Earnings Call Transcript - ODC Q3 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Third fiscal '24 Earnings Discussion. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speakers today, Dan Jaffee, President and CEO. Please go ahead.

Dan Jaffee, President and CEO

Great. Thank you, and welcome, everybody. With me today in a variety of different places through the miracle of modern science, we have Susan Kreh, CFO and CIO; Aaron Christiansen, VP of Operations; Wade Robey, VP of Ag and President of Amlan International; Chris Lamson, Group VP of Retail and Wholesale; Laura Scheland, Chief Legal Officer and Vice President and General Manager of the Consumer Products Division; Bruce Patsey, VP of our Fluids Purification Group; and Leslie Garber, Director of Investor Relations, and she will walk us through the Safe Harbor provision.

Leslie Garber, Director of Investor Relations

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 in our SEC filings, we highlight several 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. Before we begin, I'd like to note that we posted two slides on our website that can be found on both the investor landing page and under our Events tab for this webcast. We will be referring to these slides during the call, so please pull them up on your screens. Now, I'll turn the call back to Dan.

Dan Jaffee, President and CEO

Okay. Great. Thank you, Leslie. Before I turn it over, I would like to have some general remarks. First of all, we're going to be here for 45 minutes today, which will allow us to cover our acquisition in detail. So, Chris Lamson will walk us through that after Susan walks us through some highlighted financial results, and then we'll have the full Q&A like we always do. I want to highlight one thing because I don't want to steal Susan's thunder, but we have made $30.901 million in net income through nine months, which is more than any fiscal year we've ever had in our 84-year history. Last year was an all-time record of $20.551 million and that was for all 12 months. We're 4.5% ahead of last year and we're playing with the house's money in the fourth quarter. So, the team has continued to do a fantastic job of creating value from sorbent minerals. We want to thank our customers who allow us to provide that value to them. And, obviously, those strategies are working. Our legacy business is really carrying the day and our focus on animal health has never been stronger. We're completely committed to the business. It takes a while to get it up and running. While we are confident we'll finish ahead of last year, we're still not seeing the year-over-year growth that we know will hit once that snowball starts rolling, but we're also making advances. So, still very confident in animal health. Susan, at this point, I'd like to turn it over to you to walk us through the financial results.

Susan Kreh, CFO and CIO

Thank you, Dan, and good morning, everyone. It's really exciting to be here today and to share with you some of the details of our strategic acquisition of the Ultra Pet business. On several of our previous investor calls, we've been asked about our appetite for acquisitions, and we've consistently stated that we're financially prepared to execute an acquisition that is aligned with our core strategies. On an ongoing basis, we've been monitoring the market and assessing various acquisition opportunities as they become available. And in the case of Ultra Pet, strategic alignment and the value of the acquisition relative to the price we paid made this business very interesting to Oil-Dri. I'll touch more on the Ultra Pet acquisition in a few minutes, but first, I will highlight a couple of brief financial points from our fiscal third quarter, knowing that most of you have read our press release. If you do have any questions on our reported results following my comments, please feel free to ask them during our question-and-answer session that will follow Chris Lamson's remarks. For our fiscal third quarter, consolidated net sales reached $106.8 million, a 1% increase over the prior year, making this the 12th consecutive quarter of year-over-year sales growth. Higher prices and improved product mix were partially offset by lower volumes. In prior calls, Dan has discussed our focus on producing and selling higher-value products, such as renewable diesel products, under the initiative that we refer to internally as Miningball, or our mining company version of Moneyball. Our fiscal third quarter benefited from this ongoing focus as we experienced elevated sales of higher-value fluids purification and cat litter products, including co-packaged items. The third quarter of fiscal 2024 consolidated gross profit was $30.1 million, a 10% increase over the prior year. Gross margins expanded to 28% in the third quarter of fiscal 2024 from 26% during the same quarter in the prior year. The increase was driven by the higher selling prices I mentioned earlier across multiple products as well as improved product mix. During the three months ended April 30, domestic cost of goods sold per ton increased by 3%, and those cost increases were driven by labor, repair costs, depreciation and freight costs compared to the prior year. Lower packaging and natural gas costs partially offset cost increases in the former categories. Selling, general and administrative expenses during the quarter were $19.7 million compared to $13 million during the same quarter last year. This $6.7 million increase reflects an increase in compensation, in advertising expenses, as well as includes transaction costs related to our acquisition of Ultra Pet Company, Inc. The higher compensation costs were driven by increased performance-based incentives as well as a few key planned headcount additions. Advertising expenses were significantly higher in the third quarter compared to the same period last year, as the majority of the prior year's expenditures took place during the fourth quarter. So that's a timing issue. Oil-Dri does expect advertising costs for the full year of fiscal 2024 to be higher than fiscal year 2023. Additional expenses related to the integration of Ultra Pet are expected to be incurred during the fourth quarter of fiscal 2024 and then taper off as we enter fiscal 2025. Now, let's hit a couple of points related to cash. Year-over-year cash and cash equivalents are up substantially from $29.7 million at the end of the third fiscal quarter of 2023 to $46.8 million at the end of the third fiscal quarter of 2024. Of that $17 million increase, $10 million relates to the issuance of notes payable that were issued to support the funding for the Ultra Pet acquisition, and I'll cover more details on that momentarily when I talk about acquisition financing. As we've discussed on previous calls, we continue to invest in our manufacturing facilities to replace our aged infrastructure in order to provide reliable capabilities to service our customers. We see the tangible benefits of this investment and our targeted inventory build and our historically high service levels to our customers. Year-to-date, we invested $24 million compared to $17 million in the prior year, ensuring modern and reliable production capabilities and supporting our growth, and those remain key goals for our capital allocation. If I shift gears to the acquisition of Ultra Pet. On May 1, 2024, Oil-Dri successfully completed the $46 million acquisition of privately-held Ultra Pet Company, Inc., a prominent supplier of silica gel-based crystal cat litter based in Anderson, South Carolina. This acquisition occurred during our fiscal fourth quarter. The structure of the deal was a stock purchase with Oil-Dri acquiring all of the issued and outstanding shares of the capital stock of Ultra Pet. The purchase was financed with a combination of $26 million of cash on hand, the issuance of $10 million in aggregate principal amount of notes that actually occurred during the third quarter and a $10 million advance under our existing credit agreement, which occurred during the fourth quarter. At closing, Ultra Pet became a wholly-owned subsidiary of Oil-Dri. This acquisition strengthens Oil-Dri's position as one of the largest cat litter producers in North America and helps to fast-track entry into the rapidly growing crystal litter segment. We anticipate that the Ultra Pet acquisition will be accretive from day one, inclusive of transaction costs. Included in our third quarter results were transaction-related costs of $900,000. We anticipate a similar level of costs during the fourth quarter and then a significant tapering off of these costs as we enter fiscal 2025.

Chris Lamson, Group VP of Retail and Wholesale

Thanks, Susan, and good morning, everybody. I'd like to spend some time discussing Ultra Pet from a financial perspective, while also answering some of the questions we've received through Leslie regarding the transaction. We posted two slides on our Oil-Dri Investor website under the Events tab. In a few minutes, I'll actually be referring to those slides, just really two slides. So, take a look, pull them up if you can, and it'll help the story come to life a bit. Let me first tell you a little bit more about Ultra Pet. They're a small privately-held company located in Anderson, South Carolina, actually not far from Clemson, and we have 18 new teammates down there. Ultra Pet is a prominent supplier of silica gel-based cat litter with net sales of approximately $24 million. Some of you have asked about Ultra Pet's EBITDA. However, we really don't disclose operating earnings at a principal product level. Ultra Pet was a pioneer in the alternative cat litter market and really the pioneer of the crystal cat litter market with their Litter Pearls brand, which they introduced in the US all the way back in 1998. So, there's already a strong similarity to Oil-Dri, who innovated in the lightweight category some 10, 12 years later. Ultra Pet has expanded its product portfolio to include additional brands such as Ultra Pearls, Neon Litter, as well as many private label cat litter products focused on crystals. While they do sell a few related accessories such as cat toys, we made the decision to exclude those durable items from the purchase. There are a few alternative litter items that Ultra sells that we will assess over the next year to ensure that we can compete and win in those smaller segments. Ultra Pet sells to customers both domestically and internationally, through e-commerce, pet specialty, and grocery brick-and-mortar retail stores. As with other silica gel cat litters sold in the US, Ultra Pet's crystal litter is currently manufactured in China by a couple of strategic suppliers. These suppliers are well-integrated and operate impressive supply chains. The Ultra Pet team possesses strong knowledge of sourcing from overseas, and will partner with the Oil-Dri team to develop options that mitigate geopolitical risk going forward. Since these products are co-manufactured in China, we did not acquire any significant hard assets with the deal. We pursued this acquisition for two key reasons. First, as an entry into the rapidly growing crystal cat litter segment of the market, and second, for its extraordinary strategic fit, and I might add cultural fit as well, with the Oil-Dri litter business and the Oil-Dri company overall. So first, let's discuss how the acquisition allowed us to enter and fast-track our ability to get into the crystal litter segment. Please refer to the first slide of that two-slide deck that I mentioned. The crystal cat litter market has been experiencing tremendous growth. Segment sales have increased five times over the last five years, from about $60 million to around $300 million. While I can't share specifics on Ultra Pet's historic sales, I can tell you that their revenue growth has been equally impressive. The crystal segment has seen more growth than any other segment within cat litter over the last five years. From a volume perspective, crystals have accounted for approximately one-third of total cat litter gains. You might think that if crystal litter has grown so much over the last few years, it must be taking share away from clay cat litter products, but the litter category is strong enough to keep its base growing even as new forms emerge and take some market share. So, both lightweight and crystals are the two fastest-growing segments, and we believe we have a strong market position in the fastest-growing segment of the overall litter category.

Leslie Garber, Director of Investor Relations

Great. Thank you, Chris. Yes. And please submit your questions using the Ask a Question field on the webcast and click Submit. We have a few in the queue right now. So, I'm going to read them off. The first question comes from Ethan Starr, individual investor. He asks, 'Given the inflation of the last couple of years, is there any evidence that more consumers are switching to private label cat litter?' Chris, can you answer that, please?

Chris Lamson, Group VP of Retail and Wholesale

Yeah. It's a good short answer, Ethan. The answer is yes. The private label is showing across the litter category, the greatest share gains of any other manufacturer.

Leslie Garber, Director of Investor Relations

Okay. Great. The next question comes from John Bair from Ascend Wealth Advisors. He asks, 'Are you experiencing any headwinds of sales or adoption of your animal health products due to the ongoing outbreaks of avian flu domestically or elsewhere?' Wade, can you answer that, please?

Wade Robey, VP of Ag and President of Amlan International

Thank you, Leslie, and thank you, John. That's an excellent question. We've seen challenges not only from avian influenza but also from African swine fever, which has primarily affected the global swine markets. Our products do not specifically address these issues. Regarding avian influenza, it is classified as a Type A virus, for which there are no treatments available aside from depopulation. Therefore, while our products generally enhance animal productivity and improve financial performance, they do not directly address these outbreaks. The outbreak presents challenges to sales, particularly because it limits our ability to visit customer locations, especially farms. Biosecurity is crucial in the animal production industry, and with the depopulation of around 96 million birds due to avian influenza, our access to company farms can be restricted. This complicates the sales process, but we have managed to adapt by reaching out to customers through different methods.

Leslie Garber, Director of Investor Relations

Great. Thank you. We have another question from Ethan Starr. He asks, 'Do you see continued growth for your products in the renewable diesel market?' Bruce?

Bruce Patsey, VP of Fluids Purification Group

Yes, there's going to be continued growth in this marketplace. Several plants are being built right now. We expect over the next two to four years, new plants coming in that will drive sales of our bleaching clay products. We're excited about this new industry and it should help drive growth in our business.

Leslie Garber, Director of Investor Relations

Great. Thank you. Next question again is from John Bair. How did the Ultra Pet deal unfold? What was the catalyst for them to join the Oil-Dri family versus any of your larger competitors? Chris, can you answer that, please?

Chris Lamson, Group VP of Retail and Wholesale

Yeah, you bet. John, I'm excited you asked the question as I think it's a good story for us to tell. First, I'll go back to our thought processes. We have various management routines, but once a year, Dan gets us together off-site for some strategic planning, and I'll give Susan props. We're looking at market data and obviously, our largest category in which we compete is cat litter. Susan was pressing the issue of, 'Hey, how do we get into this segment?' We did some work around how we could enter, either on our own or via acquisition. We identified Ultra Pet as the best acquisition method to do that. Ironically, within a week, we actually got their book. They had put themselves on the market for sale. On the softer side, after conversations with them as our teammates, we've had candid discussions around how things transpired on their end. They shared with us that we were not necessarily the highest payer, but we spent time in our communications discussing culture and how they would fit in and how we would grow the business together. That cultural overlap and symbiotic culture pushed us to the top of their list, which I think is reflective of our values at Oil-Dri.

Leslie Garber, Director of Investor Relations

Great. Thank you. The next question is from Ethan Starr. What progress is Amlan making? How are trials of Amlan products with potential customers going? Wade, I'm going to turn that one over to you.

Wade Robey, VP of Ag and President of Amlan International

Yeah. Thanks, Leslie. Thanks again, Ethan, for that question. Even though we've had challenging markets in ag over the last 12 months, we've not seen a slowdown in customer interest in our products, especially the new products we're bringing out like Phylox internationally, Amsure, and NeutraPath. We have trials ongoing in various global regions. Each time we've entered trials with customers, we've seen a positive response. This is part of the longer sales cycle in animal health, where customer usage of the products in the field is essential for adoption and subsequent commercial activity. We're excited that these trials have continued with a high degree of customer interest.

Leslie Garber, Director of Investor Relations

Great. Thank you. The next question is from John Bair. Are there other crystal litter manufacturers or larger competitors developing this type of product? Chris?

Chris Lamson, Group VP of Retail and Wholesale

Yeah. Thanks, again, John. Clorox with their Fresh Step brand has been in crystal litter for over a decade. Pretty Litter, which was an independent company that started with an online direct-to-consumer subscription model, really lit the segment on fire with significant digital consumer interaction starting about four or five years ago. With that growth, Ralston with the Tidy Cat brand has also entered this segment. We want to see that growth because it helps fuel the category. Our unique positioning allows us to offer fantastic price value with great efficacy in the segment, both from a branded and private label perspective.

Leslie Garber, Director of Investor Relations

Great. Our next question is from Sean McMahon. Can management please discuss the cash flow ROI or ROIC expected from the recent acquisition? If not, how should we evaluate if this acquisition is successful if we won't provide the EBITDA estimates? What was the hurdle rate return expectation IRR for this deal? Susan, can you comment on that?

Dan Jaffee, President and CEO

Actually, Leslie, I think I'm going to take this. But Susan has teed me up with some of the details. Our weighted average cost of capital is just under 9%. We target an IRR in excess of 15% when we make a major capital investment, and this one meets that criteria. There were very few cost synergies put in the model. We expect to have 1 plus 1 equal 3 on the market side, and we're seeing positive responses from our existing customer base regarding crystals. Overall, the Ultra Pet and Cat's Pride combination is proving to be a powerful partnership, although I must always caution due to the safe harbor. If anything, we are more pleased than we thought we would be from a market receptivity perspective.

Leslie Garber, Director of Investor Relations

Great. Thank you. The next question is from Ethan Starr. How much goodwill or intangibles were added to the Oil-Dri balance sheet with the Ultra Pet acquisition?

Susan Kreh, CFO and CIO

Thanks, Ethan, for your question. We just acquired it this quarter, so we are going through the acquisition accounting process. We've engaged a third party to perform the valuations for us. As an asset-intensive business, we expect a good amount of this purchase price to be goodwill. But until we complete the valuations, I'm not comfortable giving a definitive number. We can update more on where we are in that process during our next call in October.

Leslie Garber, Director of Investor Relations

Great. Thanks, Susan. The next question is from Sean McMahon. How much of management's bonuses could be based on meeting Ultra Pet's financial expectations? Dan, I'll have you answer that one.

Dan Jaffee, President and CEO

Sure, Sean. Good question. For fiscal '23, with Gen 731, I would say none whatsoever that we are tracking against our original plan. While this acquisition is immediately accretive, the team won't benefit from it this year. However, it will factor into the fiscal '24 bonus and budget would start with that. We feel confident about it, but we will hold ourselves accountable, as will the compensation committee of the Board of Directors.

Leslie Garber, Director of Investor Relations

Okay. So, there are no other questions in the queue. If anyone would like to submit any additional questions via the webcast portal, please do so. We'll wait about a minute or so. If not, we'll conclude the call. No further questions. Dan, do you want to close it out?

Dan Jaffee, President and CEO

Sure. I'm always passionate about our business, but I'm not going to be falsely optimistic. I sincerely believe the best is yet to come. We're going to see continued growth in the next fiscal year, which starts August 1, in renewable diesel. We're going to have the Ultra Pet acquisition moving forward. We believe very strongly in the animal health business and we will continue to see growth there. Our core businesses are all doing well, so it's a good time to be creating value from sorbent minerals. As I've said numerous times, if there's no value in sorbent minerals, you should run because that's our focus. If there is, we're a great investment. I hope you all saw that we gave a larger than usual increase to our dividend, which reflects our confidence in the future. We generally raise it every June by $0.01 a share for a quarter. This year, we raised it by $0.02 in the quarter and $0.08 for the year. We're feeling good, and we were happy we were able to finance the acquisition with zero equity and over half of it in cash. We have plenty of dry powder, and while we will be disciplined, we'll certainly give any right deal a hard look. Thank you. We look forward to talking to you soon after the next quarter.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.