Balchem Corp (BCPC) 2007 Q3 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Balchem Corporation third quarter 2007 earnings conference call.

At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Frank Fitzpatrick, CFO for Balchem. Thank you, Mr. Fitzpatrick, you may begin.

Ladies and gentlemen, thank you for joining our conference call this afternoon to discuss the results of Balchem Corporation for the period ending September 30, 2007. My name is FranK Fitzpatrick, Chief Financial Officer and hosting this call with me is Dino Rossi, our President and CEO.

Following the advice of our counsel, auditors and the SEC at this time, I would like to read our forward-looking statements. This release does contain or likely will contain forward-looking statements, which reflect Balchem's expectation or belief concerning future events that involve risks and uncertainties. We can give no assurance that the expectations reflected in forward-looking statements will prove correct and various factors could cause results to differ materially from our expectations, including risks and factors identified in Balchem's annual report on Form 10-K for the year ended December 31, 2006. Forward-looking statements are qualified in their entirety by this cautionary statement. The financial information that is referenced in this meeting was disclosed this morning in our quarterly press release at 9:30 a.m. eastern time.

I will now turn the call over to Dino A. Rossi, our President and CEO.

Good afternoon, ladies and gentlemen, and welcome to our conference call.

We are pleased to report that the consolidated revenue of the third quarter was again a new quarterly record for the Company at $50.5 million. This level was approximately 101% ahead of the $25.1 million result in the prior year comparable quarter and approximately 14% ahead sequentially of the second quarter result of 2007. All three segments achieved new third quarter record revenue results, with the BCP Ingredients segment extremely strong due to the performance of the previously announced Akzo and Chinook businesses, extremely solid organic growth out of the core BCP business, the Encap/Nutrition business and stayed growth levels out of the ARC segment.

The acquisitions contributed $22 million in the third quarter and the balance of the core businesses grew 13% over the prior year quarter. These revenues led to the generation of a new record quarter and consolidated net earnings as well, closing the quarter at $4.5 million, up from approximately $3.2 million in the prior-year quarter, or an increase of approximately 41.4%. This result also reflects net interest expense of $576,000, an increase of $573,000 over the prior-year quarter, which is being incurred for the $39 million borrowed to complete the mentioned acquisitions. This quarterly net income translated into diluted earnings per share of $0.24 or 41.2% increase from the $0.17 we posted in the comparable quarter of 2006.

In the quarter, we incurred approximately $734,000 of amortization expense related to the Chinook acquisition, which will continue for the ten-year life of the amortizable assets acquired. Tax affected on a non-GAAP basis, this is equal to $0.026 per share, per quarter, at today's outstanding share level.

Our consolidated gross margins of $12.6 million were 25% of sales in the quarter, down from the 35% in the prior-year quarter. This level of profitability reflects the initial impact of the acquisitions in the animal-grade choline business, which we know carry lower gross margins and which were even lower due to unfavorable variances realized in Italy due to the traditional summer holiday in Europe. We are still working on integration efficiencies, which should increase the results of this segment by a couple of percentage points.

We also realized increased raw material costs that our largely petroleum derivative, which have not been presented as price increases to our customers in the third quarter. These raw material costs have continued to rise at a very swift pace and are being studied for certain products affected. Price increases will be implemented beginning in the fourth quarter as our businesses will remain affected by these higher costs.

At the consolidated operating expense level, you will note a 47% increase to $5.4 million for the quarter. This $1.7 million increase was due primarily to the $734,000 of additional amortization, plus sales and technical personnel expense associated with the Chinook and Akzo acquisition. We also incurred approximately $160,000 of commercial development expenses toward our pharmaceutical market initiatives in the quarter.

With these increases, operating expenses were 10.7% of sales or 4 percentage points less than the operating expenses as a percentage of sales incurred in last year's comparable quarter. This level is also 1.5% lower sequentially than the 12.2% of sales we incurred in the second quarter of this year, as we continue to leverage off of our existing infrastructure going forward.

Overall, it was a strong quarter, especially with the unfavorable manufacturing variances incurred at the Marano facility due to the summer holiday period in Europe, and the escalating raw material cost. We did recognize approximately $9.2 million of EBITDA in the quarter, which translates into $0.49 per share and points out that we are incurring approximately $2 million per quarter of non-cash expense. Interest expense of $672,000 was a full $656,000 higher than the previous year quarter. This was in direct relationship to the long-term debt incurred to achieve the noted acquisitions and is equal to $0.024 per share on a tax affected basis.

Noting our strong EBITDA, the long-term debt, and the impact of interest expense on our quarterly results, we plan to accelerate our debt reduction. In the quarter, we paid $5.2 million of which $2.5 million was accelerated and we will reduce our debt load more aggressively in the coming months and quarter, driving off of our strong cash flow, our desire to reduce interest expense, and improve earnings and generate even more accretive results from the recent acquisition.

In an effort to detail our consolidated results better for our shareholders, I'm now going to have Frank Fitzpatrick discuss the ARC Specialty Products and BCP ingredient segment.

The ARC Specialty Products segment posted a new third quarter sales record of approximately $8.2 million or 3.5% over the prior-year comparable quarter. This increase in sales was primarily derived from improvement in volume of 100% packaged EO and the EO (inaudible) product line.

With this product mix and volume increases, our quarterly business earnings increased 2.5% to $2.9 million versus the prior-year comparable quarter. Sequentially, this results as 3.8% lower than the record quarter we posted for this segment at June 30, 2007. This reflects the early impact of the quickly escalating raw material increases in the quarter. We have begun to increase prices to offset this impact already in the fourth quarter and expect to have passed these increases through to the market as contracts allow by the first quarter of 2008. We continue working on a number of initiatives to broaden and build on the ARC business model.

Next I want to report on the BCP Ingredients segment, which is the segment that manufacturers and markets unencapsulated choline supplements to the animal feed industry as well as other choline derivative products. As Mr. Rossi noted, this segment has been significantly impacted by acquisitions. For the quarter, we set another new quarterly sales record of $29.4million, up 331% over the prior-year quarter and realized record segment earnings of approximately $2.1 million or 91% over the prior-year comparable quarter. These increases were driven particularly by sales volumes of the acquisitions, which contributed approximately 94% of the sales revenue increase with an additional 18.6% organic growth in the base.

The Chinook acquisition contributed most significantly to this growth at $10.7 million as we integrated their base of business into our Saint Gabriel and Verona, to a lesser degree, our Verona plant. The volume increases helped us achieve plant operating efficiencies in Saint Gabriel and Verona. The Balchem Italia BZ operation generated the balance, or $10.7 million, all through the Marano/Ticino site.

In this third quarter, the 2006 acquired choline chlorine plant in Saint Gabriel, Louisiana, produced approximately 25 million pounds of product. This is approximately 80% of the plant's nameplate capacity. The additional capacity of this operation gives us the opportunity to continue our growth plans for this business segment, both domestically and on the international front.

The integration of the Chinook and Akzo business highlight significant opportunities to synergize our operating plants, to drive costs out of logistic issues, and efficiencies into plant operations, which we expect to utilize to strengthen this commodity-oriented market for our customers and shareholders. This is especially critical as we deal with the escalating raw material costs previously mentioned. Numerous choline for choline derivative product opportunities for markets outside of animal nutrition are currently being worked on and look quite promising as well. We are very pleased with the immediate accretive impact on our financial results from both of these recent acquisitions.

I will now turn over the call to Mr. Rossi for him to discuss the Encapsulate segment.

Thanks, Frank.

For the quarter, the Encap Nutrition Product segment realized a 25% sales improvement to $12.9 million over the prior-year comparable quarter. This quarterly result does reflect the first full quarter of the previously noted human choline business of the Akzo acquisition, which contributed an increase of $700,000 in revenue to this segment for the quarter. Business segment earnings of $2.2 million is an improvement of 113% over the same period of the last year, improving to approximately 17% of sales. The human food, nutrition, and pharma sector of the Encap segment experienced both weakness and strength. The calcium, pharma, and international food sectors combined were approximately $439,000 below prior year.

The calcium line continued to be soft versus the prior year quarter, but did improve by 61% over the second quarter revenue result and more importantly, it moved to a near break-even level in this quarter after posting a $600,000 loss through the first six months. The international food sector continues to improve, but is still soft through September, lagging the prior year-to-date levels by 42%. The domestic food business is comparable to the prior year-to-date revenue results.

Particularly positive is the continued growth of the human grade choline sector. We continue to see increased consumer recognition of the benefits of choline, hence choline inclusion in more supplements and fortified drinks. This sector was 53% ahead of the prior-year quarter and is now 52% ahead of prior September year-to-date results.

We have utilized the excess capacity recently acquired in the Marano/Ticino facility capitalizing on logistics and currency to improve profitability of this sector in Europe and Asia. We continue to position choline as an essential ingredient with excellent therapeutic benefits for all ages not just new born infants. Our pharmaceutical delivery systems commercial development effort continues, but as previously noted, is a long process. We are confident that these efforts will yield good end results, but in the near-term is a net expense to the business segment. We incurred $160,000 of expense in the quarter and we now expect to sign a number of small research and development agreements in the fourth quarter, helping to offset these expenses near-term.

In the animal, nutrition, and health sector, the core business recognized $5 million of revenue, up approximately 62% when compared to the previous year quarter. The two key product lines in this sector are REASHURE, our encapsulated choline product, and our Keylated minerals product line.

The REASHURE product line has continued the uptrend seen in 2006, with the third quarter of '07 up 36% versus the previous year comparable quarter. With the integration of the Keylated mineral product line, combined sales efforts, and favorable field trial results, we expect to get better penetration in all markets for all ANH products.

Although we still have some roller coaster effect quarter to quarter in the various market sectors, we are very pleased with the overall volume and revenue growth in the Encap segment. Adding the acquired Akzo products, European customer base, and technology have strengthened our growth platform and we are confident that more business will be generated based on the unique platform of products that we offer or soon will offer the market.

We continue to build the financial strength of the Company while we have borrowed $29 million in quarter one and another $10 million in quarter two, we continue to manage the asset base aggressively, yielding improved results while building our technology base. Near-term, we are focused on completing the integration of our recent strategic acquisitions, however, we do continue to explore alliances, acquisitions, and/or joint ventures to leverage our technology and strong human asset base.

This now concludes the formal portion of the conference. At this point, I will open the conference call for questions.

Thank you. (OPERATOR INSTRUCTIONS)

Our first question comes from the line of Dan Khoshaba with KSA Capital. Please proceed with your question.

Hi, good afternoon.

Hi, Dan.

What were the margins on the acquired businesses in the BCP section of the Company's results?

When you say the margins, at what level are you talking?

The operating margin for the--I believe it was two acquired businesses in BCP?

Yes, well, certainly I think they both have different levels, to be clear. They were both probably in the neighborhood of, I'm going to say, I'll say 6% to probably 11%, and the 6% is there predominantly on the Chinook acquisition because of the amortization expense, which is actually pretty heavy. We've talked about that before, and certainly better results on the Italian business.

Okay, but on average, if you combine the two businesses, were they below the existing business? I suspect they were, pretty significantly?

They certainly were below, absolutely.

Okay. Related to that, now, you have plans, obviously, to do some integration and to take some cost out. Where do you think you can get margins in those two--in two businesses? Is there 100 basis points of margin to get, or is there two, or three, and over what period of time?

Yes, I think that there's certainly more than 100 to get. We look at the core business that we had and we expect to certainly be able to get back to there in fairly short order and actually up another probably 2 or 3 percentage--or basis points over that.

Okay -- I'm sorry.

But the time line on it is--short of coming into this quarter with what's been going on in raw materials, I would say that our plan was to get there certainly towards the end of next year. The raw material increases are probably maybe dampening that a little bit right now. So it should probably be a little bit further out.

Okay, but we should see sequential--if margins--resin held steady, and I know you're trying to push some pricing through, taking resin out of the equation, should we see some margin improvement sequentially as you go through the process of taking costs out of those two businesses?

Normally I would say yes. I think to some degree, it really just depends what happens with the raw materials?

Okay.

Yes.

And then if I could just ask one more. The pricing that you have put through in the marketplace, right now, how much of the increased cost of resin does that make up for?

Well, certainly--what you have to understand what's going on in the raw material market today is we're seeing significant increases every month and while we've put together plans to pass on the raw material costs as best we can, the challenge right now is to predict at what moment we're going to meet the top of that raw material cost increase.

Yes.

Every month the industry keeps saying, oh, we've reached the ceiling, we've reached the ceiling, it can't go any higher, and I supposed-- I don't think we're alone in this, for sure, but it has continued to move up every month. So while I agree, I think it's about--got to get--have been to where it's going to be without causing serious economic ramifications, much broader than us, so I'm optimistic that we will be pretty close to the ceiling now and that hopefully will be a number that we can pass on into the market.

What I will tell you is certainly our belief too, is that the raw material costs are going to come down. I don't think that they're going to stay up here for an extended period of time. I don't have a crystal ball for sure, but just studying the--I'm going to say the recent history of these certain raw materials, certainly there's been an absolute roller coaster up and down. I think the question is, how long are the peaks and how long are the valleys now.

Yes, okay, great. Thank you. Good quarter.

Thank you.

Our next question comes from the line of Jonathan Leichter with Sidoti & Company. Please proceed with your question.

Hi, guys.

Hi, Jonathan.

If not for the slowdown in Italy over the summer, how much revenue would BCP Ingredients have had, roughly?

Well, I think the revenue number was actually a pretty decent revenue number. I mean, it might have had a little bit of a hair cut. We had built inventory levels to some degree to bridge over, but the more important factor was the unfavorable manufacturing variances incurred in the month of August, and that probably knocked off maybe $200,000 to $300,000 of pretax income.

Just in August?

Yes.

Okay, and was it 18% growth in BCP Ingredients, the organic growth there?

That's correct.

Where did that come from?

Actually, I would say it mostly came from export business. We had a pretty strong hold on the domestic business, and at a certain moment, it starts to blur with the acquisitions now because the domestic business that we did not have did accrue to us through the acquisitions, and--but I think straight up looking and studying the growth, it's more exports South America to some degree, some into Mexico and certainly I would--probably the other market is Russia.

Doesn't Chinook serve the Russian market?

Well, the Chinook business did serve the Russian market, but we've actually managed to pick up more business as well.

Okay, and do you have any specifics for debt reduction?

I would say that we plan to be as aggressive as we can. We're going to operate the business from a as efficient as possible standpoint from cash flow, because money in the bank is costing us via not reduction of debt. So we'll probably be as aggressive as we can at taking it down and maybe in the quarter, you might see another $7 million or so come out.

Thanks a lot.

Sure.

(OPERATOR INSTRUCTIONS)

Gentleman, there no further questions in the queue at this time. Do you have some closing--oh, no we do have another question.

Our next question comes from the line of Lawrence Goldstein with Santa Monica Partners. Please proceed with your question.

Hi.

Hello.

The--in the course of time, in the fullness of time, from what you've said, you're going to get back to the type of high margin that you had prior to acquisitions, is that fair? I mean, for example, you're 19%, almost 20% pretax a year ago in the quarter and now you're 13% or so. So when everything plays out and it's "normalized", are you talking about getting to that level or higher?

I think the question earlier, Larry, was directed to the BCP business. At least that's what I responded to question-wise, and I think the acquisitions came in and were--when you look at the-- they kind of really aligned themselves with the BCP Ingredients business, and they actually run at a lower level than what the core BCP Ingredient business did. So our immediate challenge is to certainly get those businesses back to the core BCP level and then certainly we expect to be able to get that up a couple basis points, but as you look at the consolidated number, yes, with the weight of the BCP-type business now, the ability to get back to that old average number is not in the cards.

Okay. Now, are you headed en route to having the Encap be the largest profit segment of the business or not?

Well, I think--largest profit segment, I want them all to be large, but I think that certainly there's a shift going on right now in the business. We definitely have a much larger position in the animal health business, especially when you combine the specialty animal health business with the commodity animal health, and we're starting to leverage that on a combined basis out in the market, both with our sales effort, with our manufacturing platform, certainly in logistics, where we can now--and even from a marketing standpoint, where we can go to a number of the same customers with a variety of products that nobody else can come to them and pull purchasing efforts.

So we expect to capitalize on that in a bigger way, and so I think we just want to drive as much profitability out of that as we can. Certainly, that's separate from the human Encap part of the business and we do expect that to continue to grow as well. And with our efforts in the pharmaceutical space, which are still yet in a big way probably a year, 18 months, two years away, that--once we get there, obviously, could yield some much better profitability as well.

Now, with the price of milk--I mean, throughout the last decades, milk was always in oversupply and I used to hear prior to your even coming aboard and then early on that farmers didn't want to pay for a product like REASHURE, but now the price of milk is going sky high and I guess there are actually shortages. So has REASHURE got a bigger market today than it did yesterday?

Oh, yes, absolutely, and I think we referenced in the call here today, maybe earlier on, that it grew year-over-year about 56%. So we continue to see it growing pretty nicely. We expect that to continue, and what's going to happen with milk prices going forward, again, I think it's one of those numbers that it's much stronger than it's ever been in my time here and certainly it's a scenario that doesn't meet our--I'm going to say expensive product with as much challenge.

So is this worldwide or North America or U.S. or what?

Well, we're selling the product on a global note, for sure. Even historically, Japan has been a very good market for us. Milk prices in Japan actually are under stress right now. So we have continued to do our business there as we have. We haven't seen any growth out of that market right now and I think part of that is because of the pressure on milk prices. So I think it's a little bit of a mixed bag what's going on in milk prices around the world.

In the U.S., are dairy farmers under the--in the--believing that if they use REASHURE, they're going to get more pounds per animal or whatever the measurement is?

Well, that's certainly what we promote and I think obviously the product continues to move well, so I think that that's--I think becoming better understood in the market.

Can you say anything about penetration? I would imagine that the kind of volume you're doing is like a thimble's worth.

It is. I think we're definitely under 10% of the North American market, for sure.

So how do--what does it take to get to 20, 30, 40, 50, whatever?

I think just more time in front of the right people, convincing them, and I think there's still yet a lot of show-me on my herd attitude out there, which is pretty typical of the industry that they want to see it to believe it themselves, but we're building--we've added some more sales people, we've added some more tech service people in this space. We're conducting a number of seminars for the industry and we're just going to continue to try and get in front of the right people and get the message out there.

So you say you think you have 10% of the market, what does 10% amount to, what volume, or what's the market?

Well, we've run the math and I've shared this with a number of people in the past. North America alone, if you were to get 100% of the dairy cows would be about $110 million market. Obviously, we're well short of that today, and that's just North America.

So that hasn't changed a whole lot. So is it conceivable to you that it takes a few more veterinarians of herds to say, hey, it works, or what--what's the obstacle we have to overcome?

I think it's just getting their confidence level up and--

How many more years does that take?

Larry, I think it's a product that always has to be sold, and I think that's typical in the animal health industry. You can point to some of the best products out there. Especially the more expensive ones and it's easy for them to not want to spend the money, if you will, because times are good and they're making good money on the milk so why spend anymore than they have to, but I think it's a product that constantly has to be sold, and we're out there advertising more and getting in front of the right people and you're right, you need to be in front of the vets, the nutritionists and whatnot who influence those buying decisions even more than the herd managers, for sure.

Say something about return on capital, return on equity, how you look at it and what kind of levels you think will be normalized levels?

Well, what's normalized. Well, let me just say our objective certainly is to be in the high teens on returns, if you will, and I'd say closer to a 19 or 20, and so our objective, as we look at running our business, certainly is to continue to drive that kind of return. In the interim, there might be some soft spots there as we--even doing an acquisition and achieving some of the integration results and whatnot, but I think when you look at the blend of our business, that'll probably be challenged, especially when we take on the kind of acquisition that we did, that, for instance, won't carry a return like the ARC Specialty Products does, but I think we're going to continue to push that ahead and continue to certainly be in the mid to high double digit teens, if you will, which hopefully will drive a good return for all the shareholders.

Is the current quarter going to be--how's it going to compare in volume with this quarter?

Current quarter being fourth?

Yes.

Volume in revenue, you mean?

Yes.

I think our expectation right now is it's going to be, I'd say comparable. I would tell you October started out very, very strong for us into the quarter and things are continuing to move well. We alluded to the European holiday. There it took a little edge off the top line, but that's back online--

So you're going to be about 175 million this year and you're going at a 200 million rate going forward so you'll be in excess of that next year?

That certainly would be a pretty good projection.

Well, you should be doing better than that at the annual rate at the moment for next year. No, yes?

I can't argue with you.

Okay. What are your biggest worries? What do you worry about the most, what could go wrong?

Well, there's always stuff, but I think right now--

Particularly.

Yes, the most interesting thing in this is not, as I said--I alluded to before, unique to us, is just what's going to go on with raw material prices and whether the barrel of oil or natural gas that's driving a lot of this--a lot of speculation, I think, that's causing the market to get overheated and we just have deal with it in the interim here. It's those challenges near-term that are challenges. I wouldn't say they necessarily keep me awake, but it's something that's right there in front of us every day.

A couple of questions about that. Are the raw material prices having to do with oil-based items?

Absolutely, yes. In terms of significant impact, I mean, there's some other things a little bit going on, but certainly the most significant are oil derivatives.

And what kind of resistance, if any, is there to price increase? Why, for example, can't you--if you pay for the next batch of whatever the material is and the price is higher, why can't you pass that on immediately?

I think there's just market dynamics there, Larry, that don't always let that happen so easily. There are alternative products in some scenarios that can be used. I think we have to be cognizant of some of those which are not oil-derived driven. So those are things that just, we've paid real close attention to as we look at price increases.

So your comment about you think prices will go down in time because they always have and if they don't--let's say the price of oil a year from now is considerably higher.

Okay. What's going to happen?

Yes.

I think obviously, we will go to the market and try to position price increases to pass it on.

Always with a lagging effect.

Well, I think in some of our businesses, we can be much more timely than others, and I think we pay real close attention to this and then we try to pass it on where we can, sometimes there's contract limitations that might stop us for a quarter or something like that, but we try to be as timely as we can in getting it through.

I tell you, I'm back from a brief visit to the oil fields of Russia and I don't get the impression anybody there doesn't think the price of oil will be a lot higher in the years to come.

Yes, I won't--I can't argue one way or another there--

You don't--neither--none of us can predict it, but I think that that sounds like a more likely scenario.

Well, I think the entire dynamics of the world economy are going to change then too, so it won't affect just the--

So you'll be in proportion and everybody will just have to accept it.

There you go.

Yes, yes, okay.

Okay?

Anything else you'd like us all to know that we weren't smart enough to ask about?

No, I think you've done a pretty good job of open-ended questions there and hopefully it helped everybody else that was listening in.

A chance of yet another acquisition in the next 12 months? High, low, or medium likelihood?

I would say probably medium--I'd say medium. There's things that we're looking at, I wouldn't say that they're right on the front burner and actively chased, but certainly we have a desire to move in that direction yet.

Are you about to outgrow any facility, any manufacturing facility, or be capacity restrained in anything?

There's a couple areas where we're getting a little bit of tightness. We are, in fact, debottlenecking several areas out in our Verona, Missouri site, both on the human grade and on the feed grade choline product line. I think on the Encap line we're in pretty good shape and probably the one area that we're a little stressed on is corporate headquarters and the people here, just with laboratory space and whatnot, but overall we're in pretty good shape.

Anything to be said about Probiotics?

Other than we continue to work on them, but I don't think anything in a big way right now.

Okay.

Okay?

Okay. Thank you.

Thank you.

Gentleman, there are no further questions in the queue. Do you have any closing comments?

Sure. I would like to thank everybody that listened into the conference call today and certainly hope that people are clear on the state of the business. I think it was a very, very good quarter. I think there's normal challenges out there like every other business today and we're doing everything to tackle those. So with that, thanks and we'll talk to you at the end of the next quarter. Bye.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.