Balchem Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Amounts are in thousands of dollars unless otherwise noted. Balchem develops specialty ingredients for food, nutrition, pharmaceutical, animal health, agricultural, industrial and medical-device sterilization markets.
Financial performance
| Metric | Three months 2016 | Three months 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $138,794 | $134,773 | $273,935 | $279,635 |
| Gross margin | $46,449 | $41,867 | $89,273 | $84,997 |
| Gross margin % | 33.5% | 31.1% | 32.6% | 30.4% |
| Operating earnings | $23,333 | $23,774 | $43,301 | $48,812 |
| Operating margin | 16.8% | 17.6% | 15.8% | 17.5% |
| Net earnings | $14,150 | $14,916 | $26,036 | $30,088 |
| Diluted EPS | $0.44 | $0.47 | $0.82 | $0.95 |
- Q2 sales rose 3.0%, while net earnings declined 5.1%. For the first half, sales fell 2.0% and net earnings fell 13.5%.
- Six-month operating expenses increased to $45,972 from $36,185, reflecting Albion operating costs and $1,430 of transaction and integration costs, partly offset by a favorable legal settlement.
- Interest expense was $1,905 for Q2 and $3,748 for the first half. Effective tax rates were 33.8% and 33.9%, respectively, versus 32.7% and 33.5% in the comparable periods.
Segment trends and material changes
- Human Nutrition & Health: Q2 sales increased 11.3% to $74,800; first-half sales increased 8.4% to $146,355. Albion contributed $9,648 in Q2 and $16,742 in the first half. Growth was partly offset by weaker cereal sales in Q2 and lower Powder & Flavor Systems sales for the first half.
- Animal Nutrition & Health: Sales declined 7.8% in Q2 and 7.9% in the first half. The filing cites weaker dairy economics, competition, and lower average selling prices for feed-grade choline; higher volumes and lower raw-material costs provided partial offsets.
- Specialty Products: Sales increased 47.2% in Q2 and 36.7% in the first half, with Albion contributing $5,835 and $9,358, respectively. Acquired-inventory fair-value adjustments weighed on segment gross margin.
- Industrial Products: Sales declined 56.5% in Q2 and 62.0% in the first half, primarily due to lower demand for choline derivatives used in shale-fracking applications.
- Gross-margin improvement reflected product mix and lower raw-material costs. Results also included acquired-inventory fair-value expense of $1,703 in Q2 and $5,046 in the first half, and acquisition transaction/integration costs. Management reported first-half operating earnings, excluding amortization, acquired-inventory valuation, transaction/integration costs and the favorable legal settlement, of $63,774, or 23.3% of sales, versus $62,045, or 22.2%, in 2015.
Cash flow, liquidity and debt
- Cash from operations was $55,958 for the first half, compared with $49,866 in 2015. Capital expenditures were $14,736.
- Investing cash outflow was $125,923, including $110,601 paid for Albion, net of acquired cash. Financing cash inflow was $18,235; the company paid $10,727 in dividends.
- Cash declined to $33,421 from $84,795 at year-end 2015; working capital decreased to $94,036 from $117,172. Management attributed the cash decline primarily to the Albion acquisition. Foreign subsidiaries held $15,339 of cash that the company intended to permanently reinvest abroad.
- Total debt was $325,000: $280,000 term debt and $45,000 drawn on a $100,000 revolving facility. The company had $55,000 of revolving capacity available. The term loan and revolver mature May 7, 2019; the stated interest rate was 1.96% at June 30. The company reported compliance with its debt covenants.
- Management expected operating cash flow to fund working capital, capital investment and debt service, and said it continued to pursue acquisitions. A 100-basis-point change in interest rates was estimated to change annual interest expense and cash flow by approximately $3,250.
Acquisition, outlook and risks
- Balchem acquired 100% of Albion International on February 1, 2016 for approximately $116,434, funded with $65,000 of revolver borrowings and existing cash. The preliminary purchase accounting included $61,484 of goodwill and acquired finite-lived intangibles. Allocation and certain valuations remained subject to finalization.
- The filing provides no specific earnings or sales guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
- Risks discussed include dairy-market economics and competition, commodity and fracking-related demand, foreign-exchange and raw-material price exposure, and variable-rate borrowing. The company also disclosed ongoing environmental monitoring/remediation matters and other litigation; management did not expect current claims to have a material effect. No material changes to the risk factors in the 2015 Form 10-K were reported.
- Albion integration was ongoing; the company expected to include the acquired business in its internal-control assessment as of December 31, 2016. Management said disclosure controls were effective.
Important facts for investors to verify
- Whether Albion’s expected sales, earnings contribution, synergies and preliminary purchase-price allocation develop as anticipated.
- Whether weaker Animal Nutrition & Health and Industrial Products demand persists, and whether human-nutrition growth offsets those declines.
- How acquired-inventory valuation, amortization and integration expenses affect reported margins and earnings compared with management’s adjusted presentation.
- Debt paydown, covenant headroom, available revolver capacity and sensitivity to interest-rate changes.
- Final acquisition accounting, foreign-cash repatriation implications, and any developments in environmental or other contingencies.