Chalk it up to the temporary (?) bear market we've been traveling through these past few days, but I expected investors to treat Oil-Dri (NYSE:ODC) better.

The nation's largest manufacturer of kitty litter -- and so many other absorbent products -- reported its fiscal Q2 and first-half 2007 earnings last week. With the exception of a clump or two in the neighborhood of business-to-business sales, this litter box looked clean through and through. Despite quarterly sales sliding 2%, the firm continued reinflating its margins, with the result that profits came in 8% stronger this year than last. For the first half, the disparity was even more striking; sales grew a mere 3%, but net income grew a remarkable 25%.

Cash flow corner
So much for the GAAP results. As longtime Fool readers know, I'm much more interested in how much actual cash profit a company produces than in its "accounting profits." In this regard, you'll recall that last quarter, I wasn't entirely pleased with the firm's negative free cash flow for Q1. Nor was I entirely concerned, however, given Oil-Dri's propensity for making up first-quarter cash flow deficits in the second quarter. Luckily for its investors, old habits die hard.

In Q2, Oil-Dri did indeed reverse its cash outflows, and much in the manner I had hoped for. Inventories, which had been rising faster than sales in the past, declined faster than sales this time around -- down 7%. Similarly with accounts receivable, which fell 5% as the firm collected on its bills and put the cash in the bank.

How much cash, you ask? Year to date, $3 million in free cash flow -- a striking turnaround from the negative $4.1 million that the firm had racked up by this time last year. Relative to its much larger rivals, Amcol International (NYSE:ACO) and Church & Dwight (NYSE:CHD), that performance is less impressive; it doesn't hold a candle to the latter's $132 million generated over the last six months. But it compares quite favorably to the $5 million Amcol generated in all of last year -- on three times greater revenues.

More objectively, I'm tempted to take Oil-Dri's $3 million in first-half free cash flow, multiply it by two, and argue that with an annual run rate of $6 million, the firm still looks pretty pricey selling at 20 times free cash flow, with a return on equity still in the single digits. But the fact of the matter is that Oil-Dri's free cash flow is so lumpy, there's really no telling how good it will look in any given quarter -- quarters three and four of this current fiscal year included. It could do better; it could do worse than $6 million by year-end. The best advice I can give you, therefore, is to heed the words of the CEO: "We are optimistic about our financial results as we head into the final two quarters of our fiscal year ... [but] there are obvious challenges we face to recover some of the lost sales momentum we experienced in the second quarter."

Proceed with caution.

What did we expect out of Oil-Dri last quarter, and what did we get? Find out in:

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Fool contributor Rich Smith does not own shares of any company named above. The Fool's disclosure policy absorbs worries and cares.