Church & Dwight Co Inc: Form 10-Q for the period ended Sep 30, 2023

Recent Developments

We continue to monitor the impact of both inflation and recessionary indicators including the effect of corresponding government actions, such as raising interest rates to counteract inflation, that may negatively impact consumer spending, especially for our discretionary brands, and how these factors will potentially influence future cash flows for the short and long term.

Inflation and recessionary concerns are continuing to drive a decline in consumer spending for our most discretionary brands, Waterpik and Flawless, as consumers reduce spending in these categories and shift to lower cost alternatives. Most notably, a growing number of water flosser consumers have switched to more value-branded products. To address these demand shifts, we are taking steps to better manage production schedules and inventory levels for those products along with increasing promotional activities and marketing spend, as well as continuing efforts to develop lower cost water flosser alternatives.

In our vitamin business, we have experienced residual impacts from previous vitamin-specific supply chain challenges that, in some cases, have resulted in reduced shelf space at certain retailers.

In addition, our Specialty Products business has been negatively impacted by the entrance of new foreign competition in the United States dairy market. We expect that low-priced imports will continue to enter the market.

Looking forward, the impact that these challenges will continue to have on our operational and financial performance will depend on future developments, including inflationary impacts, rising interest rates, recessionary concerns, retail customers' acceptance of all or a portion of any price increases, the spread and severity of new COVID-19 variants, and the long-term impact of vaccines. Additionally, we may be impacted by our ability to recruit and retain a workforce and engage third-parties to manufacture and distribute our products, as well as any future government actions affecting employers and employees, consumers and the economy in general. While we expect that many of these effects will be transitory and that our value-focused portfolio positions us well in inflationary and slowing economic environments, it is impossible to predict their impact.

For additional discussion of how we are addressing decreased consumer demand for discretionary brands, as well as lower growth and increased competition in the vitamin category, please refer to Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K.

Results of Operations

Consolidated results

Diluted Net Income per share was $0.71 in the third quarter of 2023 as compared to $0.76 in the third quarter of 2022. Diluted Net Income per share was $2.43 in the first nine months of 2023 as compared to $2.35 in the same period in 2022.

Net Sales

Net sales for the quarter ended September 30, 2023 were $1,455.9, an increase of $138.6 or 10.5% as compared to the same period in 2022. Net sales for the nine months ended September 30, 2023 were $4,339.9, an increase of $400.3 or 10.2% over the comparable nine month period of 2022. The components of the net sales increase are as follows:

(1) On October 13, 2022, we completed the Hero Acquisition. Hero is included in our results since the date of acquisition.

For both the three and nine months ended September 30, 2023, the volume change reflects increased product unit sales in the Consumer Domestic and Consumer International segments, with volume declines in SPD. For both the three and nine months ended September 30, 2023, price/mix was favorable in the Consumer Domestic and Consumer International segments and unfavorable in SPD.

Gross Profit / Gross Margin

Our gross profit was $646.3 for the three months ended September 30, 2023, a $96.6 increase as compared to the same period in 2022. Gross margin increased 270 basis points (“bps”) in the third quarter of 2023 compared to the same period in 2022, due to the positive impact of productivity programs of 160 bps, favorable price/volume/mix of 140 bps, benefits from the Hero Acquisition of 120 bps, and lower transportation costs of 110 bps, partially offset by higher manufacturing costs including labor and commodities of 260 bps. Gross profit was $1,907.2 for the nine months ended September 30, 2023, a $259.7 increase compared to the same period in 2022. Gross margin increased 210 bps in the first nine months of 2023 compared to the same period in 2022, due to favorable price/volume/mix of 190 bps, the impact of productivity programs of 160 bps, benefits from the Hero Acquisition of 120 bps, lower transportation costs of 100 bps, and favorable foreign exchange rates of 10 bps, partially offset by higher manufacturing costs including labor and higher commodities of 370 bps.

Operating Expenses

Marketing expenses for the three months ended September 30, 2023 were $167.8, an increase of $27.1 or 19.3% as compared to the same period in 2022. Marketing expenses as a percentage of net sales in the third quarter of 2023 increased by 80 bps to 11.5% as compared to 10.7% in the same period in 2022 due to 180 bps on higher expense from increased marketing spend as fill rates improved, offset by 100 bps of leverage on higher net sales. Marketing expenses for the nine months ended September 30, 2023 were $422.3, an increase of $76.8 or 22.2% as compared to the same period in 2022. Marketing expenses as a percentage of net sales for the first nine months of 2023 increased by 90 bps to 9.7% as compared to 8.8% in the same period in 2022 due to 170 bps on higher expense from increased marketing spend as fill rates improved, offset by 80 bps of leverage on higher net sales.

SG&A expenses were $222.7 in the third quarter of 2023, an increase of $67.6 or 43.6% as compared to the same period in 2022. SG&A as a percentage of net sales increased 360 bps to 15.3% in the third quarter of 2023 as compared to 11.7% in the same period in 2022. The increase is due to 460 bps on higher expenses, primarily from the Hero Acquisition (including $7.3 of expense related to restricted stock issued for the acquisition) and higher incentive compensation costs which reflects improved business performance, offset by 100 bps of leverage associated with higher sales. SG&A expenses for the first nine months of 2023 were $643.6, an increase of $137.8 or 27.2% as compared to the same period in 2022. SG&A as a percentage of net sales increased 200 bps to 14.8% in the first nine months of 2023 compared to 12.8% in 2022 due to 320 bps on higher expenses, primarily from the Hero Acquisition (including $21.9 of expense related to restricted stock issued for the acquisition) and higher incentive compensation costs which reflects improved business performance, offset by 120 bps of leverage associated with higher sales.

Other income (expense), net for the three and nine months ended September 30, 2023 increased $3.1 and $6.1 to $3.7 and $6.7, respectively, as compared to the same periods in 2022, primarily due to higher investment income.

Interest expense for the three and nine months ended September 30, 2023 increased $3.5 and $24.3 to $27.2 and $83.9, respectively, as compared to the same periods in 2022, primarily due to higher average interest rates on outstanding debt.

Income Taxes

The effective tax rate for the three months ended September 30, 2023 was 24.1%, compared to 20.2% in the same period in 2022. The increase in the rate is mainly due to a discrete benefit related to a state tax rate reduction in the period ending September 30, 2022.

The effective tax rate for the nine months ended September 30, 2023 was 22.1%, compared to 22.6% in the same period in 2022. The decrease in the rate relates to the benefit from higher stock option exercises in the current quarter partially offset by a one-time state tax rate reduction in the period ending September 30, 2022.

Segment results

We operate three reportable segments: Consumer Domestic, Consumer International and SPD. These segments are determined based on differences in the nature of products and organizational structure. We also have a Corporate segment.

The Corporate segment income consists of equity in earnings of affiliates. As of September 30, 2023, we held 50% ownership interests in each of Armand Products Company (“Armand”) and The ArmaKleen Company (“ArmaKleen”), respectively. Our equity in earnings of Armand and ArmaKleen, totaling $1.7 and $3.7 for the three months ended September 30, 2023 and 2022, respectively, and $8.1 and $10.0 for the nine months ended September 30, 2023 and 2022, respectively, are included in the Corporate segment. Certain 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 set forth below.

Segment net sales and income before income taxes for the three and nine months ended September 30, 2023 and September 30, 2022 are as follows:

(1) Intersegment sales from Consumer International to Consumer Domestic, which are not reflected in the table, were $4.7 and $3.9 for the three months ended September 30, 2023 and September 30, 2022, respectively, and were $11.7 and $12.5 for the nine months ended September 30, 2023 and September 30, 2022, respectively.

(2) In determining income before income taxes, interest expense, investment earnings and certain aspects of other income and expense were allocated among the segments based upon each segment’s relative income from operations.

(3) Corporate segment consists of equity in earnings of affiliates from Armand and ArmaKleen for the three and nine months ended September 30, 2023 and September 30, 2022.

Product line revenues from external customers are as follows:

Household Products include laundry, deodorizing, and cleaning products. Personal Care Products include condoms, pregnancy kits, oral care products, skin care and hair care products, cold and remedy products, and gummy dietary supplements.

Consumer Domestic

Consumer Domestic net sales in the third quarter of 2023 were $1,133.1, an increase of $122.7 or 12.1% as compared to the same period in 2022. Consumer Domestic net sales for the nine months ended September 30, 2023 were $3,378.2, an increase of $368.0 or 12.2% as compared to the same period in 2022. The components of the net sales change are the following:

(1) Hero has been included in our results since October 13, 2022 (the date of the acquisition).

The increase in net sales for three months ended September 30, 2023, reflects the impact of the Hero Acquisition, and the impact of higher sales of THERABREATH® mouth wash, ARM & HAMMER® cat litter, XTRA® liquid detergent, WATERPIK® water flossers, and BATISTE® dry shampoo, partially offset by declines in VITAFUSION® and L’IL CRITTERS® gummy vitamins, FINISHING TOUCH FLAWLESS® hair removal products, and FIRST RESPONSE® pregnancy kits. The increase in net sales for the nine-month period ending September 30, 2023, reflects the impact of the Hero Acquisition, and the impact of higher sales of THERABREATH® mouth wash, ARM & HAMMER® cat litter, ARM & HAMMER® liquid detergent, XTRA® liquid detergent, and BATISTE® dry shampoo, partially offset by declines in FINISHING TOUCH FLAWLESS® hair removal products, and FIRST RESPONSE® pregnancy kits.

Consumer Domestic income before income taxes for the third quarter of 2023 was $203.4, a $9.5 increase as compared to the third quarter of 2022. The increase is due to the gross margin benefit of higher sales volumes related to the Hero Acquisition of $57.1, lower manufacturing and distribution expenses of $20.9, favorable price/mix of $18.6, partially offset by higher SG&A expenses of $63.5 (including $24.3 related to Hero), higher marketing expenses of $22.0, and higher interest and other expenses of $1.6. For the nine-month period ended September 30, 2023, income before income taxes was $662.8, a $44.5 increase as compared to the first nine months of 2022. The increase is due to favorable price/mix of $141.0, the gross margin benefit of higher sales volumes related to the Hero Acquisition of $118.6, lower manufacturing and distribution expenses of $4.6, partially offset by higher SG&A expenses of $129.6 (including $67.4 related to Hero), higher marketing expenses of $71.7, and higher interest and other expenses of $18.4.

Consumer International

Consumer International net sales were $244.4 in the third quarter of 2023, an increase of $24.7 or 11.2% as compared to the same period in 2022. Consumer International net sales in the first nine months of 2023 were $716.9, an increase of $52.1 or 7.8% as compared to the same period in 2022. The components of the net sales change are the following:

(1) Hero has been included in our results since October 13, 2022 (the date of the acquisition).

Excluding the impact of foreign exchange rates, sales growth in the third quarter ended September 30, 2023 is driven by STERIMAR® nasal congestion relief, OXICLEAN® stain removers, and VITAFUSION® and L’IL CRITTERS® gummy vitamins in the Global Markets Group ("GMG"), STERIMAR® nasal congestion relief and ARM & HAMMER® liquid detergent in Mexico, STERIMAR® nasal congestion relief in Europe, and GRAVOL® anti-nauseant and ANUSOL® hemorrhoid ointments in Canada. The increase in net sales for the nine-month period ending September 30, 2023, is driven by BATISTE® dry shampoo, THERABREATH® mouth wash, OXICLEAN® stain removers and STERIMAR® nasal congestion relief in GMG, BATISTE® dry shampoo, GRAVOL® anti-nauseant, THERABREATH® mouth wash, and OXICLEAN® stain removers in Canada, STERIMAR® nasal congestion relief and BATISTE® dry shampoo in Europe, and STERIMAR® nasal congestion relief, ARM & HAMMER® liquid detergent, and ARM & HAMMER® dental care in Mexico.

Consumer International income before income taxes was $22.7 in the third quarter of 2023, which is consistent compared to the third quarter of 2022. Favorable price/mix of $17.2, favorable foreign exchange rates of $2.9, the impact of higher sales volumes of $1.2, and lower interest and other expenses of $0.5 were offset by higher SG&A expenses of $10.2, higher manufacturing and commodity costs of $6.3, and higher marketing expenses of $5.3. For the first nine months of 2023, income before income taxes was $79.1, a $1.7 decrease as compared to the same period in 2022. Higher manufacturing and commodity costs of $27.0, higher SG&A expenses of $16.9, higher marketing expenses of $5.3, and higher interest and other expenses of $0.7, were partially offset by favorable price/mix of $38.4, the impact of higher sales volumes of $8.4, and favorable foreign exchange rates of $1.2.

Specialty Products (“SPD”)

SPD net sales were $78.4 in the third quarter of 2023, a decrease of $8.8 or 10.1% as compared to the same period in 2022. SPD net sales were $244.8 for the first nine months of 2023, a decrease of $19.8, or 7.5% as compared to the same period in 2022. The components of the net sales change are the following:

Net sales decreased in the three and nine months ended September 30, 2023 primarily due to competitive imports within our domestic dairy business.

SPD income before income taxes was $6.2 in the third quarter of 2023, a decrease of $8.0 as compared to the same period in 2022 due to higher SG&A expenses of $4.0, lower sales volumes of $2.2, unfavorable price/product mix of $1.6, and unfavorable manufacturing costs of $0.8 partially offset by lower interest and other expenses of $0.6. SPD income before income taxes was $22.2 in the first nine months of 2023, a decrease of $15.9 as compared to the same period in 2022 due to higher SG&A expenses of $8.7, lower volumes of $5.2, unfavorable price/product mix of $2.3, and unfavorable manufacturing costs of $0.3, partially offset by lower interest and other expenses of $0.8.

Corporate

The Corporate segment includes equity in earnings of affiliates from Armand and ArmaKleen in the three and nine months of 2023 and 2022. The Corporate segment income before income taxes was $1.7 in the third quarter of 2023, as compared to $3.7 in the same period in 2022. The Corporate segment income before income taxes was $8.1 for the first nine months of 2023, as compared to $10.0 in the same period in 2022.

Liquidity and Capital Resources

On June 16, 2022, we entered into a credit agreement (the “Credit Agreement”) that provides for our $1,500.0 unsecured revolving credit facility (the “Revolving Credit Facility”) that matures on June 16, 2027, unless extended. We have the ability to increase our borrowing up to an additional $750.0, subject to lender commitments and certain conditions as described in the Credit Agreement. Borrowings under the Credit Agreement are available for general corporate purposes and are used to support our $1,500.0 commercial paper program.

As of September 30, 2023, we had $573.3 in cash and cash equivalents, and approximately $1,495.0 available through the Revolving Credit Facility and our commercial paper program. To preserve our liquidity, we invest cash primarily in government money market funds, prime money market funds, short-term commercial paper and short-term bank deposits.

In the first quarter of 2023, we repaid $200.0 of our $400.0 Term Loan due December 22, 2024 with cash on hand and commercial paper borrowings.

The current economic environment presents risks that could have adverse consequences for our liquidity. See “Unfavorable economic conditions could adversely affect demand for our products” under “Risk Factors” in Item 1A of our Form 10-K. We continue to manage all aspects of our business including, but not limited to, monitoring the financial health of our customers, suppliers and other third-party relationships, implementing gross margin enhancement strategies and developing new opportunities for growth. We do not anticipate that current economic conditions will adversely affect our ability to comply with the financial covenant in the Credit Agreement because we currently are, and anticipate that we will continue to be, in compliance with the requirements under the Credit Agreement.

On October 28, 2021, the Board authorized a share repurchase program, under which we had initial availability to repurchase up to $1,000.0 in shares of Common Stock (the “2021 Share Repurchase Program”). The 2021 Share Repurchase Program does not have an expiration and replaced the 2017 Share Repurchase Program. The 2021 Share Repurchase Program did not modify our evergreen share repurchase program, authorized by the Board on January 29, 2014, under which we may repurchase, from time to time, Common Stock to reduce or eliminate dilution associated with issuances of Common Stock under its incentive plans. There have been no stock repurchases in 2023.

As of September 30, 2023, there remains $729.7 of share repurchase availability under the 2021 Share Repurchase Program.

On February 1, 2023, the Board declared a 4% increase in the regular quarterly dividend from $0.2625 to $0.2725 per share, equivalent to an annual dividend of $1.09 per share. The increase raises the annual dividend payout from $255.0 to approximately $265.0.

We anticipate that our cash from operations, together with our current borrowing capacity, will be sufficient to fund our share repurchase programs, pay debt and interest as it comes due, fund dividends, and meet our capital expenditure program costs. Capital expenditures in 2023 are expected to be approximately $230.0 primarily for manufacturing capacity investments in laundry, litter and vitamins to support expected future sales growth. Cash, together with our current borrowing capacity, may be used for acquisitions that would complement our existing product lines or geographic markets.

Cash Flow Analysis

Net Cash Provided by Operating Activities – Our primary source of liquidity is the cash flow provided by operating activities, which is dependent on net income and changes in working capital. Our net cash provided by operating activities in the nine months ended September 30, 2023 increased by $261.0 to $795.1 as compared to $534.1 in the same period in 2022 due to an improvement in working capital and an increase in cash earnings (net income adjusted for non-cash items) including the impact of recent acquisitions. The improvement in working capital is primarily related to lower investment in inventory for our discretionary brands and higher incentive compensation accruals. We measure working capital effectiveness based on our cash conversion cycle. The following table presents our cash conversion cycle information for the quarters ended September 30, 2023 and 2022:

Our cash conversion cycle (defined as the sum of DSO and DIO less DPO) which is calculated using a two-period average method, decreased 1 day from the prior year primarily due to lower investments in inventory for our discretionary brands. We continue to focus on reducing our working capital requirements.

Net Cash Used in Investing Activities – Net cash used in investing activities during the first nine months of 2023 was $128.4, primarily reflecting $121.5 property, plant and equipment additions. Net cash used in investing activities during the first nine months of 2022 was $100.7, primarily reflecting $98.1 for property, plant and equipment additions.

Net Cash Used in Financing Activities – Net cash used in financing activities during the first nine months of 2023 was $363.0, reflecting $199.9 of cash dividend payments and $270.6 of net debt repayments, partially offset by $107.6 of proceeds from stock option exercises. Net cash used in financing activities during the first nine months of 2022 was $226.0, reflecting $191.2 of cash dividend payments, $49.7 of net debt repayments, and $7.5 of deferred financing costs, partially offset by $22.4 of proceeds from stock option exercises.

Market risk

For quantitative and qualitative disclosures about market risk affecting the Company, see “Quantitative and Qualitative Disclosures About Market Risk” in Item 7A of Part II in the Form 10-K.

a) Evaluation of Disclosure Controls and Procedures

The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) at 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 effective to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the United States Securities and Exchange Commission (the “Commission”), and (ii) accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding the disclosure.

b) Change in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurring during the Company’s most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

CAUTIONARY NOTE ON FORWARD-LOOKING INFORMATION

This report contains forward-looking statements, including, among others, statements relating to net sales and earnings growth; gross margin changes; trade, marketing and SG&A spending; marketing expense as a percentage of net sales; sufficiency of cash flows from operations; earnings per share; the impact of new accounting pronouncements; cost savings programs; recessionary conditions; interest rates; inflation; consumer demand and spending; the effects of competition; the effect of product mix; volume growth, including the effects of new product launches into new and existing categories; the decline of condom usage; the Company’s hedge programs; the impact of foreign exchange, and commodity price fluctuations; impairments and other charges; the Company’s investments in joint ventures; the impact of acquisitions (including earn-outs) and divestitures; capital expenditures; the Company’s effective tax rate; the impact of tax audits; tax changes; the effect of the credit environment on the Company’s liquidity and capital resources; the Company’s fixed rate debt; compliance with covenants under the Company’s debt instruments; the Company’s commercial paper program; the Company’s current and anticipated future borrowing capacity to meet capital expenditure program costs; the Company’s share repurchase programs; payment of dividends; environmental and regulatory matters; the availability and adequacy of raw materials, including trona reserves and the conversion of such reserves; and the customers and consumer acceptance of certain ingredients in our products. Other forward-looking statements in this report are generally identified by the use of such terms as “may,” “could,” “expect,” “intend,” “believe,” “plan,” “estimate,” “forecast,” “project,” “anticipate,” “to be,” “to make” or other comparable terms. These statements represent the intentions, plans, expectations and beliefs of the Company, and are based on assumptions that the Company believes are reasonable but may prove to be incorrect. In addition, these statements 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. Factors that could cause such differences include a decline in market growth, retailer distribution and consumer demand (as a result of, among other things, political, economic and marketplace conditions and events), including those relating to the outbreak of contagious diseases; other impacts of the COVID-19 pandemic and its impact on the Company’s operations, customers, suppliers, employees, and other constituents, and market volatility and impact on the economy (including contributions to recessionary conditions), resulting from global, nationwide or local or regional outbreaks or increases in infections, new variants, and the risk that the Company will not be able to successfully execute its response plans with respect to the pandemic or localized outbreaks and the corresponding uncertainty; the impact of regulatory changes or policies associated with the COVID-19 pandemic, including continuing or renewed shutdowns of retail and other businesses in various jurisdictions; the impact of new legislation such as the U.S. CARES Act, the EU Medical Device Regulation, new cosmetic and device regulations in Mexico, and the U.S. Modernization of Cosmetic Regulation Act; the impact on the global economy of the Russia/Ukraine war, including the impact of export controls and other economic sanctions; potential recessionary conditions or economic uncertainty; the impact of continued shifts in consumer behavior, including accelerating shifts to on-line shopping; unanticipated increases in raw material and energy prices, including as a result of the Russia/Ukraine war or other inflationary pressures; delays and increased costs in manufacturing and distribution; increases in transportation costs; labor shortages; the impact of price increases for our products; the impact of inflationary conditions; the impact of supply chain and labor disruptions; the impact of severe or inclement weather on raw material and transportation costs; adverse developments affecting the financial condition of major customers and suppliers; competition; changes in marketing and promotional spending; growth or declines in various product categories and the impact of customer actions in response to changes in consumer demand and the economy, including increasing shelf space or on-line share of private label and retailer-branded products or other changes in the retail environment; consumer and competitor reaction to, and customer acceptance of, new product introductions and features; the Company’s ability to maintain product quality and characteristics at a level acceptable to our customers and consumers; disruptions in the banking system and financial markets; the Company’s borrowing capacity and ability to finance its operations and potential acquisitions; higher interest rates; foreign currency exchange rate fluctuations; implications of the United Kingdom’s withdrawal from the European Union; transition to, and shifting economic policies in the United States; potential changes in export/import and trade laws, regulations and policies of the United States and other countries, including any increased trade restrictions or tariffs; increased or changing regulation regarding the Company’s products and its suppliers in the United States and other countries where it or its suppliers operate; market volatility; issues relating to the Company’s information technology and controls; the impact of natural disasters, including those related to climate change, on the Company and its customers and suppliers, including third party information technology service providers; integrations of acquisitions or divestiture of assets; the outcome of contingencies, including litigation, pending regulatory proceedings and environmental matters; and changes in the regulatory environment in the countries where we do business.

The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by the United States federal securities laws. You are advised, however, to consult any further disclosures the Company makes on related subjects in its filings with the United States Securities and Exchange Commission (the “Commission”).

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Item 1A, “Risk Factors” in the Form 10-K, which could materially affect the Company’s business, financial condition or future results.