Ecolab Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Ecolab supplies cleaning, sanitation, water-treatment and related products and services through Global Industrial, Global Institutional, Global Energy and Other segments. Interim financial information was reviewed, not audited, by PwC.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $3,689.6 million | $3,460.0 million | $7,160.5 million | $6,622.4 million |
| Operating income | $494.6 million | $419.6 million | $848.9 million | $776.8 million |
| Net income attributable to Ecolab | $351.3 million | $294.8 million | $598.6 million | $548.8 million |
| Diluted EPS | $1.20 | $1.00 | $2.04 | $1.86 |
| Reported gross margin | 41.6% | 40.9% | 40.8% | 41.2% |
Reported sales grew 7% in Q2 and 8% in the first half. At fixed currency rates, sales increased 4% and 5%, respectively; acquisition-adjusted fixed-currency growth was 5% in both periods. Q2 volume and price each contributed 3% and 2%, respectively. Reported operating income rose 18% in Q2 and 9% in the first half, while adjusted operating income increased 5% in both periods; adjusted diluted EPS rose 13% in Q2 to $1.27 and 14% in the first half to $2.18. These adjusted measures exclude special items and, where specified, discrete tax items.
Adjusted gross margin was 41.6% in Q2, flat year over year, and 40.8% for the first half versus 41.5%. Management cited higher delivered product costs and segment mix as pressures, partly offset by pricing and cost savings. Q2 reported tax rate was 22.8%, versus 21.4%; first-half rates were 22.4% and 19.6%. Net interest expense declined to $56.3 million in Q2 and $112.7 million in the first half, primarily due to lower interest rates on debt.
Cash flow, debt and liquidity
- First-half operating cash flow was $785.7 million, down from $859.7 million. Capital expenditures were $412.5 million, up from $378.2 million; cash flow after capital expenditures was $373.2 million.
- Investing activities used $444.4 million, compared with $1,203.9 million in 2017, which included substantially higher acquisition spending. Financing activities used $506.5 million, versus $226.0 million provided in the prior-year period. Ecolab paid $252.3 million in dividends and repurchased $215.8 million of shares.
- At June 30, cash was $54.2 million, current assets were $4,607.9 million and current liabilities were $3,623.8 million. Total debt was approximately $7.22 billion and net debt $7.16 billion; net debt/EBITDA was 2.4x. Short-term debt was $874.5 million, including $189.1 million of commercial paper and $647.5 million of current maturities.
- The company had a $2.0 billion revolving credit facility expiring in November 2022, with no borrowings outstanding. Management said it expected strong operating cash flow and sufficient borrowing capacity to meet foreseeable needs; debt covenants were met. Long-term credit ratings were A- (S&P) and Baa1 (Moody’s), both stable.
Material changes and segment trends
- Global Industrial fixed-currency sales grew 6% in Q2, but operating income declined 2%; margin fell to 12.8% from 13.9%, reflecting costs and business investment.
- Global Institutional sales grew 4% at fixed currency in Q2; operating income declined 2% and margin fell to 19.2% from 20.4%, with investment and delivered product costs weighing on results.
- Global Energy sales rose 5% at fixed currency in Q2, while operating income increased 27% and margin improved to 10.7% from 8.9%. Management cited well-stimulation growth and gains in production and downstream businesses.
- Other fixed-currency sales fell 8%, primarily because of the 2017 Equipment Care divestiture; acquisition-adjusted sales rose 8%, with Pest Elimination growth.
- Foreign currency translation added to reported sales growth, while management’s fixed-currency measures exclude exchange-rate changes. Comparisons reflect retrospective adoption of the new revenue and pension accounting standards. The revenue standard also changed presentation of service revenue and reclassified certain costs.
Outlook, unusual items and risks
- A restructuring plan formally commenced after Q2, with limited related actions and $10.1 million of charges recorded in Q2. The company expects approximately $170 million of costs ($130 million after tax) through 2020 and about $200 million of annual savings by 2021; costs are expected mainly to be cash severance and facility-closure expenses. Actual costs and savings may differ. No numerical full-year sales or EPS guidance is provided in the supplied filing text.
- Q2 and first-half special charges were $12.0 million and $38.0 million, respectively, versus $61.2 million and $68.9 million in 2017. First-half 2018 included a $25 million Ecolab Foundation commitment. The Tax Act transition-tax estimate generated additional expense of $18.2 million in Q2 and $29.5 million in the first half; the estimate remained provisional, and the company had not selected an accounting policy for GILTI.
- Management identified exposure to higher raw-material/product costs, oil and gas market volatility, foreign exchange and political/economic risks, substantial indebtedness, tax-law changes, cybersecurity and ERP implementation, and litigation and environmental matters. Nine Deepwater Horizon-related cases remained pending against Nalco; the company said it expected dismissal under an earlier ruling but could not predict outcomes. It reported participation in environmental assessments/remediation at approximately 45 locations.
- A non-U.S. subsidiary reported Iran-related sales of $1.2 million in its fiscal second quarter and $0.2 million in June 2018, with estimated pretax profit of $0.1 million for each period. Following revocation of General License H, the subsidiary began winding down the activities under the applicable wind-down authorization.
- Management reported effective disclosure controls and no material change in internal control during the first half. ERP implementation will affect processes relevant to financial reporting controls and requires testing.
Important facts for investors to verify
- Whether reported growth converts into sustained organic growth and margin recovery, particularly in Industrial and Institutional, given rising delivered costs and ongoing investments.
- Restructuring execution: timing and cash cost of the $170 million plan versus the projected $200 million annual savings by 2021.
- Cash conversion and working-capital trends, capital spending, and the effect of low cash balances alongside upcoming debt maturities and commercial-paper usage.
- Final Tax Act transition-tax accounting and the effect of discrete tax items on reported earnings and comparability.
- Developments in Deepwater Horizon and environmental matters, Iran wind-down disclosures, and ERP/control testing as implementation proceeds.