Oil-Dri Corporation of America (ODC) 2017 Q2 法說會逐字稿

Welcome to the Oil-Dri Corporation of America Second Quarter 2017 Earnings Conference Call.

(Operator Instructions)

As a reminder, this conference call may be recorded.

I would now like to turn the conference over to Dan Jaffee, President and CEO.

Welcome, everybody, to our six months investor teleconference.

With me we have the usuals -- Doug Graham, General Counsel; Dan Smith, CFO; special guest Mike McPherson, our Chief Development Officer. He'll be here to answer specific questions including things related to Amlan as Ron Cravens is somewhere in Asia, I think, right now. And Laura Scheland, our Assistant General Counsel, will be monitoring the call and taking us through the Safe Harbor Provisions.

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 ask that you review and consider those factors in evaluating the company's comments and in evaluating any investments in Oil-Dri's stock. Thank you for joining us.

Great. Thank you.

And, Dan, will you walk us through the quarter and the six months?

I will.

Good morning to everyone. Oil-Dri reported EPS of $0.58 per diluted share for the second quarter of FY17, which was about 10% better than the $0.53 reported in the second quarter of FY16. For the first six-months, we reported $0.86 per diluted share, which was down substantially from the $1.28 reported in the same period in FY16.

Second quarter sales of about $65.2 million were down slightly from the second quarter of FY16. Year-to-date our sales of $131.8 million were down about 1% from FY16. The sales decline for the quarter and year-to-date were driven by the decision to walk away from some low margin cat litter sales during the second half of FY16.

Our gross margin continued to grow despite the sales decline. Sales of our higher value added product lines offset cost increases for the natural gas we use to dry our products.

However, earnings for the year to date were still down compared to last year due to about $5 million more in advertising expenses in the retail and wholesale segment.

Our retail and wholesale team reported about $5 million of profit for the quarter, which was up above 16% better than the second quarter of FY16. Sales were down due to the discontinued low margin business I'd mentioned earlier.

Gross profit was up due to our focus on Cat's Pride, Fresh & Light Ultimate Care and private label lightweight cat litters. Year-to-date the segments profit was down compared to FY16 largely due to the effect we've invested about $5 million more in advertising and marketing this year. The spending increase was part of our ongoing marketing campaign to promote our Fresh & Light Ultimate Care lightweight cat litters.

However, we anticipate in the second half of FY17 we will reallocate some of our spending from advertising to trade promotion. Therefore, we expect our full year advertising spend to be significant but less than FY16.

The B2B team continued to see sales growth. Sales were up 3% for the quarter to $23.3 million and 5% for the first six months at $50.7 million when comparing the same periods in FY16. Sales were up for our fluid purification products during the quarter and for the first six months.

Sales of our animal health products were down a bit for the quarter, but were strongly up for the first six months. The growth of these two product lines have helped increase the segment's profit for quarter and year-to-date as compared to FY16.

Looking at our balance sheet, our total assets remain over $200 million and our debt is down to about $12.3 million. Our cash and investment balance was $24.9 million, which was down about $4 million from the same period a year ago, but was up about $3.5 million from the first quarter of FY17. We paid out about $1.5 million in dividends during the quarter. This brings our year-to-date dividends payout to be about $3 million.

Thanks. I'll turn the meeting back over to Dan Jaffee.

Great. Thank you Dan. Yes, great quarter. We're right on target with what we thought we were going to do and we're delivering, so that's great.

We'd like to open it up to Q&A. And as always, ask your most important question first and then go to the back of the queue to allow everybody a chance to get at least one question in.

(Operator Instructions)

Ethan Starr, a private investor.

You're spending a lot of money advertising the Fresh & Light Ultimate Care litters and I'm wondering to what extent the retail sales are not meeting, meeting or exceeding your internal return on investment hurdles. And is the shift of retailers' trade promotions from advertising due to the return on investment from advertising not meeting expectations?

You're only allowed to ask one question -- no, I'm just kidding. I'll cover both. It's a good question and obviously any time you're trying to get a snowball to roll your initial spend is going to be greater than what you could justify based on sales or income.

However, as you'll recall, if you go back, I don't know, maybe six years ago, when we launched lightweight, I really said it was a two-pronged strategy that what we needed to do was get the dominos falling on the branded side and hope that the competition would jump in, validate the category and then jump in and come out with the private label side.

So when I do the math, I count that all together because we can't get the private label if the brand doesn't succeed. Nobody wants a private label of some item if there isn't an existing successful brand that they aspire to purchase at a lower price but hopefully equal to or better quality. So when I run the metrics, that's how I do it.

If you isolate just the Ultimate Care sales, which is what the commercials are running and then put the spend 100% against that, yes, no that would be an ugly ROI and not long-term sustainable.

But I would say the way I look at the business as I total our entire lightweight business, which started at zero really six years ago and then I take that entire business which has been growing and healthy, which is why you're seeing the margins of the company swing the way they have in the last five years and then you put the media spend against that, it's still not great. But the snowball is growing and so it is more than sustainable, which again is why we continue to generate cash even when we are spending so much against media.

So net, net, net, am I happy with the spend? The answer is absolutely yes. It's been an unmitigated success for Oil-Dri and you can see it in the numbers. I've regaled you guys all with the metrics of per ton sales and per ton gross profit and you guys can see the margin, the percentages that have gone up, up, up. So net, net, net it's been a big win.

And the shift to more trade promotions?

That's just a marketing mix thing. So we aren't trying to play money ball. Look, just because you spend X millions of dollars doesn't mean every single spend has equal value. And what we're finding is if you run too much media, all you really do if you don't get the trade behind it drive your out of stocks up. So instead of going out of stock on Saturday, you go out of stock on Thursday, but either way you're not selling any more incremental units because there are no more units until Sunday night when they replenish the shelves and prepare for the next week.

So what we're doing is just balancing it out where we're getting the trade to load up. So we're dangling incentive deals where they're giving us end-aisle displays, end caps, quarter pallets, half pallets, all sorts of incremental. They only get the money if we get incremental distribution so that we can increase the holding power at shelf. Then you run the TV and, lo and behold, you see the incremental lift because there's more units to be sold. Does that make sense?

Absolutely. Very helpful. I'll get back in the queue.

Yes.

Robert Smith, Center of Performance.

Yes, so I guess you said that Mike's onboard here?

He is.

Okay. So in your press release about Varium, you said, "It is well known that there is a global effort to reduce or eliminate the use of antibiotics in livestock production. We continue to believe that Varium will become one of several viable options helping poultry producers in this effort."

Mike, could you give me a heads up on what are the other options that are available?

Sure. Poultry producers around the world, especially in Europe where antibiotics have been banned for a while, they'll use essential oils such as oregano oil, peppermint oil. Those types of oils are believed to have antimicrobial properties and will kill certain types of bacteria.

Do you have any idea as to how Varium stacks up against those other options?

Yes. We've compared that in vivo and it compares well, so it's favorable.

So you have a better product?

We're proving it out in the field. We've also had some producers that have trialed it in a production environment against essential oils and Varium has come out favorable, meaning it's had a greater impact on the birds than essential oil.

Fatty acids -- and there's 17 of them, I won't get into all the different types, but various fatty acids are used. They're also believed to have antimicrobial properties. Direct feed microbials is another class. Various plant extracts are reported to have properties. A lot of these, if not most of them, have no efficacy data to support their claims. You got a lot of marketing, lot of PR, not a lot of research like Varium.

Yes. The release that said that they had 10 for 1 return on investment sounds tremendous, I mean you can take that to the bank.

So how are you guys seeing that taken in the field so to speak? Did that get -- raise some eyebrows?

Yes. From a producer standpoint, yes, it's raised a lot of eyebrows. They couldn't believe the results, so they did another study. That's usually what we're seeing. Results have been very positive. They go back and do another study to further validate it. That particular producer had two studies in a row with that level.

They're now using it in about half their production and they're going to run that way for about six more months. And if it continues to have the favorable effect, they're going to be eliminating antibiotics even though they have no regulatory pressure to get rid of them, because it's performing equally, but then it does some other things to the birds that are favorable.

Okay. It sounds like you're on the cusp of something really very, very positive, so I'll keep my fingers crossed. Thanks. I'll get back in the queue.

Great.

John Bair, Ascend Wealth Advisors.

In your press release, you mentioned that the removal of low margin cat litter business lowered sales. To what extent is the removal of that coarse grain stuff being replaced or augmented by the newer product, or are those sales just kind of going away? Does that make sense?

Yes. Like anything, it's not black and white. It's not 100% where we've gotten out of the coarse, so we've replaced it with high value lightweight, but there are numerous examples of where that's happening. Unfortunately, there's a timing issue.

So in one of the major accounts that we moved away from, we are now -- we have been awarded their lightweight business. I'm not going to get into the details, but we're working on packaging and all that kind of stuff. So it hasn't started shipping yet. So we've had all the negative erased really because it wasn't great business for us, but from the top line stand point we're taking all the hit and the positive boost is still yet to come.

Okay. And is that typically what happens if a private label coarse buyer decides to, or maybe it's on your front where you back off of it, there's a lag time to convert them to saying, hey, you really need to do the finer grain modern day product?

Yes and it's so dynamic. This is such a disruptive innovation that a lot of this is uncharted territory. It's not like this goes on everyday where you go to a retailer and say we no longer want the old technology business even though there are plenty of consumers that are going to stick with it, but it's just not profitable for us, we want the new technology and this is where you want to go as a retailer because this is where all the growth in the category is.

So there's a lot of fits and starts to it, but net, net, net, it's a big win. It's not like one step up and two steps back. It's the other way around. It's one step back and two steps forward and it's just going to take patience. It's going to start. It's already showing in the margin line, but it will even start showing in the top line as we move forward.

Okay. I've got another question, but I'll get back in the queue per your instructions.

Hey, you're the only one who listens to me. Ethan and Bob fire off two, three at a time.

Ethan Starr, private investor.

Hey, I just follow what everyone else does.

You're the leader. No one's ever gotten in before you.

Well, I try. I know you just mentioned in your response to John Bair a new private label lightweight customer. Have you had gain from the other new private label customers in the last three months?

Numerous. The dominos are continuing to fall. Our technology is proving to be the best. And what's really going on now is many of our partners now are wanting to put the efficacy, the loads concept on to the package so that's going to start rolling out. We want that to become the industry standard.

And so that you'll actually have to tell the consumer how many loads you're delivering, because what's happening is people are calling stuff lightweight, which would be like calling something concentrated in liquid detergent analogy, but then instead of it being 80 loads in the big format and 80 loads in the small format, they just took out 40 loads and it's 80 and 40. That's a rip-off. That's not innovation.

So we're putting it on the package. We're putting it on all our brands. And now our private label partners are all putting it on their packaging. So we believe that the competition is going to get dragged kicking and screaming into adopting this as the standard, where they're going to have to disclose how many loads they're delivering to the consumer.

So when will you see all these new private label customers, private label lightweight customers going to the top-line and bottom-line?

I mean, I don't know. It takes time. I know everyone's impatient, but this is going to be a big win, long-term win for the company. So getting the packaging right, they've got to take off old stuff, they got to work in the new stuff, they have to rebalance shelves. There's all sorts of dynamics going on. So I don't get too much forward guidance, but within your lifetime you'll see it.

Quickly, how are the Katherine Heigl packaging doing as far as retail velocity compared to the packages without her picture?

Too soon to read, but certainly the anecdotals are very good. We're waiting for it to actually hit the syndicated data, but that's too soon to read that. But--

Okay, thanks. I'll get back in the queue.

Robert Smith, Center for Performance.

So I just wanted to have a clarification. So for the first six months year-end promotion budget was up $4.6 million. Is that true?

Robert, about $5 million.

Yes, $5 million minus $400,000 so you're --

For the first six months, it was up about $5 million.

Okay. So that's going to be retraced in the second half, so you'll be adding really $5 million for the second half versus the comparative figure for the last six months of the prior fiscal year?

That's not necessarily the case. We had --

You said your total end promotion budget will be lower than '16, than FY16?

Okay. Yes, the total advertising spend is currently projected to be lower than FY16, but you're assuming that the first half and the second half plans were exactly equal, which they may not have been.

No. I'm trying to recapture the $5 million in the first half, which was an incremental spend, right? So if that's going to be reduced to less than last year, so it's got to be minus $5 million, doesn't it?

Robert, we're refocusing some of that advertising spend to trade promotion. So we're still spending money, it's just being spent differently.

Okay. So, I misinterpreted what you said.

I believe that's fair to say.

Okay.

You're not the first one.

All right. So I'll get back in the queue. Thanks.

John Bair, Ascend Wealth Advisors.

Okay. Thank you. I want to go back to your response to Bob's question about the Varium. Can you shed some light on the differential of using those oregano oils and I forget what the other one was versus Varium? Is there a cost effectiveness of using one versus the others from the poultry producer's vantage point? In other words, how competitive is your product versus those alternatives I guess is what I'm getting at.

On a cost per use basis, Varium is favorable to any one additive. What we're finding when we talk to producers in the United States and pretty much anywhere in the world due to the fact that those alternatives to antibiotics that I mentioned, essential oil, plant extracts, direct feed microbials, none of them have the same efficacy or the same outcome that you get with using an antibiotic.

So as a result, they use combinations of those things. Without a lot of rhyme and reason, the industry I'd say is still trying to find the efficacious solution. So they'll use, for example, a yeast, a little bit of an essential oil and a little bit of a plant extract and they'll do that and use it for a while. And then when they have an upset condition in their farm and the mortality starts to go up or the feed conversion starts to rise, they'll just change. They'll get rid of the essential oil and they'll substitute some other material in.

So I'd say typically no fewer than two, but I'd say more typical, three different additives are used to try to get the same outcome as an antibiotic. Varium, we're finding, can be used by itself without any of those other additives and from that standpoint it's less expensive.

Okay. And how does the animal ingest that? Is it just mixed in with the feed or how just in general? I'm just curious.

Most of it is put into the feed. There'll be a couple of additives that are added to the watering system and some do both. Some will put the essential oil in the feed. Some will deliver it through the watering system.

Then roasted chicken would have an oregano flavor to it. That'd be interesting. Okay. Thanks very much.

Pre-seasoned chicken.

Ethan Starr, private investor.

Per the to 10Q you sold 26% more tons of animal health and nutrition products in China and this year's Q2 versus last year's Q2. Is that increase sustainable or were there one-time factors behind this?

Is it sustainable?

Yes.

We fully expect it to continue growing strong, that's been all, we're relatively new to China. All of that is new account acquisition and prior accounts that we obtained in the previous year more broadly using our products in their operation as you might imagine.

These producers in China are absolutely enormous. Most are involved in poultry and swine, so sometimes you get into their swine operation. They'll expand into various parts, different segments of their swine business over the course of a 12-month period and then begin to expand you into the poultry business. So growing with these big mega-producers is a multi-year prospect, but once they love your products they provide a lot of growth.

Okay, but it sounds like it's still pretty small in dollar terms.

Yes, yes.

It's probably a fair statement.

Anything new coming out of the innovation center?

You want us to tell you all our secrets. Yes. No, I can't talk about this stuff, but, yes, we got exciting things going on really in every division. And then I would say the most exciting thing we're doing out there is breaking down the barriers because the chemistry around something you might do in one division actually has applicability to another division.

So it used to be very siloed and now it reports up into Mike. I don't know if you want to talk about it, but I'm loving the cross collaboration. I'm loving when I'm reading the reports and I'm seeing things one guy is working on and we used to have nothing to do with cat litter, for instance. He's now taking his expertise on formulations or whatever and then bringing it over to the cat litter group.

I'll get back in the queue. Thank you.

Thank you. Robert Smith, Center for Performance.

Hi. So Wal-Mart's been putting some pressure on suppliers to reduce prices and I'm wondering how that affects you or might affect you. And the question of them doing free shipping would seem to imply that it would be in their best interest to really push the lightweight litter, so just give me some idea as to how you feel about that.

Look, I love Wal-Mart. They're transparent with their strategy. You make it sound like this is a new direction for Wal-Mart, like now Wal-Mart's going to be all about price. They've always battled hard. They've made it clear to us they are not our customer, their customer is our customer. And we need to work together to take cost out of the supply chain, do everything we can so that there they can bring really a better quality of life to the middle and lower half of America.

I think they ran a statistic and I'm probably misquoting it, but I'll be directionally correct, that like 70% of their shoppers don't have a credit card. These people get the pay check, cash it and go right to Wal-Mart. That's why their first week of each month their business spikes because that's when people are often getting paid.

So that's not a new direction for them and they're very transparent with their strategy, which I like because I tend to do better at bowling when I can see the pins and they let you see the pins which is great.

And then regarding lightweight, absolutely. Think about it, not only is it good for the environment, but if the whole category switches to lightweight and we can cut the number of trucks in half, that frees up I think something like 22,000 truckloads not having to go into Wal-Mart distribution centers.

That's a big problem for them is bottleneck at their DCs and so it's absolutely in their best interest to see lightweight continue to take over the category, because they can cut the number of trucks coming into their distribution centers in half. So it's good for the environment. It's good for consumer. It's good for the retailer and just coincidentally, it's good for Oil-Dri.

Yes. I was thinking more in terms of them shipping the product to their customers. So if they are providing free shipping, it's certainly a cost advantage to them to pay less in shipping the products.

Sure. No, that's true and same is true of Amazon and Chewy. And so the e-tailing business in cat litter is actually going up and I think that's the exact reason why because there's more value per pound than there ever was. You couldn't afford to ship a 50-pound bag of low value coarse cat litter anywhere.

Thank you. Ethan Starr, private investor.

How was your effort to upgrade consumer manufacturing lines progressing?

Excellent. As you know, we did a divide and conquer strategy when we brought in Aaron Christiansen and his team are, as we say, that's not even low-hanging fruit. They have to step over the fruit to get to the line. And Mike and his development team have been working hand in glove with them and they're making huge progress.

So our quality has never been better, our efficiencies have never been higher and yet we all believe we have a long way to go. So it's all about continuous improvement, but we don't feel like we've played out the string on either one of them, either the quality or the efficiency side.

And as we all know, higher quality leads to lower cost because you reduce waste, you reduce mass inspection so it all works hand in glove. And I would literally say we're at the beginning of the whole curve, not the end, but it's exciting because we're finding huge areas to focus and improve on. So it's been a great focus for the company.

Great. And then the ERP implementation, how is that going and are you already seeing cost savings?

No cost savings.

But, Dan, why don't you take that?

The ERP process is going, Ethan. We've spent a little bit of money. Our CapEx is up. But it's a journey, we don't anticipate getting the system up and running until mid to late FY18.

Wow.

And just I guess to manage expectations, so at the beginning it's going to increase cost.

Right. Sure.

So, for instance, let's give him a forward look at one thing. The Grant Thornton is basically going to have audit two systems when we go live. They're going to have to. It's almost doing a new audit and so their auditing costs are going to go up that year. It's not going to be a saving. Now, that will be a one-time thing and then the next year they'll start to trend back and eventually it should get back to where it was. And maybe it'll end up being even lower because they can have greater reliance on systems.

And you're going to spend a lot of capital dollars putting the system in place and that will raise your cost initially, but then you hope to get productivity and operational gains from better information, that type of thing.

Sure.

But I will tell you again, this is good disclosure for those on the call vis a vis Oil-Dri and if you're involved in any other businesses. For years, we tried to justify it on a pure ROI basis and so we never approved it because it's so disastrous. You're using all this incremental resource.

And then finally you get to the point where it's infrastructure, it's like we have lead pipes and we needed to put in copper. We had tube and knob, but we needed conduit. Just to be able to come in and go work and ship, bill and invoice, we needed to gut the house and put in new infrastructure.

We really didn't get -- we are going to get some new rooms and maybe the lights will come on a little faster, but in reality it was just to allow us to keep doing business. We could no longer find people that could program on the old system. Nobody wanted to learn that technology because it was literally started back with the old cards on the System Three in the late '60s. So it was all about infrastructure in the future.

So in my mind, any efficiency gains we get is gravy, but really the goal is the day after the implementation to be able to ship and bill and invoice. And if we can do that, I'll be a happy camper.

Thank you. And that is all the time we have for questions today. I'd like to hand the call back over to Dan Jaffee for any closing remarks.

And thanks, everybody, for your interest and we'll be with you in 90 days to report the third quarter in nine months. So thanks very much. Bye, bye.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone, have a great day.