and the timing of increased sales, restocking of inventory, and payments to suppliers. Investing Activities As previously noted, on June 21, 2022, we completed the acquisition of Kappa, a leading science-based manufacturer of specialty vitamin K2 for the human nutrition industry, headquartered in Oslo, Norway. Cash paid for the acquisition, net of cash acquired, amounted to $295,660 . 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 $20,799 and $13,760 f or the six months ended June 30, 2022 and 2021, respectively. Financing Activities As previously noted, the acquisition of Kappa was primarily funded through the 2018 Credit Agreement. We borrowed $365,000 against the revolving loan and made total loan payments of $40,000 during the six months ended June 30, 2022, resulting in $66,431 available under the 2018 Credit Agreement as of June 30, 2022. In addition, we also made payments of $30,648 on the acquired debt related to the acquisition of Kappa. 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 3,068,905 shares have been purchased. We repurchase shares from employees in connection with settlement of transactions under our 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 $1,328 and $3,886 for the six months ended June 30, 2022 and 2021, respectively. Dividend payments were $20,704 and $18,700 for the six mont hs ended June 30, 2022 and 2021, respectively. Other Matters Impacting Liquidity We currently provide postretirement benefits in the form of two retirement medical plans, as discussed in Note 15 – Employee Benefit Plans. The liabil ity recorded in "Other long-term liabilities" on the condensed consolidated balance sheets as of June 30, 2022 and December 31, 2021 was $1,221 and $1,293, 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 June 30, 2022 and December 31, 2021 was $8,220 and $6,251, respectively, and was included in "other long-term obligations" on our balance sheet. The related rabbi trust assets were $8,255 a nd $6,267 as of June 30, 2022 and December 31, 2021, respectively, and were included in "other non-current assets" on the condensed consolidated 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 amount recorded for these obligations on our balance sheets as of June 30, 2022 and December 31, 2021 were $641 and $684, respective ly, and were included in "other long-term obligations." 35 Table of Contents Critical Accounting Policies There were no changes to the Company's Critical Accounting Policies, as described in its December 31, 2021 Annual Report on Form 10-K, during the six months ended June 30, 2022. Related Party Transactions We were engaged in related party transactions with St. Gabriel CC Company, LLC during the three and six months ended June 30, 2022. Refer to Note 18, "Related Party Transactions".