Oil-Dri Corporation of America (ODC) 2004 Q2 法說會逐字稿

Good morning. My name is Amanda, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Oil-Dri Corporation of America's second-quarter earnings teleconference. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during this time, (OPERATOR INSTRUCTIONS). And at this time, I would like to turn the teleconference over to our host, Daniel Jaffee, President and CEO of Oil-Dri Corporation. Mr. Jaffee, please begin.

Thank you, Amanda, and welcome, everybody, to our second quarter teleconference. Before we get started, Rhonda, you have got some statements to make?

Sure. Thank you, Dan. As always, it's my job to remind everyone that this teleconference may contain forward-looking statements regarding the Company's performance for future periods, and actual results for such periods may materially differ. To review those factors subject to uncertainties, you can refer to the written earnings news release and to other documents that the Company files with the SEC. Thank you.

Thank you. And I'm sure everyone has been looking forward to our teleconference. It was an excellent quarter, continuing the momentum we have established, really, six quarters ago; it's our sixth consecutive year-over-year quarter advancement. And I'm going to cover some qualitative highlights, and then Jeff Libert, our CFO, will dive into the numbers. And as always, then we will spend the majority of our time in a question-and-answer session. So please feel free to get your questions ready.

A couple of things that are qualitatively impacting our business, both, really, on the positive side and one's on sort of the strategic neutral side -- on the positive side, the grocery strike out in California ended today. And that's very positive because the acquisition that we made, Jonny Cat, is overdeveloped, I will say, on the grocery and in the West Coast.

It enjoys the largest market share out there and would be the brand that would be most impacted by a grocery strike, although people still need to buy cat litter. So they may go to other alternative formats, and even the stores were getting creative with just dropping pallets off at the stores to try and keep the store stocked.

But be that as it may, we are very happy to hear that the grocery strike is ended and that the workers are expected to return some time this week.

Segueing into Jonny Cat -- and I don't like to get into the IRI information too much, but it is something that we do monitor on all our brands and in particular with Jonny Cat, because when we took the brand over, it was showing steep double-digit decline for, really, a two-year period. It was dropping at 20 percent a year for two consecutive years. And one of our big concerns when we made the acquisition last December was, could we stabilize the patient or was the patient in trauma and not going to come back?

And very, very happy to see that our assumption that it was due to neglect and not a lack of brand relevance was why the brand was in decline has really shown itself 52 weeks later. We've had the acquisition for a little over a year, but these -- you know, IRI information gets a little bit of a lag. So in the most recent period, in the course category and let's just look at a 12-week snapshot first. The course category is down 6.5 percent because, as you guys know who have been following our stocks, people have in general been going from course to scoop. And so, on a dollar basis, the dollar ring on scoop is higher. The course category has been declining in dollars pretty much every year for the last 10 years, and it is showing the same. Down 6.5 percent.

But Jonny Cat course during that same period of time was up 1.5 percent, so we outperformed the category by a significant margin and not only stabilized the patient but are actually starting to show a little growth.

If you look at the four-week period, which tends to be misleading but it was pretty particularly gratifying because it was right in the heart of the strike, we tried to be aggressive with keeping our focus and attention on Jonny Cat. And so, the category was down another 6.4 percent, so very similar to the 12-week period. But the Jonny Cat course was up 14 percent during the most recent four-week period.

So clearly, the job that Wade Bradley and Tom Swank and John Blackitch (ph), our key executives, are doing on that brand is paying off. And it's been package improvement, it's been getting quality back into the bag. We have improved the products where we have removed the dust and added more odor control. And I think those moves, along with just getting some trade support around it, have really not only stabilized that brand but given some vitality to it.

So checkmark number one as major concern is now behind us from the acquisition; that was certainly an unknown looking forward. And now, a year out, we are real happy that this is the case. I probably would have been happy if we had just stabilized it to a minus five or keeping pace with category.

And we are actually showing that we are outperforming in the category, so that's very good news.

The next strategic issue I'd like to cover is the exit of Phoebe (ph) products, where we sold our dog treat business during the quarter. And really, this was for strategic reasons. When we got into the dog treat business, it was to leverage our trade presence through our cat litter brands and try and piggyback another pet item. And so we said, what could we get into? How about pet treats?

Well, the strategy actually worked fairly well because we were able to get good distribution on Smart snacks, which was the brand that we created around dog treats, and we got distribution at major retailers like Wal-Mart, major grocery players in the Midwest and elsewhere -- Dollar General. We got a lot of good distribution on it.

And, while the product did sell in various venues, it either didn't sell well enough (indiscernible) hurdles where other guys jumped in, knocked us off and knocked us out, or it sold well enough where it then made the retailer take pause and say, hey, I can do that same thing, that healthy treat, only I will get someone else to do it cheaper and offer better value for my consumer.

And that's what they did because we never spent enough money to really develop a brand equity behind it. We were not going to do that; that would have been a big bet the ranch scenario, which was not going to happen.

So we really did test the strategy. And I'm glad we did. We call a lot of that stuff kissing frogs exercise; it's when you kiss-a-frog and you are not sure whether it's going to pop up to be a princess or not. This one looked like a princess for a little while, but in the end it really ended up a frog.

And the dog treat plant, though, is doing fairly well. It's a regional private label, what we call functional treat facility where the treats have some healthy benefit to them. And Pete Fillman (ph) -- who has acquired the business back from us -- we acquired from him, and he ran it for us the past few years -- is going to have a good little regional business there. But that is not what we were getting into it for; we were not looking to be a regional, private-label, functional treat supplier. So this was really a good strategic move for us, good for him. We can focus our manufacturing logistics guys' attention to continue improving our products and taking costs out of our core business and not getting diverted every once in a while to have to run off and take a look at dog treats.

So I really think this is going to help the rest of the business. It does not have any kind of material impact on our sales or earnings, and so you don't have to change anything going forward in your models. We are certainly not, and this is just another chapter in our strategic history, as it were.

The last subject I would like to cover before turning it over to Jeff is just the general topic of stock options. We -- at Oil-Dri have granted stock options for years and years. I can tell you, in my seventeen years here, though, they have never been a real source of value like they are now. And that is good news because the Company is doing well and the stock is performing well and we have had them long enough to be vested.

And so you're starting to see some insider sales by some executives who are trying to diversify other portfolio. And frankly, I encourage them to make whatever decision they think is in their best interest. This is an individual decision, and I in no way am putting any kind of signals to them that any kind of an exercise we would look down upon.

It's completely up to them; this is their asset, they have helped create the value, and they should do it, what they think is prudent.

I am asking myself the same questions, and my wife and I are going through the analysis. And certainly, from a diversification standpoint, it probably will make sense to take some of the money off the table so that then we can let the rest of it really ride as the rocketship continues to take off.

I mean, that's my opinion -- and again, I am qualifying this. But this is my opinion, that the best is yet to come. I've said that before, that on a scale of one to ten I think we are at about a three. But on the other hand, my grandfather some 60 years ago impressed upon my father, who impressed upon me -- and they certainly did not invent this, but it has permeated the Jaffee family. Bears make money, Bulls make money, pigs don't. And I have another friend who said, I never heard anyone go broke taking a profit.

So I am probably going to start looking and, once the window opens, taking some percentage. I can't imagine it would be any more than 20 percent, so I would certainly let 80 percent of my option continue to run. But then that will give me the confidence to let it run. So I'm just sharing this with you because I don't want it to ever look like any kind of an indication that I think the best has already occurred and that now it's all downhill from here. I actually think the opposite is true, that we are really at the beginning of a very exciting run and look forward to each quarter, proving that in the results like we did here in the second quarter.

So with that segue, I'm going to turn it over to Jeff Libert, our Vice President and Chief Financial Officer, for the play-by-play.

Thanks, Dan. Very strong quarter to report about and a half-year to report about. Sales have increased for the quarter -- 7.5 percent -- and 14.5 for the year-to-date. Fully diluted EPS increased to 29 cents from 21 cents a year ago for the quarter, and to 58 cents from 29 cents a year ago for the half. That is a 38 percent and 100 percent increase, respectively.

Beyond the EPS, the actual dollar numbers of earnings are even a little bit more impressive. Net income increased to 1.7 million in the quarter versus 1.2 million a year ago or 42 percent for the year. I'm sorry, for the quarter --

-- and increased to $3.4 million versus $1.6 million a year ago, or 111 percent. And the reason those numbers are a little bit better than the EPS numbers is dilution that Dan talked about a little bit ago. We are seeing some stock appreciation that is affecting our EPS calculation for dilution. As usual, we have some unusual items which we like to tell you about so you can assess them as you will. Last year -- in the year-to-date, I'm sorry, we included a -- last year's year-to-date we included $139,000 gain on the sale of mineral rights in the quarter, and in the year-to-date included a one-time contractual gain for $175,000.

This quarter's numbers include a loss on impaired assets of $464,000 and a packaging write-off related to the sale of Phoebe Products related to the Smart Snacks business of $200,000. If you took these items out, pre-tax income would have been $5.5 million this year and last year would have been $1 million and some change excluding (ph) these items. So as you can see, this year's items were negative and last year's items were positive. Year over year comparison is more impressive when you take these items out.

So one of the most key reasons, though, for the improvement is year-to-date improvement in the gross profit percentage. This year's gross profit percentage is 23.6 percent. A year ago we were two points less than that at 21.6 percent. And so that has really been a big factor in driving our improvement and profitability.

Getting into the details as to why, I think I will hit on some of the same things we talked about in previous teleconferences. The Taft and Jonny Cat acquisitions continue to perform very well. We added in that acquisition higher-margin brand of businesses, and we are seeing that fall to our bottom-line.

But in addition to that, we are also focusing on selling more profitable items of our portfolio. We're selling a lot more branded scoopable cat litter then we have in years past, and that is helping our overall margins. In addition to that, we also have been taking price increases. Our average selling price for the Company is up 8 percent year over year. A lot of that is due to mix, some of that is due to price increases, but a lot of that has fallen to our bottom-line.

So a very positive story there.

In addition to that, we are seeing good volumes across all of our businesses and so, while we are selling a more profitable mix and while we have increased prices, we have not seen that affect our volume at all. We are continuing to see very strong movement of our product.

We are also -- another key reason would be that we are focusing on process improvement in our manufacturing. We're seeing cost decreases, we are focusing on obtaining purchasing efficiencies and continuing to focus on increasing our plan productivity. A lot of that has fallen to our bottom-line. So that is really the major themes that we talked about in the past that continues to affect our quarter and our year-to-date.

We have, however, seen some negative things. We have overcome a few things, for one. We have seen a 23-percent increase in the cost of our energy. And, as many of you who have participated in these teleconferences know, we are a very energy-intensive business.

We use fuel to drive out the cost of moisture in our products, and for those of you who have opened your utility bill, you'll see that this year gas prices have continued to be very high this winter. And it's been much higher, overall, for the year if you look at the total mix of what our fuel costs has been.

Additionally, one other small thing is, we've incurred $120,000 worth of cost related to closure of our Crystal (ph) Valley facility. We closed the facility late last fiscal year, and we see a little bit of cost coming through to this year affecting our overall numbers.

Looking at the individual businesses, looking at consumer, sales are up 8 percent for the quarter and 17 percent for the half. Again, we will hit upon the major theme of the Jonny Cat acquisition; that's a big driver of that, in addition to selling more profitable items, higher-margin and higher-priced products. As Dan mentioned, we were in a steep decline in sales at the time of the purchase. And we've invested in the product and stabilized the brand. We're beginning to see that in the numbers. And year over year we're seeing virtually no decline in the business.

Additionally, north of the border, in Canada, we are seeing strong private-label sales, and that is affecting our numbers in addition to the strong Canadian dollar versus our U.S. dollar beginning to make an impact. And we are also seeing that in our sales numbers and profitability numbers.

In new crop production and horticultural products, sales were flat for the quarter but we were up 17 percent for the half. We had a very strong first-quarter with our ag business, and in the second-quarter we're seeing that level out. And I think what is causing that is we tend to have very strong second and third quarters in the ag business. We actually sell out our plant facility; we maximize production. And we can not actually produce anymore than we have because we are maximized at the plant. And so, therefore, there is not that many possibilities for increasing revenue year over year.

When we have strong years, it's because we have very strong first and fourth quarters.

Our sport serve (ph) sales, however, did have a slow quarter. We're down slightly for the year in that business. However, typically, our strongest quarter is the third quarter. And we are hopeful that we will see improved sales this spring.

Our industrial business is up 8 percent for the quarter, and 11 percent for the year. It has been very stable. We have seen these increases, due to the Taft acquisition and the accounts we obtained along with the acquisition, and additionally we also raised prices and so we are seeing some of the effect of that.

Our specialty area is up 18 percent for the quarter and five percent for the year. Leashing earth (ph) business was very strong during the quarter. Oil processors were very active. They tend to be somewhat cyclical; there are strong years with the quality of the actual product out of the field, they use less. Where there is weaker crop harvest and there is more say impurity in the oil, we see stronger sales of our products. And I believe that's what's going on this year.

Additionally, our Poultry Guard business has seen strong growth. We have attracted and retained new customers as we continue to demonstrate added benefits of this product.

One of the things that we always talk about that we are especially proud of is the progress we're seeing in our balance sheet. As in the past, we continue to see very impressive gains. Cash investments were up almost $8 million from a year ago, while debt is down $4 million. Included in that -- numbers you have to consider to consider that we repurchased $2.7 million of stock during the year, and during this quarter we have repurchased about $300,000 worth of stock. So cash gains have been impressive. Our balance sheet continues to be healthy.

Days outstanding of receivables is flat from a year ago, and inventory turns remain about the same as a year ago. And so we continue to focus on cash management, and we also continue to focus on efficient management of capital expenditures. We have underspent depreciation by about $2 million for the half. In the second half I expect expenditures to be more at a level consistent with our depreciation. We have some large capital investments that we are making in the second half of the year to support growth opportunities and also to reduce our cost.

So overall, I still see our balance sheet as very positive, and we are continuing to generate cash.

A very good story to report this quarter.

Thank you, Jeff. And before opening up to Q&A, a couple of things that I would like to add. We did raise the earnings expectations; we outlined that in the news release. I think we started the year at 70 to 85 cents. We then raised it at the end of the first-quarter to 75 to 85 cents, just bumping the bottom of the range. And this time we raised at a full-time dime on both levels, at 85 to 95 cents. And to me, the most gratifying part about that is we are really doing this but with the absolute communication to you guys that we're going to be investing heavily in the back half of the year on rolling out some of the new product initiatives that are going to benefit F '05 and beyond.

So we believe we will be able to show our shareholders a very nice increase over the 54 cents we made last year but still be investing heavily enough to then make F '05 the banner year that we all hope it will turn out to be. So that was particularly gratifying.

Moving on to Q&A, we actually found that we had more authority here than we thought. We have the ability to turn off people's power to ask questions. And we almost used this. And we almost used this. We almost threw Bill Patterson into the Q&A penalty box, but we decided not to do that to him this time.

But I do encourage all of you to be on your best behavior because Amanda has told us we do have that authority, and by God, we will exercise it. No, I'm just kidding.

Amanda, at this time, we would like to go to the Q&A session of our conference.

(OPERATOR INSTRUCTIONS).

I probably scared everybody. I was just kidding.

They are rephrasing the questions.

Larry Litton with Second Line Capital Management. Mr. Litton, your line is open, sir.

First of all, can you refresh our memories as to what percentage of the cost of goods is energy prices? And thinking along those lines, if energy prices were to spike dramatically, additionally, over the next 12 to 24 months, is there a price point where you feel there is a substitution problem, a competitor substitution issue with our product with other litters or something else?

First question, Larry, is, what the percentage of our cost of goods is energy. And we have looked at this in the past, and energy sort of takes a number of different forms in our product. We use a lot of energy to dry out the moisture from our product; but also, in delivering our product, we have a bulky, heavy product; and energy is a significant cost of transportation. I think we looked at it not recently but it's been about (technical difficulty)

And, Larry, Larry, let me answer your second questions. I always hesitate to answer in too much detail, only if in the event that I would then educate competition. But on this one, I don't think I will. So I can be perfectly open with you and not hurt ourselves competitively.

Fortunately, gas represents less than 15 percent of the fuel we use. So, a spike in natural gas -- what it does tend to do to us is the other fuel sources that we would use tend to follow along, but they have their own competitive dynamic. So let's say they were all to spike, which they don't tend to all move together. But let's just say somehow they were, to answer your question theoretically.

It would have to be unbelievably dramatic before there could before they could be some sort of substitution because that has been both -- that has really been the blessing of this business in the 63 years that we have been running it is that he or she that is closest to the market is going to be more competitive because freight -- while fuel is what fuel is, freight is about one-third of our delivered cost of goods. It's always the single largest component of our cost of goods sold.

So there really is not going to be something coming up -- they tried the silica gels from China, and it has taken a couple of percent of the market but it's showing no growth and it's not really going anywhere. So now they are sprinkling it into the clay cat litter so they can call it a mix. But it's literally less than five percent blend. The other 95 percent is still clay.

And so, no. I don't think substitution is the real issue. The real issue is, are we going to have the guts -- and we did last year, and I am telling you now we are going to have them again this year -- to quantify the impact and pass it along to the customers? Because this is not a cost we can control in terms of the price. Certainly, the usage is something that we are very focused on and we're trying to be as efficient as we can. And as we pointed out, we try not to use the most expensive fuels when they spike.

But at the end of the day we will know what that bucket of incremental cost is going to be, and we are committed to recouping it in the market.

And at this point, is our product -- what degree of today's market price of fuel is priced into our product? Or do we perhaps have a price advantage over competitors for the moment because we are pricing things off of a forward contract as opposed to market?

You know, they have not disclosed. I'm not sure what our competition is doing, but I can tell you what we're doing, which was -- a year ago we had the same exercise. And we nailed the price pretty well somebody well; we put in what we call a fuel tool where we put in the gas and the other fuels that we will use. We project what we think the cost will be; we basically hit calc, and then it tells us what the incremental cost in fuel will be by SKU. And then I go to the general managers, and I give them their target for the year. And they know what they have got to recover, or we are going to see margins decline. And nobody wants to see that happen. And they executed very well against that strategy.

But I am not clear, though. The contracts that we are working under, the forward fuel contracts -- we are buying fuel that is considerably below market, on average?

I would say the market is something you have got to look at on an annual basis as opposed to a month because there's been months where we have been better and there have been months where we have been worse. And I wouldn't say that the current price or our future is a bargain by historical standards. The price of gas used to be in the 2s, and if you look at our 10-Q you will see that the price when we (indiscernible) in the fives. So it is not something that has been a recent phenomenon or all of a sudden it has spiked up and we have got this great bargain that we are moving on this year. We are looking at it year to year and see how we change, and we are seeing upward pressure on fuel, but it's not likely we have got a bargain today.

Larry, I guess the number-one take away I would as an investor want to feel (indiscernible) the answer to, and you can feel good about the answer, is that we did a year ago plug these into our models. We went out and raised prices. And at the midpoint our tonnage volume is up. So what you're seeing is we do have pricing leverage, and we were able to communicate very well to our customers why our products are still a very good value to them, why we're doing everything we can to control all inputs that we can control. But there are some inputs like natural gas that are outside of our control. OPEC does not tend to call us too often when they are making their moves, and yet our volume has gone up, not down. And to me that was a very clear signal that this business is not only sustainable but has some real powerful aspects to it.

Ethan Starr, private investor.

What are the new products you plan to introduce?

You mentioned making a marketing investment in new products introductions. Can you tell us anything about those?

Yes. Again, I hate to give too much because I don't want to give the competition advance warning on this. But let me just say that they are all utilizing existing core technology; they are all going to be clay-based in some way, shape or form. And the major ones that we will be announcing later in the year because they will be out in the public by then are basically taking existing products into new geographies where there is a current void, yet there is certainly a lot of relevance in those markets -- the people are buying products, just not our products. We have done the testing to show that they would love to be able to buy our products in those formats.

So it's going to be like product line extensions but in new geographies. But I don't want to get into too much detail because all I am going to do is create a lot of competition.

Well, is one of the new products a porous ceramic product that will benefit bricks?

No, that is not one of the ones that I was just referring to. If you have an idea along that, feel free to send me an email. That could be a possibility; I'm always looking to get new applications.

No. Okay, but nothing else new in research and development, I take it, since last quarter?

We have a lot new, but nothing -- you were referring specifically to my comments on increasing our spend in the back half of the year for these rollouts. And no; those are not coming out of what we call the innovation center.

Okay. So there is a lot new in R&D, then? What is new?

There is a lot new.

And again, I -- basically nothing new since the last teleconference other than we are moving along the testing cycle in one of these exciting applications. And, obviously, you want your customers, your new customers, to be very methodical because when they do adopt you it will then make knocking you out that much more difficult because they are very slow to change. So they went with very small pilot tests, a little larger pilot test. Well, now we're anticipating and we are already on schedule to where they are blocking out the full-scale production time to doing major tests in plant. And so we're clearing the hurdles as we go, but it's methodical, maybe slower than we would like. But at the end of the day, when we do get into them, we are still confident that we will, that our products will have a lot of sustainability. So that one is the big and bright one that we talked about three months ago.

Robert Smith with Center Four (ph) Performance.

Congratulations. I feel very good about how the business is going. It's been a while, but things seem to be clicking. So congratulations again.

I need a clarification on a couple of numbers. One, I thought I heard you say that you took price increases averaging 8 percent across the board?

No, no, that's not what I said. I said our average sales price is up 8 percent. That's a combination of price increases and product mix.

So what price increases?

We did not do one across the board because we did --

I mean in the companywide index. I just was wanting to get an idea as to how much of the revenue increase is price.

Around three percent.

I'd say 3 percent is price and 5 percent is mix.

And then the specialty category -- what was that up for the quarter?

Specialty category was up 18 percent for the quarter.

I think in the text it said 12 percent, so that's why --

We will take a look at that. (indiscernible) right; I probably misspoke -- probably 12.

Okay, so it is 12? All right. And what can you tell me about Poultry Guard? You made a comment that it was going well.

I prepared for Poultry Guard, and I don't believe this is material enough to trigger any kind of FD disclosures. But if it is, so be it. At the midway point last year, we had done under $.5 million of Poultry Guard. And now at the midway point this year, we are basically just under $1 million. So we have doubled the running rate of Poultry Guard, which is nice. I will say that we are still not to where we need to get. A year ago we year ago we were still in the investment spend, where we had way more resources than the volume would justify. So this year I would say we are basically at breakeven, at that current level. So we need to see probably another doubling again a year from now to say, hey, this thing is contributing now to the profits of the Company. But, incrementally, it is certainly doing better than a year ago because a year ago it was in the red and now we're sort of at break even. So the trendline is very healthy on Poultry Guard.

It's a seasonal product; right? So what is the peak season?

Well, you know, that's a good point. When we launched it, it was a seasonal product. So the peak season were these winter months. But we have had such a strong first half, most of which was not winter, because we are finding uses outside of the traditional use, which was pure ammonia control in the winter months when they closed the windows down because the heating costs and takes over the cost of using a litter treatment to knock out the ammonia.

Now what we are finding is there's this whole other application where they are using it to fight the Darkling beetles and -- pathogens -- thank you; that was the word I was looking for, pathogen control. Ronda pitched in. This is the footnote there. Pathogen control.

And so they are using it year-round now, so we had a very strong first quarter, which is August, September and October, which -- a year ago and in past years was just inventory build time when we saw no orders. So this -- it's getting exciting. We're even, now, looking at the export market for it and finding some nibbles overseas as well.

So it's moving in the right direction. It just needs to be bigger before I can claim it a victory.

And how about Camp (indiscernible)? What is happening there?

I knew you're going to ask about Camp Jerker (ph) there really is nothing new in Camp Jerker unfortunately. Jeff, I don't know if you --

I do have a small update. There's this other technology they are working on with liquid feeders, and those continue to be promising. But in terms of the basic priming technology, that seems to be status quo.

You have told me in the past that the acreage planting has been going up. Is that still true?

I have no update for you there; sorry.

Pardon?

I have got no update for you there; sorry, Bob.

I will commit that next quarter -- because I know nothing is on the front burner; that's for sure. But will commit -- we will give you a full-scale update on Cam Jerker (ph) for next teleconference.

Larry Litton with Second Line Capital Management.

I like your comment on kind of the flip side of the commodity question. We have this theory about China and India, and I realize we are not going to be exporting cat litter there. but everything from coffee to oranges too precious metals to nonprecious metals -- there seems to be a demand factor that is leading to fairly dramatic or gradual commodity price increases. Is there a point, either in terms of product application or anything else, whereby clay begins to appreciate based on it being a limited resource and grow in worldwide demand?

Yes. I think you are already seeing that in some sense. I mean, what you're seeing is that the demand is continuing to either bump up or in some cases outstrip the ability to supply. You have seen a number of competitors fall off the map, either through acquisition or through outright plant closures. And so you're at a point now where going forward you have got this nonrenewable resource. And you have got a couple of companies who are committed on the supply side.

Really, there is only one company, and that's us who is doing the basic research necessary to find the new applications. And it's pretty exciting, because you go through the discussions with the team. When we were talking about price increases, for instance -- how long are you going to lose X percent of my business? So then you apply that percentage to our total, and we've said this before. We do it a million times. Let's just say, they are all claiming they are going to lose 25 percent of the business if they raise the price.

Okay, that's 250,000 tons. Where is it going to go? There's nobody out there with that kind of idle capacity looking for 250,000 tons. It's a game of musical chairs, and you have got about 18 people running in a circle, and there are only about seven chairs. So it wasn't going to happen. It didn't happen. We raised prices, and the volume grew.

So, we didn't see a 25 percent reduction. So I think your point is well taken; there is no crystal ball, but, clearly, it's one of the reasons why I do feel on a scale of 1 to 10 we are still at the beginning of this whole thing.

The demand equation is still very North American factor. Nothing that goes on in Europe or the Far East hasn't had an effect on demand. Unless there's a new application, perhaps -- construction or bricks or something -- whereby we become a competitive product to cement or steel in some applications or something like that.

You are always going to have to overcome that freight hurdle. We have certain geographical spheres of influence, and the products like Oil-Dri floor absorbent which has been around for 60 years, have a smaller sphere. You're going to sell close in and make money. If you try and sell far away from your plant, you're not going to make money because someone is going to be closer. Or there are substitutes, as you pointed out, and the consumer will go to those.

You've got the higher-end stuff, where there's a lot of value and where freight means much less to the equation, like our bleaching earths that we sell into 60 different countries and the world, your circle is pretty wide. You can ship that stuff all over.

So clearly, what we're spending our research dollars on is finding those value-added applications where our sphere could be quite large or where at least the defined market is so large that maybe it is near our plants but it's so big, it's fine; we don't need to go into far-flung places to make our next millennium as positive as it can be.

Lastly, is there any application for us in any of the construction markets, bricks or something like that?

You know, if you have got specific ideas, I'm all ears. We are looking at everything, so clearly we want to be in daily reusables, big applications, big business-to-business versus consumer. So you're touching on some clear areas that we would love to see our products used in, and, certainly, that is what Steve Azzarello and his people are trying to find applications for. But if you have specific ideas, please email them to me because we are all ears.

Ethan Starr.

Considering the rather heavy volume of trading in Oil-Dri stock in the second quarter, why didn't you buy back more stock during the quarter?

Ethan, it's Charlie Brissman. While we are delighted to see the average daily volume up so significantly on a percentage basis, you do need to keep in mind the tiny base off of which we were operating. But I guess the more direct answer to your question is, as a practical matter, our insider trading compliance procedures effectively keep the management team and the Company out of the market for significant portions of the quarter, just as we process our quarterly results and that sort of thing.

So, while the Company has standing authorization from the board to continue the buyback program, that activity is always subject to our trading window closing as it does in almost every publicly traded Company from time to time.

Also how many shares are outstanding at the end of the quarter?

I believe it's 5,700,000.

Fully diluted. It's 5 million --

No, no; basic.

(MULTIPLE SPEAKERS)

Yes, 5,600,000 -- 5,500,000.

(indiscernible)

Robert Smith with Center For Performance.

I have a couple. First, when you say your new estimate range is 85 to 95 cents, conservatively, what kind of an upside do you have in something like that? In other words, you say you're going to have some additional expenses in the second half, marketing. How do you define conservative?

Bob, unfortunately, you are asking another question that goes to the lawyer. It's Charlie Brissman. That's the sort of commentary that I don't think we're in a position to get into.

Yes, but why did you add the work conservatively? That's what interests me. You gave a range, so if someone would give a range I would say that, well, 85 cents would probably be conservative. 95 cents is more optimistic. But you guys say 85 to 95 cents, conservatively. So that's what kind of turned my head.

Well, Bob, but you're talking about a Company that really gives guidance according to one benchmark, and that is EPS for the year. When we find ourselves, as we did this quarter, warning to change that guidance on the upside, I think that word is in there to remind investors that we're dealing with sort of an inherently difficult-to-predict animal and we are doing it with still half of the year to come.

Second question. I thought I heard the word, when you're talking about new products, now it slipped my mind with the word was. You used the word that -- well, embarrassingly, I don't know what the word is. It's on the tip of my tongue and --

I used the word, or one of the questioners?

Yes. When you're discussing the new products you -- okay, let it past.

Go back in the queue and maybe it will pop back.

Okay, I will.

Okay, good.

Larry Litton with Second Line Capital Management.

I may end up back in the lawyer's queue but --

Or in the penalty box!

Worse yet. The comment, The best is yet to come -- can you expand on that a little bit? And is it possible to talk about kind of three- to five-year theoretical business model targets, perhaps, in terms of gross margins where you think you might be able to -- what you would like to do longer-term? And, also, revenue growth longer-term, what you would like to be able to do?

Yes. And Jeff and his team are just in the process of refreshing our three-year rolling-forward plan and all that. So what I am talking about is real qualitative, I'm going to disclaim it as much as I can under your forwards Safe Harbors and everything.

But you've asked the question, so let me tell you, because I have used the best is yet to come a number of times. And I have said that I think we're a 3 on a scale of about a 1 to 10. The reason I say that is because really what you have seen thus far are two things.

Number one, you have seen us really hunker down and clean up the core business. We're focusing on selling to accounts where our products have the most relevance, and where we can make a reasonable profit and have some sort of sustainable competitive advantage. So a year and a half ago, two years ago, almost, now, we walked away from a big chunk of business at Wal-Mart because the markets were way too far from our plants and we were just losing too much money, and there were other people that were in a better position to supply those than ours. So that was a big strategic move which helped us recover. We have done a pretty good job; we have done a great job of developing momentum, but this only showed up a little bit so far in the results, of really focusing on our manufacturing and logistical processes. Tom Cofsky and Dave (indiscernible) and (indiscernible) John MacMaster -- these guys are daily working on very hard on improving our processes and have shown tremendous progress, and it's starting to show up in our numbers. So I believe that still has a long way to go.

So cleaning up the shop, we are probably farther along the curve on than the second part of where I see the real excitement coming from, which is all the money we're investing in the new products and development effort. About three years ago, we made a major reorganization out at what we call the innovation center. We promoted one of our best technical salesmen to take over the facility. He left his market in South America and moved to Vernon Hills, Illinois, to take over the team, really developed a new sense of urgency around commercializing products -- not just increasing our body of knowledge but coming up with ideas that we can commercialize.

He brought in new people, really energized the place, put into a whole new methodology -- what we call a pipeline methodology, which is used by most good new product development companies. And so we didn't reinvent the wheel there.

And a year and a half later, stuff is starting to get ready to come out of the pipeline. It's still too early to claim victory. We do hope that some of it will have a material impact on F '05. But until that's out in the marketplace I don't even want to talk about it because all I'm going to do is bring in competition, and I do want to do that. Now, the day the patent gets issued, then I'm going to be in much better shape to talk about it. And some of these things we have applied for patents. Other of them is going to be more proprietary, more know-how and so forth. And so those I will be probably reticent to talk about, too, for a while. But these are the kind of things that give me a lot of confidence that the best is yet to come.

When I do my math, I don't focus so much on the sales, because we are really committed to making sure that at each critical juncture, i.e., let's say we put on one of these new applications and let's say it uses our existing processing. Well, then, rather than build another plant and bring more capacity in the industry, I'm going to take a look at the bottom 10 percent of our product line and sales and see do they justify building this new plant? It's not for the new one, because the new one will.

That's going to be high value added, but I can make the new one at our existing plants. So the question is, can I justify building a new plant based on the old bottom 10 or 20 percent of our volume? If the answer is yes, great; we'll build the plant. If the answer is no, then we are going to raise prices to the bottom 10-20 percent. And it will either get into the area where it now can justify it because the customers keep buying from us, even at the higher prices, or we will lose the volume, free up the capacity and just do this trade thing that Jeff talks about, where our average selling price will keep going up but not necessarily the number of tons that we sell -- because we do have a nonrenewable resource, and I am not looking to spend tons of capital just to spend capital. So I am way more focused on the margins and profitability then I am on the sales growth. So I have no sales target for you and while I am mentally an earnings-per-share target that I think I can put together a story that gets me there, I am not sure Charlie would want me to share that.

I think he would probably have to shoot me or we would have to put up some certain of (indiscernible) fever. (indiscernible) my share of that, so I won't even share that. Just qualitatively, I have a number that clearly gets me to where I can say we are at about a three out of 10 on this continuum of what I can say is going.

Let me ask it another way. And I appreciate the answer. Where were we historically, for sustained periods of time in terms of return on equity? In years past?

I'm going to take the easy way out and say, Jeff, do you have that?

Obviously, it doesn't take a rocket scientist to know that when sales, when profits go up, return on equity goes up. And I don't have detail to share with you, but I can tell you it's been positive.

I was thinking that in the past, in our heyday, we might have been doing a 14-15 percent return on equity. And I would think that the goal would be to try to get back there, and that's what I'm asking.

Certainly, and yes; there were dynamics going on. The Company was at its absolute peak that I am not sure reproducible. But on the other hand, there are things going on now that are going to make our peak, if and when it comes, much more sustainable. The two things that really drove the peak of the Company back when it hit, which was right before the advent scoopable cat litter. So you had coarse-only cat litter, and we were the major coarse player. We were riding on the coattails of (indiscernible). Because we had developed this tremendous coarse product, Fresh Step. And so that -- we were a smaller company. That contract meant much more to the Company in terms of percent of sales and earnings than it does today. And we were the exclusive suppliers to Sam's Club; they were our single largest account. We were doing $20 million with them, and that was 13 years ago. So today we do zero with them. And so, here we are able to absorb losing our single largest account and seeing half of our market, which was cat litter, go to a substrate that we are not basic in, which is sodium bentonite. So, having said that, those days are not coming back. I don't see scoopable cat litters going away, and I think -- I wake up every day working on and hoping that we are going to get back into Sam's Club in some way, shape or form; but we will never be exclusive again. That was probably not a position that was sustainable; we were very vulnerable.

But we should not be out of them altogether, either; we have a lot of relevance to some of those geographies. So we are keeping pushing on them.

So you can't totally compare. But we are not at all shying away from this from a numbers standpoint, saying that we can reproduce or even eclipse those returns because I see where we are headed now. What we are doing now, which is something we did not do then, and my father is very complimentary of the tack we are taking, is that we are understanding the value that our products bring to these new applications and then extracting a certain percentage of that value back in terms of pricing. So it is not cost plus. Everything in the past was cost-plus. What has it cost us? What does it cost us? Okay, it cost us X dollars a ton to pull out of the ground; let's mark it up a little bit and sell it. Well, we are not into that.

With these new applications, which -- literally -- are massive, we are going to protect our rights through patenting and other proprietary know-how, and then, we are communicating our very sophisticated basis with these guys, how to use our products, what they need to *. If they spend a dollar with us, they are going to make $1.70 -- So every rational person would take that bet all day long, as often as they could pick that could. But that dollar with us translates into a margin that you can't even look at compared to the historical company.

And I can talk margins there. We're talking 70 to 80 percent gross margin, and you're looking at a company that is making 24 percent. So even if we have to deal a little bit, and it ends up being 50 percent or 60 percent, to get competitive on it, it is still a huge win for the Company and a major trade up. So that's where, if and when those things hit, -- and God, I hope they do, and so do you. Yes, I think we can meet or exceed the past heyday.

Two brief modeling questions. Capital spending in depreciation come about even for the second half after being a good source of funds for the first half. Do you have any sense as we go out longer term, '05-'06, would capital spending in depreciation continue to run close to even, or do they go back to being a nice source of funds?

That is really going to depend on where our investment goes into, and I would say that we know some things that are out there that we want to do, to try to reduce our costs. And so, depending on how fast these things go -- my speculation does not mean much. But it could be even -- it could be a little bit less. If acquisitions come up, there could be more. It can go any which way. But the important thing is, we continue to maintain, at this point, focus on really controlling our expenditures, those things that we need to do to maintain our business we will do. And those things that we need to do to grow our business, we're going to take a very disciplined look at upfront to make sure that we believe that they are going to have the right returns before we spend the money.

And lastly, it ties into Bob's earlier question -- refresh my memory about seasonality. Sometimes we have seasonality, sometimes we don't. And if we do, the second half -- the quarters might be kind of 2 million less than the first half quarters? Is that kind of how it works?

You know --

We can look at the trend of all of our prior sales and quarters, and, clearly, we tend to make more money in the first half than the second half but not so dramatically. Last year, we made 28 cents in the first half and 26 cents in the second half. Really, what is going to drive the change, why you can't just take this year and double it, is the incremental marketing that we are planning on doing in the back half of the year because the way a lot of this works now is you drop a coupon or something, you are supposed to recognize it all immediately. I mean, Jeff, you can talk about this, but it's no longer -- I don't know; you can talk about some of the accounting of all this.

Sure, sure. There's been a lot of things that impacted the way we account for trade spending as FASB has required. But I think, if you look at the expenditures we are making, these kinds of investments generally need to be expensed immediately. And so, as we make investments to grow our business, we will see the expense and then we will experience the benefit later. And so, by the way this timing happens to work we're going to see a lot of these in the second half of the year with benefits to come in future periods.

So the revenues in the second half of the year might approximate the first-half revenues, but the expenses will be running higher?

Hard to say. If you were to look at a trend of -- the way our second half goes versus our first half, last year was clearly an exception because of the acquisition that was in the second half but not the first. The first quarter -- well, the second and third quarters tend to be our strongest with the fourth quarter being the weakest and the first quarter somewhere coming in between. And so, if I were to speculate, I'd say it would probably go like that again this year.

In '02, and the first half we did 84 million. This is pre-acquisition; that's why I'm going back to 82. Then we did about 78 to 79 million in the second half, and '01 was about the same. Now '03 was the exception.

We do see some seasonality in our business. It's not as dramatic as, say, other businesses but it does exist. And, generally, the second half is a little bit slower than the first.

Does the grocery strike impact on revenues material in California? Will that then pick up?

Yes; we do expect that suspect that to help the task plant and pick up what's going on out West. The other thing -- it's going to --

(MULTIPLE SPEAKERS) yes, I mean that's the main thing. We're still in there with Stater Brothers, who was not on strike, but the other big guys were -- wondering, Ralphs and Albertsons. And so they are going to be returning to work; that's definitely going to be good for us.

Good. I think we're at our 11:00 witching hour here, so I think we're going to pull it back for some closing comments. But I really want to compliment you guys. Nobody is getting put in the Q&A penalty box because the questions were all very good. It's clear that your continued participation is giving you guys, I hope, a better insight into what we're doing and where we're going. I will again encourage you, to the extent you can curtail your own curiosity, if you're going to ask a question that you know I'm going to (indiscernible) for competitive reasons, let's try not to ask them, anyway, because that in itself is an indication to the competition of what we're doing and where we're spending our time.

So we all want the benefit of what we're doing to show up in our numbers, which, ultimately, show up in our stock price. We don't want to talk about all these great things and not have them materialize; that won't do any of us any good. So I am going to continue to be pretty vigilant about not educating the competition on what we're doing. Let them do what they are doing, let us do what we're doing. And to the extent they want to mimic us, let them do that a year or two after we roll it out because now they have figured out what we're doing. So, rather than get a preemptive job at us.

So we're going to continue doing what we're doing. We're looking forward to being with you again in three months for our third-quarter teleconference, and thank you for your continued interest and support.

We would like to thank everyone for joining today's conference call, and you may now disconnect.