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Balchem Corporation (NASDAQ:BCPC)

Q4 2012 Earnings Call

February 21, 2013 11:00 AM ET

Executives

Frank Fitzpatrick – CFO, Treasurer and Assistant Secretary

Dino Rossi – Chairman, President and CEO

Analysts

Tim Ramey – DA Davidson

Daniel Rizzo – Sidoti & Company

Andrew O’Conor – BMO Asset Management

Greg Garner – Singular Research

Brian Rafn – Morgan Dempsey Capital Management

Lenny Dunn – Freedom Investors

Anthony Polak – Aegis Capital

Lawrence Goldstein – Santa Monica Partners

Operator

Greetings, and welcome to the Balchem Corporation’s Fourth Quarter 2012 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Frank Fitzpatrick, CFO for Balchem Corporation. Thank you, Mr. Fitzpatrick. You may begin.

Frank Fitzpatrick

Thank you. Ladies and gentlemen, thank you for joining our conference call this morning to discuss the results of Balchem Corporation for the period ending December 31, 2012. My name is Frank Fitzpatrick, Chief Financial Officer; and hosting this call with me is Dino Rossi, our Chairman, President and CEO.

Following the advice of our counsel, auditors and the SEC, at this time, I would like to read our forward-looking statements. This release does contain or likely will contain forward-looking statements, which reflects 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 A.M. Eastern Time.

I will now turn the call over to Dino Rossi, our Chairman, President and CEO.

Dino Rossi

Thanks, Frank. Good morning, ladies and gentlemen, and welcome to our conference call. We are pleased to report record fourth quarter net earnings of $9.9 million on record quarterly consolidated net sales of $80 million for the quarter ended December 31, 2012. These fourth quarter sales of $80 million were approximately 15% greater than the $69.7 million result of the prior-year comparable quarter.

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

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

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

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

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

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

We continue to work on operational efficiencies and I am happy to report that we had commenced production and are now shipping products from our new Covington, Virginia plant in January of this year. This expansion will more than double production capacity of our ruminant stable products.

At the consolidated operating expense level, you will note a 30% increase totaling $7.4 million for the quarter, which equals 9.2% of sales versus the prior year metric of 10.3% of sales. This level of spending represents certain increases in R&D and marketing levels, but we continue to leverage off of our existing SG&A infrastructure and exercise a control over all controllable operating expenses.

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

Our effective income tax rate for the fourth quarters of 2012 and 2011 were 34.5% and 31% respectively. This increase in the effective tax rate is primarily attributable to a change in a portion that’s relating to state income taxes and the availability of certain tax credits in the prior year. For example, our effective tax rate in 2012 is reflective of the expiration of the federal tax credit for research and development activities that was available in the prior year. Enactment of the American Taxpayer Relief Act of 2012 on January 2, 2013 retroactively reinstated an extended U.S. Federal Research and Experimentation Tax for all of 2012 and 2013. As a result the company expects to recognize an effective tax rate benefit to be reflected in our fiscal 2013 first quarter results. Our annualized effective income tax rate for all of 2013 is currently estimated to be approximately 33%.

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

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

As you could see, we continued to aggressively manage all areas of working capital, driving strong cash flow, improving cash earnings and generating quality organic results from our core businesses. In an effort to detail our consolidated results better for our shareholders, I’m now inviting Frank Fitzpatrick to discuss the ARC Specialty Products and the Food, Pharma & Nutrition segments.

Frank Fitzpatrick

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

Our quarterly business earnings increased 9.3% to a fourth quarter record of $5.5 million versus the prior year comparable quarter. This increase is largely a direct correlation to the improved sales volume of ethylene oxide and propylene oxide products. Slightly increased overall average selling prices were derived from a favorable product mix. Late in the quarter, we did release additional increases in the cost of certain petrochemical commodities. We continue to monitor raw material price volatility closely and seek to implement price adjustments within contractual guidelines.

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

Overall, the FPN sector sales did have strong quarter as compared to 2011 and was comparable sequentially to Q3, 2012, particular strength in the international encapsulated sales up approximately 40%, we realized ingredients for baking and prepared food preservation and confection market. As in the past, results for this segment continue to reflect roller coaster effect of pipeline sales, inventory level management and delayed marketing initiatives. Our growth drivers do however remain intact for this sector as food sales remain strong in the early part of 2013. On that note, we also realize strong double-digit growth in sales of our VitaShure products for this nutritional enhancements.

Last quarter, we reported that we were working with a large sports nutrition company on the introduction of sustained release amino acid products and we have made our first sale for this launch in Q4. In the quarter, we realize modest growth in sales of our human choline products for nutritional enhancement. Here we continue to focus on building consumer awareness of the benefits of choline, positioning choline with nutritional and pharmaceutical companies as an essential ingredient with excellent therapeutic benefits for all ages. We continue to effectively utilize the three structured function claims awarded to Balchem for EFSA in Europe.

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

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

Dino Rossi

Thanks, Frank. In the Animal Nutrition & Health segment, we realized record quarterly sales of $56.4 million, an increase of $8.6 million or 18.1% as compared to the prior year comparable quarter.

ANH ruminant products realized sales growth of 33.4% from the prior year comparable quarter. As mentioned in this morning’s press release, our quarter results in this sector of ANH were actually much stronger than the 3.4% suggest as our comparative results were adversely impacted by the previously announced suspension of sales of our AminoShure-L, 52% Lysine.

Sales of non AminoShure products were up 15.2% in the quarter met by strong volume growth of Reashure and Nitroshure as excellent product performance in dairy economics continue to support greater demand for our products effectively offsetting the AminoShure-L decision.

With respect to the second quarter suspension of sales of AminoShure-L 52% Lysine product. We are diligently working to make the required product improvement and we look to reintroduce this product into the dairy industry once improvements are completed and confirmed with dairy industry experts.

At this time, our work continues. However, we are unable to give a precise estimate as to when this work will be completed.

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

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

Our global feed grade choline product sales were up 5.1% from the prior year comparable quarter as we saw a modest volume growth principally in North America. Sales of our European produce product were however unfavorably impacted by foreign currency fluctuations totaling approximately $400,000.

Volumes sold in these markets are strongly influenced by the various dynamics of our customer base, predominantly the poultry production industry, but also swine and aquaculture market

North America Choline volumes sold, closely track with broiler chick placements and egg sets. The current USDA forecast for broiler meat production has improved slightly for 2013 due to slight increase in hatchery production and anticipated higher bird weight.

These forecasts however, are dependent on more normal crop and grain growing condition. We constantly evaluate export Choline sales opportunities for the poultry market but again found Q4 to be a very challenging export market when factoring in raw material cost increases and foreign competitor activity. In the coming quarters, we may like to be more aggressive and seeking to win additional business depending upon the then current cost and market conditions.

Sales of industrial grade products were very strong, as sales were up 62.8% over the prior year quarter and sales in the North American fracing market improving 5% on a sequential basis particularly due to volume. Sales of methylamines, derivatives and choline for industrial applications in Europe were also up in the quarter. We continue to see solid sales of choline and choline derivative products for various industrial applications in North America, especially for the gas fracing opportunities.

We remain confident that these products will continue to show strength in 2013 driving steady to increasing levels of sales and profitability even at current rig deployment levels. We continue to evaluate industrial opportunities with core technology to determine how we can drive innovative solutions into this and other markets to derive the most positive value and are diligently working with new technology for areas where our core technology is not sufficient.

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

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

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

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

Our business continues to create good balance, yielding profitable growth opportunities through the various market challenges of any single segment or product line. We remain focused on helping our customers generate reinvestment level returns, making money in this tough economy while maintaining our own operating discipline.

Overall, we continue to build the financial strength of the company, managing the working capital base aggressively and using improved financial results. Near term, we remain focused on implementing operational and logistic improvement, new product development and new product introductions. We also continue to explore alliances, acquisitions or joint ventures to continue building and leveraging our strategic marketing direction, technology and strong human asset base.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question is coming from Tim Ramey from DA Davidson. Please proceed with your question.

Tim Ramey – DA Davidson

Good morning, thanks. The Covington facility, how should we think about that impacting results in 2013? Should we think about this primarily as incremental capacity that can cause growth rate to accelerate or should we think about it more from market perspective, maybe you can shed some further light on that?

Dino Rossi

Yeah. I think it’s a little bit of both. For sure, we’re viewing this is incremental capacity and validates our reference I think in the press release that went out earlier where in Q4 we had moved into a bit of an allocation mode because we were tight without Virginia on board. So with Virginia now coming on board, instantly it is incremental.

You know with any new plants I think an under capacity run rate as we talked about the cost in the quarter of running and getting kind of this kind of expenses and I think it will probably be at end of the month or so yes before we have that all lined out but clearly we’re viewing this as a relief valve for sure, given the demand for this product, I’d say built up demand, if you will. So, we’re looking to run that, definitely the near term on an incremental basis. And then I think on a go forward basis, clearly, we’re going to look to leverage that up in the market. I think there is definitely strong demand that’s been built by the sales marketing and the technology of the products out there. So, our expectation is that we’ve really yield, certainly our beneficial result in sales force were alone profit for us well.

Tim Ramey – DA Davidson

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

Dino Rossi

Well, I think our view as a North American market in particular is one that we believe will be positive but not dramatically positive. I think it’s – our expectations this is based on a lot of industry publications and data who had suggested this should grow from a live herd production standpoint rate probably 2%. So that’s or view. I think as we look at this market and we allude to constantly looking at explore opportunities. But the one thing that we have not talked about but it’s out there in the public eye is that a large Chinese producer had a major incident and near term out of business and they are probably one of the largest producers/exporters into as we would know to be the export markets today.

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

Tim Ramey – DA Davidson

All right. Thanks for help.

Operator

Thank you. Our next question is coming from Daniel Rizzo from Sidoti & Company. Please proceed with your question.

Daniel Rizzo – Sidoti & Company

Good morning. I’m sorry if I missed it, but what was industrial corn sales year-over-year in the quarter?

Dino Rossi

$7 million

Daniel Rizzo – Sidoti & Company

$7 million, okay, I apologize. And then what’s a (inaudible), you indicated that you’re still kind of waiting, is there a timing, do you have a timeframe on when you expect to hear something for the deal with new product that you guys waiting?

Frank Fitzpatrick

You know, again, I think Dan, we’ve had – we talked about this before we’re not really in control of that marketing process per se. Indications are that, I think they expect to file their MD&A here in Q1 now and then I think the FDA has six months to respond that. Now, that they could response sooner but certainly they have up to six months to respond. So that’s probably the most current information that I can give you on that.

Daniel Rizzo – Sidoti & Company

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

Dino Rossi

Well, I wouldn’t say they are necessarily along the same lines, I mean we’re working on a couple of other products and it’s definitely early if you will. Utilizing our encapsulation technology to deliver some ingredients as we’ve been kind of asked to respond. So those are in the background. I can’t’ get out there. There’s a huge CAGR I understand but clearly, more and more is coming to light about where those opportunities are on that space and so we’re running down that path right now that’s – I’ve been reluctant to try and jump up and say how big your opportunity might be?

Daniel Rizzo – Sidoti & Company

Okay. Thank you guys.

Dino Rossi

Thank you.

Operator

(Operator Instruction) Our next question is from Andrew O’Conor from BMO Asset Management. Please proceed with your question.

Andrew O’Conor – BMO Asset Management

Good morning Dino, Frank.

Dino Rossi

Good morning.

Andrew O’Conor – BMO Asset Management

You guys refresh me. What is your strategy in mainly to the balance sheet, is there a couple of structure that you view as optimal for Balchem? Thanks, so much.

Dino Rossi

Yeah. I think – so the question really comes down to I think what we’re going to do with cash and

Andrew O’Conor – BMO Asset Management

Yes

Dino Rossi

As cash has continued to build yeah so, it’s a fair question. I mean our strategy certainly is to look, I think everybody that we made reference to that we accelerated and increased our dividend payments for 2012. And our view is to continue to file money into the business and I can quickly point to the investment in the Virginia plants that I think will absolutely support organic growth. But I can also tell you strategically, we don’t think that that’s enough.

Our view is certainly to find other acquisitions or joint ventures that will accelerate the growth of the business. Certainly I’d say more geographically would be desirable since we’re still probably 67% of our revenue is North America. So we’re still very North American centric if you will and certainly see good opportunities in rest of the world that we have to get into a position to take advantage of. And I think our view there is to try to acquire something that represents almost a pleasant play whether it’s manufacturing, capabilities, sales organization which I would say would have to be strong technical sales organization and/or some new technology. So those are kind of – and I wouldn’t limit it to any one particular segment but I think as we look geographically, it’s probably looking more at the animal health and/or food businesses as key targets there.

Andrew O’Conor – BMO Asset Management

Got you. And then since the company is debt free, are there other near term priorities for cash that some of them not seeing or picking up?

Dino Rossi

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

Andrew O’Conor – BMO Asset Management

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

Dino Rossi

Yeah, a lot of that is really kind of stay in business type capital. We are now up to eight manufacturing sites and to be sure manufacturing sites require capital wind. And so, that as we got it identified today and believe me we do a detail budget in support of that kind of number. It’s mostly sand business. A few ROI projects are in there for sure but that’s really the flavor of that money.

Andrew O’Conor – BMO Asset Management

Thanks very much.

Dino Rossi

You bet.

Operator

Thank you. Our next question is coming from Greg Garner from Singular Research. Please proceed with you question.

Dino Rossi

Hi, Greg.

Greg Garner – Singular Research

Hi, Dino, hey Frank. First of all, couple of quick follow-up questions from the prior questioners. You mentioned about the Chinese producers out of business but there is about – you also mentioned the incidents or it makes me wonder, is this, are they totally out of business, will not come back or is it a incident that like a plant blow up that they could reconstruct the – can you give us any flavor on those, a permanent thing. Should we look as temporary change?

Dino Rossi

Yeah, that’s a great question. So, in fact the plant did blow up. And clearly they there’s YouTube videos out there. You can go through and see it. Quite honestly, it’s pretty devastating actually, number of people injured, supposedly no deaths, I don’t know if that’s true or not but it was a major incident in Seoul. And I think from our point trying to get details, I was at Chinese press with our Chairman, but what we do know is, is that plant basically was leveled. And so, what the fall out of that would, I think, I would say we haven’t necessarily felt it yet but given what we understand there, kind of volumes to be, the capacity to be – it’s going to cause – how in fact it affects in China, let alone export, I think is very early to determine.

Greg Garner – Singular Research

So, were they the largest Chinese export of choline?

Dino Rossi

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

Greg Garner – Singular Research

And how long will it take to rebuild the plant like that, two years, one year?

Dino Rossi

I’d say you’re in that 18 months to two year window.

Greg Garner – Singular Research

Okay. So there is an opportunity for the industry to pick up the slack once any excess inventory is worked off.

Frank Fitzpatrick

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

Greg Garner – Singular Research

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

Frank Fitzpatrick

Absolutely, I think our census will see that, as I will think by the end of Q1 for sure.

Greg Garner – Singular Research

Okay. And the other item you mentioned about potential higher than $8 million CapEx for 2013, is that for some existing products that, some programs take off, does this happen to be for that the new product that you said would be introduced in the end of the year for amino acid absorption or?

Frank Fitzpatrick

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

Greg Garner – Singular Research

Okay. So, that would be in the Food Pharma Nutrition, right?

Frank Fitzpatrick

In fact yes. Still would be, yes.

Greg Garner – Singular Research

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

Dino Rossi

That’s correct.

Greg Garner – Singular Research

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

Dino Rossi

Well, I told you it was sort of choline product and it could be as much as doubling that requirement in this that we’re selling into that market today. And I think, I’d like to wave it right there for now.

Greg Garner – Singular Research

Okay.

Dino Rossi

Yeah.

Greg Garner – Singular Research

Sure. Okay and you have a history, just you always going to be sort of battered around a bit, so to speak from raw material price changes that are quick and the timeline to past it onto customers and adjusting to be a normal event. Based on where it is right now, if there were no change in raw material pricing, how long or will it just be one quarter to get back up to above 30% in gross margin or just wondering

Dino Rossi

Yeah. I think that I mean if you kind of follow our models that are out there we’ll suggest a one quarter lag and that’s going back to you and I want to make sure we understand that if raw materials were to stay flat.

Greg Garner – Singular Research

Right.

Dino Rossi

Our near history here is not – that’s not been a case and so I won’t going to sit there and kind of promise that kind of view given the volatility that we’ve seen.

Greg Garner – Singular Research

Okay. Right, it helps me always helps me understand where the current situation is. In the industrial choline on the sale into the fracking with a flat rig count, are you seeing that it’s been accepted another basis perforans or is it just really more – frackers are recognizing the advantages of it, any characterization of that. Just trying to get a sense for how that might continue?

Dino Rossi

Yeah, I think the answer is, I mean to what you pose is, yes, yes and yes. We know that we are in more basins; we don’t get an absolute track on that because of the distribution channel that we use, but certainly it’s being used more broadly. I think the environmental aspect of this is definitely picking up a bit more speed. And our sense is that it’s, well, even though there is not maybe a new rig there or being refracked. So you’re picking up additional consumption in existing wells. And we do know there is some working done too with the products outside of just frac food but we’re kind of on the fringe of that but definitely it’s being looked at, I’d say bit more broadly in the oil and gas space.

Greg Garner – Singular Research

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

Dino Rossi

I think our view right now on the progress that we made is that it’s couple of quarters away, maybe we might have the product out here in Q4 of this year because there is typically a fairly long three to six month window of animal testing that has to be done.

Greg Garner – Singular Research

Okay.

Dino Rossi

And so I’d say earliest would be Q4 this year and certainly by virtue of that I’d say that’s hopefully our target.

Greg Garner – Singular Research

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

Dino Rossi

Four months

Greg Garner – Singular Research

Okay. And just one last item, just on a very general sense about the food, pharma nutrient, I know there is lot of opportunities there in especially with this, you mentioned some of the products we talked about it CapEx, may increase forward and also the amino acid absorption product and revenue just sort of being, sort of roughly flat or so. So, I guess should we look at it as these new product ventures that you’re working on, this is the future for this segment here?

Dino Rossi

So, it’s a great observation and I know I’ve talked to a number of investors about and it will suite from our business. I’d say food nutrition to miss the pharma side of this but the reality is there is some volatility fluctuation if you will. I think we found it more to be on the food headcap rather than the choline side of the business. And that’s where you kind of get caught up in the life cycle of any given product.

We get expect in and not because of products, if there’s anything wrong but perhaps it doesn’t sell as well as the food companies flat. So they discontinue the product. I think if you went in and look at the life cycle of products today in the food industry you’re going to find that they’re shorter and they’re always looking for that next new product if you will, which usually means they’re going to pull some product off. And so, for us it’s kind of being making sure that we’re kind of in the innovation side of the new product development groups and to work with them, get – become knowledgeable about how encaps can work.

So, it’s about having that front end pipeline full of these opportunities and on full way convert them all or is that, it might take 12 months to 18 months to convert a piece of that business. So, it becomes some timing issues there. For us to say, we can lock down that backdoor and not see any leakage is not going to happen, just the markets in and off themselves are going to discontinue some of those products which is out of our control. So that’s a little bit of the volatility that you’re going to see there. And in any given quarter and/or let’s go to a year, I think is probably a better look, you may see solid double-digit maybe 15% kind of growth going on the encap part of the business and it may last two or three years but then, too you could lose the piece that kind of falls out that back door, hopefully it’s not as big as. But the key here is continue to have that pipeline full of those new opportunity.

Greg Garner – Singular Research

In the growth Europe there, that’s been relatively low contributor in this segment as I understand and new that can sustain itself or can you give us any flavor on that, or is that a product line that has lot more?

Dino Rossi

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

Greg Garner – Singular Research

Okay. All right, great. Thank you.

Dino Rossi

Thank you.

Operator

Thank you. Our next question is coming from Brian Rafn from Morgan Dempsey Capital Management. Please proceed with your question.

Brian Rafn – Morgan Dempsey Capital Management

Good morning, Dino and Franc.

Dino Rossi

Good morning.

Brian Rafn – Morgan Dempsey Capital Management

Give me a sense Dino, you talk a little bit about, can you identify some of your raw materials feed stocks and might – give me a range as to what they might be up kind of year-over-year in to December of 2012, that’s 10%, 20%, 50% double.

Dino Rossi

Then when you say ‘12 versus ‘11?

Brian Rafn – Morgan Dempsey Capital Management

Yeah. Just whole year, right. ‘12 versus ‘11?

Dino Rossi

Yeah. I’d said that raw material costs are certainly up in the – I’m going to say some – we always kind of look at kind of blended averages in the fluctuation but I’d say it’s fair to say that our key raw materials have gone up minimally 10 to 12%, 10% to 15%. I mean that’s a little bit off the cost but I think we’re solidly in that zone.

Brian Rafn – Morgan Dempsey Capital Management

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

Dino Rossi

Well a lot of them are petrochemical derivatives that were used in particular for choline or ARC business and that’s really comes down to ethylene oxide, Trimethylene hydrochloric acid even has gone as well was just typically a byproduct kind of product. So those have gone out and then a couple of products that are used in manufacturing of our human grade choline which is typically been a natural type product. I’ll drift over to say organic here and quasi and that’s too has really found significant increases this past year which have been difficult to pass on into that market. But not for lack of trying and we’re looking at alternatives i.e. reformulation of some of those products to try and get away from that. So, those end markets get a little relief rather than just hammering through a price increase.

Brian Rafn – Morgan Dempsey Capital Management

Yeah, okay. And you hesitated when you little as you got in to 2013 year. Are you seeing incremental raw material inflation over and above what you saw through the end of 2012 into 2013?

Dino Rossi

Yes. It’s a great question. I will tell you there is some volatility there. Unfortunately I think we’re still seeing some increases but we’re also getting a little relief on a couple of others. So that’s probably net-net how will it shakeout in the quarter I think still yet to be determined. Remember, these key raw materials especially the petrochemicals are subject to move every month. These are products that are basically commodities in the market and the pricing model in the chemical industry today is month-to-month volatility if you will.

So, that’s why it’s a little bit difficult to predict although we do get a forecast, but occasionally too we get surprised month-to-month on what the actual movement versus what the forecast was all of 30 days earlier. So, there’s still definitely some volatility there. And I won’t say that I think it’s all justified, it’s kind of, I think it’s the control of that molecule at a certain moment in the supply chain that probably influences what profitability is being taken out of the chain.

Brian Rafn – Morgan Dempsey Capital Management

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

Dino Rossi

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

Brian Rafn – Morgan Dempsey Capital Management

Yeah, okay, okay. You talked a little bit about your human grade choline and some of that. There’s been a lot of disruption at least starting in the packaged food market, Heinz been taken out by Berkshire Hathaway and 3G post as rent being cut off into a 1,000 pieces, does that in all Dino inhibit the organic development or product development internal when you got M&A deals or accomplice doing deals?

Dino Rossi

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

Brian Rafn – Morgan Dempsey Capital Management

Okay. All right, fair enough. You talked, you kind of look across your eight bakery plants, how many shifts maybe start with probably and how many shift are you guys running at Covington, how many people have you added and then what kind of maybe shift, labor shifts and maybe overtime if you look at some of the other plants?

Frank Fitzpatrick

Well, I think any given plant might be running 24/7 and on a pretty consistent basis, some of our plants are batch operations, so even though they’re running 24/7 they may not be at 100% of capacity. Certain units in those, especially the batch operations you will find will be running 24/7 in particular. So I would say of the eight, probably I saw it five or under a kind of 24/7 scenario, again maybe not at 100% given certain units running or not. But I think you’re going to find at least five of them running on 24/7 type scenario. Covington is running probably I’d say on 24/5 right now and certainly as we – and part of that is just getting it ramped up. I think today we’ve employed about 35, 40 people down there. And certainly they’re on the low end of the learning curve but definitely producing quality product out of the operations that we’re shipping today. So, I think we’re real pleased with the way that that has come online.

Brian Rafn – Morgan Dempsey Capital Management

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

Frank Fitzpatrick

Yes they are away and they will be absolutely.

Brian Rafn – Morgan Dempsey Capital Management

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

Dino Rossi

Yeah, that’s a great question. I think so remember when we talk about exports the Chinese export a fair bit of dry product into the European market in particular for a fee. And then to some degree we found them exporting some products to the United States for fracking. So, I think there is kind of two different animals there in terms of end market if you will that may lend themselves a bit more a quality and not. At the end of the day, I think everybody is under price pressure.

And I won’t sit here and say that there – that the plant has heavy issues, quality good-bad, on and off I think is always there. Some people have learnt to live with it and we’ll leverage the low cost that they offer into the market. We have not gone there as I said. We’ve looked at export business in other parts of the world and quite honestly, yeah I can tell you we can be competitive but the margins just are not interesting. So, as they’re willing to take a price into that market, that’s quite honestly a very, very low margin position.

Well, and again I’m not going to make accusations but I’m not sure they’re generating investment type returns and maybe that’s why an incident happened. So, it all ripples down, if you’re a healthy supplier and you can do good business then chances are you’re going to have a good business. And hopefully the marketplace would value your quality and quality goes to not only the product in and of itself, but I think from a financial performance capability to be there long-term for you. And that’s yeah so we kind of fight ourselves in.

Brian Rafn – Morgan Dempsey Capital Management

Okay, no, it’s a good answer, good answer. Where the $144.7 million, where is that cash invested?

Dino Rossi

We have it in critically in two major banks and basically it’s the money market type accounts, all very safe and no real risk involved in any of it.

Brian Rafn – Morgan Dempsey Capital Management

Okay, okay. And maybe one question, your sense on kind of the U.S. dairy market, there was a little discussion you said there looks like their herd calling is decreasing a little bit. And are you seeing maybe for your products deeper penetration with individual farmers or are you seeing broader penetration for more dairy farmers?

Dino Rossi

I think the answer is yes and yes and remember I mean our product is still the lot through nutritionist as nutritionist has worked for a number of diary managers if you will. So, definitely seen greater penetration if you will with an existing but also definitely seen growth outside of that to other herds as well.

Brian Rafn – Morgan Dempsey Capital Management

Hey, thanks guys, super job. Thank you.

Dino Rossi

Thank you.

Operator

Thank you. Our next question is coming from Lenny Dunn from Freedom Investors. Please proceed with your question.

Lenny Dunn – Freedom Investors

Good morning.

Dino Rossi

Good morning.

Lenny Dunn – Freedom Investors

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

Dino Rossi

Well I would say that there is probably three of four projects that we have underway and coming back to the other question about lot of our cash is I mean we’re trying to keep this really available to do transactions which should give you an idea that we think there is some things maybe we can get done near-term but you never know until you know. So, we’re trying to take position for that accordingly. As your question about buying higher margin businesses, while we can sit here and point to maybe a little, maybe 1% or 2% erosion in our margins, I’m going to say largely due to raw materials and to product mix. I think that they’re still yet strategically in the direction that we want to go.

So to think that we’re going to go out and buy some that’s truly a higher margin business, I am not sure I really want to do that so I think that maybe we can make an acquisition and we can leverage based on what we are to get higher margins i.e. 1+1=3 would be desirable and certainly always you know kind of an interesting piece of the puzzle as we look at these possible acquisitions.

So you know, I know, I’ve been in the past been accused of being a buyer that’s on the low end of the deals, I think that’s worked well for shareholders and we’ll be able to continue to do that on a go forward basis, I am not sure but certainly as we are conscious of the fact that may be we have to pay a little bit more for some of these deals, the answer is yes. And I would tell you so to that’s not at all rate limiting in terms of our view of these possible acquisitions. The key is that they are strategically good fit for us and are fitting if you will the strategic objectives that we’ve identified.

Lenny Dunn – Freedom Investors

Well, I not am clear but my point really is clearly you are getting some top-line growth without getting commensurate bottom-line growth that we had in the past and the cash itself in the current environment earned actually nothing.

Dino Rossi

I don’t disagree, you know we are not happy that it’s not deployed and being levered I’ll say for the benefit of shareholders that’s the we don’t like it perhaps anymore than you do and so I’d say we continued to look at these opportunities in an effort to get it deployed and earning a better return.

Lenny Dunn – Freedom Investors

Okay, well thank you for answering my questions.

Dino Rossi

Thank you.

Operator

Thank you. Our next question is coming from Tony Polak from Aegis Capital. Please proceed with your question.

Anthony Polak – Aegis Capital

Good morning.

Dino Rossi

Good morning Tony.

Anthony Polak – Aegis Capital

Tax rate going forward, we expected them at 34.5% level.

Dino Rossi

No about 33%, Tony.

Anthony Polak – Aegis Capital

Okay. So there was something this quarter that was made it higher specifically?

Frank Fitzpatrick

Yeah, we talked a little bit about the – R&A credit did not come through at the end of 2012, so it’s all being, for 2012 is all being pushed into ‘13 and just some additional states coming into the mix had to have resulted in the right coming up little bit.

Anthony Polak – Aegis Capital

Good, could you refresh my memory what the capacity of the Virginia plant will be?

Frank Fitzpatrick

Well, the first tranche of it is high, and I say that because we’ve definitely build it to be kind of modular in terms of the ability to expand, first tranches to produce, ballpark, I am going to say approximately 20 million pounds of products.

Anthony Polak – Aegis Capital

And which is...

Frank Fitzpatrick

Which is about as doubling of what we have today.

Anthony Polak – Aegis Capital

What is that in dollars?

Frank Fitzpatrick

Oh, no that’s pound.

Anthony Polak – Aegis Capital

No, what if in dollars?

Frank Fitzpatrick

Near probably 40 million to 50 million.

Anthony Polak – Aegis Capital

Okay and, is there an expectation when you go get to that level?

Dino Rossi

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

Anthony Polak – Aegis Capital

So, correct me if I’m wrong and you think you can be at that run rate sometime in the second half this year?

Dino Rossi

No, I said that, I don’t know we’ll be sold out.

Anthony Polak – Aegis Capital

Okay.

Dino Rossi

So, we are not projecting that we will be at that run rate. But I think that what we would do would be look to be in advance of if that market does continue we’re and certainly we’re in position financially, we can easily do that. But if that expansion could come in terms of positioning for the what would believe to be the future growth opportunity in that market to be in place by Q4.

Anthony Polak – Aegis Capital

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

Dino Rossi

Yeah, hang on a second. Tony we’re going to dig it out and get it to you. I can send you an email.

Anthony Polak – Aegis Capital

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

Dino Rossi

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

Anthony Polak – Aegis Capital

Great. Great quarter. Thanks a lot.

Dino Rossi

Okay. Thank you.

Operator

Thank you. Our next question is coming from Lawrence Goldstein from Santa Monica Partners. Please proceed with your question.

Lawrence Goldstein – Santa Monica Partners

Hi. When I first invested in the company, the revenues were $8.4 million that was before you were born, that was in the – it was actually 1988. And what got me interested among other things was, encapsulated food ingredients. And obviously that’s grown although I don’t think we know what share it is of the $300 million of revenues and you don’t’ have to say it but if you would that’d be interesting to know.

But what I am wondering is, I get the feeling that it hasn’t grown in line with the whole company and the other day when there was a press release put out about Van Eeghen partnership and by the way I imagine you didn’t put it out maybe they did. Correct me if I’m wrong. I’m wondering is that something that that partnership that you think can become a material factor or should we just dismiss it as so much PR and by the same token if I’m not mistaken, Propel Pepsi Propel has been out maybe 10 years or maybe even a little more.

And I presume you’re still selling them cooling that’s in it has that become of any – is it percent of the business. And so what’s going to, what’s going to happen if anything that you can foresee to make food ingredients, encapsulated food ingredients ever really take off and I realize it was Van Eeghen and the Propel is not capsulated.

Dino Rossi

Yes, so as the Van Eeghen deal is really choline rather encap food ingredients. And certainly we’ve done that because we think that that market is going to grow, we got the EFSA approvals and so we think the opportunity to move choline into more products like Propel if you will. We don’t need some formula and what not, our real opportunities over there and that was the key driver behind, getting that employee that shared employee if you will on board and being focused clearly on that within the Van Eeghen organization.

So yeah, we did it because we really think there is upside opportunity there and we want to be able to leverage if you will those EFSA claims in a larger way with local people. So that’s really what was behind that, clearly with the absences and the view that there is upside opportunity there.

A lot of that development work on getting Colleen in those other products will really rest clearly back here in the States in terms of technical development and we are working on that. So I think our view is that there is definitely good upside opportunity on the Colleen piece of that FPN business. Jumping on to the Encap side is a business I think that, there is definitely been volatility where you’ve said it, I think I’ve said it earlier and in terms of back to, kind of the life cycle of a lot of these new products and we’ve seen this business grow, 15, 16, 17% on the back of new Encaps being launched into those markets and then it backs off a little bit, some of that’s ramp-up of new products into this space.

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

So, we’ve really done a lot of work on if you will stage gate management of those project in an effort to make sure that we’re spending our time on good quality, upside opportunity projects there to hopefully see a more, I would say a consistent growth rate there, take out some of the volatility but as I said there is nothing that we can do to stop one of the larger food companies from discounting our product. It just doesn’t happen to be moving as much in the market anymore. So that’s always kind of the backdoor that we really just can’t control.

Lawrence Goldstein – Santa Monica Partners

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

Dino Rossi

No, in fact, I think you will only find choline with them in one or two of their propel products not across the Board. So and I think there too things are little bit out of our control for sure but depending on the flavors of those products and the introduction of different ingredients you may have off flavors they could generate and then take away from the ability to put them in there and so they go through sensory testing and panels and whatnot. So I think they would like to have a product that has as much nutritional value and lot of these vitamin water type propels whatever drink, I think the answer is yes all day long but what we know as we haven’t been successful in getting into everyone of those.

Lawrence Goldstein – Santa Monica Partners

I see, thank you.

Dino Rossi

Thank you.

Operator

Thank you. This concludes our question-and-answer session. I would like to turn the floor back to management for any further or closing comments.

Frank Fitzpatrick

Okay. In respect the answer to Tony’s question regarding research and development in the quarter there, we spent approximately $800,000. Dino?

Dino Rossi

Yeah, and so with that said too, I just – this is Dino, I just wanted to say thanks to everybody for listening in to the conference call. Hopefully, it was a good session, posed a lot of good questions. I think our view going forward here is – still very, very positive, lot of good opportunities, new challenges always but look forward to talking to you all again in the next quarter thanks bye.

Operator

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

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