Balchem Corp (BCPC) 2010 Q3 法說會逐字稿

Greetings, and welcome to the Balchem Corporation's Third Quarter 2010 Earnings Call. (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. You may begin.

Ladies and gentlemen, thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the period ending September 30, 2010. My name is Frank Fitzpatrick, CFO, 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.

30 AM Eastern Time.

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

Thanks, Frank. Good morning, ladies and gentlemen, and welcome to our conference call. We are pleased to report record net earnings of $8.5 million on record consolidated sales of $63.9 million for the quarter ended September 30, 2010.

These third quarter sales of $63.9 million were approximately 18% greater than the $54 million result 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 16.1% due principally to growth from our basic choline and industrial products, which were up 19.5%.

The Food, Pharma and Nutrition business posted 23.8% growth, resulting in record quarterly sales of $10.7 million, with particular strength in the domestic food markets and human-grade choline products. The ARC specialty product segment generated record quarterly sales of $10.8 million, an 18.6% improvement over the prior year quarter, principally the result of an increase in volumes sold.

As previously noted, consolidated net income closed the quarter at a record $8.5 million, up from approximately $6.9 million in the prior year quarter, for an increase of approximately 24%. This quarterly net income translated into diluted EPS of $0.29, a 21% 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 $20.2 million were equal to 31.7% of sales in the quarter. This level is a 1.5 percentage point improvement as a percent of sales from the prior year quarter, reflecting improved sales volumes, product mix and plant efficiencies.

We did, however, on a comparative basis realize higher cost levels of certain key raw materials, largely due, again, to a force majeure supply situation. These raw material increase particularly affected unfavorably our Animal Nutrition and Health segment. We have begun to see some relief from these force majeure events early in the fourth quarter.

At the consolidated operating expense level, you will note a $1.1 million increase to $7.2 million for the quarter, which was approximately equal to 11.3% of sales versus the prior year, which was 11.2% of sales. As noted in our press release, this spending level reflects some increased expenses related to the Aberco acquisition, recruiting fees, relocation expenses, and consultancy fees. We do continue to leverage off of our existing infrastructure and exercise tight control over various other controllable operating expenses.

Overall, it was another strong quarter. We are particularly pleased with the results of our Human Food and Choline product lines that generated the margin improvement previously discussed, largely due to new product launches, increased volumes, production and logistic efficiencies. Operating margin percentages also remained strong for both ANH and ARC specialty product segments.

Consolidated earnings from operations finished at 20.4% of sales for the quarter as compared to 19% in the prior year quarter. Other expense of $73,000 compares unfavorably to the $20,000 of income incurred in the previous year comparable quarter. This is principally related to unfavorable fluctuations in foreign currency exchange rates between the U.S. dollar and the euro, partially offset by interest income earned in the quarter.

Net income of $8.5 million translated to $0.29 per diluted common share, or an increase of 21% over the comparative prior year quarter, generating approximately $15.2 million of EBITDA in the quarter, which translates into $0.51 per diluted share and, when including our non-cash stock-based compensation charge, we generated $16.3 million of EBITDA in the quarter, equaling approximately 25% of sales.

At September 30, 2010, our outstanding borrowings were approximately $5 million but zero net of our cash balance of approximately $65 million. We continue to aggressively manage all areas of working capital, driving strong cash flow, which result in improved earnings to generate even more accretive results from our core businesses.

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 the Food, Pharma and Nutrition segments.

The ARC specialty product segment posted record quarterly sales of approximately $10.8 million, or a 19% increase over the prior year comparable quarter. This increase in sales was derived principally from an increase in volume sold, largely propylene oxide, in support of the recent acquisition of Aberco, Inc., which targets spice and nut meat fumigation. Excluding approximately $1.2 million of sales associated with the Aberco transaction, ARC quarterly sales would have been up 5.4% compared to the prior year.

ARC quarterly business earnings increased 20.9% to $4.5 million versus the prior year comparable quarter. This increase is largely a result of the aforementioned increased sales of propylene oxide and, as previously reported, higher average selling prices on certain ethylene oxide products. These increased selling prices were implemented late in the second quarter to help offset key raw material cost increases incurred through the first half of 2010. However, these improvements were partially offset by increased expenses related to development work on our ERC technology for repackaging, distribution and delivery of a product for the fruit ripening industry and certain costs related to the aforementioned Aberco acquisition.

As previously reported, we continue working on initiatives to broaden and build on the ARC business model with particular application development work on the ERC technology. As we reported to you in the previous quarter, we are disappointed at the slow pace with which fruit producers and wholesalers are moving to this new technology. Trials with large fruit producers and wholesalers have continued to take place with continuous positive results, and we recently exhibited this technology at the Fresh Summit International Convention and Exposition. We continue working closely with the produce industry on this project, developing marketing and product launch strategies that should result in more positive news as we look toward 2011.

The Food, Pharma and Nutrition segment realized a 23.8% sales increase to a quarterly record $10.7 versus the prior year comparable quarter. Business segment earnings of $2.5 million were 84% greater than the prior year quarter. As stated in this morning's press release, the domestic food sector was significantly up again 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 the continued rebound of sales into the supplement marketplace. In 2009, we had seen many customers aggressively managing the inventory levels down by delaying orders in response to certain retail product line slowness, and in large retail chains, the elimination of multiple SKUs that had previously included choline. We continue to focus on building consumer awareness of the benefits of choline, hence choline inclusion in more foods such as Gerber Baby Food and fortified beverages.

Additional independent research on the benefits of choline has been completed recently, recently published, and is 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. This FP&N segment did see another difficult quarter in our calcium product line in the over-the-counter pharmaceutical market.

As reported in the prior quarters, we had experienced certain production issues relating to this product line. We have made modifications to our equipment and process, and continue to perform testing to assure that all issues are being addressed and resolved. While the third quarter results do reflect modest sales for this product line, we are currently evaluating strategic alternatives for this business line.

Our pharmaceutical drug delivery commercial development efforts continue. In the quarter, we did not generate any R&D milestone payments. However, as previously reported, a licensee of our technology has been authorized by the FDA and continues to conduct a phase 3 clinical trial utilizing our technology. We are cautiously optimistic 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 now turn the call over to Mr. Rossi for him to discuss the Animal Nutrition & Health segments.

Thanks, Frank.

In the Animal Nutrition & Health segment, we realized sales of $42.4 million, an increase of $5.9 million, or 16.1% as compared to the prior year comparable quarter. Within this segment, specialty ANH product sales were flat with the prior year comparable quarter but were up 4% sequentially as some regional improvements in dairy economics supported greater demand for certain products, particularly sales of Aminoshure-L, our protected -- our rumen protected lysine, and Reashure. These improved sales were, however, offset by a decline in sales to our chelated mineral products, principally into the international market.

We continue to be pleased with the progress we have made with Aminoshure-L launch as more prospective customers trialing the product are realizing positive experiences. These overall increases clearly coincide with the 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 due mainly to higher expected feed prices.

In addition, improving output per 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, grew approximately 3% as compared to the prior year quarter. There were a number of factors contributing to this end result.

In the quarter, we saw improved sales of our Italian-produced choline sold into markets outside of North America, even though our euro-denominated sales were negatively impacted by the strength of the US dollar relative to the euro in the quarter. We also saw North American choline sales improve slightly even as the US broiler meat production levels for the third quarter did not meet expectations. The new US broiler meat production forecast for all of 2010 is now projecting an increase of 2.4% from the previous year.

Exports of liquid and dry choline from our North American plants declined in the quarter largely due to the currency issues and in combination with global competition, resulting in our declining to bid on certain international business in the quarter. We continue to evaluate these export sales opportunities and, in coming quarters, may elect to be more aggressive in seeking to win this business depending upon the then-current cost and market conditions.

Sales of industrial derivatives had another very strong quarter. Sales of methylamines and other industrial products, including a [toll] produced methylamine derivative from our Italian operation 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 continued to evaluate these growing industrial opportunities to determine how we will derive the most positive value. This strong performance has continued into the early part of the fourth quarter, and we are fairly confident that this upward trend will continue into 2011, driving increases in sales and profitability.

Earnings from operations for this entire segment improved to a record $6.1 million as compared to $5.3 million in the prior year comparable quarter, largely due to improved volume sold, product mix, and certain favorable production and logistic efficiencies. The improved dollar profitability of the ANH segment was achieved with the constant reevaluation of global raw material costs, 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 to drive costs out of our business model.

With the bulk of the feed-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. We 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 products or market sectors, but we are very pleased with this overall quarterly consolidated earnings result. We continue to strengthen our global growth platform and are confident that more business will be generated based 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, and-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 up the conference call for questions if the operator will help.

Thank you. (Operator instructions.)

Daniel Rizzo with Sidoti & Company.

Hi, guys.

Hi, Dan.

With choline sales, are you guys producing at capacity right now?

Actually, we're not. We're certainly growing and getting very, very close to capacity levels. I'd say at some locations more than others, but we still do have some head space, but certainly it's starting to get snug. And I think to that end, we're currently looking at a de-bottlenecking-slash-expansion of our choline capacity here in North America, which we expect to get underway and probably have online, I'm going to say, maybe late Q1, early Q2 of 2011.

And are you guys looking at possibly -- I mean, looking for foreign choline producers to maybe -- to acquire or to join up with?

In fact, we are. We're studying that real hard. I think, given -- the entire situation of choline capacity and raw material supply issues that will likely dictate one way or another very closely where that new capacity for us, anyway, may come from.

All right. Thanks, guys.

Sure.

Tim Ramey with D.A. Davidson.

Good morning. Congratulations on the quarter.

Thanks.

Interested in a little more detail, if possible, on the sales of industrial choline. I know you'd talked about maybe making that its own segment, taking it out of Animal Health & Nutrition. Is that still a possibility? And what's the trend there? Is that still quite strong?

It is. It certainly does still remain quite strong. I think we alluded to that in the press release and also here this morning. It's consistently strong, and I would say growing. It is a significant piece, as we alluded to in last quarter, and again this quarter. I think the decision to break it out separately, it's probably something that we'll study real hard by the end of the year. And again -- and I think a little bit of the hedge here is is we're confident that it's continuing growing, that we will break it out separately.

And even to that end, I mean, our confidence level is pretty high that we've now actually hired a person who's going to start with us, actually next week, focused on the industrial applications. So I'd say that's probably a vote of confidence on our part that we think it's real, and probably with the right kind of push, can be much greater.

And if I could, a follow-up on the ARC business. Is there a bit of seasonality to the acquired fumigation of nut business? I mean, does that get better, or is there more business around harvest, or is it pretty ratable throughout the year?

Yes, that's a good question, actually because we were wondering the same thing as we did the acquisition. And in fact, what you find is that the nuts are harvested at one -- kind of on a seasonal basis for sure, but in fact the treatment goes on throughout the year as the nuts are processed and pushed into the market. So it tends to be pretty steady throughout. Maybe a little bit of fluctuation, but generally it's not going to be -- peak in one quarter because the harvest, and then see it disappear. It's pretty ratable throughout the year.

Thank you.

Sure.

Greg Garner with Singular Research.

First of all, nice quarter, gentlemen.

Thank you.

A continuation on the question about choline and for industrial versus animal use. Apparently you're reassessing how to allocate the choline production, I guess. Might some of the production be geared more towards industrial, going forward, and not -- the domestic choline production not really need to be animal-based? Is that what I'm hearing?

Well, I think if we run into a capacity situation, which we're not there right now, those are things that we would look at real hard. I mean, on a go-forward basis, do we see a faster rate of growth coming out of the industrial side likely than on the animal side? I'd say the answer is yes. And part of the reason that we're doing the de-bottlenecking and expansion that I mentioned -- and that's in our Louisiana site -- is largely looking to what we think is going to be the pretty decent growth rate out of the industrial space.

So we're not in an allocation mode. Let's be clear about that. We do have capacity. But we're certainly looking forward here, near-term, to try and deal with what we believe will be continued growth in that industrial space.

Okay, thanks for that clarity. In the US broader market, about the industry growth, 2.4% for the year, does that mean there's a little catch-up on the fourth quarter, or does that mean slower growth in fourth quarter? How does that look to you throughout the whole -- through the fourth quarter, based on what's happened through three quarters now?

Yes. I think at the last conference call, we had talked that we thought it was going to be a -- well, I think the industry thought it was going to be a bit better for the year, and certainly I think there was a bit slowing in Q3. But we do expect a little bit of a recovery in Q4, and actually, if you were to look at the data, which is [chick] placements in particular, you'd see week to week these guys are talking about, right now, [chick] placement's up 6% or 7% week on week, so that's pretty encouraging.

How sustainable that is, I think we'll have to wait and see, but certainly we think there's going to be a bit of a recovery here in Q4.

Okay. And it was mentioned that you're looking at strategic alternative for, I guess, the calcium lines in the Food, Pharma & Nutrition. Can you tell us a little bit more about that?

Yes. I mean, in particular, that comment was directed to the calcium business. And as Frank had mentioned, we had some production issues there that we've worked through, for sure, over the last, I'm going to say, six months at least. And this had to do with an FDA audit, and so we've got it resolved. I think the thing that we're looking at, quite honestly, is strategic looking forward whether it's a platform that is going to meet kind of the growth objectives that we're looking for, or are we better off doing something with that business and refocusing the resources now that are being spent to support it.

So it's being studied real hard right now, so let's be sure that that comment -- while that business is (inaudible), Food, Pharma & Nutrition is really focused on the calcium business.

Okay. In the margins in that line, the Food, Pharma & Nutrition are -- just been really improved these last few quarters. Is this primarily volume-driven?

Yes, in fact, it is. I mean, we've seen significant uptake. We mentioned the domestic food business, the international food businesses continue to do very, very well. Lot of that is [hooked] to new product launches that started earlier in the year. Certainly the human-grade choline business continues to do well, continue to get into new products. Not huge, I would say, but certainly a number of new product applications, whether it's supplements and-or mainline food, that we certainly believe will continue to happen.

Okay, and just one last question on the new ERC product. Can you tell us anything about what's going on with testing or different food producers or wholesalers, how they're partly implementing it, or any more flavor there?

Yes, sure. I think -- and I think Frank mentioned we're probably disappointed with the -- I'm going to say the slow ramp that's happening, if you want to call it that. We continue to be in trials with the product with -- I'm going to say existing and new targets. And so, we're -- and we're getting -- continuing to get very good results out of them. We went through a little round of kind of maybe our price point wasn't right for the market, and so we've made some adjustments here recently and have taken those out in the market, as well. So we're kind of optimistic that that's going to resolve maybe a hurdle that these guys had seen.

The interesting thing is that -- and in particular, our focus here is bananas, and bananas are the largest imported fruit into North America, and I think into most countries today. But it's also, many times, a loss leader in grocery stores. And if you go to a Wal-Mart, you'll probably find bananas today at $0.39 a pound whereas, six months ago, you might find them in the other stores at $0.69 a pound. So there's always a lot of price pressure in this space, as we've learned.

So we're trying to come in with a price point here that's going to make sense, and we think we have it now. So we'll continue to do these trials, kind of conveying that value proposition to the market. And optimistically, I think we'll begin to see some revenue being generated. I know I'd said that I thought it would start this year. I think, in any significant way, you know, we've now shifted that back a year, so hopefully it'll start up next year.

Okay. Well, thank you. It's been a nice quarter, yes.

Thank you.

Lawrence Goldstein with Santa Monica Partners.

Two questions, one mine. I just noticed on the balance sheet that long-term borrowings at $11.8 million, and that's probably -- most of that is probably deferred taxes, isn't it? You just didn't -- right?

Correct, Larry. Long-term debt -- the long-term portion of the debt is about $3.9 million.

Yes, that's what I assumed. What is your share currently in Choline of the animal use and the human use, and in the US and in the world?

Yes. Well, I think, on a global note, on the feed-grade side, we -- based on all the numbers we have pulled together, we think we're number one, and we have about 26% market share, probably the most significant, I'm going to say, area of competition comes from Chinese producers. There are a couple other producers in Europe, but far and away, the most aggressive competitor in that space are a couple Chinese companies.

On the -- and I would say, in the North American market today, we probably have about 90%, 95% of that market, and so (inaudible) the global side. I think on the human side, certainly we probably have a solid 90%, 95% of the human market in North America. On a global note, we probably have about 50% market share. So again, a leader with the human-grade choline, as well.

Thank you.

Thank you.

[Andrew Matalone] with [Friese] Association.

Hi, guys. Can you hear me?

Sure can, thanks.

Yes. Can you just talk about the price differences for choline being sold into the industrial markets versus the sort of more traditional markets? I mean, that's pretty quickly become almost a third of your biggest business. And I'm just wondering sort of how the pricing dynamics compare to each other.

Yes, that's a good question. I think right now if you look at it -- and not sure what you mean when you allude to traditional market, but, I mean, for us the traditional market for choline is really the animal feed side.

But if you looked real close, and a lot of it depends on freight terms and delivery terms, but the average price is pretty close to flat. A little bit of upside, if you will, on the industrial side, but pretty close to flat right now.

Okay. And then, could you also sort of compare that to -- I mean, I understand. I mean, I guess I understand it that, you know, the choline into the drilling fluid market is replacing something else. And so, compared to whatever that something else is, where are your prices compared to that?

Yes. I mean, that's part of the reasoning that the prices are kind of flat, is that we're very comparable to the product that's being replaced. I think we went into this space, quite honestly, cognizant of what the price point was for that product, and so we priced accordingly. And so you would find it to be a push today.

I will say that product that we're looking to replace has fluctuated a fair bit. It's probably on the lower side right now of its price point over the last two years. But it ends up being, I'm going to say, manipulated a bit by what goes on in the fertilizer industry, and there's times when it's been as much as 50% higher than what it is today. But we've gone in with a price point very competitive to where they are today, trying to make the price not an issue.

Okay. And then, can you -- maybe last question -- sort of put into perspective -- I mean, what's the size of the opportunity here for choline into the drilling fluid marketplace? And you've obviously had some really good rapid growth here recently, but, I mean, how much of the market do you think you have now? How large do you think this sort of opportunity is?

Yes, that's a very good question. I think we're trying to get our hands on it. I just want to maybe clarify one point. There's really kind of three markets here. You mentioned drilling fluids, and there are drilling fluids for straight-up drilling, and then there's frac fluids, which is really where we are focused more than anything, and then there's completion fluids, all of which use this product that we're looking to displace in the frac fluids today. So order for magnitude, it's a very, very, very large number. I'm not going to sit here and pretend that we will displace it in every one of those applications. Our focus right now is on the frac fluids.

And what you get into is various shale structures, and in some cases we work equal to, and that's where we're easily a target to replace the product in some of those shale structures. And there's other places where the KCL, which is the product we're looking to replace, actually works better in some of those shale structures.

So I think trying to quantify how big it can be is a bit difficult right now. We are, I'm going to say, looking at these other areas, i.e. drilling fluids and-or completion fluids. Certainly not -- it's not on the front burner with us right now, but see where that could be an opportunity, as well, but right now the focus is on frac fluid.

So I know I really haven't answered your question. I think we're still trying to get our hands around exactly where the product is most efficient and effective. And I think the bottom line, though, is one key advantage we have where it does work is the fact that it's greener. And so that, I think, is what certainly gives us an advantage today and certainly should lead to sustainability at least in the frac fluid side, going forward.

Okay. No, thanks, that's helpful. I mean, the reason I sort of asked the last part of the question is just to understand. I mean, if this is a situation where you're just sort of scratching the surface and you're already talking about having to de-bottleneck some of the existing production to meet what demand is, then at some point you're obviously going to have to think about bringing on more capacity. And I guess, to some extent, you can't really do that until you have a firm sort of grasp on how big and how durable the opportunity is.

Yes, you're absolutely right. I think we're trying to get our hands around the market size. And I would tell you, we haven't really gone out there and really promoted this technology in any big way. Our plans, as I mentioned, with the new person coming on board is to get more aggressive out there in the space and really promote it a bit more. So we certainly believe that that will help. But we're also seeing some opportunities develop for some of our [end cap] technology in this industrial space as well, so we're pretty optimistic that not only will it be choline for these applications, but perhaps some encapsulated ingredients, as well.

Okay. Thank you.

Thank you.

(Operator instructions.)

Tony Pollack with Maxim Group.

Good morning.

Morning.

The force majeure that was from the key supplier, could you give us -- just quantify some numbers on what that cost you, and is that still in effect?

Well, they officially haven't lifted the force majeure, but probably in Q3 it cost us a little over $400,000, and that was on the heels of Q2 where it cost us actually more than that in Q2. But in fact, I mean, the supply chain has been restored and things are moving well. They just haven't officially lifted the force majeure declaration.

So can we assume, third or fourth quarter, that that cost will be coming out of the business?

Unless there's another one. We've gone through a window here this year where there's been, I think, three or four different force majeure events declared. So hopefully we won't see another one in Q4. We should not realize that kind of uptick.

Right. Could you go into a little on the unfavorable currency fluctuations and what you see, going forward, on that?

I'll let Frank answer that for you.

Sure. As we look at our euro-denominated sales from a year ago, had we translated at the same rate as we did a year ago, our sales would have actually been up about $1.3 million. So that's kind of the impact that it had.

As compared to the prior year quarter, I saw a note out there this morning that Morgan Stanley has just given some guidance that they see the euro going up to 145 or so here by the end of the year, which would take us all the way back to where we were a year ago. So kind of the thought here is that we are going to see a weakening of the dollar.

Good. Could you go a little more into the new market opportunities for the packaged gases?

Well, I think that in particular, that's the ERC technology that we've talked about, and certainly the Aberco acquisition. So the Aberco acquisition has been integrated. I think Frank mentioned the impact that we saw on revenue from that business here in Q3 was a little over $1 million in addition to what our core business had done. So our expectation is that it's going to be that plus on a go-forward basis. We continue to work to try and broaden where PO can be used in those applications, not only North America but also in other parts of the world. So we expect to see better growth out of that even as we go forward.

On the ERC side, I kind of mentioned where we were already with that technology, that sort of banana ripening, and so we've kind of been through -- continue to go through trials in the industry, continue to see good results coming out of it. And hopefully now we've come back to the industry with a price point that's going to make this an easier decision for them to go with. So we'll see how that goes, but I will tell you, we have trials. We're working trials right now, so that's still all very positive. The industry understands how it works and why it's there, so hopefully the economic value proposition we put out there will be compelling enough.

Good. Could you go a little more on the new commercial encapsulation technology for the Animal Health business? What is that, actually, and when do you see any significant revenues on that?

Yes. Actually we have internally developed some new technology that's basically an extrusion process still [within] microencapsulated version of a couple of the feed ingredients that we're already out there in the market with. We see this as a way to, I'd say, continue to deliver the quality but drive the price point down of that efficacy of that product so that it'll be, I'm going to say, easier to sell in what becomes a difficult dairy industry as milk prices go down, feed costs go up, rationalize. We feel that we want to be in a lower cost position, which has led to the development of this technology that we think will be more broadly accepted.

So we're pretty excited about it. It is a significant project for us that we've undertaken, expect to have it online in early Q1, probably about a $3 million project to put this technology in. So we -- pretty unique. Like I say, it developed internally with consultants from the extrusion industry, so we're pretty excited to get that online here.

Could you give us an idea of what net costs the pharmaceutical [trine], or however you say it, potential is in this quarter?

When we said it was a net expense in the quarter?

Yes.

Yes, okay. Frank's quickly looking for a number on that, so we'll -- go ahead -- we can come back to that. Okay?

What kind of sales did you do in the choline to the industrial market this quarter?

I think we were right between $8 million and $9 million.

Okay. And do you see that increasing, going forward?

Well, our expectation is that it will, Tony. I think that what we're -- we're seeing it kind of stable and up a little bit at this moment. And again, I think with -- to be honest with you, is a barrel of oil continues to move up, I think there's going to be continued interest to harvest as much natural gas as they can, which will keep a lot of interest in fracking those wells. And that should lead to continued utilization of that product. So we'll continue to get a better read here. As I mentioned, we're putting a full-time person on this to really drill down harder. This is a guy who's been in the industry probably 25, 30 years, so we're looking forward to, I'm going to say, capturing better market data here near-term.

Right. Okay.

Tony, the answer to your question regarding the Pharma, it was about $200,000 in the quarter.

Okay. Has there been any more results issued on the one big project that's in phase 3?

No new information. It's continued. It's tracking well. And they kind of keep all that information pretty buttoned up, so everything we're hearing is it's continued to track well. And I think the intent is to wrap up that phase three tier, I'm going to say, end of this year, early in Q1 with, I think expected knowledge of the results somewhere in Q2.

Right. Great. Thank you very much.

Thank you.

Lawrence Goldstein with Santa Monica Partners.

Hey, I've never seen a shale shaker, but we're probably getting closer to them since they're upstate New York and Pennsylvania. Have you ever seen one? Because this [KTL] is used, I presume, in place of a drilling [mud], or [KTL], rather, is drilling mud, isn't it?

Well, KCL is one of the ingredients that's used in the fluids. So it's a key component, but it's not the entire part of it at all.

So is it used with the shale shakers?

In the fracking for--?

--Yes.

Yes, it is, absolutely.

So, I mean, that market is really exploding big-time, right?

Well, except for New York.

Well, it may here, too. Have you ever seen it used on-site?

I can't say that I've personally been onsite where it's been used. I've been -- I've had the whole process walked through with me. Typically, you have your oil and gas development companies that go out there. These are people like Halliburton or Slumberger or whoever will work in the well, and they're the ones that are actually mixing up and completing the fluids onsite, and a lot of that kind of changes as they go, depending on the results that they get out of that well. So there's a lot of tweaking of these formulas of these fluids that take place onsite, and then clearly pumped into the ground to get that better flow rate.

So -- and you sold $8 million or $9 million worth of that stuff for that purpose, [rather] choline for that purpose?

Yes, we did.

And so you're going at that rate a quarter, and actually not at that rate. You're accelerating each quarter, aren't you?

It's going up a little bit quarter by quarter, for sure.

Yes.

So to understand this, we're talking about maybe $40 million -- well, you've got a run rate of maybe $35 million, $36 million or something like that. That right?

That's a pretty good number.

And are you selling it to -- in the geography where it's used, and it's used in a lot of places around the country, right?

And even the world, but yes.

And even the world, yes. So are you selling to -- is it being used everywhere as a replacement, or a little here or there, or a certain market? In other words, are you just -- I don't literally mean this -- are you just in Pennsylvania, so you have the rest of the country and rest of the world to go, or are you -- where's your stuff being used, location-wise?

Well, okay, let me answer this two ways. Number one, we're typically not shipping directly to the site where it's used. There's an industry kind of in between that does the oil well servicing, and those guys are selling not only our product, but a number of other products to these sites. A number of these locations are in either Dallas, or outside of Dallas, or the Houston area. And so that's typically where our shipments are going. And then, these guys may be actually blending the product or shipping it direct to those sites. Those sites now, we know, are in certainly Pennsylvania, Ohio, Tennessee, in the Midwest, part -- Barnett Shale in Texas, so up into Wyoming. So it's not just in this Marcellus Shale here, [even though it'd be] -- right.

So that must mean that it's being used only partially in these locations, because the amount of money we're talking about is a lot to Balchem, but it's not a lot in the business.

Your -- I think your assumption there is--.

--So I'm sort of wondering whether the drillers are using it in test -- I think they use it in conjunction with the shale shaker. Maybe it goes in the well. I'm not clear on that. But they must be using it on some of their equipment, some of their work, but not all. Do you know how that's working, or are some people using it exclusively, or what?

Well, we know it's being used repetitively at certain locations. And again, it's going to come down to that particular cell structure and what works best. And it could be used -- it can be used in conjunction with KCL, let alone replacing KCL. So I think these guys definitely do -- these mud engineers, if you will, they tweak the product as they're using it, given the lifting rates that they're getting out of those wells.

So this product is being pumped into the ground, Larry. It's not being used just as some shale shaker. So they're looking at the performance, and they're tweaking it and continuing to use certainly in existing sites and a lot of new developed sites, as well.

Okay. And in your revenue breakdown, your three categories, which category is the $8 million to $10 million in?

It's in the Animal Health business.

So it's like 20% of that or more. And so the percentage of it increasing -- that's a big part of the increase you're getting, from $36 million to $42 million in the quarter.

No question.

Yes. Wow. Anything else you could say about it that you haven't already?

I don't think so. I mean, not just in your questioning but the others, I think I've pretty much touched on where we are.

Well, when you say you have -- you're bringing on one experienced guy -- salesman, there must be a very large number of drilling supply outfits. So why aren't you having -- I don't mean it literally -- an army of salespeople?

I think we're looking at it one step at a time, Larry. If it continues to progress as we think, then certainly I think your point would be valid, to hire more people.

Okay.

All right?

Thank you.

Thank you.

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

Thank you. This is Dino again. And again, thanks, everybody, for listening in. I do think it was a very good quarter. We feel pretty good about the outlook, going forward. All these little challenges for sure, whether it's raw material supply issues, force majeure events, but I think we've managed through them pretty nicely.

So we're pretty optimistic, and look forward to continued growth. We'll talk to you soon, next quarter. Thanks. Bye.

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