Earnings Call Transcript - BCPC Q1 2021

Operator, Operator

Greetings, ladies and gentlemen, and welcome to the Balchem Corporation's First Quarter 2021 Earnings Conference Call. Operator instructions were provided to participants. It is now my pleasure to introduce your host, Mr. Martin Bengtsson. Thank you. Sir, you may begin.

Martin Bengtsson, Chief Financial Officer

Good morning everyone. Thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending March 31, 2021. My name is Martin Bengtsson, Chief Financial Officer. And 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 will 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.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Martin. Good morning and welcome to our conference call. This morning we reported strong first quarter results with solid revenue growth, earnings growth and free cash flow growth. Our revenues of $185.7 million were up 6.4% and our adjusted earnings from operations were $37.3 million, up 7.5% versus the prior year quarter. Our first quarter net income of $23.4 million, an increase of 18.4%, resulted in earnings per share of $0.72 on a GAAP basis. On an adjusted basis, our first quarter non-GAAP net earnings were $28.4 million, or $0.87 per share, an increase of 7.1%. And we continue to deliver strong cash flows. Cash from operations was $40.6 million for the first quarter of 2021 with quarterly free cash flow of $34.4 million, an increase of 97.7% compared to the prior year quarter. Overall, a great start to 2021. And while there are many challenges to manage in the overall macroeconomic environment at the moment, these results highlight the strength and resilience of our business model. Before passing the call back to Martin to cover the detailed financial results, I would like to update you on the impact of COVID-19 on our company, as well as a few of our important strategic activities and growth initiatives. It is incredible to think that it has been more than one year that we have all been living with the COVID-19 pandemic and all of the related challenges it has created. This time last year, we were talking with you about our early response actions of activating our crisis management team, helping domestic and international travel, implementing new strict safety protocols at our manufacturing sites, working from home for our office employees, and stress testing our balance sheet to ensure we could withstand extreme scenarios as we headed into the market uncertainties ahead of us, just to name a few. While the pandemic is certainly not behind us yet, 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 extremely pleased with our response to the pandemic. And ultimately, the performance of the company in light of the challenges we have faced. We have indeed responded well to the changes in this dynamic market environment. And we are today having to respond to new challenges that are at least partly related to the pandemic as well as the economic recovery, regarding significantly higher raw material and freight costs. While we don't believe these cost increases are differentially impacting Balchem, we are having to dedicate significant resources to various mitigating activities to effectively manage through this aspect of the pandemic and macroeconomic environment, just as we have through all previous challenges stemming from the pandemic. Moving on to a few highlights relative to our important strategic activities and growth initiatives. Within our Animal Nutrition and Health segment, the launch of AminoShure-XM, our next-generation rumen-protected offering for the dairy market continues to go well. As the product is gaining acceptance with progressive dairy producers we are looking to maximize profitability by growing the milk protein portion of their output. Additionally, our companion animal team has been working hard to grow our PetShure line of products, including several sensory-related products. We are excited to have one of these PetShure sensory products included in a recently launched fruit-flavored dog treat product by a leading brand. We continue to be bullish about the companion animal market and our ability to bring differentiated solutions to solve the new and developing needs of the market. To that end, we have a large number of Balchem-sponsored research trials relating to our PetShure line of products that have been submitted for presentation at scientific meetings in 2021. We're also celebrating today our one-year anniversary of the Real Science lecture series, which has now expanded to include all three species segments—ruminants, swine, and poultry—and companion animals. These educational and science-based webinars have been hugely successful, attracting over 8,000 live attendees, and over 17,000 people have watched the recorded sessions. This pivot of our marketing approach during the pandemic has enabled us to effectively reach and interact with an expanded target audience, despite the pandemic. And speaking of marketing approaches, as we have talked about in the past, our Human Nutrition and Health segment has strengthened its marketing capabilities to accelerate awareness around existing science and to better showcase to our customers through marketing campaigns how they can incorporate and benefit from our products. This year, we launched three new marketing campaigns. The first was focused on the benefits of our Albion-branded chelated magnesium as a solution for sleep and relaxation. The second showcased the importance of choline in a prenatal vitamin regimen. And the third was a new food campaign that was based on proprietary market research focused on consumer interests around products featuring our novel inclusions for baked goods applications. In the coming months, we'll be highlighting campaigns around immunity, cognition and our enhanced capabilities in protein crisps and beverage. We're excited by how these campaigns are already creating opportunities by developing new leads and building loyalty among existing customers. In the quarter, we also continued to progress our efforts to consolidate all of our ERP systems into one, Microsoft Dynamics 365. This initiative is critical for the continued growth and operational efficiency of the company. We successfully added one more site to the new system in the quarter, leaving just two international sites left on legacy systems. We now have approximately 96% of our revenues on the new system and remain on track to complete implementation of the project this year. Additionally, in our continuing effort to advance our environmental, social and governance (ESG) efforts, Balchem proudly signed the CEO Action for Diversity & Inclusion pledge as a further commitment to advance diversity and inclusion within our workplace. The CEO pledge outlines a specific set of actions the signatory CEOs will take to cultivate a trusting environment where all ideas are welcomed, and employees feel comfortable and empowered to have discussions about diversity and inclusion. Just earlier this week, we released our third sustainability report, which captures the company's commitment to managing our ESG performance. This report demonstrates the company's continuing promise to provide our employees, customers, shareholders and the communities within which we operate with information on Balchem sustainability initiatives. Of particular note in this year's report, we have for the first time published our 2030 goals to reduce both greenhouse gas emissions and water usage by 25% by that year. We are very proud of the report and the progress we have been making, and I would encourage you to go to balchem.com to read the report. While on balchem.com, you will also notice that our website was recently updated, consolidating all of our many legacy Balchem websites into one with a more modern look, feel and navigation capability that should serve us well as we continue to grow and become more global. I'm now going to turn the call back over to Martin to go through the detailed financial results and the results for each of our individual segments. Martin?

Martin Bengtsson, Chief Financial Officer

Thank you, Ted. As Ted mentioned, we delivered overall strong financial results in a challenging environment. Our first quarter net sales of $185.7 million were 6.4% higher than the prior year comparable quarter. We delivered record sales in our Human Nutrition and Health and Animal Nutrition and Health segments, while showing sequential improvement and slight year-over-year growth in the Specialty Product segment. The impact of foreign exchange to our sales was a positive $2.4 million, primarily due to the stronger euro, contributing a positive 1.35% impact for year-over-year sales growth. Our first quarter consolidated gross margin dollars of $58.7 million were up $3.4 million or 6.1% compared with $55.3 million for the same period in the prior year. Our consolidated gross margin percent was 31.6% of sales in the quarter, down 9 basis points compared to 31.7% in the first quarter of 2020. The 9 basis point decrease was primarily due to a significant increase in certain raw material and distribution costs, partially offset by favorable mix and manufacturing efficiencies. Consolidated operating expenses for the first quarter of 2021 were $28.2 million as compared to $29.1 million in the prior year. The decrease was principally due to a decrease in transaction and integration costs, travel, bad debt, and amortization, partially offset by certain higher compensation-related costs. Looking forward, we will continue to focus on controlling our operating expenses and leveraging our existing SG&A infrastructure where possible. GAAP earnings from operations for the first quarter were $30.6 million, an increase of $4.3 million or 16.4% compared to the prior year quarter. On an adjusted basis, as detailed in our earnings released this morning, non-GAAP earnings from operations of $37.3 million were up $2.6 million or 7.5% compared to $34.7 million in the prior year. Record adjusted EBITDA of $45.7 million was $3.4 million or 7.9% above the first quarter of 2020 and interest expense for the first quarter of 2021 was $0.7 million and our net debt was $65 million with an overall leverage ratio on a net debt basis of 0.4. The company's effective tax rates for the first quarter of 2021 and 2020 were 21.9% and 19.3%, respectively. The increase in the effective tax rate was primarily due to reduction in certain tax credits, and higher enacted tax rates in several states within the United States. Consolidated net income closed the quarter at $23.4 million, up 18.4% from the prior year quarter. This quarterly net income translated into diluted net earnings per share of $0.72 for the current year, an increase of $0.11 or 17.9% from last year's comparable quarter. On an adjusted basis, our first quarter adjusted net earnings were $28.4 million or $0.87 per diluted share, up $2 million or 7.6% compared with the prior year quarter. We generated quarterly free cash flow of $34.4 million, up 98% compared to prior year quarter and we closed out the quarter with $88.5 million of cash on the balance sheet. From a segment perspective, for the quarter, our Human Nutrition & Health segment generated record quarterly sales of $104.5 million, an increase of $9 million or 9.4% from the prior year. The sales increase was driven both by strong sales growth of chelated minerals and choline nutrients as well as higher sales within food and beverage markets. Our minerals and choline nutrients business saw increased demand when the COVID-19 pandemic started last year and there have been no signs of any slowdown to date. In fact, the last two quarters have shown sequential growth in this part of the portfolio and we're pleased to see the increased awareness around the health benefits of these products. We were also pleased to see the growth on the food ingredient side of our business, where we are seeing a modest but steady improvement in food service along with a gradual reopening of our economy. Our Human Nutrition & Health segment also delivered record quarterly earnings from operations of $19.7 million, an increase of $7.6 million, or 62.3% compared to prior year, primarily due to the aforementioned higher sales, product mix, and manufacturing efficiencies, partially offset by higher raw material costs. Our Animal Nutrition & Health segment generated record quarterly sales of $51.1 million, an increase of 5.2% or $2.5 million compared to the prior year. The increase in sales was primarily the result of higher sales in both monogastric and ruminant animal markets, and a favorable impact related to changes in foreign exchange rates, which contributed $1.4 million or 2.8% of growth to the segment. Our ruminant business grew volumes 6.5%, and we continue to successfully drive penetration of our rumen-protected encapsulated products in the market. In terms of dairy economics, milk and milk protein prices continue to be volatile and have come down a bit during the first quarter, but are still at relatively healthy levels. On the monogastric side, overall volumes were relatively flat, with good growth in companion animals, as well as U.S. feed grade calling, but offset by lower European demand for calling. Animal Nutrition & Health quarterly earnings from operations of $5.1 million were down $3.0 million, or 37.1% from the prior year quarter, primarily due to increases in raw material costs and distribution costs, along with an unfavorable mix. We have arrangements in place to recover a significant portion of the raw material increases through price increases to our customers. However, there is a timing delay between the raw material inflation and the selling price adjustments, and there is on average a one-quarter delay. Our Specialty Products segment delivered quarterly sales of $28.0 million, up very slightly from the same quarter in 2020, primarily due to higher sales of products for the medical device sterilization market, and a favorable impact related to changes in foreign currency exchange rates, offset by lower sales in the plant nutrition business. While volumes related to sales into the device sterilization markets were down on a year-over-year basis, they improved sequentially versus the fourth quarter of 2020. It is encouraging to see gradual improvement as elective surgeries are slowly recovering. The Specialty Product segment had first quarter earnings from operations of $7.2 million versus $8.0 million in the prior quarter, a decrease of $0.8 million, or 10%. The decrease was primarily due to increases in raw material costs and distribution costs. I'm now going to turn the call back over to Ted for some closing remarks.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Martin. We are extremely pleased with the outcomes and financial results reported earlier this morning, and we certainly carried the positive momentum from 2020 into 2021. In the first quarter of 2021, we delivered all-time record revenues with revenue growth in all three of our business segments, not only versus the prior year's quarter, but also sequentially versus the fourth quarter 2020, reflecting the modest, gradual reopening of economies around the world. We achieved record first quarter consolidated GAAP net earnings, record quarterly non-GAAP adjusted net earnings, record adjusted EBITDA, and strong cash flows from operations, while facing certain higher raw material and distribution costs and complexities associated with logistical disruptions. These very strong results reported today 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?

Martin Bengtsson, Chief Financial Officer

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

Operator, Operator

Thank you. Operator instructions were provided to participants. Our first question comes from the line of Bob Labick with CJS Securities. Please proceed with your question.

Bob Labick, Analyst, CJS Securities

Good morning, and congratulations on an excellent start to the year.

Martin Bengtsson, Chief Financial Officer

Thanks, Bob.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Bob.

Bob Labick, Analyst, CJS Securities

I wanted to start with one of the things you mentioned in your prepared remarks. You talked about strengthening the marketing to accelerate awareness. Could you expand upon that a little bit? Are you using new channels? Are you spending more dollars? Is this like a shift in dollars? What was the impetus behind this? How should we think about where you were, where you are, and where you're going in these marketing campaigns?

Ted Harris, Chairman, Chief Executive Officer and President

Yes, we're really excited about the changes that we have made. Overall, it's more of a shift in dollars as opposed to a dramatic increase. We traditionally relied more on basic advertising as well as the efforts of our sales organization. While the sales organization remains a critical part of building awareness, we've also added to the team some real marketing expertise and capability and are paying for that a little bit with reduced advertising expense and are now able to do campaigns in house. For example, some of the campaigns I talked about we've recently really done on our own. We've added not only marketing expertise and leadership, we've added market research capabilities that we never had before. We're conducting focus groups and really digging into the needs of the market and trying to target those needs with these campaigns. So we're not spending a lot more than we used to; it's really a shift toward building internal capabilities and we're really pleased with the initial progress from all of that.

Bob Labick, Analyst, CJS Securities

Got it. That's great, thank you. And then I know you highlighted this a little bit—I wanted to get more specific in terms of margins. The Human Nutrition & Health margins were, I think, a couple of years, if not all-time high on the adjusted EBIT basis and then obviously, Animal Nutrition & Health and Specialty were more impacted by raw materials. So the question is one, what was the driver of the H&H margins and has anything materially changed for the long term or is this timing, mix, etc.? And just how should we think about the recovery from the raw material pressures in A&H and Specialty? Thanks.

Martin Bengtsson, Chief Financial Officer

Hi. If you take Human Nutrition & Health first, you did see very strong margins in the first quarter. It's primarily driven by favorable product mix in the sense that you have very strong minerals and nutrients, which relatively speaking have higher margin compared to the food ingredients. As those minerals and nutrients are growing at very rapid rates—20%, 30%—that drives a favorable mix that's helping the margin. In addition, they also had a strong manufacturing quarter. In previous quarters we mentioned some of the inefficiencies we saw in manufacturing operations negatively impacting results, and in the first quarter, as we worked through many of those issues, we saw an uptick and improved performance which also helped margins for H&H. For Animal Nutrition & Health and Specialty Products, both were significantly impacted by raw materials and freight and distribution. For a number of our key raw materials, prices started to creep up in the fourth quarter but really took off in the first quarter in terms of material inflation. On our ability to price that through to our customers, we are usually in a relatively good position to recapture that through pricing, and over time the margins tend to come back. But it takes a quarter and sometimes two quarters to recapture that. Some of our pricing arrangements have language around index-based adjustments tied to commodity indices, but we can’t always tie back to the actual raw material inflation itself. There is generally a quarter lag to implement selling price adjustments. So an upward trend creates margin pressure until pricing catches up; in a downward trend it helps margins in the same way. Over time, historically, it tends to even out and margins return to averages.

Bob Labick, Analyst, CJS Securities

Got it. Super, thank you so much.

Operator, Operator

Thank you.

Martin Bengtsson, Chief Financial Officer

Thank you, Bob.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Bob.

Operator, Operator

Our next question comes from the line of Mark Connelly with Stephens Incorporated. Please proceed with your question.

Mark Connelly, Analyst, Stephens Incorporated

Thanks. If we start with the human side, I was hoping you could help us understand where the volume growth is coming from in terms of: is it higher volumes on existing customer products or is it new launches? It feels like product launches are accelerating, so I'm curious what your perspective has been.

Ted Harris, Chairman, Chief Executive Officer and President

So, Mark, I will take that one. It is somewhat across the board—if you look at all of our product lines and sub-businesses within Human Nutrition & Health, essentially they all grew in the first quarter, some more than others. There was significant growth of existing products with increased demand in the marketplace. Minerals and nutrients are being driven by increased awareness around nutrition and the immunity-boosting nature of many of our products. Those are essentially existing products with increased demand. In food, we are seeing the pickup in foodservice and those are existing products selling to a greater extent, but we are also seeing our customers launch new products. For example, some of our customers have come out with product line extensions that include our VitaCholine—launches such as yogurt pouches and drinks fortified with choline, and baby puffs with VitaCholine are product line extensions. So we are seeing benefits from new products being launched to consumers that include our products. I would say overall it's a mix of increased sales of existing products and launches of new consumer products, rather than a large number of brand-new Balchem fundamental products driving the growth at this point.

Mark Connelly, Analyst, Stephens Incorporated

Right. We've heard a lot of folks express concern that the immunity-boosting stuff would fall off, so it’s nice to hear it hasn't. Can you talk a bit about the EO products for agriculture? I know it's a small piece of the pie, but I'm curious how much of a resource investment it is for you and where you are going with it?

Ted Harris, Chairman, Chief Executive Officer and President

When we talk about our Specialty Products segment and plant nutrition, those are really chelated minerals for plant nutrition. We are not selling EO products. Within Specialty Products, we have a nice, profitable plant nutrition business that we view as a growth business that can continue to grow at double-digit rates. One challenge at times is weather, but for the last couple of years weather has cooperated and we have driven double-digit growth. We have differentiated micronutrient solutions for the marketplace and have launched some new Balchem products there that are making a difference. We have room to grow through market penetration, adding additional crops, and geographic expansion. It's a business with good representation around the globe and a lot of room to grow geographically, so we remain bullish on it even though Q1 was not the strongest for that business.

Mark Connelly, Analyst, Stephens Incorporated

That's helpful. I was jumping ahead to my next question: I am curious how you think the normalization of hospital activity is going to affect Performance Gases—are we going to see a bump up or down?

Ted Harris, Chairman, Chief Executive Officer and President

We believe overall we are going to see a bump up. We did see nice growth sequentially in our Performance Gases business—volume was up about 11% sequentially, which is a nice bump. Q4 was up a little over Q3, so we are seeing sequential improvement. Part of the Q1 increase may reflect some supply chain inventory building in anticipation of the return to elective surgeries, so some orders could have been placed in advance to build inventory. Stepping back, we believe Q2 will be up over Q2 of last year, Q3 up over Q3 of last year, and that trend should continue as elective surgeries come back. So it’s a bump up overall, with a caveat about some inventory build in the supply chain.

Mark Connelly, Analyst, Stephens Incorporated

Super helpful. Thank you.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks Mark. Appreciate it.

Operator, Operator

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

Mitra Ramgopal, Analyst, Sidoti

Yes, hi. Good morning. Thanks for taking the questions. First, coming back on margins: on the raw materials side it seems like price increases should mitigate most of the impact there, but I'm curious about the increase in distribution costs that you are seeing. What can you do to stem that back and when should we expect that to normalize for you?

Martin Bengtsson, Chief Financial Officer

Hi, Mitra. We certainly have a challenge with inflation right now. To dimensionalize it, if you look at price paid year-over-year in Q1 this year versus Q1 last year for the same products, that impact is about $4.0 to $4.5 million of increased price paid for the same inputs, so it's very relevant. On distribution costs, we have seen almost a 50 basis point impact to gross margin just from increased distribution costs due largely to international shipment issues—shortage of containers and negotiated rates not being available. You sometimes have to go to second, third, fourth options and pay higher prices because your first option declines your order. There's a limit to what we can do to reduce those costs as it's a supply and demand situation right now. The industry has been disrupted: demand is high and supply is low. We are focused on taking these increased costs and effectively passing them through to our customers. Ultimately, that is where we expect recovery to come from, because we are somewhat limited in how we can manage the input costs in this case.

Mitra Ramgopal, Analyst, Sidoti

Okay, that's great. Then on the pandemic recovery: with vaccine rollout and restrictions lifting, we'd expect the Specialty Products business to bounce back. On the Human Nutrition side, especially in foodservice, are improvements showing up yet or is it still too early?

Ted Harris, Chairman, Chief Executive Officer and President

We have talked about approximately $50 million to $60 million of sales that went into foodservice in 2019 that were significantly impacted, and we are absolutely seeing an increase in that business. It's still volatile and not fully consistent, but it's coming back in an encouraging way. Parts of the company have been negatively impacted by COVID and parts have been positively impacted—for example, the business with Keurig Dr Pepper benefited from work-from-home trends, which helped offset some foodservice declines. The strength and awareness built around supplements and other health-related products over the last year has staying power, and we expect continued strength in that business. As foodservice continues to come back over the course of the year, that will provide a positive offset and we feel good about the H&H business for the rest of the year.

Mitra Ramgopal, Analyst, Sidoti

That's great. Finally, you have done a great job on the balance sheet—steadily paying down debt while building cash. I'm curious about the acquisition pipeline—are you seeing opportunities now that might not have existed pre-COVID?

Ted Harris, Chairman, Chief Executive Officer and President

There was a short slowdown last year in the early stages of the pandemic and we even struggled a bit with how to do a transaction. The market is very active—lots of assets for sale—and we are back to being active. We've been involved in some processes that didn't ultimately make sense strategically or didn't present appropriate value, but we are active in the pipeline and encouraged about opportunities. We are also watching potential tax legislation which could influence private companies' decisions to monetize. So, we remain busy, active, and encouraged about the opportunities out there.

Mitra Ramgopal, Analyst, Sidoti

That's great. Thanks for taking the questions.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Mitra. Appreciate it.

Martin Bengtsson, Chief Financial Officer

Thanks, Mitra.

Operator, Operator

At this time, I would like to turn the floor back to Ted Harris for closing comments.

Ted Harris, Chairman, Chief Executive Officer and President

Thanks, Jen. Once again, I'd like to thank everybody for joining our call today and more importantly your continued interest in our company. We are really pleased with our first quarter 2021 results that we released today and the ongoing progress we are making on our key growth initiatives. As a reminder, please visit our website to look at our new sustainability report. We are really proud of it and I think you will be as well. We appreciate your time today and look forward to reporting on Q2 results in July. In the meantime, we will be presenting at several conferences: we will be at the Wells Fargo Industrials Conference on May 6, the Stephens Food & Ag Disrupted Conference on May 25, and the Jefferies Industrials Conference in August. We hope to see some of you at one of those events or in other forums. Thanks again for joining today. Appreciate it.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.