Oil-Dri Corporation of America (ODC) 2005 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the third-quarter earnings release 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. (OPERATOR INSTRUCTIONS). Thank you. Mr. Jaffee, you may begin your conference.

Thanks and welcome, everyone, to the third-quarter teleconference. We are going to use our usual format. Let me introduce who is here. We have Charlie Brissman, who is our Vice President and General Counsel, and Andy Peterson, who is our Vice President and CFO. And you have me, Dan Jaffee, who is our President and CEO. So Charlie, will you take us through the Safe Harbor?

Certainly. Thanks, Dan. Ladies and gentlemen, as you know, the Company's comments today will contain forward-looking statements regarding the Company's performance in future periods. As I'm sure you can appreciate, our actual results in those periods may materially differ. In our press release and our SEC filings, we highlight a number of trends and uncertainties that may affect our future performance, and we urge you to review and consider those trends and uncertainties in evaluating the Company's comments today and in evaluating any investment in Oil-Dri common stock.

Great. Thanks, Charlie. And we're going to stick to our usual format. Andy is going to take us through a little play-by-play of the quarter and then I will have a few color commentary points. And then we're going to spend the majority of our time opening it up to Q&A for any questions that our listeners might have.

And as always, we're happy to stay until 11 o'clock and answer as many of your questions as we can, so try and prioritize and get the most important ones first. And please ask one question and then go to the back of the queue, although I have a feeling the queue is going to be short, this being a holiday weekend. So we apologize for that. But as always, this will be webcast and put out on our website. So people will always link into it sometime after today.

So Andy, please take us through the quarter.

Thanks, Dan. I would summarize third-quarter results as pretty good, considering the difficult environment. Revenues for the quarter are 48,249,000, or up 4% from last year's 46,616,000. Net income for the quarter was 1,972,000. EPS, $0.33, up 10% from last year's $0.30.

The quarter's results in comparison to last year were positively impacted by improved operating income from the Specialty Products group, negatively impacted by operating income reductions in Consumer Products group, Crop Production and Horticultural group and the Industrial and Automotive Products group. Gross profit as (technical difficulty) for the quarter decreased to 20.2% from last year's 23.7%. The decline in margin was caused by significant cost increases in fuel, transportation and other commodities.

Income for the quarter was positively impacted by an 18% decrease in operating expenses in comparison with last year's third quarter. This was primarily the result of reductions in incentive compensation and amortizing expenses.

We are revising our projected EPS range for fiscal 2005 to $1.00 to $1.10. This compares to EPS in fiscal 2004 of $0.84.

In looking at balance sheet and cash flow, I would summarize the ending balance sheet and third-quarter cash flow as a continuation of good news. During the quarter, the Company continued its aggressive stock buyback program, buying back 167,900 shares of common stock at a cost of 3,135,000. The Company also paid 568,000 in dividends and finished the quarter with cash, cash equivalents and short-term investments of 16,930,000.

Indicative of management's continued efforts to improve working capital component, sales in the quarter were up 4%, while accounts receivable and inventory were down slightly compared with last year's third quarter.

The Company continues to generate significant cash. EBITDA for the third quarter and the nine months to date was $4,838,000 and $13,991,000, respectively. When capital expenditures are deducted, this results in free cash flow of $3,572,000 and $8,761,000 for the third quarter and nine months to date. Dan?

Great. Andy, thank you. And I'd like to touch on some of the comments you made, and maybe put a little flavor behind what went on. Our average selling price in the quarter was up again. We had been discussing this in the past; it's been a real focus of ours to sell more of our value-added items along with raising prices. And so our average selling price was up 4.7% to 180 to 18 in the quarter; that was good.

Unfortunately, our cost of goods sold went up from 137 to 150 a ton, and that was up 9.5%. So selling price goes up $8 a ton, cost of goods sold goes up $13 a ton, net-net gross profit goes down $5 a ton or 10.8%. And you know, when you do a million tons a year, or 250,000 tons a quarter, $5 dollars a ton is a lot of money to a company our size. So clearly, that is the story. What is causing it are a host of things. The most obvious and apparent to everybody on this call and throughout really the United States, probably throughout the world, is what is going on in fuel prices.

And this doesn't just affect our processing cost, which is certainly a big number, but freight, all of our hauling costs, and freight is our single largest component of our delivered cost of goods. And so freight obviously is going up as diesel prices are going crazy. The cost of mining is going on up -- moving along all this heavy equipment. We've saw that, just using diesel out in our mining equipment. Packaging -- and not just poly, where the resin prices have going crazy, but even paper, because the paper bag producers are using energy to make the bags, and so they are all hitting us with that.

So clearly, our margins are being threatened by the fuel prices. And we're not just sitting back taking it. We're doing the best we can to past these costs along. I would say we are suffering the cost faster than our ability to raise prices, and that's why you saw what I hope will be the worst of the margin decline in the third quarter. Don't know that to be a fact, but that is my hope, that the fourth-quarter margins will still be threatened, but they won't be down as much. And that by the first quarter of our next fiscal year, which will then be fiscal '06, you'll start to see some repairing of margins as many of the price increases will have taken effect.

So we are actually expecting, or hoping, let's say, to have a strong July this year, because we do have so many price increases in effect for August 1 that we expect a lot of our customers to buy in in advance of that. So you might see a big spike in July. You might see a smaller-than-typical August. We don't report months. But it could have an impact on the quarters and how those come in.

I want to touch base on something Andy alluded to and focused on, which is something we're very focused on here at Oil-Dri. And I think -- I know; I don't even think, I know our largest investors are equally focused, which is our ability to generate free cash flow. And I did a historical analysis, just for myself, to look back because in the early '80s, we weren't a value stock, we were a growth stock. My dad and his management team were growing the Company at a 15% a year clip. And whenever you're doing that, a lot of times you're going to be chewing up cash.

And I found it very interesting that we had many years where we had pretty significant reported earnings and reported EPS, but didn't generate near the cash that we have been generating these last couple of years. I mean, some of that standout years, just to give you a juxtaposition -- in '88, we made $0.94 a share. In 2005, we made $0.91 a share. So those are kind of similar years. In 1988, we generated a negative free cash flow of $4.3 million, meaning we used up more cash than we generated. Our EBITDA that year was only $11.6 million.

In 2005, on that same -- you know, on less earnings, $0.91 versus $0.94, our EBITDA was just a shade under $14 million and our free cash flow, instead of being a negative 4.3, was a positive 8.7, a $13 million difference.

So certainly, if you are a growth company, you can hang your hat on your growth back in '88. But really being more of a value stock and running the Company in a line with that, much more proud of that $13 million swing in free cash flow and why 2004 was such a strong year.

You know, I look back and I could never find two consecutive 10 million-plus free cash flow years other than 2003 and 2004. We made 10.1 million in 2003 and 10.8 million in 2004. As Andy said, we've made nearly 8.8 million through three quarters in 2005, so we are well on our way to our third consecutive year of $10 million or more free cash flow generated.

Our debt-to-equity is down significantly. You've got to go way back to find levels this low. And my father shared with me a little metric. You guys all have your own measures of whether or not your investment in Oil-Dri is likely to go up, down or sideways, but this analysis he showed was that for companies like ours, our size and our composition, tend to trade at a little over nine times EBITDA. Pick your own multiple. But at 9.16, actually, was what this study showed. So at 9.16 times 2004's EBITDA, it would say that our Company should be trading at $27.55 a share.

So again, it shows why a lot of savvy investors are still buying our stock and/or continuing to hold, even though they have significant gains in their stock. So it will be interesting to see how we finish. And Andy said, we're just under $14 million in EBITDA through three quarters. I just for the fun of it applied that 9.1 to our EBITDA of today. Now, this is only three quarters, and it generates $22.89. So who knows what the fourth quarter will hold? But if you just prorated it or straight-lined it, you'd be up over $30 a share.

So who knows? I guess it is my way of trying to turn lemons into lemonade. Sure, we would love not to have had to lower our guidance on reported earnings for the year, but the more we're running this business, the less we are really looking at reported earnings as the be-all and end-all.

We are much more focused on our EBITDA and our free cash flow. And lo and behold, those are areas that are going well. I'm not disclaiming reported earnings or our ability to meet our goals. Like I said, I am disappointed that we had to do it, but we had to do it. And we were not going to do anything to jeopardize anything to try and meet some artificial number. So I would rather change the number. And that is what we did.

So $1.00 to $1.10 is something we feel a lot more comfortable with based on all of the pressures we're seeing at our margins and the rapidity at which we can raise our prices. We just don't feel it was prudent to try and jam those price increases down a lot of our customers' throat. We're working with our customers to get those price increases in place in a timely manner where they can then turn around and raise their prices to their customers. So it is a long-term perspective versus a short-term hit -- a one-year goal perspective.

So with that, Shayla, what I would like to do is open up the phone lines to a Q&A and answer any and all questions that our investors have.

(Operator Instructions.) Paul Johnson.

I have been a shareholder for a long time. But I'm glad you're focusing on free cash flow, because I think that is the right way to do it, and most long-term shareholders are. But I have a few issues with the way you are calculating free cash flow. I think most investors today consider free cash flow to be cash from operations, and then any changes in working capital. They don't look at EBITDA because EBITDA is -- interest and taxes are very real costs. And then to exclude those doesn't make a lot of sense.

And so I am coming up with very different numbers than you guys are coming up with. It looks to me like your actual free cash flow for 2004 was about 12 million, but for '03 it was about 6 million. And it looks like it is declining this year, which -- leaving aside changes in working capital, which we know can fluctuate a lot. In fact, you had -- over the last four or five years you had a lot more free cash flow, it looks like, because you had some big changes in working capital.

But it looks to me like your D&A and your CapEx are coming closer and closer together. So I am wondering why it wouldn't make more sense to, on the conservative side, assume that your free cash flow is going to be pretty close to your earnings going forward, if you follow what I'm saying. In other words, leaving aside the fluctuations in working capital, which we cannot control, or we can control to a limited extent, why wouldn't your reported earnings be pretty close to your free cash flow going forward, the way that I defined free cash flow?

Well, I guess in terms of the way I would define free cash flow is I like to look at free cash flow and EBITDA and kind of like Dan did, and then apply a multiplier to determine the valuation of the Company. Because theoretically, what you are able to generate should be sustainable into the future. If you're looking at working capital components, I think we have made some strides there. But you really can't assume that you're going to keep improving your working capital components kind of on a going-forward basis.

Agreed. Agreed. That is my whole point. In other words, leaving aside the working capital changes, really, your free cash flow should be whatever net income you have, add in the D&A and subtract the CapEx.

If your point is as depreciation and fixed assets become close, then basically you are not going to see the growth unless you expand the EBITDA number.

Almost. What I'm getting at -- if D&A and CapEx are roughly equal going forward, and they've come close and closer, I would think that your net earnings should be pretty close to your cash flow, leaving aside those fluctuations in working capital.

I guess I would disagree. I think in terms of the CapEx number, we've probably got a maybe a $3 million a year kind of a normal replacement fixed assets. And then anything in excess of that we are typically burning in excess of a 20% return on those assets, which will result in future expansions in EBITDA. So I think kind of depending on what those opportunities look like going forward, as we look at our CapEx, I think is going to be the driver as to whether depreciation and CapEx additions are going to be the same. So I'm not sure that I would necessarily project it as it's going to be equal.

Except that the numbers don't reflect that. I mean, the trailing 12 months, if I'm doing the math correctly, you had CapEx of about 7.5 million. You have about 6 million in '04. In '03, you had 11.5 million. Now, maybe that was a flukey year. But it's been coming pretty close together. You've had some pretty big CapEx over the years.

'03 was the Taft acquisition. So I think yes, if you -- I think you're right, if you want to assume that it is likely that every second or third year we're likely to make an acquisition, I think that is likely. Then yes, then I think what you're saying is right. However, the sort of core business, we are continuing to underspend our depreciation and our historical depreciation and amortization.

And mostly because -- I've mentioned this on other calls, but it's worth repeating because it's sort of the way we're approaching it. Rather than approaching it from a top-down basis saying, okay, you plants, you get $8 million a share, go spend it, which is how we used to do it, we do it from a bottom-up, which says, okay, you've got to build your list. And any kind of health and safety issue you don't need an ROI on; you're going to get that money. But then other than that, any kind of investment spend, you're going to need to justify with an ROI.

And as long as, as Andy said, the ROI is real attractive, we are going to spend as much as they can reasonably implement during the fiscal year. That tends to be right around that number of 6, 7 million, because they just can't digest much more than that. But if those returns weren't there, we would spend a lot less.

But your point is well taken. I guess it's just apples -- or it is however you want to look at it. I am open-minded. I kind of looked at it the way Andy and I both sort of agreed to look at it. I'm going to try and dig into it and look at it your way and see which one to me feels better.

I appreciate that. And we are holding on to the stock for the long term. I just think that we ought to be agreeing on that. I think you'll find that the metrics that most use, it's really the cash from operations less the D&A and less the CapEx. And the EBITDA is old school, for good reasons.

Paul, is that is excellent input. And that's why I love these teleconferences. So we're going to take that under advisement. And we will mention that to you the next time that we agree or disagree. And we'll discuss it. So thank you.

Ethan Starr (ph).

I am wondering how are sales of Cat's Pride doing with the new packaging having been on the shelves for a few months? And have you seen evidence the packaging is making a difference?

Yes and no. Yes, we have seen a difference, but we are not seeing the financial difference that we would have liked. We were hoping for, although we didn't really do any sophisticated testing that you would have done at Procter & Gamble and all that where they would tell you what the exact lift was and all that kind of stuff. We had our belly button and sort of the anecdotal stories that when you change the packaging like this, you're going to see X-and-such lift.

Unfortunately, we are not seeing that. We're seeing a lot of competitiveness in the marketplace. Where we are seeing a lot of benefit is that the retailers have received it very well, have then bought into our concept of a brand block. Our old packaging was so dissimilar that they really didn't buy into our line of reasoning that we need to be near each other on the shelf. Because, like they said, it won't cost you anything anyway, so I'm just going to put it where I want it. Well, now they are giving us the brand block so that we get a little more elbow room. And what we're finding is that our discontinuances have gone down. So that is a good thing, meaning the bad news is less than it used to be. There isn't -- so I guess that's good news, the cessation of a negative is a positive.

So that's about all I can say for it. We haven't seen a huge lift. But we have not been losing distribution. We have been maintaining our key position with our key retailers -- Wal-Mart, Kroger, Safeway, Albertson's, you name them. In fact, in your area I was going to mention to you, you should be seeing very soon on the shelf our items in giant. And so I hope you will do retailing and give me your feedback.

Yes, they are already in Giant. And my feedback is already out there.

Oh good, good. Okay, I'll have to go onto the site and grab it. So thank you.

I understand that Oil-Dri is infusing Cat's Pride with Odor-Eaters. Am I'm wondering how will this product fit in with the rest of the Cat's Pride SKUs and through which retail channels will it be sold?

You are amazing. It's actually sort of morphed now into Odor-Eaters by Cat's Pride, meaning it's really going to be touting the Odor-Eaters. As you know, as a long-time follower, people use cat litter primarily to control orders. So the concept of an Odor-Eater cat litter goes hand in glove; that's just a nice fit.

And so where we have been taking it initially and with a lot of receptivity is into the pet specialty class of trade. So that's where it will certainly start. That's where you get the most involvement between the shop owners or the people working the aisles and the customers. And a lot of innovative ideas -- scoopable cat litter, every cat kit, everything pretty much started in pet specialty and then eventually migrates towards the more everyday channels like grocery and mass market.

So is Odor-Eaters a co-pack? Or are you just licensing the name?

We are making it ourself; we are licensing -- we have an exclusive license with Combe Industries. And they are very supportive, very helpful, sharing a lot of information and data with us, what their name means and who it means it to. And we get the halo effect of all the advertising they do behind Odor-Eaters. So it is fun to be playing with some offense.

Can you tell us any more about the new co-pack litter you mentioned a couple of quarters ago?

No, other than it is doing well; it's meeting expectations. And we are going to be meeting with the partner in a few weeks to get their direct feedback. But so far, everything we're hearing is that they are happy with the initial movement.

Where is it selling?

If I told you that, then I'd have to kill you. No, I'm just -- sorry.

Next question. Now that Oil-Dri recently received a patent on one of its new products, are you able to discuss this product in more detail? Or should we just move on to the next question?

You know what? Let's talk about it a little bit. I knew you were going to bring it up, but I certainly appreciate you teeing it up in such a way that if I didn't want to talk about it I wouldn't have to. So thank you.

This product is an additive, let's call it in a mainstream construction process. So I mean, to the extent that we're adopted in any way or form, it would be a huge volume boom for us. The patent, I mean, Charlie, do you want to talk about how we feel how well the patent protects us in this application?

Sure. Ethan, as you know, we had a patent issued in March of this year that covers micropores, a ceramic additive for a large class of building materials. We, from a legal and practical standpoint, feel it is a very good patent. That is, it claims meaningful innovation and makes claims that are defensible by us as the owner of exclusive rights to exploit this technology for the life of the patent. Like all good ideas, though, what it means in commercial terms is a function of being able to find customers and sell effectively. And that's, long short, the point in the process we find ourselves.

And the good news about -- and the flipside is that this product is something that we can make already with our existing assets. It is not going to require any new capital. And it is of a value-added nature such that to the extent our customers prove it out, what we've seen in trials and in our own facilities prove that out in their full-scale production runs. They will garner enough value to justify buying it from us at a value-added price, which is good.

So it is a better use of our clay, put it that way. It is a very good use of our clay. High-volume. Their plants tend to be near our plants, so not a lot of freight, which is good. And we have our first couple of orders. I mean, we have been in touch with a number of these manufacturers. And the one we -- was the closest in and sort of the middle of the bull's-eye has already started to order to go into more full-scale production runs. I cannot say they've have adopted it into their recipe yet, but I would say they have cleared every hurdle on the way. And this was the largest hurdle to date. And they are now buying the material, paying for the material and using the material.

So it is exciting. It is still in its early infancy. I am not declaring victory yet, but I am a lot closer to it now that we have orders. But it will be real nice once we know that they've adopted, it's in their formula and every -- they are using a truck or day or something like that. That will feel real good.

You mentioned the possibility of an acquisition every two or three years. What is happening with the (indiscernible) acquisition area and the consolidation in the clay industry?

We are taking the same approach that we've always taken, which is we are not trying to steal anybody's business from them. But we're certainly not trying to pry it away from them, either. And we're not really -- it sounds obvious, but it's sort of the position we're in -- we're not really desirous of bidding against ourselves. Like I said, we're not trying to steal anyone's business, but we are pretty much the only likely strategic acquirer of a number of plants that are out there. You could potentially get a financial buyer, but the odds of a financial buyer being able to outbid us is probably not likely because we benefit from all the synergies.

So we are in contact with all of them. None of them, I would say, are at any stage where you need to know anything. But if and when one of them decided, hey, now the time is right, I kind of want to liquefy my investment, they know that we are interested. And I talk to them routinely. But there's nothing to talk about right now.

Robert J. Smith, Center for Performance Investing.

I have several, so -- in Consumer Products, you say strong competitive marketing also continues to pressure sales growth. So the instituting of price increases, how does that play? Are you a price leader? Or are you following? Or what is happening?

Well, fortunately, the leader in the category put out a general release that they are raising prices 4.5%. I will let you determine who you think that is. But that helps us. Now, to the extent that that gets to be implemented coast-to-coast, then we are clearly a follower. Depending on how you want to measure, we are either the third or fourth in the category. So we're not price leaders by any stretch of the imagination. On the other hand, we in the past have not shied away from raising our prices when costs went up. I mean, they got to do what they got to do, we got to do what we got to do. And we've generally seen that a nickel at shelf or a dime at shelf doesn't seem to change a lot of your velocity. You can't go crazy. But you can take little price increases here and there.

So we are raising our prices. It is good news that the leaders seem to be raising theirs, too. And so, hopefully, everyone will just raise their prices and we will move on.

So the comment about strong competitive marketing, is that essentially what you're talking about? The price, or what else is there?

What else is there is that we launched these scoopable products out last. And it made sense. But we saw a lot more competitive activity than I think we anticipated because we didn't see all that much in the test market. We saw a little bit. They knew we were out there. And I guess strategically if I were trying to kill an initiative, I think it's easier to kill it in the test market than it is to let it get rolled out. So I kind of assumed, wrongly, that whatever level of marketing they did in the test market is sort of what they would do, maybe even less, in the full rollout.

The opposite occurred. They didn't do much in the test market, and then they seemed to maybe wake up to it or something and came out guns blazing once we rolled this stuff out in a broader region of the country.

So it's fine, to where we haven't lost any distribution. And we are doing well. The retailers recognize that we are the reason that they are doing all this activity. So they like us. I mean, that just brings dollars to their category. And so they like that we are stirring the pot because these other guys weren't spending this kind of money before we shook things up. So, if anything, we have increased our position in the category. But we're having to defend ourselves to a much larger degree than I thought we would.

I'm sorry, I missed the product itself?

The Jonny Cat scoopable. Sorry. We rolled out two scoop items in the western United States to round out our Taft acquisition.

Then in Agriculture, you say genetically modified then treated seed played a role. But this is going to be an ongoing process itself with GMS capturing more -- it's pretty consistently. So what does that hold for the future?

Here is how I see it. And nobody has a crystal ball. But I think what you're saying is what everyone generally believes to be the case, that the future will generally mean more adoption, not less, of GMO crops. And so the trendline over any long period of time, call it 10 years, is going to be down for clay carrier. However, this year was like the perfect storm. We not only got hit with the GMO, we also got hit with the fact -- and this used to happen every three or four years, where they finish a season with way too much inventory, miss their projections and then don't buy a lot in the upcoming year. So we got hit with both this year.

So we believe that '06 will actually be better than '05, but that that isn't the trend. It's just a rebound from the inventory piece of the equation, but that the GMO trend is going to continue to be down. So what you are going to have is a declining line, but it's going to bounce up and down as we move towards the end of whenever this is. So vis-a-vis '06, we believe '06 will be better than '05.

Is there any difference domestically and in South America?

I don't know. I don't know the answer to that.

And there was talk of some disease that is threatening the soybean crop. How are you with that?

I don't know the answer to that one, either. I can get the answers.

Okay, so I would just come back to you on that?

Maybe call Ronda. I'll arm Ronda with the answers to both of those. The soybean disease and then South America.

Poultry Guard?

Here is what's happening with Poultry Guard. We have done well with Poultry Guard. It's fine. We went back to our original research and what it said was what the customer wanted was something to control ammonia throughout the entire grow-out, which is seven weeks. They currently don't get that. The market leader is Jones-Hamilton PLT product. It works for two weeks and that's it. So we came out and ours worked for two weeks, so we felt pretty good about ourselves. But they didn't just make this a me-too product; we got some benefits, they got some benefits. You're going to trade customers; you're going to fight; you're going to do some things. But you're not really going to take the world by storm on that front, because we still did not meet their need.

So Steve Azzarello and group out of the innovation center are going back to the lab. We're keeping the product in the field, but we're challenging ourselves with trying to meet the customers' need. And so I think if we were able to do that, I think we'd have a very fast-growing product because we now know who the customers are. We have the channels of distribution. And we've just got to put the right product into the distribution channel.

I wasn't aware that there was a competitor and that they were first.

Yes. In fact, we were a follower. There was a multiple of competitors. There's liquid guys -- they're more of a solid guy, like we are, meaning it's on a carrier. And we still -- I think we think the whole market size is still only about $10 million, whereas originally we had projected that the market size by this time would be 20 million. But again, we were basing that on a promise that we had a product that met the customers' need. I think if we met the customers' need, the market would be 20 million.

So you have flattened, or sales have declined, or what?

Not declined. I would say flat to slightly up, but not enough that we're -- you know, a product that small, you don't want big double-digit growth. It's small single-digit growth.

An on the new product that Ethan asked about, can you again say what it was? I got micropores--?

Basically, let me just make it easy on you, if this helps. What it does is it takes our product and its unique properties, its ability to be calcined very hard, to hold its pore structure, and to then get blended into other aggregate material in a small percentage, but you're talking about these aggregate materials -- we're talking building materials, so at a 2% inclusion, we are a different Company if that were to happen coast to coast. In my wildest dreams, I don't believe it will.

But I'm just telling you, if you do the math on this thing, it's phenomenal. All we're looking at right now is what we call our blue zone, where we draw a circle around our plants and say who within this 200-mile radius of our plants is making these kind of materials? That is who we are calling on first, because if we can't show value to them, we don't believe we'll be able to show value to the guy who's got to pay a lot of freight to get our stuff there. And all they need to do is blend in a certain percentage of our clay, which is a lighter density than their overall blend. So right out of the gate, they get a big freight advantage when they go to ship this stuff out.

You can imagine, if they're -- and they are -- if they are weighting out a truck versus cubing out a truck, meaning they are not selling fluff, they're selling heavy aggregate material, that they can get 6 or 7% more on that truck for the same freight cost because it weighs less. So that's almost one of the least of our benefits. I mean, we are actually showing them that their production goes up, their yield goes up, a thing called bat loss (ph), where the stuff that they can't sell that breaks down goes down to almost zero.

So they are very excited. We are too. And it's right in our sweet spot. It's only certain of our clays, only certain of our plants, only certain of our reserves can meet this need. And that can also limit the competition. But what ultimately really limits the competition is this patent, which we feel real good about.

Do you have a patent number?

Not off the top of my head.

And when you say only a certain part of your clay reserve, what part?

I don't think we are disclosing that yet, only for competitive reasons. So that's a strategic -- a trade secret, let's call it, of Oil-Dri that we're not going to disclose. But put it this way, enough to where we could capitalize on the opportunity.

So we will be hearing more about this quarter to quarter?

Yes, I mean, because I'm definitely assuming you guys are going to ask me about it. So the answer is yes. And we did start getting orders. So by next quarter, you should be able to ask me, is that guy still ordering or did he stop? And if he stops, that is not going to be good. If he is still ordering, that is going to be very good.

Within a 200-mile radius? Is there any way to look at the market potential?

It is vague. This is the nature -- and it's also -- the interesting thing about this industry that we're selling into is because freight is so big for them, it's such a huge percentage of their cost of goods, they have -- not only do they have no problem, they actually seem to go out of their way to share information with their competitors, because there know their competitor can't really compete with them anyway. They each have their own little carved-out niche of their geography.

And so what we are understanding is that the odds of getting one or two customers is almost slim or none. You are either going to get zero or you are going to get a lot, because either there is no benefit and no one is going to adopt, but if there is enough benefit for one to adopt, then it is very likely that you are going to get a lot of adopters. And they're big enough that you don't need that many. One plant, for instance, could buy 20,000 tons a year from us. So you put on a couple of plants and you are fat and happy. So it is a home run. This is one that is either a strikeout or a home run. This is not a single, double or triple.

Any other comments on new products?

No, I think I got myself into enough trouble today.

How about Camter (ph)?

That I absolutely have no comment on. I didn't get Rutherford here today.

It was somewhat of a surprise, because when I saw the announcement of the price increase, I didn't realize we would be so over the edge (ph), to that extent, at least, near term. But I understand that it is a strategic move and something that is faced by many companies.

The ripple effect of where -- everything that is impacted by fuel is just brutal.

And the futures market? I mean, were you still in there?

Yes, we are locked in now for next year. And we feel it just shows how far we have come. A few years ago, if we were hesitant to lock in at $3 an MMBTU, I think we are now at 7.60 or something?

Right.

And like happy to take it.

For about half your needs, or--?

No, about -- well, it would equate to about 25% of our needs on natural gas. 770. And what, last year was 630?

Yes.

So that shows you how much it is up. Because fortunately, we're not nearly as reliant on natural gas as we used to be. So we are locking in our other things as well. So we will have 50% of our overall fuel locked in. But on the gas front, it's 771.

Looking at fiscal '06, I mean, you're going in against some good early numbers, this burden of higher cost profile. So you said something about the fourth quarter, and then also about the first quarter of next year. So quarterly comparisons going forward for the next six, seven months are not going to be anything to write home about probably?

I'm not sure. Let me put you on hold for one second. I'm going to ask Charlie a question. Okay, Bob, thanks. Yes, Charlie straightened me out here. Yes, we are going to keep our comments where they were. I'm not going to go any farther than sort of the comments I gave you, which was I'm sort of expecting a strong July and maybe a little weaker August just due to buy-in. And that -- and a ramping-in of our price increases, where we're already seeing a lot of the cost increases. Let's leave it at that and that will keep me out of trouble.

The stock buyback program is still in effect?

Our window is closed, but as soon as the window opens, it's going to go right back into effect. We still have -- I don't know how many shares we have left under our authorization.

It is approximately 250,000.

So yes, we still have plenty of shares under our authorization. Luckily our average daily buy-in has been good, which then -- you know, we're limited by that, a percentage of that. And so the higher the average daily volume, the more we can go out and buy back.

Actually, it was 282,904 as of April 30.

I think looking at the numbers you issued, the change in outstanding shares was very minor. Is that essentially because of the stock option program?

Yes, it is the stock option program and it is the way they do that diluted calculation. Ironically, the higher the stock price, the more it assumes dilution, right? And then the lower the stock price, the less it assumes dilution. So it is very dependent on where the stock price is. So anyone's guess is anyone's guess. But whatever the reaction is to this earnings guidance could have an impact, then, on what our outstanding shares look like on a fully diluted basis.

Chris Kiper, Ridgestone Corporation.

Could you guys comment a little bit -- I got the April 15 press release, which basically you were commenting that the index that you're looking to was up 7.6% and that you had price increases that were scheduled for immediate implementation. Now it sorts of sounds in your comments earlier today like some of those things are longer leadtime items that actually get pushed through to the end-customer. Can you talk about those price increases and sort of when they will be fully impacting?

And I guess the second part of that is when we go back and look at margins, your margin historically here the last two quarters had been trending up towards 23%. Obviously, this quarter somewhat of a disaster down at 20%. And I guess if you sort of look at what you must be forecasting for the fourth quarter, I don't see that you are forecasting probably much improvement from the third-quarter level. But leaving out the next couple quarters, because sort of who really cares, right? -- what is the longer-term margin picture? Where do you see it going back to given everything you know today about the price increases you hope to push through and commodity pricing in general?

Okay, I think I got your questions. First of all, timing. Certainly a lot of the price increases have already taken place. Some of the biggest ones are already in effect, which is good. But a lot of them haven't. A lot of retailers require you give them 60 days or 90 days before you can raise their price. It's just part of doing business with them. You know it. They know it. Everyone knows it. So you go at them. And then they say, okay, we'll raise it 90 days from now or something. It's just sort of a little trick they play. And we try and do the same trick with the people raising our prices. And sometimes you are in a better position to do it than others.

And so I think it sort of dovetails into your question on margins -- is that I do see the -- what did we make -- 20.7, 20.2%, was that--?

Yes.

20.2% in the quarter after making 23.4 the quarter before or 23.7 a year ago. I do hope -- let's say that I am going to leave it as hope, again, under the Safe Harbor laws -- I do hope that is the bottom, that we will show an improvement in the fourth quarter, nowhere near enough to get us to 23. But that we will then keep that stair-stepping improvement.

I believe we have the sustainability to maintain margins in the 23.5 range. I never felt like we were pushing things to where we couldn't sustain our volume then at that level. Having said that, to the extent we can blend in any kind of new business, I guarantee you everything we're trying to do from a new business standpoint has margins well in excess of 23%. So to the extent any of that stuff becomes a material percentage of the Company, you could easily see a 25 or a 26% blended margin. I mean easily.

So I think the core business could and should return to 23, 23.5, and that the new stuff as it gets going and then if it represents 10% of the business or something could bump us up higher.

I think the other element to look at is as you look at our cost of sales, obviously there is a significant fixed portion. And so as you are comparing -- as you look at an individual quarter, typically fourth-quarter revenues are a little lower than many of the other quarters during the course of the year. So I think that is the other piece, as you are taking gross profit and dividing it by sales, is what is the level of revenues going to be?

That is a good point. And it also then speaks to the fact that if we get the growth engine going -- and we are very focused on doing that -- while we're happy to be up 4% in sales, that's nothing to write home about. We want to get the growth engine going to some extent, not enough where you would classify us as growth stock or anything like that. But I mean, if we could be clicking along at 7, 8, 9%, that kind of incremental volume, we know we make about 41% on every incremental ton we sell regardless. I mean, once we have padded our breakeven point, our margin is about 41 points. So there is no doubt that incremental margin can also skew the margin. Incremental volume can skew the margins up or down depending on which way it is going.

I think all of us would like to see some bottom-line growth. Because, I mean, if you basically go back to last year and adjust for the patent settlement and some asset impairment charges that you guys had, you have a down year this year.

Yes, you are right. If you only want to adjust last year for one-timers, I will agree with you. Frankly, I don't think that is fair. But you can do that. I mean, Sarbanes-Oxley has hit this year to almost $1 million. And that is a one-timer of documentation trying to get 404-compliant. If you want to say I'm going to take out the lawsuit, but I'm not going to take out SOX, yes, you can -- I allow you the opposite, and now I'm way up. I mean, so I think you've either got to take all the one-timers out or you've got to leave all the one-timers in and let the dice fall where they fall. I think to take some one-timers out and not others, I think now you're looking at apples and oranges.

Can you talk at all about the incentive compensation that you basically it looked like reversed from quarters one and two in the third quarter, how big that number was?

I took away Charlie and Andy's bonus and --

I don't think we want to be that specific. We don't want to share Charlie's bonus.

Just from a modeling perspective going forward, I don't think that the G&A level as a percentage of sales is sustainable at all.

Do you think it was artificially low?

Yes, I mean, you're at 14%. You have never been that low in any of the last 12 quarters.

Well, yes, it went through because they've been good and we have been paying out more bonus. That's probably true. Certainly it is showing that the incentive plan works and it's sort of recognizing, to an extent, what you're saying. I'm not calling this year a disaster, but you would say that this year was not nearly as successful relative to its prior year as last year was. So clearly, we have an incentive program which is challenging all of us to grow the business.

The status quo is not getting us full bonus. So I think as an investor, you should be happy that what you're saying is what we are all incentivized to do, which is grow the business.

At this time, there are no further questions.

Perfect. It is 10.54 on my watch, which I know I am always fast. Well, thank you, guys. And again, we enjoy the give and take. I hope we always sound receptive to it, because we mean to. It is good. It keeps us sharp. It keeps us focused on what you are focusing on. And we've got some follow-up points. We are going to have some answers to Ronda for Bob. And we're going to take a look for Paul at the free cash flow and try to come to some consensus on that. So thanks very much. We'll talk to you again in three months. Have a good holiday weekend.

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