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Edited Transcript of BCPC earnings conference call or presentation 27-Feb-18 4:00pm GMT

Q4 2017 Balchem Corp Earnings Call

NEW HAMPTON Mar 28, 2018 (Thomson StreetEvents) -- Edited Transcript of Balchem Corp earnings conference call or presentation Tuesday, February 27, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mary Theresa Coelho

Balchem Corporation - CFO

* Theodore L. Harris

Balchem Corporation - Chairman & CEO

* William A. Backus

Balchem Corporation - CAO & Treasurer

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Conference Call Participants

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* Anthony Polak

* Brett Michael Hundley

The Vertical Trading Group, LLC, Research Division - Research Analyst

* Francesco Pellegrino

Sidoti & Company, LLC - Research Analyst

* Hamed Khorsand

BWS Financial Inc. - Principal & Research Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Balchem Corporation Fourth Quarter Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Terry Coelho, Chief Financial Officer for Balchem Corporation. You may now begin.

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Mary Theresa Coelho, Balchem Corporation - CFO [2]

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Ladies and gentlemen, thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending December 31, 2017. My name is Terry Coelho, Chief Financial Officer, and hosting this call with me is Ted Harris, our Chairman, CEO and President; and Bill Backus, our Chief Accounting Officer.

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 materially differ 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.

I will now turn the call over to Ted Harris, our Chairman, CEO and President.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [3]

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Thanks, Terry. Good morning, ladies and gentlemen, and welcome to our conference call. Before I get into the quarter, I would like to reflect for a minute on the full year performance and note we are very pleased to report another full year of sales and adjusted net earnings growth while delivering record cash generation from operations of $111 million. In addition, we are pleased to declare a $0.42 per share dividend or $13.4 million this year that represented nearly an 11% increase per share.

While we faced certain headwinds during 2017, including higher raw material costs across all segments, we were pleased with the sales and earnings growth in 3 of our 4 segments, the strategic progress we have made as a company, including the 2 small acquisitions made during the year that helped strengthen our Human Nutrition & Health and our Animal Nutrition & Health segments, and the record cash flows from operations we generated. We also have made significant investments in new production capacity and technology that leave us well positioned to continue our growth story in 2018 and beyond.

This morning, we reported fourth quarter consolidated net sales of $159.3 million, which resulted in record fourth quarter net income of $42 million, or $1.30 per share on a GAAP basis. This result includes a $24.9 million benefit from the Tax Cuts and Jobs Act or Tax Reform that Bill Backus will review in more detail later in the call, and significant non-cash amortization expenses of $6.8 million for acquisition-related intangible assets which were recorded in the fourth quarter GAAP financial statements. The amortization expense is a direct result of acquisition valuation and business combination accounting rules.

This quarter also includes $315,000 of transaction and integration costs. Consequently, our fourth quarter non-GAAP net earnings of $21.9 million, or $0.68 per share reported in our press release earlier this morning, exclude these items to facilitate comparative evaluation of this current period operating performance versus the prior year period. These non-GAAP net earnings of $21.9 million or $0.68 per share were 2.4% or $507,000 above the comparable prior year quarter of $21.4 million, or $0.67 per share.

We delivered fourth quarter cash flows from operations of $31.2 million, and also made scheduled and accelerated principal payments of $16.8 million on long term debt. Our revolver continues to be fully available to provide flexibility for both organic and acquisitive growth.

Our fourth quarter sales of $159.3 million were 13.2% higher than the $140.8 million result of the prior year comparable quarter. Sales growth in all 4 of our reporting segments contributed to the increase, with Human Nutrition & Health achieving an all-time record quarter and Specialty Products achieving a record fourth quarter.

The primary sales drivers were increased sales into the shale fracking market within Industrial Products, the added sales from the IFP acquisition, strong choline nutrients and human chelated mineral volumes, and higher powder system sales within Human Nutrition & Health, increased monogastric species sales with Animal Nutrition & Health, and higher repackaged gas sales within Specialty Products. These increases were partially offset by a decline in flavor systems sales within Human Nutrition & Health and lower ruminant species sales resulting from continued unfavorable dairy economics within Animal Nutrition & Health.

Our Q4 consolidated gross margin dollars of $51.6 million were up $4.7 million, or 10% compared with the same period in the prior year. On an adjusted basis, adjusted this year by $715,000 for the previously mentioned amortization expense related to acquisition valuation and business combination accounting rules, adjusted gross margin dollars were $52.4 million, up $4.8 million, or 10.1%, compared with the prior year quarter. The increase was primarily driven by the higher sales, partially offset by unfavorable segment, product, and customer mix and higher raw material costs within the current quarter across all of our segments.

Our consolidated gross margin percent was 32.4% of sales in the quarter, down 90 basis points from 33.3% in Q4 of 2016. Adjusted gross margin was 32.9% of sales, down 90 basis points from 33.8% in the prior year comparative period. The decline was primarily due to the aforementioned mix and higher raw material costs.

Gross margin percentage for the Human Nutrition & Health segment increased by 170 basis points, primarily due to a favorable mix.

Gross margin percentage decreased for the Animal Nutrition & Health segment by 280 basis points, primarily due to unfavorable product mix, certain decreased volumes, and cost increases of certain key raw materials. On a sequential basis, Animal Nutrition & Health gross margins improved 360 basis points due to favorable mix and strong monogastric volumes with improved margins for both ruminant and monogastric species.

Gross margin percentage for the Specialty Products segment decreased by 190 basis points as compared to the prior year comparable quarter, primarily due to mix and certain higher raw material costs. Industrial Products gross margin decreased by 40 basis points primarily due to higher raw material costs partially offset by higher volumes.

Consolidated operating expenses for the 3 months ended December 31, 2017 were $25 million as compared to $22.3 million for the 3 months ended December 31, 2016. The increase was principally due to the inclusion of IFP operating expenses, additional R&D spend, certain compensation related expenses and increased transaction and integration costs, partially offset by a reduction in the amount of non-cash operating expense associated with amortization of intangible assets.

Excluding transaction and integration costs of $315,000, and non-cash operating expense associated with amortization of intangible assets of $5.9 million, operating expenses were $18.7 million, or 11.8% of sales. Looking forward, we will continue to focus on tightly controlling our operating expenses and leveraging our existing SG&A infrastructure.

U.S. GAAP earnings from operations were $26.7 million, which increased $2.1 million, or 8.4%, compared with the prior year comparable quarter. This increase was primarily due to earnings growth in our Human Nutrition & Health and Industrial Products segments. On an adjusted basis, as detailed in our earnings release this morning, earnings from operations of $33.6 million increased $1.5 million, or 4.5%, from the prior year comparable quarter, again, due to higher earnings in our Human Nutrition & Health and Industrial Product segments.

Interest expense for the 3 months ended December 31, 2017 was $1.8 million, and our net debt on December 31 was $179 million. The company's effective tax rates for the 3 months ended December 31, 2017 and 2016 were negative 71.2% and 30.2%, respectively. The decrease in the effective tax rate is primarily attributable to the aforementioned tax reform. The one-time tax benefits in the fourth quarter of 2017 associated with Tax Reform have been adjusted out of adjusted net earnings to aid in comparability of results to prior periods.

As previously noted, consolidated net income closed the quarter at $42.0 million, up $26.1 million from the prior year quarter. This quarterly net income translated into diluted net earnings per share of $1.30 for the current year, an increase of $0.80 per share over last year's comparable quarterly result of $0.50. On an adjusted basis, and as detailed in our earnings release, our adjusted net earnings were $21.9 million, or $0.68 per diluted share, up $507,000 or 2.4% compared with $21.4 million or $0.67 per diluted share in the prior year quarter.

Our fourth quarter results generated $40.0 million of adjusted EBITDA, or 25.1% of sales in the quarter, compared with $37.7 million, or 26.8% of sales in the prior year, an increase of $2.3 million or 6.1%.

As previously noted, our cash flow remains strong as we generated fourth quarter cash flows from operations of $31.2 million and closed out the quarter with $40.4 million of cash. This reflects scheduled and accelerated principal payments on long term debt of $16.8 million, along with $9.9 million of capital expenditure funding in the quarter. Free cash flow for the fourth quarter was strong at $21.3 million even with capital expenditures being higher than usual as we closed out certain key projects.

Before getting into more detail on the impact of Tax Reform and the detailed results by segment, I would like to update you on a few of our key growth initiatives. Relative to the Albion Clearfield fire recovery efforts, we are now manufacturing salable product out of the new facility we have built at our Ogden, Utah site. We will continue to utilize interim manufacturing capabilities including leveraging the acquired IFP assets and know-how to make some of our products at one of the IFP manufacturing sites in Minnesota until all products are brought back in house which we estimate to be midyear. We are extremely pleased to be nearing the end of this unforeseen journey.

We continue to work hard to progress awareness around choline, the Reference Dietary Intake issued by the Food and Drug Administration and the European Food Safety Authority's first ever intake recommendation for this essential nutrient. Last quarter, we informed you of the advocacy choline received from the American Medical Association. This quarter, we were extremely pleased to see that the American Academy of Pediatrics has identified choline as one of the most essential brain building nutrients for infants and young children in their first 1,000 days of life. Choline awareness is building and we are starting to experience accelerated growth with sales growth of 22% in 2017.

We are also excited to report that after Balchem funded a pilot study, Dr. Steven Zeisel, Director for the University of North Carolina's Nutrition Research Institute, received a $2.6 million grant from a unit of the National Institutes of Health to develop a test to determine the proper levels of choline in humans. We believe that if a test were to be developed, it would significantly progress the ultimate supplementation of identified deficiency in humans. We will aggressively continue our VitaCholine market development activities through both consumer awareness initiatives and the strategic expansion of our sales channels.

The third Phase 3 clinical trial for the CureMark drug to be utilized in the treatment of autism continues to progress. We informed you last quarter that enrollment for the trial was achieved. We are pleased to let you know today that the last patient last visit occurred within the month of December, effectively completing the 14-week double-blind, randomized, placebo-controlled Phase 3 study, reaching another important milestone in this project. The project has therefore entered the data analysis phase in preparation for the NDA submission. In the meantime, Balchem remains focused on our manufacturing and supply chain preparedness for the launch of the product, while continuing to manufacture additional trial quantities of the encapsulated enzyme for rollover participants from previous trials. We are encouraged by the progress made over the past few months toward critical milestones within this key growth initiative.

Before turning the call back over to Terry to go through the segments detailed results, I would like Bill Backus, our Chief Accounting Officer, to discuss the impact of the Tax Cuts and Jobs Act in more detail given its significance to Balchem.

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William A. Backus, Balchem Corporation - CAO & Treasurer [4]

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Thanks, Ted. For Balchem, the provisions from the Tax Cuts and Jobs Act, or Tax Reform Act, most impactful to our effective tax rates include the reduction of the corporate tax rate from 35% to 21%, the elimination of the domestic production activities deduction, or DPAD, the deemed repatriation tax, and potentially the impact from eliminating the Section 162M Performance Based Compensation exception to the $1 million yearly limit for covered employees. In addition, we are still analyzing the impact of the provision related to the taxation of global low-taxed income, or GILTI, and the deduction for foreign-derived intangible income, or FDII. Both are complex and require additional analysis.

In particular, GILTI requires analysis of whether we expect to have future US inclusions in taxable income related to this provision and whether we will have offsetting foreign tax credits. Specifically, for 2017, the Tax Reform Act resulted in a $24.9 million benefit to our 2017 results, with the resulting effect of tax rate being a negative 71.2% in the fourth quarter. This net tax benefit was primarily due to the company recognizing a benefit of $27.3 million due to remeasurement of deferred tax assets and liabilities based on the new lower corporate tax rate along with a tax charge of $1.4 million due to the transition tax on deemed repatriation.

Based on SEC accounting guidance, these amounts are provisional amounts and reasonable estimates at December 31, 2017, so they are subject to adjustment during the measurement period of up to one year following the December, 2017 enactment of the Tax Reform Act. In 2018, we will continue to see a net tax benefit from the Tax Reform Act, primarily from the lower corporate tax rate which will be partially offset by the de-pat elimination and potentially an unfavorable 162M impact.

Based on our current estimates, we are expecting a 2018 effective tax rate of 25% to 27%. This compares to a normalized 2017 effective tax rate of 33% which is normalized for the exclusion of tax benefits related to the adoption of updated share-based payment accounting and one-time beneficial items in 2017. Also, as previously mentioned, the 2017 amounts recorded due to Tax Reform are provisional amounts subject to adjustment in 2018.

I will now turn the call over to Terry Coelho to discuss the segments in more detail.

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Mary Theresa Coelho, Balchem Corporation - CFO [5]

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Thanks, Bill. For the quarter, sales of our consolidated Human Nutrition & Health segment were $83.3 million, an all-time record quarter and an increase of $7.4 million, or 9.8% from the comparable prior year quarter. The sales increase was primarily driven by added sales from the IFP acquisition, strong choline nutrient and chelated mineral volumes, and higher powder systems product sales, partially offset by lower flavor systems sales.

Fourth quarter earnings from operations for this segment were $12.1 million, an increase of $1.8 million or 17.2% compared with $10.3 million in the prior year comparable quarter. Excluding the effect of non-cash expense associated with amortization of acquired intangible assets of $5.8 million, fourth quarter adjusted earnings from operations for this segment were $17.9 million compared to $16.4 million in the prior year quarter. Earnings from operations for the quarter were driven by the aforementioned sales growth and favorable mix contributing to improved gross margins. Supply chain optimization and recovery of higher raw material costs through pricing actions continue to be important focus areas of this business.

The Animal Nutrition & Health segment sales of $44.6 million increased 4.7% or $2 million compared to the prior year comparable quarter. Sales of product lines targeted for ruminant animal feed markets decreased by $2.3 million, or 14.9% compared to the prior year, primarily due to lower ruminant product volumes resulting from challenging dairy economics, particularly in North America where milk protein prices were lower in the fourth quarter.

Global monogastric species sales increased $4.3 million or 15.7% from the prior year comparable quarter, primarily due to both strong chelated mineral sales and international, particularly European, feed grade choline sales as the acquisition of Chol-Mix and our recent expansion investment at our manufacturing facility in Italy reaped benefits.

Europe remains an important growth focus for our Animal Nutrition & Health Segment. Additionally, we are experiencing some increased demand for feed grade choline due to supply disruptions in the market from Chinese choline producers who appear to be experiencing production constraints as a result of recent government environmental controls. We are not certain how long this situation will continue, but we do view it as likely only being a short-term benefit.

Animal Nutrition & Health quarterly earnings from operations were slightly higher at $8.1 million compared to the prior year comparable quarter as the aforementioned higher sales were partially offset by mix and cost increases of certain key raw materials. On a sequential basis, results for the Animal Nutrition & Health segment improved nicely with sales up $6.5 million or 17.2% and earnings from operations up $2.9 million or 56.6% on higher sales and improved margins for both ruminant and monogastric species.

The Specialty Products segment achieved record fourth quarter sales of $16.5 million for the 3 months ended December 31, 2017 as compared with $16.2 million for the 3 months ended December 31, 2016. The increase of 2.1% was driven by higher ethylene oxide sales for medical device sterilization.

Specialty Products quarterly earnings from operations were $4.8 million versus $5.3 million in the prior year comparable quarter, a decrease of $497,000, or 9.3%. Excluding the effect of non-cash expense associated with amortization of acquired intangible assets of $757,000, fourth quarter adjusted earnings from operations for this segment were $5.6 million compared to $6.1 million in the prior year quarter, a decrease of 8.4%. The decrease was driven by mix and higher raw material costs. We are actively raising prices to help mitigate the increased raw material costs, as well as other rising costs, where contract terms permit.

In the Industrial Products segment, sales increased $8.7 million, or 141.8% from the prior year comparable quarter, primarily due to significantly higher sales of choline and choline derivatives used in shale fracking applications. Compared sequentially to the third quarter 2017, sales increased $820,000 or 5.8%. Our earnings from operations for the Industrial Products segment were $2.0 million, an increase of $1.1 million compared with the prior year quarter, and primarily reflects the aforementioned higher sales, partially offset by certain higher raw material costs.

We have now had 6 consecutive quarters of sales growth into the oil and gas industry. While we remain cautious about this industry, we are certainly pleased with the recovery to date of our Industrial Products volumes and profits as rig counts have improved.

I'm now going to turn the call back over to Ted for some closing remarks.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [6]

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Thanks, Terry. In Q4, we delivered year-over-year revenue growth in all 4 of our segments and operating earnings growth in 3 segments, with consolidated revenues of $159.3 million, adjusted net earnings of $21.9 million, and operating cash flow of $31.2 million, despite several challenges, including raw materials, price inflation across segments, and unfavorable dairy economics impacting Animal Nutrition & Health. We continue to generate strong cash flows. Our revolver remains fully available and our net debt has been reduced to $179 million as of December 31, or 1.2x trailing 12-months adjusted EBITDA, further strengthening our balance sheet.

In addition to the challenges we are facing within the Animal Nutrition & Health segment, the global macroeconomic environment continues to present headwinds to our company. As previously indicated, recovery of higher raw material costs through pricing actions continues to be an important focus of our business teams. Additionally, we are pleased with the progress made on our key strategic growth initiatives, in particular the growing awareness of choline as a critical nutrient and the integration of IFP and Chol-Mix. We will continue to strengthen our company by focusing on these initiatives, exercising disciplined cost management, and seeking value-creating acquisition opportunities.

I would now like to hand the call back over to Terry who will open up the call for questions. Terry?

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Mary Theresa Coelho, Balchem Corporation - CFO [7]

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Francesco Pellegrino, Sidoti & Company.

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Francesco Pellegrino, Sidoti & Company, LLC - Research Analyst [2]

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Just to start, in the Specialty segment, was EO pricing a headwind or a tailwind? Did you get any pricing for EO in that segment?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [3]

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We certainly did raise prices somewhat in the beginning of the year as contracts permitted. But raw materials do continue to escalate in that marketplace so we did overall experience some margin headwind if you will in the EO business. But we are raising prices and trying to catch up to the higher raw materials.

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Francesco Pellegrino, Sidoti & Company, LLC - Research Analyst [4]

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I know you guys had highlighted the different types of contracts that you have in each segment. Is there a particular segment that you guys operate in, and right now I'm just talking about raw material costs across the board, that it's a little bit more quicker to pass along these cost increases in some segments than others? Or certain contracts in one segment a lot shorter than in other segments? As a majority of your raw materials costs are probably going to continue to increase, just trying to understand how quickly you're able to pass along price increases across each segment.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [5]

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Sure. Maybe we need to go segment by segment, Francesco. I would say generally speaking, we feel like we have relatively good pricing power as a company in the products we're in and the markets that we serve. Certainly, in the Industrial segment, we really do not have significant long-term contracts that reduce our ability to raise prices, so we have fairly good pricing flexibility. Obviously that's a relatively competitive market which impacts ability to raise prices, but contractually we can move relatively quickly in that market. Specialty Products is actually an area where we have probably more restriction than some others. We have longer term contracts in that segment that restricts our ability to fully raise prices there. We have been raising prices to the extent we can with contracts, but that is one area that we have longer term contracts that inhibit us from very quickly raising prices. If we move to Animal Nutrition & Health, I think we have generally speaking relatively good quarterly ability, maybe not monthly ability, but quarterly ability to raise prices. We tend to have contracts that have raw material price escalators in them that give us the ability to raise prices for raw material costs minimally on a quarterly basis. And then in Human Nutrition & Health, across most of the business we have I think very good flexibility. In the business that is more tied to food ingredients, we do tend to negotiate prices on an annual basis and we have I think quite good pricing power there, but we do tend to set prices on an annual basis in much of that business and so we need to get our pricing negotiations right at the beginning of the year to take into consideration our forecast for raw materials for the rest of the year. Hopefully that helps.

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Francesco Pellegrino, Sidoti & Company, LLC - Research Analyst [6]

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Yes, it did a lot. In the Animal Nutrition & Health, I think you had highlighted a $4.3 million increase for monogastric, a $2.3 million decrease for ruminant. I know whenever we talk about the ruminant part of that segment, we have to discuss the choline and then the amino acids. So I guess when looking at the ruminant falloff, how much of that was due to lower amino acid sales? Because I was rather surprised about how well the segments' margin held up knowing that amino acids, when milk protein prices go below $2 per pound, producers pull back on the aminos first. And since it's lower margin, you get the margin lift. So it was nice to see that hold up, but I'm wondering how much of the falloff in revenues was attributable to aminos as maybe compared to just some of the choline products that are sold into ruminant.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [7]

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You are absolutely right on all of the facts that you included in the question, Francesco. ReaShure is our brand for rumen-protected choline and in Q4 our ReaShure sales were actually up about 5%. Which is lower than the growth rate that we have historically had and anticipate having in the future as dairy economics improve. But ReaShure sales did grow in Q4, so essentially all of the decline that we experienced in the ruminant business is related to all of the other products with the amino acids being a primary part of the other products. So the strength in Animal Nutrition this quarter, and we're very pleased with the performance in Animal Nutrition both year-over-year and sequentially, was really driven by growth in the monogastric business and with the very strong sequential growth. And there's a lot going on in there. Our European business is doing extremely well with the capacity expansion that we invested in late last year with the Chol-Mix acquisition. We are raising prices in that market to try to catch up to raw materials. We're still behind, but our pricing is starting to catch up which resulted in some improvement in margins. And then finally, something that Terry talked about briefly, we are seeing some increased demand as Chinese suppliers struggle to supply the market, caused we believe by increased Chinese government environmental scrutiny and restrictions. So that has provided a higher demand opportunity for us, really both in Europe and the U.S.

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Francesco Pellegrino, Sidoti & Company, LLC - Research Analyst [8]

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Okay, and my last two questions before I jump into queue, is human grade choline now a $25 million base? And could you just provide us with a timeline for what you're anticipating for CureMark? On the fourth quarter call last year, you had provided us with a timeline, just given where the trial had ended in early December, just when CureMark would think about submitting the data and when we could potentially be hearing back? Because this could potentially be the last -- well, I'd think maybe we'd hear back from you as of the first quarter call, but any type of color we can get on that front would be great.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [9]

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Human grade choline is not quite a $25 million business for us yet. But as I mentioned, sales were up in the quarter by 22%, 13% for the year. So as we had anticipated, demand is picking up and we expect continued growth and accelerating growth in 2018. But we're not quite at $25 million. Relative to CureMark, again, very pleased with the fact that the last patient last visit occurred in Q4. That really is an important milestone and I think everybody knows that that clinical trial took quite a long time to recruit the 300 patients. But very pleased again to see last patient last visit happen in December. So are now in the data analysis phase and we certainly would hope that by midyear to Q3 we should be submitting NDA approval, certainly before the end of the year you would think, and so that's exciting news for the CureMark project.

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Francesco Pellegrino, Sidoti & Company, LLC - Research Analyst [10]

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Just a follow-up, so are we talking about a Q1 2019 decision potentially, if Q3 submission?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [11]

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Yes, I think that again, it's very difficult for us to estimate the FDA on this. I think it could come as early as Q4 of 2018. That may be aggressive, I think Q1 of 2019 as you say is a reasonable assessment based on the fact that was have fast track status and it's a rolling NDA process. So I think that's probably a pretty good target.

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Operator [12]

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Brett Hundley, The Vertical Group.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [13]

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Just following onto that real quick, just very quickly to make sure I'm crystal clear, if the NDA goes in Q4 this year or Q1 of 2019, what type of guidance should you give us on thinking about when production and business actually starts to materialize?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [14]

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Again, Brett, it's a difficult forecast to make. We have spent time trying to understand the timeline associated with similar approval processes and we think that minimally we should expect the FDA to take approximately 6 months. It could be longer than that, but the fact that we have again, rolling NDA process, fast track status, we think that 6 months should not be unrealistic. So once the NDA is filed, we're thinking that we should be counting on 6 months again probably at the soonest that we would see ultimate approval. And that's when we would certainly start ramping up production which we can do quite rapidly.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [15]

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I appreciate that. And then, Terry, you mentioned some of the greater manufacturing focus in China. That's something that we've been watching and I guess I'm trying to understand the proper way to think about that. You guys mentioned that you don't know how long it's going to last but you do view it as a short-term benefit. Is that a material benefit to say sales on the ANH side, but as we think about the impact to margins or overall earnings, it's relatively limited? Is that the right way to think about that? And I guess as a side question to that, was that effect "material" in the quarter? Did you see it across all 3 months or is that something that's kind of building into calendar Q1 here?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [16]

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Maybe I'll take a stab at that, Brett. There really are 2 ways to look at this. One is, short term, clearly there is disruption in the Chinese companies' ability to supply global markets, that we are benefitting from. Very specifically, this started probably very late Q3, and our estimate would be that we benefitted approximately $3 million in revenue over the course of Q4 from business that we believe we picked up based on the shortages. So our typical margin in that business is call it 20%, so that would be the financial benefit. We believe that that will continue at that rate into Q1 for sure. And then it gets a little bit foggy trying to figure out exactly how long this is going to last and what the broader impacts of it will be. Some would speculate that while capacity may indeed come back onstream, easing up the supply disruption, it may be at a different cost point. Some of what the companies in China are being forced to do is move from coal to natural gas. That's not a cheap endeavor. The choline producers are not only having to do that, but some of the suppliers of the raw materials are having to do that. There are increasing restrictions around how you can ship some of the raw materials that we use. As you know, ethylene oxide is a dangerous chemical and there are some increasing restrictions in China around shipping ethylene oxide, or maybe not restrictions, but increasing focus and concern about changes relative to shipping EO in tank truck through residential areas. So I do think there could be a longer term benefit that changes the competitive dynamics with Chinese suppliers essentially at a new cost point that I think could have positive ramifications for our business longer term. Obviously there's some speculation in there. There's zero question we had benefit in Q4 from the supply disruptions, we're going to have benefit in Q1 from the supply disruptions, but it's uncertain long-term whether some of those other items I mentioned will come to fruition. But you could see how they could have a longer lasting impact on our business.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [17]

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That's helpful perspective, I appreciate that. I'm curious, Ted, if you think you're seeing any benefits related to that in your Industrial business. The only reason I ask is, your Q4 sales performance in Industrial was much stronger than I thought. I mean usually you guys track kind of inline or within at least a certain band relative to US rig count growth. In this quarter, you were well above US rig count growth and I was just curious if you were maybe seeing any benefits related to China or if you potentially picked up a big chunk of share from potassium chloride or if there was any inventory loading. Did you see any of that going on in the quarter in that business?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [18]

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For sure, Brett, we are benefiting somewhat in the Industrial segment as well from the Chinese supply disruption. You're right, rig counts were up I think just a little bit less than 50% in the quarter year-over-year and our volume was up I think about 125% in the quarter. At some point in time, we've talked about this in the past, that rig count theoretically is not necessarily the best metric that should correlate with our volume because a well can be drilled but not necessarily fracked. So we're not quite sure whether that's playing a role here in the fact that our volume was higher than the rig count specifically in Q4 or not, but we definitely are benefitting right now from the supply disruption from China in Industrial as well. Less so than in the Animal Nutrition & Health space, but we are impacted. And the majority of our benefit in the Animal Nutrition & Health space was in Europe where the Chinese supply a bigger portion of the market. The Chinese are present certainly in North America, but are not as significant suppliers to the US market as they are in China. So therefore, we're seeing much more benefit in the European market and our business in Europe really had an all-time record Q4.

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Brett Michael Hundley, The Vertical Trading Group, LLC, Research Division - Research Analyst [19]

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I appreciate that. Then my last question for you, Ted, relates to your balance sheet and your M&A strategy. Your balance sheet is in a very attractive position today. And the way that your business is set up I think lends you a lot of opportunities that maybe a traditional flavor or even a traditional ingredients company might not have as it relates to going after certain M&A opportunities. As we've just kind of done additional work on the private ingredient producer landscape out there, both in North America and globally, it seems like there really would be some nice attractive assets for you guys that might bleed across a number of your product categories and be really additive to your business. Now some of these companies are parts of larger enterprises which might be hard to shake loose. It still might be hard to just go out and buy an existing entity out there because of multiples in place. But I want to kind of revisit M&A with you given where your balance sheet is and just get a sense of maybe do you still -- do you aim to stay US-centric with your M&A filter? Or have you broadened that? Have you broadened your size filter at all or even your product characteristics that you're looking at? Do you see the ability to get deals done over the next 12 to 18 months or do you think that it may still be somewhat challenging and that you may be very selective? And maybe you can talk about ways that you might look to return shareholder capital otherwise. Thank you.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [20]

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Great question, Brett, a lot in there. Really, our capital deployment strategy remains unchanged. First and foremost, we are trying to drive organic growth and we were quite pleased with the organic growth we delivered in Q4. We're ramping up our R&D investments. We're investing significantly in our manufacturing capabilities and need to continue to do that in 2018. And then thirdly, we are I would say ramping up our focus on smart, accretive, good return acquisitions. And we feel as though we've made 3, maybe 1 medium size and 2 small ones in the last couple of years that have been very, very beneficial to our company, both financially but also strategically. So do see significant value in M&A investments for the company. But we've spent a lot of time talking about the benefits of tax reform, Bill went through that. They are pretty significant for our company and we have now access to a little bit more cash based on that. But fundamentally, access to capital has never really been our problem, we have good borrowing capabilities. So fundamentally, I think our strategy is not changing there. We want to be very disciplined about it. We are looking at, do look at more sizable acquisitions. It's not just these smaller bolt-on ones that we explore. Those happen to be the ones that were doable and we were able to get across the goal line in the last couple of years. So it's always partly what's available and so forth. But we do have an appetite for larger acquisitions as well as these smaller bolt-ons. Geographic expansion is definitely a filter for us. We are interested in broadening our company and expanding internationally. Primarily because we think that our products really fit in those international markets and so we've got some excitement about having infrastructure and capabilities to take some of our existing technologies to those markets. Adjacent products are definitely in the focus and a filter for us as I think we probably said last time. We're really not looking necessarily for a fifth leg to the stool, a diversification of any kind. It's more around adjacent products, adjacent applications, potentially markets, submarkets, as well as geographic expansion.

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Operator [21]

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(Operator Instructions) Hamed Khorsand, BWS Financial.

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Hamed Khorsand, BWS Financial Inc. - Principal & Research Analyst [22]

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I just have one question for you. Could you talk about the substitution process? Is it really more regulatory or if there is any solution into that just to manage your margins?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [23]

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I'm sorry, would you mind sort of elaborating on substitution? Sort of in this market or…

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Hamed Khorsand, BWS Financial Inc. - Principal & Research Analyst [24]

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Sure, you're talking about material costs going up, your raw material costs. So I'm just trying to ask if there is any ability to sort of substitute some of these raw materials that are going up. And if it's a regulatory approval process that hinders that?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [25]

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Right. So there is some opportunity, but I would say generally speaking, across our company, it's fairly limited. In our choline business, really there is essentially no ability to substitute out and use different raw materials. In our food ingredient business, there is some, and there may be a different way to use a different protein source or other ingredient. But I would say generally speaking, we don't have a whole lot of flexibility. And where we do, it typically would be an approval process, a label change for our customer, and so it's not something that we can do really quickly. It's something we could do in collaboration with the customer, but it's going to take some time.

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Operator [26]

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Tony Polak, Aegis Capital.

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Anthony Polak, [27]

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Could you give us a little more clarity on the capital expenditure increase for the 3 months and anything on R&D, what you're spending money on?

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [28]

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Sure. Capital expenditures for Q4 were I think $9.9 million and we came in for the year around $17.5 million. I'm sorry, $27.5 million. And I think we had guided around $26 million to $27 million, so we came in pretty close to where we thought for the year, but Q4 was a little bit higher than normal. And I would say that was really just timing of when projects finished and closed. In particular, our biggest capital expenditure in 2017 was associated with the Clearfield fire and kind of building a new facility at our Ogden, Utah site. And that project closed a little bit earlier than we had originally expected and that caused the increase in Q4. So again, we came in about where we thought we would for the year, Q4 was a little bit higher. Relative to R&D, we tend to spend most of our R&D dollars on the Animal Nutrition & Health business as well as the Human Nutrition & Health business. We tend to spend almost as much externally as we do internally in whether it's clinical work, field trials and so forth. For example, I mentioned today in the Human Nutrition space, we believe very deeply that if a biomarker were to be developed for choline, that could significantly help the growth efforts of choline. So we funded a small pilot study at the University of North Carolina, I think spending a little less than a couple hundred thousand dollars. And that resulted ultimately in this $2.6 million grant, so we feel really pleased that we were able to spend a little bit of strategic money here and ultimately get much more substantive funding for a project that's very important to us. So we do quite a bit of that kind of spending and I would say that's increasing. The addition of Albion to our portfolio and their expertise and their -- some of the team members honestly that joined Balchem have really I think propelled our R&D efforts in the Human Nutrition space. But we're spending money on next generation encapsulated products, we're spending money on enhanced handling properties in choline. Those are two of our biggest areas and it's really a combination of internal and external investments.

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Anthony Polak, [29]

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Do you have a number for R&D that you spent in 2017? Or in the fourth quarter?

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William A. Backus, Balchem Corporation - CAO & Treasurer [30]

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Tony, it's Bill. It's $9.3 million for the full year.

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Operator [31]

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There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to Mr. Ted Harris, Chairman of the Board, CEO and President, for closing remarks.

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Theodore L. Harris, Balchem Corporation - Chairman & CEO [32]

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Thanks. I just want to wrap up and say thank you again for joining our call and your continued interest in our company. We're very pleased with our Q4 results and the momentum we have going into 2018. We have several non-deal roadshows hosted by Sidoti in New York and Boston next week that we'll be attending, and then with Canaccord in Minneapolis and Milwaukee the week of March 12, so we hope to see some of you there at those events or other events. We certainly look forward to speaking with you on our next call in early May. So thanks again for joining today's call.

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Operator [33]

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This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful rest of your day.