Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
(All amounts in thousands, except share and per share data)
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, 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. See “Cautionary Statement Regarding Forward-Looking Statements.”
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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 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".
COVID-19
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
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 years ended December 31, 2022, 2021 and 2020 (in thousands):
Business Segment Net Sales
2022 2021 2020
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
Other and Unallocated (1)
21,492 12,494 7,557
Total $ 942,358 $ 799,023 $ 703,644
Business Segment Earnings From Operations
2022 2021 2020
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
Other and Unallocated (1)
(5,784) (4,728) (7,030)
Total $ 145,186 $ 127,502 $ 111,147
(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. Unallocated corporate expenses consist of: (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.
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Acquisitions
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. Business.
Results of Operations - Fiscal Year 2022 compared to Fiscal Year 2021
Summary of Consolidated Statements of Earnings
(in thousands) 2022 2021 Increase
(Decrease) % Change
Net sales $ 942,358 $ 799,023 $ 143,335 17.9 %
Gross margin 280,451 243,174 37,277 15.3 %
Operating expenses 135,265 115,672 19,593 16.9 %
Earnings from operations 145,186 127,502 17,684 13.9 %
Other expenses 11,437 2,269 9,168 404.1 %
Income tax expense 28,382 29,129 (747) (2.6) %
Net earnings $ 105,367 $ 96,104 $ 9,263 9.6 %
Management's discussion and analysis of the Consolidated Statements of Earnings is included below:
Net Sales
Increase
(Decrease)
(in thousands) 2022 2021 % Change
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 %
Other 21,492 12,494 8,998 72.0 %
Total $ 942,358 $ 799,023 $ 143,335 17.9 %
• 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 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%.
• 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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Gross Margin
(in thousands) 2022 2021 Increase
(Decrease) % Change
Gross margin $ 280,451 $ 243,174 $ 37,277 15.3 %
% of net sales 29.8 % 30.4 %
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.
Operating Expenses
(in thousands) 2022 2021 Increase
(Decrease) % Change
Operating expenses $ 135,265 $ 115,672 $ 19,593 16.9 %
% of net sales 14.4 % 14.5 %
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
(in thousands) 2022 2021 Increase
(Decrease) % Change
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 %
Other and unallocated (5,784) (4,728) (1,056) (22.3) %
Earnings from operations $ 145,186 $ 127,502 $ 17,684 13.9 %
% of net sales (operating margin) 15.4 % 16.0 %
• 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.
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Other Expenses (Income)
(in thousands) 2022 2021 Increase
(Decrease) % Change
Interest expense, net $ 10,268 $ 2,456 $ 7,812 318.1 %
Other, net 1,169 (187) 1,356 (725.1) %
$ 11,437 $ 2,269 $ 9,168 404.1 %
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
(in thousands) 2022 2021 Increase
(Decrease) % Change
Income tax expense $ 28,382 $ 29,129 $ (747) (2.6) %
Effective tax rate 21.2 % 23.3 %
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
(All amounts in thousands, except share and per share data)
Contractual Obligations
Our short-term purchase obligations primarily include contractual arrangements in the form of purchase orders with suppliers. 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 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. 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 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. 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 $195,761 at December 31, 2022 as compared to $178,430 at December 31, 2021, an increase of
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$17,331. 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
(Decrease) % Change
Cash flows provided by operating activities $ 138,536 $ 160,514 $ (21,978) (13.7) %
Cash flows used in investing activities (416,014) (35,300) (380,714) 1078.5 %
Cash flows provided by (used in) financing activities 246,679 (102,178) 348,857 (341.4) %
Operating Activities
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, 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. These capital expenditures are part of our continuous efforts to support our growing businesses.
Financing Activities
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 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.
Proceeds from stock options exercised were $3,212 and $6,943 for the years ended December 31, 2022 and 2021, respectively. Dividend payments were $20,713 and $18,723 during 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 liability recorded in other long-term liabilities on the consolidated balance sheets as of December 31, 2022 and December 31, 2021 was $1,465 and $1,293, respectively, and the plans are not funded. Historical cash payments made under these plans have typically been less than $200 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 compensated employees. Assets of the plan are held in a rabbi trust, which are included in non-current assets on our balance sheet. They are subject to additional risk of loss in the event of bankruptcy or insolvency of the Company. 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
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$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. 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 sheet as of December 31, 2022 and December 31, 2021 was $393 and $684, respectively, and was included in other long-term obligations.
Related Party Transactions
We were engaged in related party transactions with St. Gabriel CC Company, LLC for the years ended December 31, 2022 and December 31, 2021. Refer to Note 18, Related Party Transactions.
Critical Accounting Estimates
Critical accounting estimates are those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. Our management is required to make these critical accounting estimates and assumptions during the preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America. These estimates and assumptions impact the reported amount of assets and liabilities and disclosures of contingent assets and liabilities as of the date of the consolidated financial statements. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the consolidated financial statements in the period they are determined to be necessary. Actual results could differ from those estimates.
Our critical accounting estimates are those that require application of management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and that may change in subsequent periods. Management considers the following to be critical accounting estimates.
Goodwill and Intangible Assets
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.
Income Taxes
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.
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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.