Balchem Corporation (BCPC) CEO Ted Harris on Q3 2021 Results - Earnings Call Transcript

Oct. 29, 2021 5:08 PM ETBalchem Corporation (BCPC)
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Balchem Corporation (NASDAQ:BCPC) Q3 2021 Earnings Conference Call October 29, 2021 11:00 AM ET

Company Participants

Martin Bengtsson - Chief Financial Officer

Ted Harris - Chairman, Chief Executive Officer & President

Conference Call Participants

Bob Labick - CJS Securities

Ram Selvaraju - H.C. Wainwright

Mitra Ramgopal - Sidoti

Operator

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 [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Martin Bengtsson, Chief Financial Officer. Thank you. You may begin.

Martin Bengtsson

Good morning, everyone. Thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending September 30, 2021. My name’s Martin Bengtsson, Chief Financial Officer; 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 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

Thanks, Martin. Good morning and welcome to our conference call. This morning we reported strong third quarter results with record third quarter sales in all three of our reporting segments, as well as record third quarter net earnings and adjusted EBITDA and strong free cash flow.

Our revenues of $197.9 million were up 13% and our adjusted earnings from operations were $39.6 million, up 9.2% versus the prior year quarter. Our net income of $25 million, an increase of 16%, resulted in earnings per share of $0.77 on a GAAP basis.

On an adjusted basis, our third quarter non-GAAP net earnings were $30 million, an increase of 11.3%, resulting in earnings per share of $0.92 on a non-GAAP basis and we continued to deliver strong cash flows. Cash flows from operations were $39.6 million for the third quarter, an increase of $4.3 million from the prior year, with quarterly free cash flow of $31.1 million.

Before passing the call back to Martin to cover the detailed financial results, I would like to update you on a few items. Last quarter, we informed you that we experienced a flash flood event at our Verona, Missouri manufacturing facility in May. The plant was shut down for several weeks in the second quarter, while we repaired affected equipment, clean the site and safely restarted activities.

Since that time, the plant has been fully functional. And while this event was categorized as a once-in-500-year event, our focus has turned to implementing actions that will help to mitigate the impact of another such event.

We recognized an additional $500,000 of expense in the third quarter, primarily due to additional expenses associated with the write-off of damaged inventory and the costs associated with external service providers used for the cleanup efforts. We do not expect any further expense associated with this event to impact subsequent quarters and should start to receive insurance reimbursements in the coming quarters.

While we remain focused on maneuvering the company through the pandemic and our priorities remain the same; employee safety first, keeping our manufacturing sites operational, satisfying customer needs, preserving cash and ensuring strong liquidity and responding to changes in this dynamic market environment as appropriate.

We are increasingly having to focus on managing the extraordinary supply chain disruptions that are challenging the markets we operate within. We are experiencing severe input cost inflation, raw material shortages, logistics disruptions and labor availability issues.

These challenges have been with us to some extent since the beginning of the year, but have accelerated as the year has progressed and certainly through the third quarter. We expect this trend to continue to accelerate in the fourth quarter of 2021 and be with us at least through the first half of 2022.

We will continue to focus on dampening the impacts of these challenges by leveraging our global supply chain capabilities and redundancies to ensure continuity of production, while raising prices where we can to offset the extraordinary input cost inflation. Within our Human Nutrition & Health segment research conducted by Professor Marie Caudill at Cornell University into the role of choline and DHA and omega-3 fatty acid metabolism during pregnancy has been completed and a manuscript has been submitted for peer review.

Also in the final stages of review is the long-awaited paper from Cornell University reporting on a seven-year follow-on study of offspring from mothers supplemented with adequate levels of choline during their third trimester pregnancy. The seven to 7.5 year old children were subjected to a variety of validated cognitive tests and the first results are expected to be published soon. We expect the results of both of these studies to further support the need for choline supplementation.

Additionally we continue to accelerate our marketing efforts in the quarter, launching a functional beverage campaign promoting our choline and chelated minerals for functional beverage applications and a campaign introducing novel plant and dairy based extruded protein crisps to the market. We also announced an agreement with the best-selling author of the children's book series Ninja Life Hacks to secure strategic partners for branded food products to enable food innovations that deliver on consumer demand for children's nutrition.

In the third quarter, our Animal Nutrition & Health segment continued to progress several key strategic advances around the technical support for our products and portfolio. Our team was present to preview the early results from the updated and long-awaited nutrient requirements of dairy cattle or NRC from the National Academies of Sciences. The NRC committee reviewed all of the available research over the past 20 years and validated the beliefs that an effective source of rumen protected choline fed to dairy cows before and after caving 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 products such as Reassure and it will certainly bring more focus on to room and protected choline as a fundamental supplemental nutrient during the dairy transition period.

Additionally in our companion animal business there were numerous accepted publications and technical presentations made during the return of several important industry meetings. These included the National Animal Science Association, the International Food Technology Scientific Symposium and the highly anticipated return of the pet food industry's premier event the pet food forum held in Kansas City Missouri. It was at this event that new research was presented demonstrating the important value proposition of our unique PetShure portfolio.

Research was presented in collaboration with Auburn University that demonstrated the value of restructuring proteins derived from animal code products for the manufacturer of highly nutritious treats. This novel application uses our proprietary encapsulated ingredients and allows for a sustainable and nutritious ingredient option for treat and pet food manufacturers.

The pet food forum was also the venue for two other research presentations surrounding Valcom's technology. The first was new research demonstrating the value of PetShure encapsulated acids towards controlling salmonella and raw meat based diets conducted at Kansas State University. The second invited talk focused on the benefits of supplemental PetShure choline in controlling obesity and cats with that research being led by the Ontario veterinarian college at the University of Guelph.

Within the Specialty Products segment, we started out a new manufacturing line for our Metalosate foliar applied plant nutrition products at Balchem's existing complex in Merano, Italy. This new production capability in Europe will augment our existing North American production and will enhance our ability to serve the growing needs of our international customer base and strengthen the robustness of our supply chain capabilities.

We have also substantially completed our project to consolidate seven ERP systems into one Microsoft Dynamics 365 with the recent go-live of our last major manufacturing site on the system. We now have near 100% of our revenues on the new system. We are extremely pleased with the completion of this project that was delivered on budget and on-time relative to the pandemic adjusted timeline. This initiative is critical for the continued growth and operational efficiency of the company and we are very pleased to move from focusing on implementation to realization of the many benefits of being on one integrated system across the entire company.

Additionally, in our continuing effort to advance our environmental, social, and governance, or ESG efforts, Balchem celebrated the one-year anniversary of signing our commitment to the UN Global Compact principles. Since becoming a member of the UN Global Compact on September 30th, 2020, we have made significant progress and we are particularly proud of publishing in April of this year 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.

As we look back on the last year, joining the UN Global Compact was an important step in our continuous improvement journey relative to our corporate social responsibilities and the achievement of our higher purpose of making the world a healthier place.

I'm now going to turn the call back over to Martin to go through the detailed consolidated financial results for the company and the results for each of our business segments.

Martin Bengtsson

Thank you, Ted. As Ted mentioned, overall, we delivered strong financial results in a challenging environment. Our third quarter net sales of $197.9 million were up 13% compared to prior year and we delivered strong sales growth in all three segments; Human Nutrition 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. The 139 basis point decrease was primarily due to increased raw material and freight and distribution costs, partially offset by higher selling prices. We've been managing inflationary pressures all year, although input cost increases further accelerated in the third quarter.

In the third quarter, we experienced approximately $13 million of raw material inflation compared to the prior year quarter and approximately $4 million sequentially compared to the second quarter. In addition freight and distribution costs have increased dramatically driving approximately $2 million of increased costs in the quarter compared to the prior year.

As mentioned by Ted earlier, we expect this trend of increased inflationary pressures on our input costs to continue into the fourth quarter and into 2022. As such we have and we'll continue to work hard to recover these cost increases by passing them through to our customers.

In the third quarter, we passed through approximately $10 million of price increases. There's usually a timing difference between increased costs and our ability to raise prices and we will continue to work hard to fully recover the higher costs over a period of time.

Operating expenses for the third quarter of 2021 were $28.4 million as compared to $27.3 million in the prior year. The increase was primarily due to higher selling expenses driven by an increase in compensation-related costs and an increase in research and development, partially offset by the timing of an insurance recovery.

GAAP earnings from operations for the third quarter were $32.5 million, an increase of $3.5 million or 12% compared to the prior year quarter. On an adjusted basis, non-GAAP earnings from operations of $39.6 million were up $3.3 million or 9.2% compared to the prior year quarter.

Third quarter adjusted EBITDA of $48.3 million were $3.9 million or 8.8% above the third quarter of 2020. The company's effective tax rates for the third quarters of 2021 and 2020 were 22.0% and 22.7%, respectively. The decrease in the effective tax rate was primarily due to higher tax benefits from stock-based compensation and the prior year being negatively impacted by clarifying regulations related to tax reform.

Net income closed the quarter at $25 million, up 16% from the prior year. This translated into diluted net earnings per share of $0.77, an increase of $0.11 or 15.5% from last year's comparable quarter. On an adjusted basis, our adjusted net earnings were $30 million or $0.92 per diluted share, up $3.1 million or 11.3% compared with the prior year quarter. We generated quarterly free cash flow of $31.1 million and we closed out the quarter with $90 million of cash on the balance sheet.

As we look at it from a segment perspective, our Human Nutrition & Health segment generated record third quarter sales of $111.2 million, an increase of 7.3% from the prior year. The sales increase was driven primarily by strong sales growth within our Minerals and Choline Nutrients business that continues to see strong demand. We delivered double-digit sales growth in both the Choline and Mineral product lines while our Food business grew modestly with notable growth in encapsulated products.

Our Human Nutrition & Health segment delivered quarterly earnings from operations of $19.8 million, an increase of 13.2% compared to the prior year quarter, primarily due to the aforementioned higher sales, favorable mix and the timing of an insurance recovery, partially offset by higher manufacturing input costs and distribution costs.

Excluding the effect of non-cash expense associated with amortization of intangible assets of $4.3 million and excluding the direct expenses related to the Verona flash flood event of $0.2 million, adjusted earnings from operations for this segment were $24.3 million, an increase of 8.2%.

Our Animal Nutrition & Health segment generated all-time record quarterly sales of $56.2 million, an increase of 21.2% compared to the prior year. The increase in sales was primarily the result of higher volumes and prices in both Monogastric and Ruminant animal markets. Our Ruminant business grew volumes 7.4% and we continued to successfully drive penetration of our Ruminant protected encapsulated products in the market.

The dairy market remains volatile, although milk and milk protein prices remain at relatively healthy levels and are trending positively. On the Monogastric side, overall volumes were up 11.3%, driven by higher volumes of feed grade choline as well as strong demand for our animal chelated minerals and our offerings for the companion animal market.

Animal Nutrition & Health quarterly earnings from operations of $7.4 million were up 6.1% from the prior year quarter due to the aforementioned higher sales, partially offset by an increase in manufacturing input costs and distribution costs. Excluding the effect of non-cash expense associated with amortization of intangible assets of $0.2 million and excluding the direct expenses related to the Verona flash flood event of $0.3 million, third quarter adjusted earnings from operations for this segment were $7.8 million, an increase of 9.4%.

Our Specialty Products segment delivered record third quarter sales of $27.6 million, an increase of 20% compared to the prior year quarter, due to higher sales of products in both the plant nutrition business and medical device sterilization markets. Sales of our performance gases products, which largely go into the medical device sterilization market grew nicely year-over-year but were down sequentially, showing the volatility in the return of elective surgeries and the recovery of this market.

While our plant nutrition business is seasonal with the majority of business being in the first half of the year, we continue to see good growth year-over-year in this business with strong growth in the third quarter contributing to an approximate 30% growth year-to-date in that business.

Specialty Products segment had third quarter earnings from operations of $6.5 million, an increase of 20.7% versus the prior year. The increase was primarily due to the aforementioned higher sales, partially offset by increases in manufacturing input costs and distribution costs. Excluding the effect of noncash expense associated with amortization of intangible assets of $1.2 million, third quarter adjusted earnings from operations for this segment were $7.7 million, an increase of 11.5%.

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

Ted Harris

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

I would now like to hand the call back over to Martin who will open up the call for questions. Martin?

Martin Bengtsson

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

Question-and-Answer Session

Operator

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

Bob Labick

Good morning. Congratulations on a nice quarter. Great execution.

Ted Harris

Thanks Bob.

Martin Bengtsson

Thanks Bob.

Bob Labick

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 mitch, 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?

Ted Harris

Yes Bob. Animal did very well in the quarter from a growth perspective, you know, 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. 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.

Martin Bengtsson

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 point, a couple of hundred basis points growth that we're not able to fully supply, because of some constraint whether it's raw material or capacity at this point, so demand does remain strong. We're not able to fully satisfy it all. But we're doing everything we can to deal with all of these challenges that we're facing in the marketplace.

Bob Labick

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

Ted Harris

Yeah. 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 results 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 and 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 guide book that is very critical to the industry. And what we have is now that guide book for the first time saying that feeding a rumen protected -- efficacious rumen protected choline does enhance milk production through the lactation cycle.

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 podcast, 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 US. I think that the US is one of the most efficient dairy markets in the world. So I think dairy markets outside the US do look to the US, and so I think we'll be able to leverage it outside the US that's not singularly a US thing, but clearly driving increased US penetration, we believe will be benefited by this new NRC finding.

Bob Labick

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

Ted Harris

Yes, certainly. We, obviously, can't talk about any specific 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 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 then the new owner of those assets, at least in part because we didn't feel like the value was appropriate for the asset. And we'll continue to do that. We're active.

We think this hot market if you will, will present opportunities for us at the right value and correct strategic contribution to our company. So you're right to point out, we have $90 million of cash. Our net debt leverage ratio is effectively zero. And we have the ability to act on acquisitions as they come. And we're confident that those will come over time but we're going to continue, I think as we always have been to be selective and make sure we can get the right return on these.

So that's where we are, somewhat disappointing that we haven't been able to add an acquisition to our portfolio over the last couple of years, but we're working hard to get something done in the foreseeable future.

Bob Labick

Okay. Great. Thanks so much.

Ted Harris

Thanks. Thanks, Bob.

Operator

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

Ram Selvaraju

Hi, thanks very much for taking my question and certainly congratulations are in order for the performance in what continued to be relatively challenging time. 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 whether if you take price increases in the context of the current supply chain environment, how likely are these to remain sustainable even after the supply chain issues have gone away? In other words, you're talking about seeing healthy volume demand even at increased prices. So what implications does that have for the pricing paradigm that you might be able to sustainably enforce as it were going forward?

Ted Harris

Yes. 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 the used word today, but a very unusual environment.

And so I think we're going to have to see how much of that sustains over time and how much falls back. There's no question that our margins lag 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 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. 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 ourselves in. So, we'll just have to see as we go.

Ram Selvaraju

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

Ted Harris

Yes. So, 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 PetShure products that we have launched over the last few years that are really more specialty encapsulated and other products. For example, those grew 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 introduce 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.

Ram Selvaraju

Okay. And then just very quickly a couple last few ones. Firstly, furthering the M&A discussion I was wondering to what extent you expect to potentially employ equity issuances as specifically an M&A tool, particularly given where the stock currently trades?

And then I think these are just for Martin. I was wondering if you could offer some commentary on where you see the effective tax rate going? I think last quarter you were guiding towards it being around 23%. The effective tax rate currently looks like it's around 22%. So, how should we be thinking about that going forward?

And then when do you expect to receive whatever insurance payouts are view in the weight of the flash flood incident? Thanks.

Ted Harris

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 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. Martin?

Martin Bengtsson

Yes. With regards to the tax rate has not really changed from the last quarter discussion that 2021 GAAP tax rate estimate of around 23% 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.

You also asked around the flash floods. We had about $3.8 million of expenses impacting the second quarter. We had another $0.5 million impacting the third quarter here so call it $4.3 million of impact to the P&L. We do expect to get fully reimbursed for that less the deductible based on what we're seeing today. We expect to receive some payments here in the fourth quarter and then the remaining payments early next year as you go through all the work of tying everything up with the insurance company. We do expect full recovery less the deductible.

Raghuram Selvaraju

Thank you very much.

Ted Harris

Thanks, Ram.

Operator

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

Unidentified Analyst

Hi. On inflation, my own perspective is, it's going to be a runaway. If you want to make that assumption with me for the moment, historically, the company has been able to raise prices. But with the time lag are you raising prices with a time lag now? The margins don't -- you can't see that. So if and when the inflations stops, what about the stickiness of the price increases that you're making, if indeed, you are?

Secondly, can you tell us about the size of the pet market? The companies that have gone public that service the United States pet market, which has grown enormously during the pandemic, are showing big increases similar to yours, but they've got hundreds of millions of sales, give us some idea of yours?

And thirdly, I'm wondering, are many or any of the companies you have your eye on as acquisitions being acquired by others? And finally, in reverse, like Buffett said, if the phone don't ring, you'll know it's me. Does your phone ever ring?

Ted Harris

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 the lag. 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 raising prices additionally in Q4. And unfortunately, as we also said, raw materials continue to escalate. So we expect in Q4 to continue to be on the negative or unfavorable side of that lag.

So we are absolutely 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 we'll 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, 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.

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 -- 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 novel ingredients. So, I think that's partly why we're pretty bullish about the companion animal market for Balchem.

Unidentified Analyst

Thank you.

Ted Harris

Yeah, thanks Larry. Appreciate it.

Operator

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

Mitra Ramgopal

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

Martin Bengtsson

Hi, Mitra. I would say, we always evaluate all headcount expansions based on really 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 etcetera that's a very challenging environment and this is very competitive at the moment. And you see a scarcity of labor and also wage inflation as a result.

When we look at our, call it, overhead costs or selling and marketing and R&D etcetera, 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.

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 continue in the strategy that we've deployed so far.

Ted Harris

And Mitra the other thing I would add to Martin's comments is that 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 is experiencing that are buying the same raw materials and -- in the same geographic regions that we are in. So, there's nothing differential here, but that doesn't mean that we don't have to deal with it and we're working really, really hard to deal with it.

Mitra Ramgopal

Okay. That's great. Thanks. And then on the Specialty Products segment more specifically on the medical device sterilization, you had nice growth year-over-year, down a little sequentially. I was just wondering in terms of what you're seeing into the fourth quarter and your expectations for this business to bump back as we counted in 2017?

Ted Harris

Yes. Again, 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, it was up year-over-year, but down sequentially. We did just this morning get some data from the industry in the US 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.

Mitra Ramgopal

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

Ted Harris

Yeah. So, yeah, 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 the issues there. 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 what's behind our perspective that things are accelerating, 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 Q4. But things that 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 in higher costs. 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. So again it's just a complicated supply chain right now.

And I think what's behind your question is the recognition that that is even more extreme in Europe right now than it is in the US. But we're managing it. We do have pricing power and flexibility in Europe. We have fewer, kind of, lock-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 in Europe than it is in the US 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 US, so demand remains strong and we see that continuing again for certainly the next few quarters.

Mitra Ramgopal

Okay. Thanks, again for taking the questions. Congrats.

Ted Harris

Thanks, Mitra. Appreciate it.

Operator

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

Ted Harris

Hey, Tony.

Unidentified Analyst

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. So you've abandoned. Could you talk a little bit about the Chinese choline situation and what's happening?

Martin Bengtsson

You take the analyst line. 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.

Ted Harris

Okay. Maybe I'll answer your third question next. The Chinese choline 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, choline, their participation in western markets has been 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, so raw material costs some of the increases, 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 shipped containers from Malaysia to Antwerp and it used to be about €15,000 container and now it's €20,000. 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.

And the Blue Skies initiative is somewhat back. 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 capabilities. So supply is restrained, restricted from China and the costs are higher. Providing some opportunity for us in the short-term, again depending 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 choline, I would say just another notch in the volatile history of product coming out of China.

New products, 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 AminoShure-XM product that we launched a couple of 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 it's relatively new to the market that we have a lot of excitement about. I talked a little bit earlier about the PetShure 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 is a very significant market that we can penetrate with those products.

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 a plant-based. 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.

Unidentified Analyst

Thank you.

Operator

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

Ted Harris

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 Stephens Annual Investment Conference in December. So, hopefully, we'll see you or talk to you at one of those upcoming meetings. Other than that, thank you again for joining today. Appreciate it.

Operator

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.

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