Ecolab Inc. — Q3 2018 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Ecolab provides products and services for industrial, institutional, energy and other markets. Its reportable segments are Global Industrial, Global Institutional and Global Energy. Amounts are in U.S. dollars unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $3,747.2 million | $3,564.5 million | $10,907.7 million | $10,186.9 million |
| Operating income | $516.2 million | $564.1 million | $1,365.1 million | $1,340.9 million |
| Net income attributable to Ecolab | $435.4 million | $393.2 million | $1,034.0 million | $942.0 million |
| Diluted EPS | $1.48 | $1.34 | $3.53 | $3.20 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1,450.4 million | $1,444.9 million |
- Sales: Reported sales increased 5% in Q3 and 7% year to date. Fixed-currency sales increased 6% in both periods; Q3 volume contributed 5% and pricing 2%.
- Margins: Reported gross margin was 41.3% in Q3 (42.1% prior year) and 41.0% year to date (41.5%). Reported operating margin was 13.8% in Q3 (15.8%) and 12.5% year to date (13.2%). Higher delivered product costs and a greater contribution from lower-margin Global Energy weighed on gross margin; pricing and cost savings partly offset the pressure.
- Adjusted results: Excluding special items, Q3 adjusted operating income rose 5% and adjusted diluted EPS rose 11% to $1.53. These are non-GAAP measures. Reported Q3 operating income fell 8%, largely amid higher special charges.
- Cash flow and investment: Nine-month operating cash flow was nearly flat year over year. Capital expenditures were $634.1 million versus $594.0 million. Cash used in investing was $648.9 million, compared with $1,421.9 million, primarily reflecting lower acquisition spending than in 2017.
- Liquidity and debt: Cash was $203.6 million at September 30. Total debt was approximately $7.1 billion, down from $7.3 billion at December 31, 2017; net debt was $6.9 billion. Current liabilities were $3.59 billion and current assets $4.82 billion. The company reported net debt/EBITDA of 2.3x and net debt/adjusted EBITDA of 2.2x. It had $81.2 million of Euro commercial paper outstanding and no borrowings under its $2.0 billion credit facility; it stated that it was in compliance with debt covenants.
- Shareholder returns and interest: Nine-month dividends paid were $370.8 million and share repurchases were $321.4 million. Net interest expense was $168.4 million for the nine months, down from $177.2 million.
Material changes and segment trends
- Q3 fixed-currency sales rose 8% in Global Industrial, 6% in Global Institutional and 9% in Global Energy. Other-segment sales declined 6%, principally reflecting the 2017 Equipment Care divestiture; acquisition-adjusted fixed-currency sales there grew 8%.
- Global Energy growth was led by well stimulation, with moderate gains in production and downstream. Management said the segment remains exposed to oil and gas market volatility.
- Corporate costs and special items contributed to the contrast between segment operating-income growth and consolidated reported operating income. Q3 consolidated special charges were $79.2 million, versus $5.2 million a year earlier.
- At September 30, short-term debt was $769.4 million, up from $564.4 million at year-end, reflecting commercial paper borrowings and debt reclassified as current. Long-term debt was $6,334.8 million, down from $6,758.3 million.
Outlook, risks and unusual items
- Accelerate 2020 restructuring: Launched in Q3 to leverage technology and systems investments and reorganize the business. Ecolab expects completion by the end of 2020, total costs of $170 million pretax ($130 million after tax) over three years, and approximately $200 million of annual savings by 2021. Q3 charges were $79.4 million after tax effects; the plan liability was $75.8 million at quarter-end. Costs and savings are estimates and may vary.
- Taxes: The reported tax rate was 9.0% in Q3 versus 24.6%; the nine-month rate was 17.2% versus 21.7%. Discrete tax benefits, tax planning and the lower U.S. corporate rate affected comparisons. Ecolab continued to assess the Tax Act and said transition-tax estimates remained provisional; it had not selected an accounting policy for GILTI.
- Liquidity outlook: Management expected operating cash flow to remain strong and planned to fund foreseeable needs—including debt repayments, investment, acquisitions, dividends, repurchases and pension contributions—from operations and, as needed, borrowings. The company reported sufficient borrowing capacity.
- Risks and contingencies: Risks include foreign exchange and economic conditions, oil and gas volatility, raw-material costs, execution of business and ERP initiatives, cybersecurity, regulation, tax uncertainty, substantial indebtedness and potential impairment. Ecolab reported environmental remediation at approximately 40 locations and various legal claims; it said it did not believe material losses beyond accrued amounts were reasonably possible, but adverse developments could cause future charges. Eight Deepwater Horizon-related cases remained pending against Nalco and were expected by the company to be dismissed, but outcomes could not be predicted.
- Iran disclosure: A non-U.S. subsidiary reported $1.7 million of Iran-related sales during its fiscal third quarter ended August 31, 2018, with estimated pretax profit of $0.7 million, while winding down activity under the applicable authorization. Separate sales related to the Rhum gas field were also disclosed; the company said it intended to continue those activities under a specific license.
- Other reporting matters: Ecolab adopted revenue-recognition and pension-presentation standards retrospectively. It expected adoption of the new lease standard in 2019 to materially increase recognized operating lease assets and liabilities, without a material effect on consolidated net earnings. The interim financial statements received a limited review, not an audit.
Important facts for investors to verify
- Whether Accelerate 2020 delivers the stated $200 million annual savings by 2021 and stays within the estimated $170 million pretax cost.
- How delivered product costs, pricing and segment mix affect gross and operating margins in subsequent periods.
- The final tax-reform and transition-tax accounting, including any further discrete tax impacts.
- Cash conversion, working-capital movements, capital spending and the company’s ability to maintain or reduce leverage while funding shareholder returns.
- Developments in environmental, Deepwater Horizon and other legal matters, and any changes to the Iran-related activities or associated sanctions requirements.
- The balance-sheet effect of lease-standard adoption and the execution and control implications of the phased ERP upgrade.