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BCPC > SEC Filings for BCPC > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for BALCHEM CORP

Form 10-K for BALCHEM CORP


27-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 reportable segments are strategic businesses that offer industrial products and services to different markets. We presently have three reportable segments: Specialty Products; Food, Pharma & Nutrition; and Animal Nutrition & Health.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6 - "Selected Financial Data" and our Consolidated Financial Statements and the related notes included in this report. Those statements in the following discussion that are not historical in nature should be considered to be forward-looking statements that are inherently uncertain. See "Cautionary Statement Regarding Forward-Looking Statements."

Specialty Products

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 sterilized. Our 100% ethylene oxide product is distributed in uniquely designed, recyclable, double-walled, stainless steel drums to assure compliance with safety, quality and environmental standards as outlined by the EPA and the DOT. Our inventory of these specially built drums, along with our two filling facilities, represents a significant capital investment. 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.

Propylene oxide is marketed and sold as a fumigant to aid in the control of insects and microbiological spoilage; and to reduce bacterial and mold contamination in shell and processed nut meats (except peanuts), processed spices, cacao beans, cocoa powder, raisins, figs and prunes. We distribute our propylene oxide product primarily in recyclable, single-walled, carbon steel cylinders according to standards outlined by the EPA and the DOT. Our inventory of these cylinders also represents a significant capital investment. Propylene oxide is also sold 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.

Management believes that future success in this segment is highly dependent on the Company's ability to maintain its strong reputation for excellent quality, safety and customer service.


Food, Pharma & Nutrition

The Food, Pharma & Nutrition ("FPN") segment provides 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 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.

Management believes this segment's key strengths are its proprietary technology and end-product application capabilities. The success of the Company's efforts to increase revenue in this segment is highly dependent on the timing of marketing launches of new products in the U.S. and international food and nutrition markets by the Company's customers and prospects. The Company, through its innovative proprietary technology and applications expertise, continues to develop new products designed to solve and respond to customer problems and innovative needs.

Animal Nutrition & Health

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. Our proprietary chelation technology provides enhanced nutrient absorption for various species of production and companion animals and is marketed for use in animal feed throughout the world. 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. Methylamines are a primary building block for the manufacture of choline products and are also used in a wide range of industrial applications.

Sales of specialty products for the animal nutrition and health industry are highly dependent on dairy industry economics as well as the ability of the Company to leverage the results of university research on the animal health benefits of the Company's products. Management believes that success in the commodity-oriented basic choline chloride marketplace is highly dependent on the Company's ability to maintain its strong reputation for excellent product quality and customer service. In addition, the Company must continue to increase production efficiencies in order to maintain its low-cost position to effectively compete in a highly competitive global marketplace.

The Company sells products for all three segments through its 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 years ended December 31, 2013, 2012 and 2011 (in thousands):


Business Segment Net Sales:
                              2013          2012          2011
Specialty Products          $  51,086     $  49,990     $  47,851
Food, Pharma & Nutrition       47,569        44,070        42,525
Animal Nutrition & Health     238,518       216,333       201,491
Total                       $ 337,173     $ 310,393     $ 291,867

Business Segment Earnings From Operations:

                              2013         2012         2011
Specialty Products          $ 20,224     $ 20,332     $ 18,636
Food, Pharma & Nutrition      11,233       11,335       11,113
Animal Nutrition & Health     34,145       28,110       26,476
Total                       $ 65,602     $ 59,777     $ 56,225

Fiscal Year 2013 compared to Fiscal Year 2012
(All amounts in thousands, except share and per share data)

Net Sales

Net sales for 2013 were $337,173 as compared with $310,393 for 2012, an increase of $26,780 or 8.6%. Net sales for the Specialty Products segment were $51,086 for 2013, as compared with $49,990 for 2012, an increase of $1,096 or 2.2%. Approximately 79% of this increase in sales was from propylene oxide products for use in industrial applications and nutmeat fumigation. The balance of the increased sales is principally a result of higher sales from ethylene oxide products for use in medical device sterilization. Net sales for the Food, Pharma & Nutrition segment were $47,569 for 2013 compared with $44,070 for 2012, an increase of $3,499 or 7.9%. This result was primarily due to a 10.2% increase in sales in the food sector, principally due to higher volumes and product mix of encapsulated ingredients for baking and food preservation end markets. Also contributing to the higher sales was an increase in sales of 28.2% for VitaShure® products for nutritional enhancement, including sustained release amino acid products for sports performance products. Net sales of $238,518 were realized for 2013 for the Animal Nutrition & Health segment, as compared with $216,333 for the prior year, an increase of $22,185 or 10.3%. The ANH specialty ingredients, largely targeted to the ruminant and companion animal markets, realized 6.6% sales growth from the prior year comparable period. The improvement was due to higher sales of non-AminoShure® products, which were up 22.5% compared with prior year, and were led by strong volume growth of ReaShure, NitroShure and chelated minerals. This was partially offset by lower volumes of AminoShure products, related mainly to the adverse impact of the previously announced suspension of sales of AminoShure-L, 52% lysine (the "Product") in the second quarter of 2012. Global feed grade choline product sales increased by approximately 5.1% due to modest price increases, implemented globally, to partially offset increased raw material costs. The Company experienced increased sales of various choline and choline derivative products used for industrial applications, predominantly in North America, including usage in fracking for natural gas. Industrial sales grew 20.4% over the prior year with the increase coming primarily from higher volumes for usage in fracking. Sales for industrial applications comprised approximately 34.7% of the sales in this segment for 2013.

Gross Margin

Gross margin for 2013 increased to $97,421 compared to $89,539 for 2012, an increase of 8.8%. This $7,882 increase was principally a result of higher sales volumes. Gross margin percentage for 2013 increased to 28.9% as compared to 28.8% in the prior year comparative period, primarily due to operating efficiencies from higher volumes, which were partially offset by increases in certain key raw material costs. Gross margin percentage for the Specialty Products segment increased by 0.7% primarily due to product mix and operating efficiencies from higher volumes. Gross margin percentage in the Food, Pharma & Nutrition segment decreased by 2.3% primarily due to higher raw material costs for human choline products. Gross


margin percentage in the Animal Nutrition and Health segment increased by 0.9%, principally due to operating efficiencies from increased volumes.

Operating Expenses

Operating expenses for 2013 were $31,819, as compared to $29,762 for 2012, an increase of $2,057 or 6.9%. This was principally due to an increase of employee headcount and additional compensation-related expenses totaling $1,039, higher outside services and professional fees of $277 and increased advertising of $238. Operating expenses were 9.4% of sales or 0.2 percentage points less than the operating expenses as a percentage of sales in the prior year. During 2013 and 2012, the Company spent $3,622 and $3,422 respectively, on research and development programs, most of which pertained to the Company's Food, Pharma & Nutrition and Animal Nutrition & Health segments.

Earnings From Operations

Principally as a result of the above-noted details, earnings from operations for 2013 were $65,602 as compared to $59,777 for 2012, an increase of $5,825 or 9.7%. Earnings from operations as a percentage of sales ("operating margin") for 2013 increased to 19.5% from 19.3% for 2012. The Company is continuing to focus on leveraging its plant capabilities, driving efficiencies from core volume growth, broadening product applications of human and animal health specialty products into both the domestic and international markets, as well as capitalizing logistically on the Company's varied choline production capabilities. Earnings from operations for the Specialty Products segment were $20,224, a decrease of $108 or 0.5%, primarily due to certain higher operating expenses, which were partially offset by the above-noted higher sales of propylene oxide and operating efficiencies from increased volumes. Earnings from operations for Food, Pharma & Nutrition were $11,233, a decrease of $102 or 0.9%, due largely to the aforementioned higher raw material costs for human choline products, which were partially offset by the previously-noted higher sales. Earnings from operations for Animal Nutrition & Health increased by $6,035 or 21.5% to $34,145, principally due to the aforementioned higher sales and operating efficiencies from increased volumes, partially offset by certain higher operating expenses.

Other Expenses (Income)

Interest income for 2013 totaled $277 as compared to $10 for 2012. The Company has invested available cash primarily in certificates of deposit and money market investments that have been classified as cash equivalents due to the short maturities of these investments. Interest expense was $24 for 2013 compared to $10 for 2012. Other expense of $37 for 2013 is primarily the result of unfavorable fluctuations in foreign currency exchange rates between the US Dollar (the reporting currency) and foreign functional currencies. Other income of $67 for 2012 is primarily the result of a favorable adjustment related to a prior year sale of a non-core calcium carbonate product line.

Income Tax Expense

The Company's effective tax rate for 2013 and 2012 was 31.8% and 33.2%, respectively. This decrease in the effective tax rate is primarily attributable to the timing of certain tax credits and deductions.

Net Earnings

Principally as a result of the above-noted details, net earnings were $44,874 for 2013, as compared with $40,005 for 2012, an increase 12.2%.


Fiscal Year 2012 compared to Fiscal Year 2011
(All amounts in thousands, except share and per share data)

Net Sales

Net sales for 2012 were $310,393 as compared with $291,867 for 2011, an increase of $18,526 or 6.3%. Net sales for the Specialty Products segment were $49,990 for 2012, as compared with $47,851 for 2011, an increase of $2,139 or 4.5%. Approximately 83% of this increase in sales was from ethylene oxide products for medical device sterilization, resulting from higher volumes and modest price increases to partially offset rising raw material costs. The balance of the increase is principally a result of higher sales from propylene oxide for use in the fumigation of certain nut meats and spice fumigation. Net sales for the Food, Pharma & Nutrition segment were $44,070 for 2012 compared with $42,525 for 2011, an increase of $1,545 or 3.6%. This result was primarily due to a $2,547 increase in sales of human choline for both food applications and the supplement markets. Partially offsetting this was a 6.1% decrease in sales in the food market, principally due to lower volumes sold of encapsulated ingredients. Also offsetting the increased sales was lower sales of calcium products, which were down approximately $301, a result of our having sold this product line in late 2010, but which was still winding down in 2011. Net sales of $216,333 were realized for 2012 for the Animal Nutrition & Health segment, as compared with $201,491 for the prior year comparable period, an increase of $14,842 or 7.4%. The ANH specialty ingredients, largely targeted to the ruminant and companion animal markets, realized 22.3% sales growth from the prior year comparable period. The improvement was due to volume increases, as some regional improvement in global dairy economics supported greater demand, particularly for our rumen protected choline, lysine, and methionine products. However, during the second quarter of 2012, the Company announced a decision to suspend sales of its AminoShure-L, 52% lysine. There were no safety concerns relating to the Product; however, research indicated that the lysine bioavailability of the Product was lower than originally designed and projected, hence found to not meet our internal expectations. The sales credits issued related to this decision were approximately $1.0 million in this period. Global feed grade choline product sales decreased by approximately 2.4% due to lower volumes, partially offset by modest price increases, implemented globally, partially offsetting rising raw material costs. In addition, sales of the Company's European produced product were unfavorably impacted by foreign currency fluctuations totaling $2,838 or a 2.7% decline in global feed grade choline product sales. The Company experienced increased sales of various choline and choline derivative products used for industrial applications, predominantly in North America, including usage in fracking for natural gas. Industrial sales grew 16.1% over the prior year with the increase coming primarily from higher volumes for usage in fracking, along with increased average selling prices, which partially offset rising raw material costs. Sales for industrial applications comprised approximately 31.8% of the sales in this segment for 2012.

Gross Margin

Gross margin for 2012 increased to $89,539 compared to $86,001 for 2011, an increase of 4.1%. This $3,538 increase was principally a result of higher sales and a favorable product mix, partially offset by increased raw material costs and approximately $800 due to the net effect of the aforementioned Product sales suspension. Gross margin percentage for 2012 decreased to 28.8% as compared to 29.5% in the prior year, primarily due to increases in certain key raw material costs and the impact of the Product sales suspension. Partially offsetting this was a favorable product mix. Gross margin percentage for the Specialty Products segment increased by 0.7% primarily due to a favorable product mix. Gross margin percentage in the Food, Pharma & Nutrition segment decreased by 0.8% primarily due to higher raw material costs and an unfavorable product mix. Partially offsetting this was the sale of the non-core calcium carbonate product line in the fourth quarter of 2010, which was winding down in 2011. Gross margin percentage in the Animal Nutrition and Health segment decreased by 0.6%, principally from increases in the cost of certain petro-chemical raw materials used to manufacture choline and the impact of the Product sales suspension, partially offset by higher overall Animal Nutrition & Health sales volumes and a favorable product mix.


Operating Expenses

Operating expenses for 2012 were $29,762, or flat as compared to $29,776 for 2011. This was principally due to lower consultancy fees of $413 primarily incurred to study acquisition opportunities and related to the 2010 Aberco acquisition that were incurred during 2011. Also contributing to the decrease was lower advertising of $168. Offsetting this was increased research costs of $377 and $160 related to the Product sales suspension. Operating expenses were 9.6% of sales or 0.6 percentage points less than the operating expenses as a percentage of sales in last year's comparable period. During 2012 and 2011, the Company spent $3,422 and $2,890 respectively, on research and development programs, substantially all of which pertained to the Company's Food, Pharma & Nutrition and Animal Nutrition & Health segments.

Earnings From Operations

Principally as a result of the above-noted details, earnings from operations for 2012 increased to $59,777 as compared to $56,225 for 2011, an increase of $3,552 or 6.3%. Earnings from operations as a percentage of sales ("operating margin") for 2012 was 19.3%, which was equivalent to 2011. The Company is continuing to focus on leveraging its plant capabilities, driving efficiencies from core volume growth, broadening product applications of human and animal health specialty products into both the domestic and international markets, as well as capitalizing logistically on the Company's varied choline production capabilities. Earnings from operations for the Specialty Products segment were $20,332, an increase of $1,696 or 9.1%, primarily due to the above-noted higher sales of ethylene oxide and propylene oxide, and certain lower operating expenses. This was partially offset by the aforementioned higher raw material costs. Earnings from operations for Food, Pharma & Nutrition were $11,335, an increase of $222 or 2.0%, due largely to the above-noted increased sales of human choline products and the sale of the non-core calcium carbonate product line in the fourth quarter of 2010, which generated an operating loss in 2011. Partially offsetting this was lower sales volumes in the food market and higher raw material costs. Earnings from operations for Animal Nutrition & Health increased by $1,634 to $28,110, a 6.2% increase from the prior year comparable period, principally due to the aforementioned increased sales, favorable product mix, and certain lower operating expenses, partially offset by increases in the cost of certain petro-chemical raw materials used to manufacture choline and the impact of the Product sales suspension.

Other Expenses (Income)

Interest income for 2012 totaled $10 as compared to $184 for 2011. Interest expense was $10 for 2012 compared to $84 for 2011. Other income of $67 for 2012 is primarily the result of a favorable adjustment related to a prior year sale of a non-core calcium carbonate product line. Other income of $413 for 2011 is primarily the result of a net gain of $243 related to the sale of a non-core calcium carbonate product line and 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 2012 and 2011 was 33.2% and 31.7%, respectively. This increase in the effective tax rate is primarily attributable to a change in apportionment relating to state income taxes and the timing of certain tax credits.

Net Earnings

Principally as a result of the above-noted details, net earnings were $40,005 for 2012, as compared with $38,765 for 2011, an increase of 3.2%.


LIQUIDITY AND CAPITAL RESOURCES
(All amounts in thousands, except share and per share data)

Contractual Obligations

The Company's contractual obligations as of December 31, 2013, 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)   $   3,939     $       921     $     1,607     $     1,144     $         267
Purchase obligations (2)              8,043           8,043               -               -                 -
Total                             $  11,982     $     8,964     $     1,607     $     1,144     $         267

(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).

(2) Principally includes open purchase orders with vendors for inventory not yet received or recorded on our balance sheet.

The table above excludes a $2,374 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.

The Company expects its operations to continue generating sufficient cash flow to fund working capital requirements and necessary capital investments. The Company is actively pursuing additional acquisition candidates. The Company could seek additional bank loans or access to financial markets to fund such acquisitions, its operations, working capital, necessary capital investments or other cash requirements should it deem it necessary to do so.

Cash

Cash and cash equivalents increased to $208,747 at December 31, 2013 from $144,737 at December 31, 2012 primarily resulting from the activity detailed below. At December 31, 2013, the Company had $6,799 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 as needed and potentially invest in additional 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 operations in the U.S., we could be required to pay additional U.S. taxes to repatriate these funds. Working capital amounted to $242,021 at December 31, 2013 as compared to $181,675 at December 31, 2012, an increase of $60,346.

Operating Activities

Cash flows from operating activities provided $55,692 for 2013 compared to $53,781 for 2012. The increase in cash flows from operating activities was primarily due to higher net earnings, partially offset by unfavorable changes in various components of working capital, particularly in inventories and accounts payable and accrued expenses, along with income taxes.


Investing Activities

Capital expenditures were $8,187 for 2013 compared to $13,883 for 2012. In 2013 and 2012, respectively, $3,341 and $7,281 of the capital expenditures were for the Company's new manufacturing facility in Covington, Virginia.

Financing Activities

At December 31, 2013 and December 31, 2012, the Company had no debt outstanding.

Proceeds from stock options exercised and restricted shares purchased totaled $9,082, $1,905 and $4,451 for 2013, 2012 and 2011, respectively. Dividend payments were $-0-, $11,703, and $4,311 for 2013, 2012 and 2011, respectively. $6,466, or $0.22 per share, of the 2012 dividend payments represents an accelerated dividend in 2012 that would normally have been paid in the first quarter of 2013, but was accelerated due to the anticipated increase in the federal tax on dividends paid after December 31, 2012.

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 amount recorded on the Company's balance sheet as of December 31, 2013 for this obligation is $1,152.
The postretirement plan is not funded. Historical cash payments made under such . . .

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