PHIBRO ANIMAL HEALTH CORP (PAHC) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Our management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided to assist readers in understanding our performance, as reflected in the results of our operations, our financial condition and our cash flows. The following discussion summarizes the significant factors affecting our consolidated operating results, financial condition, liquidity and cash flows as of and for the periods presented below. This MD&A should be read in conjunction with our consolidated financial statements and related notes thereto included under the section entitled “Financial Statements and Supplementary Data.” Our future results could differ materially from our historical performance as a result of various factors such as those discussed in “Risk Factors” and “Forward-Looking Statements and Risk Factors Summary.”
Overview of our business
Phibro Animal Health Corporation is a leading global diversified animal health and mineral nutrition company. We develop, manufacture and market a broad range of products for food and companion animals including poultry, swine, beef and dairy cattle, aquaculture and dogs. Our products help prevent, control and treat diseases, and support nutrition
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to help improve animal health and well-being. In addition to animal health and mineral nutrition products, we manufacture and market specific ingredients for use in the personal care, industrial chemical and chemical catalyst industries. We sell approximately 780 product lines in over 80 countries to approximately 3,790 customers.
Factors affecting our performance
Armed Conflict between Russia and Ukraine
In response to the armed conflict between Russia and Ukraine that began in February 2022, we and our employees have provided support to Ukraine in the form of monetary donations, free product and humanitarian services. Our limited intent for the Russian market is to continue to provide medicines and vaccines, and related regulatory and technical support, to help existing customers combat disease challenges in the production of food animals on their farms. We have no production or direct distribution operations and no planned investments in Russia.
Since the conflict began, the United States and other North Atlantic Treaty Organization (“NATO”) member states, as well as non-member states, announced targeted economic sanctions on Russia, including certain Russian citizens and enterprises. The continuation of the conflict may trigger additional economic and other sanctions, as well as broader military conflict. The potential impacts of any resulting bans, sanctions, boycotts or broader military conflicts on our business is uncertain at the current time due to the fluid nature of the conflict. The potential impacts could include supply chain and logistics disruptions, macroeconomic impacts resulting from the exclusion of Russian financial institutions from the global banking system, volatility in foreign exchange rates and interest rates, inflationary pressures on raw materials and energy as well as heightened cybersecurity threats. Our annual sales to Russia and Ukraine represent approximately 1% of consolidated net sales.
We cannot know if the conflict could escalate and result in broader economic and security concerns that could adversely affect our business, financial condition, or results of operations.
Effects of the COVID-19 pandemic
The global food and animal production industry has experienced demand disruption, production impacts, price volatility and currency volatility in international markets due to the COVID-19 pandemic. The situation surrounding the COVID-19 pandemic remains fluid. We are unable to predict the future impact of COVID-19 on the economies where we manufacture and/or sell our products. We continue to evaluate the nature and extent of the effects of COVID-19 on our business, consolidated results of operations, financial condition and liquidity. For additional considerations and risks associated with COVID-19 on our business, please refer to Item 1A. “Risk Factors.”
Industry growth
We believe global population growth, the growth of the global middle class and the productivity improvements needed due to limitations of arable land and water supplies have supported and will continue to support growth of the animal health industry.
Regulatory Developments
Our business depends heavily on a healthy and growing livestock industry. Some in the public perceive risks to human health related to the consumption of food derived from animals that utilize certain of our products, including certain of our MFA products. In particular, there is increased focus, in the United States and other countries, on the use of medically important antimicrobials. As defined by the FDA, medically important antimicrobials (“MIAs”) include classes that are prescribed in animal and human health and are listed in the Appendix of the FDA-CVM Guidance for Industry (GFI) 152. Our products that contain virginiamycin, oxytetracycline or neomycin are classified by the FDA as medically important antimicrobials. In addition to the United States, the World Health Organization (WHO), the E.U., Australia and Canada have promulgated rating lists for antimicrobials that are used in veterinary medicine and that include certain of our products.
The classification of our products as MIAs or similar listings may lead to a decline in the demand for and production of food products derived from animals that utilize our products and, in turn, demand for our products. Livestock producers may experience decreased demand for their products or reputational harm as a result of evolving consumer views of nutrition and health-related concerns, animal rights and other concerns. Any reputational harm to the livestock industry may also extend to companies in related industries, including us. In addition, campaigns by interest groups,
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activists and others with respect to perceived risks associated with the use of our products in animals, including position statements by livestock producers and their customers based on non-use of certain medicated products in livestock production, whether or not scientifically-supported, could affect public perceptions and reduce the use of our products. Those adverse consumer views related to the use of one or more of our products in animals could have a material adverse effect on our financial condition and results of operations.
In April 2016, the FDA began initial steps to withdraw approval of carbadox (the active ingredient in our Mecadox product) via a regulatory process known as a Notice of Opportunity for Hearing (“NOOH”), due to concerns that certain residues from the product may persist in animal tissues for longer than previously determined. In the years following, Phibro has continued an ongoing process of responding collaboratively and transparently to the FDA’s Center for Veterinary Medicine (“CVM”) inquiries and has provided extensive and meticulous research and data that confirmed the safety of carbadox. In July 2020, the FDA announced it would not proceed to a hearing on the scientific concerns raised in the 2016 NOOH, consistent with the normal regulatory procedure, but instead announced that it was withdrawing the 2016 NOOH and issuing a proposed order to review the regulatory method for carbadox. Phibro reiterated the safety of carbadox and the appropriateness of the regulatory method and offered to work with the CVM to generate additional data to support the existing regulatory method or select a suitable alternative regulatory method.
In the event the FDA continues to assert that carbadox should be removed from the market, we will argue that we are entitled to and expect to have a full evidentiary hearing on the merits before an administrative law judge. Should we be unable to successfully defend the safety of the product, the loss of carbadox sales will have an adverse effect on our financial condition and results of operations. Sales of Mecadox (carbadox) for the twelve months ended June 30, 2022, were $21 million. As of the date of this Annual Report on Form 10-K, Mecadox continues to be available for use by swine producers.
See also “Business — Compliance with Government Regulations — United States — Carbadox”; and “Business — Compliance with Government Regulations — Global policy and guidance.”
Our global sales of antibacterials, anticoccidials and other products were $361 million, $330 million and $322 million for the years ended June 30, 2022, 2021 and 2020, respectively.
Competition
The animal health industry is highly competitive. We believe many of our competitors are conducting R&D activities in areas served by our products and in areas in which we are developing products. Our competitors include specialty animal health businesses and the animal health businesses of large pharmaceutical companies. In addition to competition from established participants, there could be new entrants to the animal health medicines and vaccines industry in the future. Principal methods of competition vary depending on the region, species, product category or individual products, including reliability, reputation, quality, price, service and promotion to veterinary professionals and livestock producers.
Foreign exchange
We conduct operations in many areas of the world, involving transactions denominated in a variety of currencies. For the year ended June 30, 2022, we generated approximately 40% of our revenues from operations outside the United States. Although a portion of our revenues are denominated in various currencies, the selling prices of the majority of our sales outside the United States are referenced in U.S. dollars, and as a result, our revenues have not been significantly affected by currency movements. We are subject to currency risk to the extent that our costs are denominated in currencies other than those in which we earn revenues. We manufacture some of our major products in Brazil and Israel and production costs are largely denominated in local currencies, while the selling prices of the products are largely set in U.S. dollars. As such, we are exposed to changes in cost of goods sold resulting from currency movements and may not be able to adjust our selling prices to offset such movements. In addition, we incur selling and administrative expenses in various currencies and are exposed to changes in such expenses resulting from currency movements. For the year ended June 30, 2022, our expenses were not significantly affected by currency movements. Because our financial statements are reported in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our results of operations.
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Climate
Adverse weather events and natural disasters may interfere with and negatively impact operations at our manufacturing sites, research and development facilities and offices, which could have a material adverse effect on our financial condition and results of operations, especially if the impact of an event or disaster is frequent or prolonged.
Our operations, and the activities of our customers, could be disrupted by climate change. The physical changes caused by climate change may prompt changes in regulations or consumer preferences which in turn could have negative consequences for our and our customers’ businesses. Climate change may negatively impact our customers’ operations, particularly those in the livestock industry, through climate-related impacts such as increased air and water temperatures, rising water levels and increased incidence of disease in livestock. Potential physical risks from climate change may include altered distribution and intensity of rainfall, prolonged droughts or flooding, increased frequency of wildfires and other natural disasters, rising sea levels and a rising heat index, any of which could cause negative impacts to our and our customers’ businesses. If such events affect our customers’ businesses, they may purchase fewer of our products, and our revenues may be negatively impacted. Climate driven changes could have a material adverse effect on our financial condition and results of operations.
There has been a broad range of proposed and promulgated state, national and international regulations aimed at reducing the effects of climate change. Such regulations could result in additional costs to maintain compliance and additional income or other taxes. Climate change regulations continue to evolve, and it is not possible to accurately estimate potential future compliance costs.
Product development initiatives
Our future success depends on our existing product portfolio, including additional approvals for new claims for our products, for use of our products in new markets, for use of our products with new species and for cross-clearances enabling the use of our medicated products in conjunction with other products. Our future success also depends on our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition. The majority of our R&D programs focus on product lifecycle development, which is defined as R&D programs that leverage existing animal health products by adding new species or claims, achieving approvals in new markets or creating new combinations and reformulations. We commit substantial effort, funds and other resources to expanding our product approvals and R&D, both through our own dedicated resources and through collaborations with third parties. We also commit significant resources to development of new vaccine technologies.
Our current strategic initiatives include several projects. We are working to develop a vaccine for African Swine Fever, a virulent disease that is highly lethal in swine. We have also developed pHi-Tech, a portable electronic vaccination device and software that ensures proper delivery of vaccines and provides health management information. We continue to invest in a vaccine production facility in Sligo, Ireland to manufacture poultry vaccines, with our first commercial sale of product realized in February 2022, and longer-term expectations to add swine and cattle vaccines. We are developing microbial products and bioproducts for a variety of applications serving animal health and nutrition, environmental, industrial and agricultural customers. We are also building a vaccine production facility in Guarulhos, Brazil to manufacture and market autogenous vaccines against animal diseases for swine, poultry and aquaculture. We continue to build our companion animal business and pipeline. Our Rejensa joint supplement for dogs continues to gain customer acceptance. Our companion animal development pipeline includes an early-stage atopic dermatitis compound, a novel Lyme vaccine delivery system product, two early-stage oral care compounds, and we entered into an agreement with Rejuvenate Bio, Inc. to collaborate on the development and commercialization of a gene therapy for MVD in canines.
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Analysis of the consolidated statements of operations
Summary Results of Operations
| | | | | | | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||||||||
| For the Year Ended June 30 | | 2022 | 2021 | 2020 | 2022 / 2021 | 2021/ 2020 | | ||||||||||||||
| | (in thousands, except per share amounts and percentages) | ||||||||||||||||||||
| Net sales | | $ | 942,261 | $ | 833,350 | $ | 800,354 | $ | 108,911 | | 13 | % | $ | 32,996 | 4 | % | |||||
| Gross profit | | 285,400 | | 271,377 | | 256,882 | | 14,023 | | 5 | % | 14,495 | 6 | % | |||||||
| Selling, general and administrative expenses | | 206,414 | | 196,509 | | 187,688 | | 9,905 | | 5 | % | 8,821 | 5 | % | |||||||
| Operating income | | 78,986 | | 74,868 | | 69,194 | | 4,118 | | 6 | % | 5,674 | 8 | % | |||||||
| Interest expense, net | | 11,875 | | 12,880 | | 12,856 | | (1,005) | | (8) | % | 24 | 0 | % | |||||||
| Foreign currency (gains), net | | (5,216) | | (4,480) | | 826 | | (736) | | | * | (5,306) | | * | |||||||
| Income before income taxes | | 72,327 | | 66,468 | | 55,512 | | 5,859 | | 9 | % | 10,956 | 20 | % | |||||||
| Provision for income taxes | | 23,152 | | 12,083 | | 21,960 | | 11,069 | | 92 | % | (9,877) | (45) | % | |||||||
| Net income | | $ | 49,175 | | $ | 54,385 | | $ | 33,552 | | $ | (5,210) | | (10) | % | $ | 20,833 | 62 | % | ||
| | | | | | | | | | | | | | | | | | | | | | |
| Net income per share | | | | | | | |||||||||||||||
| Basic | | $ | 1.21 | | $ | 1.34 | | $ | 0.83 | | $ | (0.13) | | | | | $ | 0.51 | | ||
| Diluted | | $ | 1.21 | | $ | 1.34 | | $ | 0.83 | | $ | (0.13) | | | | | $ | 0.51 | | ||
| | | | | | | | | | | | | | | | | | | | | | |
| Weighted average number of shares outstanding | | | | | | | |||||||||||||||
| Basic | 40,504 | | 40,473 | | 40,454 | | | | | ||||||||||||
| Diluted | 40,504 | | 40,504 | | 40,504 | | | | | ||||||||||||
| | | | | | | | | | | | | | | | | | | | | | |
| Ratio to net sales | | | | | | | | | | ||||||||||||
| Gross profit | 30.3 | % | 32.6 | % | 32.1 | % | | | | ||||||||||||
| Selling, general and administrative expenses | 21.9 | % | 23.6 | % | 23.5 | % | | | | ||||||||||||
| Operating income | 8.4 | % | 9.0 | % | 8.6 | % | | | | ||||||||||||
| Income before income taxes | 7.7 | % | 8.0 | % | 6.9 | % | | | | ||||||||||||
| Net income | 5.2 | % | 6.5 | % | 4.2 | % | | | | ||||||||||||
| Effective tax rate | 32.0 | % | 18.2 | % | 39.6 | % | | | |
Certain amounts and percentages may reflect rounding adjustments.
| Column 1 | Column 2 |
|---|---|
| * | Calculation not meaningful |
Changes in net sales from period to period primarily result from changes in volumes and average selling prices. Although a portion of our net sales is denominated in various currencies, the selling prices of the majority of our sales outside the United States are referenced in U.S. dollars, and as a result, currency movements have not significantly affected our revenues.
Our effective income tax rate has varied from period to period and from the federal statutory rate, due to the mix of taxable profits in various jurisdictions; changes in tax rates from period to period, including changes in income tax legislation in the United States and various international jurisdictions; and the effects of changes in uncertain tax positions and valuation allowances. Our future effective income tax rate will vary due to the relative amounts of taxable income in various jurisdictions, future changes in tax rates and legislation and other factors. We intend to continue to reinvest indefinitely the undistributed earnings of our foreign subsidiaries where we could be subject to applicable non-U.S. income and withholding taxes if amounts are repatriated to the U.S. See “Notes to Consolidated Financial Statements — Income Taxes” for additional information.
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Net sales, Adjusted EBITDA and reconciliation of GAAP net income to Adjusted EBITDA
We report Net sales and Adjusted EBITDA by segment to understand the operating performance of each segment. This enables us to monitor changes in net sales, costs and other actionable operating metrics at the segment level. See “— General description of non-GAAP financial measures” for descriptions of EBITDA and Adjusted EBITDA.
Segment net sales and Adjusted EBITDA:
| | | | | | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | |||||||||
| For the Year Ended June 30 | 2022 | 2021 | 2020 | 2022 / 2021 | 2021 / 2020 | |||||||||||||||
| Net sales | | (in thousands) | ||||||||||||||||||
| MFAs and other | | $ | 361,538 | | $ | 330,017 | | $ | 322,300 | | $ | 31,521 | 10 | % | $ | 7,717 | 2 | % | ||
| Nutritional specialties | | 157,196 | | 142,760 | | 129,264 | | 14,436 | 10 | % | 13,496 | 10 | % | |||||||
| Vaccines | | 88,321 | | 72,939 | | 75,340 | | 15,382 | 21 | % | (2,401) | (3) | % | |||||||
| Animal Health | | 607,055 | | 545,716 | | 526,904 | | 61,339 | 11 | % | 18,812 | 4 | % | |||||||
| Mineral Nutrition | | 259,512 | | 220,560 | | 214,412 | | 38,952 | 18 | % | 6,148 | 3 | % | |||||||
| Performance Products | | 75,694 | | 67,074 | | 59,038 | | 8,620 | 13 | % | 8,036 | 14 | % | |||||||
| Total | | $ | 942,261 | | $ | 833,350 | | $ | 800,354 | | $ | 108,911 | 13 | % | $ | 32,996 | 4 | % | ||
| | | | | | | | | | | | | | | | | | | | | |
| Adjusted EBITDA | | | | | | | ||||||||||||||
| Animal Health | | $ | 124,106 | | $ | 123,953 | | $ | 123,106 | | $ | 153 | 0 | % | $ | 847 | 1 | % | ||
| Mineral Nutrition | | 24,038 | | 17,116 | | 14,678 | | 6,922 | 40 | % | 2,438 | 17 | % | |||||||
| Performance Products | | 8,706 | | 9,437 | | 4,534 | | (731) | (8) | % | 4,903 | 108 | % | |||||||
| Corporate | | (45,767) | | (42,624) | | (40,178) | | (3,143) | 7 | % | (2,446) | 6 | % | |||||||
| Total | | $ | 111,083 | | $ | 107,882 | | $ | 102,140 | | $ | 3,201 | 3 | % | $ | 5,742 | 6 | % | ||
| | | | | | | | | | | | | | | | | | | | | |
| Adjusted EBITDA ratio to segment net sales | | | | | | | ||||||||||||||
| Animal Health | | 20.4 | % | 22.7 | % | 23.4 | % | | | |||||||||||
| Mineral Nutrition | | 9.3 | % | 7.8 | % | 6.8 | % | | | |||||||||||
| Performance Products | | 11.5 | % | 14.1 | % | 7.7 | % | | | |||||||||||
| Corporate(1) | | (4.9) | % | (5.1) | % | (5.0) | % | | | |||||||||||
| Total(1) | | 11.8 | % | 12.9 | % | 12.8 | % | | |
| Column 1 | Column 2 |
|---|---|
| (1) | Reflects ratio to total net sales. |
Certain amounts and percentages may reflect rounding adjustments.
| Column 1 | Column 2 |
|---|---|
| * | Calculation not meaningful |
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A reconciliation of net income, as reported under GAAP, to Adjusted EBITDA:
| | | | | | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | Change | ||||||||||
| For the Year Ended June 30 | 2022 | 2021 | 2020 | 2022/ 2021 | 2021/ 2020 | |||||||||||||||
| | | (in thousands) | ||||||||||||||||||
| Net income | | $ | 49,175 | | $ | 54,385 | | $ | 33,552 | | $ | (5,210) | (10) | % | $ | 20,833 | 62 | % | ||
| Interest expense, net | | 11,875 | | 12,880 | | 12,856 | | (1,005) | (8) | % | 24 | 0 | % | |||||||
| Provision for income taxes | | 23,152 | | 12,083 | | 21,960 | | 11,069 | 92 | % | (9,877) | (45) | % | |||||||
| Depreciation and amortization | | 32,705 | | 31,885 | | 32,341 | | 820 | 3 | % | (456) | (1) | % | |||||||
| EBITDA | | 116,907 | | 111,233 | | 100,709 | | 5,674 | 5 | % | 10,524 | 10 | % | |||||||
| Gain on sale of investment | | (1,203) | | — | | — | | (1,203) | * | | — | * | | |||||||
| Acquisition-related cost of goods sold | | 316 | | — | | 280 | | 316 | * | | (280) | * | | |||||||
| Acquisition-related transaction costs | | 279 | | — | | 462 | | 279 | * | | (462) | * | | |||||||
| Acquisition-related other, net (1) | | — | | — | | (2,821) | | — | * | | 2,821 | * | | |||||||
| Stock-based compensation | | — | | 1,129 | | 2,259 | | (1,129) | * | | (1,130) | * | | |||||||
| Restructuring costs | | | — | | | — | | | 425 | | | — | * | | | (425) | | * | | |
| Foreign currency (gains) losses, net | | (5,216) | | (4,480) | | 826 | | (736) | * | | (5,306) | * | | |||||||
| Adjusted EBITDA | | $ | 111,083 | | $ | 107,882 | | $ | 102,140 | | $ | 3,201 | 3 | % | $ | 5,742 | 6 | % |
(1) Acquisition-related other, net was primarily a result of a reduction to acquisition-related contingent consideration.
Certain amounts and percentages may reflect rounding adjustments.
| Column 1 | Column 2 |
|---|---|
| * | Calculation not meaningful |
Comparison of the years ended June 30, 2022 and 2021
Net sales
Net sales of $942.3 million for the year ended June 30, 2022, increased $108.9 million, or 13%, as compared to the year ended June 30, 2021. Animal Health, Mineral Nutrition and Performance Products increased $61.3 million, $39.0 million and $8.6 million, respectively.
Animal Health
Net sales of $607.1 million for the year ended June 30, 2022, increased $61.3 million, or 11%. Net sales of MFAs and other increased $31.5 million, or 10%, due to increased demand for our MFAs, particularly in the Latin America and Canada regions, and for processing aids used in the ethanol fermentation industry, and due to higher average selling prices. Net sales of nutritional specialty products grew $14.4 million, or 10%, due to domestic demand for dairy products, international growth and volume growth in our companion animal product. Net sales of vaccines increased $15.4 million, or 21%, with increased demand in most regions.
Mineral Nutrition
Net sales of $259.5 million for the year ended June 30, 2022, increased $39.0 million, or 18%, primarily driven by higher average selling prices. The increase in average selling prices is correlated with the movement of the underlying raw material costs.
Performance Products
Net sales of $75.7 million for the year ended June 30, 2022, increased $8.6 million, or 13%, as a result of higher volumes of ingredients for personal care products and increases in average-selling prices of copper-based products.
Gross profit
Gross profit of $285.4 million for the year ended June 30, 2022, increased $14.0 million, or 5%, as compared to the year ended June 30, 2021. Gross margin decreased 230 basis points to 30.3% of net sales for the year ended June 30,
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2022, as compared to 32.6% for the year ended June 30, 2021. The year ended June 30, 2022, included $0.3 million of acquisition-related cost of goods sold.
Animal Health gross profit increased $7.9 million due to increased sales, partially offset by increases in material costs. Mineral Nutrition gross profit increased $7.3 million, driven by increases in average selling prices, partially offset by increases in raw material costs. Performance Products gross profit decreased $0.8 million, driven by higher raw material and production costs. Acquisition-related cost of goods sold reduced gross profit by $0.3 million.
Selling, general and administrative expenses
SG&A expenses of $206.4 million for the year ended June 30, 2022, increased $9.9 million, or 5%, as compared to the year ended June 30, 2021. SG&A for the year ended June 30, 2022, included a $1.2 million gain on sale of investment and $0.3 million of acquisition-related transaction costs. SG&A for the year ended June 30, 2021, included $1.1 million of stock-based compensation. Excluding these items, SG&A increased $12.2 million, or 6%.
Animal Health SG&A increased $8.7 million, primarily due to increases in employee and related costs, marketing, product development and travel. Mineral Nutrition and Performance Products SG&A were comparable to the prior year. Corporate expenses increased $3.1 million, driven by investments in strategic initiatives. The gain on sale of investment, acquisition-related transaction costs and stock-based compensation accounted for a $2.1 million decrease in SG&A.
Interest expense, net
Interest expense, net of $11.9 million for the year ended June 30, 2022, decreased by $1.0 million as compared to the year ended June 30, 2021. Interest expense for the year ended June 30, 2021, included $1.0 million of expense related to the April 2021 refinancing.
Foreign currency (gains) losses, net
Foreign currency gains, net for the year ended June 30, 2022, were $5.2 million, as compared to net gains of $4.5 million for the year ended June 30, 2021. Foreign currency gains, net primarily arose from intercompany balances, driven by the movement of the Brazilian and Turkish currencies relative to the U.S. dollar.
Provision for income taxes
The provision for income taxes was $23.2 million and $12.1 million for the years ended June 30, 2022 and 2021, respectively. The effective income tax rate was 32.0% and 18.2% for the years ended June 30, 2022 and 2021, respectively. Our effective income tax rate has varied from period to period and from the federal statutory rate, due to the mix of income in the various jurisdictions where we have operations, changes in tax rates from period to period and the effects of certain other items. The provision for income taxes during the year ended June 30, 2022, included (i) a $2.6 million benefit from the reversal of uncertain tax positions related to settlements and the lapse of statute of limitations of prior years, (ii) a $4.1 million expense related to increases to reserves for uncertain tax positions due to the complex nature of tax law in various jurisdictions and related interpretations of tax law, (iii) a $1.0 million benefit from the release of a valuation allowance, and (iv) a $0.3 million expense related to a detailed analysis of various other items. The effective income tax rate, without these items, would have been 30.9% for the year ended June 30, 2022.
Net income
Net income of $49.2 million for the year ended June 30, 2022, decreased $5.2 million, as compared to net income of $54.4 million for the year ended June 30, 2021. The decrease was a result of a $11.1 million increase in the provision for income taxes and increased SG&A costs of $9.9 million. These decreases were partially offset by higher operating income of $4.1 million, lower interest expense, net, of $1.0 million and increased foreign currency gains of $0.7 million. SG&A costs increased due to employee and related costs, marketing, product development, travel and incremental investments relating to strategic initiatives.
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Adjusted EBITDA
Adjusted EBITDA of $111.1 million for the year ended June 30, 2022, increased $3.2 million, or 3%, as compared to the year ended June 30, 2021. Animal Health Adjusted EBITDA increased $0.2 million, driven by higher gross profit, mostly offset by higher SG&A expenses. Mineral Nutrition Adjusted EBITDA increased $6.9 million driven by increases in average selling prices, partially offset by increases in raw material costs. Performance Products Adjusted EBITDA decreased by $0.7 million, or 8%, due to higher raw material and production costs. Corporate expenses increased $3.1 million because of incremental investments relating to strategic initiatives.
Comparison of the years ended June 30, 2021 and 2020
For a comparison of our results of operations for the years ended June 30, 2021 and 2020, and an analysis of our financial condition, liquidity and capital resources for the year ended June 30, 2021, see “Part II. Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2021, filed with the SEC on August 25, 2021.
Analysis of financial condition, liquidity and capital resources
Net increase (decrease) in cash and cash equivalents was:
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||
| For the Year Ended June 30 | 2022 | 2021 | 2020 | 2022/ 2021 | 2021/ 2020 | ||||||||||
| | | (in thousands) | |||||||||||||
| Cash provided (used) by: | | | | | | | | | | | | | | | |
| Operating activities | | $ | 31,649 | | $ | 48,306 | | $ | 59,348 | | $ | (16,657) | | $ | (11,042) |
| Investing activities | | (22,582) | | (18,580) | | (120,390) | | (4,002) | | 101,810 | |||||
| Financing activities | | 16,343 | | (16,995) | | 40,936 | | 33,338 | | (57,931) | |||||
| Effect of exchange-rate changes on cash and cash equivalents | | (1,374) | | 1,138 | | (1,124) | | (2,512) | | 2,262 | |||||
| Net increase in cash and cash equivalents | | $ | 24,036 | | $ | 13,869 | | $ | (21,230) | | $ | 10,167 | | $ | 35,099 |
Net cash provided by operating activities was comprised of:
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||
| For the Year Ended June 30 | 2022 | 2021 | 2020 | 2022 / 2021 | 2021 / 2020 | ||||||||||
| | | (in thousands) | |||||||||||||
| EBITDA | | $ | 111,083 | | $ | 111,233 | | $ | 100,709 | | $ | (150) | | $ | 10,524 |
| Adjustments: | | | | | | ||||||||||
| Gain on sale of investment | | (1,203) | | — | | — | | (1,203) | | — | |||||
| Acquisition-related cost of goods sold | | 316 | | — | | 280 | | 316 | | (280) | |||||
| Acquisition-related transaction costs | | 279 | | — | | 462 | | 279 | | (462) | |||||
| Acquisition-related other, net | | — | | — | | | (2,821) | | — | | 2,821 | ||||
| Stock-based compensation | | | — | | | 1,129 | | | 2,259 | | | (1,129) | | | (1,130) |
| Restructuring costs | | | — | | | — | | | 425 | | | — | | | (425) |
| Foreign currency (gains), net | | (5,216) | | (4,480) | | 826 | | (736) | | (5,306) | |||||
| Interest paid, net | | (11,159) | | (10,808) | | (11,577) | | (351) | | 769 | |||||
| Income taxes paid | | (17,854) | | (19,395) | | (20,866) | | 1,541 | | 1,471 | |||||
| Changes in operating assets and liabilities and other items | | (44,597) | | (29,373) | | (10,349) | | (15,224) | | (19,024) | |||||
| Net cash provided by operating activities | | $ | 31,649 | | $ | 48,306 | | $ | 59,348 | | $ | (16,657) | | $ | (11,042) |
Certain amounts may reflect rounding adjustments.
Operating activities
Operating activities provided $31.6 million of net cash for the year ended June 30, 2022. Net cash provided by operating activities was driven by strong business performance, resulting in cash provided by net income and non-cash
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items, including depreciation and amortization, of $76.3 million, offset by cash used in the ordinary course of business for changes in operating assets and liabilities of $44.6 million. Changes in operating assets and liabilities included $23.6 million of cash used to fund a build of accounts receivable correlated with strong growth in net sales, particularly in the fourth quarter, $47.0 million of cash used to replenish inventory levels during a period when inflation was driving higher costs of material and labor, offset by $26.4 million of cash provided by accounts payable related to the timing of payments to suppliers, with the remaining $0.4 million of cash used to fund changes in other current assets, other assets and accrued expenses and other liabilities.
Operating activities provided $48.3 million of net cash for the year ended June 30, 2021. Profitable business performance resulted in cash provided by net income and non-cash items, including depreciation and amortization, of $78.2 million. Cash used in the ordinary course of business for changes in operating assets and liabilities was $29.9 million. Accounts receivable used $18.2 million of cash due to increased sales and timing of collections. Cash used for inventory was $12.5 million, primarily due to forecasted future demand and internal production schedules. For certain products, we are maintaining safety stocks to mitigate potential disruptions in production. Other current assets and other assets used $1.6 million and $1.9 million of cash, respectively. Accounts payable provided $3.2 million of cash due to timing of payments. Accrued expenses and other liabilities provided cash of $1.2 million due to timing of payments for employee-related liabilities.
Investing activities
Investing activities used $22.6 million of net cash for the year ended June 30, 2022. Capital expenditures were $37.0 million as we continued to invest in expanding production capacity and productivity improvements. Net proceeds from maturities of short-term investments were $26.0 million. We used $13.5 million for the acquisition of a business in Brazil, which develops, manufacturers and markets processing aids used in the ethanol industry. Other investing activities provided $2.0 million of cash.
Investing activities used $18.6 million of net cash for the year ended June 30, 2021. Capital expenditures were $29.3 million as we continued to invest in expanding production capacity and productivity improvements. Net proceeds from maturities of short-term investments were $12.0 million. Other investing activities used $1.3 million of cash.
Financing activities
Financing activities provided $16.3 million of net cash for the year ended June 30, 2022. Net borrowings on our 2021 Revolver provided $50.0 million. We paid $19.4 million in dividends to holders of our Class A and Class B common stock. We paid $9.4 million in scheduled debt maturities. We paid $4.8 million for acquisition-related contingent consideration.
Financing activities used $17.0 million of net cash for the year ended June 30, 2021. We used proceeds from the April 2021 refinancing to pay all outstanding term loan and revolving credit balances under the 2017 Credit Facilities. We paid $2.9 million in debt issuance costs relating to the refinancing. We paid $19.4 million in dividends to holders of our Class A and Class B common stock.
Liquidity and capital resources
We believe our cash on hand, our operating cash flows and our financing arrangements, including the availability of borrowings under the 2021 Revolver and foreign credit lines, will be sufficient to support our ongoing cash needs. We have considered the current and potential future effects of the macroeconomic market conditions in the financial markets. At this time, we expect adequate liquidity for at least the next twelve months. However, we can provide no assurance that our liquidity and capital resources will be adequate for future funding requirements. We believe we will be able to comply with the terms of the covenants under the 2021 Credit Facilities and foreign credit lines based on our operating plan. In the event of adverse operating results and/or violation of covenants under the facilities, there can be no assurance we would be able to obtain waivers or amendments. Other risks to our meeting future funding requirements include global economic conditions and macroeconomic, business and financial disruptions that could arise, including those caused by COVID-19. There can be no assurance that a challenging economic environment or an economic downturn would not affect our liquidity or our ability to obtain future financing or fund operations or investment opportunities. In addition, our debt covenants may restrict our ability to invest. Certain relevant measures of our liquidity and capital resources follow:
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| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||
| As of June 30 | 2022 | 2021 | 2020 | 2022 / 2021 | 2021 / 2020 | ||||||||||
| | | (in thousands, except ratios) | |||||||||||||
| Cash and cash equivalents and short-term investments | | $ | 91,248 | | $ | 93,212 | | $ | 91,343 | | $ | (1,964) | | $ | 1,869 |
| Working capital | | 299,152 | | 250,956 | | 222,006 | | 48,196 | | 28,950 | |||||
| Ratio of current assets to current liabilities | | 2.70:1 | | 2.62:1 | | 2.60:1 | | |
We define working capital as total current assets (excluding cash and cash equivalents and short-term investments) less total current liabilities (excluding current portion of long-term debt). We calculate the ratio of current assets to current liabilities based on this definition.
At June 30, 2022, we had $145.0 million in outstanding borrowings under the 2021 Revolver. We had outstanding letters of credit and other commitments of $2.5 million, leaving $102.5 million available for borrowings and letters of credit, subject to restriction in our 2021 Credit Facilities.
We currently intend to pay quarterly dividends on our Class A and Class B common stock, subject to approval from the Board of Directors. Our Board of Directors has declared a cash dividend of $0.12 per share on Class A common stock and Class B common stock, payable on September 28, 2022. Our future ability to pay dividends will depend upon our results of operations, financial condition, capital requirements, our ability to obtain funds from our subsidiaries and other factors that our Board of Directors deems relevant. Additionally, the terms of our current and any future agreements governing our indebtedness could limit our ability to pay dividends or make other distributions.
We do not expect to contribute to the domestic pension plan during 2023, based on the funded status at June 30, 2022.
At June 30, 2022, our cash and cash equivalents and short-term investments included $88.5 million held by our international subsidiaries. There are no restrictions on cash distributions to PAHC from our international subsidiaries.
Contractual obligations
Our contractual obligations include maturities under the 2021 Credit Facilities, including future interest accruals, operating lease commitments, and certain purchase obligations. See “Notes to Consolidated Financial Statements – Debt, Leases, and Commitment and Contingencies.”
Analysis of the consolidated balance sheets
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||
| As of June 30 | 2022 | 2021 | 2020 | 2022 / 2021 | 2021 / 2020 | ||||||||||
| | | (in thousands) | |||||||||||||
| Accounts receivable - trade | | $ | 166,537 | | $ | 146,852 | | $ | 126,522 | | $ | 19,685 | | $ | 20,330 |
| DSO | | 59 | | 60 | | 61 | | |
Payment terms outside the U.S. are typically longer than in the United States. We regularly monitor our accounts receivable for collectability, particularly in countries where economic conditions remain uncertain. We believe that our reserve for credit losses is appropriate. Our assessment is based on such factors as past due history, historical and expected collection patterns, the financial condition of our customers, the robust nature of our credit and collection practices and the economic environment. We calculate DSO based on a 360-day year and compare accounts receivable with sales for the quarter ending at the balance sheet date.
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | | | | | | | | | | Change | ||||
| As of June 30 | 2022 | 2021 | 2020 | 2022 / 2021 | 2021 / 2020 | ||||||||||
| | | (in thousands) | |||||||||||||
| Inventories | | $ | 259,158 | | $ | 216,312 | | $ | 196,659 | | $ | 42,846 | | $ | 19,653 |
Inventory increased by $42.8 million in 2022, primarily due to higher raw material and production costs.
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Off-balance sheet arrangements
We currently do not use off-balance sheet arrangements for the purpose of credit enhancement, hedging transactions, investment or other financial purposes.
In the ordinary course of business, we may indemnify our counterparties against certain liabilities that may arise. These indemnifications typically pertain to environmental matters. If the indemnified party were to make a successful claim pursuant to the terms of the indemnification, we would be required to reimburse the loss. These indemnifications generally are subject to certain restrictions and limitations.
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Selected Quarterly Financial Data (Unaudited)
To facilitate quarterly comparisons, the following unaudited information presents the quarterly results of operations, including segment data, for the years ended June 30, 2022 and 2021. This quarterly financial data was prepared on the same basis as, and should be read in conjunction with, the audited consolidated financial statements and related notes included herein.
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Quarters | | Year | |||||||||||
| | September 30, | December 31, | March 31, | June 30, | June 30, | ||||||||||
| For the Periods Ended | | 2021 | | 2021 | | 2022 | | 2022 | | 2022 | |||||
| | | (in thousands) | |||||||||||||
| Net sales | | | | | | ||||||||||
| MFAs and other | | $ | 83,758 | | $ | 91,724 | | $ | 84,330 | | $ | 101,726 | | $ | 361,538 |
| Nutritional Specialties | | 35,997 | | 37,330 | | 41,394 | | 42,475 | | 157,196 | |||||
| Vaccines | | 21,249 | | 21,873 | | 22,865 | | 22,334 | | 88,321 | |||||
| Animal Health | | $ | 141,004 | | $ | 150,927 | | $ | 148,589 | | $ | 166,535 | | $ | 607,055 |
| Mineral Nutrition | | 54,432 | | 66,655 | | 69,033 | | 69,392 | | 259,512 | |||||
| Performance Products | | 19,229 | | 15,130 | | 21,997 | | 19,338 | | 75,694 | |||||
| Total net sales | | 214,665 | | 232,712 | | 239,619 | | 255,265 | | 942,261 | |||||
| Cost of goods sold | | 149,987 | | 162,040 | | 167,993 | | 176,841 | | 656,861 | |||||
| Gross profit | | 64,678 | | 70,672 | | 71,626 | | 78,424 | | 285,400 | |||||
| Selling, general and administrative expenses | | | 50,066 | | | 48,378 | | | 52,432 | | | 55,538 | | | 206,414 |
| Operating income | | | 14,612 | | | 22,294 | | | 19,194 | | | 22,886 | | | 78,986 |
| Interest expense, net | | 2,889 | | 2,953 | | 2,925 | | 3,108 | | 11,875 | |||||
| Foreign currency (gains) losses, net | | 2,128 | | (4,189) | | (10,564) | | 7,409 | | (5,216) | |||||
| Income before income taxes | | 9,595 | | 23,530 | | 26,833 | | 12,369 | | 72,327 | |||||
| Provision for income taxes | | 3,061 | | 6,065 | | 9,144 | | 4,882 | | 23,152 | |||||
| Net income | | $ | 6,534 | | $ | 17,465 | | $ | 17,689 | | $ | 7,487 | | $ | 49,175 |
| Net income per share | | | | | | ||||||||||
| basic | | $ | 0.16 | | $ | 0.43 | | $ | 0.44 | | $ | 0.18 | | $ | 1.21 |
| diluted | | $ | 0.16 | | $ | 0.43 | | $ | 0.44 | | $ | 0.18 | | $ | 1.21 |
| Adjusted EBITDA | | | | | | ||||||||||
| Animal Health | | $ | 27,637 | | $ | 33,696 | | $ | 29,232 | | $ | 33,541 | | $ | 124,106 |
| Mineral Nutrition | | 4,533 | | 5,525 | | 7,303 | | 6,677 | | 24,038 | |||||
| Performance Products | | 2,138 | | 1,324 | | 2,865 | | 2,379 | | 8,706 | |||||
| Corporate | | (11,842) | | (11,453) | | (11,404) | | (11,068) | | (45,767) | |||||
| Adjusted EBITDA | | $ | 22,466 | | $ | 29,092 | | $ | 27,996 | | $ | 31,529 | | $ | 111,083 |
| Reconciliation of net income to Adjusted EBITDA | | | | | | ||||||||||
| Net income | | $ | 6,534 | | $ | 17,465 | | $ | 17,689 | | $ | 7,487 | | $ | 49,175 |
| Interest expense, net | | 2,889 | | 2,953 | | 2,925 | | 3,108 | | 11,875 | |||||
| Provision for income taxes | | 3,061 | | 6,065 | | 9,144 | | 4,882 | | 23,152 | |||||
| Depreciation and amortization | | 7,854 | | 8,001 | | 8,445 | | 8,405 | | 32,705 | |||||
| EBITDA | | | 20,338 | | 34,484 | | 38,203 | | 23,882 | | 116,907 | ||||
| Acquisition-related cost of goods sold | | — | | — | | 78 | | 238 | | 316 | |||||
| Acquisition-related transaction costs | | — | | — | | 279 | | — | | 279 | |||||
| Gain on sale of investment | | | — | | | (1,203) | | | — | | | — | | | (1,203) |
| Foreign currency (gains) losses, net | | 2,128 | | (4,189) | | (10,564) | | 7,409 | | (5,216) | |||||
| Adjusted EBITDA | | $ | 22,466 | | $ | 29,092 | | $ | 27,996 | | $ | 31,529 | | $ | 111,083 |
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| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Quarters | | Year | |||||||||||
| | September 30, | December 31, | March 31, | June 30, | June 30, | ||||||||||
| For the Periods Ended | | 2020 | | 2020 | | 2021 | | 2021 | | 2021 | |||||
| | | (in thousands) | |||||||||||||
| Net sales | | | | | | ||||||||||
| MFAs and other | | $ | 78,703 | | $ | 81,577 | | $ | 78,530 | | $ | 91,207 | | $ | 330,017 |
| Nutritional Specialties | | 32,600 | | 36,394 | | 36,978 | | 36,788 | | 142,760 | |||||
| Vaccines | | 17,066 | | 18,267 | | 18,872 | | 18,734 | | 72,939 | |||||
| Animal Health | | $ | 128,369 | | $ | 136,238 | | $ | 134,380 | | $ | 146,729 | | $ | 545,716 |
| Mineral Nutrition | | 51,440 | | 54,157 | | 58,153 | | 56,810 | | 220,560 | |||||
| Performance Products | | 15,385 | | 15,754 | | 19,196 | | 16,739 | | 67,074 | |||||
| Total net sales | | 195,194 | | 206,149 | | 211,729 | | 220,278 | | 833,350 | |||||
| Cost of goods sold | | 131,075 | | 137,884 | | 142,564 | | 150,450 | | 561,973 | |||||
| Gross profit | | 64,119 | | 68,265 | | 69,165 | | 69,828 | | 271,377 | |||||
| Selling, general and administrative expenses | | | 48,431 | | | 48,375 | | | 49,033 | | | 50,670 | | | 196,509 |
| Operating income | | | 15,688 | | | 19,890 | | | 20,132 | | | 19,158 | | | 74,868 |
| Interest expense, net | | 2,810 | | 3,214 | | 2,933 | | 3,923 | | 12,880 | |||||
| Foreign currency (gains) losses, net | | (3,631) | | 624 | | (583) | | (890) | | (4,480) | |||||
| Income before income taxes | | 16,509 | | 16,052 | | 17,782 | | 16,125 | | 66,468 | |||||
| Provision (benefit) for income taxes | | 4,207 | | 3,251 | | 5,621 | | (996) | | 12,083 | |||||
| Net income | | $ | 12,302 | | $ | 12,801 | | $ | 12,161 | | $ | 17,121 | | $ | 54,385 |
| Net income per share | | | | | | ||||||||||
| basic | | $ | 0.30 | | $ | 0.32 | | $ | 0.30 | | $ | 0.42 | | $ | 1.34 |
| diluted | | $ | 0.30 | | $ | 0.32 | | $ | 0.30 | | $ | 0.42 | | $ | 1.34 |
| Adjusted EBITDA | | | | | | ||||||||||
| Animal Health | | $ | 30,101 | | $ | 33,349 | | $ | 30,962 | | $ | 29,541 | | $ | 123,953 |
| Mineral Nutrition | | 3,047 | | 4,185 | | 5,232 | | 4,652 | | 17,116 | |||||
| Performance Products | | 1,972 | | 2,266 | | 2,929 | | 2,270 | | 9,437 | |||||
| Corporate | | (10,831) | | (11,258) | | (11,073) | | (9,462) | | (42,624) | |||||
| Adjusted EBITDA | | $ | 24,289 | | $ | 28,542 | | $ | 28,050 | | $ | 27,001 | | $ | 107,882 |
| Reconciliation of net income to Adjusted EBITDA | | | | | | ||||||||||
| Net income | | $ | 12,302 | | $ | 12,801 | | $ | 12,161 | | $ | 17,121 | | $ | 54,385 |
| Interest expense, net | | 2,810 | | 3,214 | | 2,933 | | 3,923 | | 12,880 | |||||
| Provision (benefit) for income taxes | | 4,207 | | 3,251 | | 5,621 | | (996) | | 12,083 | |||||
| Depreciation and amortization | | 8,036 | | 8,088 | | 7,918 | | 7,843 | | 31,885 | |||||
| EBITDA | | | 27,355 | | 27,354 | | 28,633 | | 27,891 | | 111,233 | ||||
| Stock-based compensation | | 565 | | 564 | | — | | — | | 1,129 | |||||
| Foreign currency (gains) losses, net | | (3,631) | | 624 | | (583) | | (890) | | (4,480) | |||||
| Adjusted EBITDA | | $ | 24,289 | | $ | 28,542 | | $ | 28,050 | | $ | 27,001 | | $ | 107,882 |
General description of non-GAAP financial measures
Adjusted EBITDA
Adjusted EBITDA is an alternative view of performance used by management as our primary operating measure, and we believe that investors’ understanding of our performance is enhanced by disclosing this performance measure. We report Adjusted EBITDA to reflect the results of our operations prior to considering certain income statement elements. We have defined EBITDA as net income (loss) plus (i) interest expense, net, (ii) provision for income taxes or less benefit for income taxes, and (iii) depreciation and amortization. We have defined Adjusted EBITDA as EBITDA plus (a) (income) loss from, and disposal of, discontinued operations, (b) other expense or less other income, as separately reported on our consolidated statements of operations, including foreign currency gains and losses, and (c) certain items that we consider to be unusual, non-operational or non-recurring. The Adjusted EBITDA measure is not, and should not be viewed as, a substitute for GAAP reported net income.
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The Adjusted EBITDA measure is an important internal measurement for us. We measure our overall performance on this basis in conjunction with other performance metrics. The following are examples of how our Adjusted EBITDA measure is utilized:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | senior management receives a monthly analysis of our operating results that is prepared on an Adjusted EBITDA basis; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | our annual budgets are prepared on an Adjusted EBITDA basis; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | other goal setting and performance measurements are prepared on an Adjusted EBITDA basis. |
Despite the importance of this measure to management in goal setting and performance measurement, Adjusted EBITDA is a non-GAAP financial measure that has no standardized meaning prescribed by GAAP and, therefore, has limits in its usefulness to investors. Because of its non-standardized definition, Adjusted EBITDA, unlike GAAP net income, may not be comparable to the calculation of similar measures of other companies. Adjusted EBITDA is presented to permit investors to more fully understand how management assesses performance.
We also recognize that, as an internal measure of performance, the Adjusted EBITDA measure has limitations, and we do not restrict our performance management process solely to this metric. A limitation of the Adjusted EBITDA measure is that it provides a view of our operations without including all events during a period, such as the depreciation of property, plant and equipment or amortization of acquired intangibles, and does not provide a comparable view of our performance to other companies.
Certain significant items
Adjusted EBITDA is calculated prior to considering certain items. We evaluate such items on an individual basis. Such evaluation considers both the quantitative and the qualitative aspect of their unusual or non-operational nature. Unusual, in this context, may represent items that are not part of our ongoing business; items that, either as a result of their nature or size, we would not expect to occur as part of our normal business on a regular basis.
We consider acquisition-related activities and business restructuring costs related to productivity and cost saving initiatives, including employee separation costs, to be unusual items that we do not expect to occur as part of our normal business on a regular basis. We consider foreign currency gains and losses to be non-operational because they arise principally from intercompany transactions and are largely non-cash in nature.
New accounting standards
For discussion of new accounting standards, see “Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies and New Accounting Standards.”
Critical accounting policies
Critical accounting policies are those that require application of management’s most difficult, subjective and/or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Not all accounting policies require management to make difficult, subjective or complex judgments or estimates. In presenting our consolidated financial statements in accordance with generally accepted accounting principles in the United States of America (GAAP), we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results that differ from our estimates and assumptions could have an unfavorable effect on our financial position and results of operations.
The following is a summary of accounting policies that we consider critical to the consolidated financial statements.
Revenue Recognition
We recognize revenue from product sales when control of the products has transferred to the customer, typically when title and risk of loss transfer to the customer. Certain of our businesses have terms where control of the underlying product transfers to the customer on shipment, while others have terms where control transfers to the customer on delivery.
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Revenue reflects the total consideration to which we expect to be entitled, in exchange for delivery of products or services, net of variable consideration. Variable consideration includes customer programs and incentive offerings, including pricing arrangements, rebates and other volume-based incentives. We record reductions to revenue for estimated variable consideration at the time we record the sale. Our estimates for variable consideration reflect the amount by which we expect variable consideration to affect the revenue recognized. Such estimates are based on contractual terms and historical experience, and are adjusted to reflect future expectations as new information becomes available. Historically, we have not had significant adjustments to our estimates of customer incentives. Sales returns and product recalls have been insignificant and infrequent due to the nature of the products we sell.
Net sales include shipping and handling fees billed to customers. The associated costs are considered fulfillment activities, not additional promised services to the customer, and are included in costs of goods sold when the related revenue is recognized in the consolidated statements of operations. Net sales exclude value-added and other taxes based on sales.
Business Combinations
Our consolidated financial statements reflect the operations of an acquired business beginning as of the date of acquisition. Assets acquired and liabilities assumed are recorded at their fair values at the date of acquisition; goodwill is recorded for any excess of the purchase price over the fair values of the net assets acquired. Significant judgment may be required to determine the fair values of certain tangible and intangible assets and in assigning their respective useful lives. Significant judgment also may be required to determine the fair values of contingent consideration, if any. We typically utilize third-party valuation specialists to assist us in determining fair values of significant tangible and intangible assets and contingent consideration. The fair values are based on available historical information and on future expectations and assumptions deemed reasonable by management, but are inherently uncertain. We typically use an income method to measure the fair value of intangible assets, based on forecasts of the expected future cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflect consideration of other marketplace participants, and include the amount and timing of future cash flows, specifically the expected revenue growth rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances could affect the accuracy or validity of the estimates and assumptions. Determining the useful life of an intangible asset also requires judgment. Our estimates of the useful lives of intangible assets primarily are based on a number of factors including the competitive environment, underlying product life cycles, operating plans and the macroeconomic environment of the countries in which the products are sold. Intangible assets are amortized over their estimated lives. Intangible assets associated with acquired in-process research and development activities (“IPR&D”) are not amortized until a product is available for sale and regulatory approval is obtained.
Long-Lived Assets and Goodwill
We periodically review our long-lived and amortizable intangible assets for impairment and assess whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. Such circumstances may include a significant decrease in the market price of an asset, a significant adverse change in the manner in which the asset is being used or in its physical condition or a history of operating or cash flow losses associated with the use of an asset. We recognize an impairment loss when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss is the excess of the asset’s carrying value over its fair value. In addition, we periodically reassess the estimated remaining useful lives of our long-lived and amortizable intangible assets. Changes to estimated useful lives would affect the amount of depreciation and amortization recorded in the consolidated statements of operations.
Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired in a business combination. We assess goodwill for impairment annually during the fourth quarter, or more frequently if impairment indicators exist. Impairment exists when the carrying amount of goodwill exceeds its implied fair value. We may elect to assess our goodwill for impairment using a qualitative or a quantitative approach, to determine whether it is more likely than not that the fair value of goodwill is greater than its carrying value. During the three months ended June 30, 2022, we tested goodwill using a quantitative approach and determined goodwill was not impaired. We have not recorded any goodwill impairment charges in the periods included in the consolidated financial statements.
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We evaluate our investments in equity method investees for impairment if circumstances indicate that the fair value of the investment may be impaired. The assets underlying a $2.7 million equity investment are currently idle; we have concluded the investment is not impaired, based on expected future operating cash flows and/or disposal value.
Income Taxes
The provision for income taxes includes U.S. federal, state and foreign income taxes and foreign withholding taxes. Our annual effective income tax rate is determined based on our income, statutory tax rates and tax planning opportunities available in the various jurisdictions in which we operate and the tax impacts of items treated differently for tax purposes than for financial reporting purposes. Tax law requires certain items be included in the tax return at different times than the items are reflected in the financial statements. Some of these differences are permanent, such as expenses that are not deductible in our tax return, and some differences are temporary, reversing over time, such as depreciation expense. These temporary differences give rise to deferred tax assets and liabilities. Deferred tax assets generally represent the tax effect of items that can be used as a tax deduction or credit in future years for which we have already recorded the tax benefit in our income statement. Deferred tax liabilities generally represent the tax effect of items recorded as tax expense in our income statement for which payment has been deferred, the tax effect of expenditures for which a deduction has already been taken in our tax return but has not yet been recognized in our income statement or the tax effect of assets recorded at fair value in business combinations for which there was no corresponding tax basis adjustment.
The recognition and measurement of a tax position is based on management’s best judgment given the facts, circumstances and information available at the reporting date. Inherent in determining our annual effective income tax rate are judgments regarding business plans, planning opportunities and expectations about future outcomes. Realization of certain deferred tax assets, primarily net operating loss carryforwards, is dependent upon generating sufficient future taxable income in the appropriate jurisdiction prior to the expiration of the carryforward periods. We establish valuation allowances for deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit.
We may take tax positions that management believes are supportable, but are potentially subject to successful challenge by the applicable taxing authority in the jurisdictions where we operate. We evaluate our tax positions and establish liabilities in accordance with the applicable accounting guidance on uncertainty in income taxes. We review these tax uncertainties in light of changing facts and circumstances, such as the progress of tax audits, and adjust them accordingly.
We account for income tax contingencies using a benefit recognition model. If our initial assessment does not result in the recognition of a tax benefit, we regularly monitor our position and subsequently recognize the tax benefit if: (i) there are changes in tax law or there is new information that sufficiently raise the likelihood of prevailing on the technical merits of the position to “more likely than not;” (ii) the statute of limitations expires; or (iii) there is a completion of an audit resulting in a favorable settlement of that tax year with the appropriate agency. We regularly re-evaluate our tax positions based on the results of audits of federal, state and foreign income tax filings, statute of limitations expirations, and changes in tax law or receipt of new information that would either increase or decrease the technical merits of a position relative to the “more-likely-than-not” standard.
Our assessments concerning uncertain tax positions are based on estimates and assumptions that have been deemed reasonable by management, but our estimates of unrecognized tax benefits and potential tax benefits may not be representative of actual outcomes, and variation from such estimates could materially affect our financial statements in the period of settlement or when the statutes of limitations expire. Finalizing audits with the relevant taxing authorities can include formal administrative and legal proceedings, and, as a result, it is difficult to estimate the timing and range of possible changes related to our uncertain tax positions, and such changes could be significant.
Because there are a number of estimates and assumptions inherent in calculating the various components of our income tax provision, certain future events such as changes in tax legislation, geographic mix of earnings, completion of tax audits or earnings repatriation plans could have an impact on those estimates and our effective income tax rate.
We consider undistributed earnings of foreign subsidiaries to be indefinitely reinvested in our international operations. The undistributed earnings of foreign subsidiaries were subject to the U.S. one-time mandatory toll charge and are eligible to be repatriated to the U.S. without additional U.S. tax under the Tax Act. Should our plans change and
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we decide to repatriate some or all of the remaining cash held by our international subsidiaries, the amounts repatriated could be subject to applicable non-U.S. income and withholding taxes in international jurisdictions.
For more information regarding our significant accounting policies, estimates and assumptions, see “Notes to Consolidated Financial Statements — Summary of Significant Accounting Policies and New Accounting Standards.”
Contingencies
Legal matters
We are subject to numerous contingencies arising in the ordinary course of business, such as product liability and other product-related litigation, commercial litigation, environmental claims and proceedings and government investigations. Certain of these contingencies could result in losses, including damages, fines and/or civil penalties, and/or criminal charges, which could be substantial. We believe that we have strong defenses in these types of matters, but litigation is inherently unpredictable and excessive verdicts do occur. We do not believe that any of these matters will have a material adverse effect on our financial position. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations or cash flows in the period in which the amounts are paid and/or accrued.
We have accrued for losses that are both probable and reasonably estimable. Substantially all of these contingencies are subject to significant uncertainties and, therefore, determining the likelihood of a loss and/or the measurement of any loss can be complex. Consequently, we are unable to estimate the range of reasonably possible loss in excess of amounts accrued. Our assessments are based on estimates and assumptions that have been deemed reasonable by management, but the assessment process relies heavily on estimates and assumptions that may prove to be incomplete or inaccurate, and unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions.
Environmental
Our operations and properties are subject to Environmental Laws and regulations. As such, the nature of our current and former operations exposes us to the risk of claims with respect to such matters, including fines, penalties and remediation obligations that may be imposed by regulatory authorities. Under certain circumstances, we might be required to curtail operations until a particular problem is remedied. Known costs and expenses under Environmental Laws incidental to ongoing operations, including the cost of litigation proceedings relating to environmental matters, are generally included within operating results. Potential costs and expenses may also be incurred in connection with the repair or upgrade of facilities to meet existing or new requirements under Environmental Laws or to investigate or remediate potential or actual contamination and from time to time we establish reserves for such contemplated investigation and remediation costs. In many instances, the ultimate costs under Environmental Laws and the time period during which such costs are likely to be incurred are difficult to predict.
While we believe that our operations are currently in material compliance with Environmental Laws, we have, from time to time, received notices of violation from governmental authorities, and have been involved in civil or criminal action for such violations. Additionally, at various sites, our subsidiaries are engaged in continuing investigation, remediation and/or monitoring efforts to address contamination associated with historic operations of the sites. We devote considerable resources to complying with Environmental Laws and managing environmental liabilities. We have developed programs to identify requirements under, and maintain compliance with Environmental Laws; however, we cannot predict with certainty the impact of increased and more stringent regulation on our operations, future capital expenditure requirements, or the cost of compliance.
The nature of our current and former operations exposes us to the risk of claims with respect to environmental matters and we cannot assure we will not incur material costs and liabilities in connection with such claims. Based upon our experience to date, we believe that the future cost of compliance with existing Environmental Laws, and liabilities for known environmental claims pursuant to such Environmental Laws, will not have a material adverse effect on our financial position, results of operations, cash flows or liquidity.
For additional details, see “Notes to Consolidated Financial Statements — Commitments and Contingencies.”
For additional details, see “Business — Environmental, Health and Safety.”
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