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Oil-Dri Corporation of America (NYSE:ODC)

F4Q08 Earnings Call

October 13, 2008 11:00 am ET

Executives

Daniel S. Jaffee – President, Chief Executive Officer & Director

Andrew N. Peterson – Chief Financial Officer & Vice President

Charles P. Brissman – Vice President, General Counsel & Secretary

Rhonda Williams – Director of Investor Relations

Analysts

Ethan Star

Robert Smith

Jim Swartz

Operator

Welcome to the Q4 2008 Oil-Dri Corporation of America earnings conference call. (Operator Instructions) I would now like to turn the call over to Daniel Jaffee, President and CEO.

Daniel S. Jaffee

Welcome everyone to our fourth quarter and fiscal year end teleconference. We just concluded our 67th fiscal year in business and as always I’d like to introduce everyone who is here. Andy Peterson our CFO, Charlie Brissman, our General Counsel and Rhonda Williams our Director of Investor Relations. Rhonda, you’ve got some Safe Harbor comments for us?

Rhonda Williams

Welcome everyone and thank you for joining us for our fourth quarter teleconference. 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 urge you to review and consider those factors in evaluating the company’s comments and in evaluating any investment in Oil-Dri stock. Just to remind everyone on the call today, it will last a half hour so please prioritize your questions so that everyone can get their most important questions in first.

Daniel S. Jaffee

Before I hand it over to Andy I’ll exercise my executive prerogative here and give some color before he even gets in to the play-by-play. We’re very pleased with both the quantitative and the qualitative results of the accomplishments of the fiscal year. As we manage our business for the long haul its sort of hard to even measure things in 12 month periods, certainly we can’t even do it quarterly.

But, going back even farther you’ll see in the news release, there’s a chart that takes you back to F04 but, I go back even farther when I look at various metrics. One of them I want to highlight for you is the second metric down which is notes payable minus cash and equivalents. We call it debt net of cash and you’ll see we actually finished the fiscal year with more cash than debt, $684,000 more in cash than debt.

What makes that number so impressive is if you go back to fiscal 2000, we had $38.6 million of net debt meaning we had $38.6 million more in debt than we had in cash. So, you move forward eight fiscal years and you end up cash positive and you say, “Okay, that’s fine but did you invest in the business?” If you jus tightened your belt so much that you don’t try and grow that’s not nearly as impressive results.

The fact is since fiscal 2000 we’ve invested over $110 million back in to our business and paid down the – or not all paid down, paid down debt in part also just accumulated cash in excess of debt to that swing of $39 million. You’re talking almost $150 million of cash that was generated during that period that was put towards things like capital expenditures. We spent $61 million in capital expenditures during this time period.

You’ve got the Williams’ mill, the Taft plant acquisition actually I think was on top of that, the acquisition of an LVM business, a floor absorbent and [ultraclear] business, we made in the fourth quarter of this fiscal year. We’ve launched new products and we’ve invested over $19 million in research and development to better fulfill our mission of creating value from absorbent minerals. The better we understand our mineral the more likely we are to be able to meet or exceed the expectations of our customers.

At the same time, we’ve rewarded our shareholders. We’ve paid out over $21 million in dividends during that period of time and we’ve either maintained it every year or in the last four and five years, we’ve raised that dividend pretty significantly. And, we’ve paid out $18 million of bonuses back to our internal stakeholders. So, $150 million later we’re cash positive. I think that speaks volumes as to the long term sustainability and viability of our business.

You guys have heard me mention it many times but, one of the metrics we focus on is our average selling price per ton because we’re in the business of shipping tons to our customers and trying to maximize the value we get for our non-renewable clay mineral. They’re in the business of using our product and shipping dollars back to us to pay for those goods and services. If you just go back seven years, they were paying us about $155 a ton and during the most recent fiscal year that just closed on July 31st, we eclipsed $226 a ton.

So up over $70 a ton and very interesting that the tonnage was almost identical, it’s 1,031,000 in 01, it was 1,028,000 in 02 and it was 1,026,000 in ’08. It’s pretty much the exact same tonnage, a million tons times an extra $70 a ton or an extra $70 million that was generated during ’08. Before we get too happy with ourselves, the fact of the matter is that our margins still declined in ’08 and Andy will highlight the financial metrics, so we’re very much focused on not only repairing it but getting back to the targets we set for ourselves.

But, it’s clear we are creating value from absorbent minerals. Using the tortoise and the hare analogy, Oil-Dri is the ultimate tortoise. We think in long term chunks, we’re in the earth moving really basic things. So, in today’s environment with the back drop of all the things that are going on in Wall Street and everywhere else, it’s a really good time to be a turtle, there’s no doubt about it. In the dot com boom, it wasn’t so fun to be a turtle, the hares were all blowing past us.

Now, we’d like to think just by putting one foot in front of the other and making good long term investments back in to our business that seven, eight years later we have not only kept up with the hares but passed many of the hares. I have recently spoke to over 700 of our Oil-Dri employees and we only have 800 of them so I literally hit almost 90% of them, to deliver the message of how well the business is doing, how financially strong we are.

One of the analogies or examples that I pointed out to them was Lehman. Everyone in our plant, everywhere around the country has followed the Lehman mess and how a 158 year old business could pretty quickly be catered. There are probably many reasons why but one of the biggest reasons why was leverage. They were levered at 30 to 1. Their debt to equity leverage was 30 to 1. Oil-Dri’s is at .3 to 1 so they were 100 times more leveraged than Oil-Dri.

Those of you who are long time followers of Oil-Dri, this is going to blow your mind. You can just run the math, if we wanted to get levered to 30 to 1 we’d have to go out and borrow over $2 billion, little Oil-Dri. As absurd as that sounds and as crazy as that sounds, respectable companies were doing just that and nobody was blinking an eye until these respectable companies go to the government with their palms up and look to get bailed out.

As I closed with the Oil-Dri employees I said, “Unless you get too comfortable that okay they’re just a rouge outlier, the Lehman Brothers and the AIGs of the world and there really aren’t many other companies, certainly there aren’t any household names that look like those guys. The fact of the matter is that there aren’t a lot of companies that look like those guys.” I did a little search just for the fun of it and GE is levered at 20 to 1. We’d have to borrow over $1.5 billion to look like GE.

I don’t even need to put any more adjectives on that. The fact of the matter is we are very happy that we have the capital and financial structure that we have. Could we use a little more leverage? Maybe, and it if the right opportunity comes up, certainly. We’ve shown in the past we’re not debt adverse at reasonable levels but, the one lesson that my father taught me from a very early age was you always match the length of the opportunity with the length of the investment i.e., you don’t borrow short and invest long in illiquid assets that when things hit the fan you can’t get out of.

That’s exactly what these guys did. They borrowed short, invested long and got themselves caught in a wood saw. So, the debt that we do have is long term, fixed in nature. Our cash is invested in T-bills and so we are as turtlie, if that’s an adjective as you can be. But, we don’t apologize for it. We puff our shell out and we’re proud of being the turtles we are. I’ll get off my soapbox but in today’s environment it’s almost hard not to step back and look at what is everyone else doing, what are we doing, what should we be doing like them but what shouldn’t we be.

We’re pretty proud of our discipline in this environment. Andy, I’m going to turn it over to you for the play-by-play.

Andrew N. Peterson

We had a strong fourth quarter revenue growth in both the retail wholesale products group and the business-to-business products group. We had record sales of $59.5 million for the quarter up 10% from last year’s $54.2 million. The increase was due to higher average selling prices and increased volume. We were disappointed in the 18.9% gross profit margin in the quarter down from last year’s 22.2%.

Margins were negatively impacted by higher fuel, packaging and transportation costs offset by a $300,000 reduction in cost of sales due to the sale of emission credits. Operating expenses were 13.4% of sales which was down from 18.2% as a percentage of sales in last year’s fourth quarter. Net income was 4.1% of sales which was up from 3.8% in last year’s fourth quarter. EPS in the quarter was $0.34 up 17% compared to $0.29 in last year’s fourth quarter.

The sale of emission credits positively impacted fourth quarter EPS by $0.03 this year compared with a $0.06 positive impact in last year’s EPS due to the proceeds of life insurance policies on former key employees. Looking at the balance sheet cash flow, cash provided from operations in fiscal 2008 was $11.3 million compared with $16.9 million in the prior year. Higher accounts receivable and inventory balances relating to the 10% increase in sales reduced cash from operations by $6.1 million in fiscal 2008.

Dividends paid for the year of $3.4 million were up 11% in comparison to the prior year. We finished the year with cash and investments of $27.8 million compared to last year’s $30.0 million. Cash and investments exceeded notes payable by $684,000 at July 31, 2008. It’s a great time to have such a strong balance sheet.

Daniel S. Jaffee

Before we open up just a couple more comments. Our stock price, at least last time I checked was up to about $12.25 from a low of about $11.60ish. At that range our PE now is under $10 and our dividend yield is over 4.5. It’s an interesting valuation to say the least. [Keynisha], we’d like to open it up and as always, we’d like to encourage everyone to prioritize your questions, ask your most important question first and then get back to the end of the queue which will allow everyone to at least get one question in before we hit the time bell.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ethan Star.

Ethan Star

I’m wondering how is the current economic and credit environment affecting Oil-Dri’s sales and receivables? And, might the credit squeeze force any competitors to sell out or shut down?

Andrew N. Peterson

I think in looking at it in terms of our customers I don’t think we’ve seen a change. Our customers are relatively large companies that I think are doing pretty well. As it relates to how are our competitors doing, Dan?

Daniel S. Jaffee

In general you would think that the smaller, the weaker the player, the more regional the player is going to be more impacted. So, you can draw your own conclusions from that. But, clearly we like our position going forward.

Operator

Our next question comes from Robert Smith.

Robert Smith

I’m amazed that you guys turned the market the way you did. It was amazing.

Daniel S. Jaffee

Are you telling us we turned it up or down?

Robert Smith

Up. Wasn’t that the reason for the strong rally this morning?

Daniel S. Jaffee

If you can figure out the reason for anything, I’m all ears.

Robert Smith

You mentioned in the press release about becoming more aggressive with new products so what can you tell us about that?

Daniel S. Jaffee

Just that we’ve been investing heavily. Our, what we call our 2008 all in initiative launched on time and on budget. We’re just now getting it out to the marketplace, getting the necessary registrations, we have very high expectations for that. We are already investing in the 2009 all in initiative which will be launched sometime towards the end of this fiscal year.

Additionally, and I think I mentioned these on prior conference calls, we did launch a couple of cat litter items, Cat’s Pride Natural to go with the green movement and Cat’s Pride Complete to go right after multi cat owners who want the best odor control. Those have been received very well and are doing well. Knock on wood, so far all new product launches are moving in the right direction.

Robert Smith

Dan, what is all in?

Daniel S. Jaffee

All in is just a term, obviously it’s a general term but for us it focuses us. When we were trying to do everything we tended to get nothing done and so we identify one real big opportunity every year that everybody can rally around, we can put our resources behind and we can make sure that we nail it. Both from a manufacturing standpoint but also from a support standpoint, a marketing standpoint and it’s clearly going to be in line with our mission of creating value from absorbent minerals.

Robert Smith

But you haven’t said what it is or have you?

Daniel S. Jaffee

We haven’t to you. Those internally all know what it is.

Robert Smith

So when can you do that?

Daniel S. Jaffee

Well, it’s like anything, you want us to maximize your investment so the earlier we start cheering before we get in to the end zone, the greater chance the defense is going to tackle us.

Robert Smith

No, all I’m asking is when you think you might be able to tell us something?

Daniel S. Jaffee

I mean Charlie can answer that better than I can because it comes down to an SEC materiality.

Charles P. Brissman

Bob, as you’ve heard us say in prior years, our general approach on these new product initiatives is we don’t even think about talking to the investment community about them until the disclosure rules tell us it’s time to talk about them. We hope a lot of time doesn’t pass because it will tell us we’re off schedule in how we’ve envisioned these initiatives moving forward. But, you’ve heard Dan say our 2008 initiative is off and running, we’re queued up with the 2009 initiative.

As soon as we have to talk about them with you, we will and it will be a great day for Oil-Dri and its stockholders.

Robert Smith

It sounds very mysterious to me.

Charles P. Brissman

Bob, I’ll just say this, I think over the years most of you have picked up that part of the Oil-Dri personality is to not sort of beat our chest and say, “Look at us.” Very often Dan’s remarks at the opening of the call today are about as far as you’re ever going to see us go and that’s only because the way we’re running our business is so very different from the vast majority of American businesses that are currently in the news.

Robert Smith

But in the past when the product has come to the market, you’ve shared what it was with us.

Charles P. Brissman

I’m not sure I’d agree with you. We’ve certainly had occasions where either the nature of the industry or our branding effort brought the initiative to the public’s attention before we would have wanted to and then we’d talk about it as well.

Operator

Our next question comes from Jim Swartz.

Jim Swartz

Just curious, nationwide distribution that you guys have has that become a pretty sustainable advantage in this environment? And, who else that you compete against has the kind of nationwide distribution you have?

Daniel S. Jaffee

Are you referring specifically to cat litter?

Jim Swartz

To cat litter, yes.

Daniel S. Jaffee

It’s a huge source of sustainable competitive advantage for us. The only other player that has a similar layout, although not the same would be nationally Purina and they focus on branded products as you would expect. So, from a private label cat litter standpoint we have by far the best geographic layout in an area, private label. [Freight] is even more important to private label than its going to be for branded because at times it can be at lower prices and lower margins so that’s a good competitive position for us to be in.

Jim Swartz

Then just last question, with natural gas and the fixes now from the 13s and as important as that is for you guys, when do you think we start seeing some kind of help on the gross margin line going forward? How long does it take to kind of trickle down?

Daniel S. Jaffee

Help you should start seeing because even though we forward buy half of our needs we are pretty much at market for the other half so we are taking advantage of these lower spot prices. We’re actually buying some contracts out in to the second quarter and third quarter because it’s still below what we’ve budgeted for which is good news.

Certainly, you’re going to see help right away. The question is how high to do you want that help to be before you’re impressed with that help and also how do you measure the help? I’ve come to two realizations, you can look at percentages which is certainly one way to look at it but as you start to gross up the sales for all of this fuel the per ton number is also relevant i.e, you make 25% on $200 a ton, you’re making $50 a ton. If you make 20% on $250 a ton, you’re making $50 a ton.

So obviously we can’t ignore the percentages but we also can’t just assume because gas is run up that we can maintain a margin willy nilly on every product we have as gas runs up, that’s not likely. To put it another way for you that makes it most extreme, five years ago the gas bill for the company, the fuel bill for the company to dry our clays was about $5 million or $6 million. When the gas was at $12 or $13 it was looking like it was going to be $29 million, just five years later.

So, making 20 points on $5 million is $1 million of gross profit. Making 20 points on almost $30 million is $6 million of gross profit just on your fuel. So, it is a tempering factor on the percentage although it should not at all drag down the per ton. So, we’re looking at both metrics. On either metric, we weren’t happy with ’08. I mean, the percentage was down from 21.5% to 19.8%, the per ton was down.

We tell you how many tons we’re doing so you can calculate it. We had made $46.50 per ton in ’07, we were down to $44.89 in ’08. So clearly, our first goal is get the per ton number moving in the right direction which will help the percentage. A long winded answer but there’s a couple of ways to measure progress.

Operator

Our next question comes from Ethan Star.

Ethan Star

The press release stated that Oil-Dri will be building its infrastructure to support its growth in the coming fiscal year and I’m wondering what infrastructure are you investing in? And, how will these initiatives effect total capital spending for the short and long term?

Daniel S. Jaffee

Let me give you the second answer first which is, and I’m glad you brought it up because while we’re trumpeting the fact that we are cash positive here in fiscal ’08 year end, we will hopefully not be cash positive at fiscal ’09 year end because we have CapEx on the works that has high return on investments. We’ve got these growth opportunities we’re investing behind and so I think it would be highly unlikely that we’ll finish ’09 in that same position but, for all good reasons.

I don’t really foresee that we’ll be taking on more debt, I just see we’ll be using up some of our cash war chest to go after some of these opportunities. So, that’s sort of expectations going forward. In terms of what we’re specifically doing, I don’t think we’re going to get in to the specifics of our projects but just to remind you, as always, we have our return on investments disciplines in place for capital expenditures and we target an ROI of north of 20% and these projects all meet with that unless they are health and safety related and then obviously you’ve got to do them regardless of the ROI.

But, most of these are ROI type projects and really would help the future profitability and growth of the business, help support that. So, all positive stuff.

Ethan Star

What’s the CapEx budget for fiscal ’09? Can you share that?

Andrew N. Peterson

I think in the 10K we say it’s about $5 million over kind of what our recent efforts are. So, if we’ve been spending $7.5 so it’s $12 or $13 kind of number.

Ethan Star

One other quick question, Oil-Dri appears to be making a significant strategic investment in the animal health and nutrition area. You’ve hired a number of new employees and stuff, can you add some more color to that?

Daniel S. Jaffee

Just that, that’s in the B-to-B and keeping with our hope of obviously keeping the core business which a lot of it is retail/wholesale healthy and growing. But, you can all see one third of our sales but two thirds of our profits come from B-to-B so clearly we’re able to add more value and create more value in B-to-B. Our products work very well in the animal health world. They bind mycotoxins which are things like aflatoxins and zearalenone which would inhibit the animal from achieving its potential.

We’re not talking companion animal, we’re talking about livestock production animals. So, this is really a global business. That one, we can sell throughout the world. We have a great team of people in place and they’re excited about growing that business because it is growing. The market itself as best as we can tell and there’s no Neilsen or IRIs so it’s hard to get your arms around but, it appears in the past five years it’s had a compounding annual growth rate of right around 18% or 19% and its continued to project that forward.

As regulation and food safety and so forth grows and increases throughout the world then obviously taking out things like toxins is a big deal. This is great, this is a value added use for Oil-Dri.

Ethan Star

Just only the other thing I would say is I would urge you to buy back stock as you feel you have the cash to spare to do that.

Daniel S. Jaffee

Yes, at these prices sure.

Operator

Our next question comes from the line of Robert Smith.

Robert Smith

I was reading your comment about the dividend. I hope you continue to increase the dividend annually. I think it says a lot about your philosophy in the business. Are you guys still hedging about half of the natural gas costs?

Daniel S. Jaffee

Yes, long term we’re hedged at half and then short term we take opportunistic reads and if we can buy spot prices even a month or two out, we’ll do that. If it’s at a price that to us is sort of below where we’ve set our prices at then it’s going to help us with margins. So, yes that’s exactly what we’re doing.

Ethan Star

Is the CapEx increment basically machinery and equipment as opposed to bricks and mortar?

Andrew N. Peterson

It’s both.

Daniel S. Jaffee

I will tell you the good news about – you know, I mentioned earlier, we’re doing the same million tons but now we’re getting $226 a ton instead of $150 per ton so the business has been able to grow accordingly. If we had done the opposite, if we had held our pricing at $155 a ton and still tried to get the 233 million tons, we would have had to sell almost 50% more tonnage. And that incremental tonnage would have meant more CapEx, more plants, more permitting, quicker use up rate of our clays, all negativity.

We wouldn’t be having any kind of results. So, the beauty is we’ve been able to support the growth of the business with almost the identical infrastructure. As you know, we built that new bleaching facility a few years ago and that went very well. That business is strong as you can tell from our releases. The tact we’re on of trying to maximize the value for every ton we ship for many reasons appears to be the obviously tact and the right tact.

Ethan Star

Dan, in the past the new products have a lot of promise but really didn’t click so I hope this all in really works for your guys.

Daniel S. Jaffee

Thanks, we do too.

Operator

At this time there are no more questions in queue.

Daniel S. Jaffee

Just wrapping up, I appreciate everyone conforming to the format. It keeps the focus, keeps the pace appropriately. Next time we’ll be back at you after the first quarter results and just like you, we are all hoping we’ll be able to show some not only continued top line growth but repair the margins and some bottom line benefit as well. Thank you for your support and we look forward to talking to you at the end of the first quarter.

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