Balchem Corporation — Q3 2012 Form 10-Q
Business context and period. Balchem develops and sells specialty ingredients for food, pharmaceutical, nutrition, animal-health and medical-device sterilization markets. This unaudited report covers the quarter and nine months ended September 30, 2012; comparative periods are 2011. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $75.1 | $74.4 | $230.3 | $222.1 |
| Gross margin | $23.4 | $22.6 | $67.1 | $65.2 |
| Operating earnings | $16.2 | $15.2 | $44.7 | $42.5 |
| Net earnings | $10.9 | $10.8 | $30.1 | $29.3 |
| Diluted EPS | $0.36 | $0.36 | $0.99 | $0.97 |
| Operating cash flow | Not separately provided | Not separately provided | $44.4 | $34.1 |
- Q3 gross margin was 31.1% of sales versus 30.4%; operating margin was 21.6% versus 20.4%. Nine-month gross margin was 29.1% versus 29.3%, while operating margin improved to 19.4% from 19.1%.
- Q3 sales increased 0.9% and net earnings 0.8% year over year. Nine-month sales rose 3.7% and net earnings 2.9%.
- At September 30, cash was $147.2, up from $114.8 at year-end 2011. Working capital was $179.1. Total liabilities were $36.4; the company reported no borrowings at quarter-end. Current assets were $207.5 and current liabilities $28.3.
- Capital expenditures were $7.5 for the first nine months, compared with $4.9 a year earlier. Dividends paid were $5.2; share repurchases totaled $1.0.
Business trends and material changes
- Q3 segment sales: Specialty Products $12.3 (+1.0%); Food, Pharma & Nutrition $10.9 (−0.9%); Animal Nutrition & Health $51.9 (+1.3%). Specialty Products and Animal Nutrition & Health operating earnings increased; Food, Pharma & Nutrition operating earnings declined 8.0% to $2.9.
- Nine-month segment sales: Specialty Products $37.0 (+4.3%); Food, Pharma & Nutrition $33.4 (+1.5%); Animal Nutrition & Health $159.9 (+4.0%). Animal Nutrition & Health remained the largest segment.
- Management attributed Q3 margin improvement to favorable product mix, higher volumes and modestly lower costs for certain raw materials. Operating expenses fell 3.8% in Q3, mainly because of lower consulting and payroll-related costs.
- Nine-month gross margin was affected by rising raw-material costs and the suspension of AminoShure-L, a rumen-protected lysine product. Balchem said research found its lysine bioavailability below expectations, with no safety concern identified. The company issued about $1.0 in related sales credits; the net gross-margin impact was approximately $0.8, with an additional $0.2 of operating expenses related to the suspension.
- Animal Nutrition & Health specialty ingredients grew strongly, while global feed-grade choline sales fell amid lower volumes and unfavorable foreign exchange. Industrial applications, including fracking-related uses, grew 13.6% in Q3 and 5.4% year to date.
Liquidity, outlook and risks
- Operating cash flow increased to $44.4 from $34.1, aided by earnings and favorable working-capital movements, including income taxes. Cash increased by $32.4 over the nine months.
- The European term loan was paid in full. The European and U.S. revolving facilities matured May 31, 2012 and were not renewed. Management said operating cash flow should be sufficient for working capital and necessary capital investments, and noted it was pursuing acquisition candidates. No quantitative earnings or revenue guidance was provided.
- Management identified foreign-currency and raw-material price exposure, managed where possible through pricing and operational measures. High grain prices and weakness in poultry demand affected choline volumes; foreign exchange also reduced reported sales of European-produced choline.
- Environmental matters include ongoing discussions with New York regulators regarding a former drum site and monitoring obligations at the Verona, Missouri Superfund site. Management believes litigation and claims will not materially affect financial position, results or liquidity; the filing does not provide a clear estimate of potential future remediation costs.
- The company renewed its general-office and laboratory lease for six years, with an option for a further five years. Operating lease minimum payments totaled $3.6. The Verona retiree medical plan is unfunded; the recorded obligation was $1.2.
- Unrecognized tax benefits were approximately $2.1, with accrued interest and penalties of about $0.6. Management did not anticipate a material change in unrecognized tax benefits over the next 12 months.
Important facts for investors to verify
- Whether the AminoShure-L suspension and associated credits, and the product’s future status, continue to affect Animal Nutrition & Health results.
- Whether gross-margin pressure from raw-material costs, product mix and foreign exchange changes in subsequent periods.
- How durable growth is in specialty animal-health products and industrial applications, given weaker feed-grade choline volumes and end-market conditions.
- Management’s acquisition intentions, capital spending needs, and use of substantial cash, including $2.5 held by foreign subsidiaries that the company intends to reinvest abroad.
- Potential outcomes or costs from environmental matters, tax exposures and the unfunded retiree medical obligation.