Oil-Dri Corporation of America (ODC) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q4 2014 Oil-Dri Corporation of America earnings conference call. My name is Michelle, and I would be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would now like to turn the call over to Mr. Dan Jaffee. Please proceed, sir.

Thank you, Michelle; and welcome, everybody, to our year-end teleconference. With me in the Chicago conference room is Dan Smith, our CFO; and Doug Graham, VP and General Counsel; and Reagan Culbertson, our Investor Relations Manager. She is going to walk us through the Safe Harbor provision.

Thank you, Dan. Welcome, everyone. 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 evaluating any investment in Oil-Dri stock. Thank you for joining us.

Thank you, Reagan; and I would like to turn it over to Dan Smith for a review of the year and the quarter.

Very good. Good morning, everyone. Oil-Dri’s sales for the fourth quarter and the full year of fiscal 2014 have continued to benefit from additional private-label cat litter business from the MFM acquisition and improved branded cat litter sales. For the full year we generated $266.3 million in sales, up 6% from fiscal 2013. However, our earnings reflected increased materials packaging freight costs for both business segments, along with incremental promotional spending for our cat litter products. Our EPS of $0.07 per diluted share for the quarter and $1.17 for the full year were both down significantly from the same periods in fiscal 2013. Our gross profit percentage for the year was 22.4% versus 26.5% in fiscal 2013. Gross profit was negatively impacted by the cost increases that I previously stated, plus 21% increase in the cost of natural gas used in our manufacturing facilities, and the fact that our private-label cat litter business generate lower gross profit per sales dollar. Also impacting our earnings in fiscal 2014 was our tax rate, which was 26.3%, which was much higher than the 16.6% in fiscal 2013, but more in line with historical norms. Our retail wholesale team reported strong top-line sales growth for both the quarter and the year. Sales of Cat's Pride Fresh & Light products led the way with a 33% increase for the year. Also, our private-label litter sales were up 24% for the year; however, the retail and wholesale group reported significantly reduced earnings for the quarter and the year. Increased costs and increased advertising and promotional spending were key drivers of this change. B2B sales were up for the year but down for the quarter as compared to fiscal 2013. Sales increased to edible oil processors and to users of our animal health and nutrition products. Our ag team generated reduced sales to corn rootworm pesticide formulators. Finally, our co-pack traditional cat litter sales were down slightly. Increased costs adversely impacted the segment's income for both the quarter and the year as compared to fiscal 2013's values. Our balance sheet remains strong. Our cash and investment balance at the end of the year was about $19 million, which was down $23 million from fiscal 2013 but similar to the $20 million at the end of the third quarter of fiscal 2014. The decrease was driven in large part by the approximate $13 million November 1 asset acquisition of the MFM Industries Inc. and our capital spending for the year. Finally, we increased our dividend payments for the 11th straight year. We paid out just under $5 million in dividends in fiscal 2014. Thanks, and I'll turn the meeting back over to Dan Jaffee.

Thank you, Dan. And as always, we would like to open it up to Q&A so we can cover those areas that are most interesting to our investors. And so, Michelle, I would just like to encourage everybody to prioritize as to most important question first and then go to the end of the queue, as we are on a strict 30-minute timeline. So, Michelle, let's open up the question lines.

[Operator Instructions] The question we have comes from the line of Jim Schwartz from Harvey Partners. Please go ahead. Jim Schwartz – Harvey Partners, LLC: Hey, Dan. How are you?

Hi, Jim. Fine. How are you? Jim Schwartz – Harvey Partners, LLC: Good. Thanks. A question for you, just on Fresh & Light, the sales are up 33% year over year. Can you kind of just go through the payoff that, as investors, we'll see from you guys being kind of the disruptor in a space that has never really been disrupted before. Obviously hard to tell with the numbers right now, but in future years, what kind of payoff do you expect from the investment that you are making here?

Sure. That's a great question, and that's really what's at the heart of the strategic investment in Oil-Dri, is – and I won't get into too much historic detail for our longtime investors, but it's important to put it all into context. You mentioned being a disruptor. So the last major disruption was in 1991, when sodium bentonite – scoopable cat litter – was launched. And it was all about when the animal urinated, it formed a clump; the consumer could scoop it out and get that odor out of the box altogether. So fast-forward – that was 0% of the category when it launched, and it's become 70% of the dollars-ish of the category. So it's been a major disruptor of the category. While sodium bentonite has a lot of nice attributes in terms of swelling and clumping, it has a major disadvantage in that it's very heavy in bulk density. If you took a cubic foot – a box that was a cubic foot and filled it with sodium bentonite, it's going to weigh anywhere from 65 to 75 pounds per cubic foot. Historically, cat litter has weighed about 35 to 45 pounds a cubic foot. So it's almost doubled the density, meaning the consumer is getting half as much material. And we all know consumers use it by volume, not by weight. So they buy it by weight, but they put it in their tray up to 2 and 3 inches. So you are weighting out trucks; you are shipping all this heavy sodium bentonite all over the United States; and the consumer is having to use way more material to fill a box in terms of pounds than they ever had to use before. So major negatives from that standpoint. So Oil-Dri is sitting on the largest quality and quantity of reserves in the United States of light-density, highly absorbent, great at odor controlling mineral reserves all the way from California to Georgia. And so, as they say, necessity is the mother of invention. So we were sitting here 3.5, 4 years ago with our nose pressed against the window, hoping to get into the scoopable cat litter segment in a much better way – but always seeming to be on the outs, because the accounts were all looking at price per pound, and we were disadvantaged. So I'm going to tell you a little story real quick. So the largest account we had when I took over was Sam's Club. Back in 1995, I take over, and literally the first week I'm on the job, we get called down to Bentonville, and they throw us out. And why did they throw us out? We were supplying them 22-pound Lasting Pride in a 5-gallon pail for $5-ish. They were getting quotes for 28 pounds of scoopable for $4. So they were very upset with us. So we get thrown out – and supposedly we were gouging them, and so forth and so on. The $4 item, which was 28 pounds, was sold in a 3.5 gallon pail; ours was in a 5-gallon pail. So the consumer got 30% less material for a 20% lower price. Not a great deal for the consumer, and yet we looked bad, because it was all priced per pound. So I'm just showing you – as the category started to go that way, a race to the bottom, many of our competitors have the bright idea – well, hey, if heavy is good, then really, heavy has got to be really good. And if I could put some really cheap, heavy stuff into my cat litter, I could look good without actually performing. So I'm not going to name names, but many of our competitors densified their cat litter. They put dolomite, which is stone; they put calcium carbonate, which is limestone, into the product. It's purely a diluent that is there to densify the clay, so that – for instance, we had a competitor that had a 25-pound box, and lo and behold, they were able to put 28 pounds in the same box, same fill, same everything, and say: 3 pounds free! And the consumer bought it, hook, line, and sinker. And they were one of the fastest-growing brands. So all very frustrating for Oil-Dri, who knew we were sitting on the highest-quality, best products but couldn't get it communicated to the consumer. So Proctor and Gamble and Unilever come along and launched concentrated liquid detergent, where they were urged by major retailers to take water out of the formulation, because we're shipping water all over the United States; consumers have water in their home. They don't need to bring more water home. But if they could understand that, yes, your price per ounce is going to triple, but you are going to be able to do 3 times as many loads, your cost per load is going to stay the same. And at the end of the day, you, the consumer, are buying liquid detergent to do loads of laundry. So they spent $110 million educating the American consumer on this. And, fast-forward, go to your shelves – you will see 0% of the old liquid detergents. It's 100% concentrated. All the private labels, on the off-brands, all the major brands. So – I'm sorry. Dan, you are distracting me. So we then had the idea that we are going to launch a lightweight cat litter that is going to deliver all the benefits of the highest-performing cat litter. So very strong clumping, fantastic odor control, no dust. Just absolutely – marketing perspective, no dust. The scientists can find it; the consumers can't. So it scores extremely well on all metrics. And at the same time, it's going to be up to 25% lighter on a bulk density basis than the other scoopable cat litters that are out there. So, for instance, if you are able to put – you know, you've got to do the math, and it depends on pallet weights and everything. If we are shipping a truckload to Walmart with 2,000 units in it, all of a sudden we can put 2,500 units into it. They could reduce the number of trucks on the road by 25%. So they saw the benefit of it. And the consumer, who is using the product by volume – once they understand, hey, I'm getting the same volume; and now I can carry home less weight; this is a good thing for me. Because the predominant buyer in cat litter are – they're women, 25 to 54, and they are not looking to bring home 40-pound boxes if they could bring home 30 or 20-pound boxes; or if they were buying a 20-pound size, and now it can weigh 15 or 12. So you'd get all those forces going. And it made Oil-Dri say, hey, we are going to invest $35 million in launching this lightweight branded cat litter. And I checked with our team today just to see – what is our cash flow since inception? We told you we had invested $35 million. While we have generated sales and generated gross profit, we are still very negative from a cash flow perspective. Over time, the IRI is very positive – the 10-year and terminal value and all the things you do to make yourself feel good. But through 3 years, I can tell you, more cash has left Oil-Dri than has come in as we have launched this. But as you know as a longtime holder, I've been sort of the crazy mad scientist, saying, we are going to get 100% of the category to go lightweight. Once consumers get it, they are never going to un-get it. It's good for the retailer; it's good for the consumer. It's phenomenal for Oil-Dri, because we are sitting on all this lightweight raw material. And the category – once the consumers can get a lightweight Tidy Cat versus a heavy Tidy Cat, so they are going to buy the lightweight Tidy Cat. Why would they say, I want to bring home more weight? They can do their weightlifting in the gym. So fast-forward, that's what has happened. It's all coming. Tidy Cat has jumped in, and they have done very well, which is good. Clorox is now jumping in. They are just launching – I've seen their TV ads, and that's all good for us. So it's really what we call the tsunami. The category is switching, and it's going to become lightweight. And that's what the consumers are going to want. And now they are going to finally evaluate cat litter not on price by pound, but they will look at the relative volumes, and they will say, okay; for the price and the performance, which one do I want? And on those bases, we love to compete, because we are very competitive. We've got, like I said, the geographical distribution of raw materials; and our freight, then, picture is better than anybody's. And our performance is outstanding. We are absolutely committed. Our best and our brightest get up every day and work on cat litter. I can guarantee you the best and the brightest of Nestle/Purina – if they are on cat litter, they are looking to get promoted off of cat litters. I mean, it's a food company. So I'm not saying we are competing with people who aren't very bright; they obviously are very bright. But their hope is not to spend their career on cat litter; their hope is to get back into the mainstream and get on food. So it's all good for Oil-Dri. And then the final win, which I – again, you as a long holder know – that it's huge for Oil-Dri is as you start to become mainstream with lightweight, the retailers are going to want it in their private label, in their private brand. So Kroger, Pet Pride, or Walmart's Special Kitty. You can go on and on. All the accounts have their own private label. So when you go in the store, you can buy a brand or you can buy their private label. And they are not going to lead the change; they will absolutely follow the change. And as it gets to be a bigger and bigger percentage of a category, they are going to want more and more SKUs dedicated to it. Well, the good news is we have always been very aggressive about putting on private-label accounts. However, historically, before lightweight, our share of the course – the traditional private-label course – was great. Very strong share, 40%, 50%. On the scoopable side, less than 2%, because it was a race to the bottom. It was all about densifying and what's your cheap price per pound. I don't want to hear about your quality; I don't want to hear about your dust; I don't want to hear about your supply and your on-time delivery. What's your price per pound? We are going to do online bidding, and if you are not the lowest, you are not getting it. So there's a guy out there who – that's his model, and it's great. And he's taken 90%-some-odd share of the private-label scoop-heavy category. Well, now, as the lightweight comes, now the game changes. Now we are the low-cost, high-quality player. We have the raw material. We have the quality. So we can quote very competitive prices at healthy margins to Oil-Dri and start to get a much greater share than 1% or 2%. Now, how high is up? You know, that's – again, I can't give all that forward stuff. But I did look at IRI. And roughly, in the 52-week period at retail, $200 million of private-label cat litter was sold at retail. Like I said, $100 million some-odd of that was scoop, and we had less than a 2% share of that. So do the math on it. If you think Oil-Dri can get a 20% share of that, a 40% share, a 50% share of that number, it's a big number for Oil-Dri. It's a big number. Now, again, those are at retail; you've got to back off whatever you think their margin is and try and get to a wholesale number for Oil-Dri. But I have told you that historically there has been a lot of synergy between our brand and our private label at key accounts. So when we do their private label, we are a true partner. So when we come to the table; and we're shipping trucks; and we're mixing, and matching, and filling those trucks out, it's just easier for them to take our branded items and give us a greater share of shelf. So we believe it will all play to Oil-Dri's benefit to a much greater degree than the past. I really can't do the math for you; you guys are going to have to do it. But it's very exciting. 3.5 years ago when we came up with this idea, we filed the patents on all this. The patents are pending; they are at the US Patent office. The win-win-win-win would also be to get those patents issued, and we deserve to get compensated for really inventing and changing a $2 billion category. It's a long-winded answer, but I think it's the story at Oil-Dri right now. If you're investing in Oil-Dri, you really need to understand that. So I apologize if I went too detailed for you, Jim, but I think it was important for everybody to hear. Jim Schwartz – Harvey Partners, LLC: Yes. Thanks, Dan. And could you touch on, maybe, the gross margin difference in Fresh & Light versus the other pieces of business?

Yes, and I can do it in general terms. Jim Schwartz – Harvey Partners, LLC: Okay.

In general terms, our brands have not carried enough gross margin to enable us to support them with media. So internally, everyone says, oh, Dan is anti-media; Dan is anti-marketing. No, Dan is anti-losing money. So when our margins are too low, like they have been historically, we couldn't support it. These items carry healthy consumer product margins, where – you know, Paul Ziemnisky was from Kraft; and Lisa Mak was from Kraft; Kati Rust from ConAgra. We've got real – Anheuser-Busch – Craig is from Anheuser-Busch. We've get real consumer product people on our sales team who is all from the consumer-product world. They are all used to these margins, and this is what it takes to fight in that arena. Now, having said that, way better to be Tidy Cat with these margins – and they have a 20%-some-odd share – than be Fresh & Light, who is just trying to grow as a 2% share. So, clearly, we've got to get the critical mass there to actually make money. But these products do carry the margin necessary to support them going forward. Jim Schwartz – Harvey Partners, LLC: Thanks, Dan.

Okay, thank you.

The next question we have comes from the line of John Bair from Ascend Wealth Advisors. Please go ahead. Your line is now open. John Bair – Ascend Wealth Advisors: Thank you. Good morning. Dan, a number of questions. I'll give you 2 here, and then I'll get back in the queue. It seems that every quarter that we get higher costs of shipping and resin costs, looking in your K at resin costs and so forth. And yet we see a pretty good decrease in the cost of natural gas and so forth. I realize your fourth quarter, the recent decline didn't hit until end of this first quarter. So looking at your expense there, are you able to improve the cost of goods sold? What are you working on to do that? Because that seems to be a variable every quarter. So if you could talk about that a little bit? Because – I could start to refer you to the prior year. Hopefully your gas prices, which have dropped quite a bit, should help you out quite a bit in your operating costs. Thanks.

Absolutely. No, look, it's a great question. And you have as an investor every expectation going forward. As we start to become more business-as-usual with what I'm calling the tsunami, absolutely – we should be able to get the cost of goods down. However, when you are in the middle of the tsunami, you've got 2 choices: meet the orders or cut the costs. It's very hard to do both. So we had many dynamic periods where the growth was outstripping what our supply chain was really happy to be handling. And at the same time, we them acquired the mid-Florida mining business and threw that on top of it. So I can just tell you – we missed orders, and we focused too hard on cutting costs and process improvement projects while under-delivering and underwhelming our customers. Not a good long-term move for Oil-Dri. Now, wouldn't it have been great if we could do both? Absolutely. We didn't. Clearly, we didn't; it shows in the margins. But the top line was up; the customers are happy; the business is moving. And so, going forward, we will absolutely be more focused on being more efficient at cutting costs and getting our margins where they need to be. However, I will tell you, in any given period, if we see the opportunity to keep our foot on the accelerator in this lightweight opportunity, we are going to do it. This is not a quarterly – I have always said, we really don't run for the quarters. We are in a, as Jim said, disruptive, game-changing, paradigm-shifting moment in the cat litter category. And Oil-Dri is the one that is going to benefit the most if we play this hand out right. And so that's where our focus is. I will be happy to apologize to you guys that maybe we didn't save as much as we could have on packaging efficiency, or running Lean manufacturing while the storm was hitting us. But I will guarantee you that once the storm settles down, and our boat is nicely afloat at the top of the heap, we will definitely dedicate the time and energy to that. It's not an all-or-nothing, but I can just tell you where the focus and priority is.

Okay. Well, I'm just looking at it from the standpoint of – you know, you had mentioned in your K, I think, costs of resins were up. That seemed a little counterintuitive to me, given that a lot of – with the shale boom, and all the energy-derivative products that are coming out of natural gas liquids, and natural gas prices starting to come down, that I would think there would be some benefit there. But – and to your point about the quarter to quarter, I get that. I've been a long-term holder of the stock, so I've watched the ups and downs. One last quick question, and that is: you mentioned that your CapEx for next year is probably going to be on track with what you spent in 2014. Could you address what you are doing at your plants that is requiring the maintaining of those capital expenditure levels? And I'll get in the queue. Thanks.

John, this is Dan Smith. I'll take your question on CapEx. As Dan has already indicated, we are looking at spending quite a little bit of money in the lightweight cat litter business. We are looking at expanding our capacities in our other plants to support that business. So that's where a lot of the CapEx coming up in fiscal 2015 will be at. In terms of your comments on packaging resin, we have contracts with our resin suppliers. Those contracts adjust based on the cost of the input, so we feel pretty good about our contract pricing. But they do have inflators or deflators, depending on the increases or decreases they see in the marketplace or the inputs. And then, finally, in terms of natural gas prices, yes, natural gas prices have started to come down; however, looking through July, they were still up. And, certainly, they were still up as compared to similar periods in the prior fiscal year. So more of… John Bair – Ascend Wealth Advisors: Right. No, I recognize…

More of that move-down has been in recent months. John Bair – Ascend Wealth Advisors: Yes, and that should benefit you, hopefully, in this first quarter by a decent amount. Okay. Thank you.

The last question we had come from the line of Robert Smith from Center For Performance Investing. Please go ahead. Robert, your line is now open. Please go ahead.

Michelle, I'd be happy to field a question from Ethan, if he's got one, because I went long on my little soliloquy. It sounds like Bob does not have a question. Do we had anybody else in the queue?

Yes. We have another question from John Bair from Ascend Wealth Advisors. John Bair – Ascend Wealth Advisors: Very good. Thanks. Since those other ones aren't in there – wanted to ask you about Flo-Fre, the microgranules you had mentioned in your K, that there was a drop-off in that. Was that a function of grain inventories overall, that the end users that are using that product were not buying as much? And do you see any change in the trends there? And, actually, is that a very meaningful and high-margin product for you?

Yes, John, this is Dan Smith. Flo-Fre we see as more of an opportunistic product than anything. So it depends on our supply availability, which depends on the mix of products we are selling; and, to some extent, what the grain suppliers and other waste handlers are using the product for. So it's really more of an opportunistic product. John Bair – Ascend Wealth Advisors: Is there a seasonality to it?

Not that I am immediately aware of.

And it's not that meaningful. If you are making an investment in Oil-Dri, it's not… All right, well, good. Well, listen – thank you, everybody. And I hope you can sense from our comments and everything our long-term – mid- and long-term enthusiasm remains extremely high. Having said that, would it be – as we put in here in the news release, we are never happy when earnings are down compared to the prior year. It's just the fact. So while we don't run the business for the quarter, and we are not going to do anything to manufacture earnings or do anything like that, we are not Pollyanna-ish, either. So when the quarter is down, we are disappointed. When the quarter is up, we are happy. But from a long-term and mid-term perspective, we are very happy. My family is continuing to increase ownership in the Company. I've got some restricted stock that's vesting, and I'm going to have to pay some tax on that, but I'm going to, net, walk away with, again, an increased position. And that should tell you I'm putting my money where my mouth is, and you guys will have to decide what you are going to do. But I absolutely appreciate both your input and your loyal ownership and look forward to doing my best and the team's best to rewarding you over the long term. So thank you, and we will talk to you again in 90 days.

Thank you for participation in today's conference call. This concludes your presentation. You may now disconnect. Thank you for joining.