Oil-Dri Corp of America (ODC) Q3 2022 Earnings Call Transcript

Good day, and thank you for joining us for the Third Quarter Fiscal Year 2022 Investor Teleconference. At this time, all participants are in a listen-only mode. I would now like to turn the conference over to our speaker today, President and Chief Executive Officer, Dan Jaffee. Please proceed.

Thank you, and thank you, and welcome, everyone, to our third quarter teleconference. With me here either physically or on the line is Susan Kreh, our Chief Financial Officer; Aaron Christiansen, Vice President of Operations; Chris Lamson, Group VP of Retail and Wholesale; Jessica Moskowitz, Vice President and General Manager of our Consumer Products division; Wade Robey, our Vice President of Agriculture and Amlan Marketing; Laura Scheland, Vice President, General Counsel and Secretary; David Atkinson, Vice President and Controller; and Leslie Garber, our Manager of Investor Relations. Leslie?

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 in our SEC filings, we highlight a number of important risk factors, trends, and uncertainties that may affect our future performance. We ask that you review and consider those factors in evaluating the Company's comments and in evaluating any investment in Oil-Dri stock. Thank you for joining us.

Thank you, Leslie, and thanks, everyone, for sending in a whole host of questions, really good questions. And so, we've got a very informative session for you. So, I'll not waste a lot of time. I'm not covering what you didn't want to hear. So, let's turn it over to Susan first for some financial results, and we'll go from there.

All right. Thanks, Dan. This morning, we have a special guest with us that is our Vice President and Corporate Controller, Dave Atkinson. Dave’s been with us about a year. He's joining us today to discuss the details of the significant accounting charge we took during the quarter, a one-time non-cash charge. And he'll go through the details with you and then be available to answer any questions you might have related to that accounting event. So, with that, Dave, do you want to talk to us about goodwill impairment, please?

Sure. Thank you, Susan, for the opportunity to be here today and to talk about our one-time noncash goodwill impairment charge that we took in the third fiscal quarter. For background, the goodwill intangible asset is established during acquisition accounting when the purchase price exceeds the sum of the net fair value of assets acquired and liabilities assumed. In the case of this particular goodwill asset, it relates to multiple acquisitions that took place eight years ago or longer. We test goodwill for impairment each year as of May 1st. In performing this test, we determined that we had experienced a triggering event in the third fiscal quarter due to continued adverse impact of rising costs and supply chain constraints on our gross margins. We determined that in the third quarter, the carrying value of the Retail and Wholesale segment was higher than its fair value based on our discounted cash flow model. As a result, we recorded a goodwill impairment of $5,644,000, which has no remaining goodwill in our Retail and Wholesale segment. Now tax impact, this resulted in a reduction of earnings of $4,397,000 or $0.65 per common share. The remaining goodwill on our balance sheet of $3,618,000 relates to our higher-margin Business to Business segment, which does not require impairment based on having fair value in excess of its carrying value. In addition, we do not expect future goodwill impairment charges related to the Business to Business segment.

Thanks, Dave. The goodwill charge that Dave mentioned does not affect our liquidity as it was a noncash charge. Additionally, we maintain strong relationships with our lending partners and collaborated with them to exclude the goodwill impairment from our covenant calculations. The updated documents were submitted with our fiscal third quarter 10-Q for anyone interested. Moving from liquidity to cash, so far this year, we have issued $25 million in notes at a favorable rate of 3.25%. We have used these proceeds to facilitate our growth by building inventory. This decision was influenced not only by rising supply chain costs but also by longer freight delivery times, necessitating a greater inventory of finished goods to maintain high service levels for our customers. We are also investing in our manufacturing facilities through capital investments to support our growth. Additionally, we have taken the opportunity to repurchase shares of stock, as we believe they are currently valued attractively. I want to leave ample time for questions, knowing that there will be a queue. Highlighting this quarter, we experienced robust revenues across all our businesses, benefitting from our pricing initiatives and volume growth. If I break it down, about three-quarters of the strong revenue growth came from pricing and the other quarter from volume. I am particularly encouraged by the 13% growth in our animal health products, which is a strategic area for us. We are making strategic investments in both capital and SG&A to enhance sales and leadership in order to capitalize on growth opportunities. We'll conclude on that positive note and turn it back to you, Dan.

Thank you. Before we move on to other questions, I want to prioritize a couple since they can be discussed together. John Bair asked for the most positive takeaway from this quarter's results and any encouraging trends. Susan already touched on the positives, so I'll focus on the trends. Ethan Star inquired about what is needed for significant growth in Amlan sales and the progress being made, which can also be combined with the previous question. We're observing some really positive trends, and there was another question about our new products, but the real excitement and growth are coming from our established products, which are rooted in the minerals Mother Nature has provided. Our approach is to selectively mine and process those minerals to enhance their natural benefits, and that’s what's driving enthusiasm among our end users and customers. We have seen greatly encouraging test results, and it's crucial to ensure the industry is adapting systematically, considering changes impact the human food chain. It’s promising that significant entries into new accounts are yielding results that exceed expectations. To achieve growth, we began by building our team, bringing in Heath, Jay, and Chuck in the U.S., as we previously lacked a strong presence there. Their strong industry reputations helped us attract them, and I encouraged them to thoroughly investigate our products before committing. They all joined us after confirming the validity of our offerings, which is a testament to our potential. While we typically don't disclose much about animal health, I can share that we achieved about $14.4 million in sales there. Due to global supply chain issues, we're facing challenges in revenue recognition as products are still moving to customers. However, we believe we have sufficient inventory to reach between $20 and $22 million, exceeding last year's $18 million figure, with our projections pointing towards around $40 million for next year. The growth is steady, and although this industry moves slowly, once relationships are established, they tend to be resilient. Nutritionists communicate extensively, helping spread success stories. That’s why we are conducting trials with a diverse range of customers simultaneously. While I’m sharing more details than usual, I felt it necessary because while our top-line results are strong, we need to improve our bottom line. We’re seeing a positive impact from pricing increases, but the gross profit margin has decreased compared to last year because our later price hikes only started taking effect in May and June. Looking ahead, we expect to better manage the pressures of global inflation in the fourth quarter. We are implementing price increases and surcharges that will be adjusted depending on fuel prices. Regarding hedging, I have been clear that we operate in a rational market, and if our hedging predictions are off, we wouldn’t want to pass that risk onto our customers. Our strategy is to adapt to market conditions rather than make speculative decisions. Now, let’s see where we should go next.

So, the next question is from John Bair from Ascend Wealth Advisors. And he asked, are you seeing any shift by the consumer away from your premium cat litter products to lower-end offerings?

Yes. Good morning, John. This is Chris. I'll take the question. Thanks for the question. And I think we had a similar question last quarter, and the answer largely remains the same. So, as we look at the total category, really what we see is a bit of a barbell effect. So, super premium products, so real price premium per use, specifically litter crystals are growing very nicely. And then, at the other end of the market, those brands and retail brands, private label brands that are obviously more value-oriented, are also seeing growth that is in excess of the category. I would put both of our significant businesses within litter into that latter bucket. And as a result, I'd say, we're benefiting from what I'd call fairly modest tailwinds above the category. Category is already doing well, right, tracked in the low teens. Those value brands that perform particularly well, can't pull the consumer for long. Value brands performed particularly well, premium private label and our Cat’s Pride and Jonny Cat brands are performing ahead of either the segment that they play in or the overall category.

Okay, great. Thank you. Our next question comes from Ethan Star. What kind of results are Amlan customers seeing with Amlan products, both in the United States and around the world, and especially interested in hearing about results for the newer Amlan products?

Yes. Thank you, Dan. Good morning, Ethan, and thank you for the question. We're seeing excellent results around the world. As we've discussed in previous calls, part of the sales cycle with Amlan products in this industry is to evaluate in the field, our products in customer operations. We certainly share R&D results. We do at CROs or universities, but customers really want to try the products firsthand. In the trials we've been conducting over the last 12, 18 months, we've universally seen excellent results. Our customers are seeing improved performance with our products. As we look around the world and the launch of our new products, we're beginning to evaluate those as well. As we mentioned, again, in a previous call and with our IPP launches, we're launching two new products internationally, our NutriPat product and our product. Both of those products are in testing now with customers. And again, we're seeing them perform as expected, and we're starting to make great progress in moving those products into the market.

Okay, great. Thank you, Wade. Our next question also comes from Ethan Star. The 10-Q indicates that you'll be spending $6.5 million to renovate one of your manufacturing facilities. Which plant are you renovating, what improvements are you making, and what benefits will result from this?

And Aaron Christiansen, our newly promoted Vice President of Operations, will take that one. Aaron?

Yes. That's a great question. Thanks for asking, Ethan. Susan already largely alluded to the answer. Our capital spend continues to be heavy in our aging infrastructure. The bulk of the spend is in the areas where we support the Amlan business and lightweight cat litter. It's a combination of investments that add capacity, flexibility, redundancy in some cases, and address our cost structure. The question specifically states the location, I'd rather avoid that detail, but it is most definitely clear to indicate that the capital spend is definitely targeted in the areas where our commercial teams are targeting strategic growth.

Great. Thank you. The next question comes from Curt Cornwell, who is a long-time shareholder. Was the decision to take the goodwill impairment charge in this quarter related to the substantial increase in inventories year-to-year? And are you satisfied with current inventory levels?

I'll start and then hand it over to Aaron. Thanks for the question. The inventory levels were not what led to the impairment charge this quarter. Regarding your second question, we have noticed an increase in finished goods due to the great situation and the longer lead times for getting our products to customers this year. For further details on overall inventory levels, I'll let Aaron, our VP of Operations, address that.

Extremely hard to predict where we go over the next quarter. The market dynamics right now, in particular in freight and export freight are incredibly unpredictable, unstable. The bulk majority of the increase in working capital over the past quarter has been in export production and volume for several pieces of our business, where we simply have not been able to move the product at the rate that we have historically. All indications are export freight, in particular, is not going to improve over the coming quarter. We're finding unique ways to manage our working capital down. But obviously, we have to have the product to begin with to be able to move the freight. So, we'll monitor as the freight market and other aspects of the supply chain stabilize in the months ahead.

Great. Thank you. And we have a couple of questions. Ethan asked, what is the number of different countries you have already sold Amlan products in? And John Bair asked what do you attribute the sales decline in Mexico and Asia? Is it a demand drop or a logistic issue or both? And Wade, I'm going to call on you to take on those two.

Yes. Thank you, Dan, and thank you for the questions, guys. I'll start with the question related to the countries we're targeting. Ethan, we're targeting approximately 27 countries today and selling around the world really and all key world area geographies, except for the EU, and we've discussed why we haven't approached that market yet. These are really the countries that we're focusing on. We're not going to have a large expansion in that number over the next 12 months. We'll see instead more significant investment in the key geographies, like in the Americas, North America, South America as well as in key countries in Asia, but that list will gradually expand in time. As we look at Mexico and the change that we saw there, if you look at the third quarter of fiscal year 2022 versus 2021, which I think is the reference question you're asking, we saw a decrease in net sales of approximately $147,000, which constituted about 25% for the quarter. And that really was related to a discontinuation of certain product lines that were sold by Agromex that were more equipment or mechanical in nature. It wasn't related to our core products, but rather products that we chose to discontinue that were core to our strategy. And so, we see that really as a temporal event.

Okay, great. Thank you. Our next question comes from Ethan Star. In the slide presentation at the annual meeting, Oil-Dri noted that Amlan has an opportunity to target companion animal rations. I have three questions related to that. First, has the innovation center already developed a scientifically proven product? Second, are you already working with a pet food manufacturer, either informally or with a contractual agreement? And third, what can you tell us about when this product might begin to generate revenue for Oil-Dri? Wade, do you want to take that question?

Yes, sure. And again, thank you, Ethan, and thank you for the breadth of the question because it is an opportunity that we see is pretty significant for the Company in the future. What's great about our product, and Dan mentioned this, and certainly, our core clay mineral products is that they are effective in a broad range of species. So although we're initially targeting, say, poultry and swine in the key geographies we're looking to penetrate, we're also pursuing markets like the ruminant market, specifically in dairy and also companion animal. And the reason is that the products work across species really the same. This is basically true for our formulated products as well with some exceptions, but we have a breadth of portfolio that we can target, not only production animals but also companion animals. We're in the process currently of talking with large companion animal feed or food producers. What's fortunate about that is a lot of these very large food companies that we do business with today are vertically integrated and cross species. So, they might produce both poultry feed, ruminant feed and sometimes companion feed as well. So it makes it a very efficient way for us to penetrate the market. We're not in testing yet in companion animal rations. We're going down a cycle of providing them data and convincing the validation test, but we hope to do that in the near future. And I would hope that in fiscal year 2023, we begin to see some sales into the companion animal market. But again, we'll have to validate the product with customers and then begin sales in that order.

Great. Thanks, Wade. We have a question from Eric Simon. Oil-Dri has a long history of maintaining a very strong balance sheet. Given it's been a capital heavy year with elevated capital expenditures, working capital growth, dividends, and buybacks, leverage has increased. Does the Company have a maximum net debt or leverage ratio in mind? And should we expect free cash flow to improve over the next year, or will cash needs remain high?

Susan?

Yes, there were many questions in that. Let me start by saying we expect our free cash flow to improve. We plan to keep investing capital because we have identified opportunities at our current spending levels for this fiscal year and the next couple of years. We have some strong opportunities ahead. Regarding inventories, as previously mentioned, we are investing in our inventory to better serve our customers and support the volatility we are experiencing in freight and shipping. Our balance sheet remains robust, with a debt to total capital ratio of 18.4%, which is quite low. This gives us the flexibility to fund emerging opportunities. We have a specific ratio in mind and have discussed that we wouldn't exceed a debt ratio of 40% unless an exceptional opportunity presented itself. This provides us ample room for accretive ventures. As for dividends, we plan to continue supporting them, and we will take a strategic approach to share buybacks, although the current stock price is quite attractive. We have spent about $11 million on share repurchases year-to-date. Currently, we do not have any further plans for buybacks, but we see it as a valuable opportunity, albeit secondary to our priorities. Growing our business will take precedence in how we use our cash for capital and working capital investments.

Thank you. As I review our balance sheet, we have $200 million in assets. The question arises: can we replace all five of our major U.S. locations - Georgia, two in Mississippi, one in Mounds, Illinois, and one in Taft, California - for $240 million? The answer is far from yes. These figures reflect historical and depreciated values. As these facilities age, Aaron and his team will not only need to upgrade but also maintain them to meet current standards. Additionally, as environmental regulations become more stringent, the amount of pollutants allowed decreases, requiring more air quality equipment and similar investments. Ultimately, this is a capital-intensive business. Regarding dividends, they are extremely important to us. We have consistently paid dividends for over 40 years, and we’ve increased them for 19 consecutive years.

18.

That's what I thought. 18 years in a row, no worries. And we always look at it in June, and this is June. So, it's certainly on the agenda for today's Board meeting, and that will be a subject for discussion and a review and approval by the Board. And what they're going to want to see is, do we believe that our margins are going to come back, we'll start generating the cash necessary to not only fund the maintenance and growth of the business, but also to then increase the dividend. So, I would say, you'll know more by close of business today, because that will be a strong signal one way or the other. And Susan and her team will be presenting some cash flow information and so forth, and so that they can make a more informed decision. Good. So, we have what, one more question?

We have time for one more question, which comes from Ethan Star. In the most recent 10-K, it is stated that Oil-Dri is working with a significant customer, so that the customer would pay freight charges directly and such costs wouldn't be included in the price Oil-Dri charges for its products. What is the approximate impact of this change on the top line per quarter? If you can't give a precise figure, could you at least tell us whether it's more or less than $1 million per quarter?

So, Ethan, it's Chris. The key point here is that there is no real net bottom line impact from this. It's just lower sales over the past year, and we will annualize this effect going into the next quarter, specifically Q4, with a corresponding adjustment in the freight line in our detailed profit and loss statement. Over the last year, this amounts to a couple of points of sales that were depressed. Again, there is no impact on the bottom line, just a shift.

So more than $1 million a quarter. Yes, yes. So good question. Well, thank you, everybody. And look, we're all looking forward to the fourth quarter. We will have significant price increases already showing, but then more coming and all around trying to recapture costs and protect our margins, and we're very focused on it and nose to the grindstone, and we'll be back with you and whenever that is not quite 90 days, probably a little longer. But after we close the fourth quarter, we'll talk to you then.

Thank you. That concludes our call.

This concludes the conference call. You may now disconnect.