Oil-Dri Corporation of America (ODC) 2004 Q3 法說會逐字稿

Good morning. My name is Tracey and I will be your conference facilitator today. At this time I would like to welcome everyone to the third quarter earnings conference call.

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, [Caller Instructions]. Thank you.

Mr. Jaffee, you may begin your conference.

Okay. Thank you. Thank you, Tracey, and welcome, everybody, to the third quarter and nine-month investor teleconference for Oil-Dri. We are very pleased with the bottom line growth that we were able to report for the quarter. And as always, we are going to start with some Safe Harbor comments from the lovely and talented Rhonda Williams.

Thank you, thank you. 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 factors subject to uncertainties you can refer to the written earnings news release and other documents the company files with the SEC. Thank you very much. Dan.

Thank you Rhonda, and I think in the future we are going to have you sing it. That is one of Rhonda's many talents, since she can actually sing, which I cannot.

I am going to give you some 50,000-foot comments and then Jeff Libert our Chief Financial Officer will take you down to ground level for sort of a play by play of the quarter. And as always Charles Brissman our Vice President and General Counsel is here, number one , to keep me out of trouble and, number two, to answer any questions that may arise that are in his bailiwick. So that's who's here today.

You know, the at the 50,000-foot level this quarter really was, I don't want to call it perfect but a very good illustration of what we can accomplish by sticking to what we are calling our focus on blue and pink zones which isn't going to mean anything to you but it's basically doing business where we have strengths and trying not to business where we have weaknesses. And so what that has done is allowed us to layer on new good business and at the same time shed old not so good business, and so the top line kind of stayed pretty close to the same. It was only 1%.

But the profits, the margins continued their expansion. So we are on a four-year trend now and I've talked about this in the past but it's so positive it's worth repeating especially for first time participants. In FY 01 we closed the year with a gross margin percentage of 18%, we closed '02 with 19.1, '03 with 20.6 and '04 through the nine-month mark we are at 23.5. So we've put on 5.5 gross margin points in three years, which is fairly incredible. And obviously that's what's leading to the growth at the bottom line.

So despite a lot of cross pressures from fuel and resin and freight, you know, this whole hours of service regulation that's hit the trucking industry, all of those thing are putting upward pressure on our costs. But despite that we have been able to cover a lot of that through internally controlling our costs and then through margin expansion by focusing on selling the higher priced products to the exclusion of the lower priced products.

So one metric that I like to look at is net debt. And net debt through this time last year was at $16.5 million. And I take net debt as being a long-term debt plus the current maturities of long-term debt minus all liquid investments all cash like investments, we put them in various vehicles but it's basic cash.

So a year ago it was 16.5 million. Now 12 months later during that period we've raised the dividend, we've continued to funds capital projects as they've come due, we've continue a dramatic increase in the investment out at our innovation center. Yet despite all that our net debt is down from 16.5 million a year ago to $5.8 million this year. Which is a drop of over $10 million in 12 months. Which, again, is pretty much the pace we've been doing for the last few years. So that feels very good.

So 50,000 feet things looked very good. As always there are clouds on the horizon that we are doing our best to navigate around. But the positives still out way the negatives and so we continue to remain bullish not just for the end of this full year but for fiscal '05 and beyond. So, Jeff, I hope I didn't steal too much of your thunder. I tried to stay up in the clouds.

Just a few morsels for me, Dan, thank you.

To go through a the top line metrics, sales, as Dan mentioned, increased 1% for the quarter and 10% for the year. Fully diluted EPS increased from 17 cents a year ago in the quarter to 30 cents this quarter; an increase of 77% for the year. Our EPS fully diluted is 89 cents versus 46 cents a year ago. That's a 94% increase. Net income increased to 2,231,000 in the quarter versus 1.474 million a year ago. And for the year we increased to 5,270,000, from 2,606,000 a year ago, and that's an increase of 101% for the year and 51% for the quarter, the difference between EPS and net income being, of course, the effective dilution and stock repurchases.

As usual we have some one time items. Actually we have no one time item for the quarter, but for the year we had a write down of 454,000 related to some equipment and a reserve for obsolete packaging inventory of 200,000. In the quarter last year we had an asset right off of 385,000. We had a right off for goodwill of 350,000. And we had a gain on the sale of real estate of 310,000.

In addition for last year, not in the quarter but in the first two quarters of last year we had a gain related to a land sale of 135,000. And a gain related to a payment from a customer who failed to meet their contractual obligation of 675,000. If you take all this out, what does this all mean? Last year's, I'm sorry, this quarters income would have been, as it is, 2,231,000, versus 1,899,000 a year ago, and the income would have been for the year 7,748,000, versus last year, 3,442,000.

As Dan mentioned our gross profit has been very strong. Last year at this time year-to-date, we were at 21.3%. This year we were at 23.6%. And the other change from a years ago with our tax rate is down significantly. Last year year-to-date we were at 32%. This year year-to-date we are at 25.6%. And that is due to a relooking at the way of the way we calculate the key driver of our tax position of depletion and we came up with a more advantages look.

In terms of why the business is changed the way it has, and I apologize if things are starting to get repetitive for those of you who attend our investor conferences repeatedly but it's really the same thing we have been talking about in the past, our [inaudible], plant and Jonny Cat acquisitions continue to perform. We added higher margin business of branded business.

However, as we thinking about quarters and year-to-date this is the first quarter we are talk to you and say that our quarter actually included, we had been a full year of Jonny Cat in our earnings and so quarter-to-quarter we are looking at a comparable business. Year-to-date, of course, we still have some lapping to do.

So really if you look at the quarter it really wasn't due to the acquisition it's really due to these other items which I'm about to mention. We continue to focus on selling more profitable item. Our brand of [inaudible] cat litter continued to do well. We have obtained selective price increase in various businesses and our overall sales prices actually increased 7% year-to-year and we continue to focus on productivity enhancements. Looking for cost reduction, manufacturing and looking for ways of increasing our efficiency throughout the organization.

This favorable results has happened in spite of one significant negative, and that's energy costs. Year-over-year we paid 18% more in energy than we did a years ago and we are very energy intensive business as we need to dry moisture out of or minerals.

Another thing that's occurred is we had $120,000 of closure costs related to our Christmas Valley facility that happened in the first quarter of this year.

Going around the horn to our various businesses, on the consumer side our sales were up 2% for the quarter and 12% for the nine months. A lot of the sales increase for the year is due to the Jonny Cat acquisition, but as I mentioned to you just at minute ago we continue to see strong performance of our Cat's Pride brands, particularly in Wal-Mart and we continue to sell a more profitable mix of things.

In Canada we continued to do well with private label sales and we are also seeing some positives on the sales side because of favorable exchange rates versus a year ago. On the crop production and horticultural product segment sales were down 14% for the quarter but up 3% for the nine months. And what we are seeing there is we've had a very strong first half and in the agriculture chemical sector where the formulators really did their purchasing of our products earlier this year than we've seen in the past. There was a lot of shifting between the quarters. And we didn't see a very strong third quarter.

In the sports turf arena we saw a slow quarter of sales and we've been slower for the first nine months. However, this was due to golf course construction, that business tends to be very sporadic. We are expecting a strong fourth quarter in that area.

In the industrial side of our business is up 5% for the quarter, 9% for the year. Again, it was being driven by new customers and related to the acquisition that we did a years ago and price increases. The specialty business, sales were up 11% for the quarter and 8% for the year. Our bleaching [inaudible] business was strong for the quarter, oil processors were active especially in the U.S. Our animal health nutrition business did very well, that's also part of the specialty group.

We continue to see increases of sales for our poultry guard products, that's chicken house litter amendment and condition aids, that controls various things in animal feed, toxins. Be and we continue to attract new customers as we continue to demonstrate the products, the benefits of the products.

As Dan mentioned, our balance sheet is very strong. Dan talked about our net debt, cash and cash investments are up $5.6 million from a years ago. And our debt is down 3.6 million. That explains that the net debt figure that Dan described. And we are doing this while we spent over the last 12 months $2.8 million in the repurchase of stock. 588,000 of which came in this quarter. So I don't want to forget to talk about that in terms of the positive cash momentum of this business.

Days outstanding of receivables is flat from a years ago and inventory turns are about flat from a years ago. Both of those figures continue to be strong and we are very encouraged by our performance there.

We continue to focus on the efficient management of Capex. We have under spent depreciation by $2.3 million for the first nine months of the year. And the fourth quarter I do expect expenditures at a level more consistent with depreciation. We know that we do have some large capital items coming up to support the growth opportunities that we are pursuing. And some of the cost reduction that we have planned.

So the overall picture is thing are very positive, very good news to report at this time.

Great, thanks, Jeff. Before we open it up to the Q&A session, we do have some questions in from Ethan Starr who can't be with us today but he did sends us some questions and I do want to cover them because he is always very good at keeping his hand close to the pulse of Oil-Dri so we appreciate his coverage and so I want to recognize his, and respond to his questions.

His first question, how is your business with Wal-Mart going both wholesale and retail? And there will there be any changes as far as what the Oil-Dri are in the new plan-a-gram?

Business with Wal-Mart continues to be very good. They went through sort of an inventory correction program company-wide which brought everybody in the categories in stock percentage down a little bit. And so we have been working very closely with them to get those in stocks back the way they want. But that's just sort of a short term blip.

But the good news is sales through the register are very strong. Our brands continued to well for them. And the plan, this is plan-a-gram season at Wal-Mart and every indication we've been given is we will retain 100% of our slots going forward which is very good news. And that they are challenging us to figure out what is the maximum way to use those slots.

So, for instance, we are rolling out, you know, the Jonny Cat scoopable products in various parts of the U.S. and so we are working with them to look at taking out some slower moving SKUs in those areas to put in the new Jonny Cat scoopable SKUs. So basically, again, sticking with what's been successful for us company-wide, which is take out nonperformers as you layer in performers. So net/net our total slot should stay the same but we expect that our sales to grow equal to or greater than their overall category growth. We have been outperforming their category growth and we expect to continue that into the new year.

So that's good news. Ethan, the next question was regarding our liners, he's wondering if we've been successful so far in increasing the number of stores selling the liners and in fact we have.

The IRI information, this is all public information so I can quote this freely, tracks something known as ACV, all commodity volume. Basically what that means is if you are on every shelf in America and your product went across the scanners you would have an ACV of 100%. And so not all shelves carry it so the whole liner category has an AC V of 95. That means that there are 5% of the shelves in either grocery, food or drug that report and let me remind you that Wal-Mart does not report. So Wal-Mart is not in these numbers. So the ACV on liners in general is 95%. So that 5% of the stores or shelves that don't even carry a liner of any sort. And our ACV is growing quite nicely.

Our ACV on a 52-week basis is up 7.4%, up to 54% of the United States. So we still have a long way to go to grow. It's up 8.6 in the twelve-week period. You can see it's up faster in the 12 and it's up 9.5% in the four. So there's a lot of momentum. We are putting on new distribution.

What's exciting is with only, let's take the twelve-week number, a 55% ACV, we have a 32 share which is the number one share in the category. The next highest player has a 26 share and they have a 71 ACV. So they are on a great percentage of the shelves but generating much slower to velocity through the registers. So clearly we have a great story to tell where our product gets slotted it moves at a higher velocity than anybody else.

So we are using that to expand the distribution of our liners. So it was just sort of another unexpected benefit of the acquisition and so far it's going well. It helps round out our line.

So those, that answers Ethan's two consumer questions. And this probably will come up later, but I will ask it again, he asked a general question about R&D and when might we expect an announcement of a new product? And, again, I am going to stick to my guns here and say we are going to let the consumers announce the new product. When the orders start coming in and they are material then we will be talking about them. But until then we are not and so you can read between the lines then since we didn't announce anything in this quarter that there's nothing material to report regarding new product development.

We are still very bullish. We still have a number of if you want to use a horse race an analogy, there are a number of thorough breeds in the field that we feel very good about, and I still feel like I felt, I have been on the road a little bit, I was in New York, talked to investors here in Chicago, and I have used this horse racing analogy. We have got about three really good thorough breads out there right now, and the odds of all three of them winning are probably pretty slight, but the odds all three of them losing we feel are equally slight. We do believe that one or two of them will across the finish line which will mean significant new gross margin and net income dollars for the company so we are still very excited about what's going on at what we call the IC, the innovation center.

So Tracey at this point in time we would like to open it up for questions because as always we like to dedicate our time to responding to whatever is on your guys radar screen.

[Caller instructions]. Your first question comes from the line of Robert J. Smith.

Hi, good morning.

Hi, Bob.

Congratulations on a good quarter. I think we have a horse race going here and it's nice to see it.

Thank you.

The price increase I think you said that you had taken a 7% price increase or it averages out at that. Is that company-wide or just for the cat litter business?

Let me clarify. That is a combination of price increases and mix. So that's a net effect. Basically we take our sales, divided by all the tons we ship, we are up about 7% this year.

So what is the price part of that?

It's, probably splits out pretty well half and half, it is probably about 3.5% price and 3.5% mix.

Okay. And would you call yourself the price leader or follower or how do you look at that?

Well, in classic theory you are supposed to be the market leader to be the price leader and there are some markets obviously the carriers and some of the other markets where we are the market leader and so there I would say we are a classically defined price leader. There are other areas where we are not, we are not even one, two or three, but economic reality dictates we have to do what we have to do. And so I wouldn't call us the price leader because I don't see anybody following. But we are just, I would call us common sense business people who when their external inputs go up have to raise the prices.

So your competition didn't follow you?

There were news releases out there so I can talk about it and they said they were and in some places we didn't see it and in other places, we certainly didn't see anything that would lead us to believe it was across the board and pervasive. So as far as I can tell it was sporadic.

So it didn't hurt you at all?

No. I mean, no, that's fortunate. Knock on wood, a year ago when the troops and I sat down to discuss price increases a year ago because gas was going [inaudible] a year ago and nobody was raising prices really in the economy so we really were leaders a year ago, but we saw that we were extra 731 and if we don't raise our prices our margins were not only going to continue to grow they were going to decline and we said, hey, we are going to raise prices. And they all, all jams came to me because nobody had raised prize in five to six years and told me, Henny Penny in the sky was going to fall, they were all going to lose significant chunks, of business, so I added it all up and it was a huge number. I said, okay, now, who is going to make that.

And they look at me with this blank stare, well what do you mean, and I said, okay, let's assume you're right, you are going to lose X percent, and your going to lose Y, and your going to lose Z, now who is going to make it? Or are you telling me there are substitutes out there that cats are going to use the toilets and people are going to going to stop growing their crops and purify their oil, what are the substitutes? Well there are none. Okay.

Let's look at available capacity in the industry. Well, there isn't enough. So what's the conclusion? The conclusion is we are not going to lose the business. Okay. So they went back out, they raised their prices and low and behold a year later our volume on a pounds basis is actually up a little bit. Not much but a little bit. But it certainly didn't drop 30 some odd percent like they were predicting.

So you can draw any conclusions you want on that. Again, using classic economic theory I see pricing leverage. I mean, I see that there is finite supply and the cost of switching is a lot higher than a 3.5% price increase.

Thank you. I have quite a few additional questions but I will get back in the queue.

Thanks, Bob.

[Caller Instructions].

Bob, it may be you because Ethan is not here today.

Your follow-up question comes from Robert J. Smith.

So let me continue. If you see someone else there I will step back for a moment. Wal-Mart and the radio frequency I.D., where are you with that?

On that one we are definitely not in their front beta site companies and we are happy about that. We would rather be a follower rather than a leader because at the moment it's still an expensive proposition. And if you sell something that's pretty expensive, you know, like a DVD player or something like that, you can try and justify it on some of the soft savings of people not walking out of the stores without paying and all that kind of stuff. When you are selling $1.97 bag of 25-pound cat litter throwing on an RFID on that bag is not a great proposition.

Now fortunately at the moment they are keeping it to the pallet level, I think. I don't even think it's going down to the case level. But we are clearly following it but we are at least I would say 24 months from having to do anything because they are not rolling out the new beta people. I think they originally said in the spring of '05 and now I've heard that's even getting pushed back into '06 so we are not going to be a leader on that one.

But at some point that's an additional expense?

Well, our theory again, obviously the market will determine whether we have the leverage, would be to pass along the cost unless there are inherent savings and we are all in favor of it. It's hard to justify if you look at the way to justify it, it's on small high value items and we are the opposite, we are a large, relatively low value item. So I'm hoping they don't ever bring it to cat litter, frankly.

Can you just elaborate a little on the Poultry Guard, where the product is comparative wise?

Yeah, you know, Poultry Guard and I think we mentioned this last time it's finally turning a profit and it did that by basically not quite doubling but dramatically increasing its sales for the year and we have put a target out there that they feel they can hit for next year which would take them to really having a significant contribution for a small company like us.

The beauty being that they are finding applications for it beyond just pure ammonia control. And again probably to avoid educating the competition too much, I would just say we are finding new applications for it that are making it instead of just being a seasonal ammonia control in the winter product we are finding application that allow it to be a year-round product and one that our product seems to be uniquely suited to serve in this application.

So we are very bullish on it. I was actually talking this morning with the head of the IC and we are looking at doing some more research on it to better understand how big this opportunity could be. So that we can then decide how much resources we should put behind it. But, Poultry Guard there is new life in Poultry Guard which is great.

What is the projection for '05? You said it's material -- what kind of percentage gain are you looking for?

It would be big on a percentage basis. I would say the dollars are still relatively material but on a company our size it could mean, it could account for three to four cents per share of incremental earnings; which, for a company our size, we have a range out there of 95 cents to 1 dollar just to make a the math easy let's say we do a buck, and we haven't seen the roll up yet on the budgets but, you know, I can at least see enough big picture things where I know that F '05 is going to be significantly better than F '04, you know, your definition of significant is going to be what drives the tail but three to four cents per share would be three to 4% increase just on Poultry Guard. And believe me that's not what we are seeing as the key to getting us to the promise land. So it's nice when you are this small when you see things like this happen.

With respect to the innovation center, will you announce new products as they were introduced?

We will not announce them as they are introduced but we will certainly announce them as they begin to have a material impact on the results.

Okay. So have you introduced any new products?

We have. But they have yet to have a material impact on the results.

Okay. So why is sort of the cat and mouse? Is it its out there,? It's out, why aren't we -- can't we know about them?

Well, because, you are going to benefit from them when they hit the results. The knowledge isn't really going to benefit anything other than to get maybe some hysteria yeah behind our stock but I would rather have our stock trade on our results quite frankly because you can't keep up that hysteria, I mean right now you are all seeing that there..I'm sorry Bob, go..

Believe me, as a long-term investor I'm not hysterical. But if the product is being offered, can't I know about it.

Because, I don't mind you know about it but I mind all our competition knowing about it doing something preemptive, or jumping in before its time.

Okay, so how many products have been introduced?

Bob, Charlie has a comment.

Bob, you may be thinking that all of these introductions are consumer products and are going to be sitting on shelves everywhere and a lot of our business is business to business. They are niche products in specialized markets. They are out there but there is literally a very small audience of customers to whom we are speaking about these exciting opportunities and that's why we prefer to, sort of, keep them out of the very public eye until they are actually contributing to results. That's all Dan is getting at.

So how many products have you introduced?

There are two out thereof real significance right now. There's a third that is sort of making it's way from the IC down to manufacturing. Sort of as we speak. That one will probably not get introduced until the beginning of F '05.

And the fourth which is the classic new product which we already talked about which is the Jonny Cat scoopable, I have no problem talking about because everybody knows about it because it is on is on consumer shelves, and so that is all public to our competition and that one is already being rolled out as we speak. We are paying the slotting, a lot of costs is going to show up in F '04 and most of the benefit is going to show up in F '05 and beyond.

So, you have two classic business to business products that are out there right now in various stages of tests. You have the consumer product that's being launched and then you have the fourth one which is making it's way out of the IC down to the plants.

So things are kind of right around the corner so to speak with all these things?

I mean, yeah, if you ask Steve ASERELLA who is running our IC, he would tell you, you know, it's taking to long and it's driving him crazy and that's what I love about him and it's good, but we didn't put him in the job until two years ago so he had to start planting seeds and harvesting and doing all the things you have to do to start showing fruits of your labors and it's now starting to bubble up which is good.

The beauty is when this starts happening there are seeds that he planted 18 months ago that will probably bubble up in 12 months and that kind of thing. So it will become routine once we get a few successes under our belt, but until we do, I'm like anybody, hey, show me, so that's why I don't want to talk about them. I want to deliver. Talk is cheap. Show me the order.

What's on the, what's being worked on now, would you say that did your trying to shoot for two or three new products a year?

Yeah, I mean that's a good question. I can talk in general because this should absolutely impact your investment decision. What we are shooting for is to continually keep what we call our new product development pipeline full. That pipeline is generally, I mean 95% going to be geared toward business to business applications. We may every once in awhile but I have a consumer product that bubbles out but it's most likely going to be a line extension or some sort of a tweak versus a roll-out. There's going to be no TV, that's just not going to happen.

If we were to do something like that we would take it to a consumer company that would role it out much better than we could. And we would just manufacture it for them. So, I'm not saying we won't develop consumer products, I am just saying we are not going to launch them. so, its not like we are going to be back where we are tanking the earnings every three years as we roll these things out, that's not going to happen.

So, on the business to business is where we are focused, and then what we have done is we have the classic matrix if you want to draw yourself a little box and have four quadrants, okay, and going up on the vertical axis do old and then new and that's your products, and then along the horizontal do old and do new and that's your markets. Okay?

So where we are today is in old old. We have old products in old markets. That's where everything we are serving today. 20% what have we are working on out at the IC is basically dedicated to supporting our old old. We then want to have 30% in each of the old new and new old quadrants. So really 60% of our total time will either be on old products for new markets, or new products for existing markets that we already serve but in the business to business arena.

And then the final part of the portfolio is having 20% of our time focused on new new, but still fitting our mission which is to leverage our raw materials resources and know how, because it may be that we don't have the raw materials in-house and we either have to go out and acquire them or will license this technology to a raw material company that does have it. So to leverage our raw material resources and know how to maximize the return for our shareholders. So that new new is not going to be microchips. It's not going to be DVD players. It's going to be something very much in the industrial minerals arena. But it is going to be a new product to Oil-Dri in a new market that we don't currently compete in.

Thanks, and do you have a comparable number for R&D for nine months?

Let me give you the annual because I don't know exactly where he's at vis-a-vis.

Two years ago before he moved into the job we were spending about $2 million a year in R&D. And only about 25% of that was going towards new product development, the other 75 was either admin or what we call tech service which is just supporting our existing products. So basically you can say $500,000 was going to new products.

This year we are going to spend $2.5 million on R&D. But it's been flip flopped the other way where three-quarters of that or almost 80% to make the math easy, 2 million of that is going into new product development. So we are dramatically reduced the dollars that are going to the tech service and the admin to the benefit of new product development. So basically in two years we quadrupled the dollars that we are putting behind new product development.

That's impressive.

And to be able to deliver the results we have and still be able to fund this I can tell you ASERELLA feels like the most fortunate guy in the world, because he knows that had he stepped in the job in like 00, right when the you know what hit the fat, the first thing we would be crush something do we want to keep investing in ASERELLA whereas his timing has been impeccable. So we've been able to deliver to the street at the same time of ramping up our new product development.

How did you get the admin costs do down.

Partial what will we did is we pushed it out into the divisions. I said wait a second, these guys are here for you, you've been getting a free pass, you either need to pay for it or we have to stop doing it and so the division now are picking up a huge burden of the IC and working it into their budgets, but they still have to deliver their bottom line. So, they no longer got a free pass and it's worked so it's been good .

I'm sorry, I lost my place in my notes here. The capital expenditures, you said you were looking for a large increase coming up. Can you be a little more specific about that?

Well, we are investing in some efficiency enhancing machinery in our plants. We are doing some automation projects, and those do involve significant capital dollars but they lead to cost improvement.

Let me give you a perfect example of how this has paid off. I mean.

I was just looking for a number, Dan. When you said there was a large increase coming so.

It's more consistent. Like I said more consistent with our depreciation rather than.

So it's not that large?

No, right.

Let me just because Jeff brought it up and people are wondering, how can you show a 1% increase in sales yet 77% increase in profitability. And another major area we are doing it is in the area of efficiency.

Tom Cross, our VP of manufacturing and his team have done a great job but frankly they've been supported by the business units who because we are very focused now on our core business we've gotten out of dog treats, we have gotten out of a lot of thing that have taken their eye off the ball, so now they know, hey, we are a clay manufacturing and processing company, now we can go ahead and streamline, automate, do all these kind of things.

Well, our unit volume is up a little bit this year over last last year yet our company-wide payroll is down over 10% without any layoffs or anything, just through natural attrition we have a corporate mantra of never having full-time people lose their job due to automation, because we want them to embrace it, not feel threatened by it, and so what we do is either let go temps, because we always have a certain percentage of temps. Or we keep the people until natural attrition takes its course and they move or do whatever they do and we close the position. So we are down 10% with no reductions in force, like that, in our core business. And that's been one of the key drivers of efficiency.

Anything from camcorder this quarter?

Not report at all for camcorder. If it continues on on an even keel but nothing new to report.

Are they adequately funded at the moment? Yeah, they are breaking even or .. No, no, I mean, well...

They are a company that's part operating company and part R&D company so in terms of funding, the operating company is profitable and pays the bills and the R&D company sort of lives off the operating company. So they have a lot of discretion in terms of how they are liquid and to my knowledge they are liquid.

In the energy sector, could you quantify the increment to the cost that you've absorbed this year?

I mean, I mentioned 18%. That's roughly equal to $2 million.

We expect it to be up another 1.5 million next year.

I can tell you my, you know, my meetings with the GMs on next year's price increases went a lot smoother than last year's. And because they had a lot of wind at their back. There have been a lot of articles in the paper about companies accepting price increases now, so we just had to do it.

I occasionally go to the Internet boards to look at some comments. There aren't very many but one chapter has raised the category of dog litter and had some interesting comments to make about the past history of the product and in sharing his thoughts I was wondering, is that anything looking at that catagory?

I can talk for hours on dog litter.

What he suggested was that the product had a cent of the dog in it or something? Well, that's the gist of what I followed from his comments.

Yeah, I have dogs. And so I have trained my ten years old lab to use dog litter. We have a six by ten run outside. It needs to be [inaudible], you can't use cat litter because that will turn to mud so that has to say processed and I had to battle her like you can't imagine. Dogs want to mark. They don't want to keep going in the same place. They are not like cats. Now, I finally trained her and for the last seven years thing have been good. But what do I do, I go get another puppy and I am battling Murray, our second dog like you can't imagine. He doesn't care. It's not like he's against the clay but if I turn my back he runs over and goes on the lawn because that's what he wants to do. So it's very hard. It isn't the product, it's the behavior. It's very, very hard. So I don't see a big future for dog litter. I really don't.

Okay. I got on the call just a little late. When I came on what I heard was a figure 50,000, I don't know what that was about. Can you look back on your notes and just give me a clue?

Did I say it or did Jeff say it?

I think you said it.

I said 50,000? Frankly I can't remember.

Okay.

I'm drawing a blank. It will be on the webcast. You can actually listen to it and pick up whatever you missed.

Okay. And then is there a percentage pay out in the dividends that you would like to stay with going forward?

You know, again, I'm just one of the nine board members. All I can say is I never heard a percentage be what's driven the discussion. It's always been around future prospects, cash-flow and, you know, trying to continually reward the shareholders. So it hasn't been a driver or an inhibitor either way. So, no, I would say there isn't a number.

Okay. So if that's true and what you have indicated to be the determinant, it looks pretty positive. So I assume you exam the dividend, what, annually or, how do you look at that with the board meetings?

Yeah, pretty much annually. I mean, it gets nominated every quarter to sustain it but we pretty much look at increasing it every year. So I'd be surprised if it came up this board meeting but I would be surprised if it didn't come up the one in the fall like it did last year. So I'm sure it will be a hot topic of discussion.

Okay. Well I think I'm kind of done.

Good. I appreciate your questions and hopefully your question have helped to answer questions other people maybe would have asked and maybe someone is in the queue.

One last point. What is Dick doing these days?

You know, last time you asked that you and I almost got in a fight but I'm a lot calmer now. He's doing great. He's very active on boards including the Oil-Dri board. As you know corporate governance is a big issue these days and so he takes his Chairman duties seriously but he's also Vice Chairman of Rush Medical Hospital here in Chicago and the IIT; Illinois Institute of Technology. So he's bringing a lot to our board through activities on other boards.

Is he doing anything specifically for the company as far as his interest, I mean, we discussed his connection with Cam Turner quite awhile ago?

No but he is heading up what we call our regulatory affairs committee and basically he's very helpful in taking on what he calls all the Tom Sawyer activities, where he calls me Tom Sawyer, and I get him to paint the fence. Thing that aren't truly in line with the day-to-day operation of the business that would just take my eye off the ball, he is more than happy to step in and take over that burden. So we are a great team and it really helps me then focus and the company focus on running the business which I think you need, we don't have a Chief Operating Officer. So because of that I think this kind of split helps.

When you speak see him please give him my best.

I will. Thank you.

Thanks very much and good luck going forward.

Your next question comes from the line of David Andre.

That was a long time to get in.

Sorry, David, we didn't know there was anyone else looking for a question.

You mentioned at Wal-Mart, I think you mentioned that they went through a little inventory correction. Does that suggest that they were over supplied or that deliveries to them were curtailed during some period of time?

You know, everyone has their perspective. We are somewhat cynical because what we think it is is they use a thing called category captains and we were challenged that their category captain filled their stores with their products to the detriment of everybody else and then Wal-Mart catches on that their inventories are going up and everybody gets knocked back when they try to correct the inventory.

That's our perspective. I'm sure the catagory captain would have a totally different perspective. I don't know what it is. All I can tell as you our inventory levels never got too high but when they did a general correct in the pet aisle we got pulled into the same whirlpool with everybody else and so then our in stocks went down and we had to fight to get them back up and they are on the climb which is good.

My question is, did it impact this past quarter? Were your shipments either abnormally down at Wal-Mart or maybe abnormally up if they were stocking it back up? Or did it all take place in the quarter and what impact might it have on next quarter which is usually a seasonally weaker quarter.

That's a good question. I would say that this quarter was generally weaker than it should have been vis-a-vis Wal-Mart and the next quarter will be generally stronger than it would otherwise be vis-a-vis Wal-Mart but the fourth quarter will still be less than the third quarter because of the seasonality you have just alluded to, but relative to the fourth quarter a year ago I'll would expect our Wal-Mart business to be stronger this quarter.

That helps. Thank you.

You spent a lot of time avoiding the new product introductions and I certainly appreciate that from a competitive standpoint. The one product that you talked, you talked about two products of significance that are business to business. Is the third product, is that a consumer product or is it a business to business product?

The one that I said is going from the IC down to the plant?

Correct.

That one is also a business to business.

So all three of them are really business to business?

Right.

You said, can you tell us you have limited sales. Is it like a beta test almost where you work with a couple customers where they are using the product to determine both the efficacy of the product and maybe to tweak it in order to really start promoting it on a mass basis?

Yeah, that's exactly what it is and a lot of the tweaking involved is understanding the value proposition. What it means to that customer, they are sharing data with us, that's how they got to be a beta site. They really want the product and so we made it available to them if they would share data with us and so then we can use that data to help quantify how much money they are saving by using our product so we know when we price this product they get good value, but we get good value, we don't just cost plus it.

Would those products be sold on a, if you will, on a direct basis or is there a distribution channel that they would be taken through? How would you really anticipate that they were sold and when would you put in those, I guess the salespeople and/or the distributors to do that in?

Well, one of the them is clearly going to be a direct deal and so that one has already been decided. The other one, it's still sort of an up to, we are still determining what the best way to supply them. If it does end up being through distribution the good thing is we already have a lot of know how or are already supplying distributors that supply these markets even though we are not specifically in these markets.

So we can pretty much use our existing distribution base to get the products to them. We just can't decide if that's going to be efficient and necessary. So we only want to add in distribution if it adds value, so the good news is we don't have to create whole new channels.

On the direct presumably you might, you would have to add at least a sales force?

Yeah, on the direct what we've done in both of these areas we've already contracted with experts who sort of lease with an option to buy. If this thing hits they are going to want to join us full time but because we are in a wait and see mode rather than bring them in full time we just contracted with them for anywhere from six months to a year to go ahead and get these things out into the marketplace.

A manufacturer rep arrangement or something like that?

Yeah, I would say that's a good description.

Okay. You mentioned you brought down your net debt levels and that's fantastic. Any thoughts to buying back some of that debt and or maybe it's not possible, maybe they are penalties and I know you have about $4 million coming due next year that you are going to pay down obviously. But you do have a lot of cash and some of that debt is 7% maybe or so with today's interest rates, maybe in a year or so maybe that will be an attractive rate but the question is, any consideration of paying down some debt by early prepayment?

I will address that question.

We have periodically revisited that question and we looked at it and our debt has various clauses in it that make that just not advantages so we've decided that's not a right way to go at this time.

The make hold provision are pretty honest, so we are just, you know, hanging on to the cash and paying off the debt as it comes due. Okay. Lastly I guess, I'm sorry, could you reiterate what stock you bought back in the quarter?

We bought back in dollars $588,000 worth of shares.

And you didn't give a number on that?

In shares, I don't have that number in front of me. But, let's just say, $15 per share on average, it might be.

That's good enough. I'm looking for a ballpark.

It was roughly 35,000 shares.

In the quarter.

In the quarter.

Right.

Lastly, guidance, I understand that it is a seasonally weak quarter but you've shown some pretty nice year-over-year sequential improvements and last year you did about 44 million, I think, almost 45 million. Just a healthy dose of conservatism in that number?

Yeah, I mean I guess that's what it coming out to be because every quarter I give a range and every quarter I keep raising it but a year ago we made 8 cents in the fourth quarter. So it was not a huge quarter by any stretch of the imagination. If we were to make eight cents this year, we would finish at 97. Which would be right smack dab in the middle of 95 to 100. If you put any kind of growth rate on that 8 cents then you can see where you can push your estimate. But...

I think the real question, Dan, is looking at it, if last year you did an 18% margin in the fourth quarter, you have delivered consistently 23.5 plus margins for the first three quarters. I wouldn't expect volumes to drop off the end of the year, so I don't think it's unrealistic to expect $45 million in revenues assuming that, and that would suggest, that's not volumes that would hurt your capacity and thus overhead absorption that badly so I would think that would be a pretty conservative number.

I can look at our budget and I don't always no exactly because it's splitting our budget up into quarters is not an easy thing to do but I can tell you that the troops have [inaudible] for lower GMs in the fourth quarter, greater than the 18.6 you refer to a year ago but less than the 23.5 or six we are clicking along at now. So I would be disappointed if we certainly don't end up in the range and won't be that surprised if we end up at the higher end or where ever.

Well, you've exceeded expectations for every quarter so far this year so I suspect we will do the same in the fourth. Congratulations on an excellent third and actually positioning well for the fourth and we look forward to an even better 2005.

Thank you. And you know, that's definitely something that I've said and I will continue to say, that the beauty or the best news is, this is not like one of these years where everything is clicking and this is as good as it's going to get and so that next year if anything is going to be worse. From everything I can see and nobody has a crystal ball and we have all our Safe Harbor, you know, exclusions here, but everything I can see, this has been a good year, I give it maybe it maybe a B, but I see a lot of thing going on that's going to make '05 significantly better. So we are still moving along the continuum, maybe I said on a scale of one to ten we are at a three, maybe now I would upgrade us to a four but we are certainly not an eight or nine. We certainly have a lot of room to go and none of that includes the new products. So once any of those start to hit then I will be changing the scale again.

Good. Any other questions?

Your next question comes from the line of Larry Litton.

Hi Larry.

Good afternoon. We started in the morning. We are getting close. I won't take too much time.

Can someone reiterate why the tax rate dropped and more importantly, does it stay there for the next couple years or is it kind of a head wind as it goes back to a more normal rate?

I will handle the question. We've actually brought some new tax experts into our situation. And so in conjunction with bringing some new people involved we really have assessed the way we do thing are we doing things in the most advantages way. And so we've assessed and we found room for reduction in our tax rate. And it really has to do with the way we do our depletion estimation.

And in terms of the future, I mean it's a complicated situation and depends on what the IRS rules are and depends on what our product mix is. But I see it staying where it is for the foreseeable future.

So maybe at least the neck 12 months, maybe the next couple years?

I could foresee that.

Certainly our expectation.

In terms of the cash generation, at least range of magnitude, next year do we still hope to maybe generate another 10 million plus of free cash-flow?

Certainly hope to.

Okay. Then lastly, any kind of rough guidance for FY '05? I mean specifically, or in general sense revenues, 10% plus or 10% minus, if you think of the drivers for '05, looking at revenues, gross margins, and operating expenses, what's the order of what's most important?

Well, it clearly revenue is not the most important because what we have continued to do is starting with walking away from that $10 million of unprofitable private label business that we talked about two years ago is every time we bump up against capacity we have new opportunities at higher margins, we shed some of the old stuff. So certainly there is a one-step up, one step back but at the same time then we put more of our profit into the cigar box mentality here.

So certainly sales will not be up 10% next year baring an acquisition. What I would see as sort of our core businesses are going to grow at, some of them the AGZ and are not going to grow very much, the fluids tend to grow with population maybe a little bit better, a couple percent, cat litters have been growing at four to 5% and I would expect that kind of work to happen. And then we have our price increases layered on top of that which are certainly we are not expecting to lose volume. And throw on a three or a 3.5% number on that; is not bad. So, you can get to a sales growth target, pick your number, but it's going to be south of ten but its going to be positive is our hope.

And then, most of the leverages in the gross margin line, not the operating expense line.

Exactly.

Okay.

Exactly.

One final question then, I know it's just arithmetic it's not necessarily the way one runs the business but just curious in terms of, kind of, a long-term planning cycle when you look at the book value, I mean, at this point are you able to think about that number and a fair return on that number or that's not a focus now?

Not really a focus, no. I mean, just, we are clearly trying to run the business as well as we can and one of our major metrics is cash. I think I've said this before but just so you know what kind of company you are investing in, earning are an opinion, cash is a fact.

And I think we've all been romanced by companies that show great earnings growth and then like Enron end up going bankrupt because there was no cash, it was all a fiction. I think we will continue to be the opposite. We will continue to where when you take out the one timers they are going to be non-cash type stuff and the cash-flow generation will continue to be either equal to or greater than the actual earnings, whatever accounting earnings that have been reported and we are just conservative and this is a great cash business. So that's how we focus.

One other thing, somewhat related, in terms of the acquisition of radar screen, do you see much on it or nothing that likely at this point?

Yes and Yes. I mean there are definitely strategic acquisitions out there but I stay in pretty close touch with the key decision makers at each of them and they are all at different stages but I don't see anything happening in the next 12 months. I wish there would but I don't want to pry it. I don't want to make it happen. It's got to be more natural. It's got to be they made a decision to get out and we are the likely acquirer and we won't look to steal the business but they won't look to rob us either. So, its got to be a fair deal on both sides.

Okay, great, thank you.

I think we are at the witching hour here of eleven o'clock. I very much appreciate it. I think Ethan is going to be impressed with the level of questions that went on in his absence and look very much forward to being with you in three months. At that time we'll have the year end results and we'll even have some guidance for fiscal '05 at that time. We'll have our budgets rolled together and we'll be ready to talk to you a lot more specifically about what we see in F '05 and beyond.

Thank you for your continued support and patience and we are going to keep doing our best to deliver against those expectations. We'll talk to you in three months. Have a great holiday week end, by the way.

This concludes today's conference call. You may now disconnect.