Oil-Dri Corporation of America (ODC) Q4 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to Oil-Dri Corporation of America's Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] And as a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Dan Jaffee, President and CEO. Sir?

All, thank you, and welcome to our year-end teleconference, fourth quarter and year-end teleconference for Oil-Dri. Joining me here in our Chicago conference room is Mike McPherson, our Chief Development Officer and in charge of all B2B businesses. So he can answer those questions. Dan Smith, Chief Financial Officer; Doug Graham, our General Counsel; and of course, Reagan Culbertson, and she's going to -- does all of our Investor Relations and she's also going to handle the safe harbor provision.

Thank you, Dan. 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.

Great. Thanks. And Dan, why don't you walk us through the quarter and year-end?

Sure. Good morning, everyone. Oil-Dri reported EPS of $1.47 per diluted share for fiscal 2017. This value is down from the $1.87 reported in fiscal '16. However, the key driver of the change was our income tax rate. The fiscal '17 tax rate was just under 26% while fiscal '16 was just over 5%. In fiscal '16, the company released the valuation allowance of about $1.7 million related to our domestic alternative minimum tax credits, which lowered our tax rate. Our pretax income in fiscal '17 was approximately $14.5 million, which was up 1% from fiscal '16's total of about $14.4 million. The tax rate change was in comparison of the fourth quarter more difficult. However, if you would calculate our pretax income for the fourth quarter of fiscal '17, it was only down about 4% versus the approximate 75% reduction shown if you look at an EPS comparison for the quarters. Sales for fiscal '17 were almost identical to fiscal '16. We reported sales of about $262.3 million for both years. Our B2B team reported sales growth about 4% while our retail wholesale team saw a decline of about 2%. The sales decline in Retail and Wholesale was driven in large part by the decision to discontinue business with 2 major low-margin cat litter customers. Sales of about $65.8 million for the fourth quarter of '17 were up about 1% as compared to fourth quarter '16. Our gross margins contracted in the fourth quarter and for the full year compared to fiscal '16. Increased fuel costs and increased nonfuel manufacturing costs were the key drivers. Gross margin percentage for the quarter was down to 24.4% versus 29.1% last year. Increased manufacturing cost accounted for the vast majority of the decline. We believe about 40% of the increase in cost was onetime in nature. Increased sales of our higher value-added product lines helped offset some of the manufacturing cost increases for the quarter and year to date. Retail wholesale team reported a profit of about $800,000 for the quarter and about $6.8 million for the full year. Both of these values was substantially improved over the fiscal '16 totals. Gross margin percentage for the quarter was down to 24.4% versus 29.1% last year. Increased manufacturing cost accounted for the vast majority of the decline. We believe about 40% of the increase in cost was onetime in nature. Increased sales of our higher value-added product lines helped offset some of the manufacturing cost increases for the quarter and year to date. Retail and Wholesale team reported a profit of about $800,000 for the quarter and about $6.8 million for the full year. Both of these values were substantially improved over the fiscal '16 totals. Sales were up about 2% for the quarter but down 2% for the full year for reasons I previously mentioned. The profit increase for the year was a result of about $4.3 million less in advertising spending as compared to fiscal '16 and improvements were offset by higher fuel and nonfuel manufacturing costs. B2B team... [Audio Gap] up 4% for the full year compared to fiscal '16. The sales were strong in our animal health product line during the year. We also experienced solid sales results for fluid purification and agricultural product lines. Profitability was down for the quarter and flat for the full year as costs increase negatively impacted business segment. Looking at our balance sheet, our total assets were over $212 million and our debt was down to about $12.3 million. We continue to generate cash in fiscal '17. Our cash and investment balances were up to about $32.7 million, which was a 13% increase from the fiscal '16 year-end values. Finally, we increased our dividend rate for the 14th consecutive year. Thanks. I'll turn the meeting back over to Dan Jaffee

Dan, thank you. And James, at this time, we will open it up to Q&A. As always, try to ask your most important question first and then go to back of the queue. Thanks.

[Operator Instructions] Our first question comes from John Bair with Ascend Wealth Advisors.

May I ask if you see your conversion trends from course to lightweight within the private-label area continuing on the pace it has been or are you seeing it increasing? What can you share with us on that?

Sure. And thanks, John. It's a good question and definitely at the top of our mind. And really what we look at it from the heavy to the lightweight, so not really the course. From course to scoop, it's continuing to migrate towards scoop, where course is a much smaller -- the non-clumping is a much smaller segment of the category. And then as those who invest [indiscernible] right now back in 2011, we invented and patented lightweight cat litter, rolled out our first Fresh & Light items and really, it was all then selling scoopable cat litter instead of on a per pound basis, selling it on a volumetric basis. So that's the backdrop. And then what happens, as the brand starts to build, the retailers then come in with private label. So let me just take a step back and then I'll get to your specific answer to your question. So back in 2011, when we launched Fresh & Light, at the end of that year, in our retail division, 99% of our scoopable of our sales were non-lightweight and 1% were lightweight because we didn't do much that first year. Fast forward now to 2017 and then in this past year, 37% of the sales in the consumer division are in lightweight and 63% are in heavy. So the heavy has come down, the lightweight is going. And the reason why that's a very important transition is because we're basic in lightweight. That's where our minerals are and we have the lowest delivered cost because our plants are geographically situated throughout the U.S. And so our overall margins on heavy were dramatically lower than the company average. Our margins on lightweight are dramatically higher than the company average. So as we -- I'll keep talking about that shift, but you can see it's gone from 99% heavy and 1% light and 63% heavy and 37% light. And then, John, your specific question was on private label. And so private-label lightweight really started to hit in 2015 and we saw our sales double in '16 and then doubled again in '17 from '16. So the snowball is still very much going in private-label lightweight. And as we've executed this line pricing strategy, where our retail partners now, our -- are retailing the lightweight scoopable offerings at the exact same retail price as the heavy. So for instance, at accounts that before, and I'm not going to name all the accounts and I probably shouldn't anyway, but I'll just anecdotally tell you when accounts before the transition, the heavy results selling the lightweight 10:1. Now that it's the line price and it's pretty quick as it's just been through the last 6 months or so with most accounts, it's 2:1. Meaning, 1/3 of the sales are now on lightweight and 2/3 are on heavy, whereas 90% plus were in heavy before. So we believe that over time, when you talk to consumers and our predominant buyer of cat litter is women 25 to 54, that all things being equal, now that they can get the product they want at the price they want, they will choose lightweight. They will not choose to carry home twice as much weight. They just have to believe they're getting the performance and the price. The price is now there. Now they got to get the performance. We know it's there, but they need to believe it and that takes time. So we're very, very excited about this transition. Our retail partners are all in because it's good for them. Easier to stock their shelves. They're seeing their velocity grow. Our retail partners who have done this are seeing their private-label category outpace category growth. So we're seeing that this is a very much a winning strategy and that they are stealing business from the only couple of private-label partners we don't have that are out there at $8.99 on a relative basis instead of $6.99. So their products are not moving. They are still seeing that 10:1 ratio and our partners are starting to really win, and so it's great for everybody. Great for the consumer, great for the environment, great for our partners and great for all of us.

Our next question comes from Robert Smith with Center for Performance.

This is [ Ethan Starr ] in the guise of Robert Smith. Maybe Mike can give us some color on fiscal '18 with respect to Amlan and what the prospects are?

Well, before he jumps in, just so you know, we don't really give forward guidance. He can certainly talk where momentum is, he can talk...

Yes, let's do that and whatever he can say about registration and things like that, or what's happening?

Yes, the -- where we expect to see higher levels of performance in F '18. We continue to have a number of large poultry producers around the world trial our new product Varium, which they're using to either replace the use of antibiotics. They're used as growth promoters. Or several of them have tried Varium in addition to antibiotics, since not all countries ban the use of antibiotics, to try to enhance their performance. So we have had success in the last year with that product, which has led to increased sales. And we expect that to continue going forward. The product is performing very much like it did in the research phase and we're putting a lot of emphasis in expanding in Southeast Asia. We are we've invested in additional sales resources there as well as the Middle East, in Africa, where we have a number of registrations that were just completed. We've hired a number of new distributors there. They were all trained in our last fiscal year, and we expect to see improved sales performance in F '18 from that region.

At Calibrin and Verge?

At Calibrin, the mycotoxin and bacterial binders continue to perform well. We put renewed focus and more emphasis on Calibrin's ability to bind bacterial toxins, which actually cost the livestock industry more financially than do mycotoxins. That message is being received by the livestock industry. So that's helping the sales of Calibrin. And the sales of Verge continue to grow. We're working on a number of new customer prospects for Verge. That's our engineering -- agricultural carrier. I can't get to the specifics of it, but we have a number of new markets and new customers that we're working on for that technology. We're also looking at that technology in conjunction with a human pharma company to develop advanced delivery systems for our new generation of animal health products that the Verge process is basically like a pharmaceutical process. So we're looking to apply that platform technology in our animal health division not just to make agricultural carriers.

[Operator Instructions] And we do have a follow-up from John Bair.

With the stock off today, you're looking at possible stock purchases?

Probably not. I mean, if we can get a Board meeting coming up, I'm sure it will be on the agenda. We'll talk about it. We feel like we have such better uses of our cash that this just isn't something that we actively do. So not that -- I'm very bullish. Look, you're going to see me -- I get every year around this time, I invest in restricted stock. And I'm going to keep as much as I can keep of that, net of the taxes. I still believe the best is yet to come. But on any short-term basis, it will do what it will do.

Sure. If I might follow up also with regards to going back to the Calibrin and Varium and so forth. Is there a cost advantage to the poultry or swine growers to use that product versus the actual antibiotics? Do you have any can you share that or do you have any senses whether that is a cost-effective situation for them?

Yes, I can comment on that. In general, every alternative that's being promoted in the livestock industry is an alternative to an antibiotic is more expensive than an antibiotic. They're -- especially the ones that are made in -- most of them are all patented. A lot of them now were made in China. They're dirt cheap. They're very effective at what they're intended to do. They're very well established over the decades, so it's the incumbent technology. In the case of Varium, when you're -- what we found in our research was that it provides a 3:1 return in growing broiler chickens relative to the cost. What producers are telling us that when you go antibiotic-free, obviously, that the cost base of antibiotics goes out the window. They realized now in order to satisfy the growing consumer demand for a completely drug-free meat, it is going to come at a higher cost, not just for feed additives, but also the way they run their entire farm to minimize disease. So in that environment, would they go antibiotic-free? Varium is every bit as competitive with anything else that is sold as an alternative to antibiotics. With the noted exception, Varium actually works where the producers are finding in an actual production environment, it does provide a 3:1 return on their investment over the cost of paying for Varium, where we also discovered in just the last 6 months is several poultry producers tested Varium in addition to their antibiotics. Because it's all in the numbers with birds. If you're raising 1 billion birds and they operate on $0.01 a bird margin, they don't really care what it costs. They only care that they're going to get a return on the investment. So several producers said, "Listen, we see primary results that Varium enhances the level of growth of the birds beyond the cost of Varium." So they rolled that out into a production environment where they'll do it on a few 100,000 birds. Then they'll do another trial at about 500,000 birds. Then they roll it out to several million birds. And in every step of the way, Varium covers the cost by at least 3:1 even when they use it with an antibiotic, mainly by reducing the mortality of the birds. So, so far, all the data that we're getting back from the field is whether it replaces an antibiotic or you use it in addition to, there's financial benefit in broiler production to using Varium.

That's quite interesting. Are you seeing any trends by the growers to promote the fact that they are antibiotic free or trying to gravitate in that direction?

Yes. Especially, you'll see it in the United States. I think it's -- even Purdue now in their TV ads talk about that they use oregano oil, which is an essential oil, which are known to have some antibacterial properties. So yes, they've gone from not only saying that they're drug-free all the time, but they're actually promoting what solution they're using to achieve that. Other parts of the world, they just generally go antibiotic-free. They don't market it. It's mainly kind of the first phase overseas. It's for people who make meat for McDonald's, Kentucky Fried Chicken, or U.S. restaurant chains. They're almost all drug-free overseas. And then they start there, and then they begin to expand their production to more antibiotic-free because in general, the consumers want it when they go to the grocery store.

Okay. I'm just wondering if they would actually promote it as being antibiotic free, would that not give them some sort of a marketing or competitive edge relative to other competitors in their respective markets. Are you seeing any trends in that direction?

Mainly in the United States, but I don't know how much of an advantage it is anymore because every major broiler publisher in the United States has some portion of their production that's antibiotic-free. You just can't serve the U.S. market anymore with your products loaded with hormones or antibiotics or antigens that consumers don't want.

Our next question comes from Jim Schwartz with Harvey Partners.

So you talked about 40% of the increase in cost being onetime in nature. And what I appreciate you not pro forming out all the cost, like most public companies do. But that said, there's probably a 230 basis point uplift in gross margin if the onetime in costs -- onetime nature of the cost kind of goes away, obviously, you guys are -- you're increasing your efficiency and you're working to improve the gross profit. As we look at '18, these onetime costs, I'd assume go away? And maybe just maybe explain that a little bit more if you can, I appreciate that.

Yes, Jim. This is Dan Smith. The onetime cost, we made a business decision to take a look at our fuel delivery systems. And we took a long-term preventative maintenance action at 2 of our major plants to improve those systems and position us from an environmental standpoint and better condition than we were. So we ended taking some writeoffs on some fuel oil and we spent some money working on our maintenance.

Yes. I guess, look, you guys have heard this from me for 10 years. Earnings aren't opinion. Cash is a fact. So this hold our earnings, help our cash and reduce the risk profile of the company. So it was better off or worse off after we executed the strategy, way better off. However, from just a reported earnings standpoint, a margin standpoint and income standpoint, looks like the oil guys were soft. So I just challenged you, guys, you -- and I know you guys are loyal holders, not just you, Jim. I'm talking about everybody. Just try and look through it. You got to do your own work, but what happened to the cash during the year? What happened? We raised the dividend for the 14th year in a row. We have basically no debt. We're down to $9 million in long and $3 million in current maturities. We've got $30-some-odd million in cash, so -- and now we had $25 million at the end of last year.

About $13.

No, Dan, I don't dispute any of that. And my only point is that there -- that -- $230 million uplift should come right back because you guys, you took, I guess, smartly took some inefficiencies out of the way and whatever. It's a one quarter thing and then it bounces back. I mean that's -- I don't think any investor would disagree with that move.

No, no, I know. I'm not really talking to you. I'm just talking about the fact that, look, we announce these earnings in the stock tanks. So I'm assuming that people think that we have some of disasters quarter or disastrous year. And okay, then we're running 2 different businesses. I can tell you the Jaffee family is very happy with the year, couldn't have been more happy with the year. It was a great year. But was it our best year ever? No. It's probably our second best year ever. So in 77 years. This was our second best year ever depending on how you want to look at it. I'm looking at it the way the Jaffees do, who are the biggest holder. And I'll -- that's all I can do. So we are going to continue to run the business for the long-term value creation. We are way more interested in cash than we are in reported earnings. And I'm just -- I'm not really talking to you. I'm just to talking to whoever is out there selling because they somehow see these results and they panic. I would just say that I have not done a good job communicating, and so I'm trying to. I don't know what better I can do, but if people are looking at the cash generation and all the qualitative and quantitative things we did during the year, and that's what disappointed them, I'm not sure what they were looking for. My guess is that they're looking at the EPS, the reported earnings. They're disappointed and then they're selling. Well, then I...

I mean, the funny thing is if anyone took out the onetime cost, your EPS is close to $0.40, not $0.18. But that's not something that you do, and I think your long-term investors appreciate that.

Yes.

And Jim, as I highlighted in my discussion, our pretax income of $14.5 million, that's the second-highest in company history. So as Dan said, this is #2 year.

Yes, I used your question at the platform to get a message across that I wanted to get across. So I'm going to keep trying to communicate that, that is how we run the business and people who are into that should buy our stock and those who aren't, really shouldn't. I mean, I don't know what to do about that. So James, do we have other questions?

Yes, sir, we do. We have a follow-up from Robert Smith's line.

Dan, could you go over the litigation landscape and what the time line might be as far as your judgment?

I'm going to let Doug could fill that question.

Sure. We disclosed some information about the tendency of some of our patent litigation -- patent cases go on for a fairly long period of time, so we're not looking at that as a short-term situation. That could go on for several years.

How about what public available knowledge occurred since the last telecast?

While I'd -- in last year, we --

Not last year, last quarter.

Last quarter. We've wrapped up the proceeding challenging our patent in the U.S. Patent and Trade Office. That's on appeal now and that will be briefed throughout the year. And the litigation is proceeding in federal court and discovery is going on. We're in the midst of all that early discovery and depositions, et cetera. And we've had some rulings in that case that are publicly available, which are positive to our case.

I'm talking about lightweight patents. Anything public that you can talk about there? Nothing? Nothing new?

We continue to file and obtain allowed claims in our patents in the lightweight area.

The appeals process can go on just for so long. So where is that in the process, so to speak? Your best judgment.

I believe that the current time line is about 14 months from initiation of an appeal to the resolution of it. And the appeal was -- well, I think we're about 5 or 6 months into the appeal process.

So later in the current fiscal year?

Yes, it was average.

We'll be getting a ruling in the next fiscal year.

And just this question of the recapture of the differential in the increased cost, will we see that immediately in the next quarter?

Well, Bob, the incremental cost in the fourth quarter are a onetime thing. So we're not going to repeat those in the first quarter.

So I'd just note we're actually coming up to our final closing time. So I'd like to turn the call back over.

Great. Well, thank you. Yes, look, we were very happy with fiscal '17. And from our vantage point, the best is yet to come. Obviously, we've got the safe harbor provisions and everything and who knows with how the future will play out. But I'm just telling you, we, who the closest to it and have the most invested in it, are still very excited about the short, medium and long-term prospects of the business. So the team has never been stronger. We have a phenomenal team, and they're really executing the strategy. We had our global sales meeting in September out in really beautiful and lovely Lisle, Illinois. We always go to very hot spots and so forth. So the year before it was in Lisle. And I think the 5 years before that, it was also in Lisle. So we just love Lisle. We have our bowling events we do all that kind of stuff, but I would say it was so heartwarming to see, really, we have close to 150 people there, I think, -ish, pulling in the same direction. Every division is executing a different version of their -- or is along a different time line of executing the same strategy. We're just creating value from some of our minerals every single division. And yes, some are probably long than others, some are doing it in a little different way whether it's to replace antibiotics or whether it's to move from heavy to lightweight or every division is doing it. So I -- it was a great year. We look forward to talking to you again in a quarter and look forward to continuing to discuss our prospects. So thank you for your loyalty, and we do appreciate it.

Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect and have a wonderful day.