Balchem Corp Q3 FY2021 Earnings Call

Greetings and welcome to Balchem Corporation's Third Quarter 2021 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please follow the operator's instructions. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Martin Bengtsson, Chief Financial Officer. Thank you. You may begin.

Good morning, everyone. Thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending September 30, 2021. My name’s Martin Bengtsson, Chief Financial Officer; hosting this call with me is Ted Harris, our Chairman, CEO and President. Following the advice of our counsel, auditors and the SEC, at this time I would like to read our forward-looking statement. This release does contain or likely will contain forward-looking statements which reflect Balchem's expectation or belief concerning future events that involve risks and uncertainties. We can give no assurance that the expectations reflected in forward-looking statements will prove correct and various factors could cause results to differ materially from our expectations, including risks and factors identified in Balchem's Form 10-K. Forward-looking statements are qualified in their entirety by this cautionary statement. I will now turn the call over to Ted Harris, our Chairman, CEO and President.

Thanks, Martin. Good morning and welcome to our conference call. This morning we reported strong third quarter results with record third quarter sales in all three of our reporting segments, as well as record third quarter net earnings and adjusted EBITDA and strong free cash flow. Our revenues of $197.9 million were up 13% and our adjusted earnings from operations were $39.6 million, up 9.2% versus the prior year quarter. Our net income of $25 million, an increase of 16%, resulted in earnings per share of $0.77 on a GAAP basis. On an adjusted basis, our third quarter non-GAAP net earnings were $30 million, an increase of 11.3%, resulting in earnings per share of $0.92 on a non-GAAP basis and we continued to deliver strong cash flows. Cash flows from operations were $39.6 million for the third quarter, an increase of $4.3 million from the prior year, with quarterly free cash flow of $31.1 million. Before passing the call back to Martin to cover the detailed financial results, I would like to update you on a few items. Last quarter, we informed you that we experienced a flash flood event at our Verona, Missouri manufacturing facility in May. The plant was shut down for several weeks in the second quarter while we repaired affected equipment, cleaned the site and safely restarted activities. Since that time, the plant has been fully functional. And while this event was categorized as a once-in-500-year event, our focus has turned to implementing actions that will help to mitigate the impact of another such event. We recognized an additional $500,000 of expense in the third quarter, primarily due to additional expenses associated with the write-off of damaged inventory and the costs associated with external service providers used for the cleanup efforts. We do not expect any further expense associated with this event to impact subsequent quarters and should start to receive insurance reimbursements in the coming quarters. While we remain focused on maneuvering the company through the pandemic and our priorities remain the same: 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. We are increasingly having to focus on managing the extraordinary supply chain disruptions that are challenging the markets we operate within. We are experiencing severe input cost inflation, raw material shortages, logistics disruptions and labor availability issues. These challenges have been with us to some extent since the beginning of the year, but have accelerated as the year has progressed and certainly through the third quarter. We expect this trend to continue to accelerate in the fourth quarter of 2021 and be with us at least through the first half of 2022. We will continue to focus on dampening the impacts of these challenges by leveraging our global supply chain capabilities and redundancies to ensure continuity of production, while raising prices where we can to offset the extraordinary input cost inflation. Within our Human Nutrition & Health segment research conducted by Professor Marie Caudill at Cornell University into the role of choline and DHA and omega-3 fatty acid metabolism during pregnancy has been completed and a manuscript has been submitted for peer review. Also in the final stages of review is the long-awaited paper from Cornell University reporting on a seven-year follow-on study of offspring from mothers supplemented with adequate levels of choline during their third trimester of pregnancy. The seven to 7.5 year old children were subjected to a variety of validated cognitive tests and the first results are expected to be published soon. We expect the results of both of these studies to further support the need for choline supplementation. Additionally, we continue to accelerate our marketing efforts in the quarter, launching a functional beverage campaign promoting our choline and chelated minerals for functional beverage applications and a campaign introducing novel plant and dairy-based extruded protein crisps to the market. We also announced an agreement with the best-selling author of the children's book series Ninja Life Hacks to secure strategic partners for branded food products to enable food innovations that deliver on consumer demand for children's nutrition. In the third quarter, our Animal Nutrition & Health segment continued to progress several key strategic advances around the technical support for our products and portfolio. Our team was present to preview the early results from the updated and long-awaited nutrient requirements of dairy cattle, or NRC, from the National Academies of Sciences. The NRC committee reviewed all of the available research over the past 20 years and validated the beliefs that an effective source of rumen-protected choline fed to dairy cows before and after calving will increase milk production and efficiency in the subsequent lactation cycle, while also reducing the incidence of several metabolic health disorders. This exciting new NRC release emphasizes the importance of efficacious encapsulated products such as Reassure and it will certainly bring more focus on rumen-protected choline as a fundamental supplemental nutrient during the dairy transition period. Additionally, in our companion animal business there were numerous accepted publications and technical presentations made during the return of several important industry meetings. These included the National Animal Science Association, the International Food Technology Scientific Symposium and the highly anticipated return of the pet food industry's premier event, the Pet Food Forum held in Kansas City, Missouri. It was at this event that new research was presented demonstrating the important value proposition of our unique PetShure portfolio. Research was presented in collaboration with Auburn University that demonstrated the value of restructuring proteins derived from animal co-products for the manufacture of highly nutritious treats. This novel application uses our proprietary encapsulated ingredients and allows for a sustainable and nutritious ingredient option for treat and pet food manufacturers. The Pet Food Forum was also the venue for two other research presentations surrounding Valcom's technology. The first was new research demonstrating the value of PetShure encapsulated acids towards controlling Salmonella in raw meat-based diets conducted at Kansas State University. The second invited talk focused on the benefits of supplemental PetShure choline in controlling obesity in cats with that research being led by the Ontario Veterinary College at the University of Guelph. Within the Specialty Products segment, we started up a new manufacturing line for our Metalosate foliar-applied plant nutrition products at Balchem's existing complex in Merano, Italy. This new production capability in Europe will augment our existing North American production and will enhance our ability to serve the growing needs of our international customer base and strengthen the robustness of our supply chain capabilities. We have also substantially completed our project to consolidate seven ERP systems into one Microsoft Dynamics 365 with the recent go-live of our last major manufacturing site on the system. We now have near 100% of our revenues on the new system. We are extremely pleased with the completion of this project that was delivered on budget and on time relative to the pandemic-adjusted timeline. This initiative is critical for the continued growth and operational efficiency of the company and we are very pleased to move from focusing on implementation to realization of the many benefits of being on one integrated system across the entire company. Additionally, in our continuing effort to advance our environmental, social, and governance, or ESG efforts, Balchem celebrated the one-year anniversary of signing our commitment to the UN Global Compact principles. Since becoming a member of the UN Global Compact on September 30th, 2020, we have made significant progress and we are particularly proud of publishing in April of this year our 2030 goals to reduce both greenhouse gas emissions and water usage by 25% and all of the work that is going on across our company to realize these important goals. As we look back on the last year, joining the UN Global Compact was an important step in our continuous improvement journey relative to our corporate social responsibilities and the achievement of our higher purpose of making the world a healthier place. I'm now going to turn the call back over to Martin to go through the detailed consolidated financial results for the company and the results for each of our business segments.

Thank you, Ted. As Ted mentioned, overall, we delivered strong financial results in a challenging environment. Our third quarter net sales of $197.9 million were up 13% compared to prior year and we delivered strong sales growth in all three segments: Human Nutrition & Health, Animal Nutrition & Health, and Specialty Products. The impact of foreign exchange to our sales was minimal in the quarter, a positive $0.3 million primarily due to the stronger euro. Third quarter gross margin of $60.9 million was up $4.6 million or 8.1% compared to prior year. Our gross margin percent was 30.8% of sales in the quarter, down 139 basis points compared to 32.2% in the third quarter of 2020. The 139 basis point decrease was primarily due to increased raw material and freight and distribution costs, partially offset by higher selling prices. We've been managing inflationary pressures all year, although input cost increases further accelerated in the third quarter. In the third quarter, we experienced approximately $13 million of raw material inflation compared to the prior year quarter and approximately $4 million sequentially compared to the second quarter. In addition, freight and distribution costs have increased dramatically, driving approximately $2 million of increased costs in the quarter compared to the prior year. As mentioned by Ted earlier, we expect this trend of increased inflationary pressures on our input costs to continue into the fourth quarter and into 2022. As such, we have and we'll continue to work hard to recover these cost increases by passing them through to our customers. In the third quarter, we passed through approximately $10 million of price increases. There's usually a timing difference between increased costs and our ability to raise prices and we will continue to work hard to fully recover the higher costs over a period of time. Operating expenses for the third quarter of 2021 were $28.4 million as compared to $27.3 million in the prior year. The increase was primarily due to higher selling expenses driven by an increase in compensation-related costs and an increase in research and development, partially offset by the timing of an insurance recovery. GAAP earnings from operations for the third quarter were $32.5 million, an increase of $3.5 million or 12% compared to the prior year quarter. On an adjusted basis, non-GAAP earnings from operations of $39.6 million were up $3.3 million or 9.2% compared to the prior year quarter. Third quarter adjusted EBITDA of $48.3 million were $3.9 million or 8.8% above the third quarter of 2020. The company's effective tax rates for the third quarters of 2021 and 2020 were 22.0% and 22.7%, respectively. The decrease in the effective tax rate was primarily due to higher tax benefits from stock-based compensation and the prior year being negatively impacted by clarifying regulations related to tax reform. Net income closed the quarter at $25 million, up 16% from the prior year. This translated into diluted net earnings per share of $0.77, an increase of $0.11 or 15.5% from last year's comparable quarter. On an adjusted basis, our adjusted net earnings were $30 million or $0.92 per diluted share, up $3.1 million or 11.3% compared with the prior year quarter. We generated quarterly free cash flow of $31.1 million and we closed out the quarter with $90 million of cash on the balance sheet. As we look at it from a segment perspective, our Human Nutrition & Health segment generated record third quarter sales of $111.2 million, an increase of 7.3% from the prior year. The sales increase was driven primarily by strong sales growth within our Minerals and Choline Nutrients business that continues to see strong demand. We delivered double-digit sales growth in both the Choline and Mineral product lines while our Food business grew modestly with notable growth in encapsulated products. Our Human Nutrition & Health segment delivered quarterly earnings from operations of $19.8 million, an increase of 13.2% compared to the prior year quarter, primarily due to the aforementioned higher sales, favorable mix and the timing of an insurance recovery, partially offset by higher manufacturing input costs and distribution costs. Excluding the effect of non-cash expense associated with amortization of intangible assets of $4.3 million and excluding the direct expenses related to the Verona flash flood event of $0.2 million, adjusted earnings from operations for this segment were $24.3 million, an increase of 8.2%. Our Animal Nutrition & Health segment generated all-time record quarterly sales of $56.2 million, an increase of 21.2% compared to the prior year. The increase in sales was primarily the result of higher volumes and prices in both monogastric and ruminant animal markets. Our ruminant business grew volumes 7.4% and we continued to successfully drive penetration of our ruminant protected encapsulated products in the market. The dairy market remains volatile, although milk and milk protein prices remain at relatively healthy levels and are trending positively. On the monogastric side, overall volumes were up 11.3%, driven by higher volumes of feed-grade choline as well as strong demand for our animal chelated minerals and our offerings for the companion animal market. Animal Nutrition & Health quarterly earnings from operations of $7.4 million were up 6.1% from the prior year quarter due to the aforementioned higher sales, partially offset by an increase in manufacturing input costs and distribution costs. Excluding the effect of non-cash expense associated with amortization of intangible assets of $0.2 million and excluding the direct expenses related to the Verona flash flood event of $0.3 million, third quarter adjusted earnings from operations for this segment were $7.8 million, an increase of 9.4%. Our Specialty Products segment delivered record third quarter sales of $27.6 million, an increase of 20% compared to the prior year quarter, due to higher sales of products in both the plant nutrition business and medical device sterilization markets. Sales of our performance gases products, which largely go into the medical device sterilization market, grew nicely year-over-year but were down sequentially, showing the volatility in the return of elective surgeries and the recovery of this market. While our plant nutrition business is seasonal with the majority of business being in the first half of the year, we continue to see good growth year-over-year in this business with strong growth in the third quarter contributing to an approximate 30% growth year-to-date in that business. Specialty Products segment had third quarter earnings from operations of $6.5 million, an increase of 20.7% versus the prior year. The increase was primarily due to the aforementioned higher sales, partially offset by increases in manufacturing input costs and distribution costs. Excluding the effect of non-cash expense associated with amortization of intangible assets of $1.2 million, third quarter adjusted earnings from operations for this segment were $7.7 million, an increase of 11.5%. I'm now going to turn the call back over to Ted for some closing remarks.

Thanks Martin. We are very pleased with Balchem's financial results reported earlier this morning. We delivered record third quarter revenues in all three of our business segments, record third quarter net earnings and adjusted EBITDA and strong cash flows from operations. All of this while facing continued higher raw material costs and global logistics and distribution challenges. We also continue to progress our strategic growth initiatives and remain encouraged about the long-term growth opportunities ahead of us. These strong results continue to show that we are well positioned in attractive markets where we have the leadership and capabilities to be successful, not only today, but also into the future. I would now like to hand the call back over to Martin who will open up the call for questions. Martin?

Thank you, Ted. This now concludes the formal portion of the conference. At this point we will open up the conference call for questions.

Thank you. Our first question comes from the line of Bob Labick with CJS Securities. Please proceed with your question.

Good morning. Congratulations on a nice quarter. Great execution. I wanted to start. You touched on volume a little bit on the animal side, maybe talk about the overall demand environment. I know you have lots of little moving parts, so it might be hard, but is there a way to think about how much of the growth of the maybe 13% top line is volume-related versus price related? And then kind of a tack on to that question is, have you been constrained in reaching the demand out there because of the supply chain, raw material, labor, transportation and could volume even be higher, I guess, is the demand higher than what you're able to supply right now?

Yes Bob. Animal did very well in the quarter from a growth perspective, growing almost 21% on revenue. If you separate that between volumes and price, it's almost half and half where volumes were up around 10% and the remaining piece being higher selling prices. So, it's about half and half between those two. In terms of whether we could sell more given the demand, the demand is very strong at the moment across the board, not only in these businesses but almost across the board. The limiting factors at the moment are really raw material availability, labor availability, freight and distribution availability — not in all cases and in all areas of our businesses, but in many areas that is a little bit of a limiting factor versus where the demand sits. So, there is not a demand issue at the moment. It is really a matter of how effectively you can procure material, retain labor, run effective operations and get the products to the customers.

And just kind of adding to that Bob, I think if you look at the company as a whole, we delivered about 13% revenue. In round numbers you could think of about 7% of that driven by volume growth — so a little bit over half of that driven by volume growth and the rest being pricing-related growth, and a little bit of mix in there. Certainly, we've been constrained in some areas, not in all areas; in some areas it's quite significant and we're leaving maybe 10% volume growth on the table in those pockets. But I think when you look at it across the whole company, it might be a one to two percentage point growth that we're not able to fully supply because of some constraints, whether it's raw material or capacity at this point. So demand does remain strong. We're not able to fully satisfy it all, but we're doing everything we can to deal with all of these challenges that we're facing in the marketplace.

Got it, great. That's really helpful. And then as it relates to the nutrient requirements for dairy cattle, the NRC information you put in the release and mentioned the validation for Reassure, et cetera, how does that affect the market going forward? How do you get the word out there? How do you think that will play out ultimately for Reassure? And is this kind of a US centric organization, or does this potentially help boost the penetration in Europe, which I think is lagging the US?

That's very true that the last statement is accurate. If you remember we've been talking about the NRC for some years. It's been delayed. It still has not officially been released. We expect it to officially be released in December but effectively a preview of it was shared with the industry recently. We've also talked about this finding of the NRC is not maybe a grand slam for us, but it's a very good result that we're pleased with. Basically this is the handbook that many dairies, and primarily in North America, use to guide them and what they feed their cows. They also use nutritionists and there are a lot of opinions out there. But this is a basic guidebook that is very critical to the industry. What we have now is that guidebook for the first time saying that feeding an efficacious, rumen-protected choline does enhance milk production through the lactation cycle. The grand slam would have been if it had specified exact amounts to feed, and unfortunately it does not say that because the science isn't clear as to exactly how much you should feed, but we're pleased with the results. We are taking it upon ourselves, prior to the full release of this, to communicate in a series of webinars and podcasts the fact that this is out, what the finding is and what it means for the average dairy. We're really taking this and running with it. We think it's an important new step and we're really trying to leverage it. It does have some impact outside of the U.S. I think the U.S. is one of the most efficient dairy markets in the world, so dairy markets outside the U.S. do look to the U.S., and I think we'll be able to leverage it outside the U.S. That's not singularly a U.S. thing, but clearly driving increased U.S. penetration, we believe will be benefited by this new NRC finding.

That's great. That's very exciting. Super. Okay. One last one for me and I'll get back in queue. I know you've been busy looking at M&A for quite some time and the balance sheet continues to add cash. Any update on availability of M&A or valuations out there or opportunities for you?

We obviously can't talk about any specific opportunities that we're working on. But this is one of the hottest M&A markets that there's ever been. It's very active. There are a lot of properties for sale but that also comes with some of the highest valuations that we’ve ever seen. We're taking our responsibilities very seriously around wanting to augment our organic growth strategy with acquisitions but also doing it in a smart targeted way where we can earn a return. We've been involved in several processes but, at the end of the day, chose not to proceed on some assets, in part because we didn't feel the value was appropriate for the asset. We'll continue to do that. We're active. We think this hot market will present opportunities for us at the right value and correct strategic contribution to our company. We have $90 million of cash. Our net debt leverage ratio is effectively zero. We have the ability to act on acquisitions as they come. We're confident that those will come over time but we're going to continue to be selective and make sure we can get the right return on these. It is somewhat disappointing that we haven't been able to add an acquisition to our portfolio over the last couple of years, but we're working hard to get something done in the foreseeable future.

Okay. Great. Thanks so much.

Thanks. Thanks, Bob.

Our next question comes from the line of Ram Selvaraju with H.C. Wainwright. Please proceed with your question.

Hi, thanks very much for taking my question and certainly congratulations are in order for the performance in what continued to be a relatively challenging time. I wanted to drill down on the pricing situation and what its long-term implications may be. Because I think one of the things that we're curious to learn more about here is whether if you take price increases in the context of the current supply chain environment, how likely are these to remain sustainable even after the supply chain issues have gone away? In other words, you're talking about seeing healthy volume demand even at increased prices. So what implications does that have for the pricing paradigm that you might be able to sustainably enforce as it were going forward?

Maybe I'll take a stab at that and Martin can chime in with specifics. Obviously, it's a complicated environment that is more extreme than any of us have really seen before. We are seeing in many cases freight lanes up 1,000%, we're seeing certain raw materials up 500% or 200%; some with more modest increases. So it's an unusual environment. We'll have to see how much of that sustains over time and how much falls back. There's no question that our margins lag when we're in an inflationary environment. There's also no question that margins on the upside will lag as costs come down over time. It's hard to predict the speed that they'll come down, but we will see a beneficial lag effect when costs start to normalize and decline because of the nature of our pricing formulas. Some of our customers get the benefit of those as costs go up and we'll get the benefit as costs come down. So that's the primary answer to your question. It does raise the question around value-based pricing of our products in certain areas and the opportunity that they bring and I think we'll have to evaluate and possibly change our pricing practices going forward based on the new information and situations that we find ourselves in. We'll just have to see as we go.

Okay. And then with respect to the pet food segment you featured this to some extent in your prepared remarks. I was just wondering relativistically speaking, do you see this segment increasing meaningfully in importance as a driver of revenue growth over the course of the coming quarters?

Yes. The pet food business for us is already quite sizable — about a third of our monogastric business in total is pet food, essentially selling choline into the pet food industry. That's going to have more modest growth, but still healthy. What's growing rapidly are the PetShure products that we have launched over the last few years that are more specialty encapsulated and other products. For example, those grew 45% year-over-year in Q3. When you continue to grow at those kinds of rates, it can have a meaningful impact to the business. When you add that to the base companion animal business — the choline that we sell — this is an important segment to us. We feel there is a lot of innovation and opportunity to introduce novel products to the market and drive meaningful growth. We're pretty excited about the companion animal market and the products that we have to offer to it.

Okay. And then just very quickly a couple last few ones. Firstly, furthering the M&A discussion I was wondering to what extent you expect to potentially employ equity issuances as specifically an M&A tool, particularly given where the stock currently trades? And then I think these are just for Martin. I was wondering if you could offer some commentary on where you see the effective tax rate going? I think last quarter you were guiding towards it being around 23%. The effective tax rate currently looks like it's around 22%. So, how should we be thinking about that going forward? And then when do you expect to receive whatever insurance payouts are due in relation to the flash flood incident? Thanks.

Relative to using equity for acquisitions, we believe that is a tool in our toolbox and we have that ability to use equity. Having said that, it's highly likely we will maximize the borrowing component first and then move on to equity. Typically, you would see us use equity on a very sizable, more transformative type of acquisition as opposed to the types of M&A deals that we have done in the recent past. But it's definitely a tool that we have in the toolbox and we would use it if needed, probably only on something more transformative than where our focus has primarily been.

With regards to the tax rate, there has not really been a change from the last quarter discussion: the 2021 GAAP tax rate estimate of around 23% is still a good number, with the adjusted rate being about a percentage point higher than that — more like 24% based on where we sit today. Regarding the flash flood: we had about $3.8 million of expenses impacting the second quarter and another $0.5 million impacting the third quarter here, so call it $4.3 million of impact to the P&L. We do expect to get fully reimbursed for that less the deductible based on what we're seeing today. We expect to receive some payments here in the fourth quarter and then the remaining payments early next year as we finalize all the work with the insurance company. We do expect full recovery less the deductible.

Thank you very much.

Thanks, Ram.

Our next question comes from the line of Lawrence Goldstein, a private investor. Please proceed with your question.

Hi. On inflation, my own perspective is it's going to be a runaway. If you want to make that assumption with me for the moment, historically, the company has been able to raise prices. But with the time lag are you raising prices with a time lag now? The margins don't — you can't see that. So if and when the inflation stops, what about the stickiness of the price increases that you're making, if indeed, you are? Secondly, can you tell us about the size of the pet market? The companies that have gone public that service the United States pet market, which has grown enormously during the pandemic, are showing big increases similar to yours, but they've got hundreds of millions of sales, give us some idea of yours? And thirdly, I'm wondering, are many or any of the companies you have your eye on as acquisitions being acquired by others? And finally, in reverse, like Buffett said, if the phone don't ring, you'll know it's me. Does your phone ever ring?

On the last one, our phone has not rung yet. Regarding your first question, it's a really important one. It is an all-hands-on-deck type of situation relative to the inflation we're dealing with and needing to raise prices. Yes, we are absolutely raising prices, but with a lag. When costs are going up, that lag is negative to our margins. When you look at gross margins, they are impacted fairly significantly. We approximately had about $15 million of inflation hitting our P&L in Q3 and we raised prices to the tune of about $10 million. So that $5 million reflects, to some extent, the lag. We're raising prices additionally in Q4. Unfortunately, raw materials continue to escalate. So we expect in Q4 to continue to be on the unfavorable side of that lag. We are raising prices aggressively and benefiting our margins significantly because of that. If we hadn't, our margins would really be depressed. We'll continue to do that and when costs start to flatten and decline, we'll catch up and eventually be on the favorable side of that lag as things come down. As to stickiness, it's hard to tell at this point. There's so much inflation and volatility in the marketplace; we'll have to see how the situation evolves. Regarding the pet market size: it is a very sizable market. Our position is relatively modest in comparison, but our pet business in total is probably about a $50 million business with the bulk of that being the base choline we supply into the market and a smaller portion being the novel ingredients we've been introducing. Even the base part of the pet food market is growing faster than the monogastric market as a whole. We're bullish on the pet food market. A $50 million piece of our company is a sizable business for us and we have relevant positions with the big pet food companies, which gives us access we can leverage with new novel ingredients.

Thank you.

Our next question comes from the line of Mitra Ramgopal with Sidoti. Please proceed with your question.

Yes, hi. Good morning and thank you for taking the question. So I was just curious, given the inflationary environment and labor shortages you're seeing etc., are you more inclined to be less aggressive in terms of headcount expansion and sort of manage costs a little more aggressively?

Hi, Mitra. I would say we always evaluate all headcount expansions based on what we get in return for it. Fundamentally that has not changed in terms of how we evaluate our cost structure versus opportunities. The current environment is unique in the sense that when you look at your manufacturing footprint and the ability to properly staff the plants with hourly workers, that's a very challenging environment and very competitive at the moment. You see a scarcity of labor and wage inflation as a result. When we look at our overhead costs — selling, marketing and R&D — we have actually made a number of investments over the last two years based on opportunities we're seeing where we're generating returns. I don't think anything has fundamentally changed such that we will go after aggressive headcount reductions or cost cuts unless something unexpected happens. We always evaluate based on performance. We've proven over the last two years during the pandemic that we've kept it all together, delivered strong results and expect to continue to manage the situation well. Should that change, we'll reassess, but for now we continue with the strategy we've deployed.

And Mitra, I would add that we do not feel differentially impacted relative to our competitors and the market as a whole. The issues we're experiencing — raw material and labor pressures — are ones many others are also dealing with. That doesn't mean we don't have to manage them; we're working hard to do so.

Okay. That's great. Thanks. And then on the Specialty Products segment more specifically on the medical device sterilization, you had nice growth year-over-year, down a little sequentially. I was just wondering in terms of what you're seeing into the fourth quarter and your expectations for this business to ramp back as we counted in 2021?

We are pleased with the performance of Specialty Products in Q3, both the sterilization business and the plant nutrition business grew nicely. The sterilization business was up year-over-year but down sequentially. We did get some data from the industry in the U.S. around elective surgeries and it validated that elective surgeries were indeed up year-over-year but down sequentially. Partly that was pent-up demand that came back in Q2 that was somewhat fulfilled, and partly due to the rise in the delta variant cases in Q3. Our expectation is that we'll continue to see year-over-year growth in Q4 as this industry recovers, but it will likely be relatively modest year-over-year growth similar to what we saw in Q3 and not to the extent of the rebound in Q2.

Okay. Thanks. And then could you comment a little on the international markets in terms of what you're seeing on both the demand side and maybe on the cost especially areas like Italy or Belgium where you have a physical presence?

I'll start on the cost side. You're probably aware of the extreme inflation in Europe, particularly around natural gas. Many of our raw materials for choline, for example, and for our sterilization business stem from natural gas to one extent or another. That's a significant pressure. The natural gas crisis in Europe built in Q3 and continues to build and really started impacting us severely in September and will continue in Q4. Products derived from natural gas like urea, ammonia and methanol are important raw materials for us and those costs are going up dramatically. Europe is one area where the inflation is most extreme, but we're managing through it. It's not just higher costs; there's also curtailment — some suppliers are giving us only 75% allocation on certain raw materials because they're cutting back production as costs rise. It's a complicated supply chain. We do have pricing power and flexibility in Europe and fewer long-term locked-in contracts with customers there, so we're able to raise prices a bit faster; our lag is a little shorter in Europe than in the U.S., and we're leveraging that. From a demand side, demand remains quite strong across our businesses in Europe, similar to the U.S., and we see that continuing for the next few quarters.

Okay. Thanks again for taking the questions. Congrats.

Thanks, Mitra. Appreciate it.

Our next question comes from the line of Tony Polak, a private investor. Please proceed with your question.

A few questions. I didn't see what the amount of money in R&D was this quarter versus last quarter? Second, can you talk a little bit about any new products that you're working on? I know in the past some have been very successful. And could you talk a little bit about the Chinese choline situation and what's happening?

You take the analyst line. Tony, just quickly on R&D: we spent in the third quarter about $3.2 million versus $2.9 million in the prior quarter and $2.7 million in the first quarter, so approximately $300,000 more than the prior quarter from an R&D perspective.

I'll answer the Chinese choline question. The Chinese situation is fairly volatile. The Chinese are significant producers of animal-grade and industrial-grade choline and their participation in western markets has been up and down over the years for various reasons, whether shipment of contaminated product or regulatory initiatives that restricted production. Right now, costs in China are dramatically up and raw material costs are increasing there as well. They're also dealing with very high freight costs; all their production has to be containerized and shipped. For example, shipping containers from Malaysia to Antwerp used to be about €15,000 and are now about €20,000, which adds a lot to the landed cost of choline. So we're seeing less supply coming out of China today and the supply that is coming out is at higher prices. The so-called "Blue Skies" initiative is somewhat back, and with the Olympics and other factors there's curtailment of certain production. That is restraining supply from China and raising costs, providing some short-term opportunity for us depending on our ability to get raw materials and produce at capacity. So that's the latest on Chinese choline — another notch in the volatile history of product coming out of China.

On new products: our R&D teams have continued to innovate through the pandemic. The product we've talked most about is AminoShure-XM that we launched a couple years ago; it is having a meaningful impact on our revenue within Animal & Health and is relatively new to the market. I also discussed PetShure products, which are largely encapsulated and include flavor inclusion systems that we have high hopes for. We are also bringing Z-crisps — plant and dairy protein crisps ideal for inclusion in bars and nutritional products — to market, making hemp and pea protein-based crisps. New product development continues to be an important part of our growth. We're still achieving about 25% of our revenues based on products introduced to the market in the last five years and we're pleased with that; we'll continue to push that metric upward with additional launches.

Thank you.

There are no further questions in the queue. I'd like to hand the call back over to Ted Harris for closing remarks.

Okay. Once again thank you very much for joining our call today. We really are very pleased with the third quarter 2021 results that we released today and the ongoing progress we're making on our key strategic growth initiatives. We really appreciate your time. We look forward to reporting Q4 2021 results in February. We'll be presenting at a few conferences: the Baird Industrial Conference in November and the Stephens Annual Investment Conference in December. Hopefully we'll see you or talk to you at one of those meetings. Thank you again for joining today. Appreciate it.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.