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) Forward-Looking Statements This report contains forward-looking statements, within the meaning of the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, which reflect our expectation or belief concerning future events that involve risks and uncertainties. These forward-looking statements generally are identified by the words "believe," "project," "expect," "anticipate," "estimate," "forecast," "outlook," "intend," "strategy," "future," "opportunity," "plan," "may," "should," "will," "would," "will be," "will continue," "will likely result," or the negative thereof or variations thereon or similar expressions generally intended to identify forward-looking statements. 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, 2022 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. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Factors that may affect our forward-looking statements include, among other things: (1) adverse impacts to our business operations due to the global COVID-19 pandemic and our ability to predict the full extent of such impacts; (2) our ability to manage risks associated with our sales to customers and manufacturing operations outside the United States; (3) supply chain disruptions due to political unrest, terrorist acts, and national and international conflicts; (4) reliability and sufficiency of our manufacturing facilities; (5) our ability to recruit and retain a highly qualified and diverse workforce; (6) our ability to effectively manage labor relations; (7) the effects of global climate change or other unexpected events, including global health crises, that may disrupt our operations; (8) our ability to manage risks related to our information technology and operational technology systems and cybersecurity; (9) our reliance on third-party vendors for many of the critical elements of our global information and operational technology infrastructure and their failure to provide effective support for such infrastructure; (10) disruption and breaches of our information systems; (11) increased competition and our ability to anticipate evolving trends in the market; (12) global economic conditions, including inflation, recession, changes in tariffs and trade relations; (13) raw material shortages or price increases; (14) currency translation and currency transaction risks; (15) interest rate risks; (16) our ability to successfully consummate and manage acquisitions, joint ventures and divestitures; (17) our ability to effectively manage and implement restructuring initiatives or other organizational changes; (18) changes in our relationships with our vendors, changes in tax or trade policy, interruptions in our operations or supply chain; (19) adverse publicity or consumer concern regarding the safety or quality of food products containing our products; (20) the outcome of any litigation, governmental investigations or proceedings; (21) product liability claims and recalls; (22) our ability to protect our brand reputation and trademarks; (23) claims of infringement of intellectual property rights by third parties; (24) risks related to corporate social responsibility and reputational matters; (25) improper conduct by any of our employees, agents or business partners; (26) changes to, or changes in interpretations of, current laws and regulations, and loss of governmental permits and approvals; and (27) ability of our customers to use the ethylene oxide process to sterilize medical devices. 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, Segment Information , 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. 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 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. 30 Table of Contents As of June 30, 2023, we employed approximately 1,284 fu ll time employees worldwide. Although we are facing challenging labor markets, we believe that we have been successful in attracting skilled, experienced, and diverse 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. 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 . 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, 2023 and 2022: Business Segment Net Sales Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Human Nutrition & Health $ 135,669 $ 131,628 $ 268,322 $ 254,073 Animal Nutrition & Health 61,329 62,600 126,218 131,942 Specialty Products 32,726 36,647 64,957 69,981 Other and Unallocated (1) 1,528 5,818 4,295 9,564 Total $ 231,252 $ 236,693 $ 463,792 $ 465,560 Business Segment Earnings From Operations Three Months Ended June 30, Six Months Ended June 30, 2023 2022 2023 2022 Human Nutrition & Health $ 27,499 $ 23,705 $ 45,934 $ 44,008 Animal Nutrition & Health 7,662 7,586 17,160 18,907 Specialty Products 9,298 9,919 17,244 17,680 Other and Unallocated (1) (1,623) (1,290) (3,094) (2,339) Total $ 42,836 $ 39,920 $ 77,244 $ 78,256 (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 $651 and $1,216 for the three and six months ended June 30, 2023, respectively, and $872 and $1,176 for the three and six months ended June 30, 2022, respectively, and (ii) Unallocated amortization expense of $0 and $312 for the three and six months ended June 30, 2023, and $741 and $1,479 for the three and six months ended June 30, 2022, respectively, related to an intangible asset in connection with a company-wide ERP system implementation. 31 Table of Contents Results of Operations - Three Months Ended June 30, 2023 and 2022 Net Earnings Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Net sales $ 231,252 $ 236,693 $ (5,441) (2.3) % Gross margin 77,349 71,876 5,473 7.6 % Operating expenses 34,513 31,956 2,557 8.0 % Earnings from operations 42,836 39,920 2,916 7.3 % Other expenses 4,436 662 3,774 570.1 % Income tax expense 8,290 9,476 (1,186) (12.5) % Net earnings $ 30,110 $ 29,782 $ 328 1.1 % Net Sales Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 135,669 $ 131,628 $ 4,041 3.1 % Animal Nutrition & Health 61,329 62,600 (1,271) (2.0) % Specialty Products 32,726 36,647 (3,921) (10.7) % Other 1,528 5,818 (4,290) (73.7) % Total $ 231,252 $ 236,693 $ (5,441) (2.3) % • The increase in net sales within the Human Nutrition & Health segment for the second quarter of 2023 as compared to the second quarter of 2022 was primarily driven by the contribution from recent acquisitions, partially offset by lower sales within food and beverage markets and the minerals and nutrients business. Total sales for this segment grew 3.1%, with average selling prices contributing 5.8%, the change in foreign currency exchange rates contributing 0.1%, and volume and mix contributing -2.8%. • The decrease in net sales within the Animal Nutrition & Health segment for the second quarter of 2023 compared to the second quarter of 2022 was driven by lower sales in monogastric markets, partially offset by higher sales in the ruminant species markets. Total sales for this segment decreased by 2.0%, with average selling prices contributing -1.6%, volume and mix contributing -1.0%, and the change in foreign currency exchange rates contributing 0.6%. • The decrease in net sales within the Specialty Products segment for the second quarter of 2023 compared to the second quarter of 2022 was due to lower sales in both the plant nutrition and performance gases businesses. Total sales for this segment decreased by 10.7%, with volume and mix contributing -15.9%, the change in foreign currency exchange rates contributing 0.5%, and average selling prices contributing 4.7%. • Sales relating to Other decreased from the prior year due to lower 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. 32 Table of Contents Gross Margin Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Gross margin $ 77,349 $ 71,876 $ 5,473 7.6 % % of net sales 33.4 % 30.4 % Gross margin dollars increased in the second quarter of 2023 compared to the second quarter of 2022 due to higher average selling prices and a decrease in cost of goods sold of $10,914. The 6.6% decrease in cost of goods sold was mainly driven by certain lower manufacturing input costs. Operating Expenses Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Operating expenses $ 34,513 $ 31,956 $ 2,557 8.0 % % of net sales 14.9 % 13.5 % The increase in operating expenses in the second quarter of 2023 compared to the second quarter of 2022 was primarily due to restructuring-related impairment and asset disposal charges of $6,146, incremental operating expenses related to the acquisitions of Kappa and Bergstrom of $3,210, and an increase in amortization of $691, partially offset by favorable adjustments to transaction costs of $8,000. Earnings from Operations Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 27,499 $ 23,705 $ 3,794 16.0 % Animal Nutrition & Health 7,662 7,586 76 1.0 % Specialty Products 9,298 9,919 (621) (6.3) % Other and unallocated (1,623) (1,290) (333) (25.8) % Earnings from operations $ 42,836 $ 39,920 $ 2,916 7.3 % % of net sales (operating margin) 18.5 % 16.9 % • Human Nutrition & Health segment earnings from operations increased $3,794. Gross margin contribution from incremental sales was $6,792, which was partially offset by an increase in operating expenses of $2,996, primarily due to restructuring-related impairment and asset disposal charges of $4,769, incremental operating expenses related to the Kappa and Bergstrom acquisitions of $3,133, and higher amortization of $1,207, partially offset by favorable adjustments to transaction costs of $6,400. • Animal Nutrition & Health segment earnings from operations increased $76. Gross margin contribution was $96, which was offset by a slight increase in operating expenses of $21, primarily due to restructuring-related impairment charges of $1,088, partially offset by favorable adjustments to transaction costs of $1,600. • Specialty Products segment earnings from operations decreased $621, primarily driven by lower sales volumes, partially offset by higher average selling prices and lower manufacturing input costs. • The decrease in Other and unallocated was primarily driven by the aforementioned lower sales. 33 Table of Contents Other Expenses Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Interest expense $ 5,163 $ 960 $ 4,203 437.8 % Other (income) expense, net (727) (298) (429) 144.0 % $ 4,436 $ 662 $ 3,774 570.1 % Interest expense for the three months ended June 30, 2023 and 2022 was primarily related to outstanding borrowings under the 2022 Credit Agreement. The increase of $4,203 in interest expense is due to the additional borrowings in connection with the acquisitions and higher interest rates. Income Tax Expense Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Income tax expense $ 8,290 $ 9,476 $ (1,186) (12.5) % Effective tax rate 21.6 % 24.1 % The decrease in the effective tax rate was primarily due to certain lower state taxes and higher tax benefits from stock-based compensation. Results of Operations - Six Months Ended June 30, 2023 and 2022 Net Earnings Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Net sales $ 463,792 $ 465,560 $ (1,768) (0.4) % Gross margin 150,519 143,382 7,137 5.0 % Operating expenses 73,275 65,126 8,149 12.5 % Earnings from operations 77,244 78,256 (1,012) (1.3) % Other expenses 9,725 1,368 8,357 610.9 % Income tax expense 14,699 18,176 (3,477) (19.1) % Net earnings $ 52,820 $ 58,712 $ (5,892) (10.0) % Net Sales Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 268,322 $ 254,073 $ 14,249 5.6 % Animal Nutrition & Health 126,218 131,942 (5,724) (4.3) % Specialty Products 64,957 69,981 (5,024) (7.2) % Other 4,295 9,564 (5,269) (55.1) % Total $ 463,792 $ 465,560 $ (1,768) (0.4) % • The increase in net sales within the Human Nutrition & Health segment for the six months ended June 30, 2023 as compared to 2022 was primarily driven by the contribution from recent acquisitions, partially offset by lower sales within food and beverage markets and the minerals business. Total sales for this segment grew 5.6%, with average selling prices contributing 8.7% and volume and mix contributing -3.1%. • The decrease in net sales within the Animal Nutrition & Health segment for the for the six months ended June 30, 2023 as compared to 2022 was driven by lower sales in monogastric markets and an unfavorable impact related to changes in foreign currency exchanges rates, partially offset by higher sales in the ruminant species markets. Total sales for this segment decreased by 4.3%, with volume and mix contributing -5.6%, the change in foreign currency exchange rates contributing -0.4%, and average selling prices contributing 1.7%. 34 Table of Contents • The decrease in net sales within the Specialty Products segment for the six months ended June 30, 2023 as compared to 2022 was primarily due to lower sales in both the plant nutrition and performance gases businesses, and an unfavorable impact related to changes in foreign currency exchange rates. Total sales for this segment decreased by 7.2%, with volume and mix contributing -13.9%, the change in foreign currency exchange rates contributing -0.4%, and average selling prices contributing 7.1%. • Sales relating to Other decreased from the prior year due to lower 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 Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Gross margin $ 150,519 $ 143,382 $ 7,137 5.0 % % of net sales 32.5 % 30.8 % Gross margin dollars increased in the six months ended June 30, 2023 as compared to 2022 due to higher average selling prices and a decrease in cost of goods sold of $8,905. The 2.8% decrease in cost of goods sold was mainly driven by certain lower manufacturing input costs. Operating Expenses Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Operating expenses $ 73,275 $ 65,126 $ 8,149 12.5 % % of net sales 15.8 % 14.0 % The increase in operating expenses in the six months ended June 30, 2023 as compared to 2022 was primarily due to the incremental operating expenses related the Kappa and Bergstrom acquisitions of $6,561, restructuring-related impairment and asset disposal charges of $6,146, and higher amortization of $1,728, partially offset by favorable adjustments to transaction costs of $6,400. Earnings from Operations Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 45,934 $ 44,008 $ 1,926 4.4 % Animal Nutrition & Health 17,160 18,907 (1,747) (9.2) % Specialty Products 17,244 17,680 (436) (2.5) % Other and unallocated (3,094) (2,339) (755) (32.3) % Earnings from operations $ 77,244 $ 78,256 $ (1,012) (1.3) % % of net sales (operating margin) 16.7 % 16.8 % • Human Nutrition & Health segment earnings from operations increased $1,926. Gross margin contribution from incremental sales was $9,599, which was partially offset by an increase in operating expenses of $7,671, primarily due to the incremental operating expenses related to the Kappa and Bergstrom acquisitions of $6,395, and restructuring-related impairment and asset disposal charges of $4,769, partially offset by favorable adjustments to transaction costs of $5,120. • Animal Nutrition & Health segment earnings from operations decreased $1,747. Gross margin decreased $1,209 primarily due to lower sales. Additionally, operating expenses for this segment increased by $538, which was largely related to restructuring-related impairment charges of $1,088, higher amortization of $247, and an increase in travel expenses of $208, partially offset by favorable adjustments to transaction costs of $1,280. 35 Table of Contents • Specialty Products segment earnings from operations decreased $436, which was primarily driven by the aforementioned lower sales, partially offset by a 850 basis point increase in gross margin as a percent of sales. The increase in gross margin was due to higher average selling prices and decreases in certain manufacturing input costs. • The decrease in Other and unallocated was primarily driven by the aforementioned lower sales. Other Expenses Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Interest expense $ 10,728 $ 1,505 $ 9,223 612.8 % Other (income) expense, net (1,003) (137) (866) 632.1 % $ 9,725 $ 1,368 $ 8,357 610.9 % Interest expense for the six months ended June 30, 2023 and 2022 was primarily related to outstanding borrowings under the 2022 Credit Agreement. The increase of $9,223 in interest expense is due to the additional borrowings in connection with the acquisitions and higher interest rates. Income Tax Expense Six Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Income tax expense $ 14,699 $ 18,176 $ (3,477) (19.1) % Effective tax rate 21.8 % 23.6 % The decrease in the effective tax rate was primarily due to certain lower state taxes and higher tax benefits from stock-based compensation. Liquidity and Capital Resources During the six months ended June 30, 2023, 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, 2022. 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 $66,856 at June 30, 2023 from $66,560 at December 31, 2022. At June 30, 2023, the Company had $58,626 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 $222,148 at June 30, 2023 as compared to $195,761 at December 31, 2022, an increase of $26,387. Cash at June 30, 2023 reflects net repayments on the revolving loan of $35,000, the payment of declared dividends in 2023 of $22,869, and capital expenditures and intangible assets acquired of $17,952. Three Months Ended June 30, Increase (Decrease) (in thousands) 2023 2022 % Change Cash flows provided by operating activities $ 69,829 $ 55,261 $ 14,568 26.4 % Cash flows used in investing activities (13,672) (316,412) 302,740 95.7 % Cash flows used in financing activities (58,077) 239,694 (297,771) 124.2 % 36 Table of Contents Operating Activities The increase in cash flows from operating activities was primarily driven by the impact from changes in working capital. 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 $17,952 and $20,799 f or the six months ended June 30, 2023 and 2022, respectively. Financing Activities During 2023, we borrowed $13,000 under the 2022 Credit Agreement and made total loan payments of $48,000, resulting in $144,431 available under the 2022 Credit Agreement as of June 30, 2023. 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 3,099,224 shares have been purchased. We 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. Open market repurchases of common stock could be made pursuant to a trading plan established pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, which would permit common stock to be repurchased at a time that we might otherwise be precluded from doing so under insider trading laws or self-imposed trading restrictions. We also repurchase (withhold) shares from employees in connection with the tax settlement of vested shares and/or exercised stock options under the Company's omnibus incentive plan. Share repurchases are funded with existing cash on hand. Proceeds from stock options exercised were $3,826 and $1,328 for the six months ended June 30, 2023 and 2022, respectively. Dividend payments were $22,869 and $20,704 for the six months ended June 30, 2023 and 2022, 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, 2023 and December 31, 2022 was $1,419 and $1,465, respectively, an d 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. 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, 2023 and December 31, 2022 were $392 and $393, respectively, and were included in "Other long-term obligations." We provide 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 the Company's condensed consolidated 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 June 30, 2023 and December 31, 2022 was $9,618 and $8,527, respectively, and is included in "Other long-term obligations" on the condensed consolidated balance sheets. The related rabbi trust assets were $9,635 and $8,547 as of June 30, 2023 and December 31, 2022, respectively, and were included in "Other non-current assets" on the condensed consolidated balance sheets. Significant Accounting Policies There were no changes to our Significant Accounting Policies, as described in its December 31, 2022 Annual Report on Form 10 - K, during the six months ended June 30, 2023. 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, 2023. Refer to Note 18, Related Party Transactions . 37 Table of Contents