Good day, and thank you for standing by. Welcome to the third quarter fiscal year 2022 investor teleconference. At this time, all participants are in a listen-only mode. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, President and Chief Executive Officer, Dan Jaffe. Please go ahead.
Thank you. 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 Schelin, 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. Thanks everyone for sending in a whole host of questions, really good questions. We've got a very informative session for you, so I'll not waste a lot of time, not covering what you didn't want to hear. 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 just about a year. He's joining us today to discuss the details of a significant accounting charge we took during the quarter, a one-time non-cash charge. He'll go through the details with you and then be available to answer any questions you might have related to that accounting event. With that, Dave, 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 non-cash goodwill impairment charge that we took in the third fiscal quarter. For background, 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 first. In performing this test, we determined that we had experienced a triggering event in the third fiscal quarter due to continued adverse impacts of rising costs and supply chain constraints in 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 left no remaining goodwill in our retail and wholesale segment. Now, the tax impact, this resulted in a reduction of earnings of $4,397,000 or sixty-five cents 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.
Yeah. Thanks, Dave. The goodwill, that charge that Dave described does not impact our liquidity. The charge itself was a non-cash charge. Further, we have strong relationships with our lending partners, and we worked with both of them to exclude the impact of the goodwill impairment from our covenant calculations. The amended and modified documents were filed with our fiscal third quarter 10-Q for any of those who might be interested. Transitioning from liquidity to cash. Year to date, we've issued $25 million in notes at a very favorable rate of 3.25%. We've used those proceeds to fund our growth, and through building inventory.
We're doing that not only because of the increased cost of the supply chain, because of the fact that getting freight out is taking longer, so we have more finished goods on hand, and just to provide overall higher service levels to our customers. We are also making investments to support our growth in our manufacturing facilities as well through capital investment. We also have opportunistically repurchased shares of stock as we believe they are currently at a very good value. I want to leave a lot of time for questions because I know there will be a few. If I think about highlights for the quarter, strong revenues in all of our businesses, and we're seeing the benefits of our pricing initiatives as well as volume growth.
If I break that down, I'd say the strong revenue growth is about three-quarters pricing and the other quarter is volume. I'm particularly optimistic about the quarterly growth in our animal health product that was 13% and growing. This is a business which is strategic, and we're making strategic investments in both capital as well as in SG&A to build out sales and leadership to drive the growth opportunities there. We'll end on that positive note and turn this back over to you, Dan.
Great. Thank you. Before we address some other questions, we've prioritized a couple just 'cause I'm gonna take them. I've combined two. John Baer wrote in, "What is your most positive takeaway from the results of this quarter and any positive, encouraging trends you see unfolding?" I think Susan covered the positives. I'm gonna go with the trends. Ethan Starr wrote, "What will it take to significantly grow Amlan sales and what progress is being made toward that?" The two of them can be combined together because we're seeing really positive trends.
There was even a third question that we may or may not get to. I think Ethan was more interested in our newer products, but I will tell you what's really driving the excitement and the growth are the older products, the stuff that Mother Nature put in the ground billions of years ago. Our clay is and as we say, you know, minerals by nature, performance by design, our clay selectively mined, selectively processed, to maximize what Mother Nature did billions of years ago, is really what's driving all the excitement with the actual end user, the actual customers. We have had incredibly positive tests. This is an industry that you'll be thankful to hear it's slow to move because it's impacting the human food chain.
It wouldn't even be good if they were just, you know, bouncing back and forth, changing things left and right without being very methodical, and getting deep into the data and making sure they see repeat performance. Having said that, all, you know, major entries into new accounts are moving forward with results better than what, you know, they had even hoped for when they went ahead and agreed to test the products. You know, what do we need to grow? It started with building the team. It started with, you know, bringing in Heath and Jay and Chuck, and in the U.S., and really because we never really had a U.S. presence.
Their reputation in the industry is so strong that when they left Cobb and joined us because they truly believe in our mineral. Before they joined the company, I gave each of them you know, the same spiel, which was, "Look, I'm an accountant. I'm excited about our clay, but I don't really understand this industry. Go out to the research center, go to the Dan Jaffee Innovation Center and the Dan Jaffee Microbiology Lab, get into the data and come back to me and either tell me, Dan, you're chasing rainbows. There's nothing here, and I'm staying in my 22-year career here at Cobb, or No, it's real. In fact, it's even better than we thought." They all joined, and you know, the proof is in the pudding.
It's very exciting. The results are very positive. While we don't generally disclose too much of just the animal health, I know in the Q we said we did about $14.4 million in animal health sales. You know, depending on revenue recognition, because, you know, the global supply chain is such a mess right now, that we have product that's sitting on the water, sitting in docks, that until it gets in the hands of the customer and can be properly recognized in our revenue streams, I can't really tell you exactly where we'll be. We believe we have enough on hand already to be around, you know, $18 million, sorry, over $20 million. We did $18 million last year. That was last year's number.
We're at 14.4 at the three-quarter point this year, and we believe we'll be north of 20. If everything that's on the water gets invoiced, we could push 22, but we'll be somewhere in between 20 - 22. We already have enough confidence in the tests we've seen, the commitments we've gotten, the expansion in the trials to be budgeting for around 40 next year. You kind of see, you know, what we're seeing, which is this continued snowball growth. Again, as slow as this industry is to move, they are also then gonna be slow to move away from it, meaning once they build their diets, and it really does, I'm learning, Ron, word of mouth that, you know, you're not really gonna hit a single in this industry.
You're gonna hit a grand slam or you're gonna strike out. They talk. These nutritionists talk, rightly so, and they should because they're all trying to help, the U.S. food chain and the global food chain. When someone starts to have success, it gets around the industry pretty well, and that's why we're getting trials with such a wide variety of customers, all at the same time. I'm probably not gonna get any more definition than that. It's a little more than I usually give, but I felt like I needed to because, you know, the results are still not what we want them to be on the bottom line. You know, the top line results have been great.
You can see some benefit of price increases, but, you know, while we did show gross profit up on a dollar basis, it still was down on a percentage basis from a prior year in the quarter. You know, it's because our second and third round of price increases really didn't hit until May fifteenth and June first. We had bunches of headwinds, and you can see it, but, you know, the fourth quarter is when you really should start to see us get on top of this gorilla of global inflation, gas prices tripling, diesel prices rising, everything sort of happening at the same time. We are taking absolute price increases, we're implementing surcharges, and we're increasing those surcharges as the gas price goes up. We will certainly relieve those surcharges as the gas price goes down.
We did have a question on hedging. Look, I've been pretty consistent. We're in a rational market. If we hedge and we hedge wrong, we cannot go to our customers and say, "Look, we thought gas was at $9, and we thought it was going to $15, so we forward bought, and now it's back down to $3, but we don't wanna relieve the hedge, you know, the fuel surcharges because we guessed wrong." You know, that's not gonna be a real fun sales call to have.
As we all know, the definition of a market is for every buyer, there's a seller. Everyone buying gas at $9.30, there's someone selling it at $9.30, meaning that there's someone thinking it's going down, there's someone thinking it's going up, and our best move is to ride the wave and then merely handle the dollars.
We've never professed to be natural gas experts. We don't profess to be going forward, and we're just gonna stay and ride with the market. If that means we're 30 days late to the market, then so be it. We believe that's in our customer's best interest than trying to guess and potentially guess wrong, which would be really detrimental to either us or our customers or both. That knocked off about 3 or 4 questions. Leslie, where are we going next?
The next question is from John Baer from Ascend Wealth Advisors, and he asks, "Are you seeing any shift by the consumer away from your premium cat litter products to lower-end offerings?
Yep. Morning, John. This is Chris. I'll take the question. Thanks for the question. I think we had a similar question last quarter, and the answer largely remains the same. As we look at the total category, really what we see is a bit of a barbell effect. Super premium products, real price premium per use, specifically litter crystals are growing very nicely. 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. 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 up, you know, tracked in the low teens. Those, what I'll call value brands that perform particularly well can't fool the consumer for long. Value brands that perform 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 Starr: What kind of results are Amlan customers seeing with Amlan products, both in the United States and around the world? I'm especially interested in hearing about results for the newer Amlan products.
Yeah, Wade, will you take that?
Good morning. Yeah, 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 wanna 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 in 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 IPPE launches, we're launching two new products internationally, our NeutraPath product and our Phylox 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 Starr. 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?
Aaron Christiansen, our newly promoted Vice President of Operations, will take that one. Aaron?
Yeah, that's a great question. Thank you for asking, Ethan. Susan already largely alluded to the answer. You know, 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. You know, the question specifically states the location. I'd rather avoid that detail, but it is most definitely clear to kind of 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 Kurt Cornwell, who is a longtime shareholder. Was the decision to take the goodwill impairment charge in this quarter related to the substantial increase in inventory year to year, and are you satisfied with current inventory levels?
Susan.
I'll start, and then I'll hand it over to Aaron. How's that? Thanks for the question. No, the inventory levels weren't part of what triggered the impairment charge of the quarter. The second half of your question, are we satisfied with the inventory level? Certainly, we've seen an increase in finished goods as the whole situation with freight and the long lead times getting our product to customers has caused quite an increase this year. As to the rest of inventory levels, I'll let Aaron, our VP of Operations, answer what he thinks about inventory levels.
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 and unstable. The bulk and 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. Obviously, we have to have the product to begin with, to be able to move the freight. We'll monitor as the freight market and other aspects of the supply chain stabilize in the months ahead.
Great. Thank you. We have a couple questions. Ethan asked, "What is the number of different countries you have already sold Amlan products in?" John Baer asked, "To what do you attribute the sales decline in Mexico and Asia? Is it a demand drop or logistics issue or both?" Wade, I'm gonna call on you to take on those two.
Yeah. Thank you, Dan. 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 in all key world area geographies, except for the EU. We've discussed, you know, why we haven't approached that market yet. These are really the countries that we're focusing on. We're not gonna 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. 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. That really was related to a discontinuation of certain product lines that were sold by Agro-Metz 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 weren't core to our strategy. We see that really as a temporal event.
Okay, great. Thank you. Our next question comes from Ethan Starr. 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 wanna take that question?
Yeah, sure. Again, thank you, Ethan, and thank you for the breadth of the question 'cause 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. 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. 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.
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. They might produce both poultry feed, ruminant feed, and sometimes companion feed as well. 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 them to do validation tests, but we hope to do that in the near future.
I would hope that in fiscal year 2023, we begin to see some sales into the companion animal market. 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 Cinnamond. 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?
Yeah. A lot of different questions there. Let me start. Do we expect free cash flow to improve? We expect to continue spending capital because we've got identified opportunities at the level that we're spending it here in fiscal 2022 into the next fiscal year or two. We've got some really good opportunities there. Inventories, Aaron talked about earlier. We have made an investment in our inventories to serve our customers just because the port volatility we're seeing in freight and shipping. We do have a strong balance sheet. We still are sitting with a debt to total capital of 18.4%, so really pretty low, and that means we've got dry powder to fund the opportunities as they come along.
Do we have a specific ratio in mind? I think we've had conversations where unless the opportunity was something we can't even really imagine, that we would not see that going above 40%. That leaves a whole lot of opportunity for things that are. With that, as far as dividends, and we intend to keep supporting the dividend. Share buybacks will be opportunistic, but to be honest, it's very attractive at the price the stock is at right now. Do we have any? We spent about $11 million year-to-date on share repurchases. As we sit here today, we don't have any more plans to do so, but that is a good opportunity for us, but it comes last in our ranking of opportunities.
Growth in our business would trump that and be the first user so of our cash in the forms of capital and working capital investments.
Thank you. You know, the only thing I would add is, you know, as I look at our balance sheet, we've got $200 million of assets. The question is, does that mean that, you know, could we replace all 5 of our major U.S. locations, Georgia, 2 in Mississippi, 1 in Mounds, Illinois, 1 in Taft, California, for $240 million? The answer is not even close. You know, these are historic values, they're depreciated values and so forth. You know, so as these get older, and as Aaron and his team upgrade, and just not even upgrade in some sense, it's just maintain, keep up to standard.
As you layer on the fact that, you know, environmental compliance only gets more strict, the amount of particulate you can emit, all that kind of stuff. You have to have more and more air quality equipment and things like that. It's just it's capital-intensive business. That's the bottom line. On the dividend side, obviously, very important. We've always, you know, been paying a continuous dividend for what seems like forever. I mean, I was looking back, I mean, it's in one of our releases. I don't remember, but I wanna say over 40 years, we've paid a continuous dividend, and we've raised it 18, 19 years in a row.
Right.
It's always on 19 years in a row.
18.
18. That's what I thought. Okay. 18 years in a row. No worries. We always look at it in June, and this is June, so it's certainly on the agenda for today's board meeting. You know, that'll be a subject for discussion and a review and approval by the board. What they're gonna wanna see is, you know, do we believe that our margins are gonna come back, that 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. I would say you'll know more by close of business today 'cause, you know, that will be a strong signal one way or the other.
you know, 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. We have what? One more question.
We have time for one more question, which comes from Ethan Starr. In the most recent 10-K, it is stated that Oil-Dri revised its terms with the 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 product. 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?
Ethan, it's Chris. I think the key point here and from the nature of your question, I think you understand this, but just really wanna emphasize that there is no real net bottom line impact to this. It's simply a lower sales over the last year. We will annualize this effect going into this next quarter, going into Q4, with an offset in really in the freight line in our detailed P&L, if you will. You know, roughly, how much does that approximate to over the last year? Approximately a couple points in sales that were depressed. And again, no bottom line impact, simply a shift between-
More than $1 million a quarter?
Yeah.
Yeah. Good question. Well, thank you, everybody. 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, nose to the grindstone. We'll be back with you in whenever that is. Not quite 90 days, probably a little longer. 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.