Balchem (NASDAQ:BCPC) Q3 2021 Earnings Call

0:00 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. If anyone can require operator assistance during a conference, please press star zero on your telephone keypad. 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.

0:29 Morning, everyone. Thank you for joining our conference call this morning to discuss the results of Balcombe Corporation for the quarter ending September 30th, 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 FCC, 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 Balkem'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 Balkem's Form 10-K.

1:16 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.

1:26 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 77 cents on a gap basis.

2:12 On an adjusted basis, our third quarter non-gap net earnings were $30 million, an increase of 11.3%, resulting in earnings per share of 92 cents 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.

3:03 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 recognize 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.

3:58 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.

4:44 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 and health segment, research conducted by Professor Marie Caudel at Cornell University into the role of choline in DHA and omega-3 fatty acid metabolism during pregnancy has been completed and a manuscript has been submitted for peer review.

5:38 Also in the final stages of review is a long-awaited paper from Cornell University reporting on the seven-year follow-on study of offspring from mothers supplemented with adequate levels of choline during their third trimester of pregnancy. The seven to seven and a half 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.

6:47 In the third quarter, our animal nutrition and health segment continued to progress several key strategic advances around the technical support for our products and portfolios. 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 belief 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 an efficacious encapsulated product such as Reassure, and it will certainly bring more focus onto rumen-protected choline as a fundamental supplemented nutrient during the dairy transition period.

7:54 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 PetShare portfolio. Research was presented in collaboration with Auburn University that demonstrated the value of restructuring proteins derived from animal coproducts for the manufacture of highly nutritious treats.

8:43 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 Valchem's technology. The first was new research demonstrating the value of PetSure 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 pet-sure choline in controlling obesity in cats, with that research being led by the Ontario Veterinarian College at the University of Guelph.

9:28 Within the specialty product segment, we started up a new manufacturing line for our metallisate foliar applied plant nutrition products at Balchem's existing complex in Murano, 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.

10:16 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 Thank you very much. We have made significant progress and we are particularly proud of publishing in April of this year of 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.

11:22 As we look back on the last year, joining the UN Global Compact was an important step Thank you, Ted. As Ted mentioned, overall, we delivered strong financial results in a challenging environment.

11:55 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 and health, animal nutrition and 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 were 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.

12:43 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.

13:35 As such, we have and will 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.

14:24 Gap 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-gap 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 or $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.

15:11 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 77 cents, an increase of 11 cents 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.

15:58 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 and 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.

16:43 Our human nutrition and 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 and 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.

17:50 Our ruminant business grew volumes 7.4%, and we continued to successfully drive penetration of our rumen-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 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.

18:42 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 product 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 Market. 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.

19:39 While our plant nutrition business is seasonal, with a 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 expenses 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.

20:39 Thanks, Martin. We are very pleased with Valchem'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?

21:31 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. Ladies and gentlemen, at this time we will be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Bob Lubick with CJS Securities. Please proceed with your questions.

22:11 Good morning. Congratulations on a nice quarter. Great execution.

22:16 Thanks, Bob. Thanks, Bob.

22:18 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 niches, 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? Yeah.

22:58 Yeah, Bob, an 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. and it is you know the limiting factors at the moment is really raw material availability, labor availability, freight and distribution availability where 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.

24:01 So I guess I would answer it as there's not a really 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.

24:23 Yeah, and just kind of adding to that, Bob, I think if you look at the company as a whole, we delivered about 13% revenue. I think that you could just in round numbers think of 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. And certainly we've been constrained in some areas, not in all areas. Some areas it's quite significant and we're leaving Maybe 10% volume growth on the table, but I think when you look at it across the whole company, it might be 100 basis points, a couple hundred basis points kind of growth that we're not able to fully supply because of some sort of constraint, whether it's raw material or capacity at this point. So demand does remain strong.

25:29 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.

25:42 Got it. Great. That's really helpful. Thanks. 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, etc. 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 U.S.-centric organization, or does this potentially help boost the penetration in Europe, which I think is lagging the U.S.?

26:15 That's very true, that last statement, certainly. And 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. And we've also talked about this finding of the NRC is not maybe a grand slam for us, but it's a really good result that we're pleased with and basically this is the handbook that many dairies and as you point out primarily in North America use to guide them in what they feed their cows they also obviously use nutritionists and so forth and there are a lot of opinions out there but this is a basic guidebook that is very critical to the industry and what we have is now that guidebook for the first time saying that feeding a rumen-protected, efficacious rumen-protected choline does enhance milk production through the lactation cycle.

27:38 The grand slam would have been if it had said, and you should feed this amount, 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 on ourselves prior to the full release of this to communicate in a series of webinars and podcasts the fact that this is out. What is the finding and what does it mean for the average dairy? So 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. And it does have some impact outside of the U.S. I think that the U.S. is one of the most efficient dairy markets in the world. So I think dairy markets outside the U.S.

28:41 do look to the U.S. And so I think we'll be able to leverage it outside the U.S. It's not singularly a U.S. thing, but clearly driving increased U.S. penetration, we believe, will be benefited by this new NRC finding.

29:03 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, you know, availability of M&A or, you know, valuations out there or, you know, opportunities for you?

29:31 Yes, certainly. You know, we obviously can't talk about any specific options. opportunities that we're working on. But we all probably know that 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 probably some of the highest valuations that we've ever seen. And so, you know, 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. And so we've been involved in several processes, have not at the end of the day been the new owner of those assets, at least in part because we didn't feel like the value of was appropriate for the asset. And we'll continue to do that.

30:35 We're active. We think this hot market, if you will, will present opportunities for us at the right value and the correct strategic contribution to our company. So you're right to point out we have $90 million of cash, our net Thank you. That's where we are. You know, somewhat disappointing that we haven't been able to add an acquisition to our portfolio over the last couple years, but we're working hard to get something done in the foreseeable future.

31:46 Okay, great. Thanks so much. Thanks. Thanks, Bob. Our next question comes from the line of Wren. with HC 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 continue to be relatively challenging times. So 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 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?

32:53 Maybe I'll take a stab at that and Martin can chime in with any specifics. Obviously, it's a complicated environment that maybe 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%, 200%. Obviously, some with more modest increases. So it's a very unusual, unprecedented, maybe it's an overused word today, but very unusual environment. So I think we're going to have to see how much of that sustains over time and how much falls back.

33:47 You know, there's no question that our margins lagged. as we see as we're in an inflationary environment to the negative. And there's no question to maybe your specific point that our margins to the positive will lag as costs come down over time. And it's very hard to predict the speed that they'll come down, but we will see a A beneficial lag effect when costs start to normalize and start to come down just because of the nature of their formulas and so forth. Some of our customers are getting the benefit of those as costs go up and we'll get the benefit of those as costs come down.

34:45 So that's, I think, the primary answer to your question. But it does raise the question around the value pricing of our products in certain areas and the opportunity that they bring. And I think we'll have to evaluate that and challenge our pricing practices going forward based on kind of this new information and these new situations that we find that So we'll just have to see as we go. Okay. And then with respect to the pet food segment, you know, you featured this to some extent in your prepared remarks. I was just wondering, you know, relativistically speaking, do you see this segment increasing meaningfully in importance as a driver of revenue growth over the course of the coming quarters?

35:43 I'll take that one as well. I think the answer to that is yes. The pet food business for us is already quite a sizable business. About a third of our monogastric business in total is pet food selling essentially choline into the pet food industry. That's going to have More modest growth, but still healthy. What's growing rapidly are the PetShore products that we have launched over the last few years that are really more specialty encapsulated and other products.

36:28 For example, those grew at 45% year over year in Q3. And when you continue to grow at those kinds of rates, it can have a meaningful impact to the business. And when you add that to the kind of the base companion animal business that we have, the choline that we sell, this is an important segment to us. And we feel like there's a lot of innovation, a lot of opportunity for us to introduced novel products to the market and drive meaningful growth. And so we're pretty excited about the companion animal market and the products that we have to offer to it.

37:16 Okay, and then just very quickly, a couple last few ones. Firstly, you know, furthering the M&A discussion, you know, 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 the wake of the flash flood incident? Thank you.

38:03 So maybe I'll take the first one and Martin can take the last two. Relative to using equity for acquisitions, we definitely believe that 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 of our debt first and then move on to equity. So I think that you would typically 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 that we would use if needed, but probably only on something more transformative than where our focus has primarily been.

39:05 Martin? With regards to the tax rate, it has not really changed from the last quarter discussion that 2021 gap tax rate estimate of around 23%. is still a good number with the adjusted rate being, call it a percentage point higher than that, more like a 24% based on where we sit today. We also asked around the flash flood and we had about 3.8 million of expenses impacting the second quarter. We had another half a million impacting the third quarter here, so call it 4.3 million of impact to the P&L.

39:52 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 you go through all the work of tying everything out with the insurance company. We do expect full recovery less the deductible Thank you very much.

40:23 Thanks, Ram. Our next question comes from the line of Lawrence Goldstein, a private investor.

40:30 Please proceed with your question. Hi. On inflation, my own perspective is it's going to be runaway. If you want to make that assumption with me for the moment, historically, the company has been able to raise prices But with a time lag, are you raising prices with a time lag now? The margins don't, you know, 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?

41:16 You know, 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?

42:03 Thanks, Larry, for the questions. On the last one, does our phone ever ring? I have not received a call, I guess, point blank. So The phone has not rung yet. Going back to your first question, I think it's a really important question because it's a, and Ram asked a similar question, it really is, I almost want to say, all hands on deck type of situation relative to the inflation that we're dealing with today and needing to raise prices. And yes, We are absolutely raising prices, but with a lag.

42:50 And when costs are going up, that lag is negative to our margins. And so when you see our gross margins, they are impacted fairly significantly. And you heard... Martin, give you the numbers on the gross margin. So we are raising prices. We approximately had about $15 million of inflation hitting our P&L in Q3, and we raised prices about to the tune of $10 million. And so that $5 million sort of reflects to some extent the lag. And we're Thank you very much.

43:57 raising prices aggressively and benefiting our margins significantly because of that. If we hadn't done that, our margins would really be depressed. But we're doing that. We'll continue to do that. And when costs start to flatten and even decline, we'll catch up and then at some point will be on the favorable side of that lag as things come down. And I think Ram was really kind of getting at how much of this is sticky. And I guess my answer there is it's a little bit hard to tell at this point in time. There's just so much inflation and so much volatility in the marketplace.

44:43 We'll have to see that as the situation evolves. But It's a significant focus effort for the team right now to get prices up. And the pet market, size-wise, it is a very, very sizable market. You're absolutely right. All in all, we have a relatively small position. But our business in total is probably about a $50 million business. with the bulk of that being that kind of base choline that we supply into the market and a smaller portion of that being these new novel ingredients that we've been introducing to the market.

45:31 But even the base part of the pet food market is growing faster than the monogastric market as a whole. So we're, again, pretty bullish on the pet food market. We Yeah, a $50 million piece of our company is a sizable business for us, and we have very relevant, important positions with the big pet food companies that gives us a voice and access and contacts that we can leverage with these new and novel ingredients. So I think that's partly why we're pretty bullish about the companion animal market for Malcolm.

46:17 Thank you.

46:18 Yeah, thanks, Larry. Appreciate it. Our next question comes from the line of Mitra Ramgopal with Sudoti. Please proceed with your question.

46:29 Yes, hi. Good morning, and thanks for taking the questions. First, I was just curious, given the inflationary environment and labor shortages you're seeing, et cetera, are you more inclined to be less aggressive in terms of headcount expansion, et cetera, and sort of manage costs a little more aggressively.

46:53 Good morning, Mitra. I would say we always evaluate all headcount expansions based on really, you know, what do we get in return for it. So I think fundamentally that has not changed in terms of how we evaluate our cost structure versus the opportunities. I think the current environment is unique in the sense that when you look at your manufacturing footprint and the ability to staff properly the plants with hourly workers etc that's a very challenging environment and they're you know it's just very competitive at the moment and you see a scarcity of labor and also wage inflation as as a result when we look at our call it We have actually done a number of investments over the last two years based on opportunities we're seeing where we're generating the returns on it. So I don't think anything has fundamentally changed or that we will go after aggressive cost cuts or anything similar unless Something unexpected happens here.

48:08 You know, you always evaluate that based on the performance you're delivering. But I think we've proven that so far during the last two years and going through this pandemic, we've kept it all together, delivered strong results and expect to continue to manage the situation well. And should that change, then obviously we'll reassess that. But for now, we We continue in the strategy that we've deployed so far.

48:36 Yeah, Mitra, the other thing I would add to Martin's comments is we really do not feel like we have been differentially impacted relative to our competitors and really the market as a whole. The things that we are experiencing, everybody's experiencing, that are buying the same raw materials and in the same – Geographic Regions that we are in. So, you know, there's nothing differential here, but that doesn't mean that we don't have to deal with it. And, you know, we're working really, really hard to deal with it.

49:16 Okay. No, that's great. Thanks. And then on the specialty product segment, more specifically on the medical device sterilization, you had nice growth year over year down a little sequentially as this wondering in terms of what you're seeing into the fourth quarter and your expectations for this business to bounce back as you look out to 2022.

49:38 Yeah, again, you know, we are very pleased with the performances of specialty products in Q3. Both the sterilization business and the plant nutrition business grew nicely. the sterilization business as you said accurately was up year over year but down sequentially. We did just this morning get some data from the industry in the U.S. around elective surgeries and they validated basically our results that elective surgeries were indeed up year over year but down sequentially and I think that partly that was the pent-up demand that came back in the second quarter that was somewhat fulfilled. And then I think it's also partly the rise in the Delta variant cases in the third quarter. Our expectation is that we'll continue to see year-over-year growth in Q4 as this industry recovers, but I think it will be relatively modest year-over-year growth similar to what we saw in Q3 and not to the extent that we saw in Q2.

51:02 Okay, thanks. And then could you comment a little on the international markets in terms of what you're seeing? from both the demand side and maybe on the cost, especially in areas like Italy and Belgium, et cetera, where you have a physical presence.

51:20 Yeah. So, you know, I think I'll start on the cost side of things, and you're probably all aware of the extreme inflation that's going on in Europe, particularly around natural gas and oil. Well, unfortunately, many of our raw materials for choline, for example, as well as our sterilization business stem from natural gas to one extent or another. And so that's really a significant pressure that we're experiencing. And part of the What's behind our perspective that things are accelerating?

52:10 The natural gas crisis, I would say, in Europe really built in Q3 and continues to build and really started impacting us severely in September and will continue in June. and Q4, but products that come from natural gas like urea, like ammonia, like methanol are all important raw materials for us and those costs are going up dramatically. So Europe is one area that I would say the inflation is the most extreme, but we're managing through it. It's also not just manifesting itself at higher costs.

52:57 There's also curtailment. Some of our suppliers are giving us only 75% allocation, for example, on certain raw materials because they're cutting back production because costs are up. Again, it's just a complicated supply chain right now. I think what's behind your question is recognition that That is even more extreme in Europe right now than it is in the U.S. But we're managing it. We do have pricing power and flexibility in Europe. We have fewer kind of locked-in contracts with our customers in Europe, so we are able to raise prices a little bit faster, so our lag is a little shorter.

53:50 in Europe than it is in the U.S., and so we're leveraging that position. From a demand side, I would say our demand still remains quite strong, and so our sales have been healthy in Europe, really across the board in all of our businesses, similar return to elective surgeries in Europe, similar demands from the monogastric market. that we're seeing in the U.S. So demand remains strong and we see that continuing again for certainly the next few quarters.

54:30 Okay. Thanks again for taking the questions.

54:33 Congrats. Thanks, Fisher. Appreciate it. Our next question comes from the line of Tony Pollack, a private investor. Please proceed with your question. Hey, Tony.

54:45 A few questions if you could... I didn't see what the amount of money in R&D was this quarter versus last quarter. Second, if you can talk a little bit about any new products that you're working on. I know in the past some have been very successful, some you've abandoned. Could you talk a little bit about the Chinese choline situation and what's happening in autism?

55:13 Why don't you take the R&D? Good morning, Tony. This is Martin. Just quickly on the 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 call it approximately $300,000 more than the prior quarter from an R&D perspective.

55:34 Okay, thanks. Maybe I'll answer your third question next. The Chinese coaling situation, again, maybe an overused word right now, but is fairly volatile. As, again, you all know, the Chinese are significant producers of animal-grade and industrial-grade coaling. Their participation in Western markets has been You know, up and down, in and out over the years for various reasons, whether it was the shipment of contaminated product or the Blue Skies initiatives in China that restricted production and so on and so forth. And right now we're in a situation where costs in China are dramatically up to raw material costs.

56:35 Some of the increases we're seeing, they are seeing in China and I would say it's even more extreme there than maybe what we're seeing. They're also having to deal with these incredibly high freight costs. All of their production has to be put in containers and shipped and just as an example, we ship containers from Malaysia to and Twerp and it used to be about 15,000 euros a container and now it's 20,000 euros. So that adds an awful lot to a container of choline. So we're seeing less supply coming out of China today and the supply that is coming out of China is at higher prices.

57:25 and the Blue Skies Initiative is somewhat back. You know, there's discussion around the Olympics coming up in China and so there's curtailment of certain production. So that is also having an impact on their production capability. So supply is restrained, restricted from China and the costs are higher, providing some opportunity for us in the short term Again, dependent on our ability to get raw materials and be able to produce at capacity or above. So that's kind of the latest on Chinese coaling. I would say just another notch in the volatile history of product coming out of China.

58:17 New products, you know, we continue to – develop new products. Our R&D teams have been continuing to innovate and come into the labs throughout the pandemic. The product that we've talked most about is our AminoSure XM product that we launched a couple years ago. That, Ram used the word meaningful earlier, that is having a meaningful impact on our revenue within A&H and is a product that we is relatively new to the market that we have a lot of excitement about. I talked a little bit earlier about the Tetcher line of products, which are largely encapsulated products, but also some flavor inclusion systems that we again have very high hopes for and feel like there's a very significant market that we can penetrate with those products. We're also, I talked a little bit about the Z crisps and plant and dairy protein crisps that we're bringing to the market that are ideal for inclusion in bars, nutritional bars and trying to up the protein content but also have the protein content being plant-based.

59:46 We're making hemp and pea protein-based crisps, and so we're excited about those products as well. So definitely new product development continues to be an important part of what we view as our growth. We're still achieving about a 25% of our revenues based on products that we've introduced to the market in the last five years, and we're really pleased with that, and we're going to continue to strive to push that metric upwards with additional new product launches. Thanks, Tony. Appreciate the questions.

1:00:35 You got autism. That was the last question. There are no further questions in the queue. I'd like to hand the call back over to Ted Harris for closing remarks.

1:00:45 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 out Q4 2021 results in February. It's hard to believe it's already coming in on the end of the year, but we'll talk to you again in February of 2022. In the meantime, we will be presenting at a few conferences, the Baird Industrial Conference in November and the Stevens Annual Investment Conference in December. So hopefully we'll see you or talk to you at one of those upcoming meetings.

1:01:30 Other than that, 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.