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 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 pandemics, epidemics or other public health emergencies; (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. 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. 28 Table of Contents As of September 30, 2023, we employed approximately 1,297 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 nine months ended September 30, 2023 and 2022: Business Segment Net Sales Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Human Nutrition & Health $ 144,455 $ 142,655 $ 412,777 $ 396,728 Animal Nutrition & Health 53,944 65,604 180,162 197,546 Specialty Products 30,004 29,641 94,961 99,622 Other and Unallocated (1) 1,545 6,367 5,840 15,931 Total $ 229,948 $ 244,267 $ 693,740 $ 709,827 Business Segment Earnings From Operations Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Human Nutrition & Health $ 31,275 $ 20,584 $ 77,209 $ 64,592 Animal Nutrition & Health 5,070 8,036 22,230 26,943 Specialty Products 8,740 7,105 25,984 24,785 Other and Unallocated (1) (1,471) (2,100) (4,565) (4,439) Total $ 43,614 $ 33,625 $ 120,858 $ 111,881 (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 and unallocated legal fees totaling $384 and $1,600 for the three and nine months ended September 30, 2023, respectively, and $1,640 and $2,816 for the three and nine months ended September 30, 2022, respectively, and (ii) Unallocated amortization expense of $0 and $312 for the three and nine months ended September 30, 2023, and $734 and $2,213 for the three and nine months ended September 30, 2022, respectively, related to an intangible asset in connection with a company-wide ERP system implementation. 29 Table of Contents Results of Operations - Three Months Ended September 30, 2023 and 2022 Net Earnings Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Net sales $ 229,948 $ 244,267 $ (14,319) (5.9) % Gross margin 76,544 68,430 8,114 11.9 % Operating expenses 32,930 34,805 (1,875) (5.4) % Earnings from operations 43,614 33,625 9,989 29.7 % Other expenses 7,139 2,540 4,599 181.1 % Income tax expense 7,400 5,836 1,564 26.8 % Net earnings $ 29,075 $ 25,249 $ 3,826 15.2 % Net Sales Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 144,455 $ 142,655 $ 1,800 1.3 % Animal Nutrition & Health 53,944 65,604 (11,660) (17.8) % Specialty Products 30,004 29,641 363 1.2 % Other 1,545 6,367 (4,822) (75.7) % Total $ 229,948 $ 244,267 $ (14,319) (5.9) % • The increase in net sales within the Human Nutrition & Health segment for the third quarter of 2023 as compared to the third quarter of 2022 was primarily driven by higher sales within the minerals and nutrients business, the incremental contribution of the Bergstrom acquisition, and a favorable impact related to changes in foreign currency exchange rates, partially offset by lower sales within food and beverage markets. Total sales for this segment grew 1.3%, with volume and mix contributing 2.6%, the change in foreign currency exchange rates contributing 0.6%, and average selling prices contributing -2.0%. • The decrease in net sales within the Animal Nutrition & Health segment for the third quarter of 2023 compared to the third quarter of 2022 was driven by lower sales in both the ruminant and monogastric species markets, partially offset by a favorable impact related to changes in foreign currency exchange rates. Total sales for this segment decreased by 17.8%, with volume and mix contributing -15.2%, average selling prices contributing -4.8%, and the change in foreign currency exchange rates contributing 2.2%. • The increase in net sales within the Specialty Products segment for the third quarter of 2023 compared to the third quarter of 2022 was due to higher sales in the plant nutrition business and a favorable impact related to changes in foreign currency exchange rates, partially offset by lower sales in the performance gases business. Total sales for this segment increased by 1.2%, with average selling prices contributing 3.4%, the change in foreign currency exchange rates contributing 2.4%, and volume and mix contributing -4.5%. • 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. 30 Table of Contents Gross Margin Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Gross margin $ 76,544 $ 68,430 $ 8,114 11.9 % % of net sales 33.3 % 28.0 % Gross margin dollars increased in the third quarter of 2023 compared to the third quarter of 2022 due to higher average selling prices and a decrease in cost of goods sold of $22,433. The 12.8% decrease in cost of goods sold was mainly driven by certain lower manufacturing input costs. Operating Expenses Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Operating expenses $ 32,930 $ 34,805 $ (1,875) (5.4) % % of net sales 14.3 % 14.2 % The decrease in operating expenses in the third quarter of 2023 compared to the third quarter of 2022 was primarily due to reduced transaction and integration-related costs of $4,708, partially offset by a restructuring-related impairment charge of $1,618 and higher compensation-related expenses of $1,576. Earnings from Operations Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 31,275 $ 20,584 $ 10,691 51.9 % Animal Nutrition & Health 5,070 8,036 (2,966) (36.9) % Specialty Products 8,740 7,105 1,635 23.0 % Other and unallocated (1,471) (2,100) 629 30.0 % Earnings from operations $ 43,614 $ 33,625 $ 9,989 29.7 % % of net sales (operating margin) 19.0 % 13.8 % • Human Nutrition & Health segment earnings from operations increased $10,691 and the gross margin contribution was $10,110. In addition, operating expenses decreased by $578, primarily due to a favorable adjustment to transaction costs of $2,800, partially offset by a restructuring-related impairment charge of $1,262 and increased compensation-related expenses of $625. • Animal Nutrition & Health segment earnings from operations decreased $2,966. Gross margin decreased $2,367. In addition, operating expenses increased by $598, primarily due to increased compensation-related expenses of $586 and a restructuring-related impairment charge of $356, partially offset by a favorable adjustment to transaction costs of $700. • Specialty Products segment earnings from operations increased $1,635, primarily driven by higher average selling prices and lower manufacturing input costs. • The increase in Other and unallocated was primarily driven by lower unallocated corporate expenses, partially offset by the aforementioned lower sales. 31 Table of Contents Other Expenses Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Interest expense $ 6,594 $ 3,642 $ 2,952 81.1 % Other (income) expense, net 545 (1,102) 1,647 (149.5) % $ 7,139 $ 2,540 $ 4,599 181.1 % Interest expense for the three months ended September 30, 2023 and 2022 was primarily related to outstanding borrowings under the 2022 Credit Agreement. The increase of $2,952 in interest expense is due to higher interest rates. Income Tax Expense Three Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Income tax expense $ 7,400 $ 5,836 $ 1,564 26.8 % Effective tax rate 20.3 % 18.8 % The increase in the effective tax rate was primarily due to certain higher state taxes and lower tax benefits from stock-based compensation. Results of Operations - Nine Months Ended September 30, 2023 and 2022 Net Earnings Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Net sales $ 693,740 $ 709,827 $ (16,087) (2.3) % Gross margin 227,063 211,812 15,251 7.2 % Operating expenses 106,205 99,931 6,274 6.3 % Earnings from operations 120,858 111,881 8,977 8.0 % Other expenses 16,864 3,908 12,956 331.5 % Income tax expense 22,099 24,012 (1,913) (8.0) % Net earnings $ 81,895 $ 83,961 $ (2,066) (2.5) % Net Sales Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 412,777 $ 396,728 $ 16,049 4.0 % Animal Nutrition & Health 180,162 197,546 (17,384) (8.8) % Specialty Products 94,961 99,622 (4,661) (4.7) % Other 5,840 15,931 (10,091) (63.3) % Total $ 693,740 $ 709,827 $ (16,087) (2.3) % • The increase in net sales within the Human Nutrition & Health segment for the nine months ended September 30, 2023 as compared to 2022 was primarily driven by the contribution from recent acquisitions and a favorable impact related to changes in foreign currency exchange rates, partially offset by lower sales within food and beverage markets and the minerals and nutrients business. Total sales for this segment grew 4.0%, with average selling prices contributing 4.8%, the change in foreign currency exchange rates contributing 0.2%, and volume and mix contributing -1.0%. • The decrease in net sales within the Animal Nutrition & Health segment for the nine months ended September 30, 2023 as compared to 2022 was primarily driven by lower sales in the monogastric market, partially offset by incremental sales related to the Bergstrom acquisition, and a favorable impact related to changes in foreign currency exchange rates. Total sales for this segment decreased by 8.8%, with volume and mix contributing -8.8%, average selling prices contributing -0.4%, and the change in foreign currency exchange rates contributing 0.5%. 32 Table of Contents • The decrease in net sales within the Specialty Products segment for the nine months ended September 30, 2023 as compared to 2022 was primarily due to lower sales in both the plant nutrition and performance gases businesses, partially offset by a favorable impact related to changes in foreign currency exchange rates. Total sales for this segment decreased by 4.7%, with volume and mix contributing -11.1%, the change in foreign currency exchange rates contributing 0.4%, and average selling prices contributing 6.0%. • Sales relating to Other decreased from the prior year primarily 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 Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Gross margin $ 227,063 $ 211,812 $ 15,251 7.2 % % of net sales 32.7 % 29.8 % Gross margin dollars increased in the nine months ended September 30, 2023 as compared to 2022 due to higher average selling prices and a decrease in cost of goods sold of $31,338. The 6.3% decrease in cost of goods sold was mainly driven by certain lower manufacturing input costs. Operating Expenses Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Operating expenses $ 106,205 $ 99,931 $ 6,274 6.3 % % of net sales 15.3 % 14.1 % The increase in operating expenses in the nine months ended September 30, 2023 as compared to 2022 was primarily due to restructuring-related impairment and asset disposal charges of $7,764, incremental operating expenses related to the Kappa and Bergstrom acquisitions of $7,099, and higher compensation-related expenses of $1,306, partially offset by reduced transaction and integration-related costs of $10,625. Earnings from Operations Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Human Nutrition & Health $ 77,209 $ 64,592 $ 12,617 19.5 % Animal Nutrition & Health 22,230 26,943 (4,713) (17.5) % Specialty Products 25,984 24,785 1,199 4.8 % Other and unallocated (4,565) (4,439) (126) (2.8) % Earnings from operations $ 120,858 $ 111,881 $ 8,977 8.0 % % of net sales (operating margin) 17.4 % 15.8 % • Human Nutrition & Health segment earnings from operations increased $12,617 and the gross margin contribution was $19,709. This was partially offset by an increase in operating expenses of $7,093, primarily due to the incremental operating expenses related to the Kappa and Bergstrom acquisitions of $6,902 and restructuring-related impairment and asset disposal charges of $6,031, partially offset by favorable adjustments to transaction costs of $7,920. • Animal Nutrition & Health segment earnings from operations decreased $4,713. Gross margin decreased $3,576 primarily due to lower sales. Additionally, operating expenses for this segment increased by $1,136, which was largely related to restructuring-related impairment charges of $1,444, higher compensation-related costs of $529, an increase in amortization of $363, and incremental operating expenses related to the Bergstrom acquisition of $197, partially offset by favorable adjustments to transaction costs of $1,980. 33 Table of Contents • Specialty Products segment earnings from operations increased $1,199, which was primarily driven by a 434 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 increase was partially offset by an increase in operating expenses of $776, primarily driven by higher compensation-related expenses of $1,114. • The decrease in Other and unallocated was primarily driven by the aforementioned lower sales, partially offset by decreases of unallocated corporate expenses. Other Expenses Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Interest expense $ 17,322 $ 5,147 $ 12,175 236.5 % Other (income) expense, net (458) (1,239) 781 (63.0) % $ 16,864 $ 3,908 $ 12,956 331.5 % Interest expense for the nine months ended September 30, 2023 and 2022 was primarily related to outstanding borrowings under the 2022 Credit Agreement. The increase of $12,175 in interest expense is due to the additional borrowings in connection with the acquisitions and higher interest rates. Income Tax Expense Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Income tax expense $ 22,099 $ 24,012 $ (1,913) (8.0) % Effective tax rate 21.3 % 22.2 % 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 nine months ended September 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 $76,952 at September 30, 2023 from $66,560 at December 31, 2022. At September 30, 2023, the Company had $65,475 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 $233,184 at September 30, 2023 as compared to $195,761 at December 31, 2022, an increase of $37,423. Cash at September 30, 2023 reflects net repayments on the revolving loan of $60,000, capital expenditures and intangible assets acquired of $26,317, and payment of declared dividends in 2023 of $22,872. 34 Table of Contents Nine Months Ended September 30, Increase (Decrease) (in thousands) 2023 2022 % Change Cash flows provided by operating activities $ 116,355 $ 96,881 $ 19,474 20.1 % Cash flows used in investing activities (22,948) (401,525) 378,577 94.3 % Cash flows (used in) provided by financing activities (83,175) 268,080 (351,255) 131.0 % 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 $26,317 and $35,793 f or the nine months ended September 30, 2023 and 2022, respectively. In 2022, we completed the acquisitions of Kappa and Bergstrom. Cash paid for these acquisitions, net of cash acquired, amounted to $1,252 and $365,780, for the nine months ended September 30, 2023 and 2022, respectively. Financing Activities During 2023, we borrowed $18,000 under the 2022 Credit Agreement and made total loan payments of $78,000, resulting in $169,431 available under the 2022 Credit Agreement as of September 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 3,099,999 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 $3,888 and $2,172 for the nine months ended September 30, 2023 and 2022, respectively. Dividend payments were $22,872 and $20,708 for the nine months ended September 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 September 30, 2023 and December 31, 2022 was $1,462 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 September 30, 2023 and December 31, 2022 were $379 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 September 30, 2023 and December 31, 2022 was $9,594 and $8,527, respectively, and is included in "Other long-term obligations" on the condensed consolidated balance sheets. The related rabbi trust assets were $9,613 and $8,547 as of September 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 nine months ended September 30, 2023. 35 Table of Contents Related Party Transactions We were engaged in related party transactions with St. Gabriel CC Company, LLC during the three and nine months ended September 30, 2023. Refer to Note 18, Related Party Transactions .