Balchem Corporation — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Dollar amounts are in thousands unless stated otherwise. Balchem develops and sells specialty ingredients and products for food, nutrition, animal health, agriculture, industrial and medical-device sterilization markets.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $147,082 | $138,794 | $284,810 | $273,935 |
| Gross margin | $46,761 | $46,449 | $91,190 | $89,273 |
| Gross margin % | 31.8% | 33.5% | 32.0% | 32.6% |
| Operating earnings | $24,831 | $23,333 | $47,534 | $43,301 |
| Operating margin | 16.9% | 16.8% | 16.7% | 15.8% |
| Net earnings | $16,536 | $14,150 | $32,053 | $26,036 |
| Diluted EPS | $0.51 | $0.44 | $1.00 | $0.82 |
Q2 sales increased 6.0% and net earnings rose 16.9% year over year; six-month sales increased 4.0% and net earnings rose 23.1%. Lower effective tax rates contributed to earnings growth: 26.7% versus 33.8% in Q2 and 25.9% versus 33.9% for the half year. The company attributed the lower rates chiefly to stock-compensation tax benefits, a purchase-price reduction related to the SensoryEffects acquisition, and lower taxes or rates in certain jurisdictions.
Segment trends: Q2 Human Nutrition & Health sales increased 4.3%; Animal Nutrition & Health sales declined 3.6%; Specialty Products grew 2.1%; and Industrial Products grew 113.9%. For the first half, the respective changes were +3.3%, -3.2%, +5.6% and +51.9%. Animal Nutrition weakness reflected lower ruminant-product volumes, including a significant customer’s inventory correction, and pressure from raw-material costs and competition. Industrial growth was driven principally by choline products for shale-fracking applications. Human Nutrition growth included increased cereal-system sales and, in Q2, IFP acquisition sales.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was $45,692, down from $55,958 a year earlier; management cited higher inventories and lower accounts payable/accrued expenses, partly offset by higher earnings.
- Investing cash outflow was $25,908, including $16,759 for acquisitions and $10,819 of capital expenditures. Financing cash outflow was $16,301. Cash increased $4,956 to $43,599.
- At June 30, cash was $43,599, working capital was $117,169, and total debt outstanding was $276,500. Debt included $245,000 of term-loan principal and $31,500 drawn on the revolving facility; $68,500 remained available. The reported interest rate was 2.73%, and debt matures May 7, 2019. The company was in compliance with its loan covenants.
- Cash and cash equivalents held by foreign subsidiaries totaled $21,534. Balchem said it intends to reinvest those funds abroad; repatriation for U.S. needs could entail additional U.S. taxes.
- Management expects operations to generate sufficient cash for working capital, capital investment and debt service, and may use additional borrowing or financial markets for acquisitions or other needs.
Material changes, outlook and risks
- Balchem acquired Innovative Food Processors (IFP) on June 1, 2017, broadening Human Nutrition & Health processing technology and market reach. The preliminary purchase accounting recorded no goodwill; the allocation remained subject to finalization. IFP represented about 3% of consolidated assets at June 30 and about 1% of six-month sales.
- The company also acquired Chol-Mix assets in Hungary to add European dry-choline capacity and technical expertise. The 2016 Albion acquisition affected comparisons: the prior-year period included a fair-value step-up in acquired inventory that raised cost of sales.
- Q2 operating results included a $2,087 favorable indemnification settlement and $1,899 of transaction, integration and legal-settlement costs; the six-month amounts were the same. Management noted that the favorable settlement and the prior-year inventory step-up benefited comparisons. Animal Nutrition profitability remained an area of pressure.
- Balchem identifies risks including animal-nutrition demand and dairy economics, competition and raw-material costs, foreign-exchange exposure, interest-rate changes, and acquisition and integration execution. A 100-basis-point rate change applied to June 30 borrowings would change annual interest expense and cash flow by approximately $2,765.
- Management reported no material change in the risk factors from the 2016 Form 10-K and no material change in contractual obligations outside the ordinary course. It gave no quantified full-year earnings or revenue guidance; interim results are not necessarily indicative of full-year results.
- Environmental matters include ongoing discussions with New York regulators concerning a former drum-remediation site and a Superfund site at the Verona, Missouri facility; management described monitoring costs as low and stated that the prior owner is responsible for any further Superfund remedy. Management believes pending litigation, claims and assessments will not materially affect financial position, results or liquidity.
- The filing disclosed a single sale of ReaShure exported by a U.S. customer to Iran during the half year: 765 bags for $82,238. Balchem stated the sale complied with applicable law and qualified for an exemption from U.S. sanctions.
Most important facts for investors to verify
- Whether Human Nutrition growth and the IFP integration offset sustained weakness in Animal Nutrition, particularly ruminant products.
- How gross-margin pressure, raw-material costs and competitive conditions evolve, and how much reported earnings benefit from settlements, tax items and prior-year acquisition accounting comparisons.
- Debt repayment and refinancing plans ahead of the May 2019 maturity, covenant headroom, and sensitivity to interest-rate changes.
- Final purchase accounting and realized performance for IFP and Chol-Mix, as well as the expected cash requirements for acquisitions and capital investment.
- Cash-flow conversion, inventory levels, and the availability and tax implications of foreign-held cash.