Balchem Corporation (BCPC) CEO Ted Harris on Q2 2021 Results - Earnings Call Transcript

Balchem Corporation (NASDAQ:BCPC) Q2 2021 Earnings Conference Call July 30, 2021 11:00 AM ET

Company Participants

Martin Bengtsson - Chief Financial Officer

Ted Harris - Chairman, Chief Executive Officer & President

Conference Call Participants

Mark Connelly - Stephens

Bob Labick - CJS Securities

Mitra Ramgopal - Sidoti & Company

Ram Selvaraju - H.C. Wainwright

Operator

Greetings. Welcome to Balchem Corporation's Second Quarter 2021 Financial Results Conference Call. At this time all participants are in a listen-only- mode. A question-and-answer session will follow the formal presentation [Operator Instructions] Please note this conference is being recorded.

I will now turn the conference over to Martin Bengtsson, Chief Financial Officer. Thank you. You may begin.

Martin Bengtsson

Thank you, Sherry. Good morning, everyone. Thank you, for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending June 30, 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, Chairman, CEO and President.

Ted Harris

Thanks, Martin. Good morning and welcome to our conference call. This morning we reported strong second quarter results with record sales in all three of our business segments solid consolidated earnings growth and strong free cash flow. Our revenues of $202.4 million were up 16.7% and our adjusted earnings from operations were $41.1 million up 14.6% versus the prior year quarter.

Our second quarter net income of $22.7 million, an increase of 7.6%, resulted in earnings per share of $0.70 on a GAAP basis. On an adjusted basis our second quarter non-GAAP net earnings were $30.4 million, an increase of 10.3%, resulting in earnings per share of $0.93 on a non-GAAP basis and we continue to deliver strong cash flows.

Cash flows from operations were $35.8 million, for the second quarter of 2021 with quarterly free cash flow of $28.4 million. Before passing the call back to Martin, to cover the detailed financial results, I would like to update you on a few items.

In May, our Verona Missouri plant experienced a flash flood as a result of very localized storms in the southwest part of the state. The plant was shut down for several weeks as we repaired affected equipment, cleaned the site and safely restarted activities. All three of our business segments provide products and services out of the Verona Missouri site. So each of the segments was affected by the temporary site shutdown to a varying degree. The negative direct financial impact to the quarter was approximately $3.8 million primarily due to the write-off of damaged inventory and the costs associated with external service providers used for the cleanup efforts.

We also expect an additional spend of approximately $1.5 million to impact the third quarter. Customer requirements were largely satisfied through inventory on hand and by leveraging alternate and redundant manufacturing capabilities across our supply chain. The manufacturing site is now fully operational and all activities are functioning normally.

As part of our enterprise risk management plan, we have extensive insurance coverage to help mitigate the impact of such an event. Our deductible in this particular case is $2 million and we believe at this point all of the remaining costs should be fully recovered in subsequent quarters from our insurance coverage.

While the flash flood was a very unfortunate event, it highlighted the value of our enterprise risk management plan and the benefits of preparedness for such an event as well as the risk mitigation strategies implemented in advance of the event such as our insurance coverage but also the redundant manufacturing capabilities we have for many of our products and services across our global supply chain network.

I would like to once again thank the Balchem team for their incredible teamwork during and after the event that enabled us to get back up and running safely in a relatively short amount of time with minimal disruption to our customers.

Moving on to a different topic. I am very excited to share that in June, Balchem's Board of Directors, elected Ms. Kathy Fish, to fill a vacancy on the Board. Ms. Fish, recently retired from the position of Chief Research Development and Innovation Officer at the Procter & Gamble Company. Over a long career at P&G Kathy, held various roles within the research and development function of increasing responsibility before leading the global function from 2014 to 2020.

Kathy brings to the Balchem Board important new product development and direct-to-consumer expertise along with her international business acumen and experience in driving a growth culture. Kathy will serve on the corporate governance and nominating committee and we are very pleased with her addition to our Board of Directors.

As mentioned on our last earnings call in April, we released our third sustainability report. We have for the first time published our 2030 goals to reduce both greenhouse gas emissions and water usage by 25%. These are significant and important goals that further our commitment to operate with excellence as strong stewards of our stakeholders while providing innovative solutions for the health and nutritional needs of the world.

Lastly, despite numerous challenges to manage in the overall macroeconomic environment at the moment and discrete challenges in the quarter related to the flash flood event at our Verona Missouri manufacturing facility, we achieved solid second quarter results, which highlights the strength and resilience of our business model. As was always -- as was also mentioned on our last earnings call while the significantly higher raw material and freight costs we are facing are not differentially impacting Balchem. We continue to dedicate significant resources to various mitigating activities to effectively manage through these very significant challenges.

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.

Martin Bengtsson

Thank you, Ted. As Ted mentioned, overall we delivered strong financial results in a challenging environment. Our second quarter net sales of $202.4 million or 16.7% higher than the prior year comparable quarter. We delivered record sales in all three segments: Human Nutrition and Health Animal Nutrition & Health and Specialty Products. The impact of foreign exchange to our sales was a positive $2.3 million primarily due to the stronger euro contributing a positive 1.3% impact to our year-over-year sales growth.

Second quarter consolidated gross margin dollars of $59.4 million were up $4.1 million or 7.3% compared with $55.4 million for the same period in the prior year.

Our gross margin percent was 29.4% of sales in the quarter, down 257 basis points compared to 31.9% in the second quarter of 2020. The 257 basis point decrease was primarily due to a significant increase in certain raw material and distribution costs and the costs associated with the recovery from the flash flood event, partially offset by favorable mix and overall manufacturing efficiencies.

Consolidated operating expenses for the second quarter of 2021 were $28.9 million as compared to $28.5 million in the prior year. The slight increase was primarily due to higher compensation-related costs, partially offset by the prior year being negatively impacted by a goodwill impairment charge related to business formally included in the Industrial Products segment and a decrease in transaction and integration costs.

GAAP earnings from operations for the second quarter were $30.6 million, an increase of $3.7 million or 13.7% compared to the prior year quarter. On an adjusted basis, as detailed in our earnings release this morning, non-GAAP earnings from operations of $41.1 million were up $5.2 million or 14.6% compared to the prior year quarter.

Adjusted EBITDA of $50.1 million was $6.3 million or 14.3% above the second quarter of 2020. Interest expense for the second quarter of 2021 was $ 0.6 million and our net debt was $43.7 million with an overall leverage ratio on a net debt basis of $0.2 million.

The company's effective tax rates for the second quarters of 2021 and 2020 were 24.3% and 18.7% respectively. The increase in the effective tax rate was primarily due to a reduction in certain tax credits and lower tax benefits from stock-based compensation.

Consolidated net income closed the quarter at $22.7 million, up 7.6% from the prior year quarter. This quarterly net income translated into diluted net earnings per share of $0.7 an increase of $0.05 or 7% from last year's comparable quarter.

On an adjusted basis, our second quarter adjusted net earnings were $30.4 million or $0.93 per diluted share, up $2.8 million or 10.3% compared with prior year quarter. We generated quarterly free cash flow of $28.4 million and we closed the quarter with $79.9 million of cash on the balance sheet.

As we look at it from a segment perspective, for the quarter, our Human Nutrition & Health segment generated quarterly sales of $111.5 million, an increase of $14 million or 14.4% from the prior year. The sales increase was driven both by strong sales growth within food and beverage markets as well as higher sales within the minerals and nutrients businesses.

We were very pleased to see significant year-over-year and sequential growth on the food ingredient side of our business as well as continued strong sales within our Minerals and Choline Nutrients business.

Our Human Nutrition & Health segment delivered quarterly earnings from operations of $19 million, an increase of $3.5 million or 22.7% compared to the prior year quarter, primarily due to the aforementioned higher sales and overall manufacturing efficiencies, partially offset by higher raw material and distribution costs and the costs associated with the recovery from the flash flood event that we experienced at our Verona, Missouri manufacturing site.

Excluding the effect of noncash expense associated with amortization of intangible assets of $4.3 million and excluding the direct expenses related to the Verona flash flood event, second quarter adjusted earnings from operations for this segment were $25.3 million, an increase of $5 million or 24.6%.

Our Animal Nutrition & Health segment generated quarterly sales of $54.5 million an increase of $8.1 million or 17.6% 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 currency exchange rates, which contributed $1.3 million or 2.8% of growth to the segment.

Our Ruminant business grew volumes 31.8% and we continue to successfully drive penetration of our rumen protected and capsulated products in the market. In terms of dairy economics milk and milk protein prices have come down a bit during the second quarter, but are still at relatively healthy levels where our products have a strong value proposition.

On the Monogastric side, overall volumes were down slightly due to lower European demand for choline. However, the financial impact of this volume decrease was fully offset by higher volumes of US feed grade choline, an increase in average selling prices and higher sales of chelated minerals and companion animal products.

Animal Nutrition & Health quarterly earnings from operations of $3.6 million were down $2.9 million or 44.6% from the prior year quarter, primarily due to increases in raw material and distribution costs and the costs associated with the recovery from the flash flood event at our Verona, Missouri manufacturing facility.

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 blood event of $1.4 million, second quarter adjusted earnings from operations for this segment were $5.2 million, a decrease of $1.4 million or 21.8%.

As raw material escalations slows and given the pricing mechanism we have currently in place in the vast majority of our Animal Nutrition & Health customer contracts, we're expecting that margins will improve in this business segment as we progress through the second half of the year and into 2022.

Our Specialty Products segment delivered quarterly sales of $34 million, an increase of $5.8 million or 20.7% compared to the prior year quarter, primarily due to higher sales for products sold both to the medical device sterilization and the plant nutrition markets.

The Specialty Products segment had second quarter earnings from operations of $9.7 million, an increase of $1.7 million or 21.5% versus the prior year quarter. The increase was primarily due to the aforementioned higher sales partially offset by increases in raw material and distribution costs.

Excluding the effect of non-cash expense associated with amortization of intangible assets of $1.3 million and excluding the direct expenses related to the Verona flash flood event, second quarter adjusted earnings from operations for this segment were $11.2 million, an increase of $1.6 million or 16.8%.

I'm now going to turn the call back over to Ted for some closing remarks.

Ted Harris

Thanks, Martin. We are very pleased with Balchem's financial results reported earlier this morning delivering all-time record revenues in all three of our business segments. We achieved record second quarter consolidated GAAP net earnings, record quarterly non-GAAP adjusted net earnings, record adjusted EBITDA and strong cash flows from operations.

All of this while facing continued higher raw material costs, global logistics and distribution challenges and manufacturing disruption and inventory loss related to the flash flood event at our Verona plant. These 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 will now turn the call back over to Martin to open it up for questions. Martin?

Martin Bengtsson

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

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Mark Connelly with Stephens. Please proceed.

Mark Connelly

Thank you. Ted last quarter my question about normalization of hospital activity was probably premature. Are you seeing any retrenchment at hospitals in terms of suspending elective surgeries and, sort of, reversing that early normalization?

Ted Harris

Thanks for the question, Mark and the short answer is no we are not yet. But as we all can reflect maybe on the news of the last few days it's obviously -- continues to be a rapidly changing environment relative to the pandemic and the Delta variant. So while we're not seeing that today, we're watching it closely.

I would say we're pleased with the sterilization business has been slowly returning. Volumes are up both year-over-year and sequentially. But I would also say it has been a little bit lumpy in that return and it continues to be a bit lumpy.

I think as we see real demand return with increased selective surgeries, but also the replenishment of supply chains that were depleted during the pandemic. But again the short answer is no -- we're not seeing that yet. But obviously that could be a possibility going forward so we need to watch that closely.

Mark Connelly

Switching gears. We're hearing from a number of companies that the big wellness push with the surge in vitamin supplements last year has slowed and in some cases reversed. How does that affect your expectations for the nutrient part of human health for the rest of the year?

Ted Harris

Certainly, the pandemic and the focus on immunity boosting minerals and vitamins has benefited our nutrients business over the last year or so. We have not yet seen a slowdown in demand. We are seeing the growth year-over-year is slower than it was last quarter for example. So we're seeing a slowing in the growth year-over-year partly because we're now comparing to quarters that saw some benefit last year.

But demand remains very strong. And at this point in time, we continue to believe that the changing in consumer behavior relative to increased attention to these types of products and supplementation will continue. But certainly the year-over-year growth will wane as we saw in Q2. But we're still very pleased with the strong demand for our products.

Mark Connelly

I hope you continue to buck that trend. And just one last question. Your market share in choline in the animal market you saw a nice boost this quarter. What are the biggest challenges to driving penetration rates? And how do you decide how aggressively to go after that on a sort of a year-over-year basis?

Ted Harris

So again as you're well aware there are two very different aspects to our choline business for the animal market. One certainly is the monogastric market that includes companion animal, swine and poultry primarily. We have very strong market share in the US strong market share in Europe. We really don't have much presence in Asia and South America.

So our business is primarily a North American and European business. And our business there tends to grow with the market I would say. There is some share to be gained. But really I think the opportunity is more around driving increased usage of choline. There are alternatives.

We've talked about betaine in the past. So replacement of betaine which grows the overall choline market that would grow our business. Using science to show that choline should be fed at higher dose levels than it currently is. That also would drive higher demand for us and increased usage for choline.

So those really are more of the growth drivers in the monogastric and the feed grade choline, the companion animal business obviously is growing very quickly with the overall market that is certainly showing up in our results. So that's really how we're driving growth there.

From a penetration perspective, choline is very highly penetrated in those markets. Most companion animal products, include choline; most poultry swine diets, include choline. So it's not so much penetrating the market. It's very different to our sort of highly engineered encapsulated choline that we sell into the dairy industry, where we feel as though in North America choline is only penetrated, let's say, 40% at this point in time. And in Europe, it's still less than 5%. So that's really where we have an opportunity to be very aggressive about driving penetration.

And it's again, a lot by developing new science, bringing our old science to customers and convincing nutritionists that there's a significant payback and benefit of feeding choline. And we're learning through new studies that choline is important for more than maybe just we originally positioned it as a fatty liver product that addresses fatty liver. We've recently done a study that shows that choline may be very beneficial to heat stress in cows. And that really could bring a very different value proposition to choline and therefore help penetration and broaden the use of choline.

So I think the opportunity to really drive increased penetration and be very aggressive both in Europe and the US for that is really where our focus is and we're doing that through science. We're doing it through more nutritionists on our staff, more salespeople on the ground, boots on the ground matters here, and that's where we're focused.

Mark Connelly

Super helpful. Thank you, Ted

Ted Harris

Thanks, Mark.

Operator

Our next question is from Bob Labick with CJS Securities. Please proceed.

Bob Labick

Good morning. Congratulations on nice quarter and execution.

Ted Harris

Thanks, Bob.

Bob Labick

I wanted to start on the human nutrition side. How would you characterize the food and beverage, the flavors and powder sales? Are they back to pre-COVID levels yet? And what are the growth drivers that you're focused on from here?

Ted Harris

So our sales in aggregate certainly are back and ahead of pre-COVID levels. We've been growing nicely. If you just look at the food business so you exclude nutrients, we were up about 17% in the quarter. And that's really as a result I think of just good solid fundamental growth in the markets that we serve. I think certainly some of our growth initiatives are coming to fruition there. But there's also a bit of a replenishment of the supply chain that is happening.

There is a return of demand associated with those parts of the market that were depressed, because of the pandemic specifically foodservice, which I think in aggregate we would say is probably not quite back to pre-pandemic levels, but getting close. We've certainly seen it come back nicely.

And also lastly, no real decline in the aspects of the business that benefited somewhat from the pandemic. So, it's really a fairly kind of broad-based growth that we're experiencing, and certainly our sales levels are higher than our pre-pandemic levels. But we don't believe all of the foodservice business is fully back, and we also don't believe that some of the benefits that we have seen that we expect to slow down a little bit.

We believe that they're still there and they haven't waned fully yet. So, we feel good about the growth in the overall business in human nutrition health in the quarter and expect that we can continue to drive nice growth for the rest of the year.

Bob Labick

Okay. Great. And yes, I'm sticking with the human nutrition and health. The margins remain very strong on an adjusted basis as well above prior levels. Is that a benefit from mix, or how are you thinking about the kind of margin profile in H&H going forward?

Ted Harris

Let me start and then Martin can add to or correct me. But certainly mix is playing a role in the margin performance of the business. But we're also seeing if you recall in probably 2019, 2018, we talked a fair bit about manufacturing inefficiencies that we were struggling in certain areas from an efficiency perspective in some of our human nutrition health plants.

And a really our business teams and our supply chain and operations teams have really done a good job of addressing many of those inefficiencies. And so as you saw in the prepared remarks, we're seeing some favorable manufacturing efficiencies partly driven by higher volumes, but also partly driven just by eliminating some of those inefficiencies that we were experiencing. So mix for sure is part of it, addressing some of those inefficiencies is also a big part of it offset, somewhat by the higher raw material costs that while clearly very significantly impacting our animal nutrition business are also impacting human nutrition in a material way. So Martin, I'll pass it back to you with any other color.

Martin Bengtsson

No maybe the only thing I would add there is that our human business are the ones that have been best enabled to-date to also pass-through the raw material increases to their customers. So they've seen less of an impact there. So the efficiencies that Ted mentioned have therefore been able to shine through and show up in the P&L. So that's maybe what I would add there.

Bob Labick

Got it. Great. And then the last one for me, I can jump back in queue. On the last call, we talked about your pivot marketing spending and how you're reallocating dollars. Can you give us any examples of what you're doing now? I know it's still relatively new if there's any way to quantify the outcomes or if you're happy with the results so far, or any update on that initiative?

Ted Harris

Yes. We really are happy. I have to do say -- I have to say, it's still all relatively new. So we're not necessarily seeing a lot of fruits from our labor at this point in time, but we're really pleased with the team that we've built. We are seeing -- we had a campaign for example this quarter for -- within beverages for the use of our branded choline which we call VitaCholine as well as our Albion minerals. We've also kind of introduced a bit of an indulgent product, but in our encapsulates and inclusions business glimmer varigates that are getting some attention that basically are glimmering pieces that you can put into ice cream and treats and things like that that are pretty cool. And like I said getting some attention and frozen desserts and so forth.

So we are excited about the types of things that we can do based on market research that we're doing in-house right now as well as the market expertise that we're bringing to our customers and the market. So I think there's a lot more to come there because this is all new, but early signs are very positive. And we continue to be excited just about the new launches that our customers are launching out their products that have our products in them. Premier Nutrition for example just launched a new SKU that includes choline and a protein beverage. And that really is a leading consumer brand in the protein beverage segment. And there are various other launches that we're excited about. So I think overall we're really headed in the right direction from a marketing perspective and something that was really missing in the past for us.

Mark Connelly

Sounds superb. Thank you very much

Ted Harris

Thanks.

Operator

Our next question is from Mitra Ramgopal with Sidoti & Company. Please proceed.

Mitra Ramgopal

Yes. Hi, good morning and thanks for taking the questions. First, I just want to get a sense as you look at gross margin clearly seeing some pressure from the -- as you mentioned higher raw material and distribution costs. And I was just curious as we look out to the second half of the year, if we should anticipate maybe some improvement off of 2Q, or it's still too early to get a sense as to how that plays out.

Martin Bengtsson

Yeah. Good morning, Mitra. This is Martin. The -- I think the -- when you think about where the pressure is coming from, obviously the raw materials is the big one and it's significant. We saw almost above $9 million of inflation in the second quarter on like-for-like items year-over-year, which is a huge number when you think about it and nothing that we've ever seen in the past. And we've passed through a lot of that not all of it, we passed through in terms of pricing call it about $7 million of this. We still end up with a couple of million of gross margin pressure. When we think about that raw, is it going to go away, I don't know when it will go away. If it will go away and to what extent, prices will start coming down. It's just hard to tell right now. For us, it is primarily around chemicals, it's around oils. It's around some proteins that we buy et cetera where we're seeing just commodity price increases that are pretty significant. So I think it's going to be a matter of how that curve develops. So will it happen in the third quarter, fourth quarter? Will it be in 2022, it's almost impossible to say. And in the meanwhile, we're really focused on getting the right pricing in the market and recovering our costs around this.

As Ted pointed out before, we're not really differentially impacted versus our competition. We're all in the same boat here, which makes it a little bit easier for us also to go out and recover some of these costs. From a production standpoint and an efficiency in our supply chain network, our plants have been running well. We had the flood event, but that's more of a discrete unique event that you can't necessarily control. But apart from that our plants have been running very well in the last few quarters and we anticipate that to continue. You mentioned the distribution costs which are just like the raws, seen significant increases just with all the disruptions and containers being in the wrong places and prices going up et cetera. And for us that was -- when you look at it on a year-over-year basis call it a 50, 60 basis points impact to our profitability from that. And you would have to think that supply and demand will balance and prices will come down to more normalized level at some point. It's not like suddenly all the containers are gone. But they're in the wrong places at the moment and then the system is not working well.

So I just can't say whether that's going to happen, third quarter, fourth quarter or 2022, but you would have to think that it will start normalizing at some point. So that's a little bit what we're living through at the moment. It's managing the raws, getting the pricing in the market, passing that through and just trying to be efficient on the distribution side, while obviously ensuring that our own backyard in terms of how we run our plants is running very efficiently and that's kind of where the attention is at the moment.

Mitra Ramgopal

No that's great. I definitely appreciate the color there. And then on the ERP platform, I believe that's almost on us in terms of the implementation. I was wondering if you're starting to see some efficiencies there, or is it a little too early yet?

Martin Bengtsson

No, we're definitely seeing efficiencies. I mean we're -- call it 98% to 99% done. We have two international smaller locations to go in the implementation and that we plan. So we plan to be done this year in 2021. On budget as well. I should point out because we're pretty proud of that. That's not the case in ERP implementation. But if we take a step back and as I said, why do we do this in the first place, right? For us being on five systems and with acquisitions that grow into seven systems getting that down to one, just from a business continuity it was very important. Some of these other systems were closer to the end of life and we're willing to have a modern system in place. It was a lot around the controls and the security which we feel very good about at the moment just in terms of that enhanced visibility and controls.

And also, just from a cybersecurity and all the attention around that trying to stay on top of it and managing that situation. It's a lot easier for us having one system to manage then than many. And then like the growth and scalability. As we're growing as a business, growing on this one platform enable us to actually do that and not be prohibited. And lastly from a cost perspective, which was not the primary incentive why we did D 365, we're seeing some efficiencies there. We're doing a lot more with the resources we have in terms of not needing to add resources as we've grown here over the last two years. And we've also made some smaller organizational changes in some areas in terms of efficiencies. But I would not call that out as the key big driver of trying to take cost out. It's more to build a proper platform that supports our growth, our controls, and just the continuity of the business.

Mitra Ramgopal

That's great. And then finally, I guess a little of time and I assume with this – with the ERP it probably makes it a little easier to digest new acquisitions. And I'm just curious, if you had any update in terms of activity levels you might be seeing on the acquisition front?

Ted Harris

Yeah. I think that activity levels are reasonably high, again, as I've said, probably in the last few calls as we entered 2020 things really did slow down in the market, but also at Balchem. We were struggling with how do we complete a transaction in a remote environment. And I would say, we're very much through that and the market is busy and active and we are as well.

So we continue to feel good about the pipeline of opportunities that we see out there and the specific opportunities that are active. So we're spending a fair amount of resources focused on our inorganic growth. Obviously, our primary focus is driving the organic growth of the company, but we are spending, I would say, back to pre-pandemic levels amount of resources and time on inorganic opportunities.

Mitra Ramgopal

Okay. That's great. Thanks for taking the questions.

Ted Harris

Thanks, Mitra.

Martin Bengtsson

Thanks, Mitra.

Operator

Our next question is from Ram Selvaraju with H.C. Wainwright. Please proceed.

Ram Selvaraju

Thanks very much for taking my questions. Just a couple of minor housekeeping ones. I think these are probably for Martin. Can you just comment on, how the accounting treatment is going to look like for whatever insurance recovery you're able to accomplish in the wake of the flash flood event in Verona, Missouri? How is that potentially going to show up from a P&L perspective and also from a cash flow perspective? And can you comment at this time on – when you talk about partial recovery what does that mean half 10% approximately?

Martin Bengtsson

Yeah. So in terms of recovery, I'll answer that first. We do expect I can't guarantee it, since we haven't gone through it with the insurance company yet, but it would be reasonable to expect that we would recover our costs with it exception of the insurance deductible, right? So, there's a $2 million deductible. So, our costs less the $2 million is what we expect to recover. We had about call it $3.8 million of impact in the second quarter. We expect another $1.5 million of costs show up in the third quarter. So take those two and deduct $2 million that's what we expect to get back.

From an accounting perspective, where you would see it at the moment in the second quarter right is you see it in our COGS almost exclusively in terms of where the negative impact has hit in cost of goods sold, the $3.8 million. We adjusted it out for adjusted earnings as an adjustment. As we go forward, and have insurance recoveries. Our intention is also to adjust out those recoveries. So that is an apples-for-apples, right? We adjusted out a negative impact now. We will adjust out the insurance recoveries as we go forward.

From a cash flow perspective, obviously, it will be positive cash flow when we receive the insurance recoveries as we've had negative cash outlays here in this period. But most of this is flowing through COGS at the moment, since that's where we're having our expenses. I don't know, if that answers your question Ram or not happy to add any additional color.

Ram Selvaraju

No. That's – no that's very helpful. So whatever the impact is going to be, both the negative impact and the positive impact, the vast majority of it is going to be on the COGS line?

Martin Bengtsson

Correct. Correct.

Ram Selvaraju

Yes. Okay. And you would anticipate that; A, there's not going to be any further negative impact after this quarter is over; and B, that you will get the insurance proceeds before the end of this year. Is that reasonable?

Martin Bengtsson

I would just clarify that in saying we do expect the third quarter to have $1.5 million of negative impact. We had $3.8 million in the second quarter. We expect another $1.5 million in the third quarter of negative impact. When we will get the insurance recoveries? I don't want to comment on that because sometimes it moves relatively quickly. Sometimes it's a longer process. I don't know whether we will see any in the third quarter whether it will come in the fourth quarter whether it will come early in 2022. I just don't have that knowledge as to when exactly the process will conclude. So it will depend on the process there.

Ram Selvaraju

No that's fair. Secondly, I wanted to ask in a general sense about the medical sterilization business. And if you believe that we are now seeing a level of activity in that domain, a level of demand in that arena which is commensurate with steady state demand, or if you expect there to be further tailwinds going forward given the current status of the pandemic some normalization around that. Just wanted to get a sense of where you think things stand on that front?

Ted Harris

Yes. So, while we've seen really improvement quarter-on-quarter for three or four quarters now I would say, that we're still not back to steady state and a pre-pandemic level. And certainly, elective surgeries are the driver here. And I do think that people while hospitals are allowing elective surgeries and there's room for elective surgeries. I do think some people still are choosing to not have an elective surgery just for concern about going to the hospital.

So the business has improved quarter-on-quarter. We feel good about that but I would not say that it's back to pre-pandemic levels and we do think that there is more improvement that we will see in subsequent quarters barring any very significant kind of change in the progress that we've been making relative to the pandemic and any mandates around elective surgeries that could stall the slow recovery or cause it to regress. But as I said earlier, we are not seeing that today in our orders or hearing that from our customers, we're still seeing that sort of slow steady recovery.

Ram Selvaraju

Okay, thanks. And then just to revert back to Martin once more. Not sure if I missed this. What is your guidance regarding effective tax rate percentage for the second half of 2021?

Martin Bengtsson

So we're at about 23.1% year-to-date. And I think around their 23% plus or minus a little bit is the right estimate for 2021.

Ram Selvaraju

Great. And congrats on an excellent quarter despite these challenges with the flash flood.

Ted Harris

Thanks Ram.

Operator

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Mr. Harris for closing remarks.

Ted Harris

Thanks Sherry. Once again thank you very much for joining the call today. We really are very pleased with the second quarter 2021 results that we released today and the ongoing progress, we're making on our key strategic growth initiatives. So, we really appreciate your time. We look forward to reporting out Q3 results in October.

In the meantime, we will be presenting at the Jefferies 2021 Industrials Conference next week. And later in the year we’ve signed up for the Baird Industrials conference in November and the Stephens Annual Investment Conference in December. I'm sure we'll attend some other conferences. But hopefully, we'll see some of you at the virtual conference next week the Jefferies one. And if not there and one of the other ones. So, thanks again for joining today. Have a great weekend.

Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.