Oil-Dri's (ODC) CEO Dan Jaffee on Q4 2016 Results - Earnings Call Transcript

| About: Oil Dri (ODC)

Oil Dri Corporation of America (NYSE:ODC)

Q4 2016 Results Earnings Conference Call

October 11, 2016, 11:00 AM ET

Executives

Reagan Culbertson - Investor Relations Manager

Ron Cravens - President of Amlan International

Dan Jaffee - President and Chief Executive Officer

Dan Smith - Chief Financial Officer

Doug Graham - VP and General Counsel

Lisa Mak - Vice President of Marketing and Consumer Products Division

Analysts

Ethan Starr - Private Investor

Robert Smith - Center for Performance Investing

Operator

Good day, ladies and gentlemen, and welcome to the Oil-Dri Corporation of America Fourth Quarter and Fiscal 2016 Investor Teleconference. My name is Dave and I'll be your operator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. [Operator Instructions] As a reminder, the call is being recorded for replay purposes.

I'll now like to turn the call over to Mr. Dan Jaffee, President and CEO of Oil-Dri. Please proceed sir.

Dan Jaffee

Thank you, Dave and welcome everyone to the fourth quarter and year end Oil-Dri teleconference. With me in the conference room, Doug Graham, our General Counsel; Dan Smith, Chief Financial Officer; Lisa Mak, Vice President of Marketing and the Consumer Products Division in case we get any questions along those lines and Dr. Ron Cravens, President of Amlan International and finally last but not least Reagan Culbertson to cover the Safe Harbor provision.

Reagan Culbertson

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 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 in evaluating any investment in Oil-Dri stock. Thank you for joining us.

Dan Jaffee

Thank you, Dan, take over from here.

Dan Smith

Good morning everyone. Oil-Dri finished the year with similar trends for sales, gross profit spending as reported in prior periods. Sales for the quarter were $64.9 million and for the year were $262.3 million. Both of these values were within 1% of the comparative prior year amounts.

Our gross profit percentage was significantly improved through our efforts to sell more value-added products and because of lower natural gas, packaging, and freight costs. However, the margin improvements were offset by increased advertising and promotional spending. For the full year we spent about $13 million more in advertising and promotional costs. Also we expect to continue this increase in spending in fiscal 2017.

A major factor for the EPS amount for the quarter and year was the release of evaluation allowance related to our domestic alternative minimum tax credits. This item helped drive our full year tax rate down to 5.2% from 19.8% in fiscal 2015. The decision to release about $1.7 million of reserves was made in large part by our ability throughout fiscal 2016 to sell more value-added products and our belief that we will be able to fully utilize our remaining AMT tax credits in the future.

Our tax rate was positively impacted for both fiscal 2016 and fiscal 2015 due to the release of the valuation allowance reserves. Since these attributes have now been fully utilized, it is our belief that our F17 tax rate will probably be more in line with our historical tax rates assuming no major changes to the U.S. tax code.

Our EPS of $1.87 per diluted share for the year was better than the $1.59 reported in fiscal 2015. Our gross profit percentage for the year of 29.4% was much better than the 23% reported in 2015.

Our retail wholesale team reported lower top line sales for both the quarter and the year. We walked away from about $8 million of low margin sales in fiscal 2016 to focus on higher margin lightweight cat litter business. This decision helped increase the segment's gross profit for the quarter and the year as compared to fiscal 2015. However, the large increase in advertising and promotional spending mentioned above resulted in the segment's operating loss for the quarter and a slightly lower profit for the full year as compared to fiscal 2015.

B2B sales were up for the quarter and the year as compared to fiscal '15 sales increased for animal health, fluids purification and Ag products for both the quarter and for the full year as compared to the prior year. Improved product mix, reduced costs for freight, kiln fuel and packaging, all helped to increase the segment's profit for the quarter and the year compared to the same time frame in fiscal '15.

Our balance sheet remained strong. Our cash in investment balance grew over $6 million from the end of fiscal '15. Our cash flow from operating activities of $25.2 million was the third highest in the company's history. Our total assets ended over $200 million for the first time in the company's history.

Finally, we increased our dividend payments again this year. We paid out approximately $5.6 million in dividends in fiscal '16. Our dividend yield would be about 2.3% based on our 7/31/16 closing price of $37.45 per share and our latest quarterly dividend rate of $0.22.

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

Dan Jaffee

Great. Thank you, Dan. And Dave, at this time, what I'd like to do is open it up to Q&A and answer whatever questions are on our investors' minds. And as always, ask your most important question first and then go to the back of the queue, so we make sure everybody has time to get at least one question in.

Question-and-Answer Session

Operator

Thank you very much. [Operator Instructions] Please standby for your first question which comes from the line of Ethan Starr, private investor. Go ahead please.

Ethan Starr

Good morning. Nice quarter and year.

Dan Jaffee

Thank you, Ethan.

Ethan Starr

I'm curious, you put out a press release, it was on September 21 about announcing the hiring of a new scientist for R&D and for the first time I can ever recall seeing this in the company's - at least as long as I've been an investor in Oil-Dri. You mentioned specifically research into the uses of clay for humans. Can you please - what do you see happening there and is there actually, I've always thought it was only [indiscernible] that worked.

Ron Cravens

Oh, hi Ethan, this Ron Cravens. I'll take a shot at that. We've long known that our materials have broader potential use than just the farm animals, which we currently market into. The first recognition is that, in fact, humans are animals and the digestive systems, the anatomy, much of the physiology and certainly a lot of the function are similar to our monogastric animals that being the chicken and the pig that we sell into extensively.

We have a great deal of the research in the area of digestive diseases, and in particular, we have interest in the clostridial diseases where we've demonstrated utility in major diseases caused by toxins from those organisms in both poultry and pigs. And interestingly enough, there's a major disease in humans called Clostridium difficile, which is also a toxin caused disease and is the number one nosocomial infection in the United States today.

So the opportunity is there. We've expanded our capability by hiring Dr. Hahn Yu [ph], who is an MD researcher with a great deal of experience in the area of human gas health and nutritional management of that. So we see that there's some potential there. We'll be exploring it as we go forward.

Ethan Starr

Okay, thank you. I'll go back in the queue.

Operator

Thank you. The next question is from the line of Robert Smith of the Center for Performance Investing. Please go ahead.

Robert Smith

Hi good morning. Thanks for taking my question. Congratulations on the year. Great to see Ron at the Board. I truly hope there is a way that you could come into Boston next week. I'd love to see him. I still need to know about the Clorox and so does that refer to your lightweight product?

Dan Jaffee

I'm not sure what note on Clorox you're referring to.

Robert Smith

That was the redacted agreement about the new product that you were doing for them.

Dan Smith

It's back in the back of the 10-K. I think we just made an amendment to the agreement. I think it has something to do with bar coding.

Dan Jaffee

But that's all historical, it's not a new product. The fresh step of course that we manufacture and have since they went….

Robert Smith

Yes, I misinterpreted it. Something about an incremental factor, I guess, to you guys.

Dan Jaffee

Yes, no, nothing new there.

Robert Smith

All right, so just let me circle back to this question of the life sciences and humans. So can you tell me something about the effort, I mean, as far as headcount and perhaps increase in the budget? I mean, what are you kind of looking for? What are your goals here?

Dan Jaffee

You know, we've looked at this for some time and we've got some core capability and we've put together some additional resources for the new MD that's come to the IC. We're - we just brought him onboard and we're just in the process of putting the plans together. First and foremost, we still are focused on our base business and getting our new products out and maintaining, developing a pipeline to support that. But at the same time, we'll be looking more aggressively into the potential for use of the materials in humans. So that's really all I think I want to say about that at this point.

Robert Smith

Okay, I'll get back in the queue, thank you.

Dan Jaffee

Thanks Bob.

Operator

Thank you. The next question is again from Ethan Starr a private investor. Please go ahead.

Ethan Starr

Yes. I'm curious, can you tell us a little bit about the new NeoPrime products? What countries is it registered in already and just more generally, what kind of results are your customers in China seeing? Are they seeing kind of things and talk to their fellow farmers about or people who raise pigs?

Dan Jaffee

Okay. I'll just talk about actually both the products, Varium and NeoPrime.

Ethan Starr

Okay.

Dan Jaffee

They both have unique combinations of functional additives that have been tailored to produce certain effects, one in poultry, the NeoPrime in the weanling pig, really about development of early gut development in both epithelial cells as well as the immune system so that you get the animal off to a good start. We've just recently received registration approvals in China for both products. Varium is actually slightly different, at least position different.

We've been able to demonstrate equivalency with antibiotics, which are under extreme pressure to be removed from the market and this product has no antibiotic activity. It would not contribute in any way to antibiotic resistance and yet, it's demonstrated utility in delivering reduced mortality and improved growth performance in broiler chickens. So that product actually has probably more of our focus today than NeoPrime. We have limited resources and we're going to put them on the places we think we'd get the most bang for the buck.

We are registered in about 10 countries, major countries at this point. We just had an introduction this morning in fact at a major meeting in Mexico. They plan a meeting of poultry veterinarians. So we're actively in the process of rolling this out. So far, responses from the field have been very positive and we anticipate this to have a good opportunity for us going forward.

Ethan Starr

Okay, great. Thank you. I'll go back in the queue.

Operator

Thanks. The next question is from the line of Robert Smith of the Center for Performance Investing. Please go ahead.

Robert Smith

All right, so let's piggyback on this. So what is your opportunity here? I mean, can you give us some idea as to the market size and if you have equivalency with antibiotics? This seems like - how would you define equivalency? So instead of having the same action, so to speak, but is it truly equivalent to antibiotics than some of this could be really something, I mean, so just give me a little flavor about this?

Dan Jaffee

Okay, first we need to talk just a brief bit about the whole antibiotic issue and this whole antibiotic issue as you probably read regularly in the Wall Street as well as in the other in the popular press, is driven by low-level feeding of common antibiotics, tetracycline, sulfonamides, some penicillins, Salinomycin, and several different antibiotics, which have been used since the '50s.

The issue is related to the development of bacteria that are resistant to these antibiotics, which are still used in humans and the potential and risk of those organisms moving out of the animals and into the human population and that's what really driving it. From a market size, historically, this antibiotic feed market has been multiple billions of dollars. Europe, about 1996 banned the use of low-level antibiotics. FDA is now not banning, but actively suggesting or asking manufacturers to remove those label claims.

You may have read Tyson is in the process of going at least 50% antibiotic-free production. Pilgrim's has announced it's going to be fully antibiotic-free in the future here. So there's a lot of movement in the market to try to reduce the use of antibiotics in farm animals as a means of reducing the risk to humans.

The reason the products were used was that to improve health and productivity under modern management practices. What we have been able to demonstrate is that Varium will perform similarly to an antibiotic without the whole antibiotic issues. So you're managing gut-related issues through different mechanisms than the antibiotics did. The result is the same, improved performances and reduced disease.

So the market opportunity will depend on the customer's desire to eliminate antibiotics and look for alternatives that would be of value in their production. So, you could say the opportunity is billions. We're not going to sit and say that, that's what it's going to be, but we anticipate that this is going to be a very attractive market going forward.

Robert Smith

So Ron, are the first targets at Tyson or Pilgrim's or that type?

Ron Cravens

We talk to all customers depending on who they are and what types of things they may be interested in, we will talk to anybody. But we don't disclose at this point any of our customers or where we're at in that sales process.

Robert Smith

Oh I wouldn’t think you would, but so on the order of priority, I mean, are you essentially going to the companies that have stated what their plans are? I mean, when they move away from antibiotics, do they go and use nothing or would they gladly accept what you have to offer as opposed to a company that's...

Dan Jaffee

Yes, Bob, I think we've covered enough of this. Let's move on. I mean, obviously we're going to do what makes sense. So what you're outlining is perfect time and since, and we try and follow that as much as we can. So we will go to those customers that we think that this will have the strongest message and will be in the best shape to receive it and value from it. So, but great, it’s a great opportunity.

Robert Smith

Any chance that Ron will be available next week?

Dan Jaffee

Zero chance.

Ron Cravens

I'm in China next week.

Dan Jaffee

He's in China next week. I'll be in Boston next week, just don’t ask me any of these types of questions and that will be great.

Robert Smith

Moving and meeting with China, I'll get back in the queue.

Dan Jaffee

All right, thank you.

Operator

Thanks. The next question is from the line of Ethan Starr, a private investor. Please go ahead.

Ethan Starr

Yes, I'm wondering if you since the last call you've gotten anymore private label accounts for the lightweight cat litter?

Dan Jaffee

We have, we've gotten some big ones, but they haven't shipped yet, so I'm not sure we're going to talk about them. So, but yes, we are continuing to put on new business. We've got some big ones shipping in December, which will be exciting and we could probably talk to you at the end of that conference call or that quarter. Since nobody has asked, I'm going to ask the question. I'm commandeering the conference call. And I want to hear from Lisa Mak, I want to hear about our 360 marketing program around the whole Ultimate Care launch.

Lisa Mak

Absolutely. So this year in March we launched our biggest media campaign ever, and we're going to continue to build upon that momentum. And we know that it's been working for us in terms of building brand awareness and purchase interest and driving sales. So this fiscal year, we're going to have over 60% increase in media investments. A lot of that is spent on TV and video because we know that, that has been working really well for us. And then we're also going to have digital, social e-mail, native advertising, mobile, all sorts of elements of the 360 marketing plan because we want to make sure that we are touching across all of the consumers touch points as she is going from educating herself and researching products all the way to purchase, so covering that entire path to purchase.

We recently did a brand integration with Live with Kelly starring Kelly Ripa. She is the host of the show, number two rated syndicated talk show right behind Ellen. And we were able to get a weeklong sponsorship the week of September 19, which did extremely well for us. So what that meant was we were sponsoring a contest that was - had a grand prize of $10,000 as well as a year's worth of Cat's Pride Fresh & Light Litter.

And we had great exposure, great participation in that contest. We had over 48,000 entries in the contest that performed well above ABC's Live with Kelly contest in the past and so it was extremely strong. We had over 87,000 video views on our micro site. So it was on Live with Kelly micro site, which basically showed the Katherine Heigl partnership video as well as Kelly Ripa's announcement of the contest. And we've seen a huge uptick in our website traffic as a result of this contest.

So overall, we have 48 million impressions that, that contest brought to us, which is huge. And then we are going to continue to do more brand integrations in spring on Good Morning America, The Today Show as well as The Talk, so great plans in store for next year.

Dan Jaffee

Great, thank you. Other questions?

Operator

We do have another question for you. This is from Robert Smith at the Center for Performance investing. Go ahead please.

Robert Smith

So how much of the $18 million was media?

Dan Jaffee

Did we break that out? We didn't break that out.

Robert Smith

Well, can you give us some feel for the incremental ad spending in fiscal '17?

Dan Jaffee

Yes we did, it's going to be up 60%.

Robert Smith

Okay, in total. Got you. So could you also address the question of the pension expense line, which is really moving? So you have a 7.5% expected return. Is that realistic in today's environment? How do you feel about that?

Dan Smith

Robert, this is Dan. First of all the pension expense went up because the discount rate went down, went down to 3.36% so the liability went up year-over-year. In terms of our expectation of 7.5%, that is generally in line with our historical average for return on our assets. And who knows what's going to happen over the next 10 or 20, 30 years? I mean, pension is a very long-term asset. Will we continue to assess that as we go along? We have a committee that meets quarterly to discuss our pension assets and so for now we believe that is a reasonable assessment, given a very, very long-term view.

Robert Smith

Great and just finally from me, the question, you made some kind of statement that in the last quarter that due to the competitive environment, the growth rate slowed in the lightweight. So can you just give us some color on that?

Dan Jaffee

Sure. Yes, the good news is that the marketplace is very active, both in terms of lightweight and none and so I'd say good because we want this lightweight thing to take hold. Look, I'm going to pause for a second. Yes, so I'm back. I just want to make sure I can talk about all this. But yes, I think August 7 was when the final of our patents got issued. So we have gotten 100% of our patents issued on all the lightweight that we filed 5 years ago and so that's - so we want lightweight to win. I love when the competitors invest behind lightweight, media and to get that ball rolling. We believe that's all going to pay to our benefit, both on the private labels side, the brand side and the intellectual property side. So that's good.

The downside is, it's making it hard to slug it out with our little brand. But on a 52-week basis, we gave it a 24-week in the IRR released. I just pulled this, just to say how do we do for the year? We're sitting here a year later. Ultimate Care was up 94% for the year and Fresh & Light, which was the core business was down, but we did walk away some of that money that we walked away from in the dollar channel was Fresh & Light. I looked at it.

So net-net-net, our total all Lightweight brand was up for the 52 weeks. And it depends on how you want to look at it with that factor, but we're spending our money on Ultimate Care. And that brand is growing rapidly from a small base, but it's moving well. And then private label lightweight, well, it's still a small number. It was up 955% during the year. But it's still a small piece of the category. The total sales were only $2.4 million. Our total lightweight business at retail was $63 million for the year. That made us the number two player with a 21 share.

Now, one was Tidy Cat with a 46 share at $137 million. Number three was ARM & HAMMER, Church and Dwight with a 17 share, and then Fresh Up was number four with a 12 share. So we jumped to the number 2, so obviously, if the whole category went lightweight, we would be in great shape. That's what we're hoping for. And I think as consumers can find the product they want at the price they want with the performance they want, they're all going to choose lightweight. I have yet to find anyone who said, "I prefer to take home a heavier product." So yes, if you give me even product at the same relative price points, same performance, I'm going to take the one that's heavier because I just like to carry home more weight.

I mean it defies logic and it's bad for the environment. So we're going to keep pushing the message. In the upcoming year we're really going to focus on days of use and efficacy because we believe that's an area that we excel in and that some of the competitors have heard the efficacy of the product. Just to get light, they put in lightweight fillers. It would be very analogous to when liquid detergent went concentrated. If the loads went from 80 to 40, that wouldn't have been innovation just making it smaller that would have been a rip off and that's sort of what's happening at some of the product lines.

So days of use is going to be something we are going to talk about and then sort of the tertiary benefit we are testing is the whole idea of the carbon footprint and the environmental aspects of going light. You can put 50% more units or 100% more units, depending on how much lighter you're getting, on a truckload, which would cut the carbon footprint significantly made by cat litter. So...

Robert Smith

So do you think that domestically reconsideration will be, in fiscal '17, the decision on that?

Dan Jaffee

Not on the lightweight, no. I mean we just filed suit on the lightweight. That's public knowledge, too. The earlier suit we filed was on a different technology, and you could do your own homework or that. And that one - these things take a long time. They just do. So I wouldn't put a time frame on it. I have no idea. All I can tell you is at this point, we feel better today than we felt a year ago. We have - I don't know if you want to cover the public actions that happened, and they all went in our favor. So Doug Graham will cover that real quick, but we had a good year from an IP standpoint.

Doug Graham

Great. So there was a challenge by Nestle of our patent in the U.S. patent office, and all of those claims that were raised against us by Nestle were dismissed. There is a rehearing on that pending we are waiting to hear on that rehearing, but it's fairly rare for all claims to be, all patent claims to be challenged and upheld by the Patent Office. And they were all upheld..

Dan Jaffee

And on our lightweight patents, we filed something like 35 claims, and all 35 were issued.

Doug Graham

All of those have been issued. We have other continuing claims as well.

Dan Jaffee

The good IP year for Oil-Dri, but it's going to take a lot of years to monetize it really. But the good news is the lightweight patents now run through 2030.

Robert Smith

20-year-patents?

Dan Jaffee

Yes, so 32 I want to say, ish?

Doug Graham

No, around 36.

Dan Jaffee

No, I thought it went back to 12. I don't know. Some of them may, some of the claims go to 32, I think and maybe some go to 36. But anyway, they go for a long time. So we want the snowball to keep growing, and we'll play it out.

Operator

Dan Jaffee

Good. Well, thank you, everybody. I mean, I hope you sensed the general enthusiasm we have. The good news is, as we sort of communicated so I can communicate it to you, is we truly believe as well as we're doing and to see our gross profit margin jump during the year the way it did was what we've sort of been predicting was going to happen as we walked away from old, unprofitable business and layered in the high-value Amlan business and Ultimate Care. These are high-value applications for our mineral.

So we generated an extra $17 million of gross profit during the year, which is pretty incredible. And of course, then I spent it all. So - but it allowed us to really hit the gas pedal and not hurt our balance sheet. I mean and that's the cool thing. And so I'm going to reiterate the little bit of guidance we've ever given, which is our goal is to keep this up. We're not going to drive the company into debt, and we're going to keep recommending to the board that we increase the dividend, and they'll look at that every June like they always do.

But my expectations are we will raise our dividend again in June. And so I'm just giving you that forward guidance. So as an investor, you could say, "Yes, there I can see the profit will come as they start to someday pull back on the spending or the sales start to be commensurate with the spending, one or the other.

Right now, we are investing heavily in media greater than the sales with warrant. But at least they've given me the assurance they're not going to go into debt to do this whole thing and they're going to keep raising my dividend. So I'm going to be in it for the long haul. That's how me and my family look at it, and that's about the best guidance or the most guidance we've ever given. So thank you. Whoever is coming to Boston next week, I look forward to seeing you there and if not, we'll talk to you again in a quarter.

Operator

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

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