Ecolab Inc. — Q2 2010 Form 10-Q
Business context and reporting period. Ecolab provides cleaning, sanitizing and related services. This unaudited quarterly filing covers the quarter and six months ended June 30, 2010, compared with the same 2009 periods. The interim financial statements received a review, not an audit.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Net sales | $1,520.2m | $1,441.5m | $2,952.3m | $2,789.7m |
| Operating income | $204.3m | $165.0m | $358.1m | $262.5m |
| Net income attributable to Ecolab | $129.3m | $99.1m | $224.8m | $156.5m |
| Diluted EPS | $0.54 | $0.41 | $0.94 | $0.65 |
| Net cash provided by operating activities | — | $365.0m | $299.4m |
- Q2 sales grew 5% as reported and 3% at fixed currency; the six-month increases were 6% and 3%, respectively. Q2 growth reflected 2% volume, 1% pricing and 2% foreign exchange.
- Gross margin was 50.7% in Q2 versus 49.7%, and 50.3% for the first half versus 48.6%. Management cited volume, pricing and lower delivered product costs.
- Reported operating income rose 24% in Q2 and 36% year to date. Excluding special gains and charges, adjusted operating income rose 8% and 12%, respectively; these are non-GAAP measures.
- Adjusted diluted EPS was $0.56 in Q2, up 12%, and $0.97 for the first half, up 17%. Reported diluted EPS increased 32% and 45%, respectively. Comparisons were affected by prior-year restructuring charges and discrete tax items.
- SG&A was 37.2% of sales in Q2 versus 36.5%, and 38.1% for the first half versus 37.4%. The company attributed the increase to business, personnel and systems investment and other cost increases.
- Q2 sales at fixed currency increased 5% internationally and 3% in U.S. Cleaning & Sanitizing; U.S. Other Services sales were flat. Asia Pacific and Latin America each grew 9% internationally.
Financial position, liquidity and cash flow
- At June 30, cash was $121.3m; total debt was approximately $963.7m, versus $967.3m at year-end 2009. Debt to capitalization rose to 34% from 32%, reflecting lower equity, including share repurchases and currency translation.
- Current debt increased to $326.7m from $98.5m at year-end, primarily because $150m of 6.875% notes due February 2011 became current and commercial paper borrowings increased. Long-term debt was $637.0m.
- Operating cash flow was $365.0m, up from $299.4m. Capital expenditures were $125.4m and capitalized software spending was $21.1m; investing activities used $134.9m. Financing activities used $163.8m, including $202m of share repurchases and $73.4m of dividends.
- The company reported $121m of U.S. commercial paper outstanding and none under its European program. Its $600m credit facility, expiring June 2012, supports combined commercial paper programs capped at $600m. Management said it was compliant with debt covenants and had sufficient borrowing capacity and expected cash resources for foreseeable needs.
Material changes, outlook and risks
- Management described Q2 earnings growth as strong, citing sales growth, cost savings and lower delivered product costs. It continued to invest in sales and service, IT, R&D and new markets. No specific full-year earnings or sales guidance is provided in the filing.
- Special charges were $0.6m in Q2 2010 and $4.1m for the first half, compared with $25.0m and $51.5m in the corresponding 2009 periods. The 2010 first-half amount included a $4.2m charge from Venezuela’s currency devaluation; management did not expect related future remeasurement effects to be material.
- At the annual goodwill test, management found no impairment for GCS Service’s $43m goodwill; estimated fair value would need to fall approximately 30% to indicate potential impairment. The estimate is particularly sensitive to revenue growth, with risks including weak economic conditions, uncertainty in U.S. foodservice and timing of customer additions.
- Risks include ordinary-course litigation and environmental matters; adverse developments could cause material charges or affect results and cash flows, though the company did not expect a material effect on consolidated financial position. A wage-hour class settlement received final court approval and was paid in May; it had been accrued and was not material.
- The company expects approximately $12m of additional international pension contributions in the second half of 2010; it was not required to contribute to its U.S. pension or postretirement health plans for 2010. It also disclosed $108m of gross uncertain tax positions and did not expect significant payments within the next year.
- Management reported no material change in risk factors from the 2009 Form 10-K. Foreign exchange remains significant: translation reduced reported sales and lowered accumulated other comprehensive equity during the first half. The company uses derivatives and foreign-currency debt to manage exposures and says it does not use derivatives speculatively.
Investor verification priorities
- Reconcile GAAP growth with non-GAAP adjusted results, including special charges, discrete tax items and favorable currency effects.
- Review near-term refinancing and liquidity needs, particularly the $150m notes due February 2011 and the rise in current debt to $326.7m.
- Assess whether international and U.S. sales growth, pricing and margin improvements are sustainable given the market conditions described by management.
- Monitor GCS Service performance and the revenue-growth assumptions underpinning its goodwill valuation.
- Track Venezuela currency effects, pension funding, uncertain tax positions and legal or environmental contingencies.
- Consider the effect of the $202m share repurchase program on equity, leverage and cash available for investment and dividends.