UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 1, 2004
Commission file Number 1-10585
CHURCH & DWIGHT CO., INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
Registrant’s telephone number, including area code: (609) 683-5900
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes x No ¨
As of November 5, 2004, there were 62,379,765 shares of Common Stock outstanding.
TABLE OF CONTENTS
ITEM
1.
2.
3.
4.
6.
2
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CHURCH & DWIGHT CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(Unaudited)
(Dollars in thousands, except per share data)
Net Sales
Cost of sales
Gross Profit
Marketing expense
Selling, general and administrative expenses
Income from Operations
Equity in earnings of affiliates
Investment earnings
Loss on early extinguishment of debt
Other income (expense), net
Interest expense
Income before taxes and minority interest
Income taxes
Minority interest
Net Income
Retained earnings at beginning of period
Dividends paid
Retained earnings at end of period
Weighted average shares outstanding - Basic
Weighted average shares outstanding - Diluted
Earnings Per Share:
Net income per share - Basic
Net income per share - Diluted
Dividends Per Share
See Notes to Condensed Consolidated Financial Statements.
3
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
Assets
Current Assets
Cash and cash equivalents
Accounts receivable, less allowances of $3,176 and $1,969
Inventories
Deferred income taxes
Note receivable – current
Net assets held for sale
Prepaid expenses
Total Current Assets
Property, Plant and Equipment (Net)
Note Receivable
Equity Investment in Affiliates
Long-term Supply Contracts
Tradenames and Other Intangibles
Goodwill
Other Assets
Total Assets
Liabilities and Stockholders’ Equity
Current Liabilities
Short-term borrowings
Accounts payable and accrued expenses
Current portion of long-term debt
Income taxes payable
Total current liabilities
Long-term Debt
Deferred Income Taxes
Deferred and Other Long Term Liabilities
Postretirement and Postemployment Benefits
Minority Interest
Commitments and Contingencies
Stockholders’ Equity
Preferred Stock-$1.00 par valueAuthorized 2,500,000 shares, none issued
Common Stock-$1.00 par valueAuthorized 100,000,000 shares, issued 69,991,482 shares
Additional paid-in capital
Retained earnings
Accumulated other comprehensive (loss)
Common stock in treasury, at cost:
7,637,954 shares in 2004 and 8,812,445 shares in 2003
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW
Cash Flow From Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, depletion and amortization
Plant impairment charge and other asset write-offs
Net loss on early extinguishment of debt
Other
Change in assets and liabilities:
Decrease in accounts receivable
(Increase) decrease in inventories
Decrease in prepaid expenses
Increase (decrease) in accounts payable
Increase in income taxes payable
Decrease in other liabilities
Net Cash Provided By Operating Activities
Cash Flow From Investing Activities
Additions to property, plant and equipment
Armkel acquisition (net of cash acquired)
Proceeds from note receivable
Distributions from affiliates
Contingent acquisition payments
Other long-term assets
Proceeds from sale of fixed assets
Net Cash Used In Investing Activities
Cash Flow From Financing Activities
Long-term debt borrowing
Long-term debt (repayment)
Short-term debt borrowing
Short-term debt (repayment)
Proceeds from stock options exercised
Payment of cash dividends
Deferred financing costs
Net Cash Provided by (Used In) Financing Activities
Effect of exchange rate changes on cash and cash equivalents
Net Change In Cash and Cash Equivalents
Cash And Cash Equivalents At Beginning Of Year
Cash And Cash Equivalents At End Of Period
Acquisitions in which liabilities were assumed are as follows:
Fair value of assets
Cash paid and investment in and receivable from Armkel
Liabilities assumed
5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The consolidated balance sheet as of October 1, 2004, the consolidated statements of income and retained earnings for the three and nine months ended October 1, 2004 and September 26, 2003 and the consolidated statements of cash flow for the nine months then ended have been prepared by the Company without audit. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and cash flow at October 1, 2004 and for all periods presented have been made.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2003. The results of operations for the period ended October 1, 2004 are not necessarily indicative of the operating results for the full year.
On May 28, 2004, the Company completed the previously announced purchase of the remaining 50% ownership interest of Armkel, LLC (“Armkel”) from affiliates of Kelso & Company (“Kelso interest”) for a purchase price of $253.7 million plus fees and Armkel was merged into the Company. Results of operations for the business are included in the Company’s consolidated financial statements from May 29, 2004.
Quarterly periods are based on a 4-4-5 methodology. As a result, the first quarter can include a partial or expanded week in the first four week period of the quarter. Similarly, the last five week period in the fourth quarter could be a partial or expanded week.
2. Inventories consist of the following:
(In thousands)
Raw materials and supplies
Work in process
Finished goods
3. Property, Plant and Equipment consist of the following:
Land
Buildings and improvements
Machinery and equipment
Office equipment and other assets
Software
Mineral rights
Construction in progress
Less accumulated depreciation, depletion and amortization
Net Property, Plant and Equipment
In the second quarter of 2004 the Company recorded a plant impairment charge of $1.5 million, which was recorded as cost of sales in the Consumer Domestic segment, as the value could not be supported by projected cash flows.
6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. Earnings Per Share
Basic EPS is calculated based on income available to common shareholders and the weighted-average number of shares outstanding during the reported period. Diluted EPS includes additional dilution from potential common stock issuable pursuant to the exercise of stock options outstanding. The weighted average number of common shares outstanding used to calculate Basic EPS is reconciled to those shares used in calculating Diluted EPS as follows:
Basic
Dilutive effect of stock options
Diluted
Anti-dilutive stock options outstanding
On August 6, 2004 the Company announced a 3 for 2 stock split. The shares resulting from the stock split were distributed on September 1, 2004 to stockholders of record at the close of business on August 16, 2004. All share and per share information in this report reflects the impact of the stock split.
In August 2003, the Company issued $100 million of 5.25% convertible senior debentures that may be converted into shares of the Company’s common stock prior to maturity at a conversion price of approximately $31.00 per share, subject to adjustment in certain circumstances. Because of the inclusion of a contingent convertibility feature of the debentures, the Company’s diluted net income per common share does not give effect to the dilution from the conversion of the debentures until the Company’s share price exceeds 120% of the initial conversion price or the occurrence of other specified events.
The Emerging Issues Task Force (EITF) concluded in EITF Issue 04-8: The Effect of Contingently Convertible Debt on Diluted Earnings per Share that contingently convertible debt (“Co-Cos”) be treated for diluted EPS purposes as if converted from debt to equity, beginning with the date the contingently convertible debt instrument is initially issued, even if the triggering events (such as stock price) have not yet occurred. The effective date would be reporting periods ending on or after December 15, 2004 and prior period EPS amounts presented for comparative purposes, would have to be restated.
The change in accounting rules for reporting Co-Cos will have an estimated $0.02 dilutive effect on earnings per share in 2004.
5. Stock-Based Compensation
The Company accounts for costs of stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees”, rather than the fair-value based method in Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation”. In connection with purchasing Kelso’s interest in Armkel, the Company paid cash and issued options to purchase 97,500 shares of Company common stock at an exercise price of $22.88 per share to certain executives under the Equity Appreciation Rights Plan (“EAR Plan”). The unvested portion of the EAR Plan options is being amortized over a two year vesting period and is recognized as expense as vesting occurs. In 2004, the amount recognized as expense for the stock options granted under the EAR Plan was $0.17 million for the third quarter and was $0.23 million for the nine months ended October 1, 2004.
During 2004, options to purchase approximately 900 thousand shares of Company common stock were granted at an average fair value of $10.58 per share.
The Company’s pro forma net income and pro forma net income per share for the third quarter of 2004 and 2003, determined as if the Company had adopted the fair value method of SFAS 123, are as follows:
(In thousands, except for per share data)
As reported
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects
Pro forma
Net Income per Share: basic
Net Income per Share: diluted
7
6. Segment Information
As a result of purchasing the Kelso interest, the Company has redefined its operating segments. These segments are based on differences in the nature of products and organizational and ownership structures. Specifically, the Company has identified the following segments: Consumer Domestic, Consumer International, and Specialty Products Division (“SPD”).
Segment revenues are derived from the sale of the following products:
Segment
Products
Consumer Domestic
Consumer International
SPD
The domestic results of the acquired Armkel business since May 29, 2004 are included in the Consumer Domestic segment and Armkel’s former international subsidiaries (in addition to the Company’s existing international consumer subsidiary) comprise the Consumer International segment. There has been no change to the SPD segment. The Company’s earnings, prior to its acquisition of Kelso’s interest in Armkel, attributable to the Company’s equity investment in Armkel’s domestic and international operations are included in Income Before Taxes and Minority Interest of the Consumer Domestic and Consumer International segments, respectively. The Company’s earnings attributable to its equity investment in Armand Products and The Armakleen Company are included in Income Before Taxes and Minority Interest of the Corporate segment. Prior to purchasing Kelso’s interest in Armkel, the Company’s segments were: Church & Dwight Consumer, Armkel, Church & Dwight SPD, and Other Equity Affiliates. All prior periods have been conformed to the new segment presentation.
Segment sales and income before taxes and minority interest for the third quarter and nine month periods of 2004 and 2003 and total segment assets as of October 1, 2004 and December 31, 2003 are as follows:
(in thousands)
Third Quarter 2004
Third Quarter 2003
2004 Year to Date
2003 Year to Date
Income Before Taxes and Minority Interest (1)
October 1, 2004
December 31, 2003
The Company’s net sales and total assets changed significantly since December 31, 2003 as a result of the consolidation of the operations and the assets associated with the former Armkel business.
The following table shows product line revenues from external customers for the three and nine months ended October 1, 2004 and September 26, 2003:
Deodorizing Products
Laundry Products
Personal Care Products
Total Consumer Domestic
Total Consumer International
Total SPD
Total Consolidated Net Sales
8
7. Supplemental Financial Information of Guarantor and Non-Guarantor Operations
The 9 1/2 % senior subordinated notes due 2009 assumed by the Company as a result of Armkel’s merger into the Company are fully and unconditionally guaranteed by Church & Dwight Co., Inc. and certain domestic subsidiaries of the Company on a joint and several basis.
Supplemental information for condensed consolidated balance sheets at October 1, 2004 and December 31, 2003, condensed consolidated income statements for the three and nine months ended October 1, 2004 and September 26, 2003, and condensed consolidated statements of cash flows for the nine-month periods ended October 1, 2004 and September 26, 2003 is summarized as follows (amounts in thousands):
Statements of Income
For The Three Months Ended
Guarantor
Subsidiaries
Non-
Total
Consolidated
Net sales
Gross profit
Operating expenses
Income from operations
Intercompany income (expense)
Other income (expense)
Income before taxes
September 26, 2003
9
For The Nine Months Ended
10
Consolidated Balance Sheet
Accounts receivable (net of allowances)
Notes Receivable
Intercompany accounts
Total Current Liabilities
Notes Payable
Deferred and Other Long-term Liabilities
Common Stock
Common stock in treasury, at cost
11
12
Statements of Cash Flows
Cash Flow From Operating Activities:
Plant Impairment charge and other net asset write-offs
Decrease (increase) in accounts receivable
Decrease (increase) in inventories
Increase in accounts payable
Increase (decrease) in income taxes payable
(Decrease) increase in intercompany and other liabilities
Net Cash Provided by (Used in) Operating Activities
Cash Flow From Investing Activities:
Additions to property, plant & equipment
Net Cash Used in Investing Activities
Cash Flow from Financing Activities:
Intercompany debt transactions
Net Cash Provided by Financing Activities
Net Change In Cash & Cash Equivalents
Cash And Cash Equivalents At Beginning of Year
Cash And Cash Equivalents At End of Period
13
Decrease in inventories
Decrease (increase) in prepaid expenses
Decrease in accounts payable
Net Cash Provided by (Used in) Financing Activities
14
8. Armkel, LLC
On May 28, 2004, the Company completed the previously announced purchase of the remaining 50% of Armkel that it did not previously own from affiliates of Kelso for a purchase price of $253.7 million plus fees.
The Armkel acquisition was funded using available cash and by obtaining new Term A and B Loans through an amendment to the Company’s existing credit agreement. In connection with the amendment, the Company, among other things, was provided with a new Term A Loan in the amount of $100 million, and a new Term B Loan in the amount of $440 million, which were used to replace the Company’s existing credit facility of approximately $194 million, to replace Armkel’s principal credit facility of approximately $136 million and to provide $210 million to fund a portion of the purchase price for the transaction. The new Term B Loan has essentially the same terms as the replaced loans, but with more favorable interest rate provisions. Results of operations for the business are included in the Company’s consolidated financial statements from May 29, 2004.
Pro forma comparative net sales, net income and basic and diluted earnings per share for the nine months ended October 1, 2004 and September 26, 2003 are as follows:
Nine Months Ended
September 16, 2003
Earnings Per Share Basic
Earnings Per Share Diluted
The pro forma information gives effect to the Company’s purchase of Kelso’s interest in Armkel as if it occurred at January 1, 2003. Pro forma adjustments include the inventory step-up charge, equity appreciation rights, additional interest expense and the related income tax impact, as well as elimination of intercompany sales. In the current quarter, the reported and pro forma results are not applicable because the acquired business is included in the Company’s results.
Pro forma results of operations for the three months ended April 2, 2004, the year ended December 31, 2003 and the balance sheet as of April 2, 2004 were filed by the Company on Form 8-K on June 28, 2004.
The following table summarizes the preliminary purchase price allocation relating to purchasing Kelso’s 50% interest in Armkel. An independent appraisal is currently in process:
Property, plant and equipment
Tradenames and patents
Total Assets acquired
Current liabilities
Long-term debt
Other long-term liabilities
Net assets acquired
The following table summarizes financial information for Armkel for the periods ending prior to May 28, 2004 during which the Company accounted for its 50% interest under the equity method.
Three Months Ended
Income statement data:
Net income
Equity in affiliate’s income recorded by the Company
15
The Company invoiced Armkel $10.2 million and $19.0 million for primarily administrative and management oversight services (which is included as a reduction of selling, general and administrative expenses), and purchased $0.8 million and $1.4 million of deodorant anti-perspirant inventory produced by Armkel in the first five months of 2004 and the first nine months of 2003, respectively. The Company sold Armkel $0.7 million and $1.9 million of Arm & Hammer products to be sold in international markets in the first five months of 2004 and the first nine months of 2003, respectively. The Company had a net open receivable from Armkel at December 31, 2003 of approximately $6.7 million that primarily related to administrative services, partially offset by amounts owed for inventory.
9. Short-term borrowings and Long-Term Debt
Short-term borrowings and long-term debt consist of the following:
Syndicated Financing Loan
Term A Loan
Amount due 2004
Amount due 2005
Amount due 2006
Amount due 2007
Amount due 2008 & subsequent
Term B Loan
Convertible Debentures due on August 15, 2033
Securitization of Accounts Receivable due on January 15, 2005
Senior Subordinated Note (9 1/2%) due August 15, 2009
Discount on Senior Subordinated Note
Various Debt from Brazilian Banks$4,830 in 2004, $557 in 2005, $557 in 2006 and$205 due in 2007
Industrial Revenue Refunding BondDue in installments of $685 from 2004-2007 and $650 in 2008
Total debt
Less: current maturities
Net long-term debt
The principal payments required to be made are as follows:
2004
2005
2006
2007
2008
2009 and subsequent
16
On May 28, 2004, the Company entered into an amended and restated credit agreement (the “Credit Agreement”) with several banks and other financial institutions, The Bank of Nova Scotia, Fleet National Bank and National City Bank, each as a documentation agent, Citicorp North America, Inc., as syndication agent, and J.P. Morgan Chase Bank, as administrative agent. The Credit Agreement provides for (i) a five year term loan in a principal amount of $100 million (the “Term A Loan”), (ii) a seven year term loan in a principal amount of $440 million, which term loan may be increased by up to an additional $250 million upon the satisfaction of certain conditions (the “Term B Loan,” and together with the Term A Loan, the “Term Loans”), and (iii) a five year multi-currency revolving credit and letter of credit facility in an aggregate principal amount of up to $100 million (the “Revolving Loans”). The Term Loans were used to finance the acquisition of the remaining 50% interest in Armkel not previously owned by the Company, pay amounts outstanding under Armkel’s principal credit facility of approximately $136 million and refinance the Company’s principal credit facility of approximately $194 million. The Revolving Loans, which are currently undrawn, are available for general corporate purposes. The obligations of the Company under the Credit Agreement are secured by substantially all of the assets of the Company and certain of its domestic subsidiaries. Those domestic subsidiaries have also guaranteed the loan obligations under the Credit Agreement. The Term Loans and the Revolving Loans bear interest under one of two rate options, selected by the Company, equal to either (i) a eurocurrency rate (adjusted for any reserve requirements) (“Eurocurrency Rate”) or (ii) the greater of the prime rate, the secondary market rate for three-month certificates of deposit (adjusted for any reserve requirements) plus 1%, or the federal funds effective rate plus 0.5% (“Alternate Base Rate”), plus (b) an applicable margin. The applicable margin is determined by the Company’s then current leverage ratio. At the closing date of the Credit Agreement, the applicable margin was (a) 1.75% for the Eurocurrency Rate and (b) 0.75% for the Alternate Base Rate.
As a result of the purchase of the Kelso interest in Armkel, LLC, the Company assumed $225 million of 9.5% subordinated notes (“Notes”) that were issued on August 28, 2001 at a discount and are due in 2009, with interest paid semi-annually on February 15 and August 15. The effective yield on the Notes is approximately 9.62%. The terms of the Notes provide for an optional prepayment of principal at a premium. The issue discount is being amortized using the effective interest method. The Notes are guaranteed by the Company and certain of the Company’s domestic subsidiaries. The Notes contain various financial and non-financial covenants. In connection with the acquisition, a fair value appraisal of the notes is currently in process.
During July 2004, as a result of purchasing Kelso’s interest in Armkel, the Company amended its Accounts Receivable Securitization Agreement to increase the capacity that can be borrowed from $60 million to $100 million. The increase in borrowing was used to fund a voluntary bank debt payment on Term A Loan on August 4, 2004.
10. Goodwill, Tradenames and Other Intangible Assets
The following table discloses the carrying value of all intangible assets:
Amortized intangible assets:
Tradenames
Formulas
Non Compete Agreement
Unamortized intangible assets - Carrying value
The increase in tradenames as compared to the values at December 31, 2003 is primarily due to the inclusion of tradenames acquired in connection with the purchase of Armkel and the final valuation adjustments associated with the Unilever brands acquired in 2003.
The Armkel tradenames are currently valued at their book value as of May 28, 2004. An appraisal is currently in process.
17
The changes in the carrying amount of goodwill for the nine months ended October 1, 2004 are as follows:
Balance December 31, 2003
Tradename and fixed asset valuation adjustments
Book value of Armkel’s goodwill on day of acquisition
Additional goodwill associated with Armkel purchase
Balance October 1, 2004
Intangible amortization expense amounted to $4.8 million for the nine months of 2004 and $2.1 million for the same period of 2003. The estimated intangible amortization will be approximately $7.2 million in each of the next five years.
11. Comprehensive Income
The following table presents the Company’s Comprehensive Income for the three and nine months ended October 1, 2004 and September 26, 2003:
Other Comprehensive Income, net of tax:
Foreign exchange translation adjustments
Interest rate swap agreements
Company’s portion of Armkel’s Accumulated
Other Comprehensive Income (Loss)
Comprehensive Income
12. Investment in Del Labs Inc.
On July 2, 2004, the Company announced that it has agreed to invest $30 million in a company formed by Kelso, to acquire Del Laboratories, Inc. The Company’s investment will be substantially in the form of convertible preferred stock, and will represent about 20% of the equity financing. Kelso will provide the remaining equity, with the participation of Del’s existing management team.
As part of this transaction, the Company will have certain rights with respect to the Orajel brand, including an option to acquire the business after three years. In the event that the Company does not exercise this option, the Company will have the right, subject to certain conditions, to convert its preferred stock into a 20% interest in the common stock of the new Del company.
The Company expects the transaction to close in this year’s fourth quarter subject to regulatory, financing and other customary conditions and will use cash on hand to fund the transaction.
13. Pension Disclosure
The following table presents the net periodic benefit cost for the Company’s Pension Plan and Post-retirement Plan for the three and nine months ending October 1, 2004 and September 26, 2003.
Pension Costs
Components of Net Periodic Benefit Cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized actuarial (gain) or loss
Net periodic benefit cost
18
Post-retirement Costs
The Company estimates it will be required to make a cash contribution to its pension plans of approximately $1.5 million during 2004. The contribution is $0.8 million higher than previously estimated due to the inclusion of Armkel’s pension plan.
In January 2004, the FASB issued FASB Staff Position (FSP) No. 106-1 “Accounting and Disclosure Requirements to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the Act). The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The adoption of the provisions of FSP 106-1 in this quarter did not have a significant impact to the Company’s postretirement accumulated projected benefit obligation or net periodic benefit cost.
14. Commitments, contingencies and guarantees
Medpointe and certain former Carter-Wallace shareholders were party to an indemnification agreement pursuant to which such shareholders would be required to indemnify Medpointe from a portion of the damages suffered by Medpointe in relation to the exercise of appraisal rights by the former Carter-Wallace shareholders in the merger. Pursuant to the agreement, the shareholders agreed to indemnify Medpointe for 40% of any Appraisal Damages (defined as the recovery greater than the per share merger price times the number of shares in the appraisal class) suffered by Medpointe in relation to the merger; provided that if the total amount of Appraisal Damages exceeds $33.3 million, then the indemnifying stockholders will indemnify Medpointe for 100% of any damages suffered in excess of that amount. The Company, in turn, was party to an agreement with Medpointe pursuant to which it agreed to indemnify Medpointe and certain related parties against 60% of any Appraisal Damages for which Medpointe remains liable. The maximum liability to the Company pursuant to the indemnification agreement was $12 million.
On March 27, 2003, GAMCO Investors, Inc. filed another complaint in the New York Supreme Court seeking damages from MedPointe, the former directors of Carter-Wallace, and one of the former shareholders of Carter-Wallace. The complaint alleges breaches of fiduciary duty in connection with certain employment agreements with former Carter-Wallace executives, the sale of Carter Wallace’s consumer products business to the Company and the merger of MCC Acquisition Sub Corporation with and into Carter-Wallace. The complaint sought monetary damages and equitable relief, including among other things, invalidation of the transactions. On May 21, 2004, the court dismissed certain of the plaintiffs’ claims. The Company was not named as a defendant in this action and believed it had no liability.
On October 12, 2004, Medpointe and the plaintiffs settled both of the legal actions described above. In connection with the settlement of the legal actions, the Company entered into a settlement agreement and release with Medpointe pursuant to which, in settlement of the Company’s indemnification obligations or other claims that Medpointe may have against the Company and certain persons related to the Company, the Company agreed to pay Medpointe $8.1 million, of which $4.9 million is included in interest expense in the third quarter of 2004 and $3.2 million was applied towards goodwill as of October 1, 2004. Payment was made by the Company on October 13, 2004.
19
15. Reclassification
Certain prior year amounts have been reclassified in order to conform with the current year presentation.
20
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
Results of Operations
The discussion of results of operations at the consolidated level is followed by a more detailed discussion of results of operations by segment for the third quarter and nine month periods of 2004 compared to the third quarter and nine month periods of 2003. With the acquisition of the remaining 50% interest in Armkel that the Company did not previously own from affiliates of Kelso on May 28, 2004, and Armkel’s subsequent merger with the Company, the results of operations of the former Armkel business are consolidated in the accompanying financial statements from the date of acquisition.
Consolidated Results
Net sales for the quarter increased by $154.7 million or 58.2% to $420.3 million, as compared to $265.6 million in the previous year’s third quarter. Of the increase, $114.8 million reflects sales of products formerly owned by Armkel and now included in Company sales as a result of the acquisition of Kelso’s interest in Armkel late in the second quarter and $27.6 million reflects sales resulting from the acquisition of the former Unilever oral care business in the fourth quarter of 2003. Other increases included the reversal of prior year promotion accruals of approximately $1.3 million as a result of a change in estimate and favorable foreign exchange rates of $0.8 million (excluding the impact of the former Armkel subsidiaries). For the nine month period, net sales increased $287.0 million or 37.3% to $1,057.1 million. The primary reasons for the sales increase are the sales of products formerly owned by Armkel of $158.3 million and sales of $85.8 million resulting from the acquisition of the Unilever oral care business. Sales also increased due to favorable foreign exchange rates of $3.6 million, the reversal of the previously mentioned prior year promotion reserves of $4.3 million and the effect of six extra days in the first quarter of this year’s fiscal calendar.
Operating Costs
The Company’s gross margin in the current quarter increased to 38.2% from 30.3% in the prior year. The increase is in large part a result of the products formerly owned by Armkel and the oral care business acquired from Unilever as these products carry a higher gross profit margin than existing Company products. The margin was also impacted by the effect on the third quarter of 2004 of the Armkel acquisition related inventory step up charge of $6.2 million, and the reversal of the previously mentioned prior year promotion reserves. In addition, efficient promotion spending, and supply chain efficiencies offset commodity price increases for the quarter and new product launch costs were higher in last year’s third quarter. Gross margin for the nine month period was 35.6% as compared to 30.4% for the nine month period of 2003. The reasons for the improvement are consistent with those affecting the current quarter and includes a second quarter 2004 plant impairment charge of $1.5 million.
Marketing expenses in the current quarter increased by $28.1 million to $51.0 million as compared to the same period of 2003 primarily as a result of both the Armkel and Unilever oral care business acquisitions. Marketing expenses for the Company’s pre-existing product lines were essentially unchanged. For the nine month period, marketing expenses of $111.3 million were $45.2 million higher than in 2003 for the same reasons as referenced above, as well as an increase in advertising expenses in support of certain household deodorizing and oral care products.
Selling, general and administrative (“SG&A”) expenses in the current quarter increased $27.4 million as compared to the same period last year. This is primarily a result of costs associated with the Armkel business of approximately $18.0 million, higher broker commission costs of $1.6 million as a result of higher sales, higher compensation related costs of $3.9 million and costs to comply with certain provisions of the Sarbanes-Oxley Act of 2002 and related regulations of $1.1 million. SG&A expenses for the nine month period increased $47.1 million as compared to the same period last year. This is primarily a result of costs associated with the Armkel business of approximately $25.0 million, higher broker commission costs of $4.3 million as a result of higher sales, tradename amortization expenses associated with the acquired Unilever oral care business of $1.9 million, higher compensation related costs of $6.9 million, higher information system costs of $1.8 million and costs to comply with certain provisions of the Sarbanes-Oxley Act of 2002 and related regulations of $2.3 million.
Other Income and Expenses
The decrease in equity in earnings of affiliates of $4.0 million in the current quarter as compared to the year ago period was entirely due to the Company’s acquisition of Kelso’s interest in Armkel on May 28, 2004. The combined results of other equity investments, Armand Products Company (“Armand”) and The Armakleen Company (“Armakleen”), slightly increased. For the nine month period the decrease in equity in earnings of affiliates of $12.1 million is primarily due to the reasons noted for the third quarter. Armkel’s net income for the five months ended May 28, 2004 was reduced as a result of an international tradename impairment charge of approximately $3.2 million (net of tax). The impact to the Company was a reduction of earnings in equity of affiliates of approximately $1.6 million. Armkel’s nine month 2003 results were positively impacted by a litigation settlement, partially offset by an impairment of an asset held for sale.
21
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS (Continued)
Other income and expense in 2004 results from a gain on the sale of a warehouse by our Canadian subsidiary and in 2003 reflect foreign exchange gains by the Company’s Brazilian subsidiary.
Interest expense increased in the quarter and the nine month period as a result of interest associated with the third quarter settlement of the former Carter-Wallace shareholder appraisal suit of $4.9 million, interest associated with the assumption of the $225 million principal amount of Armkel’s 9.5% Senior Subordinated Notes, the increase in debt required to purchase Kelso’s interest in Armkel and to purchase the Unilever oral care business in late 2003, partially offset by the settlement of the Company’s remaining fixed rate interest rate swap contracts in the first quarter of 2004.
The loss on early extinguishment of debt pertained to existing deferred financing costs that were written off when the Company refinanced its bank debt.
Taxation
The effective tax rate for the nine month period was 31.5% as compared to 31.7% for the same period of last year. Last year’s tax rate reflected the settlement of a state tax dispute, offset by a higher state tax rate and taxes associated with Armkel’s sale of its Italian subsidiary, which helped to depress the tax rate. The current year rate was impacted favorably by the estimated amount of additional research and development tax credits included in recently filed and amended income tax returns.
Segment results
The domestic results of the acquired Armkel business since May 29, 2004 are included in the Consumer Domestic segment and its international subsidiaries (in addition to the Company’s existing international consumer subsidiary) comprise the Consumer International segment. There has been no change to the SPD segment. There are no material intersegment sales. The Company’s earnings, prior to its acquisition of Kelso’s interest in Armkel, attributable to the Company’s equity investment in Armkel’s domestic and international operations are included in Income Before Taxes and Minority Interest of the Consumer Domestic and Consumer International segments, respectively. The Company’s earnings attributable to its equity investment in Armand Products and the Armakleen Company are included in Income Before Taxes and Minority Interest of the Corporate segment. Prior to purchasing Kelso’s interest in Armkel, the Company’s segments were: Church & Dwight Consumer, Armkel, Church & Dwight SPD and Other Equity Affiliates.
22
Segment sales and income before taxes and minority interest for the third quarter and nine month period of 2004 and 2003 are as follows:
For the third quarter of 2004, Consumer Domestic Net Sales increased $90.7 million or 43.5% to $299.3 million. The increase includes sales of $56.0 million associated with the domestic results of the former Armkel business, $27.2 million of sales associated with the fourth quarter 2003 acquisition of the oral care brands from Unilever and the reversal of $0.9 million of prior year promotion reserves due to a change in estimate. At the product line level, sales of deodorizers were moderately higher than last year and existing personal care products were flat. Laundry consumption was also higher than last year, although shipments were flat due to the timing of promotional activities. At the brand level, sales of Arm & Hammer and Xtra liquid laundry detergent, Arm & Hammer Baking Soda and Arm & Hammer Super Scoop were all significantly higher than last year, while sales of Arm & Hammer powder laundry detergent, fabric softener and antiperspirants were lower.
For the nine month period of 2004, Consumer Domestic Net Sales increased $189.0 million or 31.2% to $794.2 million. The increase includes sales of $79.6 million associated with the domestic results of the former Armkel business, $84.1 million of sales associated with the fourth quarter 2003 acquisition of the oral care brands from Unilever and the reversal of $3.8 million of prior year promotion reserves due to a change in estimate. At the product line level, deodorizing products and laundry products net sales were higher than last year and existing personal care products decreased. At the brand level, sales of Arm & Hammer and Xtra liquid laundry detergent, Arm & Hammer Baking Soda, Arm & Hammer toothpaste and Arm & Hammer Super Scoop were higher than last year while sales of Arm & Hammer powder laundry detergent and antiperspirants were lower. The nine month period was also affected by six extra days in the first fiscal quarter of this year as compared to the first fiscal quarter of 2003.
Consumer Domestic Income before Taxes and Minority Interest for the current quarter increased $5.9 million to $28.2 million mainly due to operating results associated with the former Armkel business (despite the impact of the inventory step up charge of $4.6 million) and the contribution from the acquired Unilever brands. This increase was partially offset by higher allocated interest expense (which includes the segment’s allocation of the interest expense element of the Medpointe Settlement Agreement) and as a result of purchasing Kelso’s interest in Armkel, the elimination of earnings in equity of affiliates.
For the nine month period, Income before Taxes and Minority Interest increased $10.0 million to $82.4 million due to operating results associated with the former Armkel business (despite the impact of the inventory step up charge of $8.0 million) and the contribution from the acquired Unilever brands. This increase was partially offset by a plant impairment charge of $1.5 million, higher allocated interest expense (which includes the segment’s allocation of the interest expense element of the Medpointe Settlement Agreement), the segment’s allocation of the deferred financing cost write-off and as a result of purchasing Kelso’s interest in Armkel, a reduction of earnings in equity of affiliates.
The Company expects to significantly increase its marketing spending in the fourth quarter compared to the same period last year. In part, this increase is to support several personal care products introduced earlier in the year, including Arm & Hammer Enamel Care™ toothpaste, a patented product which combines the cleaning and whitening properties of baking soda with fluoride and liquid calcium to fill tooth surfaces and restore enamel luster; and Trojan® condoms with Warming Sensations™, a unique lubricant system which warms the skin on contact for enhanced pleasure. In addition, the increase reflects new initiatives in support of the acquired oral care products, particularly Mentadent® toothpaste and toothbrushes and Close-Up® toothpaste. On the household products side of the business, there will also be marketing spending to support the new cat litter product, Arm & Hammer Multi-Cat, designed for households with two or more cats.
23
Consumer International net sales for the current quarter as compared to the same period of last year increased $60.1 million to $69.9 million and for the nine month period increased $80.8 million to $107.8 million as a result of the inclusion of the former Armkel business results following the acquisition and the effect of favorable foreign exchange rates.
Income before Taxes and Minority Interest increased $2.2 million in the current quarter to $4.9 million and increased $4.8 million to $13.9 million for the nine month period as a result of the inclusion of the former Armkel business results since the acquisition (despite the impact of the inventory step up charge of $1.6 million in the current quarter and $2.3 for the nine month period.). This increase was partially offset by the higher interest expense and the segment’s allocation of the deferred financing cost write-off and the Medpointe settlement agreement.
Specialty Products
Specialty Products Net Sales grew $4.0 million or 8.5% to $51.1 million in the current quarter, as a result of higher sales of Animal Nutrition and Specialty Chemical products and favorable foreign exchange rates. For the nine month period, net sales increased $17.2 million or 12.4% to $155.1 million for the same reasons as are applicable to the current quarter.
Specialty Products Income before Taxes and Minority Interest increased by $0.2 million to $3.9 million primarily due to higher income associated with higher net sales, partially offset by an allocation of higher interest expense and the deferred financing write-off. For the nine month period, Income before Taxes and Minority Interest increased $1.7 million to $13.1 million. The reasons for the nine month increase are consistent with the third quarter and were also impacted by the extra shipping days in the first quarter of 2004 as compared to the first quarter of 2003.
Liquidity and Capital Resources
The Company had outstanding total debt of $901.8 million and cash of $145.4 million (of which approximately $48.0 million resides in foreign subsidiaries). This compares to total debt of $397.0 million at December 31, 2003. The reason for the increase of total debt since December 31, 2003 is due to the Company’s assumption of $225 million principal amount of Armkel’s 9.5% Senior Subordinated Notes due 2009, the Company’s assumption of Armkel’s bank debt of approximately $136 million and additional amounts borrowed in connection with the acquisition of Kelso’s interest in Armkel of approximately $254 million. The $613 million increase of debt was partially offset by debt repayments of approximately $108 million.
The Company entered into an amended and restated credit agreement (the “Credit Agreement”) with several banks and other financial institutions, The Bank of Nova Scotia, Fleet National Bank and National City Bank, each as a documentation agent, Citicorp North America, Inc., as syndication agent, and J.P. Morgan Chase Bank, as administrative agent. The Credit Agreement provides for (i) a five year term loan in a principal amount of $100 million (the “Term A Loan”), (ii) a seven year term loan in the principal amount of $440 million, which term loan may be increased by up to an additional $250 million upon the satisfaction of certain conditions (the “Term B Loan,” and together with the Term A Loan, the “Term Loans”), and (iii) a five year multi-currency revolving credit and letter of credit facility in an aggregate principal amount of up to $100 million (the “Revolving Loans”). The Term Loans were used to finance the acquisition of the remaining 50% interest in Armkel not previously owned by the Company, pay amounts outstanding under Armkel’s principal credit facility of approximately $136 million and refinance the Company’s principal credit facility of approximately $194 million. The Revolving Loans, which are currently undrawn, are available for general corporate purposes. The obligations of the Company under the Credit Agreement are secured by substantially all of the assets of the Company and certain of its domestic subsidiaries. Those domestic subsidiaries have also guaranteed the loan obligations under the Credit Agreement. The Term Loans and the Revolving Loans bear interest under one of two rate options, selected by the Company, equal to either (i) a eurocurrency rate (adjusted for any reserve requirements) (“Eurocurrency Rate”) or (ii) the greater of the prime rate, the secondary market rate for three-month certificates of deposit (adjusted for any reserve requirements) plus 1%, or the federal funds effective rate plus 0.5% (“Alternate Base Rate”), plus (b) an applicable margin. The applicable margin is determined by the Company’s current leverage ratio. At the closing date of the Credit Agreement, the applicable margin was (a) 1.75% for the Eurocurrency Rate and (b) 0.75% for the Alternate Base Rate.
The principal debt payments required to be made are as follows:
24
During July 2004, as a result of purchasing Kelso’s interest in Armkel, the Company amended its Accounts Receivable Securitization Agreement to increase the capacity that can be borrowed from $60 million to $100 million. The proceeds of the increased borrowing were used to make a voluntary Term A Loan payment on August 4, 2004.
Adjusted EBITDA is a required component of the financial covenants contained in the Company’s primary credit facility and management believes that the presentation of Adjusted EBITDA is useful to investors as a financial indicator of the Company’s ability to service its indebtedness. Adjusted EBITDA may not be comparable to similarly titled measures used by other entities and should not be considered as an alternative to cash flows from operating activities, which is determined in accordance with accounting principles generally accepted in the United States. Financial covenants include a total debt to Adjusted EBITDA leverage ratio and an interest coverage ratio, which if not met, could result in an event of default and trigger the early termination of the credit facility, if not remedied within a certain period of time. Adjusted EBITDA was approximately $180.6 million for the first 9 months of 2004. The leverage ratio (total debt to Adjusted EBITDA) for the 12 months ended October 1, 2004 which, under the loan agreement, permits the inclusion of Armkel’s EBITDA prior to its acquisition by the Company for pro forma purposes was approximately 3.14 versus the agreement’s maximum 4.25, and the interest coverage ratio (Adjusted EBITDA to total interest expense) was approximately 6.04 versus the agreement’s minimum of 3.0. This credit facility is secured by the assets of the Company and certain domestic subsidiaries. The reconciliation of Net Cash Provided by Operating Activities (the most directly comparable GAAP financial measure) to Adjusted EBITDA is as follows (in thousands):
Net Cash Provided by Operating Activities
Interest Expense
Current Income Tax Provision
Distributions from Affiliates
Change in Working Capital and Other Liabilities
Investment Income
Deferred Financing Write-off
Adjusted EBITDA (per loan agreement)
During the nine months of 2004, cash flow from operating activities was $144.0 million. Major factors affecting cash flow from operating activities included operating earnings before non-cash charges for depreciation and amortization, the write-off of deferred financing costs and a decrease in working capital. Operating cash flow, together with an increase in bank debt, distributions from affiliates, proceeds from stock option exercises and existing cash, were used to fund the purchase of Kelso’s interest in Armkel, additions to property, plant and equipment, payment of dividends and debt repayments.
On July 2, 2004, the Company announced that it has agreed to invest $30 million in a company formed by Kelso & Company, a private equity group, to acquire Del Laboratories, Inc. The Company’s investment will be substantially in the form of convertible preferred stock, and will represent about 20% of the equity financing. Kelso & Company, New York, will provide the remaining equity, with the participation of Del’s existing management team.
As part of this transaction, the Company will have certain rights with respect to the Orajel brand, including an option to acquire the business after three years. In the event that the Company does not exercise this option, the Company will have the right, subject to certain conditions, to convert its preferred stock into a 20% interest in the common stock of the new Del Company.
The Company’s cash and cash equivalents will be used to invest in Del Labs, make voluntary debt repayments, pay cash dividends, make investments in property, plant and equipment and support operating needs.
Recent Accounting Pronouncements
In August 2003, the Company issued $100 million of 5.25% convertible senior debentures that may be converted into shares of the Company’s common stock prior to maturity at an initial conversion price of approximately $31.00 per share, subject to adjustment in certain circumstances. Because of the inclusion of the contingent convertibility feature of the debentures, the Company’s diluted net income per common share does not give effect to the dilution from the conversion of the debentures until the Company’s share price exceeds 120% of the initial conversion price or until the occurrence of certain specified events.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is facing higher costs for several categories of raw and packaging materials, particularly those based on energy prices. The Company has successful strategies in place to improve its margin structure, and will intensify these strategies to counter the effect of these cost increases. These strategies include traditional cost reduction programs designed to improve supply chain and organizational efficiency; more efficient promotion spending using recently developed analytical tools; and selective price increases.
ITEM 4. CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this report are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.
No change in the Company’s internal control over financial reporting occurred during the Company’s third fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Cautionary Note on Forward-Looking Statements
This report contains forward-looking statements relating, among others, to short- and long-term financial objectives, sales and earnings growth, gross profit margin, earnings per share, non-cash accounting charges, increased marketing and R&D spending, new product launches, adoption of new accounting guidance, effect of the Company’s fiscal calendar, and financial forecasts. These statements represent the intentions, plans, expectations and beliefs of Church & Dwight, and are subject to risks, uncertainties and other factors, many of which are outside the Company’s control and could cause actual results to differ materially from such forward-looking statements. The uncertainties include assumptions as to market growth and consumer demand (including the effect of political and economic events on consumer demand), increases in raw material, packaging and energy prices, the Company’s ability to raise prices or reduce promotion spending, the Company’s ability to implement cost reduction programs in response to commodity price increases, the financial condition of major customers, trade, competitive and consumer reactions to the Company’s products and other factors described in Church & Dwight’s quarterly and annual reports filed with the SEC.
The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures the Company makes on related subjects in its filings with the U.S. Securities and Exchange Commission. This discussion is provided in reliance upon the Private Securities Litigation Reform Act of 1995.
26
PART II - Other Information
ITEM 6. EXHIBITS
Exhibits
(31.1) Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act.
(31.2) Certification of the Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act.
(32.1) Certification of the Chief Executive Officer of Church & Dwight Co., Inc. pursuant to Rule 13a-14(b) under the
Exchange Act and 18 U.S.C. Section 1350.
(32.2) Certification of the Chief Financial Officer of Church & Dwight Co., Inc. pursuant to Rule 13a-14(b) under the
27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
/s/ Zvi Eiref
/s/ Gary P. Halker
28
EXHIBITS
29