Ecolab Inc. — Second-Quarter 2013 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and six months ended June 30, 2013, compared with the corresponding 2012 periods. Ecolab provides cleaning, sanitizing, water treatment, food safety, healthcare, pest elimination and energy-related products and services. On April 10, 2013, it completed the acquisition of Champion Technologies, adding a global oil-and-gas products and services business to Global Energy. Segment comparisons use Ecolab’s new 2013 reporting structure; 2012 segment results were recast.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $3,337.8 million | $2,958.7 million | $6,209.9 million | $5,769.6 million |
| Operating income | $352.3 million | $326.5 million | $614.0 million | $492.3 million |
| Net income attributable to Ecolab | $213.1 million | $184.5 million | $372.7 million | $234.2 million |
| Diluted EPS | $0.69 | $0.62 | $1.23 | $0.79 |
| Operating cash flow | Not separately presented | Not separately presented | $393.0 million | $211.1 million |
Q2 sales rose 13% as reported and 14% at fixed currency; acquisition-adjusted fixed-currency sales increased 6%. Q2 operating income rose 8%, net income 16% and diluted EPS 11%. Excluding special charges and discrete tax items, management reported Q2 adjusted operating income growth of 19% and adjusted diluted EPS growth of 19% ($0.86 versus $0.72). For the six months, sales increased 8%, reported operating income 25%, net income 59% and diluted EPS 56%; adjusted operating income increased 15% and adjusted diluted EPS 20%. Adjusted measures are non-GAAP and should be considered alongside GAAP results.
Margins and taxes. Reported gross margin was 45.2% in Q2 2013 versus 45.6% in Q2 2012; six-month margin was 45.4% versus 44.1%. Adjusted gross margin was broadly stable: 45.7% versus 45.7% for Q2 and 45.6% versus 45.5% for the six-month periods. SG&A was 32.5% of sales in Q2 versus 33.2%, and 33.5% versus 34.2% for the six-month periods. The reported effective tax rate was 24.6% for Q2 and 22.5% for the six months, affected by special items and discrete tax benefits; adjusted rates were 28.5% and 28.4%, respectively.
Cash flow, debt and liquidity. Six-month operating cash flow increased to $393.0 million from $211.1 million, with improved income and lower pension contributions partly offset by acquisition-related liabilities, taxes and restructuring payments. Capital expenditures were $265.1 million. Investing activities used $1.729 billion, including $1.452 billion for acquisitions, principally Champion. Financing activities provided $557.8 million. Cash and equivalents fell to $375.2 million from $1.158 billion at year-end 2012; $345 million was held outside the U.S. At June 30, total debt was approximately $7.5 billion, up from $6.5 billion at year-end; debt-to-capitalization increased to 53% from 52%. Current assets were $4.698 billion and current liabilities $3.246 billion. Management said the company was in compliance with debt covenants and had sufficient borrowing capacity for foreseeable needs.
Material changes and operating performance
- Champion generated much of Global Energy’s reported growth: Q2 segment sales rose 64% at fixed currency, while acquisition-adjusted sales grew 14%; six-month growth was 36% and 11%, respectively. The acquired business had approximately $1.3 billion of 2012 sales. Purchase accounting remains preliminary.
- Q2 fixed-currency sales rose 4% in Global Industrial and 3% in Global Institutional. Other segment sales declined 5%, but increased 5% on an acquisition-adjusted basis excluding the Vehicle Care divestiture.
- Management attributed adjusted operating growth to pricing, sales volume, synergies and cost savings, partly offset by business investment. Adjusted gross margin was held steady as pricing, volume, synergies and savings were offset by unfavorable mix, including Global Energy and Champion.
- Assets increased to $19.654 billion from $17.572 billion, largely reflecting Champion. Goodwill rose to $6.862 billion and other intangible assets to $4.945 billion. Goodwill and indefinite-lived intangible impairment tests found no impairment.
Outlook, unusual items and risks
- Restructuring and synergies: The Champion-related Energy Restructuring Plan is expected to cost approximately $80 million pretax through 2015, with $40–$50 million expected in 2013. The plan targets approximately 500 workforce reductions and about $25 million of 2013 cost savings and synergies, rising to $150 million annually by the end of 2015; 2013 savings were not yet significant. The Combined Plan is expected to be substantially complete by year-end 2013, with total charges of $80–$100 million pretax and approximately $25–$45 million still to incur at June 30. Management expected approximately $110 million of incremental 2013 savings versus 2012 from that plan; about $50 million had been achieved in the first half.
- Acquisition and other special items: Q2 special gains and charges totaled $89.1 million, including restructuring, Champion acquisition/integration costs and inventory fair-value step-up. Six-month total was $142.5 million, including a $23.4 million charge related to Venezuela’s February currency devaluation. Adjusted comparisons exclude these and other discrete items.
- Funding and capital allocation: Champion was funded with a $900 million floating-rate term loan, previously issued notes and commercial paper. The term loan is due by April 2016. Management expected foreseeable cash needs—including debt repayments, investment, dividends, repurchases and pension contributions—to be funded from operating cash flow, cash reserves and borrowing. It expected to complete the remaining approximately $126 million of its $1 billion share-repurchase program in 2013, subject to market conditions.
- Business and financial risks: About half of sales are outside the U.S.; management cited currency, political and economic uncertainty, including challenging European conditions. Venezuela represented about 1% of first-half sales; further currency devaluation, exchange controls, supply availability and government price actions could affect results. Champion purchase-price allocations and the estimated $83.9 million additional seller payment remain subject to adjustment or conditions.
- Contingencies: Ecolab disclosed wage-hour litigation and Deepwater Horizon-related claims against Nalco. The court dismissed claims in the B3 master complaint against Nalco with prejudice, but the ruling was not a final judgment for appeal purposes; other claims and cross-claims remain. Management said it believed the claims were without merit and did not expect a material loss beyond accruals, while acknowledging litigation outcomes remain uncertain.
- No subsequent events were reported. The interim financial statements received a limited review, not an audit.
Investor verification priorities
- Track Champion’s contribution to organic growth and profitability separately from acquisition-driven growth, and monitor final purchase accounting, goodwill and intangible-asset amortization.
- Verify delivery, timing and cash costs of the Energy and Combined restructuring plans against stated savings targets.
- Monitor debt, floating-rate term-loan repayment, commercial-paper reliance, cash balances and refinancing capacity.
- Assess the sustainability of reported earnings growth after special charges and discrete tax benefits, using GAAP results alongside management’s non-GAAP measures.
- Follow Venezuela exposure and currency controls, as well as the status and potential financial impact of Deepwater Horizon and wage-hour litigation.