Good day, ladies and gentlemen, and welcome to the Q4 2018 Oil Dri Corporation of America Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions for how to participate will follow at that time.

[Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Mr. Dan Jaffee, President and CEO. Sir, you may begin..

All right, thank you. Welcome everybody to the fourth quarter and fiscal year 2018 Oil Dri investor teleconference. With me today participating will be Laura Scheland, our General Counsel; Dan Smith, CFO; Mike McPherson, CDO; Mark Lewry, COO; and Reagan Culbertson, our Director of Investor Relations.

And Reagan if you would walk us through the safe harbor, I would appreciate it..

No problem, good morning. On today’s call, comments may contain forward-looking statements regarding the company’s performance in future periods. Actual results in those periods may materially differ.

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

All right, thank you, Reagan, and as always, I’d like to turn it over to Dan Smith to walk us through the quarter and year-end, and then, we’ll obviously open it up to Q&A..

Thank you, Dan. Good morning everyone. Oil Dri reported earnings per share of $1.11 per diluted share for fiscal 2018. This value is down from the $1.47 reported in fiscal 2017. The decline was driven by a one-time tax expense increase of about $0.54 per diluted share in fiscal 2018.

Without this adjustment, Oil Dri would have reported about 12% increase in EPS as compared to fiscal 2017. Sales for fiscal 2018 were up about 1% from last year. We reported sales of approximately $266 million, which was slightly below our record year of fiscal 2014. The B2B team reported sales growth of about 5% as compared to fiscal 2017.

The retail wholesale group sales were down about 1% compared to fiscal 2017. Our gross margin percentage in fiscal 2018 was 27.1% which was lower than the 28.1% we reported in fiscal 2017. We experienced higher freight, packaging and non-fuel manufacturing cost in fiscal 2018. Freight costs were up about 12% compared to fiscal 2017.

The new federal regulations and an industry wide driver shortage both impacted our freight expense for the year. Kiln fuel costs were relatively flat with fiscal 2017. Our retail wholesale team reported about $7 million profit from the fiscal 2018. This value was about 3% improvement from fiscal 2017.

Sales for this segment were down slightly from fiscal 2017. Lower branded cat litter sales were mostly offset by increased private label lightweight cat litter sales. Increases in cost of goods sold adversely impacted gross margins for the segment.

The decrease in gross margin was offset by over $3 million decrease in advertising expenses in fiscal 2018 versus fiscal 2017. Our B2B team was up almost 5% from fiscal 2017 for sales. Improved sales of ag, fluid purification and animal health products more than offset the decline in co-packaged cat litter sales.

Ag led the sales increase for the segment with a 13% improvement, thanks in large part to the addition of a new customer in the traditional ag chemical carrier market. Profit for B2B also increased from fiscal 2017. Profit was up about 5%, increased sales and improved product mix helped overcome the higher cost of goods sold.

There were several significant changes to our balance sheet during the year. Oil Dri took advantage of the old federal tax rate and made an incremental $11.5 million tax deductible pension contribution in the third quarter of fiscal 2018. This payment was the primary driver of the $12.8 million decrease in cash and investments.

The payment, along with increased interest rates, lowered our pension liability by over $13 million. We continue to invest in our fixed assets. Our capital expenditures exceeded our depreciation and amortization by over $2 million or about 18%. Thanks. I’ll turn the meeting back over to Dan Jaffee..

Thank you, Dan, and I guess, before we open it up to Q&A, I just want to take a head-on something we’ve put out in the news release, because we don’t often give any kind of forward guidance certainly, we try and avoid quarterly and if we get into anything, it’s on an annual basis. But obviously, we’ve had a significant hurdle to overcome.

We went live on our new information system, it’s something we call ODIN, the Oil Dri Information Network. And I guess, the best way to analogize this is, if you are going from one system that’s a company enterprise resource planning system to another, it’s really not as disruptive on an organization as when you are going from no system to a system.

And yes, we’ve had a system in the past but it was really for financial accounting and analytic performance, it wasn’t for manufacturing, for forecasting, for replenishment, all the various aspects of order fulfillment. And so this really was groundbreaking for Oil-Dri and a major change from how we went to business.

So we were not only having to implement a new system, we were having to implement processes where processes didn't exist. I'm happy to say I've been down to the plants, and the team is – really was energizing me. They were very positive, they were embracing it.

They were barcoding and wanding and doing all sorts of neat stuff, which is going give us real-time information in long term and enable us to better serve our customers. But short term, it's painful.

In the past, if a network went down or if a wand went down, that wasn't really a problem, they weren't using the network or a wand in order to fulfill orders. Now they are. And so they are embracing the new technology, it's who they are, it's what they are used to with their cell phones and everything else.

But it's just the departure for what – how Oil-Dri went to business for 77 years. And so we have given guidance that we are going to be impacting all sorts of our business in the short run just because it is just painful to get everything up out the door, invoiced, received, closed, the whole deal.

We are 100% confident that the numbers will be scrubbed and cleaned by the time we have to report our first quarter earnings after the close of October 31, but we're sort of preparing ourselves and a lot of our investors that, that first quarter is not going to be real comparable to the first quarter of the year ago.

First quarter of the year ago, we weren't implementing a new system and having to go through all these gyrations. This time, we are.

And so while we're very confident in the long-term growth prospects of all of our businesses, I felt and what the whole team did that we needed to give you guys the same transparency and visibility into the short-term results, so that you could prepare yourselves for the first quarter closing.

I can't really monetize it yet, we're still closing our books and getting our arms around the numbers, but I can tell you, we're shipping, we're billing, we're invoicing. And hopefully, this will not amount to a lot.

But we all felt it was material enough to disclose it and give you some sort of heads-up on it, even if it wasn't a very specific heads-up. So at this point, I'd like to open it up to Q&A. I'll answer questions on this.

The team's here or anything else but this is short term, and for those of you who have been long-term holders of Oil-Dri know we are more than willing to make painful short-term bets in order to reap the benefits over the long haul. And that sort of tortoise mentality has served us very well for these past 15 years to 20 years.

So let’s open it up to Q&A, and as always, ask your most important question first, and then we can go to the end of the queue and let everybody ask a question..

Thank you. [Operator Instructions] Our first question comes from private investor Ethan Starr. Your line is now open..

Good morning..

Good morning..

What are the prospects for lightweight private label litter in fiscal 2019, both in terms of new and increased customers or distribution and also better velocity off the shelf?.

Great question. And as always, I want to be general enough to answer your question, but not so specific – or I guess, specific enough to answer your question, but general enough not to tip-off the competition as to what plays running.

So we are at the end of the fiscal year, so in the fourth quarter, we rolled out a new and improved version of lightweight litter with a major retailer, who has – and you can figure it out who – yourself but they have over 10,000 stores in the U.S.

And when they initially launched it at our – we were involved in it but the pricing and the size was messed up, and we worked together to get the pricing and the size right. We partnered up. We helped contribute to that but they re-launched it in a size that's exactly the same as their heavy.

So they carry a heavy 10 pounder, a $3.95 and in the same sized jug, they carry a lightweight five pounder at $3.95, and lo and behold, the velocity has exploded. So we are doing very, very well with that account and it's really giving us confidence to – that our line pricing strategy is working.

And so we've gone to line pricing with all of our major partners.

And those of who have implemented it have seen a 3x and 4x and 5x velocity increase over what they were moving, and are starting to see the velocity get to within shouting distance of the heavies, and in some cases, actually equal the heavies, which is giving those retailers confidence to decrease or maybe get out of their heavies altogether.

Because at the end of the day, women 25 to 54 are the primary purchaser of cat litter. And all things being equal, performance, price, they prefer less weights, not more, makes sense. But when things aren't equal, i.e. the price is too high or the performance isn't there, they are willing to carry home more weight.

So what we're doing is taking all the objections out of the equation. The product is fantastic, performs every bit as well as the heavies. And then, get the price point on a par with the heavies. And now, they have to decide, do I want a great cat litter at $3.95 that weighs 10 pounds or a great cat litter at $3.95 that weighs five pounds.

And they are voting every day that they much rather carry home less weight. In the larger size, it means even more. So if their choice is 20 to 10 or 40 to 20, they are boding well for the lightweight. So we're very bullish. We’re going to continue to roll out new retailers and continue to align price and adjust retails with existing retailers.

So I don’t want to get into too many specifics but I will tell you that we are very bullish on the future prospects of lightweight private label in the U.S. and Canada..

Okay.

So there’s still more new customers to – who don’t have lightweight private label at all coming on this year?.

Correct, and we’ll have another major one rolling out. I think we started to fill their distribution channel in November. So it won’t really help the first quarter, but – and then it will hit their shelves in early December, and once it’s public and out there, I’ll be able to give you more details around that..

Okay, great.

And what’s the major TV brand integration, it’s Litter for Good?.

Yes, so – well, I guess – I mean, if you’ve been out on the web because it’s public information out there..

I’ve looked, I couldn’t find it. Not yet..

Well, okay. Well, it’s public, and so I guess I’ll challenge all of our investors to go out to Ellentube, www.ellentube.com and play treasure hunt and see if you can figure out what week this is for Ellen and who’s sponsoring it. And there’s my teaser and my homework for you guys.

But it’s a major deal because it’s – everyone knows or it’s public information again. Ellen reaches about 18 million to 20 million viewers every week – every day actually, and it’s primarily women 25 to 54 which fits perfectly with our demographic. And so we are – I’m going to leave it at that..

Okay. I’ll hop back in the queue. Thank you..

Thank you..

Thank you. And our next question comes from Robert Smith with the Center for Performance. Your line is now open..

Yes, I don’t want this to count as a question.

But, Dan, when you referenced the enterprise resource planning system when you’ll issue the first quarter numbers are you going to break out the cost of that at that time?.

Dan Smith, I’ll let you answer that..

Yes, Robert, the cost of the system is mostly been encouraging in previous years, it’s going to be really….

No, no, you misunderstood the question.

When you’ll issue the first quarter earnings report, are you going to break out the incremental cost that will cost you in that quarter, so we can have our arms around what the number is?.

Robert, I’m going to have to defer that question because I’m not sure if we are able to capture that specifically based on our reporting. But I understand your question and let me ponder it a bit more. But I’m not sure – after we’re being able to grab that information specifically as you may like it..

Okay, and then just the – another housekeeping question, not to count as my question.

Were you at all affected by the hurricanes?.

Mark Lewry?.

Yes, this is Mark Lewry. Good morning. Yes we were. Our Georgia plant, which is a significant part of our overall production footprint, was affected last week. We were down for three days. We are back up and running. Started back up late Friday and are running. So we had a short-term impact.

Actually, it was probably as minimal an impact as we could have expected or hoped for..

And the infrastructure is there as well, I mean?.

Yes, there was no damage to the plant. There was a little tent that was blown off. But no, no significant damage to the plant. We were able to get back up and running for….

And transportation is okay?.

Yes..

Okay, so my question then is, what is Terra-Green?.

That’s your seventh question and you’ve run out of time. I apologize for that, you’ll have to get back in the end of the queue. The Terra-Green is not – it’s not material anymore, it’s an old, old….

Okay, it’s the first time I saw it mentioned..

Yes, it’s an old trademark that my dad launched in the 1960s. Anyway, it’s an ag product..

Okay. So I’ll get back in the queue..

Yes. And boy, for not asking questions, you asked a lot of questions..

Thank you. Our next question comes from John Bair with Ascend Wealth Advisors. Your line is now open..

Thank you. That was pretty slick, Bob, nice job there. There’s been quite a bit of issue with swine disease and so forth over in China recently.

I was wondering if that’s had any positive impact on your work over there in China as far as new interest and as a side on that too, is any of this tariff tiff going on, is that having an impact on your operations there? Thanks..

Great question. Mike, will you….

Yes, this is Mike McPherson, I can answer those. On the tariff front, no, there’s been a minimum couple percent impact on the duty. And U.S. products in general are still viewed very favorably by Chinese livestock producers. It’s not enough of an impact to really affect our business.

The disease front, there is a range of different type of illnesses and swine, from respiratory to bacteria. We continue to get strong interest from producers when they have bacterial-related diseases in swine, which is kind of a persistent ongoing problem. But when they have flare-ups in respiratory diseases, those tend to be viral.

And our products don’t work on virus as they work on bacteria..

Okay.

You’re working on anything on respiratory front?.

No. We’re not..

Okay. Great. I’ve other questions. I’ll get back in the queue. Thanks..

All right. Thank you, John..

Thank you. And our next question comes from John Barr with Needham & Company. Your line is now open..

Hi, Dan, I was wondering in this quarter, you made reference in the private label growth, you gave us a number but you also mentioned e-commerce as one of the elements there that contributed.

Maybe you could just give us your point of view on that market and how Oil-Dri and lightweight fit?.

Great question and thank you and thanks for asking the question. So yes, e-commerce is very important to retailing in general.

But really, it’s really important to challenge your brands, because in the past, the power that a PNG or a Unilever or a Nestle Purina would have that was very hard for a challenger brand to overcome was they controlled the shelves. And it’s a physical constraint.

If the retailer is going to carry 40 SKUs and they have 30 of them, there’s not a whole lot of room to challenge even if you get your product out there, they give you one little facing and in a category like ours where their holding power is only three jugs, you go out of stock instantly and it doesn’t get replenished till the next Monday or Sunday night.

And so you really don’t have a chance to grow your brands. On e-commerce, those physical constraints are gone. We have the same presence on Amazon or chewy.com or walmart.com as do the big boys.

And so what we’re seeing is greater than our historic brick-and-mortar share at these retailers, and that they are really seeing, they can rapidly grow their business by partnering with us. So we’re not only getting branded business, we do have private label business with one of the major – really the biggest in pet e-commerce player.

And then, we’re in discussions with the other guys about doing private label for them as well. So we see – look, we’re – for us, we’re agnostic in general, which is, whoever wants to buy cat litter, wherever they want to buy it, we want them to have a chance to get Cat’s Pride.

What we’re seeing is, we have the best chance of getting it through them through e-commerce than we do with brick-and-mortar. So we’re still very committed to our brick-and-mortar partners.

And frankly, what we’ve done at the study and those brick-and-mortar partners, who have dedicated more than the typical share to Cat’s Pride, and Cat’s Pride made private label products are outperforming the category. I can name them. First of all, Walmart gives us a greater than – we have a three branded share, and they give us way more than that.

And they are outperforming with Cat’s Pride Scoopable being one of their best moving items. Meyer in the Midwest, Publix in the Southeast, DeMoulas in the Northeast, Albertsons/Safeway. These retailers have all gotten behind and partnered with us. And they are outperforming the category.

So they know that by giving the consumer more access to unique value-added products at great prices, they can actually gain share and gain customers and ultimately that grows their whole store because of the whole market basket concept, that people buy litter are also buying food and other items.

So a lot of e-commerce, a lot of those retailers that are really going to partner with us – sorry, H-E-B in Texas in the South has partnered with us and it’s going very well. So other national players, I mean look, that’s just public.

You’re going to a Kroger, you’re hard-pressed to find any of our products anywhere, and from what we can see on the national syndicated data, they are underperforming the category. So that strategy, from our vantage point, isn’t working. Hope I answered your question but I really appreciate you asking your question..

Great. Thanks, Dan..

Thank you. And our next question comes from Jim Schwartz with Harvey Partners. Your line is now open..

Hey Dan. So one of the – just comparing the 10K of 2018 to the 10K of 2017, just following up, I guess, on what John asked you about. One of the additions was direct customers through e-commerce in the retail and wholesale products group.

And I guess, without naming names, maybe kind of size up the opportunity there and if you want to name names, even better. And then I had a follow-up to that. Thanks..

Yes, I don’t think I’ll name names. But I think we all believe – well, I can’t say we all. I believe that e-commerce is going to continue to grow. I do not believe it’s plateaued, peaked, or is working its way down.

To me, people, and especially the millennials, are going to want to be doing more and more convenient shopping, where they may integrate brick-and-mortar with the e-commerce, and that could be something that continues to give people like Walmart and Target and people with a brick-and-mortar footprint a leg up in the e-commerce world which sort of speak to why Amazon went ahead and bought Whole Foods.

But having said that, I just believe in general, the trajectory is going to continue to grow. So we need to be wherever people are buying cat litter and e-commerce is definitely a high-growth aspect. So we want to be there with our brands, and we want to be there with our private labels.

And we do believe that our share in e-commerce is greater than our share in brick-and-mortar. So as e-commerce continues to win, Oil-Dri will win disproportionally..

Okay. And just following up on that, you added a microbiology lab this fiscal year for animal health. Maybe just, kind of, talk about what – why and what it’s working on and just….

Yes. Great question. Great question. It’s the Richard M. Jaffee Microbiology Lab and I’m going to let Mike McPherson handle this one..

We work on a range of different microbiology projects. Actually, when you look across most of our divisions, if you take a look at cat litter for example. If we want to make our litters more antimicrobial, you’ll have to have a foundation in microbiology. We were firming out a tremendous amount of that work, which we now do in-house.

But the heavy lifting is actually within our Ag division and with our animal health division. On the Ag side increasingly, there is a growth in microorganisms to grow – I’m sorry, to protect against different tests, whether it’s weeds or insects. So, the old chemistry was the synthetic molecules that would be used for pest control.

Increasingly, people are going to natural microorganisms. Sometimes those are spray applied, but increasingly, they’re put on the granules, and you need to be able to demonstrate the ability for these microorganisms to live on our granules, they need to be basic in microbiology.

And then all of our new products that are focused on bacterial-related enteric diseases in livestock are all about how to kill or control microorganisms in the gut.

Again, you have to be basic in microbiology, and we just found that we were farming out way too much of that work, took too much time, slowed down our development effort so by hiring the microbiologists and building the lab, we were able to move much faster and much smarter in our product development efforts..

Okay, great. Thank you..

Yes. And, Jim, what I might add, Mike touched on there at the end, what sold me on the investment was speed to market, and obviously, return on investment. It was costing us time and money to farm all the stuff out. We’re now keeping that knowledge in-house.

Dongping and Shalaka are doing a phenomenal job out there, and in fact, it’s growing so fast they’ve outgrown their space. So we’re going to be looking at doubling or even tripling the size of our microbiology lab this coming fiscal year.

and ultimately, the goal is to turn it into a profit center, where we’ve got enough capacity to then farm out our services to customers, where they – we could do work for them at a price. And so we’re all in on this. We believe this is going to be another competitive advantage for Oil-Dri..

Great..

Great. Well, at this time, I’d like to just thank everybody for your support. We’ve got the Annual Meeting coming up. I’ve been strongly encouraged to include a President’s letter this year, and I will do so. I’ve been working on it, and I’m glad I have because of so much – so many good things have gone on this year.

With one, overwhelmingly glaringly negative and that was the passing of my father. So, I’m using this President’s letter as a way to recognize the incredible contribution he made, but focus on the future and talk about all the things that he is going to miss. But you know what, his dad missed everything.

His dad died when he was only 26 years old and he took over in 1960, his dad died in 1962. So, his dad missed the total run up of Oil-Dri. I was fortunate enough that I took over in 1995, he and I worked together for 33 years.

And he got to see the incredible growth of all the seeds he had planted and the new seeds that we planted in fields he never dreamed of. But I do spend a good portion of the letter talking about all the things that he is going to miss. And I believe he is looking down but the future is very bright for Oil-Dri.

And so I hope you appreciate the President’s letter. And like I said, it’s going to be focused not so much on the past, but really the future.

So, we’ll be back at you again in three months and appreciate your continued support and definitely, do that a little hunt there for our major integration that’s running all week long, starting today on network television, but it’s actually been posted out on Ellentube. So, there is your hint. Thanks very much, everybody..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude your program, and you may all disconnect. Everyone, have a great day..