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 September 29, 2006
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 a large accelerated filer, an accelerated filer or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes ¨ No x
As of November 2, 2006, there were 65,233,786 shares of Common Stock outstanding.
TABLE OF CONTENTS
ITEM
2
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
CHURCH & DWIGHT CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
(Unaudited)
Net Sales
Cost of sales
Gross Profit
Marketing expense
Selling, general and administrative expenses
Income from Operations
Equity in earnings of affiliates
Investment earnings
Other income (expense), net
Interest expense
Income before minority interest and income taxes
Minority interest
Income before income taxes
Income taxes
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
Net income per share - Basic
Net income per share - Diluted
Dividends Per Share
See Notes to Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED BALANCE SHEETS
Assets
Current Assets
Cash and cash equivalents
Accounts receivable, less allowances of $1,627 and $1,826
Inventories
Deferred income taxes
Note receivable – current
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
Pension, Postretirement and Postemployment Benefits
Minority Interest
Commitments and Contingencies
Stockholders’ Equity
Preferred Stock-$1.00 par value
Authorized 2,500,000 shares, none issued
Common Stock-$1.00 par value
Authorized 150,000,000 shares, issued 69,991,482 shares
Additional paid-in capital
Retained earnings
Accumulated other comprehensive income (loss)
Common stock in treasury, at cost:
4,872,035 shares in 2006 and 5,602,568 shares in 2005
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
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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
Distributions from unconsolidated affiliates
Asset impairment charges and other asset write-offs
Non cash compensation expense
Unrealized foreign exchange (gain)loss
Other
Change in assets and liabilities:
Accounts receivable
Other liabilities
Excess tax benefit on stock options exercised
Net Cash Provided By Operating Activities
Cash Flow From Investing Activities
Additions to property, plant and equipment
Proceeds from assets held for sale
Return of capital from equity affiliates
Proceeds from note receivable
Acquisitions
Contingent acquisition payments
Change in other long-term assets
Net Cash Used In Investing Activities
Cash Flow From Financing Activities
Long-term debt repayment
Long-term debt borrowings
Short-term debt borrowings - net
Bank overdrafts
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
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW-CONTINUED
Cash paid during the nine months for:
Interest (net of amounts capitalized)
Acquisitions in which liabilities were assumed are as follows:
Fair value of assets
Purchase price
Liabilities assumed
Supplemental disclosure of non-cash investing activities:
Property, plant and equipment expenditures included in Accounts Payable
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The condensed consolidated balance sheet as of September 29, 2006, the condensed consolidated statements of income for the three and nine months ended September 29, 2006 and September 30, 2005 and the condensed consolidated statements of cash flow for the nine months ended September 29, 2006 and September 30, 2005 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 at September 29, 2006 and results of operations and cash flow 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, 2005. The results of operations for the periods ended September 29, 2006 are not necessarily indicative of the operating results for the full year.
The Company’s fiscal year begins on January 1st and ends on December 31st. Quarterly periods are based on a 4 weeks - 4 weeks - 5 weeks 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 include a partial or expanded week. Certain subsidiaries operating outside of North America are included for periods beginning and ending one month prior to the period presented.
The Company incurred research & development expenses in the third quarters of 2006 and 2005 of $11.5 million and $9.2 million, respectively. The Company incurred research & development expenses in the first nine months of 2006 and 2005 of $31.5 million and $26.9 million, respectively. These expenses are included in selling, general and administrative expenses.
2. Recently Adopted Accounting Pronouncement
On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share Based Payment” (“SFAS No. 123R”), which requires the determination of the fair value of share-based compensation at the grant date and the recognition of the related expense over the period in which the share-based compensation vests. The Company adopted SFAS No. 123R using the modified prospective transition method under which the Company recognizes compensation cost on or after the effective date of the Company’s adoption of SFAS No. 123R for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant date fair value of those awards calculated under the original SFAS 123 for pro forma disclosures. Prior period financial statements have not been restated. In the third quarter of 2006, the Company recorded a pre-tax charge of $2.8 million associated with the fair-value of unvested stock options, of which $2.5 million was included in selling, general and administrative expenses and $0.3 million in cost of goods sold. The after-tax impact of the charge was $1.7 million. Basic and Diluted EPS were negatively impacted by $0.03 per share. In the first nine months of 2006, the Company recorded a pre-tax charge of $7.6 million associated with the fair-value of unvested stock options, of which $6.7 million was included in selling, general and administrative expenses and $0.9 million in cost of goods sold. The after-tax impact of the charge was $4.7 million. Basic and Diluted EPS were negatively impacted by $0.07 per share.
3. Inventories consist of the following:
Raw materials and supplies
Work in process
Finished goods
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. 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
Depreciation, depletion and amortization of property, plant and equipment amounted to $9.1 million and $8.7 million for the three months ended September 29, 2006 and September 30, 2005, respectively. Depreciation, depletion and amortization of property, plant and equipment amounted to $27.0 million and $25.6 million for the nine months ended September 29, 2006 and September 30, 2005, respectively. Interest charges in the amount of $0.1 million and $0.1 million were capitalized in connection with construction projects for the three months ended September 29, 2006 and September 30, 2005, respectively. Interest charges in the amount of $0.4 million and $0.3 million were capitalized in connection with construction projects for the nine months ended September 29, 2006 and September 30, 2005, respectively.
5. 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 and the dilutive effect of convertible debentures. 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
Dilutive effect of convertible debentures
Diluted
Anti-dilutive stock options outstanding
6. Stock-Based Compensation
The Company has options outstanding under three equity compensation plans. Under the 1983 Stock Option Plan and the 1998 Stock Award Plan, the Company may grant options to key management employees. Under the Stock Option Plan for Directors, the Company grants options to non-employee directors. Options outstanding under the plans are issued at market value on the date of the grant, vest on the third anniversary of the date of grant and must be exercised within ten years of the date of grant. A total of 10.5 million shares of the Company’s common stock is authorized for issuance for the exercise of stock options. Issuances of Common Stock to satisfy employee option exercises are currently made from treasury stock.
Prior to January 1, 2006, the Company accounted for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. The Company’s pro forma net income and pro forma net income per share for the three and nine months of 2005 determined as if the Company had adopted the fair value method of SFAS No. 123R, is presented below:
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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
A summary of option activity during the nine months ended September 29, 2006 is as follows:
Outstanding at January 1, 2006
Granted
Exercised
Cancelled
Outstanding at September 29, 2006
Exercisable at September 29, 2006
During the third quarter of 2006 and 2005, the Company issued approximately 85 thousand and 11 thousand stock options at an average fair value of $14.52 and $14.62 per share, respectively, based upon the Black Scholes option pricing model. Key assumptions used for the third quarter of 2006 and 2005, respectively, were: expected life 6.5 years and 6.4 years, expected volatility 30.9% and 33.1%, risk-free interest rate 4.7% and 4.0%, dividend yield 0.7% and 0.6%. The Company determined the options’ expected life based on historical exercise behavior and determined the option’s expected volatility and dividend yield based on the historical changes in stock price and dividend payments. The risk free interest rate is based on the yield of an applicable term Treasury instrument. The total intrinsic value of options exercised during the third quarter of 2006 and 2005 was $6.2 million and $5.5 million, respectively.
During the first nine months of 2006 and 2005, the Company issued approximately 890 thousand and 730 thousand stock options at an average fair value of $13.55 and $13.56 per share, respectively, based upon the Black Scholes option pricing model. Key assumptions used for the nine months of 2006 and 2005, respectively, were: expected life 6.5 years and 6.6 years, expected volatility 30.4% and 33.0%, risk-free interest rate 5.0% and 4.0%, dividend yield 0.7% and 0.7%. The Company determined its expected volatility and dividend yield based on the historical changes in stock price and dividend payments. The risk free interest rate is based on the yield of an applicable term Treasury instrument. The total intrinsic value of options exercised during the first nine months of 2006 and 2005 was $16.8 million and $24.0 million, respectively. As of September 29, 2006, there was an approximate fair value of $16.3 million related to unamortized compensation expense, which is expected to be recognized over a weighted-average period of approximately one year. The Company’s 2006 Condensed Consolidated Statements of Cash Flow reflects the add back to Net Cash Provided by Operating Activities of $7.8 million of non cash compensation expense. Net Cash Used in Financing Activities in 2006 reflects $5.4 million of excess tax benefits on stock options exercised. The total tax benefit for the nine months ended September 29, 2006 and September 30, 2005 was $5.9 million and $8.6 million, respectively. During the third quarter of 2006, there were no modifications made to any options outstanding.
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During 2005, the Company instituted a program under which officers who elect to receive up to 50% of their annual incentive compensation in shares of the Company’s common stock or stock equivalents, or otherwise increase their share ownership during a specified period of time, will be awarded restricted shares having a fair market value of 20% of the amount of stock and stock equivalents that an officer elects to receive or otherwise acquires. The restricted shares vest on the third anniversary of the date of grant. During the three year vesting period, officers holding these shares will have voting rights and receive dividends either in cash or through reinvestment in additional shares. During the nine months of 2006, approximately 41 thousand restricted shares were issued, of which 35 thousand shares pertain to a new executive employment agreement in the third quarter. The $1.5 million value of these restricted shares are expensed primarily over the three year graduated vesting period.
7. Acquisitions
Late in the second quarter of 2006, the Company reacquired the distribution rights from USA Detergents (“USAD”) to sell Xtra laundry detergent and Nice N’ Fluffy liquid fabric softener in Canada for $7.0 million and agreed to make an additional performance-based payment of a maximum of $2.5 million based upon the one year performance during the one year period following the closing date. The acquisition was funded out of the Company’s available cash. The accompanying financial statements reflect the final asset allocation, which assigns the purchase price to intangible assets.
On August 7, 2006, the Company closed on its previously announced acquisition of the net assets of Orange Glo International, Inc. (“OGI”), which sells laundry and cleaning products such as OXICLEAN a premium-priced laundry pre-wash additive, KABOOM bathroom cleaner and ORANGE GLO household cleaner. The Company paid approximately $326.0 million, plus fees of approximately $4.1 million, which was financed through a $250.0 million addition to its existing bank credit facility and available cash. The transaction is structured as an asset purchase and an appraisal of the net assets acquired is in process. The Company’s financial statements reflect the results of operations from the acquisition date. The following table summarizes the preliminary purchase price allocation relating to the OGI acquisition:
Current assets
Property, plant and equipment
Tradenames and other intangibles
Other long-term assets
Total assets
Current liabilities
Net assets
8. Segment Information
The Company maintains three reportable 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
The Company has 50 percent ownership interests in Armand Products Company (“Armand”) and The ArmaKleen Company (“ArmaKleen”). Since the Company does not control these entities, they are accounted for under the equity method in the consolidated financial statements of the Company. The equity earnings of Armand and ArmaKleen are presented in the table below under Corporate.
Some of the subsidiaries that are included in the Consumer International segment manufacture and sell personal care products to the Consumer Domestic segment. These sales are eliminated from the Consumer International segment results.
The domestic results of operations for OGI are included in the Consumer Domestic segment. The results of operations for OGI’s foreign operations are included in the Consumer International segment.
Segment sales and income before taxes and minority interest for the third quarter and year to date periods of 2006 and 2005, and identifiable segment assets as of September 29, 2006 and December 31, 2005, are as follows:
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Third Quarter 2006
Third Quarter 2005
Year to Date 2006
Year to Date 2005
Income before Minority Interest and Income Taxes(1)
Identifiable Assets
September 29, 2006
December 31, 2005
The following table discloses product line revenues from external customers for the three and nine month periods ended September 29, 2006 and September 30, 2005.
Household Products
Personal Care Products
Total Consumer Domestic
Total Consumer International
Total SPD
Total Consolidated Net Sales
Household Products include deodorizing and cleaning products and laundry products. Personal Care Products include condoms, pregnancy kits, oral care and skin care products.
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9. Short-term Borrowings and Long-Term Debt
Short-term borrowings and long-term debt consist of the following:
Securitization of accounts receivable due in April 2007
Various debt due to Brazilian banks
Bank overdraft debt
Total short-term debt
Long-term debt
Tranche A term loan facility
Incremental tranche A term loan facility
Amount due 2006
Amount due 2007
Amount due 2008
Amount due 2009
Amount due 2010
Amount due 2011
Amount due 2012
Convertible debentures due on August 15, 2033
Senior subordinated notes (6%) due December 22, 2012
Total long-term debt
Less: current maturities
Net long-term debt
The long-term debt principal payments required to be made are as follows:
Due in September 2007
Due in September 2008
Due in September 2009
Due in September 2010
Due in September 2011
Due October 2011 and subsequent
During the third quarter and first nine months of 2006, the Company paid approximately $3.6 million and $22.2 million of its Tranche A term loan, of which $0.0 million and $11.5 million were voluntary payments, respectively. The Company’s Brazilian subsidiary paid down its borrowings by a net amount of approximately $1.5 million in the third quarter and $6.4 million in the first nine months in 2006.
The Company entered into a cash flow hedge agreement effective as of September 29, 2006, to reduce the impact of interest rate fluctuations on its Tranche A term loan debt. The hedge covers $100.0 million of zero-cost collars for 5 years with a cap of 6.5% and a floor of 3.57%. There was no income statement impact as a result of this agreement as of September 29, 2006. All changes in the hedging option’s fair value will be recorded in Other Comprehensive Income on the balance sheet.
In April 2006, the accounts receivable securitization facility was renewed with similar terms to the facility previously in place and with a new maturity date of April 2007.
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10. Goodwill and Other Intangible Assets
The following table provides information related to the carrying value of all intangible assets:
Amortized intangible assets:
Tradenames
Customer Relationships
Patents/Formulas
Non Compete Agreement
Total
Unamortized intangible assets-carrying value
Tradenames, both amortized and unamortized, and customer relationships increased in the third quarter of 2006 due to the acquisition of Orange Glo International, Inc. The acquired tradenames and customer relationships reflect their preliminary allocable purchase price as of August 7, 2006.
In the first six months of 2006, the Company recorded $2.7 million in trademark impairment charges, of which $0.4 million related to a Consumer Domestic brand and $2.3 million related to Consumer International brands. The impairment charges were a result of increased competitive activity. The amounts recorded were the differences between the carrying values and the net present values of estimated cash flows, which represent the estimated fair value of the assets. The charges are included in selling, general and administrative expenses in the respective segments.
Intangible amortization expense included in SG&A expenses amounted to $3.4 million for the third quarter of 2006 and $9.2 million for the first nine months of 2006. Intangible amortization expense amounted to $2.1 million for the third quarter of 2005 and $6.0 million for the first nine months of 2005. The Company’s estimated intangible amortization will be approximately $15.0 million in each of 2007-2009 and approximately $14.5 million in 2010 and 2011.
The changes in the carrying amount of goodwill for the nine months ended September 29, 2006 are as follows:
Balance December 31, 2005
Additional goodwill associated with Unilever contingent payment
Goodwill associated with the USAD Canada acquisition
Goodwill associated with the OGI acquisition(1)
Balance September 29, 2006
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11. Comprehensive Income
The following table provides information relating to the Company’s comprehensive income for the three and nine months ended September 29, 2006 and September 30, 2005:
Other Comprehensive Income, Net of Tax:
Foreign Exchange Translation Adjustments
Comprehensive Income
12. Pension and Postretirement Plans
The following table discloses the net periodic benefit cost for the Company’s pension and postretirement plans for the three and nine months ended September 29, 2006 and September 30, 2005.
Pension Costs
Three Months Ended
Nine Months Ended
Components of Net Periodic Benefit Cost:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service cost
Recognized actuarial loss
Net periodic benefit cost
Postretirement Costs
Recognized actuarial (gain) or loss
The Company made cash contributions of approximately $8.9 million to certain of its pension plans during the first nine months of 2006 and expects to make additional contributions of $1.9 million during the remainder of the year.
13. Commitments, contingencies and guarantees
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14. Related Party Transactions
The Company divested the USA Detergents (“USAD”) non-laundry business and other non-core assets to former USAD executives in connection with its acquisition of USAD in 2001. The Company has a $0.6 million ownership interest in USAD. The Company has been supplying USAD with certain laundry and cleaning products at cost plus a mark-up, and USAD had the exclusive rights to sell these products in Canada. In addition, the Company leases office and laboratory space to USAD under a separate agreement.
During the nine month periods ended September 29, 2006 and September 30, 2005, the Company sold $12.3 and $16.2 million, respectively, of laundry and cleaning products to USAD. Furthermore, the Company billed USAD $0.2 million and USAD billed the Company $0.2 million for leased space. As of September 29, 2006 and September 30, 2005, the Company had outstanding accounts receivable from USAD of $2.7 and $3.4 million, respectively.
For the nine months ended September 29, 2006 and September 30, 2005, the Company invoiced Armand $1.2 and $1.2 million, respectively, for administration and management oversight services (which was recorded as a reduction of selling, general and administrative expenses). Intercompany sales of Armand products to the Company over the same periods were $7.7 and $8.1 million, respectively. As of September 29, 2006 and September 30, 2005, the Company had outstanding accounts payable to Armand of $0.8 and $1.0 million, respectively. Also, the Company had outstanding accounts receivable from Armand of $1.2 and $1.2 million as of September 29, 2006 and September 30, 2005, respectively.
For the nine months ended September 29, 2006 and September 30, 2005, the Company invoiced ArmaKleen $2.1 and $1.9 million, respectively, for administration and management oversight services (which was recorded as a reduction of selling, general and administrative expenses). Intercompany sales of inventory to ArmaKleen over the same periods were $3.9 and $3.7 million, respectively. As of September 29, 2006 and September 30, 2005, the Company had outstanding accounts receivable from ArmaKleen of $1.3 and $0.2 million, respectively.
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15. Supplemental Financial Information of Guarantor and Non-Guarantor Operations
The Company’s 6% senior subordinated notes are fully and unconditionally guaranteed by Church & Dwight Co., Inc. and certain domestic subsidiaries of the Company on a joint and several basis. The following information is being presented in response to Item 3-10 of Regulation S-X, promulgated by the Securities and Exchange Commission.
Supplemental information for condensed consolidated balance sheets at September 29, 2006 and December 31, 2005, and condensed consolidated income statements and condensed consolidated statements of cash flows for the three and nine month period ended September 29, 2006 and September 30, 2005 are summarized as follows (amounts in thousands):
Net sales
Gross profit
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Consolidated Balance Sheet
Other Liabilities
17
Statements of Cash Flows
For the Nine Months Ended
Net Cash Provided by (Used in) Operating Activities
Net Cash Used in Investing Activities
Net Cash (Used in) 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
September 30, 2005
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS
Results of Operations
Consolidated Results
Net Sales for the quarter ended September 29, 2006 were $518.6 million, $75.8 million or 17.1% above net sales during the same quarter last year. Favorable foreign exchange rates accounted for $4.1 million of the increase. This year’s sales included revenue of $62.8 million for three businesses acquired since late last year, the SPINBRUSH battery-powered toothbrush business, a skin care brand in Brazil, and the recently completed acquisition on August 7, 2006 of the net assets of Orange Glo International, Inc. (“OGI”), which markets OXICLEAN and other products. The quarterly results were also favorably affected by price increases that became effective February 1, 2006. The Company estimates that the increased prices increased net sales by approximately 2% and volumes were slightly higher.
Net Sales for the nine months ended September 29, 2006 were $1,419.6 million, $114.3 million or 8.8% above net sales during last year’s nine month period. Included in the 2006 results are $94.9 million associated with the acquired businesses and favorable foreign exchange rates of $3.1 million. The Company assumed responsibility for all SPINBRUSH sales and other functions in the U.S., Canada and the U.K. on April 1, 2006, and has recognized the gross amount of sales and expenses from the SPINBRUSH business within the consolidated statement of earnings for the U.S. and foreign locations since that date. During the transition period prior to April 1, 2006, when the seller of the SPINBRUSH business maintained these responsibilities, the Company accounted for the net cash received as other revenue. The nine month results were also affected by price increases that became effective February 1, 2006; however, due to the timing of previously planned promotional events, especially for laundry products, the full benefit of the price increases were not realized until the second quarter. The Company estimates that the effect of increased prices affected net sales by 3%, which was offset by the effect of lower volumes.
Operating Costs
The Company’s gross profit in the quarter ended September 29, 2006 increased to $203.0 million, an increase of $35.4 million compared to the third quarter of 2005. Approximately $25.8 million of the increase was associated with the acquired businesses’ products and the balance of the increase is due to the net effect of the price increases, partially offset by a substantial increase in commodity costs over the past year, particularly for oil-based raw and packaging materials used in the laundry and specialty products businesses. As a result, the Company’s gross margin increased 130 bps to 39.1% in the current quarter from 37.8% in the third quarter of 2005. For the nine month period, gross profit increased $60.1 million to $556.7 million. Approximately $45.3 million of the increase was associated with the acquired businesses. Gross margin improved to 39.2% as compared to 38.1% for the first nine months of 2005. The reasons for the increase are consistent with those for the third quarter.
Marketing expenses in the third quarter of 2006 were $62.6 million, an increase of $10.6 million as compared to last year’s third quarter. The increase is primarily associated with expenses in support of the acquired businesses. Marketing expenses for the nine month period ended September 29, 2006 increased $9.5 million as compared to the comparable prior year period. Support for acquired businesses and an increase in Consumer International expenses were partially offset by lower expenses for pre-existing Consumer Domestic products.
Selling, general and administrative expenses (“SG&A”) of $71.5 million in the third quarter of 2006 increased $9.8 million or 15.9% as compared to last year’s third quarter. The prior year third quarter includes an $8.3 million charge related to litigation. Included in the third quarter 2006 SG&A is $2.5 million of stock option expense associated with the Company’s adoption of SFAS No. 123R on January 1, 2006, an increase of $5.0 million of personnel and related expenses, higher research and development expenses of $2.3 million and operating and amortization expense in support of the acquired businesses. SG&A expenses for the nine month period ended September 29, 2006 increased $23.6 million as compared to the first nine months of 2005. Included in the increase is stock option expense of $6.7 million, higher personnel and related expenses of $7.0 million, higher research and development expenses of $4.6 million and operating and amortization expense in support of the acquired businesses.
Other Income and Expenses
Interest expense in the third quarter of 2006 increased $3.7 million as compared to the third quarter of 2005 as a result of the increase in debt to purchase OGI and higher interest rates partially offset by lower average pre-existing debt outstanding. Investment income for the third quarter of 2006 increased $0.2 million as compared to the third quarter of 2005 as a result of higher interest rates. Interest expense for the first nine months of 2006 increased $5.1 million and investment income increased $1.0 million for the same reasons as pertained to the third quarter increases.
Other income/expense for the nine months of 2006 primarily includes the fair market value of common stock the Company received in connection with the demutualization of an insurance company in which the Company was the policyholder of a guaranteed annuity contract associated with a defined benefit plan. Also included are foreign exchange gains related to intercompany loans between the Company’s subsidiaries. In 2005, the Company reported foreign exchange losses associated with these loans.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS (Continued)
Taxation
The third quarter 2006 tax rate was 31.7%, compared to last year’s 21.6%. This year’s rate includes a $3.3 million reduction of tax liabilities primarily as a result of the completion of a tax audit, partially offset by a partial valuation allowance of $1.5 million for one of the Company’s foreign subsidiaries. Last year’s third quarter rate includes a $6.0 million reduction of tax liabilities relating to tax positions for which the statute of limitations had expired.
For the nine month period ended September 29, 2006, the tax rate was 36.5%, compared to 30.8% for the nine month period ended September 30, 2005. This increase was primarily due to the expiration of the research and development tax credit, last year’s third quarter tax liability reduction described above and certain other tax adjustments.
Segment results
The Company maintains three reportable 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 sales and income before taxes and minority interest for the third quarter and year to date periods of 2006 and 2005 and identifiable segment assets as of September 29, 2006 and December 31, 2005 are as follows:
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Product line revenues for external customers for the three and nine month periods ended September 29, 2006 and September 30, 2005 were as follows:
Consumer Domestic
Consumer Domestic net sales were $370.1 million in the third quarter of 2006, an increase of $55.3 million or 17.6% as compared to the third quarter of 2005. The increase is primarily due to sales of SPINBRUSH, which was acquired late in 2005 and the recently completed OGI acquisition, which contributed approximately $53.0 million. Sales of the segment’s pre-existing product lines increased slightly as a result of higher prices, offset by slightly lower volume. Effective February 1, 2006, the Company implemented price increases ranging from 4% to over 10% for products representing about 35% of its U.S. consumer products portfolio. These products include ARM & HAMMER and XTRA liquid laundry detergents, ARM & HAMMER SUPER SCOOP cat litter and ARM & HAMMER baking soda. Management believes the price increase may have caused the Company to experience lower product demand as consumers adjusted to the higher prices. However, management believes that these price increases are improving the Company’s margins and contribute to achievement of its financial goals. Also contributing to the higher sales was growth in pregnancy kits and pet care, partially offset by lower toothpaste and deodorizer sales.
For the first nine months of 2006, Consumer Domestic net sales were $1,005.2 million, an increase of $85.5 million or 9.3% as compared to the same period of 2005. The increase is primarily due to sales associated with the OGI and SPINBRUSH products, which contributed approximately $76.1 million. The Company assumed responsibility for all SPINBRUSH sales and other functions in the U.S., Canada and the U.K. on April 1, 2006, and recognized the gross amount of sales and expenses from the SPINBRUSH business within the consolidated statement of earnings for the U.S. and most foreign locations during the second quarter. During the transition period prior to April 1, 2006, when the seller of the SPINBRUSH business maintained these responsibilities, the Company accounted for the net cash received as other revenue. Also contributing to the higher sales were effective price increases associated with liquid laundry detergent (partially offset by slightly lower volumes), and higher volumes of pregnancy kits, condoms and pet products. Partially offsetting these higher sales were lower toothpaste and antiperspirant product sales.
Consumer Domestic Income before Minority Interest and Income Taxes for the third quarter of 2006 was $42.8 million, a decrease of $1.0 million as compared to the third quarter of 2005, and was $142.7 million, for the first nine months of 2006, an increase of $20.6 million as compared to the first nine months of 2005. The third quarter decrease is due to higher SG&A costs (primarily higher research and development costs, stock option expense, and higher legal professional fees), and higher allocated interest expense virtually offset by contributions from OGI and SPINBRUSH and the effect of the higher prices which more than offset slightly lower volumes. The nine month increase is due to the contributions from OGI and SPINBRUSH, the effect of higher gross margins for liquid laundry detergents, and lower marketing costs relating to certain oral care products. The higher profitability was partially offset by higher oil based manufacturing and freight costs and higher SG&A expenses (primarily stock option expense, higher legal professional fees and costs associated with the OGI and SPINBRUSH businesses). SG&A for the nine months of 2006 and 2005 included an intangible asset impairment charge of $0.4 million and $1.9 million, respectively.
Consumer International
Consumer International net sales were $93.8 million in the third quarter of 2006, an increase of $19.4 million or 26.1% as compared to the third quarter of 2005. The 2006 net sales include $9.5 million associated with the OGI, SPINBRUSH products, and the skin care product acquired late in 2005, as well as favorable exchange rates of $4.0 million. Strong sales in Canada and Europe also contributed to higher sales.
Consumer International net sales were $249.1 million in the first nine months of 2006, an increase of $27.2 million or 12.3% as compared to the first nine months of 2005. The 2006 net sales reflect $18.9 million associated with the OGI and SPINBRUSH products and the skin care product acquired late in 2005, and favorable exchange rates of $3.5 million. Strong sales in Canada and increased European exports were offset by lower sales of certain skin care brands in Europe.
Consumer International Income before Minority Interest and Income Taxes was $8.8 million in the third quarter of 2006, an increase of $14.0 million as compared to the third quarter of 2005, and $21.9 million for the first nine months of 2006, an increase of $8.1 million as compared to the first nine months of 2005. The increases are a result of the contributions from the products of the acquired businesses. Moreover, the 2005 periods reflected a litigation charge of $8.3 million. Partially offsetting the increases are higher manufacturing and distribution costs, an unfavorable sales mix (more lower margin household products), and an increase in marketing expenses in England in support of certain personal care products. Both nine month periods include tradename impairment charges ($2.3 million in 2006 and $2.4 million in 2005).
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Specialty Products (SPD)
Specialty Products net sales were $54.7 million in the third quarter of 2006, an increase of $1.2 million or 2.2% as compared to the third quarter of 2005. The increase is primarily due to growth in international sales.
Specialty Products net sales were $165.3 million for the first nine months of 2006, an increase of $1.6 million as compared to the first nine months of 2005. The increase is due to growth in international sales, partially offset by lower animal nutrition product sales and unfavorable foreign exchange rates of $0.5 million.
Specialty Products Income before Minority Interest and Income Taxes were $3.1 million in the third quarter of 2006, a $1.7 million decrease as compared to the third quarter of 2005, and were $11.2 million for the first nine months of 2006, a decrease of $3.0 million as compared to the first nine months of 2005, principally due to higher manufacturing costs for certain animal nutrition products, increased SG&A expenses and higher allocated interest expense.
Liquidity and Capital Resources
Net Debt
The Company had outstanding total debt of $982.8 million and cash of $95.8 million (of which approximately $50.5 million resides in foreign subsidiaries) at September 29, 2006. Total debt less cash (“net debt”) was $887.0 million at September 29, 2006. This compares to total debt of $756.5 million and cash of $126.7 million, resulting in net debt of $629.8 million at December 31, 2005. The increase of net debt since the beginning of the fiscal year is primarily due to the acquisition of OGI.
In the second quarter of 2006, the Company paid $7.0 million to reacquire distribution rights from USAD for sales in Canada of certain laundry products. The acquisition was funded out of the Company’s available cash. On August 7, 2006, the Company acquired OGI for approximately $326.0 million, plus fees of approximately $4.0 million, in cash, which was financed through a $250.0 million addition to the Company’s existing bank credit facility and with available cash.
Net Cash Provided by Operating Activities
Net Cash Used in Financing Activities
Net Cash Provided by Operations – The Company’s net cash provided by operations in the first nine months of 2006 decreased $21.9 million to $109.3 million as compared to the same period in 2005. The decrease was primarily due to an increase in working capital in support of SPINBRUSH. Operating cash flows are expected to be sufficient to meet the anticipated operating cash requirements for the remainder of the year.
For the nine month period ending September 29, 2006, the components of working capital that significantly impacted operating cash flow are as follows:
Accounts receivable increased $31.0 million primarily due to receivables relating to SPINBRUSH sales.
Inventories increased by $22.6 million primarily due to the purchase of SPINBRUSH inventory.
Net cash used in Investing Activities – Net cash used in investing activities during the first nine months of 2006 was $370.2 million, reflecting $33.2 million of additions for property, plant and equipment, $7.0 million to purchase the USAD Canadian business and approximately $330.1 million for the purchase of OGI (see note 7 to the condensed consolidated financial statements included in this report for additional information).
Net cash provided by Financing Activities – Net cash provided by financing activities during the first nine months of 2006 was $226.7 million. This represents an increase in variable rate debt of $250.0 million to purchase OGI, $7.5 million in short-term borrowings related to our accounts receivable securitization, and proceeds of and tax benefits from stock option exercises of $15.1 million partially offset by Tranche A term loan payments of $23.2 million and the payment of cash dividends of $12.3 million.
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Adjusted EBITDA is a required component of the financial covenants contained in the Company’s primary credit facility. 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 $272.9 million for the first nine months of 2006. The leverage ratio (total debt to Adjusted EBITDA) for the 12 months ended September 29, 2006 was 2.98 which is below the maximum of 4.00 permitted under the agreement, and the interest coverage ratio (Adjusted EBITDA to total interest expense) for the twelve months ended September 29, 2006 was 6.75 which is above the minimum of 3.0 permitted under the agreement. This credit facility is secured by the assets of Church & Dwight Co., Inc. and one of its domestic subsidiaries. The reconciliation of Net Cash Provided by Operating Activities (the most directly comparable GAAP financial measure) to Adjusted EBITDA for the nine months ended September 29, 2006 is as follows (in millions):
Interest Expense
Current Portion Of Income Tax Provision
Tax Benefit On Stock Options Exercised
Change in Working Capital and Other Liabilities
Investment Income
Adjusted EBITDA (per loan agreement)
Recent Accounting Pronouncements
On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation Number 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes.” FIN 48 seeks to reduce the significant diversity in practice associated with recognition and measurement in the accounting for income taxes. It applies to all tax positions accounted for in accordance with Statement of Financial Accounting Standards No. 109, “Accounting for Income Tax.” The effective date of FIN 48 is the first fiscal year beginning after Dec. 15, 2006. The Company is currently assessing what impact, if any, the adoption of this statement will have on its consolidated financial statements.
SFAS No. 157, “Fair Value Measurements”, was issued in September 2006 and is effective for fiscal years beginning after November 15, 2007. SFAS No 157 provides a single definition of fair value to be utilized under other accounting pronouncements that require fair value measurements, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. The statement generally is to be applied prospectively, so that it does not require any new fair value measurements. The Company is currently assessing what impact, if any, the adoption of this statement will have on its consolidated financial statements.
SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”, was issued in September 2006 and is effective for the Company as of the end of the Company’s current fiscal year ending December 31, 2006. SFAS No. 158 is an amendment of SFAS Nos. 87, 88, 106, and 132(R) and is intended to improve financial reporting of pension and postretirement plans. This statement requires employers to a) recognize the funded status of a benefit plan, b) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost, c) measure the defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end, and d) include additional disclosures in the notes to the financial statements about effects on net periodic benefit cost that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. The Company is currently assessing the impact the adoption of this statement will have on its consolidated financial statements.
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SEC Staff Accounting Bulletin No. 108 (“SAB 108”), which expresses the staff’s views regarding the effects of prior year misstatements when quantifying misstatements in current year financial statements, was issued in September 2006. The SEC staff issued this SAB to address the diversity in practice in quantifying material financial statement misstatements and the potential under current practice for the build up of improper amounts on the balance sheet. The effective date of SAB 108 is for fiscal years ending on or before November 15, 2006. This pronouncement is not expected to have a material impact on the Company’s consolidated financial statements.
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. In response, the Company has intensified its margin enhancement strategies, and is in the process of implementing a range of formulation, packaging, logistics and other cost reduction programs.
Interest Rate Risk
The Company’s domestic operations and its Brazilian subsidiary have other short and long-term debt that are floating rate obligations. If the floating rate were to change by 10% from the September 29, 2006 level, additional annual interest expense associated with the floating rate debt would be approximately $3.5 million.
Foreign Currency
The Company is also subject to translation exposure of the Company’s foreign subsidiaries financial statements. A hypothetical 10% change in the exchange rates for the U.S. Dollar to the currencies noted above at September 29, 2006 would result in a year-to-date currency translation gain or loss of approximately $1.5 million in 2006.
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 the Company’s 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 (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
No change in the Company’s internal control over financial reporting occurred during the Company’s most recent 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, margin improvement, marketing and advertising spending, the timing of benefits from pricing changes made in prior periods, new product introductions, the effect of the SpinBrush and Orange Glo International, Inc. (“OGI”) net asset acquisitions and the operational transition of these businesses with the Company, market demand as consumers adjust to higher prices, achievement of financial goals, earnings per share and the effect of the adoption of Statement of Financial Accounting Standards No. 123 (revised) on earnings per share. These statements represent the intentions, plans, expectations and beliefs of the Company, 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 and price increases on consumer demand), raw material and energy prices, the financial condition of major customers, the integration of the OGI business and the effect on marketing spending of product introduction timelines. With regard to the new product introductions referred to in this report, there is particular uncertainty relating to trade, competitive and consumer reactions. Other factors, which could materially affect the results, include the outcome of contingencies, including litigation, pending regulatory proceedings, environmental remediation and the divestiture of assets. For a description of additional factors that could cause actual results to differ materially from the forward looking statements, see the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2005, including the information in Item 1A, “Risk Factors.”
The Company undertakes no obligation to publicly update any forward-looking statements. You are advised, however, to consult any further disclosures the Company makes on related subjects in our filings with the U.S. Securities and Exchange Commission.
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PART II - OTHER INFORMATION
ITEM 1A. RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results.
ITEM 6. EXHIBITS
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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/ Matthew T. Farrell
/s/ Gary P. Halker
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EXHIBIT INDEX
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