CLX

Business Context and Reporting Period

Company: The Clorox Company
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Three and six months ended December 31, 2005 (Fiscal Year 2006, Q2)
Business Overview: The Company manufactures and markets household and professional products, including bleach, cleaning, water-filtration, automotive-care, plastic bags, wraps, containers, charcoal, cat litter, and food products. Operations are segmented into Household Group – North America, Specialty Group, and International.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 6% for both the three and six-month periods compared to the prior year, driven by a 2% volume increase, price increases, and favorable foreign exchange rates.
• Profitability Decline: Diluted EPS from continuing operations decreased 24% ($0.17) for the quarter and increased only 3% ($0.04) for the six-month period. The prior year included a $20 gain on the exchange of an equity investment in Henkel Iberica, S.A., which is not present in the current period.
• Margin Compression: Gross profit margins declined by 210 basis points (quarter) and 180 basis points (six months) due to higher raw material costs and transition costs related to Kingsford charcoal improvements.
• Expense Increases: Selling and administrative expenses rose 20% (quarter) and 16% (six months), primarily due to the adoption of SFAS No. 123-R (share-based compensation) and higher incentive compensation accruals. Interest expense increased significantly due to $1,650 in senior notes issued in connection with the Henkel share exchange.
• Cash Flow: Net cash provided by operations dropped to $83 million for the six months ended Dec 31, 2005, from $405 million in the prior year, largely due to a $151 million income tax settlement payment and higher working capital requirements.

Guidance, Outlook, and Risks

• Price Increases: Management plans to implement price increases ranging from 5% to 15% on approximately 40% of its portfolio in the third quarter of fiscal 2006 to offset rising raw material and energy costs.
• Cost Management: The Company is reducing travel and consulting fees, eliminating or delaying projects, and pursuing additional cost savings.
• Share Repurchases: The Company repurchased 2.4 million shares for $135 million under its "evergreen" program to offset dilution. An open-market program with $768 million remaining authorization had no activity in this period.
• Accounting Changes: Adoption of SFAS No. 123-R effective July 1, 2005, resulted in additional compensation costs of $15 million for the six-month period.
• Contingencies:
  • Tax Settlement: Paid $151 million to resolve IRS issues from 1997-2000.
  • Environmental: Recorded liability of $30 million for remediation costs, primarily related to a site in Dickinson County, Michigan.
  • Guarantees: Aggregate maximum exposure of $299 million related to indemnifications, primarily a $250 million indemnity to Henkel KGaA.

Investor Verification Checklist

• Raw Material Costs: Verify the impact of rising resin, diesel, and chlor-alkali costs on future gross margins and the effectiveness of planned price increases.
• Debt Service: Assess the impact of increased interest expense from the $1,650 million senior notes on future earnings and cash flow.
• Share-Based Compensation: Monitor the ongoing impact of SFAS No. 123-R adoption on operating expenses and EPS.
• Environmental Liability: Review the status of the Dickinson County, Michigan remediation and potential for costs to exceed the $30 million recorded liability.
• Customer Concentration: Note that Wal-Mart Stores, Inc. accounted for 27% of consolidated net sales for the period.