Balchem Corp (BCPC) 2015 Q2 法說會逐字稿

Greetings, and welcome to the Balchem Corporation second quarter 2015 earnings conference call. At this time participants are in a listen-only mode. A 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, Bill Backus, CFO of Balchem Corporation. Thank you. Mr. Backus, you may now begin.

Ladies and gentlemen, thank you for joining our conference call this morning to discuss Balchem Corporation for the quarter ending June 30th, 2015. My name is Bill Backus, Chief Financial Officer, and hosting this call with me is Ted Harris, our President and CEO. Following the advice of our counsel, auditors and the SEC, at this time I would like to read our forward-looking 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 Ted Harris, our President and CEO.

Thanks Bill. Good morning ladies and gentlemen, and welcome to our conference call. This morning we reported record second quarter consolidated net sales of $134.8 million, which resulted in record second quarter net income of $14.9 million, or $0.47 a share. As disclosed in this morning's press release, these second quarter results conclude business relating to the acquisition of SensoryEffects, that we acquired on May 7th, 2014. SensoryEffects is reported on in consolidation with the legacy food, pharma and nutrition sector. As mentioned, for the second quarter we reported earnings of $0.47 per share on a GAAP basis. This result includes significant noncash amortization expenses of $6.8 million for acquisition related intangible assets which were expensed in these second quarter GAAP financial statements. This charge is a direct result of acquisition valuation and business combination accounting rules. Consequently they are non-GAAP earnings of $0.62 per share reported earlier in our press release excludes this expense, to facilitate comparative evaluation of this current period operating performance versus the prior year period.

Our second quarter sales of $134.8 million were 1.9% greater than the $132.2 million result of the prior year comparable quarter. This sales result was unfavorably impacted 10.7% by the significant downturn in the fracking market, and 2.8% by foreign currency. Excluding the negative impacts related to fracking and foreign currency, net sales increased 15.4% compared to the prior year comparable quarter. In the SensoryEffects segment net sales were $67.2 million, an increase of $18 million from the comparable prior year quarter, and effectively flat sequentially compared with the first quarter 2015. Net sales from the acquisition of the SensoryEffects business contributed $17.6 million of this overall increase. We also realized 3.2% growth in sales of the legacy FPN business, or 7.6% growth foreign currency adjusted, with particular strength in choline nutrients and encapsulated ingredients for baking and food preservation in the domestic markets.

Animal nutrition and health sales at $41.6 million decreased 3.7% over the comparable quarter, but increased 2.4% foreign currency adjusted. In addition, sales in the ANH ruminant ingredient sector were strong, increasing approximately 14% from the comparable prior year quarter. Primarily due to higher volume sold and product mix, with particular strength in rumen protected choline and amino acids. Monogastric product sales decreased 10%, primarily due to the negative impact of the currency exchange, and a difficult comparable quarter, as the prior year quarter reflects the peak of the adverse impact on Chinese competitors of GMO contamination issues in the EU market, in which we realize both incremental contractual and spot volume.

In the quarter, specialty products generated record second quarter sales of $13.8 million, and grew 1.2% over the prior year quarter, with particular strength in sales of ethylene oxide products for medical device sterilization. Industrial product sales decreased 53.8% from the prior year comparable quarter, as volumes sold of choline and choline derivatives for industrial applications, notably for shale fracking decreased due to the well publicized significant downturn in the fracking market. Additionally average selling prices were lower as a result of pressures related to this industry activity downturn, and operators desire to curb hydrocarbon production costs. The lower costs of certain raw materials partially offset these lower average selling prices.

Our consolidated gross profit was $41.9 million, or 31.1% of sales in the quarter. An increase of $9.5 million, or $29.5%, and up from a 24.5% of sales level in Q2 of 2014. The gross margin improvement was primarily due to the prior year recognition of an acquisition inventory adjustment, favorable product mix, certain lower raw material costs, and manufacturing efficiencies, which were partially offset by the impact of previously noted lower volumes and higher logistics costs. Gross margin percentage from the SensoryEffects segment increased by 930 basis points, primarily due to the prior year recognition of the noted inventory adjustment, product and customer mix within the SensoryEffects acquired business, certain lower material costs, and plan efficiencies. These positive factors were partially offset by the combined segment product mix, which as experienced since the acquisition, now reflects the heavier weighting toward the powder and flavor systems of SensoryEffects, which typically generates a lower gross margin.

It is important to note that on a sequential basis gross margin percentage in the SensoryEffects segment increased by 230 basis points. Gross margin percentage increased for the animal nutrition and health segment by 540 basis points, primarily due to product mix, production efficiencies, as well as cost decreases of certain key petrochemical raw materials. Gross margin percentage for the ARC specialty product segment increased 320 basis points, primarily due to product mix, manufacturing efficiencies, and cost decreases of certain key petrochemical raw materials. Industrial products gross margin declined by 420 basis points, reflecting the reduced volumes, unusually high logistics costs, and lower average selling prices, which were slightly offset by favorable purchase prices of certain raw materials.

Consolidated operating expenses for the three months ended June 30th 2015 were $18.1 million, or 13.4% of net sales, as compared to $15.9 million, or 12% of net sales for the three months ended June 30th, 2014. The increase was primarily due to a complete quarter of SensoryEffects operating and acquisition amortization expenses. Excluding non-cash operating expense associated with amortization of intangible assets of $6.4 million, operating expenses were $11.7 million, or 8.7% of sales. Looking forward we expect to leverage off of our existing SG&A infrastructure and exercise tight control over all controllable operating expenses. US GAAP reported earnings from operations were $23.8 million, an increase of $7.3 million, or 44% from the prior year comparable quarter. On a non-GAAP basis as detailed in our earnings release this morning, earnings from operations of $30.4 million increased $3 million, or 10.9% from the prior year comparable quarter.

As previously noted, consolidated net income closed the quarter at $14.9 million up, from $9.7 million in the prior year quarter. This quarterly net income translated into diluted net earnings per share of $0.47, as compared to the $0.31 we posted in the comparable quarter of 2014, or a 52% increase. On a non-GAAP basis and as detailed in our earnings release, our diluted net earnings per share were $0.62, as compared to $0.53 in the prior year quarter, or a 17% increase. Interest expense for the three months ended June 30th 2015 was $1.6 million, and is related to the term loan for the acquisition of SensoryEffects. The term loan has a remaining balance of $315 million as of June 30th, and our net debt at June 30th was $243 million.

The Company's effective tax rate for the three months ended June 30th, 2015 and 2014 was 32.7% and 36.4% respectively. This decrease in the effective tax rate was primarily attributable to a change in the apportionment relating to state income taxes, and a change in the income proportion towards jurisdictions with lower tax rates. As outlined in our earnings release our second quarter results approximately generated $35 million of adjusted EBITDA in the quarter, which translates to 26% of sales, and equals approximately $1.11 per diluted share. Our balance sheet continued to strengthen, and our cash flow remains strong, as we closed out the quarter with approximately $72 million of cash, and this reflects scheduled principal payments of long term debt of $8.8 million, along with $8.9 million of capital expenditure funding in the quarter. I am now going to have Bill Backus discuss the segments.

Thanks Ted. As previously noted for the quarter sales of consolidated SensoryEffects segment were $67.2 million, an increase of $18 million from the comparable prior year quarter. Earnings from operations for this segment were $9.1 million, versus $2.9 million in prior year comparable quarter. Excluding the effect of noncash expenses associated with amortization of SensoryEffects acquired intangible assets, non-GAAP earnings from operations for this segment were $14.7 million. Sequentially earnings from operations from this segment increased 17.9% due to product and customer mix, manufacturing efficiencies, cost decreases of certain key raw materials, and tight control of selling and administrative expenses. While we are pleased with the margin improvement in this segment, we experienced certain sales positives and negatives.

On the positive side flavors inclusions and choline nutrients are performing well, and there was particular strength in encapsulated ingredients for baking and food preservation in the domestic markets. There were top line challenges in powders, in part driven by our previously noted efforts to cull lower margin business, and we have indeed seen margin improvement due to these efforts. Certain customers have been experiencing softness in their market space, particularly the single serve coffee and specialty beverage market. And consequently have been tightly controlling their inventory levels. However, we remain optimistic by the opportunities presented by our pipeline, the glamorization initiative which is on track for the end of 2015, and the newer novel products we are introducing to the market place. The profitability of this combined segment is strongly contributing, as we continue to realize improved efficiencies, and improve the value proposition and related margins of our product portfolio. We are building consumer awareness on the benefits of choline, positioning choline with food and nutritional supplement companies, as an essential ingredient to be included in existing, new, and novel sensory solutions, which we expect to introduce to the market later in 2015.

We are supporting additional external scientific research, and remain excited about the FDA proposal at an RDI, or Recommended Daily Intake for choline be accepted. As previously discussed, our pharmaceutical delivery development efforts continue. We continue to work closely with the licensee with our technology, who is in the process of performing a third Phase 3 clinical for their drug to be utilized in the treatment of autism. Their new drug application is being filed with the US Food and Drug Administration, and we are collaborating as required. In the near term this sector remains a net expense to the business segment. In the Animal, Nutrition, and Health segment, we realized sales of $41.6 million as compared with $43.2 million for the three months ended June 30th, 2014. A decrease of $1.6 million, or 3.7%. However adjusted for foreign currency sales increased by 2.4%. Sales of product lines targeted for ruminant animal feed markets increased by $1.6 million, or 14% from the prior year comparable period. Most notably from increased sales volumes of ReaShure and AminoShure.

The economics of the US dairy industry and certain export markets continue to support strong demand for our products. Lower feed prices along with lower fluid milk prices continue to generate strong demand for milk. These key factors are expected to continue to drive producer profitability in 2015, and therefore provide support for greater expected utilization of our products which are targeted to maximize results of production animals. The ruminant product line continues to provide a significant growth platform for us, as we look to continually penetrate the market, gain market share, and develop new and novel products to satisfy global market demands. Global monogastric species sales including feed grade choline products decreased $3.2 million, or 10%, primarily due to the negative impact of the currency exchange.

Also impactful was a difficult comparable quarter as the prior year quarter reflects the peak of the adverse impact on Chinese competitors of GMO contamination issues in EU market, in which we realized both incremental, contractual and spot volume. As lower feed prices, and favorable economic conditions provide incentive for broiler integrators to expand production, there has been an increase and excess, and a higher number of chicks placed for grow out. ANH quarterly earnings from operations were $7.5 million, an increase of $2.0 million, or 35.5%. This increase was a benefit of the noted product mix, production efficiencies, as well as cost decreases of certain key petrochemical raw materials. The ARC Specialty product segment posted quarterly sales of approximately $13.8 million for the three months ended June 30th, 2015, as compared with $13.6 million for the three months ended June 30th 2014, an increase of 1.2%. These higher sales are primarily due to the product mix of ethylene oxide products for medical device sterilization, and propane oxide for fumigation, pasteurization, and industrial applications.

All quarterly earnings were $6.1 million, an increase of $630,000, or 11.5%. This increase is due to the noted revenue growth, manufacturing efficiencies, cost decreases of certain petro chemical raw materials, and tight control of selling and administrative expenses. During the quarter we continue to incur additional expenses pursuing other new end market applications. In the industrial product segment, sales declined 53.8% from the prior year comparable quarter, as volumes sold to various choline and choline derivatives for industrial applications, notably for shale fracking, decreased due to the well published significant downturn in the fracking market. Additionally average selling prices were lower, as a result of pressures related to this industry activity downturn, and operators desire to curb hydrocarbon production costs. The lower cost of certain raw materials partially offset these lower average selling prices.

The headwinds in this industry are likely to continue for the remainder of the year, and as we discussed during the first quarter earnings call, sales declined throughout that first quarter. During the second quarter demand further declined before stabilizing, and we have seen a modest sales improvement in the early part of the third quarter. We will look to continue to leverage the competitiveness and efficacy of our products, capitalizing on opportunities to gain additional market share through both our existing product portfolio, and the development and introduction of more cost effective alternatives, while also aggressively managing supply chain costs. However we remain cautious about this industry, and as previously noted expect there to be challenges for the remainder of the year.

Our earnings from operations for the industrial product segment were $1.1 million, a reduction of $3 million, or 73% compared with the prior year comparable quarter, and primarily a reflection of the reduced volume, unusually higher logistics costs and lower average selling prices, which were only slightly offset by favorable purchase prices of certain raw materials. I am now going to turn the call back over to Ted for some closing remarks.

Thanks Bill. We are pleased with the second quarter record sales and earnings. And these results underscore the strength of our business model, particularly in light of the macro economic headwinds we have been facing in the shale fracking market, the strength of the US dollar, and certain global economic weakness. We realized improved operating margins due largely to a shift in product mix, manufacturing efficiencies, and a focus on management of base costs. Cash flow remains strong, and during the quarter we generated $23 million in cash flows from operating activities.

Looking ahead while the macroeconomic headwinds we experienced in Q2 are likely to continue for the remainder of the year, we will continue to drive strategic growth initiatives, and add value to the markets we serve, while also aggressively managing supply chain costs and controlling selling, general and administrative spend. Before we open up the conference call for questions, I would like to reflect back on my first few months at Balchem, and share with you some of my observations. Since joining the Company, I have spent much of my time on the road meeting many of our customers, suppliers, partners, current and prospective shareholders, and employees in our various locations.

My first observation is that Balchem has four strong business platforms targeting good markets and market niches, and where we are very well-positioned with differentiated product and service offerings. Secondly, unique leading science is behind much of what we do, and how we create value for our customers. Microencapsulation, choline and its many derivatives and unique properties, emulsified powder and flavor systems, and ethylene oxide capabilities provide synergistic strength across multiple if not all of our businesses.

Thirdly, we have numerous organic growth opportunities in our pipeline, positioning us well to drive significant growth for our Company, from plant expansion to new customer acquisition to new application or geographic expansion to market or chemistry development. Fourthly, our Company has a solid financial structure built from businesses with strong margins, a very lean and low cost operating model, with clear capital allocation discipline and low debt burden.

And lastly and maybe most importantly, Balchem has a very strong team that is passionately executing on our operating and growth plans. I am extremely pleased and energized with what I have learned about the fundamentals of our Company over the last few months. As we head into the second half of the year, my priorities are clear. Number one, deliver on our financial commitments and targets. As I said earlier, I am pleased with our second quarter results in light of the macroeconomic challenges we are facing. These challenges will likely continue in the coming quarters, and executing our plans across all of our businesses will be critical, while we take appropriate additional actions as we did in Q2, to manage our cost position on lower volumes to oil and gas.

Number two, complete on time and on budget significant capital projects currently underway, including the Verona animal nutrition and health expansion, the Murano Italy co-generation and choline chloride dry expansion. The continuous conglomeration unit and Defiance, and the instant formula capabilities in Redding. All of these projects are high return growth projects, that we need to execute on, both from an operations perspective and a commercial launch perspective.

Number three, accelerate the development and launch efforts on key pipeline projects, such as our Vita choline and choline nutrients in light of the pending RDI. Our new P protein system to replace traditional dairy and soy protein systems. Various egg replacement, flavor and powder systems, in light of the extremely high egg prices. Next generation encapsulated choline and amino acid products for enhanced animal nutrition. New applications to expand Balchem's participation in the lactation cycle for dairy cows, as well as expanded participation in the life cycle of poultry and swine, and many others that I can't discuss yet, as our intellectual property protection needs to further materialize.

Number four, aggressively explore possible alliance, acquisition, and/or joint venture opportunities, to build and leverage on our strategic platforms, technologies, and strong human asset base. We have a good pipeline of opportunities that we are working actively. While multiples are relatively high today, we continue to believe there are good, actionable opportunities for Balchem to pursue, to create value for our shareholders while strengthening the Company. And number five, protect and strengthen where possible our value proposition, and points of differentiation to the markets and market niches we serve.

As I said earlier, Balchem is very well-positioned with differentiated product and service offerings. As we develop our 2016 to 2020 strategic plans, we will focus on ensuring that we aggressively protect and strengthen these unique market positions. We as a Company have a lot to do, and I certainly still have much to learn, but these priorities will help me and the broader team to focus our resources and efforts on the most value creating opportunities as we head into Q3 and Q4. I would now like to hand the call back over to Bill, who will open up the call for questions. Bill.

Thanks Ted. This now concludes the formal portion of the conference. At this point we will open the conference call for questions.

Thank you. (Operator Instructions). One moment while we poll for questions. Our first question comes from Mike Ritzenthaler from Piper Jaffray.

Yes, good morning. Kick it off here with a couple of questions about SensoryEffects. First, qualitatively at least what are your expectations for organic growth within the SensoryEffects business with 3Q lapping the first quarter of ownership of the assets, and much of the low margin pruning complete, is low single digits, mid single digits, where is a fair assumption for the back half of the year, or are there some impacts in surreal effects that will draw that down a bit?

Yes Mike, this is Ted. Thanks for the question. As we really peel the onion back on the SensoryEffects business, we are reasonably pleased with the underlying growth of the business. When you look at the individual product lines and the applications, culling effects are certainly masking some of the growth. And as Bill talked about, we have some customers in the single serve coffee and specialty beverage market who are experiencing difficult market conditions in the space, which you have probably read about. That said the base business with the programs, the growth programs we have in place should grow in the mid to high single digits, and as we progress in the second half of the year, we really should start to see increasing evidence of that. So I do think you should start to see some low single digit year-over-year growth in the coming quarters, building to more of that mid to high single digit growth that we have been talking about.

That's helpful. As a follow-up on SensoryEffects were there any meaningful impacts to the margins from FX? And I guess the spirit of the question is around non-GAAP margin sustainability looking out the next couple of quarters. Given some of the sales positives in the quarter, but then there are some puts and takes around that too?

I'll let Bill answer that.

As far as FX goes, very little impact except to some degree on choline nutrients out of Italia. For the most part, it is really ANH, and I say choline nutrients with regard to the segment obviously, not the SensoryEffects acquired businesses. In terms of the acquired businesses very little FX impact. There is some, but a lot these impactful than it is on ANH.

Fair enough. And just as a final question from me on industrial products, I appreciate all of the color that you put into your prepared remarks, but more specifically I am wondering how the soft end markets influence, Ted, maybe how you manage the costs in that business?

We have spent a lot of time doing just that, managing the costs across our business, doing the typical blocking and tackling that you might expect, not back filling open positions, really aggressively implementing a legacy Balchem profit enhancement program across all of the businesses, focusing on improved inventory management. We targeted a 50% reduction in inventory write downs, and we far exceeded that. We are certainly not covering vacations and reduced overtime. Running their plants in campaign modes, taking extended outages. Obviously the industrial business is not people intensive, so it is largely around what we can do with the plants, and we are working that very hard, and at the end of the day, relatively pleased with what we were able to do in Q2, and we will plan on continuing that for the rest of the year. Just expanding on that a little bit as we said in our Q1 earnings call we said we saw sales decline through that quarter, and in Q2 April sales were a little bit lower even than March sales. But through the quarter we did see some stabilization in sales, and as Q3 has started we have seen some very modest pick up, obviously with how dynamic that market place is, we are not going to take that to the bank, but that has been encouraging, but we are watching it very closely.

Thanks very much and congratulations.

Thanks.

Thank you. Our next question comes from Tim Ramey from Pivotal Research Group.

Thanks so much. In regard to industrial product had bill I think you used the term, maybe I got it wrong, but being, higher logistical costs being perhaps out of alignment with where you needed product. Can you explain what that was? It didn't tie back to anything I am particularly aware of?

Sure Tim. I think like a lot of people we got caught in a very dramatic downturn in the market. So it is somewhat related to the merge, and on the raw material side the supply chain, and trying to make sure we had enough to service the market, and dealing with that. What happened is the dramatic downturn in the market put us in a situation where we were carrying more inventory, and dealing with some supply chain costs that were unusually higher than they would have been because of that very dramatic downturn.

And then on SensoryEffects you've I think at one point I think you guys mentioned that you talked about single serve coffee, and I believe that is Green Mountain. Is their 2.0 product of benefit to you? Is there any particular new product cycle that would be helpful here? Can you discuss that a little bit?

Let me take a stab at that, Tim. That is an important segment for us. It isn't just that one customer, but that market is really going through I would say a lot of change. As you know the growth rate and single serve coffee specialty beverage was extremely high for a while. That market is facing a lower growth today and that's had some pretty significant impact on the supply chain and inventory. As you know we don't participate in the coffee part of it. We participate in the specialty beverage part of it. Some of the players have come out with new machines, and I think those have not particularly met expectations. The industry built up some inventory for those new machines, that haven't played out as expected, so that only exacerbated some of the supply chain issues in that market place. The market has gone through a lot of changes and some challenges, but we continue to see opportunity for Balchem in the market place, from our unique formulated products to even the new agglomeration unit. That is an important segment for us going forward, and it should be good for us. We are also interested in the cold platform. It is not currently in place, but we do see if that is successful, some opportunity coming out of that for us.

Also relative to that business site, I think I heard you mention P protein. I noticed a new product at Costco that was P protein based. Can you expand a little bit on what you are seeing there? Is that a promising area?

It is a promising area. I don't think we fully understand just the size of the opportunity going forward, but we are pretty excited about it. We have some unique products in that area, and it certainly is a trend that is attractive. The desire to replace traditional dairy proteins and clean labels. It is a very attractive offer. It is high protein, it is non-dairy and non-soy, it is PHO free. It is suitable for vegan applications. It is an attractive protein replacement, and we've developed some interesting formulations that offer P protein to the market place, whether it is in sports nutrition, or instant shakes or smoothies, so we are pretty excited about the products that we have, and the opportunity in the market place. At the recent IFT in Chicago, it was one of the major showcase products, and got a lot of interest and very favorable feedback about it. Again, an interesting opportunity for us.

Thanks Ted.

Yes.

Thank you. Our next question comes from Lenny Dunn from Freedom Investment Corporation.

First congratulations on a good quarter. My observation is you made this acquisition at a very perspicuous time, because the choline business looks like it will be slow for a while, and probably lower margin, as to the fracking end of it. I wanted to congratulate you both on the acquisition, and the timing of it. You replaced what would have been a slow growing business, with a faster growing business. So glad to see that. I am not misreading your take on what's going to go forward with the choline, because it sure looks like the fracking business is going to be slow for a while, and there will be pressure on margins there too. Is that accurate?

First of all, we appreciate your comments. Thank you very much. And yes. You can read oil is at $46 a barrel today, and you can read just as many articles that tell you it will go up as it is going to go down. Our read on the situation is really day by day, and I think you've accurately picked up our perspective. We know what has happened to our business. At this point in time, based on everything that we know about the market place, we are expecting that to continue for at least the next couple of quarters, if not longer.

That was my comments and questions. Again congratulations on repositioning the business so we can still grow without having growth in the choline segment.

Great. Thank you.

Thank you.

Thank you. Our next question comes Debra Fiakas from Crystal Equity Research. I apologize, her line has disconnected. At this time we have no further questions. I will turn the call back over to Ted Harris for closing comments.

Thank you everybody for joining our call today, and talk to you next quarter. Thanks.

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