Oil-Dri Corporation of America (ODC) 10-Q2023 Q1 Quarterly report

Certain statements in this report, including, but not limited to, those under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and those statements elsewhere in this report and other documents that we file with the Securities and Exchange Commission (“SEC”), contain forward-looking statements that are based on current expectations, estimates, forecasts and projections about our future performance, our business, our beliefs and our management’s assumptions. In addition, we, or others on our behalf, may make forward-looking statements in press releases or written statements, or in our communications and discussions with investors and analysts in the normal course of business through meetings, webcasts, phone calls and conference calls. Words such as “expect,” “outlook,” “forecast,” “would,” “could,” “should,” “project,” “intend,” “plan,” “continue,” “believe,” “seek,” “estimate,” “anticipate,” “may,” “assume,” “potential,” “strive,” and variations of such words and similar expressions are intended to identify such forward-looking statements, which are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Such statements are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially, including, but not limited to, those described herein and in Item 1A, "Risk Factors", in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022, and from time to time in our filings with the SEC. Should one or more of these or other risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, intended, expected, believed, estimated, projected or planned. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Except to the extent required by law, we do not have any intention or obligation to update publicly any forward-looking statements after the distribution of this report, whether as a result of new information, future events, changes in assumptions or otherwise.

“Oil-Dri” and “Ultra-Clear” are registered trademarks of Oil-Dri Corporation of America.

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and in compliance with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. The financial statements and the related notes are condensed and should be read in conjunction with the Consolidated Financial Statements and related notes for the fiscal year ended July 31, 2022 included in our Annual Report on Form 10-K filed with the SEC.

The unaudited Condensed Consolidated Financial Statements include the accounts of Oil-Dri Corporation of America and its subsidiaries. All significant intercompany transactions are eliminated. Except as otherwise indicated herein or as the context otherwise requires, references to “Oil-Dri,” the “Company,” “we,” “us” or “our” refer to Oil-Dri Corporation of America and its subsidiaries.

The unaudited Condensed Consolidated Financial Statements reflect all adjustments, consisting of normal recurring accruals and reclassifications which are, in the opinion of management, necessary for a fair presentation of the statements contained herein. Operating results for the three months ended October 31, 2022 are not necessarily an indication of the results that may be expected for the fiscal year ending July 31, 2023.

Our significant accounting policies, which are summarized in detail in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022, have not materially changed. The following is a description of certain of our significant accounting policies.

Additionally, it is our policy to capitalize the purchase cost of land and mineral rights, including associated legal fees, survey fees and real estate fees. The costs of obtaining mineral patents, including legal fees and drilling expenses, are also capitalized. Pre-production development costs on new mines and any prepaid royalties that may be offset against future royalties due upon extraction of the minerals are also capitalized. All exploration related costs are expensed as incurred.

Certain of our leases provide for variable lease payments that vary due to changes in facts and circumstances occurring after the commencement date, other than the passage of time. Variable lease payments that are dependent on an index or rate (e.g., Consumer Price Index) are included in the initial measurement of the lease liability and the ROU asset. Variable lease payments that are not known at the commencement date and are determinable based on the performance or use of the underlying asset, are expensed as incurred. Our variable lease payments primarily include common area maintenance charges based on the percentage of the total square footage leased and the usage of assets, such as photocopiers.

Some of our contracts may contain lease components as well as non-lease components, such as an agreement to purchase services. As allowed under ASC 842, we have elected not to separate the lease components from non-lease components for all asset classes and we will not allocate the contract consideration to these components. This policy was applied to all existing leases upon adoption of ASC 842 and will be applied to new leases on an ongoing basis.

We have an unconditional right to consideration under the payment terms specified in the contract upon completion of the performance obligation. We may require certain customers to provide payment in advance of product shipment. We recorded a liability for these advance payments of $0.5 million at both October 31, 2022 and July 31, 2022. This liability is reported in Other within Accrued Expenses on the unaudited Condensed Consolidated Balance Sheet. Revenue recognized during the three months ended October 31, 2022 that was included in the liability for advance payments at the beginning of the period was $0.3 million.

There have been no other accounting pronouncements issued but not yet adopted by us which are expected to have a material impact on our Consolidated Financial Statements.

The composition of inventories is as follows (in thousands):

Inventories are valued at the lower of cost (first-in, first-out) or net realizable value. Inventory costs include the cost of raw materials, packaging supplies, labor and other overhead costs. The inventory obsolescence reserve was $0.8 million at both October 31, 2022 and July 31, 2022. Inventories have increased due to a combination of rising costs and building inventory levels for anticipated demand.

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The inputs used to measure fair value are prioritized into categories based on the lowest level of input that is significant to the fair value measurement. The categories in the fair value hierarchy are as follows:

Cash equivalents are primarily money market mutual funds classified as Level 1. We had no cash equivalents as of October 31, 2022 and July 31, 2022.

Balances of accounts receivable and accounts payable approximated their fair values at October 31, 2022 and July 31, 2022 due to the short maturity and nature of those balances.

Notes payable are reported at the face amount of future maturities. The estimated fair value of notes payable, including current maturities, was $30.1 million and $31.8 million as of October 31, 2022 and July 31, 2022, respectively, and are classified as Level 2. The fair value was estimated using the exit price notion of fair value.

We apply fair value techniques on at least an annual basis associated with: (1) valuing potential impairment loss related to goodwill, trademarks and other indefinite-lived intangible assets and (2) valuing potential impairment loss related to long-lived assets. See Note 5 of the Notes to the unaudited Condensed Consolidated Financial Statements for further information about goodwill and other intangible assets.

Intangible assets, other than goodwill, include trademarks, patents, customer lists and product registrations. Intangible amortization expense was $0.1 million in both the first three months of fiscal years 2023 and 2022. Estimated intangible amortization for the remainder of fiscal year 2023 is $0.2 million. Estimated intangible amortization for the next five fiscal years is as follows (in thousands):

We have one acquired trademark recorded at a cost of $0.4 million that was determined to have an indefinite life and is not amortized.

We are not aware of any triggering events in the first quarter of fiscal year 2023 that would indicate a new impairment analysis is needed.

We are party to various legal actions from time to time that are ordinary in nature and incidental to the operation of our business, including ongoing litigation. While it is not possible at this time to determine with certainty the ultimate outcome of these or other lawsuits, we believe that none of the pending proceedings will have a material adverse effect on our business, financial condition, results of operations or cash flows. In June 2020, the Company received notice from a former service provider alleging a breach of contract regarding the payment of a contingency fee. Such party subsequently, in July 2020, filed a lawsuit seeking to require the Company to participate in binding mediation regarding this matter. Although we believe this claim to be without merit, as of July 31, 2020, we determined a reasonable estimate of this liability within a range, with no amount within that range being a better estimate than any other amount, and therefore recorded that estimate in Other within Accrued expenses. There have been no changes during fiscal 2022 or the three months ended October 31, 2022 that would have changed this estimate. We believe that any loss related to this matter is unlikely to be material. However, the outcome of this legal matter is subject to significant uncertainties. The ability to predict the ultimate outcome of this legal matter involves judgments, estimates and inherent uncertainties. The actual outcome could differ materially from management’s estimates.

On August 30, 2022, we entered into (i) the Sixth Amendment to Credit Agreement (the “Sixth Amendment”), which amends the Credit Agreement, dated as of January 27, 2006 (as previously amended, the “Credit Agreement”), among us, BMO Harris Bank N.A (“BMO”), and certain of our domestic subsidiaries; and (ii) Amendment No. 3 (the “Third Amendment”) to our Amended and Restated Note Purchase and Private Shelf Agreement, dated as of May 15, 2020 (as previously amended, the “Note Agreement”), with PGIM, Inc. (“Prudential”) and certain existing noteholders affiliated with Prudential named therein.

The Sixth Amendment amended the Credit Agreement to, among other things: extend the facility termination date to August 30, 2027; replace the LIBOR-based reference rate with an adjusted term Secured Overnight Financing Rate (“SOFR”); revise the method for calculating consolidated EBITDA and consolidated debt for purposes of the Credit Agreement; modify certain restrictive covenants, including increasing the unsecured indebtedness basket from $50 million to $75 million; and revise the existing financial covenants by replacing the consolidated debt covenant with a covenant to maintain a maximum debt to earnings ratio, lowering the minimum fixed charge coverage ratio level and revising the method for calculating the fixed charge coverage ratio.

The Third Amendment amended the Note Agreement to, among other things, modify the existing fixed charge coverage financial covenant and replace the existing consolidated debt financial covenant with a maximum debt to earnings ratio and effect certain changes consistent with the Sixth Amendment, including modifying the method for calculating consolidated EBITDA and the excess leverage fee.

We have operating leases primarily for real estate properties, including corporate headquarters, customer service and sales offices, manufacturing and packaging facilities, warehouses, and research and development facilities, as well as for rail tracks, railcars and office equipment. Certain of our leases for a shared warehouse and office facility, rail track and railcars have options to extend which we are reasonably certain we will exercise and, accordingly, have been considered in the lease term used to recognize our ROU assets and lease liabilities. To determine the present value of the lease liability, we use an incremental borrowing rate, which is defined as the rate of interest that the Company would have to pay to borrow (on a collateralized basis over a similar term) an amount equal to the lease payments in similar economic environments. Further information about our accounting policy for leases is included in Note 1 of the Notes to the unaudited Condensed Consolidated Financial Statements.

We have no material finance leases, and variable costs for operating leases are immaterial for the three months ended October 31, 2022. Operating lease costs are included in Cost of Sales or SG&A expenses based on the nature of the lease. The following table summarizes total lease costs for our operating leases (in thousands):

Supplemental cash flow information related to leases was as follows (in thousands):

Operating lease ROU assets and operating lease liabilities are separately presented on the unaudited Condensed Consolidated Balance Sheet, excluding leases with an initial term of twelve months or less. Other supplemental balance sheet information related to leases was as follows:

The Oil-Dri Corporation of America Pension Plan (“Pension Plan”) is a defined benefit pension plan for eligible salaried and hourly employees. Pension benefits are based on a formula of years of credited service and levels of compensation or stated amounts for each year of credited service. On January 9, 2020, we amended the Pension Plan to freeze participation, all future benefit accruals and accrual of benefit service, including consideration of compensation increases, effective March 1, 2020. Consequently, the Pension Plan is closed to new participants and current participants no longer earn additional benefits on or after March 1, 2020. On September 20, 2022, the Company's Board of Directors approved a resolution to terminate the Company's defined benefit pension plan. The Company expects to complete the termination over a period of eighteen months.

The non-service cost components of net periodic benefit cost are included in Other Income (Expense) in the line item Other, net on the unaudited Condensed Consolidated Statements of Income.

The postretirement health plan is an unfunded plan. We pay insurance premiums and claims from our assets.

The medical cost trend assumption for postretirement health benefits was 8.50%. The graded trend rate is expected to decrease to an ultimate rate of 4.90% in fiscal year 2044.

We have two operating segments: (1) Business to Business Products Group and (2) Retail and Wholesale Products Group. These operating segments are managed separately and each segment's major customers have different characteristics. The Retail and Wholesale Products Group customers include: mass merchandisers; wholesale clubs; drugstore chains; pet specialty retail outlets; dollar stores; retail grocery stores; e-commerce retailers; distributors of industrial cleanup and automotive products; environmental service companies; and sports field product users. The Business to Business Products Group customers include: processors and refiners of edible oils, petroleum-based oils and biodiesel fuel; manufacturers of animal feed and agricultural chemicals; distributors of animal health and nutrition products; and marketers of consumer products. Our operating segments are also our reportable segments. The accounting policies of the segments are the same as those described in Note 1 of the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022.

We do not rely on any segment asset allocations and we do not consider them meaningful because of the shared nature of our production facilities; however, we have estimated the segment asset allocations below for those assets for which we can reasonably determine. The unallocated asset category is the remainder of our total assets. The asset allocation is estimated and is not a measure used by our chief operating decision maker about allocating resources to the operating segments or in assessing their performance. 

Net sales and operating income for each segment are provided below. The corporate expenses line includes certain unallocated expenses, including primarily salaries, wages and benefits, purchased services, rent, utilities and depreciation and amortization associated with corporate functions such as research and development, information systems, finance, legal, human resources and customer service. Corporate expenses also include the estimated annual incentive plan bonus accrual for employees. In addition, Income from our Business to Business and Retail and Wholesale Products as well as Corporate Expenses for the three months ended October 31, 2021 were adjusted for a change in management organization. See Note 1 of the Notes to the unaudited Condensed Consolidated Financial Statements.

The Oil-Dri Corporation of America 2006 Long Term Incentive Plan, as amended (the “2006 Plan”), permits the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards and other stock-based and cash-based awards. Our employees and outside directors are eligible to receive grants under the 2006 Plan. The total number of shares of stock subject to grants under the 2006 Plan may not exceed 1,219,500. As of October 31, 2022, there were 239,985 shares available for future grants under this plan.

There were 40,000 and 75,000 restricted shares of Common Stock granted during the first quarter of fiscal years 2023 and 2022, respectively. Stock-based compensation expense was $0.8 million and $0.6 million for the first quarter of fiscal years 2023 and 2022, respectively.

The following table summarizes the changes in accumulated other comprehensive (loss) income by component as of October 31, 2022 (in thousands):

One member of our Board of Directors (the “Board”) retired from the role of President and Chief Executive Officer of a customer of ours in September 2019 and is currently party to a post-employment agreement with the customer. Total net sales to that customer, including sales to subsidiaries of that customer, were $55,158 and $75,296 for the first quarter of fiscal years 2023 and 2022 respectively. Outstanding accounts receivable from that customer, and its subsidiaries, were $863 as of October 31, 2022 and $5,608 as of July 31, 2022.

One member of our Board is currently the President and Chief Executive Officer of a vendor of ours. Total payments to this vendor for fees and cost reimbursements were $62,360 and $215,418 for the first quarter of fiscal years 2022 and 2021 respectively . There were no outstanding accounts payable to that vendor as of October 31, 2022 or July 31, 2022.

We develop, mine, manufacture and market sorbent products principally produced from clay minerals, primarily consisting of calcium bentonite, attapulgite and diatomaceous shale. Our principal products include agricultural and horticultural chemical carriers, animal health and nutrition products, cat litter, fluid purification and filtration bleaching clays, industrial and automotive floor absorbents and sports field products. Our products are sold to two primary customer groups, including customers who resell our products as originally produced to the end consumer and other customers who use our products as part of their production process or use them as an ingredient in their final finished product. We have two reportable operating segments based on the different characteristics of our two primary customer groups: the Retail and Wholesale Products Group and the Business to Business Products Group, as described in Note 11 of the Notes to the unaudited Condensed Consolidated Financial Statements. Each operating segment is discussed individually below.

Consolidated net sales and gross profits for the first quarter of fiscal 2023 across both the Retail and Wholesale Products Group and the Business to Business Products Group were up from the same period of fiscal year 2022. Although expenses increased, consolidated net income for the three months ended October 31, 2022 was $5.2 million, compared to $0.6 million in the three months ended October 31, 2021.

Consolidated net sales increased approximately $16.0 million or 19% in the first quarter of fiscal year 2023 compared to first quarter of fiscal year 2022. Consolidated income from operations in the first quarter of fiscal year 2023 increased by $6.1 million compared to the first quarter of fiscal year 2022. This increase is driven by strategic pricing increases as well as growth in the demand for our products, as further discussed below.

Our Consolidated Balance Sheets as of October 31, 2022, and our Consolidated Statements of Cash Flows for the first quarter of fiscal year 2023 show a decrease in total cash and cash equivalents from fiscal year-end 2022 driven by higher inventories and capital expenditures on PP&E.

CONSOLIDATED RESULTS

Consolidated net sales for the three months ended October 31, 2022 were $98.5 million, a 19% increase compared to net sales of $82.5 million for the three months ended October 31, 2021. Net sales increased for both our Retail and Wholesale Products Group and Business to Business Products Group, primarily due to price increases implemented across both product groups.

In the first three months of fiscal year 2023, we have been able to reduce our backlog of orders. The actions taken to increase personnel, expand our production shifts, increase production equipment, make various repairs to equipment, and utilize alternative modes of transportation have driven a reduction of our backlog by $1.1 million, a 17% decrease from July 31, 2022. Furthermore, export tonnages shipped for the first three months of fiscal year 2023 exceeded all quarters in fiscal years 2022 and 2021. We continue to implement strategies related to further reduce manufacturing and freight constraints in order to meet the increase in customer demand. Segment results are discussed further below.

Consolidated gross profit for the first three months of fiscal year 2023 was $22.3 million, or 23% of net sales, compared to $13.8 million, or 17%, of net sales, for the first three months of fiscal year 2022. The increase is driven by higher selling prices, with multiple price increases across our businesses, which are beginning to offset the increases in costs of goods sold. Costs of goods sold continued to rise, driven primarily by per ton increases in natural gas, non-fuel manufacturing and freight costs, offset by lower packaging costs. The cost of natural gas per ton used to operate kilns that dry our clay was 97% higher in the first three months of fiscal year 2023 compared to first three months of fiscal year 2022. There was also a 15% increase in per ton non-fuel manufacturing costs during the first three months of fiscal year 2023 compared to the first three months of fiscal year 2022, due to higher costs for labor, purchased materials, repairs, utilities, electricity, and diesel. Domestic freight costs per ton increased approximately 21% in the first three months of fiscal year 2023 compared to the same period of fiscal year 2022. Ocean freight costs have also increased due to rising fuel costs and export fees. In addition, our overall freight costs can vary between periods depending on the mix of products sold and the geographic distribution of our customers. Packaging costs per ton decreased by approximately 8% in the first three months of fiscal year 2023 compared to the first three months of fiscal year 2023 due to lower commodity costs, particularly as it relates to resin and pallet costs. Many of our contracts for packaging purchases are subject to periodic price adjustments, which trail changes in underlying commodity prices.

Total other (expense) income, net of $(0.1) million for the first three months of fiscal year 2023 was mostly driven by foreign currency translations compared to the net other income of $0.3 million in the first three months of fiscal year 2022.

Consolidated net income before taxes for the first three months of fiscal year 2023 was $6.4 million compared to $0.7 million for the first three months of fiscal year 2022. Results for the first three months of fiscal year 2023 were driven by the factors discussed above.

We had a tax expense for the first three months of fiscal year 2023 of $1.2 million compared to $0.1 million for the first three months of fiscal year 2022. Our tax expense was driven primarily by higher net income. We used an estimated annual effective tax rate (“ETR”) in determining our provision for income taxes, which is based on expected annual taxable income and the assessment of various tax deductions, including depletion.

BUSINESS TO BUSINESS PRODUCTS GROUP

Net sales of the Business to Business Products Group for the first three months of fiscal year 2023 were $33.7 million, an increase of $8.9 million, or 36%, from net sales of $24.8 million for the first three months of fiscal year 2022, with strong increases across all three of our businesses in this group. Net sales of our agricultural and horticultural chemical carrier products increased approximately $3.8 million, or 61%, for the first three months of fiscal year 2023 compared to the same period in fiscal year 2022. This is a result of price increases as well as strong demand from several large customers. Net sales of our fluids purification products increased approximately $3.2 million, or 21%, compared to the first three months of the prior fiscal year. The increase in net sales was driven by price increases and continued demand for our products used in the filtration of edible oil, renewable diesel, and jet fuel. Net sales increased in all regions except for the UK, with the majority of the increase in North America and Latin America when compared to the first three months of fiscal year 2022. Net sales of our animal health and nutrition products increased $1.9 million, or 52%, during the first three months of fiscal year 2023 compared to the first three months of the prior year. We saw growth in net sales in all regions except Asia (excluding China) with the most impact coming from Latin America. Latin American sales continued to benefit from the European Union's ("EU") regulations for antibiotic-free foreign protein imports, as a large percentage of meat is exported from that region to the EU. North American sales rose due to a new product line and increased distribution. The decrease in Asia is due to timing and ocean freight delays and not indicative of projected sales for the year.

SG&A expenses for the Business to Business Products Group increased approximately 24% or $0.8 million for the first three months of fiscal year 2023 compared to the same period of the prior fiscal year. The majority of the increase relates to research and development expenses that are now allocated to the animal health business (a change in where existing costs were allocated), previously included in unallocated corporate expenses and increased travel costs.

The Business to Business Products Group’s operating income for the first three months of fiscal year 2023 was $7.3 million, an increase of $1.8 million, or 31%, from operating income of $5.5 million for the first three months of fiscal year 2022. The increase in operating income was driven by higher net sales due to strategic price increases and continued volume growth.

RETAIL AND WHOLESALE PRODUCTS GROUP

Net sales of the Retail and Wholesale Products Group for the first three months of fiscal year 2023 were $64.9 million, an increase of $7.2 million, or 12%, from net sales of $57.7 million for the first three months of fiscal year 2022 driven by higher net sales of cat litter, industrial and sport products, slightly offset by a small decline in our co-packaged cat litter business. Total cat litter net sales were approximately $5.7 million, or 12%, higher compared to the first three months of the prior fiscal year driven mostly by price increases. Domestic cat litter net sales were $46.8 million an increase of $5.2 million from the first three months of fiscal year 2022 driven primarily by price increases on branded and private label lightweight and coarse litter partially offset by a decrease in net sales of accessories (liners) and private label heavy weight litter. Net sales of co-packaged products decreased by approximately $0.3 million compared to the same period in fiscal year 2022. This decrease was primarily due to our customer discontinuing export sales to one of their foreign subsidiaries as well as softer sales volumes domestically. Net sales of cat litter by our subsidiary in Canada increased period over period, as discussed in “Foreign Operations” below. Net sales of our global industrial and sports products increased approximately $1.5 million, or 17%, compared to the first three months of fiscal year 2022, primarily due to price increases across both industrial and sport products.

SG&A expenses for the Retail and Wholesale Products Group were lower by approximately $0.4 million, or 10%, during the first three months of fiscal year 2023 compared to the first three months of fiscal year 2022, primarily due to significantly lower advertising costs partially offset by higher broker sales commissions which are percentage based on net sales, as well as higher travel costs. We anticipate total advertising expense in fiscal year 2023 to be higher than fiscal year 2022 and more in line with historical levels, with spending concentrated in the second half of the year.

The Retail and Wholesale Products Group experienced an operating income for the first three months of fiscal year 2023 of $7.6 million, an increase of $6.3 million, or 491%, from operating income of $1.3 million for the first three months of fiscal year 2022. This was driven primarily by the increase in gross margins due to selling price increases partially offset by higher costs of goods sold, and to a much lesser extent lower than expected advertising spend in the first quarter.

FOREIGN OPERATIONS

Foreign operations include our subsidiary in Canada which is reported in the Retail and Wholesale Products Group, and our subsidiaries in the UK, Mexico, China and Indonesia, which are reported in the Business to Business Products Group. Net sales by our foreign subsidiaries during the first three months of fiscal year 2023 were $5.8 million, an increase of $1.4 million, or 32%, compared to net sales of $4.4 million during the first three months of fiscal year 2022. All of our foreign operations, with the exception of our subsidiary in the UK, experienced an increase in net sales during the first three months of fiscal year 2023 compared to fiscal year 2022. Total net sales of our subsidiary in Canada during the first three months of fiscal year 2022 increased by $0.8 million, or 29%, compared to the same period in fiscal year 2022 driven by higher private label cat litter net sales. The increase in cat litter sales was mainly driven by price increases instituted in response to rising costs and to a lesser extent by increases in demand. Net sales of industrial absorbent granules were also higher in the first three months of fiscal year 2022 driven mainly by price increases. Net sales of our subsidiary in the United Kingdom in the first three months of fiscal year 2023 decreased by $47 thousand, or 9%, compared to net sales in the first three months of fiscal year 2022. The decrease relates to the impact of foreign currency in addition to softer sales. Net sales of our subsidiary in Mexico increased during the first three months of fiscal year 2022 compared to the same period of fiscal year 2022 by $0.2 million, or 38% due to growing demand of our animal health products. Net sales of our subsidiary in China increased $0.3 million, or 63%, during the first three months of fiscal year 2023 compared to the first three months of fiscal year 2022 due primarily to the addition of a new customer. Net sales by our foreign subsidiaries represented 6% and 5% of our consolidated net sales during the first three months of fiscal years 2023 and 2022, respectively.

Our foreign subsidiaries reported net income of $0.5 million for the first three months of fiscal year 2023, compared to a net loss of $0.3 million for the first three months of fiscal year 2022. The net income in the first three months of fiscal year 2023 was driven by price increases in Canada on our cat litter products, and increased demand in China and Mexico offset by unfavorable impacts of foreign exchange rates primarily in the UK.

Identifiable assets of our foreign subsidiaries as of October 31, 2022, were $17.7 million, compared to $17.4 million as of July 31, 2022.

Our principal liquidity needs are to fund our capital requirements, including funding working capital needs; purchasing and upgrading equipment, facilities (including significant renovations at one of our plants), information systems, and real estate; supporting new product development; investing in infrastructure; repurchasing stock; paying dividends; making pension contributions; and, from time to time, business acquisitions, and funding our debt service requirements. During the first three months of fiscal year 2023, we principally funded these short and long-term capital requirements using cash from current operations as well as cash generated in fiscal year 2022 from borrowings under our Series Senior C Notes.

The following table sets forth certain elements of our unaudited Condensed Consolidated Statements of Cash Flows (in thousands):

In addition to net income, as adjusted for depreciation and amortization and other non-cash operating activities, the primary sources and uses of operating cash flows for the first three months of fiscal years 2023 and 2022 were as follows:

Accounts receivable, less allowance for doubtful accounts, increased $1.6 million in the first three months of fiscal year 2023 compared to an increase of $2.3 million in the first three months of fiscal year 2022. The increase in accounts receivable was driven primarily by higher net sales as sales prices increased offset by the level and timing of collections due to payment terms.

Inventory increased by $5.1 million in the first three months of both fiscal year 2023 and 2022 due to a combination of rising costs, specifically due to natural gas, purchased materials, electricity, diesel, and freight and the building of inventory levels for anticipated seasonal demand and thwart potential supply chain disruptions.

Other assets decreased by $1.4 million in the first three months of fiscal year 2023 compared to a decrease of $0.2 million in the first three months of fiscal year 2022. The decrease in other assets in the first three months of fiscal year 2023 relates to capitalized pre-production costs being transferred to property, plant and equipment as the mines are now in production.

Accounts payable increased by $1.9 million in the first three months of fiscal year 2023 compared to an increase of $1.3 million in the first three months of fiscal year 2022. Trade and freight payables vary in both periods due to the timing of payments, higher cost of goods and services we purchased, production volume levels and vendor payment terms.

Accrued expenses decreased $1.6 million in the first three months of fiscal year 2023 compared to an increase of $0.7 million in the first three months of fiscal year 2022. The payout of the prior fiscal year's bonus reduced accrued salaries in both fiscal years, but to a greater extent in fiscal year 2023 as the accrual was higher at year end 2022 than the prior fiscal year. The decrease in accrued expenses is also impacted by the decrease in advertising expenses and other accruals. The decrease in accrued bonus in the first three months of fiscal year 2022 was offset by an increase in accrued advertising, real estate taxes, professional fees and accrued utilities. These accruals can vary based on timing. In addition, accrued plant expenses can also fluctuate due to timing of payments, changes in the cost of goods and services we purchase, production volume levels and vendor payment terms.

Other liabilities decreased by $0.4 million in the first three months of fiscal year 2023 compared to a decrease of $0.5 million in the first three months of fiscal year 2022. The decreases in both fiscal years 2022 and 2023 relate primarily to a reduction in our operating lease liability.

Cash used in investing activities of $7.5 million in the first three months of fiscal year 2023 were higher compared to cash used in investing activities of $6.7 million in the first three months of fiscal year 2022 driven by capital expenditures. During the first three months of fiscal year 2023 we expanded our plant equipment and improved our facilities to support increased demand for our products as well as made improvements to our IT network.

Cash used in financing activities of $1.9 million in the first three months of fiscal year 2023 was lower than cash used in financing activities of $4.2 million in the first three months of fiscal year 2022 driven by less share repurchases.

Total cash and investment balances held by our foreign subsidiaries of $2.6 million as of October 31, 2022 were slightly lower than July 31, 2022 balances of $3.3 million. See further discussion in “Foreign Operations” above.

We are party to a credit agreement (as amended, the “Credit Agreement”) with BMO Harris Bank N.A. (“BMO Harris”), which terminates on August 30, 2027. The agreement provides for a $45 million unsecured revolving credit facility and a maximum of $10 million for letters of credit. The agreement terms also state that we may select a variable interest rate based on either the BMO Harris prime rate or an adjusted SOFR-based rate, plus a margin that varies depending on our debt to earnings ratio, or a fixed rate as agreed between us and BMO Harris. As of October 31, 2022, the variable rates would have been 6.25% for the BMO Harris prime-based rate or 4.10% for the adjusted SOFR-based rate. The Credit Agreement contains restrictive covenants that, among other things and under various conditions, limit our ability to incur additional indebtedness or to dispose of assets. The agreement also requires us to maintain a minimum fixed charge coverage ratio and a maximum net debt to earnings ratio. As of October 31, 2022 and 2021, we were in compliance with the covenants. There were no borrowings during the first three months of either fiscal year 2022 or 2023.

We are party to an Amended and Restated Note Purchase and Private Shelf Agreement (as amended, the “Note Agreement”) with PGIM, Inc. (“Prudential”) and certain existing noteholders and purchasers affiliated with Prudential named therein pursuant to which, among other things, we issued $10 million in aggregate principal amount of our 3.95% Series B Senior Notes due May 15, 2030 of which $8 million aggregate principal amount remained outstanding as of October 31, 2022. The Note Agreement provides us with the ability to request, from time to time until May 15, 2023 (or such earlier date as provided for in the agreement), the issuance of additional senior unsecured notes in an aggregate principal amount of up to $75 million minus the aggregate principal amount of the notes then outstanding and the additional notes that have been accepted for purchase. The issuance of such additional notes is at the discretion of the noteholders and purchasers and on an uncommitted basis. Pursuant to the Note Agreement, on December 16, 2021, we issued $25 million in aggregate principal amount of our 3.25% Series C Senior Notes due December 16, 2031. As of October 31, 2022 outstanding notes payable totaled $32.8 million, net of $0.2 million of unamortized debt issuance costs.

See Note 8 of the Notes to the unaudited Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for discussion on amendments made to the credit agreement with BMO Harris and our Senior Note Agreements.

As of October 31, 2022, we had remaining authority to repurchase 433,166 shares of Common Stock and 273,100 shares of Class B Stock under a repurchase plan approved by our Board of Directors (the “Board”). Repurchases may be made on the open market (pursuant to Rule 10b5-1 plans or otherwise) or in negotiated transactions. The timing, number and manner of share repurchases will be determined by our management pursuant to the repurchase plan approved by our Board.

We believe that cash flow from operations, availability under our revolving credit facility, current cash and investment balances and our ability to obtain other financing, if necessary, will provide sufficient liquidity for foreseeable working capital needs, capital expenditures at existing facilities, deferred compensation payouts, dividend payments and debt service obligations for at least the next 12 months. We expect capital expenditures in fiscal year 2023 to be greater than in fiscal year 2022. We do not believe that these increased capital expenditures will dramatically impact our cash position; however our cash requirements are subject to change as business conditions warrant and opportunities arise. Our anticipated advertising expense for fiscal year 2023 is expected to be higher compared to fiscal year 2022 and in line with historical pre-pandemic levels.

We continually evaluate our liquidity position and anticipated cash needs, as well as the financing options available to obtain additional cash reserves. Our ability to fund operations, to make planned capital expenditures, to make scheduled debt payments, to contribute to our pension plan and to remain in compliance with all financial covenants under debt agreements, including, but not limited to, the current credit agreement, depends on our future operating performance, which, in turn, is subject to prevailing economic conditions and to financial, business and other factors. The timing and size of any new business ventures or acquisitions that we complete may also impact our cash requirements.

This discussion and analysis of financial condition and results of operations is based on our unaudited Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP for interim financial information and in compliance with instructions to Form 10-Q and Article 10 of Regulation S-X. The preparation of these financial statements requires the use of estimates and assumptions related to the reporting of assets, liabilities, revenues, expenses and related disclosures. In preparing these financial statements, we have made our best estimates and judgments of certain amounts included in the financial statements. Estimates and assumptions are revised periodically. Actual results could differ from these estimates. See the information concerning our critical accounting policies included under “Management’s Discussion of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended July 31, 2022.

Management conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Quarterly Report on Form 10-Q. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”). Based upon the controls evaluation, our CEO and CFO have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that such information is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

We have not experienced any material impact to our internal controls over financial reporting despite the fact that many of our employees are still working remotely. We are continually monitoring and assessing the effects of a hybrid work model on our internal controls to minimize the impact to their design and operating effectiveness.

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter ended October 31, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our management, including the CEO and CFO, do not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

Items 1, 3 and 5 of this Part II are either inapplicable or are answered in the negative and are omitted pursuant to the instructions to Part II.

During the three months ended October 31, 2022, we did not sell any securities which were not registered under the Securities Act of 1933. The following chart summarize our Common Stock and Class B stock purchases during this period. There are no shares of our Class A Common Stock currently outstanding.

Our mining operations are subject to regulation by the Mine Safety and Health Administration under authority of the Federal Mine Safety and Health Act of 1977, as amended. Information concerning mine safety violations or other regulatory matters required by section 1503(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act and Item 104 of Regulation S-K is included in Exhibit 95 to this Quarterly Report on Form 10-Q.

OIL-DRI CORPORATION OF AMERICA

Dated:  December 6, 2022