Ecolab Inc. — Q2 2012 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2012. Ecolab’s December 2011 merger with Nalco materially changed the business; comparisons with reported 2011 results are therefore not directly comparable. Management also provides 2011 pro forma comparisons assuming the merger had occurred earlier. Figures are in millions except per-share amounts.
Key financial results
- Q2 revenue: $2,958.7, up 74% from reported 2011; against pro forma 2011, up 3% (6% at fixed currency). Growth reflected 3% volume and 2% pricing, partly offset by 3% adverse currency translation.
- Q2 profit: Operating income was $326.5, up 65% reported and 12% versus pro forma; adjusted operating income rose 14% pro forma. Net income attributable to Ecolab was $184.5, up 47% reported. Diluted EPS was $0.62, up 17%; adjusted diluted EPS was $0.72, up 13% pro forma.
- Six-month results: Revenue of $5,769.6 was up 79% reported and 6% pro forma. Operating income of $492.3 rose 41% reported but fell 24% versus pro forma; adjusted operating income increased 16% pro forma. Net income attributable to Ecolab was $234.2, up 7% reported; diluted EPS of $0.79 declined 15%, while adjusted diluted EPS of $1.22 increased 12%.
- Margins and expenses: Reported gross margin was 45.6% in Q2 and 44.1% for the half, versus 49.3% in each 2011 reported period. Adjusted gross margin was 45.7% for Q2 and 45.5% for the half, compared with pro forma 2011 margins of 45.9% and 46.0%. Six-month reported margin included a 1.4 percentage-point impact from Nalco inventory fair-value step-up and restructuring. SG&A was 33.2% of Q2 sales and 34.2% for the half; leverage from sales and cost savings helped reduce the ratios.
- Cash flow: Operating cash flow was $211.1 for the first half, down from $302.1. The company cited higher pension contributions ($201 versus $123 in 2011) and restructuring payments as factors. Investing used $280.3, including $254.5 of capital expenditures; financing used $1,454.1, chiefly reflecting $1.7 billion of long-term debt repayments.
- Debt and liquidity: Cash was $304.9 at June 30, down from $1,843.6 at year-end. Short-term debt was $1,445.3 and long-term debt $4,879.2, or approximately $6.3 billion total, versus $7.6 billion at year-end. Debt-to-capitalization declined to 53% from 57%. Commercial paper outstanding was $1.3 billion at a 0.5% average annual rate; credit facilities were undrawn. Management said covenant requirements were met and borrowing capacity was sufficient for foreseeable needs.
- Other measures: Ecolab declared dividends of $0.20 per share in Q2 versus $0.175 a year earlier. Total assets were $16.5 billion versus $18.2 billion at year-end. The effective tax rate was 30.2% for Q2 and 33.5% for the first half.
Material changes and management commentary
- The Nalco merger added Global Water, Global Paper and Global Energy reporting segments. On a pro forma basis, Q2 Global Energy sales grew 19%, while Global Water grew 1% and Global Paper declined 2%; Global Energy operating income grew 18%, while Global Paper operating income fell 9%.
- Management attributed adjusted operating-income growth to volume and pricing gains, which more than offset higher delivered product costs and business investment. Global Energy growth was driven by strong upstream volumes and market-share gains; Global Paper faced lower plant utilization, downtime and the exit of certain low-margin business.
- For the six months, special gains and charges totaled $175.8, including $71.2 of Nalco inventory fair-value step-up, $18.2 of debt-extinguishment loss, merger and integration costs, and restructuring charges. The 2011 pro forma comparison also included a $136.0 gain on Nalco business sales.
- Management expects the 2011 restructuring plan to cost about $150 million through 2013 and generate approximately $120 million in annualized savings when fully realized. The merger restructuring plan is expected to cost about $180 million through 2013; merger restructuring and synergies together are expected to reach approximately $250 million in annual savings by the end of 2014. These are estimates, not guarantees.
- Management expected to fund foreseeable requirements over the next 12 months with operating cash flow, cash reserves and borrowings. It also anticipated approximately $75 million of 2012 savings and synergies from merger-related actions.
Risks, contingencies and unusual matters
- Management highlighted European economic weakness and possible euro disruption, foreign-exchange exposure, and Venezuelan currency and government-policy uncertainty. Europe represented about 20% of first-half sales; Venezuela about 1%.
- Nalco remains involved in litigation related to its COREXIT dispersant and the Deepwater Horizon incident, including claims consolidated in federal multidistrict litigation and related cross-claims. Proposed BP/claimant settlements were preliminarily approved, with a fairness hearing scheduled for November 2012. Ecolab said it believes claims against Nalco are without merit and intends to defend them; outcomes and potential future exposure are uncertain.
- Other contingencies include wage-hour, product liability, environmental, tax and commercial matters. The filing does not provide a clear quantified potential loss for the Deepwater Horizon claims. Management stated it did not believe material losses beyond amounts accrued were reasonably possible for the legal matters generally, while noting litigation uncertainty.
- The company completed its annual goodwill impairment testing and reported no impairment. However, goodwill and certain Nalco purchase-price allocation amounts remained subject to change. Interim financial statements were reviewed by the independent auditor, not audited.
- The filing disclosed immaterial balance-sheet classification corrections related to deferred taxes and March 2012 classifications; management said they did not affect income or total operating cash flow and were immaterial to previously issued statements.
Important facts for investors to verify
- Compare performance using the merger pro forma and adjusted measures, and review the reconciliations and excluded items alongside GAAP results.
- Track whether promised restructuring savings and merger synergies materialize relative to their expected costs, timing and workforce reductions.
- Monitor operating cash conversion, pension contributions, capital spending, commercial-paper balances and upcoming short-term debt maturities.
- Assess Global Energy growth sustainability and Global Paper trends, alongside currency effects and European and Venezuelan exposure.
- Follow the Deepwater Horizon litigation and settlement process, any developments in estimated liabilities, and finalization of Nalco purchase-price allocations.