Balchem Corp (BCPC) 2010 Q2 法說會逐字稿

Greetings and welcome to the Balchem Corporation's second quarter 2010 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, Frank Fitzpatrick, CFO for Balchem Corporation. 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 June 30, 2010. My name is Frank Fitzpatrick, Chief Financial Officer, and hosting this call with me is Dino Rossi, our Chairman, 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 beliefs concerning future events that involve risks and uncertainties. We can give no assurance that the expectations reflected in forward-looking statements will prove correct, and various factors could cause results to differ materially from our expectations, including risks and factors identified in Balchem's Form 10-K.

Forward-looking statements are qualified in their entirety by this cautionary statement. The financial information that is referenced in the meeting was disclosed this morning, in our quarterly press release at nine-thirty AM Eastern Time. I will now turn the call over to Dino A. Rossi, our Chairman, President, and CEO.

Good afternoon ladies and gentlemen, and welcome to our conference call. We are pleased to report record net earnings of $8.3 million on consolidated sales of $61.5 million for the quarter ended June 30, 2010. These second quarter sales of $61.5 million were approximately 16% greater than the $53 million results of the prior year comparable quarter. Disciplined management of our businesses enabled us to improve operating margins, and deliver strong profitability and cash flow.

All three segments achieved double-digit revenue growth this quarter, with the Animal Nutrition and Health segment up 16.8% due to growth from our basic choline, and Industrial Products, which were up 17.9%, and strong specialty sales, which were up 11.4%. The Food, Pharma, and Nutrition business posted 16.4% growth, resulting in record quarterly sales of $10.6 million, with particular strength in the domestic food marks and human-grade choline products.

The ARC Specialty Products segment generated record quarterly sales of $10.2 million, a 12.4% improvement over the prior year quarter, principally a result of an increase of the volume sold, largely due to propylene oxide sold in support of the recent acquisition of Aberco, which targets nut meat fumigation. As previously noted, consolidated net income closed the quarter at a record $8.3 million, up from approximately $6.9 million in the prior year quarter, or an increase of approximately 21%. This quarterly net income translated into diluted earnings per share of $0.28, a 17% increase from the $0.24 we posted in the comparable quarter of 2009.

Looking between the top and bottom line, you will see that our consolidated gross profits of $19.1 million were equal to 31.1% of sales in the quarter. This level is a 1.6 percentage point decline as a percent of sales from the prior year quarter, as we did on a comparative basis. We realized higher cost levels of certain key raw materials that are largely petroleum-based derivatives, and due to a force majeure supply event. These raw material increases unfavorably impacted both our Animal Nutrition and Health, and ARC Specialty Products segment. Price increases due to the noted raw material cost increases were implemented where we are contractually able to do so in the second quarter of 2010, as shown by the 2 percentage point increase sequentially from the first quarter results. Notably our Food, Pharma and Nutrition segment improved 4.4 percentage points on a sequential basis. We have begun to see some relief from the raw materials costs late in the second quarter and early third quarter.

At the consolidated operating expense level, you will note a $344,000 decrease to $6.7 million for the quarter, which equaled 10.9% of the sales versus the prior year, which was approximately 13.2% of sales. As noted in the press release, our spending level reflects some increased expenses related to the Aberco acquisition, which were offset by completion of a number of research contracts and reversal of accounts receivable reserves for international accounts, that were an expense reserve item in the prior year comparable quarter. This level also favorably compares sequentially to the 11.6% of sales we incurred in the first quarter of 2010, as we continue to leverage off of our existing infrastructure and exercise tight control over variable controllable operating expenses.

Overall, it was another strong quarter, and we are particularly pleased with the results of the Human Food and Choline product lines, that generated margin improvement previously discussed, largely due to new product launches, increased volumes, and production and logistic efficiencies. Operating margin percentages, while slightly lower, still remain strong for both Animal Nutrition and Health, and our Specialty Products segments, closing with consolidated earnings from operations at 20.2% of sales for the quarter. .

Other income of $110,000 compares favorably to the $18,000 of income incurred in the previous year comparable quarter. This improvement is principally related to the greater interest income earned in the quarter, and favorable fluctuations in foreign currency exchange rates between the US dollar and the Euro. Net income of $8.3 million translated to $0.28 per diluted common share, on increase of 17% over the comparative prior year quarter.

We also realized approximately $14.5 million EBITDA in the quarter, which translates into $0.49 per diluted share, and when including our non-cash stock based compensation charge, we are generating $15.5 million of EBITDA in the quarter, equaling approximately 25% of sales. At June 30, 2010, our outstanding borrowings were $5.1 million, but zero net of our cash balance of approximately $50.3 million. We continue to aggressively manage all areas of working capital, driving strong cash flow, reducing interest expense, and improving earnings, to generate even more accretive results from our core businesses. In an effort to detail our consolidated results better for our shareholders, I am now going to have Frank Fitzpatrick discuss the ARC Specialty Products, and the Food, Pharma, and Nutrition segments.

The ARC Specialty Products segment posted record quarterly sales of approximately $10.2 million, or a 12% increase over the prior year comparable quarter. This increase in sales was derived principally from an increase in volumes sold, largely propylene oxide in support from the recent acquisition of Aberco Inc., which targets nut meat fumigation. Excluding sales associated with the Aberco transaction, our quarterly sales would have been up 4.5% compared to the prior year.

ARC quarterly business earnings decreased 3.5%, to $3.6 million, versus the prior year comparable quarter. This decline is largely a result of the product mix, increased petrochemical raw material cost, increased expenses related to the development of the ERC technology, and the Aberco acquisition. We continue working on a number of initiatives to broaden and build on the ARC business model, with particular application development work on the ERC licensed technology, to repackage, distribute, and deliver another chemical for the fruit ripening industry.

As disclosed in previous quarters, a number of tests with large fruit producers and wholesalers have continued to take place, and our confidence level is building with continuous positive trial results. While we did realize modest revenue in this quarter, we are mildly disappointed at the pace with which fruit producers and wholesalers are moving to deploy this new technology. We continue working closely with the industry partners on this project, developing a marketing and product launch strategy, that should result in greater sales going forward.

The Food, Pharma, and Nutrition segment realized a 15.4% sales increase, to a quarterly record $10.6 million versus the prior year comparable quarter. Business segment earnings of $2.8 million were more than doubled the same period last year, and also improved 44% on a sequential basis. As stated in this morning's press release, the domestic food sector was significantly up again this quarter, as we continue to see solid double-digit growth of encapsulated ingredients for baking, preservation, and confection markets.

In the quarter, we also realized double-digit growth of our human choline products, targeting new food and beverage applications, and continued rebound of sales into the supplement market place. In 2009, we had many customers aggressively managing inventory levels down by delaying orders in response to certain retail product line slowness. And in certain large retail chains, the elimination of multiple SKUs that had previously included choline. We continue to focus on building consumer recognition of the benefits of choline. And choline inclusion in more foods, such as Gerber baby food and fortified beverages. More independent research on the benefits of choline have been completed, recently published, and available through our choline web-page. We continue to position choline with nutritional and pharmaceutical companies, as an essential ingredient with excellent therapeutic benefits for all ages.

The FP&N segment did see another difficult quarter in our calcium product sales into the over-the-counter pharmaceutical markets. As reported in the first quarter, we have been experiencing certain production issues relating to this product line, that resulted in an inability to meet all orders. We have made modifications to our equipment and processes, and continue to perform testing to assure that all issues are being addressed and resolved. A number of new calcium products are currently under development, or have been sampled to prospects in the nutritional supplement marketplace.

Our pharmaceutical drug delivery commercial development efforts continue. In the quarter, we did not generate any R&D milestone payments. However, as previously reported, the licensee of our technology has been authorized by the FDA to conduct a Phase III clinical trial utilizing our technology. Patients has been enrolled, and the trial is currently underway. We are cautiously confident that these efforts will yield good end results, but in the near term, this sector remains a net expense to the business segment. I will turn the call over to Mr. Rossi for him to discuss the Animal Nutrition and Health segment.

Thank you, Frank. In the Animal Nutrition and Health segment, we realized sales of $40.7 million, increase of $5.9 million, or 16.8% as compared to the prior year comparable quarter. Within the segment, specialty ANH product sales realized 11% growth from the prior year comparable quarter, and some improvement in dairy economics created improved demand for our products. These increases are principally the result of increased sales of Aminoshure-L, our Rumen-Protected Lysine.

We continue to be pleased with the progress we have made with the Aminoshure-L launch, as more prospective customers trialing the product are realizing positive experiences. These overall increases clearly coincide with a dairy economy that has improved over the past several months. However, we are monitoring this very closely, as futures currently point toward dairy prices that are at levels which will continue to challenge the economics for producers. Lower feed prices, and improving output for cow is expected to boost milk production this year and in 2011. The increased output per cow is expected to more than offset the targeted reduced herd size this year, resulting in more milk which may act to keep prices from rising much into 2011.

Sales of our largest ANH product group, aqueous and dry feed grade choline products were flat with prior year quarter. There were a number of factors contributing to this end result. During the quarter, we saw slightly improved sales of liquid and dry choline into the North American feed segment, reflecting poultry production levels that appear to have stabilized and are showing modest growth. Exports of liquid and dry choline from our North American plants declined, as rising raw materials cost, in combination with global competition and unfavorable currency rates, resulted in our declining to bid on certain business in the quarter. We continue to evaluate these export sales opportunities, and in the coming quarters, may elect to be more aggressive in seeking to win this business, depending upon the then current cost and market conditions.

Sales volume of our liquid and dry Italian-produced choline were even with the prior year quarter as well. However, sales dollars were lower, as our Euro-denominated sales were negatively impacted by the strength of the US dollar relative to the Euro. Sales of industrial derivatives had another very strong quarter. Sales of methylamines and other industrial products, including a tool produced methylamine derivative from our Italian operations, specifically for Europe, continued strong despite the general poor economic climate in Europe.

We again, saw exceptionally strong sales of choline derivative products being sold for various industrial applications in North America. We continue to evaluate these growing industrial opportunities to determine how we will derive the most positive value from it. This strong performance has continued into the early part of the third quarter, and we are fairly confident that this upward trend will continue for the balance of 2010, driving increase in sales and profitability.

Earnings from operations for this entire segment improved to a record $6 million, as compared to $5.3 million in the prior year comparable quarter. Largely due to improved volumes sold, product mix, and certain favorable production and logistic efficiencies. This also represents a 15% improvement sequentially versus the first quarter of 2010. The improved dollar profitability of the ANH segment was achieved with a constant reevaluation of global raw materials cost, product reformulation, currency review, and our ultimate ability to meet market needs from our various global facilities.

The opportunity to capitalize in this fashion is a direct result of our acquisitions, growth strategies, and the ability it drive costs out of our business model. With the bulk of the C-grade choline predominantly going to the poultry and swine markets, we are very sensitive to continued economic pressures on the large production animal integrators. Feed ration costs have corrected near term, but retail poultry and swine prices remain low, keeping significant downward pressure on profitability for this global end market. As indicated in our press release this morning, we will continue to closely monitor raw material costs for all segments of our business, and implement cost pass-throughs as appropriate.

As noted in previous calls, we continue to see a revenue roller coaster effect quarter-to-quarter in the various market sectors. But we are very pleased with the overall quarterly consolidated earnings result. We continue to strengthen our global growth platform, and are confident that more business will be generated on the unique platform of products that we offer or soon will offer the markets we serve. Our business portfolio continues to create good balance, yielding profitable growth opportunities, through the various challenges of any single segment or product line. We continue to deliver solid revenue and operating income growth by staying focused on helping our customers save and make money in this tough economy, while maintaining our own operating discipline.

Overall, we continue to build the financial strength of the company, managing the asset base aggressively, reducing debt and interest expense, which also assists in yielding improved financial results. Near term, we remain focused on implementing operational and logistic improvements, new product development, and new product marketing. We also continue to explore alliances, acquisitions, or joint ventures to continue building and leveraging 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, ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions). One moment while we pull for questions. Our first question comes from the line of Daniel Rizzo with Sidoti. Please proceed with your question.

Hi, guys.

Hi, Dan.

Am I right that the Aberco acquisition will add $3 million in annual sales?

Our expectation is a little bit more than that. Probably closer to five annually at the current acquisition base.

There is no cyclicality in it all, is there? Seasonality, I mean, excuse me.

Not really. The large crop here is almonds and pistachios are in there as well as pine nuts, and things like that, but the largest crop is almonds and typically they are harvested once a year and treated throughout the year. So, while the harvest season would lead to a seasonality question, but the actual treatment happens throughout the year.

Okay. You indicated that raw materials costs have increased during the quarter. What are they doing now. Are raw materials prices going up or stabilized, going down?

In the quarter, it still remained a mixed bag. But in fact, key raw materials are starting to go down a little bit right now. That's kind of positive. I would tell you that early in Q2, they had continued to move up much to our surprise. We thought they would start at the level off but drifted into the first month of the quarter and started to level in decline.

Okay. That's it, thanks, guys.

Thank you.

Thank you. Our next question comes from the line of Greg Garner with Singular Research. Please proceed with your question.

Good afternoon, gentlemen. Nice quarter. First question about the industrial applications in the Animal Nutrition and Health. Can you characterize that and give us an better understanding of what the applications are? That is the main driver for the improved revenues?

Yes, well, a couple of things. In particular, the methylamines business out of Italy continues to have a good quarter for us. So we are seeing just general industry pick up there on that part. We mentioned a product that we told manufacturers for another company in Europe that quite honestly is a seasonal product and it is more of an agro-chemical product that the season has extended in Europe and we are seeing better sales out of that product as well. And then you know, our choline chloride products that are sold into the industrial space, which are certainly bit more aligned with the oil and gas industry, have continued to do well. Most of that is targeted for on shore oil and gas wells. And more and more work is being done with that product. To be used for either tracking fluid or drilling fluid.

That is primarily sold in the US or is that a worldwide product? That last choline chloride product.

I would say today it is US and today, my sense is that the application will become more a global tech product.

Okay. In the Specialty Products' new ERC, you mentioned that you are disappointed with how the adoption rate, even though you are working with these customers there, and the results are favorable, but it is not translating into orders at which you thought or the ramp up as which you thought. Can you explain, is there any sense for why these customers aren't ordering as much? Or is there anything more to help us better understand what is happening there?

I think to some degree, let me back up and say that we haven't continued to run trials proving that the technology works and to get into more detail would take a little bit more time. And basically, I am going to say near term candidate are entities that do conditioning and ripening, if you will, of certain fruits and I say near term, because if they are running out of capacity in their conditioning capabilities, which are hard assets on the ground, then we become there quickly the first alternative to go to in lieu of investing in capital.

To some degree, there is slowness on imports and in particular, bananas. And there were strikes that took place. And some floods actually that slowed down the movement of bananas into certainly the US market. That kind of took a little edge off of where we thought we were going to be. And move the product a little bit more aggressively here in Q2. I won't use that necessarily as an excuse. Part of it is continuing to get out there and sell the value proposition to those end users. These are major grocery chains, including people like WalMart and Costco and people like that, and we have to go out there and do a better job of selling the product and the benefits of the product. Am I confident that the product works? Absolutely. It is taking a little bit longer to get it implemented out there in the States.

Okay. On the new product to the Food, Pharma and Nutrition, the Phase III trial, any sense for when that would complete. Before, you mentioned it would be first half or middle of 2011, I believe. Is there any update on that?

That is still the current or the expectation is that they are going to get all of the patients through the trials and this is expectations. So, by the end of this year and it takes another 90 or 120 days to analyze all the data and that's why were projecting middle of next year for the kind of a time line to know any better. Trials are continuing. Patients are in, actually, many patients have already gone through the trial period, and what we hear is that as high as maybe 80% of the patients have stayed on the product. I would say that is encouraging news. And so we are still waiting for them to complete the required number of patients to conclude all the data.

Okay. And again Food, Pharma and Nutrition, is there any landmark new products that in addition to the Gerber or fortified beverages that you are working on that maybe coming through here or have we really seen increased volumes of all of these products?

Well, definitely we are seeing increased volumes. I am going to say of what have been standard products. Especially choline products that are out there. We haven't introduced new choline products. We have gotten into new applications, but we have also seen choline being pulled back into the supplement market where it stalled last year because of the economy. And those are back on line. So we are seeing the increase in the volume there. And we are getting choline into other products out there. Frank already mentioned the Gerber baby food, which was a breakthrough for us here, late in Q1 coming into Q2 more predominantly. Fortified drinks, we have actually now in two of the Vitamin Water drinks out there. You will see the name on the bottles. And getting in more and more of those type applications with the product.

Then on the straight up food end cap side, part of the business, we are seeing very strong growth promoting to our platforms there for preservatives and nutritional enhancement. In particular, we have a number of ingredients in a new Unilever product that is being done for PF Chang, the Chinese restaurant chain, who is now marketing the product in grocery stores and seeing up take of that product and looking at more and more of the prepared food type products who can use the benefits of our ingredients.

So the last product of PF Chang, that's a Chinese only product. Is that right?

That is correct.

One final question on the gross margin, just looking at raw materials costs, you mentioned how the last couple of quarters they have been increasing and you have done a better job of rolling contracts over to reflect that, is that, based on that and your comment about the raw materials cost stabilizing to showing some decline right now, does that point to a better gross margin picture in the second half of the year?

I would generally say I'd like to think so. We do have, and I've talked about this in previous meetings, some pricing philosophies or models where we will pass price decreases on to some of the customer base as well. There tend to be a quarter lag that's up or down on that particular product line, so there might be some giveback, but net-net, you should look for improved profitability on those products, and I say that because what I just talked about did not apply to every product line we have out there, so prices are out there. In many cases, those products will see margin improvement as some of these key raw materials do decline.

Okay. Food, Pharma and Nutrition has very strong margins.

Yes.

Very strong. Is this a sustainable area here in the mid-20s. It has been in the mid- to upper teens before.

Yes. That's not just a function of raw materials cost. We had good volumes going through the segment as well and we leverage up very nicely on our plant operations end cap as well as choline, so throughput, utilizing the capacity of those plants at a higher level really as well causes improved margins flowing through the P&L in particular. Sustainable? I believe so. And certainly with the volume levels in ARC location, we expect to see that continue.

Is there any capacity constraint at the volume? Seems like there was a significant volume increase? Are you reaching any capacity constraint?

Yes, I think on the straight up end caps we are good shape. We probably still had 20%, 25% excess capacity at the main plant here in New York. On the choline side, we just, early this quarter we completed the debottlenecking of our Italian human grade choline plant and so that freed up another 30% in capacity. We were bumping our head there. We have excess in the choline plant here in Missouri as well. So, I think in the Food, Pharma and Nutrition side, we are in pretty good shape. And so, we don't see that as any real major issue right now.

Okay, thank you.

Thank you.

(Operator Instructions). Our next question comes from the line of Tim Ramey with [Balchem Corporation]. Please proceed with your question.

Frank, just wondering if there is any quantifiable impact of FX in the quarter and what FX outlook is for the second half?

Yes, I believe we reported 2% of our total sales were impacted by foreign currency in the quarter. On a go forward basis, this principally impacts our Italian operation. We are looking at about, we are looking at it coming back to $1.30 to $1.35, somewhere in that range. So we don't think it will have a meaningful impact on volume. We will have some impact on translating sales back into US dollars.

On the acquisition, how much of that was actually booked in the Q2. And because it seems like it did have a fairly large impact on the ARC Specialty Products in Q2, more than I would have thought?

Probably about $600,000, $700,000.

Okay. And some of the stuff that I was able to just Google on their product opportunities, was some discussion of replacing methyl bromide in strawberries and other things. have you talked about the potential for the markets.

Not at this point. We are certainly aware of those potential opportunities but we certainly view them as very far out in the future.

Okay, thanks.

Thank you. Our next question comes from the line of Tony Pollack with Maxim Group. Please proceed with your question.

You talk about investing in new commercial encapsulation technologies for the animal health. Can you go into that a little more?

Tony, I can say that we have, we started a project to change the technology. And it is going to be a new and improved technology. I don't want to get into major disclosure about it quite yet. Our expectation is that the technology is in place by the end of the year and the capital project is well underway. And certainly it will not only increase our capacity but really come up with a new and improved product that will give us the ability to compete in the broader space with the lower cost and yet as efficient product. It is probably not going to be launched until very early next year. That's the plan right now.

What type of volume are you addressing there in terms of the present volume and what you expect improvement on?

Well, I mean, this is net additional volume that we would be looking to add.

Okay.

So, I mean, net is 100% increase over the current rate that we have. And I think the good news about the technology, it is very modular. And if it goes as we expect, quite honestly. I would like to be talking to you next year about expanding that line.

Could you comment on the substitute of choline for salt?

Yes. I mean we continue to sample the product out there in the human space. And it is in the, a number of food companies' hands today, where it's being worked into, our trying to be worked into certain applications. It certainly works as a sodium replacement, if you will, and gives you a salty flavor. And in other cases it is other profile flavors that are coming through and there are sensory issues that are overriding. I don't mean terrible. But looking at ways to overcome another flavor profile that is being picked up because of that product. Certainly as a substitute, we know it can be used. And there is a lot of people studying it right now. I would tell you it is certainly not being used in any significant way at the moment.

Can you give us an example of where it is definitely working?

Well, I can pint to some potato chip applications and things like that where we know the product is working. And actively being promoted for or because of the salt replacement. I would say not yet. And certainly, that is one easy example.

Right. Can you give us an example of what type of volume you are doing in the choline replacement for chemicals for the oil wells and how big a product you could envision that?

Frank is going through some numbers here. Hold on one second. Yes. This past quarter we probably did about 15 million-pounds into that space. That's an improvement of probably 100% year-over-year.

Is that dollar volume?

That's volume.

What kind of dollar volume is that?

Probably about $8 million or so.

Okay.

Yes. And as far as the upside of the opportunity, there is currently a lot of work going on looking at that product in this application and I would probably be projecting without a hard base to say how large the opportunity could be. And what we know, the product works and clearly, it is being used and obviously as I mentioned here, we are seeing growth here year-over-year pretty nicely. Our expectation is that the product will stay on the line. And certainly on shore drilling will continue at a pretty good clip. And we are exploring to use it in more and more drilling mud as well. We believe certainly, that the product works and at you know, an economic as well as efficient price point. So we will continue to explore this. And hopefully develop it in a much bigger way.

Great. Thanks.

There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

I have no other comments. I think it was a very good quarter. I want to thank everybody for attending this conference call, and I look forward to talking to you all here in another three months. Thanks. Bye.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.