Church & Dwight Co., Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unless otherwise noted, amounts are in millions of dollars. Comparisons are with the corresponding 2017 periods.
Business context and results
The company sells household and personal care products through Consumer Domestic and Consumer International, and specialty chemical products through its Specialty Products Division (SPD). It acquired Passport Food Safety Solutions on March 8, 2018, for approximately $50 million, with potential additional consideration of up to $25 million based on sales performance through 2020.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $1,027.9 | $898.0 | $2,033.9 | $1,775.2 |
| Gross profit | $454.9 | $410.4 | $906.4 | $809.7 |
| Income from operations | $173.8 | $123.2 | $394.1 | $319.3 |
| Net income | $121.7 | $72.9 | $279.5 | $204.4 |
| Diluted EPS | $0.49 | $0.29 | $1.12 | $0.79 |
| Gross margin | 44.3% | 45.7% | 44.6% | 45.6% |
| Operating margin | 16.9% | 13.7% | 19.4% | 18.0% |
Performance drivers and changes
- Sales grew 14.5% in Q2 and 14.6% year to date. Acquired product lines contributed 9.6 percentage points in both periods; volume contributed 5.4 points in Q2 and 4.7 points year to date. Pricing/product mix reduced growth by 1.0 and 0.6 points, respectively.
- Consumer Domestic sales rose 14.1% in Q2; Consumer International rose 21.4%; SPD rose 4.0%. Growth reflected acquisitions and higher consumer-segment volumes. SPD volumes declined, particularly in animal productivity, where management cited weak dairy-industry demand.
- Gross margin fell 140 basis points in Q2 and 100 basis points year to date. Management cited higher commodity, transportation and manufacturing costs, unfavorable mix, and lower margins on acquired businesses; productivity programs partly offset the pressures. Oral-care recall and FDA-mandated withdrawal costs were included among the factors affecting acquired-business and price/mix comparisons.
- Operating income increased 41.1% in Q2 and 23.4% year to date. SG&A was lower year over year in Q2, mainly because the 2017 period included a $39.2 million international pension settlement charge. Q2 2017 net income also included the after-tax pension charge of $31.5 million ($0.12 per share), making the comparison more favorable in 2018. The 2017 first half also included a $3.5 million charge related to the Brazil chemical-business sale.
- Interest expense increased $10.9 million in Q2 and $22.8 million year to date, principally reflecting higher average debt following the 2017 senior-note issuance. Effective tax rates were 21.7% for Q2 and 21.5% year to date, versus 37.6% and 33.4%; the reduction primarily reflected the Tax Act’s lower U.S. corporate tax rate.
- On April 1, the company changed the remaining approximately 17% of inventory from LIFO to FIFO. It recorded an approximately $4.0 million pretax reduction in cost of goods sold in Q2; prior periods were not restated because the effect was considered immaterial.
Cash flow, debt and liquidity
- Six-month operating cash flow was $322.7 million, compared with $249.3 million. Investing cash outflow was $71.2 million, including $49.8 million for Passport and $19.6 million of capital expenditures. Financing cash outflow was $439.5 million, including $200.0 million of share repurchases, $106.2 million of dividends and $159.8 million of net debt repayments.
- Cash and equivalents were $89.3 million at June 30, down from $278.9 million at year-end. Total debt was approximately $2.21 billion, including $110.8 million of short-term borrowings; $299.5 million of debt was classified as current. The $300 million floating-rate senior notes mature in January 2019.
- The company reported approximately $887.7 million available through its revolving facility and commercial-paper program. In March, it replaced its $1.0 billion revolving facility with a new facility maturing in March 2023, with potential borrowing capacity increases of up to $600 million subject to conditions. Management expected available cash and borrowing capacity to be sufficient for operations, planned spending and repayment of the 2019 notes, and said it anticipated compliance with its leverage covenant.
- Management expected 2018 capital expenditures of approximately $60 million. The board raised the regular quarterly dividend 14% to $0.2175 per share, equivalent to $0.87 annually. The company repatriated approximately $150 million of foreign earnings in the first half.
- The cash conversion cycle increased to 24 days from 17 days a year earlier, primarily due to a four-day increase in inventory days; management attributed part of the working-capital burden to acquisitions.
Outlook, risks and contingencies
- The filing provides no specific quantified full-year sales or EPS guidance. Management’s outlook included expected adequate liquidity, approximately $60 million of 2018 capital expenditures, and the ability to fund dividends and repurchases subject to management decisions.
- Management cited intense pricing and product competition in laundry detergent and gummy vitamins, higher input and transportation costs, and soft dairy-sector demand. It cautioned that category declines may not be offset by product launches, marketing or trade spending.
- A personal-care trade name had a reduced estimated fair-value cushion of approximately $34 million, or 12%, in 2017 after weaker performance and increased competition. Management said further adverse changes in sales, profitability or discount-rate assumptions could require an impairment charge; its 2018 goodwill test found fair values substantially exceeded reporting-unit carrying values.
- Scantibodies Laboratory seeks more than $20 million in a contract dispute. The company is defending the case, has recorded an immaterial reserve, and stated that it is reasonably possible it could ultimately pay all or substantially all amounts sought; the outcome and any amount above the reserve could not be estimated. Other ordinary-course proceedings were not expected to have a material adverse effect.
- The company identified commodity and energy prices, transportation, competition, consumer demand, foreign exchange, manufacturing/distribution disruption, acquisitions, regulatory matters and litigation among forward-looking risks. It reported no material change in market-risk exposure since year-end.
Important facts for investors to verify
- Whether sales growth and earnings momentum persist after separating acquisition contributions, prior-year pension charges and the Q2 inventory-accounting benefit.
- Whether commodity, freight and manufacturing-cost pressures continue to outweigh productivity gains, and whether oral-care recall and withdrawal effects recur.
- Debt repayment and refinancing plans for the $300 million notes due January 2019, alongside cash levels, commercial-paper availability and covenant compliance.
- Progress on working-capital efficiency, especially inventory days and the longer cash conversion cycle.
- Developments in the Scantibodies litigation, the personal-care trade-name impairment risk, and potential Passport contingent consideration.
- Final Tax Act measurement-period adjustments and the effects of new lease-accounting requirements, which the company was still evaluating.