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Item 7. Management’s Discussion and Analysis

2023-02-24 compared with 2022-02-24 · 71 added, 68 removed, 130 unchanged (52% of the section changed)

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Consolidated Financial Statements and the related notes included in this report.

Refer to Part II, Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 (filed with the SEC on February 19, 2021) for additional discussion of our financial condition and results of operations for the year ended December 31, 2019, as well as our financial condition and results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019.

Refer to Part II, Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 (filed with the SEC on February 24, 2022) for additional discussion of our financial condition and results of operations for the year ended December 31, 2020.

In addition, discussion of year-to-year comparisons between 2021 and 2020 are not included in this Annual Report on Form 10-K, and can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2021.

Those statements in the following discussion that are not historical in nature should be considered to be forward-looking statements that are inherently uncertain.

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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 consolidated financial statements.

Human Nutrition and Health, Animal Nutrition and Health, and Specialty Products, as more fully described in Note 11, Segment Information, of the 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 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.

COVID-19 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 accelerated as 2021 progressed and are likely to continue for some time.

Our COVID-19 response has focused 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.

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 in a hybrid setting.

The COVID-19 pandemic continued to negatively affect the global economy and the markets we operate in during 2022.

We experienced severe input cost inflation, raw material shortages, logistics disruptions, and labor availability issues throughout the year.

Some of these indirect pandemic-related challenges eased slightly during the second half of 2022, however these challenges are likely to continue for some time.

Segment Results

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2022 2021 2020

Human Nutrition & Health $ 442,733 $ 400,330 $ 347,433

Animal Nutrition & Health 226,776 192,191 177,557

Human Nutrition and Health $ 527,131 $ 442,733 $ 400,330

Animal Nutrition and Health 262,297 226,776 192,191

Specialty Products 131,438 117,020 103,566

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2022 2021 2020

Human Nutrition & Health $ 76,031 $ 61,397 $ 48,429

Animal Nutrition & Health 26,179 29,979 25,868

Human Nutrition and Health $ 82,125 $ 76,031 $ 61,397

Animal Nutrition and Health 36,056 26,179 29,979

Specialty Products 32,789 30,020 26,801

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(i) Transaction and integration costs, ERP implementation costs, and unallocated legal fees totaling $3,581, $1,264 and $2,410 for years ended December 31, 2022, 2021 and 2020, respectively, and (ii) Unallocated amortization expense of $2,951, $2,510, and $1,606 for years ended December 31, 2022, 2021, and 2020, respectively, related to an intangible asset in connection with a company-wide ERP system implementation.

On December 13, 2019, the Company completed an acquisition of Zumbro.

The Company made payments of $52,403 on the acquisition date, amounting to $47,058 to the former shareholders and $5,345 to Zumbro's lenders to pay Zumbro debt.

Considering the cash acquired of $686, net payments made to the former shareholders were $46,372.

In May 2020, we received an adjustment for working capital acquired of $561.

Zumbro is integrated within the HNH Segment.

On May 27, 2019, we acquired Chemogas.

We made payments of approximately €99,503 (translated to $111,324) on the acquisition date, amounting to approximately €88,579 (translated to $99,102) to the former shareholders and approximately €10,924 (translated to $12,222) to Chemogas' lender to pay off all Chemogas bank debt.

Considering the cash acquired of €3,943 (translated to $4,412), net payments made to the former shareholders were €84,636 (translated to $94,690).

Chemogas is integrated within the Specialty Products Segment.

RESULTS OF OPERATIONS

(All amounts in thousands, except share and per share data)

Fiscal Year 2021 compared to Fiscal Year 2020

On August 30, 2022, we completed the acquisition of Bergstrom, a leading science-based manufacturer of methylsulfonylmethane ("MSM"), based in Vancouver, Washington, and 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.

Details related to both acquisitions are disclosed in Note 2, Significant Acquisitions, and the "Acquisitions" section in Item 1.

Results of Operations - Fiscal Year 2022 compared to Fiscal Year 2021

Summary of Consolidated Statements of Earnings

(in thousands) 2022 2021 Increase

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Net earnings $ 105,367 $ 96,104 $ 9,263 9.6 %

Management's discussion and analysis of the Consolidated Statements of Earnings is included below:

(in thousands) 2022 2021 % Change

Human Nutrition & Health $ 442,733 $ 400,330 $ 42,403 10.6 %

Animal Nutrition & Health 226,776 192,191 34,585 18.0 %

Human Nutrition and Health $ 527,131 $ 442,733 $ 84,398 19.1 %

Animal Nutrition and Health 262,297 226,776 35,521 15.7 %

Specialty Products 131,438 117,020 14,418 12.3 %

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Total $ 942,358 $ 799,023 $ 143,335 17.9 %

• The increase in net sales within the Human Nutrition & Health segment for 2021 as compared to 2020 was primarily attributed to sales growth within food, beverage, and nutrition markets.

• The increase in net sales within the Human Nutrition and Health segment for 2022 compared to 2021 was primarily attributed to sales growth within food and beverage markets, the contribution from recent acquisitions, as well as higher sales within the minerals and nutrients business, partially offset by an unfavorable impact related to change in foreign currency exchange rates.

Total sales for this segment grew 19.1%, with average selling prices contributing 17.2%, volume and mix contributing 2.2%, and the change in foreign currency exchange rates contributing -0.3%.

• The increase in net sales within the ANH segment for 2021 compared to 2020 was primarily the result of higher sales in both monogastric and ruminant animal markets.

• The increase in net sales within the Animal Nutrition and Health segment for 2022 compared to 2021 was primarily the result of higher sales in monogastric and ruminant species markets, partially offset by an unfavorable impact related to changes in foreign currency exchange rates.

Total sales for this segment grew 15.7%, with average selling prices contributing 25.5%, the change in foreign currency exchange rates contributing -3.3%, and volume and mix contributing -6.5%.

• The increase in Specialty Products segment sales for 2022 compared to 2021 was primarily due to higher sales of performance gases and plant nutrition sales, partially offset by an unfavorable impact related to changes in foreign currency exchange rates.

Total sales for this segment grew 12.3%, with average selling prices contributing 16.9%, volume and mix contributing -1.5%, and the change in foreign currency exchange rates contributing -3.1%.

• The increase in Specialty Products segment sales for 2021 compared to 2020 was primarily due to year over year sales growth in both the medical device sterilization market and plant nutrition business.

Total sales for this segment increased 13.0%, with average selling prices contributing 8.6%, volume and mix contributing 3.4%, and the change in foreign currency exchange rates contributing 1.1%.

• Sales relating to Other increased from the prior year due to higher demand.

• Sales relating to Other increased from the prior year primarily 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.

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% of net sales 29.8 % 30.4 %

Gross margin dollars increased in 2021 compared to 2020 due to the aforementioned higher sales of $95,379, partially offset by an increase in cost of goods sold of $76,102.

The 15.9% increase in cost of goods sold was primarily driven by the significant inflation of manufacturing input costs, primarily related to raw materials.

Gross margin dollars increased for 2022 compared to 2021 due to the aforementioned higher sales of $143,335, partially offset by an increase in cost of goods sold of $106,058.

The 19.1% increase in cost of goods sold was mainly driven by the higher sales and significant inflation of manufacturing input costs, primarily related to raw materials.

Price increases lagged this inflation, leading to a 60 basis point decrease in gross margin as a percentage of sales.

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% of net sales 14.4 % 14.5 %

The increase in operating expenses was primarily due to certain higher compensation-related costs of $8,748, partially offset by a decrease in consulting costs and outside services of $3,000, a decrease in amortization and depreciation expenses of $1,392, and the timing of an insurance recovery amounting to $1,051.

The increase in operating expenses was primarily due to incremental operating expenses related to the acquisitions of $6,804, an increase in outside services of $6,265, and higher compensation-related costs of $2,931.

Earnings From Operations

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(Decrease) % Change

Human Nutrition & Health $ 76,031 $ 61,397 $ 14,634 23.8 %

Animal Nutrition & Health 26,179 29,979 (3,800) (12.7) %

Human Nutrition and Health $ 82,125 $ 76,031 $ 6,094 8.0 %

Animal Nutrition and Health 36,056 26,179 9,877 37.7 %

Specialty Products 32,789 30,020 2,769 9.2 %

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% of net sales (operating margin) 15.4 % 16.0 %

• Earnings from operations for the Human Nutrition & Health segment increased primarily due to the aforementioned higher sales and a 60 basis point increase in gross margin.

• Animal Nutrition & Health segment earnings from operations decreased primarily due to a 430 basis point decrease in gross margin as a percentage of sales, driven by a significant increase in certain manufacturing input costs, primarily related to raw materials, partially offset by the aforementioned higher sales.

Additionally, total operating expenses for this segment increased by $3,240, primarily due to higher compensation-related costs of $3,031.

• The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by a 240 basis point decrease in gross margin as a percentage of sales, driven by a significant increase in certain manufacturing input costs, primarily related to raw materials.

• The increase in Other and unallocated was primarily driven by a decrease in transaction and integration costs of $1,562 and the prior year being negatively impacted by a goodwill impairment charge related to business formerly included in the Industrial Products segment of $1,228, partially offset by an increase in costs related to a company-wide ERP implementation of $1,300.

• Earnings from operations for the Human Nutrition and Health segment increased primarily due to the aforementioned higher sales, partially offset by a 140 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.

Additionally, operating expenses for this segment increased by $12,629, primarily due to incremental operating expenses related to the acquisitions of $6,654 and outside services of $3,831.

• Animal Nutrition and Health segment earnings from operations increased primarily due to the aforementioned higher sales and a 130 basis point increase in gross margin as a percentage of sales primarily related to higher average selling prices, partially offset by a significant increase in certain manufacturing input costs, largely related to raw materials.

Additionally, operating expenses for this segment increased by $1,596, primarily related to higher outside services of $1,084.

• The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by a 140 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.

Additionally, operating expenses for this segment increased by $2,276, primarily related to higher compensation-related costs of $1,586 and higher outside services of $1,264, partially offset by lower amortization of $697.

• Earnings from operations relating to Other and unallocated decreased from the prior year primarily due to an increase in transaction costs, mainly related to the acquisitions, partially offset by the aforementioned higher sales.

Other Expenses (Income)

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$ 11,437 $ 2,269 $ 9,168 404.1 %

Interest expense for 2021 and 2020 was primarily related to outstanding borrowings under our credit facility.

The decrease was due to a reduction in borrowings during 2021.

Interest expense for 2022 and 2021 was primarily related to outstanding borrowings under the 2022 Credit Agreement and the 2018 Credit Agreement, respectively.

The increase in interest expense is due to the additional borrowings in connection with the acquisitions and rising interest rates.

Income Tax Expense

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(Decrease) % Change

Income tax expense (benefit) $ 29,129 $ 21,794 $ 7,335 33.7 %

Income tax expense $ 28,382 $ 29,129 $ (747) (2.6) %

Effective tax rate 21.2 % 23.3 %

Our effective tax rate for 2021 and 2020 wa s 23.3% and 20.5%, respectively.

The increase was primarily due to a reduction in certain tax credits, lower tax benefits from stock-based compensation, and higher enacted state tax rates.

The decrease in the effective tax rate was primarily due to an increase in certain tax credits and deductions and certain lower state taxes.

Liquidity and Capital Resources

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As of December 31, 2022, such purchase obligations were $69,269.

For debt obligations, see Note 8, Revolving Loan, and for operating and finance lease obligations, see Note 16 Commitments and Contingencies.

For debt obligations, see Note 8, Revolving Loan, and for operating and finance lease obligations, see Note 19, Leases.

The contractual obligations exclude a $5,815 liability for uncertain tax positions, including the related interest and penalties, recorded in accordance with ASC 740-10, as we are unable to reasonably estimate the timing of settlement, if any.

We know of no current or pending demands on, or commitments for, our liquid assets that will materially affect our liquidity.

During the twelve months ending December 31, 2022, we drew down $345,000 and $70,000 from our revolving credit facility to fund the acquisitions of Kappa and Bergstrom, respectively.

Depending on whether financial and other targets are met, we may be required to pay contingent consideration liabilities in connection with the recent acquisitions in 2024.

These liabilities are valued at $11,400 as of December 31, 2022 (see Note 2, Significant Acquisitions).

Excluding the events previously mentioned, there were no other material changes during the year ended December 31, 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.

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 expect our operations to continue generating sufficient cash flow to fund working capital requirements and necessary capital investments.

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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 and cash equivalents increased to $103,239 at December 31, 2021 from $84,571 at December 31, 2020.

Cash and cash equivalents decreased to $66,560 at December 31, 2022 from $103,239 at December 31, 2021.

At December 31, 2022, we had $47,526 of cash and cash equivalents held by our foreign subsidiaries.

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Working capital was $195,761 at December 31, 2022 as compared to $178,430 at December 31, 2021, an increase of

Working capital reflects the payment of the 2020 declared dividend in 2021 of $18,723, net payments on the revolving debt of $55,000, capital expenditures and intangible assets acquired of $37,449, and common stock repurchases of $35,239.

Cash at December 31, 2022 reflects the payment of the 2021 declared dividend in 2022 of $20,713, payments on the revolving loan and acquired debt of $133,988, capital expenditures and intangible assets acquired of $50,290, and common stock repurchases of $35,423.

(in thousands) 2022 2021 Increase

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Cash flows used in investing activities (416,014) (35,300) (380,714) 1078.5 %

Cash flows used in financing activities (102,178) (101,164) (1,014) (1.0) %

Cash flows provided by (used in) financing activities 246,679 (102,178) 348,857 (341.4) %

Operating Activities

The increase in cash flows from operating activities was primarily due to increased earnings and improved changes in assets and liabilities.

The decrease in cash flows from operating activities was primarily driven by changes in working capital.

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, and on August 30, 2022, we completed the acquisition of Bergstrom, a leading science-based manufacturer of MSM, based in Vancouver, Washington.

Cash paid for these acquisitions, net of cash acquired, amounted to $365,780.

We continue to invest in corporate projects, improvements across all production facilities, and intangible assets.

Total investments in property, plant and equipment and intangible assets were $50,290 and $37,449 for the years ended December 31, 2022 and 2021, respectively.

As of December 31, 2021, capital expenditures are projected to range from $30,000 to $40,000 for 2022.

As of December 31, 2022, capital expenditures are projected to be approximately $40,000 to $50,000 for 2023.

As mentioned above, we expect that our operations will continue to generate sufficient cash flow to fund the commitments for capital expenditures.

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Financing Activities

We borrowed $5,000 against the revolving loan and made total debt payments of $60,000 during 2021, resulting in $391,431 available under the Credit Agreement as of December 31, 2021.

The acquisitions of Kappa and Bergstrom were funded through our credit agreements (see Note 8, Revolving Loan).

We borrowed $435,000 under our credit agreements and made total loan payments of $103,000 during the year ended December 31, 2022, resulting in $109,431 available under the 2022 Credit Agreement as of December 31, 2022.

We also made payments of $30,988 on the acquired debt related to the acquisitions.

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 2,818,244 shares have been purchased.

Since the inception of the program in June 1999, a total of 3,070,548 shares have been repurchased.

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.

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 exercised were $3,212 and $6,943 for the years ended December 31, 2022 and 2021, respectively.

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The deferred compensation liability as of December 31, 2022 and December 31, 2021 was $8,543 and $6,270, respectively, and is included in other long-term obligations on our balance sheet.

The related rabbi trust assets were $8,547 and

$6,267 as of December 31, 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.

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Goodwill and Intangible Assets

The valuation methods and assumptions used in assessing the impairment of goodwill and identified intangibles, as well as determining the useful life of an intangible asset involve a significant level of estimation uncertainty.

The valuation methods and assumptions used in valuing goodwill and identified intangibles and assessing the impairment of goodwill and identified intangibles involves a significant level of estimation uncertainty.

In addition, the assumptions used in determining the useful life of an intangible asset involves a significant level of estimation uncertainty.

Refer to the Goodwill and Acquired Intangible Assets section in Note 1, Business Description and Summary of Significant Accounting Policies, for details related to the valuation and impairment process of both goodwill and intangible assets.

Changes in market conditions, laws and regulations, and key assumptions made in future quantitative assessments, including expected cash flows, competitive factors and discount rates, could result in the recognition of an impairment charge, and in turn could have a material impact on our financial condition or results of operations in subsequent periods.

Contingent Consideration Liabilities

In connection with recent acquisitions (see Note 2, Significant Acquisitions), the sellers of each of the acquired entities have an opportunity to receive an additional payment if certain financial performance targets and other metrics are met, thereby requiring us to record contingent consideration liabilities on our balance sheet.

The valuation methods and assumptions used in assessing the contingent consideration liabilities involve a significant level of estimation uncertainty.

The value of the contingent consideration liability could change depending on the performance results of the acquired entities, resulting in additional expenses or income, and in turn could have a material impact on our financial condition or results of operations in subsequent periods.

The valuation methods and assumptions used in calculating income taxes, deferred tax assets and liabilities, and valuation allowances involve a significant level of estimation uncertainty.

Refer to the Income Taxes in Note 1, Business Description and Summary of Significant Accounting Policies, for details.

Changes in the assumptions such as our forecast of future market growth, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies could result in income taxes adjustments, and in turn could have a material impact on our financial condition or results of operations in subsequent periods.

Significant Accounting Policies and Recent Accounting Pronouncements

See Note 1 in Notes to Consolidated Financial Statements regarding significant accounting policies and recent accounting pronouncements.

See Note 1, Business Description and Summary of Significant Accounting Policies, in Notes to Consolidated Financial Statements regarding significant accounting policies and recent accounting pronouncements.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis