Balchem Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Financial amounts below are in U.S. dollars; unless stated otherwise, amounts are approximate and in millions.
Business context
Balchem develops and sells specialty ingredients and products across Human Nutrition & Health, Animal Nutrition & Health, Specialty Products, and Industrial Products. On May 27, 2019, it acquired Chemogas Holding NV, a Belgian specialty-gases company, expanding its packaged ethylene oxide reach for medical-device sterilization in Europe and Asia.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $158.6 | $155.0 | $477.2 | $480.1 |
| Gross margin | $54.0 | $48.0 | $157.0 | $152.9 |
| Gross margin percentage | 34.1% | 31.0% | 32.9% | 31.9% |
| Operating earnings | $26.0 | $25.5 | $78.9 | $79.9 |
| Net earnings | $20.7 | $19.2 | $59.3 | $58.2 |
| Diluted EPS | $0.64 | $0.59 | $1.82 | $1.79 |
| Operating cash flow | — | $91.5 | $79.2 |
Q3 sales grew 2.3% and net earnings rose 7.6%; nine-month sales declined 0.6%, while net earnings increased 1.8%. Nine-month operating margin was 16.5%, versus 16.6% a year earlier. The effective tax rate fell to 15.4% in Q3 from 18.3%, and to 20.0% for nine months from 21.1%, primarily due to discrete tax items.
At September 30, cash was $59.4, working capital was $167.9, and revolving debt was $218.6. The credit facility had $281.4 of unused capacity and matures in June 2023; the reported borrowing rate was 3.179%. The company was in compliance with its debt covenants. Nine-month capital expenditures and intangible-asset purchases were $21.7. Operating cash flow funded part of $103.1 of investing cash outflow, including $94.7 of net acquisition spending; financing activities provided $17.6. Cash included $29.8 held by foreign subsidiaries that the company intended to reinvest abroad.
Material changes and management commentary
- Specialty Products sales rose 41.2% in Q3 and 17.1% for nine months, reflecting Chemogas and higher legacy ethylene oxide sales. Segment earnings also increased.
- Industrial Products sales fell 52.5% in Q3 and 42.4% for nine months, mainly from lower sales of choline and derivatives used in shale-fracking applications; segment earnings declined.
- Human Nutrition & Health sales were broadly stable in Q3 and higher for nine months. Animal Nutrition & Health sales increased modestly year to date, but segment earnings fell 16.2%, reflecting lower global feed-grade choline volumes and competitive pressure in European monogastric products.
- Gross-margin improvement reflected product mix, lower raw-material costs, and manufacturing efficiencies in several segments. Operating expenses rose, including Chemogas costs and the effect of insurance recoveries recognized in the prior-year periods.
- Management expects operations to generate sufficient cash to fund working capital and necessary capital investment and says it is pursuing additional acquisition candidates. It may use additional borrowing or financial markets if needed. The filing provides no quantified earnings or revenue guidance.
Risks, contingencies, and unusual items
- Chemogas was primarily debt-financed. The acquisition added $59.3 of goodwill, which is not tax-deductible; the purchase-price allocation remained preliminary. Transaction and integration costs, including costs related to other potential transactions, were recorded in general and administrative expenses.
- The company entered into a $108.6 notional interest-rate swap and a $108.6 cross-currency swap, both maturing in 2023, to hedge borrowing-rate exposure and its net investment in Chemogas. A 100-basis-point rate change applied to period-end borrowings would affect annual interest expense and cash flow by approximately $2.2, according to the filing.
- Management identifies exposure to raw-material prices and U.S.-dollar/euro exchange-rate changes. It also cites competitive conditions in animal nutrition and weaker shale-fracking demand. The company reported no material changes to the risk factors in its 2018 Form 10-K.
- The company is indemnified for certain potential Superfund liabilities relating to its Verona, Missouri facility; the prior owner is responsible for further remediation. Management believes other litigation, claims, and assessments will not materially affect financial position, results, or liquidity.
- The filing reports effective disclosure controls and procedures as of September 30, 2019, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether Chemogas integration, its preliminary purchase accounting, and the added debt deliver the expected strategic and financial benefits.
- Whether the sharp Industrial Products decline and competitive pressure in parts of Animal Nutrition & Health persist.
- How sustainable gross-margin gains are after accounting for segment mix, raw-material costs, acquisition-related costs, and prior-year insurance recoveries.
- Debt levels, interest-rate exposure after the swap, covenant compliance, and the availability of cash held overseas for U.S. needs.
- The effect of future acquisitions, capital spending, share repurchases, and dividends on liquidity and cash generation.