Ecolab Inc. — Q1 2017 Form 10-Q
Business context and reporting period. The filing reports unaudited results for the three months ended March 31, 2017, compared with Q1 2016; balance-sheet comparisons are with December 31, 2016. Ecolab provides products and services across industrial, institutional, energy and other markets. The interim statements received a limited review by PwC, not an audit.
Key financial results
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Net sales | $3,161.6 million | $3,097.4 million; up 2% reported and at fixed currency |
| Operating income | $373.3 million | $371.5 million; approximately flat |
| Operating margin | 11.8% | 12.0% |
| Net income attributable to Ecolab | $253.5 million | $230.8 million; up 10% |
| Diluted EPS | $0.86 | $0.77; up 12% |
| Gross margin | 46.5% | 47.3% |
| Net interest expense | $62.5 million | $66.1 million |
| Cash from operating activities | $425.7 million | $472.5 million |
Management’s non-GAAP adjusted diluted EPS was $0.80, up 4%; adjusted net income attributable to Ecolab rose 2% to $235.9 million. These measures exclude special items and discrete tax items. The reported tax rate was 17.4%, versus 24.0%; management reported an adjusted rate of 24.9%, versus 25.7%.
Financial position, cash flow and liquidity
- At March 31, cash and cash equivalents were $212.1 million, total debt was $7.541 billion and net debt was $7.329 billion. Net debt to EBITDA was 2.6x and net debt to adjusted EBITDA was 2.5x.
- Short-term debt was $1.699 billion, including $874.6 million of commercial paper and $809.3 million of current maturities; long-term debt was $5.842 billion. Total debt was $6.839 billion at year-end 2016. The increase in short-term borrowings primarily reflected commercial paper issued during the quarter.
- Cash used in investing activities was $941.5 million, including $826.6 million for acquisitions and investments. Capital expenditures were $152.0 million and capitalized software expenditures were $15.5 million.
- Cash provided by financing activities was $395.5 million, including $858.8 million net issuance of commercial paper and notes payable, $374.5 million for reacquired shares, and $113.2 million in dividends paid. Cash declined by $115.3 million during the quarter.
- The company had a $2.0 billion revolving credit facility expiring in December 2019, with no facility borrowings outstanding. U.S. and Euro commercial paper programs had a combined issuance limit of $2.0 billion; $874.6 million was outstanding at quarter-end. Management said it expects operating cash flow and additional borrowing to fund foreseeable requirements and believes borrowing capacity is sufficient. Debt covenants were met.
Material changes and operating drivers
- Sales growth comprised 1% volume and 1% pricing; acquisitions and foreign currency had no material effect on consolidated reported growth.
- Global Industrial sales increased 3% at fixed currency, while operating income declined 3%. Global Institutional sales increased 4% and operating income was approximately flat. Global Energy sales declined 2%, but operating income rose 17%. Other sales increased 5% and operating income rose 1%.
- Reported gross margin fell 0.8 percentage points. Management attributed the decline primarily to higher delivered product costs, including an unfavorable currency-hedge impact, which more than offset pricing and cost savings. SG&A declined to 34.5% of sales from 35.1%, reflecting volume leverage and savings that more than offset business investment.
- Operating cash flow was $46.8 million lower year over year, primarily due to income-tax and working-capital comparisons, including inventory and accounts payable.
Acquisition, unusual items and management outlook
- Ecolab acquired European hygiene and disinfection products company Anios on February 1 for total consideration of $798.5 million, including repayment of $193.0 million of debt. Anios had approximately $245 million of pre-acquisition annual sales and joined Global Institutional. Preliminary purchase accounting included $530.4 million of goodwill; the allocation remained subject to refinement.
- Q1 special gains and charges totaled $7.7 million, including $6.3 million of acquisition and integration costs and $1.5 million of Anios inventory fair-value step-up, partly offset by a $0.3 million restructuring gain.
- Adoption of share-based compensation accounting guidance contributed $16.0 million of excess tax benefits in Q1 and a $1.9 million cumulative-effect adjustment. Management expected excess tax benefits to reduce the full-year 2017 tax rate by approximately 1–3 percentage points; the amount depends partly on stock price and option exercises. Reported earnings therefore benefited from tax items that may vary between periods.
- Management said it expects operating cash flow to remain strong and to fund foreseeable cash needs, but the filing provides no specific full-year sales or EPS guidance. It cited depressed oil-and-gas activity as a risk to Global Energy, while expressing confidence in the segment’s long-term prospects. Approximately 24% of sales were generated by Global Energy, and about half of sales were outside the United States.
- Risk factors include foreign-exchange and economic uncertainty, energy-market volatility, raw-material costs, substantial indebtedness, environmental and regulatory obligations, and litigation. Nalco’s Deepwater Horizon-related claims were dismissed at an earlier stage, but further individual complaints and cross-claims remained; the company expected certain complaints to be dismissed but said outcomes and future litigation could not be predicted. Environmental assessments and remediation involved approximately 40 locations, excluding Anios sites under review.
- The filing disclosed Iran-related sales by a non-U.S. subsidiary under U.S. General License H: approximately $925,588 in the subsidiary’s quarter ended February 28 and $117,748 in March, with estimated pretax profit of $489,380 and $7,650, respectively. The subsidiary intended to continue qualifying activity in compliance with applicable requirements.
Important facts for investors to verify
- Whether underlying earnings growth is sustained after separating the $16.0 million share-based compensation tax benefit and other discrete tax items from operating performance.
- Whether margins recover from the reported gross-margin decline and continued higher delivered product costs and currency-hedge effects.
- How Anios performs, and whether its preliminary purchase-price allocation, integration costs and expected synergies develop as anticipated.
- How the $1.7 billion of short-term debt and current maturities are refinanced or repaid, and whether leverage remains within management’s stated capacity and covenant limits.
- Whether working-capital trends and operating cash flow improve, given the year-over-year cash-flow decline and acquisition-related investment outlays.
- Developments in Deepwater Horizon litigation, environmental remediation, and the compliance and financial implications of the disclosed Iran-related transactions.