Business context and reporting period
Ecolab Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2009. The company provides cleaning, sanitizing and related services. Comparisons are with the corresponding 2008 periods unless stated otherwise. The interim financial statements received a review, not an audit.
Financial performance
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Net sales | $1,441.5m | $1,570.0m | $2,789.7m | $3,027.9m |
| Operating income | $165.0m | $210.5m | $262.5m | $371.2m |
| Net income attributable to Ecolab | $99.1m | $139.0m | $156.5m | $241.9m |
| Diluted EPS | $0.41 | $0.55 | $0.65 | $0.96 |
| Gross margin | 49.7% | 49.1% | 48.6% | 49.2% |
| Net interest expense | $15.2m | $15.3m | $31.0m | $30.1m |
Reported Q2 sales fell 8%; at fixed exchange rates they were flat. Volume declined 4%, pricing contributed 4%, and currency reduced sales 8%. For the six months, fixed-currency sales declined 1%; volume was down 5%, pricing added 4%, and currency reduced sales 7%. Q2 reported operating income declined 22%, but management said it was flat excluding special items; excluding special items and unfavorable currency, fixed-currency operating income rose 8%. For the first six months, reported operating income declined 29%; excluding special items and unfavorable currency, fixed-currency operating income fell 2%.
Q2 reported diluted EPS declined 25%. Management said Q2 net income rose 1% excluding special gains and charges and discrete tax items. Reported Q2 effective tax rate was 33.6% versus 28.8%; the adjusted rate was 31.3% versus 32.8%. Six-month reported tax rates were 32.1% and 29.0%, respectively.
Segments and operating trends
- U.S. Cleaning & Sanitizing sales rose 1% in Q2; operating income increased 18%. Kay and Healthcare each grew 13%.
- U.S. Other Services sales fell 5%, while operating income increased 40%; GCS Service sales were down 15%.
- International sales declined 1% at fixed currency rates and 17% at public exchange rates. Fixed-currency operating income declined 17%; EMEA sales fell 4%, offset in part by growth in Canada (10%), Latin America (8%) and Asia Pacific (4%).
Cash flow, balance sheet and liquidity
For the six months, operating cash flow was $299.4m versus $310.7m. Investing activities used $128.9m versus $387.0m, reflecting lower acquisition and capital spending; financing activities used $156.5m versus providing $154.4m. Cash increased $16.0m to $82.7m. Operating cash flow was reduced by a $50m voluntary U.S. pension contribution and lower earnings.
At June 30, total assets were $4,928.3m and total equity was $1,812.1m. Short-term debt was $241.8m and long-term debt was $842.8m, approximately $1.1bn combined. The debt-to-capitalization ratio was 37%, down from 42% at year-end 2008. Current assets were $1,749.9m and current liabilities $1,339.9m. Management reported compliance with debt covenants and sufficient borrowing capacity. Of a $600m multi-year credit facility, $405m was available; another $107m of international credit lines was undrawn and available.
Cash from operations and available credit were expected to fund foreseeable 2009 needs, including debt repayments, investment, dividends, possible acquisitions and pension contributions. The company had continued access to commercial paper markets despite credit-market volatility. It did not expect significant share repurchases during the remainder of 2009.
Material changes, outlook and risks
Special charges materially affected comparisons: Q2 2009 included $25.1m of total special charges, including $24m of restructuring expense; Q2 2008 included a $24m plant-sale gain. Six-month total special charges were $59.6m in 2009 versus net gains of $17.4m in 2008. The 2009 restructuring program targets about 1,000 job reductions (approximately 4% of the workforce) and fewer plant and distribution sites. Full-year pretax charges were forecast at $65m–$75m, with annualized pretax savings of $70m–$80m; management expected $50m of pretax savings in 2009. About $23m of estimated $60m–$70m cash restructuring costs had been paid by June 30.
Management cited the global recession, weak lodging and foodservice demand, lower customer spending, higher delivered product costs (particularly in Europe), and unfavorable currency as pressures. It did not expect improvement in U.S. Institutional end markets during 2009. Key stated risks include economic and credit-market conditions, foreign exchange and raw-material costs, competition, customer/vendor consolidation, contract pricing constraints, regulatory and environmental obligations, public-health outbreaks, litigation and execution of acquisitions and business investments.
The company reported various ordinary-course legal and environmental matters. A California wage-hour class-action settlement of approximately $27.4m plus post-award interest was appealed; the award and related interest were accrued. Management said future adverse developments could cause material charges to earnings or cash flow, though it did not expect any such charge to materially affect consolidated financial position. Gross uncertain-tax-position liability was $115m; significant payments were not expected within the next year. Goodwill impairment testing in Q2 found no impairment.
Important facts for investors to verify
- Whether sales and operating performance stabilize as recession-sensitive end markets and international conditions evolve.
- Whether restructuring charges stay within the $65m–$75m forecast and savings reach the stated $70m–$80m annualized target.
- How currency movements, delivered product costs and pricing affect margins and cash generation.
- Debt maturities, commercial-paper access, available credit capacity and any additional pension contributions.
- Developments in the appealed $27.4m wage-hour settlement, other litigation, environmental matters and uncertain tax positions.