Greetings and welcome to Balchem's Second Quarter 2023 Earnings 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 reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Martin Bengtsson, Chief Financial Officer. Thank you. You may begin..

Good morning, everyone. Thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the quarter ending June 30th, 2023. My name is Martin Bengtsson, Chief Financial Officer and hosting this call with me is Ted Harris, our Chairman, President and CEO.

Following the advice of our counsel, auditors and the SEC, at this time, I would like to read our forward-looking statements. Statements made in today's call that are not historical facts are considered forward-looking statements.

We can give no assurance that the expectations reflected in forward-looking statements will prove correct, and various factors could cause actual results to differ materially from our expectations, including risks and factors identified in Balchem's most recent Form 10-K, 10-Q and 8-K reports.

The Company assumes no obligation to update these forward-looking statements. Today's calls and commentary include non-GAAP financial measures. Please refer to the reconciliation in our earnings release for further details. I will now turn the call over to Ted Harris, our Chairman, President and CEO..

Thanks, Martin. Good morning and welcome to our conference call. This morning, we reported solid second quarter financial results with improved margins and higher profitability year-over-year despite softer sales volumes. Our revenues of $231 million were down 2.3% versus the prior year's very strong quarterly results. Gross margin grew 7.6%.

And we expanded our gross margin percentage by 300 basis points to 33.4%. Earnings from operations of $43 million were up 7.3% versus the prior-year quarter. And we delivered a record quarterly adjusted EBITDA of $59 million, an increase of 4.6% and adjusted EBITDA margin was 25.5% of sales, up 169 basis points from the prior year.

Our second quarter net income of $30 million, an increase of 1.1%, resulted in earnings per share of $0.93 on a GAAP basis. On an adjusted basis, our second quarter non-GAAP net earnings of $34 million were flat with the prior year, resulting in earnings per share of $1.06 on a non-GAAP basis.

Cash flows from operations were $35 million for the second quarter of 2023 with quarterly free cash flow of $32 million. Overall, another solid quarter for Balchem with performance that highlights the strength and resilience of our business model in a market environment that continues to be challenging.

Before passing the call back to Martin to cover more detailed financial results, I would like to make a few comments about the overall market environment and what we are seeing. The current market environment continues to be quite challenging with a high degree of uncertainty.

We believe that the broad-based destocking activities that followed the post-pandemic easing of supply chain constraints are now largely behind us.

However, we are experiencing a prolonged impact in certain markets from our customers, and in some cases, their customers' efforts to reduce inventories across their supply chains as a result of end market demand uncertainty, given the overall macroeconomic environment.

While it is hard for us to predict the timing of when the broader markets will truly normalize and reset for continued growth, we do believe they will gradually improve as the year progresses as we are now starting to see in certain markets such as within our human minerals and nutrients business.

And we are well positioned to benefit when that time comes. The Balchem team has been able to maneuver through these volatile times very well.

While our second quarter revenues were relatively flat compared to the first quarter of 2023, we were able to grow our gross margins and earnings from operations year-over-year and sequentially as we started to recapture some of the gross margin percent that was, over the last few years, given the extreme inflationary pressures we experienced.

I am very pleased with our overall financial results reported this morning. While the Balchem team effectively manages through this challenging market environment, we also continue to advance our strategic growth initiatives. One area of focus over the last few years has been to add manufacturing capacity in support of our strategic growth businesses.

As we have discussed on previous calls, we recently added manufacturing capacity for our microencapsulation business as well as our plant nutrition business.

As we highlighted in our press release earlier this morning in Q2, we were pleased to have mechanically completed a new manufacturing unit for VitaCholine, Balchem's leading brand of the essential nutrient choline for human nutrition to support the worldwide growth we are experiencing in infant, toddler, and adult nutritional formulas, as well as dietary supplement and food and beverage fortification applications.

We continue to be excited about the long-term growth potential for VitaCholine as awareness increases and market penetration grows for this essential nutrient. And our expanded capacity will facilitate significant growth for years to come.

The new manufacturing unit is currently being commissioned and should be fully operational by the end of the year. And lastly, on a very personal note, I would like to inform everyone, particularly those very longstanding shareholders on the call that Dr. Herb Weiss one of the three original founders of Balchem passed away on Wednesday evening.

He was 93 years old. Dr. Weiss was there at the beginning. He had the vision to build a company focused on commercializing microencapsulated food ingredients using patented microencapsulation technologies. And then he spent the next 30 years of his life helping to build Balchem into what it is today. His legacy will live on forever in Balchem.

And with that, I will now turn the call back over to Martin to go through the detailed financial results..

Thank you, Ted. As mentioned, overall, the second quarter was another solid quarter for Balchem, particularly in the context of the very strong first half of 2022 as the comparable.

Also, the strong margin rate performance from gross margin, earnings from operations, and adjusted EBITDA was encouraging to see and shows that we are well positioned to benefit as inflationary pressures ease.

Our second quarter net sales of $231 million were 2.3% lower than the prior year quarter and essentially flat sequentially to the first quarter as end market demand has continued to be volatile and we're yet to see a more broad-based recovery across our segments. Sales from our recent acquisitions contributed $14 million to our second quarter.

And the impact from foreign currency exchange driven primarily by the stronger euro, had a favorable impact on our sales of approximately $0.6 million. Our second quarter gross margin dollars of $77 million were up $5 million or 7.6% compared to the prior year.

Our gross margin percent was 33.4% of sales in the quarter, up 300 basis points compared to 30.4% in the prior year. The improvement in margins was primarily driven by higher prices, lower input costs and a favorable mix. The 33.4% gross margin rate is a significant improvement sequentially to the 31.5% we saw in Q1, 2023.

Consolidated operating expenses for the second quarter were $35 million as compared to $32 million in the prior year. The increase was primarily due to incremental expenses and amortization related to the Kappa and Bergstrom acquisitions.

As well as restructuring-related impairment charges offset partially by favorable adjustments to transaction costs. GAAP earnings from operations for the second quarter were $43 million, an increase of $3 million or 7.3% compared to the prior year quarter.

On an adjusted basis, as detailed in our earnings release this morning, non-GAAP earnings from operations of $49 million were up 4.8% compared to the prior year quarter. Adjusted EBITDA of $59 million was $3 million or 4.6% above the second quarter of 2022.

Interest expense for the second quarter was $5 million, an increase of $4 million compared to the prior year. This increase in interest expense is driven both by the increased debt level following our 2022 acquisitions and the significantly higher interest rate environment. We continue to use our solid cash flows to pay down debt.

And we reduced our debt by $26 million in the second quarter and ended the quarter with net debt of $333 million with an overall leverage ratio on a net debt basis of 1.5 times. The Company's effective tax rates for the second quarters of 2023 and 2022 were 21.6% and 24.1% respectively.

The decrease in the effective tax rate was primarily due to certain lower state taxes and higher tax benefits from stock-based compensation. Consolidated net income closed the quarter at $30 million, up 1.1% from the prior year.

This quarterly net income translated into diluted net earnings per share of $0.93, an increase of $0.01 compared to prior year. Our second quarter adjusted net earnings were flat at $34 million or $1.06 per diluted share. Cash flows from operations were $35 million. And we closed out the quarter with $67 million of cash on the balance sheet.

On a year-to-date basis, cash flows from operations were $70 million, an increase of $15 million or 26.4%. And free cash flow was $57 million, an increase of $22 million or 62.3% as we continue to translate our earnings into cash.

As we look at the quarter from a segment perspective, for the second quarter our Human Nutrition & Health segment generated sales of $136 million, an increase of 3.1% from the prior year.

The increase was driven by the contribution from recent acquisitions, partially offset by lower sales within food and beverage markets and the minerals and nutrients business. Our Human Nutrition & Health segment delivered quarterly earnings from operations of $27 million, an increase of 16% compared to the prior year.

This was driven by the aforementioned higher sales and lower manufacturing input costs, partially offset by higher operating expenses. Second quarter adjusted earnings from operations for this segment were $32 million, an increase of $4 million or 14.7%.

We are continuing to experience volatility and overall market demand softness in our Human Nutrition & Health segment.

As Ted mentioned earlier, as the quarter progressed, we were pleased to see the minerals and nutrients business shows signs of stabilization and a return to more normal order patterns after several quarters of significant volatility while the food ingredients business remained quite volatile throughout the quarter.

We continue to believe that as the year progresses, we will start to see a broader-based stabilization, which will ultimately lead to a return to growth. Sequentially compared to the first quarter of 2023 sales for Balchem's Human Nutrition & Health segment were up 2.3%.

Our Animal Nutrition & Health segment generated quarterly sales of $61 million, a decrease of 2% compared to the prior year, driven by lower sales in monogastric markets, partially offset by higher sales in the ruminant species markets.

Animal Nutrition & Health delivered earnings from operations of $8 million, an increase of 1% from the prior year, primarily due to higher average selling prices and a decrease in manufacturing input costs, partially offset by lower sales volumes. Second quarter adjusted earnings from operations for this segment were $8 million, a decrease of 2.2%.

Similar to what we discussed in our Q1 earnings call, our Animal Nutrition & Health segment is experiencing increased volatility and demand softness, particularly in Europe. The European food animal feed market continues to show demand softness, which is in direct contrast to the relatively strong demand experienced this time last year.

Hopefully, with lower energy costs and some disinflation, we believe we will see some stabilizing and normalization in the European food animal feed markets as we progress through 2023, but it remains a very challenging market at the moment.

While Europe has been more challenge lately, our larger US market has been more stable and has not experienced anywhere near the same type of demand volatility.

Our Specialty Products segment delivered quarterly sales of $33 million, a decrease of 10.7% compared to the prior year due to lower sales both in the Plant Nutrition and Performance Gases businesses.

Specialty Products delivered earnings from operations of $9 million, a decrease of 6.3% versus the prior year, primarily driven by lower sales volumes partially offset by higher average selling prices and lower manufacturing input costs. Second quarter adjusted earnings from operations for this segment were $10 million, a decrease of 5.7%.

Within Specialty Products, we continue to see higher margins in our Performance Gases business due to pricing actions we have taken and sequential reductions in raw material costs that have benefited the business.

But volumes have not yet fully recovered to pre-pandemic levels yet as many of our customers have taken longer than usual outages to upgrade their emissions control systems in anticipation of updated regulations.

With regards to Plant Nutrition, we saw lower sales into the Western United States driven by the unusually wet spring, which negatively impacted the planting season. While volumes in Specialty Products were below expectations in the second quarter, margins were very strong, and we are in a great position as volumes start to normalize.

I'll turn the call back over to Ted for some closing remarks..

Thanks, Martin. We are pleased with the solid financial results reported earlier this morning, with improved margin performance leading to record adjusted EBITDA for the quarter, particularly, in light of the strength of the prior year's comparable and the continued economic uncertainties we are facing in the marketplace.

We continue to show resilience during this time of elevated economic market uncertainty and ability to manage through challenging and dynamic market environments. While the current market environment continues to be volatile, we remain confident in the long-term growth outlook for our markets and for Balchem as a company.

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

Martin?.

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

[Operator Instructions] Our first question comes from the line of Bob Labick with CJS Securities. Please proceed with your question..

Good morning. Congratulations on very strong margins in the quarter. I wanted to start. You highlighted this earlier. I wanted to dig a little deeper. You mentioned the VitaCholine manufacturing unit I guess expansion.

Can you talk a little bit more about the capacity it adds? Maybe how long it takes to fill capacity? And will there be like a P&L impact initially once depreciation runs through as it's underutilized? Or how should we think about that impacting the P&L in the business looking ahead?.

Yes. So first of all, I'll start with just the fact that we're really excited that this new manufacturing unit has now been mechanically complete, we are in the midst of getting customer approvals for the product and so forth. And it should be up and running fully by the end of the year. It essentially doubles our capacity for VitaCholine.

We have been - over the last few years with increased demand been bumping up against our capacity limits, we've done a really good job of getting more out of the existing assets and have been kind of pleased with the efficiencies getting out of the plant, but it has been restricting our growth overall.

And so by doubling the capacity, it really frees us up to fully satisfy demand. But given that it is in fact doubling our capacity, it will take some time to really fill out the plant fully. But we've got great plans to do that every time. But certainly, for the next four or five years, we're not really going to have to be worried about capacity.

The overall investment was about $20 million. And so you can kind of think through the impact there. But we really feel like the growth will be able to absorb that additional depreciation pretty easily and the financial burden on the P&L should not be material from my perspective. But I'll let Martin kind of chime in as well..

I agree with that. And also, from a depreciation standpoint, while there's obviously as depreciation as you would expect, we also have other parts that are kind of coming off. And as I model out depreciation is not going to have a material impact or change as you look out into the future based on the timing of what's coming in and what's coming out..

Okay, great. And then maybe just discuss the CapEx plans going forward and how you decide when you are adding capacity, your targeted ROI. You mentioned the encapsulation that nutrition has done now.

So, what's kind of like next in the Q or in the agenda? And how do you decide on what are your targeted returns on the CapEx?.

Yes. As part of both the strategic plan that we refresh every year as well as the budget process we work through the CapEx requirements with both the businesses and our supply chain organization.

And in an ideal case, right, as you start getting up to capacity utilization of assets, getting up there and starting to exceed 80%, you really don't want to get up into the high numbers of that. You need to plan for the next tranche of capacity.

That being said, we saw with the significant acceleration during the pandemic where demand of some of our assets went really high really fast that squeezed that capacity as we talked about in the past and you sort of sold out on some of these assets, which has now eased off a little bit.

But under normal circumstances, that's a little bit how we approach the planning and you lay that out to what the right timelines are, where in the network, it fits in, and should we expand capacity? Do we work with a partner? Et cetera. Depending on what kind of product and the strategic importance and fit of it.

As you look at the return on it, we look at that primarily really from a cash flow perspective, right? There is a cash investment upfront. And obviously, we need to recoup that and generate a return and a little bit the size of that there is not a specific number to say. Okay. If it exceeds X then it's yes. And if it's below, then it's no.

Depends a little bit on the risk of the investment, how well do we know the technology, how well are we sort of feeling confident in being able to fill the asset, et cetera. And so there is a risk balance there between what kind of return you expect obviously when making that decision.

But in general, the returns are pretty high on the organic investments you do and the capital investments we make. So it's usually a pretty straightforward decisions..

I think certainly, Bob, over time and this is maybe the no-brainer comment of the day. But over time we certainly find that the lowest risk, highest return investments that we made typically are in our own asset expansion because we are in the market, we have good line of sight into the growth. Our margins are healthy.

And so we really like to be able to invest in the existing products and infrastructure and go after the growth platforms and the market affords us in these products..

Okay. Great. A lot of helpful color there. Appreciate that. And then just switching over to just HNH in general, a very strong margins in the quarter. I'm wondering if you could talk about Kappa which was, I believe, higher margin business, but then impacted by inventory correction.

Has that kind of got back to normalization? Or how is that impacting the margins in HNH? And how is that progressing on terms of which normalization sales cycle?.

Yes. So you're right. We were really pleased with overall HNH results. Obviously, from an organic growth perspective, it's not where we would like it to be, given the overall market environment. But margins were very strong. And we really had to do with a favorable mix.

The businesses that performed the best tended to be the higher-margin businesses, I think our price discipline was very, very good in the quarter as it normally is. Raw material deflation is benefiting but also spend controls in our manufacturing plants on somewhat lower volume. So it's multifaceted.

And we were very pleased to see the overall profitability margin improvement in the quarter. And yes, the K2 sales from Kappa are accretive. The margin profile of Kappa is higher than our average profile as a company and the average profile of HNH. So the margin profile of that business is accretive and contributed.

And while I wouldn't say -- you used the word has it normalized, I would not say it has normalized, nor would I say that the overall minerals and nutrients business has normalized. We did comment that we're really pleased to think -- to see that it had stabilized over the course of the quarter.

And I would say that was true about the K2 and the Kappa business. Q2 of 2023 was the best quarter for Kappa and K2 since the acquisition. Of course, we acquired it just as the market was turning down. And so we've seen it stabilize, starts to pick up not quite back to the normalization that we would like to see.

But the margins are contributing nicely and the overall Kappa business contributed nicely to the results this quarter as well..

Our next question comes from the line of Ram Selvaraju with H.C. Wainwright. Please proceed with your question..

Hi. Thanks for taking my questions and congrats on the strong bottom-line performance.

With respect to the HNH business, I just wanted to get a little bit more clarity on ultimately what you see as the long-term upside potential in the VitaCholine business, if you can offer us kind of any color on the long-term kinetics of growth there, given the status of VitaCholine is very much a flagship type product for you as well as how you are thinking about the growth curve, particularly with regard to the Kappa product lineup and you mentioned earlier, inventory normalization and the fact that you don't -- you're not looking at that business is having been totally normalized yet.

But whether we should look at this as being a situation where you expect it to hit its stride in terms of growth before the end of this year or if we should really expect sort of the after-burners to be turned on in the Kappa product line in 2024?.

Yes. So I'll take a stab at that. Martin, you can chime in to add some color. But really two questions there. One around VitaCholine and the market potential. And then one around Kappa growth. On VitaCholine, we continue to be very excited about the potential of this essential nutrient.

It is really a special nutrient that we believe just has underperformed over the years because of lack of awareness. Not really because of lack of studies, but really lack of awareness.

And so we are, as I've talked in the past, really focusing on building a marketing, if you will, communication platform for effectively and comprehensively communicating about VitaCholine and our other portfolio of minerals and vitamins. And we do believe that we're starting to make strides there and starting to impact overall awareness.

And it's a bit of a journey. And it will take some time. But we believe that the size of the VitaCholine market really is, I want to say, three to five times what it is today. And that should allow for not only double-digit growth, which we have already been achieving by penetrating the market through awareness but more significant growth.

I'm not going to be satisfied until we're growing this market by 20%, 25% a year. And I think we need to be growing at those sorts of rates in order to achieve that three to five times market growth. And we need to do it by building awareness in the cognitive space. We need to do it by building awareness in the liver health space and so forth.

And that's what we're focused on. So hopefully that gives you a little bit of a feel for what we think is possible there and hence why we're investing in more capacity. Relative to Kappa, I do think that the rest of the year will continue to be uncertain although we see some stabilization and a return to more normal conditions.

I guess, I would like to say that going into 2024, we're going to start to see growth really accelerate in our portfolio and in products like our K2. We certainly have a lot of new launch opportunities that we're working on.

And the team is excited about -- there's no question that the coming together of the Balchem team and the Kappa team is creating synergistic opportunities. And I think we're going to start to realize that more and more as the year progresses. But as we go into 2024, we should be back up into the, call it, 15%, 20% type growth year-over-year of K2.

Little bit similar to choline. And we think that the market should be substantially larger than it is today, and we need to drive awareness there, maybe we need to do a few more studies, but we continue to be excited about K2 as a specialty vitamin..

Great, thanks for that color. Just a couple of quick housekeeping financial questions. Maybe these are more for Martin.

First of all, as I perennially asked, how should we be thinking about the effective corporate tax rate going forward? Generally speaking, I think in the past, you've always tended to guide us towards a number that's meaningfully higher than the number that was reported for this most recent quarter.

So I was just wondering whether anything has changed there or if we should, for the remainder of 2023, expect an effective tax rate more in the 23% plus range? And then also with respect to debt repayment pace, can you give us a sense of whether what you reported for the second quarter is kind of around where you expect to be repayments in the months and quarters ahead or if you expect the pace of debt repayments to change meaningfully up or down? Thanks..

Yes. Thank you, Ram. On the tax rate, I guess I'm pleased that we beat the guidance a little bit. We normally guide at an effective tax rate around 23% as you mentioned. And recently, we've been able to beat that through call it discrete items and projects that the tax team has developed together with the businesses and so on.

23% is sort of where you land if you do the math and you do the paper exercise. So where we're based and what kind of income we're generating, et cetera, you fall out right around there. But then we have been effective at finding call it discrete items to come in lower than that.

I think from a guidance perspective, I will still continue to guide to the 23%, because I don't know what those discrete items will be going forward. And I can't guarantee that we'll continue to come up with them. We will certainly do our best to continue to do that. And I sort of cautiously optimistic that we'll be able to beat it.

But 23% is sort of where you end up if you just do the math before you come up with new ideas. On the debt repayment, we paid back $26 million in the second quarter. I would say that that kind of level plus or minus a little bit for a normal quarter is very reasonable to assume with the exception of Q1's.

If I put it that way, we paid the dividend in Q1. So we have less, call it, excess cash to pay down debt. So we have a little less capacity in the first quarter every year. But for other quarters, what we did in Q2, I would say, is not unique. And we should be able to continue something along those lines here going forward..

There are no further questions in the queue. I'd like to hand the call back to Ted Harris for closing remarks..

Great. Thanks, Doug. Once again, just thank you all very much for joining the call today. We really appreciate your support as well as your time. And we certainly look forward to reporting out our progress in Q3, 2023 results in October.

In the meantime, we will be presenting at a few conferences, the Jefferies Conference in New York City on September 6th, as well as the H.C. Wainwright Conference in New York on September 11th. So hopefully, we'll see some of you at one of those conferences though. Thank you again for your time today. Appreciate it..

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