This report contains forward-looking statements, within the meaning of Section 21E of the Exchange Act, which reflect our expectation or belief concerning future events that involve risks and uncertainties. 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 the Annual Report on Form 10-K for the year endedDecember 31, 2019 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 nutritional, food, pharmaceutical, animal health, medical device sterilization, plant nutrition and industrial markets. Previously, our four reportable segments were: Human Nutrition and Health, Animal Nutrition and Health, Specialty Products, and Industrial Products. However, effective in the first quarter of 2020, in order to align with our strategic focus on health and nutrition, allocation of resources, and evaluation of operating performance, and given the previously noted 2019 reduction in portfolio scale of Industrial Products, we have revised our reporting segment structure to three reportable segments: Human Nutrition and Health, Animal Nutrition and Health, and Specialty Products. These reportable segments are strategic businesses that offer products and services to different markets. This realignment has been retrospectively applied. Sales and production of products outside of our reportable segments and other minor business activities are included in "Other and Unallocated" and applied retroactively to 2019. There was no change to the Consolidated Financial Statements as a result of the change to the reportable segments. We expect that the new reportable segment structure will provide investors greater understanding of and alignment with our strategic focus. In order to ensure appropriate transparency and visibility into the financial performance of the Company, sufficient detail will continue to be provided relative to Other and Unallocated, including material contributions from oil and gas and other industrial market activities. COVID-19 Response: The COVID-19 response effort has been the primary focus for the company since early in the first quarter. Two of our three manufacturing facilities inEurope are inItaly , one of the first countries to be impacted by the pandemic. The need for an early response to the situation inItaly , prepared us well for actions that needed to be taken in the rest of the world to respond to the pandemic.Balchem's Crisis Management Plan has been effectively deployed to respond to the COVID-19 pandemic, activating our Crisis Management Team (CMT), to manage the day-to-day activities and to make timely decisions. Some examples of the early decisions made by the CMT are: 26
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•Holding a special Board of Directors meeting to ensure Board engagement and involvement in the response plan •Creation of an individual response plan for the eventuality of positive cases within our employee base, based on theCenters for Disease Control and Prevention (CDC ) guidelines •International and domestic travel restrictions •Execution of a communications strategy to keep employees and customers informed of requirements, decisions, and outcomes •Site visitation restrictions to both internal and external personnel •Strict protocols to deal with necessary visitors to sites (e.g. delivery drivers) •Elimination of large group gatherings •Mandatory work from home for all non-manufacturing and non-research and development employees •Separation of employees into smaller work groups to reduce density within work teams •New protocols relative to Personal Protection Equipment (PPE) including face masks and sanitation procedures •Key raw material and finished goods inventory builds •Employee responsibility guidelines to manage individual protection measures; and •Approval of special bonuses to non-executive employees to recognize the hourly and salaried workforce attendance and hard work during the pandemic These are just some examples of the decisions made byBalchem's CMT in response to the pandemic. To date, all of our manufacturing sites are operating at near normal conditions enabling us to supply our customers with the important products and services they need, our research and development teams are advancing our innovation efforts, and all of our other employees are carrying on their responsibilities and functions remotely. We have had two employees, that we are aware of, out of our approximately 1,400 employees, test positive for COVID-19. Both cases were in the early stages of the pandemic and both employees are recovering well. We managed the cases effectively using our individual response plan, which is based on theCDC guidelines, and believe our early adoption of exposure mitigation actions played an important role in mitigating the impact of these cases on other employees and the company. While impact on demand in the first quarter was minimal, we are watching the markets that we serve closely. We have stress tested our balance sheet under various significant downturn scenarios and, given our relatively low net debt position (1.1 times TTM adjusted EBITDA), cash on hand, access to our undrawn revolving credit facility, and expected free cash flows, we are pleased with the strength of our balance sheet going into this uncertain market environment. Despite this relative strength, we are taking actions to reduce capital expenditures and non-critical cash expenses wherever possible to preserve cash. Sales over the next few quarters will be challenged by weaker demand in food services, the animal protein markets including dairy protein, medical device sterilization due to fewer elective surgeries, and lower fracking activities. We anticipate that there will be somewhat offsetting potential strengthening demand in grocery store food products, functional technologies aiding food preservation needs, immunity strengthening minerals and nutrients, and certain benefits from lower raw material costs. While we understand the market dynamics impacting these downsides and upsides, it is very difficult at this time to tell the specific dimensional impact of these forces, but our overall expectation is that we will experience sequentially lower overall revenues in the second quarter and for the duration of the pandemic, given the significant disruption on economic activity across global markets. We will watch each of these markets very closely and remain nimble, flexible, and ready to respond accordingly.Balchem has dedicated significant resources to the COVID-19 response over the first quarter and we are pleased with the results to date particularly as it relates to keeping our employees safe and our customers supplied. In the near term, we will have to continue to dedicate a significant amount of our resources to further response activities. We will maintain our focus on employee safety first, keeping our manufacturing sites operational, satisfying customer needs, preserving cash and ensuring strong liquidity, and responding to changes in this dynamic market environment as appropriate. 27 -------------------------------------------------------------------------------- Table of Contents Segment Results We sell products for all three segments through our own sales force, independent distributors, and sales agents. The following tables summarize consolidated net sales by segment and business segment earnings from operations for the three months endedMarch 31, 2020 and 2019: Business Segment Net Sales Three Months Ended March 31, 2020 2019 Human Nutrition & Health$ 95,508 $ 85,149 Animal Nutrition & Health 48,641 43,361 Specialty Products 27,996 18,424 Other and Unallocated (1) 2,291 10,095 Total$ 174,436 $ 157,029 Business Segment Earnings From Operations Three Months Ended March 31, 2020 2019 Human Nutrition & Health$ 12,135 $ 13,703 Animal Nutrition & Health 8,044 5,256 Specialty Products 7,986 6,697 Other and Unallocated (1) (1,887) 824 Total$ 26,278 $ 26,480 (1) Other and Unallocated consists of a few minor businesses which individually do not meet the quantitative thresholds for separate presentation and corporate expenses that have not been allocated to a segment. Unallocated corporate expenses consist of: (i) Transaction and integration costs, ERP implementation costs, and unallocated legal fees totaling$1,272 and$804 for the first quarter of 2020, and 2019, respectively, and (ii) Unallocated amortization expense of$401 and$9 for the first quarter of 2020 and 2019, respectively, related to an intangible asset in connection with a company-wide ERP system implementation. Acquisitions OnDecember 13, 2019 , the Company acquired Zumbro. The Company made payments of$52,403 on the acquisition date, amounting to$47,058 to the former shareholders and$5,345 to Zumbro's lenders to pay Zumbro debt. Considering the cash acquired of$686 , net payments made to the former shareholders were$46,372 . Zumbro is integrated within the HNH Segment. OnMay 27, 2019 , we acquired Chemogas. We made payments of approximately €99,503 (translated to$111,324 ) on the acquisition date, amounting to approximately €88,579 (translated to$99,102 ) to the former shareholders and approximately €10,924 (translated to$12,222 ) to Chemogas' lender to pay off all Chemogas bank debt. Considering the cash acquired of €3,943 (translated to$4,412 ), net payments made to the former shareholders were €84,636 (translated to$94,690 ). Chemogas is integrated within the Specialty Products Segment. 28
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RESULTS OF OPERATIONS (All amounts in thousands, except share and per share data) Three months endedMarch 31, 2020 compared to three months endedMarch 31, 2019 . Net Earnings Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change Net sales$ 174,436 $ 157,029 $ 17,407 11.1 % Gross margin 55,331 49,095 6,236 12.7 % Operating expenses 29,053 22,615 6,438 28.5 % Earnings from operations 26,278 26,480 (202) (0.8) % Other expenses 1,788 1,687 101 6.0 % Income tax expense/(benefit) 4,722 6,010 (1,288) (21.4) % Net earnings$ 19,768 $ 18,783 $ 985 5.2 % Net Sales Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change HNH$ 95,508 $ 85,149 $ 10,359 12.2 % ANH 48,641 43,361 5,280 12.2 % Specialty Products 27,996 18,424 9,572 52.0 % Other 2,291 10,095 (7,804) (77.3) % Total$ 174,436 $ 157,029 $ 17,407 11.1 % •The increase in net sales within the HNH segment for the three months endedMarch 31, 2020 as compared to 2019 was primarily driven by higher sales within food and beverage markets, strong sales growth of chelated minerals and choline nutrients, and increased sales to the cereal market, partially offset by the elimination of sales associated with theReading, PA manufacturing site that we divested in 2019. •The increase in net sales within the ANH segment for the three months endedMarch 31, 2020 compared to 2019 was primarily the result of higher volumes in both the ruminant species and monogastric species markets. Approximately 200 basis points of the growth realized in the quarter related to certain European customers increasing their stock due to COVID-19 uncertainties. •The increase in Specialty Products segment sales for the three months endedMarch 31, 2020 compared to 2019 was primarily driven by higher sales of ethylene oxide for the medical device sterilization market due to both the contribution of Chemogas and higher legacy product sales, as well as increased volumes in the plant nutrition business. •Sales relating to business formerly included in the Industrial Products segment decreased from the prior year due to a decline in shale fracking activity.
Gross Margin
Three Months EndedMarch 31 ,
Increase
(in thousands) 2020 2019 (Decrease) % Change Gross margin$ 55,331 $ 49,095 $ 6,236 12.7 % % of net sales 31.7 % 31.3 % •Gross margin as a percentage of sales increased for the three months endedMarch 31, 2020 compared to 2019 primarily due to mix and certain lower raw material costs. •Gross margin percentage for the HNH segment decreased by 0.6% for the three months endedMarch 31, 2020 compared to 29.3% in 2019 due to an unfavorable mix and certain higher production costs. 29 -------------------------------------------------------------------------------- Table of Contents •Gross margin percentage for the ANH segment increased by 2.0% due to higher volumes for both the ruminant species and monogastric species markets, a favorable mix, and certain lower raw material costs. •Gross margin percentage for the Specialty Products segment decreased by 8.3%, primarily due to mix and certain higher production costs.
Operating Expenses
Three Months EndedMarch 31 ,
Increase
(in thousands) 2020 2019 (Decrease) % Change Operating expenses$ 29,053 $ 22,615 $ 6,438 28.5 % % of net sales 16.7 % 14.4 %
The increase in operating expenses was primarily due to the prior year benefiting from the timing of an insurance recovery and incremental operating expenses related to the Chemogas and Zumbro acquisitions.
Earnings from Operations Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change HNH$ 12,135 $ 13,703 $ (1,568) (11.4) % ANH 8,044 5,256 2,788 53.0 % Specialty Products 7,986 6,697 1,289 19.2 % Other and unallocated (1,887) 824 (2,711) (329.0) % Earnings from operations$ 26,278 $ 26,480 $ (202) (0.8) % % of net sales (operating margin) 15.1 % 16.9 % •Earnings from operations for the HNH segment decreased primarily due to higher operating expenses resulting from the prior year benefiting from the timing of an insurance recovery, partially offset by the aforementioned higher sales. •ANH segment earnings from operations increased primarily due to the aforementioned higher sales and certain lower raw material costs. •The increase in earnings from operations for the Specialty Products segment was primarily due to the aforementioned higher sales, partially offset by mix. •The year-over-year decrease in other and unallocated was driven primarily by lower earnings from the business formerly reported in the industrial products segment (a decrease of$1,854 ), as well as increased transaction and integration costs and unallocated amortization related to a company-wide ERP implementation. Other Expenses (Income) Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change Interest expense$ 1,696 $ 1,589 $ 107 6.7 % Other, net 92 98 (6) (6.1) %$ 1,788 $ 1,687 $ 101 6.0 %
Interest expense for the three months ended
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Table of Contents Income Tax Expense Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change Income tax expense (benefit)$ 4,722 $ 6,010 $ (1,288) (21.4) % Effective tax rate 19.3 % 24.2 %
The decrease of effective tax rate was mainly attributable to lower enacted tax rates from several states.
FINANCIAL CONDITION LIQUIDITY AND CAPITAL RESOURCES (All amounts in thousands, except share and per share data) During the three months endedMarch 31, 2020 , there were no 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 endedDecember 31, 2019 . We expect our operations to continue generating sufficient cash flow to fund working capital requirements and necessary capital investments. We are actively pursuing additional acquisition candidates. We could seek additional bank loans or access to financial markets to fund such acquisitions, our operations, working capital, necessary capital investments or other cash requirements should we deem it necessary to do so. Cash Cash and cash equivalents increased to$73,959 atMarch 31, 2020 from$65,672 atDecember 31, 2019 . AtMarch 31, 2020 , the Company had$37,841 of cash and cash equivalents held by foreign subsidiaries. It is our intention to permanently reinvest these funds in foreign operations by continuing to make additional plant related investments, and potentially invest in partnerships or acquisitions; therefore, we do not currently expect to repatriate these funds in order to fundU.S. operations or obligations. However, if these funds are needed forU.S. operations, we could be required to pay additional withholding taxes to repatriate these funds. Working capital was$198,961 atMarch 31, 2020 as compared to$162,688 atDecember 31, 2019 , an increase of$36,273 . Working capital reflects the payment of the 2019 declared dividend in 2020 of$16,704 , net proceeds from the revolving debt of$5,000 , and capital expenditures and intangible assets acquired of$5,394 . Three Months Ended March 31, Increase (in thousands) 2020 2019 (Decrease) % Change Cash flows provided by operating activities$ 22,565 $ 22,483 $ 82 0.4 % Cash flows used in investing activities (5,394) (5,780) 386 6.7 % Cash flows used in financing activities (8,160) (31,574) 23,414 74.2 % Operating Activities Cash flows from operating activities provided$22,565 for the three months endedMarch 31, 2020 as compared to$22,483 for the three months endedMarch 31, 2019 . The increase in cash flows from operating activities was primarily due to increased earnings and depreciation and amortization, partially offset by working capital changes. Investing Activities We continue to invest in corporate projects, improvements across all production facilities, and intangible assets. Total investments in property, plant and equipment and intangible assets were$5,394 and$8,507 for the three months endedMarch 31, 2020 and 2019, respectively. Financing Activities Net proceeds from the revolving loan amounted to$5,000 during the three months endedMarch 31, 2020 and we have$246,431 available under the credit agreement as ofMarch 31, 2020 . We have an approved stock repurchase program. The total authorization under this program is 3,763,038 shares. Since the inception of the program inJune 1999 , a total of 2,439,991 shares have been purchased, and we had 130,573 shares remaining in treasury atMarch 31, 2020 . We intend to acquire shares from time to time at prevailing market prices if and to the extent we 31
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Table of Contents deem it is advisable to do so based on our assessment of corporate cash flow, market conditions and other factors. The Company also repurchases shares from employees in connection with settlement of transactions under the Company's equity incentive plans. Proceeds from stock options exercised were$4,435 and$288 for the three months endedMarch 31, 2020 and 2019, respectively. Dividend payments were$16,704 and$15,135 for the three months endedMarch 31, 2020 and 2019, respectively. Other Matters Impacting Liquidity We currently provide postretirement benefits in the form of two retirement medical plans, as discussed in Note 15 - Employee Benefit Plans. The liability recorded in other long-term liabilities on the consolidated balance sheets as ofMarch 31, 2020 andDecember 31, 2019 was$1,100 and$1,076 , respectively, and the plans are not funded. Historical cash payments made under these plans have typically been less than$100 per year. We do not anticipate any changes to the payments made in the current year for the plans. OnJune 1, 2018 , we established an unfunded, nonqualified deferred compensation plan maintained for the benefit of a select group of management or highly compensated employees. Assets of the plan are held in a rabbi trust, which are subject to additional risk of loss in the event of bankruptcy or insolvency of the Company. The deferred compensation liability as ofMarch 31, 2020 andDecember 31, 2019 was$2,830 and$1,982 , respectively, and was included in other long-term obligations on our balance sheet. The related rabbi trust assets were$2,832 and$1,982 as ofMarch 31, 2020 andDecember 31, 2019 , respectively, and were included in other non-current assets on the our balance sheets. Chemogas has an unfunded defined benefit plan. The plan provides for the payment of a lump sum at retirement or payments in case of death of the covered employees. The amount recorded for these obligations on our balance sheet as ofMarch 31, 2020 andDecember 31, 2019 was$584 and$596 , respectively, and was included in other long-term obligations. Critical Accounting Policies There were no changes to the Company's Critical Accounting Policies, as described in itsDecember 31, 2019 Annual Report on Form 10-K, during the three months endedMarch 31, 2020 . Related Party Transactions We were engaged in related party transactions withSt. Gabriel CC Company, LLC during the three months endedMarch 31, 2020 . Refer to Note 18, "Related Party Transactions".
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