Balchem Corporation — Q3 2017 Form 10-Q
Business context and reporting period. This unaudited report covers the quarter and nine months ended September 30, 2017. Balchem develops and sells specialty ingredients and products across Human Nutrition & Health, Animal Nutrition & Health, Specialty Products, and Industrial Products. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $150.7 | $138.5 | $435.5 | $412.4 |
| Gross margin | $46.2 | $44.7 | $137.4 | $133.9 |
| Gross margin % | 30.6% | 32.2% | 31.5% | 32.5% |
| Operating earnings | $23.1 | $22.9 | $70.6 | $66.2 |
| Operating margin | 15.3% | 16.6% | 16.2% | 16.1% |
| Net earnings | $16.0 | $14.0 | $48.1 | $40.0 |
| Diluted EPS | $0.50 | $0.44 | $1.49 | $1.26 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $79.5 | $79.8 |
- Q3 sales rose 8.8% year over year; net earnings increased 14.5%. Nine-month sales rose 5.6% and net earnings increased 20.1%.
- Q3 gross margin percentage fell 1.6 percentage points, while operating margin declined 1.3 points. For the nine months, gross margin percentage fell 1.0 point and operating margin edged up 0.1 point.
- The effective tax rate declined to 22.5% in Q3 from 32.5%, and to 24.8% for nine months from 33.4%. The company attributed the lower rates primarily to stock-compensation tax benefits, a SensoryEffects purchase-price adjustment, and lower taxes or rates in certain jurisdictions.
- At September 30, cash was $34.7; working capital was $103.8, versus $87.4 at year-end 2016. Total debt was $236.3, including $35.0 current and $200.6 long-term on the balance sheet; $100.0 of revolving capacity was undrawn. The stated borrowing rate was 2.74%, and the company was in compliance with debt covenants.
Material changes and business drivers
- Segment sales, Q3 / nine months: Human Nutrition & Health $81.4 / $232.5; Animal Nutrition & Health $38.0 / $113.1; Specialty Products $17.3 / $56.8; Industrial Products $14.1 / $33.1.
- Human Nutrition & Health growth reflected legacy sales and the June 2017 acquisition of Innovative Food Processors (IFP). Industrial Products sales surged, principally on increased choline and derivatives used in shale-fracturing applications.
- Animal Nutrition & Health sales and earnings weakened. Management cited unfavorable dairy economics, lower ruminant volumes and customer order timing, raw-material cost increases, and competition. Nine-month ruminant sales were also affected by a significant customer’s inventory correction.
- Balchem acquired IFP in June 2017 and certain Chol-Mix assets in Hungary in March. IFP expands food and nutrition processing capabilities; Chol-Mix adds European dry-choline capacity and technical expertise. IFP purchase accounting remained preliminary. The 2016 Albion acquisition also affects comparisons: 2017 included an additional month of Albion results, while 2016 earnings bore acquired-inventory fair-value charges.
Cash flow, outlook, risks, and unusual items
- Nine-month operating cash flow was $79.5, nearly unchanged year over year. Investing used $33.5, including $17.4 for acquisitions and $17.7 for capital expenditures. Financing used $52.0; cash declined $3.9 to $34.7.
- Management expects operations to generate sufficient cash to fund working capital, capital investment, and debt service, and continues to pursue acquisition candidates. The filing provides no specific earnings or revenue guidance and cautions that interim results are not necessarily indicative of full-year results.
- Capital spending included approximately $8.3 to expand Utah manufacturing capacity following a site fire. Interest-rate exposure is variable: management estimated a 100-basis-point rate change would alter annual interest expense and cash flow by approximately $2.36. The company also cited foreign-exchange and raw-material price exposure.
- Risk factors were reported as unchanged from the 2016 Form 10-K. The company described ongoing monitoring/remediation matters at Slate Hill, New York, and Verona, Missouri; management said litigation, claims, and assessments were not expected to materially affect financial condition, results, or liquidity.
- Other notable items: a $2.1 indemnification settlement benefited nine-month 2017 results; transaction, integration, and legal-settlement costs were $2.2. The filing disclosed a single $82,238 sale of animal-feed ingredient to a U.S. intermediary for export to Iran, which the company said was conducted under applicable exemptions and in compliance with law.
- Approximately $24.9 of cash was held by foreign subsidiaries and management said it intended to reinvest those funds abroad; repatriation for U.S. needs could entail additional taxes. Adoption of new stock-compensation accounting reduced the tax provision, including approximately $2.6 of excess tax benefits for the nine months.
Important facts for investors to verify
- Whether weaker Animal Nutrition & Health demand, dairy-market economics, raw-material inflation, and competitive pressure persist.
- How much Industrial Products’ growth from shale-related demand is sustainable and how segment mix affects consolidated margins.
- IFP integration, final purchase-price allocation, and the financial contribution of recent acquisitions.
- Debt repayment and refinancing plans ahead of the May 2019 loan maturity, including sensitivity to floating rates and covenant headroom.
- The sustainability of earnings growth given the lower effective tax rate and prior-period acquisition-related inventory charges and settlements.
- Potential cash-use constraints or tax costs associated with foreign-held cash, and any developments in environmental monitoring or other contingencies.