Balchem Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Dollar amounts below are in millions unless otherwise noted.
Business context
Balchem develops and sells specialty ingredients and products for food, nutrition, pharmaceutical, animal health, and medical-device sterilization markets. Its reportable segments are Specialty Products, SensoryEffects, and Animal Nutrition & Health. On May 7, 2014, Balchem acquired Performance Chemicals & Ingredients Company (SensoryEffects) for approximately $569 million, expanding its food-ingredient business.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $132.2 | $83.3 | $218.2 | $167.9 |
| Gross margin | $32.3 | $24.9 | $55.6 | $49.1 |
| Gross margin percentage | 24.5% | 29.9% | 25.5% | 29.2% |
| Operating earnings | $16.5 | $16.6 | $29.9 | $32.5 |
| Operating margin | 12.5% | 19.9% | 13.7% | 19.3% |
| Net earnings | $9.7 | $11.6 | $18.6 | $22.5 |
| Diluted EPS | $0.31 | $0.38 | $0.60 | $0.73 |
- Q2 sales rose 58.7%; six-month sales rose 29.9%. SensoryEffects contributed $36.4 million of sales from May 7 through June 30, so acquisition timing materially affects comparisons.
- Q2 and six-month net earnings fell 16.0% and 17.1%, respectively, despite higher sales. Management attributed margin pressure principally to acquisition-related inventory fair-value expense, acquired-intangible amortization, transaction and integration costs, product mix, and higher input and distribution costs.
- The acquisition-date inventory fair-value adjustment increased cost of sales by $4.7 million. Transaction and integration costs were $1.5 million in Q2 and $2.8 million for six months; the filing also reports $3.5 million of incremental amortization related to acquired intangibles.
- Management reported operating earnings excluding the inventory valuation adjustment, acquired-intangible amortization, and transaction/integration costs of $26.3 million (19.9% of sales) for Q2 and $41.0 million (18.8%) for six months. These are management-adjusted figures, not GAAP results.
Segments and material changes
- Q2 sales: Specialty Products $13.6 million, up 3.2%; SensoryEffects $49.2 million versus $12.1 million, including the acquired business; Animal Nutrition & Health $69.4 million, up 19.8%.
- Animal Nutrition & Health benefited from stronger ruminant-product demand, global feed-grade choline volumes, and industrial applications including shale-related uses. Specialty Products saw higher ethylene oxide sales partly offset by lower propylene oxide industrial sales.
- SensoryEffects’ reported operating earnings were $2.9 million in Q2, versus $3.3 million in the prior-year segment; acquisition-related costs and acquired inventory and intangible-asset charges affected comparability.
- Pro forma results assuming the acquisition occurred at the start of the periods were sales of $157.6 million and net earnings of $14.7 million for Q2 2014, and sales of $302.2 million and net earnings of $26.5 million for the first half. The filing cautions these unaudited figures are not a projection or necessarily indicative of actual results.
Cash flow, debt, and liquidity
- Six-month operating cash flow was $27.6 million, compared with $23.8 million a year earlier. Capital expenditures were $3.5 million.
- Acquisition-related investing cash outflow was $566.6 million; total investing cash outflow was $570.2 million. Financing cash inflow was $393.6 million, including $350 million of term debt and $50 million drawn on a revolving facility.
- Cash declined to $59.7 million from $208.7 million at December 31, 2013. Working capital was $116.8 million, down from $242.0 million, largely reflecting the acquisition and financing activity.
- Debt outstanding was $400 million at June 30: $350 million term loan and $50 million revolver. The facility also had $50 million undrawn. The loans mature May 7, 2019; the stated interest rate was 1.90% at quarter-end, and quarterly term-loan installments begin September 30, 2014. Debt is secured by company assets.
- Balchem said it complied with the loan covenants at June 30 and expected operating cash flow to fund working capital, capital investment, and debt service. A 100-basis-point rate change applied to quarter-end borrowings would change annual interest expense and cash flow by approximately $4 million.
Outlook, risks, and unusual items
- No specific revenue, earnings, or margin guidance was provided. Management said it continued to pursue acquisition candidates and could use additional borrowing or capital-market access to fund acquisitions and other needs.
- Key sensitivities include integration and acquisition execution, lower-margin acquired product mix, raw-material and distribution costs, foreign exchange, and floating interest rates. Management identified no material changes to the risk factors in its 2013 Form 10-K.
- Acquisition accounting remained preliminary, including fair values and working capital acquired. Goodwill recorded from the acquisition was $357.1 million; total goodwill was $385.6 million. The company expected to finalize the purchase-price allocation.
- Environmental matters include ongoing discussions with New York regulators about a former drum site and monitoring/remediation matters at the Verona, Missouri Superfund site. Management believes pending litigation and claims will not materially affect financial position, results, or liquidity. The filing does not quantify a clear potential loss for these matters.
- Management stated disclosure controls were effective. SensoryEffects was being integrated into internal controls; the company expected to exclude the acquired business from its year-end 2014 internal-control assessment.
Important facts for investors to verify
- Final acquisition purchase-price allocation, acquired working capital, and the expected earnings contribution and integration costs of SensoryEffects.
- How margins develop after the one-time inventory fair-value charge and as acquired-intangible amortization continues.
- Debt repayment, interest-rate exposure, covenant headroom, and progress in reducing acquisition-related leverage.
- Whether cash generation and working-capital needs support stated debt-service and investment expectations.
- Potential financial exposure, if any, from environmental matters and uncertain tax positions; the filing reports approximately $5.0 million of unrecognized tax benefits, with timing of settlement not reasonably estimable.