Balchem Corp (BCPC) 2012 Q4 法說會逐字稿

Greetings, and welcome to the Balchem Corporation's fourth quarter 2012 earnings 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.

Thank you. Ladies and gentlemen, thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the period ending December 31, 2012. 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 statement. 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 Form 10-K.

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 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 fourth quarter net earnings of $9.9 million on record quarterly consolidated net sales of $80 million for the quarter ended December 31, 2012. These fourth quarter sales of $80 million were approximately 15% greater than the $69.7 million result of the prior year comparable quarter.

In the quarter, our Specialty Products segment generated record quarterly sales of $13 million, a 5.1% improvement over the prior year quarter, a result of increased sales volumes of packaged ethylene oxide and propylene oxide in the quarter.

Animal Nutrition and Health, at $56.4 million, was up 18.1% over the prior year comparable quarter. Sales of choline, choline derivatives, and other products for industrial applications had a very strong quarter, up approximately $7 million from the comparable year quarter. Sales of choline from monogastric animals, poultry, and swine were up approximately 5%, and the ANH Specialty Ingredients, largely targeted to the ruminant animal markets, realized approximately 3.4% sales growth to the prior year comparable quarter, where strength in other encapsulated products sold substantially, offsetting the impact of having discontinued the AminoShure product.

Food, Pharma, and Nutrition sales, at $10.7 million, were up 11%, led by strength in VitaShure products and sales of encapsulated products sold into the European food markets.

Earnings from operations of $15 million improved 9.8% over the prior year quarter, equaling 18.8% of sales. As previously noted, consolidated net income closed the quarter at $9.9 million, up from $9.5 million in the prior year quarter. This quarterly net income translated into diluted net earnings per share of $0.33 as compared to the $0.31 we posted in the comparable quarter of 2011, an increase of 6.5%.

Looking between the top and bottom line, you will see that our consolidated gross profits of $22.4 million declined to 28% of sales in the quarter. This decline as a percent of sales from the prior year quarter reflects improved plant efficiencies resulting from strong sales volume. However, it also reflects the shift in the product segment mix, higher costs of certain key raw materials, and startup costs relating to our new manufacturing facility in Virginia.

Various raw material increases affected unfavorably our ANH and FPN product segments. As mentioned in previous conference calls, certain raw material costs have continued to rise, and while some were passed on to customers, additional price increases have been and will be implemented in the first quarter, as our businesses are likely to remain affected by these higher costs into 2013.

We continue to work on operational efficiency, and I'm happy to report that we have commenced production and are now shipping product from our new Covington, Virginia, plant in January of this year. This expansion will more than double production capacity of our rumen stable products.

At the consolidated operating expense level, you will note a 3% increase, totaling $7.4 million for the quarter, which equals 9.2% of sales versus the prior year metric of 10.3% of sales. This level of spending represents certain increases in R&D and marketing levels, but we continue to leverage off of our existing SG&A infrastructure and exercise tight control over all controllable operating expenses.

Overall, we are generally pleased with our earnings from operations for the quarter, especially considering the continuing tough economic environment occurring in North American and European markets. Consolidated earnings from operations percentages remained strong and finished at 18.8% of sales, or $15 million for the quarter, up approximately $1.3 million, or 9.8% over the prior year quarter.

Our effective income tax rates for the fourth quarters of 2012 and '11 were 34.5% and 31%, respectively. This increase in the effective tax rate is primarily attributable to a change in apportionment relating to state income taxes and the availability of certain tax credits in the prior year. For example, our effective tax rate in 2012 is reflective of the expiration of the federal tax credit for research and development activities that was available in the prior year.

The enactment of the American Taxpayer Relief Act of 2012 on January 2, 2013, retroactively reinstated an extended US federal research and experimentation tax for all of 2012 and '13. As a result, the Company expects to recognize an effective tax rate benefit, to be reflected in our fiscal 2013 first quarter results. Our annualized effective income tax rate for all of 2013 is currently estimated to be approximately 33%.

Net income of $9.9 million equated to $0.33 per diluted common share, which is a 6.5% improvement over the comparative prior year quarter. These results generated approximately $17.5 million of EBITDA in the quarter, which translates to $0.57 per diluted share. And when including our non-cash stock-based compensation charge, we generated $18.4 million of EBITDA in the quarter, equaling approximately $0.61 per share, or 23% of sales.

Our balance sheet remains strong and our cash flow robust, as we closed out the year with $145 million of cash, having prepaid all outstanding long-term debt, and reflects the accelerated payment of our annual cash dividend in December, which totaled $6.5 million. In addition, we have spent $13.9 million of capital for the 12 months ended December 31, 2012, which includes substantial costs relating to our new manufacturing facility in Virginia. Capital expenditures for all of 2013 are expected to be approximately $8 million.

As you can see, we continue to aggressively manage all areas of working capital, driving strong cash flow, improving cash earnings, and generating quality organic 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.

Thank you, Dino. The ARC Specialty Products segment posted record fourth quarter sales of approximately $13 million, or approximately 1% increase over the prior year comparable quarter. This increase in sales was derived principally from volumes of ethylene oxide products sold for medical device sterilization and increased volumes of propylene oxide, particularly for nut and meat fumigation applications.

ARC quarterly business earnings increased 9.3% to a fourth quarter record of $5.5 million versus the prior year comparable quarter. This increase is largely a direct correlation to the improved sales volumes of ethylene oxide and propylene oxide products. Slightly increased overall average selling prices were derived from a favorable product mix.

Late in the quarter, we did realize additional increases in the costs of certain petrochemical commodities. We continue to monitor raw material price volatility closely and seek to implement price adjustments within contractual guidelines.

For the quarter, the Food, Pharma, and Nutrition segment realized sales of $10.7 million, up approximately 11% over the prior year comparable quarter. Business segment earnings of $2.3 million were down approximately 10.7% from the prior year quarter, largely due to product mix and increased raw material costs within the various sectors of this segment.

Overall, the FP&N sector sales did have a strong quarter as compared to 2011 and was comparable sequentially to Q3 2012. Particular strength in the international encapsulate sales, up approximately 40%, were realized in ingredients for baking, prepared food, preservation, and inspection markets. As in the past, results for this segment continue to reflect the roller-coaster effect of pipeline sales, inventory level management, and delayed marketing initiatives. Our growth drivers do, however, remain intact for this sector, as food sales remain strong in the early part of 2013.

On that note, we also realized strong double-digit growth in sales of our ReaShure products for nutritional enhancement. Last quarter we reported that we were working with a large sports nutrition company on the introduction of sustained release amino acid products, and we have made our first sales from this launch in Q4.

In the quarter we realized modest growth in sales of our human choline products for nutritional enhancement. Here we continue to focus on building consumer awareness of the benefits of choline, positioning choline with nutritional and pharmaceutical companies as an essential ingredient with excellent therapeutic benefits for all ages. We continue to effectively utilize the three structured function claims awarded to Balchem for EFSA in Europe.

Our pharmaceutical delivery development efforts continue. As previously reported, the licensee of our technology being used for treating autism concluded a Phase 3 clinical trial, and we await the unblinding of this trial, as we are working with them in support of their NDA filing. In the near term, this sector remains a net expense to the business segment. However, we have initiated a few new projects with other pharma companies as well.

I will now turn the call back over to Dino for him to discuss the Animal Nutrition and Health segment.

Thanks, Frank. In the Animal Nutrition and Health segment, we realized record quarterly sales of $56.4 million, an increase of $8.6 million, or 18.1% as compared to the prior year comparable quarter. ANH ruminant products realized sales growth of 3.4% from the prior year comparable quarter. As mentioned in this morning's press release, our quarter results in this sector of ANH were actually much stronger than the 3.4% suggests, as our comparative results were adversely impacted by the previously announced suspension of sales of AminoShure-L 52% lysine. Sales of non-AminoShure products were up 15.2% in the quarter, led by strong volume growth of ReaShure and NitroShure, as excellent product performance and dairy economics continued to support greater demand for our products, effectively offsetting the AminoShure-L decision.

With respect to the second quarter suspension of sales of AminoShure-L 52% lysine product, we are diligently working to make the required product improvements, and we'll look to reintroduce this product into the dairy industry once improvements are completed and confirmed with dairy industry experts. At this time, our work continues. However, we are unable to give a precise estimate as to when this work will be completed.

Dairy economics continues to forge strong demand for our products, despite the increasing challenges of production animal feed/ration prices. Milk prices are currently forecasted to remain strong, and the pace of dairy herd contraction is occurring at a slower rate than projected. Although feed prices are forecasted to remain high, current overall indicators should support greater utilization of our products as herd managers will look to continue to maximize results of the production animals.

As mentioned previously, in order to support this expected growth, a new manufacturing facility in Virginia has been constructed, more than doubling output capacity for our rumen stable products, and we have commenced production at this site in January of 2013.

Our global feed grade choline product sales were up 5.1% from the prior year comparable quarter, as we saw modest volume growth, principally in North America. Sales of our European-produced product were, however, unfavorably impacted by foreign currency fluctuations totaling approximately $400,000. Volumes sold in these markets are strongly influenced by the various dynamics of our customer base, predominantly the poultry production industry, but also swine and aquacultural markets.

North American choline volumes sold closely tracked with broiler chick placement and egg sets. The current USDA forecast for broiler meat production has improved slightly for 2013 due to a slight increase in hatchery production and anticipated higher bird weights. These forecasts, however, are dependent on more normal crop and grain growing conditions.

We constantly evaluate export choline sales opportunities for the poultry market, but again found Q4 to be a very challenging export market when factoring in raw material cost increases and foreign competitor activity. In the coming quarters, we may elect to be more aggressive in thinking to win additional business, depending upon the then-current costs and market conditions.

Sales of industrial grade products were very strong, and sales were up 62.8% over the prior year quarter, and sales in the North American fracking market improving 5% on a sequential basis, particularly due to volume. Sales of methylamines derivatives and cholines for industrial applications in Europe were also up in the quarter. We continue to see solid sales of choline and choline derivative products for various industrial applications in North America, especially for the gas fracking opportunity. We remain confident that these products will continue to show strength in 2013, driving steady to increasing levels of sales and profitability, even at current rig deployment levels.

We continue to evaluate industrial opportunities with core technology to determine how we can drive innovative solutions into this and other markets to derive the most positive value and are diligently working with new technology for areas where our core technology is not sufficient.

Earnings from operations for this entire segment grew to $7.2 million as compared to $6 million in the prior year comparable quarter, principally a result of increased volumes sold. Earnings were, however, unfavorably impacted by increases in raw materials during the quarter. These raw materials continue to be a concern. As we mentioned earlier, we are closely monitoring raw material price volatility and will seek to implement price adjustments within our contractual guidelines.

The profitability of the ANH segment continues to be achieved with a constant reevaluation of global raw material costs, product reformulation, currency review, and the ultimate ability to economically meet market needs from our various global facilities and transload sites. The opportunity to capitalize in this fashion has been a direct result of our effective integration of acquisitions, operational benchmarking, marketing strategies, and the ability to drive cost out of our business model.

With the bulk of the feed grade choline predominantly going to the poultry and swine markets, we remain very sensitive to continued economic pressures on the large production animal integrators. Feed ration costs remained high in Q4 due to the US drought situation. And while retail poultry prices have stabilized, pressure on profitabilities for this global end market continues.

As noted in previous calls, we continue to see a revenue roller coaster effect quarter to quarter within the various products or market sectors. This quarter was no different. We remain committed to organic growth as we look to continually expand our product offerings and move into new geographies. We will continue to strengthen our global growth platform and are confident that more business can be generated based on the unique portfolio of products that we offer to markets we serve.

Our business continues to create good balance, yielding profitable growth opportunities through the various market challenges of any single segment or product line. We remain focused on helping our customers generate reinvestment-level returns, making money in this tough economy while maintaining our own operating discipline. Overall, we continue to build the financial strength of the Company, managing the working capital base aggressively and yielding improved financial results.

Near term, we remain focused on implementing operational and logistic improvements, new product development, and new product introductions. We also continue to explore alliances, acquisitions, or joint ventures to continue building and leveraging our strategic marketing direction, 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. We will now be conducting a question-and-answer session. (Operator Instructions.) Tim Ramey, D.A. Davidson.

The Covington facility -- how should we think about that impacting results in 2013? Should we think about this primarily as incremental capacity that can cause growth rates to accelerate? Or should we think about it more from a market perspective? Maybe you can shed some further light on that.

Yes, I think it's a little bit of both. For sure, we're viewing this as incremental capacity. And Lynn made reference, I think, in the press release that went out earlier, where Q4, we had moved into a bit of an allocation mode because we were tight without Virginia onboard.

So with Virginia now coming onboard, it instantly, it is incremental. With any new plant, I think, and under-capacity run rates, we talked about the cost in the quarter of not running it, getting current those kinds of expenses. And I think it will probably be another month or so yet before we have that all lined out. But clearly, we're viewing this as a release valve for sure, given the demands of those products -- I'd say built-up demand, if you will. So we're looking to run that, definitely near term, on an incremental basis.

And then I think on a go-forward basis, clearly, we're going to look to leverage that up in the market. I think there is definitely strong demand that's been built by the sales marketing and the technology of the product out there. So our expectation is that it will yield, certainly, a beneficial result from sales growth, let alone profit growth as well.

Got it. And then on the choline chloride business, I clearly have been too bearish on the impact of the lower swine numbers, and that, as you point out, has turned a bit. As you think about that for 2013, is that mostly a domestic opportunity? Does that mean that you're going to be more aggressive internationally? How would you think about the choline chloride business in 2013?

I think our view of the North American market, in particular, is one that we believe will be positive, but not dramatically positive. I think our expectation of this is based on a lot of industry publications and data, which suggested it should grow from a live bird production standpoint weight probably 2%. So that's our view.

I think, as we look at this market and we allude to constantly looking at export opportunities, the one thing that we have not talked about is -- but it's out there in the public eye -- is that a large Chinese producer had a major incident, and is, near term, out of business. And they are probably one of the largest producers/exporters into, as we would know, to be the export market today.

So I can't sit here and say what the impact of that will be. I have to believe there should be some positive, but I'd say that it's still yet unknown what the impact of that, as well as what's going on in the global market, will be. I think the view of the global market overall is that it's going to grow somewhere between 6% and 8%, but a lot of that growth, i.e., not North America and N4, is likely going to be in that 6% to 8% in places like Brazil. Russia just published that they were up 9%, and certainly the Chinese market in and of itself is growing.

Great. Thanks for your help.

Daniel Rizzo, Sidoti and Company.

I'm sorry if I missed it, but what was industrial choline sales up year over year in the quarter?

$7 million.

$7 million. Okay, I apologize. And then one particular remark, you indicated that you're still waiting. Is there a timing? Do you have a timeframe on when you expect to hear something for the deal with the new product that you guys are waiting on?

Again, I think, Dan, we've talked about this before. We're not really in control of that marketing process per se. Indications are that I think they expect to file their NDA here in Q1 now, and then I think the FDA has six months to respond to that. Now, they could respond sooner. But certainly, they have up to six months to respond. So that's probably the most current information that I can give you on that.

Okay. I don't know if you can, but could you just provide some color on the other new products you're working that seems to be along the same lines in the pharmaceutical arena?

I wouldn't say they're necessarily along the same lines. We're working on a couple other products, and it's definitely early, if you will, utilizing our encapsulation technology to deliver some ingredients that we've been asked to work on. So those are in the background. I don't want to hang that out there as a huge carrot or anything, but clearly, more and more is coming to light about where those opportunities are in that space. And so we're running down that path right now. But I'd be reluctant to try and jump out and say how big the opportunity might be.

Okay, thank you, guys.

(Operator Instructions.) Andrew O'Connor, BMO Asset Management.

Dino, can you guys refresh me -- what is your strategy in managing the balance sheet? Is there a capital structure that you view as optimal for Balchem? Thanks so much.

Yes, I think -- so the question really comes down to, I think, what are we going to do with the cash?

Yes.

And cash has continued to build, yes, so it's a fair question. Our strategy certainly is to look -- I think everybody, and we've made reference to that we accelerated and increased our dividend payment for 2012. And our view is to continue to plow money into the business. And I guess you'd quickly point to the investment in the Virginia plant that I think will absolutely support organic growth.

But I can also say that strategically, we don't think that that's enough. Our view is certainly to find other acquisitions or joint ventures that will accelerate the growth of the business. Certainly, I'd say more geographically would be desirable, since we're still probably 67% of our revenue is North America, so we're still a very North American venture, if you will.

And it certainly would be a good opportunity to the rest of the world that we have to get into a position to take advantage of. And I think our view there is to try to acquire something that represents almost a plug-and-play, whether it's manufacturing capability, sales organization, which I will say would have to be a strong technical sales organization, and/or some new technology. So those are -- I wouldn't limit it to any one particular segment, but I think if we look geographically, probably we're looking more at the animal health and/or food businesses as we target them.

Got you. Since the Company's debt-free, are there other near-term priorities for cash that somehow I'm not seeing or picking up on?

I would say not. There's always -- you know, I made reference, too, in the conference call earlier that our capital budget is to be $8 million. To be honest, there are some other projects that we're working on that could require some spend, maybe another $5 million to $6 million over and above that if certain other things develop here for an existing product line that we have. So short of that, it's consistent with what I said earlier. That's our view going forward. And quite honestly, we recognize that we're way under-leveraged. And so while we can talk about a cash position, in our mind it's cash-plus, with the idea of doing some things that are going to move the needle.

Sure. And then on the $8 million, how will that be spent in '13? Thanks, Dino.

Yes, a lot of that is really stay-in-business type capital. We're now up to eight manufacturing sites, and to be sure, manufacturing sites require capital. And so, as we've got it identified today -- and believe me, we do a detailed budget in support of that kind of number -- it's mostly stay in business. A few, our live projects are in there, for sure, but that's really the flavor of that money.

Thanks very much.

Greg Garner, Singular Research.

First of all, a couple of follow-up questions from the prior questions. You mentioned about the Chinese producer out of business, but you also mentioned an incident, so it makes me wonder. Are they totally out of business and will not come back, or is it an incident like a plant blow-up that they could reconstruct? Or can you give us any flavor on that? Is it a permanent thing? Should we look at it as a temporary change?

Yes, that's a great question. So, in fact, the plant did blow up. And clearly, there's YouTube videos out there. You can go to it and see it. Quite honestly, it's pretty devastating, actually -- a number of people injured, supposedly no deaths. I don't know if that's true or not. But it was a major incident, if you will. And I think, from our standpoint, trying to get details out of the Chinese press is always a challenge. But what we do know is that the plant basically was leveled.

So what the fallout of that will be, I think I would say we haven't necessarily felt it yet. But given what we understand their volumes to be, their capacity to be, it's going to cause -- how, in fact, it affects in China, let alone export, I think is still yet to be determined.

So were they the largest Chinese exporter of choline?

We believe that to be true, that they were the largest exporter. I will say that a lot of data that comes out on Chinese production may be questionable in terms of how accurate it is. But certainly, I think what we know -- and we do know of these guys. Certainly, they were, if not the largest, one of the top three.

And how long would it take to rebuild a plant like that? Two years? One year?

I'd say you're in that 18-month to two-year window.

Oh, okay. So there's an opportunity for the industry to pick up the slack once any excess inventory is worked off?

Yes, and that's assuming that there's not enough excess in the global market to offset that near term. But your observation is probably more right than not.

So some time in the next few quarters, you should get some sign of the impact of that by some orders that may come from Italy or for other parts of the world?

Absolutely. I think our sense is we'll see that, I would think, by the end of Q1 for sure.

Oh, okay. And the other, you mentioned about potential higher than $8 million CapEx for 2013. Is that for some existing products, that some programs take off? Does this happen to be for that new product that you said would be introduced at the end of the year for amino acid absorption for --

Actually, no. That's not what we're talking about. We're really looking at, actually, a human-grade choline opportunity that may require an expansion.

Okay, so that would be in the Food, Pharma, and Nutrition, though, right?

In fact, yes, it still would be, yes.

Okay. So there are some big things happening there that you would have to increase production to meet potential demand? Is that what you're looking at?

That's correct.

Okay. Can you tell us anything more about what that is or what product or anything?

Well, I told you it was for a choline product, and it could be as much as doubling that requirement that we're selling into that market today. And I think I'd like to leave it right there for now.

Okay, sure. And you have a history, you're always going to be batted around a bit, so to speak, from raw material price changes that are quick, and the time lag to pass it on to customers, and it just seems to be a normal event. Based on where it is right now, if there were no change in raw material pricing, how long -- would it just be one quarter to get back up to above 30% in gross margin? I was just wondering.

Yes, I think that -- if you follow our models that are out there, it would suggest a one-quarter lag. And that's, going back to your -- and I want to make sure we understand it -- that if raw materials were to stay flat. Our near history here, that's not been the case. So I wouldn't want to sit here and kind of promise that kind of view, given the volatility that we've seen.

Okay. All right, well, it helps me understand where the current situation is. And in the industrial choline, the sale into the fracking with the flat rig count, are you seeing that it's being accepted in other basins, perhaps? Or is it just really more frackers are recognizing the advantages of it? Any characterization of that? I'm just trying to get a sense for how that might continue.

Yes, I think the answers to what you posed is yes, yes, and yes. We know that we're in more basins. We don't get an absolute track on that because of the distribution channel that we use. But certainly, it's being used more broadly. I think the environmental aspect of it is definitely picking up a bit more speed. And our sense is that wells, even though there's not maybe a new rig there, are being re-fracked. So you're picking up additional consumption in existing wells.

And we do know there's some work being done, too, with the product outside of just frack fluids. But we're on the fringe of that. But definitely it's being looked at, I'd say, a bit more broadly in the oil and gas space.

Okay. Okay, thanks. And the AminoShure-L, the reformulation of that -- I know you don't really know when that's going to be finalized. But does that look like it's just a couple of quarters away, or is it a couple of years away? Any at least general sense?

I think our view right now on the progress that we've made is that it's a couple of quarters away. Maybe we might have the product out here in Q4 of this year. Because there's typically a fairly long, a three- to six-month window, of animal testing that has to be done. And so I'd say earliest would be Q4 of this year, and certainly, by virtue of that, I'd say that's hopefully our target.

So that would mean there would have to be some testing started in, let's say, three or four months or so?

Absolutely.

Okay, okay. And just one last item, just on a very general sense about the Food, Pharma, and Nutrition. It seems like there's a lot of opportunity there, especially with this -- you mentioned some other products. We talked about it, CapEx may increase for, and also the amino acid absorption product. But revenues have just been roughly flat or so. I guess, should we look at it as these new product ventures that you're working on, this is the future for this segment here?

It's a great observation, and I know I've talked to a number of investors about the food and pharma business. I'd say food and nutrition, not so much the pharma side of this. But the reality is, there is some volatility, fluctuation, if you will. I think we've found it more to be on the food encap rather than the choline side of the business. And that's where you get caught up in the life cycle of any given product. We get inspected, and not because our product does anything wrong, but perhaps it doesn't sell as well as the food companies thought, so they discontinue the product.

I think if you went in and looked at the life cycle of products today in the food industry, you're going to find that they're shorter than they ever were. They're always looking for that next new product, if you will, which usually means they're going to pull some product off. And so for us, it's making sure that we're in the innovation side of the new product development groups and to work with them to get them knowledgeable about encaps can work. So it's about having that front-end pipeline full of these opportunities. And on full, you don't have to convert them all, or that it might take 12 to 18 months to convert a piece of that business.

So it becomes some timing issues there. For us to say, "Gee, we can lock down that back door and not see any leakage," is not going to happen. Just the markets, in and of themselves, are going to discontinue some of those products, which is out of our control.

So that's a little bit of the volatility that you're going to see there. And in any give quarter and/or -- let's go to a year, I think, is probably a better look -- you may see solid double-digit, maybe 15% growth going on, on the encap part of the business, and it may last two or three years. But then, too, you could lose a piece that falls out that back door. Hopefully, it's not as big as. But the key here is to continue to have that pipeline full of those new opportunities.

In the growth in Europe there, that's been a relatively low contributor in this segment, as I understand?

Yes.

Anything new that can sustain itself, or can you give us any flavor on that? Is there a product line that has a lot more potential?

Yes, so we have reshuffled the deck over there and employed some new distributors in that food space. We've put our own person on the ground over there. So I think with a more committed effort than simply distributors is our near-term approach to this. I'd say we're happy with what we're seeing early on, not only in conversions, but also the pipeline, which is causing us, clearly, to look at that more aggressively, that market. I think we've always felt that it was a better market than what we were realizing. I think our near-term experience is they have proven that out, which again, it puts that on the radar screen as a possible acquisition, certainly growth opportunities.

Okay, all right, great. Thank you.

Brian Rafn, Morgan-Dempsey Capital Management.

Give me a sense, Dino. You talked a little bit about, can you identify some of your raw materials feedstocks and might give me a range as to what they might be up year over year in the December of 2012? Is it 10%, 20%, 50%, or double?

When you say '12 versus '11?

Yes. Whole year, right -- '12 versus '11.

Yes, I'd say that raw materials costs are probably up in the, I'm going to say some -- you've always got to look at blended averages in the fluctuation. But I'd say it's fair to say that our key raw materials have gone up, minimally, 10% to 12% to 15%. That's a little bit off the cuff, but I think we're solidly in that zone.

And can you identify just in broad range what some of these key materials are?

A lot of them are petrochemical derivatives that we use, in particular, for choline or our ARC business. And that really comes down to ethylene oxide, trimethylamine. Hydrochloric acid, even, has gone up as well, which is typically a byproduct kind of product. So those have gone up, and then a couple of products that are used in manufacturing of our human-grade choline, which has typically been a natural-type product. I'll drift over to say "organic" here, or quasi.

And that, too, has really found significant increases this past year, which have been difficult to pass on into that market, but not for lack of trying, and we're looking at alternatives, i.e., reformulation of some of those products to try and get away from that so that those end markets get a little relief rather than us just hammering through a price increase.

Yes, okay. And you hesitated a little, and you talked a little as you got into 2013 here. Are you seeing incremental raw material inflation over and above what you saw through the end of 2012 into 2013?

Yes, it's a great question. I would say there's some volatility there. Unfortunately, I think we're still seeing some increases, but we're also getting a little relief on a couple of others. So that's the positive. Net-net, how will it shake out in the quarter? I think it's still yet to be determined.

Remember, these key raw materials, especially the petrochemicals, are subject to move every month. These are products that are basically commodities in the market, and the pricing model in the chemical industry today is month-to-month volatility, if you will. So that's why it's a little bit difficult to predict, although we do get a forecast. But occasionally, too, we get surprised month to month on what the actual movement is versus what the forecast was all of 30 days earlier.

So there's still definitely some volatility there. And I won't say that I think it's all justified. It's kind of who gets to control that molecule at a certain moment in the supply chain that probably influences where profitability's being taken out of the chain.

Okay, and you guys primarily purchase in the spot markets, or have you done any forward buying?

No, we're under contract. We do very, very, very little spot buying. But the reality is, even under contract, it still has -- the major suppliers will not deviate from movement on a month-to-month basis. But then we have a formula behind that that gives us, certainly, a benefit over the spot market.

Yes, okay, okay. You talked a little bit about your human-grade choline and some of that. There's been a lot of disruption, at least starting, in the packaged food market -- Heinz being taken out by Berkshire Hathaway and 3G, Hostess Brands being cut up into 1,000 pieces. Does that at all, Dino, inhibit the organic development of product development internal when you've got M&A deals or accountants doing deals?

I'd like to think not, but I think with any, if you will, public company going private, you know there's going to be pressure there, and so they're going to look at supply chains intensely. I would say as it relates to bringing a new product to market, I don't see that that's going to change anything. They're going to want to be as aggressive, or more aggressive as you go get a new product out into the market and picking up market share. And so I don't see that as rate-limiting for us.

Okay, all right. Fair enough. You look across your eight factory plants -- how many shifts, maybe start with Covington, how many shifts are you guys running at Covington? How many people have you added? And then what kind of a maybe shift, labor shift, or maybe over time, if you look at some of the other plants?

Well, I think any given plant might be running 24/7, and on a pretty consistent basis. Some of our plants are batch operations, so even though they're running 24/7, they may not be at 100% of capacity. Certain units in those, especially the batch operations, you will find will be running 24/7, in particular.

So I would say of the eight, probably a solid five are under a 24/7 scenario. Again, maybe not at 100%, given certain units running or not, but I think you're going to find at least five of them running on a 24/7 type scenario.

Covington is running probably, I'd say, on a 24/5 right now. And certainly, as we -- and part of that's just getting it ramped up. I think today we've employed about 35 to 40 people down there. And certainly, they're on the low end of the learning curve, but definitely producing quality product out of the operation that we're shipping today. So I think we're real pleased with the way that that has come online.

Okay. If you take that comment, Dino, that five of the eight that are doing 24/7, might there be some incremental demand, maybe, out of 2014 or '15, to expand the brick-and-mortar footprint?

Yes, there may well be, absolutely.

Okay, okay, okay. You talked about that Chinese plant that blew up or burnt to the ground. If you were to replace some of that with Balchem product, how much of that business would be a customer that you could capture? Is there a price-quality-value relationship there, or is it something that's strictly based on price, and you may get an 18-month bill, and then they might go back to the Chinese producer? I'm just wondering, if you capture incremental business from that, is that something you can hold onto? Is there brand loyalty?

Yes, that's a great question. I think when we talk about exports, the Chinese exporters are prepared to drive product into the European market, in particular for feed. And then it's something we have found in exporting some product into the United States for fracking. So I think there's two different animals there in terms of end market, if you will, that may lend themselves a bit more quality-loyal than not.

At the end of the day, I think everybody's under price pressure. And I won't sit here and say that the plant that had the issues -- you know, quality, good, bad, on and off, I think is always there. Some people have learned to live with it and will leverage the low cost that they offer into the market.

We have not gone there, as I've said. We've looked at export business in other parts of the world, and quite honestly, I can tell you, we can be competitive, but the margins just are not interesting. So if they're willing to take a price into that market that's, quite honestly, a very, very low margin position, well -- and again, I'm not going to make accusations -- but I'm not sure they're generating investment-type returns, and maybe that's why an incident happened.

So it all ripples down. If you're a healthy supplier and you can do good business, then chances are you're going to have a good business, and hopefully, the marketplace would value quality. And if quality goes to not only the product in and of itself, but I think, from a financial performance, capability to be there long term for you. And that's what we pride ourselves one.

Okay. Good answer, good answer. Of the $144.7 million, where is that cash invested?

We have it in, principally, two major banks. And basically, it's been money market type accounts, all very safe, and no real risk involved in any of it.

Okay, okay. I have one question. Your sense on the US dairy market. There was a little discussion, and you said that it looks like the herd culling is decreasing a little bit. And are you seeing maybe for your products, deeper penetration with individual farmers, or are you seeing broader penetration from more dairy farmers?

I think the answer is yes and yes. And remember, our product is sold a lot through nutritionists, and nutritionists work for a number of dairy managers, if you will. So definitely seeing greater penetration, if you will, within existing, but also definitely seeing growth outside of that to other herds as well.

Okay, thanks, guys. Super job. Thank you.

Lenny Dunn, Freedom Investors.

This is a little bit of a follow-up to the use of cash. In the past, you have made strategic acquisitions that add to earnings, and you've been very good at that. And I certainly wouldn't want to see you rush out and do anything, but with the margins having detracted the way they have over the last 12 months, it seems like opportunistic use of cash by buying a little bit more higher-margin business would be very beneficial. Is there anything that you think that might be imminent without telling me what it is?

I would say that there's probably three or four projects that we have underway. And coming back to the earlier question about where our cash is, we're trying to keep this readily available to do transactions, which should give you an idea that we think there's some things maybe we can get done near term. But you never know until you know. So we're trying to stay positioned for that accordingly.

As to your question about buying higher-margin businesses, while we can sit here and point to maybe a 1% or 2% erosion in our margins, I'm going to say largely due to raw material spend or product mix, I think that they're still yet strategically in the direction that we want to go. So to think that we're going to go out and buy something that's truly a higher-margin business, I'm not sure I really want to do that.

Do I think that maybe we can make an acquisition and we can leverage, based on what we like to get, higher margins, i.e., 1+1=3 would be desirable, and certainly always an interesting piece of the puzzle as we look at these possible acquisitions. So I know I've in the past been accused of being a buyer that's on the low end of deals. I think that's worked well for shareholders. Will we be able to continue to do that on a go-forward basis? I'm not sure, but certainly, are we conscious of the fact that maybe we have to pay a little bit more for some of these deals? The answer is yes.

And I would tell you, though, too, that's not at all rate-limiting in terms of our view of these possible acquisitions. The key is that they're strategically good fits for us and are fitting, if you will, the strategic objectives that we've identified.

That's clear, but my point really is clearly, you're getting some top line growth without getting commensurate bottom line growth that you have in the past. Cash itself, in the current environment, earns virtually nothing.

I don't disagree. We're not happy that it's not being deployed and being leveraged, I'll say for the benefit of shareholders. We don't like it, perhaps, any more than you do. And so I'd say we continue to look at these opportunities in an effort to get it deployed and earning a better return.

Okay. Well, thank you for answering my questions.

Tony Polak, Aegis Capital.

Tax rate going forward, you expect it in the 34.5% level?

No, no, about 33%, Tony.

Okay, so there was something this quarter that made it higher, specifically?

Yes, we talked a little bit about that. The R&D credit did not come through at the end of 2012, so for 2012, it's all being pushed into '13. And just some additional states coming into the mix have resulted in the rate coming up a little bit.

Could you refresh my memory what the capacity of the Virginia plant will be?

Well, the first tranche of it, and I say that because we've definitely built it to be modular in terms of the ability to expand. The first tranche is to produce, ballpark, I'm going to say approximately 20 million pounds of product, which is about a doubling of what we have today.

What is that in dollars?

Oh, no, no. That's pounds.

I know. What is that in dollars?

Probably $40 million to $50 million.

And is there an expectation when you will get to that level?

Well, I think we may well be looking at an expansion. If things continue to track, if markets in terms of end market prices for milk and feed ration numbers stay the same, I think we believe we can certainly get more market penetration. And part of that's built on the pent-up demand that we saw in Q4. So we may well be looking to expand that site -- expand, not sell out -- but to expand that site later this year.

So correct me if I'm wrong -- then you think you can be at that run rate some time in the second half of this year?

No, I said that I don't know that we'll be sold out, so I'm not projecting that we'll be at that run rate. But I think that what we would do would be to look to be in advance of, if that market does continue -- and certainly, we're positioned financially where we can easily do that. But that expansion could come in terms of positioning for what we would believe to be the future growth opportunity of that market to be in place by Q4.

Do you have an R&D number that was expensed in the last quarter?

Yes, hang on a second.

Tony, we're going to dig it out and get it to you. I can send you an email.

Okay. And could you give us an idea of the expenses that you've had in terms of the Caremark and any other pharmaceutical or pharmaceutical-type projects you're working on, what kind of expenses you had in those in the last quarter?

I think it's probably carrying a burn rate, if you will, of maybe $200,000 to $250,000.

Okay, great. Great quarter. Thanks a lot.

Lawrence Goldstein, Santa Monica Partners.

You know, when I first invested in the Company, the revenues were $8.4 million. That was before you were born. It was actually 1988. And what got me interested, among other things, was encapsulated food ingredients. And obviously, that's grown, although I don't think we know what share it is of the $300 million in revenues, and you don't have to say. But if you would, that would be interesting to know.

But what I am wondering is I get the feeling that it hasn't grown in line with the whole Company. And the other day, when there was a press release put out about the Van Eeghen partnership -- and by the way, I imagine you didn't put it out. Maybe they did; correct me if I'm wrong. I'm wondering, is that something, that partnership, that you think could become a material factor? or should we just dismiss it as so much PR?

And by the same token, if I'm not mistaken, Propel, Pepsi's Propel, has been out maybe 10 years, and maybe even a little more. And I presume you're still selling them the choline that's in it. Has that become of any -- is it a percent of the business? And so what's going to happen, if anything, that you can foresee to make food ingredients, encapsulated food ingredients, ever really take off? And I realize the Van Eeghen and the Propel is not encapsulated.

So the Van Eeghen deal is really choline rather than encapping food ingredients. And certainly we've done that because we think that's market's going to grow. We got the EFSA approvals and so we think the opportunity to move choline into more products like Propel, if you will, let alone the infant formula and what-not, are real opportunities over there. And that was a key driver behind getting that employee, that shared employee, if you will, onboard and being focused, clearly, on that within the Van Eeghen organization.

So yes, we did it because we really think there is upside opportunity there, and we want to be able to leverage, if you will, those EFSA claims in a larger label with local people. So that's really what was behind that. Clearly, we have the view that there is upside opportunity there.

A lot of that development work on getting choline in those other products will really rest, still, right here in the States in terms of technical development. And we are working on that. So I think our view is that there is definitely good upside opportunity on the choline piece of that FPN business.

Jumping over to the encap side of the business, I think that there's definitely been volatility, Larry. You've said it; I think I've said it earlier. And it comes back to the life cycle of a lot of these new products. We've seen this business grow 15%, 16%, to 17% on the back of new encaps being launched into those markets, and then it backs off a little bit. Some of that's a ramp-up of a new product into the space.

And then ultimately, there's been some that have been discontinued, so there is a lot of volatility there. And as I said, our key objective is to get good -- and I'd say, over the last two years in particular, we're trying to be smarter, if you will, about the projects that are in the pipeline and the probability of success of those products in the pipeline and, quite honestly, the order of magnitude of those products.

So we've really done a lot of work on, if you will, stage gate management of those projects in an effort to make sure that we're spending our time on good quality upside opportunity projects there to, hopefully, see a more, I'd say consistent growth rate there to take out some of the volatility.

But as I said, though, too, there's nothing that we can do to stop one of the larger food companies from discontinuing a product that just doesn't happen to be moving as much in the market anymore. So that's always the back door that we really just can't control.

Have sales to Pepsi been on a growth path for the 10 years it's been out?

No. In fact, I think you will only find choline with them in one or two of their Propel products, not across the board. And I think there, too, things are a little bit out of our control, for sure. But depending on the flavors of those products and the introduction of different ingredients, you may have off flavors that get generated that take away from the ability to put them in there. And so they go through sensory testing and panels and what-not.

Do I think they would like to have a product that has as much nutritional value in a lot of these vitamin water type Propels, whatever, drinks? I think the answer is yes, all day long. But what we know is we haven't been successful in getting into every one of those.

I see. Thank you.

Thank you. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further or closing comments.

Real quick, the answer to Tony's question regarding research and development in the quarter -- we spent approximately $800,000.

Yes, and so with that said, too, I just -- this is Dino -- I just want to say thanks to everybody for listening in to the conference call. Hopefully, it was a good session for everybody, a lot of good questions. I think our view going forward here is still very, very positive -- a lot of good opportunities. New challenges, always, but look forward to talking to you all again at the end of next quarter. Thanks. Bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day. We thank you for your participation today.