News Column

BALCHEM CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations (All dollar amounts in thousands)

August 8, 2014

This Report contains forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which reflect our expectation or belief concerning future events that involve risks and uncertainties. Our actions and performance could differ materially from what is contemplated by the forward-looking statements contained in this Report. Factors that might cause differences from the forward-looking statements include those referred to or identified in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013 and other factors that may be identified elsewhere in this Report. Reference should be made to such factors and all forward-looking statements are qualified in their entirety by the above cautionary statements.



Overview

We develop, manufacture, distribute and market specialty performance ingredients and products for the food, nutritional, pharmaceutical, animal health and medical device sterilization industries. Our three reportable segments are strategic businesses that offer products and services to different markets: Specialty Products; SensoryEffects (formerly Food, Pharma & Nutrition); and Animal Nutrition & Health.

Acquisition of Performance Chemicals & Ingredients Company (d/b/a SensoryEffects) and Long-term Debt

On May 7, 2014, the Company acquired 100 percent (the "Acquisition) of the outstanding common shares of Performance Chemicals & Ingredients Company (d/b/a SensoryEffects) a privately held supplier of customized food and ingredient systems, headquartered in St. Louis, Missouri, for a purchase price of approximately $569,000, including working capital acquired. The purchase price included a $5.5 million deposit made on March 31, 2014 with an escrow agent pursuant to the terms of a Letter of Intent. SensoryEffects is a leader in powder, solid and liquid flavor systems, creamer and specialty emulsified powders, cereal-based products and other functional ingredient food and beverage delivery systems. The Acquisition of SensoryEffects accelerates the Company's growth into health and wellness markets. SensoryEffects was merged with the Company's Food, Pharma & Nutrition segment, strengthening its market leadership position, and the segment was renamed SensoryEffects. On May 7, 2014, the Company and a bank syndicate entered into a loan agreement providing for a senior secured term loan of $350,000 and revolving loan of $100,000 (collectively referred to as the "loans"). The term loan and $50,000 of the revolving loan were used to fund the Acquisition of SensoryEffects and for general corporate purposes.



Specialty Products Segment

Our Specialty Products segment operates in industry as ARC Specialty Products.

Ethylene oxide, at the 100% level, is sold as a sterilant gas, primarily for use in the health care industry. It is used to sterilize a wide range of medical devices because of its versatility and effectiveness in treating hard or soft surfaces, composites, metals, tubing and different types of plastics without negatively impacting the performance of the device being 21 -------------------------------------------------------------------------------- sterilized. Contract sterilizers and medical device manufacturers are our principal customers for this product. In addition, we also sell single use canisters with 100% ethylene oxide for use in medical device sterilization. As a fumigant, ethylene oxide blends are highly effective in killing bacteria, fungi, and insects in spices and other seasoning materials. We sell propylene oxide as a fumigant: to aid in the control of insects and microbiological spoilage; and to reduce bacterial and mold contamination in certain shell and processed nut meats, processed spices, cacao beans, cocoa powder, raisins, figs and prunes. We also sell propylene oxide to customers seeking smaller (as opposed to bulk) quantities and whose requirements include utilization in various chemical synthesis applications, such as increasing paint durability and manufacturing specialty starches and textile coatings.



SensoryEffects Segment

Our SensoryEffects segment supplies ingredients in the food and beverage industry; providing customized solutions in powder and liquid flavor delivery systems, spray dried emulsified powder systems, and cereal systems. Our products include creamer systems, dairy replacers, powdered fats, nutritional beverage bases, beverages, juice & dairy bases, chocolate systems, ice cream bases & variegates, ready-to-eat cereals, grain based snacks, and cereal based ingredients. Additionally, we provide microencapsulation solutions to a variety of applications in food, pharmaceutical and nutritional ingredients to enhance performance of nutritional fortification, processing, mixing, and packaging applications and shelf-life. Major product applications are baked goods, refrigerated and frozen dough systems, processed meats, seasoning blends, confections, and nutritional supplements. We also produce and market human grade choline nutrient products through this segment for wellness applications. Choline is recognized to play a key role in the development and structural integrity of brain cell membranes in infants, processing dietary fat, reproductive development and neural functions, such as memory and muscle function.



Animal Nutrition & Health Segment

Our Animal Nutrition & Health ("ANH") segment provides the animal nutrition market with nutritional products derived from our microencapsulation and chelation technologies in addition to basic choline chloride. Commercial sales of REASHURE® Choline, an encapsulated choline product, NITROSHURETM, an encapsulated urea supplement, and NIASHURETM, our microencapsulated niacin product for dairy cows, boosts health and milk production in transition and lactating dairy cows, delivering nutrient supplements that survive the rumen and are biologically available, providing required nutritional levels. We also market chelated mineral supplements for use in animal feed throughout the world, as our proprietary chelation technology provides enhanced nutrient absorption for various species of production and companion animals. ANH also manufactures and supplies choline chloride, an essential nutrient for animal health, predominantly to the poultry and swine industries. Choline, which is manufactured and sold in both dry and aqueous forms, plays a vital role in the metabolism of fat. Choline deficiency can result in reduced growth and perosis in poultry; fatty liver, kidney necrosis and general poor health condition in swine. Certain derivatives of choline chloride are also manufactured and sold into industrial applications predominately as a component for hydraulic fracturing of shale natural gas wells. The ANH segment also includes the manufacture and sale of methylamines. 22



--------------------------------------------------------------------------------

Methylamines are a primary building block for the manufacture of choline products and are also used in a wide range of industrial applications.

The Company sells products for all three segments through its own sales force, independent distributors, and sales agents.

The following tables summarize consolidated business segment net sales and earnings from operations for the three and six months ended June 30, 2014 and 2013:

Business Segment Net Sales:

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Specialty Products $ 13,642$ 13,219$ 26,434$ 25,999 SensoryEffects 49,199 12,146 61,349 23,154 Animal Nutrition & Health 69,389 57,931 130,442 118,794 Total $ 132,230$ 83,296$ 218,225$ 167,947



Business Segment Earnings From Operations:

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Specialty Products $ 5,463$ 5,279$ 10,269$ 10,188 SensoryEffects 2,874 3,269 5,475 5,776 Animal Nutrition & Health 9,675 8,068 16,968 16,517



Transaction and integration costs (1,503 ) - (2,848 )

- Total $ 16,509$ 16,616$ 29,864$ 32,481 RESULTS OF OPERATIONS



Three months ended June 30, 2014 compared to three months ended June 30, 2013.

Net Sales

Net sales for the three months ended June 30, 2014, were $132,230, as compared with $83,296 for the three months ended June 30, 2013, an increase of $48,934 or 58.7%. Net sales for the SensoryEffects segment (formerly Food, Pharma & Nutrition) were $49,199, as compared with $12,146 for the three months ended June 30, 2013, an increase of $37,053 or 305.1%. Net sales from the newly acquired SensoryEffects business contributed $36,395 to the overall increase. The acquired Powder & Flavor Systems, and Cereal Systems product lines comprised $31,120 and $4,297 of the increase, respectively. Also contributing to the higher sales was a $971 increase or 15.7% in encapsulated ingredients used for baking and food preservation, due to increased volume and a favorable product mix. Net sales for the Animal Nutrition & Health segment were $69,389 for the three months ended June 30, 2014, as compared with $57,931 for the three months ended June 30, 2013, an increase of $11,458 or 19.8%. Sales of product lines targeted for ruminant 23 -------------------------------------------------------------------------------- animal feed markets increased by $3,680 or 46.1% from the prior year comparable period. Strong dairy economics supported increased sales volume of our products. Global feed grade choline product sales increased $3,449 or 13.2% primarily due to increased volumes of choline products sourced from our Italian operation into the European and other international markets. Sales for industrial applications comprised approximately 37.7% of sales in the segment, as compared to 38.5% for the comparable three months ended June 30, 2013. Industrial sales grew $3,847 or 17.2% over the prior year period principally due to volume increases of various choline and choline derivatives for industrial applications, most notably for shale fracking. Net sales for the Specialty Products segment were $13,642 for the three months ended June 30, 2014, as compared with $13,219 for the three months ended June 30, 2013, an increase of $423 or 3.2%. Increased sales of ethylene oxide products used for medical device sterilization were partially offset by lower sales volumes of propylene oxide for industrial applications.



Gross Margin

For the three months ended June 30, 2014, gross margin increased to $32,335 compared to $24,885 for the three months ended June 30, 2013. Gross margin as a percentage of sales for the three months ended June 30, 2014 decreased to 24.5% from 29.9% in the prior year comparative period. Gross margin for the SensoryEffects segment declined 18.7% for the three months ended June 30, 2014 as compared to the three months ended June 30, 2013 primarily due to the valuation of acquired inventory to fair value, which increased cost of sales by $4,735. Powder & Flavor Systems carries a lower gross margin which also contributed to the decline. Gross margin percentage declined for the Animal Nutrition & Health segment by 1.1% primarily due to a heavier weighting towards choline chloride products, increases in certain petrochemical raw material costs, and higher distribution costs related to customer mix. Gross margin for the Specialty Products segment declined 0.4% primarily due to an unfavorable product mix. Operating Expenses Operating expenses for the three months ended June 30, 2014 were $15,826 or 12.0% of net sales as compared to $8,269 or 9.9% of net sales for the three months ended June 30, 2013. The increase was primarily due to increased amortization expense of $3,456 related to the acquired intangible assets as a result of the Acquisition as well as transaction and integration expenses of $1,503.



Earnings from Operations

Principally as a result of the above-noted details, earnings from operations for the three months ended June 30, 2014 were $16,509 as compared to $16,616 for three months ended June 30, 2013, a decrease of $107 or 0.6%. Earnings from operations as percentage of sales ("operating margin") for the three months ended June 30, 2014 were 12.5%, declining from 19.9% for the three months ended June 30, 2013, primarily due to the aforementioned impact of the valuation of acquired inventory, amortization expense associated with acquired intangible assets, transaction and integration expenses and unfavorable product mix. Excluding the impact of the valuation of the acquired inventory, amortization expense, and transaction and integration expenses, the earnings from operations were $26,299 or 19.9% of sales. Earnings from the SensoryEffects segment were $2,874, a decrease of $395 or 12.1% primarily due to the impact of the valuation of the acquired 24 -------------------------------------------------------------------------------- inventory and amortization expense, partially offset by increased sales from the Acquisition. Animal Nutrition & Health segment earnings from operations were $9,675, an increase of 19.9%, primarily due to higher net sales, partially offset by an unfavorable product mix, increases in certain petrochemical raw material costs, and higher distribution costs. Earnings from operations from the Specialty segment were $5,464, an increase of $184 or 3.5%.



Other Expenses (Income)

Interest expense for the three months ended June 30, 2014 was $1,315 and is primarily related to the loans entered into on May 7, 2014 to finance the Acquisition of SensoryEffects. Interest income was $13 and $61 for the three months ended June 30, 2014 and 2013, respectively. The Company has invested available cash primarily in certificates of deposits and money market investments that have been classified as cash equivalents due to the short maturities of these investments. Other income of $84 and $7 for the three months ended June 30, 2014 and 2013, respectively, is primarily the result of favorable fluctuations in foreign currency exchange rates between the U.S. dollar (the reporting currency) and functional foreign currencies.



Income Tax Expense

The Company's effective tax rate for the three months ended June 30, 2014 and 2013 was 36.4% and 30.6% respectively. The increase in the effective tax rate is primarily attributable to the impact of new jurisdictions related to the SensoryEffects acquisition, a change in apportionment relating to state income taxes, a change in the income proportion towards jurisdictions with higher tax rates, and the timing of certain tax credits and deductions.



Net Earnings

Principally as a result of the above-noted details, net earnings for the three months ended June 30, 2014, were $9,732, as compared with $11,582 for the three months ended June 30, 2013, a decrease of $1,850 or 16.0%.



Six months ended June 30, 2014 compared to six months ended June 30, 2013.

Net Sales

Net sales for the six months ended June 30, 2014, were $218,225, as compared with $167,947 for the six months ended June 30, 2013, an increase of $50,278 or 29.9%. Net sales for the SensoryEffects segment (formerly Food, Pharma & Nutrition) were $61,349, as compared with $23,154 for the six months ended June 30, 2013, an increase of $38,195 or 165.0%. Net sales from the newly acquired SensoryEffects business contributed $36,395 to the overall increase. The acquired Powder & Flavor Systems, and Cereal Systems product lines comprised $31,120 and $4,297 of the increase, respectively. Contributing to the higher sales was a $1,214 increase or 10.2% in encapsulated ingredients used for baking and food preservation, due to increases in volume and a favorable product mix. Additionally, sales of human choline products for both food applications and the supplement markets increased $1,120 or 10.8%, primarily due to higher volumes. Net sales for the Animal Nutrition & Health segment were $130,442 for the six months ended June 25 -------------------------------------------------------------------------------- 30, 2014, as compared with $118,794 for the six months ended June 30, 2013, an increase of $11,648 or 9.8%. Sales of product lines targeted for ruminant animal feed markets increased by $2,667 or 13.9% from the prior year comparable period, primarily due to strong dairy economics, which increased demand for our products. Global feed grade choline product sales increased $4,205 or 7.8% primarily due to increased volumes of choline products sourced from our Italian operation into the European and other international markets. Sales for industrial applications comprised approximately 35.5% of sales in the segment, as compared to 35.4% for the comparable six months ended June 30, 2013. Industrial sales grew $4,332 or 10.3% over the prior year period with the increase principally due to volume increases of various choline and choline derivatives for industrial applications, most notably for shale fracking, which offset lower average selling prices. Net sales for the Specialty Products segment were $26,434 for the six months ended June 30, 2014, as compared with $25,999 for the six months ended June 30, 2013, an increase of $435 or 1.7%. Increased sales of ethylene oxide products used for medical device sterilization were partially offset by lower sales volumes of propylene oxide for industrial applications. Gross Margin For the six months ended June 30, 2014, gross margin increased to $55,550 compared to $49,117 for the six months ended June 30, 2013. Gross margin as a percentage of sales for the six months ended June 30, 2014 decreased to 25.5% from 29.2% in the prior year comparative period. Gross margin for the SensoryEffects segment declined 14.4% for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013, primarily due to the valuation of acquired inventory to fair value, which increased cost of sales by $4,735. Powder & Flavor Systems carries a lower gross margin which also contributed to the decline. There was also a negative impact from unfavorable manufacturing variances resulting from the food sector product mix. Gross margin percentage declined for the Animal Nutrition & Health segment by 1.6% primarily due to a heavier weighting towards choline chloride products, increases in certain petrochemical raw material costs, and higher distribution costs related to customer mix. Gross margin for the Specialty Products segment was flat.



Operating Expenses

Operating expenses for the six months ended June 30, 2014 were $25,686 or 11.8% of net sales as compared to $16,636 or 9.9% of net sales for the six months ended June 30, 2013. The increase was primarily due to increased amortization expense of $3,456 related to the acquired intangible assets as a result of the Acquisition, as well as transaction and integration expenses of $2,848.



Earnings From Operations

Principally as a result of the above-noted details, earnings from operations for the six months ended June 30, 2014 were $29,864 as compared to $32,481 for the six months ended June 30, 2013, a decrease of $2,617 or 8.1%. Earnings from operations as percentage of sales ("operating margin") for the six months ended June 30, 2014 were 13.7%, declining from 19.3% for the six months ended June 30, 2013, primarily due to the aforementioned impact of the valuation of the acquired inventory, amortization expense associated with acquired intangible assets, transaction and integration expenses and 26 -------------------------------------------------------------------------------- unfavorable product mix. Excluding the impact of the valuation of the acquired inventory, amortization expense, and transaction and integration expenses, the earnings from operations were $40,999 or 18.8% of sales. Earnings from the SensoryEffects segments were $5,475, a decrease of $301 or 5.2%, primarily due to the impact of the valuation of acquired inventory and amortization expense, partially offset by increased sales from the Acquisition. Animal Nutrition & Health segment earnings from operations were $16,968, an increase of 2.7%, primarily due to higher net sales, partially offset by an unfavorable product mix, increases in certain petrochemical raw material costs, and higher distribution costs. Earnings from operations from the Specialty segment were $10,269, an increase of $81 or 0.8%.



Other Expenses (Income)

Interest expense for the six months ended June 30, 2014 was $1,316 and is primarily related to the loans entered into on May 7, 2014 to finance the Acquisition of SensoryEffects. Interest income was $59 and $113 for the six months ended June 30, 2014 and 2013, respectively. The Company has invested available cash primarily in certificates of deposits and money market investments that have been classified as cash equivalents due to the short maturities of these investments. Other income of $56 for the six months ended June 30, 2014, is primarily the result of favorable fluctuations in foreign currency exchange rates between the U.S. dollar (the reporting currency) and functional foreign currencies. Other expenses of $46 for the six months ended June 30, 2013, are primarily the result of unfavorable fluctuations in foreign currency exchange rates between the U.S. dollar (the reporting currency) and functional foreign currencies.



Income Tax Expense

The Company's effective tax rate for the six months ended June 30, 2014 and 2013 was 35.0% and 31.0% respectively. The increase in the effective tax rate is primarily attributable to the impact of new jurisdictions related to the SensoryEffects acquisition, a change in apportionment relating to state income taxes, a change in the income proportion towards jurisdictions with higher tax rates, and the timing of certain tax credits and deductions.



Net Earnings

Principally as a result of the above-noted details, net earnings for the six months ended June 30, 2014 were $18,626, as compared with $22,470 for the six months ended June 30, 2013, a decrease of $3,844 or 17.1%. FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES (All amounts in thousands, except share and per share data)



Contractual Obligations

The Company's contractual obligations and commitments are principally associated with future minimum non-cancelable operating lease obligations, long-term debt obligations and purchase orders principally with vendors for inventory not yet received or recorded on the balance sheet. 27



--------------------------------------------------------------------------------

The Company's contractual obligations as of June 30, 2014, are summarized in the table below: Payments due by period Less than 1 More than 5

Contractual Obligations Total year 1-3 years 3-5 years years Operating lease obligations (1) $ 8,741$ 1,858$ 2,867$ 1,693$ 2,323 Purchase obligations (2) 27,269 26,798 471 - - Debt (3) 400,000 35,000 70,000 295,000 - Total $ 436,010$ 63,656$ 73,338$ 296,693$ 2,323



(1) Principally includes obligations associated with future minimum

non-cancelable operating lease obligations (including the headquarters office

space entered into in 2002 and extended in 2012 for six (6) years) and warehouse space entered into in 2013 for three (3) years.



(2) Principally includes open purchase orders with vendors for inventory not yet

received or recorded on our balance sheet.

(3) Consists of $350,000 senior secured term loan and $50,000 revolving loan.

The table above excludes a $5,000 liability for uncertain tax positions, including the related interest and penalties, recorded in accordance with ASC 740-10, as we are unable to reasonably estimate the timing of settlement, if any.



The Company knows of no current or pending demands on, or commitments for, its liquid assets that will materially affect its liquidity.

During the six months ended June 30, 2014, other than the long-term debt and other obligations related to the Acquisition of Performance Chemicals & Ingredients Company (d/b/a SensoryEffects), there were no other material changes outside the ordinary course of business in the specified contractual obligations set forth in our Annual Report on Form 10-K for the year ended December 31, 2013. The Company expects its operations to continue generating sufficient cash flow to fund working capital requirements, capital investments and service future debt payments. The Company continues to pursue additional acquisition candidates. The Company could seek additional bank loans or access to financial markets to fund such acquisitions, its operations, working capital, capital investments, or other cash requirements as deemed necessary.



Cash

Cash and cash equivalents decreased to $59,714 at June 30, 2014 from $208,747 at December 31, 2013 primarily resulting from the activity detailed below. At June 30, 2014, the Company had $6,216 of cash and cash equivalents held by our foreign subsidiaries. It is our intention to permanently reinvest these funds in our foreign operations by continuing to make additional plant related investments, and potentially invest in partnerships or 28 -------------------------------------------------------------------------------- acquisitions; therefore, we do not currently expect to repatriate these funds in order to fund our U.S. operations or obligations. However, if these funds are needed for our U.S. operations, we could be required to pay additional U.S. taxes to repatriate these funds. Working capital was $116,818 at June 30, 2014 as compared to $242,021 at December 31, 2013, a decrease of $125,203.



Operating Activities

Cash flows from operating activities provided $27,603 for the six months ended June 30, 2014 as compared to $23,784 for the six months ended June 30, 2013. The increase in cash flows from operating activities was primarily due to higher amortization and depreciation expense adjustments and less unfavorable working capital changes, partially offset by lower net income.



Investing Activities

As previously noted, on May 7, 2014, the Company acquired SensoryEffects for a purchase price of approximately $569,000. Capital expenditures were $3,504 for the six months ended June 30, 2014 compared to $5,171 for the six months ended June 30, 2013. The capital expenditures that occurred during 2013 were predominately for the Company's new manufacturing facility in Covington, Virginia.



Financing Activities

On May 7, 2014, the Company and a bank syndicate entered into a loan agreement providing for a senior secured term loan of $350,000 and revolving loan of $100,000. The term loan and $50,000 of the revolving loan were used to fund the Acquisition of SensoryEffects and for general corporate purposes. The Company has an approved stock repurchase program. The total authorization under this program is 3,763,038 shares. Since the inception of the program in June 1999, a total of 2,092,703 shares have been purchased, none of which remained in treasury at June 30, 2014. During the six months ended June 30, 2014, a total of 4,969 shares have been purchased at an average cost of $53.81 per share. The Company intends to acquire shares from time to time at prevailing market prices if and to the extent it deems it advisable to do so based on its assessment of corporate cash flow, market conditions and other factors. Proceeds from stock options exercised were $2,881 and $5,088 for the six months ended June 30, 2014 and 2013, respectively. Dividend payments were $7,856 and $-0- for the six months ended June 30, 2014 and 2013, respectively. The Company's 2012 annual dividend was accelerated due to the anticipated increase in the federal tax on dividends paid after December 31, 2012 and no dividends were paid in 2013.



Other Matters Impacting Liquidity

The Company currently provides postretirement benefits in the form of a retirement medical plan under a collective bargaining agreement covering eligible retired employees of its Verona, Missouri facility. The liability recorded on the consolidated balance sheet as of June 30, 2014 is $1,206 and the plan is not funded. Historical cash payments made under the plan have typically been less than $100 per year. 29



--------------------------------------------------------------------------------

Critical Accounting Policies

There were no changes to the Company's Critical Accounting Policies, as described in its December 31, 2013 Annual Report on Form 10-K, during the six months ended June 30, 2014.

Related Party Transactions

The Company was not engaged in related party transactions during the six months ended June 30, 2014.

30



--------------------------------------------------------------------------------


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters