PHIBRO ANIMAL HEALTH CORPORATION 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 global diversified animal health and mineral nutrition company. We develop, manufacture and market a broad range of products for food animals including poultry, swine, beef and dairy cattle, and aquaculture. Our products help prevent, control and treat diseases, enhance nutrition to help improve health and performance and contribute to balanced mineral nutrition. 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 more than 1,625 product presentations in over 80 countries to approximately 3,725 customers. 53 Table of Contents
Factors affecting our performance
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 response to the global outbreak of COVID-19 continues to evolve. Governmental authorities continue to implement measures to contain virus outbreaks, such as travel bans, quarantines, shelter-in-place orders, site closures and business shutdowns. Although vaccines are now available, distribution efforts vary widely country-by-country and state-by-state. The pandemic may have significant economic impacts on customers, suppliers and markets. New information may continue to emerge concerning COVID-19 and the actions required to contain or treat it may affect the duration and severity of the economic impact. We believe the global food and animal production industry is returning to stability, but the potential impact of COVID-19 continues to evolve and future industry outlooks remain uncertain. Phibro is an integral participant in the essential production of meat, milk, eggs and aquaculture for human consumption. In the face of the pandemic, we have focused on the safety of our employees, while continuing to supply our customers. Our global production facilities have continued to operate without interruption, despite supply chain and logistical challenges. Our sales and technical service people remain in close virtual contact with our customers, as most travel and in-person meetings have been cancelled. Most of our administrative and management staff are working remotely. We have experienced some cost increases from the safety measures implemented to protect our employees as well as from supply chain disruptions. We have maintained headcount and compensation at or above constant levels. We continue to monitor sales trends, cash flow and liquidity. The uncertainties surrounding the COVID-19 pandemic remain fluid. We are unable to predict the supply, distribution or effectiveness of COVID-19 vaccines and hence the impact on the economies where we manufacture and sell our products. While we continue to adapt our operations and mitigate the risks and challenges posed by COVID-19, the demand for our products will be dependent upon economic conditions and the ability of our customers and end users of our products to operate their businesses and production facilities. Our business and future operational results may be impacted by government mandated response efforts, supply chain and manufacturing disruptions, increased volatility in raw material costs and decreased demand due to changes in our customer purchasing patterns and preferences. We are unable to predict with confidence the nature and timing of when any of these events may occur and the effects COVID-19 will have on our business, our consolidated results and the broader economic environment going forward.We will 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, inthe 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 tothe United States , theWorld Health Organization (WHO ), the E.U.,Australia andCanada 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 54
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companies in related industries, including us. In addition, campaigns by interest groups, 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. InApril 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. The NOOH process provided Phibro with an opportunity to defend the safety of carbadox prior to the FDA taking final steps to remove carbadox from the market. Over the next four years, as part of an ongoing process of responding to the inquiries from theFDA's Center for Veterinary Medicine ("CVM"), we provided extensive and meticulous research and data that confirmed the safety of carbadox. InMarch 2018 , the FDA indefinitely stayed the withdrawal proceedings. InJuly 2020 , the FDA announced it does not agree with Phibro's scientific conclusions that carbadox is safe under the current conditions of use. Instead of proceeding to a hearing on the scientific concerns raised in the 2016 NOOH, consistent with the normal regulatory procedure, the FDA announced that it was withdrawing the current NOOH and issuing a proposed order to review the regulatory method for carbadox. The approved regulatory method determines if there are residues of carcinogenic concern in animal tissue at the time of slaughter. If the order is finalized, the FDA has indicated it plans to issue a new NOOH proposing the withdrawal of carbadox from the market because of a lack of an approved regulatory method. InSeptember 2020 , Phibro commented on the proposed order, reiterating the safety of carbadox and the appropriateness of the regulatory method, and further offered to work with the CVM to generate additional data to support the existing regulatory method or select a suitable alternative regulatory method. Phibro disagrees with the agency's actions and has submitted a request to theFDA Office of the Commissioner that the agency continue the NOOH process it started in 2016 and proceed with a hearing to review the substantial body of data supporting the safety of carbadox. There is no defined timeline for the conclusion of this matter. Should we be unable to successfully defend the safety of the product, the loss of carbadox sales would have an adverse effect on our financial condition and results of operations. Sales of carbadox for the twelve months endedJune 30, 2021 , were$23 million . As of the date of this Annual Report on Form 10-K, Mecadox continues to be available for use by swine producers. Our global sales of antibacterials, anticoccidials and other products were$330 million ,$322 million and$350 million for the years endedJune 30, 2021 , 2020 and 2019, 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 the animal health businesses of large pharmaceutical companies and specialty animal health businesses. 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 endedJune 30, 2021 , we generated approximately 40% of our revenues from operations outsidethe United States . Although a portion of our revenues are denominated in various currencies, the selling prices of the majority of our sales outsidethe United States are referenced inU.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 inBrazil andIsrael and production costs are largely denominated in local currencies, while the selling prices of the products are largely set inU.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 55 Table of Contents
movements. Because our financial statements are reported in
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 a number of projects. We are working to develop a vaccine for African Swine Fever, a virulent disease that is highly lethal in swine. We also have developed pHi-Tech, a portable electronic vaccination device and software that ensures proper delivery of vaccines and provides health management information. We are developing a facility inSligo, Ireland for the production of animal vaccines and have recently received EU GMP approval for the facility and have submitted product registration applications in various markets. We are developing microbial products and bioproducts for a variety of applications serving animal health and nutrition, environmental, industrial and agricultural customers. 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 and two early-stage oral care compounds. 56
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Analysis of the consolidated statements of operations
Summary Results of Operations
Change
For the Year Ended
June 30 2021 2020 2019 2021 / 2020 2020/ 2019
(in thousands, except per share)
Net sales $ 833,350 $ 800,354 $ 827,995 $ 32,996 4 % $ (27,641) (3) %
Gross profit 271,377 256,882 264,624 14,495 6 % (7,742) (3) %
Selling, general and 196,509 187,688 181,398 8,821 5 % 6,290 3 %
administrative expenses
Operating income 74,868 69,194 83,226 5,674 8 % (14,032) (17) %
Interest expense, net 12,880 12,856 11,776 24 0 % 1,080 9 %
Foreign currency (4,480) 826 (55) (5,306) * 881 *
(gains) losses, net
Income before income
taxes 66,468 55,512 71,505 10,956 20 % (15,993) (22) %
Provision for income
taxes 12,083 21,960 16,792 (9,877) (45) % 5,168 31 %
Net income $ 54,385 $ 33,552 $ 54,713 $ 20,833 62 % $ (21,161) (39) %
Net income per share
basic $ 1.34 $ 0.83 $ 1.35 $ 0.51 $ (0.52)
diluted $ 1.34 $ 0.83 $ 1.35 $ 0.51 $ (0.52)
Weighted average number
of shares outstanding
basic 40,473 40,454 40,412
diluted 40,504 40,504 40,523
Ratio to net sales
Gross profit 32.6 % 32.1 % 32.0 %
Selling, general and
administrative expenses 23.6 % 23.5 % 21.9 %
Operating income 9.0 % 8.6 % 10.1 %
Income before income
taxes 8.0 % 6.9 % 8.6 %
Net income 6.5 % 4.2 % 6.6 %
Effective tax rate 18.2 % 39.6 % 23.5 %
Certain amounts and percentages may reflect rounding adjustments.
* 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 outsidethe United States are referenced inU.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 inthe 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 theU.S. See "Notes to Consolidated Financial Statements - Income Taxes" for additional information. 57
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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 2021 2020 2019 2021 / 2020 2020 / 2019
(in thousands)
Net sales
MFAs and other $ 330,017 $ 322,300 $ 350,468 $ 7,717 2 % $ (28,168) (8) %
Nutritional specialties 142,760 129,264 113,215 13,496 10 % 16,049 14 %
Vaccines 72,939 75,340 68,291 (2,401) (3) % 7,049 10 %
Animal Health 545,716 526,904 531,974 18,812 4 % (5,070) (1) %
Mineral Nutrition 220,560 214,412 233,782 6,148 3 % (19,370) (8) %
Performance Products 67,074 59,038 62,239 8,036 14 % (3,201) (5) %
Total $ 833,350 $ 800,354 $ 827,995 $ 32,996 4 % $ (27,641) (3) %
Adjusted EBITDA
Animal Health $ 123,953 $ 123,106 $ 136,049 $ 847 1 % $ (12,943) (10) %
Mineral Nutrition 17,116 14,678 15,712 2,438 17 % (1,034) (7) %
Performance Products 9,437 4,534 4,728 4,903 108 % (194) (4) %
Corporate (42,624) (40,178) (38,452) (2,446) * (1,726) *
Total $ 107,882 $ 102,140 $ 118,037 $ 5,742 6 % $ (15,897) (13) %
Adjusted EBITDA ratio to segment net sales Animal Health 22.7 % 23.4 % 25.6 % Mineral Nutrition 7.8 % 6.8 % 6.7 % Performance Products 14.1 % 7.7 % 7.6 % Corporate(1) (5.1) % (5.0) % (4.6) % Total(1) 12.9 % 12.8 % 14.3 %
(1) Reflects ratio to total net sales.
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A reconciliation of net income, as reported under GAAP, to Adjusted EBITDA:
Change
For the Year Ended June 30 2021 2020 2019 2021/ 2020 2020/ 2019
(in thousands)
Net income $ 54,385 $ 33,552 $ 54,713 $ 20,833 62 % $ (21,161) (39) %Interest expense, net 12,880 12,856 11,776 24 0 % 1,080 9 % Provision for income taxes 12,083 21,960 16,792 (9,877) (45) % 5,168 31 % Depreciation and amortization 31,885 32,341 27,564 (456) (1) % 4,777 17 % EBITDA 111,233 100,709 110,845 10,524 10 % (10,136) (9) % Stock-based compensation 1,129 2,259 2,259 (1,130) (50) % - 0 % Restructuring costs - 425 6,281 (425) * - (93) % Acquisition-related cost of goods sold - 280 - (280) * 280 * Acquisition-related transaction costs - 462 213 (462) * 249 117 % Acquisition-related other, net (1) - (2,821) - 2,821 * (2,821) * Other, net - - (1,506) - * 1,506 * Foreign currency (gains) losses, net (4,480) 826 (55) (5,306) * 881 * Adjusted EBITDA$ 107,882 $ 102,140 $ 118,037 $
5,742 6 %
Certain amounts and percentages may reflect rounding adjustments.
* Calculation not meaningful
Comparison of the years ended
Net sales
Net sales of
Net sales of$545.7 million for the year endedJune 30, 2021 , increased$18.8 million , or 4%. Net sales of MFAs and other increased$7.7 million , or 2%, due to increased domestic demand in swine and increased international sales in poultry. These gains were partially offset by an$8.9 million decline in net sales inChina following regulatory changes effectiveJanuary 1, 2020 . Net sales of nutritional specialty products grew$13.5 million , or 10%, due to international and domestic volume growth in dairy products, partially offset by lower sales in domestic poultry. Net sales of vaccines declined$2.4 million , or 3%, as challenging economic conditions inEastern Europe more than offset domestic volume growth and increased demand in theAsia Pacific region.
Mineral Nutrition
Net sales of$220.6 million for the year endedJune 30, 2021 , increased$6.1 million , or 3%, due to higher overall average selling prices and increased unit volumes. The increase in average selling prices is correlated with the movement of the underlying raw material costs.
Performance Products
Net sales of
Gross profit
Gross profit of$271.4 million for the year endedJune 30, 2021 , increased$14.5 million , or 6%, as compared to the year endedJune 30, 2020 . Gross margin increased 50 basis points to 32.6% of net sales for the year endedJune 30, 2021 , as compared to 32.1% for the year endedJune 30, 2020 . The year endedJune 30, 2020 , included$0.3 million of acquisition-related cost of goods sold. 59
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Animal Health gross profit increased$7.2 million due to sales growth. Mineral Nutrition gross profit increased$2.4 million , driven by increases in average selling prices, partially offset by increases in raw material costs. Performance Products gross profit increased$4.8 million , driven by higher volumes, higher average selling prices and decreases in raw material and production costs. Acquisition-related cost of goods sold in the prior year accounted for$0.3 million of the gross profit improvement in the current year.
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") of $196.5 million for the
year ended June 30, 2021 , increased $8.8 million , or 5%, as compared to the year
ended June 30, 2020 . SG&A for the year ended June 30, 2021 , included $1.1
million of stock-based compensation. SG&A for the year ended June 30, 2020 ,
included $2.3 million of stock-based compensation, $0.4 million of restructuring
costs, $0.5 million of acquisition-related transaction costs and income of $2.8
million from other acquisition-related items. Excluding these items, SG&A
increased $8.0 million , or 4%.
Animal Health SG&A increased $5.6 million , primarily due to increased
professional fees to support the continued use of carbadox and investments in
international expansion initiatives. Mineral Nutrition and Performance Products
SG&A were comparable to the prior year. Corporate expenses increased $2.5
million , driven by investments in strategic initiatives, plus incremental costs
for performance-related compensation and information technology. Overall costs,
including marketing, product development and travel, continued to be restrained
due to COVID-19 limitations. The stock-based compensation, restructuring costs,
acquisition-related transaction costs and other acquisition-related income items
accounted for a net $0.8 million increase in SG&A.
Interest expense, net
Interest expense, net of$12.9 million for the year endedJune 30, 2021 , was flat as compared to the year endedJune 30, 2020 . Interest expense decreased primarily due to favorable variable interest rates, offset by higher levels of debt outstanding and a$1.0 million of expense related to theApril 2021 refinancing.
Foreign currency (gains) losses, net
Foreign currency gains, net for the year endedJune 30, 2021 , were$4.5 million , as compared to net losses of$0.8 million for the year endedJune 30, 2020 . Foreign currency gains, net primarily arose from intercompany balances, driven by the movement of the Mexican, South African and Turkish currencies relative to theU.S. dollar. Provision for income taxes
The provision for income taxes was$12.1 million and$22.0 million for the years endedJune 30, 2021 and 2020, respectively. The effective income tax rate was 18.2% and 39.6% for the years endedJune 30, 2021 and 2020, 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 endedJune 30, 2021 , included (i) a$5.3 million benefit from the reversal of uncertain tax positions related to settlements and lapse of statute of limitations of prior years, (ii) a$1.5 million benefit related to final regulations issued inJuly 2020 for the Global Intangible Low-Taxed Income ("GILTI") tax related to the years endedJune 30, 2020 and 2019, (iii) a$1.2 million benefit related to exchange rate differences on intercompany dividends, and (iv) a$0.9 million benefit related to a detailed analysis of various other items. The effective income tax rate, without these items, would have been 31.6% for the year endedJune 30, 2021 . The provision for income taxes for the years endedJune 30, 2021 and 2020, included$0.9 million and$3.5 million of GILTI federal tax expense, respectively. Net income Net income of$54.4 million for the year endedJune 30, 2021 , increased$20.8 million , as compared to net income of$33.6 million for the year endedJune 30, 2020 . The increase was primarily driven by higher operating income of$5.7 million , increased foreign currency gains of$5.3 million and a$9.9 million decrease to the provision for income taxes. The increase in operating income was driven by a$14.5 million increase in gross profit, partially offset by increased SG&A costs of$8.8 million . 60 Table of Contents Adjusted EBITDA Adjusted EBITDA of$107.9 million for the year endedJune 30, 2021 , increased$5.7 million , or 6%, as compared to the year endedJune 30, 2020 .Animal Health Adjusted EBITDA increased$0.8 million , driven by increased gross profit, partially offset by higher SG&A expenses. Mineral Nutrition and Performance Products Adjusted EBITDA for the year endedJune 30, 2021 , increased$2.4 million and$4.9 million , respectively, on higher gross profit. Corporate expenses increased$2.4 million driven by investments in strategic initiatives as well as incremental costs for performance-related compensation and information technology.
Comparison of the years ended
Net sales
Net sales of
Net sales of$526.9 million for the year endedJune 30, 2020 , decreased$5.1 million , or 1%. Net sales of MFAs and other declined$28.2 million , or 8%, due to a$30.9 million sales decline inChina driven by the effects of African Swine Fever and regulatory changes. Net sales of nutritional specialty products grew$16.0 million , or 14%, due to volume growth in poultry and dairy products. TheAugust 2019 Osprey acquisition accounted for approximately two-thirds of the nutritional specialty sales growth. Net sales of vaccines increased$7.0 million , or 10%, due to international demand and increased market penetration. Excluding a domestic distribution arrangement that was terminated inOctober 2018 , net sales of vaccines would have increased approximately 14%. We experienced a short-term decline in demand for our products during the quarter endedJune 30, 2020 due to the COVID-19 pandemic, primarily in theAnimal Health segment. The animal production industry faced unprecedented demand disruptions, production impacts, price declines and currency volatility in international markets. Animal producers rapidly adjusted the number of animals and amount of milk being produced.
Mineral Nutrition
Net sales of
Performance Products
Net sales of
Gross profit
Gross profit of
Animal Health gross profit decreased$6.0 million due to volume declines in MFAs and other, partially offset by volume growth in nutritional specialty and vaccine products. In theAnimal Health segment, unfavorable product mix contributed to a lower gross profit ratio compared to the prior year. Mineral Nutrition gross profit decreased$0.7 million , as declines in average selling prices outpaced favorable raw material costs and increased unit volumes. Performance Products gross profit decreased$0.7 million due to lower overall volume. 61 Table of Contents
Selling, general and administrative expenses
Selling, general and administrative expenses ("SG&A") of $187.7 million for the
year ended June 30, 2020 , increased $6.3 million , or 3%, as compared to the year
ended June 30, 2019 . SG&A for the year ended June 30, 2020 , included
$0.4 million of restructuring costs, $0.5 million of acquisition-related
transaction costs and a $2.8 million benefit from acquisition-related other,
primarily as a result of a reduction to acquisition-related contingent
consideration. SG&A for the year ended June 30, 2019 , included $6.3 million of
restructuring costs, $0.2 million of acquisition-related transaction costs and a
$1.5 million benefit from the cancellation of a certain business arrangement.
Excluding the effects of these costs, SG&A increased $13.2 million , or 8%.
Animal Health SG&A increased $10.8 million , including increased investments in
product development and the effect of the Osprey acquisition. Mineral Nutrition
SG&A increased $0.5 million due to increased employee-related costs. Performance
Products SG&A increased $0.2 million . Corporate expenses increased $1.7 million
due to increased costs of strategic initiatives and public company costs. The
restructuring costs, acquisition-related transaction costs, acquisition-related
other items and the benefit in the prior year from the cancellation of a certain
business arrangement resulted in a net $6.9 million decrease to SG&A.
Interest expense, net
Interest expense, net of$12.9 million for the year endedJune 30, 2020 , increased$1.1 million , or 9%, as compared to the year endJune 30, 2019 . The increase in interest expense was primarily driven by the increase in outstanding borrowings on the Revolver. The increased outstanding borrowings were partially offset by the benefit of lower variable interest rates. Interest income from short-term investments was comparable to the prior year.
Foreign currency (gains) losses, net
Foreign currency (gains) losses, net for the year endedJune 30, 2020 , amounted to net losses of$0.8 million , as compared to net gains of$0.1 million for the year endedJune 30, 2019 . Increased foreign currency losses from the effects of currency devaluations were partially offset by foreign currency gains from intercompany transactions, driven by currency volatility during the three months endedJune 30, 2020 . Provision for income taxes
InMarch 2020 , in response to economic instability prompted by the COVID-19 pandemic,the United States government enacted the Coronavirus Aid, Relief and Economic Security ("CARES") Act. The CARES act established various stimulus measures, including certain tax provisions. We have utilized certain CARES Act provisions, including modifications to the interest deduction limitation, technical corrections to tax depreciation methods for qualified improvement property and deferral of employer social security payments. The provision for income taxes was$22.0 million and$16.8 million for the years endedJune 30, 2020 and 2019, respectively. The effective income tax rates were 39.6% and 23.5% for the years endedJune 30, 2020 and 2019, respectively. The fiscal year 2020 effective income tax rate was substantially higher than the federal statutory rate primarily due to income tax expense for:
Global Intangible Low-Taxed Income (GILTI) federal tax of
foreign tax credits, which added 6.2 percentage points to the effective income
? tax rate. The GILTI federal tax for the year ended
domestic profitability and limitations on offsetting credits.
Changes in uncertain tax positions of
points to the effective income tax rate. Changes in uncertain tax positions for
? the year ended
uncertain tax positions for the current year were elevated due to the complex
nature of tax law in various jurisdictions and related interpretations of tax
law.
Increases in the valuation allowance of
3.6 percentage points to the effective income tax rate. Increases in the
? valuation allowance for the year ended
in the valuation allowance for the current year were elevated due to losses in
certain international jurisdictions, in part
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due to the unfavorable effect of foreign currency losses, partially caused by
the economic effects of the pandemic, and in part due to the start-up of new
international locations with no current income tax benefit.
Net income
Net income of$33.6 million for the year endedJune 30, 2020 , decreased$21.2 million , or 39%, as compared to net income of$54.7 million for the year endedJune 30, 2019 . The decrease was primarily due to a$14.0 million decline in operating income, coupled with a$5.2 million increase in the provision for income taxes, higher interest expense of$1.1 million and unfavorable foreign currency movements of$0.9 million . The decline in operating income was driven by a$7.7 million reduction in gross profit and increased SG&A costs of$6.3 million . The decline in gross profit was primarily driven by lower overall volume and unfavorable product mix in ourAnimal Health business. Increased SG&A costs reflect our investments in product development and strategic growth initiatives and the effects of the Osprey acquisition.
Adjusted EBITDA
Adjusted EBITDA of$102.1 million for the year endedJune 30, 2020 , decreased$15.9 million , or 13%, as compared to the year endedJune 30, 2019 . Animal Health Adjusted EBITDA decreased$12.9 million due to the sales and related gross profit declines, coupled with increased SG&A costs. The SG&A increase was driven by investments in product development and strategic growth initiatives and the effects of the Osprey acquisition. Mineral Nutrition Adjusted EBITDA declined$1.0 million as a result of lower gross profit and increased SG&A costs. Performance Products Adjusted EBITDA decreased$0.2 million as compared to the prior year. Corporate expenses increased$1.7 million driven by investments in strategic initiatives and increased public company costs.
Analysis of financial condition, liquidity and capital resources
Net increase (decrease) in cash and cash equivalents was:
Change
For the Year Ended June 30 2021 2020 2019 2021/ 2020 2020/ 2019
(in thousands)
Cash provided by/(used in):
Operating activities $ 48,306 $ 59,348 $ 47,169 $ (11,042) $ 12,179
Investing activities (18,580) (120,390) (14,133) 101,810 (106,257)
Financing activities (16,995) 40,936 (4,107) (57,931) 45,043Effect of exchange-rate changes on 1,138 (1,124) (524) 2,262 (600) cash and cash equivalents Net increase/(decrease) in cash and cash equivalents$ 13,869 $ (21,230) $ 28,405 $ 35,099 $ (49,635) 63 Table of Contents
Net cash provided (used) by operating activities was comprised of:
Change
For the Year Ended June 30 2021 2020 2019 2021 / 2020 2020 / 2019
(in thousands)
EBITDA $ 111,233 $ 100,709 $ 110,845 $ 10,524 $ (10,136)
Adjustments
Stock-based compensation 1,129 2,259 2,259 (1,130) -
Restructuring costs - 425 6,281 (425) (5,856)Acquisition-related cost of goods sold - 280 - (280) 280 Acquisition-related transaction costs - 462 213 (462) 249 Acquisition-related other, net - (2,821) - 2,821 (2,821) Foreign currency (gains) losses, net (4,480) 826
(55) (5,306) 881 Interest paid, net (10,808) (11,577) (12,250) 769 673 Income taxes paid (19,395) (20,866) (16,215) 1,471 (4,651) Changes in operating assets and liabilities and other items (29,373) (10,349) (42,403) (19,024) 32,054 Net cash provided by operating activities$ 48,306 $ 59,348 $ 47,169 $ (11,042) $ 12,179
Certain amounts may reflect rounding adjustments.
Operating activities
Operating activities provided$48.3 million of net cash for the year endedJune 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 and other items 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 . Inventory increases were 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 assets and prepaid expenses used$1.9 million and$1.6 million of cash, respectively. Accounts payable provided$3.1 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. Operating activities provided$59.3 million of net cash for the year endedJune 30, 2020 . Profitable business performance resulted in cash provided by net income, adjusted for the effect of non-cash charges of$73.0 million . Cash used in the ordinary course of business for changes in operating assets and liabilities and other items was$13.7 million . Accounts receivable provided$28.7 million of cash, due to reduced sales levels and improved collection timing; days sales outstanding atJune 30, 2020 , of 61 days improved from 70 days at the prior year end. Inventory used$12.9 million of cash, driven by the timing of sales and consistent production levels, primarily in ourAnimal Health segment. Other current assets and other assets used$11.2 million and$2.1 million , respectively, due to the timing of payments in international regions and timing of domestic tax and insurance payments. Accounts payable used$7.7 million of cash, primarily due to the timing of domestic inventory purchases. Accrued expenses and other liabilities used$8.5 million , driven by payments for long-term incentive compensation and restructuring costs.
Investing activities
Investing activities used$18.6 million of net cash for the year endedJune 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$1.6 million of cash. Investing activities used$120.4 million of net cash for the year endedJune 30, 2020 . Capital expenditures were$34.0 million as we continued to invest in our existing manufacturing facilities and for capacity expansion and productivity improvements. The Osprey acquisition used$54.5 million of cash. We purchased$31.0 million of short-term investments 64 Table of Contents Financing activities
Financing activities used$17.0 million of net cash for the year endedJune 30, 2021 . We used proceeds from theApril 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. Financing activities provided$40.9 million of net cash for the year endedJune 30, 2020 . Net borrowings on our Revolver provided$73.0 million , primarily to fund the Osprey acquisition. We paid$19.4 million in dividends to holders of our Class A and Class B common stock. We paid$12.7 million in scheduled debt and other requirements.
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 Revolver and
foreign credit lines, will be sufficient to support our ongoing cash needs. We
have considered the current and potential future effects of COVID-19 on 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 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:
Change
As of June 30 2021 2020 2019 2021 / 2020 2020 / 2019
(in thousands, except ratios)
Cash and cash equivalents and
short-term investments $ 93,212 $ 91,343 $ 81,573 $ 1,869 $ 9,770
Working capital 250,956 222,006 242,902 28,950 (20,896)
Ratio of current assets to current
liabilities 2.62:1 2.60:1 2.71:1
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.
AtJune 30, 2021 , we had$95.0 million in outstanding borrowings under the 2021 Revolver. We had outstanding letters of credit and other commitments of$2.7 million , leaving$152.3 million available for borrowings and letters of credit, subject to restriction in our 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$0.12 per share on Class A common stock and Class B common stock, payable onSeptember 22, 2021 . Our future ability to pay dividends will depend upon our results of operations, financial condition, capital requirements, our ability to obtain funds from our subsidiaries and other factors that our Board of Directors deems relevant. Additionally, the terms of our current and any future agreements governing our indebtedness could limit our ability to pay dividends or make other distributions.
Based on the funded status on
At
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Contractual obligations
Payments due under contractual obligations as of
Years
Within 1 Over 1 to 3 Over 3 to 5 Over 5 Total
(in thousands)Long-term debt (including current portion)$ 9,375 $ 31,875
$ 256,875 $ -$ 298,125 Revolving credit facility - - 95,000 - 95,000 Interest payments 11,032 17,697 13,829 - 42,559 Lease commitments 7,733 10,444 6,563 16,559 41,301 Contingent consideration 4,840 - - - 4,840 Other 1,094 1,593 1,360 628 4,675
Total contractual obligations$ 34,074 $ 61,610
$ 373,628 $ 17,187 $ 486,499 For purposes of estimating interest payments, we assumed long-term debt will decrease in accordance with the scheduled payments and the Revolver continues unchanged at theJune 30, 2021 , balance. We assumed future interest rates and applicable rates are the same as the rates atJune 30, 2021 . Excluded from the contractual obligations table is the liability for unrecognized tax benefits totaling$5.7 million . This liability for unrecognized tax benefits has been excluded because we cannot make a reliable estimate of the periods in which the liability will be realized.
Analysis of the consolidated balance sheets
Change
As of June 30 2021 2020 2019 2021 / 2020 2020 / 2019
(in thousands)
Accounts receivable - trade $ 146,852 $ 126,522 $ 159,022 $ 20,330 $ (32,500)
DSO 60 61 70
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
allowance for doubtful accounts 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 2021 2020 2019 2021 / 2020 2020 / 2019
(in thousands)
Inventories $ 216,312 $ 196,659 $ 198,322 $ 19,653 $ (1,663) Inventory increased by
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 endedJune 30, 2021 and 2020. 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 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
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Quarters Year
September 30, December 31, March 31, June 30, June 30,
For the Periods Ended 2019 2019 2020 2020 2020
(in thousands)
Net sales
MFAs and other $ 75,034 $ 91,955 $ 82,670 $ 72,641 $ 322,300
Nutritional Specialties 30,433 33,062 34,636 31,133 129,264
Vaccines 16,383 18,672 21,668 18,617 75,340
Animal Health $ 121,850 $ 143,689 $ 138,974 $ 122,391 $ 526,904
Mineral Nutrition 52,649 55,685 56,200 49,878 214,412
Performance Products 15,221 14,638 15,565 13,614 59,038
Total net sales 189,720 214,012 210,739 185,883 800,354
Cost of goods sold 132,057 144,908 141,188 125,319 543,472
Gross profit 57,663 69,104 69,551 60,564 256,882
Selling, general and administrative
expenses 47,516 49,495 48,232 42,445 187,688
Operating income 10,147 19,609 21,319 18,119 69,194
Interest expense, net 3,354 3,432 3,263 2,807 12,856Foreign currency (gains) losses, net 3,221 (718) (608) (1,069) 826 Income before income taxes 3,572 16,895 18,664 16,381 55,512 Provision (benefit) for income taxes 1,057 5,001 5,163 10,739 21,960 Net income $ 2,515$ 11,894 $ 13,501 $ 5,642 $ 33,552 Net income per share basic $ 0.06 $ 0.29$ 0.33 $ 0.14 $ 0.83 diluted $ 0.06 $ 0.29$ 0.33 $ 0.14 $ 0.83 Adjusted EBITDA Animal Health $ 25,061$ 33,838 $ 34,635 $ 29,572 $ 123,106
Mineral Nutrition 3,475 3,684 4,055 3,464 14,678 Performance Products 852 1,457
1,506 719 4,534
Corporate (9,728) (10,491) (10,064) (9,895) (40,178)
Adjusted EBITDA $ 19,660 $ 28,488 $ 30,132 $ 23,860 $ 102,140
Reconciliation of net income to
Adjusted EBITDA
Net income $ 2,515 $ 11,894 $ 13,501 $ 5,642 $ 33,552
Interest expense, net 3,354 3,432 3,263 2,807 12,856
Provision (benefit) for income taxes 1,057 5,001 5,163 10,739 21,960
Depreciation and amortization 7,781 8,148
8,248 8,164 32,341
EBITDA 14,707 28,475 30,175 27,352 100,709
Restructuring costs 425 - - - 425Stock-based compensation 565 564 565 565 2,259 Acquisition-related cost of goods sold 280 - - - 280 Acquisition-related transaction costs 462 - - - 462 Acquisition-related other, net - 167 - (2,988) (2,821) Foreign currency (gains) losses, net 3,221 (718)
(608) (1,069) 826
Adjusted EBITDA $ 19,660 $ 28,488 $ 30,132 $ 23,860 $ 102,140 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 portray 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)
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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.
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:
? senior management receives a monthly analysis of our operating results that is
prepared on an Adjusted EBITDA basis;
? our annual budgets are prepared on an Adjusted EBITDA basis; and
? 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 purchased 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 inthe 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 full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations and financial condition will depend on future developments that are uncertain. Although vaccines are now available, distribution efforts vary widely country-by-country and state-by-state. New information may continue to emerge concerning COVID-19, and actions required to contain or treat it may affect the duration and severity of the pandemic. The pandemic may have significant economic impacts on customers, suppliers and markets. The pandemic may affect our future revenues, expenses, reserves and allowances, manufacturing operations and employee-related 69
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costs. Our financial statements include estimates of the effects of COVID-19 and there may be changes to those estimates in future periods.
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.
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 effect 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
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.
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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 endedJune 30, 2021 , we tested goodwill using a qualitative approach and determined goodwill was not impaired. We have not recorded any goodwill impairment charges in the periods included in the consolidated financial statements. 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 idled; 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 includesU.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 71
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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 theU.S. one-time mandatory toll charge and are eligible to be repatriated to theU.S. without additionalU.S. tax under the Tax Act. Should our plans change and 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.
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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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