Oil-Dri Corporation of America (ODC) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2008 Oil-Dri Corporation of America earnings conference call. My name is Sean, and I will be your coordinator for today. At this time, all participants are in a listen-only mode. (OPERATOR INSTRUCTIONS) I would now like to turn the presentation over to your host for today's call, Mr. Dan Jaffe, President and Chief Executive Officer. Please proceed.

Thanks, Sean, and welcome everybody to our second quarter earnings teleconference. As always, Andy Peterson, our CFO, is here; Charlie Brissman, our VP and General Counsel; and Ronda Williams, who will be doing the Safe Harbor and this time it covers not only any forward-looking comments we might make, but it also covers any kind of telephone numbers we might put out. (laughter) Can we hear the Safe Harbor, Ronda?

I do apologize for the mistake that was made today and I will take the heat today for that. On today's call comments may contain forward-looking statements regarding the Company's performance in future periods. Actual results in those periods may materially differ.

In our press release and our SEC filings we highlight a number of important risk factors, trends and uncertainties that may affect our future performance. We urge you to review and consider those factors in evaluating the Company's comments and in evaluating any investment in Oil-Dri stock. Thanks, again, and I will give it back to Dan.

Thanks, Ronda. Okay, good, and as always we will cover the same format, Andy will take us through some of the details of the quarter.

I may or may not have some comments to add to that, and then we will open it up to Q&A so we can cover the big issues that are on your radar screen. As always, I encourage you to prioritize, try and get your most important one or two questions asked. After you ask one question, go back to the queue so other people can get their question asked and everyone can get on with their day. Andy, will you cover the quarter for us?

Sure. We had a strong second quarter revenue growth in both the retail and wholesale products group and the business to business products group. We had record sales of $58 million for the quarter, up 10% from last year's $52.9 million. The increase was due to higher average selling prices and increased volume. We were disappointed in the 19.6% gross profit margin in the quarter, down from last year's 21.7%.

Margins were negatively impacted by higher freight, packaging and material costs offset by $507,000 reduction in cost of sales due to the sale of emission credits. Operating expenses were 14.2% of sales which was down from 16.4% as a percentage of sales in last year's second quarter. Net income was 3.6% of sales which was down slightly from 3.7% in last year's second quarter. EPS in the quarter was $0.29 compared with $0.28 in the second quarter of fiscal 2007.

Through the first six months of fiscal 2008, $2.7 million of cash was provided by operating activities compared with $7.1 million in the comparable period last year. This was due to a higher cash bonus pay out in fiscal 2008 that was earned in fiscal 2007 and higher accounts receivable and inventory balances relating primarily to the 10% increase in sales.

Dividends of $1.7 million paid in the first six months of fiscal to 2008 were up 11% in comparison with the prior year. Cash and investments at January 31, 2008 was $28.7 million or about the same as last year's $28.4 million. Dan?

Thanks, Andy. About the only color I would add to your comments is first of all when I back out the emission credit for my own apples-to-apples comparison what I see is our margins dropped even more. Really, they would have been about 18.7% without those numbers and so clearly, dramatizes the impact of the rising costs that has had on cost of goods sold.

There's no doubt costs are going up faster than our ability to raise prices, however, on the good news side revenue was very strong, our tonnage was very strong and you know, Bud Selig, our board member always says nothing is good or bad except by comparison meaning you can't really see something unless you compare it to something else. We did make over $2 million net income in the quarter, which the $2.089 million we made was more than any quarter we made last year in fiscal '07.

We didn't break $2 million once in fiscal 2006. So it just shows that we have raised the bar rightly so and we hold ourselves to a much higher standard continually growing as we move forward.

Our major source of discontent was twofold. One was in comparison to the first quarter which was such a strong quarter, and then, two, was just generally we want to be delivering incremental value and to do that we have to show a greater profit per ton sold, or however unit of measure you want to use. And so when you look at the margins and you see them drop down that's very disconcerting and that's why, as we put in the news release, we're very focused on getting -- we already have price increases in the pipeline, we have been taking price increases, but obviously they weren't enough. And I have talked about our average price per ton and it was very strong in the quarter.

It was over $220 a ton in the quarter, and a year ago it was under $214 so it was up, but it just wasn't up enough to cover the incremental cost. So it is our commitment to go back out to the marketplace and share with our customers that we are doing everything we can to control those costs that are in our control.

Our operating efficiencies were excellent. Our usage of various inputs was excellent, but the cost o of some of those inputs, anything that's resin-based, petroleum-based, those kind inputs went up dramatically, and fortunately we took some of the volatility out with our hedging program, which as we have said a million times is never about timing the market or beating the market. It is all about taking out some of the volatility.

So we do have somewhat of a buffer going forward, but net-net, costs were up and we need to be raising prices. So, good, well, Sean that's all for my introductory comments, and I think what we'd like to do now is open it up to our investors and see what's on their minds.

Sure. (OPERATOR INSTRUCTIONS) Your first question comes from the line of Ethan Starr, private investor.

Good morning.

Hi, Ethan.

I'm just wondering, I know that Oil-Dri is developing a couple of non-medicated additives for animal feeds. What can you tell us about those products and when will they generate revenue?

Again, just usually, I am a broken record but I say it every call, so I will say it again. Maybe you are trying to see if I am nothing if not consistent, but we are never going to dance until we get into the end zone.

Until we have something material there's no reason, I mean it is not going to help you as an investor and I am not even referencing this particular thing that you are referring to. I am just saying in general with new products, while it may be somewhat frustrating from an investor standpoint, long term it is really in your best interest that I don't signal to the competition which play we are going to run before we run it. So no comment on that.

Since it is a no comment can I ask another one, or do you want me to get back in the queue?

You can ask another unless it is about new products and then you can get back in the queue. (laughter)

Okay, what can you tell us about Project Snowdrop and what it might mean as far as increased sales for Oil-Dri?

I'm not sure, as I allowed to, Charlie? I can't answer that one either. You are two for two, Ethan.

Okay. I will get back in the queue.

Your next question is from the line of Robert Smith with Oil-Dri. Please proceed.

Hi, good morning.

Good morning, Robert.

So can you tell me about the time line for implementation of the price increases that will get you back to where you want to be?

Yes. I mean some of them are contractually driven. Any, it has been a commitment of ours for the last, I don't know five years that is any contract over a year in length has a PPI escalator mechanism in it which is something the U.S. government put in place so companies could do business over the long haul.

So those things are automatically driven. We have a big one going up at the end of April, another one going up at the end of June. So those are going to kick in, as they kick in and interestingly enough, I mean the PPI is up significantly in the last 12 months. We will see what this next month of data does, but everything we see is something north of 6%, something less than maybe right around 7%, something in that range is what you are looking at year-over-year, which is telling you costs in this country are going up significantly at the producer level.

So those are going to take care of themselves. Anywhere where we are sort of at will, let's call it, then often times because we take such a long-term perspective of pricing we take annual and if it is a really dramatic type season for increases we will take semiannual increases.

We try not to just react to daily blips in the price of oil or something like that and put our customers into cardiac arrest. We buffer it and wait and see what happens, we do our forward buying and then we go ahead and pass along the increase to our customers or if there were a decrease, we would you know pass that along. It just hasn't seemed to happen in the last, well, since I have been running the Company in the last 10 years.

So we have got significant increases coming on line in the, towards the end of the third, end of the fourth quarter, and then really our annual increases all pretty much timed, a lot of them anyway, with August 1. So you will have some big ones coming with the new fiscal year. So I would say if you are going to try to measure progress you may or may not see a lot of margin progress in the third quarter.

You should see some in the fourth quarter, but again this is hoping that the cost pressures are going to be plateauing. If those keep going up more than price increases then you are not going to see that, and then you will see hopefully some return to more historic margin levels by the first quarter of fiscal '09.

Okay. That's fair. I will get back in the queue.

Okay. Thanks.

(OPERATOR INSTRUCTIONS) You have a follow-up question from the line of Ethan Starr. Please proceed.

Yes, I really hate to think where Oil-Dri would be today had you not brought in the whole procurement team a few years ago, and I am wondering if the procurement team is still finding many ways to save money?

Yes, you know, we have a lot of discussions, Brian Bancroft is our chief procurement officer and in a rising type environment like this, as he points out, it is really their job in many cases to just chip away at the increases. So it is sometimes hard to measure because you are taking increases, but are you taking an increase less than what you would have otherwise taken and we absolutely believe that to be the case.

Our procurement process is very robust and they go through a whole strategic sourcing discipline to find strategic suppliers and the best of both of parties abilities' share information so that we can help them save money and they can in turn pass some of those savings back to us.

So, yes, it has been a major victory for the Company both in terms of procurement and in terms of the spill over effect around the Company. A lot of it doesn't necessarily show up the way you would like it to show up in the bottom line in a rising cost environment.

Okay. Well, related to that question, would it be possible to switch the [rosin] you use in your packaging to the type of [rosin] that uses less petroleum in the manufacturing process, and thus, costs less or has that already been done?

I think you mean resin.

Resin?

Yes, resin. The baseball season is right around the corner and rosin is always a big part of the baseball season. But, yes, absolutely. They look at can they take grams out of the package, can we go to more environmentally friendly/cheaper packaging, as well.

Jugs and pails are pretty plastic intensive and very resin intensive. So we are absolutely looking at those things and continually looking at it. The balance is like if you take too much out of and it gets too weak, now it either has a bad appearance on the shelf or else you increase your damages and now the accounts aren't happy with you. You are always trying to strike that balance between strong enough, but not too strong and putting excess dollars in the package.

Okay, any chance of going back to boxes or not?

I mean I hope not. I mean it is hard. I mean the box, our foray into boxes was not all that successful. If you are running whatever pound, 14-pound tide and that line gets to be set up 24/7, 365 days a year, it is easy to get operationally excellent.

If instead you are continually changing the footprint or changing the SKU because you don't have those 365 day runs, things like box lines tend to really not appreciate the changeovers. I mean bags are forgiving, boxes just weren't. So until the whole market went a certain way I'm not so sure we would follow again.

Okay, that's kind of the impression I had, but just wanted to ask, it would be nice, it would save the money if it would work.

Yes, that's true. It just seemed our efficiency was so bad that it was hard to find that savings.

Okay. I will get back in the queue.

Your next question comes from the line of Brad Evans from Heartland. Please proceed.

Yes, good morning, everybody.

Hi, Brad.

Could you just comment, Dan, on the SG&A run rate in the second quarter? You came down about 5% year-over-year is and it was down nicely sequentially. Is that $8.25 million a good number we should be thinking about on a go forward basis for quarterly SG&A?

I will take from a general standpoint, and then, Andy, if you have any specifics you want to beef up. I always do it just as a matter of discipline. I go on to the Yahoo! chat room and see what are investors talking about before I come into the call, and there were some bantering back and forth about this very issue.

The big driver really is the bonus accrual. I mean when we have big earnings you are going to have a bigger bonus accrual, when we have not so big earnings, you're going to have not so big a bonus accrual. I will let Andy agree or disagree with me, but to me the biggest delta change in the SG&A was probably the bonus. Is that correct?

Yes.

So, is it sustainable? I hope not, meaning because it is running with earnings. So --

Yes, I think kind of where we are for six months would probably be a better look for kind of how we are with operating expenses.

We had such a huge first quarter that the bonus accrual had to be beefed up commensurately, and then the second quarter was, we put it in there, disappointing, so the bonus accrual wasn't near what it was in the first quarter.

I'm sorry. So did you reverse the bonus accrual in the second quarter or just not accrue for it?

We accrued less.

You would accrue less, yes.

You accrued less. Okay. I will get back in queue. Thank you.

Your next question comes from the line of Jim Schwartz with Harvey partners. Please proceed.

Hi, guys.

Hi, Jim.

Could you touch on international sales? Dan, in past calls you talked about the motes and how the weaker dollar makes those motes even stronger. I am just curious what international sales look like to you on a go-forward basis and maybe that could buttress up gross margin a bit.

Also, on the last call you talked about it not being unreasonable to shoot for a 25% gross margin. I guess between late November and now there has been a pretty big impact of raw material prices and freight costs for the most part for you guys.

Maybe touch on the goal you set last call, if it has changed it all and also the international piece of the business? Thanks.

Okay. I'll take the first part first, international. I think the best way to look at it from an Oil-Dri standpoint is North and South our business is very strong. Into Central and South America and so forth we are finding that those markets are very much responding to both the product offerings we have in terms of value, and then the weakening dollar is helping in those markets.

East, heading East, we are not seeing it so much, but I think the bigger drag is not the ocean it's the regulatory environment. And so you know, those markets are more closed, however you want to talk about it, to our products and they seem to be -- while they're interested in our product certainly from a weakening dollar standpoint due to the regulatory environment and so forth they're not taking a huge advantage of it. Charlie, would you --

Yes, I mean, Jim, for products in and around the food chain if you are looking to bring new products into the European Union these days or expand existing sales, and so for us, bleaching earth in the European Union. As the Europeans sort of approach risk in the food chain from a precautionary principle standpoint rather than a risk-based standpoint, we are finding it is just tougher to expand the sales base in the EU.

We will continue to work at it but for years and years of thinking of the U.S. as sort of the most rigorous regulatory framework, the Europeans are clearly in first place, for better or for worse, when it comes to food chain issues and that's a big part of where we would see expanding sales in the EU.

Regarding the margins, my memory, and if I'm wrong you'll have to discount what I'm saying, my memory is, what I was saying is when you layer in the impact, hopeful impact, of the new products it would not be unreasonable to think we could see 25%, but with the core business, I am not so sure, I think I said the high end of the goal might be but we were hoping to get back to around the 23% range.

I'm not sure I said that specifically but I think I did talk about the new products. It is still reasonable that if and when we are successful with these new products to the extent they have a greater and greater impact on the business, getting to a 25% margin is a very realistic goal in the mid to long-term, call it 24 months and beyond.

In the short run, that would not be realistic because the new products are not going to have as big of an effect on the short run and as we have seen, the costs are going up faster than our ability, our ability to raise the prices. I guess I would temper the ability with more our desire meaning we make the conscious choice, as I said earlier, not to just knee jerk, just jam our accounts every time something jumps and you are right, diesel's at an all-time high so for a freight intensive business that's a huge deal.

Many of our businesses you can have fuel surcharges so we can at least share some of those costs with those customers. That's mostly on the [B to B] front, and on the consumer retail front that's just not the way they handle cost increases. You cannot put through a fuel surcharge they will just deduct it and penalize you for having a non-conforming invoice. You really just have to raise your price.

So in some areas we are are the price leader and we are out there raising prices, and in other areas we are more of a follower and that's just the way it is goes going to be. We'll have to wait and see.

Okay, thanks.

Thanks.

You have a follow-up question from the line of Robert Smith. Please proceed.

Could you give us some color on the cat litter market, what's going on there and your competitive position market shares, things like that? What's happening that's new?

You know, new, it is still dominated in dollars by scoopable, the pounds are, I think the scoopable pounds have actually eclipsed the [course] pounds. It is hard to tell these days because the single largest player is Wal-Mart and they don't share information. So we see our piece of the Wal-Mart business so we can kind of add that to the numbers, but I think the estimate now is a 20% to 23% of all of the cat litter sold in America is being sold through Wal-Mart.

So, when almost a quarter of the market is not reporting and then you add in Sam's Club which is their sister company, they don't report, and a lot of the other players, the PETCO's and the PetSmart's are not reporting, this is my understanding, now maybe something has changed, but I don't think so. None of the major outlets in cat litter are reporting.

So when you get this scanner data you get a very skewed look. You are pretty much seeing the historic avenues of sales, but not the current avenues of sales. If you figure where the growth has come in the last 10 years, it has been at the pet specialties, the PETCO the PetSmart, it has been at the mass merchant players, like a Wal-Mart or a club like Sam's, or even again these guys don't report either. The dollar stores, the Dollar Generals', the Family Dollars', and the Family Trees.

So it is hard to answer your question. We can give you sort of anecdotal stuff, it is just not nearly as transparent as it used to be.

Any scuttlebutt, I mean new products, anything like that that might affect the market?

Nothing in terms of format changes meaning all of a sudden something is going away from clay. Everyone has got their new items. We have some new items that are just product line extensions, there's nothing revolutionary, they're pretty much evolutionary and the same can be said for our competition. It seem that is the competition is at the moment as much or more focused on the packaging as they are on the actual product.

And that makes sense because in every usage and attitude study we have done in cat litter people are more size loyal and package loyal than they are brand loyal. Meaning if they go into a store looking for a 20-pound bag of X brand, if there's not a 20-pound bag of that brand, but there is a 20-pound bag of somebody else's brand they're more likely to leave with that than they are to leave with a different size of the brand they were looking for.

They really can't even recall most of them the brand, they can sometimes recall the color of the package they buy, but they absolutely can recall the package. I either buy the big size or I buy the jug or I buy the pail, they're way more sized and packaged loyal than they are brand loyal. So it is never totally quiet on the western front, but there really is at the moment nothing evolutionary going on in cat litter.

Thanks. I will get back in the queue.

Thanks.

(OPERATOR INSTRUCTIONS) You have a follow-up question from the line of Brad Evans. Please proceed.

Dan, I was just curious with row crop prices where they are today and the probability of some marginal acreage being planted this year, CRP acreage, do you see anything on the horizon that might incite some demand on the [ag-carrier] side?

The traditional ag-carrier business is in a pretty strong decline because of GMO, genetically modified organisms, however, planting more acreage does take some of the slope out of the decline, there's no doubt about it and we are really in the best position to benefit from that.

They have to set aside a certain percentage of acres every year to avoid resistance on the GMO. I think it's 15% or 20% of the acreage. So the more acres that are planted, the more set aside acres there's going be and then you still have a certain percentage of the farmers who have not adopted GMO either because they don't believe in the technology, they can't afford the technology or they aren't seeing the benefits of the technology for whatever reason they are not. So a bigger pie is good for us, but our share of that pie is going to keep declining.

Okay. Thank you.

You have a follow-up question from the line of Ethan Starr. Please proceed.

Yes, a couple of years ago you increased capacity in a higher margin product line by 50%. I am wondering how much of that additional capacity are you now using?

That has been -- And I say it is better to be lucky than smart. That has been great for us. That business is doing very well and without that capacity we would never have been able to deliver near the results you are seeing.

How much of it is left over? That's just tipping off competition as to how much we can respond to new business or not. Let me just, suffice it to say we would not be in the position we are in today if we wouldn't have made that investment and like I said, you would love to think it wasn't luck, but at the end of the day you are building in advance of the orders, no one is saying if you build that thing I will wait and then I'll give you all my business. It's like that old adage, you can't go business from an empty wagon.

We had to put the capacity in place. We had faith in our product line, faith in our team and that has paid off nicely.

Okay. The 10-Q noted that you gained some new business that included (inaudible) in the biodiesel production industry. I'm wondering what's the potential for further growth in this area?

Yes, it is, that's been nice. And I would say the more adoption there is to biodiesel, the more chance there is for us to participate in that market. So that's, that's been a good thing.

What product is being used for that?

Multitude of products. I mean again, not.

Okay. I will get back in the queue.

Okay. Thank you.

You have a follow-up question from the line of Brad Evans. Please proceed.

Hey, Dan you have been, the balance sheet has been holding roughly $3 to $4 a share in cash going on seven or eight quarters now, how do you prioritize the use of that cash going forward between raising the dividend and perhaps either buying back stock or acquisitions, I guess?

Yes. I would saw if you had to make me prioritize those three at the moment anyway, acquisitions would be at the top of the list. Dividends are are always very important. You know, Andy, and I have had a lot of discussions. Michael Nemeroff, who is a board member of ours who is well in tune to the M&A market has helped me understand that a strategic buyer sitting on both cash and available leverage is going to have opportunities in this marketplace.

The private equity guys are reeling the credit they used to be able to open a spigot and have it flow right to them. That spigot has been dialed back, if not completely shut down, and so the ability of the financial guys to outbid strategic guys and run up the multiples at the moment is seeming to be curtailed. So, we are going to continue to be disciplined.

We are not just going to spend money because it is sitting in our pocket. On the other hand, we are going to be opportunistic if we can, if there's value to the seller and value to us as the buyer, then an acquisition would be great.

If I had to prioritize your three, I would say acquisitions with dividends -- we are not going to cut the dividend or anything like that. We have a history of always either maintaining or growing it and we are covered by Safe Harbor I can say I don't see any changes in the near term from that history.

And then, the stock buy back, I think we still have some shares authorized that if we wanted to get opportunistic there we could do that as well. But ranking the three, that's my perspective.

Can you just talk about the M&A pipeline, what does it look like qualitatively today versus six or 12 months ago?

It is going to be interesting because let me analogize it to you. I don't have a crystal ball but my analogy is it's like the housing market right now. If you were trying to sell your home and you were sitting on it six months ago you were thinking it was worth X and today it may be worth 10% less than X, but it is really probably worth 20% to 25% less than X.

So are you going be willing to take that hair cut and sell your home? I don't know, but that's sort of what I am seeing in the acquisition world is that while we are in discussions like we always are on strategic acquisitions, the buyers have not, the sellers, I'm sorry, have not necessarily lowered their expectations given today's market.

So then they have two choices, they can decide not to sell and just wait for the market to come back around which may or may not happen. That's going to be the claw, or they can hope to find a buyer that's willing to buy today assets at six months ago or a year ago prices.

And who knows? Like I said, I don't have a crystal ball, but that's my concern about whether we will or will not be able to complete any kind of acquisitions in the near term is whether or not the sellers are adjusting to today's market.

I'm sorry. My last just to dovetail on that, with respect to the cash and the short term investments you have no exposure to auction rate securities?

None.

Okay. Thank you.

You have a follow-up question from the line of Robert Smith. Please proceed.

Just as a comment on something that was referenced before, I would like to see you guys continue to annually increase the dividend. I think that's important. Then, Ethan's question about biodiesel. Is this now a seven figure revenue product? Is it over $1 million?

I don't know. I would hate to answer that and be wrong.

I don't think, I had rather not be that specific.

I don't think we break it out.

No, we don't.

Okay. Anything new in the specific areas that I kind of questioned you guys each quarter, [cam kerder, rick].

No, nothing, nothing new there.

Okay, so is there any time line on the introduction of new products? Are we going to see anything this calendar year?

Well, we have already rolled out some new products on the consumer end. We have run some ads, so it's not anything --

I am thinking more B to B.

On the B to B side, still targeting for the end of the fourth quarter, with a, no material impact on this fiscal year.

Right --

But hopefully a material impact or at least a reportable impact on the next fiscal year.

Okay. When you introduce this product, when will you be able to share some information with us about it?

Trust me we are all in the same boat. You don't want me to share with you any sooner than --

Yes, that's what I am asking.

Right. I don't know. I can't tell you that. I don't know the answer to that question.

As soon as I am legally required to share it with you I will, until then I am not going to because it will just mount defense against our effort. So what's the point? Doesn't help you, doesn't help us.

Okay. Put me down. I will buy one unit. (laughter)

You can have it.

Okay. Thank you.

All right. I guess we have, this is good. We have hit our new half hour format, and I hope everyone appreciated getting the Q in advance of the call. That was the first time has happened, right, because we've changed the schedule around.

So at least you have the benefit of the Q versus we have the call and then the Q comes out and then you have a bunch more questions and you have to wait another 90 days to get it. The next 90 days what we are focusing heavily on is really everything you guys surfaced during the call.

We have to get our prices up, we have to control our costs, we want to keep taking advantage of opportunities as they present themselves to us, and luckily or not luckily due to a lot of discipline our balance sheet allows us to do that. We did not benefit from any of the crazy financial derivatives that maybe some of these companies for a short period of time benefited from, but we are not suffering from their rapid decline either.

We are, almost 100% in U.S. treasuries, so that's where we have decided to park our cash and where it is always pretty much been parked. We had a little bit in some, I don't know, other mutual fund thing, but even that was Treasury backed. So regardless, today's exposure is zero and we have nothing going there.

So it is like we always talk about, we're the ultimate turtle in the tortoise and the hare race, but we never apologize for that because the tortoise wins the race every time. We believe that through our disciplined approach towards long-term focus on creating value from sorbent minerals we are going to be in a very good position to take advantage of those opportunities as they materialize.

So, thank you for your patience. I know it must get frustrating from time to time, some of our activity may look glacial in nature, but in reality we are making a lot of progress. We have come a long way, but we still have a long way to go.

We still feel the best is yet to come. We will talk to you again in 90 days. Thanks, very much.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.