Bill Backus - CFO Ted Harris - President and CEO.

Mike Ritzenthaler - Piper Jaffray Tim Ramey - Pivotal Research Group Lenny Dunn - Freedom Investments Corporation.

Greetings and welcome to the Balchem Corporation Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a remainder 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 the results of Balchem Corporation for the quarter ending June 30, 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 statements. 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 include business relating to the acquisition of SensoryEffects that we acquired on May 7, 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 non-cash 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, our non-GAAP earnings of $0.62 per share reported in our press release earlier this morning, exclude 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 ingredients sector were strong, increasing approximately 14% from the comparable prior-year quarter, primarily due to higher volumes 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 realized 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 Products 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 cost 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 for 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 raw 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 a heavier weighting toward the powder and flavor systems of SensoryEffects, which typically generates a lower gross margin.

It’s 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 Products segment increased by 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 30, 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 30, 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. U.S.

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 30, 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 at June 30 and our net debt at June 30 was $243 million. The company's effective tax rate for the three months ended June 30, 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 rate.

As outlined in our earnings release, our second quarter results generated approximately $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 remained strong as we closed out the quarter with approximately $72 million of cash and this reflects scheduled principal payments on long-term debt of $8.8 million, along with $8.9 million of capital expenditure funding in the quarter.

I'm now going to have Bill Backus discuss the segments..

Thanks Ted. As previously noted for the quarter, sales of our 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 the prior-year comparable quarter.

Excluding the effect of non-cash 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 topline challenges in powders in part driven by our previously noted efforts to call lower margin business and we had indeed seen margin improvements 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 regarding the opportunities presented by our pipeline, the agglomeration initiative, which is on track through the end of 2015 and the new and novel products we are introducing to the marketplace.

The profitability of this combined segment is strongly contributing as we continue to realize improved efficiencies and improved 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 of our technology, who is in the process of performing a third Phase III clinical for their drug to be utilized in the treatment of autism. Their New Drug Application is being filed with the U.S. 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 30, 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 U.S. 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 is 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 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 in egg sets 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 Products segment posted quarterly sales of approximately $13.8 million for the three months ended June 30, 2015, as compared with $13.6 million for the three months ended June 30, 2014, an increase of 1.2%.

These higher sales were primarily due to the product mix of ethylene oxide products and medical device sterilization and propylene oxide for fumigation, pasteurization and industrial applications. ARC quarterly earnings from operations 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 key petrochemical raw materials and high control of selling and administrative expenses. During the quarter, we continued to incur additional expenses pursuing other new end market applications.

In the Industrial Products 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-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 operator’s desire to curb hydrocarbon production costs. The lower costs to 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’ll look to continue to leverage the competitiveness and efficacy of our products capitalizing on opportunities to gain additional market share to 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 Products 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'm 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 macroeconomic headwinds we have been facing in the shale fracking market, the strength of the U.S. 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 cost. Cash flow remained 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’ve 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 synergetic 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 of 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 had 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 the significant capital projects currently underway including the Verona Animal Nutrition and Health Production Expansion, the Marano Italy co-generation and choline chloride dry expansion, the continuous agglomeration unit in Defiance and the instant formula capabilities in Redding.

All of these projects are high-return growth projects, but 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 VitaCholine and choline nutrients in light of the pending RDI, our new P protein systems 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 lifecycle 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, actual opportunities for Balchem to pursue, to create value for our shareholders, while strengthening the company. And number five, protecting strength and 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 products and service offerings. As we develop our 2016 to 2020 strategic plans, we will focus on ensuring while 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 please while we hold for questions. Our first question comes from Mike Ritzenthaler from Piper Jaffray..

Yes, good morning.

I’ll kick it off here with a couple of questions around SensoryEffects perhaps first, qualitatively at least what are your expectations for organic growth within the SensoryEffects business with 3Q lapping the first full 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 are going to draw that down a bit?.

Yeah, Mike this is Ted. Thanks for the question.

As we really peel the onion back on the SensoryEffects business we’re 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 marketing conditions in the space which you probably read about.

You know that said the base business with the growth programs we have in place should grow in the mid-to-high single digits and as we progress into 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’ve been talking about..

Okay. That’s really 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..

Yeah, hi Mike, now as far FX goes, very little impact except to some degree on choline nutrients out of Italia, but for the most part, it’s really ANH and I think choline nutrients with regard to the segment obviously not the SensoryEffects acquired businesses so in terms of the acquired businesses very little FX impact, segment there is some but lot less impact for when it is on ANH..

Okay. Fair enough.

And just as a final question from me on Industrial Products, appreciate all the color that you put into your prepared remarks, but I guess more specifically I’m wondering how the soft end markets sort of influence, Ted, maybe how you manage the costs in that business?.

Yeah, we’ve 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 backfilling open positions, really aggressively implementing kind of a legacy Balchem profit enhancement program across all of the businesses, focusing on improved inventory management.

We sort of targeted a 50% reduction in inventory write-downs and we far exceeded that. We’re certainly not covering vacations and reduced over time. You know, running the plants in campaign modes, taking extended outages.

Obviously, the industrial business is not people intensive, so it’s largely around what we can do with the plants and we’re working that very hard and at the end of the day relatively pleased with what we’re able to do in Q2 and we’ll plan on continuing that for the rest of the year.

Just kind of expanding on that a little bit, as we said in our Q1 earnings call, 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’ve seen some very modest pickup obviously with how dynamic that marketplace is, we’re not going to take that to the bank, but that has been encouraging, but we’re watching it very closely..

Alright. Thanks very much and congrats..

Thanks..

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

Thanks so much. Again, with regard to Industrial Products, 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 that it didn't tie back to anything that I’m 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’s somewhat related to March and on the raw material side through supply chain and trying to make sure we had enough supply to service the market and dealing with that and what happened is again the dramatic downturn in the market put us in a situation where 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..

Okay. And then on SensoryEffects, I think at one point you guys mentioned that you talked about single serve coffee, and I believe that is Green Mountain.

Is their 2.0 product a benefit to you or is there any particular new product cycle that would be helpful here or can you discuss that a little bit?.

Yeah, let me take a stab at that Tim.

That is an important segment for us and it isn’t just that one customer, but that market really is going through I would say with a lot of change as you know that the growth rate in single serve coffee, especially beverage was extremely high for a while, that market’s facing lower growth today and that’s had some pretty significant impact on the supply chain and inventory.

As you know, we do not participate on 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 typically 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 marketplace.

So, the market’s really gone through a lot of changes and some challenges, but we continue to see opportunity for Balchem in the marketplace from our unique formulated products to even the new agglomeration unit that’s an important segment for us going forward and it should be good for us. We’re also interested in the cold [ph] platform.

It’s 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 and I don’t think we fully understand just the size of the opportunity going forward, but we’re 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, clean labels, it’s very attractive, [indiscernible] high proteins, it’s non-dairy, non-soy, it’s PHO-free, suitable for vegan applications.

So, it’s an attractive protein replacement and we’ve developed some interesting formulations that offer P protein to the marketplace whether it’s in sports nutrition or instant shakes or smoothies and so, we’re pretty excited about the products that we have and the opportunity in the marketplace.

At recent IFT in Chicago, it was one of their major showcased products and got a lot of interest and very favorable feedback about it, so again, an interesting opportunity for us..

Thanks Ted..

Yeah..

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

First congratulations on a good quarter and my observation is that you made this acquisition at a very perspicuous time, because the choline business looks like it’s going to be slow for a while, probably lower margin, as to the fracking end of it.

So, I wanted to congratulate you both on the acquisition, and the timing of it because you replaced what would have been a slow growing business, with a faster growing business. So, glad to see that.

I’m 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?.

Yeah, first of all we appreciate your comments, thank you very much. And yes, you can read oil’s at $46 a barrel today and you can read just as many articles that tell you it’s going to go up as it’s going to go down.

So, our read on the situation is really day by day and I think you’ve accurately picked up our perspective, we know what’s happened to our business and at this point in time, based on everything that we know about the marketplace we’re expecting that to continue for at least the next couple of quarters, if not longer..

Okay. Well, that was my comments and question and again congratulations on repositioning the business so we can still grow without having growth in the choline segment..

Thanks. Thank you..

Thank you..

Thank you. Our next question comes from 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..

Okay. 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..